Bread Financial - 10-Q quarterly report FY

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the Quarter Ended March 31, 2002

OR

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:  001-15749

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  ý    No o

ALLIANCE DATA SYSTEMS CORPORATION

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ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(amounts in thousands, except per share amounts)

Part I. – Financial Information
Item 1. Financial Statements

See accompanying notes to unaudited condensed consolidated financial statements

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ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(amounts in thousands, except per share amounts)

See accompanying notes to unaudited condensed consolidated financial statements

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ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(amounts in thousands)

See accompanying notes to unaudited condensed consolidated financial statements

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ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.  BASIS OF PRESENTATION

The 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 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.

The unaudited condensed consolidated financial statements included herein reflect all adjustments (which include only 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 accounting principles generally accepted in the United States of America 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.

Subsequent to the issuance of the Company’s interim financial statements for the three months ended March 31, 2001 it was determined that an economic hedge on debt related to World Financial Network Credit Card Master Trust did not meet the criteria for hedge accounting under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 133, as amended.  Accordingly, the previously reported financial information for the three months ended Month 31, 2001 have been restated.  Such restatement is further discussed in Note 9 to the Company’s financial statements included herein.

2.  OTHER COMPREHENSIVE INCOME (LOSS)

The components of other comprehensive income (loss) are as follows:

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3.  EARNINGS PER SHARE

Basic earnings per share is based on the weighted average number of common shares outstanding, excluding any dilutive effects of options or other dilutive securities. Diluted earnings per share is based on the weighted average number of common shares and potentially dilutive common shares, dilutive stock options and other dilutive securities outstanding during the year. However, as the Company generated net losses attributable to common stockholders for the three months ended March 31, 2001 presented below, the weighted average number of common shares including dilutive securities, composed of incremental common shares issuable upon exercise of stock options and warrants and upon conversion of Series A cumulative convertible preferred stock, is not used in determining diluted net income (loss) per share for the period because such shares are anti-dilutive.  Such potentially dilutive common shares were 11.4 million shares, primarily related to the preferred stock, in 2001.  The following table sets forth the computation of basic and diluted net income (loss) per share for the periods indicated:

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4.  INTANGIBLE ASSETS, NET

On January 1, 2002, the Company adopted SFAS No. 142 “Goodwill and Other Intangible Assets.”  SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually.  The Company has $426.0 million of goodwill that is no longer being amortized.  The Company also is required to complete the first step of the transitional impairment test for goodwill within six months of adoption of SFAS No. 142 and to complete the final step of the transitional impairment test by the end of the calendar year.  The Company does not expect the results of this assessment to have a material impact on the consolidated financial statements.  Pro forma net income and net income per share for the three months ended March 31, 2001, adjusted to eliminate historical amortization of goodwill, net of tax, and comparable amounts for the three months ended March 31, 2002 are as follows:

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5.  SEGMENT INFORMATION

The Company classifies its businesses into three segments: Transaction Services, Credit Services and Marketing Services.

6.  ACQUISITIONS

In January 2002, the Company acquired Frequency Marketing, Inc., a small marketing services firm, adding new products for the Company’s loyalty and one-to-one marketing offerings in the U.S.  The preliminary purchase price allocation, which equals the total purchase price, net of cash received, of $26.0 million resulted in identifiable intangible assets of $12.2 million, which are being amortized over a 2-5 year period, and goodwill of $17.2 million.

7.  RECENT DEVELOPMENTS

On March 15, 2002, the Company further amended its credit agreement to add a short term $50.0 million revolving loan facility, remove a requirement that The Limited maintain ownership of a stated amount of the Company’s common stock, and adjust certain other covenants related to leverage ratios, adjusted consolidated net worth, the interest coverage ratio, and allow for prepayment of certain subordinated debt owed to Limited Commerce Corp. and an affiliate of Welsh, Carson, Anderson & Stowe. The Company uses the credit agreement and free cash flow to support its acquisition strategy.

During April 2002, the Company repaid $50.0 million of its subordinated debt held by WCAS Capital Partners II, L.P., an affiliate of Welsh, Carson, Anderson & Stowe, and Limited Commerce Corp.  As a result, Limited Commerce Corp. does not hold any of the Company’s subordinated debt and an affiliate of Welsh, Carson, Anderson & Stowe holds the remaining $52 million of the Company’s subordinated debt.

8.  RECENTLY ISSUED ACCOUNTING STANDARDS

In October 2001, the FASB issued SFAS No. 144, “Impairment or Disposal of Long-Lived Assets”, which is applicable for financial statements issued for fiscal years beginning after December 15, 2001. The provisions of this statement provide a single accounting model for impairment of long-lived assets. The Company is in the process of determining the impact, if any, of adopting SFAS No. 144.

