UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

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

For the Quarterly Period Ended September 30, 2004

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

ALLIANCE DATA SYSTEMS CORPORATION

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 x No o

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

     As of October 29, 2004, 81,672,558 shares of the registrant’s common stock, par value $0.01 per share, were outstanding.

ALLIANCE DATA SYSTEMS CORPORATION

INDEX

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PART I

Item 1. Financial Statements

ALLIANCE DATA SYSTEMS CORPORATION

See accompanying notes to unaudited condensed consolidated financial statements.

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ALLIANCE DATA SYSTEMS CORPORATION

See accompanying notes to unaudited condensed consolidated financial statements.

4

ALLIANCE DATA SYSTEMS CORPORATION

See accompanying notes to unaudited condensed consolidated financial statements.

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ALLIANCE DATA SYSTEMS CORPORATION

1. BASIS OF PRESENTATION

     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, 2003.

     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.

2. SHARES USED IN COMPUTING NET INCOME PER SHARE

     The computation of the number of shares used in calculating basic and diluted net income per share is as follows. No adjustments were made to net income in the computation of diluted net income per share for all periods presented.

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ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

3. INTANGIBLE ASSETS AND GOODWILL

     Intangible assets consist of the following:

Goodwill

     The changes in the carrying amount of goodwill for the nine months ended September 30, 2004, are as follows:

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ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

4. DEBT

     Debt consists of the following:

     The Company amended its 364-day credit facility by and among the Company, the guarantors from time to time party thereto, the banks from time to time party thereto, and Harris Trust and Savings Bank, as Administrative Agent, as of April 8, 2004, to extend for an additional 364 days the terms of the previous 364-day credit facility dated as of April 10, 2003, by and among the same parties. As of September 30, 2004, no amounts have been drawn against the 364-day credit facility. On October 21, 2004 the Company made further amendments to its credit facilities-see Note 11.

     As of September 30, 2004, the certificates of deposit had effective annual fixed rates ranging from 1.9% to 3.1%, and the credit facilities had an average interest rate of 3.0%.

5. DEFERRED REVENUE

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

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ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

6. INCOME TAXES

     For the three and nine months ended September 30, 2004, the Company has utilized an effective tax rate of 37.7% 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 2004 based on all known variables.

7. COMPREHENSIVE INCOME

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

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ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

8. SEGMENT INFORMATION

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

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ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

9. STOCK COMPENSATION

     At September 30, 2004, the Company had three 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 net income 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.

     As of September 30, 2004, performance based restricted stock awards representing an aggregate of approximately 320,898 shares are outstanding and subject to restrictions of which 199,120 shares were granted in 2001.

10. RESTATEMENT

     Subsequent to the issuance of its condensed consolidated financial statements for the three months and nine months ended September 30, 2003, the Company determined that the translation of the Company’s Canadian subsidiary’s financial statements was not in accordance with SFAS No. 52, “Foreign Currency Translation”. The Company had been using historical exchange rates in the translation of deferred revenue and goodwill instead of the correct current period exchange rates. As a result, the financial statements presented for three months and nine months ended September 30, 2003, have been restated. A summary of the significant effects of the restatement is as follows:

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ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

11. SUBSEQUENT EVENTS

     On October 21, 2004, the Company entered into amendments to its three credit facilities. Collectively, the three amendments increased the aggregate amount of revolving commitments under the three credit facilities from $400.0 million to $435.0 million. The amendment to the 3-year credit facility increased the amount of revolving commitments thereunder from $150.0 million to $200.0 million. The amendment to the 364-day credit facility increased the amount of revolving commitments thereunder from $150.0 million to $185.0 million. The amendment to the Canadian credit facility decreased the amount of revolving commitments thereunder from $100.0 million to $50.0 million. In addition, the amendments increased the aggregate amount of commitments permitted under the three credit facilities from $450.0 million to $500.0 million. As a result, the Company has the right to obtain commitments under the three credit facilities for an additional $65.0 million in the aggregate without having to amend the credit facilities. Except as described above, the remaining terms of each credit facility remain unchanged.

