Back to GetFilings.com

Use these links to rapidly review the document
ALLIANCE DATA SYSTEMS CORPORATION INDEX

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

Commission File Number: 001-15749

ALLIANCE DATA SYSTEMS CORPORATION
(Exact Name of Registrant as Specified in its Charter)

17655 Waterview Parkway
Dallas, Texas 75252
(Address of Principal Executive Office, including zip code)

        (972) 348-5100
(Registrant's Telephone Number, Including Area Code)

        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

        As of October 31, 2002, 74,860,724 shares of the registrant's common stock, par value $0.01 per share, were outstanding.

ALLIANCE DATA SYSTEMS CORPORATION


INDEX

2

Part I.—Financial Information
Item 1. Financial Statements

ALLIANCE DATA SYSTEMS CORPORATION

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(amounts in thousands, except per share amounts)

See accompanying notes to unaudited condensed consolidated financial statements.

3

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.

4

ALLIANCE DATA SYSTEMS CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(amounts in thousands)

5

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 for the year ended December 31, 2001.

        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 September 30, 2001 and for the nine months ended September 30, 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 September 30, 2001 and for the nine months ended September 30, 2001 have been restated. Such restatement is further discussed in Note 9 to the Company's financial statements included herein.

6

2. COMPREHENSIVE INCOME (LOSS)

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

(1)

Reclassifications into earnings arise from interest rate swaps, a foreign currency hedge, and amortization of amounts recorded in connection with the adoption of SFAS No. 133.

7

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 September 30, 2001 and the nine months ended September 30, 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 periods because such shares are anti-dilutive. Such potentially dilutive common shares were 1.2 million shares and 7.3 million shares, primarily related to the preferred stock and stock options, for the three and nine months ended September 30, 2001, respectively. The following table sets forth the computation of basic and diluted net income (loss) per share for the periods indicated:

8

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 has selected July 31 as its annual assessment date in accordance with the standard. Accordingly, the Company has completed its annual impairment test for goodwill as of July 31, 2002 and determined that no impairment exists. No further testing of goodwill impairment will be performed until July 31, 2003, unless circumstances exist which indicate an impairment may have occurred. Pro forma net income and net income per share for the three months ended September 30, 2001 and for the nine months ended September 30, 2001, adjusted to eliminate historical amortization of goodwill, net of tax, and comparable amounts for the three months ended September 30, 2002 and for the nine months ended September 30, 2002 are as follows (the weighted average diluted shares for the three and nine months ended September 30, 2001 are 73.8 million and 65.5 million, respectively):

9

5. SEGMENT INFORMATION

        Consistent with prior periods, the Company continues to classify 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 United States. The preliminary purchase price allocation, which equals the total purchase price of $23.8 million, resulted in identifiable intangible assets of $12.2 million, which are being amortized over a two to five year period, goodwill of $15.0 million and net liabilities of $3.4 million.

        In September 2002, the Company acquired Enlogix Group, formerly wholly owned subsidiaries of Duke Energy Corporation, which provides customer information services to utilities in Canada. The preliminary purchase price allocation, which equals the total purchase price of $13.5 million, resulted in identifiable intangible assets of $5.0 million, which are being amortized over a five year period, goodwill of $7.9 million and net assets of $0.6 million. In the event that Enlogix Group enters into agreements with three potential customers within eight months of closing of the acquisition, the purchase price will increase by up to $4.5 million.

7. RECENT DEVELOPMENTS

        In March 2002, the Company reached agreement with its bankers to amend its credit agreement to add a short term $50.0 million revolving loan facility, remove a requirement that Limited Brands, Inc.

10

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 working capital needs as well as potential acquisitions. The final agreement was signed on May 22, 2002.

        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.