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9.  RESTATEMENT

Subsequent to the issuance of the Company’s condensed consolidated financial statements for the three months ended March 31, 2001, the Company determined that an economic hedge on debt related to World Financial Network Credit Card Master Trust did not meet the criteria for hedge accounting under the provisions of SFAS No. 133, as amended, which was adopted on January 1, 2001.  In its previously issued interim financial statements for 2001, the Company had designated an interest rate swap agreement as a hedge against its cash flow exposures and included the change in fair value of the interest rate swap in other comprehensive income. These changes should have been included in earnings.  Accordingly, the condensed consolidated financial statements for the three months ended March 31, 2001 have been restated.  A summary of the significant effects of the restatement is as follows (items that were not changed were not affected by the restatement).

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The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and related notes thereto presented elsewhere in this document.  The Management’s Discussion and Analysis of Financial Condition and Results of Operations presented below reflects the restatement of our condensed consolidated financial statements for the three months ended March 31, 2001, as discussed in Note 9 to the condensed consolidated financial statements.

Recent Developments

In January 2002,we acquired Frequency Marketing, Inc., a small marketing services firm, adding new products for our loyalty and one-to-one marketing offerings in the U.S.  The preliminary purchase price allocation, which equals the total purchase price, net of cash received, of $26.0 million resulted in identifiable intangible assets of $12.2 million, which are being amortized over a 2-5 year period, and goodwill of $17.2 million.

On March 15, 2002, we further amended our credit agreement to add a short term $50.0 million revolving loan facility, remove a requirement that The Limited maintain ownership of a stated amount of our common stock, and adjust certain other covenants related to leverage ratios, adjusted consolidated net worth, the interest coverage ratio, and allow for prepayment of certain subordinated debt owed to Limited Commerce Corp. and an affiliate of Welsh, Carson, Anderson & Stowe. We use the credit agreement and free cash flow to support our acquisition strategy.

During April 2002, we repaid $50.0 million of our subordinated debt held by WCAS Capital Partners II, L.P., an affiliate of Welsh, Carson, Anderson & Stowe, and Limited Commerce Corp.  As a result, Limited Commerce Corp. does not hold any of our subordinated debt and an affiliate of Welsh, Carson, Anderson & Stowe holds the remaining $52 million of our subordinated debt.

Use of EBITDA and operating EBITDA.  We evaluate operating performance based on several factors of which the primary financial measure is operating income plus depreciation and amortization, or “EBITDA.” EBITDA is presented because it is an integral part of our internal reporting and performance evaluation for senior management. EBITDA eliminates the uneven effect across all segments of considerable amounts of non-cash amortization of purchased intangibles recognized in business combinations accounted for under the purchase method. In addition, we use operating EBITDA to monitor compliance with the financial covenants in our amended credit agreement such as debt-to-operating EBITDA, interest coverage ratios and minimum operating EBITDA .We also use operating EBITDA to measure the performance and liquidity of our reportable segments. EBITDA and operating EBITDA are not intended to be a performance measure 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 the statement of cash flows as a measure of liquidity. In addition, 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 accounting principles generally accepted in the United States of America. The EBITDA and operating EBITDA measures presented may not be comparable to similarly titled measures presented by other companies.

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Results of Operations

Three months ended March 31, 2001 compared to the three months ended March 31, 2002

Revenue.   Total revenue increased $29.1 million, or 16.1%, to $210.3 million for the three months ended March 31, 2002 from $181.2 million for the comparable period in 2001. The increase was principally due to a 12.6% increase in Transaction Services revenue, a 10.5% increase in Credit Services revenue and a 23.4% increase in Marketing Services revenue as follows:

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Operating Expenses.  Total operating expenses, excluding depreciation and amortization, increased $26.8 million, or 17.6%, to $179.4 million during the three months ended March 31, 2002 from $152.6 million during the comparable period in 2001. Total EBITDA margin decreased to 14.7% for the three months ended March 31, 2002 from 15.8% for the comparable period in 2001. The decrease in EBITDA margin is due to margin decreases in Transaction Services and Credit Services, partially offset by an increase in the Marketing Services margin.

Operating Income.  Operating income increased $3.7 million, or 33.3%, to $14.8 million for the three months ended March 31, 2002 from $11.1 million during the comparable period in 2001. Operating income increased primarily from revenue gains and a decrease in depreciation and amortization.

Interest Expense.  Interest expense decreased $3.3 million, or 34.4%, to $6.3 million for the three months ended March 31, 2002 from $9.6 million for the comparable period in 2001 due to a decrease in average debt outstanding.

Taxes.  Income tax expense increased $5.2 million to $4.4 million for the three months ended March 31, 2002 from a $0.8 million benefit in 2001 due to an increase in taxable income.  Our effective rate for the three months ended March 31, 2002 was approximately 50%.

