Filed Pursuant to
Rule 424(b)(1)
Registration No. 333-94623
PROSPECTUS
13,000,000 SHARES
[LOGO]
COMMON STOCK
------------------
This is an initial public offering of 13,000,000 shares of our common stock. We
are selling all the shares offered under this prospectus.
Our common stock has been approved for listing on the New York Stock Exchange
under the symbol "ADS."
SEE "RISK FACTORS" BEGINNING ON PAGE 7 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.
------------------------
PER SHARE TOTAL
--------- ------------
Public offering price....................................... $12.00 $156,000,000
Underwriting discounts and commissions...................... $ 0.84 $ 10,920,000
Proceeds, before expenses, to us............................ $11.16 $145,080,000
The underwriters may purchase up to an additional 1,950,000 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
June 13, 2001.
------------------------
BEAR, STEARNS & CO. INC. MERRILL LYNCH & CO.
CREDIT SUISSE FIRST BOSTON
THE DATE OF THIS PROSPECTUS IS JUNE 7, 2001.
TABLE OF CONTENTS
PAGE
----
Prospectus Summary................... 1
Risk Factors......................... 7
Special Note Regarding
Forward-Looking Statements......... 18
Use of Proceeds...................... 19
Dividend Policy...................... 19
Dilution............................. 20
Capitalization....................... 21
Unaudited Pro Forma Consolidated
Financial Information.............. 22
Selected Historical Consolidated
Financial and Operating
Information........................ 26
Management's Discussion and
Analysis of Financial Condition and
Results of Operations.............. 29
Business............................. 46
Management........................... 61
PAGE
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Principal Stockholders............... 73
Certain Relationships and Related
Transactions....................... 76
Description of Capital Stock......... 80
Shares Eligible for Future Sale...... 83
Underwriting......................... 84
Legal Matters........................ 88
Experts.............................. 88
Where You Can Find More Information.. 88
Index to Consolidated Financial
Statements......................... F-1
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 transaction services, credit services and
marketing services to retail companies in North America. We focus on
facilitating and managing electronic transactions between our clients and their
customers through multiple distribution channels including in-store, catalog and
the Internet. Our credit and marketing services assist our clients in
identifying and acquiring new customers, as well as helping to increase the
loyalty and profitability of their existing customers.
We have a client base in excess of 300 companies, comprised mostly of
specialty retailers, petroleum retailers, supermarkets and financial services
companies. We generally have long-term relationships with our clients, with
contracts typically ranging from three to five years in duration. The Limited,
together with its retail affiliates, including Victoria's Secret Stores,
Victoria's Secret Catalogue, Express, Lane Bryant, Bath & Body Works, Lerner New
York, Henri Bendel and Structure, is our largest client, representing
approximately 25.3% of our 2000 consolidated revenue.
OUR PRODUCTS AND SERVICES
Our products and services are centered around three core
capabilities--Transaction Services, Credit Services and Marketing Services. We
have traditionally marketed and sold our products and services on a stand-alone
basis, but increasingly are marketing and selling them on a bundled and
integrated basis. Our products and services and target markets are listed below.
SEGMENT PRODUCTS AND SERVICES TARGET MARKETS
----------------------------- --------------------------------------- -------------------------
TRANSACTION SERVICES - Transaction Processing - Specialty Retail
- Network Services - Petroleum Retail
- Merchant Bankcard Services - Regulated and
- Account Processing and Servicing De-regulated Utility
- Card Processing - Mass Transit
- Billing and Payment Processing - Tollways
- Customer Care - Parking
CREDIT SERVICES - Private Label Receivables Financing - Specialty Retail
- Underwriting and Risk Management - Petroleum Retail
- Merchant Processing
- Receivables Funding
MARKETING SERVICES - Loyalty Programs - Specialty Retail
- Air Miles - Petroleum Retail
- One-to-One Loyalty - Supermarkets
- Database Marketing Services - Financial Services
- Enhancement Services - Regulated and
- Direct Marketing De-regulated Utility
1
OUR MARKET OPPORTUNITY AND GROWTH STRATEGY
Our services are applicable to the full spectrum of commerce opportunities
involving companies that sell products and services to individual consumers.
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 generates valuable
information on individual consumers and their purchasing preferences. Many
retailers, however, lack the economies of scale and core competencies necessary
to support their own transaction processing infrastructure or credit card or
database operations. In addition, we see an increasing acceptance by companies
to outsource the development and management of their marketing programs, such as
loyalty programs and database marketing services.
Our current strategy to capitalize on these opportunities includes:
- increasing the penetration of our products and services to existing
clients;
- expanding our client base in our existing market sectors;
- continuing to expand our services and capabilities to help our clients
succeed in multi-channel commerce; and
- considering focused, strategic acquisitions and alliances to enhance our
core capabilities or increase our scale.