        In August 2002, the Company extended its client relationships through August 2009 with Limited Brands, Inc. and its retail affiliates, including The Limited, Victoria's Secret Stores, Victoria's Secret Catalogue, Express, Bath & Body Works, Lerner New York, Henri Bendel and Structure, which includes Express for Men. Limited Brands, Inc., indirectly through Limited Commerce Corp., is one of the Company's largest stockholders and together with its retail affiliates, is the Company's largest client, representing approximately 17.2% of the Company's annual 2001 consolidated revenue.

        During November 2002, the Company completed a $600 million offering of five-year asset-backed notes as part of its securitization program for its private label credit card subsidiary. The notes were issued through World Financial Network Credit Card Master Note Trust. The notes are secured by a beneficial interest in a pool of receivables that arise under World Financial's private label revolving credit card accounts. The notes were issued to retire an existing series of investor certificates. Additionally, World Financial Network Credit Card Master Note Trust entered into an interest rate swap, which converts the variable rates on the notes to fixed rate amounts.

8. RECENT ACCOUNTING PRONOUNCEMENTS

        In April 2002, the Financial Accounting Standards Board, or FASB, issued SFAS No. 145 "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections," which is applicable for financial statements issued for fiscal years beginning after December 15, 2002. This omnibus statement (1) eliminates the automatic classification of debt extinguishment as extraordinary, (2) requires certain lease modifications be accounted for in the same manner as sale-leaseback transactions and (3) provides for other corrections to the technical literature that are not substantive. The Company is in the process of determining the impact, if any, of adopting SFAS No. 145.

        In June 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated with Exit or Disposal Activities," which is applicable for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. This statement nullifies EITF 94-3 and requires that a liability for a cost associated with an exit or disposal activity be recognized only when the liability is incurred. The Company is in the process of determining the impact, if any, of adopting SFAS No. 146.

11

9. RESTATEMENT

        Subsequent to the issuance of the Company's condensed consolidated financial statements for the three months and nine months ended September 30, 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 September 30, 2001 and the nine months ended September 30, 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).

12

Item 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

        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 September 30, 2001 and for the nine months ended September 30, 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 United States. The preliminary purchase price allocation, which equals the total purchase price of $23.8 million, resulted in identifiable intangible assets of $12.2 million, which are being amortized over a two to five year period, goodwill of $15.0 million and net liabilities of $3.4 million.

        In March 2002, we reached agreement with our bankers to amend 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 working capital needs as well as potential acquisitions. The final agreement was signed on May 22, 2002.

        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.

        In August 2002, we extended our client relationships through August 2009 with Limited Brands, Inc. and its retail affiliates, including The Limited, Victoria's Secret Stores, Victoria's Secret Catalogue, Express, Bath & Body Works, Lerner New York, Henri Bendel and Structure, which includes Express Men's. Limited Brands, Inc., indirectly through Limited Commerce Corp., is one of our largest stockholders and together with its retail affiliates, is our largest client, representing approximately 17.2% of our annual 2001 consolidated revenue.

        In September 2002, we acquired Enlogix Group, formerly wholly owned subsidiaries of Duke Energy Corporation, which provides customer information services to utilities in Canada. The preliminary purchase price allocation, which equals the total purchase price of $13.5 million, resulted in identifiable intangible assets of $5.0 million, which are being amortized over a five year period, goodwill of $7.9 million, and net assets of $0.6 million. In the event that Enlogix Group enters into agreements with three potential customers within eight months of closing of the acquisition, the purchase price will increase by up to $4.5 million.

        During November 2002, we completed a $600 million offering of five-year asset-backed notes as part of our securitization program for our private label credit card subsidiary. The notes were issued through World Financial Network Credit Card Master Note Trust. The notes are secured by a beneficial interest in a pool of receivables that arise under World Financial's private label revolving credit card accounts. The notes were issued to retire an existing series of investor certificates. Additionally, World Financial Network Credit Card Master Note Trust entered into an interest rate swap, which converts the variable rates on the notes to fixed rate amounts.

13

        Use of 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. EBITDA is 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 is 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 measures presented may not be comparable to similarly titled measures presented by other companies.

