<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JUNE 9, 2000
REGISTRATION NO. 333-94623
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
AMENDMENT NO. 2
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
--------------------------
ALLIANCE DATA SYSTEMS CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
<TABLE>
<S> <C> <C>
DELAWARE 7374 31-1429215
(State or Other Jurisdiction of (Primary standard (I.R.S. Employer
Incorporation or Organization) industrial classification Identification Number)
code number)
</TABLE>
--------------------------
17655 WATERVIEW PARKWAY
DALLAS, TEXAS 75252
TELEPHONE: (972) 348-5100
(Address, Including Zip Code, and Telephone Number, Including Area Code,
of Registrant's Principal Executive Offices)
J. MICHAEL PARKS
CHAIRMAN OF THE BOARD, CHIEF EXECUTIVE OFFICER AND PRESIDENT
17655 WATERVIEW PARKWAY
DALLAS, TEXAS 75252
TELEPHONE: (972) 348-5100
(Name, Address, Including Zip Code, and Telephone Number,
Including Area Code, of Agent for Service)
--------------------------
WITH A COPY TO:
<TABLE>
<S> <C>
TERRY M. SCHPOK, P.C. KENNETH M. DORAN, ESQ.
Akin, Gump, Strauss, Hauer & Feld, L.L.P. Gibson, Dunn & Crutcher LLP
1700 Pacific Avenue, Suite 4100 333 South Grand Avenue
Dallas, Texas 75201 Los Angeles, California 90071
Telephone: (214) 969-2800 Telephone: (213) 229-7000
Facsimile: (214) 969-4343 Facsimile: (213) 229-7520
</TABLE>
--------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
AS SOON AS PRACTICABLE ON OR AFTER THE EFFECTIVE DATE OF THIS REGISTRATION
STATEMENT.
--------------------------
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. / /
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. / / _________
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / / _________
If this form is a post-effective amendment filed pursuant to Rule 462(d)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / / _________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. / /
--------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION,
ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
<PAGE>
SUBJECT TO COMPLETION, DATED JUNE 9, 2000
THE INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY
NOT SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER
TO SELL THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE
SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT PERMITTED.
<PAGE>
PROSPECTUS
20,000,000 SHARES
[LOGO]
COMMON STOCK
------------------
This is an initial public offering of 20,000,000 shares of our common stock. We
anticipate the initial public offering price will be between $14.00 and $16.00
per share. We are selling all the shares offered under this prospectus.
We have applied to have our common stock listed on the New York Stock Exchange
under the symbol "ADS."
SEE "RISK FACTORS" BEGINNING ON PAGE 9 TO READ ABOUT RISKS THAT YOU SHOULD
CONSIDER BEFORE BUYING SHARES OF OUR COMMON STOCK.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY OTHER REGULATORY BODY HAS
APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE ADEQUACY OR
ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
------------------------
<TABLE>
<CAPTION>
PER SHARE TOTAL
------------- -------------
<S> <C> <C>
Public offering price....................................... $ $
Underwriting discounts and commissions...................... $ $
Proceeds, before expenses, to us............................ $ $
</TABLE>
The underwriters may purchase up to an additional 3,000,000 shares of our common
stock from us at the initial public offering price less the underwriting
discounts, solely to cover over-allotments.
The underwriters are severally underwriting the shares being offered. Bear,
Stearns & Co. Inc. expects to deliver the shares in New York, New York on
, 2000.
------------------------
BEAR, STEARNS & CO. INC. MERRILL LYNCH & CO.
DONALDSON, LUFKIN & JENRETTE
THE DATE OF THIS PROSPECTUS IS , 2000.
<PAGE>
Inside front cover
- Half gatefold with a four colored schematic depicting a "multiple
transaction and communications points" process. The schematic
show's our client's customer; our client's distribution channel;
our process and our target markets including our logo.
The gatefold has the following test: "We provide electronic
transactions services, credit services and loyalty and database
marketing services. We help our clients manage their customer
relationships by:
- Facilitating transactions with their customers through multiple
channels including in-store, internet and catalog
- Assisting them in identifying and acquiring new customers
- Increasing both the loyalty and profitability of existing customers
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary................... 1
Risk Factors......................... 9
Special Note Regarding
Forward-Looking Statements......... 22
Use of Proceeds...................... 23
Dividend Policy...................... 24
Dilution............................. 25
Capitalization....................... 26
Unaudited Pro Forma Consolidated
Financial Information.............. 27
Selected Historical Consolidated
Financial and Operating
Information........................ 32
</TABLE>
<TABLE>
Management's Discussion and
Analysis of Financial Condition and
Results of Operations.............. 34
Description of Our Business.......... 56
<CAPTION>
PAGE
----
<S> <C>
Management........................... 71
Principal Stockholders............... 81
Certain Relationships and Related
Transactions....................... 84
Description of Capital Stock......... 87
Shares Eligible for Future Sale...... 90
Underwriting......................... 91
Legal Matters........................ 93
Experts.............................. 93
Where You Can Find More Information.. 94
Index to Consolidated Financial
Statements......................... F-1
</TABLE>
<PAGE>
PROSPECTUS SUMMARY
THIS SUMMARY CONTAINS BASIC INFORMATION ABOUT US AND THE OFFERING. BECAUSE
IT IS A SUMMARY, IT DOES NOT CONTAIN ALL THE INFORMATION THAT YOU SHOULD
CONSIDER BEFORE INVESTING. YOU SHOULD READ THE ENTIRE PROSPECTUS CAREFULLY,
INCLUDING THE RISK FACTORS AND OUR FINANCIAL STATEMENTS AND THE RELATED NOTES TO
THOSE STATEMENTS INCLUDED IN THIS PROSPECTUS.
OUR COMPANY
We are a leading provider of electronic transaction services, credit
services, and loyalty and database marketing services. We develop and execute
programs designed to help our clients target, acquire and retain loyal,
profitable customers. We create value for our clients by assisting them in
managing their customer relationships. Specifically we:
- facilitate transactions between our clients and their customers through
multiple channels including in-store, catalog and Internet;
- assist our clients in identifying and acquiring new customers; and
- increase the loyalty and profitability of our clients' existing customers.
We had revenue of $639.2 million in 1999 and $178.6 million for the three
months ended March 31, 2000. We have a client base in excess of 300 companies.
Our six largest clients, based on their contribution to our 1999 revenue, are:
- the retail affiliates of The Limited, including Limited Too, Victoria's
Secret, Express, Lane Bryant, Bath & Body Works, Lerner New York, Henri
Bendel and Structure;
- Brylane;
- Bank of Montreal;
- Equiva Services, LLC, which is the service provider to Shell branded
locations in the U.S.;
- CITGO; and
- Canada Safeway.
The Limited, together with its retail affiliates, is our largest client,
representing approximately 26.7% of our 1999 revenue. In addition, Limited
Commerce Corp., an affiliate of The Limited, owns approximately 25.8% of our
common stock, before giving effect to this offering. After this offering,
Limited Commerce Corp. will have the right to designate up to two nominees for
election to our board of directors, depending on its percentage ownership of our
common stock.
OUR MARKET OPPORTUNITY
Our services are applicable to the full spectrum of commerce opportunities
involving companies that sell products and services to individual consumers. We
currently target our service offerings to select market sectors, including
specialty retailers, petroleum retailers, supermarkets and financial services
providers, as well as companies in market sectors with rapidly evolving
electronic payment and customer management needs such as gas and electric
utilities, mass transit, tollways and parking.
Common challenges to our clients are the rapid development of new
competitors and sales channels, the intensifying competition for customers and
the erosion of consumer brand loyalty. The Internet has accelerated these trends
by providing consumers with almost instant access to a multitude of competing
products and services without traveling to an actual store location. As a
result, companies are looking for tools to facilitate transactions and improve
customer communications across all channels.
1
<PAGE>
Companies increasingly seek services that compile and analyze customer
purchasing behavior, enabling them to more effectively communicate with their
customers. The continuing shift to electronic payment systems, namely credit,
debit, stored value and pre-paid cards, generates highly valuable information on
individual consumers and their purchasing preferences, while the dramatic
proliferation of computer technology has enabled companies to capture, access
and use this information easily and almost instantaneously. Many retailers,
however, lack the economies of scale and core competencies necessary to support
their own transaction processing infrastructure and credit card programs,
including the extension of credit. In addition, many retailers seek to outsource
the development and management of loyalty programs and database marketing
services. We believe we are well-positioned to provide these services to meet
the evolving needs of our clients and potential clients.
OUR PRODUCTS AND SERVICES
Our products and services are centered around three core
capabilities--Transaction Services, which represents 45.0% of our 1999 revenue,
Credit Services, which represents 30.8% of our 1999 revenue, and Loyalty and
Database Marketing Services, which represents 24.2% of our 1999 revenue.
<TABLE>
<CAPTION>
LOYALTY AND DATABASE
TRANSACTION SERVICES CREDIT SERVICES MARKETING SERVICES
--------------------------------- ---------------------------- ---------------------------------
<S> <C> <C>
- Transaction Processing - Underwriting - Loyalty Programs
- Network Services - Risk Management - Private Label Cards
- Bankcard Settlement - Air Miles-TM- reward program
- Card Processing and Servicing - One-to-One Loyalty
- Account Processing - Database Marketing Services
- Billing and Payment - Direct Marketing
Processing
- Customer Care - Enhancement Services
</TABLE>
We market and sell our services on both a stand-alone and bundled basis. By
providing services that span our three core offerings, we believe we can become
a key element in our clients' success.
TRANSACTION SERVICES
Providing flexible, convenient, rapid customer payment options is
fundamental to customer satisfaction and retention. Through our predecessor
company, we have provided these services since 1983. We facilitate and manage
transactions between our clients and their customers through multiple
distribution channels, including in-store, catalog and the Internet, through our
state-of-the-art, highly scalable processing systems. Our services include
instantaneous authorizations, efficient payment processing, billing services and
effective customer care.
We are a leading provider of electronic transaction services, processing
1.8 billion transactions in 1998 on a pro forma basis for acquisitions.
According to the Faulkner and Gray Card Industry 2000 report, this level of
activity ranked us fourth among U.S. payment processors in 1998, giving effect
to those acquisitions. According to the Neilson Report, there were approximately
24.2 billion electronic payment transactions in the U.S. in 1998, and another
published report predicts the number to climb to nearly 50 billion by 2005. By
fully integrating our transaction services with our loyalty and database
marketing services, we are able to execute more effective customer acquisition
and retention strategies for our clients. Our clients within this segment are
made up primarily of specialty retailers and petroleum retailers.
CREDIT SERVICES
We have demonstrated to many of our existing clients that a private label
credit card is one of the most effective loyalty and marketing tools available.
As part of our service, we offer our clients the experience and flexibility to
provide a funding vehicle for private label credit card receivables. Through our
predecessor company, we have owned and managed private label receivables since
1986. This
2
<PAGE>
service appeals to those clients that choose to focus their financial and
operational resources on their core operations and prefer a single-source
integrated solution. Clients who utilize this service are predominantly
specialty retailers. As part of this service, we currently provide underwriting
and risk management services to 43 of our 48 private label card clients,
representing approximately 49.4 million cardholders. We finance substantially
all our credit card receivables through asset securitization transactions.
LOYALTY AND DATABASE MARKETING SERVICES
Our clients are focused on targeting, acquiring and retaining loyal and
profitable customers. Since 1992 we have created and managed loyalty programs
that have successfully resulted in securing more frequent and sustained customer
purchasing. For example:
- we have demonstrated to many of our existing clients that a private label
credit card is one of the most effective loyalty and marketing tools
available. We manage 48 distinct programs for specialty and petroleum
retailers, representing 73.6 million cardholders. Our private label
programs can be further enhanced by our ability to provide database
marketing services, which enable us to capture unique and proprietary
item-level transaction data and use it to target customers.
- in Canada, we have developed and operate the Air Miles reward program,
which we believe to be the largest loyalty program in Canada. The program
has over 100 brand names represented by the program sponsors. Based upon
the most recent census data available, in 1999 our active participants
represented over 55% of all Canadian households. We have issued over six
billion Air Miles reward miles since the program's inception in 1992.
- we have also developed an on-line, electronic loyalty program that
recognizes, acknowledges and rewards customers at the point of sale. Using
the retailer's existing point-of-sale terminal or cash register and our
network services, we can capture points, communicate program status and
issue targeted awards at the point of sale.
Our loyalty programs provide our clients with tools to help drive customer
acquisitions and reward customer loyalty while providing us with the ability to
better understand the purchasing behavior of our clients' customers. As a result
of these programs and our marketing database programs, we have captured detailed
purchase information on approximately 60 million U.S. consumers and 6.1 million
Canadian households. By combining massive amounts of detailed data with our
proprietary data mining algorithms and our experience in developing and
executing marketing campaigns, we provide our clients with highly successful and
sophisticated targeted marketing solutions. Our clients within this segment are
specialty retailers, petroleum retailers, supermarkets and financial service
providers.
CLIENT CASE STUDY
Victoria's Secret provides an example of our ability to integrate our
products and services to assist our clients in facilitating transactions and
communications with their customers, whether in stores, through catalogs or
through Web sites. We provide transaction services, credit services and database
marketing services to Victoria's Secret. The Victoria's Secret credit card that
we issue allows us to capture customer name and address as well as transaction
data in any channel the consumer chooses to shop. We deliver the information to
our marketing database, which is supplemented with additional data from
Victoria's Secret as well as from external sources. This gives us a detail-rich
database that we, together with Victoria's Secret, use in developing customer
acquisition strategies and managing customer relationships. We also utilize the
information we collect and manage for the credit card program to enhance the
transaction services we provide to Victoria's Secret, which include billing,
payment processing and customer care.
3
<PAGE>
OUR STRATEGY
Our strategy is to become a critical component in our clients' success by
helping them build loyal customer relationships. We will do this by continuing
to build and enhance our consumer databases, our marketing capabilities and our
processing efficiencies to help improve our clients' relationships with their
customers. To execute this strategy we intend to:
- increase the penetration of products and services we provide to our
existing client base;
- expand our client base in our existing market sectors;
- continue to expand our services and capabilities to help our clients
succeed in multi-channel commerce--in-store, catalog and Internet; and
- consider focused, strategic acquisitions and alliances to enhance our core
capabilities or increase our scale.
OUR HISTORY AND OWNERSHIP
We are the result of the 1996 merger of two entities acquired by Welsh,
Carson, Anderson and Stowe --J.C. Penney's transaction services business, BSI
Business Services, Inc., and The Limited's credit card bank operation, World
Financial Network National Bank. Since then, we have made the following
acquisitions, each accounted for as a purchase, with the results of operations
of the acquired businesses included from the respective closing dates:
- In November 1996, we acquired the private label portfolio of National City
Bank of Columbus, which consisted of approximately $370.0 million in
receivables, which have been securitized, and represented over 25
retailers in a broad range of industries including soft goods, building
materials, furniture and electronics.
- In July 1998, we acquired Loyalty Management Group Canada Inc.
- In September 1998, we acquired Harmonic Systems Incorporated.
- In July 1999, we acquired the network services business of SPS Payment
Systems, Inc., a wholly-owned subsidiary of Associates First Capital
Corporation.
As of March 31, 2000, Welsh, Carson, Anderson & Stowe beneficially owned
74.0% of our common stock, and The Limited, through its wholly owned subsidiary
Limited Commerce Corp., beneficially owned approximately 25.8% of our common
stock. After this offering, Welsh Carson will have the right to designate up to
three nominees for election to our board of directors and Limited Commerce Corp.
will have the right to designate up to two nominees, depending on their
percentage ownership of our common stock.
------------------------
Our corporate headquarters are located at 17655 Waterview Parkway, Dallas,
Texas 75252, and our telephone number is 972-348-5100.
4
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common stock offered......................... 20,000,000 shares
Common stock to be outstanding after the
offering................................... 76,804,572 shares
Use of proceeds.............................. We intend to use approximately
$204.9 million of the net proceeds from the
offering to repay outstanding debt, and the
remaining net proceeds for other general
corporate purposes, including working
capital. In the event that we identify
suitable acquisition candidates or investment
opportunities, we may also use a portion of
the net proceeds to acquire or invest in
complementary businesses, services or
products. We currently have no commitments or
agreements with respect to any acquisition or
investment transactions.
Proposed New York Stock Exchange symbol...... "ADS"
</TABLE>
Unless otherwise indicated, all information in this prospectus:
- gives effect to the 1-for-9 reverse stock split of our common stock
effected on March 15, 2000; and
- reflects the conversion of all outstanding shares of our Series A
cumulative convertible preferred stock into an aggregate of
9,275,729 shares of common stock as of March 31, 2000.
The number of shares of common stock described as being outstanding after
this offering excludes the following:
- 2,366,388 shares that we may issue upon the exercise of stock options
outstanding as of March 31, 2000 at a weighted average exercise price of
$9.51 per share;
- 6,272,763 additional shares that we may issue under our stock option and
restricted stock plan; and
- up to 3,000,000 additional shares that we may issue upon exercise of the
underwriters' over-allotment option.
5
<PAGE>
SUMMARY UNAUDITED CALENDAR YEAR AND PRO FORMA CONSOLIDATED FINANCIAL AND
OPERATING INFORMATION
Prior to December 31, 1998, our fiscal year was based on a 52/53-week fiscal
year ending on the Saturday closest to January 31. We have since changed our
fiscal year end to December 31. In order to provide a better basis of
comparison, we have recast our historical operating results to a calendar year
basis for the years ended December 31, 1997 and 1998. In our opinion, these
historical recast financial statements reflect all normal recurring adjustments
necessary for a fair presentation of such financial statements. The information
presented herein has been restated from amounts previously reported to reduce
the amortization period of the premium on purchased credit card portfolios from
15 years to three years. See Note 22 to the consolidated financial statements
included in this prospectus.
The selected consolidated financial data for the three months ended
March 31, 1999 and 2000 have been derived from our unaudited consolidated
financial statements, which are included in this prospectus and which, in our
opinion, reflect all adjustments, consisting only of adjustments of a normal and
recurring nature, necessary for a fair presentation. Results for the three
months ended March 31, 2000 are not necessarily indicative of results for the
full year.
We have also included the following unaudited pro forma information, which
we derived from our unaudited pro forma consolidated financial information
included in this prospectus. The data contained in the pro forma columns give
effect to the following completed acquisitions as if those acquisitions had been
consummated on January 1, 1998:
- the acquisition of Loyalty Management Group Canada Inc. on July 24, 1998;
- the acquisition of Harmonic Systems Incorporated on September 15, 1998;
and
- the acquisition of the network transaction processing business of SPS
Payment Systems, Inc., a wholly-owned subsidiary of Associates First
Capital Corp., on July 1, 1999.
The supplemental pro forma loss per share gives effect to the conversion of
all outstanding shares of our Series A preferred stock and the exercise of all
outstanding warrants as if the conversion and the exercise had occurred at the
beginning of the period. The pro forma as adjusted data give effect to this
offering as if it occurred on March 31, 2000. The unaudited pro forma data do
not purport to present what our results of operations or financial position
would actually have been, or to project our results of operations or financial
position for any future period. You should read the following pro forma
information along with the information contained throughout this prospectus,
including the financial statements and the related notes that are included in
this prospectus.
The operating data include EBITDA, which is equal to operating income plus
depreciation and amortization. EBITDA is presented because we use our EBITDA
measure as an integral part of our internal reporting and performance evaluation
for senior management. In addition, 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 generally accepted accounting
principles. The EBITDA measure presented in this prospectus may not be
comparable to similarly titled measures presented by other companies.
6
<PAGE>
<TABLE>
PRO FORMA
-----------------------------------------------
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------- FOR THE FOR THE YEARS FOR THE
THREE MONTHS ENDED ENDED THREE MONTHS ENDED
RECAST MARCH 31, DECEMBER 31, MARCH 31,
---------------------- ---------------------- ----------------------- ----------------------
1997 1998 1999 1999 2000 1998 1999 1999 2000
---------- ---------- ---------- ---------- ---------- ----------- ---------- ---------- ----------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA
Total revenue...... $ 339,824 $ 474,933 $ 639,254 $ 147,813 $ 178,628 $ 606,462 $ 663,576 $ 159,370 $ 178,628
Operating expenses
Processing and
servicing...... 164,968 226,525 341,496 76,827 94,027 325,401 358,443 85,349 94,027
Salaries and
employee
benefits....... 113,752 169,799 193,699 46,236 54,489 184,493 196,880 47,857 54,489
Depreciation and
other
amortization... 8,904 8,782 16,183 3,396 5,997 10,035 16,183 3,396 5,997
Amortization of
purchased
intangibles.... 26,050 45,746 58,553 14,182 13,011 78,920 64,482 17,147 13,011
---------- ---------- ---------- ---------- ---------- ----------- ---------- ---------- ----------
Total operating
expenses......... 313,674 450,852 609,931 140,641 167,524 598,849 635,988 153,749 167,524
---------- ---------- ---------- ---------- ---------- ----------- ---------- ---------- ----------
Operating income... 26,150 24,081 29,323 7,172 11,104 7,613 27,588 5,621 11,104
Other expense...... -- -- -- -- 2,476 -- -- -- 2,476
Interest expense... 15,713 29,295 42,785 10,324 8,776 38,519 42,785 10,324 8,776
Income tax
expense.......... 2,844 6,702 12,316 1,923 3,077 4,511 11,344 1,437 3,077
---------- ---------- ---------- ---------- ---------- ----------- ---------- ---------- ----------
Income (loss) from
continuing
operations....... 7,593 (11,916) (25,778) (5,075) (3,225) (35,417) (26,541) (6,140) (3,225)
Income (loss) from
discontinued
operations, net
of taxes......... (5,635) (3,948) 7,688 1,715 -- (3,948) 7,688 1,715 --
Loss on disposal of
discontinued
operations, net
of taxes......... -- -- (3,737) -- -- -- (3,737) -- --
---------- ---------- ---------- ---------- ---------- ----------- ---------- ---------- ----------
Net income
(loss)........... $ 1,958 $ (15,864) $ (21,827) $ (3,360) $ (3,225) $ (39,365) $ (22,590) $ (4,425) $ (3,225)
========== ========== ========== ========== ========== =========== ========== ========== ==========
Earnings (loss) per
share from
continuing
operations--basic
and diluted...... $ 0.21 $ (0.29) $ (0.61) $ (0.11) $ (0.11) $ (0.90) $ (0.71) $ (0.17) $ (0.11)
Earnings (loss) per
share--basic and
diluted.......... $ 0.05 $ (0.38) $ (0.53) $ (0.07) $ (0.11) $ (0.98) $ (0.63) $ (0.13) $ (0.11)
Weighted average
shares used in
computing per
share
amounts--basic
and diluted...... 36,612 41,308 47,498 47,487 47,529 46,969 47,498 47,487 47,529
Supplemental pro
forma loss per
share from
continuing
operations--
basic and
diluted.......... $ (0.63) $ (0.47) $ (0.11) $ (0.06)
Supplemental pro
forma loss per
share--basic and
diluted.......... $ (0.70) $ (0.40) $ (0.08) $ (0.06)
Weighted average
shares used in
computing
supplemental pro
forma per share
amounts--basic
and diluted...... 56,025 56,554 56,543 56,585
</TABLE>
7
<PAGE>
<TABLE>
PRO FORMA
-----------------------------------------------
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------- FOR THE FOR THE YEARS FOR THE
THREE MONTHS ENDED ENDED THREE MONTHS ENDED
RECAST MARCH 31, DECEMBER 31, MARCH 31,
---------------------- ---------------------- ----------------------- ----------------------
1997 1998 1999 1999 2000 1998 1999 1999 2000
---------- ---------- ---------- ---------- ---------- ----------- ---------- ---------- ----------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
OTHER FINANCIAL DATA
EBITDA............. $ 61,104 $ 78,609 $ 104,059 $ 24,750 $ 30,112 $ 96,568 $ 108,253 $ 26,164 $ 30,112
EBITDA as a
percentage of
revenue.......... 18.0% 16.6% 16.3% 16.7% 16.9% 15.9% 16.3% 16.4% 16.9%
SEGMENT OPERATING
DATA
Air Miles reward
miles issued..... -- 666,542 1,583,239 352,785 440,086 1,361,013 1,583,239 352,785 440,086
Transactions
processed........ 922,678 1,134,902 1,839,857 310,673 566,275 1,814,271 2,104,554 438,687 566,275
Statements
generated........ 113,940 130,895 132,817 32,702 34,253 130,895 132,817 32,702 34,253
Securitized
portfolio........ $1,821,016 $2,135,340 $2,232,375 $1,984,914 $2,037,529 $ 2,135,340 $2,232,375 $1,984,914 $2,037,529
Credit sales....... $3,001,461 $3,049,151 $3,132,520 $ 646,507 $ 702,593 $ 3,049,151 $3,132,520 $ 646,507 $ 702,593
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
----------------------------------
RECAST AS OF PRO FORMA
---------------------- MARCH 31, AS
1997 1998 1999 2000 ADJUSTED
---------- ---------- ---------- ---------- ----------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
Cash and cash
equivalents...... $ 29,304 $ 47,036 $ 56,546 $ 67,069 $ 122,499
Credit card
receivables and
seller's
interest......... 170,938 139,458 150,804 134,452 134,452
Intangibles and
goodwill......... 83,915 286,179 420,055 407,898 407,898
Total assets....... 589,876 997,648 1,166,894 1,137,445 1,205,727
Certificates of
deposit.......... 40,300 49,500 116,900 116,000 116,000
Short-term debt.... 148,000 98,484 -- -- --
Long-term and
subordinated
debt............. 117,673 332,000 318,236 300,785 95,875
Total
liabilities...... 386,104 701,980 775,513 747,521 542,611
Series A preferred
stock............ -- -- 119,400 119,400 --
Total stockholders'
equity........... 203,772 295,668 271,981 270,524 770,666
</TABLE>
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RISK FACTORS
BEFORE MAKING AN INVESTMENT DECISION, YOU SHOULD CAREFULLY CONSIDER THE
FOLLOWING RISKS. THE RISKS DESCRIBED BELOW ARE NOT THE ONLY ONES THAT WE FACE.
ANY OF THE FOLLOWING RISKS COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS,
FINANCIAL CONDITION AND OPERATING RESULTS. ADDITIONAL RISKS AND UNCERTAINTIES OF
WHICH WE ARE UNAWARE OR CURRENTLY BELIEVE ARE IMMATERIAL MAY ALSO IMPAIR OUR
BUSINESS OPERATIONS. THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE DUE TO
ANY OF THESE RISKS, AND YOU COULD LOSE ALL OR PART OF YOUR INVESTMENT IN OUR
COMMON STOCK. BEFORE MAKING AN INVESTMENT DECISION, YOU SHOULD ALSO READ THE
OTHER INFORMATION INCLUDED IN THIS PROSPECTUS, INCLUDING OUR FINANCIAL
STATEMENTS AND THE RELATED NOTES.
RISKS RELATED TO OUR BUSINESS
THE FAILURE TO EFFECTIVELY INTEGRATE RECENT ACQUISITIONS COULD ADVERSELY AFFECT
OUR BUSINESS.
Since August 1996, we have made several acquisitions, principally of Loyalty
Management Group Canada Inc., Harmonic Systems Incorporated and the network
transaction processing business of SPS Payment Systems, Inc. We are currently in
the process of integrating the operations of the network transaction processing
business of SPS, acquired in July 1999. We expect this integration process to
continue through 2000. If we are unable to successfully integrate the SPS
operations or any other acquired businesses, we may incur substantial costs and
delays or other operational, technical or financial problems, any of which could
harm our business and impact the trading price of our common stock. In addition,
the failure to successfully integrate acquisitions may divert management's
attention from our existing business and could damage our relationships with key
clients and employees.
OUR BUSINESS IS DEPENDENT ON A SMALL NUMBER OF LARGE CLIENTS.
Our 10 largest clients were responsible for approximately 64.1% of our
consolidated revenues during the year ended December 31, 1999.
TRANSACTION SERVICES. Our 10 largest clients in this segment were
responsible for approximately 70.1% of our Transaction Services revenue in 1999.
The Limited and its retail affiliates were the largest Transaction Services
client in 1999, representing in excess of 10% of this segment's 1999 revenue.
Our contracts with The Limited and its retail affiliates expire in 2006. Equiva
Services, LLC is one of our 10 largest clients in this segment and on a
consolidated basis. We recently began the process of renegotiating our contract
with Equiva, which expires in December 2001. We can give no assurance that we
will successfully reach an agreement with Equiva on similar terms or at all. If
our renegotiations with Equiva result in a decrease in pricing or in the number
and types of the transaction services we provide to Equiva, our revenue and
profitability attributable to Equiva would be adversely affected, which could
have a material adverse affect on us.
CREDIT SERVICES. Our two largest clients in this segment were responsible
for 85.2% of our Credit Services revenue in 1999. The Limited and its retail
affiliates and Brylane were the largest Credit Services clients in 1999. Our
contracts with these clients expire in 2006.
LOYALTY AND DATABASE MARKETING SERVICES. Our 10 largest clients in this
segment were responsible for approximately 64.3% of our Loyalty and Database
Marketing Services revenue in 1999. Bank of Montreal and Canada Safeway were the
two largest Loyalty and Database Marketing Services clients in 1999, each
representing in excess of 10% of this segment's 1999 revenue. Our contracts with
these clients expire between one and three years from now. We can give no
assurance that these contracts will be renewed on similar terms or at all.
A significant decrease in revenues attributable to any of our significant
clients could have a material adverse effect on our business, financial
condition and operating results in general, and those of the affected operating
segment, in particular. In addition, if any of our significant clients were
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acquired and the client's new management team elected to phase-out or
discontinue the client's business relationship with us, we could suffer a
material adverse effect. This risk is particularly germane as many of our
significant clients are in market sectors such as petroleum, specialty retail,
supermarkets and financial services, which have recently experienced, and are
experiencing, fairly considerable consolidation.
A LARGE NUMBER OF OUR CLIENTS ARE AFFILIATES OF LIMITED COMMERCE CORP., ONE OF
OUR LARGEST PRINCIPAL STOCKHOLDERS.
A large number of our clients are affiliates of Limited Commerce Corp., a
wholly owned subsidiary of The Limited, which beneficially owned approximately
25.8% of our common stock as of March 31, 2000 and maintains two designees on
our board of directors. The Limited, together with its affiliates, is our
largest client, representing approximately 26.7% of our 1999 consolidated
revenue. The Limited and its retail affiliates represented the largest
Transaction Services client in 1999, and together with Brylane were the largest
Credit Services clients in 1999. As a significant stockholder, The Limited,
unlike our other clients, is able to exercise significant influence over matters
requiring stockholder approval, including the election of directors and the
approval of significant corporate transactions. In addition, Limited Commerce
Corp., through a stockholders agreement, has the right to maintain up to two
members of our board of directors.
WE ARE SUBSTANTIALLY DEPENDENT UPON AIR CANADA, THE SINGLE DOMINANT DOMESTIC AIR
CARRIER IN CANADA, AS A MAJOR SUPPLIER OF AIRLINE TICKETS THAT WE ISSUE TO
COLLECTORS OF AIR MILES REWARD MILES.
Historically, Canadian Airlines has been the major supplier of airline
tickets that we issue to collectors of Air Miles reward miles. Although our Air
Miles reward miles can be redeemed for tickets on other airlines as well as for
merchandise, approximately 42% of the Air Miles reward miles redeemed during
1999 were used for airline tickets on Canadian Airlines. Our Air Miles reward
program accounted for approximately 26% of our revenues for 1999 and accounts
for a substantial portion of the revenue and profits of Loyalty and Database
Marketing Services. In December 1999, Air Canada acquired effective control of
Canadian Airlines and announced its intention to merge the operations of
Canadian Airlines with those of Air Canada. Air Canada began to consolidate
route structure between the two airlines resulting in the reduction of routes,
flights and seats offered by the merged airline. Air Canada also announced that
it would attempt to restructure the debt and other obligations of Canadian
Airlines. It is our expectation that, whether or not such restructuring is
successful, Air Canada will emerge as the single dominant Canadian domestic air
carrier for the foreseeable future. We cannot predict what impact route
consolidation or elimination or changes in the merged airlines' operations will
have on our ability to satisfy and retain active collectors and sponsors of the
Air Miles reward program and the profitability of our Air Miles reward program.
On March 24, 2000 Canadian Airlines filed for court protection under the
Canadian Companies' Creditors Arrangement Act. On April 25, 2000, Canadian
Airlines filed a plan of reorganization which included us in a list of unsecured
creditors. Prior to that time, we negotiated and entered into a new supply
agreement with Air Canada, dated April 24, 2000, to begin May 1, 2000 and end on
December 31, 2004, which is not subject to the plan of reorganization or
creditor approval. In addition, we agreed with Canadian Airlines, as part of the
new arrangement, to terminate the old supply agreement, and Canadian Airlines
agreed to become subject to the terms and conditions of the new supply agreement
with Air Canada beginning April 24, 2000 for a period of up to nine months, or
until approval of Canadian Airlines' plan of reorganization, if earlier. The new
supply agreements provide that airline tickets will be available on both
Canadian Airlines and Air Canada, but the Air Canada agreement contains periodic
reductions in capacity guarantees on certain routes after December 31, 2002. The
new supply agreements also provide for price increases for the airline tickets
we purchase over those previously charged by Canadian Airlines under the old
supply agreement. We have assigned
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to Air Canada our claims, resulting from the termination of our old supply
agreement, as an unsecured creditor of Canadian Airlines in the restructuring
proceedings.
We are in the process of integrating the new supply agreements into our cost
structure. This integration will include adjusting some reward offers and
attempting to enter into new supply arrangements with other airlines. Adjusting
our reward offers will likely entail increasing the number of miles required to
redeem a reward and providing incentives to effectuate a change in the mix of
rewards selected by collectors. In addition, we are currently negotiating with
other airlines for additional capacity. If we are unable to secure additional
capacity from other airlines, our supply of airline seats after December 31,
2002 may not be sufficient to cover collector demand due to the periodic
reductions in capacity guarantees contained in our new supply agreement with Air
Canada during the latter part of its term or due to unforeseen growth in demand.
We cannot predict what impact the integration of the new supply agreements into
our cost structure will have on our ability to satisfy and retain active
collectors and participating sponsors in, and the profitability of, our Air
Miles reward program. The inability to successfully enter into agreements with
other airlines for additional capacity or the inability to satisfy and retain
active collectors or participating sponsors in the program after integration of
the new supply agreement into our cost structure could materially adversely
affect the profitability of our Air Miles reward program. We can give no
assurance that our efforts to adjust our cost structure will not affect the
profitability of our Air Miles reward program.
WE ARE SUBJECT TO INTENSE COMPETITION, AND WE EXPECT TO FACE INCREASED
COMPETITION IN THE FUTURE.
GENERAL. The markets for our products and services are highly competitive.
We compete with traditional and online marketing companies, credit card issuers
and data processing companies, as well as with current and potential in-house
operations of our clients. Many of our current and potential competitors have
greater resources than we do, which may impair our ability to compete. Many of
our current and potential competitors have longer operating histories, stronger
brand names and greater financial, technical, marketing and other resources than
we do. In addition, these companies may have existing relationships with our
potential clients and may be able to respond to changes in market dynamics and
technology faster than we can. We cannot assure you that we will be able to
compete successfully against our current and potential competitors. If we are
unable to compete successfully against our competitors, our business will
suffer.
TRANSACTION SERVICES. The payment processing industry is highly
competitive, especially among the five largest payment processors in the U.S.,
which processed approximately 14 billion transactions during 1998. Such
competition requires that we continue to invest resources in technological
developments and restricts the prices we can charge for certain services. The
market requires that payment processors provide advanced and efficient
technology, causing some financial institutions and other payment processors to
either leave the business or merge with other providers, resulting in
significant consolidation in the payment processing industry. Industry
consolidation has enabled a few of our competitors to gain access to significant
capital, management, marketing and technological resources that are equal to or
greater than ours. We cannot assure you that we will continue to be able to
compete successfully with such payment processors.
CREDIT SERVICES. We also face intense and increasing competition from
numerous financial services providers, some of which have greater resources than
we do. We compete against third party private label credit card issuers who may
offer lower discount fees and greater incentives to secure new business.
Additionally, our private label cards compete with other card payment types,
primarily general-purpose credit cards like Visa, MasterCard and American
Express, as well as cash, checks and debit cards.
LOYALTY AND DATABASE MARKETING SERVICES. As a provider of loyalty and
database marketing products and services, we generally compete with advertising
and other promotional and loyalty
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<PAGE>
programs, both traditional and online, for a portion of a client's total
marketing budget. In addition, we compete against internally developed products
and services created by our existing and potential clients. For each of our
loyalty and database products and services, we expect competition to intensify
as more competitors enter our market. In addition, new competitors with our Air
Miles reward program may target our sponsors and reward miles collectors as well
as draw rewards from our rewards suppliers. Due to the significant funding
requirements to establish such a program, we have decided not to operate a
program in the U.S. similar to the Air Miles reward miles program we operate in
Canada. Rather, our existing stockholders have decided to pursue such a program
in the U.S. through the creation and funding of a separate and distinct company
called U.S. Loyalty Corp. Given the nexus of the U.S. and Canada and the number
of companies that have operations in, and target consumers in, both countries,
U.S. Loyalty Corp. may in the future become a competitor of ours for the
marketing budgets of existing and potential clients. Over the past year, over
half of the Air Miles reward program revenues came from the top 10-15% of our
Air Miles reward miles collectors. The loss of these collectors could impact our
ability to generate significant revenue from sponsors and loyalty partners. The
continued attractiveness of our loyalty and rewards programs will depend in
large part on our ability to remain affiliated with sponsors that are desirable
to consumers and to offer rewards that are both attainable and attractive to
consumers. For our database marketing services, our ability to continue
collecting detailed transaction data on consumers is critical in providing
effective customer strategies for our clients.
LOSS OF DATA CENTER CAPACITY OR INTERRUPTION OF TELECOMMUNICATION LINKS COULD
ADVERSELY AFFECT OUR BUSINESS.
Our ability to protect our data centers against damage from fire, power
loss, telecommunications failure and other disasters is critical to our future.
Our services depend on links to telecommunication providers. Any damage to our
data centers or any failure of our telecommunication links that causes
interruptions in our operations could have a material adverse effect on our
ability to meet our clients' requirements, which could adversely effect our
business, financial condition and operating results.
In order to provide many of our services, we must be able to store,
retrieve, process and manage large databases and periodically expand and upgrade
our capabilities. Any interruption or loss of these capabilities from a computer
malfunction or other reasons could have a material adverse effect on our
business, financial condition and operating results.
We are dependent on a major supplier for transport services to our
transaction processing business. Should there be disruption of the services it
provides to us, the disruption would require us to redirect service to another
provider. To do so would require manual intervention to all locations that are
impacted.
FAILURE TO SAFEGUARD OUR DATABASE AND CONSUMER PRIVACY COULD AFFECT OUR
REPUTATION AMONG OUR CLIENTS AND THEIR CUSTOMERS.
An important feature of our loyalty and marketing database programs and
credit services is our ability to develop and maintain individual consumer
profiles. As part of our reward miles redemption and credit services, we
maintain a marketing database containing information on consumers' account
balances. Although we have extensive security procedures, our databases may be
subject to unauthorized access. If we experience a security breach, the
integrity of our marketing databases could be affected. With respect to our
loyalty and database programs, security and privacy concerns may cause consumers
to resist providing the personal data necessary to support this profiling
capability. The use of our loyalty and database programs or credit services
could decline if any well-publicized compromise of security occurred. We could
also be subject to legal claims from consumers. Any public perception that we
released consumer information without authorization would adversely affect our
ability to attract and retain consumers.
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<PAGE>
THE FAILURE TO ACCURATELY ESTIMATE THE REDEMPTION OBLIGATION FOR OUR AIR MILES
REWARD PROGRAM COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR BUSINESS, FINANCIAL
CONDITION AND OPERATING RESULTS.
Our historical financial statements reflect our estimates of the future
payments to purchase airline tickets and other rewards for our Air Miles reward
program. If actual redemptions or reward costs are greater than our estimates,
our redemption obligation may be understated, and that could have a material
adverse effect on our business, financial condition and operating results.
We use several components to estimate this future obligation, which we
record as a redemption obligation on our balance sheet. The most significant
component is our estimate of the number of Air Miles reward miles that will
ultimately be redeemed. The percentage of unredeemed reward miles is known as
"breakage" in the loyalty industry. While our Air Miles reward miles currently
do not expire, reward miles are not redeemed by collectors for a number of
reasons, including:
- loss of interest in the program or sponsors;
- collectors moving out of the program area; and
- death of a collector.
A second component relates to the reward cost, which is based on the mix of
rewards anticipated to be provided. Although we believe that our estimation
process is reasonable in light of our analysis and our seven years of operating
experience with the Air Miles reward program, we cannot assure you that our
actual breakage rates or reward cost estimates will approximate our current
assumptions.
FLUCTUATIONS IN THE TIMING OR QUANTITY OF REWARD MILES REDEEMED BY COLLECTORS
COULD INCREASE OUR NEED FOR WORKING CAPITAL.
We cannot control the timing of a collector's decision to redeem Air Miles
reward miles or the quantity of reward miles redeemed. We could experience a
need for increased working capital to fund redemptions if collectors redeem Air
Miles reward miles at a rate that is more rapid than we anticipated, which could
have a material adverse effect on our business, financial condition and
operating results. We currently maintain cash, cash equivalents and fixed-income
securities in a separate reserve account, which we believe are adequate to fund
this obligation.
LITIGATION RELATING TO INTELLECTUAL PROPERTY RIGHTS COULD HARM OUR BUSINESS.
Third parties may infringe or misappropriate our trademarks or other
intellectual property rights, which could have a material adverse effect on our
business, financial condition or operating results. The actions we take to
protect our trademarks and other proprietary rights may not be adequate.
Litigation may be necessary to enforce our intellectual property rights, protect
our trade secrets or determine the validity and scope of the proprietary rights
of others. We cannot assure you that we will be able to prevent misappropriation
or infringement of our proprietary information. Any infringement or
misappropriation could harm any competitive advantage we currently derive or may
derive from our proprietary rights.
Third parties may assert infringement claims against us. Any claims and any
resulting litigation could subject us to significant liability for damages. An
adverse determination in any litigation of this type could require us to design
around a third party's patent or to license alternative technology from another
party. In addition, litigation is time-consuming and expensive to defend and
could result in the diversion of our time and attention. Any claims from third
parties may also result in limitations on our ability to use the intellectual
property subject to these claims.
DEFAULTS AND BANKRUPTCIES RELATED TO OUR CONSUMER UNSECURED LENDING COULD
ADVERSELY AFFECT US.
The primary risk associated with unsecured lending is the risk of default or
bankruptcy of consumers, resulting in accounts being charged-off as
uncollectible. In addition, general economic
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<PAGE>
factors, such as the rate of inflation, unemployment levels and interest rates,
may result in greater delinquencies and credit losses among consumers. We may
not be able to successfully identify and evaluate the creditworthiness of
cardholders to minimize delinquencies and losses. Also, we cannot assure you
that our pricing strategy can offset the negative impact on profitability caused
by increases in delinquencies and losses. Increases in writeoffs could have a
material adverse effect on our business, financial condition and operating
results.
AS THE AVERAGE AGE OF OUR LOAN PORTFOLIO INCREASES, WE WILL LIKELY EXPERIENCE
INCREASING OR FLUCTUATING LEVELS OF DELINQUENCY AND LOAN LOSSES.
In addition to being affected by general economic conditions and the success
of our collection and recovery efforts, our delinquency and net credit card
receivable charge-off rates at any point in time are affected by, among other
factors, the credit risk of credit card receivables and the average age of our
various credit card account portfolios. The credit risk of our credit card
receivables, in the aggregate, is impacted by the average age of our credit card
portfolio. The average age of credit card receivables affects the stability of
delinquency and loss rates of the portfolio because delinquency and loss rates
typically increase as the average age of accounts in a credit card portfolio
increases. At March 31, 2000, 20.6% of securitized accounts and 37.7% of
securitized loans were less than 24 months old. Accordingly, we believe that our
loan portfolio will experience increasing or fluctuating levels of delinquency
and loan losses as the average age of our accounts increases. This trend is
already reflected in the change in our net charge-off ratio. The net charge-off
ratio reflects what percent of the average securitized receivables at the
beginning of each month in the period indicated consisted of principal losses
from cardholders unwilling or unable to pay their credit card balances, as well
as bankrupt and deceased cardholders, less current period recoveries. For the
three months ended March 31, 2000, our securitized net charge-off ratio on an
annualized basis was 7.6% compared to 6.9% for the three months ended March 31,
1999. For the year ended December 31, 1999, our securitized net charge-off ratio
on an annualized basis was 7.2% compared to 7.8% for fiscal 1998 and 8.3% for
fiscal 1997. We believe that this ratio will continue to fluctuate but generally
rise over the next year, and over future years, as the average age of our
accounts increases. Any material increases in delinquencies and losses beyond
our expectations could have a material adverse impact on us and the value of our
net retained interests in loans securitized.
BILLING DISPUTES BETWEEN A CARDHOLDER AND A MERCHANT AND FRAUDULENT TRANSACTIONS
SUBMITTED BY A MERCHANT INVOLVING ELECTRONIC PAYMENT CARDS SUCH AS CREDIT
CARDS, DEBIT CARDS OR STORED VALUE CARDS PRESENT RISKS TO OUR PROFITABILITY.
In our bank card processing business, when a billing dispute between a
cardholder and a merchant is resolved in favor of the cardholder, or, when a
card issuer detects fraudulent transactions submitted by a merchant, we charge
back the amount of the transaction to the merchant. We then credit the amount of
the transaction to the cardholder's account. These billing disputes or
chargebacks relate to, among others:
- nonreceipt of merchandise or services;
- unauthorized use of a credit card; and
- general disputes between a customer and a merchant as to the quality of
the goods purchased or the services rendered by the merchant.
If we or our clearing banks are unable to collect amounts charged back to a
merchant's account, and if the merchant refuses or is unable due to bankruptcy
or other reasons to reimburse us for the chargeback, we bear the loss for the
amount of the refund paid to the cardholder. Our contingent liability is greater
in certain industries, such as the direct response marketing industry, where the
cardholder is not present to provide a signature. We attempt to reduce our
exposure to such losses by performing initial and periodic credit reviews of our
merchant clients, by adjusting our rates based, in
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<PAGE>
part, on the merchant's credit risk, business and industry, and by requiring
merchants to create escrow accounts for the purpose of satisfying amounts
charged back to the merchant. We face chargeback risks with respect to the
private label credit card programs we fund that are similar to the risks we face
in our bankcard processing programs. We cannot assure you that we will not
experience significant losses from chargebacks in the future. Increases in
chargebacks not paid by merchants could have a material adverse effect on our
business, financial condition and operating results.
CHANGES IN ASSUMPTIONS OVER TIME, SUCH AS THE AMOUNT OF PREPAYMENTS FROM AND
DEFAULTS BY CARDHOLDERS, MAY CAUSE A DECREASE IN THE ESTIMATED VALUE OF THE
INTEREST ONLY STRIPS, AND THE RESIDUAL INTEREST WE RETAIN IN THE CREDIT CARD
RECEIVABLES WE SELL IS ILLIQUID.
ASSUMPTIONS REGARDING FUTURE PREPAYMENTS AND DEFAULT ASSUMPTIONS ARE SUBJECT
TO VOLATILITY THAT COULD MATERIALLY AFFECT OPERATING RESULTS. We finance
substantially all our credit card receivables through asset securitization
transactions in which we sell our credit card receivables to a master trust that
holds the receivables as trustee for third-party investors. We retain the right
to service the receivables we sell. We maintain a residual interest in the
credit card receivables and retain an interest only strip representing the
present value of the right to the excess cash flows generated by the securitized
receivables. We calculate the gain on the sale of receivables and the value of
the interest only strips based on the present value of the anticipated cash flow
stream from the securitized receivables, which is the difference between
(1) interest and other fees paid by cardholders and (2) the sum of the
following:
- pass-through interest paid to third-party investors;
- trustee fees;
- servicing fees that we receive from the trust; and
- estimated loan portfolio losses.
A significant factor affecting the level of anticipated cash flows is the
rate at which the underlying principal of the securitized credit card
receivables is reduced. Prepayments represent principal reductions in excess of
the contractually scheduled reductions. Additional assumptions include estimated
future credit losses and a discount rate commensurate with the risks involved.
The rate of cardholder prepayments or defaults on credit card balances may be
affected by a variety of economic factors, including interest rates and the
availability of alternative financing, most of which are not within our control.
A decrease in interest rates could cause cardholder prepayments to increase,
thereby requiring a write down of the interest only strips.
Assumptions regarding future prepayments and credit losses are subject to
volatility that could materially affect operating results. Both the amount and
timing of estimated cash flows are dependent on the performance of the
underlying credit card receivables, and actual cash flows may vary significantly
from expectations. If prepayments from cardholders or defaults by cardholders
exceed our estimates, we may be required to decrease the carrying value of the
interest only strips through a charge against earnings.
THE RESIDUAL INTEREST WE RETAIN IN THE CREDIT CARD RECEIVABLES WE SELL IS
ILLIQUID. In addition, we cannot assure you that the interest only strips could
in fact be sold at their stated value on the balance sheet, if at all, due to
the lack of a known market for interest only strips.
We recognize a gain on sale and the related interest only strip in the
period during which we sell the credit card receivables, while we actually
receive the cash payments we receive from our pooling and servicing agreements
and servicing fees from the trusts over the lives of the receivables we sell.
This difference in the timing of cash flows could cause a cash shortfall, which
could have a material adverse effect on our financial condition.
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WE DEPEND ON OUR ABILITY TO SELL AND SECURITIZE OUR CREDIT CARD RECEIVABLES TO
FUND NEW RECEIVABLES.
Since January 1996, we have used a program involving the sale and
securitization of our credit card receivables as our primary funding vehicle for
credit card receivables. A number of factors affect securitization transactions,
some of which are beyond our control, including:
- conditions in the securities markets in general;
- conditions in the asset-backed securitization market;
- conformity of credit card receivables to rating agency requirements and
changes in those requirements; and
- availability of credit enhancement.
These factors could adversely affect our ability to effect securitization
transactions or the benefits to us of securitization transactions, including the
value of our interest only strips or our ability to sell interest only strips or
portions of our interest in the receivables.
In addition, we have overcollateralized and maintained an interest in our
securitizations in order to achieve better credit ratings. Failure to obtain
acceptable credit ratings or more stringent credit enhancement requirements
could decrease the efficiency of or have an adverse effect on the timing of, or
our ability to effect, future securitizations. Securitization transactions
subject us to covenants such as receivables performance and the continued
solvency of private label program participants. If we do not satisfy these
covenants, an early amortization event could occur. In an early amortization
event, the trustee would hold our interest in the related receivables and excess
interest income until such time as the securization investors are fully repaid.
The occurrence of an early amortization event would significantly limit our
ability to securitize additional receivables.
All receivables held by the World Financial Network Credit Card Master Trust
III relate to Service Merchandise, which is in voluntary Chapter 11 bankruptcy.
This bankruptcy triggered an early amortization event. As of March 31, 2000,
this trust had a balance of $89.9 million in credit card receivables related to
this account in our securitization trusts, which together with excess interest
income, is being held in the trust until other holders of interests in the trust
are fully repaid.
We intend to continue public securitizations of our credit card receivables.
The inability to securitize credit card receivables due to changes in the
market, the unavailability of credit enhancements, an early amortization event,
or any other circumstance or event would have a material adverse effect on our
business, financial condition and operating results.
THE TRUST MAY TERMINATE OUR SERVICING RIGHTS.
The pooling and servicing agreements related to our securitizations provide
that the trustee may terminate our servicing rights if we fail to perform our
servicing obligations under those agreements, such as the failure to make timely
payments to certificate holders. As of the date of this prospectus, no servicing
rights had been terminated. However, we cannot assure you that we will be able
to perform our servicing obligations and, if we are unable to perform those
obligations, that our servicing rights will not be terminated. A termination of
our servicing rights would have a material adverse effect on our business,
financial conditions and operating results.