OUR LIQUIDITY SOURCES
We finance our growth through cash from operations, issuing certificates of
deposit through our credit card bank subsidiary, a $100.0 million revolving loan
commitment and a securitization program. We utilize cash flow from operations,
certificates of deposit and the revolving loan commitment to finance our
operating activities and to fund credit enhancement and seller's interest in our
securitizations. We finance substantially all our private label credit card
receivables through a securitization program, which involves the packaging and
selling of both current and future receivable balances of private label credit
card accounts to a master trust. Our securitizations are treated as sales for
accounting purposes and, accordingly, securitized receivables are removed from
our balance sheet. We retain a residual interest in the trust that is commonly
referred to as an "interest only strip".
OUR HISTORY AND OWNERSHIP
We are the result of the 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 Network National Bank. Since then, we have made several complementary
portfolio and business acquisitions.
Immediately prior to this offering, Welsh, Carson, Anderson & Stowe
beneficially owned approximately 74.7% of our common stock, and The Limited,
through its wholly owned subsidiary Limited Commerce Corp., beneficially owned
approximately 24.9% 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 continued ownership of our common stock above
minimum thresholds.
Our corporate headquarters are located at 17655 Waterview Parkway, Dallas,
Texas 75252, and our telephone number is 972-348-5100.
2
THE OFFERING
Common stock offered......................... 13,000,000 shares
Common stock to be outstanding after the
offering................................... 71,861,486 shares
Use of proceeds.............................. We intend to use approximately
$100.8 million of the net proceeds from the
offering to repay outstanding debt, and the
balance for general corporate purposes,
including potential acquisitions and working
capital.
New York Stock Exchange symbol............... "ADS"
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
- assumes the conversion of all outstanding shares of our Series A
cumulative convertible preferred stock into 11,199,340 shares of common
stock.
The number of shares of common stock described as being outstanding after
this offering excludes up to:
- 4,351,105 shares that we may issue upon the exercise of stock options
outstanding as of April 30, 2001 at a weighted average exercise price of
$12.43 per share;
- 3,698,743 additional shares that we may issue under our stock option and
restricted stock plan;
- 1,500,000 shares that we may issue under our employee stock purchase plan;
and
- 1,950,000 additional shares that we may issue upon exercise of the
underwriters' over-allotment option.
3
SUMMARY CONSOLIDATED FINANCIAL DATA
In connection with your review of the summary consolidated financial data
you should consider the following information for a better understanding of the
data presented:
RECAST 1998. 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 to our results for 1999 and 2000, we have recast our
historical operating results to a calendar year basis for the year ended
December 31, 1998. In our opinion, the recast historical financial information
reflects all normal recurring adjustments necessary for a fair presentation of
such financial information.
QUARTERLY INFORMATION. The summary consolidated financial data for the
three months ended March 31, 2000 and 2001 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, 2001 are not necessarily indicative of results
for the full year.
PRO FORMA INFORMATION. We have also included unaudited pro forma
information for 2000. The data contained in the pro forma column give effect to
the Utilipro acquisition as if it had been consummated on January 1, 2000. The
supplemental pro forma loss per share data give effect to the conversion of all
outstanding Series A preferred shares 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, 2001. 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.
USE OF OPERATING EBITDA. Other financial data include operating EBITDA,
which is equal to operating income plus depreciation and amortization and the
change in deferred revenue less the change in redemption settlement assets. We
have presented operating EBITDA because we use it to monitor compliance with the
financial covenants in our amended credit agreement, such as debt-to-operating
EBITDA, interest coverage ratios and minimum operating EBITDA. We also use
operating EBITDA as an integral part of our internal reporting to measure the
performance and liquidity of our reportable segments. In addition, we believe
operating 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.
Operating 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, operating 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 operating EBITDA measure presented in this prospectus
may not be comparable to similarly titled measures presented by other companies.