Results of Operations

Three months ended September 30, 2001 compared to the three months ended September 30, 2002

        Revenue.    Total revenue increased $17.0 million, or 8.4%, to $218.7 million for the three months ended September 30, 2002 from $201.7 million for the comparable period in 2001. The increase was due to a 1.8% increase in Transaction Services revenue, a 20.0% increase in Credit Services revenue and a 15.1% increase in Marketing Services revenue as follows:

•

Transaction Services.  Transaction Services revenue increased $2.3 million, or 1.8%, due primarily to an increase in revenue per statement associated with utility and private label clients, offset in part by the loss of certain low margin merchant services clients.



•

Credit Services.  Credit Services revenue increased $14.1 million, or 20.0%, primarily due to increases in finance charges, net, and merchant fees from higher private label credit sales during the three months ended September 30, 2002. Finance charges, net increased $7.9 million primarily as a result of a 10.1% increase in average core accounts receivables, lower financing costs and a decrease in charge-offs compared to the same period in 2001.

14

•

Marketing Services.  Marketing Services revenue increased $8.1 million, or 15.1%, primarily due to an increase in reward revenue related to a 18.1% increase in the redemption of AIR MILES® reward miles and an increase in the accretion of deferred services revenue. Our deferred revenue balance increased 6.2% to $349.8 million at September 30, 2002 from the balance at December 31, 2001 due to continued growth in the program, including a 9.3% increase in AIR MILES Reward miles issued during the three months ended September 30, 2002 over the comparable period in 2001.

        Operating Expenses and Margins.    Total operating expenses, excluding depreciation and amortization, increased $11.6 million, or 6.9%, to $179.2 million during the three months ended September 30, 2002 from $167.6 million during the comparable period in 2001. Total EBITDA margin increased to 18.1% for the three months ended September 30, 2002 from 16.9% for the comparable period in 2001, primarily due to increased margins for Transaction Services and Marketing Services, offset by a lower collected yield in Credit Services.

•

Transaction Services.  Transaction Services operating expenses, excluding depreciation and amortization, decreased $0.1 million, or 0.1%, to $111.9 million for the three months ended September 30, 2002 from $112.0 million for the comparable period in 2001, and EBITDA margin increased to 16.4% for the three months ended September 30, 2002 from 14.9% during the comparable period in 2001. The EBITDA margin improved primarily due to the increasing scale now benefiting our utility services and continued margin improvement in merchant services from the loss of certain low margin clients and issuer services from increased scale as a result of new clients.



•

Credit Services.  Credit Services operating expenses, excluding depreciation and amortization, increased $12.5 million, or 19.7%, to $76.1 million for the three months ended September 30, 2002 from $63.6 million for the comparable period in 2001, and EBITDA margin increased to 10.3% for the three months ended September 30, 2002 from 9.9% for the same period of 2001. The increased margin is the result of favorable revenue trends from increased receivable balances, lower financing costs and lower charge-offs.



•

Marketing Services.  Marketing Services operating expenses, excluding depreciation and amortization, increased $6.7 million, or 14.6%, to $52.7 million for the three months ended September 30, 2002 from $46.0 million for the comparable period in 2001, and EBITDA margin increased to 14.4% for the three months ended September 30, 2002 from 13.9% for the comparable period in 2001. The increase in EBITDA margin is being driven by the AIR MILES Reward miles program from the benefits of increased scale, as the program issued over 500 million AIR MILES Reward miles in the three months ended September 30, 2002.



•

Depreciation and Amortization.  Depreciation and amortization decreased $1.8 million, or 9.8%, to $16.6 million for the three months ended September 30, 2002 from $18.4 million for the comparable period in 2001 due primarily to a $5.0 million decrease in the amortization of goodwill relating to the implementation of SFAS No. 142, offset by an increase in depreciation and other amortization of $3.2 million from capital spending.