WE EXPECT GROWTH IN OUR CREDIT SERVICES SEGMENT RESULTING FROM NEW AND ACQUIRED
PRIVATE LABEL CARD PROGRAMS, WHOSE CREDIT CARD RECEIVABLE PERFORMANCE MAY NOT
BE CONSISTENT WITH THAT OF OUR EXISTING PROGRAMS.
An important source of growth in our private card operations is expected to
come from the acquisition of existing private label programs and from initiating
new private label programs at retailers that previously did not operate a
program. Although we believe our pricing and models for determining
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credit risk are designed to evaluate the credit risk of existing programs and
the credit risk we are willing to assume for start-up programs, there can be no
assurance that the loss experience on newly acquired and start-up plans will be
consistent with our more established programs. The failure to successfully
underwrite these private label programs may result in increased portfolio losses
and reduce our profitability and could have a material adverse effect on our
business, financial condition and operating results.
INTEREST RATE FLUCTUATIONS IMPACT THE YIELD ON OUR ASSETS AND FUNDING EXPENSE.
An increase or decrease in market interest rates could have a negative
impact on the amount we realize from the net interest spread between the yield
on our assets and our cost of funding. A rise in market interest rates may
indirectly impact the payment performance of consumers or the value of, or
amount we could realize from the sale of, interest only strips. We try to
minimize the impact of changes in market interest rates on our cash flow, asset
value and net income primarily by funding fixed-rate assets with fixed-rate
funding sources and by using interest-rate derivatives to match asset and
liability repricings. Nonetheless, changes in market interest rates may have a
negative impact on us.
OUR HEDGING ACTIVITY SUBJECTS US TO OFF-BALANCE SHEET RISK.
The interest rate swap and treasury lock agreements we use to reduce our
exposure to fluctuations in interest rates subject us to off-balance sheet risk.
These off-balance sheet financial instruments involve elements of credit and
interest rate risk in excess of the amount recognized on our balance sheet. Our
hedging policy subjects us to risks relating to the creditworthiness of the
commercial banks with whom we contract in our hedging transactions. If one of
these banks cannot honor its obligations, we may suffer a loss. The purpose of
our hedging policy is to reduce the effect of interest rate fluctuations on our
results of operations. Therefore, while our hedging policy reduces our exposure
to losses resulting from unfavorable changes in interest rates, it also reduces
or eliminates our ability to profit from favorable changes in interest rates.
POSTAL RATE INCREASES COULD LEAD TO REDUCED VOLUME OF BUSINESS.
Postal rate increases have negatively impacted the direct marketing industry
during the past years. Any future increases may force us and our clients that
are direct mailers to mail fewer pieces. This response by direct mailers could
decrease the amount of processing services purchased from us, which could have a
material adverse effect on our business, financial condition and operating
results.
FLUCTUATIONS IN THE EXCHANGE RATES BETWEEN THE U.S. DOLLAR AND CANADIAN DOLLAR
MAY AFFECT OUR OPERATING RESULTS.
A large portion of our Loyalty and Database Marketing services revenue
relates to the Air Miles reward program and is in Canadian dollars. We are
exposed to fluctuations in the exchange rate between the U.S. dollar and the
Canadian dollar through our operations in Canada. Although we have entered into
cross-currency hedge transactions to fix the exchange rate on any Canadian debt
repayment due to a U.S. counter party, we do not hedge our net investments in
foreign operations. Significant changes in the exchange rate could have a
material adverse effect on our business, financial condition and operating
results.
IF OUR BANK SUBSIDIARY FAILS TO MEET CREDIT CARD BANK CRITERIA, WE MAY BECOME
SUBJECT TO REGULATION UNDER THE BANK HOLDING COMPANY ACT.
Our bank subsidiary, World Financial, is a limited purpose credit card bank.
The Bank Insurance Fund, which is administered by the Federal Deposit Insurance
Corporation, insures the deposits of World Financial. World Financial is subject
to regulation and examination by the Office of the
17
<PAGE>
Comptroller of the Currency, its primary regulator, and is also subject to
regulation by the Board of Governors of the Federal Reserve System and the
Federal Deposit Insurance Corporation, as back-up regulators. World Financial is
not a "bank" as defined under the Bank Holding Company Act because it is in
compliance with the following requirements:
- it engages only in credit card operations;
- it does not accept demand deposits or deposits that the depositor may
withdraw by check or similar means for payment to third parties;
- it does not accept any savings or time deposits of less than $100,000,
except for deposits pledged as collateral for extensions of credit;
- it maintains only one office that accepts deposits; and
- it does not engage in the business of making commercial loans.
If World Financial failed to meet the credit card bank criteria described
above, World Financial would be a "bank" as defined by the Bank Holding Company
Act, subjecting us to the provisions, requirements and restrictions of the Bank
Holding Company Act as a bank holding company. We believe that becoming a bank
holding company would significantly harm us, as we could be required to either
divest any activities deemed to be non-banking activities or cease any
activities not permissible for a bank holding company and its affiliates.
OUR BUSINESS MAY SUFFER IF WE ARE UNABLE TO RETAIN KEY PERSONNEL.
Our future success is substantially dependent upon the continued services of
our senior management team. The loss of the services of any of our executive
officers could have a material adverse effect on our business. Many of our
executive officers have only been employed by us for a short time. We do not
currently have "key person" life insurance policies on any of our employees, and
we generally do not enter into employment agreements with our employees. Our
future success also depends on our ability to attract and retain highly
qualified personnel. The competition for qualified personnel in our markets is
intense, and we may be unable to attract or retain highly qualified personnel in
the future.
SOME OF OUR STOCKHOLDERS OWN A SIGNIFICANT AMOUNT OF OUR COMMON STOCK.
As of March 31, 2000, Limited Commerce Corp., a wholly owned subsidiary of
The Limited, and the affiliated entities of Welsh, Carson, Anderson & Stowe, in
the aggregate beneficially owned approximately 99.8% of our outstanding common
stock and would have owned 73.8% of our common stock as of that date after
giving pro forma effect to this offering. As a result, these stockholders are
able to exercise significant influence over, and in most cases control, matters
requiring stockholder approval, including the election of directors and approval
of significant corporate transactions. Their continued concentration of
ownership after this offering may also have the effect of delaying, preventing
or deterring a change in control that may otherwise be beneficial to you.
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<PAGE>
DELAWARE LAW AND OUR CHARTER DOCUMENTS COULD PREVENT A TAKEOVER THAT MIGHT BE
BENEFICIAL TO YOU.
Delaware law, as well as provisions of our certificate of incorporation and
bylaws, could discourage unsolicited proposals to acquire us, even though such
proposals may be beneficial to you. These provisions include:
- a board of directors classified into three classes of directors with the
directors of each class having staggered, three-year terms;
- our board's authority to issue shares of preferred stock without
stockholder approval; and
- provisions of Delaware law that restrict many business combinations and
provide that directors serving on staggered boards of directors, such as
ours, may be removed only for cause.
These provisions of our certificate of incorporation, bylaws and Delaware law
could discourage tender offers or other transactions that might otherwise result
in our stockholders receiving a premium over the market price for our common
stock.
THE FAILURE TO FAVORABLY NEGOTIATE AND INTEGRATE FUTURE ACQUISITIONS COULD
ADVERSELY AFFECT OUR BUSINESS.
We have made several acquisitions since August 1996, and we intend to
acquire additional complementary businesses as part of our growth strategy.
Although we may acquire additional businesses, we may not be able to
successfully integrate them in a timely manner or at all. If we are not able to
successfully integrate acquired businesses, we may incur substantial costs and
delays or other operational, technical or financial problems. In addition, the
failure to successfully integrate acquisitions may divert management's attention
from our existing business and may damage our relationships with key clients and
employees.
To finance future acquisitions, we may issue equity securities that could be
dilutive to our stockholders. We may also incur debt and additional amortization
expenses related to goodwill and other intangible assets in future acquisitions.
The interest expense related to this debt and additional amortization expense
may significantly reduce our profitability and could have a material adverse
effect on our business, financial condition and operating results.
RISKS RELATED TO OUR INDUSTRY
THE MARKETS FOR THE SERVICES THAT WE OFFER MAY FAIL TO EXPAND OR MAY CONTRACT.
Our growth and continued profitability relies on acceptance of the services
that we offer. If demand for loyalty and database marketing, transaction or
credit services decreases, the price of our common stock could fall and you
could lose value in your investment. The use of loyalty and database marketing
by retailers is in its early stages and we cannot guarantee that merchants will
continue to use these types of marketing strategies. Changes in technology may
enable merchants and retail companies to directly process transactions in a
cost-efficient manner without the use of our services, which could have a
material adverse effect on our business, financial condition and operating
results.
INDUSTRY RISKS RELATED TO CONSUMER CREDIT PRODUCTS COULD NEGATIVELY IMPACT US.
We face a number of risks associated with unsecured lending, including the
following:
- delinquencies and credit losses will increase because of future economic
downturns;
- an increasing number of consumers will default on the payment of their
outstanding balances or seek protection under bankruptcy laws;
- fraud by cardholders and third parties will increase;
- increased criticism from consumer advocates and the media could hurt
consumer acceptance of our products; and
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<PAGE>
- litigation, including class action litigation, challenging our product
terms, rates, disclosures, collections or other practices, under state and
Federal consumer protection statutes and other laws, could adversely
affect our lending practices.
Our business, financial condition and operating results could be materially
adversely affected if we have underestimated any of these risks or are unable to
adjust our pricing for such changes.
LEGISLATION RELATING TO CONSUMER PRIVACY MAY AFFECT OUR ABILITY TO COLLECT DATA.
The enactment of legislation or industry regulations arising from public
concern over consumer privacy issues could have a material adverse impact on our
loyalty and database marketing services. Any such legislation or industry
regulations could place restrictions upon the collection and use of information
that is currently legally available, which could materially increase our cost of
collecting some data. Legislation or industry regulation could also prohibit us
from collecting or disseminating certain types of data, which could adversely
affect our ability to meet our clients' requirements.
In November 1999, President Clinton signed into law the Gramm-Leach-Bliley
Act, which requires financial institutions to comply with various notice
procedures in order to disclose nonpublic personal information about their
consumers to nonaffiliated third parties and restricts their ability to share
account numbers. The requirements of this law also apply to the disclosure of
any list, description or other grouping of consumers derived from nonpublic
personal information. This law makes it more difficult to collect and use
information that has been legally available and may increase our costs of
collecting some data.
The Clinton Administration is investigating further administrative action in
the area of privacy. In addition, Congress and a number of states are
considering further privacy legislation. It is possible that new privacy
protections will not be limited to financial institutions but could broadly
apply to the activities of all companies.
On April 13, 2000, the Canadian federal government and Minister of Industry
of Canada enacted the Personal Information Protection and Electronic Documents
Act. This act, which will become effective on January 1, 2001, comprises
comprehensive private sector privacy legislation that will apply to
organizations engaged in any commercial activities in Canada. It will enact into
law 10 privacy principles from the Canadian Standards Association's Model
Privacy Code. This act will also require organizations to obtain consent to the
collection, use or disclosure of personal information. The nature of the
required consent will depend on the sensitivity of the personal information and
will permit personal information to be used only for the purposes for which it
was collected. The Province of Quebec has had similar privacy legislation
applicable to the private sector in that province since 1994, and other
provinces are considering further privacy legislation.
CURRENT AND PROPOSED REGULATION AND LEGISLATION RELATING TO OUR CREDIT SERVICES
COULD LIMIT OUR BUSINESS ACTIVITIES, PRODUCT OFFERINGS AND FEES CHARGED.
Various Federal and state laws and regulations significantly limit the
credit services activities in which we are permitted to engage. Such laws and
regulations, among other things, limit the fees and other charges that we can
impose on customers, limit or prescribe certain other terms of our products and
services, require specified disclosures to consumers, or require that we
maintain certain licenses, qualifications and capital requirements. In some
cases, the precise application of these statutes and regulations is not clear.
In addition, numerous legislative and regulatory proposals are advanced each
year which, if adopted, could have a material adverse effect on our
profitability or further restrict the manner in which we conduct our activities.
The failure to comply with, or adverse changes in, the laws or regulations to
which our business is subject, or adverse changes in their interpretation, could
have a material adverse effect on our ability to collect our receivables and
generate fees on the receivables, thereby adversely affecting our business,
financial condition and operating results.
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<PAGE>
STATE TAX ISSUES COULD HAVE A NEGATIVE EFFECT ON OUR BUSINESS.
Transaction processing companies may be subject to state taxation of certain
portions of their fees charged to merchants for their services. If we are
required to pay such taxes and are unable to pass this tax expense through to
our merchant clients, our business, financial condition and operating results
could be adversely affected.
LAWS AND REGULATIONS PERTAINING TO THE INTERNET MAY ADVERSELY AFFECT OUR
BUSINESS.
An increasing number of laws and regulations pertain to the Internet. These
laws and regulations relate to liability for information retrieved from or
transmitted over the Internet, on-line content regulation, user privacy,
taxation and the quality of products and services. Moreover, the applicability
to the Internet of existing laws governing intellectual property ownership and
infringement, copyright, trademark, trade secret, obscenity, libel, employment,
personal privacy and other issues is uncertain and developing. Any new law or
regulation pertaining to the Internet, or the application or interpretation of
existing laws, could decrease the demand for our promotional services, increase
our cost of doing business or otherwise have a material adverse effect on our
business, results of operations and financial condition.
RISKS RELATED TO THIS OFFERING
IF THE PRICE OF OUR COMMON STOCK FLUCTUATES SIGNIFICANTLY, YOUR INVESTMENT COULD
LOSE VALUE.
Prior to this offering, there has been no public market for our common
stock. Although we have applied to have our common stock listed on the New York
Stock Exchange, we cannot assure you that an active public market will develop
for our common stock or that our common stock will trade in the public market
subsequent to this offering at or above the initial public offering price. If an
active public market for our common stock does not develop, the trading price
and liquidity of our common stock will be materially and adversely affected.
Negotiations between us and the underwriters will determine the initial offering
price, which may not be indicative of the trading price for our common stock
after this offering. In addition, the stock market is subject to significant
price and volume fluctuations, and the price of our common stock could fluctuate
widely in response to several factors, including:
- our quarterly operating results;
- changes in our earnings estimates;
- additions or departures of key personnel;
- changes in the business, earnings estimates or market perceptions of our
competitors;
- changes in general market or economic conditions; and
- announcements of legislative or regulatory change.
WE HAVE A LARGE NUMBER OF SHARES THAT ARE ELIGIBLE FOR FUTURE SALE AND, IF THESE
SHARES ARE SOLD IN THE FUTURE, YOUR INVESTMENT WILL BE DILUTED.
If a large number of shares of our common stock are sold in the open market
after this offering, or the market perceives that such sales could occur, the
trading price of our common stock could decrease. After this offering, we will
have an aggregate of 114,546,327 shares of our common stock authorized but
unissued and not reserved for specific purposes. In general, we may issue all of
these shares without any action or approval by our stockholders. We may pursue
acquisitions of competitors and related businesses and may issue shares of our
common stock in connection with these acquisitions.
Upon consummation of the offering, we will have 76,804,572 shares of our
common stock outstanding. Of these shares, all shares sold in the offering,
other than shares, if any, purchased by our
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<PAGE>
affiliates, will be freely tradable. Of the remaining 56,804,572 shares, 672,368
shares will be freely transferable and 56,132,204 shares will be "restricted
securities" as that term is defined in Rule 144 under the Securities Act. Our
executive officers, directors, our principal stockholders and a group of
significant option holders have agreed that, subject to various limitations, for
a period of 180 days following the date of this prospectus, they will not,
without the prior written consent of Bear, Stearns & Co. Inc., offer, sell, or
grant any option to purchase or otherwise dispose of our common stock or any
securities convertible into or exchangeable for our common stock.
We have also reserved 8,753,000 shares of our common stock for issuance
under our stock option and restricted stock plan, of which 2,366,388 shares are
issuable upon exercise of options granted as of March 31, 2000, including
options to purchase 1,306,133 shares exercisable as of March 31, 2000 or that
will become exercisable within 60 days after such date. Any shares issued in
connection with the exercise of currently outstanding stock options or otherwise
would further dilute your investment in our common stock.
OUR MANAGEMENT'S BROAD DISCRETION IN THE USE OF THE PROCEEDS OF THIS OFFERING
MAY ADVERSELY AFFECT YOUR INVESTMENT.
Our management can spend a significant portion of the proceeds from this
offering in ways with which our stockholders may not agree. We intend to use
approximately $204.9 million of the net proceeds from the offering to repay
outstanding debt. We expect that the remaining net proceeds will be available
for general corporate purposes, including working capital. We may, however, also
use a portion of the net proceeds to acquire or invest in complementary
businesses, technologies, products or services, although we currently have no
commitments or agreements with respect to transactions of that type.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus and the documents included in this prospectus may contain
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. 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. These forward-looking statements are subject to risks, uncertainties and
assumptions, including but not limited to those discussed under the section
"Risk Factors" and elsewhere in this prospectus.
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 prospectus 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. All subsequent
written and oral forward-looking statements attributable to us or individuals
acting on our behalf are expressly qualified in their entirety by this
paragraph. You should specifically consider the factors identified under the
section "Risk Factors" and elsewhere in this prospectus which could cause actual
results to differ before making an investment decision.
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<PAGE>
USE OF PROCEEDS
The net proceeds from this offering will be approximately $279.5 million, or
$321.8 million if the underwriters exercise their over-allotment option in full,
after deducting estimated underwriting discounts and commissions and estimated
offering expenses. We intend to use the net proceeds of this offering to repay
debt, to finance future acquisitions and for general corporate purposes.
A portion of the net proceeds and funds available under our amended credit
agreement will be used to acquire or invest in complementary businesses,
technologies, products or services. Although we are not contemplating any
specific acquisitions at this time and no portion of the net proceeds has been
allocated for any specific acquisition, we evaluate acquisition opportunities on
an ongoing basis. Our management will have broad discretion in the application
of the net proceeds. Pending use, we intend to invest the net proceeds in
short-term interest-bearing, investment-grade instruments, such as certificates
of deposit or direct or guaranteed obligations of government agencies of the
United States.
The following is a summary of the intended uses of proceeds from this
offering:
<TABLE>
<S> <C>
Prepayment of 10% Subordinated Note due October 25, 2005
issued to WCAS Capital Partners II, L.P................... $ 30,000,000
Prepayment of 10% Subordinated Note due October 25, 2005
issued to Limited Commerce Corp........................... 20,000,000
Prepayment of 10% Subordinated Note due September 15, 2008
issued to WCAS Capital Partners III, L.P.................. 52,000,000
Reduction of the outstanding term loan under our credit
agreement................................................. 102,910,000
Purchase of unexercised warrants............................ 1,002,504
Finance future acquisitions and working capital............. 73,562,496
------------
279,475,000
Estimated fees, commissions, underwriting discounts and
expenses
related to this offering.................................. 20,525,000
------------
Total proceeds............................................ $300,000,000
============
</TABLE>
The outstanding debt we will be repaid as follows:
- we will repay in full a 10% subordinated note issued to WCAS Capital
Partners II, L.P., in the principal amount of $30.0 million, and a 10%
subordinated note issued to the Limited Commerce Corp., in the principal
amount of $20.0 million. Principal on the notes is due on October 25, 2005
and interest is payable semi-annually in arrears on each January 1 and
July 1. The notes were originally issued in January 1996 to finance, in
part, the acquisition of BSI Business Services, Inc., now known as ADS
Alliance Data Systems, Inc.
- we will repay in full a 10% subordinated note issued to WCAS Capital
Partners III, L.P. in the principal amount of $52.0 million. Principal is
due in two equal installments on September 15, 2007 and September 15,
2008. Interest is payable semi-annually in arrears on each March 15 and
September 15. The note was originally issued in September 1998 to finance,
in part, the acquisition of Harmonic Systems Incorporated.
- we will repay approximately $102.9 million that is outstanding of a
$130.0 million U.S. Term Loan, which is part of our $330.0 million credit
agreement entered into in July 1998, which also consists of a
$50.0 million Canadian A Term Loan and a $50.0 million Canadian B Term
Loan, and a $100.0 million revolving loan commitment. The term loans and
the revolving loan commitment are at a daily floating rate equal to the
sum of the Euro-dollar margin plus the London Interbank Offered Rate
applicable to the period for each Euro-dollar loan. Principal is payable
annually. Interest is payable quarterly for the base rate loans and
payable on the last day of the Euro-dollar loan period for each
Euro-dollar loan. The U.S. Term Loan, the
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Canadian A Term Loan, and the revolving loan commitment mature on
July 25, 2003 and the Canadian B Term Loan matures on July 25, 2005. Since
July 1998 we have used approximately $230.0 million of the term loans for
general corporate purposes, including working capital. We use drawings
under the revolving loan commitment throughout the year for general
corporate purposes, including working capital.
The foregoing represents our best estimate of the use of the net proceeds of
this offering based on the current status of our business. Our estimates and
current expectations are subject to significant change, based on numerous
factors, including certain factors beyond our control. If we do not utilize the
net proceeds of the offering as set forth above, or if we utilize different
amounts than presently contemplated, we could use any remaining cash for other
corporate purposes, including acquisitions and working capital.
DIVIDEND POLICY
We have never declared or paid any dividends on our common stock. We do not
anticipate paying any cash dividends in the foreseeable future. We currently
intend to retain future earnings, if any, to finance operations and the
expansion of our business. Any future determination to pay cash dividends will
be at the discretion of our board of directors and will be dependent upon our
financial condition, operating results, capital requirements and other factors
that our board deems relevant. In addition, under the terms of our credit
agreement, we cannot declare or pay dividends or return capital to our
stockholders, nor can we authorize or make any other distribution, payment or
delivery of property or cash to our stockholders.
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<PAGE>
DILUTION
Our pro forma net deficit in tangible book value as of March 31, 2000 was
approximately $18.0 million, or approximately $0.32 per share of common stock,
after giving effect to the conversion of all our outstanding shares of Series A
preferred stock into common stock. Pro forma net deficit in tangible book value
per share represents the amount of tangible assets, less intangibles assets and
goodwill and total liabilities, divided by the number of shares of common stock
outstanding, after giving effect to the conversion of all our outstanding shares
of Series A preferred stock into common stock.
Dilution in net tangible book value per share represents the difference
between the amount per share paid by purchasers of our common stock in this
offering and the pro forma net tangible book value per share of our common stock
immediately after the offering. After giving effect to our sale of 20,000,000
shares of common stock in this offering at an assumed initial public offering
price of $15.00 per share and after deduction of the estimated underwriting
discounts and commissions and estimated offering expenses payable by us, our pro
forma net tangible book value as of March 31, 2000 would have been approximately
$255.2 million, or $3.32 per share. This represents an immediate increase in pro
forma net tangible book value to existing stockholders attibutable to new
investors of $3.64 per share and the immediate dilution of $11.68 per share to
new investors.
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share............. $15.00
Pro forma net deficit in tangible book value per share
before offering......................................... $(0.32)
Increase per share attributable to new investors.......... 3.64
------
Pro forma net tangible book value per share after the
offering.................................................. 3.32
------
Dilution per share to new investors......................... $11.68
======
</TABLE>
The following table sets forth as of March 31, 2000, after giving effect to
the conversion of all our outstanding shares of Series A preferred stock into
common stock, the total consideration paid and the average price per share paid
by our existing stockholders and by new investors, before deducting estimated
underwriting discounts and commissions and estimated offering expenses payable
by us at an assumed initial public offering price of $15.00 per share.
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
------------------- ------------------- PRICE PER
NUMBER PERCENT AMOUNT PERCENT SHARE
-------- -------- -------- -------- ---------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Existing stockholders.......................... 56,805 74.0% $346,049 53.6% $ 6.09
New investors.................................. 20,000 26.0 300,000 46.4 15.00
------ ----- -------- -----
Total........................................ 76,805 100.0% $646,049 100.0%
====== ===== ======== =====
</TABLE>
This table assumes no options were exercised after March 31, 2000. As of
March 31, 2000, there were outstanding options to purchase a total of 2,366,388
shares of common stock at a weighted average exercise price of $9.51 per share
and 8,753,000 shares of common stock reserved for issuance under our stock
option and restricted stock plan. If all outstanding options were exercised on
the date of the closing of the offering, new investors purchasing shares in this
offering would suffer dilution per share of $11.78.
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CAPITALIZATION
Capitalization is the amount invested in a company and is a common
measurement of a company's size. The table below shows our capitalization as of
March 31, 2000 as follows:
- on an actual basis;
- on a pro forma basis to reflect the conversion of all of our Series A
preferred stock into common stock; and
- on a pro forma as adjusted basis to give effect to the sale of the
20,000,000 shares of our common stock offered by this prospectus at an
assumed initial public offering price of $15.00 per share and the
application of the net proceeds from the sale, having deducted estimated
underwriting discounts and commissions and estimated offering expenses.
You should read this table in conjunction with the consolidated financial
statements and related notes that are included or incorporated by reference in
this prospectus.
<TABLE>
<CAPTION>
AT MARCH 31, 2000
-------------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
--------- ---------- ------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Cash and cash equivalents................................... $ 67,069 $ 67,069 $140,631
======== ======== ========
Certificates of deposit..................................... $ 90,200 $ 90,200 $ 90,200
Short-term debt............................................. 14,125 14,125 4,125
-------- -------- --------
Total short-term debt..................................... $104,325 $104,325 $ 94,325
======== ======== ========
Long-term debt, excluding current portion:
Certificates of deposit................................... $ 25,800 $ 25,800 $ 25,800
Senior credit facility.................................... 184,660 184,660 91,750
Subordinated notes........................................ 102,000 102,000 --
-------- -------- --------
Total long-term debt.................................... 312,460 312,460 117,550
Series A cumulative convertible preferred stock, $0.01 par
value; 120 shares authorized, issued and outstanding,
actual; none issued or outstanding, pro forma and pro
forma as adjusted......................................... 119,400 -- --
Stockholders' equity:
Common stock, $0.01 par value; 200,000 shares authorized,
actual, pro forma and pro forma as adjusted; 47,529
shares issued and outstanding, actual; 56,805 shares
issued and outstanding, pro forma; 76,805 shares issued
and outstanding, pro forma as adjusted.................. 475 568 768
Additional paid-in capital................................ 226,174 345,481 623,754
Retained earnings......................................... 43,875 43,875 38,595
-------- -------- --------
Total stockholders' equity.............................. 270,524 389,924 663,116
-------- -------- --------
Total capitalization.................................. $702,384 $702,384 $770,666
======== ======== ========
</TABLE>
At the closing of this offering, as set forth in an agreement between us and
the holder of a warrant to purchase 167,084 shares of our common stock, we will
purchase the unexercised warrant from the warrantholder at a purchase price
equal to the initial public offering price set forth on the cover page of this
prospectus less the exercise price of $9.00 per share. Assuming an initial
offering price of $15.00 per share, that would result in a payment to the
warrantholder at closing of approximately $1.0 million. There are no other
warrants outstanding to purchase our common stock.
We estimate that there will be 76,804,572 shares of common stock outstanding
after this offering. In addition to the shares of common stock to be outstanding
after this offering, we may issue additional shares of common stock.
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<PAGE>
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION
The following unaudited pro forma consolidated financial information is
based on the unaudited financial statements of Alliance Data Systems
Corporation, Loyalty Management Group Canada Inc., Harmonic Systems
Incorporated, and the network transaction processing business of SPS Payment
Systems, Inc. included elsewhere in this prospectus. The unaudited pro forma
adjustments are based upon certain assumptions that we believe are reasonable.
The unaudited pro forma consolidated financial information and accompanying
notes should be read in conjunction with the historical financial statements of
Alliance Data Systems Corporation, Loyalty Management Group Canada Inc.,
Harmonic Systems Incorporated and the network transaction processing business of
SPS Payment Systems, Inc., and the respective notes to those statements, and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing elsewhere in this prospectus.
The data contained in the pro forma columns give effect to the following
completed acquisitions, each accounted for under the purchase method of
accounting, as if those acquisitions had been consummated on January 1, 1998:
- the acquisition of Loyalty Management Group Canada Inc., effective
July 24, 1998;
- the acquisition of Harmonic Systems Incorporated, effective September 15,
1998; and
- the acquisition of the network transaction processing business of SPS
Payment Systems, Inc., effective July 1, 1999.
The unaudited pro forma consolidated financial information does not purport
to be indicative of the results that would have been obtained had the
transactions been completed as of the assumed dates and for the periods
presented or that may be obtained in the future. The unaudited pro forma
consolidated financial information is included in this prospectus for
informational purposes, and while we believe that it may be helpful in
understanding our combined operations for the periods indicated, you should not
unduly rely on the information.
27
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1998
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
CALENDAR YEAR ENDED DECEMBER 31, 1998
----------------------------------------------------------------------------------
HARMONIC PRO
ADSC LOYALTY(1) SYSTEMS(1) SPS(1) SUBTOTAL ADJUSTMENTS FORMA
-------- ---------- ----------- -------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Total revenue...................... $474,933 $71,765 $12,090 $47,674 $606,462 $ -- $606,462
Operating expenses
Processing and servicing......... 226,525 51,288 16,328 31,260 325,401 -- 325,401
Salaries and employee benefits... 169,799 8,363 -- 6,331 184,493 -- 184,493
Depreciation and other
amortization................... 8,782 805 448 -- 10,035 -- 10,035
Amortization of purchased
intangibles.................... 45,746 2,020 -- -- 47,766 31,154 (2) 78,920
-------- ------- ------- ------- -------- -------- --------
Total operating expenses....... 450,852 62,476 16,776 37,591 567,695 31,154 598,849
-------- ------- ------- ------- -------- -------- --------
Operating income (loss)............ 24,081 9,289 (4,686) 10,083 38,767 (31,154) 7,613
Interest expense................... 29,295 203 221 -- 29,719 8,800 (3) 38,519
Income tax expense................. 6,702 4,878 -- 3,710 15,290 (10,779)(4) 4,511
-------- ------- ------- ------- -------- -------- --------
Income (loss) from continuing
operations....................... $(11,916) $ 4,208 $(4,907) $ 6,373 $ (6,242) $(29,175) $(35,417)
======== ======= ======= ======= ======== ======== ========
Earnings (loss) per share from
continuing operations -- basic
and diluted...................... $ (0.29) $ (0.90)
======== ========
Weighted average shares used in
computing per share amounts --
basic and diluted................ 41,308 5,661 46,969
======== ======== ========
</TABLE>
See the accompanying notes on page 31.
28
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999
-------------------------------------------------------
PRO
ADSC SPS(1) SUBTOTAL ADJUSTMENTS FORMA
-------- -------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
Total revenue..................................... $639,254 $24,322 $663,576 $ -- $663,576
Operating expenses
Processing and servicing........................ 341,496 16,947 358,443 -- 358,443
Salaries and employee benefits.................. 193,699 3,181 196,880 -- 196,880
Depreciation and other amortization............. 16,183 -- 16,183 -- 16,183
Amortization of purchased intangibles........... 58,553 -- 58,553 5,929 (2) 64,482
-------- ------- -------- ------- --------
Total operating expenses........................ 609,931 20,128 630,059 5,929 635,988
-------- ------- -------- ------- --------
Operating income (loss)........................... 29,323 4,194 33,517 (5,929) 27,588
Interest expense.................................. 42,785 -- 42,785 -- 42,785
Income tax expense................................ 12,316 1,543 13,859 (2,515 )(4) 11,344
-------- ------- -------- ------- --------
Income (loss) from continuing operations.......... $(25,778) $ 2,651 $(23,127) $(3,414) $(26,541)
======== ======= ======== ======= ========
Earnings (loss) per share from continuing
operations--basic and diluted................... $ (0.61) $ (0.71)
======== ========
Weighted average shares used in computing per
share amounts--basic and diluted................ 47,498 47,498
======== ========
</TABLE>
See the accompanying notes on page 31.
29
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 1999
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31, 1999
-------------------------------------------------------
PRO
ADSC SPS(1) SUBTOTAL ADJUSTMENTS FORMA
-------- -------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
Total revenue..................................... $147,813 $11,557 $159,370 $ -- $159,370
Operating expenses
Processing and servicing........................ 76,827 8,522 85,349 -- 85,349
Salaries and employee benefits.................. 46,236 1,621 47,857 -- 47,857
Depreciation and other amortization............. 3,396 -- 3,396 -- 3,396
Amortization of purchased intangibles........... 14,182 -- 14,182 2,965 (2) 17,147
-------- ------- -------- ------- --------
Total operating expenses........................ 140,641 10,143 150,784 2,965 153,749
-------- ------- -------- ------- --------
Operating income (loss)........................... 7,172 1,414 8,586 (2,965) 5,621
Interest expense.................................. 10,324 -- 10,324 -- 10,324
Income tax expense................................ 1,923 520 2,443 (1,006 )(4) 1,437
-------- ------- -------- ------- --------
Income (loss) from continuing operations.......... $ (5,075) $ 894 $ (4,181) $(1,959) $ (6,140)
======== ======= ======== ======= ========
Earnings (loss) per share from continuing
operations--basic and diluted................... $ (0.11) $ (0.17)
======== ========
Weighted average shares used in computing per
share amounts--basic and diluted................ 47,487 47,487
======== ========
</TABLE>
See the accompanying notes on page 31.
30
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED
STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS)
The Unaudited Pro Forma Consolidated Statements of Operations for the two
years ended December 31, 1999 and the three months ended March 31, 1999 reflect
the pro forma adjustments for the acquisitions previously mentioned. The 1998
statements are presented on a recast calendar-year basis so as to provide a
better basis of comparison to the 1999 statements.
(1) Represents operating activity for each of the respective acquired businesses
for the periods set forth below:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, THREE MONTHS
------------------------- ENDED
1998 1999 MARCH 31, 1999
---------- --------- ---------------
<S> <C> <C> <C>
Loyalty............................... 7 months -- --
Harmonic Systems...................... 9 months -- --
SPS................................... 12 months 6 months 3 months
</TABLE>
(2) Represents pro forma adjustments to goodwill and other purchased
intangibles' amortization in connection with the acquisitions as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, THREE MONTHS
------------------- ENDED
1998 1999 MARCH 31, 1999
-------- -------- ---------------
<S> <C> <C> <C>
Loyalty....................................... $14,505 $ -- $ --
Harmonic Systems.............................. 4,792 -- --
SPS........................................... 11,857 5,929 2,965
------- ------ ------
$31,154 $5,929 $2,965
======= ====== ======
</TABLE>
We amortize goodwill over a 20 to 25 year life. We amortize other purchased
intangibles over a three to five year period.
(3) Represents pro forma adjustments to interest expense related to debt
incurred in connection with the Loyalty and Harmonic Systems acquisitions.
The interest expense is as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1998
-----------------
<S> <C>
Loyalty..................................................... $4,900
Harmonic Systems............................................ 3,900
------
$8,800
======
</TABLE>
(4) Represents the:
- tax effect of pro forma adjustments including amortization expense related
to the SPS acquisition but excluding amortization expense related to the
Loyalty and Harmonic Systems acquisitions; and
- recognition of tax expense for the acquired businesses which had not
recorded tax expense.
31
<PAGE>
SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING INFORMATION
We are the result of a 1996 merger of two entities acquired by Welsh,
Carson, Anderson & Stowe--J.C. Penney's transaction services business, BSI
Business Services, Inc., and The Limited's credit card bank operation, World
Financial. Prior to December 31, 1998, our fiscal year was based on a 52/53 week
fiscal year ending on the Saturday closest to January 31. We have since changed
our fiscal year end to December 31. The following table sets forth our summary
historical financial information for the periods ended and as of the dates
indicated. Fiscal 1996, fiscal 1997, fiscal 1998, and fiscal 1999 financial
statements were audited by Deloitte & Touche LLP. Fiscal 1995 financial
statements were audited by other auditors. The information presented herein has
been restated from amounts previously reported to reduce the amortization period
of the premium on purchased credit card portfolio from 15 years to three years.
See Note 22 to the consolidated financial statements included in this
prospectus. The selected consolidated financial data for the three months ended
March 31, 1999 and 2000 has been derived from our unaudited consolidated
financial statements, which are included in this prospectus and which, in our
opinion, reflect all adjustments, consisting only of adjustments of a normal and
recurring nature, necessary for a fair presentation. Results for the three
months ended March 31, 2000 are not necessarily indicative of results for the
full year. You should read the following historical financial information along
with the information contained throughout this prospectus, including the
financial statements and related notes that are included in this prospectus.
<TABLE>
<CAPTION>
FOR THE
THREE MONTHS ENDED
FISCAL MARCH 31,
---------------------------------------------------- -------------------
1995(1) 1996(2) 1997(3) 1998(4) 1999(5) 1999 2000
-------- -------- -------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA
Total revenue............................ $178,385 $280,935 $353,399 $434,309 $639,254 $147,813 $178,628
Operating expenses
Processing and servicing............. 84,883 132,663 161,360 209,013 341,496 76,827 94,027
Salaries and employee benefits....... 45,035 100,928 127,087 156,464 193,699 46,236 54,489
Depreciation and other
amortization....................... 3,629 6,318 7,402 8,270 16,183 3,396 5,997
Amortization of purchased
intangibles........................ -- 15,900 28,159 42,880 58,553 14,182 13,011
-------- -------- -------- -------- -------- -------- --------
Total operating expenses........... 133,547 255,809 324,008 416,627 609,931 140,641 167,524
-------- -------- -------- -------- -------- -------- --------
Operating income......................... 44,838 25,126 29,391 17,682 29,323 7,172 11,104
Other expenses(6)........................ -- -- -- -- -- -- 2,476
Interest expense......................... -- 5,649 15,459 27,884 42,785 10,324 8,776
-------- -------- -------- -------- -------- -------- --------
Income (loss) from continuing operations
before income taxes.................... 44,838 19,477 13,932 (10,202) (13,462) (3,152) (148)
Income tax expense....................... 15,624 5,704 5,236 3,657 12,316 1,923 3,077
-------- -------- -------- -------- -------- -------- --------
Income (loss) from continuing
operations............................. 29,214 13,773 8,696 (13,859) (25,778) (5,075) (3,225)
Income (loss) from discontinued
operations, net of taxes............... -- (3,823) (8,247) (300) 7,688 1,715 --
Loss on disposal of discontinued
operations, net of taxes............... -- -- -- -- (3,737) -- --
-------- -------- -------- -------- -------- -------- --------
Net income (loss)........................ $ 29,214 $ 9,950 $ 449 $(14,159) $(21,827) $ (3,360) $ (3,225)
======== ======== ======== ======== ======== ======== ========
Earnings (loss) from continuing
operations--basic and diluted.......... $ 0.38 $ 0.24 $ (0.33) $ (0.61) $ (0.11) $ (0.11)
======== ======== ======== ======== ======== ========
Earnings (loss) per share--basic and
diluted................................ $ 0.27 $ 0.01 $ (0.34) $ (0.53) $ (0.07) $ (0.11)
======== ======== ======== ======== ======== ========
Weighted average shares used in computing
per share amounts--
basic and diluted...................... 36,521 36,612 41,729 47,498 47,487 47,529
======== ======== ======== ======== ======== ========
</TABLE>
32
<PAGE>
<TABLE>
<CAPTION>
FOR THE THREE MONTHS
FISCAL ENDED MARCH 31,
---------------------------------------------------------------------- -----------------------
1995(1) 1996(2) 1997(3) 1998(4) 1999(5) 1999 2000
----------- ----------- ----------- ------------ ------------- ---------- ----------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
OTHER FINANCIAL DATA
EBITDA(7).................... $ 48,467 $ 47,344 $ 64,952 $ 68,832 $ 104,059 $ 24,750 $ 30,112
EBITDA as a percentage of
revenue.................... 27.2% 16.9% 18.4% 15.8% 16.3% 16.7% 16.9%
Cash flows from operating
activities................. 121,399 67,696 (30,678) 4,469 251,638 (3,789) 14,121
Cash flows from investing
activities................. 1,030,528 (148,721) (103,746) (140,534) (309,451) 21,095 15,091
Cash flows from financing
activities................. (1,122,425) 82,011 104,870 163,282 74,929 21,247 (18,351)
SEGMENT OPERATING DATA
Air Miles reward miles
issued..................... -- -- -- 666,542 1,583,239 352,785 440,086
Transactions processed....... -- 881,316 929,274 1,073,040 1,839,857 310,673 566,275
Statements generated(8)...... 100,240 126,114 113,940 117,672 132,817 32,702 34,253
Securitized portfolio(9)..... $1,290,581 $1,685,622 $2,021,599 $2,135,340 $2,232,375 $1,984,914 $2,037,529
Credit sales................. $2,464,290 $2,402,881 $3,001,029 $2,866,062 $3,132,520 $ 646,507 $ 702,593
</TABLE>
<TABLE>
<CAPTION>
AS OF
------------------------------------------------------------------------------------
FEBRUARY 3, FEBRUARY 1, JANUARY 31, DECEMBER 31, DECEMBER 31, MARCH 31,
1996(10) 1997 1998 1998 1999 2000
----------- ----------- ----------- ------------ ------------- ----------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
Cash and cash equivalents.... $ 46,918 $ 50,149 $ 20,595 $ 47,036 $ 56,546 $ 67,069
Credit card receivables and
seller's interest.......... 90,789 161,686 144,440 139,458 150,804 134,452
Intangibles and goodwill..... -- 103,261 93,909 286,179 420,055 407,898
Total assets................. 225,272 498,355 619,901 997,646 1,166,894 1,137,445
Certificates of deposit...... 67,200 68,400 50,900 49,500 116,900 116,000
Short-term debt.............. -- 80,811 82,800 98,484 -- --
Long-term and subordinated
debt....................... -- 50,000 180,000 332,000 318,236 300,785
Total liabilities............ 114,677 294,144 415,145 701,978 775,513 747,521
Series A preferred stock..... -- -- -- -- 119,400 119,400
Total stockholders' equity... 110,595 204,211 204,756 295,668 271,981 270,524
</TABLE>
------------------------------
(1) Fiscal 1995 represents the operating results of World Financial Network
Holding Corporation for the 52 weeks ended February 3, 1996.
(2) Fiscal 1996 represents the operating results of World Financial Network
Holding Corporation and BSI Business Services, Inc. for the 52 weeks ended
February 1, 1997.
(3) Fiscal 1997 represents the operating results of the merged entities under
current management for the 53 weeks ended January 1, 1998 and Financial
Automation Limited for two months.
(4) Fiscal 1998 represents the operating results of the merged entities under
current management for the 11 months ended December 31, 1998, Loyalty for
five months, and Harmonic Systems for three months.
(5) Fiscal 1999 represents the operating results of the merged entities under
current management for the year ended December 31, 1999, and SPS for six
months.
(6) Other expenses represents a non-operating loss on disposal of equity
securities.
(7) EBITDA is defined as operating income plus depreciation and amortization.
EBITDA is presented because management uses EBITDA as an integral part of
its internal reporting and performance evaluation for senior management. In
addition, 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 generally accepted
accounting principles. The EBITDA measure presented in this prospectus may
not be comparable to similarly titled measures presented by other companies.
(8) Statements generated represents the number of billing statements generated
for both securitized cardholders and cardholders and customers serviced on
behalf of other clients.
(9) Securitized portfolio represents outstanding credit card receivables at the
end of the period that we have originated or purchased, and have been
securitized.
(10) Reduction of credit card receivables in fiscal 1995 is a result of
securitizing most of the credit card receivables off-balance sheet.
33
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORMATION OF ALLIANCE DATA SYSTEMS CORPORATION
Although our predecessor companies have long operating histories, we have
largely been built by acquisition and therefore have a relatively short
operating history as a combined entity. We are the result of the 1996 merger of
two entities acquired by Welsh, Carson, Anderson and Stowe--J.C. Penney's
transaction services business, BSI Business Services, Inc., and The Limited's
credit card bank operation, World Financial. Since then, we have made the
following acquisitions, each accounted for as a purchase, with the results of
operations of the acquired businesses included from their respective closing
dates:
- in November 1996, we acquired the private label portfolio of National City
Bank of Columbus, which consisted of approximately $370.0 million in
receivables, which have been securitized, and represented over 25
retailers in a broad range of industries including soft goods, building
materials, furniture and electronics.
- in July 1998, we acquired Loyalty Management Group Canada Inc.
- in September 1998, we acquired Harmonic Systems Incorporated.
- in July 1999, we acquired the network services business of SPS Payment
Systems, Inc., a wholly-owned subsidiary of Associates First Capital
Corporation.
FISCAL YEAR
In order to have more consistent reporting periods, we changed our year end
to a calendar year end basis during 1998. Prior to December 31, 1998, we
operated on a 52/53 week fiscal year that ended on the Saturday nearest
January 31. Accordingly, fiscal 1997 represents the 53 weeks ended January 31,
1998, fiscal 1998 represents the 11 months ended December 31, 1998 and fiscal
1999 represents the year ended December 31, 1999. In addition to discussing the
results of operations on a historical basis, we are also providing a discussion
of our results of operations on a pro forma recast basis for the year ended
December 31, 1998 compared to a pro forma basis for the year ended December 31,
1999, and a pro forma basis for the three months ended March 31, 1999 compared
to the three months ended March 31, 2000.
REVENUE AND EXPENSES
Our three reportable segments derive substantially all of their revenue from
two principal sources. We receive fees for providing information and transaction
processing services and earn income from our private label credit card
receivables portfolio and securitization program.
TRANSACTION SERVICES. Our Transaction Services segment primarily generates
revenue based on the number of transactions processed, statements mailed and
customer calls handled. Operating costs include salaries and employee benefits,
processing and servicing expense, such as data processing, postage and
telecommunications, and equipment lease expense.
CREDIT SERVICES. We securitize substantially all of the credit card
receivables that we underwrite. As a result, our Credit Services segment derives
its revenue from the servicing fees and net financing income it receives from
the securitization trusts and merchant fees from the processing of private label
credit cards for our private label clients. We record gains or losses on the
securitization of credit card receivables on the date of sale based on the
estimated fair value of assets retained and liabilities incurred in the sale.
Gains represent the present value of the anticipated cash flows we have retained
over the estimated outstanding period of the receivables. This anticipated
excess cash flow essentially represents an interest only strip, consisting of
the excess of finance charges and past-due fees net of the
34
<PAGE>
sum of the return paid to certificateholders, estimated contractual servicing
fees and credit losses. The interest only strip is carried at fair value, with
changes in the fair value reported as a component of cumulative other
comprehensive loss. Factors outside our control influence estimates inherent in
the determination of fair value of the interest only strip, and as a result,
such estimates could materially change in the near term. Net financing charges
include the gains on securitizations and other income from securitizations.
Operating expenses for this segment include salaries and employee benefits,
processing and servicing expense, which includes credit bureau, postage,
telephone and data processing expense, and a portion of interest expense. A
portion of our interest expense relates to the funding of our seller's interest
in credit card receivables and other securitization assets.
LOYALTY AND DATABASE MARKETING SERVICES. Our Loyalty and Database Marketing
Services segment generates the majority of its revenue from our Air Miles reward
miles program. We earn revenue from sponsors by charging transaction fees for
participation in our loyalty program. Under the terms of sponsor contracts, we
earn fees based on the number of Air Miles reward miles issued and, in some
circumstances redeemed. We recognize revenue at the time Air Miles reward miles
are issued to collectors--the point of time that coincides with the collector's
purchasing goods or services at the sponsor. On certain of our contracts, a
portion of the transaction fee is paid at the issuance of Air Miles reward miles
and a portion is paid at the time of redemption. We recognize revenue associated
for those fees at the time of issuance and redemption, respectively. As the
earning activities take place, activity measurement data such as the number of
Air Miles reward miles issued or redeemed is accumulated and the related
revenues and receivables are recorded. Sponsor contracts generally contain a
minimum commitment as to the number of Air Miles reward miles that a sponsor
will issue. In addition to our loyalty program described above, we generate
database and direct marketing revenue from building and maintaining marketing
databases, as well as managing and marketing campaigns or projects we perform
for our clients. Operating costs include salaries and employee benefits, and
processing and servicing expense, such as the estimated cost of fulfilling
future redemption costs of the Air Miles reward program, marketing, data
processing and postage.
INTER-SEGMENT SALES. Our Transaction Services segment performs servicing
activities related to our Credit Services segment. For this, Transaction
Services receives a fee equal to its direct costs before corporate overhead plus
a margin that it would charge an unrelated third party for similar functions.
This fee represents an expense to our Credit Services segment and a
corresponding revenue for Transaction Services.
RESTATEMENT. Subsequent to the issuance of our 1999 consolidated financial
statements, we determined that the premium on purchased credit card portfolio
had been amortized using an inappropriate life in our fiscal 1997, 1998 and 1999
consolidated financial statements. As a result, the fiscal 1997, 1998 and 1999
consolidated financial statements, included elsewhere in this prospectus, have
been restated from amounts previously reported to reduce the life on the premium
on purchased credit card portfolios from 15 years to three years. As of
December 31, 1999, all amounts related to the premium on purchased credit card
portfolio have been fully amortized.
USE OF EBITDA. We evaluate operating performance based on several factors
of which the primary financial measure is operating income plus depreciation and
amortization. EBITDA is presented because it is an integral part of our internal
reporting and performance evaluation for senior management. In addition, 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. We believe that 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
35
<PAGE>
substitute for measures of performance prepared in accordance with generally
accepted accounting principles. The EBITDA measure presented in this prospectus
may not be comparable to similarly titled measures presented by other companies.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1999 (UNAUDITED) COMPARED TO
THE THREE MONTHS ENDED MARCH 31, 2000 (UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
------------------------------------------------------------------
REVENUE EBITDA OPERATING INCOME
---------------------- ------------------- -------------------
1999 2000 1999 2000 1999 2000
-------- -------- -------- -------- -------- --------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Transaction Services............... $ 80,570 $103,484 $ 3,481 $ 7,726 $(2,349) $(2,556)
Credit Services.................... 66,624 69,903 15,784 13,380 12,818 13,065
Loyalty and Database Marketing
Services......................... 42,713 52,531 5,485 9,006 (3,297) 595
Other and eliminations............. (42,094) (47,290) -- -- -- --
-------- -------- ------- ------- ------- -------
Total............................ $147,813 $178,628 $24,750 $30,112 $ 7,172 $11,104
======== ======== ======= ======= ======= =======
<CAPTION>
THREE MONTHS ENDED MARCH 31,
------------------------------------------------------------------
PERCENTAGE OF REVENUE EBITDA MARGIN OPERATING MARGIN
---------------------- ------------------- -------------------
1999 2000 1999 2000 1999 2000
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Transaction Services............... 54.5 % 57.9 % 4.3% 7.5% (2.9)% (2.5)%
Credit Services.................... 45.1 39.1 23.7 19.1 19.2 18.7
Loyalty and Database Marketing
Services......................... 28.9 29.4 12.8 17.1 (7.7) 1.1
Other and eliminations............. (28.5) (26.4) -- -- -- --
-------- --------
Total............................ 100.0 % 100.0 % 16.7% 16.9% 4.9 % 6.2 %
======== ========
</TABLE>
REVENUE. Total revenue increased $30.8 million, or 20.8%, to
$178.6 million for the three months ended March 31, 2000 from $147.8 million for
the comparable period in 1999. The increase was principally due to a 28.4%
increase in Transaction Services revenue, a 4.9% increase in Credit Services
revenue and a 23.0% increase in Loyalty and Database Marketing Services revenue
as follows:
- TRANSACTION SERVICES. Transaction Services revenue increased
$22.9 million, or 28.4%, due primarily to an increase in the number of
transactions processed. Revenue related to transactions processed
increased approximately $14.0 million as a result of an 82.3% increase in
the number of transactions processed with a significant portion of the
increases occurring among our large volume clients with a lower price per
transaction, partially offset by a decrease in the average price per
transaction. The increase in the number of transactions is primarily
related to the July 1999 acquisition of SPS with the remaining increases
resulting from new customers and an increase in the number of transactions
processed for existing customers with a significant portion of the
increase occurring among the large volume clients with a lower price per
transaction. Fees related to servicing private label credit card
statements decreased $1.7 million during the three months ended March 31,
2000 over the comparable period in 1999 primarily due to a 15.3% decrease
in price per statement offset by a 4.7% increase in the number of
statements processed. Our utilities services business, which began
operation in late 1999, generated approximately $5.0 million in revenue
for the three months ended March 31, 2000 compared to no revenue in the
comparable period in 1999. Additionally, Transaction Services benefitted
from increased inter-segment sales of $5.2 million during the three months
ended
36
<PAGE>
March 31, 2000 as a result of increased processing of credit card
receivables for our Credit Services segment.