4
HISTORICAL PRO FORMA
----------------------------------------------------------------- ---------------------------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) FOR THE
FOR THE THREE MONTHS THREE
FOR THE YEARS ENDED DECEMBER 31, ENDED MARCH 31, FOR THE YEAR MONTHS
------------------------------------- ------------------------- ENDED ENDED
ACTUAL DECEMBER 31, MARCH 31,
RECAST --------------------------------------------------- ------------- -----------
1998 1999 2000 2000 2001 2000 2001
----------- ---------- ---------- ----------- ----------- ------------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
INCOME STATEMENT DATA
Total revenue................ $ 451,537 $ 583,082 $ 678,195 $ 165,547 $ 180,692 $695,927 $184,832
Cost of operations........... 360,875 466,856 547,985 134,571 143,258 572,605 147,275
General and administrative... 23,364 35,971 32,201 7,505 9,333 32,201 9,333
Depreciation and other
amortization............... 8,782 16,183 26,265 5,997 6,367 27,526 6,741
Amortization of purchased
intangibles................ 46,977 61,617 49,879 13,795 11,113 51,560 11,393
---------- ---------- ---------- ---------- ---------- -------- --------
Total expenses............. 439,998 580,627 656,330 161,868 170,071 683,892 174,742
---------- ---------- ---------- ---------- ---------- -------- --------
Operating income............. 11,539 2,455 21,865 3,679 10,621 12,035 10,090
Other non-operating
expense.................... -- -- 2,477 2,476 -- 2,477 --
Interest expense............. 29,295 42,785 38,870 8,776 9,635 40,642 9,930
Income tax expense
(benefit).................. (2,622) (6,538) 1,841 716 933 (2,162) 611
---------- ---------- ---------- ---------- ---------- -------- --------
Income (loss) from continuing
operations................. (15,134) (33,792) (21,323) (8,289) 53 (28,922) (451)
Income (loss) from
discontinued operations,
net of taxes............... (3,948) 7,688 -- -- -- -- --
Loss on disposal of
discontinued operations,
net of taxes............... -- (3,737) -- -- -- -- --
---------- ---------- ---------- ---------- ---------- -------- --------
Net income (loss)............ $ (19,082) $ (29,841) $ (21,323) $ (8,289) $ 53 $(28,922) (451)
========== ========== ========== ========== ========== ======== ========
Loss per share from
continuing operations--
basic and diluted.......... $ (0.37) $ (0.78) $ (0.60) $ (0.21) $ (0.04) $ (0.76) $ (0.05)
Loss per share--basic and
diluted.................... $ (0.46) $ (0.70) $ (0.60) $ (0.21) $ (0.04) $ (0.76) $ (0.05)
Weighted average shares used
in computing per share
amounts--basic and
diluted.................... 41,308 47,498 47,538 47,529 47,568 47,538 47,568
Supplemental pro forma loss
per share from continuing
operations--basic and
diluted.................... $ (0.50) $ (0.01)
Supplemental pro forma loss
per share--basic and
diluted.................... $ (0.50) $ (0.01)
Weighted average shares used
in computing supplemental
pro forma per share
amounts--basic and
diluted.................... 57,705 57,735
OTHER FINANCIAL DATA
Calculation of Operating
EBITDA:
Operating income........... $ 11,539 $ 2,455 $ 21,865 $ 3,679 $ 10,621 $ 12,035 10,090
Depreciation and other
amortization............. 8,782 16,183 26,265 5,997 6,367 27,526 6,741
Amortization of purchased
intangibles.............. 46,977 61,617 49,879 13,795 11,113 51,560 11,393
---------- ---------- ---------- ---------- ---------- -------- --------
EBITDA................... 67,298 80,255 98,009 23,471 28,101 91,121 28,224
Plus change in deferred
revenue................ 20,729 91,149 40,845 10,794 13,244 40,845 13,244
Less change in redemption
settlement assets...... 11,838 63,472 18,357 3,337 6,163 18,357 6,163
---------- ---------- ---------- ---------- ---------- -------- --------
Operating EBITDA......... $ 76,189 $ 107,932 $ 120,497 $ 30,928 $ 35,182 $113,609 35,305
========== ========== ========== ========== ========== ======== ========
Operating EBITDA as a
percentage of revenue...... 16.9% 18.5% 17.8% 18.7% 19.5% 16.3% 19.1%
SEGMENT OPERATING DATA
Transactions processed....... 1,134,902 1,839,857 2,519,535 566,275 629,131
Statements generated......... 130,895 132,817 127,217 34,333 31,921
Average securitized
portfolio.................. $1,898,851 $2,004,827 $2,073,574 $2,139,647 $2,214,044
Credit sales................. $3,049,151 $3,132,520 $3,685,069 $ 755,114 $ 780,429
Air Miles reward miles
issued..................... 611,824 1,594,594 1,927,016 432,252 524,237
Air Miles reward miles
redeemed................... 158,281 529,327 781,823 162,312 192,023
5
AS OF MARCH 31,
AS OF DECEMBER 31, ---------------------------
------------------------------------ 2001 PRO FORMA
1998 1999 2000 2001 AS ADJUSTED
---------- ---------- ---------- ---------- --------------
(UNAUDITED)
(AMOUNTS IN THOUSANDS)
BALANCE SHEET DATA
Cash and cash equivalents................................. $ 47,036 $ 56,546 $ 116,941 $ 58,756 $ 99,410
Credit card receivables and seller's interest............. 139,458 150,804 137,865 125,013 125,013
Redemption settlement assets, restricted.................. 70,178 133,650 152,007 158,171 158,171
Intangibles and goodwill, net............................. 362,797 493,609 444,549 457,011 457,011
Total assets.............................................. 1,075,707 1,301,263 1,420,606 1,304,832 1,343,985
Deferred revenue--service and redemption.................. 158,192 249,341 290,186 303,430 303,430
Certificates of deposit and other receivables funding
debt.................................................... 147,984 116,900 139,400 119,700 119,700
Long-term and subordinated debt........................... 332,000 318,236 296,660 294,575 193,750
Total liabilities......................................... 780,902 921,791 1,058,215 952,609 851,783
Series A preferred stock.................................. -- 119,400 119,400 119,400 --
Total stockholders' equity................................ 294,805 260,072 242,991 232,823 492,202
6
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 GENERAL BUSINESS OPERATIONS
TEN CLIENTS WERE RESPONSIBLE FOR 63% OF OUR CONSOLIDATED REVENUE LAST YEAR, AND
THE LOSS OF ANY OF THESE CLIENTS COULD CAUSE A SIGNIFICANT DROP IN OUR
REVENUE.