        Operating Income.    Operating income increased $7.3 million, or 46.8%, to $22.9 million for the three months ended September 30, 2002 from $15.6 million during the comparable period in 2001. Operating income increased due to increases in EBITDA from each of the segments. Transaction Services and Marketing Services operating income were favorably impacted by decreases in amortization of goodwill as a result of SFAS No. 142. Credit Services has no goodwill and therefore was neither positively or negatively impacted by SFAS No. 142 but had an increase in depreciation and amortization from capital spending.

15

        Interest Expense.    Interest expense decreased $1.1 million, or 18.0%, to $5.0 million for the three months ended September 30, 2002 from $6.1 million for the comparable period in 2001 due to a decrease in average debt outstanding, lower interest rates and reduced debt issuance amortization expense.

        Taxes.    Income tax expense increased $0.1 million to $5.0 million for the three months ended September 30, 2002 from $4.9 million in 2001 due to an increase in taxable income, offset by a decrease in our effective tax rate. Our tax rate on taxable income of approximately 38% results in an effective book tax rate of approximately 39% due to the impact of non-deductible expenses.

        Transactions with Limited Brands.    Revenue from Limited Brands and its affiliates, which includes merchant and database marketing fees decreased $282,000, or 2.6% to $10.7 million for the three months ended September 30, 2002 from $11.0 million for the comparable period in 2001, partially as a result of the sale of Lane Bryant by Limited Brands. Excluding the effect of the Lane Bryant sale, there would have been an increase of $1.1 million. We generate a significant amount of additional revenue (financing charges, net) from our cardholders who are customers of Limited Brands and its affiliates.

Nine months ended September 30, 2001 compared to the nine months ended September 30, 2002

        Revenue.    Total revenue increased $68.1 million, or 12.0%, to $634.6 million for the nine months ended September 30, 2002 from $566.5 million for the comparable period in 2001. The increase was due to an 8.1% increase in Transaction Services revenue, a 16.2% increase in Credit Services revenue and a 16.2% increase in Marketing Services revenue as follows:

•

Transaction Services.  Transaction Services revenue increased $29.8 million, or 8.1%, due primarily to an increase in revenue per statement associated with utility and private label clients, offset in part by the loss of certain low margin merchant services business.



•

Credit Services.  Credit Services revenue increased $33.9 million, or 16.2%, primarily due to increases in finance charges, net, during the nine months ended September 30, 2002 over the comparable period in 2001. Merchant fees increased by $6.0 million as a result of a 21.3%

16

increase in private label credit sales. Finance charges, net, increased $21.2 million primarily as a result of a 10.0% increase in core accounts receivables, lower financing costs and a decrease in charge-offs compared to the same period in 2001.

•

Marketing Services.  Marketing Services revenue increased $24.3 million, or 16.2%, primarily due to an increase in reward revenue related to a 28.1% increase in the redemption of AIR MILES reward miles and an increase in the accretion of deferred services revenue. The increase in the deferred revenue balance is primarily related to the 6.9% increase in AIR MILES reward miles issued during the nine months ended September 30, 2002.

        Operating Expenses and Margins.    Total operating expenses, excluding depreciation and amortization, increased $55.3 million, or 11.7%, to $529.6 million during the nine months ended September 30, 2002 from $474.3 million during the comparable period in 2001. Total EBITDA margin for the nine months ended September 30, 2002 was 16.6% compared to 16.3% during the comparable period in 2001, primarily due to increased margins for Transaction Services and Marketing Services, offset by a lower collected yield in Credit Services.

•

Transaction Services.  Transaction Services operating expenses, excluding depreciation and amortization, increased $23.5 million, or 7.5%, to $338.4 million for the nine months ended September 30, 2002 from $314.9 million for the comparable period in 2001, and EBITDA margin increased to 14.6% for the nine months ended September 30, 2002 from 14.0% for the comparable period in 2001, as higher margin accounts were partially offset by the wind down of a low margin customer.