- CREDIT SERVICES. Credit Services revenue increased $3.3 million, or 4.9%,
due to increases in servicing fees and finance charges, net. Servicing fee
income increased by $1.4 million, or 17.1%, during the three months ended
March 31, 2000 due to an increase in the average outstanding credit card
receivables in the securitization trust. Finance charge, net increased
$2.8 million during the three months ended March 31, 2000 over the
comparable period in 1999 as a result of a 2.4% higher average outstanding
securitized portfolio. The yield remained relatively constant between the
periods. Merchant fee income decreased $800,000, or 4.9%, primarily due to
the discontinuance of a card program with a client partially offset by an
8.6% increase in credit sales on our private label credit cards.
- LOYALTY AND DATABASE MARKETING SERVICES. Loyalty and Database Marketing
Services revenue increased $9.8 million, or 23.0%, primarily due to a
24.7% increase in Air Miles reward miles issued during the three months
ended March 31, 2000 over the comparable period in 1999. The increase in
Air Miles reward miles issued is primarily related to an increase in the
number of active collectors.
OPERATING EXPENSES. Total operating expenses, excluding depreciation and
amortization, increased $25.4 million, or 20.7%, to $148.5 million during the
three months ended March 31, 2000 from $123.1 million during the comparable
period in 1999. Total EBITDA margin increased to 16.9% for the three months
ended March 31, 2000 from 16.7% for the comparable period in 1999. The increase
in EBITDA margin is due to increases in Loyalty and Database Marketing Services
and Transaction Services margins, partially offset by a decrease in Credit
Services margins.
- TRANSACTION SERVICES. Transaction Services operating expenses, excluding
depreciation and amortization, increased $18.7 million, or 24.3%, to
$95.8 million for the three months ended March 31, 2000 from
$77.1 million for the comparable period in 1999, and EBITDA margin
increased to 7.5% for the three months ended March 31, 2000 from 4.3%
during the comparable period in 1999. The improved EBITDA margin is
primarily related to improvements at our network services business
resulting from leverage of our processing infrastructure. The improved
network services margin was offset by a decrease in credit card processing
and servicing EBITDA margin due to the loss of volume related to a loss of
a customer.
- CREDIT SERVICES. Credit Services operating expenses, excluding
depreciation and amortization, increased $5.7 million, or 11.2%, to
$56.5 million for the three months ended March 31, 2000 from
$50.8 million for the comparable period in 1999, and EBITDA margin
decreased to 19.1% for the three months ended March 31, 2000 from 23.7%
during the comparable period in 1999. The decrease in EBITDA margin is the
result of increased processing costs from our Transaction Services segment
of $5.2 million associated with our larger securitized portfolio and the
decrease in yield on the securitized portfolio.
- LOYALTY AND DATABASE MARKETING SERVICES. Loyalty and Database Marketing
Services operating expenses, excluding depreciation and amortization,
increased $6.3 million, or 16.9%, to $43.5 million for the three months
ended March 31, 2000 from $37.2 million for the comparable period in 1999,
and EBITDA margin increased to 17.1% for the three months ended March 31,
2000 from 12.8% for the comparable period in 1999. The increased margin
was the result of approximately $2.0 million of marketing and payroll
costs associated with the start-up of a new business-to-business loyalty
program in Canada during the three months ended March 31, 1999.
- DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased
$2.6 million, or 76.5%, to $6.0 million for the three months ended
March 31, 2000 from $3.4 million for the comparable period in 1999 due to
increases in capital expenditures in 1999, especially software development
37
<PAGE>
costs that have relatively short amortization periods. Amortization of
purchased intangibles decreased $1.2 million as a result of a decrease in
amortization expense for some of the intangibles related to the
acquisition of the former J. C. Penney businesses and the premium on a
purchased credit card portfolio that were fully amortized partially offset
by amortization related to the SPS acquisition.
OPERATING INCOME. Operating income increased $3.9 million, or 54.2%, to
$11.1 million for the three months ended March 31, 2000 from $7.2 million during
the comparable period in 1999. Operating income increased primarily from revenue
gains with a relatively constant EBITDA margins, partially offset by increased
depreciation and amortization.
INTEREST EXPENSE. Interest expense decreased $1.5 million, or 15.0%, to
$8.8 million for the three months ended March 31, 2000 from $10.3 million for
the comparable period in 1999 due to a decrease in average debt. This decrease
in average debt was primarily due to the termination of a receivable financing
program in the fourth quarter of 1999.
TAXES. Income tax expense increased $1.2 million, or 63.2%, to
$3.1 million for the three months ended March 31, 2000 from $1.9 million in 1999
due to an increase in taxable income.
DISCONTINUED OPERATIONS. During September 1999, we discontinued our
subscriber services business when our principal customer for this service was
acquired by a third party. For the three months ended March 31, 1999,
discontinued operations had income of $1.7 million, net of income tax.
TRANSACTIONS WITH THE LIMITED. Revenue from The Limited and its affiliates,
which includes merchant and database marketing fees, decreased $400,000, or
3.5%, to $11.8 million for the three months ended March 31, 2000 from
$12.2 million for the comparable period in 1999. The decrease was primarily the
result of decreased credit sales offset by a small increase in database
marketing fees.
PRO FORMA THREE MONTHS ENDED MARCH 31, 1999 (UNAUDITED) COMPARED TO
THE THREE MONTHS ENDED MARCH 31, 2000 (UNAUDITED)
The following is a comparison based on pro forma results of operations
presented on pages 27 to 31 in this prospectus. The results are presented as if
we had acquired SPS's network processing business on January 1, 1998.
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
------------------------------------------------------------------
REVENUE EBITDA OPERATING INCOME
---------------------- ------------------- -------------------
1999 2000 1999 2000 1999 2000
-------- -------- -------- -------- -------- --------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Transaction Services............... $ 92,127 $103,484 $ 4,895 $ 7,726 $(3,900) $(2,556)
Credit Services.................... 66,624 69,903 15,784 13,380 12,818 13,065
Loyalty and Database Marketing
Services......................... 42,713 52,531 5,485 9,006 (3,297) 595
Other and eliminations............. (42,094) (47,290) -- -- -- --
-------- -------- ------- ------- ------- -------
Total............................ $159,370 $178,628 $26,164 $30,112 $ 5,621 $11,104
======== ======== ======= ======= ======= =======
</TABLE>
38
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
------------------------------------------------------------------
PERCENTAGE OF REVENUE EBITDA MARGIN OPERATING MARGIN
---------------------- ------------------- -------------------
1999 2000 1999 2000 1999 2000
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Transaction Services............... 57.8 % 57.9 % 5.3% 7.5% (4.2)% (2.5)%
Credit Services.................... 41.8 39.1 23.7 19.1 19.2 18.7
Loyalty and Database Marketing
Services......................... 26.8 29.4 12.8 17.1 (7.7) 1.1
Other and eliminations............. (26.4) (26.4) -- -- -- --
-------- --------
Total............................ 100.0 % 100.0 % 16.4% 16.9% 3.5 % 6.2 %
======== ========
</TABLE>
REVENUE. Total revenue increased $19.2 million, or 12.0%, to
$178.6 million for the three months ended March 31, 2000 from $159.4 million for
the comparable period in 1999. The increase was due to a 12.3% increase in
Transaction Services revenue, a 4.9% increase in Credit Services revenue and a
23.0% increase in Loyalty and Database Marketing Services revenue as follows:
- TRANSACTION SERVICES. Transaction Services revenue increased
$11.3 million, or 12.3%, primarily due to an increase in the number of
transactions processed. Revenue related to transactions processed
increased approximately $2.5 million as a result of a 29.1% increase in
the number of transactions processed with a significant portion of the
increase occurring among our large volume clients with a lower price per
transaction, partially offset by a decrease in the average price per
transaction. The increase in the number of transactions is related to new
customers and an increase in the number of transactions processed for
existing customers. Fees related to servicing of private label credit card
statements decreased $1.7 million for the three months ended March 31,
2000 from the comparable period in 1999 due to a 15.3% decrease in price
per statement, partially offset by a 4.7% increase in the number of
statements processed. Our utilities services business, which began
operation in late 1999, generated approximately $5.0 million in revenue
for the three months ended March 31, 2000 compared to no revenue in the
comparable period in 1999. Additionally, Transaction Services benefitted
from increased inter-segment sales of $5.2 million during the three months
ended March 31, 2000 as a result of increased processing of credit card
receivables for our Credit Services segment.
- CREDIT SERVICES. Credit Services revenue increased $3.3 million, or 4.9%,
due to increases in servicing fees and finance charges, net. Servicing fee
income increased by $1.4 million, or 17.1%, during the three months ended
March 31, 2000 due to an increase in the average outstanding credit card
receivables in the securitization trust. Finance charge, net increased
$2.8 million during the three months ended March 31, 2000 from the
comparable period in 1999 as a result of a 2.4% higher average outstanding
securitized portfolio. The yield remained relatively constant between the
periods. Merchant fee income decreased $800,000, or 4.9%, for the three
months ended March 31, 2000 primarily due to the discontinuance of a card
program with a client, partially offset by an 8.6% increase in credit
sales on our private label credit cards.
- LOYALTY AND DATABASE MARKETING SERVICES. Loyalty and Database Marketing
Services revenue increased $9.8 million, or 23.0% for the three months
ended March 31, 2000, primarily due to a 24.7% increase in Air Miles
reward miles issued during the three months ended March 31, 2000 over the
comparable period in 1999. The increase in Air Miles activity is primarily
related to an increase in the number of reward miles collectors.
OPERATING EXPENSES. Total operating expenses, excluding depreciation and
amortization, increased $15.3 million, or 11.5%, to $148.5 million for the three
months ended March 31, 2000 from $133.2 million for the comparable period in
1999. Total EBITDA margin increased to 16.9% for the three months ended
March 31, 2000 from 16.4% for the comparable period in 1999. The increase in
39
<PAGE>
EBITDA margin is due to increases in Loyalty and Database Marketing Services and
Transaction Services margins partially offset by a decrease in Credit Services
margins.
- TRANSACTION SERVICES. Transaction Services operating expenses, excluding
depreciation and amortization, increased $8.6 million, or 9.9%, to
$95.8 million for the three months ended March 31, 2000 from
$87.4 million for the comparable period in 1999. EBITDA margin increased
to 7.5% for the three months ended March 31, 2000 from 5.3% during the
comparable period in 1999. The improved EBITDA margin is primarily related
to improvements at our network services business resulting from leverage
of our processing infrastructure. The improved network services margin was
partially offset by a decrease in credit card processing and servicing
EBITDA margin due to the loss of volume related to a loss of customer.
- CREDIT SERVICES. Credit Services operating expenses, excluding
depreciation and amortization, increased $5.7 million, or 11.2%, to
$56.5 million for the three months ended March 31, 2000 from
$50.8 million for the comparable period in 1999. EBITDA margin decreased
to 19.1% for the three months ended March 31, 2000 from 23.7% for the
comparable period in 1999. The decrease in EBITDA margin is the result of
increased processing costs from our Transaction Services segment of $5.2
million associated with the larger securitized portfolio and the decrease
in yield on the securitized portfolio.
- LOYALTY AND DATABASE MARKETING SERVICES. Loyalty and Database Marketing
Services operating expenses, excluding depreciation and amortization,
increased $6.3 million, or 16.9%, to $43.5 million for the three months
ended March 31, 2000 from $37.2 million for the comparable period in 1999.
EBITDA margin increased to 17.1% for the three months ended March 31, 2000
from 12.8% for the comparable period in 1999. The increased margin was
partially offset by $2.0 million of marketing and payroll costs associated
with the start-up of a new business-to-business loyalty program in Canada
during the three months ended March 31, 1999.
- DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased
$2.6 million, or 76.5%, to $6.0 million for the three months ended
March 31, 2000 from $3.4 million for the comparable period in 1999 due to
increases in capital expenditures in 1998 and 1999, especially software
development costs that have relatively short amortization periods.
Amortization of purchased intangibles decreased $4.1 million as a result
of a decrease in amortization expense for some of the intangibles related
to the acquisition of the former J.C. Penney business and the premium on a
purchased credit card portfolio that were fully amortized.
OPERATING INCOME. Operating income increased $5.5 million, or 98.2%, to
$11.1 million for the three months ended March 31, 2000 from $5.6 million during
the comparable period in 1999. Operating income improved primarily from revenue
gains and decreased depreciation and amortization.
INTEREST EXPENSE. Interest expense decreased $1.5 million, or 15.0%, to
$8.8 million for the three months ended March 31, 2000 from $10.3 million for
the comparable period in 1999 due to an increase in average debt associated with
acquisitions and an increase in debt to fund receivables.
TAXES. Income tax expense increased $1.7 million, or 114.1%, to
$3.1 million for the three months ended March 31, 2000 from $1.4 million in 1999
due to an increase in taxable income.
DISCONTINUED OPERATIONS. During September 1999, we discontinued our
subscriber services business when our principal customer for this service was
acquired by a third party. For the three months ended March 31, 1999,
discontinued operations had income of $1.7 million, net of income tax.
TRANSACTIONS WITH THE LIMITED. Revenue from The Limited and its affiliates,
which includes merchant and database marketing fees, decreased $400,000, or
3.5%, to $11.8 million for the three months ended March 31, 2000 from
$12.2 million for the comparable period in 1999. The decrease was primarily the
result of decreased credit sales offset by a small increase in database
marketing fees.
40
<PAGE>
RECAST YEAR ENDED DECEMBER 31, 1998 (UNAUDITED) COMPARED TO
THE YEAR ENDED DECEMBER 31, 1999 (AUDITED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
REVENUE EBITDA OPERATING INCOME
------------------------ ------------------- -------------------
1998 1999 1998 1999 1998 1999
--------- --------- -------- -------- -------- --------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Transaction Services............ $ 308,050 $ 362,524 $ 8,683 $ 20,584 $(19,076) $(8,229)
Credit Services................. 242,377 247,824 54,175 46,124 41,373 34,064
Loyalty and Database Marketing
Services...................... 86,220 194,482 15,751 37,351 1,785 3,488
Other and eliminations.......... (161,713) (165,576) -- -- -- --
--------- --------- ------- -------- -------- -------
Total......................... $ 474,934 $ 639,254 $78,609 $104,059 $ 24,082 $29,323
========= ========= ======= ======== ======== =======
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
PERCENTAGE OF REVENUE EBITDA MARGIN OPERATING MARGIN
------------------------ ------------------- -------------------
1998 1999 1998 1999 1998 1999
--------- --------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Transaction Services............ 64.9 % 56.7 % 2.8% 5.6% (6.2)% (2.2)%
Credit Services................. 51.0 38.8 22.4 18.6 17.1 13.7
Loyalty and Database Marketing
Services...................... 18.1 30.4 18.3 19.2 2.1 1.8
Other and eliminations.......... (34.0) (25.9) -- -- -- --
--------- ---------
Total......................... 100.0 % 100.0 % 16.6% 16.3% 5.1 % 4.6 %
========= =========
</TABLE>
REVENUE. Total revenue increased $164.3 million, or 34.6%, to
$639.3 million for 1999 from $474.9 million for 1998. The increase was
principally due to a 17.7% increase in Transaction Services revenue, a 2.2%
increase in Credit Services revenue and a 125.6% increase in Loyalty and
Database Marketing Services revenue as follows:
- TRANSACTION SERVICES. Transaction Services revenue increased
$54.5 million, or 17.7%, due to the acquisitions of Harmonic Systems in
1998 and SPS in 1999. Fees related to servicing of private label credit
card statements increased $11.9 million during 1999 over 1998 due to an
11.7% increase in price per statement, a $4.5 million termination fee from
a client and a 1.5% increase in the number of statements processed. The
revenue for transaction processing increased 41.4% mainly due to
acquisition activity offset by a decrease in average price per
transaction.
- CREDIT SERVICES. Credit Services revenue increased $5.4 million, or 2.2%,
due to increases in merchant and servicing fees and finance charges, net.
Merchant fee income increased $2.5 million, or 3.9%, due to a 2.7%
increase in credit sales on our private label credit cards. Additionally,
servicing fee income increased by $3.1 million, or 10.1%, during 1999 due
to an increase in average outstanding credit card receivables in the
securitization trust. Finance charge, net increased $600,000 in 1999 over
1998. We recognized a $16.2 million gain on sale of receivables during
1998 related to two securitization transactions with no comparable
securitization transactions in 1999. Excess spread income increased 13.5%
in 1999 over 1998 as a result of a 4.6% higher average outstanding
securitized portfolio and an approximate 75 basis point increase in yield.
- LOYALTY AND DATABASE MARKETING SERVICES. Loyalty and Database Marketing
Services revenue increased $108.3 million, or 125.6%, due to the
acquisition of Loyalty Management Group Canada Inc. on July 24, 1998.
Revenue from January 1, 1998 until the date of acquisition was
approximately $71.8 million. The remaining increase is primarily related
to an increase in Air
41
<PAGE>
Miles reward miles activity, which increased 16.3% on a pro forma basis in
1999 compared to 1998. From the date of acquisition through the remainder
of 1998, we issued 666.5 million Air Miles reward miles, compared to
1,583.2 million Air Miles reward miles during 1999. The increase in Air
Miles activity is primarily related to an increase in the number of
collectors of Air Miles reward miles.
OPERATING EXPENSES. Total operating expenses, excluding depreciation and
amortization, increased $138.9 million, or 35.0%, to $535.2 million during 1999
from $396.3 million in 1998. Total EBITDA margin decreased to 16.3% for 1999
from 16.6% for 1998. The decrease in EBITDA margin is due to a decrease in
Credit Services margins, partially offset by increases in Loyalty and Database
Marketing Services and Transaction Services margins.
- TRANSACTION SERVICES. Transaction Services operating expenses, excluding
depreciation and amortization, increased $42.5 million, or 14.2%, to
$341.9 million for 1999 from $299.4 million for 1998, and EBITDA margin
increased to 5.6% for 1999 from 2.8% during 1998. The EBITDA Margin
increased due to the newly acquired SPS Network services business which
carries a higher margin than our historical processing business.
Additionally, the margin increased due to a shift in the mix of business
to higher margin card processing and servicing products.
- CREDIT SERVICES. Credit Services operating expenses, excluding
depreciation and amortization, increased $13.5 million, or 7.2%, to
$201.7 million for 1999 from $188.2 million for 1998, and EBITDA margin
decreased to 18.6% for 1999 from 22.4% during 1998 due to a $16.2 million
gain on sale of receivables in 1998 related to two securitization
transactions, with no comparable securitization transactions in 1999.
- LOYALTY AND DATABASE MARKETING SERVICES. Loyalty and Database Marketing
Services operating expenses, excluding depreciation and amortization,
increased $86.6 million, or 123.0%, to $157.1 million for 1999 from
$70.5 million for 1998, and EBITDA margin increased to 19.2% for 1999 from
18.3% for 1998. The increased margin was partially offset by $3.3 million
of marketing and payroll costs associated with the start-up of a new
business-to-business loyalty program in Canada during 1999.
- DEPRECIATION AND AMORTIZATION. Depreciation and other amortization
increased $7.4 million, or 84.1%, to $16.2 million for 1999 from
$8.8 million for 1998 due to increases in capital expenditures in 1998 and
1999, especially software development costs that have relatively short
amortization periods. Amortization of purchased intangibles increased
$12.8 million as a result of recent acquisitions, partially offset by a
decrease in amortization expense for some of the intangibles related to
the acquisition of the former J.C. Penney business which were fully
amortized.
OPERATING INCOME. Operating income increased $5.2 million, or 21.6%, to
$29.3 million for 1999 from $24.1 million during 1998. Operating income improved
primarily from revenue gains offset by a slightly lower margin and increased
depreciation and amortization.
INTEREST EXPENSE. Interest expense increased $13.5 million, or 46.1%, to
$42.8 million for 1999 from $29.3 million for 1998 due to an increase in average
debt associated with acquisitions and an increase in debt to fund receivables.
TAXES. Income tax expense increased $5.6 million, or 83.6%, to
$12.3 million for the year ended December 31, 1999 from $6.7 million for the
year ended December 31, 1997 due to an increase in taxable income.
DISCONTINUED OPERATIONS. In September 1999, we discontinued our subscriber
services business when our principal customer for this service was acquired by a
third party. As a result of discontinuing
42
<PAGE>
our subscriber services, we recognized a loss of $3.7 million, net of income
tax, on disposal of discontinued operations. In 1999, discontinued operations
had income of $7.7 million, net of income tax, compared to a loss of
$3.9 million during 1998. The difference is largely related to additional fees
we received in connection with services performed for the former customer upon
termination of its contract.
TRANSACTIONS WITH THE LIMITED. Revenue from The Limited and its affiliates,
which includes merchant and database marketing fees, increased $5.5 million, or
10.2%, to $59.3 million for 1999 from $53.8 million for 1998. The increase was
primarily the result of increased volume of credit card receivables, credit
sales and statements generated.
PRO FORMA YEAR ENDED DECEMBER 31, 1998 (UNAUDITED) COMPARED TO
PRO FORMA YEAR ENDED DECEMBER 31, 1999 (UNAUDITED)
The following is a comparison based on pro forma results of operations
presented on pages 27 to 31 in this prospectus. The results are presented as if
the Loyalty, Harmonic Systems and SPS acquisitions had been consummated on
January 1, 1998.
<TABLE>
<CAPTION>
PRO FORMA FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
REVENUE EBITDA OPERATING INCOME
------------------------ ------------------- -------------------
1998 1999 1998 1999 1998 1999
--------- --------- -------- -------- -------- --------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Transaction Services............ $ 367,814 $ 386,846 $14,528 $ 24,778 $(30,329) $(9,964)
Credit Services................. 242,377 247,824 54,175 46,124 41,373 34,064
Loyalty and Database Marketing
Services...................... 157,985 194,482 27,865 37,351 (3,431) 3,488
Other and eliminations.......... (161,713) (165,576) -- -- -- --
--------- --------- ------- -------- -------- -------
Total......................... $ 606,463 $ 663,576 $96,568 $108,253 $ 7,613 $27,588
========= ========= ======= ======== ======== =======
</TABLE>
<TABLE>
<CAPTION>
PRO FORMA FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
PERCENTAGE OF REVENUE EBITDA MARGIN OPERATING MARGIN
------------------------ ------------------- -------------------
1998 1999 1998 1999 1998 1999
--------- --------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Transaction Services............ 60.6 % 58.3 % 3.9% 6.4% (8.3)% (2.6)%
Credit Services................. 40.0 37.3 22.4 18.6 17.1 13.7
Loyalty and Database Marketing
Services...................... 26.1 29.3 17.6 19.2 (2.1) 1.8
Other and eliminations.......... (26.7) (24.9) -- -- -- --
--------- ---------
Total......................... 100.0 % 100.0 % 15.9% 16.3% 1.3 % 4.2 %
========= =========
</TABLE>
REVENUE. Total revenue increased $57.1 million, or 9.4%, to $663.6 million
for 1999 from $606.5 million for 1998. The increase was principally due to a
23.1% increase in Loyalty and Database Marketing Services revenue, a 5.2%
increase in Transaction Services revenue and a 2.2% increase in Credit Services
revenue as follows:
- TRANSACTION SERVICES. Transaction Services revenue increased
$19.0 million, or 5.2%, due to an increase in the number of transactions
processed and statements generated, partially offset by a decrease in the
average price per transaction. Fees related to servicing of private label
credit card statements increased $11.9 million during 1999 over 1998 due
to an 11.7% increase in price per statement, a $4.5 million termination
fee from a client and a 1.5% increase in the number of statements
processed. The increase in the number of private label credit card
statements processed was due primarily to the addition of new client
programs and internal growth. The
43
<PAGE>
volume of transactions processed increased 13.8% offset by a decrease in
price per transaction processed. The revenue for Transaction Services is
affected by a mix of transaction processing and card processing and
servicing.
- CREDIT SERVICES. Credit Services revenue increased $5.4 million, or 2.2%,
due to increases in merchant and servicing fees and finance charge, net.
Merchant fee income increased $2.5 million, or 3.9%, due to a 2.7%
increase in credit sales on our private label credit cards. Additionally,
servicing fee income increased $3.1 million, or 10.1%, during 1999 due to
an increase in the average outstanding credit card receivables in the
securitization trust. Finance charge, net increased $600,000 in 1999 over
1998. We recognized a $16.2 million gain on sale of receivables during
1998 related to two securitization transactions with no comparable
securitization transactions in 1999. Excess spread income increased 13.5%
during 1999 over 1998 as a result of a 4.6% higher average outstanding
securitized portfolio and an approximate 75 basis point increase in yield.
- LOYALTY AND DATABASE MARKETING SERVICES. Loyalty and Database Marketing
Services revenue increased $36.5 million, or 23.1%, mainly due to an
increase of approximately $27.5 million in Air Miles reward program
revenue, which was principally due to an 11.4% increase in the issuance of
Air Miles reward miles and an increase in revenue per Air Miles reward
mile issued. We issued 1.6 billion Air Miles reward miles in 1999 and
1.4 billion Air Miles reward miles in 1998. The increase in Air Miles
activity is due to a 15.7% increase in the average number of active
collectors, partially offset by the loss of a significant sponsor at the
end of 1998. Other increases are related to higher direct marketing fees
during 1999 as a result of an increased number of campaigns for clients,
mostly related to Loyalty clients.
OPERATING EXPENSES. Total operating expenses, excluding depreciation and
amortization, increased $45.4 million, or 9.0%, to $555.3 million for 1999 from
$509.9 million for 1998. Total EBITDA margin increased to 16.3% for 1999 from
15.9% for 1998. The increase in EBITDA margin is due to an increase in
Transaction Services margin, partially offset by decreases in Loyalty and
Database Marketing Services and Credit Services margins.
- TRANSACTION SERVICES. Transaction Services operating expenses, excluding
depreciation and amortization, increased $8.8 million, or 2.5%, to
$362.1 million for 1999 from $353.3 million for 1998, and EBITDA margin
increased to 6.4% for 1999 from 3.9% during 1998 partially due to a
one-time termination fee received from a client and due to an increase in
our higher margin card processing and servicing products.
- CREDIT SERVICES. Credit Services operating expenses, excluding
depreciation and amortization, increased $13.5 million, or 7.2%, to
$201.7 million for 1999 from $188.2 million for 1998, and EBITDA margin
decreased to 18.6% for 1999 from 22.4% for 1998 due to the timing of a
$16.2 million gain on sale of receivables in 1998 related to two
securitization transactions with no comparable securitization transactions
in 1999.
- LOYALTY AND DATABASE MARKETING SERVICES. Loyalty and Database Marketing
Services operating expenses, excluding depreciation and amortization,
increased $27.0 million, or 20.8%, to $157.1 million for 1999 from
$130.1 million for 1998, and EBITDA margin increased to 19.2% for 1999
from 17.6% for 1998. The increased margin is a result of an increased
number of Air Miles reward miles issued partially offset by $3.3 million
of marketing and payroll costs associated with the start-up of a new
business-to-business loyalty program in Canada during 1999.
- DEPRECIATION AND AMORTIZATION. Depreciation and other amortization
increased $6.2 million, or 62.0%, to $16.2 million for 1999 from
$10.0 million for 1998 due to increases in capital expenditures in 1998
and 1999, especially software development costs that have relatively short
44
<PAGE>
amortization periods. Amortization of purchased intangibles decreased
$14.4 million as a result of the expiration of intangibles related to the
former J.C. Penney business which were fully amortized.
OPERATING INCOME. Operating income increased $20.0 million, or 263.2%, to
$27.6 million for 1999 from $7.6 million for 1998. Operating income increased as
the result of revenue gains, improved margins and reduced depreciation and
amortization.
INTEREST EXPENSE. Interest expense increased $4.3 million, or 11.2%, to
$42.8 million for 1999 from $38.5 million for 1998 due to increased borrowings
for acquisitions and operations.
TAXES. Income tax expense increased $6.8 million, or 151.1%, to
$11.3 million for the year ended December 31, 1999 from $4.5 million for the
year ended December 31, 1998 due to an increase in taxable income.
DISCONTINUED OPERATIONS. In September 1999, we discontinued our subscriber
services business when our principal customer for this service was acquired by a
third party. As a result of discontinuing our subscriber services, we recognized
a loss of $3.7 million, net of income tax, on disposal of discontinued
operations. In 1999, discontinued operations had income of $7.7 million, net of
income tax, compared to a loss of $3.9 million during 1998. The difference is
due to additional fees we received in connection with services performed for the
former customer upon termination of its contract.
TRANSACTIONS WITH THE LIMITED. Revenue from The Limited and its affiliates,
which includes merchant, database and direct marketing fees, increased
$5.5 million, or 10.2%, to $59.3 million for 1999 from $53.8 million for 1998.
The increase was primarily the result of increased volume of credit card
receivables, credit sales and statements generated.
ELEVEN MONTHS ENDED DECEMBER 31, 1998 (FISCAL 1998) COMPARED TO
YEAR ENDED DECEMBER 31, 1999 (FISCAL 1999)
Due to the change in our fiscal year, fiscal 1998 is one month shorter than
fiscal 1999.
<TABLE>
<CAPTION>
HISTORICAL FISCAL PERIODS
--------------------------------------------------------------------
REVENUE EBITDA OPERATING INCOME
------------------------ ------------------- -------------------
1998 1999 1998 1999 1998 1999
--------- --------- -------- -------- -------- --------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Transaction Services........... $ 286,605 $ 362,524 $13,621 $ 20,584 $(11,798) $ (8,229)
Credit Services................ 212,663 247,824 39,396 46,124 27,633 34,064
Loyalty and Database Marketing
Services..................... 84,288 194,482 15,815 37,351 1,847 3,488
Other and eliminations......... (149,247) (165,576) -- -- -- --
--------- --------- ------- -------- -------- --------
Total........................ $ 434,309 $ 639,254 $68,832 $104,059 $ 17,682 $ 29,323
========= ========= ======= ======== ======== ========
</TABLE>
45
<PAGE>
<TABLE>
<CAPTION>
HISTORICAL FISCAL PERIODS
--------------------------------------------------------------------
PERCENTAGE OF REVENUE EBITDA MARGIN OPERATING MARGIN
------------------------ ------------------- -------------------
1998 1999 1998 1999 1998 1999
--------- --------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Transaction Services............ 66.0 % 56.7 % 4.8% 5.6% (4.1)% (2.2)%
Credit Services................. 49.0 38.8 18.5 18.6 13.0 13.7
Loyalty and Database Marketing
Services...................... 19.4 30.4 18.8 19.2 2.2 1.8
Other and eliminations.......... (34.4) (25.9) -- -- -- --
--------- ---------
Total......................... 100.0 % 100.0 % 15.8% 16.3% 4.1 % 4.6 %
========= =========
</TABLE>
REVENUE. Total revenue increased $204.9 million, or 47.2%, to
$639.3 million for fiscal 1999 from $434.3 million during fiscal 1998. The
increase was principally due to a 26.5% increase in Transaction Services
revenue, a 16.5% increase in Credit Services revenue and a 130.7% increase in
Loyalty and Database Marketing Services revenue as follows:
- TRANSACTION SERVICES. Transaction Services revenue increased
$75.9 million, or 26.5%, due to the acquisitions of Harmonic Systems in
1998 and SPS in 1999. Fees related to servicing of private label credit
card statements increased $15.7 million during fiscal 1999 over fiscal
1998 due to a 12.9% increase in price per statement, a $4.5 million
termination fee from a client and a 7.8% increase in the number of
statements processed. The revenue for transaction processing increased
52.7% mainly due to acquisition activity and as a result of fiscal 1998
being one month shorter than fiscal 1999, partially offset by a decrease
in average price per transaction.
- CREDIT SERVICES. Credit Services revenue increased $35.2 million, or
16.5%, due to increases in merchant and servicing fees and finance
charges, net. Merchant fee income increased $6.3 million, or 10.1%, due to
a 9.3% increase in credit sales on our private label credit cards and
fiscal 1998 being one month shorter than fiscal 1999. Additionally,
servicing fee income increased by $5.8 million, or 20.9%, during fiscal
1999 due to an increase in average outstanding credit card receivables in
the securitization trust and fiscal 1998 being one month shorter than
fiscal 1999. Finance charge, net increased $22.6 million during fiscal
1999 over fiscal 1998. We recognized a $7.2 million gain on sale of
receivables during fiscal 1998 related to a securitization transaction
with no comparable securitization transaction in fiscal 1999.
- LOYALTY AND DATABASE MARKETING SERVICES. Loyalty and Database Marketing
Services revenue increased $110.2 million, or 130.7%, due to the
acquisition of Loyalty Management Group Canada Inc. on July 24, 1998.
Revenue from February 1, 1998 until the date of acquisition was
approximately $62.6 million. The remaining increase is primarily related
to an increase in Air Miles reward miles activity, which increased 11.4%
on a pro forma basis in fiscal 1999 compared to fiscal 1998, and fiscal
1998 being one month shorter than fiscal 1999. From the date of
acquisition through the remainder of fiscal 1998, we issued 666.5 million
Air Miles reward miles, compared to 1,583.2 million Air Miles reward miles
during fiscal 1999. The increase in Air Miles activity is primarily
related to an increase in the number of reward miles collectors.
OPERATING EXPENSES. Total operating expenses, excluding depreciation and
amortization, increased $169.7 million, or 46.4%, to $535.2 million during
fiscal 1999 from $365.5 million during fiscal 1998. Total EBITDA margin
increased to 16.3% for fiscal 1999 from 15.8% for fiscal 1998. The increase in
EBITDA margin is due to an increase in Credit Services, Loyalty and Database
Marketing Services and Transaction Services margins.
- TRANSACTION SERVICES. Transaction Services operating expenses, excluding
depreciation and amortization, increased $68.9 million, or 25.2%, to
$341.9 million for fiscal 1999 from $273.0 million in fiscal 1998, and
EBITDA margin increased to 5.6% for fiscal 1999 from 4.8%
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<PAGE>
for fiscal 1998. The EBITDA margin increased due to the newly acquired SPS
network services business which carries a higher margin than our
historical processing business. Additionally, the margin increased due to
a shift in the mix of business to higher margin card processing and
servicing products.
- CREDIT SERVICES. Credit Services operating expenses, excluding
depreciation and amortization, increased $28.4 million, or 16.4%, to
$201.7 million for fiscal 1999 from $173.3 million for fiscal 1998, and
EBITDA margin increased to 18.6% for fiscal 1999 from 18.5% for fiscal
1998. Fiscal 1998 includes a $7.2 million gain on sale of receivables
related to the timing of a securitization transaction with no comparable
securitization transaction in fiscal 1999.
- LOYALTY AND DATABASE MARKETING SERVICES. Loyalty and Database Marketing
Services operating expenses, excluding depreciation and amortization,
increased $88.6 million, or 129.3%, to $157.1 million for fiscal 1999 from
$68.5 million for fiscal 1998, and EBITDA margin increased to 19.2% for
fiscal 1999 from 18.8% for fiscal 1998. The increased margin was partially
offset by $3.3 million of marketing and payroll costs associated with the
start-up of a new business-to-business loyalty program in Canada during
fiscal 1999.
- DEPRECIATION AND AMORTIZATION. Depreciation and other amortization
increased $7.9 million, or 95.2%, to $16.2 million for fiscal 1999 from
$8.3 million for fiscal 1998 due to increases in capital expenditures in
fiscal 1998 and 1999, especially software development costs that have
relatively short amortization periods. Amortization of purchased
intangibles increased $15.7 million as a result of recent acquisitions,
partially offset by a decrease in amortization expense for some of the
intangibles related to the acquisition of the former J.C. Penney business
which were fully amortized.
OPERATING INCOME. Operating income increased $11.6 million, or 65.5%, to
$29.3 million for fiscal 1999 from $17.7 million during fiscal 1998. Operating
income improved primarily from revenue gains and higher margins offset in part
by increased depreciation and amortization.
INTEREST EXPENSE. Interest expense increased $14.9 million, or 53.4%, to
$42.8 million for fiscal 1999 from $27.9 million for fiscal 1998 due to an
increase in average debt associated with acquisitions and an increase in debt to
fund receivables.
TAXES. Income tax expense increased $8.6 million, or 232.4%, to
$12.3 million for the year ended December 31, 1999 from $3.7 million for the
eleven months ended December 31, 1998 due to an increase in taxable income.
DISCONTINUED OPERATIONS. In September 1999, we discontinued our subscriber
services business when the principal customer for this service was acquired by a
third party. As a result of discontinuing our subscriber services, we recognized
a loss of $3.7 million, net of income tax, on disposal of discontinued
operations. For fiscal 1999, discontinued operations had income of
$7.7 million, net of income tax, compared to a loss of $300,000 during fiscal
1998. The difference is largely related to additional fees we received in
connection with services performed for the former customer upon termination of
its contract.
TRANSACTIONS WITH THE LIMITED. Revenue from The Limited and its affiliates,
which includes merchant and database and direct marketing fees, increased
$8.7 million, or 17.2%, to $59.3 million for fiscal 1999 from $50.6 million for
fiscal 1998. The increase was primarily the result of increased volume of credit
sales and database marketing fees.
47
<PAGE>
HISTORICAL ELEVEN MONTHS ENDED DECEMBER 31, 1998 (FISCAL 1998) COMPARED TO
HISTORICAL 52 WEEKS ENDED JANUARY 31, 1998 (FISCAL 1997)
Due to the change in our fiscal year, fiscal 1998 is one month shorter than
fiscal 1997.
<TABLE>
<CAPTION>
HISTORICAL FISCAL PERIODS
--------------------------------------------------------------------
REVENUE EBITDA OPERATING INCOME
------------------------ ------------------- -------------------
1997 1998 1997 1998 1997 1998
--------- --------- -------- -------- -------- --------
(AMOUNTS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Transaction Services............ $ 256,730 $ 286,605 $27,146 $ 13,621 $ 3,713 $(11,798)
Credit Services................. 211,921 212,663 29,349 39,396 17,221 27,633
Loyalty and Database Marketing
Services...................... 23,348 84,288 8,457 15,815 8,457 1,847
Other and eliminations.......... (138,600) (149,247) -- -- -- --
--------- --------- ------- -------- ------- --------
Total......................... $ 353,399 $ 434,309 $64,952 $ 68,832 $29,391 $ 17,682
========= ========= ======= ======== ======= ========
</TABLE>
<TABLE>
<CAPTION>
HISTORICAL FISCAL PERIODS
--------------------------------------------------------------------
PERCENTAGE OF REVENUE EBITDA MARGIN OPERATING INCOME
------------------------ ------------------- -------------------
1997 1998 1997 1998 1997 1998
--------- --------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Transaction Services............ 72.6 % 66.0 % 10.6% 4.8% 1.5% (4.1)%
Credit Services................. 60.0 49.0 13.8 18.6 8.1 13.0
Loyalty and Database Marketing
Services...................... 6.6 19.4 36.2 18.8 36.2 2.2
Other and eliminations.......... (39.2) (34.4) -- -- -- --
--------- ---------
Total......................... 100.0 % 100.0 % 18.4% 15.8% 8.3% 4.1 %
========= =========
</TABLE>
REVENUE. Total revenue increased $80.9 million, or 22.9%, to
$434.3 million for fiscal 1998 from $353.4 million in fiscal 1997. The increase
was principally due to a 261.0% increase in Loyalty and Database Marketing
Services revenue, a 11.6% increase in Transaction Services revenue and a 0.4%
increase in Credit Services revenue.
- TRANSACTION SERVICES. Transaction Services revenue increased
$29.9 million, or 11.6%, due partially to the effect of the acquisition of
Harmonic Systems in fiscal 1998. Revenue increased in fiscal 1998 relating
to servicing of private label credit card statements and network servicing
by $11.1 million due to a 15.5% increase in items processed, offset
partially by a reduction of transaction fee rates, and a 4.9% increase in
statements processed. Additionally, growth was provided by a
$12.4 million increase in servicing and processing of our private label
credit card portfolio.
- CREDIT SERVICES. Credit Services revenue increased $742,000, or 0.4%, due
to increased merchant fee income, partially offset by a decrease in
finance charge income. Merchant fee income increased in fiscal 1998 due to
a 14.0% increase in cardholders and a 10% increase in merchant fee rates.
Finance charge income decreased due to the shorter period in fiscal 1998
than in fiscal 1997 and a $2.0 million decrease in gain on sale of
receivables, offset in part by an increase in card balances.
- LOYALTY AND DATABASE MARKETING SERVICES. Loyalty and Database Marketing
Services revenue increased $60.9 million, or 261.0%, mainly due to the
acquisition of Loyalty in July 1998. Loyalty contributed approximately
$60.0 million in revenue during fiscal 1998. Growth in database marketing
fees of approximately $3.0 million during fiscal 1998 was offset by
decreases in enhancement services due to the shorter period in fiscal
1998.
48
<PAGE>
OPERATING EXPENSES. Total operating expenses, excluding depreciation and
amortization, increased $77.1 million, or 26.7%, to $365.5 million during fiscal
1998 from $288.4 million in fiscal 1997. Total EBITDA margin decreased to 15.8%
for fiscal 1998 from 18.4% for fiscal 1997. The decrease in EBITDA margin is due
to decreases in Loyalty and Database Marketing Services and Transaction Services
margins, partially offset by an increase in Credit Services margin.
- TRANSACTION SERVICES. Transaction Services operating expenses, excluding
depreciation and amortization, increased $43.4 million, or 18.9%, to
$273.0 million in fiscal 1998 from $229.6 million in fiscal 1997, and
EBITDA margin decreased to 4.8% for fiscal 1998 from 10.6% for fiscal 1997
due to the acquisition of Harmonic Systems, which incurred an operating
loss in fiscal 1998.
- CREDIT SERVICES. Credit Services operating expenses, excluding
depreciation and amortization, decreased $9.3 million, or 5.1%, to
$173.3 million in fiscal 1998 from $182.6 million in fiscal 1997 due
primarily to fiscal 1998 being a shorter period. EBITDA margin increased
to 18.5% from 13.8% for fiscal 1997 due to a decrease in processing
expenses.
- LOYALTY AND DATABASE MARKETING SERVICES. Loyalty and Database Marketing
Services operating expenses, excluding depreciation and amortization,
increased $53.6 million, or 359.8%, to $68.5 million in fiscal 1998 from
$14.9 million in fiscal 1997, and EBITDA margin decreased to 18.8% for
fiscal 1998 from 36.2% for fiscal 1997 due to the acquisition of Loyalty.
The largest component of the increased expense is related to the estimated
redemption cost of the Air Miles reward program and payroll costs
associated with Loyalty.
- DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased
$15.6 million, or 43.8%, to $51.2 million for fiscal 1998 from
$35.6 million for fiscal 1997 due to increased amortization of purchased
intangibles from the acquisitions in fiscal 1998 offset in part by a
shorter period in fiscal 1998.
OPERATING INCOME. Operating income decreased $11.7 million, or 39.8%, to
$17.7 million for fiscal 1998 from $29.4 million for fiscal 1997. The decrease
is the result of a shorter period, increased depreciation and amortization and a
decline in margins.
INTEREST EXPENSE. Interest expense increased $12.4 million, or 80.0%, to
$27.9 million for fiscal 1998 from $15.5 million for fiscal 1997 due to an
increased debt balance associated with fiscal 1998 acquisitions.
TAXES. Income tax expense decreased $1.5 million, or 28.8%, to $3.7 million
for fiscal 1998 from $5.2 million for fiscal 1997 due to a decrease in taxable
income.
TRANSACTIONS WITH THE LIMITED. Revenue from The Limited and its affiliates,
which includes merchant and database marketing fees, increased $1.8 million, or
3.7%, to $50.6 million for fiscal 1998 from $48.8 million for fiscal 1997. The
increase is the result of an increase in database marketing fees.
LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES. We generated cash flow from operating activities of
$14.1 million for the three months ended March 31, 2000 compared to cash used in
operating activity of $3.8 million in the comparable period in 1999. We
generated cash flow from operating activities of $251.6 million during the year
ended December 31, 1999 compared to $4.5 million for fiscal 1998 and a cash
outflow of $30.7 million for fiscal 1997. Operating cash flow in the three
months ended March 31, 2000 increased compared to the prior period as a result
of improved working capital. Operating cash flow in 1999 increased due to a
significant reduction of trade receivables and increased operating cash flows
from the Loyalty and Database Marketing Services segment, offset by increased
interest expense. Our operating cash flow is seasonal with cash utilization
peaking at the end of December due to increased
49
<PAGE>
activity related to the holidays. We utilize our operating cash flow for ongoing
business operations and to pay interest expense.
INVESTING ACTIVITIES. We generated cash flow from investing activities of
$15.1 million for the three months ended March 31, 2000 compared to
$21.1 million in the comparable period in 1999. We used cash in investing
activities of $309.5 million during the year ended December 31, 1999 compared to
$140.5 million for the year ended December 31, 1998 and $103.7 million for the
year ended December 31, 1997. Three significant components of investing
activities are as follows:
- ACQUISITIONS. Net cash outlays for acquisitions in the year ended
December 31, 1999 totaled $171.4 million, compared to $134.0 million in
1998 and $716,000 for fiscal 1997.
- RECEIVABLES FUNDING. We generally fund all private label credit card
receivables through a securitization program that provides us with both
liquidity and lower borrowing costs. As of March 31, 2000, we had over
$2.0 billion of credit card receivables outstanding under securitizations.
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. During the period from November to January, we are
required to maintain an additional 2.0% in credit enhancement. Accordingly
as of December 31, we typically have our highest balance of credit
enhancement assets. We intend to utilize our securitization program for
the foreseeable feature. We received net cash of $25.4 million for the
three months ended March 31, 2000 compared to $9.2 million in the
comparable period in 1999 in connection with funding private label credit
cards as a result of a reduction in the credit enhancement requirements
and pay down of credit card balances. We used net cash of $37.7 million
during the year ended December 31, 1999, compared to receiving
$22.6 million during fiscal 1998 and using $55.0 million during fiscal
1997, in connection with funding private label credit card receivables.
- RESERVE FUND. Restricted cash and cash equivalents and securities
available-for-sale on our balance sheet at December 31, 1999 relate to a
reserve fund we have established in connection with funding the redemption
obligation of the Air Miles reward program. We believe the reserve fund is
sufficient to meet redemption obligations for the foreseeable future. We
currently intend to set aside a portion of future transaction fees
received to fund future redemption obligations. Based on various factors,
we may reduce the amount of the reserve fund and utilize future cash flows
and excess cash for general corporate purposes.
FINANCING ACTIVITIES. Net cash payments on borrowings was $18.4 million for
the three months ended March 31, 2000 compared to net cash borrowings of
$21.2 million for the comparable period in 1999. Net cash payments on borrowings
was $44.8 million in the year ended December 31, 1999 compared to net borrowings
of $56.2 million in fiscal 1998 and $104.8 million in fiscal 1997. Our financing
activities include primarily net borrowings used to fund acquisitions and
working capital. We issued approximately $100.0 million of common stock to fund
a portion of our acquisition of the Loyalty Group during fiscal 1998.
REDEMPTION OBLIGATION. In July 1998, we assumed a redemption obligation of
$68.2 million with the acquisition of the Loyalty Group. Our redemption
obligation was $80.2 million as of December 31, 1998, $122.2 million as of
December 31, 1999 and $128.6 million as of March 31, 2000. The redemption
obligation represents our future obligation to satisfy the redemption of
outstanding Air Miles reward miles by collectors. The actual cost of redeemed
rewards is offset against the redemption obligation during the period in which
we pay for the rewards purchased from our suppliers. Air travel redemption
costs, the largest reward category, are generally higher during the first
quarter and decline over the remainder of the year due to the timing of vacation
travel plans of collectors. We expect our
50
<PAGE>
redemption obligation to continue to increase over time as our Air Miles reward
program continues to expand at a faster pace than redemptions.
We use two principal components to estimate the redemption obligation--our
estimate of the reward miles that will ultimately be redeemed and our estimated
cost of providing rewards to collectors. The factors we consider in estimating
the number of reward miles that will be redeemed include historical business
experience and patterns of usage. Of our outstanding Air Miles reward miles, we
expect that approximately 1.4 billion as of December 31, 1999 and 1.5 billion as
of March 31, 2000 will ultimately be redeemed by collectors.
During the period from our acquisition of the Loyalty Group until
December 31, 1998, the total number of Air Miles reward miles redeemed by
collectors was 60.2 million. The total number of Air Miles reward miles that
were redeemed by collectors was 223.6 million in fiscal 1999 and 70.7 million in
the three months ended March 31, 2000.
The second component we use in estimating our redemption obligation relates
to the reward cost, which is based on the mix of rewards we anticipate providing
to collectors. As part of estimating the costs associated with our obligation to
redeem outstanding Air Miles reward miles as of December 31, 1999 and March 31,
2000, we considered the effect of the temporary disruption in the Canadian
domestic airline industry resulting from the merger of Canadian Airlines and Air
Canada. As a result of this disruption and our subsequent contract
renegotiations, we expect that actual weighted average reward costs will be
higher than historical averages in the first half of 2000, but we believe it
will return to the historical averages in the second half of 2000. The weighted
average reward cost for Air Miles reward miles redeemed increased by 1.7% in
fiscal 1999 compared to fiscal 1998. In order to satisfy the redemption of Air
Miles reward miles for certain air travel rewards during the three months ended
March 31, 2000, we incurred approximately $2.1 million in additional redemption
costs or a 15% increase in our estimated reward costs as a result of the route
consolidation between Canadian Airlines and Air Canada resulting from their
merger. These additional redemption costs were offset against our redemption
obligation. Redemption costs, excluding the $2.1 million relating to the merger
of Canadian Airlines, increased by 45.3% during the three months ended
March 31, 2000 from 1999 due primarily to a 36.3% increase in the number of Air
Miles reward miles redeemed and a 6.6% increase in weighted average reward
costs. Due to the greater collector activity during 1999 and the three months
ended March 31, 2000, our redemption costs have significantly increased and will
continue to do so.
On April 24, 2000, we signed a new supply agreement with Air Canada in order
to help maintain a supply of airline seats for our collectors of Air Miles
reward miles. We are in the process of integrating the new supply agreement with
Air Canada into our cost structure. This integration may include some or all of
the following items:
- increasing the number of miles required to redeem a reward;
- providing incentives that alter the total mix of rewards available to
collectors; and
- seeking new supply agreements with additional airlines in Canada.
In January 2000, we changed the reward offer to collectors by increasing the
number of Air Miles reward miles required to redeem some air travel rewards. We
periodically review our reward offers to collectors and will continue to seek
ways to contain the overall cost of the program and make changes to enhance the
program value to collectors.
LIQUIDITY SOURCES. We issue certificates of deposit through our credit card
bank subsidiary, World Financial, which issues $100,000 certificates of deposit
in various maturities ranging between three months and two years and with
effective annual fixed rates ranging from 5.35% to 6.85%. As of March 31, 2000,
we had $116.0 million of certificates of deposit outstanding. We utilize
certificates of
51
<PAGE>
deposit to finance World Financial's operating activities and to fund credit
enhancement activity. World Financial is limited in the amounts that it can
dividend to us.
In July 1998 we entered into a $330.0 million credit agreement consisting of
a $130.0 million U.S. Term Loan, a $50.0 million Canadian A Term Loan and a
$50.0 million Canadian B Term Loan, and a $100.0 million revolving loan
commitment. The term loans and the revolving loan commitment are at a daily
floating rate equal to the sum of the Euro-dollar margin plus the London
Interbank Offered Rate applicable to the period for each Euro-dollar loan.
Principal is payable annually, and interest is payable quarterly for the base
rate loans and payable on the last day of the Euro-dollar loan period for each
Euro-dollar loan. The U.S. Term Loan, the Canadian A Term Loan and the revolving
loan commitment mature on July 25, 2003 and the Canadian B Term Loan matures on
July 25, 2005. We use the $100.0 million revolving loan commitment for general
corporate purposes. From mid-November to late January, we experience increased
needs for working capital due to increased credit card usage during the holiday
season. For additional credit enhancement during this period, our securitization
program requires us to maintain a higher percentage of securitized assets
through increased seller's interest or excess funding deposits. During 1999, the
highest outstanding balance on the revolving loan commitment was $50.0 million.