Transactions with The Limited.  Revenue from The Limited and its affiliates, which includes merchant and database marketing fees, decreased $348,000, or 3.6%, to $9.2 million for the three months ended March 31, 2002 from $9.6 million for the comparable period in 2001, partially as a result of the sale of Lane Bryant by The Limited.  Excluding the effect of the Lane Bryant sale, there would have been an increase of  $0.6 million.  We generate a significant amount of additional revenue (financing charges, net) from our cardholders who are customers of The Limited and its affiliates.

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Asset Quality

Our delinquency and net charge-off rates reflect, among other factors, the credit risk of credit card receivables, the average age of our various credit card account portfolios, the success of our collection and recovery efforts, and general economic conditions. The average age of our 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.

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. When an account becomes delinquent, we print a message requesting payment on the cardholder’s billing statement. 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 table presents the delinquency trends of our securitized credit card portfolio:

Net Charge-Offs.  Net charge-offs comprise the principal amount of losses from cardholders unwilling or unable to pay their account balances, as well as bankrupt and deceased cardholders, less current period recoveries. Net charge-offs exclude accrued finance charges and fees. The following table presents our net charge-offs for the periods indicated on a securitized basis. Average credit card portfolio outstanding represents the average balance of the securitized receivables at the beginning of each month for the period indicated.

We believe, consistent with our statistical models and other credit analyses, that our securitized net charge-off ratio will continue to fluctuate but generally rise.

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Liquidity and Capital Resources

Operating Activities.

We generated cash flow from operating activities before change in merchant settlement activity of $26.3 million for the three months ended March 31, 2002 compared to $19.0 million for the comparable period in 2001.   The increase in operating cash flows before change in merchant settlement activity is related to improved operating results for the three months ended March 31, 2002, partially offset by working capital movements.  Merchant settlement activity fluctuates significantly depending on the day in which the quarter ends.  At December 31, 2001, we carried more days of merchant settlement float than at March 31, 2002.  We utilize our operating cash flow for ongoing business operations, acquisitions and capital expenditures

Investing Activities.  We generated cash flow from investing activities of $5.5 million for the three months ended March 31, 2002 compared to the utilization of $37.2 million for the comparable period in 2001. Significant components of investing activities are as follows:

Financing Activities.  Net cash used in financing activities was $21.9 million for the three months ended March 31, 2002 compared to $20.3 million for the comparable period in 2001. Our financing activities relate primarily to funding working capital requirements and the securitization program.

Liquidity Sources.  We have four main sources of liquidity: securitization program, certificates of deposit, credit facility and issuances of equity.

Securitization Program.    As of March 31, 2002, we had over $2.3 billion of securitized credit card receivables. Securitizations require credit enhancements in the form of cash, spread accounts and additional receivables. The credit enhancement is principally based on the outstanding balances of the private label credit cards in the securitization trust and their related performance. During the period from November to January, we are required to maintain a credit enhancement level of 6% as compared to 4% for the remainder of the year. Accordingly, at December 31, we typically have our highest balance of credit enhancement assets. We intend to utilize our securitization program for the foreseeable future.

Certificates of Deposit.    We utilize certificates of deposit to finance the operating activities of our credit card bank subsidiary, World Financial Network National Bank, and to fund securitization requirements. World Financial Bank issues certificates of deposit in denominations of $100,000 in various maturities ranging between three months and two years and with effective annual fixed rates ranging from 2.8% to 7.5%. As of March 31, 2002, we had $96.8 million of certificates of deposit outstanding. Certificate of deposit borrowings are subject to regulatory capital requirements.

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Credit Facility.    At March 31, 2002, we had $87.6 million outstanding under our credit facility, consisting of $87.6 million of term loans and no outstanding borrowings under our $100.0 million revolving loan commitment. The term loans mature in installments through July 2005 and the revolving loan commitment matures in July 2003.  Our credit facility allows us to borrow up to three times our operating EBITDA. Our borrowing capacity at March 31, 2002 was approximately $512.8 million. With total outstanding borrowings as of March 31, 2002 consisting of credit facility, certificates of deposit, and subordinated debt of $286.4 million, we had additional borrowing capacity of $226.4 million. In addition, we had $77.3 million of cash and cash equivalents as of March 31, 2002. We utilize the credit facility and free cash flow to support our acquisition strategy.  During April 2002, we repaid $50.0 million of our subordinated debt that was held by an affiliate of Welsh, Carson, Anderson & Stowe and Limited Commerce Corp.  As a result, Limited Commerce Corp. does not hold any of our subordinated debt and an affiliate of Welsh, Carson, Anderson & Stowe holds the remaining $52 million of our subordinated debt.

We believe that our current level of cash and financing capacity, along with future cash flows from operations, will provide sufficient liquidity to meet the needs of our existing businesses for the foreseeable future. However, we may from time to time seek longer-term financing to support additional cash needs, reduce short-term borrowings or raise funds for acquisitions.