We depend on a limited number of large clients for a significant portion of
our consolidated revenue. Our 10 largest clients were responsible for
approximately 63% of our consolidated revenue during the year ended
December 31, 2000, with The Limited and its retail affiliates representing
approximately 25% of our 2000 consolidated revenue. A decrease in revenue from
any of our significant clients for any reason, including a decrease in pricing
or activity, or a decision to either utilize another service provider or to no
longer outsource some or all of the services we provide, could have a material
adverse effect on our consolidated revenue.
TRANSACTION SERVICES. Our 10 largest clients in this segment were
responsible for approximately 71% of our Transaction Services revenue in 2000.
The Limited and its retail affiliates were the largest Transaction Services
client in 2000, representing approximately 28% of this segment's 2000 revenue,
and Brylane, our second largest Transaction Services client, was responsible for
approximately 10% of this segment's 2000 revenue. Equiva Services, LLC was
responsible for approximately 8% of this segment's 2000 revenue. Our contracts
with The Limited and its retail affiliates and Brylane expire in 2006, and our
contract with Equiva expires in December 2001.
We provide transaction processing services to Equiva which is the service
provider to Shell-branded locations in the United States. Equiva is one of our
10 largest clients both in the Transaction Services segment and on a
consolidated basis. We have been informed by Equiva that it would like to
discontinue a portion of the services we currently provide effective upon
termination of the existing contract in December 2001. As a result of this
termination, our revenue and profitability attributable to Equiva for periods
beyond 2001 will decrease. We are now in the process of negotiating with Equiva
regarding the other services we currently provide. We can give no assurance that
we will successfully reach an agreement with Equiva on similar terms to those
currently existing, or at all. If our negotiations 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 from Equiva would be further
adversely affected.
CREDIT SERVICES. Our two largest clients in this segment were responsible
for approximately 80% of our Credit Services revenue in 2000. The Limited and
its retail affiliates were responsible for approximately 59%, and Brylane was
responsible for approximately 21%, of our Credit Services revenue in 2000. Our
contracts with these clients expire in 2006. The Limited is currently planning a
restructuring involving some of its retail affiliates. The proposed
restructuring would involve a sale of Lane Bryant and the integration of
Structure into the Express brand name as Express Men's. While we have a contract
with Lane Bryant through 2006, we cannot assure you that an acquirer of Lane
Bryant would assume the credit card processing agreement that we currently have
with Lane Bryant or that the acquirer would continue Lane Bryant's marketing
strategy of utilizing private label credit cards. The integration of Structure
into Express could lead to the closing of stores and the name change could
adversely impact credit sales causing lower revenues for our Credit Services
segment.
7
MARKETING SERVICES. Our 10 largest clients in this segment were responsible
for approximately 61% of our Marketing Services revenue in 2000. Bank of
Montreal, Canada Safeway and The Limited and its retail affiliates were the
three largest Marketing Services clients in 2000. The Bank of Montreal
represented approximately 27%, Canada Safeway represented approximately 10% and
The Limited and its retail affiliates represented approximately 7% of this
segment's 2000 revenue. Our contracts with The Bank of Montreal and Canada
Safeway expire in March 2002 and December 2002, respectively, and our contract
with The Limited expires in September 2003.
OUR LARGEST CLIENT, THE LIMITED, IS A SIGNIFICANT STOCKHOLDER, AND AS A RESULT
IT HAS THE ABILITY TO INFLUENCE OUR CORPORATE AFFAIRS IN A MANNER THAT COULD
BE INCONSISTENT WITH THE BEST INTERESTS OF OUR OTHER STOCKHOLDERS.
Eight of our clients are retail affiliates of Limited Commerce Corp., our
second largest stockholder and a wholly owned subsidiary of The Limited. The
Limited, together with its retail affiliates, is our largest client. Limited
Commerce Corp. beneficially owned approximately 24.9% of our common stock
immediately prior to this offering, and, through a stockholders agreement, has
the right to designate up to two members of our board of directors. As a
significant stockholder with board representation, 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. The interests of The Limited may not be
aligned with the interests of our company or other stockholders. The Limited
could use its influence as a major client and large stockholder to negotiate
contracts with us that have terms that are more favorable to The Limited than
could be obtained by unaffiliated retailers. In addition, The Limited could use
its influence and could act to hinder our ability to enter into contracts with
its competitors.
COMPETITION IN OUR INDUSTRY IS INTENSE AND WE EXPECT IT TO INTENSIFY.