As of March 31, 2000, there was no amount outstanding under the revolving loan
commitment.
We have incurred debt to finance our acquisitions. We have $102.0 million of
subordinated notes outstanding related to our August 1996 merger and our
acquisition of Harmonic Systems. These subordinated notes were issued to
affiliates of our stockholders, bear interest at 10% and are due between 2005
and 2008. To finance the Loyalty acquisition, we borrowed $100.0 million under
our credit agreement, consisting of a $50.0 million Canadian Term Loan with an
effective fixed interest rate of 8.99% and a $50.0 million Canadian Term Loan
with a floating rate of London Interbank Offered Rate plus the Euro-dollar
margin.
To fund the SPS acquisition, we used $50.0 million in working capital and
$120.0 million from the issuance of Series A preferred stock. The Series A
preferred stock has a 6% dividend rate payable at the discretion of our board of
directors or upon conversion.
The net proceeds from this offering will be approximately $278.5 million. We
intend to use the net proceeds to repay in full $102.0 million in subordinated
notes and pay down $102.9 million outstanding under our credit facility.
Following this $204.9 million repayment in debt, we will record an extraordinary
loss on early extinguishment of debt of approximately $5.3 million, net of tax.
We believe that our current level of cash and financing capacity, along with
future cash flows from operations, is sufficient to meet the needs of our
existing businesses. 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.
On March 23, 2000, we amended our credit agreement to, subject to specific
conditions, allow us to maintain our current borrowing capacity and re-pay the
subordinated notes. A portion of the net proceeds and funds available under our
amended credit agreement may be used to acquire or invest in complementary
businesses, technologies, products or services. Although we are not
contemplating any specific acquisitions at this time and no portion of the net
proceeds has been allocated for any acquisition, we evaluate acquisition
opportunities on an ongoing basis.
ECONOMIC FLUCTUATIONS
Although we cannot precisely determine the impact of inflation on our
operations, we do not believe that we have been significantly affected by
inflation. For the most part, we have relied on operating efficiencies from
scale and technology, as well as decreases in technology and communication
costs, to offset increased costs of employee compensation and other operating
expenses.
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Portions of our business are seasonal. Our revenues and earnings are
favorably affected by increased transaction volume and credit card balances
during the holiday shopping period in the fourth quarter and, to a lesser
extent, during the first quarter as credit card balances are paid down.
Similarly, our petroleum related businesses are favorably affected by increased
volume in the latter part of the second quarter and the first part of the third
quarter as consumers make more frequent purchases of gasoline in connection with
summer travel.
REGULATORY MATTERS
World Financial is subject to various regulatory capital requirements
administered by the Office of the Comptroller of the Currency. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have a
material adverse effect on our financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, World
Financial must meet specific capital guidelines that involve quantitative
measures of its assets, liabilities and certain off-balance-sheet items as
calculated under regulatory accounting practices. The capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require World Financial to maintain minimum amounts and ratios of total and Tier
1 capital to risk weighted assets and of Tier 1 capital to average assets. Under
the regulations, a "well capitalized" institution must have a Tier 1 capital
ratio of at least six percent, a total capital ratio of at least 10 percent and
a leverage ratio of at least five percent and not be subject to a capital
directive order. An "adequately capitalized" institution must have a Tier 1
capital ratio of at least four percent, a total capital ratio of at least eight
percent and a leverage ratio of at least four percent, but three percent is
allowed in some cases. Under these guidelines, World Financial is considered
well capitalized. As of March 31, 2000, World Financial's Tier 1 capital ratio
was 54.9%, total capital ratio was 55.7% and leverage ratio was 54.6%, and World
Financial was not subject to a capital directive order.
MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and
rates. Our primary market risks include interest rate risk, credit risk and
foreign currency exchange rate risk.
OFF-BALANCE SHEET RISK. We are subject to off-balance sheet risk in the
normal course of business including commitments to extend credit and through
financial instruments used to reduce the interest rate sensitivity of our
securitization transactions. We enter into interest rate swap and treasury lock
agreements in the management of interest rate exposure. These off-balance sheet
financial instruments involve elements of credit and interest rate risk in
excess of the amount recognized on our balance sheet. These instruments also
result in certain credit, market, legal and operational risks. We have
established credit policies for off-balance sheet instruments consistent with
those established for on-balance sheet instruments.
INTEREST RATE RISK. Interest rate risk affects us directly in our lending
and borrowing activities. Our total interest expense was approximately
$39.6 million for the three months ended March 31, 2000 and $148.0 million for
1999. Of these totals, $8.8 million of the interest expense for the three months
ended March 31, 2000 and $42.8 million of the interest expense for 1999 was
attributable to on-balance sheet indebtedness and the remainder to our
securitized credit card receivables, which are financed off-balance sheet. To
manage our risk from market interest rates, we actively monitor the interest
rates and the interest-sensitive components both on and off-balance sheet to
minimize the impact that changes in interest rates have on the fair value of
assets, net income and cash flow. To achieve this objective, we manage our
exposure to fluctuations in market interest rates by matching asset and
liability repricings and through the use of fixed-rate debt instruments to the
extent that reasonably favorable rates are
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obtainable with such arrangements. In addition, we enter into derivative
financial instruments such as interest rate swaps, caps and treasury locks to
mitigate our interest rate risk on a related financial instrument or to
effectively lock the interest rate on a portion of our variable debt. We do not
enter into derivative or interest rate transactions for trading or other
speculative purposes. At March 31, 2000, approximately 11.8% of our outstanding
debt was subject to fixed rates with a weighted average interest rate of 7.86%.
An additional 67.8% of our outstanding debt at March 31, 2000 was effectively
locked at an interest rate of 6.59% through interest rate swap agreements and
treasury locks with notional amounts totalling $1.5 billion.
The approach we use to quantify interest rate risk is a sensitivity analysis
which we believe best reflects the risk inherent in our business. This approach
calculates the impact on pretax income from an instantaneous and sustained
increase in interest rates of 1.0%. Assuming we do not take any counteractive
measures, a 1.0% increase in interest rates would result in a decrease to pretax
income of approximately $4.6 million. Conversely, a corresponding decrease in
interest rates would result in a comparable improvement to pretax income. Our
use of this methodology to quantify the market risk of financial instruments
should not be construed as an endorsement of its accuracy or the accuracy of the
related assumptions.
CREDIT RISK. We are exposed to credit risk relating to the credit card
loans we make to our clients' customers. Our credit risk relates to the risk
that consumers using the private label credit cards that we issue will not repay
their revolving credit card loan balances. We have developed credit risk models
designed to identify qualified consumers who fit our risk parameters. To
minimize our risk of loan write-off, we control approval rates of new accounts
and related credit limits and follow strict collection practices. We monitor the
buying limits as well as set pricing regarding fees and interest rates charged.
FOREIGN CURRENCY EXCHANGE RATE RISK. We are exposed to fluctuations in the
exchange rate between the U.S. and the Canadian dollar through our significant
Canadian operations. Although we have entered into cross currency hedges to fix
the exchange rate on any Canadian debt repayment due to a U.S. counter party, we
do not hedge our net investment exposure in our Canadian subsidiary.
YEAR 2000 ISSUES
We currently are not aware of any Year 2000 problem in any of our critical
systems and products. However, the success to date of our Year 2000 efforts
cannot guarantee that a Year 2000 problem affecting third parties upon which we
rely will not become apparent in the future and interfere with our operations or
otherwise harm our business.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities," which
establishes accounting and reporting standards for derivative instruments and
for hedging activities, and requires companies to recognize all derivatives as
either assets or liabilities on their balance sheet and measure such instruments
at fair value. In June 1999, the FASB issued SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities--Deferral of the Effective Date of
FASB Statement No. 133," which deferred the effective date of SFAS No. 133 to
fiscal years beginning after June 15, 2000. Adoption of SFAS No. 133 is not
anticipated to materially impact our consolidated results of operations or
financial condition but may require recognition of derivative instruments on our
balance sheet.
The Emerging Issues Task Force ("EITF") is expected to review an issue,
Issue No. 00-G, "Accounting for 'Point' and Other Loyalty Programs," that is
closely related to the our Air Miles reward program and the way revenue is
recognized for these types of programs. Similar to the discussion in Issue
No. 00-G, we award Air Miles reward miles in order to encourage our collectors
to patronize the participating sponsors, thereby generating payments from
sponsors to us. We understand
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that the EITF will likely examine this issue sometime in 2000, and that a
specific date has not been set. We believe that our revenue recognition policy
currently complies with existing generally accepted accounting policies and SEC
guidelines. When Issue 00-G is issued, if we require modification of our present
revenue recognition policy, we will adhere to the guidance provided. Without
knowing how the EITF will rule on this issue, we are unable to assess the impact
of Issue 00-G at this time.
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DESCRIPTION OF OUR BUSINESS
GENERAL
We are a leading provider of electronic transaction services, credit
services and loyalty and database marketing services. The programs that we
develop and execute create value by assisting our clients in acquiring and
developing loyal, profitable customers.
We target select market sectors that typically involve companies who sell
products and services to individual consumers. These market sectors include
specialty retailers, petroleum retailers, supermarkets and financial services
providers. Additionally, we target market sectors that we believe have rapidly
evolving needs for electronic payment processing and customer management. The
mass transit, tollway and parking sectors' increasing acceptance of electronic
payments is enabling them to improve customer convenience while at the same time
reduce operating expenses. We have also expanded our market sectors to include
electric and gas utilities as we see an increasing demand in products and
services that help them compete in their evolving marketplace.
Our client base includes over 300 companies from these market sectors. Our
top six clients based on 1999 revenues are the retail affiliates of The Limited,
including Limited Too, Victoria's Secret, Express, Lane Bryant, Bath & Body
Works, Lerner New York, Henri Bendel and Structure, Brylane, Bank of Montreal,
Equiva Services, LLC, which is the service provider to Shell branded locations
in the U.S., CITGO and Canada Safeway.
We market and sell our service offerings on both a stand-alone and bundled
basis. Our products and services are centered around three core
offerings--Transaction Services, Credit Services and Loyalty and Database
Marketing Services. All three offerings support our goal of building loyalty
through transaction-based customer management solutions.
<TABLE>
<CAPTION>
LOYALTY AND DATABASE
TRANSACTION SERVICES CREDIT SERVICES MARKETING SERVICES
------------------------------ ------------------------------ ------------------------------
<S> <C> <C>
- Transaction Processing - Underwriting - Loyalty Programs
- Network Services - Risk Management - Private Label Cards
- Bankcard Settlement - Air Miles reward program
- Card Processing and - One-to-One Loyalty
Servicing
- Account Processing - Database Marketing Services
- Billing and Payment Processing - Direct Marketing
- Customer Care - Enhancement Services
</TABLE>
INDUSTRY DYNAMICS
The growing demand for integrated marketing solutions targeting consumers
has been fueled by rapid development of new competitors and sales channels,
intensifying competition for customers and an erosion of consumer brand loyalty.
The Internet has accelerated these trends by providing consumers with almost
instant access to a multitude of competing products and services without
traveling to an actual store location. As a result, companies are looking for
tools aimed at retaining existing customers as well as identifying and targeting
new groups of potential customers through any or all distribution channels.
We believe that companies understand the value of gathering and using
transaction data to:
- manage the interactions they have with their customers,
- increase sales; and
- increase customer loyalty.
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Companies increasingly seek services that compile and warehouse transaction
data and analyze consumer behavior to more effectively interact with their
customers. The increasing acceptance of electronic payment systems, including
credit, debit and stored value cards, generates highly valuable transaction data
on individual consumers, while the dramatic proliferation of technology has
enabled companies to capture, access and use this information easily and almost
instantaneously.
While companies recognize the significant benefit of capturing and using
purchasing data, many lack the economies of scale and core competencies
necessary to support their own transaction processing infrastructure and credit
card operations, including the extension of credit. In addition, many companies
look externally for the expertise to develop and manage their loyalty and
database marketing services. Thus, companies that provide the infrastructure to
create, manage and facilitate electronic payment systems can create a database
of valuable information on the purchasing behavior of consumers that is critical
for developing more targeted and effective marketing programs. For example, the
use of private label credit cards creates an opportunity for retailers to
strengthen consumer brand loyalty by encouraging repeat purchases through
discounts and other special promotions.
We believe that in today's competitive economy, retailers will find an
increasing need to differentiate their products and services from those of their
competitors through comprehensive, innovative marketing strategies. These
strategies will likely use technology to analyze and predict consumer behavior
and to provide the information necessary to execute direct marketing and
promotional campaigns more effectively to existing and potential customers.
STRATEGY AND OPPORTUNITIES FOR GROWTH
Consistent with our goal of becoming a critical component in the success of
our clients' businesses, we will continue to build and enhance our consumer
databases, marketing capabilities and processing efficiencies. We plan to
continue to employ our consumer databases, marketing capabilities and processing
efficiencies in efforts to help our clients target, acquire and retain loyal,
profitable customers. We believe that by assisting our clients in building loyal
customer relationships, our clients will view our services as an integral part
of their business operations. To accomplish this strategy of becoming a critical
component in our clients' relationships with their customers we intend to:
INCREASE THE PENETRATION OF PRODUCTS AND SERVICES WE PROVIDE TO OUR EXISTING
CLIENT BASE. We plan to further increase the number and types of products and
services we provide to our existing client base with a focus on loyalty and
database services.
EXPAND OUR CLIENT BASE IN EXISTING MARKET SECTORS. We plan to acquire new
clients in our traditional markets by continuing to distinguish ourselves as a
provider of customer relationship management solutions. We will further benefit
by what we believe will be a continued trend toward outsourcing as our existing
clients and potential new clients have increasing needs for new technology and
new skill sets. As retailers continue to search for the tools to increase loyal,
profitable customer relationships, we believe that our integrated and
comprehensive offering of loyalty and database marketing services and
transaction processing services will appeal to retailers, including e-commerce
businesses, faced with increasing competition and decreasing profit margins.
CONTINUE TO EXPAND OUR SERVICES AND CAPABILITIES TO HELP OUR CLIENTS SUCCEED
IN MULTI-CHANNEL COMMERCE. We plan to help our clients be successful in all
channels they choose for distribution--whether in-store, catalog or the
Internet. Our current client base is predominantly traditional store front and
catalog-based retailers. However, our clients recognize the importance of using
the Internet as an additional distribution channel. We can apply the systems and
marketing programs we have built to support our store and catalog clients using
the Internet. As an added benefit we believe our private label credit card
system provides additional protection against fraud. Our vision is to provide
our clients with a
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comprehensive view of each customer across all distribution channels and to
utilize this information to execute direct marketing programs through multiple
distribution channels.
CONSIDER FOCUSED, STRATEGIC ACQUISITIONS AND ALLIANCES TO ENHANCE OUR CORE
CAPABILITIES OR INCREASE OUR SCALE. As we identify new opportunities or product
gaps, we may consider focused acquisitions and alliances to enhance our
competencies or increase our scale.
PROGRAMS AND PRODUCTS
Our program and product offerings are centered around three core
offerings--Transaction Services, Credit Services and Loyalty and Database
Marketing Services.
TRANSACTION SERVICES
Effectively managing critical interactions with customers is required to
conduct everyday business--whether the business involves store, catalog or
Internet commerce. Our services include instantaneous authorizations, effective
customer care, efficient payment processing and billing services. By fully
integrating our transaction services with our loyalty and database marketing
services, we are able to execute more effective customer acquisition and
retention strategies for our clients. Our clients within this segment are made
up primarily of specialty retailers and petroleum retailers.
TRANSACTION PROCESSING. We are a leading provider of electronic transaction
services. Including our recent acquisitions, we processed 1.8 billion
transactions in 1998 on a pro forma basis, ranking us fourth in transaction
volume according to the Faulkner and Gray Card Industry 2000 report. We
processed 566.3 million transactions in the first quarter of 2000, a 29%
increase from 438.7 million transactions processed on a pro forma basis in the
first quarter of 1999. These transactions are processed through approximately
135,000 of our point-of-sale terminals. We believe we are the largest
transaction processor to the retail petroleum industry and we have a significant
presence in the specialty retail and transportation industries.
NETWORK SERVICES. We have built a fast and highly reliable network that
enables us to process all electronic payment types including credit card, debit
card, prepaid card, electronic benefits and fleet and check transactions. Our
recent acquisition of SPS's network transaction processing business has enabled
us to offer our existing products to new market segments as well as provide
additional products to existing clients. The network services we provide include
authorization, data capture and financial settlement of transactions. We also
provide merchants with on-line, two-way mail messaging that allows our clients
to improve communications with their individual locations by broadcasting and
receiving messages through their terminal devices. We support our clients with a
comprehensive help desk, operating 24 hours per day and seven days per week, as
well as terminal deployment and servicing.
We believe that we are one of the leaders in delivering new applications at
the point-of-sale, including video and audio electronic frequency and loyalty
programs, instant credit applications, and transponder and radio frequency
payment devices. We are active participants in establishing industry
point-of-sale standards.
MERCHANT BANKING SERVICES. Our merchant banking services include fast and
accurate financial settlement of MasterCard, Visa, Discover, American Express
and other electronic card transactions, including credit, debit and stored value
cards. By providing merchant banking services, we offer our clients the
flexibility to maintain their current settlement provider or to streamline their
end-to-end transaction processing with one provider. The merchant banking
services we provide also include daily deposit verification and accounting
reports.
CARDHOLDER PROCESSING AND SERVICING. As reported in the Faulkner & Gray
Card Industry 2000 report, based on the number of acocunts on file we were the
second largest outsourcer of retail private
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label card programs in the U.S. in 1998, with 57 million accounts on file. We
assist clients in issuing credit cards branded with the retailer's name or logo
that can be used by customers at the client's store locations. We also provide
service and maintenance to our clients' private label card programs and assist
our clients in acquiring, retaining and managing valuable repeat customers. Our
commercial card processing and servicing capabilities are specifically designed
to handle the unique requirements associated with providing a credit card
program to businesses. Our services include new account processing, risk
management, card embossing, credit authorization, statement and invoice printing
and mailing, and customer service.
ACCOUNT PROCESSING. We have developed a proprietary credit card system
designed specifically for retailers that offers significant flexibility in
processing accounts. We are able to make changes to accommodate our clients'
specific needs easily and quickly. We have also built into the system marketing
tools to assist our clients in increasing sales. Customer service screens have
prompts that, based on information from our client and the private label card
program, direct the customer service representative to extend a promotional
message. We provide credit card production services in a secured environment,
embossing 9.7 million new cards in 1999.
CUSTOMER CARE. Our retail heritage lies at the core of our culture and is
evident in our customer care operations. We focus our training programs in all
areas on achieving the highest possible standards. We monitor our performance by
conducting cardholder and store employee surveys. We have over 5,000 call center
seats in 12 locations, handling over 95 million customer inquiries in 1999. We
believe that we answer calls faster than the industry average. Our call centers
are equipped to handle phone, mail, fax and Internet inquiries. We also provide
collection activities to support our retail private label programs, where we
demonstrate our merchant mentality in our approach to maintaining the customer
relationship, within reasonable parameters, even when charge privileges have
been suspended.
BILLING AND PAYMENT PROCESSING. We use highly automated technology for bill
preparation, printing and mailing. Comingling statements, presorting and bar
coding allow us to take advantage of postal discounts. We generated on behalf of
our clients approximately 132.8 million statements in 1999 and 34.3 million
statements during the first quarter of 2000. In addition, we also process
cardholder remittances using state-of-the-art technology to maximize efficiency.
By doing so, we can improve the funds availability for both our clients and for
those private label receivables that we own or securitize.
CREDIT SERVICES
We believe that a private label credit card is one of the most effective
loyalty and marketing tools available. Our private label credit card program
allows our clients to make private label credit cards available for their
customers and offers our clients a funding vehicle for the credit card
receivables. We have been able to demonstrate the effectiveness of a private
label credit card program to our clients by making it a part of their complete
customer loyalty and marketing strategy. We believe that our ability to provide
a private label credit card program in a way that allows our clients to focus
their financial and operation resources on their core business is an important
part of our private label credit card service. As part of our private label
credit card service, we currently provide underwriting and risk management
services to 43 of our 48 private label credit clients, representing
49.4 million cardholders and $2.0 billion of receivables as of March 31, 2000.
Tracing back to our predecessor company, we have gained significant experience
and expertise in successfully managing private label portfolios since 1986.
Clients who utilize our credit services are predominantly specialty retailers.
ACCOUNT UNDERWRITING AND CREDIT GUIDELINES. Our underwriting process
involves the purchase of credit bureau information for each credit applicant. We
obtain a credit report from one of the major credit bureaus based on the
applicant's mailing address and the perceived strength of each credit bureau in
that geographic region. In our initial credit evaluation process, we use one of
our six
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proprietary scorecards that have been refined to reflect performance of the
various retail programs. We continuously validate, monitor and maintain the
scorecards, and we use resulting data to ensure optimal risk performance.
RISK MANAGEMENT. We monitor and control the quality of our portfolio by
using behavioral scoring models to score each active account on its monthly
cycle date. The behavioral scoring models dynamically evaluate credit limit
assignments to determine whether credit limits should be increased, decreased or
maintained and to establish pricing on fees based on the credit worthiness of
the individual cardholder. Our proprietary scoring models consider such factors
as how long the account has been on file, credit utilization, shopping patterns
and trends, payment history and account delinquency.
DELINQUENCY AND COLLECTIONS PROCEDURES. We consider an account delinquent
if the minimum payment due is not received by the billing due date. At that
time, we assign the account a status of 30 days delinquent. We print a message
requesting payment on a consumer cardholder's billing statement after a
scheduled payment has been missed. 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.
LOYALTY AND DATABASE MARKETING SERVICES
Our clients are focused on targeting, acquiring and retaining loyal and
profitable customers. We create and manage loyalty programs that have
successfully resulted in securing more frequent and sustained customer
purchasing. Our loyalty programs include private label cards, the Air Miles
reward program and one-to-one loyalty. We utilize the information gathered
through our loyalty programs to help our clients design and implement effective
marketing programs. Our clients within this segment are specialty retailers,
petroleum retailers, supermarkets and financial service providers.
PRIVATE LABEL CARDS. We have demonstrated to our clients that a private
label credit card can be one of the most effective loyalty and marketing tools
available. By providing a program that has meaningful benefits to the customer,
we can assist the retailer in strengthening its relationship with the customer.
Our experience indicates that long-term, retail card customers typically remain
more loyal to the retailer than general purpose users, both in the number of
visits to the retail establishment and the amount spent per visit. With our
integrated marketing tools, we can quantify the value of the private label card
customer for our clients. Additionally, our private label programs can be
further enhanced by our database marketing services that enable us to capture
item-level transaction data that are used to enhance communications with
customers and create successful customer relationship management strategies,
such as targeted promotions and cross-selling opportunities.
AIR MILES REWARD PROGRAM. In Canada, we operate what we believe to be the
largest loyalty program in Canada, where a wide variety of sponsors participate.
This program, marketed under the Air Miles brand name, enables consumers to earn
Air Miles reward miles as they shop across a range of retailers and other
sponsors participating in the Air Miles reward program. The program has over 100
brand names represented by the program sponsors, including Shell Canada, Canada
Safeway, Amex Bank of Canada (American Express), Bank of Montreal, Goodyear
Canada and A&P Canada. Air Miles reward miles collectors can redeem reward miles
for products and services such as plane tickets, gift certificates for
groceries, movie and theater tickets, and free long distance phone calls, among
others. We make these reward opportunities available through over 130 rewards
suppliers, including Canadian Airlines and Air Canada, the Toronto Blue Jays,
Marine Land and A&P Canada. The Air Miles reward program has enabled sponsors to
use this tool to effectively increase revenues by bringing
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new customers to the sponsor, retaining existing customers and increasing the
amount spent by customers. Based upon the most recent census data available, in
1999 our active participants represented over 55% of all Canadian households. We
have issued over six billion Air Miles reward miles since the program's
inception in 1992.
We deal with three primary parties in connection with our Air Miles reward
program:
- sponsors--our clients who enter the Air Miles reward program to build
their customers' loyalty;
- collectors--customers of our clients who enroll in the Air Miles reward
program and become collectors of Air Miles reward miles; and
- suppliers--suppliers of the rewards that we offer collectors, such as
airlines and merchandise providers.
SPONSORS
The size of our collector base provides incentives for current sponsors to
remain with the Air Miles reward program and prospective sponsors to join the
Air Miles reward program. A sponsor enters into an agreement with us to secure
exclusive rights for its particular region and product or service category, and
to reward customers for changing their shopping behavior. We believe the Air
Miles reward program offers sponsors a source of sustainable competitive
advantage and an opportunity to develop customer loyalty over a broader consumer
group than might be available to participants in a stand-alone rewards program.
Over a number of years, we have been able to develop a membership or collector
base of 5.8 million active collectors. Through the interaction of the Air Miles
reward program's appeal to both sponsors and collectors, we are able to increase
collector spending at and loyalty to participating sponsors.
COLLECTORS
The major benefits of the Air Miles reward program to collectors are that
they:
- receive a common currency from multiple sponsors--Air Miles reward miles;
- are able to generate additional Air Miles reward miles through their
choice of sponsors in the Air Miles reward program; and
- can redeem Air Miles reward miles at one location--through us.
The Air Miles reward program offers a reward structure that provides a quick
and easy way to earn a broad selection of travel, entertainment and other
lifestyle rewards, simply by shopping at participating sponsors. By virtue of
the increasing number of sponsors who join the Air Miles reward program,
collectors are able to accumulate Air Miles reward miles on much of their weekly
spending, from gasoline to groceries to department store purchases. To increase
the program's attractiveness to collectors and potential collectors, we have
developed a variety of rewards, and continue to add suppliers, for which the
accumulated Air Miles reward miles can be redeemed.
SUPPLIERS
We enter into supply agreements with suppliers of rewards to the program
such as airlines, movie theaters and consumer electronics. Such supply
agreements allows us to purchase goods at a set price from suppliers to the Air
Miles reward program. At the time we issue Air Miles reward miles, we record a
redemption obligation on our balance sheet in connection with our estimated cost
for future redemptions of reward miles. We make payments to suppliers pursuant
to the contractual supply arrangement when a collector redeems the Air Miles
reward miles.
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We have evaluated the creation of a similar loyalty program in the U.S.
Because of the significant funding requirements to establish such a program, we
have decided not to pursue the program. Our existing stockholders have decided
to pursue the program through a separate company called U.S. Loyalty Corp.,
which they will fund. We will not have any ownership interest in U.S. Loyalty
Corp. We intend to provide various services including management support,
accounting, transaction processing, data processing and marketing services for
U.S. Loyalty Corp. under various agreements that we plan to enter into with U.S.
Loyalty Corp. prior to this offering. We contemplate that such agreements will
include a management agreement, an employee lease agreement, a processing
agreement and a royalty agreement. Under the royalty agreement, we will enable
U.S. Loyalty Corp. to use the Air Miles brand and business concept in the United
States.
ONE-TO-ONE LOYALTY. We have developed a number of one-to-one real time,
electronic loyalty programs that enable our clients to increase the frequency of
customer purchasing. Through our programs, our clients can recognize,
acknowledge and reward good customers with instant reward programs that can be
implemented at the point of sale. Using the retailer's existing point-of-sale
terminal or cash register and our network services, we can capture points,
communicate program status and issue awards to the consumer at the point of
sale. Our stored value product, electronic gift certificates and prepaid cards
also encourage consumer loyalty, especially among cash customers. The retailer
issues stored value and prepaid cards that prominently display their logo and
can only be used at their retail locations.
DATABASE MARKETING SERVICES. We have built and manage massive databases
containing information on approximately 60 million U.S. consumers and
6.1 million Canadian households. Our U.S. consumer database contains nearly four
years of purchase information as well as details and results of marketing
programs conducted over the last four years. Through these databases we have
developed a suite of data mining and profiling products that enable our clients
to better understand their customers and aim their marketing dollars toward the
optimum opportunities for developing customer relationships. We use these
databases to assist our clients in predicting, analyzing and targeting their
customers' buying patterns.
We develop and execute programs designed to acquire and retain customers. We
provide total program management using direct mail, telemarketing, in-store and
on-line marketing strategies. Our services include strategy development,
creative services, production and mailshop coordination. Selected programs
include:
- QUICK CREDIT. The cornerstone of our ability to cost effectively acquire
customers for our clients is our "Quick Credit" product, which allows us
to quickly process new applications at point-of-sale terminals or cash
register devices. We view this product as a competitive advantage to our
private label card processing and servicing.
- SMART STATEMENTS. Through our Smart Statement capabilities, we have
transformed the traditional billing statement into a powerful marketing
tool by targeting individual customers with billing statements containing
personalized messages. Additionally, we can promote to small, specially
defined groups of the customer base to cross-sell specific products and
services. Additionally, our "smart insert" function allows us to include a
promotional incentive or coupon with the statement.
- ON-LINE PRE-SCREEN. For catalog clients we offer a pre-approved card by
soliciting customers when they place an order over the phone. The product,
which works similarly to Quick Credit, enables us to extend a credit offer
to a catalog customer at the completion of the order process.
ENHANCEMENT SERVICES. We develop programs designed to maintain active
customers while generating new revenue streams for our clients by cross selling
products and services to their existing customers. Services include sourcing,
promoting and fulfillment of products. These products are
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non-competitive with the clients' merchandise offering and include merchandise,
travel clubs and credit life insurance programs.
ASSET QUALITY
We securitize substantially all of the credit card receivables that we
underwrite. As of March 31, 2000, we had $16.4 million of credit card
receivables that had not been securitized. Our delinquency and net credit card
receivable charge-off rates at any point in time 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. At March 31, 2000, 20.6% of securitized accounts and 37.7%
of securitized loans were less than 24 months old. Accordingly, we believe that
our loan portfolio will experience increasing or fluctuating levels of
delinquency and loan losses as the average age of our accounts increases.
This trend is reflected in the change in our net charge-off ratio. For the
three months ended March 31, 2000, our securitized net charge-off ratio on an
annualized basis was 7.6%, up from 6.9% for the comparable period in 1999. For
1999, our securitized net charge-off ratio basis was 7.2% compared to 7.8% for
fiscal 1998 and 8.3% for fiscal 1997. We believe, consistent with our
statistical models and other credit analyses, that this rate will continue to
fluctuate but generally rise over the next year.
Our strategy for managing credit card receivable losses consists of credit
line management and customer purchase authorizations. We further manage credit
card receivable losses through the offering of credit lines that are generally
lower than industry standard. We continually manage individual accounts and
their related credit lines using various marketing, credit and other management
processes in order to continue to maximize the profitability of accounts.
DELINQUENCIES. Delinquencies not only affect earnings in the form of net
loan losses, but are also costly in terms of the personnel and other resources
dedicated to their resolution. 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 and all related loans, interest and other fees are charged off. The
following table presents the delinquency trends of our credit card loan
portfolio on a securitized basis:
<TABLE>
<CAPTION>
JANUARY 31, % OF DECEMBER 31, % OF DECEMBER 31, % OF MARCH 31, % OF
1998 TOTAL 1998 TOTAL 1999 TOTAL 2000 TOTAL
----------- -------- ------------ -------- ------------- -------- ---------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Receivables outstanding.... $2,021,599 100% $2,135,340 100% $2,232,375 100% $2,037,529 100%
Loans contractually
delinquent:
31 to 60 days............ 62,663 3.1% 52,581 2.5% 59,840 2.7% 47,724 2.3%
61 to 90 days............ 33,010 1.6 29,925 1.4 35,394 1.6 30,211 1.5
91 or more days.......... 50,312 2.5 53,885 2.5 60,025 2.7 54,985 2.7
---------- ----- ---------- ----- ---------- ----- ---------- -----
Total.................. $ 145,985 7.2% $ 136,391 6.4% $ 155,259 7.0% $ 132,920 6.5%
========== ===== ========== ===== ========== ===== ========== =====
</TABLE>
The above numbers reflect the continued seasoning of our securitized loan
portfolio. We intend to continue to focus our resources on our collection
efforts to minimize the negative impact to net loan losses that results from
increased delinquency levels.
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<PAGE>
NET CHARGE-OFFS. Net charge-offs comprise the principal amount of losses
from cardholders unwilling or unable to pay their credit card 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:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
FISCAL MARCH 31,
------------------------------------ -----------------------
1997 1998 1999 1999 2000
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Average loans outstanding(1)....... $1,615,196 $1,905,927 $2,004,827 $2,076,117 $2,139,647
Net charge-offs.................... 133,515 135,478 143,370 35,572 40,742
Net charge-offs as a percentage of
average loans outstanding
(annualized)..................... 8.3% 7.8% 7.2% 6.9% 7.6%
</TABLE>
------------------------
(1) Average loans outstanding is the average balance of the securitized
receivables at the beginning of each month in the period indicated.
AGE OF PORTFOLIO. The following table sets forth, as of March 31, 2000, the
number of total accounts and amount of outstanding loans, based upon the age of
the securitized accounts:
<TABLE>
<CAPTION>
PERCENTAGE
NUMBER OF PERCENTAGE OF LOANS OF LOANS
AGE SINCE ORIGINATION ACCOUNTS ACCOUNTS OUTSTANDING OUTSTANDING
--------------------- --------- ------------- ----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
0-5 Months...................................... 3,452 5.7% $236,611 11.6%
6-11 Months..................................... 2,830 4.7 195,655 9.6
12-17 Months.................................... 3,289 5.5 173,603 8.5
18-23 Months.................................... 2,813 4.7 162,567 8.0
24-35 Months.................................... 6,044 10.1 269,391 13.2
36+ Months...................................... 41,624 69.3 999,702 49.1
------ ------ ------- ------
Total....................................... 60,052 100.0% 2,$037,529 100.0%
====== ====== ======= ======
</TABLE>
SAFEGUARDS TO OUR BUSINESS
DISASTER AND CONTINGENCY PLANNING. We have a number of safeguards to
protect us from the risks we face as a business and as an industry. Given the
significant amount of data that we manage, much of which is real-time data to
support our clients' commerce initiatives, we have established redundant
facilities for our data centers. We operate two data processing centers. In the
event we experience an outage in one of our two data centers, we can move all
processing to the other data center. Additionally, we have contracted with a
third party to provide disaster and contingency planning in the event that both
data centers experience an outage.
PROTECTION OF INTELLECTUAL PROPERTY AND OTHER PROPRIETARY RIGHTS. We rely
on a combination of copyright, trade secret and trademark laws, confidentiality
procedures, contractual provisions and other similar measures to protect our
proprietary information and technology. We do not currently hold any patents nor
do we have any patent applications pending.
We generally enter into confidentiality or license agreements with our
employees, consultants and corporate partners, and generally control access to
and distribution of our technology, documentation and other proprietary
information. Despite the efforts to protect our proprietary rights, unauthorized
parties may attempt to copy or otherwise obtain the use of our products or
technology that we consider proprietary and third parties may attempt to develop
similar technology independently. We pursue registration and protection of our
trademarks primarily in the U.S. and Canada. Effective protection of
intellectual property rights may be unavailable or limited in some countries.
The laws of some countries do not protect our proprietary rights to the same
extent as in the U.S. and Canada.
64
<PAGE>
COMPETITION
The markets for our products and services are highly competitive. We compete
with traditional and online marketing companies, credit card issuers and data
processing companies, as well as with the in-house staffs of our current and
potential clients.
LOYALTY AND DATABASE MARKETING SERVICES. As a provider of loyalty and
database marketing products and services, we generally compete with advertising
and other promotional and loyalty programs, both traditional and online, for a
portion of a client's total marketing budget. In addition, we compete against
internally developed products and services created by our existing and potential
clients. For each of our loyalty and database products and services, we expect
competition to intensify as more competitors enter our market. In addition, new
competitors with our Air Miles reward program may target our sponsors and reward
miles collectors as well as draw rewards from our rewards suppliers. Our ability
to generate significant revenue from clients and loyalty partners will depend on
our ability to differentiate ourselves through the products and services we
provide and the attractiveness of our loyalty and rewards programs to consumers.
The continued attractiveness of our loyalty and rewards programs will depend in
large part on our ability to remain affiliated with sponsors that are desirable
to consumers and to offer rewards that are both attainable and attractive to
consumers. Intensifying competition will make it more difficult for us to do
this. For our database marketing services, our ability to continue to capture
detailed transaction data on consumers is critical in providing effective
customer relationship management strategies for our clients.
TRANSACTION SERVICES. The payment processing industry is highly
competitive, especially among the five largest payment processors in the U.S.,
which processed approximately 14 billion transactions during 1998. Including
recent acquisitions, we were the fourth largest payment processor in the U.S.,
processing 1.8 billion transactions during 1998 on a pro forma basis. Our top
three competitors have built their businesses by focusing on merchant banking
relationships, while our focus has been on industry segments characterized by
companies with large customer bases, customer rich data and high transaction
volumes. Our focus on specific market sectors allows us to develop and deliver
solutions targeted to the needs of these sectors. This focus is consistent with
our marketing strategy for all products and services. Additionally, we believe
we effectively distinguish ourselves from other payment processors by providing
solutions that help our clients leverage investments they have made in their
payment systems by using these systems for electronic marketing programs.
CREDIT SERVICES. Within our Credit Services business, our competition
consists primarily of financial institutions whose marketing focus has been on
developing credit card programs with large revolving balances. Our competition
further drives their businesses by cross selling their other financial products
to their cardholders. Our focus has been on targeting retailers that understand
the competitive advantage of developing loyal customers. Typically these
retailers have customers that make more frequent and smaller transactions. This
results in the effective capture of detail-rich data within our database
marketing services, allowing us to mine and analyze this data to develop
successful customer relationship management strategies for our clients.
As an issuer of private label credit cards, we compete with other card
payment types, primarily general-purpose credit cards like Visa, MasterCard and
American Express, as well as cash, checks and debit cards.
REGULATION
PRIVACY LEGISLATION. The enactment of legislation or industry regulations
arising from public concern over consumer privacy issues could have a material
adverse impact on our loyalty and database marketing services. Restrictions
could be placed upon the collection and use of information, in which case our
cost of collecting some kinds of data might be materially increased. Legislation
or industry regulation could also prohibit us from collecting or disseminating
certain types of data, which could adversely affect our ability to meet our
clients' expectations.
65
<PAGE>
In November 1999, President Clinton signed into law the Gramm-Leach-Bliley
Act, which requires financial institutions to comply with various notice
procedures in order to disclose nonpublic personal information about their
consumers to nonaffiliated third parties and restricts their ability to share
account numbers. The requirements of this law also apply to the disclosure of
any list, description or other grouping of consumers derived from nonpublic
personal information. This law makes it more difficult to collect and use
information that has been legally available and may increase our costs of
collecting some data.
The Clinton Administration is investigating further administrative action in
the area of privacy. In addition, Congress and a number of states are
considering further privacy legislation. It is possible that new privacy
protections will not be limited to financial institutions but could broadly
apply to the activities of all companies.
On April 13, 2000, the Canadian federal government and Minister of Industry
of Canada enacted the Personal Information Protection and Electronic Documents
Act. This act, which will become effective on January 1, 2001, comprises
comprehensive private sector privacy legislation that will apply to
organizations engaged in any commercial activities in Canada. It will enact into
law 10 privacy principles from the Canadian Standards Association's Model
Privacy Code. This act will also require organizations to obtain consent to the
collection, use or disclosure of personal information. The nature of the
required consent will depend on the sensitivity of the personal information and
will permit personal information to be used only for the purposes for which it
was collected. The Province of Quebec has had similar privacy legislation
applicable to the private sector in that province since 1994 and other provinces
are considering further privacy legislation.
FAIR CREDIT REPORTING ACT. The Fair Credit Reporting Act regulates consumer
reporting agencies. Under this Act, an entity risks becoming a consumer
reporting agency if it furnishes consumer reports to third parties. A consumer
report is a communication of information which bears on a consumer's
creditworthiness, credit capacity, credit standing or certain other
characteristics and which is collected or used or expected to be used to
determine the consumer's eligibility for credit, insurance, employment or
certain other purposes. The Fair Credit Reporting Act explicitly excludes from
the definition of consumer report a report containing information solely as to
transactions or experiences between the consumer and the entity making the
report. An entity may share consumer reports with any of its affiliates so long
as that entity provides consumers with an appropriate disclosure and an
opportunity to opt out of this affiliate sharing.
Our objective is to conduct our operations in a manner that would fall
outside the definition of consumer reporting agency under the Fair Credit
Reporting Act. If we were deemed to be a consumer reporting agency, however, we
would be subject to a number of complex and burdensome regulatory requirements
and restrictions. These restrictions could have a significant adverse economic
impact on us.
INTERSTATE TAXATION. Several states have passed legislation that attempts
to tax the income from interstate financial activities, including credit cards,
derived from accounts held by local state residents. We believe that this
legislation will not materially affect us. Our belief is based upon current
interpretations of the enforceability of such legislation, prior court decisions
and the volume of business we conduct in states that have passed legislation.
REGULATION OF THE BANK. World Financial is a limited purpose credit card
bank chartered as a national banking association and a member of the Federal
Reserve System. The Bank Insurance Fund, which is administered by the Federal
Deposit Insurance Corporation, insures the deposits of World Financial. World
Financial is subject to regulation and examination by the Office of the
Comptroller of the Currency, its primary regulator, and is also subject to
regulation by the Board of Governors of the Federal Reserve System and the
Federal Deposit Insurance Corporation, as back-up regulators. World
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<PAGE>
Financial is not a "bank" as defined under the Bank Holding Company Act;
instead, it is a credit card bank because it is in compliance with the following
requirements:
- it engages only in credit card operations;
- it does not accept demand deposits or deposits that the depositor may
withdraw by check or similar means for payment to third parties;
- it does not accept any savings or time deposits of less than $100,000,
except for deposits pledged as collateral for extensions of credit;
- it maintains only one office that accepts deposits; and
- it does not engage in the business of making commercial loans.
If World Financial failed to meet the credit card bank criteria described
above, World Financial would be a "bank" as defined by the Bank Holding Company
Act, subjecting us to the provisions, requirements and restrictions of the Bank
Holding Company Act as a bank holding company. We believe that becoming a bank
holding company would significantly harm us, as we would be required to either
divest our non-banking activities or cease all activities that are not
permissible for a bank holding company and its affiliates.
INVESTMENT IN OUR COMPANY AND WORLD FINANCIAL NETWORK NATIONAL
BANK. Because of our ownership of World Financial, certain acquisitions of our
common stock may be subject to regulatory approval or notice under Federal law.
Investors are responsible for insuring that they do not directly or indirectly
acquire our common stock in excess of the amount that can be acquired without
regulatory approval.
EXPORTATION OF INTEREST RATES AND FEES. National banks such as World
Financial may charge interest at the rate allowed by the laws of the state where
the bank is located, and may "export" those interest rates on loans to borrowers
in other states, without regard to the laws of such other states. In 1996, the
United States Supreme Court ruled that national banks may also impose fees
material to a determination of the interest rate allowed by the laws of the
state where the national bank is located on borrowers in other states, without
regard to the laws of such other states. The Supreme Court based its opinion
largely on its deference to a regulation adopted by the Office of the
Comptroller of the Currency that includes certain fees, including late fees,
over limit fees, annual fees, cash advance fees and membership fees, within the
term "interest" under the provision of the National Bank Act that has been
interpreted to permit national banks to export interest rates. As a result,
national banks such as World Financial may export such fees.
DIVIDENDS AND TRANSFERS OF FUNDS. Federal law limits the extent to which
World Financial can finance or otherwise supply funds to us and our affiliates
through dividends, loans or otherwise. These limitations include:
- minimum regulatory capital requirements; and
- restrictions concerning the payment of dividends out of net profits or
surplus and Sections 23A and 23B of the Federal Reserve Act governing
transactions between a bank and its affiliates.
In general, Federal law prohibits a national bank such as World Financial
from making dividend distributions on common stock if the dividend would exceed
currently available undistributed profits. In addition, World Financial must get
prior approval from the Office of the Comptroller of the Currency for a dividend
if the distribution would exceed current year net income combined with retained
earnings from the prior two years less dividends paid in the current fiscal
year. World Financial cannot make a dividend payment if the distribution would
cause it to fail to meet applicable capital adequacy standards.
COMPTROLLER OF THE CURRENCY
SAFETY AND SOUNDNESS. The Federal Deposit Insurance Corporation Improvement
Act of 1991 requires banking agencies to prescribe certain non-capital standards
for safety and soundness relating generally to operations and management, asset
quality and executive compensation. This act also provides that regulatory
action may be taken against a bank that does not meet such standards.
67
<PAGE>
CAPITAL ADEQUACY. World Financial is subject to various regulatory capital
requirements administered by the Office of the Comptroller of the Currency.
Failure to meet minimum capital requirements can initiate certain mandatory and
possibly additional discretionary actions by regulators that, if undertaken,
could have a direct material effect on our financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
World Financial must meet specific capital guidelines that involve quantitative
measures of its assets, liabilities and certain off-balance-sheet items as
calculated under regulatory accounting practices. The capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require World Financial to maintain minimum amounts and ratios of total and Tier
1 capital to risk weighted assets, and of Tier 1 capital to average assets.
Under the regulations, a "well capitalized" institution must have a Tier 1
captial ratio of at least six percent, a total capital ratio of at least 10
percent and a leverage ratio of at least five percent and not be subject to a
capital directive order. An "adequately capitalized" institution must have a
Tier 1 capital ratio of at least four percent, a total capital ratio of at least
eight percent and a leverage ratio of at least four percent, but three percent
is allowed in some cases. Under these guidelines, World Financial is considered
well capitalized. As of March 31, 2000, World Financial's Tier 1 capital ratio
was 54.9%, total capital ratio was 55.7% and leverage ratio was 54.6%, and World
Financial was not subject to a capital directive order.
The Office of the Comptroller of the Currency's risk-based capital standards
explicitly consider a bank's exposure to a decline in the economic value of its
capital due to changes in interest rates when evaluating a bank's capital
adequacy. Interest rate risk is the exposure of a bank's current and future
earnings and equity capital arising from adverse movements in interest rates.
This evaluation is made as a part of World Financial's regular safety and
soundness examination.
FEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991. The
Improvement Act requires the Federal Deposit Insurance Corporation to implement
a system of risk-based premiums for deposit insurance. Pursuant to this system,
the premiums paid by a depository institution will be based on the probability
that the FDIC will incur a loss in respect of that institution. The FDIC has
adopted a system that imposes insurance premiums based upon a matrix that takes
into account a bank's capital level and supervisory rating. Due to its capital
level and supervisory rating, World Financial currently pays the lowest rate on
deposit insurance premiums.
Under the Improvement Act, only "well capitalized" and "adequately
capitalized" banks may accept brokered deposits. "Adequately capitalized" banks,
however, must first obtain a waiver from the FDIC before accepting brokered
deposits and these deposits may not pay rates that significantly exceed the
rates paid on deposits of similar size and maturity accepted from the bank's
normal market area or the national rate on deposits of comparable maturity, as
the FDIC determines, for deposits from outside the bank's normal market area.
World Financial issues certificates of deposit in amounts of $100,000 or
greater.
LENDING ACTIVITIES. World Financial's activities as a credit card lender
are also subject to regulation under various Federal consumer protection laws
including the Truth-in-Lending Act, the Equal Credit Opportunity Act, the Fair
Credit Reporting Act, the Community Reinvestment Act, the Soldiers' and Sailors'
Civil Relief Act and state consumer protection laws. Regulators are authorized
to impose penalties for violations of these statutes and, in certain cases, to
order banks such as World Financial to pay restitution to injured cardholders.
Cardholders may also bring actions for violations of these regulations. Federal
and state bankruptcy and debtor relief laws also affect World Financial's
ability to collect outstanding balances owed by cardholders who seek relief
under these laws.
For the purposes of the Office of the Comptroller of the Currency's
Community Reinvestment Act Regulations, World Financial has applied for and
received a limited purpose designation. The
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<PAGE>
regulations subject banks receiving such a designation to a community
development test for evaluating required Community Reinvestment Act compliance.
The community development performance of a limited purpose bank is evaluated
pursuant to various criteria involving qualified investments and community
development services. As of March 31, 2000, World Financial had met its minimum
responsibilities under the Act.
CONSUMER AND DEBTOR PROTECTION LAWS. From time to time legislation has been
proposed in Congress to limit interest rates and fees that could be charged on
credit card accounts or otherwise restrict practices of credit card issuers. If
this or similar legislation is proposed and adopted, our ability to collect on
account balances or maintain previous levels of finance charges and other fees
could be adversely affected. Additionally, changes have been proposed to the
Federal bankruptcy laws. Changes in Federal bankruptcy laws and any changes to
state debtor relief and collection laws could adversely affect us if these
changes result in, among other things, accounts being charged off as
uncollectible and additional administrative expenses. It is unclear at this time
whether and in what form any legislation will be adopted or, if adopted, what
its impact on us would be. Congress may in the future consider other legislation
that would materially affect the credit card and related fee-based services
industries.
Existing laws and regulations may permit class action lawsuits on behalf of
customers in the event of violations of applicable laws, and these lawsuits can
be very expensive to defend, even without any violation. If a class action were
determined adversely, it might have a material adverse effect on us.
EMPLOYEES
As of March 31, 2000, we employed approximately 5,600 people in the U.S.,
Canada and New Zealand.
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.
A breach of contract claim was filed against us in July 1999 by Service
Merchandise, Inc. in U.S. Bankruptcy Court for the Middle District of Tennessee.
Service Merchandise, which is in voluntary Chapter 11 bankruptcy, alleged that
World Financial breached its contractual obligation by changing its underwriting
standards for existing created credit card accounts, causing Service Merchandise
to suspend performance under the agreement and subsequently to terminate it.
Service Merchandise also alleged that World Financial's actions effectively
violated the automatic stay provisions of the U.S. Bankruptcy Code. In December
1999, the Bankruptcy Court dismissed Service Merchandise's complaint for lack of
standing. In February 2000, Service Merchandise and its subsidiary, Service
Credit Corp., filed an amended complaint. The amended complaint again alleged
that World Financial breached various contractual provisions by unilaterally
revising the credit standards applicable to existing cardholders and withholding
monthly program payments from Service Credit Corp. and also alleged violations
of the automatic stay provisions of the U.S. Bankruptcy Code. Service
Merchandise has not specified its alleged damages. In April 2000, we moved to
dismiss the amended complaint. Service Merchandise has not yet responded to our
motion to dismiss. We believe this suit is without merit and we intend to defend
it vigorously. Although the outcome of this matter is undetermined, we do not
believe that if this suit is ultimately determined in favor of Service
Merchandise, it will have a material adverse effect on our business, financial
condition or operating results. As of March 31, 2000, we had a balance of
$89.9 million in credit card receivables related to the Service Merchandise
agreement in our securitization trusts.
On April 25, 2000, as part of its restructuring proceedings under the
Canadian Companies' Creditors Arrangement Act, Canadian Airlines filed a plan of
reorganization with the Court of Queen's Bench in Alberta, Canada, which
included us in a list of unsecured creditors. In connection with
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<PAGE>
entering into new supply agreements with Air Canada and Canadian Airlines
relating to our Air Miles reward program, we assigned to Air Canada our claims
as an unsecured creditor of Canadian Airlines in the restructuring proceedings.
PROPERTIES
The following table sets forth information with respect to our principal
facilities.