     On October 29, 2004, the Company completed the acquisition of The Relizon e-CRM Company (“Relizon”), including its wholly-owned subsidiary Epsilon Data Management, Inc. (“Epsilon”), from Relizon Holdings, LLC (“Holdings)”. Pursuant to the Agreement and Plan of Merger, dated as of October 8, 2004, as amended as of October 29, 2004, by and among ADSC, ADS Alliance Data Systems, Inc. (“ADSI”), a wholly-owned subsidiary of ADSC, Everest Nivole, Inc., a wholly-owned subsidiary of ADSI (“Everest”), Relizon, and Holdings (“Agreement and Plan of Merger”), Everest was merged with and into Relizon, with Relizon being the surviving corporation and continuing as a wholly-owned subsidiary of ADSI. At the effective time of the merger, Relizon changed its name to “Epsilon Marketing Services, Inc.”

     The main operating subsidiary of Relizon is Epsilon, which has provided customer management and loyalty solutions for over 35 years. Epsilon utilizes database technologies and analytics to evaluate the value, growth and loyalty of its clients’ customers and assists clients in acquiring new customer relationships.

     The merger consideration consisted of approximately $310.0 million in cash. The base purchase price of $310.0 million was adjusted to $314.0 million based on pre-closing estimates of customary post-closing purchase price adjustments. The actual amount of the adjustments will be determined, in accordance with the provisions of the Agreement and Plan of Merger, after the closing. Approximately $2.0 million of the purchase price was placed into escrow pending calculation of the final closing date net working capital adjustment. Approximately $10.0 million of the purchase price was placed into escrow for a period of eighteen months to satisfy potential indemnification claims. The Company paid the merger consideration from available funds on-hand and amounts available under its credit facilities.

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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 in this quarterly report and the notes thereto included in our Annual Report filed on Form 10-K for the year ended December 31, 2003.

     The accompanying management’s discussion and analysis of financial condition and results of operations gives effect to the restatement of the results of operations for the three and nine months ended September 30, 2003 as discussed in Note 10 to the unaudited condensed consolidated financial statements.

Year to Date in Review Highlights

     Our year to date 2004 results of operations were largely impacted by new and renewed agreements with significant clients and three capital market transactions. During the first nine months of 2004, we signed or renewed agreements with several significant clients and sponsors:

•

In January 2004, we signed a long-term renewal with BMO Bank of Montreal MasterCard, a top-five client and founding sponsor in the AIR MILES Reward Program.

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In January 2004, we entered into an agreement with Stage Stores, Inc. to purchase the Peebles’ private label credit card portfolio.

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In January 2004, we signed a long-term renewal with Shell Canada Limited, a top-ten client and significant, high-frequency sponsor in the AIR MILES Reward Program.

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In January 2004, we signed a long-term renewal whereby Air Canada will continue as a rewards supplier in the AIR MILES Reward Program.

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In February 2004, we commenced a five-year agreement to start a private label credit card program with Design Within Reach.

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In March 2004, we signed a long-term, exclusive agreement with BMO Bank of Montreal and WestJet to introduce a tri-branded MasterCard.

•

In May 2004, we signed a long-term renewal with The Buckle, Inc. to provide private label credit card and marketing services.

•

In May 2004, we signed a multi-year agreement with Alimentation Couche-Tard Inc. to provide payment processing services to Circle K convenience stores across the United States.

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In June 2004, we signed a long-term agreement with Little Switzerland, Inc. to provide private label credit card and marketing services.

•

In August 2004, we signed a five-year agreement with American TV and Appliance of Madison, Inc. to provide a comprehensive business credit card program.

•

In September 2004, we signed a long-term agreement with RONA, to become a national Sponsor in the AIR MILES Reward Program.

Additionally, in the first nine months of 2004, we completed three significant capital market transactions:

•

In April 2004, we amended our 364-day credit facility to extend for an additional 364 days the terms of the previous 364-day credit facility.

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In May 2004, we completed the sale of $500.0 million in asset backed notes for our securitization trusts.

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In September 2004, we completed the sale of $900.0 million in asset backed notes for our securitization trusts.

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Subsequent Events

•

In October 2004, we entered into amendments to our three credit facilities. Collectively, the three amendments increased the aggregate amount of revolving commitments under the three credit facilities from $400.0 million to $435.0 million. In addition, the amendments increased the aggregate amount of commitments permitted under the three credit facilities from $450.0 million to $500.0 million.

•

In October 2004, we acquired, via merger, Epsilon Data Management, Inc., a provider of integrated direct marketing solutions that combine value-added marketing, transaction, technology and analytical services.

Critical Accounting Policies and Estimates

     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, 2003.