The markets for our products and services are highly competitive, and we
expect competition to intensify in each of those markets. Many of our current
competitors have longer operating histories, stronger brand names and greater
financial, technical, marketing and other resources than we do. We cannot assure
you that we will be able to compete successfully against our current and
potential competitors nor can we be sure that we will be able to successfully
market our services at our current levels of profitability.
THE MARKETS FOR THE SERVICES THAT WE OFFER MAY FAIL TO EXPAND OR MAY CONTRACT
AND THIS COULD NEGATIVELY IMPACT OUR GROWTH AND PROFITABILITY.
Our growth and continued profitability rely on acceptance of the services
that we offer. If demand for transaction, credit or marketing services
decreases, the price of our common stock could fall and you could lose value in
your investment. Loyalty and database marketing strategies are relatively new to
retailers, 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. Additionally, downturns in the economy or the
performance of retailers may result in a decrease in the demand for our
marketing strategies. Any decrease in the demand for our services for the
reasons discussed above or other reasons could have a material adverse effect on
our growth and revenue.
WE CANNOT ASSURE YOU THAT WE WILL EFFECTIVELY INTEGRATE FUTURE ACQUISITIONS,
REALIZE THEIR FULL BENEFITS OR SUCCESSFULLY MANAGE OUR COMBINED COMPANY, AND
FUTURE ACQUISITIONS MAY RESULT IN DILUTIVE EQUITY ISSUANCES OR INCREASES IN
DEBT.
If we are unable to successfully integrate any future acquisition, 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 any
8
future acquisition may divert management's attention from our core operations,
which could harm our ability to timely meet the needs of our customers and could
damage our relationships with key clients.
To finance future acquisitions, we may need to raise funds either by issuing
equity securities or incurring debt. If we issue additional equity securities,
such sales could reduce the current value of our stock by diluting the ownership
interest of our stockholders. If we incur additional debt, the related interest
expense may significantly reduce our profitability. Additionally, we are likely
to use purchase accounting for future acquisitions and the related amortization
expense associated with goodwill and purchased intangibles may significantly
reduce our profitability.
WE MAY FACE DAMAGES AS A RESULT OF LITIGATION IN CONNECTION WITH THE BANKRUPTCY
PROCEEDINGS OF ONE OF OUR FORMER CUSTOMERS, SERVICE MERCHANDISE, AND A CLASS
ACTION SUIT FILED ON BEHALF OF A GROUP OF WORLD FINANCIAL CARDHOLDERS.
World Financial, our wholly owned subsidiary, is a party to a lawsuit filed
by Service Merchandise, Inc. in U.S. Bankruptcy Court for the Middle District of
Tennessee. Service Merchandise, which is in voluntary Chapter 11 bankruptcy,
alleges that World Financial breached certain contractual provisions of an
agreement regarding a private label credit card program by, among other things,
unilaterally revising the credit standards applicable to existing cardholders
and withholding monthly program payments owed to Service Merchandise. In
addition, Service Merchandise alleges that certain actions taken by World
Financial violated the automatic stay provisions of the U.S. Bankruptcy Code.
Service Merchandise has not specified the amount of damages that it is seeking
and has asked that the amount of any such damages be determined at trial. In a
separate action, a group of World Financial cardholders recently filed a
putative class action complaint against World Financial in U.S. District Court
for the Southern District of Florida, Miami Division, alleging that World
Financial's billing practices are false, misleading and deceptive, and therefore
in breach of state and federal laws and cardholder contracts. The plaintiff
group of cardholders has not specified the amount of damages that it is seeking.
The amount of such damages, if any, would be determined at trial. See
"Business--Legal Proceedings." Due to the uncertainty inherent in litigation, we
cannot provide assurance that an ultimate result against World Financial in
either of these actions would not have a material adverse effect on us.
FAILURE TO SAFEGUARD OUR DATABASES AND CONSUMER PRIVACY COULD AFFECT OUR
REPUTATION AMONG OUR CLIENTS AND THEIR CUSTOMERS AND MAY EXPOSE US TO LEGAL
CLAIMS FROM CONSUMERS.
An important feature of our marketing and credit services is our ability to
develop and maintain individual consumer profiles. As part of our Air Miles
reward miles program, database marketing program and private label program, we
maintain marketing databases containing information on consumers' account
transactions. 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. Security and privacy
concerns may cause consumers to resist providing the personal data necessary to
support our profiling capability. The use of our loyalty, database marketing or
private label programs could decline if any well-publicized compromise of
security occurred. Any public perception that we released consumer information
without authorization could subject us to legal claims from consumers and
adversely affect our client relationships.
LOSS OF DATA CENTER CAPACITY OR INTERRUPTION OF TELECOMMUNICATION LINKS COULD
AFFECT OUR ABILITY TO TIMELY MEET THE NEEDS OF OUR CLIENTS AND THEIR
CUSTOMERS.