<TABLE>
<CAPTION>
CURRENT APPROXIMATE
MONTHLY SQUARE
LOCATION SEGMENT LEASE RATE FOOTAGE
-------- ---------------------------- -------------------------- -----------
<S> <C> <C> <C>
Northglenn, Colorado........ Transaction Services $ 37,104 65,000
Buffalo Grove, Illinois..... Transaction Services $ 35,399 24,136
Lenexa, Kansas.............. Transaction Services $ 45,244 65,000
Mission, Kansas............. Transaction Services $ 14,107 40,019
Minneapolis, Minnesota...... Loyalty and Database $ 4,386 3,105
Marketing Services and
Transaction Services
Minneapolis, Minnesota...... Loyalty and Database $ 31,997 28,442
Marketing Services and
Transaction Services
Voorhees, New Jersey........ Transaction Services $ 75, 431 67,050
Columbus, Ohio.............. Transaction Services $ 36,536 103,161
Columbus, Ohio.............. Transaction Services and $ 69,407 100,800
Credit Services
Columbus, Ohio.............. Transaction Services $ 14,400 57,600
Columbus, Ohio.............. Loyalty and Database $ 40,733 54,615
Marketing Services,
Transaction Services and
Credit Services
Columbus, Ohio.............. Transaction Services and $ 25,535 32,255
Credit Services
Columbus, Ohio.............. Loyalty and Database $ 10,820 39,951
Marketing Services,
Transaction Services and
Credit Services
Marietta, Ohio.............. Credit Services $ 5,200 6,240
Gray, Tennessee............. Transaction Services $ 2,500 1,930
Dallas, Texas............... Loyalty and Database $ 114,228 114,419
Marketing Services and
Transaction Services
Dallas, Texas............... Loyalty and Database $ 57,479 61,750
Marketing Services,
Transaction Services and
Credit Services
Dallas, Texas............... Transaction Services $ 18,224 72,897
San Antonio, Texas.......... Transaction Services $ 47,692 67,540
Mississauga, Ontario, $ 42,500 40,000
Canada.................... Loyalty and Database
Marketing Services
Toronto, Ontario, Canada.... Loyalty and Database $ 81,492 91,534
Marketing Services
Montreal, Quebec, $ 3,125 5,000
Canada.................... Loyalty and Database
Marketing Services
Calgary, Alberta, Canada.... Loyalty and Database $ 9,066 8,059
Marketing Services
Auckland, New Zealand....... Transaction Services $ 12,041 11,700
-------------------------- ----------
Total..................... $ 834,646 1,162,203
========================== ==========
<CAPTION>
LEASE
EXPIRATION
LOCATION DATE
-------- ------------------------------------
<S> <C>
Northglenn, Colorado........ August 31, 2007
Buffalo Grove, Illinois..... February 29, 2010
Lenexa, Kansas.............. January 31, 2008
Mission, Kansas............. June 30, 2000
Minneapolis, Minnesota...... August 31, 2004
Minneapolis, Minnesota...... August 31, 2004
Voorhees, New Jersey........ January 1, 2005
Columbus, Ohio.............. January 31, 2008
Columbus, Ohio.............. January 25, 2001
Columbus, Ohio.............. August 31, 2004
Columbus, Ohio.............. August 31, 2007
Columbus, Ohio.............. August 31, 2007
Columbus, Ohio.............. August 31, 2002
Marietta, Ohio.............. April 30, 2000
Gray, Tennessee............. November 14, 2000
Dallas, Texas............... November 30, 2009
Dallas, Texas............... July 31, 2007
Dallas, Texas............... April 30, 2006
San Antonio, Texas.......... January 31, 2002
Mississauga, Ontario, August 31, 2009
Canada....................
Toronto, Ontario, Canada.... September 16, 2007
Montreal, Quebec,
Canada.................... June 30, 2009
Calgary, Alberta, Canada.... December 31, 2004
Auckland, New Zealand....... September 13, 2005
Total.....................
</TABLE>
We recently signed an amendment to the lease for one of our properties in
Dallas, Texas. The amendment provides for the construction and lease of an
expansion building adjacent to one of our existing buildings. We expect the
expansion building to be completed in October 2000. We believe our current and
proposed facilities are suitable to our businesses and that we will be able to
lease, purchase
or newly construct additional facilities as needed.
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MANAGEMENT
The following table sets forth the name, age and positions of each of our
executive officers, business unit presidents and directors as of March 31, 2000:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- -------- ------------------------------------------
<S> <C> <C>
J. Michael Parks.......................... 49 Chairman of the Board of Directors, Chief
Executive Officer and President
Ivan Szeftel.............................. 46 Executive Vice President and President,
Retail Credit Services
John Scullion............................. 42 President and Chief Executive Officer, The
Loyalty Group
Ronald G. Carter.......................... 48 Executive Vice President and President,
Network Services
James E. Anderson......................... 46 Executive Vice President and President,
Utilities Services
Michael A. Beltz.......................... 44 Executive Vice President and President,
Business Development and Planning
Edward K. Mims............................ 50 Executive Vice President and Chief
Financial Officer
Dwayne H. Tucker.......................... 43 Senior Vice President, Human Resources and
Administration
Steven T. Walensky........................ 42 Senior Vice President, Chief Information
Officer
Robert P. Armiak.......................... 38 Vice President and Treasurer
Michael D. Kubic.......................... 44 Vice President, Corporate Controller and
Chief Accounting Officer
Carolyn S. Melvin......................... 47 Vice President, Secretary and General
Counsel
Richard E. Schumacher, Jr................. 33 Vice President, Tax
Bruce K. Anderson......................... 59 Director
Anthony J. deNicola....................... 35 Director
Daniel P. Finkelman....................... 44 Director
Robert A. Minicucci....................... 47 Director
Bruce A. Soll............................. 42 Director
Kenneth R. Jensen......................... 56 Director Nominee
</TABLE>
J. MICHAEL PARKS, chairman of the board of directors, chief executive
officer and president, joined us in March 1997. Before joining us, Mr. Parks was
president of First Data Resources, the credit card processing and billing
division of First Data Corporation, from December 1993 to July 1994. Mr. Parks
joined First Data Corporation in July 1976 where he gained increased
responsibility for sales, service, operations and profit and loss management
during his 18 years of service. Mr. Parks holds a Bachelor's degree from the
University of Kansas.
IVAN SZEFTEL, executive vice president and president of our Retail Services
business unit, joined us in May 1998. Before joining us, he served as chief
operating officer of Forman Mills, Inc. from November 1996 to April 1998. Prior
to that, he served as executive vice president and chief financial officer of
Charming Shoppes, Inc. from November 1981 to February 1996. Mr. Szeftel holds
Bachelor's and post graduate degrees from the University of Cape Town and is a
Certified Public Accountant in the State of Pennsylvania.
JOHN SCULLION, president and chief executive officer of Loyalty Management
Group Canada Inc., joined The Loyalty Group in October 1993. Prior to becoming
president, he served as chief operating officer for The Loyalty Group. Prior to
that, he served as chief financial officer of The Rider Group
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<PAGE>
from September 1988 to October 1993. Mr. Scullion holds a Bachelor's degree from
the University of Toronto.
RONALD G. CARTER, executive vice president and president of our Network
Services business unit, joined us in February 1998. Before joining us, he served
as president of BuyPass Corporation, the network services division of Concord
EFS, Inc., from June 1995 to February 1998. Prior to BuyPass Corporation, he
held positions at First Data Corporation from August 1992 to January 1995.
Mr. Carter holds a Bachelor's degree from the University of Tulsa.
JAMES E. ANDERSON, executive vice president and president of our Utilities
Services business unit, joined us in May 1997. Before joining us, he was
employed from November 1985 to March 1997 by First Data Corporation, serving in
various leadership capacities, the most recent of which was executive vice
president bankcard services. He holds a Bachelor's degree from the University of
Iowa and a Master's degree from National University.
MICHAEL A. BELTZ, executive vice president and president of business
development and planning, joined us in May 1997. He is responsible for database
marketing services, new market identification, corporate product development and
marketing, acquisitions and strategic planning. Before joining us, he served as
executive vice president of sales and acquisitions of First Data Corporation
from July 1983 to April 1997. Mr. Beltz holds a Bachelor's degree from the
University of Nebraska.
EDWARD K. MIMS, executive vice president and chief financial officer, joined
us in February 1998. Before joining us, he served as executive vice president
and chief financial officer of Vidpro International Inc. from May 1997 to
February 1998. Prior to that, he had served as executive vice president and
chief financial officer of Comerica Bank--Texas from October 1983 to
March 1997. He holds a Bachelor's degree from Southern Methodist University and
is a Certified Public Accountant in the State of Texas.
DWAYNE H. TUCKER, senior vice president of human resources and
administration, joined us in June 1999. He is responsible for recruitment,
organization development, training, facilities and corporate communications.
Before joining us, he served as vice president of human resources for Northwest
Airlines from February 1998 to February 1999 and as senior vice president of
human resources for First Data Corporation from March 1990 to February 1998.
Mr. Tucker holds a Bachelor's degree from Tennessee State University.
STEVEN T. WALENSKY, senior vice president and chief information officer,
joined us in July 1998. He is responsible for management of the corporate
information services organization. Before joining us, he served as senior vice
president of data center services for First Data Corporation from October 1995
to June 1998. Prior to that, he held management positions with Visa
International and Sprint. Mr. Walensky holds a Bachelor's degree from Rockhurst
College.
ROBERT P. ARMIAK, vice president and treasurer, joined us in February 1996.
He is responsible for cash management, hedging strategy, risk management and
capital structure. Before joining us, he held several positions, including most
recently, treasurer, at FTD Inc. from August 1990 to February 1996. He holds a
Bachelor's degree from Michigan State University and an MBA from Wayne State
University.
MICHAEL D. KUBIC, vice president, corporate controller and chief accounting
officer, joined us in October 1999. Before joining us, he served as vice
president of finance for Kevco, Inc. from March 1999 to October 1999. Prior to
that he served as vice president and corporate controller for BancTec, Inc. from
September 1993 to February 1998. Mr. Kubic holds a Bachelor's degree from the
University of Massachusetts and is a Certified Public Accountant in the State of
Texas.
CAROLYN S. MELVIN, vice president of legal services, general counsel and
secretary, joined us in September 1995 as vice president, general counsel and
secretary of World Financial. She is responsible for legal, audit and
compliance. Before joining us, she served as vice president and counsel for
National
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City Corporation from December 1982 until September 1995. Ms. Melvin holds a
B.A. degree from Dickinson College and a J.D. from Ohio State University College
of Law.
RICHARD E. SCHUMACHER, JR., vice president of tax, joined us in
October 1999. He is responsible for corporate tax affairs. Before joining us, he
served as tax senior manager for Deloitte & Touche LLP from 1989 to
October 1999 where he was responsible for client tax services and practice
management and was in the national tax practice serving the banking and
financial services industry. Mr. Schumacher holds a Bachelor's degree from Ohio
State University and a Master's from Capital University Law and Graduate School
and is a Certified Public Accountant in the State of Ohio.
BRUCE K. ANDERSON has served as a director since our merger in August 1996.
Since March 1979, he has been a partner and co-founder of the investment firm,
Welsh, Carson, Anderson and Stowe. Prior to that, he spent nine years with ADP
where as executive vice president and a member of the board of directors, he was
active in corporate development and general management. Before joining ADP,
Mr. Anderson spent four years in computer marketing with IBM and two years in
consulting. Mr. Anderson is currently a director of Amdocs Limited. He holds a
Bachelor's degree from the University of Minnesota.
ANTHONY J. DENICOLA has served as a director since our merger in
August 1996. Mr. deNicola is a partner with Welsh, Carson, Anderson and Stowe,
joining the firm in April 1994. Prior to that, he spent four years with William
Blair & Company, financing middle market buy-outs from July 1990 to February
1994. Mr. deNicola is currently a director of Centennial Cellular Corporation.
He holds a Bachelor's degree from DePauw University and an MBA from Harvard
Business School.
DANIEL P. FINKELMAN has served as a director since January 1998.
Mr. Finkelman is senior vice president of The Limited, Inc. and is responsible
for all brand and business planning for that specialty retailer. He has been
employed with The Limited since August 1996. Before joining The Limited, he was
self-employed as a consultant from February 1996 to August 1996 and he served as
executive vice president of marketing for Cardinal Health, Inc. from May 1994 to
February 1996. Prior to that, he was a partner with McKinsey & Company where he
was co-leader of the firm's marketing practice, focusing on loyalty and customer
relationship management. Mr. Finkelman holds a Bachelor's degree from Grinnell
College and graduated as a Baker Scholar at Harvard Business School.
ROBERT A. MINICUCCI has served as a director since our merger in
August 1996. Mr. Minicucci is a partner with Welsh, Carson, Anderson and Stowe,
joining the firm in August 1993. Before joining Welsh, Carson, Anderson and
Stowe, he served as senior vice president and chief financial officer of First
Data Corporation from December 1991 to August 1993. Mr. Minicucci is currently a
director of Amdocs Limited. Mr. Minicucci holds a Bachelor's degree from Amherst
College and an MBA from Harvard Business School.
BRUCE A. SOLL has served as a director since February 1996. Mr. Soll is
senior vice president and counsel of The Limited, where he has been employed
since September 1991. Before joining The Limited, he served as the Counsellor to
the Secretary of Commerce in the Bush Administration from February 1989 to
September 1991 where he was a senior policy official, focusing on international
trade, telecommunications and technology. Mr. Soll holds a Bachelor's degree
from Claremont McKenna College and a J.D. from the University of Southern
California Law School.
KENNETH R. JENSEN has been nominated to serve as a director. Mr. Jensen has
been executive vice president, chief financial officer, treasurer, assistant
secretary and a director of Fiserv, Inc., a public company engaged in data
processing outsourcing, since July 1984. He was named senior executive vice
president of Fiserv in 1986. Mr. Jensen holds a Bachelor's degree from Princeton
University in Economics, an MBA from the University of Chicago in Accounting,
Economics and Finance and a Ph.D. from the University of Chicago in Accounting,
Economics and Finance.
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CLASSES OF BOARD OF DIRECTORS
Our certificate of incorporation authorizes there to be between six and 12
directors. Our board of directors currently consists of six members, we have
nominated Kenneth R. Jensen to serve as an independent director, and we intend
to designate two additional independent directors before consummation of this
offering. Our board is divided into three classes that serve staggered
three-year terms, as follows:
<TABLE>
<CAPTION>
CLASS EXPIRATION OF TERM MEMBERS
----- ------------------ -----------------------
<S> <C> <C>
Class I............................. 2000 Anthony J. deNicola,
Bruce A. Soll
Class II............................ 2001 Bruce K. Anderson,
Daniel P. Finkelman
Class III........................... 2002 Robert A. Minicucci,
J. Michael Parks
</TABLE>
Newly elected directors and any additional directorships resulting from an
increase in the number of directors will be distributed among the three classes
so that, as nearly as possible, each class will consist of one-third of the
directors. There are no family relationships among any of our directors,
executive officers or division presidents.
COMMITTEES OF THE BOARD OF DIRECTORS
Our full board of directors has fulfilled the function of an audit committee
and compensation committee for the last fiscal year. Upon the consummation of
this offering, our board of directors will establish an audit committee, a
compensation committee and an executive committee.
The audit committee, which will consist of three independent directors
including Mr. Jensen, will review the scope and approach of the annual audit,
our annual financial statements and related auditors' report and the auditors'
comments relative to the adequacy of our system of internal controls and
accounting systems. The audit committee will also recommend to our board of
directors the appointment of independent public accountants for the following
year. The audit committee will consist of at least three members, all of whom
will be financially literate and will be independent directors and one of whom
will have significant experience in accounting or finance matters. Our audit
committee will adopt and periodically review a written charter that will specify
the scope of its responsibilities.
The compensation committee, which currently consists of Bruce A. Soll and
Daniel P. Finkelman, will review management compensation levels and provide
recommendations to our board of directors regarding salaries and other
compensation for our executive officers, including bonuses and incentive plans,
and will administer our stock option plan.
The executive committee, which will consist of three directors, will have
the power and authority of our board of directors to manage our affairs between
meetings. The executive committee will also regularly review significant
corporate matters and recommend action as appropriate to our board of directors.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Prior to this offering, our board of directors as a whole made decisions
relating to the compensation of Michael Parks and the executive officers
reporting directly to him. During this time, Mr. Parks participated in all
discussions concerning compensation of the executive officers reporting directly
to him, except that Mr. Parks was excluded from discussions regarding his own
compensation. None of our executive officers served as a member of the board of
directors or the compensation
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committee of any entity that has one or more executive officers serving on our
board of directors or on the compensation committee of our board of directors.
DIRECTOR COMPENSATION
All directors are reimbursed for reasonable out-of-pocket expenses incurred
while serving on the board of directors and any committee of the board of
directors. Our non-employee directors currently participate in our amended and
restated stock option and restricted stock plan. Individuals who are
non-employee directors on the day of this offering will have a choice of
receiving either (1) a nonqualified stock option to purchase 42,000 shares of
our common stock or (2) a nonqualified stock option to purchase 28,500 shares of
our common stock plus a cash compensation package providing cash compensation of
$15,000 annually, $1,000 for each board meeting attended and $500 for each
committee meeting attended. Non-employee directors who are elected after this
offering will make this choice of compensation alternatives upon becoming
directors and will receive the nonqualified stock options on the date that they
first become directors.
EXECUTIVE COMPENSATION
The following table sets forth the annual and long-term compensation for
each of the last three fiscal years for our chief executive officer and our four
other most highly compensated executive officers during 1999. These five
individuals are referred to as the named executive officers.
<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION COMPENSATION
---------------------- -----------------
SECURITIES
UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY ($) BONUS(1) OPTIONS, SARS (#) COMPENSATION
--------------------------- -------- ---------- --------- ----------------- --------------
<S> <C> <C> <C> <C> <C>
J. Michael Parks(2)........................... 1999 $ 475,000 $ 440,000 83,333 $ 25,069
Chairman of the Board, 1998 $ 475,000 $ 440,000 -- $ 18,953
Chief Executive Officer and President 1997 $ 395,833 $ 160,000 333,332 $ 61,474
Ivan Szeftel(3)............................... 1999 $ 315,625 $ 221,500 22,222 $ 10,859
President, Retail Credit Services 1998 $ 192,115 $ 155,833 111,111 $ 29,430
Michael A. Beltz(4)........................... 1999 $ 250,000 $ 219,500 22,222 $ 8,929
Executive Vice President and President, 1998 $ 250,000 $ 220,000 66,665 $ 6,448
Business Development and Planning 1997 $ 163,141 $ 125,000 44,444 $ 64,112
Edward K. Mims(5)............................. 1999 $ 232,500 $ 127,584 33,333 $ 10,781
Executive Vice President 1998 $ 189,231 $ 123,750 55,555 $ 4,294
and Chief Financial Officer
James E. Anderson(6).......................... 1999 $ 221,667 $ 134,663 33,333 $ 8,688
Executive Vice President and 1998 $ 202,500 $ 112,063 27,777 $ 5,770
President, Utilities Services 1997 $ 126,667 $ 70,000 27,777 $ 47,315
</TABLE>
--------------------------
(1) Bonuses represent amounts earned by each executive officer during the
referenced year, although paid in the following year. We historically pay
bonuses each March for the prior year.
(2) Mr. Parks has been employed with us since March 1997.
(3) Mr. Szeftel has been employed with us since May 1998.
(4) Mr. Beltz has been employed with us since May 1997.
(5) Mr. Mims has been employed with us since February 1998.
(6) Mr. Anderson has been employed with us since May 1997.
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<PAGE>
All other compensation amounts include our matching contributions to the
401(k) and Retirement Savings Plan, the Supplemental Executive Retirement Plan,
the life insurance premiums we pay on behalf of each executive officer,
relocation expenses and sign-on bonuses as follows:
<TABLE>
<CAPTION>
LIFE INSURANCE SIGN-ON
YEAR 401(K) PLAN PREMIUMS SERP RELOCATION BONUS
-------- ----------- -------------- -------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
J. Michael Parks........................ 1999 $10,603 $216 $14,250 -- --
1998 $10,923 $180 $ 7,850 -- --
1997 $ 3,829 $180 -- $57,465 --
Ivan Szeftel............................ 1999 $10,671 $187 -- -- --
1998 $ 4,286 $144 -- -- $25,000
Michael A. Beltz........................ 1999 $ 8,784 $144 -- -- --
1998 $ 4,375 $120 -- $ 1,953 --
1997 -- $120 -- $63,992 --
Edward K. Mims.......................... 1999 $10,646 $135 -- -- --
1998 $ 4,186 $108 -- -- --
James E. Anderson....................... 1999 $ 8,558 $130 -- -- --
1998 $ 4,100 $ 91 -- $ 1,578 --
1997 -- $ 91 -- $47,224 --
</TABLE>
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth certain information concerning option grants
made to the named executive officers during 1999 pursuant to our stock option
plan.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
-------------------------------------------------- POTENTIAL REALIZABLE VALUE
PERCENTAGE OF AT ASSUMED ANNUAL RATES
NUMBER OF TOTAL OPTIONS OF STOCK PRICE
SECURITIES GRANTED TO APPRECIATION FOR OPTION
UNDERLYING EMPLOYEES IN EXERCISE TERM ($)(2)
OPTIONS FISCAL PRICE EXPIRATION ---------------------------
GRANTED(#) YEAR(1) ($/SH) DATE 5% 10%
---------- ------------- -------- ---------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
J. Michael Parks.............. 83,333 12.9% $9.90 2/1/2008 $518,836 $1,314,832
Ivan Szeftel.................. 22,222 3.5% $9.90 2/1/2008 $138,355 $ 350,620
Michael A. Beltz.............. 22,222 3.5% $9.90 2/1/2008 $138,355 $ 350,620
Edward K. Mims................ 33,333 5.2% $9.90 2/1/2008 $207,533 $ 525,930
James E. Anderson............. 33,333 5.2% $9.90 2/1/2008 $207,533 $ 525,930
</TABLE>
------------------------
(1) In 1999, we granted options to purchase a total of 492,421 shares of common
stock at an exercise price of $9.90 per share and options to purchase a
total of 151,660 shares of common stock at an exercise price of $11.25 per
share.
(2) In accordance with SEC rules, the amounts shown on this table represent
hypothetical gains that could be achieved for the respective options if
exercised at the end of the option term. These gains are based on the
assumed rates of stock appreciation of 5% and 10% compounded annually from
the date the respective options were granted to their expiration date and do
not reflect our estimates or projections of the future price of our common
stock. The gains shown are net of the option exercise price, but do not
include deductions for taxes or other expenses associated with the exercise.
Actual gains, if any, on stock option exercises will depend on the future
performance of our common stock, the option holder's continued employment
through the option period, and the date on which the options are exercised.
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<PAGE>
OPTION EXERCISES IN LAST FISCAL YEAR
The following table sets forth certain information concerning all
unexercised options held by the named executive officers as of December 31,
1999. No options were exercised by named, executive officers during 1999.
<TABLE>
<CAPTION>
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED IN-THE-
OPTIONS AT MONEY OPTIONS AT
FISCAL YEAR-END(#) FISCAL YEAR-END(1)
--------------------------- -----------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
J. Michael Parks.............................. 208,332 208,333 $1,249,991 $1,175,000
Ivan Szeftel.................................. 27,778 105,555 308,333 613,332
Michael A. Beltz.............................. 36,111 97,220 210,413 544,574
Edward K. Mims................................ 13,889 74,999 80,833 412,496
James E. Anderson............................. 19,097 69,790 112,080 381,242
</TABLE>
------------------------
(1) Value for "in-the-money" options represents the positive spread between the
respective exercise prices of outstanding options and the anticipated
initial public offering price of $15.00 per share.
EMPLOYMENT AND INDEMNIFICATION AGREEMENTS
We generally do not to enter into employment agreements with our employees.
However, as part of some of our acquisitions, we have entered into agreements
with selected key individuals to ensure the success of the integration of the
acquisition and long-term business strategies. In addition, we have entered into
employment agreements with Mr. Parks and Mr. Szeftel.
J. MICHAEL PARKS. Mr. Parks entered into an employment agreement effective
March 10, 1997 to serve as our chairman of the board and chief executive
officer. The agreement provides that Mr. Parks will receive a minimum base
salary of $475,000. Mr. Parks is entitled to an incentive bonus of $400,000
based on the achievement of our annual financial goals. Under the agreement,
Mr. Parks was granted options to purchase 333,332 shares of our common stock at
an exercise price of $9.00 per share. Of these shares, 277,776 shares have
vested. The remaining 55,556 shares vest in January 2001 upon the achievement of
corporate performance goals. Additionally, Mr. Parks was granted options to
purchase 83,333 shares of our common stock at an exercise price of $9.90 in
1999, of which options to purchase 20,833 shares are currently vested.
Additionally, Mr. Parks is entitled to participate in our 401(k) and Retirement
Savings Plan, our 1999 Incentive Compensation Plan and any other employee
benefits as provided to other senior executives.
IVAN SZEFTEL. Mr. Szeftel entered into an employment agreement dated
May 4, 1998 to serve as the president of our retail services division. The
agreement provides that Mr. Szeftel is entitled to receive a minimum base salary
of $325,000, subject to increases based on annual reviews. Mr. Szeftel is
entitled to an incentive bonus of $200,000 based on the achievement of our
annual financial goals. In addition, we granted Mr. Szeftel options to purchase
111,111 shares of our common stock at an exercise price of $9.00 per share.
Mr. Szeftel was granted options to purchase 22,222 shares of our common stock at
an exercise price of $9.90 in 1999, of which options to purchase 5,556 shares
are currently vested. Mr. Szeftel is entitled to participate in our 401(k) and
Retirement Savings Plan, our 1999 Incentive Compensation Plan and any other
employee benefits as provided to other senior executives. Under the agreement,
Mr. Szeftel is entitled to severance payments if we terminate his employment
without cause or if Mr. Szeftel terminates his employment for good reason. In
such cases, Mr. Szeftel will be entitled to six months base salary if terminated
in his first year, nine months base salary if terminated in his second year and
12 months base salary if terminated after his second year.
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AMENDED AND RESTATED STOCK OPTION AND RESTRICTED STOCK PLAN
We adopted the Amended and Restated Alliance Data Systems Corporation and
its Subsidiaries Stock Option and Restricted Stock Plan in April 2000. This plan
provides for grants of incentive stock options, nonqualified stock options and
restricted stock awards to selected employees, officers, directors and other
persons performing services for us or any of our subsidiaries. A total of
8,753,000 shares of common stock have been reserved for issuance pursuant to
this plan. As of March 31, 2000, there were 2,366,388 shares of common stock
subject to outstanding options previously granted at a weighted average exercise
price of $9.51 per share.
Incentive stock options may be granted to any person employed on a full-time
basis by us or any of our subsidiaries. Nonqualified stock options and
restricted stock awards may be granted to any of our stockholders, any employees
of our stockholders that perform services for us and any person employed by, or
performing services for, us or any of our subsidiaries, including our directors
and officers. Our non-employee directors currently participate in our stock
option plan as described in "--Director Compensation" above. The exercise price
for incentive stock options granted under the plan may not be less than 100% of
the fair market value of the common stock on the option grant date. If an
incentive stock option is granted to an employee who owns more than 10% of our
common stock, the exercise price of that option may not be less than 110% of the
fair market value of the common stock on the option grant date. The exercise
price for nonqualified stock options granted under the plan may be equal to,
more than or less than 100% of the fair market value of the common stock on the
option grant date.
The plan also provides for the granting of performance-based restricted
stock awards to our chief executive officer, his direct reports and a selected
second tier of direct reports. The plan gives our committee administering the
plan the sole discretion to determine the vesting provisions for
performance-based restricted stock awards. We plan to enter into
performance-based restricted stock award agreements with certain of our
officers, including our chief executive officer. Restricted shares typically
will not vest unless certain performance measures tied to either EBITDA or
return on stockholders' equity are met. If certain performance targets based on
return on stockholders' equity are met, it is possible that all of these
restricted shares will vest over a five year period. However, it is possible
that some of the restricted shares will vest on an accelerated basis shorter
than five years if certain annual EBITDA performance targets are met.
The plan provides that our chief executive officer and a committee appointed
by our board of directors will administer the plan. The compensation committee
of our board of directors administers the plan with respect to:
- grants to members of our executive committee, which includes our chief
executive officer, our named executive officers and our directors;
- grants of awards; and
- determining the pool of shares available under options and awards.
Our chief executive officer generally has the authority to administer the
plan and act as the plan's administrative committee, except for grants of
performance-based restricted stock awards, determining the number of shares
available under the plan and amending the plan for those participants who are
not members of the executive committee or our board of directors.
The plan gives our committee administering the plan the sole discretion to
determine the vesting provisions of each individual stock option. In the event
of a change of control, our plan provides that the committee may provide for
accelerated vesting of options. Options issued prior to final approval of the
new plan vest on a common vesting date, which is the first day of February. The
normal vesting provision for options granted under our prior plan provides for
vesting of 33 1/3% of the options each
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year over a three-year period, beginning on the first day of February of the
eighth year after the options have been awarded. The options granted under our
prior plan terminate on the tenth anniversary of the date of grant. However, if
we meet the annual operating income goal as determined by our board of
directors, vesting for these options granted under our prior plan can be
accelerated. Our board of directors designates a percentage of these options
that will vest in this accelerated manner if we meet the annual operating income
goal. Historically, this designated percentage has been equal to 25% of the
options granted.
On the date of the public offering, all exempt employees and specific
employees in Canada and New Zealand will receive a one-time grant of options,
ranging from amounts of 100 to 1,000 shares. These options will vest in thirds
over a three-year period beginning on the first anniversary of the date of
grant.
ALLIANCE DATA SYSTEMS 401(K) AND RETIREMENT SAVINGS PLAN
The Alliance Data Systems 401(k) and Retirement Savings Plan is a defined
contribution plan that is qualified under Section 401(k) of the Internal Revenue
Code of 1986, as amended, so that contributions made by employees or by us to
the plan, and income earned on these contributions, are not taxable to employees
until withdrawn from the plan. The plan covers U.S. employees of ADS Alliance
Data Systems, Inc., our wholly-owned subsidiary, and any other subsidiary or
affiliated organization that adopts this plan. We and all of our U.S.
subsidiaries are currently covered under the plan. All employees who are at
least 21 years old, who we have employed for at least six months and who have
worked at least 500 hours are eligible to participate.
Under this plan, we make regular matching contributions on the first 3% of
each participant's contributions. An additional matching contribution on the
second 3% of each participant's contributions may be made annually at the
discretion of our board of directors. Each of our matching contributions vests
20% over five years for employees with less than five years of service. All
contributions vest immediately if the participating employee retires at age 65,
becomes disabled, dies or is terminated without cause. In addition to matching
contributions, we make a non-discretionary retirement contribution based on the
participant's age and years of service with us. The retirement contributions
become 100% vested once the participant has served five years with us.
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN
We adopted the ADS Alliance Data Systems, Inc. Supplemental Executive
Retirement Plan in May 1999 to help certain key individuals maximize their
pre-tax savings and company contributions that are otherwise restricted due to
tax limitations. Eligibility under the plan requires an individual to: (1) be a
regular, full-time U.S. employee of ADS Alliance Data Systems, (2) receive
compensation equal to or greater than the IRS compensation limit as of
December 31 of the previous calendar year and (3) be a participant in the
Alliance Data Systems 401(k) and Retirement Savings Plan.
This plan allows the participant to contribute:
- up to 16% of eligible compensation on a pre-tax basis;
- any 401(k) contributions that would otherwise be returned because of
reaching the statutory limit; and
- any retirement savings plan contributions for compensation in excess of
the statutory limits.
The participant is 100% vested in his or her own contributions. A participant
becomes 100% vested in the retirement savings plan contributions after five
continuous years of service. The contributions accrue interest at a rate of 8% a
year, which may be adjusted periodically by the 401(k) and Retirement Savings
Plan Investment Committee.
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<PAGE>
The participant does not have access to any of the contributions or interest
while actively employed with us, unless the participant experiences an
unforeseeable financial emergency. Loans are not available under this plan. If
the participant ceases to be actively employed, retires or becomes disabled, the
participant will receive the value of his or her account within 60 days of the
end of the quarter in which he or she became eligible for the distribution. A
distribution from the plan is taxed as ordinary income and is not eligible for
any special tax treatment.
2000 INCENTIVE COMPENSATION PLAN
The Alliance Data Systems 2000 Incentive Compensation Plan provides an
opportunity for certain U.S. employees to be eligible for a cash bonus based on
achieving certain objectives. To be eligible under the plan, employees must meet
certain eligibility requirements and be selected by the compensation committee.
Under the plan, each participant has an incentive compensation target that
is expressed as a percent of annual base earnings. The participant's incentive
compensation target is based on various objectives that are weighted to reflect
the participant's contributions to company, business unit and individual goals,
which are established at the beginning of the plan year. The company objective
is based on our operating income, the business unit objective is based on
financial and operational objectives and the individual objectives are items of
importance to us that the individual can impact. The amount of compensation a
participant receives depends on the percentage of objectives that were achieved.
Eighty percent of the objectives must be achieved before a participant is
eligible for any payout. The maximum payout is equal to 150% of the
participant's incentive compensation target.
EMPLOYEE STOCK PURCHASE PLAN
After this offering, we may implement an employee stock purchase plan that
will allow eligible employees to purchase our common stock through payroll
deductions at a discount to the fair market value of our common stock at
predetermined trading dates.
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PRINCIPAL STOCKHOLDERS
The following table sets forth information with respect to the beneficial
ownership of our common stock as of March 31, 2000 by:
(1) each person who is known by us to own beneficially more than 5% of our
common stock;
(2) each current director;
(3) each of the named executive officers; and
(4) all directors and executive officers as a group.
Except as indicated in this table and pursuant to applicable community
property laws, each stockholder named in the table has sole voting and
investment power with respect to the shares set forth opposite such
stockholder's name. Percentage of ownership is based on 56,804,572 shares of
our common stock outstanding on March 31, 2000, and 76,804,572 shares of our
common stock outstanding after completion of this offering, both of which
reflect the conversion of all outstanding shares of Series A preferred stock
into common shares.
<TABLE>
<CAPTION>
PERCENT OF SHARES
BENEFICIALLY
OWNED(1)
SHARES BENEFICIALLY -------------------
OWNED BEFORE AND BEFORE AFTER
NAME OF BENEFICIAL OWNER AFTER OFFERING(1) OFFERING OFFERING
------------------------ ------------------- -------- --------
<S> <C> <C> <C>
Welsh, Carson, Anderson & Stowe(2) ......................... 42,027,347 74.0% 54.7%
320 Park Avenue, Suite 2500
New York, New York 10022-6815
Limited Commerce Corp. ..................................... 14,663,376 25.8% 19.1%
Three Limited Parkway
Columbus, Ohio 43230
J. Michael Parks(3)......................................... 298,609 * *
Ivan Szeftel(4)............................................. 61,111 * *
Michael A. Beltz(5)......................................... 72,221 * *
Edward K. Mims(6)........................................... 36,111 * *
James E. Anderson(7)........................................ 43,055 * *
Bruce K. Anderson(8)........................................ 347,198 * *
Anthony J. deNicola(8)...................................... 33,333 * *
Robert A. Minicucci(8)...................................... 114,542 * *
All directors and executive officers as a group
(18 individuals)(9)....................................... 1,147,711 2.0% 1.5%
</TABLE>
------------------------
* Less than 1%
(1) Beneficial ownership is determined in accordance with the SEC's rules. In
computing percentage ownership of each person, shares of common stock
subject to options, warrants or convertible preferred stock held by that
person that are currently exercisable or convertible, or exercisable or
convertible within 60 days of March 31, 2000, are deemed to be beneficially
owned. These shares, however, are not deemed outstanding for the purpose of
computing the percentage ownership of each other person.
(2) Includes 9,275,729 shares issuable upon conversion of Series A preferred
stock owned of record by WCAS VIII L.P., WCAS Information Partners, L.P.,
Patrick J. Welsh, Russell L. Carson, Bruce K. Anderson, Richard H. Stowe,
Andrew M. Paul, Thomas E. McInerney, McInerney Gabrielle Family Limited
Partnership, Laura M. VanBuren, James B. Hoover, Robert A. Minicucci,
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Anthony J. deNicola, Paul B. Queally, Lawrence B. Sorrel, Priscilla A.
Newman, Rudolph E. Rupert, D. Scott Mackesy, Kenneth Melkus, David F.
Bellet, Sean Traynor, John Almeida and Jonathan M. Rather. Also includes:
- 5,555,550 shares of common stock held by Welsh, Carson, Anderson & Stowe
VI, L.P.,
- 17,922,447 shares of common stock held by Welsh, Carson, Anderson & Stowe
VII, L.P.,
- 7,161,616 shares of common stock held by Welsh, Carson, Anderson & Stowe
VIII, L.P.,
- 109,568 shares of common stock held by WCAS Information Partners LP,
- 268,398 shares of common stock held by WCAS Capital Partners II LP,
- 655,555 shares of common stock held by WCAS Capital Partners III LP,
- 193,990 shares of common stock held by Patrick J. Welsh,
- 11,111 shares of common stock held by Carol Ann Welsh FBO Eric Welsh U/A
dtd 11/26/84,
- 11,111 shares of common stock held by Carol Ann Welsh FBO Randall Welsh
U/A dtd 11/26/84,
- 11,111 shares of common stock held by Carol Ann Welsh FBO Jennifer Welsh
U/A dtd 11/26/84,
- 202,352 shares of common stock held by Russell L. Carson,
- 246,039 shares of common stock held by Bruce K. Anderson,
- 62,225 shares of common stock held by Richard H. Stowe,
- 59,835 shares of common stock held by Andrew M. Paul,
- 51,315 shares of common stock held by Thomas E. McInerney,
- 51,315 shares of common stock held by McInerney Gabrielle Family
Partnership,
- 3,914 shares of common stock held by Laura Van Buren,
- 6,820 shares of common stock held by James B. Hoover,
- 81,051 shares of common stock held by Robert A. Minicucci,
- 23,677 shares of common stock held by Anthony J. deNicola,
- 14,250 shares of common stock held by Paul B. Queally,
- 13,573 shares of common stock held by IRA FBO David F. Bellett DLJSC as
Custodian IRA Rollover Account,
- 5,050 shares of common stock held by David F. Bellett,
- 1,666 shares of common stock held by Kristin M. Anderson,
- 1,666 shares of common stock held by Daniel B. Anderson,
- 1,666 shares of common stock held by Mark S. Anderson,
- 10,101 shares of common stock held by Lawrence Sorrel,
- 2,020 shares of common stock held by Priscilla Newman,
- 10,101 shares of common stock held by Rudolph Rupert, and
- 2,525 shares of common stock held by D. Scott Mackesy.
(3) Represents options to purchase 298,609 shares of common stock which are
exercisable within 60 days of March 31, 2000.
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(4) Represents options to purchase 61,111 shares of common stock which are
exercisable within 60 days of March 31, 2000.
(5) Represents options to purchase 72,221 shares of common stock which are
exercisable within 60 days of March 31, 2000.
(6) Represents options to purchase 36,111 shares of common stock which are
exercisable within 60 days of March 31, 2000.
(7) Represents options to purchase 43,055 shares of common stock which are
exercisable within 60 days of March 31, 2000.
(8) The number of shares beneficially owned by Messrs. Anderson, deNicola and
Minicucci includes 101,159, 9,656 and 33,491 shares issuable upon conversion
of Series A preferred stock, respectively. Each of Messrs. Anderson,
deNicola and Minicucci are partners of Welsh, Carson, Anderson & Stowe and
certain of its affiliates and may be deemed to be the beneficial owner of
the common stock beneficially owned by Welsh Carson and described in note 2
above.
(9) Includes options to purchase an aggregate of 655,410 shares of common stock
which are exercisable within 60 days of March 31, 2000 held by Messrs.
Parks, Szeftel, Beltz, Mims, James E. Anderson, Armiak, Carter, Kubic,
Melvin, Schumacher, Scullion, Tucker and Walensky and 144,306 shares
issuable upon conversion of Series A preferred stock.
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<PAGE>
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
TRANSACTIONS WITH WELSH, CARSON, ANDERSON & STOWE
Welsh, Carson, Anderson & Stowe VI, L.P., Welsh, Carson, Anderson & Stowe
VII, L.P., Welsh, Carson, Anderson & Stowe VIII, L.P., WCAS Capital Partners II,
L.P., WCAS Capital Partners III, L.P., WCAS Information Partners, L.P., WCA
Management Corporation and various individuals who are limited partners of the
Welsh Carson limited partnerships beneficially owned approximately 74.0% of our
outstanding common stock as of March 31, 2000. The individual partners of the
Welsh Carson limited partnerships include Bruce K. Anderson, Anthony J. deNicola
and Robert A. Minicucci, each of whom is a member of our board of directors.
In July 1999, we sold 120,000 shares of Series A preferred stock to Welsh,
Carson, Anderson & Stowe VIII, L.P., WCAS Information Partners, L.P. and 20
individuals who are partners of some or all of the Welsh Carson limited
partnerships for an aggregate purchase price of $120.0 million. The preferred
shares were issued to finance, in part, the acquisition of the network services
business of SPS Payment Systems, Inc. Prior to the completion of this offering,
these preferred shares will be converted into an aggregate of 9,275,729 shares
of our common stock.
In July 1998, we sold 10,101,010 shares of common stock to Welsh, Carson,
Anderson & Stowe VIII, L.P., Welsh, Carson, Anderson & Stowe VII, L.P., WCAS
Information Partners, L.P., and 16 individuals who are partners of some or all
of the Welsh Carson limited partnerships for an aggregate purchase price of
$100.0 million. The shares were issued to finance, in part, the acquisition of
all outstanding stock of Loyalty.
In August 1998, we sold 30,303 shares of common stock to WCAS Capital
Partners II, L.P. for $9.90 per share as consideration for WCAS Capital
Partners II, L.P. extending the maturity of a 10% subordinated note we issued to
it in January 1996 in the principal amount of $30.0 million and originally due
January 24, 2002. Principal on the note is due on October 25, 2005 and interest
is payable semi-annually in arrears on each January 1 and July 1. The note was
originally issued to finance, in part, the acquisition of BSI Business
Services, Inc., now known as ADS Alliance Data Systems, Inc. This note will be
paid in full with the proceeds of this offering.
In September 1998, we issued 655,555 shares of common stock to WCAS Capital
Partners III, L.P. and issued a 10% subordinated note to WCAS Capital Partners
III, L.P. in the principal amount of $52.0 million to finance, in part, the
acquisition of Harmonic Systems Incorporated. Principal on the note is due in
two equal installments on September 15, 2007 and September 15, 2008. Interest is
payable semi-annually in arrears on each March 15 and September 15. This note
will be paid in full with the proceeds of this offering.
We paid Welsh, Carson, Anderson & Stowe $2.0 million in 1998 and $1.2
million in 1999 for investment banking services rendered in connection with our
acquisitions.
TRANSACTIONS WITH THE LIMITED
Limited Commerce Corp. beneficially owned approximately 25.8% of our common
stock as of March 31, 2000. Limited Commerce Corp. is owned by Structure, Inc.,
which is owned by The Limited, Inc. Therefore, The Limited, Inc., a significant
customer of ours, indirectly owns one of our principal stockholders. Pursuant to
a stockholders agreement with Welsh Carson and Limited Commerce Corp., Limited
Commerce Corp. has the right to maintain two designees on our board of
directors. Mr. Finkelman and Mr. Soll are the current Limited Commerce Corp.
designees on our board of directors.
The Limited, Inc. operates through a variety of retail and catalog
affiliates that operate under different names, including Bath & Body Works, The
Limited Stores, Structure, Victoria's Secret Catalogue, Victoria's Secret Store,
Lerner New York, Lane Bryant and Express. Many of these affiliates have entered
into credit card processing agreements with World Financial. These affiliates of
The Limited represented approximately 65% of our credit card receivables as of
March 31, 2000.
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Pursuant to these credit card processing agreements, World Financial
provides credit card processing services and issues private label credit cards
on behalf of the businesses. Under these agreements, World Financial pays the
business an amount equal to the amount charged by the business's customers using
the private label credit card issued by World Financial, less a discount, which
varies among agreements. World Financial assumes the credit risk for these
credit card transactions. Payments are also made to World Financial from the
businesses relating to credit card issuance and processing.
Most of these credit card processing agreements were entered into in 1996
and expire in 2006. These agreements give the businesses various termination
rights, including the ability to terminate these contracts under certain
circumstances after the first six years if World Financial is unable to remain
competitive with independent third parties that provide similar services.
In general, World Financial owns information relating to the holders of
credit cards issued under these agreements, but World Financial is prohibited
from disclosing information about these holders to third parties that The
Limited determines competes with The Limited or its affiliated businesses. World
Financial is also prohibited from providing marketing services to competitors of
The Limited or its affiliated businesses as determined by The Limited. World
Financial may provide marketing services to other third parties that are not
competitors of The Limited or its affiliated businesses, but it must share
revenue from these services with The Limited and its affiliated businesses.
We periodically enter into agreements with various retail affiliates of The
Limited to provide database marketing programs and projects. These agreements
are generally short-term in nature, ranging from three to six months.
We received total revenues directly from The Limited and its retail
affiliates of $53.1 million during fiscal 1997, $54.8 million during fiscal 1998
and $64.1 million during fiscal 1999.
In August 1998, we sold 20,202 shares of common stock to Limited Commerce
Corp. for $9.90 per share as consideration for Limited Commerce Corp. extending
the maturity of a 10% subordinated note we issued in January 1996 to WCAS
Capital Partners II, L.P., which sold the note to Limited Commerce Corp. The
note is in the principal amount of $20.0 million and was originally due
January 24, 2002. Principal on the note is due on October 25, 2005 and interest
is payable semi-annually in arrears on each January 1 and July 1. The note was
originally issued to finance, in part, the acquisition of BSI Business
Services, Inc., now known as ADS Alliance Data Systems, Inc. This note will be
paid in full with the proceeds of this offering.
The Limited guarantees World Financial's lease obligations under a lease for
a 100,800 square foot facility in Columbus, Ohio. The lease expires in January
2001 and the current monthly lease rate is $69,407.
STOCKHOLDERS' AGREEMENT WITH WELSH CARSON AND THE LIMITED
In connection with the above sale of shares to the Welsh Carson affiliates
and Limited Commerce Corp., we entered into a stockholders agreement, as
amended, with Limited Commerce Corp., various Welsh Carson affiliates and
various individual stockholders who are partners in some or all of the Welsh
Carson limited partnerships. This agreement contains transfer restrictions,
various stockholder rights, registration rights, provisions allowing Welsh
Carson and Limited Commerce Corp. to designate a portion of our board of
directors, provisions relating to the amendment of our certificate of
incorporation and bylaws and capital calls. Welsh Carson also has the right to
appoint a representative to attend and participate in board and committee
meetings. The Welsh Carson affiliates and Limited Commerce Corp. have waived
their registration rights in connection with this offering. Upon completion of
this offering, this stockholders agreement will be replaced with a new
agreement.
Upon completion of this offering, we will enter into a new stockholders
agreement with the Welsh Carson affiliates and Limited Commerce Corp. Under the
new stockholders agreement, the Welsh Carson affiliates and Limited Commerce
Corp. will each have two demand registration rights, as well as
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<PAGE>
"piggyback" registration rights. The demand rights will enable the Welsh Carson
affiliates and Limited Commerce Corp. to require us to register their shares
with the SEC under the Securities Act at any time after the consummation of this
initial public offering. Piggyback rights will allow the Welsh Carson affiliates
and Limited Commerce Corp. to register the shares of our common stock that they
purchased along with any shares that we register with the SEC. These
registration rights are subject to customary conditions and limitations,
including the right of the underwriters of an offering to limit the number of
shares.
Under the new stockholders agreement, the size of our board of directors is
set at nine. Welsh Carson has the right to designate up to three nominees for
election to the board of directors as long as it owns more than 20% of our
common stock. Limited Commerce Corp. has the right to designate up to two of the
members as long as it owns more than 10% of our common stock and one of the
members as long as it owns between 5% and 10% of our common stock.
U.S. LOYALTY PROGRAM
We have evaluated the creation of a loyalty program in the U.S. similar to
our Air Miles reward program in Canada. Because of the significant funding
requirements to establish such a program, we have decided not to pursue the
program. Our existing stockholders have decided to pursue the program through a
separate company called U.S. Loyalty Corp., which they will fund. We will not
have any ownership interest in U.S. Loyalty Corp.
We intend to provide various services to U.S. Loyalty Corp. including
management support, accounting, transaction processing, data processing and
marketing under various agreements that we plan to enter into with U.S. Loyalty
Corp. We contemplate that such agreements will include a management agreement,
an employee lease agreement, a processing agreement and a royalty agreement.
Under the royalty agreement, we will enable U.S. Loyalty Corp. to use the Air
Miles brand and business concept in the United States.
The stockholders of U.S. Loyalty Corp. include Welsh Carson and Limited
Commerce Corp. as well as our directors and officers who have options to
purchase shares of our common stock. Robert A. Minicucci, who is a stockholder
and one of our directors, is the sole director, only officer and a stockholder
of U.S. Loyalty Corp. Upon completion of the first round of financing for U.S.
Loyalty Corp., we anticipate that the board of directors of U.S. Loyalty Corp.
will consist of up to three Welsh Carson designees and up to two designees of
The Limited.
We have no rights to share in any profits that might be earned by U.S.
Loyalty Corp. Any sums of money received by us from U.S. Loyalty Corp. will be
limited to amounts paid to us under the above agreements, which are being
negotiated on an arm's-length basis.
INTERCOMPANY INDEBTEDNESS
In December 1998, our subsidiaries issued to us revolving promissory notes,
due November 30, 2002, as described below. Principal payments are due on demand.
These notes are still outstanding except that the note issued to us by ADS
Alliance Data Systems, Inc. in December 1998 was canceled in connection with ADS
Alliance Data Systems, Inc. issuing us a new revolving promissory note in
January 2000. The notes with our subsidiaries accrue interest at 10% per annum
and interest is payable quarterly or upon demand.
<TABLE>
<CAPTION>
AMOUNT OF PRINCIPAL
OUTSTANDING AS OF
CREDIT LINE MARCH 31, 2000
------------ -------------------
<S> <C> <C>
World Financial Network National Bank note.................. $100,000,000 $ --
ADS Alliance Data Systems, Inc. note........................ 300,000,000 235,000,000
Alliance Data Systems (New Zealand) Limited note............ 11,250,000 9,750,000
Loyalty Management Group Canada Inc. note................... 20,000,000 --
</TABLE>
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DESCRIPTION OF CAPITAL STOCK
Upon the completion of this offering, our authorized capital stock will
consist of 200,000,000 shares of common stock, par value $0.01 per share, of
which 76,804,572 shares will be issued and outstanding, and 20,000,000 shares of
preferred stock, par value $0.01 per share, of which no shares will be
outstanding. The following summary of our capital stock is qualified in its
entirety by reference to our certificate of incorporation and our bylaws filed
as exhibits to this registration statement.
COMMON STOCK
Our common stockholders are entitled to one vote for each share on all
matters voted upon by our stockholders, including the election of directors, and
do not have cumulative voting rights. Subject to the rights of holders of any
then outstanding shares of our preferred stock, our common stockholders are
entitled to any dividends that may be declared by our board of directors.
Holders of our common stock are entitled to share ratably in our net assets upon
our dissolution or liquidation after payment or provision for all liabilities
and any preferential liquidation rights of our preferred stock then outstanding.
Our common stockholders have no preemptive rights to purchase shares of our
stock. The shares of our common stock are not subject to any redemption
provisions and are not convertible into any other shares of our capital stock.
All outstanding shares of our common stock are, and the shares of common stock
to be issued in the offering will be, upon payment therefor, fully paid and
nonassessable. The rights, preferences and privileges of holders of our common
stock will be subject to those of the holders of any shares of our preferred
stock we may issue in the future.
PREFERRED STOCK
Our board of directors may from time to time authorize the issuance of one
or more classes or series of preferred stock without stockholder approval.
Subject to the provisions of our certificate of incorporation and limitations
prescribed by law, our board of directors is authorized to adopt resolutions to
issue shares, establish the number of shares, change the number of shares
constituting any series, and provide or change the voting powers, designations,
preferences and relative rights, qualifications, limitations or restrictions on
shares of our preferred stock, including dividend rights, terms of redemption,
conversion rights and liquidation preferences, in each case without any action
or vote by our stockholders.
One of the effects of undesignated preferred stock may be to enable our
board of directors to discourage an attempt to obtain control of our company by
means of a tender offer, proxy contest, merger or otherwise. The issuance of
preferred stock may adversely affect the rights of our common stockholders by,
among other things:
- restricting dividends on the common stock;
- diluting the voting power of the common stock;
- impairing the liquidation rights of the common stock; or
- delaying or preventing a change in control without further action by the
stockholders.
SERIES A PREFERRED STOCK
Upon consummation of the offering, all of the outstanding shares of
Series A preferred stock will be converted into shares of common stock and there
will be no Series A preferred stock outstanding.