•

Credit Services.  Credit Services operating expenses, excluding depreciation and amortization, increased $31.4 million, or 16.5%, to $222.1 million for the nine months ended September 30, 2002 from $190.7 million for the comparable period in 2001, and EBITDA margin decreased to 9.0% for the nine months ended September 30, 2002 from 9.3% during the comparable period in 2001. The decrease in EBITDA margin is attributed to a lower collected yield and higher charge-offs in the first quarter of 2002, as compared to the same quarter of the prior year. The decrease was offset partially by improving trends in net charge offs during the second and third quarter of 2002



•

Marketing Services.  Marketing Services operating expenses, excluding depreciation and amortization, increased $20.2 million, or 15.7%, to $148.8 million for the nine months ended September 30, 2002 from $128.6 million for the comparable period in 2001, and EBITDA margin increased to 14.6% for the nine months ended September 30, 2002 from 14.2% during the comparable period in 2001 due to operating efficiencies as scale continues to increase.



•

Depreciation and Amortization.  Depreciation and amortization decreased $4.6 million, or 8.6%, to $49.2 million for the nine months ended September 30, 2002 from $53.8 million for the comparable period in 2001 due primarily to a $13.5 million decrease in the amortization of goodwill relating to the implementation of SFAS No. 142, offset by an increase in depreciation and other amortization of $8.9 million.

        Operating Income.    Operating income increased $17.4 million, or 45.2%, to $55.9 million for the nine months ended September 30, 2002 from $38.5 million during the comparable period in 2001. Operating income increased primarily from increases in EBITDA from each of the segments. Transaction Services and Marketing Services operating income were favorably impacted by decreases in amortization of goodwill as a result of SFAS No. 142. Credit Services has no goodwill and therefore was neither positively or negatively impacted by SFAS No. 142 but had an increase in depreciation and amortization from capital spending.

17

        Interest Expense.    Interest expense decreased $8.0 million, or 32.9%, to $16.3 million for the nine months ended September 30, 2002 from $24.3 million for the comparable period in 2001 due to a decrease in average debt outstanding and lower interest rates.

        Taxes.    Income tax expense increased $6.6 million to $13.0 million for the nine months ended September 30, 2002 from $6.4 million in 2001 due to an increase in taxable income, offset by a decrease in our effective tax rate. Our tax rate on taxable income of approximately 38% results in an effective book tax rate of approximately 45% due to the impact of non-deductible expenses.

        Extraordinary Items.    During the nine months ended September 30, 2002, we repaid $50.0 million of our subordinated debt resulting in a $0.5 million, net of tax, charge. During the nine months ended September 30, 2001, we repaid our outstanding term loan as part of our initial public offering, resulting in a $0.6 million, net of tax, charge.

        Transactions with Limited Brands.    Revenue from Limited Brands and its affiliates, which includes merchant and database marketing fees, decreased $688,000, or 2.2%, to $30.7 million for the nine months ended September 30, 2002 from $31.4 million for the comparable period in 2001, partially as a result of the sale of Lane Bryant by Limited Brands. Excluding the effect of the Lane Bryant sale, there would have been an increase of $2.5 million. We generate a significant amount of additional revenue (financing charges, net) from our cardholders who are customers of Limited Brands and its affiliates.

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 bill 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. However, accrued interest and fee income on securitized accounts receivable is only recorded in our financial statements when the cash is actually received from the customer. 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 tables reflect statistics for our securitization trust as reported to the trustee for compliance reporting. Management also uses core receivables to manage and analyze the portfolios.

18

Core receivables are defined as securitized receivables less those receivables whereby the Company does not assume any risk of loss. These losses are passed on to the respective client.

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

Liquidity and Capital Resources

Operating Activities.

        We have historically generated cash flow from operating activities, as detailed in the table below, although that amount may vary based on fluctuations in working capital and the timing of merchant settlement activity.