Our ability to protect our data centers against damage from fire, power
loss, telecommunications failure and other disasters is critical. 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
damage to our data centers or any failure of our telecommunication links that
9
interrupts our operations could adversely affect our ability to meet our
clients' needs and their confidence in utilizing us for future services.
AS A RESULT OF OUR SIGNIFICANT CANADIAN OPERATIONS, OUR REPORTED RESULTS WILL BE
AFFECTED BY FLUCTUATIONS IN THE EXCHANGE RATE BETWEEN THE U.S. AND CANADIAN
DOLLARS.
A significant portion of our Marketing Services revenue is derived from our
Loyalty Group operations in Canada, which transacts business in Canadian
dollars. Therefore, our reported results from quarter-to-quarter will be
affected by changes in the exchange rate between the U.S. and Canadian dollars
over the relevant periods.
OUR HEDGING ACTIVITY SUBJECTS US TO OFF-BALANCE SHEET 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 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. 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.
OUR FAILURE TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS MAY HARM OUR COMPETITIVE
POSITION, AND LITIGATION TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS OR DEFEND
AGAINST THIRD-PARTY ALLEGATIONS OF INFRINGEMENT MAY BE COSTLY.
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 infringement of
our intellectual property rights or misappropriation 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 resources. Any claims from third
parties may also result in limitations on our ability to use the intellectual
property subject to these claims.
RISKS PARTICULAR TO TRANSACTION SERVICES
AN INABILITY TO FULLY AND EFFECTIVELY INTEGRATE THE RECENT ACQUISITIONS OF SPS
AND UTILIPRO IN OUR TRANSACTION SERVICES SEGMENT COULD RESULT IN INCREASED
COSTS WHILE DIVERTING MANAGEMENT'S ATTENTION FROM OUR CORE OPERATIONS, HARM
OUR ABILITY TO TIMELY MEET THE NEEDS OF OUR CLIENTS AND DAMAGE OUR
RELATIONSHIPS WITH THOSE CLIENTS.
We are currently in the process of integrating the network transaction
processing business of SPS Payment Systems, Inc. we acquired in July 1999, and
are beginning to integrate the Utilipro operating assets we acquired in February
2001. We expect the SPS integration process to continue through the
10
second quarter of 2001 and the Utilipro integration process to continue through
the third quarter of 2001. Although the majority of the integration process of
migrating the SPS systems to an in-house processing environment has proceeded as
planned, there were a number of service disruptions that occurred in the first
quarter of 2001 which resulted in an inefficient routing of transactions and a
backlog of authorizations. We cannot assure you that we will be able to fully or
successfully integrate SPS or Utilipro in a timely manner or at all. If we are
unable to successfully integrate the Utilipro operations or successfully
complete the SPS integration, we may incur substantial costs and delays or other
operational, technical or financial problems, any of which could harm our
business and adversely affect the trading price of our common stock. In
addition, management's attention may be diverted from core operations which
could harm our ability to timely meet the needs of our clients and their
customers and damage our relationships with those clients.
WE ARE DEPENDENT UPON TRANSACTION NETWORK SERVICES, INC., FORMERLY KNOWN AS
PSINET TRANSACTION SOLUTIONS, FOR DATA TRANSMISSION SERVICES AND POINT-OF-SALE
DIAL-UP TRANSMISSION SERVICES, AND ANY FAILURE OF TRANSACTION NETWORK SERVICES
TO PROVIDE THESE SERVICES COULD SIGNIFICANTLY DISRUPT OUR NETWORK SERVICES OR
INCREASE OUR COSTS BY REQUIRING US TO OBTAIN DATA TRANSMISSION SERVICES FROM
ANOTHER SUPPLIER.
We are dependent on Transaction Network Services, Inc., or TNS, for data
transmission services and point-of-sale dial-up transmission services for our
network services business. On April 3, 2001, an investor group led by GTCR
Golder Rauner, LLC purchased TNS from PSINet, Inc. PSINet has been experiencing
significant liquidity and cash flow shortfalls that require the addition of
substantial capital, the availability of which is uncertain. If PSINet were to
declare bankruptcy, it is possible that parties to the bankruptcy proceeding
could attempt to undo the sale of TNS to Golder Rauner and seek to reject our
contract with TNS. In the event the sale is undone and our contract with TNS
rejected, we would be forced to utilize our backup supplier or another vendor
for the contracted services. In the first half of 2001, we intend to complete
the migration of a large percentage of our data and point-of-sale dial-up
transmission needs for our network services business, representing a quarter of
the transactions we processed in 2000, to TNS. Given our dependence on TNS, if
it were to fail to perform its obligations or its services were otherwise
interrupted, for financial or other reasons, we would have to transition the
services to our current backup supplier or to another supplier. If this were to
occur, any new contract we might enter into for the long-term provision of those
services may be at a price and on terms substantially less favorable to us than
the terms of our current arrangement.