EFFECTS OF AUTHORIZED BUT UNISSUED STOCK
Upon consummation of the offering there will be 200,000,000 authorized but
unissued shares of our common stock and 20,000,000 shares of preferred stock
available for our future issuance without stockholder approval. Of the shares of
common stock available for future issuance, 8,753,000 shares have been reserved
for issuance under our stock option and restricted stock purchase plan.
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Shares of common stock and preferred stock available for future issuance may
be utilized for a variety of corporate purposes, including to facilitate
acquisitions or future public offerings to raise additional capital. We do not
currently have any plans to issue additional shares of common stock or preferred
stock, other than shares of common stock issuable under our stock option plan.
ANTI-TAKEOVER CONSIDERATIONS AND SPECIAL PROVISIONS OF THE CERTIFICATE OF
INCORPORATION, BYLAWS AND DELAWARE LAW
CERTIFICATE OF INCORPORATION AND BYLAWS. A number of provisions of our
certificate of incorporation and bylaws concern matters of corporate governance
and the rights of our stockholders. Provisions such as those that provide for
the classification of our board of directors and that grant our board of
directors the ability to issue shares of preferred stock and to set the voting
rights, preferences and other terms thereof may have an anti-takeover effect by
discouraging takeover attempts not first approved by our board of directors,
including takeovers which may be considered by some stockholders to be in their
best interests. To the extent takeover attempts are discouraged, temporary
fluctuations in the market price of our common stock, which may result from
actual or rumored takeover attempts, may be inhibited. Such provisions also
could delay or frustrate the removal of incumbent directors or the assumption of
control by stockholders, even if such removal or assumption would be beneficial
to our stockholders. These provisions also could discourage or make more
difficult a merger, tender offer or proxy contest, even if they could be
favorable to the interests of stockholders, and could potentially depress the
market price of our common stock. Our board of directors believes that these
provisions are appropriate to protect our interests and the interests of our
stockholders.
CLASSIFIED BOARD OF DIRECTORS. Our certificate of incorporation divides our
board of directors into three classes. The directors in each class serve in
terms of three years and until their successors are duly elected and qualified.
The terms of directors are staggered by class. The classification system of
electing directors may tend to discourage a third party from making a tender
offer or otherwise attempting to obtain control of our company and may maintain
the incumbency of our board of directors, as this structure generally increases
the difficulty of, or may delay, replacing a majority of the directors. Our
bylaws provide that directors may be removed only for cause by the holders of a
majority of the shares entitled to vote at an election of directors. A majority
of the directors then in office may elect a successor to fill any vacancies or
newly created directorships.
MEETINGS OF STOCKHOLDERS. Our bylaws provide that annual meetings of our
stockholders may take place at the time and place established by our board of
directors, provided that the date is not more than 120 days after the end of our
fiscal year. A special meeting of our stockholders may be called by our board of
directors or our chief executive officer and will be called by our chief
executive officer or secretary upon written request by a majority of our board
of directors.
ADVANCE NOTICE PROVISIONS. Our bylaws provide that nominations for
directors may not be made by stockholders at any annual or special meeting
thereof unless the stockholder intending to make a nomination notifies us of its
intention a specified number of days in advance of the meeting and furnishes to
us certain information regarding itself and the intended nominee. Our bylaws
also require a stockholder to provide to our secretary advance notice of
business to be brought by such stockholder before any annual or special meeting
of our stockholders, as well as certain information regarding the stockholder
and any material interest the stockholder may have in the proposed business.
These provisions could delay stockholder actions that are favored by the holders
of a majority of our outstanding stock until the next stockholders' meeting.
AMENDMENT OF THE BYLAWS. Our bylaws may be altered, amended, repealed or
replaced by our board of directors or our stockholders at any annual or regular
meeting, or at any special meeting if notice of the alteration, amendment,
repeal or replacement is given in the notice of the meeting.
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DELAWARE ANTI-TAKEOVER LAW. We are subject to the provisions of
Section 203 of the Delaware General Corporation Law regulating corporate
takeovers. This section prevents certain Delaware corporations, under certain
circumstances, from engaging in a "business combination" with:
- a stockholder who owns 15% or more of our outstanding voting stock
(otherwise known as an "interested stockholder"),
- an affiliate of an interested stockholder, or
- an associate of an interested stockholder,
for three years following the date that the stockholder became an "interested
stockholder." A "business combination" includes a merger or sale of more than
10% of our assets.
However, the above provisions of Section 203 do not apply if:
- our board approves the transaction that made the stockholder an
"interested stockholder," prior to the date of that transaction;
- after the completion of the transaction that resulted in the stockholder
becoming an "interested stockholder," that stockholder owned at least 85%
of our voting stock outstanding at the time the transaction commenced,
excluding shares owned by our officers and directors; or
- on or subsequent to the date of the transaction, the business combination
is approved by our board and authorized at a meeting of our stockholders
by an affirmative vote of at least two-thirds of the outstanding voting
stock not owned by the "interested stockholder."
This statute could prohibit or delay mergers or other change in control
attempts, and thus may discourage attempts to acquire us.
LIMITATIONS ON LIABILITY AND INDEMNIFICATION OF OFFICERS AND DIRECTORS
Our certificate of incorporation includes a provision that eliminates the
personal liability of our directors for monetary damages for breach of fiduciary
duty as a director, to the fullest extent permitted by Delaware Law.
Our certificate of incorporation and bylaws provide that:
- we must indemnify our directors, officers, employees and agents to the
fullest extent permitted by applicable law;
- we must advance expenses, as incurred, to our directors and executive
officers in connection with a legal proceeding to the fullest extent
permitted by Delaware law, subject to very limited exceptions.
Prior to the consummation of this offering, we intend to obtain directors'
and officers' insurance for our directors, officers and some employees for
specified liabilities.
The limitation of liability and indemnification provisions in our
certificate of incorporation and bylaws may discourage stockholders from
bringing a lawsuit against directors for breach of their fiduciary duty. They
may also have the effect of reducing the likelihood of derivative litigation
against directors and officers, even though an action of this kind, if
successful, might otherwise benefit us and our stockholders. Furthermore, a
stockholders' investment may be adversely affected to the extent we pay the
costs of settlement and damage awards against directors and officers pursuant to
these indemnification provisions. However, we believe that these indemnification
provisions are necessary to attract and retain qualified directors and officers.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for our common stock is EquiServe Trust
Company, N.A.
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SHARES ELIGIBLE FOR FUTURE SALE
Future sales of a substantial number of shares of our common stock in the
public market could adversely affect trading prices prevailing from time to
time. As of March 31, 2000, principal stockholders held 56,600,589 shares,
representing 99.7% of the outstanding shares of our common stock. After this
offering, we will have 76,804,572 shares of our common stock outstanding. Of
these shares, all shares sold in the offering, other than shares, if any,
purchased by our affiliates, will be freely tradable. Of the remaining
56,804,572 shares, 672,368 shares will be freely transferable and 672,368 shares
will be "restricted securities" as that term is defined in Rule 144 under the
Securities Act. Restricted shares may be sold in the public market only if such
sale is registered under the Securities Act or if such sale qualifies for an
exemption from registration, such as the one provided by Rule 144. Sales of the
restricted shares in the open market, or the availability of such shares for
sale, could adversely affect the trading price of our common stock.
LOCK-UP AGREEMENTS
Executive officers, directors and other stockholders who hold in the
aggregate approximately 56,390,486 shares of our common stock and options to
purchase approximately 899,849 shares of our common stock, have agreed not to
sell or otherwise dispose of any shares of our common stock for a period of 180
days after the date of this prospectus, without the prior written consent of
Bear, Stearns & Co. Inc. The underwriters do not intend to release the executive
officers, directors or other stockholders, including Welsh, Carson and Limited
Commerce Corp., from the lock-up agreements; however, any of these stockholders
could be released from the lock-up agreements prior to expiration without
notice.
RULE 144
In general, under Rule 144 as currently in effect, a person, or persons
whose shares are aggregated, who has beneficially owned restricted shares for at
least one year following the later of the date of the acquisition of such shares
from the issuer or from an affiliate of the issuer would be entitled to sell
within any three-month period a number of shares that does not exceed the
greater of:
- 1% of the number of shares of our common stock then outstanding; or
- the average weekly trading volume of our common stock during the four
calendar weeks preceding the sale.
Sales under Rule 144 are also subject to certain manner of sale provisions and
notice requirements and the availability of current public information about us.
RULE 144(K)
Under Rule 144(k), a person who is not deemed to have been an affiliate of
us at any time during the 90 days preceding a sale, and who has beneficially
owned the shares proposed to be sold for at least two years following the later
of the date of the acquisition of such shares from the issuer or an affiliate of
the issuer, is entitled to sell such shares without complying with the manner of
sale, public information, volume limitation or notice provisions of Rule 144.
RULE 701
In general, under Rule 701, subject to the lock-up agreements described
above, employees or directors who purchase shares from us in connection with our
stock option plan or other written agreements are eligible to resell these
shares 90 days after the date of this offering in reliance on Rule 144, without
compliance with certain restrictions contained in Rule 144, including the
holding period.
We intend to file a registration statement on Form S-8 to register shares of
common stock reserved for issuance under our stock option plan. This
registration statement will permit the resale of shares issued under the stock
option plan by non-affiliates in the public market without restriction, subject
to the lock-up agreements.
90
<PAGE>
UNDERWRITING
UNDERWRITING AGREEMENT. Subject to the terms and conditions set forth in an
underwriting agreement among us and the underwriters, each of the underwriters
named below, for whom Bear, Stearns & Co. Inc., Merrill Lynch, Pierce, Fenner &
Smith Incorporated and Donaldson, Lufkin & Jenrette Securities Corporation are
acting as representatives, has severally agreed to purchase from us the number
of shares of common stock set forth opposite its name below:
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
----------- ----------
<S> <C>
Bear, Stearns & Co. Inc.....................................
Merrill Lynch, Pierce, Fenner & Smith
Incorporated.....................................
Donaldson, Lufkin & Jenrette Securities Corporation.........
----------
Total.................................................. 20,000,000
==========
</TABLE>
The obligations of the underwriters under the underwriting agreement are
several and not joint. This means that each underwriter is obligated to purchase
from us only the number of shares of common stock set forth opposite its name in
the table above. Except in limited circumstances set forth in the underwriting
agreement, an underwriter has no obligation in relation to the shares of common
stock which any other underwriter has agreed to purchase.
The underwriting agreement provides that the obligations of the several
underwriters are subject to approval of various legal matters by their counsel
and to various other conditions including delivery of legal opinions by our
counsel, the delivery of a letter by our independent auditors and the accuracy
of the representations and warranties made by us in the underwriting agreement.
Under the underwriting agreement, the underwriters are obliged to purchase and
pay for all of the above shares of common stock if any are purchased.
PUBLIC OFFERING PRICE AND DEALERS CONCESSION. The underwriters propose
initially to offer the shares of common stock offered by this prospectus to the
public at the initial public offering price per share set forth on the cover
page of this prospectus and to certain dealers at that price less a concession
not in excess of $ per share. The underwriters may allow, and these dealers may
reallow, concessions not in excess of $ per share on sales to certain other
dealers. After commencement of this offering, the offering price, concessions
and other selling terms may be changed by the underwriters. No such change will
alter the amount of proceeds to be received by us as set forth on the cover page
of this prospectus.
OVER-ALLOTMENT OPTION. We have granted the underwriters an option, which
may be exercised within 30 days after the date of this prospectus, to purchase
up to 3,000,000 additional shares of common stock to cover over-allotments, if
any, at the initial public offering price less the underwriting discount, each
as set forth on the cover page of this prospectus. If the underwriters exercise
this option in whole or in part, each of the underwriters will be severally
committed, subject to certain conditions, to purchase these additional shares of
common stock in proportion to their respective purchase commitments as indicated
in the preceding table and we will be obligated to sell these additional shares
to the underwriters. The underwriters may exercise this option only to cover
over-allotments made in connection with the sale of the shares of common stock
offered by this prospectus. These additional shares will be sold by the
underwriters on the same terms as those on which the shares offered by this
prospectus are being sold.
91
<PAGE>
UNDERWRITING COMPENSATION. The following table summarizes the compensation
to be paid to the underwriters by us in connection with this offering:
<TABLE>
<CAPTION>
TOTAL
------------------------------------------
WITHOUT EXERCISE OF WITH EXERCISE OF THE
THE OVER-ALLOTMENT OVER-ALLOTMENT
PER SHARE OPTION OPTION
--------- ------------------- --------------------
<S> <C> <C> <C>
Underwriting discounts...........
</TABLE>
INDEMNIFICATION AND CONTRIBUTION. In the underwriting agreement, we have
agreed to indemnify the underwriters against certain liabilities, including
liabilities under the Securities Act, or to contribute to payments the
underwriters may be required to make in connection with these liabilities.
DISCRETIONARY ACCOUNTS. The underwriters have informed us that they do not
intend to confirm sales to any account over which they exercise discretionary
authority.
LOCK-UP AGREEMENTS. We, all of our directors and executive officers and
other stockholders, including Welsh, Carson and Limited Commerce Corp., holding
an aggregate of approximately 56,390,486 shares of our common stock, and options
to purchase approximately 899,849 shares of our common stock, have agreed not to
sell or offer to sell or otherwise dispose of any shares of our common stock,
subject to certain exceptions, for a period of 180 days after the date of this
prospectus, without the prior written consent of Bear, Stearns & Co. Inc. The
underwriters do not intend to release the executive officers, directors or other
stockholders, including Welsh, Carson and Limited Commerce Corp., from the
lock-up agreements; however, any of these stockholders could be released from
the lock-up agreements prior to expiration without notice.
DETERMINATION OF OFFERING PRICE. Prior to this offering, there has been no
market for our common stock. Accordingly, the initial public offering price for
the common stock was determined by negotiation between us and the
representatives of the underwriters. Among the factors considered in these
negotiations were:
- the results of our operations in recent periods;
- our financial condition;
- estimates of our future prospects and of the prospects for the industry in
which we compete;
- an assessment of our management;
- the general state of the securities markets at the time of this offering;
and
- the prices of similar securities of companies considered comparable to us.
We have applied to have our common stock listed on the New York Stock
Exchange under the symbol "ADS". There can be no assurance, however, that an
active or orderly trading market will develop for our common stock or that our
common stock will trade in the public markets after this offering at or above
the initial offering price.
RESERVED SHARE PROGRAM. The underwriters have reserved for sale, at the
initial public offering price, up to 1,000,000 shares of our common stock for
our employees, directors and other persons or entities with whom we have a
business relationship. The number of shares available for sale to the general
public in the offering will be reduced to the extent those persons purchase
these reserved shares. Purchases of reserved shares are to be made through
accounts at Merrill Lynch, Pierce Fenner & Smith Incorporated in accordance with
its procedures for opening accounts and transacting in securities. Any reserved
shares not so purchased will be offered by the underwriters to the general
public on the same terms as the other shares offered in this offering.
PROSPECTUS IN ELECTRONIC FORMAT. DLJdirect Inc., an affiliate of Donaldson,
Lufkin & Jenrette Securities Corporation and a managing underwriter, is making a
prospectus in electronic format available on its Internet Web site. The
underwriters have agreed to allocate a limited number of shares
92
<PAGE>
to DLJdirect for sale to its qualified brokerage account holders. Other than the
prospectus in electronic format, the information on such Web site is not part of
this prospectus or the registration statement of which this prospectus forms a
part, has not been approved and/or endorsed by us or any underwriter in such
capacity and should not be relied on by prospective investors.
STABILIZATION AND OTHER TRANSACTIONS. In order to facilitate this offering,
persons participating in this offering may engage in transactions that
stabilize, maintain or otherwise affect the price of the common stock during and
after this offering, including over-allotment, stabilizing and short-covering
transactions and the imposition of penalty bids. Specifically, the underwriters
may over-allot or otherwise create a short position in the common stock for
their own account by selling more shares of common stock than have been sold to
them by us. The underwriters may elect to cover this short position by
purchasing shares of common stock in the open market or by exercising the
over-allotment option granted to the underwriters. In addition, the underwriters
may stabilize or maintain the price of the common stock by bidding for or
purchasing shares of common stock in the open market and may impose penalty
bids, under which selling concessions allowed to syndicate members or other
broker-dealers participating in this offering are reclaimed if shares of common
stock previously distributed in this offering are repurchased in connection with
stabilization transactions or otherwise. The effect of these transactions may be
to stabilize or maintain the market price at a level above that which might
otherwise prevail in the open market. The imposition of a penalty bid may also
affect the price of the common stock to the extent that it discourages resales.
No representation is made as to the magnitude or effect of these stabilization
transactions. These transactions may be effected on the New York Stock Exchange
or otherwise and, if commenced, may be discontinued at any time.
NYSE UNDERTAKING. Bear, Stearns & Co. Inc., on behalf of the underwriters,
has undertaken with the New York Stock Exchange to meet the New York Stock
Exchange distribution standards of 2,000 round lot holders with 100 shares or
more, with 1.1 million shares outstanding and a minimum public market value of
$60.0 million.
LEGAL MATTERS
The validity of the shares of our common stock offered hereby will be passed
upon for us by Akin, Gump, Strauss, Hauer & Feld, L.L.P. Legal matters in
connection with this offering will be passed upon for the underwriters by
Gibson, Dunn & Crutcher LLP, Los Angeles, California.
EXPERTS
The consolidated financial statements of Alliance Data Systems Corporation
and subsidiaries as of December 31, 1998 and 1999 and for the year ended
December 31, 1999, the eleven months ended December 31, 1998 and the 53 week
period ended January 31, 1998 included in this prospectus and the related
financial statement schedules included elsewhere in the registration statement
have been audited by Deloitte & Touche LLP, independent auditors, as stated in
their reports appearing herein and elsewhere in the registration statement
(which reports express an unqualified opinion and include an explanatory
paragraph related to the restatement described in note 22) and have been so
included in reliance upon the reports of such firm given upon their authority as
experts in accounting and auditing.
The financial statements of SPS Network Services for the year ended
December 31, 1998 and the six months ended June 30, 1999 included in this
prospectus have been audited by Deloitte & Touche LLP, independent auditors, as
stated in their report appearing herein, and have been so included in reliance
upon the reports of such firm given upon their authority as experts in
accounting and auditing.
Ernst & Young LLP, independent auditors, have audited the consolidated
financial statements of Loyalty Management Group Canada Inc. as of April 30,
1997 and 1998, and for each of the two years in the period ended April 30, 1998,
as set forth in their report. We have included these financial statements in
this prospectus and elsewhere in the registration statement in reliance on Ernst
& Young LLP's report, given on their authority as experts in accounting and
auditing.
93
<PAGE>
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the Securities and Exchange Commission a registration
statement on Form S-1 under the Securities Act for the common stock sold in this
offering. This prospectus does not contain all of the information set forth in
the registration statement and the accompanying exhibits and schedules. For
further information about us and our common stock, we refer you to the
registration statement and the accompanying exhibits and schedules. Statements
contained in this prospectus regarding the contents of any contract or any other
document to which we refer are not necessarily complete. In each instance,
reference is made to the copy of the contract or document filed as an exhibit to
the registration statement, and each statement is qualified in all respects by
that reference. Copies of the registration statement and the accompanying
exhibits and schedules may be inspected without charge at the public reference
facilities maintained by the Securities and Exchange Commission at Room 1024,
450 Fifth Street, N.W., Washington, D.C. 20549 and at the regional offices of
the Securities and Exchange Commission located at Seven World Trade Center,
Suite 1300, New York, New York 10048 and Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661. Copies of these materials may be
obtained at prescribed rates from the Public Reference Room of the Securities
and Exchange Commission Room 1024, 450 Fifth Street, N.W., Washington, D.C.
20549. You may obtain information on the operation of the Public Reference Room
by calling the Securities and Exchange Commission at 1-800-SEC-0330. The
Securities and Exchange Commission maintains a Web site that contains reports,
proxy and information statements and other information regarding registrants
that file electronically with the Securities and Exchange Commission. The
address of the site is http://www.sec.gov.
After this offering, we will become subject to the information and reporting
requirements of the Securities Exchange Act. As a result, we will file periodic
reports, proxy statements and other information with the Securities and Exchange
Commission.
94
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
ALLIANCE DATA SYSTEMS CORPORATION
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
ALLIANCE DATA SYSTEMS CORPORATION AND SUBSIDIARIES
Independent Auditors' Report................................ F-2
Consolidated Statements of Operations for the fifty-three
weeks ended January 31, 1998, the eleven months ended
December 31, 1998 and the year ended December 31, 1999.... F-3
Consolidated Balance Sheets as of December 31, 1998 and
1999...................................................... F-4
Consolidated Statements of Stockholders' Equity for the
fifty-three weeks ended January 31, 1998, the eleven
months ended December 31, 1998 and the year ended
December 31, 1999......................................... F-5
Consolidated Statements of Cash Flows for the fifty-three
weeks ended January 31, 1998, the eleven months ended
December 31, 1998 and the year ended December 31, 1999.... F-6
Notes to Consolidated Financial Statements.................. F-7
Unaudited Condensed Consolidated Statements of Operations
for the three months ended March 31, 1999 and 2000........ F-32
Consolidated Balance Sheets as of December 31, 1999
(audited) and March 31, 2000 (unaudited).................. F-33
Unaudited Condensed Consolidated Statements of Cash Flows
for the three months ended March 31, 1999 and 2000........ F-34
Notes to Unaudited Condensed Consolidated Financial
Statements................................................ F-35
SPS NETWORK SERVICES
Independent Auditors' Report................................ F-38
Statements of Income for the year ended December 31, 1998
and the six months ended June 30, 1999.................... F-39
Statements of Changes in Net Assets for the year ended
December 31, 1998 and the six months ended June 30,
1999...................................................... F-40
Statements of Cash Flows for the year ended December 31,
1998 and the six months ended June 30, 1999............... F-41
Notes to Financial Statements............................... F-42
LOYALTY MANAGEMENT GROUP CANADA INC. AND SUBSIDIARY
Report of Independent Auditors.............................. F-43
Consolidated Balance Sheets as of April 30, 1997 and 1998... F-44
Consolidated Statements of Operations and Retained Earnings
(Deficit) for the two years ended April 30, 1997 and
1998...................................................... F-45
Consolidated Statements of Cash Flows for the two years
ended April 30, 1997 and 1998............................. F-46
Notes to Consolidated Financial Statements.................. F-47
</TABLE>
F-1
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
INDEPENDENT AUDITORS' REPORT
To the Stockholders of
Alliance Data Systems Corporation
We have audited the accompanying consolidated balance sheets of Alliance
Data Systems Corporation and subsidiaries as of December 31, 1998 and 1999, and
the related consolidated statements of operations, stockholders' equity, and
cash flows for the 53 weeks ended January 31, 1998, the eleven months ended
December 31, 1998 and the year ended December 31, 1999. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of the companies as of
December 31, 1998 and 1999, and the results of their operations and their cash
flows for the respective stated periods in conformity with accounting principles
generally accepted in the United States of America.
As discussed in Note 22, the accompanying consolidated financial statements
have been restated.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
Columbus, Ohio
March 1, 2000 (May 18, 2000 as to Note 22)
F-2
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
53 WEEKS 11 MONTHS
ENDED ENDED YEAR ENDED
JANUARY 31, 1998 DECEMBER 31, 1998 DECEMBER 31, 1999
---------------- ----------------- ------------------
(AS RESTATED--SEE NOTE 22)
<S> <C> <C> <C>
Revenues
Processing and servicing fees............. $225,504 $306,366 $483,179
Financing charges, net.................... 127,007 119,352 141,947
Other income.............................. 888 8,591 14,128
-------- -------- --------
Total revenue......................... 353,399 434,309 639,254
-------- -------- --------
Operating expenses
Processing and servicing.................. 161,360 209,013 341,496
Salaries and employee benefits............ 127,087 156,464 193,699
Depreciation and other amortization....... 7,402 8,270 16,183
Amortization of purchased intangibles..... 28,159 42,880 58,553
-------- -------- --------
Total operating expenses.............. 324,008 416,627 609,931
-------- -------- --------
Operating income.............................. 29,391 17,682 29,323
Interest expense.............................. 15,459 27,884 42,785
-------- -------- --------
Income (loss) from continuing operations
before income taxes......................... 13,932 (10,202) (13,462)
Income tax expense............................ 5,236 3,657 12,316
-------- -------- --------
Income (loss) from continuing operations...... 8,696 (13,859) (25,778)
Income (loss) from discontinued operations,
net of income taxes......................... (8,247) (300) 7,688
Loss on disposal of discontinued operations... -- -- (3,737)
-------- -------- --------
Net income (loss)............................. $ 449 $(14,159) $(21,827)
======== ======== ========
Earnings (loss) from continuing operations per
share--basic and diluted.................... $ 0.24 $ (0.33) $ (0.61)
======== ======== ========
Earnings (loss) per share--basic and
diluted..................................... $ 0.01 $ (0.34) $ (0.53)
======== ======== ========
Weighted average shares--basic and diluted.... 36,612 41,729 47,498
======== ======== ========
</TABLE>
See accompanying notes
F-3
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1998 1999
--------- -----------
(AS RESTATED--SEE NOTE 22)
<S> <C> <C>
ASSETS
Cash and cash equivalents................................... $ 47,036 $ 56,546
Restricted cash and cash equivalents........................ 17,909 69,571
Securities available-for-sale............................... 52,269 64,079
Trade receivables less allowance for doubtful accounts
($3,576
and $1,079 at December 31, 1998 and 1999, respectively)... 143,286 69,085
Credit card receivables and seller's interest less allowance
for
doubtful accounts ($4,888 and $3,657 at December 31, 1998
and 1999, respectively)................................... 139,458 150,804
Deferred tax asset, net..................................... 3,051 26,416
Other current assets........................................ 51,551 30,250
-------- ----------
Total current assets................................ 454,560 466,751
Property and equipment, net................................. 66,339 89,231
Deferred tax asset, net..................................... 21,664 14,903
Other non-current assets.................................... 47,462 31,470
Due from securitizations.................................... 121,442 144,484
Intangible assets and goodwill, net......................... 286,179 420,055
-------- ----------
Total assets........................................ $997,646 $1,166,894
======== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable............................................ $ 44,327 $ 83,976
Accrued expenses............................................ 58,590 75,646
Deferred income............................................. 17,733 25,805
Debt, current portion....................................... 148,149 118,225
-------- ----------
Total current liabilities........................... 268,799 303,652
Deferred income and other liabilities....................... 21,131 32,752
Redemption obligation....................................... 80,213 122,198
Long-term and subordinated debt............................. 331,835 316,911
-------- ----------
Total liabilities................................... 701,978 775,513
-------- ----------
Commitments and contingencies
Series A cumulative convertible preferred stock, $0.01 par
value;
120 shares authorized, issued and outstanding............. -- 119,400
Common stock, $0.01 par value; authorized 50,000 shares
(December 31, 1998), and 66,667 shares (December 31,
1999),
issued and outstanding, 47,487 shares (December 31, 1998)
and 47,529
shares (December 31, 1999)................................ 475 475
Additional paid-in capital.................................. 225,797 226,174
Retained earnings........................................... 71,367 49,540
Accumulated other comprehensive loss........................ (1,971) (4,208)
-------- ----------
Total stockholders' equity.......................... 295,668 271,981
-------- ----------
Total liabilities and stockholders' equity.......... $997,646 $1,166,894
======== ==========
</TABLE>
See accompanying notes
F-4
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(AS RESTATED--SEE NOTE 22)
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL OTHER TOTAL TOTAL
PAID-IN RETAINED COMPREHENSIVE COMPREHENSIVE STOCKHOLDERS'
SHARES AMOUNT CAPITAL EARNINGS LOSS LOSS EQUITY
-------- -------- ---------- -------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
FEBRUARY 1, 1997............. 36,608 $ 366 $118,768 $85,077 $ -- $204,211
Net income................... 449 449 449
Common stock issued.......... 11 96 96
------- ------ -------- ------- ------- --------
JANUARY 31, 1998............. 36,619 366 118,864 85,526 -- 204,756
Net loss..................... (14,159) $(14,159) (14,159)
Other comprehensive loss,
net of tax:
Unrealized gain on
securities
available-for-sale,
net.................... 1,207 1,207 1,207
Foreign currency
translation
adjustments............ (3,178) (3,178) (3,178)
-------
Other comprehensive loss..... (1,971)
--------
Total comprehensive loss..... $(16,130)
========
Common stock issued.......... 10,868 109 106,933 107,042
------- ------ -------- ------- ------- --------
DECEMBER 31, 1998............ 47,487 475 225,797 71,367 (1,971) 295,668
Net loss..................... (21,827) $(21,827) (21,827)
Other comprehensive loss,
net of tax:
Unrealized loss on
securities
available-for-sale,
net.................... (4,684) (4,684) (4,684)
Foreign currency
translation
adjustments............ 2,447 2,447 2,447
-------
Other comprehensive loss..... (2,237)
--------
Total comprehensive loss..... $(24,064)
========
Common stock issued.......... 42 -- 377 377
------- ------ -------- ------- ------- --------
DECEMBER 31, 1999............ 47,529 $ 475 $226,174 $49,540 $(4,208) $271,981
======= ====== ======== ======= ======= ========
</TABLE>
See accompanying notes
F-5
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
53 WEEKS 11 MONTHS
ENDED ENDED YEAR ENDED
JANUARY 31, 1998 DECEMBER 31, 1998 DECEMBER 31, 1999
----------------- ----------------- -----------------
(AS RESTATED--SEE NOTE 22)
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Income (loss) from continuing operations......... $ 8,696 $ (13,859) $ (25,778)
Adjustments to reconcile income (loss) from
continuing operations to net cash provided by
operating activities:
Income (loss) from discontinued operations....... (8,247) (300) 7,688
Loss on disposal of discontinued operations...... -- -- (3,737)
Depreciation and amortization.................... 35,561 51,652 74,736
Provision (credit) for doubtful accounts......... (294) (3,383) (3,540)
Change in operating assets:
Deferred income taxes.......................... (4,597) (4,007) (16,604)
Impairment of assets........................... -- 4,000 --
Accretion of deferred income................... (5,934) (9,395) (5,950)
Change in trade accounts receivables........... (75,876) (20,868) 81,276
Change in accounts payable and accrued
expenses..................................... 15,393 6,076 47,667
Change in other assets......................... 1,659 (17,546) 38,207
Change in redemption obligation................ -- -- 41,985
Other operating activities..................... -- -- (9,955)
Change in other liabilities.................... 2,961 12,099 25,643
--------- --------- ---------
Net cash provided by (used in) operating
activities................................. (30,678) 4,469 251,638
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchase of securities........................... -- (14,704) (12,314)
Increase in restricted cash and cash
equivalents.................................... -- -- (51,662)
Purchase of credit card receivables.............. (344,464) -- (33,817)
Change in due from securitizations............... (46,456) 5,470 (26,404)
Net cash paid for corporate acquisition.......... (716) (133,973) (171,423)
Change in intangible assets...................... (8,715) -- --
Proceeds from sale of credit card receivable
portfolios..................................... -- 94,091 --
Proceeds from securitization..................... 321,831 -- --
Change in seller's interest...................... 14,130 (76,975) 22,471
Capital expenditures............................. (39,356) (14,443) (36,302)
--------- --------- ---------
Net cash used in investing activities........ (103,746) (140,534) (309,451)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under debt agreements................. 582,497 382,043 249,625
Repayment of borrowings.......................... (477,723) (325,803) (294,473)
Proceeds from issuance of preferred stock........ -- -- 119,400
Proceeds from issuance of common stock........... 96 107,042 377
--------- --------- ---------
Net cash provided by financing activities.... 104,870 163,282 74,929
--------- --------- ---------
Effect of exchange rate changes.................... -- (776) (7,606)
--------- --------- ---------
Change in cash and cash equivalents................ (29,554) 26,441 9,510
Cash and cash equivalents at beginning of period... 50,149 20,595 47,036
--------- --------- ---------
Cash and cash equivalents at end of period......... $ 20,595 $ 47,036 $ 56,546
========= ========= =========
SUPPLEMENTAL CASH FLOW DISCLOSURE:
Interest paid.................................... $ 21,669 $ 33,695 $ 43,215
========= ========= =========
Income taxes paid................................ $ 8,466 $ 12,406 $ 25,242
========= ========= =========
</TABLE>
See accompanying notes
F-6
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION AND ACQUISITIONS
DESCRIPTION OF THE BUSINESS--Alliance Data Systems Corporation ("ADSC" or,
including its wholly-owned subsidiaries, the "Company") is a leading provider of
electronic transaction services, credit services and loyalty and database
marketing services. The Company develops and executes programs designed to help
its clients target, acquire and retain loyal, profitable customers. The Company
creates value for its clients by assisting them in managing their customer
relationships. Specifically the Company: (1) facilitates transactions between
its clients and their customers through multiple distribution channels;
(2) assists its clients in identifying and acquiring new customers; and
(3) increases the loyalty and profitability of existing customers.
The Company operates in three reportable segments: Loyalty and Database
Marketing Services, Transaction Services and Credit Services. Loyalty and
Database Marketing Services provides a membership rewards program for multiple
sponsors and marketing services to its customers by way of providing processing
services for loyalty and rewards programs, data mining and database tools and
reports. Transaction Services encompasses transaction processing, including
network services and bank card settlement and card processing and servicing,
such as account processing, billing and payment processing and customer care.
Credit Services provides underwriting and risk management services. Credit
Services generally securitizes the credit card receivables that it underwrites
from its private label programs.
BASIS OF PRESENTATION--During fiscal 1998, the Company changed its year end
to a calendar year end basis. Prior to December 31, 1998, the Company had a
52/53 week fiscal year that ended on the Saturday nearest January 31.
Accordingly, fiscal 1997 represents the 53 weeks ended January 31, 1998, fiscal
1998 represents the 11 months ended December 31, 1998, and fiscal 1999
represents the year ended December 31, 1999.
ACQUISITIONS--World Financial Network Holding Corporation ("WFNHC") provided
private label credit card services and database marketing for The Limited. On
January 24, 1996, Business Services Holdings, Inc. ("BSH") purchased J.C.
Penney's credit card transaction service business, BSI Business Services, Inc.
("BSI"). On August 30, 1996, BSH was merged into WFNHC in a transaction
accounted for as a reorganization of entities under common control. Prior to the
merger, WFNHC and BSH were under common ownership and common management.
Subsequent to the merger, WFNHC changed its name to Alliance Data Systems
Corporation and BSI changed its name to ADS Alliance Data Systems, Inc.
("ADSI").
In November 1997, the Company formed a wholly-owned subsidiary, Alliance
Data Systems (New Zealand) Limited ("ADSNZ"), to acquire the stock of Financial
Automation Limited and Financial Automation Marketing Limited (collectively,
"FAL") for approximately $10.5 million, financed through working capital. The
acquisition was accounted for using the purchase method of accounting, and the
excess purchase price over the fair value of the net identifiable assets
acquired, approximately $2.8 million, was allocated to goodwill and is being
amortized over 20 years using a straight-line basis. The results of operations
of FAL have been included in the consolidated financial statements since
November 1997. FAL developed and markets a proprietary fleet management tracking
system to companies worldwide.
In July 1998, the Company acquired the stock of Loyalty Management Group
Canada Inc. ("Loyalty") for approximately $183.0 million of net cash financed
through a capital infusion of $100.0 million from stockholders and a bank loan
of $100.0 million. The acquisition was accounted for using the purchase method
of accounting, and the excess purchase price over the fair value of the net
identifiable assets acquired, approximately $104.0 million, was allocated to
goodwill and is being
F-7
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION AND ACQUISITIONS (CONTINUED)
amortized over 25 years using a straight-line basis. The results of operations
of Loyalty have been included in the consolidated financial statements since
July 1998.
In September 1998, the Company acquired the stock of Harmonic Systems
Incorporated ("HSI") for approximately $51.3 million of net cash financed
through subordinated notes of $52.0 million. The acquisition was accounted for
using the purchase method of accounting, and the excess purchase price over the
fair value of the net identifiable assets acquired, approximately
$38.4 million, was allocated to goodwill and is being amortized over 25 years
using a straight-line basis. The results of operations of HSI have been included
in the consolidated financial statements since September 1998. HSI provides
retail chains with private data communications networks for the transmission of
electronic data between their stores, a merchant's corporate data center and
third party information service providers.
In July 1999, the Company acquired the network services business of SPS
Payment Systems, Inc. ("SPS"), a wholly-owned subsidiary of Associates First
Capital Corporation, for approximately $170.0 million, which was financed by
$120.0 million of Series A Cumulative Convertible Preferred Stock and
$50.0 million of working capital. This transaction was accounted for using the
purchase method of accounting, and the excess purchase price over the fair value
of the net identifiable assets, approximately $142.5 million, was allocated to
goodwill and other intangibles and is being amortized over periods ranging from
three to 25 years using a straight-line basis. The results of operations of SPS
have been included in the consolidated financial statements since July 1999.
SUPPLEMENTARY UNAUDITED PRO FORMA INFORMATION
Unaudited pro forma information for the Company is presented below as if the
Loyalty, the HSI and the SPS acquisitions had occurred at the beginning of
fiscal 1998 (in thousands, except per share amounts):
<TABLE>
<CAPTION>
FISCAL
-------------------
1998 1999
-------- --------
<S> <C> <C>
Revenue............................................... $592,816 $663,576
Net loss.............................................. $(34,591) $(22,590)
Earnings per share.................................... $ (0.83) $ (0.48)
Weighted average number of shares..................... 41,729 47,498
</TABLE>
2. SUMMARY OF SIGNIFICANT POLICIES
PRINCIPLES OF CONSOLIDATION--The accompanying consolidated financial
statements include the accounts of ADSC and its wholly-owned subsidiaries. All
significant intercompany transactions have been eliminated.
CASH AND CASH EQUIVALENTS--The Company considers all highly liquid
investments with an original maturity of three months or less to be cash
equivalents.
RESTRICTED CASH AND CASH EQUIVALENTS--Restricted cash and cash equivalents
relate to a reserve fund for the Air Miles reward program. The reserve fund is
maintained to fund redemptions of Air Miles reward miles from collectors.
SECURITIES AVAILABLE-FOR-SALE--Debt securities for which the Company does
not have the positive intent and ability to hold to maturity are classified as
securities available-for-sale. These securities are stated at fair value, with
the unrealized gains and losses, net of tax, reported as a component of
cumulative other comprehensive income. These securities relate to the reserve
fund for the Air Miles reward miles program and are restricted to funding of the
redemption obligation.
F-8
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT POLICIES (CONTINUED)
CREDIT CARD RECEIVABLES--Credit card receivables are generally securitized
immediately or shortly after origination. As part of its securitization
agreements, the Company is required to retain an interest in the credit card
receivables, which is referred to as seller's interest. Seller's interest is
carried at fair value and credit card receivables are carried at lower of cost
or market less an allowance for doubtful accounts.
PROPERTY AND EQUIPMENT--Furniture, fixtures, computer equipment and
software, and leasehold improvements are carried at cost, less accumulated
depreciation and amortization. Depreciation and amortization are computed on a
straight-line basis, using estimated lives ranging from 3 to 15 years. Leasehold
improvements are amortized over the remaining useful lives of the respective
leases or the remaining useful lives of the improvements, whichever are shorter.
Software development (costs to create new platforms for certain of the Company's
information systems) and conversion costs (systems, programming and other
related costs to allow conversion of new client accounts to the Company's
processing systems) are amortized on a straight-line basis over the length of
the associated contract or benefit period, which generally ranges from three to
five years.
REVENUE RECOGNITION POLICY--The Company derives substantially all of its
revenue from two principal sources. The Company receives fees for providing
information and transaction processing services. It also earns financing income
from its credit card receivables and securitization program.
PROCESSING AND SERVICING FEES--The Company earns transaction fees, which are
principally based on the number of transactions processed, statements generated
and Air Miles reward miles issued and redeemed. Transaction fees from
transactions processed and statements generated primarily relate to the
Transaction Services segment and are recognized as such services are performed.
The Company earns revenue from sponsors by charging transaction fees for
participation in its loyalty program. Under the terms of sponsor contracts, the
Company earns fees based on the number of Air Miles reward miles issued and in
some circumstances redeemed. The Company recognizes revenue at the time Air
Miles reward miles are issued to Collectors--the point of time that coincides
with the collector purchasing goods or services at the sponsor. In certain of
the Company's contracts, a portion of the transaction fee is paid at the
issuance of Air Miles reward miles and a portion is paid at the time of
redemption. The Company recognizes revenue associated for those fees at the time
of issuance and redemption, respectively. As the earning activities take place,
activity measurement data such as the number of Air Miles reward miles issued or
redeemed is accumulated and the related revenues and receivables are recorded.
Sponsor contracts generally contain a minimum commitment as to the number of Air
Miles reward miles that a Sponsor will issue.
FINANCING CHARGES, NET--Financing charges, net, represents gains and losses
on securitization of credit card receivables and interest income on seller's
interest less a provision (credit) for doubtful accounts of $(0.3 million),
$(3.4 million) and $(3.7 million) and related interest expense of $9.4 million,
$8.4 million and $10.4 million for fiscal 1997, 1998 and 1999, respectively.
The Company records gains or losses on the securitization of credit card
receivables on the date of sale based on the estimated fair value of assets sold
and retained and liabilities incurred in the sale. Gains represent the present
value of estimated future cash flows the Company has retained over the estimated
outstanding period of the receivables. This excess cash flow essentially
represents an interest only ("I/O") strip, consisting of the excess of finance
charges and past-due fees over the sum of the return paid to certificate holders
and credit losses. The I/O strip is carried at fair value, with changes in the
fair value reported as a component of cumulative other comprehensive income. The
I/O strip is
F-9
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT POLICIES (CONTINUED)
amortized over the life of the credit card receivables. Certain estimates
inherent in the determination of fair value of the I/O strip are influenced by
factors outside the Company's control and, as a result, such estimates could
materially change in the near term. The gains on securitizations and other
income from securitizations are included in finance charges, net.
REDEMPTION OBLIGATION--The Company accrues a liability for its estimated
future redemption obligations at the time it recognizes the related revenue. The
redemption obligation represents the estimated costs associated with the
Company's obligation to redeem outstanding Air Miles reward miles, which may be
converted by enrolled collectors into various free travel or other free
merchandise. The Company is liable for purchasing the rewards provided to
collectors, if and when such members seek to redeem accumulated Air Miles reward
miles upon reaching required redemption thresholds. The redemption obligation is
determined based on two factors: the number of Air Miles reward miles that are
expected to be redeemed and the weighted average cost of rewards. The estimated
number of Air Miles reward miles that are expected to be redeemed is based on
the Company's historical business experience, patterns of usage and other
factors. The weighted average cost of rewards is based on the mix of rewards
anticipated to be redeemed and the incremental cost of providing free travel and
merchandise. These redemption obligation estimates are evaluated and adjusted
quarterly. Any adjustments resulting from such evaluations are included in the
results of operations for the periods in which the evaluations are completed.
GOODWILL AND OTHER INTANGIBLES--Goodwill represents the excess of purchase
price over the fair value of net assets acquired arising from business
combinations and is being amortized on a straight-line basis over estimated
useful lives ranging from 20 to 25 years. Other intangibles primarily represent
identified intangible assets acquired in business combinations and are being
amortized over estimated useful lives ranging from 27 months to 20 years.
MARKETING--The Company expenses marketing costs as incurred.
EARNINGS PER SHARE--Basic earnings per share is based only 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 and common equivalent shares, dilutive stock
options or other dilutive securities outstanding during the year. However, as
the Company generated net losses, common equivalent shares, composed of
incremental common shares issuable upon exercise of stock options and warrants
and upon conversion of Series A preferred stock, are not included in diluted net
loss per share because such shares are anti-dilutive.
F-10
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT POLICIES (CONTINUED)
The following table sets forth the computation of basic and diluted net
income (loss) per share for the periods indicated (in thousands, except per
share data):
<TABLE>
<CAPTION>
FISCAL
------------------------------
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
NUMERATOR
Income (loss) from continuing operations.................. $ 8,696 $(13,859) $(25,778)
Preferred stock dividends................................. -- -- (3,377)
-------- -------- --------
Income (loss) from continuing operations available to
common stockholders..................................... 8,696 (13,859) (29,155)
Income (loss) from discontinued operations................ (8,247) (300) 7,688
Loss on disposal of discontinued operations............... -- -- (3,737)
-------- -------- --------
Net income (loss) available to common stockholders........ $ 449 $(14,159) $(25,204)
======== ======== ========
DENOMINATOR
Weighted average shares................................... 36,612 41,729 47,498
Weighted average effect of dilutive securities:
Net effect of dilutive stock options.................... -- -- --
Net effect of dilutive stock warrants................... -- -- --
-------- -------- --------
Denominator for diluted calculation....................... 36,612 41,729 47,498
======== ======== ========
Income (loss) from continuing operations--basic and
diluted................................................... $ 0.24 $ (0.33) $ (0.61)
Income (loss) from discontinued operations--basic and
diluted................................................... (0.23) (0.01) 0.08
-------- -------- --------
Net income (loss) per share--basic and diluted.............. $ 0.01 $ (0.34) $ (0.53)
======== ======== ========
</TABLE>
MANAGEMENT ESTIMATES--The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amount 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.
CURRENCY TRANSLATION--The assets and liabilities of the Company's
subsidiaries outside the U.S. are translated into U.S. dollars at the rates of
exchange in effect at the balance sheet dates. Income and expense items are
translated at the average exchange rates prevailing during the period. Gains and
losses resulting from currency transactions are recognized currently in income
and those resulting from translation of financial statements are included in
accumulated other comprehensive income (loss).
INCOME TAXES--Deferred income taxes are provided for differences arising in
the timing of income and expenses for financial reporting and for income tax
purposes using the asset/liability method of accounting. Under this method,
deferred income taxes are recognized for the future tax consequences
attributable to the differences between the financial statements' carrying
amounts of existing assets and liabilities and their respective tax bases, using
enacted tax rates.
LONG-LIVED ASSETS--Long-lived assets, goodwill and other intangible assets
are evaluated for impairment whenever events or changes in circumstances
indicate that the carrying amount of such assets or intangibles may not be
recoverable. Recoverability is measured by a comparison of the carrying amount
of an asset to future undiscounted net cash flows expected to be generated by
the
F-11
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT POLICIES (CONTINUED)
asset. If such assets are considered to be impaired, the impairment to be
recognized is measured by the amount by which the carrying amount of the assets
exceeds the fair value of the assets.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS--The nature and composition of some
of the Company's assets and liabilities and off-balance sheet items expose the
Company to interest rate risk. To mitigate this risk, the Company enters into
interest rate swap agreements. All of the Company's interest rate swaps are
designated and effective as hedges of specific existing or anticipated assets,
liabilities or off-balance sheet items. The Company's foreign currency
denominated assets and liabilities expose it to foreign currency exchange rate
risk. The Company has entered into cross-currency hedges to fix the exchange
rate on Canadian debt. The Company does not hedge its net investment in its
Canadian subsidiary. The Company does not hold or issue derivative financial
instruments for trading purposes.
Swap agreements involve the periodic exchange of payments over the life of
the agreements. Amounts to be paid or received are recorded on an accrual basis
as an adjustment to the related income or expense of the item to which the
agreements are designated. As of December 31, 1998, the related amount
receivable from counterparties was $1.7 million. As of December 31, 1999, the
related amount payable to counterparties was $1.5 million. Changes in the fair
value of interest rate swaps are not reflected in the accompanying financial
statements where designated to existing or anticipated assets, liabilities or
off-balance sheet items and where swaps effectively modify or reduce interest
rate sensitivity.
Realized and unrealized gains or losses at the time of maturity,
termination, sale or repayment of a derivative contract are recorded in a manner
consistent with its original designation. Amounts are deferred and amortized as
an adjustment to the related income or expense over the original period of
exposure, provided the designated asset, liability or off-balance sheet item
continues to exist, or in the case of anticipated transactions, is probable of
occurring. Realized and unrealized changes in the fair value of swaps designated
with items that no longer exist or are no longer probable to occur are recorded
as a component of the gain or loss arising from the disposition of the
designated item.
Interest rate and foreign currency exchange rate risk management contracts
are generally expressed in notional principal or contract amounts that coincide
with the notional amount of the item being hedged. However, the notional amounts
of these contracts are much larger than the amounts potentially at risk for
nonperformance by counterparties. In the event of nonperformance by the
counterparties, the Company's credit exposure on derivative financial
instruments is limited to the value of the contracts that have become favorable
to the Company. The Company actively monitors the credit ratings of its
counterparties. Under the terms of certain swaps, each party may be required to
pledge collateral if the market value of the swaps exceeds an amount set forth
in the agreement or in the event of a change in its credit rating.
SEGMENT INFORMATION--Effective December 31, 1998, the Company adopted
Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures about
Segments of an Enterprise and Related Information". The new rules establish
revised standards for public companies relating to the reporting of financial
and descriptive information about their operating segments in financial
statements. The Company did not previously report segment information.
RECENTLY ISSUED ACCOUNTING STANDARDS--In June 1998, the Financial Accounting
Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments and for hedging activities, and requires
companies to recognize all derivatives as either assets or liabilities in the
balance sheet and
F-12
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT POLICIES (CONTINUED)
measure such instruments at fair value. In June 1999, the FASB issued SFAS
No. 137, "Accounting for Derivative Instruments and Hedging Activities--Deferral
of the Effective Date of FASB Statement No. 133" which deferred the effective
date of SFAS No. 133 to fiscal years beginning after June 15, 2000. Adoption of
this statement is not anticipated to materially impact the Company's results of
operations, but may require revised balance sheet classifications and will
require revised disclosures in the notes to the consolidated financial
statements.
The Emerging Issues Task Force ("EITF") is expected to review an issue,
Issue No. 00-G, "Accounting for 'Point' and Other Loyalty Programs." that is
closely related to the Company's Air Miles Reward Miles program and the way
revenue is recognized for these types of programs. Similar to the discussion in
Issue No. 00-G, the Company awards Reward Miles in order to encourage its
Collectors to patronize the participating Sponsors, thereby generating payments
from Sponsors to the Company. The Company understands that the EITF will likely
examine this issue sometime in 2000, and that a specific date has not been set.
The Company believes that its revenue recognition policy currently complies with
existing GAAP and SEC guidelines. When Issue 00-G is issued, if it requires
modification of the present revenue recognition policy, the Company will adhere
to the guidance provided. Without knowing how the EITF will rule on this issue
the Company is unable to assess the impact of Issue 00-G at this time.
RECLASSIFICATIONS--For purposes of comparability, certain prior period
amounts have been reclassified to conform with the current year presentation.
3. SECURITIES AVAILABLE-FOR-SALE
Securities available-for-sale are primarily used to settle the Company's
redemption obligation under its Air Miles reward program in Canada. These
securities are primarily denominated in Canadian dollars. Realized gains and
losses from the sale of investment securities were not material. The principal
components of securities available-for-sale, which are carried at fair value,
are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1999
-------------------------------------------- -------------------------------------------
UNREALIZED UNREALIZED
------------------- -------------------
COST GAINS LOSSES FAIR VALUE COST GAINS LOSSES FAIR VALUE
-------- -------- -------- ----------- -------- -------- -------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Fixed income securities:
Government............. $19,951 $ 554 $ (82) $20,423 $29,981 $ -- $(1,368) $28,613
Corporate.............. 10,162 200 (300) 10,062 11,884 9 (540) 11,353
Equity securities........ 22,420 1,508 (2,144) 21,784 25,385 3,171 (4,443) 24,113
------- ------ ------- ------- ------- ------ ------- -------
Total.................... $52,533 $2,262 $(2,526) $52,269 $67,250 $3,180 $(6,351) $64,079
======= ====== ======= ======= ======= ====== ======= =======
</TABLE>
F-13
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
4. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1998 1999
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Software development and conversion costs............... $ 50,556 $ 55,156
Computer equipment and purchased software............... 13,649 23,127
Furniture and fixtures.................................. 40,197 45,741
Leasehold improvements.................................. 28,253 31,593
Construction in progress................................ 2,586 6,624
-------- --------
Total................................................. 135,241 162,241
Accumulated depreciation................................ (68,902) (73,010)
-------- --------
Property and equipment, net............................. $ 66,339 $ 89,231
======== ========
</TABLE>
During fiscal 1998, the Company recorded an impairment of $4.0 million on
computer equipment and software related to the Loyalty and Database Marketing
Services segment. The related computer equipment and software was deemed by
management to be inadequate. The related charge is included in processing and
servicing expenses in the consolidated statements of operations.