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Use of Non-GAAP Financial Measures

     EBITDA is a non-GAAP financial measure equal to net income, the most directly comparable GAAP financial measure, plus provision for income taxes, interest expense, net, fair value loss on interest rate derivative, other debt related expenses, depreciation and amortization. Operating EBITDA is a non-GAAP financial measure equal to 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 to monitor compliance with the financial covenants in our credit agreements. For the third quarter of 2004, senior debt-to-operating EBITDA was 0.3x compared to a maximum ratio of 2.0x and operating EBITDA to interest expense was 17.8x compared to a minimum ratio of 3.5x. Our covenant ratios for 2005 will be the same as 2004. As discussed in more detail in the liquidity section of the MD&A, our credit agreements together with cash flow from operations are two of our main sources of funding our acquisition strategy and of funding future working capital needs and capital expenditures. As of September 30, 2004, we had borrowings of $91.7 million outstanding under these credit agreements and had $308.3 million in unused borrowing capacity. We were in compliance with our covenants at September 30, 2004 and we expect to be in compliance with these covenants during the year ending December 31, 2004.

     We use 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. EBITDA is considered an important indicator of the operational strength of our businesses. 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 the Company’s 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. Therefore, we believe that EBITDA provides useful information to our investors regarding our performance and overall results of operations. 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, 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 EBITDA and operating EBITDA measures presented in this 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.

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Results of Operations

Three months ended September 30, 2003 compared to the three months ended September 30, 2004

     Revenue. Total revenue increased $39.8 million, or 15.4%, to $298.9 million for the three months ended September 30, 2004 from $259.1 million for the comparable period in 2003. The increase was due to a 11.4% increase in Transaction Services revenue, a 13.9% increase in Credit Services revenue and an 18.1% increase in Marketing Services revenue as follows:

•

Transaction Services. Transaction Services revenue increased $17.3 million, or 11.4%, primarily due to an increase in the number of statements generated. The increase in the number of statements generated is attributable to our utility and private label clients. Statements generated increased by 14.3%, while revenue per statement remained consistent. The increase in statements is primarily from the addition of new clients in both utility—Conservation Billing Services Inc. (acquired in September 2003) and Orcom Solutions, Inc. (acquired in December 2003) and private label—Stage Stores, Inc. (signed in September 2003) and Peebles Inc. (signed January 2004) and core growth in existing clients. Additional growth in transaction services revenue came from an increase in merchant services revenue of 7.6% as our petroleum clients experienced higher transaction volume due to higher gas prices. Higher gas prices drive more frequent visits by consumers to our petroleum clients.

•

Credit Services. Credit Services revenue increased $14.8 million, or 13.9%, primarily due to a 9.3% increase in securitization income, a 30.0% increase in servicing fees and a 18.4% increase in merchant discount fees. Securitization income increased $6.9 million primarily as a result of a 13.7% increase in average securitized accounts receivable and an 30 basis point improvement in net charge-offs partially offset by an increase in financing costs and a decrease in collected yield, representing interest and late fees collected from our cardholders,

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compared to the same period in 2003. Servicing fees increased $3.6 million, primarily as a result of a 13.7% increase in average securitized portfolio. Merchant discount fees increased $2.9 million, primarily as a result of a 10.2% increase in credit sales.

•

Marketing Services. Marketing Services revenue increased $13.0 million, or 18.1%, primarily due to a $10.2 million increase in redemption revenue related to a 17.2% increase in the redemption of AIR MILES reward miles. Deferred revenue-redemption is impacted by both the number of AIR MILES reward miles issued and redeemed, as well as foreign currency movements. Excluding foreign currency movement, deferred revenue redemption increased $5.6 million, reflecting the greater number of AIR MILES reward miles issued in the period than redeemed. Foreign currency increased deferred revenue-redemption by $19.3 million for the three months ended September 30, 2004.

     Operating Expenses. Total operating expenses, excluding depreciation and amortization, increased $30.1 million, or 14.7%, to $234.3 million during the three months ended September 30, 2004 from $204.2 million during the comparable period in 2003. Total EBITDA margin, excluding inter-segment revenue and expenses, increased to 21.6% for the three months ended September 30, 2004 from 21.2% for the comparable period in 2003, primarily due to an increased margin for Credit Services, partially offset by decreased margins for Transaction Services and Marketing Services.