IF A CARDHOLDER HAS A DISPUTE WITH A MERCHANT OR IF A CARDHOLDER IS A VICTIM OF
A FRAUDULENT TRANSACTION WITH A MERCHANT, WE MAY BE LIABLE FOR THE AMOUNT OF
ANY CHARGES RELATED TO SUCH DISPUTE OR TRANSACTION IN THE EVENT WE ARE NOT
REIMBURSED FOR SUCH CHARGES BY THE MERCHANT.
In our merchant bankcard services 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"
to the merchant the amount we originally credited to the merchant. We then
credit the amount of the transaction back to the cardholder's account. These
billing disputes or chargebacks typically relate to, among others:
- the cardholder's nonreceipt of merchandise or services;
- unauthorized use of a credit card; or
- general disputes between a cardholder and a merchant as to the quality of
the goods purchased or the services rendered by the merchant.
If we are unable to collect amounts charged back to a merchant's account, and if
the merchant refuses or is unable to reimburse us for the chargeback, we incur a
loss equal to the amount of the chargeback. We cannot assure you that we will
not experience significant losses from chargebacks in the future. Such
significant losses could arise from merchant bankruptcies or other reasons which
reduce the
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likelihood that we will be reimbursed for chargebacks. Any significant
chargeback losses in a period would have a material adverse effect on our
profitability.
IF WE ARE REQUIRED TO PAY STATE TAXES ON TRANSACTIONS PROCESSING, IT COULD
NEGATIVELY IMPACT OUR PROFITABILITY.
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, these taxes would negatively impact our profitability.
RISKS PARTICULAR TO CREDIT SERVICES
IF WE ARE UNABLE TO SECURITIZE OUR CREDIT CARD RECEIVABLES DUE TO CHANGES IN THE
MARKET, THE UNAVAILABILITY OF CREDIT ENHANCEMENTS, AN EARLY AMORTIZATION EVENT
OR FOR OTHER REASONS, WE WOULD NOT BE ABLE TO FUND NEW CREDIT CARD
RECEIVABLES, WHICH WOULD HAVE A NEGATIVE IMPACT ON OUR OPERATIONS AND
EARNINGS.
Since January 1996, we have sold substantially all of the credit card
receivables owned by our credit card bank, World Financial, to World Financial
Network Credit Card Master Trust as part of our securitization program. This
securitization program is the primary vehicle through which World Financial
finances our private label credit card receivables. If World Financial were not
able to regularly securitize the receivables it originates, our ability to grow
or even maintain our credit services business would be materially impaired.
World Financial's ability to effect securitization transactions is impacted
by the following factors, some of which are beyond our control:
- conditions in the securities markets in general and the asset-backed
securitization market in particular;
- conformity in the quality of credit card receivables to rating agency
requirements and changes in those requirements; and
- our ability to fund required overcollateralizations or credit
enhancements, which we routinely utilize in order to achieve better credit
ratings to lower our borrowing costs.
Once World Financial securitizes receivables, the agreement governing the
transaction contains covenants that address the receivables' performance and the
continued solvency of the retailer where the underlying sales were generated. In
the event one of those or other similar covenants is breached, an early
amortization event could be declared, in which case the trustee for the
securitization trust would retain World Financial's interest in the related
receivables, along with the excess interest income that would normally be paid
to World Financial, until such time as the securization investors are fully
repaid. The occurrence of an early amortization event would significantly limit,
or even negate, our ability to securitize additional receivables.
INCREASES IN NET CHARGE-OFFS BEYOND OUR EXPECTATIONS COULD HAVE A NEGATIVE
IMPACT ON OUR OPERATING INCOME AND PROFITABILITY; AS THE AVERAGE AGE OF OUR
SECURITIZED LOAN PORTFOLIO INCREASES, WE WILL LIKELY EXPERIENCE INCREASING
LEVELS OF DELINQUENCY AND LOAN LOSSES.
The primary risk associated with unsecured consumer lending is the risk of
default or bankruptcy of the borrower, resulting in the borrower's balance being
charged-off as uncollectible. We rely principally on the customer's
creditworthiness for repayment of the loan and therefore have no other recourse
for collection. We may not be able to successfully identify and evaluate the
creditworthiness of cardholders to minimize delinquencies and losses. An
increase in defaults or net charge-offs beyond historical levels will reduce the
net spread available to us from the securitization master trust and could result
in a reduction in finance charge income or a write-down of the interest only
strip. General
12
economic factors, such as the rate of inflation, unemployment levels and
interest rates, may result in greater delinquencies that lead to greater credit
losses among consumers.
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 are affected by the credit risk of credit card
receivables and the average age of our various credit card account portfolios.