5. SECURITIZATION OF CREDIT CARD RECEIVABLES
The Company regularly securitizes its credit card receivables. During fiscal
1997, fiscal 1998 and fiscal 1999, the Company securitized $4.2 billion,
$3.9 billion and $4.1 billion, respectively, of credit card receivables. The
total amount of securitized credit card receivables outstanding as of
December 31, 1998 and 1999 was $2.0 billion and $2.2 billion, respectively,
maturing from 1999 to 2003. As of December 31, 1998 and 1999, seller's interest
consisted of $139.1 million and $121.9 million, respectively.
During the initial phase of a securitization reinvestment period, the
Company generally retains principal collections in exchange for the transfer of
additional credit card receivables into the securitized pool of assets. During
the amortization or accumulation period of a securitization, the investors'
share of principal collections (in certain cases, up to a maximum specified
amount each month) is either distributed each month to the investors or held in
an account until it accumulates to the total amount, at which time it is paid to
the investors in a lump sum. One of the Company's securitization trusts has
entered an early amortization period as a result of a private label customer
entering bankruptcy proceedings. The receivables associated with the customer
are in a different trust from all of the Company's other receivables; therefore,
those proceedings will not affect the other trusts. The Company's outstanding
securitizations are scheduled to begin their amortization or accumulation
periods at various times between 2000 and 2003.
F-14
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
5. SECURITIZATION OF CREDIT CARD RECEIVABLES (CONTINUED)
"Due from securitizations" consists of spread deposits, I/O strips and
excess funding deposits as shown in the table below:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1998 1999
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Spread deposits......................................... $ 82,875 $104,222
I/O strips.............................................. 21,967 20,289
Excess funding deposits................................. 16,600 19,973
-------- --------
$121,442 $144,484
======== ========
</TABLE>
The spread deposits, I/O strips and excess funding deposits are initially
recorded at their allocated carrying amount based on relative fair value. Fair
value is determined by computing the present value of the estimated cash flows,
using the dates that such cash flows are expected to be released to the Company,
at a discount rate considered to be commensurate with the risks associated with
the cash flows. The amounts and timing of the cash flows are estimated after
considering various economic factors including prepayment, delinquency, default
and loss assumptions.
I/O strips, seller's interest and other interests retained are periodically
evaluated for impairment based on the fair value of those assets.
Fair values of I/O strips and other interests retained are based on a review
of actual cash flows and on the factors that affect the amounts and timing of
the cash flows from each of the underlying credit card receivable pools. Based
on this analysis, assumptions are validated or revised as deemed necessary, the
amounts and the timing of cash flows are estimated and fair value is determined.
The Company has one collateral type, private label credit cards, and used the
following assumptions to determine fair value at December 31, 1999:
<TABLE>
<S> <C>
Discount rate.................................... 14.0%
Collected yield.................................. 20.1% - 25.2%
Interest expense................................. 6.94%
Credit losses rate............................... 7.3% - 9.8%
Dilution (prepayment) ratio...................... 1.6% to 2.8%
Weighted average life............................ 8 months
</TABLE>
Spread deposits, carried at estimated fair value, represent deposits that
are held by a trustee or agent and are used to absorb losses related to
securitized credit card receivables if those losses exceed the available net
cash flows arising from the securitized credit card receivables. The fair value
of spread deposits is based on the maturity date of the respective series,
ranging from 4 months to 3 years and 4 months, and the discount rate. The
discount rate is based on a risk adjusted rate paid on the series less the
interest rate earned by the Company on the spread deposits and ranges from 2.1%
to 4.0%. The amount required to be deposited is 3.25% of credit card receivables
in the trust, other than with respect to the trust in early amortization, for
which all excess funds are required to be deposited. Spread deposits are
generally released proportionately as investors are repaid, although some spread
deposits are released only when investors have been paid in full. None of these
spread deposits were required to be used to cover losses on securitized credit
card receivables in the three-year period ended December 31, 1999.
F-15
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
5. SECURITIZATION OF CREDIT CARD RECEIVABLES (CONTINUED)
The Company is required to maintain minimum interests ranging from 4% to 7%
of the securitized credit card receivables. This requirement is met through
seller's interest, and is supplemented through the excess funding deposits.
Excess funding deposits represent cash amounts deposited with the trustee of the
securitizations.
6. INTANGIBLE ASSETS AND GOODWILL
Intangible assets and goodwill consist of the following:
<TABLE>
<CAPTION>
AMORTIZATION LIFE
DECEMBER 31, AND METHOD
------------------- ---------------------------
1998 1999
-------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Premium on purchased credit 3 years--straight line
card portfolio........... $ 37,539 $ 38,536
Customer contracts and 3-20 years--straight line
lists.................... 27,000 46,700
Noncompete agreement....... 19,000 2,300 5 years--straight line
Goodwill................... 174,338 333,154 20-25 years--straight line
Deferred incentives........ 10,454 11,086 27 months--straight line
Sponsor contracts.......... 37,244 39,495 5 years--declining balance
Collector database......... 45,738 48,503 15%--declining balance
-------- --------
Total.................... 351,313 519,774
Accumulated amortization... (65,134) (99,719)
-------- --------
Intangible assets and
goodwill, net............ $286,179 $420,055
======== ========
</TABLE>
F-16
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. DEBT
Debt consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1998 1999
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Certificates of deposit............................... $ 49,500 $ 116,900
Revolving credit loan agreement....................... 98,484 --
Subordinated notes.................................... 102,000 102,000
Credit agreement...................................... 130,000 120,361
Term loans............................................ 100,000 95,875
--------- ---------
479,984 435,136
Less: current portion................................. (148,149) (118,225)
--------- ---------
Long term portion..................................... $ 331,835 $ 316,911
========= =========
</TABLE>
CERTIFICATES OF DEPOSIT--Terms of the certificates of deposit range from
three months to 24 months with annual interest rates ranging from 5.1% to 5.9%
at December 31, 1998 and from 5.4% to 6.9% at December 31, 1999. Interest is
paid monthly and at maturity.
REVOLVING CREDIT LOAN AGREEMENT--In fiscal 1996, in connection with the
Company's purchase of certain trade receivables, the Company entered into a
revolving credit loan agreement that provided for revolving credit loans of up
to $100.0 million, with interest at a variable rate (5.75% at December 31,
1998). The loan was repaid in December 1999 and this credit agreement has since
expired.
SUBORDINATED NOTES--The Company has outstanding a subordinated note with an
affiliate in the principal amount of $50.0 million. Such note bears interest at
10% payable semiannually. This note was issued at a discount of approximately
$3.6 million, and such discount is accreted into interest expense using the
effective rate of approximately 12% over the life of the note. The note is to be
repaid on October 25, 2005. The Company may, at its option, prepay the note at
its face amount.
The Company has outstanding a subordinated note with an affiliate in the
principal amount of $52.0 million. Such note bears interest at 10% payable
semi-annually. This note was issued at a discount of approximately
$6.5 million, and such discount is accreted into interest expense using the
effective rate of approximately 12% over the life of the note. The discount was
issued in the form of 5.9 million shares of common stock issued to the
affiliate. The note is to be repaid in two equal installments in September 2007
and September 2008. The Company may, at its option, prepay the note at its face
amount.
CREDIT AGREEMENT--In fiscal 1997, the Company entered into a credit
agreement to borrow $130.0 million. Funds borrowed under this facility bear
interest at the higher of (i) the prime rate for such day or (ii) the sum of 1/2
of 1% plus the Federal funds rate for a base rate loan or (iii) the sum of the
Euro-dollar margin plus the LIBOR rate applicable to such period for each
Euro-dollar loan. Interest is payable quarterly in arrears. The effective
interest rates were 7.94% and 8.0% at December 31, 1998 and 1999, respectively.
Funds borrowed under the credit agreement are to be repaid in installments of
$10.0 million on July 28, 2000, $30.0 million on July 27, 2001, $40.0 million on
August 2, 2002 and the remaining balance on July 25, 2003. The Company's
obligations under the credit agreement are secured by substantially all of its
assets.
F-17
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. DEBT (CONTINUED)
TERM LOANS--The Company has outstanding two separate term loan facilities
each in the amount of $50.0 million. The first term loan is payable in four
separate annual installments of $3.1 million commencing July 30, 1999 with a
final lump sum payment of $37.5 million due July 25, 2003. The second term loan
is payable in six separate annual installments of $1.0 million commencing
July 30, 1999 with a final lump sum payment of $44.0 million due July 25, 2005.
Both loans bear interest at the higher of (i) the prime rate for such day or
(ii) the sum of 1/2 of 1% plus the Federal funds rate for a base rate loan or
(iii) the sum of the Euro-dollar margin plus the LIBOR rate applicable to such
period for each Euro-dollar loan. Interest is payable quarterly in arrears. The
effective interest rates on the two term loans were 7.07% and 8.995%,
respectively, at December 31, 1999.
LINE OF CREDIT--The Company has available borrowings under a line of credit
agreement of $100.0 million. The line of credit bears interest at the higher of
(i) the prime rate for such day or (ii) the sum of 1/2 of 1% plus the Federal
funds rate for a base rate loan or (iii) the sum of the Euro-dollar margin plus
the LIBOR rate applicable to such period for each Euro-dollar loan. The
agreement matures on July 25, 2003. There were no amounts outstanding on the
line of credit at December 31, 1998 or 1999.
Any outstanding balances, including interest, related to the credit
agreement will become payable immediately if the Company consummates a public
offering of equity securities. The Company has agreed to comply with certain
covenants as part of all non-subordinated debt agreements.
Debt at December 31, 1999 matures as follows (in thousands):
<TABLE>
<S> <C>
2000.............................................. $118,225
2001.............................................. 64,425
2002.............................................. 44,125
2003.............................................. 78,861
2004.............................................. 1,000
Thereafter........................................ 128,500
--------
$435,136
========
</TABLE>
F-18
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES
The Company files a consolidated Federal income tax return. Components of
the provision (credit) for income taxes are as follows:
<TABLE>
<CAPTION>
FISCAL
------------------------------
1997 1998 1999
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
CURRENT
Federal........................................ $ 9,464 $ 5,789 $18,827
State.......................................... 347 98 483
Foreign........................................ 22 1,777 9,610
------- ------- -------
Total current................................ 9,833 7,664 28,920
------- ------- -------
DEFERRED
Federal........................................ (4,205) (4,839) (15,081)
State.......................................... (392) (808) 1,182
Foreign........................................ 1,640 (2,705)
------- ------- -------
Total deferred............................... (4,597) (4,007) (16,604)
------- ------- -------
5,236 3,657 12,316
Tax (benefit) expense related to discontinued
operations..................................... (4,440) (159) 2,127
------- ------- -------
Total income tax provision..................... $ 796 $ 3,498 $14,443
======= ======= =======
</TABLE>
A reconciliation of recorded federal income tax expenses (benefit) to the
expected expense computed by applying the federal statutory rate of 35% for all
periods to income before income taxes is as follows:
<TABLE>
<CAPTION>
FISCAL
------------------------------
1997 1998 1999
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Expected (benefit) expense at statutory rate...... $4,877 $(3,571) $(4,712)
Increase (decrease) in income taxes resulting
from:
State and foreign income taxes.................. 225 63 296
Non-deductible foreign losses................... 159 832 623
Non-deductible acquired goodwill and other
intangibles................................... -- 5,944 18,846
Change in valuation allowance................... -- -- (3,266)
Other--net...................................... (25) 389 529
------ ------- -------
Total......................................... $5,236 $ 3,657 $12,316
====== ======= =======
</TABLE>
F-19
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. INCOME TAXES (CONTINUED)
Deferred tax assets and liabilities consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1998 1999
---------- ---------
(IN THOUSANDS)
<S> <C> <C>
DEFERRED TAX ASSETS
Deferred income.................................... $ 5,424 $13,410
Allowance for doubtful accounts.................... 2,733 1,405
Intangible assets.................................. 17,477 20,008
Estimated loss on contracts........................ 1,841 --
Net operating loss carryforwards................... 10,553 11,966
Depreciation....................................... 1,800 2,875
Discontinued operations............................ -- 2,186
Other.............................................. 3,708 3,936
------- -------
Total deferred tax assets........................ 43,536 55,786
------- -------
DEFERRED TAX LIABILITIES
Servicing rights................................... 7,771 8,120
Accrued expenses................................... 1,283 468
Other.............................................. 970 348
------- -------
Total deferred tax liabilities................... 10,024 8,936
------- -------
Valuation allowance................................ (8,797) (5,531)
------- -------
Net deferred tax asset............................. $24,715 $41,319
======= =======
</TABLE>
At December 31, 1999, the Company had approximately $18.8 million of Federal
net operating losses ("NOL's"), which expire at various times through 2013. In
addition, the Company has approximately $139.9 million of state NOL's, which
expire at various times through 2015. The utilization of the Federal NOL's are
subject to limitations under Section 382 of the Internal Revenue Code on account
of changes in the equity ownership. NOL's for both financial reporting and tax
reporting purposes are subject to a valuation allowance established for the tax
benenfit associated with their respective unrealizable federal and state NOL's.
In 1999, $7.3 million of the valuation allowance was reversed as a result of
final regulations issued by the Internal Revenue Service in June 1999. The
Company increased the valuation allowance by $4.0 million in 1999. The valuation
allowance relates primarily to state NOL's and reduces deferred tax assets to an
amount that represents management's best estimate of the amount of such deferred
tax assets that more likely than not will be realized.
F-20
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. PREFERRED STOCK
In July 1999, the Company entered into a preferred stock purchase agreement
and issued 120,000 shares of its Series A Cumulative Convertible Preferred Stock
for proceeds of $120.0 million to an affiliate. The terms of the preferred stock
purchase agreement include, among other things, the following:
- Dividends are payable by the Company upon declaration by the Board of
Directors. Dividends are cumulative and dividends not paid currently will
accrue and compound quarterly at an annual rate of 6.0%. Dividends in
arrears at December 31, 1999 were $3.4 million.
- Each share is convertible into common shares at a conversion rate of
$13.50, at the option of the holder, at any time following issuance. Upon
a $75.0 million or greater initial public offering, shares will be
mandatorily convertible into common stock at the stated conversion price.
- The shares have an aggregate liquidation preference equal to the face
amount plus all accrued and unpaid dividends.
- Each share may be voted together with the common stock on an as-converted
basis.
- All issued and outstanding shares are redeemable on July 12, 2007 at a per
share redemption price as defined in the agreement.
10. STOCKHOLDERS' EQUITY
In connection with the BSI acquisition, the Company issued warrants to
purchase up to 167,084 shares of the Company's common stock at $9.00 per share.
The warrants and any stock issued upon exercise of the warrants contain or will
contain transfer restrictions. The fair value of the warrants was included in
the acquisition purchase price. The warrants expire in January 2008.
During July 1999, the stockholders approved an increase in the number of
authorized shares from 50,000,000 shares to 66,666,667 shares.
11. STOCK COMPENSATION PLANS
Certain of the Company's employees have been granted stock options under the
Company's Stock Option and Restricted Stock Purchase Plan (the "Plan"). The
purpose of the Plan is to benefit and advance the interests of the Company by
rewarding certain employees for their contributions to the financial success of
the Company and thereby motivating them to continue to make such contributions
in the future. The stock options generally vest over a three year period,
beginning on the first day of February of the eighth year after the date of
grant and expire 10 years after the date of grant. Terms of all awards are
determined by the Board of Directors at the time of award.
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions:
<TABLE>
<CAPTION>
FISCAL
------------------------------
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
Expected dividend yield.......................... -- -- --
Risk-free interest rate.......................... 6.0% 6.0% 7.0%
Expected life of options (years)................. 4.0 yrs 4.0 yrs 4.0 yrs
Assumed volatility............................... 0.01% 0.01% 0.01%
</TABLE>
F-21
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. STOCK COMPENSATION PLANS (CONTINUED)
The weighted average fair value of each option as of the grant date was
$1.89, $2.79 and $2.43 in fiscal 1997, fiscal 1998 and fiscal 1999,
respectively. The Black Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. Option valuation models incorporate highly
subjective assumptions. Because changes in the subjective assumptions can
materially affect the fair value estimate, the existing models do not
necessarily provide a reliable single measure of the fair value of the Company's
employee stock options. Because the determination of fair value of all employee
stock options granted after such time as the Company becomes a public entity
will include an expected volatility factor and because, for pro forma disclosure
purposes, the estimated fair value of the Company's employee stock options is
treated as if amortized to exepense over the options' vesting period, the
effects of applying SFAS No. 123 for pro forma disclosures are not necessarily
indicative of future amounts.
The following table summarizes stock option activity under the Plan:
<TABLE>
<CAPTION>
OPTIONS WEIGHTED AVERAGE
OUTSTANDING EXERCISE PRICE
------------ -----------------
(IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
<S> <C> <C>
BALANCE AT FEBRUARY 1, 1997....................... 640 $ 9.00
Granted......................................... 597 9.00
Exercised....................................... (16) 9.00
Canceled........................................ (65) 9.00
-----
BALANCE AT JANUARY 31, 1998....................... 1,156 9.00
Granted......................................... 912 9.45
Exercised....................................... (57) 9.00
Canceled........................................ (194) 9.00
-----
BALANCE AT DECEMBER 31, 1998...................... 1,817 9.18
Granted......................................... 644 10.14
Exercised....................................... (42) 9.00
Cancelled....................................... (71) 9.09
-----
BALANCE AT DECEMBER 31, 1999...................... 2,348 9.54
=====
</TABLE>
The following table summarizes information concerning currently outstanding
and exercisable stock options at December 31, 1999 (in thousands, except per
share amounts):
<TABLE>
<CAPTION>
OUTSTANDING EXERCISABLE
---------------------------------------- -------------------------
REMAINING WEIGHTED WEIGHTED
RANGE OF EXERCISE CONTRACTUAL AVERAGE AVERAGE
PRICES OPTIONS LIFE (YEARS) EXERCISE PRICE OPTIONS EXERCISE PRICE
----------------- -------- ------------ -------------- -------- --------------
<S> <C> <C> <C> <C> <C>
$9.00 to $11.25 2,348 8.34 9.54 1,311 9.30
</TABLE>
The Company applies APB Opinion No. 25 and related interpretations in
accounting for the Plan. The effect of determining compensation cost for the
Company's stock-based compensation plan based
F-22
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. STOCK COMPENSATION PLANS (CONTINUED)
on the fair value at the grant dates for awards under the Plan consistent with
the methods of SFAS No. 123 is disclosed in the following pro forma information
(in thousands, except per share amounts):
<TABLE>
<CAPTION>
FISCAL
------------------------------
1997 1998 1999
-------- -------- --------
<S> <C> <C> <C>
Pro forma net income (loss)...................... $ 314 $(14,796) $(22,219)
===== ======== ========
Basic pro forma earnings per share............... $0.01 $ (0.35) $ (0.47)
===== ======== ========
Diluted pro forma earnings per share............. $0.01 $ (0.35) $ (0.47)
===== ======== ========
</TABLE>
12. EMPLOYEE BENEFIT PLANS
The Company sponsors separate defined contribution pension plans for World
Financial Network National Bank ("WFNNB") and ADSI that cover qualifying
employees based on service and age requirements. The Company makes matching
(WFNNB) or discretionary (ADSI) contributions as determined by the Board of
Directors.
13. COMMITMENTS AND CONTINGENCIES
The Company has entered into certain contractual arrangements that result in
a fee being billed to the sponsors upon redemption of Air Miles reward miles.
The Company has obtained revolving letters of credit from certain of these
sponsors that expire at various dates. These letters of credit total
$44.4 million at December 31, 1999, which exceeds the estimated amount of the
obligation to provide travel and other rewards.
The Company leases certain office facilities and equipment under
noncancellable operating leases and is generally responsible for property taxes
and insurance. Future annual minimum rental payments required under
noncancellable operating leases, some of which contain renewal options, as of
December 31, 1999 are (in thousands):
<TABLE>
<CAPTION>
YEAR:
-----
<S> <C>
2000.............................................. $ 53,002
2001.............................................. 49,496
2002.............................................. 28,887
2003.............................................. 12,009
2004.............................................. 10,056
Thereafter........................................ 34,076
--------
Total............................................. $187,526
========
</TABLE>
WFNNB is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Company's financial statements. Under capital adequacy guidelines and the
regulatory framework for prompt corrective action, WFNNB must meet specific
capital guidelines that involve quantitative measures of its assets, liabilities
and certain off-balance-sheet items as calculated under regulatory
F-23
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. COMMITMENTS AND CONTINGENCIES (CONTINUED)
accounting practices. The capital amounts and classification are also subject to
qualitative judgments by the regulators about components, risk weightings, and
other factors.
Quantitative measures established by regulation to ensure capital adequacy
require WFNNB to maintain minimum amounts and ratios of total and Tier 1 capital
(as defined in the regulations) to risk weighted assets (as defined) and of Tier
1 capital (as defined) to average assets (as defined) ("total capital ratio",
"Tier 1 capital ratio" and "leverage ratio", respectively). Under the
regulations, a "well capitalized" institution must have a Tier 1 captial ratio
of at least six percent, a total capital ratio of at least 10 percent and a
leverage ratio of at least five percent and not be subject to a capital
directive order. An "adequately capitalized" institution must have a Tier 1
capital ratio of at least four percent, a total capital ratio of at least eight
percent and a leverage ratio of at least four percent, but three percent is
allowed in some cases. Under these guidelines, WFNNB is considered well
capitalized. As of December 31, 1999, WFNNB's Tier 1 capital ratio was 50.0,
total capital ratio was 51.0 and leverage ratio was 49.1, and WFNNB was not
subject to a capital directive order.
Holders of credit cards issued by the Company have available lines of
credit, which vary by accountholder, that can be used for purchases of
merchandise offered for sale by clients of the Company. These lines of credit
represent elements of risk in excess of the amount recognized in the financial
statements. The lines of credit are subject to change or cancellation by the
Company. As of December 31, 1999, WFNNB had approximately 24.0 million active
accountholders, having an unused line of credit averaging $684 per account.
The Company has entered into certain long-term arrangements to purchase
tickets from its airline and other suppliers. These long-term arrangements allow
the Company to make purchases at set prices. At December 31, 1999, the Company
had no material minimum purchase commitments with these suppliers.
SIGNIFICANT CONCENTRATION OF CREDIT RISK--The Company's Credit Services
segment is active in originating private label credit cards in the United
States. The Company reviews each potential customer's credit application and
evaluates the applicant's financial history and ability and perceived
willingness to repay. Credit card loans are made primarily on an unsecured
basis. Card holders reside throughout the United States and are not
significantly concentrated in any one area.
14. FINANCIAL INSTRUMENTS
The Company is a party to financial instruments with off-balance sheet risk
in the normal course of business to meet the financial needs of its customers
and to reduce its own exposure to fluctuations in interest rates. These
financial instruments include commitments to extend credit through charge cards,
interest rate swaps and futures contracts. Such instruments involve, to varying
degrees, elements of credit and interest rate risk in excess of the amount
recognized in the balance sheet. The contract or normal amounts of these
instruments reflect the extent of the Company's involvement in particular
classes of financial instruments.
F-24
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. FINANCIAL INSTRUMENTS (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS--The estimated fair values of the
Company's financial instruments were as follows:
<TABLE>
<CAPTION>
DECEMBER 31
-----------------------------------------------------------
1998 1999
---------------------------- ----------------------------
CARRYING AMOUNT FAIR VALUE CARRYING AMOUNT FAIR VALUE
--------------- ---------- --------------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
FINANCIAL ASSETS
Cash and cash equivalents................ $ 47,036 $ 47,036 $ 56,546 $ 56,546
Restricted cash and cash equivalents..... 17,909 17,909 69,571 69,571
Securities available-for-sale............ 52,269 52,269 64,079 64,079
Trade receivables........................ 143,286 143,286 69,085 69,085
Credit card receivables and seller's
interest, net.......................... 139,458 139,458 150,804 150,804
Due from securitizations................. 121,442 121,442 144,484 144,484
FINANCIAL LIABILITIES
Accounts payable......................... 44,327 44,327 83,976 83,976
Long-term and subordinated debt.......... 479,984 491,192 435,136 447,861
<CAPTION>
NOTIONAL AMOUNT FAIR VALUE NOTIONAL AMOUNT FAIR VALUE
--------------- ---------- --------------- ----------
<S> <C> <C> <C> <C>
Interest swaps............................. $900,000 $(14,148) $725,000 $ (6,083)
</TABLE>
The following methods and assumptions were used by the Company in estimating
fair values of financial instruments as disclosed herein:
CASH AND CASH EQUIVALENTS--The carrying amount approximates fair value due
to the short maturity of the cash investments.
TRADE RECEIVABLES--The carrying amount approximates fair value due to the
short maturity and the average interest rates approximate current market
origination rates.
CREDIT CARD RECEIVABLES--The carrying amount of credit card receivables
approximates fair value due to the short maturity and the average interest rates
approximate current market origination rates.
SECURITIES AVAILABLE-FOR-SALE--Fair value for securities are based on quoted
market prices.
DUE FROM SECURITIZATIONS--The carrying amount of the securitization spread
account approximates its fair value due to the relatively short maturity period
and average interest rates which approximate current market rates.
ACCOUNTS PAYABLE--Due to the relatively short maturity periods, the carrying
amount approximates the fair value.
LONG-TERM AND SUBORDINATED DEBT--The fair value was estimated based on the
current rates available to the Company for debt with similar remaining
maturities.
INTEREST SWAPS--The fair value was estimated based on the cost to the
Company to terminate the agreements.
F-25
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. INTEREST SWAPS
INTEREST SWAPS--In March 1997, WFNNB entered into three interest rate swap
agreements with J.P. Morgan Company ("Morgan") with notional amounts totaling
$500.0 million. These interest rate swaps effectively change WFNNB's interest
rate exposure on $300.0 million and $200.0 million of securitized credit card
receivables to a fixed rate of approximately 6.34% and 6.72%, respectively. On
January 30, 1998, WFNNB entered into an interest rate swap agreement with Morgan
with a notional amount of $300.0 million. This interest rate swap effectively
changed WFNNB's interest rate exposure on $300.0 million of securitized accounts
receivable to a variable rate based on LIBOR. The notional amount of the swap,
$125 million at December 31, 1999, will decrease with a corresponding decrease
of the related securitized credit card receivables. In October 1998, Loyalty
entered into two cross-currency interest rate swap agreements with Morgan with
notional amounts totaling $100.0 million. The interest rate swaps effectively
changed Loyalty's interest rate exposure on $50.0 million and $50.0 million of
notes payable to a variable rate based on Canadian Bankers Acceptance and to a
fixed rate of 7.07% and 8.995%, respectively. The following briefly outlines the
terms of each swap agreement:
<TABLE>
<CAPTION>
FIXED/VARIABLE FIXED/VARIABLE
NOTIONAL AMOUNT SWAP PERIOD RATE RECEIVED RATE PAID
----------------------- --------------------------------------- ------------------------ ------------------------
<S> <C> <C> <C>
$250,000,000........... March 10, 1997 through March 10, 2000 USD-CP-H.15 6.340%
$50,000,000............ March 10, 1997 through March 10, 2000 USD-LIBOR-BBA 6.345%
$200,000,000........... May 15, 1997 through May 15, 2004 USD-LIBOR-BBA 6.720%
$125,000,000........... January 30, 1998 through March 15, 2003 5.67% USD-LIBOR-BBA
$50,000,000............ October 26, 1998 through July 25, 2003 USD-LIBOR-BBA+1.75% CAD-BA-CDOR+1.99%
$50,000,000............ October 26, 1998 through July 25, 2005 USD-LIBOR-BBA+3.0% 8.995%
</TABLE>
DEFERRED INCOME--In fiscal 1995, the Company entered into five-year and
seven-year forward rate locks to mitigate the impact of interest rate
fluctuations of the five and seven year Asset-Backed Securities ("ABS") issued
in a public offering in connection with the securitization of certain credit
card receivables. At the forward rate lock hedge determination date, the Company
was in a favorable position and received $17.7 million (five year) and
$16.8 million (seven year) which was recorded as deferred income and is being
amortized ratably over five and seven year periods, respectively. The hedging
reduced the effective interest rate of the five year ABS's from approximately
6.7% to 6.0% and reduced the effective interest rate of the seven year ABS's
from approximately 7.0% to 6.2%.
F-26
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. PARENT ONLY FINANCIAL STATEMENTS
ALLIANCE DATA SYSTEMS CORPORATION
(PARENT COMPANY ONLY)
CONDENSED FINANCIAL INFORMATION
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1998 1999
BALANCE SHEETS -------- --------
(IN THOUSANDS)
<S> <C> <C>
Assets:
Cash and cash equivalents................................... $ 889 $ --
Investment in subsidiaries.................................. 191,872 362,194
Loans to subsidiaries....................................... 271,750 181,750
Receivables from subsidiaries............................... -- 66,179
Trade receivables........................................... 97,635 --
Other....................................................... 23,151 12,867
-------- --------
Total assets.............................................. $585,297 $622,990
======== ========
Liabilities:
Long-term and subordinated debt............................. $330,600 $222,361
Borrowings from subsidiaries................................ 17,510 --
Other....................................................... 7,324 10,432
-------- --------
Total liabilities......................................... 355,434 232,793
Stockholders' equity........................................ 229,863 390,197
-------- --------
Total liabilities and stockholders' equity................ $585,297 $622,990
======== ========
</TABLE>
<TABLE>
<CAPTION>
FISCAL
------------------------------
1997 1998 1999
STATEMENTS OF INCOME -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Interest from loans to subsidiaries......................... $3,578 $17,907 $23,962
Dividends from subsidiary................................... -- -- 40,000
Processing and servicing fees............................... 695 4,457 3,404
Other income................................................ 240 156 149
------ ------- -------
Total revenue............................................. 4,513 22,520 67,515
Interest expense............................................ 1,945 21,165 25,981
Other expense............................................... 17 153 256
------ ------- -------
Total expense............................................. 1,962 21,318 26,237
------ ------- -------
Income before income taxes.................................. 2,551 1,202 41,278
Income tax expense.......................................... 848 486 720
------ ------- -------
Net income.................................................. $1,703 $ 716 $40,558
====== ======= =======
</TABLE>
Note: Alliance Data Systems Corporation accounts for its investments in
subsidiaries under the cost method.
F-27
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. PARENT ONLY FINANCIAL STATEMENTS (CONTINUED)
<TABLE>
<CAPTION>
FISCAL
---------------------------------
1997 1998 1999
STATEMENTS OF CASH FLOWS --------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Net cash provided by (used in) operating activities......... $ (59,919) $ (78,260) $ 115,555
Investing activities:
Net cash paid for corporate acquisitions.................... (3,250) (151,500) (169,322)
Loans to subsidiaries....................................... (137,669) -- --
--------- --------- ---------
Net cash used in investing activities....................... (140,919) (151,500) (169,322)
Financing Activities:
Borrowings from subsidiaries................................ -- 17,510 41,331
Issuance of long-term and subordinated debt................. 421,998 327,159 320,624
Repayment of long-term and subordinated debt................ (220,626) (221,676) (428,854)
Net proceeds from preferred stock........................... -- -- 119,400
Net proceeds from issuances of common stock................. 96 107,042 377
--------- --------- ---------
Net cash provided by (used in) financing activities......... 201,468 230,015 52,878
--------- --------- ---------
Increase (decrease) in cash and cash equivalents............ 630 255 (889)
Cash and cash equivalents at beginning of period............ 4 634 889
--------- --------- ---------
Cash and cash equivalents at end of period.................. $ 634 $ 889 $ --
========= ========= =========
</TABLE>
18. SEGMENT INFORMATION
Operating segments are defined by SFAS 131 as components of an enterprise
about which separate financial information is available that is evaluated
regularly by the chief operating decision maker, or decision making group, in
deciding how to allocate resources and in assessing performance. The Company's
chief operating decision making group is the Executive Committee, which consists
of the Chairman of the Board and Chief Executive Officer, Presidents of the
divisions; Executive Vice Presidents; and certain other officers. The operating
segments are reviewed separately because each operating segment represents a
strategic business unit that generally offers different products and serves
different markets.
The accounting policies of the operating segments are generally the same as
those described in the summary of significant accounting policies. Corporate
overhead is allocated to the segments based on a percentage of the segment's
revenues. Interest expense and income taxes are not allocated to the segments in
the computation of segment operating profit for internal evaluation purposes.
Transaction Services performs servicing activities related to Credit Services.
For this, Transaction Services receives a fee equal to its direct costs before
corporate overhead allocation plus a margin that it would charge an
F-28
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
18. SEGMENT INFORMATION (CONTINUED)
unrelated third party for similar functions. Revenues are attributed to
geographic areas based on the location of the unit processing the underlying
transactions.
<TABLE>
<CAPTION>
LOYALTY AND
TRANSACTION CREDIT DATABASE OTHER/
SERVICES SERVICES MARKETING ELIMINATION TOTAL
FISCAL 1997 ----------- -------- ----------- ----------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Revenues................................ $256,730 $211,921 $23,348 $(138,600) $353,399
Depreciation and amortization........... 23,497 12,064 -- -- 35,561
Operating profit........................ 3,713 17,221 8,457 -- 29,391
</TABLE>
<TABLE>
<CAPTION>
LOYALTY AND
TRANSACTION CREDIT DATABASE OTHER/
SERVICES SERVICES MARKETING ELIMINATION TOTAL
FISCAL 1998 ----------- -------- ----------- ----------- --------
(IN THOUSANDS)
(RESTATED - SEE NOTE 22)
<S> <C> <C> <C> <C> <C>
Revenues................................ $286,605 $212,663 $ 84,288 $(149,247) $434,309
Depreciation and amortization........... 25,419 11,763 13,968 -- 51,151
Operating profit........................ (11,798) 27,633 1,847 -- 17,682
</TABLE>
<TABLE>
<CAPTION>
LOYALTY AND
TRANSACTION CREDIT DATABASE OTHER/
SERVICES SERVICES MARKETING ELIMINATION TOTAL
FISCAL 1999 ----------- -------- ----------- ----------- --------
(IN THOUSANDS)
(RESTATED - SEE NOTE 22)
<S> <C> <C> <C> <C> <C>
Revenues................................ $362,524 $247,824 $194,482 $(165,576) $639,254
Depreciation and amortization........... 28,728 12,145 33,863 -- 74,736
Operating profit........................ (8,229) 34,064 3,488 -- 29,323
</TABLE>
Information concerning principal geographic areas is as follows:
<TABLE>
<CAPTION>
UNITED STATES REST OF WORLD(1) TOTAL
------------- ---------------- ----------
(IN THOUSANDS)
(RESTATED - SEE NOTE 22)
<S> <C> <C> <C>
Revenues
Fiscal 1997......................... $352,975 $ 424 $ 353,399
Fiscal 1998......................... 367,588 66,721 434,309
Fiscal 1999......................... 467,629 171,625 639,254
Total assets
December 31, 1998................... 689,234 308,412 997,646
December 31, 1999................... 801,219 365,675 1,166,894
</TABLE>
------------------------
(1) Primarily consists of Canada following the Loyalty acquisition in
July 1998.
19. RELATED PARTY TRANSACTIONS
One of the Company's stockholders, Welsh, Carson, Anderson & Stowe and
related affiliates ("WCAS"), have provided significant financing to the Company
since the initial merger in August 1996. The related transactions are as
follows:
- The Company issued a 10% subordinated note to WCAS in January 1996, in the
principal amount of $30.0 million. Principal on the note is due on
October 25, 2005 and interest is payable semi-annually in arrears on each
January 1 and July 1. The note was originally issued to finance, in part,
the acquisition of BSI Business Services, Inc., now known as ADSI.
Additionally, the Company issued similar notes to The Limited in the
amount of $20.0 million.
F-29
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
19. RELATED PARTY TRANSACTIONS (CONTINUED)
- In July 1998, the Company sold 10.1 million shares of common stock to WCAS
for $100.0 million. The shares were issued to finance, in part, the
acquisition of all outstanding stock of Loyalty.
- In August 1998, the Company sold 30,303 shares of common stock to WCAS for
$300,000 and 20,202 shares of common stock to The Limited for $200,000.
- In September 1998, the Company issued 655,556 shares of common stock to
WCAS and issued a 10% subordinated note to WCAS, in the principal amount
of $52.0 million. Principal on the note is due in two equal installments
on September 15, 2007 and September 15, 2008. Interest is payable
semi-annually in arrears on each March 15 and September 15. The shares and
the note was originally issued to finance, in part, the acquisition of
HSI.
The Company paid Welsh, Carson, Anderson & Stowe $2.0 million in fiscal 1998
and $1.2 million in fiscal 1999 for fees related to acquisitions.
The other significant stockholder of the Company, The Limited (through
affiliates), is a significant customer. The Company has entered into credit card
processing agreements with several affiliates of The Limited. The Company has
received fees from The Limited and its affiliates of $53.1 million for fiscal
1997, $54.8 million for fiscal 1998 and $64.1 million for fiscal 1999.
20. DISCONTINUED OPERATIONS
During September 1999, the Board of Directors decided to discontinue the
Company's subscriber services business when a major customer was acquired by a
third party. The business is expected to wind down by second quarter 2000. The
business had revenues of approximately $27.4 million, $44.9 million, $43.1
million in fiscal 1997, 1998 and 1999, respectively. The net assets of the
business were immaterial.
21. SUBSEQUENT EVENTS
On March 1, 2000, the Company's Board of Director and stockholders approved
a change in number of authorized shares of common stock to 200,000,000, and
approved a 1-for-9 reverse stock split. Such change in authorized shares and
stock split became effective March 1, 2000. All share and per share data in the
accompanying financial statements have been restated to give effect to the
reverse stock split.
22. RESTATEMENT
Subsequent to the issuance of the Company's 1999 consolidated financial
statements, the Company's management determined that the premium on purchased
credit card portfolio had been amortized using an inappropriate life in the
Company's fiscal 1997, 1998 and 1999 consolidated financial statements. As a
result, the accompanying fiscal 1997, 1998 and 1999 consolidated financial
statements have been restated from amounts previously reported to reduce the
life on premium on purchased credit card portfolios from 15 years to three
years.
F-30
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
22. RESTATEMENT (CONTINUED)
Set forth below is a summary of the significant effects of the restatement
(amounts in thousands, except per share data):
<TABLE>
<CAPTION>
PREVIOUSLY
AS RESTATED REPORTED
----------- ----------
<S> <C> <C>
At February 1, 1997:
Retained earnings......................................... $ 85,077 $ 86,071
At January 31, 1998:
Retained earnings......................................... 85,526 92,434
For the 53 weeks ended January 31, 1998
Amortization of purchased intangibles..................... 28,159 19,061
Income tax expense........................................ 5,236 8,420
Net income................................................ 449 6,363
Net income per share...................................... 0.01 0.17
At December 31, 1998:
Intangible assets and goodwill, net....................... 286,179 305,365
Deferred tax asset, net................................... 21,664 14,949
Total assets.............................................. 997,646 1,010,119
Retained earnings......................................... 71,367 83,838
For the Eleven Months Ended December 31, 1998:
Amortization of purchased intangibles..................... 42,880 34,321
Income tax expense........................................ 3,657 6,653
Net loss.................................................. (14,159) (8,596)
Net loss per share........................................ (0.34) (0.21)
At December 31, 1999:
Intangible assets and goodwill, net....................... 420,055 448,017
Deferred tax asset, net................................... 14,903 5,116
Retained earnings......................................... 49,540 67,715
Total assets.............................................. 1,166,894 1,185,069
For the Year Ended December 31, 1999:
Amortization of purchased intangibles..................... 58,553 49,777
Income tax expense........................................ 12,316 15,388
Net loss.................................................. (21,827) (16,123)
Net loss per share........................................ (0.53) (0.41)
</TABLE>
F-31
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------
1999 2000
-------- --------
<S> <C> <C>
REVENUES
Processing and servicing fees............................. $103,900 $130,507
Financing charges, net.................................... 41,509 44,359
Other income.............................................. 2,404 3,762
-------- --------
Total revenue........................................... 147,813 178,628
OPERATING EXPENSES
Processing and servicing.................................. 76,827 94,027
Salaries and employee benefit............................. 46,236 54,489
Depreciation and other amortization....................... 3,396 5,997
Amortization of purchased intangibles..................... 14,182 13,011
-------- --------
Total operating expenses................................ 140,641 167,524
-------- --------
Operating income............................................ 7,172 11,104
Other expenses.............................................. -- 2,476
Interest expense............................................ 10,324 8,776
-------- --------
Income (loss) from continuing operations before income
taxes..................................................... (3,152) (148)
Income tax expense.......................................... 1,923 3,077
-------- --------
Loss from continuing operations............................. (5,075) (3,225)
Income from discontinued operations, net of taxes........... 1,715 --
Loss on disposal of discontinued operations, net of taxes... -- --
-------- --------
Net loss.................................................... $ (3,360) $ (3,225)
======== ========
Loss per share from continuing operation--basic and
diluted................................................... $ (0.11) $ (0.11)
======== ========
Loss per share--basic and diluted........................... $ (0.07) $ (0.11)
======== ========
Shares used in computing per share amounts--basic and
diluted................................................... 47,487 47,529
======== ========
</TABLE>
See accompanying notes
F-32
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
MARCH 31, 2000
--------------------------
PRO FORMA
DECEMBER 31, STOCKHOLDERS'
1999 ACTUAL EQUITY
-------------- ---------- -------------
(RESTATED--SEE
NOTE 5)
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents............................... $ 56,546 $ 67,069
Restricted cash and cash equivalents.................... 69,571 98,298
Securities available-for-sale........................... 64,079 40,501
Trade receivables....................................... 69,085 76,319
Credit card receivables and seller's interest........... 150,804 134,452
Other current assets.................................... 56,666 56,561
---------- ----------
Total current assets................................ 466,751 473,200
Property and equipment, net............................. 89,231 89,791
Other non-current assets................................ 46,373 35,110
Due from securitizations................................ 144,484 131,446
Intangible assets and goodwill, net..................... 420,055 407,898
---------- ----------
Total assets........................................ $1,166,894 $1,137,445
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable........................................ $ 83,976 $ 76,394
Accrued expenses........................................ 75,646 68,796
Deferred income......................................... 25,805 26,596
Debt, current portion................................... 118,225 104,325
---------- ----------
Total current liabilities........................... 303,652 276,111
Other liabilities....................................... 32,752 30,322
Redemption obligation................................... 122,198 128,628
Long-term and subordinated debt......................... 316,911 312,460
---------- ----------
Total liabilities................................... 775,513 747,521
---------- ----------
Commitments and contingencies
Series A cumulative convertible preferred stock, $0.01
par value; 120 shares authorized and issued; pro
forma--none outstanding............................... 119,400 119,400 $ --
Common Stock, $0.01 par value; authorized 66,667 shares
(December 31, 1999), 200,000 (March 31, 2000), issued
47,529 shares (December 31, 1998), 47,529 shares
(March 31, 2000), 56,805 (pro forma).................. 475 475 568
Additional paid-in capital.............................. 226,174 226,174 345,481
Retained earnings....................................... 49,540 46,315 46,315
Accumulated other comprehensive loss.................... (4,208) (2,440) (2,440)
---------- ---------- --------
Total stockholders' equity............................ 271,981 $ 270,524 $389,924
---------- ---------- ========
Total liabilities and stockholders' equity............ $1,166,894 $1,137,445
========== ==========
</TABLE>
See accompanying notes
F-33
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
---------------------
1999 2000
--------- ---------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Income (loss) from continuing operations.................. $ (5,075) $ (3,225)
Adjustments to reconcile income (loss) from continuing
operations to net cash (used in) provided by operating
activities:
Income (loss) from discontinued operations................ 1,715 --
Depreciation and amortization............................. 17,578 19,008
Provision for doubtful accounts........................... 3,270 2,074
Loss on sale of equity securities......................... -- 2,467
Changes in operating assets:
Change in trade accounts receivables.................... (17,840) (7,186)
Change in other assets.................................. (1,595) 11,368
Change in other accounts payable and accrued expenses... (6,469) (14,431)
Change in other liabilities............................. (943) (1,639)
Redemption obligation................................... 6,348 6,430
Other operating activities.............................. (778) (746)
--------- ---------
Net cash (used in) provided by operating activities..... (3,789) 14,121
CASH FLOWS FROM INVESTING ACTIVITIES
Sale of securities available-for-sale, net................ -- 22,916
Increase in restricted cash and cash equivalents.......... (2,860) (28,727)
Proceeds from sale of receivables......................... 28,494 3,864
Change in seller's interest............................... (7,263) 10,366
Change in due from securitization......................... 16,489 15,031
Capital expenditures...................................... (13,765) (8,366)
--------- ---------
Net cash provided by investing activities............... 21,095 15,091
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings under debt agreements.......................... 184,709 122,700
Repayment of borrowings................................... (163,462) (141,051)
--------- ---------
Net cash provided by (used in) financing activities..... 21,247 (18,351)
Effect of exchange rate changes........................... 375 (338)
--------- ---------
Change in cash and cash equivalents....................... 38,928 10,523
Cash and cash equivalents at beginning of period.......... 46,009 56,546
--------- ---------
Cash and cash equivalents at end of period................ $ 84,937 $ 67,069
========= =========
SUPPLEMENTAL CASH FLOW DISCLOSURE
Interest paid............................................. $ 13,810 $ 13,110
========= =========
Income taxes paid......................................... $ 5,727 $ 4,695
========= =========
</TABLE>
See accompanying notes
F-34
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The condensed consolidated financial statements and related notes of the
business and operations of Alliance Data Systems Corporation (collectively, the
"Company" or "ADSC"), for the three months ended March 31, 1999 and 2000 have
been prepared in accordance with generally accepted accounting principles
pursuant to the rules and regulations of the Securities and Exchange Commission
and are unaudited.
In the opinion of management, the condensed consolidated financial
statements include all recurring adjustments and normal accruals necessary to
present fairly the Company's consolidated financial position and its
consolidated results of operations for the dates and periods presented. Results
for interim periods are not necessarily indicative of the results to be expected
during the remainder of the current year or for any future period. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
These consolidated financial statements should be read in conjunction with
the audited consolidated financial statements and notes thereto for the 53 weeks
ended January 31, 1998, the 11 months ended December 31, 1998 and the year ended
December 31, 1999 presented herein.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities,
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.
COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) was as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------
1999 2000
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Net loss.................................................. $(3,360) $(3,225)
Unrealized gains (losses) on securities
available-for-sale...................................... (445) 2,106
Currency translation adjustment........................... 376 (338)
------- -------
Total comprehensive loss.................................. $(3,429) $(1,840)
======= =======
</TABLE>
EARNINGS PER SHARE
Basic earnings per share is based only 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 and common equivalent shares, dilutive stock options or other
dilutive securities outstanding during the year. However, as the Company
generated net losses, common equivalent shares, composed of incremental common
shares issuable upon exercise of stock options and warrants upon conversion of
Series A preferred stock, are not included in diluted net loss per share because
such shares are anti-dilutive. The following table sets
F-35
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. BASIS OF PRESENTATION (CONTINUED)
forth the computation of basic and diluted net income (loss) per share for the
periods indicated (in thousands, except per share amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-------------------
1999 2000
-------- --------
<S> <C> <C>
NUMERATOR
Net loss................................................ $(3,360) $(3,225)
Preferred stock dividends............................... -- 1,800
------- -------
Numerator for basic and diluted earnings per share--loss
attributable to common stockholders................... $(3,360) $(5,025)
======= =======
DENOMINATOR
Weighted average shares................................. 47,487 47,529
Weighted average effect of dilutive securities:
Net effect of dilutive stock options.................. -- --
Net effect of dilutive stock warrants................. -- --
Net effect of dilutive convertible preferred stock.... -- --
------- -------
Denominator for diluted calculations.................... 47,487 47,529
======= =======
NET (LOSS) PER SHARE
Basic and diluted....................................... $ (0.07) $ (0.11)
======= =======
</TABLE>
PRO FORMA STOCKHOLDERS' EQUITY
If the offering contemplated by this prospectus is consummated, all of the
Series A Cumulative Convertible Preferred Stock outstanding at the closing date
will be converted into shares of common stock. The unaudited pro forma
stockholders' equity as of March 31, 2000 reflects the conversion of all
outstanding convertible preferred stock at March 31, 2000 into 9,275,729 shares
of common stock.
F-36
<PAGE>
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SEGMENT INFORMATION
The Company classifies its businesses into three segments: Transaction
Services, Credit Services and Loyalty and Database Marketing Services.
<TABLE>
<CAPTION>
LOYALTY AND
DATABASE TRANSACTION CREDIT OTHER/
MARKETING SERVICES SERVICES ELIMINATION TOTAL
THREE MONTHS ENDED MARCH 31, 1999 ----------- ----------- -------- ----------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Revenues................................. $42,713 $ 80,570 $66,624 $(42,094) $147,813
Depreciation and amortization............ 8,781 5,832 2,965 -- 17,579
Operating profit (loss).................. (3,297) (2,349) 12,818 -- 7,172
<CAPTION>
THREE MONTHS ENDED MARCH 31, 2000
<S> <C> <C> <C> <C> <C>
Revenues................................. $52,532 $103,484 $69,902 $(47,290) $178,628
Depreciation and amortization............ 8,411 10,282 315 -- 19,008
Operating profit......................... 595 (2,556) 13,065 -- 11,104
</TABLE>
3. STOCKHOLDERS EQUITY
On March 1, 2000, the Company's Board of Directors and stockholders approved
an increase in the number of authorized shares of common stock to 200,000,000,
and approved a 1-for-9 reverse stock split. Such change in authorized shares and
stock split became effective March 1, 2000. All share and per share data in the
accompanying financial statements have been restated to give effect to the
reverse stock split.
F-37
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Shareholders of
Alliance Data Systems Corporation
We have audited the accompanying statements of income, changes in net assets and
cash flows of SPS Network Services for the year ended December 31, 1998 and for
the six months ended June 30, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the results of operations and cash flows of SPS Network Services for
the year ended December 31, 1998 and the six months ended June 30, 1999, in
conformity with accounting principles generally accepted in the United States of
America.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
Columbus, Ohio
March 1, 2000
F-38
<PAGE>
SPS NETWORK SERVICES
STATEMENTS OF INCOME
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED JUNE 30,
1998 1999
------------ --------------
<S> <C> <C>
Processing and servicing fees............................... $ 47,674 $24,322
Operating expenses:
Processing and servicing.................................. 31,260 16,947
Salaries and employee benefits............................ 6,331 3,181
-------- -------
Total operating expenses............................ 37,591 20,128
-------- -------
Income before income taxes.................................. 10,083 4,194
Income taxes................................................ 3,711 1,543
-------- -------
Net income.................................................. $ 6,372 $ 2,651
======== =======
</TABLE>
See accompanying notes.
F-39
<PAGE>
SPS NETWORK SERVICES
STATEMENTS OF CHANGES IN NET ASSETS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED ENDED
DECEMBER 31, 1998 JUNE 30, 1999
------------------ --------------
<S> <C> <C>
Net assets at beginning of period........................... $ 9,074 $ 10,092
Net income.................................................. 6,372 2,650
Distribution of net income to parent........................ (5,354) (4,095)
----------- -----------
Net assets at end of period................................. $ 10,092 $ 8,647
=========== ===========
</TABLE>
See accompanying notes.
F-40
<PAGE>
SPS NETWORK SERVICES
STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED ENDED
DECEMBER 31, 1998 JUNE 30, 1999
----------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 6,372 $ 2,650
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation.............................................. 395 205
Change in accounts receivable............................. (1,435) (336)
Change in other assets.................................... 103 (54)
Change in other liabilities............................... 57 1,708
---------- ----------
Net cash provided by operating activities............... 5,492 4,173
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures...................................... (138) (78)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Distribution to parent.................................... (5,354) (4,095)
---------- ----------
Change in cash and cash at end of period.................... $ -- $ --
========== ==========
</TABLE>
See accompanying notes.