•

Transaction Services. Transaction Services operating expenses, excluding depreciation and amortization, increased $15.8 million, or 12.3%, to $144.4 million for the three months ended September 30, 2004 from $128.6 million for the comparable period in 2003, and EBITDA margin decreased to 14.8% for the three months ended September 30, 2004 from 15.5% during the comparable period in 2003. The decrease in EBITDA margin was primarily the result of our ongoing goal towards building scale in utility services, which has and will continue to require ongoing investment in personnel and operations.

•

Credit Services. Credit Services operating expenses, excluding depreciation and amortization, increased $7.0 million, or 7.9%, to $95.1 million for the three months ended September 30, 2004 from $88.1 million for the comparable period in 2003, and EBITDA margin increased to 21.7% for the three months ended September 30, 2004 from 17.3% for the comparable period in 2003. The increased EBITDA margin is the result of achieving leverage from the operating cost base compared to favorable revenue trends from increased receivable balances.

•

Marketing Services. Marketing Services operating expenses, excluding depreciation and amortization, increased $12.7 million, or 21.5%, to $71.8 million for the three months ended September 30, 2004 from $59.1 million for the comparable period in 2003, and EBITDA margin decreased to 15.5% for the three months ended September 30, 2004 from 17.9% for the comparable period in 2003. EBITDA margin decreased due to an increase in redemption expense related to the increased redemption activity during the third quarter of 2004.

•

Depreciation and Amortization. Depreciation and amortization increased $3.7 million, or 20.1%, to $21.8 million for the three months ended September 30, 2004 from $18.1 million for the comparable period in 2003 due to an increase in depreciation and other amortization of $1.9 and a $1.8 million increase in the amortization of purchased intangibles.

     Operating Income. Operating income increased $6.0 million, or 16.3%, to $42.8 million for the three months ended September 30, 2004 from $36.8 million during the comparable period in 2003. Operating income increased due to the revenue and expense factors discussed above.

     Interest Expense, net. Interest expense, net decreased $1.1 million, or 52.4%, to $1.0 million for the three months ended September 30, 2004 from $2.1 million for the comparable period in 2003 as interest expense, net in 2003 was impacted by a loss on the termination of a cross currency interest rate swap. The interest rate swap was terminated with the refinancing of the prior credit facilities and repayment of the associated term debt.

     Taxes. Provision for income taxes increased $2.6 million to $15.7 million for the three months ended September 30, 2004 from $13.1 million in 2003 due to an increase in income before income taxes. Our effective tax rate was 37.7% in 2004 and 38.3% in 2003.

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Nine months ended September 30, 2003 compared to the nine months ended September 30, 2004

     Revenue. Total revenue increased $161.9 million, or 21.6%, to $910.6 million for the nine months ended September 30, 2004 from $748.7 million for the comparable period in 2003. The increase was due to a 14.5% increase in Transaction Services revenue, a 23.1% increase in Credit Services revenue and a 23.3% increase in Marketing Services revenue as follows:

•

Transaction Services. Transaction Services revenue increased $65.0 million, or 14.5%, primarily due to an increase in the number of statements generated. The increase in the number of statements generated is attributable to our utility and private label clients. Statements generated increased by 17.8%, while revenue per statement remained consistent. The increase in statements is primarily from the addition of new clients in both utility—Centrica (signed in March 2003), Conservation Billing Services Inc. (acquired in September 2003) and Orcom Solutions, Inc. (acquired in December 2003) and private label—Stage Stores, Inc. (signed in September 2003) and Peebles Inc. (signed in January 2004) and core growth in existing clients. Additional growth in transaction services revenue came from an increase in merchant services revenue of 10.0% as our petroleum clients experienced higher transaction volume due to higher gas prices. Higher gas prices drive more frequent visits by consumers to our petroleum clients.

•

Credit Services. Credit Services revenue increased $72.3 million, or 23.1%, primarily due to a 24.5% increase in securitization income, a 20.9% increase in servicing fees and a 15.2% increase in merchant discount fees. Securitization income increased $52.6 million primarily as a result of a 15.5% increase in average securitized accounts receivable, and a 20 basis point improvement in net charge-offs partially offset by an increase in cost of funds compared to the same period in 2003. Servicing fees increased $7.7 million, primarily as a result of a 15.5% increase in average securitized portfolio. Merchant discount fees increased $6.9 million, primarily as a result of a 14.4% increase in credit sales.