Recent Accounting Pronouncements

In August 2001, the FASB issued SFAS No. 144 “Accounting for the Impairment or Disposal of Long-Lived Assets.” SFAS No. 144 supersedes SFAS No. 121 “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of” and the accounting and reporting provisions of APB Opinion No. 30 “Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” and amends ARB No. 51 “Consolidated Financial Statements.” SFAS No. 144 retains many of the requirements of SFAS No. 121 and the basic provisions of Opinion 30; however, it establishes a single accounting model for long-lived assets to be disposed of by sale. SFAS No. 144 furthermore resolves significant implementation issues related to SFAS No. 121. The provisions of SFAS No. 144 are effective for financial statements issued for fiscal years beginning after December 15, 2001 and are to be applied prospectively. We do not anticipate that the adoption of SFAS No. 144 will have a material effect on our financial position or results of operations.

Item 3.    Quantitative and Qualitative Disclosures About Market Risk Management

Market Risk

There has been no material change from our annual report on Form 10-K related to the Company’s exposure to market risk from off-balance sheet risk, interest rate risk, credit risk, foreign currency exchange rate risk and redemption reward risk.

FORWARD-LOOKING STATEMENTS

This Form 10-Q and the documents incorporated by reference herein contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  Such statements may use words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “predict,” “project” and similar expressions as they relate to us or our management.  When we make forward-looking statements, we are basing them on our management’s beliefs and assumptions, using information currently available to us.  Although we believe that the expectations reflected in the forward-looking statements are reasonable, these forward-looking statements are subject to risks, uncertainties and assumptions, including those discussed in the “Risk Factors” section in our 2001 Annual Report on Form10-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 from what we projected.  Any forward-looking statements contained in this quarterly report 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.

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PART II
OTHER INFORMATION

Item 1. Legal Proceedings.

From time to time, we are involved in various claims and lawsuits incidental to our business, including claims and lawsuits alleging breaches of contractual obligations.

On November 16, 2000, in the United States District Court, Southern District of Florida, Miami Division, a group of World Financial Bank cardholders filed a putative class action complaint against World Financial Bank.  The plaintiffs, individually and on behalf of all others similarly situated, commenced the action alleging that World Financial Bank engaged in a systematic program of false, misleading, and deceptive practices to improperly bill and collect consumer debts from thousands of cardholders.  The suit stems from World Financial Bank’s alleged practices involved in calculating finance charges and in crediting cardholder payments on the next business day if received after 6:30 a.m.  The plaintiffs contend that such practices are deceptive and result in the imposition of excessive finance charges and other penalties to cardholders.  The plaintiffs allege that World Financial Bank, through such practices, has violated the federal Fair Credit Billing Act, the federal Truth-In-Lending Act and breached cardholder contracts.  The plaintiffs have not specified an amount of damages, but have requested, individually and on behalf of a putative class, monetary and punitive damages for the alleged stated claims and permanent injunctions for alleged statutory violations.  The complaint was subsequently amended to include our subsidiary, ADS Alliance Data Systems, Inc., as a defendant.  We believe these allegations are without merit and intend to defend this matter vigorously.  We have entered into the discovery phase of the litigation.

Item 2. Changes in Securities and Use of Proceeds.
             None

Item 3. Defaults Upon Senior Securities.
             None

Item 4. Submission of Matters to a Vote of Security Holders.
             None

Item 5. Other Information.
             None

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Item 6. Exhibits and Reports on Form 8-K.
(a)         Exhibits:

EXHIBIT INDEX

*  Filed herewith

(b)     Reports on Form 8-K:

On January 18, 2002, the Company filed with the SEC a Current Report on Form 8-K, dated January 17, 2002.  The Current Report on Form 8-K relates to the posting of information on the Company website pursuant to Regulation FD, and such information shall not be deemed filed for purposes of the Securities and Exchange Act of 1934, as amended, nor is it to be incorporated by reference into any other filing by the Company.

On January 31, 2002, the Company filed with the SEC a Current Report on Form 8-K, dated January 30, 2002.   The Current Report on Form 8-K relates to the Company’s earnings for the fourth quarter of 2001and for the year ended December 31, 2001.

On April 2, 2002, the Company filed with the SEC a Current Report on Form 8-K, dated April 1, 2002.  The Current Report on Form 8-K relates to the Company’s upward adjustment to final revenue and EBITDA results for the year ended December 31, 2001.

On April l8, 2002, the Company filed with the SEC a Current Report on Form 8-K, dated April 17, 2002.  The Current Report on Form 8-K relates to the Company’s earnings for the first quarter of 2002.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

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EXHIBIT INDEX

*  Filed herewith

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