F-41
<PAGE>
SPS NETWORK SERVICES
NOTES TO FINANCIAL STATEMENTS
1. DESCRIPTION OF THE BUSINESS
SPS Network Services (the "Company") provides a range of technology
outsourcing services including the processing of credit and debit card
transactions in the United States.
On July 1, 1999, the Company was purchased by Alliance Data Systems
Corporation ("ADSC"). The Company is a wholly owned subsidiary of ADSC.
Prior to July 1, 1999, the Company provided network services for SPS Payment
Systems, Inc., a wholly-owned subsidiary of Associates First Capital
Corporation ("Associates").
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
MANAGEMENT ESTIMATES--The preparation of financial statements in conformity
with generally accepted accounting principles 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.
PROCESSING AND SERVICE FEES--Processing and service revenues include fees
from transaction processing services which are recognized as such services
are performed.
DEPRECIATION--Depreciation on furniture, fixtures and computer equipment and
software is computed on a straight-line basis, using estimated lives ranging
from three to five years.
3. INCOME TAXES
Prior to July 1, 1999 the Company was included in the consolidated tax
returns of Associates. Associates allocated income tax expense to the
Company based on its proportionate share of the consolidated federal tax
return. There was no deferred tax provision or benefit in 1998 or for the
six months ended June 30, 1999.
A reconciliation of recorded income tax expense to the expected expense
computed by applying the federal statutory rate of 35% to income before
income taxes for 1998 and the six months ended June 30, 1999 is as follows
(in thousands):
<TABLE>
<CAPTION>
SIX MONTHS
ENDED
1998 JUNE 30, 1999
-------- --------------
(IN THOUSANDS)
<S> <C> <C>
Expected expense at statutory rate...................... $3,529 $1,468
Other................................................... 182 75
------ ------
Total............................................... $3,711 $1,543
====== ======
</TABLE>
F-42
<PAGE>
LOYALTY MANAGEMENT GROUP CANADA INC.
REPORT OF INDEPENDENT AUDITORS
To the Shareholders of
Loyalty Management Group Canada Inc.
We have audited the consolidated balance sheets of Loyalty Management Group
Canada Inc. as at April 30, 1997 and April 30, 1998 and the consolidated
statements of operations and retained earnings (deficit) and cash flows for the
years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
In our opinion, these consolidated financial statements present fairly, in
all material respects, the financial position of the Company as at April 30,
1997 and April 30, 1998 and the results of its operations and its cash flows for
the years then ended in accordance with accounting principles generally accepted
in Canada.
<TABLE>
<S> <C>
Toronto, Canada /s/ Ernst & Young LLP
June 12, 1998, except as to Ernst & Young LLP
Note 14, which is as at Chartered Accountants
January 12, 2000
</TABLE>
F-43
<PAGE>
LOYALTY MANAGEMENT GROUP CANADA INC.
CONSOLIDATED BALANCE SHEETS
(CANADIAN DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
AS OF APRIL 30,
-------------------
1997 1998
-------- --------
<S> <C> <C>
ASSETS
Cash and cash equivalents................................... $11,371 $ 10,691
Trade receivables........................................... 15,269 20,841
Prepaid expenses and deposits............................... 236 1,261
------- --------
Total current assets...................................... 26,876 32,793
Restricted marketable securities and cash................... 46,002 76,613
Deferred financing costs, net............................... 1,615 --
Furniture, fixtures and equipment, net...................... 2,745 6,170
Deferred income taxes....................................... 400 560
Goodwill, net............................................... 11,254 9,917
------- --------
Total assets.............................................. $88,892 $126,053
======= ========
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIENCY)
Accounts payable and accrued liabilities.................... $12,801 $ 18,597
Income taxes payable........................................ 3,878 4,355
Deferred revenue and deposits............................... 2,938 4,804
Due to related parties...................................... 307 412
Current portion of leasehold inducement..................... -- 184
Current portion of term loan payable........................ 3,750 --
------- --------
Total current liabilities................................. 23,674 28,352
Redemption obligation....................................... 60,237 90,555
Leasehold inducement........................................ -- 1,539
Term loan payable........................................... 6,563 --
------- --------
Total liabilities......................................... 90,474 120,446
------- --------
Capital stock; 1,434,464 authorized common shares; 1,189,542
issued common shares...................................... 730 730
Retained earnings (deficit)................................. (2,312) 4,877
------- --------
Total shareholders' equity (deficiency)................... (1,582) 5,607
------- --------
Total liabilities and shareholders' equity (deficiency)... $88,892 $126,053
======= ========
</TABLE>
See accompanying notes
F-44
<PAGE>
LOYALTY MANAGEMENT GROUP CANADA INC.
CONSOLIDATED STATEMENTS OF
OPERATIONS AND RETAINED EARNINGS (DEFICIT)
(CANADIAN DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED APRIL 30,
---------------------
1997 1998
--------- ---------
<S> <C> <C>
REVENUES
Air Miles revenue........................................... $ 91,393 $143,723
Other income................................................ 6,248 9,492
-------- --------
Total revenues............................................ 97,641 153,215
-------- --------
OPERATING EXPENSES
Program operations.......................................... 73,142 119,331
General and administrative.................................. 9,380 12,518
Marketing................................................... 5,094 2,742
Amortization of goodwill.................................... 1,337 1,337
Amortization of deferred financing costs.................... 669 1,615
-------- --------
Total operating expenses.................................. 89,622 137,543
-------- --------
Operating income............................................ 8,019 15,672
Interest expense............................................ 1,130 718
-------- --------
Income before income taxes.................................. 6,889 14,954
-------- --------
Income tax expense.......................................... 3,500 7,765
-------- --------
Net income for the year..................................... 3,389 7,189
Deficit, beginning of year.................................. (5,701) (2,312)
-------- --------
Retained earnings (deficit), end of year.................... $ (2,312) $ 4,877
======== ========
</TABLE>
See accompanying notes
F-45
<PAGE>
LOYALTY MANAGEMENT GROUP CANADA INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(CANADIAN DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED APRIL 30,
---------------------
1997 1998
--------- ---------
<S> <C> <C>
OPERATING ACTIVITIES
Net income.................................................. $ 3,389 $ 7,189
Add (deduct) items not affecting cash:
Depreciation and amortization............................. 3,679 4,715
Deferred income taxes..................................... (400) (160)
Increase in redemption obligation......................... 12,930 30,318
Net change in non-cash working capital balances related to
operations................................................ 1,323 1,647
-------- --------
20,921 43,709
Increase in restricted marketable securities and cash....... (10,639) (30,611)
-------- --------
Cash provided by operating activities....................... 10,282 13,098
-------- --------
INVESTING ACTIVITIES
Capital expenditures........................................ (1,587) (5,188)
-------- --------
Cash used in investing activities........................... (1,587) (5,188)
-------- --------
FINANCING ACTIVITIES
Repayment of term loan payable.............................. (4,688) (10,313)
Leasehold inducement........................................ -- 1,723
-------- --------
Cash used in financing activities........................... (4,688) (8,590)
-------- --------
Net increase (decrease) in cash during the year............. 4,007 (680)
Cash and cash equivalents, beginning of year................ 7,364 11,371
-------- --------
Cash and cash equivalents, end of year...................... $ 11,371 $ 10,691
======== ========
Supplementary cash flow information:
Interest paid............................................... $ 1,130 $ 718
======== ========
Income taxes paid........................................... $ 20 $ 7,450
======== ========
</TABLE>
See accompanying notes
F-46
<PAGE>
LOYALTY MANAGEMENT GROUP CANADA INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(CANADIAN DOLLARS IN THOUSANDS)
1. THE COMPANY
Loyalty Management Group Canada Inc. (the "Company") was incorporated under
the laws of Ontario on May 23, 1990, and operates under the registered trademark
name of The Loyalty Group. Its business is to design, develop, market and manage
loyalty programs (the "programs") in Canada.
The Company's program, the Air Miles reward program, was launched in
March 1992 and provides travel and other awards to participating consumers and
businesses ("collectors") for purchases of products and services marketed by
sponsors. The Company provides these awards through a subsidiary company under
long-term exclusive arrangements with suppliers, including major airlines,
certain hotels and other ancillary reward-related businesses.
2. SIGNIFICANT ACCOUNTING POLICIES
BASIS OF ACCOUNTING
The consolidated financial statements of the Company are prepared in
accordance with Canadian generally accepted accounting principles ("GAAP").
Significant differences between U.S. and Canadian GAAP are discussed in
Note 14.
BASIS OF CONSOLIDATION
The consolidated financial statements of the Company include the assets,
liabilities and results of operations of its wholly-owned subsidiary, LMG Travel
Services Limited.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash and short-term investments with
original maturities of less than 90 days.
FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment are recorded at cost less accumulated
depreciation and amortization. Depreciation and amortization are provided using
the straight-line method over the estimated useful lives of the assets as
follows:
<TABLE>
<S> <C>
Office equipment and furniture.............................. 20%
Computers and telephone equipment........................... 33%
Leasehold improvements...................................... 10%
</TABLE>
GOODWILL
Goodwill acquired is amortized on a straight-line basis over its expected
life of ten years.
On an ongoing basis, the Company determines whether there has been a
permanent impairment in unamortized goodwill based on an estimation of
undiscounted long-term cash flow of the operations. To date, no such impairment
has been incurred.
F-47
<PAGE>
LOYALTY MANAGEMENT GROUP CANADA INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(CANADIAN DOLLARS IN THOUSANDS)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
LEASEHOLD INDUCEMENTS
Leasehold inducements received upon the Company's move to new premises have
been deferred in the accounts and are being amortized over the ten-year term of
the lease.
INCOME TAXES
The Company follows the deferral method of accounting for income taxes.
Accordingly, the provision for income taxes reflects the income tax effects of
timing differences between amounts claimed for income tax purposes and amounts
deducted for accounting purposes. The benefits resulting therefrom are shown as
deferred income taxes.
REVENUE RECOGNITION
The Company records revenue for Air Miles reward miles issued through
sponsors to collectors, and provides for the cost of estimated redemptions by
collectors in the year during which the Air Miles reward miles are issued.
Other revenue consists primarily of ancillary revenue derived from operation
of the program and is recorded when the services are rendered.
REDEMPTION OBLIGATION
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes.
The redemption obligation is estimated as the cost of providing travel and
other awards to collectors and related redemption service expenses required to
redeem Air Miles reward miles in the future based on management's best estimate
of the Air Miles reward miles currently issued that will ultimately be redeemed.
These estimates are revised periodically to reflect current expectations of
future redemption costs. Significant changes in future conditions or assumptions
could require a material change in the estimated amount of the redemption
obligation. The redemption obligation is expected to be partially discharged in
the following year in the amount of approximately $25.0 million due to
redemptions by collectors and the same amount of cash is expected to be drawn
from the restricted cash account to fund these payments. Due to the uncertainty
in the timing of redemption activity, no current portion of the respective asset
and liability are set out in the consolidated balance sheet.
RESTRICTED MARKETABLE SECURITIES AND CASH
In order to receive program awards, collectors must collect a specified
number of Air Miles reward miles to qualify for a particular award. Currently,
Air Miles reward miles in collector accounts which are active have no expiration
date. As such, demand for redemption is expected to occur over a considerable
period of time. This timing difference results in the availability of liquid
assets, a portion of which must be segregated to satisfy expected future
redemption costs under the terms of agreements with the Company's suppliers and
sponsors ("restricted cash"). The Company funds a segregated
F-48
<PAGE>
LOYALTY MANAGEMENT GROUP CANADA INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(CANADIAN DOLLARS IN THOUSANDS)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
investment account with a portion of amounts paid by sponsors for Air Miles
reward miles. These amounts, which earn investment income, are maintained under
the terms of agreements with a trust company entered into in December 1992.
FINANCIAL INSTRUMENTS
The carrying amounts in the consolidated financial statements for cash,
accounts receivable, accounts payable and accrued liabilities and deferred
revenue and deposits approximate fair values due to the immediate or short-term
maturities of these financial instruments.
The fair values of short-term investments and marketable securities are
recorded at quoted market value which is considered to be the closing market
price at year end.
3. CASH AND CASH EQUIVALENTS
Included in cash and cash equivalents are short-term investments as follows:
<TABLE>
<CAPTION>
1997 1998
--------------------- ---------------------
COST FAIR VALUE COST FAIR VALUE
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Short-term investments................................... $3,501 $3,505 $1,493 $1,500
====== ====== ====== ======
</TABLE>
4. RESTRICTED MARKETABLE SECURITIES AND CASH
Restricted marketable securities and cash consist of the following:
<TABLE>
<CAPTION>
1997 1998
--------------------- ---------------------
COST FAIR VALUE COST FAIR VALUE
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Cash on hand........................................... $11,756 $11,756 $11,909 $11,909
Short-term deposits--treasury bills, bankers'
acceptances, corporate paper......................... 15,462 15,523 14,695 14,695
Fixed income securities--government.................... 17,075 17,332 22,394 22,414
Fixed income securities--corporate..................... 1,709 1,767 4,978 4,915
Equity................................................. -- -- 22,637 22,399
------- ------- ------- -------
$46,002 $46,378 $76,613 $76,332
======= ======= ======= =======
</TABLE>
F-49
<PAGE>
LOYALTY MANAGEMENT GROUP CANADA INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(CANADIAN DOLLARS IN THOUSANDS)
5. FURNITURE, FIXTURES AND EQUIPMENT
Furniture, fixtures and equipment consists of the following:
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
Office equipment and furniture............................. $1,941 $ 2,963
Computer equipment......................................... 2,429 3,494
Telephone equipment........................................ 948 1,546
Leasehold improvements..................................... 730 2,508
------ -------
6,048 10,511
Less accumulated depreciation and amortization............. 3,303 4,341
------ -------
$2,745 $ 6,170
====== =======
</TABLE>
6. GOODWILL
On October 2, 1995, a financial restructuring took place involving the
purchase of the minority interest in the Company. The transaction was accounted
for under the purchase method of accounting and resulted in goodwill
approximately equal to the cash consideration paid.
Goodwill consists of the following:
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
Goodwill.................................................. $13,371 $13,371
Less accumulated amortization............................. 2,117 3,454
------- -------
$11,254 $ 9,917
======= =======
</TABLE>
7. RELATED PARTY TRANSACTIONS
Amounts due to related parties represent amounts due to a shareholder and
its subsidiaries. These amounts are non-interest bearing and due on demand.
Transactions with these related parties are recorded on a fair value basis.
During the year, transactions with related parties were as follows:
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
Royalty expense paid to subsidiaries of a shareholder....... $957 $1,501
Management fees paid to a shareholder....................... 120 120
</TABLE>
8. CAPITAL STOCK
The Company has approved stock options to management totalling 234,774
shares, 209,207 of which were granted as of April 30, 1997 and 234,774 of which
were granted as of April 30, 1998. The options are exercisable under certain
terms and conditions at a nominal price and expire on January 6, 2003.
F-50
<PAGE>
LOYALTY MANAGEMENT GROUP CANADA INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(CANADIAN DOLLARS IN THOUSANDS)
9. INCOME TAXES
A reconciliation of the combined basic federal and provincial income tax
rate to the related effective rate is as follows:
<TABLE>
<CAPTION>
1997 1998
-------- --------
<S> <C> <C>
Combined basic Canadian federal and provincial income tax
rate...................................................... 44.6% 44.6%
Non-deductible amortization of goodwill..................... 8.8 4.0
Other....................................................... (1.7) 3.3
---- ----
Effective income tax rate................................... 51.7% 51.9%
==== ====
</TABLE>
10. LEASE COMMITMENTS
Future minimum annual rental payments required under non-cancelable
operating leases are as follows:
<TABLE>
<S> <C>
1999........................................................ $1,615
2000........................................................ 1,418
2001........................................................ 1,337
2002........................................................ 1,303
2003 and thereafter......................................... 7,245
</TABLE>
The Company is also committed to its share of operating costs with respect
to office leases.
11. MARKETING AND PROGRAM OPERATIONS EXPENSES
Under the terms of contracts with certain sponsors, the Company is able to
recover a specified amount of Air Miles reward program marketing expenses.
Marketing expenses are presented net of these cost recoveries which amounted to
$2.1 million during 1997 and $3.6 million during 1998. Program operations
expenses are also presented net of cost recoveries which are received by the
Reward Services department to offset the costs of processing redemptions. Total
cost recoveries amount to $6.2 million in 1997 and $9.6 million in 1998.
12. CONTRACTUAL COMMITMENTS
The Company has entered into certain contractual arrangements that result in
an obligation to provide travel and other awards upon redemption of Air Miles
reward miles for a fee to be billed upon redemption to certain sponsors. The
Company has obtained revolving letters of credit from certain of these sponsors
that expire at various dates. The amounts of these letters of credit total
$106.4 million, which exceeds the estimated amount of the fees to be received
from these sponsors.
13. COMPARATIVE CONSOLIDATED FINANCIAL STATEMENTS
The comparative consolidated financial statements have been reclassified
from statements previously presented to conform to the presentation of the 1998
consolidated financial statements.
F-51
<PAGE>
LOYALTY MANAGEMENT GROUP CANADA INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(CANADIAN DOLLARS IN THOUSANDS)
14. DIFFERENCES BETWEEN CANADIAN AND U.S. GENERALLY ACCEPTED ACCOUNTING
PRINCIPLES
Significant differences between U.S. and Canadian GAAP for these
consolidated financial statements are as follows:
(i) Under Canadian GAAP, restricted marketable securities and cash are carried
at cost. Under U.S. GAAP, restricted marketable securities and cash are
carried at fair value with the resulting difference between cost and fair
value being recorded as a separate component of equity, net of tax. The
differences as of April 30, 1997 and 1998 would not be material to the
balance sheets or shareholders' equity (deficit).
(ii) Other differences between Canadian and U.S. GAAP are immaterial.
F-52
<PAGE>
Inside back cover
Includes an example of our "Smart Statement" and our logo
<PAGE>
-------------------------------------------------------
-------------------------------------------------------
PROSPECTIVE INVESTORS MAY RELY ONLY ON THE INFORMATION CONTAINED IN THIS
PROSPECTUS. NEITHER ALLIANCE DATA SYSTEMS CORPORATION NOR ANY UNDERWRITER HAS
AUTHORIZED ANYONE TO PROVIDE PROSPECTIVE INVESTORS WITH DIFFERENT OR ADDITIONAL
INFORMATION. THIS PROSPECTUS IS NOT AN OFFER TO SELL NOR IS IT SEEKING AN OFFER
TO BUY THESE SECURITIES IN ANY JURISDICTION WHERE THE OFFER OR SALE IS NOT
PERMITTED. THE INFORMATION CONTAINED IN THIS PROSPECTUS IS CORRECT ONLY AS OF
THE DATE OF THIS PROSPECTUS, REGARDLESS OF THE TIME OF THE DELIVERY OF THIS
PROSPECTUS OR ANY SALE OF THESE SECURITIES.
NO ACTION IS BEING TAKEN IN ANY JURISDICTION OUTSIDE THE UNITED STATES TO PERMIT
A PUBLIC OFFERING OF THE COMMON STOCK OR POSSESSION OR DISTRIBUTION OF THIS
PROSPECTUS IN ANY OF THESE JURISDICTIONS. PERSONS WHO COME INTO POSSESSION OF
THIS PROSPECTUS IN JURISDICTIONS OUTSIDE THE UNITED STATES ARE REQUIRED TO
INFORM THEMSELVES ABOUT AND TO OBSERVE THE RESTRICTIONS OF THAT JURISDICTION
RELATED TO THIS OFFERING AND THE DISTRIBUTIONS OF THIS PROSPECTUS.
------------------------------
TABLE OF CONTENTS
------------------------
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
Prospectus Summary............................. 1
Risk Factors................................... 9
Special Note Regarding Forward-Looking
Statements................................... 22
Use of Proceeds................................ 23
Dividend Policy................................ 24
Dilution....................................... 25
Capitalization................................. 26
Unaudited Pro Forma Consolidated Financial
Information.................................. 27
Selected Historical Consolidated Financial and
Operating Information........................ 32
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................... 34
Description of our Business.................... 56
Management..................................... 71
Principal Stockholders......................... 81
Certain Relationships and Related
Transactions................................. 84
Description of Capital Stock................... 87
Shares Eligible for Future Sale................ 90
Underwriting................................... 91
Legal Matters.................................. 93
Experts........................................ 93
Where You Can Find More Information............ 94
Index to Consolidated Financial Statements..... F-1
</TABLE>
------------------------------
Dealer Prospectus Delivery Obligation:
Until , 2000 (25 days after the date of this prospectus), all
dealers that buy, sell or trade these shares of common stock, whether or not
participating in this offering, may be required to deliver a prospectus. This is
in addition to the dealers' obligations to deliver a prospectus when acting as
underwriters and with respect to their unsold allotments or subscriptions.
-------------------------------------------------------
-------------------------------------------------------
[LOGO]
20,000,000 SHARES
COMMON STOCK
---------------------
PROSPECTUS
---------------------
BEAR, STEARNS & CO. INC.
MERRILL LYNCH & CO.
DONALDSON, LUFKIN & JENRETTE
, 2000
-------------------------------------------------------
-------------------------------------------------------
-------------------------------------------------------
-------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13--OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The estimated expenses in connection with the issuance and distribution of
the securities being registered, other than underwriting discounts and
commissions are set forth in the following table. The Company will pay all
expenses of issuance and distribution. Each amount, except for the SEC, NASD and
New York Stock Exchange fees, is estimated.
<TABLE>
<S> <C>
SEC registration fees..................................... $ 79,200
NASD filing fees.......................................... 30,500
New York Stock Exchange application listing fee........... 335,000
Transfer agent's and registrar's fees and expenses........ 20,000
Printing and engraving expenses........................... 850,000
Legal fees and expenses................................... 600,000
Accounting fees and expenses.............................. 600,000
Blue sky fees and expenses................................ 5,000
Miscellaneous............................................. 5,300
----------
Total................................................... $2,525,000
==========
</TABLE>
------------------------
* To be completed by amendment
ITEM 14--INDEMNIFICATION OF DIRECTORS AND OFFICERS
Alliance Data Systems Corporation's Certificate of Incorporation provides
that it shall, to the fullest extent permitted by Section 145 of the Delaware
General Corporation Law, indemnify all persons whom it may indemnify under
Delaware law.
Section 145 of the Delaware General Corporation Law permits a corporation,
under specified circumstances, to indemnify its directors, officers, employees
or agents against expenses (including attorneys' fees), judgments, fines and
amounts paid in settlements actually and reasonably incurred by them in
connection with any action, suit or proceeding brought by third parties by
reason of the fact that they were or are directors, officers, employees or
agents of the corporation, if such directors, officers, employees or agents
acted in good faith and in a manner they reasonably believed to be in or not
opposed to the best interests of the corporation and, with respect to any
criminal action or proceeding, had no reason to believe their conduct was
unlawful. In a derivative action, i.e., one by or in the right of the
corporation, indemnification may be made only for expenses actually and
reasonably incurred by directors, officers, employees or agents in connection
with the defense or settlement of an action or suit, and only with respect to a
matter as to which they shall have acted in good faith and in a manner they
reasonably believed to be in or not opposed to the best interests of the
corporation, except that no indemnification shall be made if such person shall
have been adjudged liable to the corporation, unless and only to the extent that
the court in which the action or suit was brought shall determine upon
application that the defendant directors, officers, employees or agents are
fairly and reasonably entitled to indemnity for such expenses despite such
adjudication of liability.
Alliance Data Systems Corporation's Bylaws provide for indemnification by it
of its directors, officers and certain non-officer employees under certain
circumstances against expenses (including attorneys' fees, judgments, fines and
amounts paid in settlement) reasonably incurred in connection with the defense
or settlement of any threatened, pending or completed legal proceeding in which
any such person is involved by reason of the fact that such person is or was an
officer or employee of Alliance Data Systems
II-1
<PAGE>
Corporation if such person acted in good faith and in a manner he or she
reasonably believed to be in or not opposed to the best interests of Alliance
Data Systems Corporation, and, with respect to criminal actions or proceedings,
if such person had no reasonable cause to believe his or her conduct was
unlawful. Alliance Data Systems Corporation's Certificate of Incorporation also
provides that, to the fullest extent permitted by the Delaware General
Corporation Law, no director shall be personally liable to Alliance Data Systems
Corporation or its stockholders for monetary damages resulting from breaches of
their fiduciary duty as directors.
Expenses for the defense of any action for which indemnification may be
available may be advanced by Alliance Data Systems Corporation under certain
circumstances. The general effect of the foregoing provisions may be to reduce
the circumstances which an officer or director may be required to bear the
economic burden of the foregoing liabilities and expenses. Directors and
officers will be covered by liability insurance indemnifying them against
damages arising out of certain kinds of claims which might be made against them
based on their negligent acts or omissions while acting in their capacity as
such.
ITEM 15--RECENT SALES OF UNREGISTERED SECURITIES
Since January 1997, Alliance Data Systems Corporation has issued and sold
the following unregistered securities:
(1) In July 1998, 9,634,265 shares of common stock were sold to various
Welsh, Carson, Anderson & Stowe limited partnerships and a total of
466,744 shares of common stock were sold to a total of 16 individuals
who are partners of some or all of the Welsh Carson limited
partnerships for $100.0 million to finance, in part, the acquisition of
all of the outstanding capital stock of the Loyalty Management Group
Canada Inc.
(2) In August 1998, 30,303 shares of common stock were sold to WCAS Capital
Partners II, L.P. at a value of $9.90 per share as consideration for
extending the maturity on a 10% subordinated note, issued to WCAS
Capital Partners II, originally due January 24, 2002 to October 25,
2005 and 20,202 shares were sold to Limited Commerce Corp. at a value
of $9.90 per share as consideration for extending the maturity on a 10%
subordinated note, issued to Limited Commerce Corp., originally due
January 24, 2002 to October 25, 2005.
(3) In September 1998, 655,555 shares of common stock were sold to WCAS
Capital Partners III, LP to finance, in part, the acquisition of
Harmonic Systems Incorporated.
(4) In July 1999, a total of 120,000 shares of Series A preferred stock
were sold to Welsh, Carson, Anderson & Stowe VIII, L.P., WCAS
Information Partners, L.P. and 20 individuals who are also partners of
some or all of the Welsh Carson limited partnerships for $120 million.
The shares of Series A preferred stock were issued to finance, in part,
the acquisition of the network transaction processing business of
SPS Payment Systems, Inc.
(5) Since February 1997, Alliance Data Systems Corporation has granted
stock options to purchase shares of its common stock under its stock
option plan covering an aggregate of 2,172,343 shares, at exercise
prices ranging from $9.00 to $11.25 per share. Since February 1997,
Alliance Data Systems Corporation has issued 16,351 shares of Alliance
Data Systems Corporation's common stock pursuant to the exercise of
stock options. Since February 1997, 46,699 stock options have lapsed
without being exercised.
II-2
<PAGE>
The sales and issuances of securities in the transactions described above
were deemed to be exempt from registration under the Securities Act in reliance
upon Section 4(2) of the Securities Act, Regulation D promulgated thereunder or
Rule 701 promulgated under Section 3(b) of the Securities Act, as transactions
by an issuer not involving any public offering or transactions pursuant to
compensatory benefit plans and contracts relating to compensation as provided
under Rule 701. The recipients of securities in each transaction represented
their intentions to acquire the securities for investment only and not with a
view to or for sale in connection with any distribution thereof and appropriate
legends were affixed to the securities issued in such transactions. All
recipients had adequate access, through their relationship with Alliance Data
Systems, to information about the Company.
ITEM 16--EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBITS
------- --------
<C> <S>
1 Form of Underwriting Agreement.
*2.1 Agreement and Plan of Merger, dated as of August 30, 1996,
by and between Business Services Holdings, Inc. and World
Financial Network Holding Corporation.
*2.2 Agreement and Plan of Merger, dated as of August 14, 1998,
by and among Alliance Data Systems Corporation, HSI
Acquisition Corp., and Harmonic Systems Incorporated.
*2.3 Stock Purchase Agreement, dated June 8, 1998, by and between
SPS Payment Systems, Inc., Alliance Data Systems
Corporation, SPS Commercial Services, Inc., and ADS
Network Services, Inc., amended July 12, 1999.
**2.4 Agreement for the Purchase of all the Shares of Loyalty
Management Group Canada Inc., June 26, 1998, by and
between Air Miles International Group B.V., certain other
shareholders and option holders and Alliance Data Systems
Corporation as amended July 14, 1998.
*3.1 Second Amended and Restated Certificate of Incorporation of
the Registrant.
*3.2 Second Amended and Restated Bylaws of the Registrant.
*4 Specimen Certificate for shares of Common Stock of the
Registrant.
*5 Opinion of Akin, Gump, Strauss, Hauer & Feld, L.L.P.
**10.1 Credit Card Processing Agreement between World Financial
Network National Bank, Bath and Body Works, Inc. and
Tri-State Factoring, Inc., dated January 31, 1996.
**10.2 Credit Card Processing Agreement between World Financial
Network National Bank, Victoria's Secret Catalogue, Inc.,
and Far West Factoring Inc., dated January 31, 1996
(assigned by Victoria's Secret Catalogue, Inc. to
Victoria's Secret Catalogue, LLC, May 2, 1998).
**10.3 Credit Card Processing Agreement between World Financial
Network National Bank, Victoria's Secret Stores, Inc., and
Lone Mountain Factoring, Inc., dated January 31, 1996.
**10.4 Credit Card Processing Agreement between World Financial
Network National Bank, Lerner New York, Inc., and Nevada
Receivable Factoring, Inc., dated January 31, 1996.
</TABLE>
II-3
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBITS
------- --------
<C> <S>
**10.5 Credit Card Processing Agreement between World Financial
Network National Bank, Express, Inc., and Retail
Factoring, Inc., dated January 31, 1996.
**10.6 Credit Card Processing Agreement between World Financial
Network National Bank, The Limited Stores, Inc., and
American Receivable Factoring, Inc., dated January 31,
1996.
**10.7 Credit Card Processing Agreement between World Financial
Network National Bank, Structure, Inc., and Mountain
Factoring, Inc., dated January 31, 1996.
**10.8 Credit Card Processing Agreement between World Financial
Network National Bank, Lane Bryant, Inc., and Sierra
Nevada Factoring, dated January 31, 1996, and amended
August 4, 1998 and September 12, 1999.
**10.9 Credit Card Processing Agreement between World Financial
Network National Bank, Henri Bendel, Inc., and Western
Factoring, Inc., dated January 31, 1996 and amended
May 13, 1998.
**10.10 Supplier Agreement between Canadian Airlines International
Ltd. and Loyalty Management Group Canada Inc., dated March
15, 1996, as amended.
*10.11 Lease between Deerfield and Weiland Office Building, L.L.C.
and ADS Alliance Data Systems, Inc., dated July 30, 1999.
*10.12 Indenture of Sublease between J.C. Penney Company, Inc. and
BSI Business Services, Inc., dated January 11, 1996.
*10.13 Build-to-Suit Net Lease between Opus South Corporation and
ADS Alliance Data Systems, Inc., dated January 29, 1998,
as amended.
*10.14 Industrial Lease Agreement between CIBC Development
Corporation and Loyalty Management Group Canada Inc.,
dated October 19, 1998, amended January 26, 1999.
*10.15 Lease between YCC Limited and London Life Insurance Company
and Loyalty Management Group Canada Inc. dated May 28,
1997 and amended June 19, 1997 and January 15, 1998.
*10.16 Deed of Lease between Boswell International Marine (PTE)
Limited and Financial Automation Limited, dated August 3,
1999.
*10.17 Office Lease between Office City, Inc. and World Financial
Network National Bank, dated December 24, 1986, and
amended January 19, 1987, May 11, 1988, August 4, 1989 and
August 18, 1999.
*10.18 Lease Agreement by and between Continental Acquisitions,
Inc. and World Financial Network National Bank, dated July
2, 1990, and amended September 11, 1990, November 16, 1990
and February 18, 1991.
*10.19 Lease Agreement by and between Americana Parkway Warehouse
Limited and World Financial Network National Bank, dated
June 28, 1994.
*10.20 Lease Agreement by and between Morrison Taylor II, Ltd. and
ADS Alliance Data Systems, Inc., dated June 18, 1998, and
amended June 18, 1998.
*10.21 Lease Agreement between Morrison Taylor, Ltd. and ADS
Alliance Data Systems, Inc. dated July 1, 1997, and
amended June 18, 1998.
*10.22 Commercial Lease Agreement between Waterview Parkway, L.P.
and ADS Alliance Data Systems, Inc., dated July 16, 1997.
</TABLE>
II-4
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBITS
------- --------
<C> <S>
*10.23 Preferred Stock Purchase Agreement by and between Alliance
Data Systems Corporation and several persons named in
Schedule I thereto, dated July 12, 1999.
*10.24 Amended and Restated Stockholder Agreement, by and between
World Financial Network Holding Corporation, Limited
Commerce Corp., Welsh, Carson, Anderson, and Stowe VII,
L.P., and the several other investors named in Annex 1
thereto dated August 30, 1996, and amended July 24, 1998,
August 31, 1998 and July 12, 1999.
*10.25 Securities Purchase Agreement, by and between Business
Services Holdings, Inc., and the several purchasers named
in Schedule 1 and Schedule II thereto, dated January 24,
1996, and amended August 31, 1998.
*10.26 Common Stock Purchase Agreement between Alliance Data
Systems Corporation and Welsh, Carson, Anderson, and Stowe
VII, L.P., Welsh, Carson, Anderson, and Stowe VIII, L.P.,
and the persons named in Schedule I thereto, dated July
24, 1998.
*10.27 Securities Purchase Agreement between Alliance Data Systems
Corporation and WCAS Capital Partners III, L.P., dated
September 15, 1998.
*10.28 10% Subordinated Note due September 15, 2008 issued by
Alliance Data Systems Corporation to WCAS Capital Partners
III, L.P. dated September 15, 1998.
*10.29 10% Subordinated Note due October 25, 2005 issued by
Alliance Data Systems Corporation to the Limited Commerce
Corp., dated January 24, 1996.
*10.30 10% Subordinated Note due October 25, 2005 issued by
Alliance Data Systems Corporation to WCAS Capital Partners
II, L.P. dated January 24, 1996.
*10.31 Amended and Restated Credit Agreement between Alliance Data
Systems Corporation, and Loyalty Management Group Canada
Inc., the Guarantors party thereto, the Banks party
thereto, and Morgan Guaranty Trust Company of New York,
dated July 24, 1998.
*10.32 Pooling and Servicing Agreement, dated as of January 30,
1998, by and between World Financial Network National
Bank, as Transferor and as Servicer, and The Bank of New
York, as Trustee.
*10.33 ADS Alliance Data Systems, Inc. Supplemental Executive
Retirement Plan, effective May 1, 1999.
*10.34 Amended and Restated Alliance Data Systems Corporation Stock
Option and its Subsidiaries Restricted Stock Plan.
*10.35 Form of Alliance Data Systems Corporation Incentive Stock
Option Agreement.
*10.36 Form of Alliance Data Systems Corporation Non-Qualified
Stock Option Agreement.
*10.37 Form of Alliance Data Systems Corporation Confidentiality
and Non-Solicitation Agreement.
*10.38 Alliance Data Systems Corporation 1999 Incentive
Compensation Plan.
*10.39 Letter employment agreement with J. Michael Parks, dated
February 19, 1997.
*10.40 Letter employment agreement with Ivan Szeftel, dated May 4,
1998.
</TABLE>
II-5
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. EXHIBITS
------- --------
<C> <S>
*10.41 Registration Rights Agreement dated as of January 24, 1996
between Business Services Holdings, Inc. and Welsh Carson,
Andersen, and Stowe VII, L.P., WCAS Information Partners,
L.P., WCA Management Corporation, Patrick J. Welsh,
Russell L. Carson, Bruce K. Anderson, Richard H. Stowe,
Andrew M. Paul, Thomas E. McInerney, Laura VanBuren, James
B. Hoover, Robert A. Minicucci, Anthony J. deNicola, and
David Bellet.
*10.42 Securities Purchase Agreement, dated as of August 30, 1996,
by and among World Financial Network Holding Corporation,
Limited Commerce Corp., and several persons named in
Schedules I and II thereto, and WCAS Capital Partners II,
L.P., as amended August 31, 1998.
*10.43 Amended and Restated License to Use the Air Miles Trade
Marks in Canada, dated as of July 24, 1998, by and between
Air Miles International Holdings N.V. and Loyalty
Management Group Canada Inc.
*10.44 Amended and Restated License to Use and Exploit the Air
Miles Scheme in Canada, dated July 24, 1998, by and
between Air Miles International Trading B.V. and Loyalty
Management Group Canada Inc.
*10.45 License to Use the Air Miles Trademarks in the United
States, dated as of July 24, 1998, by and between Air
Miles International Holdings N.V. and Loyalty Management
Group Canada Inc.
*10.46 License to Use and Exploit the Air Miles Scheme in the
United States, dated as of July 1998, by and between Air
Miles International Trading B.V. and Alliance Data Systems
Corporation.
*10.47 Form of Retainer Agreement entered into between ADS Alliance
Data Systems, Inc. and certain affiliates of The Limited,
Inc.
*10.48 Form of Business Solutions Master Agreement between ADS
Alliance Data Systems, Inc. and certain affiliates of The
Limited, Inc.
10.49 Second Amendment to Amended and Restated Credit Agreement,
dated as of March 23, 2000, by and among Alliance Data
Systems Corporation, Loyalty Management Group Canada Inc.,
Morgan Guaranty Trust Company of New York and Harris Trust
and Savings Bank.
*21 Subsidiaries of the Registrant.
23.1 Consent of Deloitte & Touche LLP with regard to Alliance
Data Systems Corporation and SPS Network Services.
23.2 Consent of Ernst & Young LLP with regard to Loyalty
Management Group Canada Inc.
*23.3 Consent of Akin, Gump, Strauss, Hauer & Feld, L.L.P.
(included in its opinion filed as Exhibit 5 hereto).
23.4 Consent of Kenneth R. Jensen.
*24 Power of Attorney (included on the signature page hereto)
27 Financial Data Schedule (included in SEC-filed copy only).
</TABLE>
------------------------
* Previously filed.
** Portions of Exhibit have been omitted and filed separately with the
commission pursuant to a request for confidential treatment.
II-6
<PAGE>
(b) Financial Statement Schedules
Schedule II--Valuation and qualifying accounts
ITEM 17--UNDERTAKINGS
The undersigned registrant hereby undertakes to provide to the underwriters
at the closing specified in the underwriting agreement, certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Securities Act
of 1933 and is, therefore, unenforceable. In the event that a claim for
indemnification against such liabilities (other than the payment by the
registrant of expenses incurred or paid by a director, officer or controlling
person of the registrant in the successful defense of any action, suit or
proceeding) is asserted by such director, officer or controlling person in
connection with the securities being registered, the registrant will, unless in
the opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act of 1933 and will be governed by the final adjudication of such issue.
The undersigned registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part
of this registration statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act of 1933 shall be deemed to be part of
this registration statement as of the time it was declared effective.
(2) For purposes of determining any liability under the Securities Act
of 1933, each post-effective amendment that contains a form of prospectus
shall be deemed to be a new registration statement relating to the
securities offered therein, and the offering of such securities at that time
shall be deemed to be the initial BONA FIDE offering thereof.
II-7
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, as amended, the
registrant has duly caused this Registration Statement on Form S-1 to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Dallas, State of Texas, on June 9, 2000.
<TABLE>
<S> <C>
ALLIANCE DATA SYSTEMS CORPORATION
By: /s/ J. MICHAEL PARKS
--------------------------------------------
J. Michael Parks
CHIEF EXECUTIVE OFFICER AND PRESIDENT
</TABLE>
Pursuant to the requirements of the Securities Act of 1933, as amended, this
registration statement has been signed by the following persons in the
capacities and on June 9, 2000:
<TABLE>
<CAPTION>
NAME TITLE
---- -----
<C> <S>
/s/ J. MICHAEL PARKS Chairman of the Board, Chief Executive Officer
------------------------------------------- and President
J. Michael Parks (principal executive officer)
/s/ EDWARD K. MIMS Executive Vice President,
------------------------------------------- Chief Financial Officer
Edward K. Mims (principal financial officer)
* Corporate Controller and
------------------------------------------- Chief Accounting Officer
Michael D. Kubic (principal accounting officer)
*
------------------------------------------- Director
Bruce K. Anderson
*
------------------------------------------- Director
Anthony J. deNicola
*
------------------------------------------- Director
Daniel P. Finkelman
*
------------------------------------------- Director
Robert A. Minicucci
*
------------------------------------------- Director
Bruce A. Soll
</TABLE>
<TABLE>
<CAPTION>
<S> <C>
* By: /s/ J. MICHAEL PARKS
-------------------------------------
J. Michael Parks
ATTORNEY-IN-FACT
</TABLE>
II-8
<PAGE>
SCHEDULE II
ALLIANCE DATA SYSTEMS CORPORATION
VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT BALANCE AT
DESCRIPTION BEGINNING OF PERIOD INCREASES DEDUCTIONS END OF PERIOD
----------- ------------------- --------- ---------- -------------
<S> <C> <C> <C> <C>
Allowance for Doubtful Accounts--Trade
receivables:
53 weeks ended January 31, 1998.............. $ -- $ 8,771 $ (6,150) $2,561
11 months ended December 31, 1998............ 2,561 8,151 (7,136) 3,576
Year ended December 31, 1999................. 3,576 5,814 (8,311) 1,079
Allowance for Doubtful Accounts--Credit Card
receivables:
53 weeks ended January 31, 1998.............. $6,759 $13,485 $(15,627) $4,617
11 months ended December 31, 1998............ 4,617 15,352 (15,081) 4,888
Year ended December 31, 1999................. 4,888 14,951 (16,182) 3,657
</TABLE>
1
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
1 Form of Underwriting Agreement.
*2.1 Agreement and Plan of Merger, dated as of August 30, 1996,
by and between Business Services Holdings, Inc. and World
Financial Network Holding Corporation.
*2.2 Agreement and Plan of Merger, dated as of August 14, 1998,
by and among Alliance Data Systems Corporation, HSI
Acquisition Corp., and Harmonic Systems Incorporated.
*2.3 Stock Purchase Agreement, dated June 8, 1998, by and between
SPS Payment Systems, Inc., Alliance Data Systems
Corporation, SPS Commercial Services, Inc., and ADS
Network Services, Inc., amended July 12, 1999.
**2.4 Agreement for the Purchase of all the Shares of Loyalty
Management Group Canada Inc., June 26, 1998, by and
between Air Miles International Group B.V., certain other
shareholders and option holders and Alliance Data Systems
Corporation as amended July 14, 1998.
*3.1 Second Amended and Restated Certificate of Incorporation of
the Registrant.
*3.2 Second Amended and Restated Bylaws of the Registrant.
*4 Specimen Certificate for shares of Common Stock of the
Registrant.
*5 Opinion of Akin, Gump, Strauss, Hauer & Feld, L.L.P.
**10.1 Credit Card Processing Agreement between World Financial
Network National Bank, Bath and Body Works, Inc. and
Tri-State Factoring, Inc., dated January 31, 1996.
**10.2 Credit Card Processing Agreement between World Financial
Network National Bank, Victoria's Secret Catalogue, Inc.,
and Far West Factoring Inc., dated January 31, 1996
(assigned by Victoria's Secret Catalogue, Inc. to
Victoria's Secret Catalogue, LLC, May 2, 1998).
**10.3 Credit Card Processing Agreement between World Financial
Network National Bank, Victoria's Secret Stores, Inc., and
Lone Mountain Factoring, Inc., dated January 31, 1996.
**10.4 Credit Card Processing Agreement between World Financial
Network National Bank, Lerner New York, Inc., and Nevada
Receivable Factoring, Inc., dated January 31, 1996.
**10.5 Credit Card Processing Agreement between World Financial
Network National Bank, Express, Inc., and Retail
Factoring, Inc., dated January 31, 1996.
**10.6 Credit Card Processing Agreement between World Financial
Network National Bank, The Limited Stores, Inc., and
American Receivable Factoring, Inc., dated January 31,
1996.
**10.7 Credit Card Processing Agreement between World Financial
Network National Bank, Structure, Inc., and Mountain
Factoring, Inc., dated January 31, 1996.
**10.8 Credit Card Processing Agreement between World Financial
Network National Bank, Lane Bryant, Inc., and Sierra
Nevada Factoring, dated January 31, 1996, and amended
August 4, 1998 and September 12, 1999.
**10.9 Credit Card Processing Agreement between World Financial
Network National Bank, Henri Bendel, Inc., and Western
Factoring, Inc., dated January 31, 1996 and amended
May 13, 1998.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
**10.10 Supplier Agreement between Canadian Airlines International
Ltd. and Loyalty Management Group Canada Inc., dated March
15, 1996, as amended.
*10.11 Lease between Deerfield and Weiland Office Building, L.L.C.
and ADS Alliance Data Systems, Inc., dated July 30, 1999.
*10.12 Indenture of Sublease between J.C. Penney Company, Inc. and
BSI Business Services, Inc., dated January 11, 1996.
*10.13 Build-to-Suit Net Lease between Opus South Corporation and
ADS Alliance Data Systems, Inc., dated January 29, 1998,
as amended.
*10.14 Industrial Lease Agreement between CIBC Development
Corporation and Loyalty Management Group Canada Inc.,
dated October 19, 1998, amended January 26, 1999.
*10.15 Lease between YCC Limited and London Life Insurance Company
and Loyalty Management Group Canada Inc. dated May 28,
1997 and amended June 19, 1997 and January 15, 1998.
*10.16 Deed of Lease between Boswell International Marine (PTE)
Limited and Financial Automation Limited, dated August 3,
1999.
*10.17 Office Lease between Office City, Inc. and World Financial
Network National Bank, dated December 24, 1986, and
amended January 19, 1987, May 11, 1988, August 4, 1989 and
August 18, 1999.
*10.18 Lease Agreement by and between Continental Acquisitions,
Inc. and World Financial Network National Bank, dated July
2, 1990, and amended September 11, 1990, November 16, 1990
and February 18, 1991.
*10.19 Lease Agreement by and between Americana Parkway Warehouse
Limited and World Financial Network National Bank, dated
June 28, 1994.
*10.20 Lease Agreement by and between Morrison Taylor II, Ltd. and
ADS Alliance Data Systems, Inc., dated June 18, 1998, and
amended June 18, 1998.
*10.21 Lease Agreement between Morrison Taylor, Ltd. and ADS
Alliance Data Systems, Inc. dated July 1, 1997, and
amended June 18, 1998.
*10.22 Commercial Lease Agreement between Waterview Parkway, L.P.
and ADS Alliance Data Systems, Inc., dated July 16, 1997.
*10.23 Preferred Stock Purchase Agreement by and between Alliance
Data Systems Corporation and several persons named in
Schedule I thereto, dated July 12, 1999.
*10.24 Amended and Restated Stockholder Agreement, by and between
World Financial Network Holding Corporation, Limited
Commerce Corp., Welsh, Carson, Anderson, and Stowe VII,
L.P., and the several other investors named in Annex 1
thereto dated August 30, 1996, and amended July 24, 1998,
August 31, 1998 and July 12, 1999.
*10.25 Securities Purchase Agreement, by and between Business
Services Holdings, Inc., and the several purchasers named
in Schedule 1 and Schedule II thereto, dated January 24,
1996, and amended August 31, 1998.
*10.26 Common Stock Purchase Agreement between Alliance Data
Systems Corporation and Welsh, Carson, Anderson, and Stowe
VII, L.P., Welsh, Carson, Anderson, and Stowe VIII, L.P.,
and the persons named in Schedule I thereto, dated July
24, 1998.
*10.27 Securities Purchase Agreement between Alliance Data Systems
Corporation and WCAS Capital Partners III, L.P., dated
September 15, 1998.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
*10.28 10% Subordinated Note due September 15, 2008 issued by
Alliance Data Systems Corporation to WCAS Capital Partners
III, L.P. dated September 15, 1998.
*10.29 10% Subordinated Note due October 25, 2005 issued by
Alliance Data Systems Corporation to the Limited Commerce
Corp., dated January 24, 1996.
*10.30 10% Subordinated Note due October 25, 2005 issued by
Alliance Data Systems Corporation to WCAS Capital Partners
II, L.P. dated January 24, 1996.
*10.31 Amended and Restated Credit Agreement between Alliance Data
Systems Corporation, and Loyalty Management Group Canada
Inc., the Guarantors party thereto, the Banks party
thereto, and Morgan Guaranty Trust Company of New York,
dated July 24, 1998.
*10.32 Pooling and Servicing Agreement, dated as of January 30,
1998, by and between World Financial Network National
Bank, as Transferor and as Servicer, and The Bank of New
York, as Trustee.
*10.33 ADS Alliance Data Systems, Inc. Supplemental Executive
Retirement Plan, effective May 1, 1999.
*10.34 Amended and Restated Alliance Data Systems Corporation and
its Subsidiaries Stock Option and Restricted Stock Plan.
*10.35 Form of Alliance Data Systems Corporation Incentive Stock
Option Agreement.
*10.36 Form of Alliance Data Systems Corporation Non-Qualified
Stock Option Agreement.
*10.37 Form of Alliance Data Systems Corporation Confidentiality
and Non-Solicitation Agreement.
*10.38 Alliance Data Systems Corporation 1999 Incentive
Compensation Plan.
*10.39 Letter employment agreement with J. Michael Parks, dated
February 19, 1997.
*10.40 Letter employment agreement with Ivan Szeftel, dated May 4,
1998.
*10.41 Registration Rights Agreement dated as of January 24, 1996
between Business Services Holdings, Inc. and Welsh Carson,
Andersen, and Stowe VII, L.P., WCAS Information Partners,
L.P., WCA Management Corporation, Patrick J. Welsh,
Russell L. Carson, Bruce K. Anderson, Richard H. Stowe,
Andrew M. Paul, Thomas E. McInerney, Laura VanBuren, James
B. Hoover, Robert A. Minicucci, Anthony J. deNicola, and
David Bellet.
*10.42 Securities Purchase Agreement, dated as of August 30, 1996,
by and among World Financial Network Holding Corporation,
Limited Commerce Corp., and several persons named in
Schedules I and II thereto, and WCAS Capital Partners II,
L.P., as amended August 31, 1998.
*10.43 Amended and Restated License to Use the Air Miles Trade
Marks in Canada, dated as of July 24, 1998, by and between
Air Miles International Holdings N.V. and Loyalty
Management Group Canada Inc.
*10.44 Amended and Restated License to Use and Exploit the Air
Miles Scheme in Canada, dated July 24, 1998, by and
between Air Miles International Trading B.V. and Loyalty
Management Group Canada Inc.
*10.45 License to Use the Air Miles Trademarks in the United
States, dated as of July 24, 1998, by and between Air
Miles International Holdings N.V. and Loyalty Management
Group Canada Inc.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION
------- -----------
<C> <S>
*10.46 License to Use and Exploit the Air Miles Scheme in the
United States, dated as of July 1998, by and between Air
Miles International Trading B.V. and Alliance Data Systems
Corporation.
*10.47 Form of Retainer Agreement entered into between ADS Alliance
Data Systems, Inc. and certain affiliates of The Limited,
Inc.
*10.48 Form of Business Solutions Master Agreement between ADS
Alliance Data Systems, Inc. and certain affiliates of The
Limited, Inc.
10.49 Second Amendment to Amended and Restated Credit Agreement,
dated as of March 23, 2000, by and among Alliance Data
Systems Corporation, Loyalty Management Group Canada Inc.,
Morgan Guaranty Trust Company of New York and Harris Trust
and Savings Bank.
*21 Subsidiaries of the Registrant.
23.1 Consent of Deloitte & Touche LLP with regard to Alliance
Data Systems Corporation and SPS Network Services.
23.2 Consent of Ernst & Young LLP with regard to Loyalty
Management Group Canada Inc.
*23.3 Consent of Akin, Gump, Strauss, Hauer & Feld, L.L.P.
(included in its opinion filed as Exhibit 5 hereto).
23.4 Consent of Kenneth R. Jensen.
*24 Power of Attorney (included on the signature page hereto)
27 Financial Data Schedule (included in SEC-filed copy only).
</TABLE>
------------------------
* Previously filed.
** Portions of Exhibit have been omitted and filed separately with the
commission pursuant to a request for confidential treatment.