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•

Marketing Services. Marketing Services revenue increased $47.1 million, or 23.3%, primarily due to a $37.1 million increase in redemption revenue related to a 23.4% increase in the redemption of AIR MILES reward miles. Deferred revenue-redemption is impacted by both the number of AIR MILES reward miles issued and redeemed, as well as foreign currency movements. Excluding foreign currency movement, deferred revenue redemption increased $12.7 million, reflecting the greater number of AIR MILES reward miles issued in the period than redeemed. Foreign currency increased deferred revenue-redemption by $10.2 million for the nine months ended September 30, 2004.

     Operating Expenses. Total operating expenses, excluding depreciation and amortization, increased $100.4 million, or 16.8%, to $699.4 million during the nine months ended September 30, 2004 from $599.0 million during the comparable period in 2003. Total EBITDA margin, excluding inter-segment revenue and expenses, increased to 23.2% for the nine months ended September 30, 2004 from 20.0% for the comparable period in 2003, primarily due to increased margins for Transaction Services and Credit Services, partially offset by a decreased margin for Marketing Services.

•

Transaction Services. Transaction Services operating expenses, excluding depreciation and amortization, increased $54.6 million, or 14.4%, to $435.0 million for the nine months ended September 30, 2004 from $380.4 million for the comparable period in 2003, and EBITDA margin increased to 15.0% for the nine months ended September 30, 2004 from 14.8% during the comparable period in 2003. The increase in EBITDA margin was primarily the result of an increase in revenue driven by a 17.8% increase in the segment’s key driver, statements generated.

•

Credit Services. Credit Services operating expenses, excluding depreciation and amortization, increased $28.3 million, or 10.7%, to $291.8 million for the nine months ended September 30, 2004 from $263.5 million for the comparable period in 2003, and EBITDA margin increased to 24.1% for the nine months ended September 30, 2004 from 15.6% for the same period in 2003. The increased margin is the result of favorable revenue trends from increased receivable balances, higher collected yield, lower net charge-offs and operating leverage.

•

Marketing Services. Marketing Services operating expenses, excluding depreciation and amortization, increased $39.7 million, or 23.7%, to $207.5 million for the nine months ended September 30, 2004 from $167.8 million for the comparable period in 2003, and EBITDA margin decreased to 16.8% for the nine months ended September 30, 2004 from 17.1% for the comparable period in 2003. The decrease in EBITDA margin is the result of a higher mix of lower margin redemption revenue during the year.

•

Depreciation and Amortization. Depreciation and amortization increased $13.2 million, or 24.5%, to $67.1 million for the nine months ended September 30, 2004 from $53.9 million for the comparable period in 2003 due to an increase in depreciation and other amortization of $7.3 million primarily related to the start-up of a new product offering in our Transaction Services segment and a $5.8 million increase in the amortization of purchased intangibles.

     Operating Income. Operating income increased $48.4 million, or 50.6%, to $144.1 million for the nine months ended September 30, 2004 from $95.7 million during the comparable period in 2003. Operating income increased due to the revenue and expense factors discussed above.

     Interest Expense, net. Interest expense, net decreased $7.4 million, or 61.2%, to $4.7 million for the nine months ended September 30, 2004 from $12.1 million for the comparable period in 2003 as interest expense in 2003 was impacted by a loss on the termination of a cross currency interest rate swap and lower borrowings in the nine months ended September 30, 2004 compared to the comparable period in 2003. The interest rate swap was terminated with the refinancing of the prior credit facilities and repayment of the associated term debt.

     Other Debt-Related Expenses. During the nine months ended September 30, 2003, we wrote off $4.3 million of debt issuance costs related to the refinancing of our prior credit facilities and repayment of a subordinated note.

     Taxes. Provision for income taxes increased $22.8 million to $52.3 million for the nine months ended September 30, 2004 from $29.5 million in 2003 due to an increase in income before income taxes. Our effective tax rate was 37.7% in 2004 and 38.3% in 2003.

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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. The vintage of a portfolio is a significant indicator of the quality of credit card receivables. At September 30, 2004, 44.6% of securitized accounts with balances and 40.0% of securitized receivables were less than 24 months old. The losses on newly-originated programs are typically higher in the early months before stabilizing to our historical trends. These vintages are consistent with our historical trends.

     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 after 90 days. 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 trust as reported to the trustee for compliance reporting. Management also uses core receivables to manage and analyze the portfolios. Core receivables are defined as securitized receivables less those receivables whereby we do not assume any risk of loss. These losses are passed on to the respective client.

     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 in the period indicated.