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, 2001, 19.2% of our securitized accounts and 38.6% of our securitized
loans were less than 24 months old. We believe that our credit card loan
portfolio will experience increasing levels of delinquency and loan losses as
the average age of our accounts increases. For the three months ended March 31,
2001, our securitized net charge-off ratio was 7.9% compared to 7.6% for the
three months ended March 31, 2000. Our securitized net charge-off ratio was 7.6%
for 2000 compared to 7.2% for 1999 and 7.8% for 1998. We believe that this ratio
will continue to fluctuate but generally rise over time as the average age of
our accounts increases. Also, we cannot assure you that our risk-based pricing
strategy can offset the negative impact on profitability caused by increases in
delinquencies and losses. 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 that we sell though securitizations.
CHANGES IN THE AMOUNT OF PREPAYMENTS AND DEFAULTS BY CARDHOLDERS ON CREDIT CARD
BALANCES MAY CAUSE A DECREASE IN THE ESTIMATED VALUE OF INTEREST ONLY STRIPS.
The estimated fair value of interest only strips depends upon the
anticipated cash flows of the related credit card receivables. A significant
factor affecting the 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. Other assumptions used in estimating the value of the interest only
strips 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. If prepayments from cardholders or defaults by cardholders exceed our
estimates, we may be required to decrease the estimated value of the interest
only strips through a charge against earnings.
INTEREST RATE FLUCTUATIONS COULD SIGNIFICANTLY REDUCE THE AMOUNT WE REALIZE FROM
THE SPREAD BETWEEN THE YIELD ON OUR ASSETS AND OUR COST OF FUNDING.
An increase or decrease in market interest rates could have a negative
impact on the amount we realize from the 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. At March 31, 2001, approximately 9.2% of
our outstanding debt was subject to fixed rates with a weighted average interest
rate of 8.3%. An additional 55.3% of our outstanding debt at March 31, 2001 was
locked at an effective interest rate of 6.7% through interest rate swap
agreements and treasury locks with notional amounts totaling $1.5 billion.
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
$8.6 million. Conversely, a corresponding decrease in interest rates would
result in a comparable improvement to pretax income. The foregoing sensitivity
analysis is limited to the potential impact of an interest rate swing of 1.0% on
cash flows and fair values, and does not address default or credit risk.
13
WE EXPECT GROWTH IN OUR CREDIT SERVICES SEGMENT TO RESULT FROM NEW AND ACQUIRED
PRIVATE LABEL CARD PROGRAMS, WHOSE CREDIT CARD RECEIVABLE PERFORMANCE COULD
RESULT IN INCREASED PORTFOLIO LOSSES AND NEGATIVELY IMPACT OUR NET RETAINED
INTERESTS IN LOANS SECURITIZED.
We expect an important source of growth in our private label card operations
to come from the acquisition of existing private label programs and initiating
private label programs with retailers who do not currently offer a private label
card. Although we believe our pricing and models for determining credit risk are
designed to evaluate the credit risk of existing programs and the credit risk we
are willing to assume for acquired and start-up programs, we cannot assure you
that the loss experience on acquired and start-up programs will be consistent
with our more established programs. The failure to successfully underwrite these
private label programs may result in defaults greater than our expectations and
could have a material adverse impact on us and the value of our net retained
interests in loans securitized.
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 minimum capital levels. 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 profitability.
IF OUR BANK SUBSIDIARY FAILS TO MEET CREDIT CARD BANK CRITERIA, WE MAY BECOME
SUBJECT TO REGULATION UNDER THE BANK HOLDING COMPANY ACT, WHICH WOULD FORCE US
TO CEASE ALL OF OUR NON-BANKING BUSINESS ACTIVITIES AND THUS CAUSE A DRASTIC
REDUCTION IN OUR PROFITS AND REVENUE.
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 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 regulation under the Bank Holding Company Act. Being
deemed a bank holding company could 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.
14
While the consequences of being subject to regulation under the Bank Holding
Company Act would be severe, we believe that the risk of becoming subject to
such regulation is minimal as a result of the precautions we have taken in
structuring our business.
RISKS PARTICULAR TO MARKETING SERVICES
BECAUSE WE ARE DEPENDENT UPON AIR CANADA, THE DOMINANT DOMESTIC AIR CARRIER IN
CANADA, AS A SUPPLIER OF AIRLINE TICKETS FOR OUR AIR MILES REWARD MILES
PROGRAM, WE MAY NOT BE ABLE TO MEET THE NEEDS OF OUR COLLECTORS IF THE
CAPACITY MADE AVAILABLE TO US BY AIR CANADA IS INADEQUATE TO MEET OUR
COLLECTORS' DEMANDS.
Air Canada completed its acquisition of Canadian Airlines in July 2000 and
thereby solidified its position as the dominant Canadian domestic airline. Air
Canada has merged the operations of Canadian Airlines and consolidated routes
resulting in the reduction of routes, flights and seats offered by the merged
airline. As a result of the acquisition, we entered into a new supply agreement
with Air Canada that runs through 2004, superseding our prior agreement with
Canadian Airlines. Notwithstanding our agreement with Air Canada, we cannot
predict what impact route consolidation or elimination or changes in the merged
airline's operations will have on our ability to satisfy and retain active
collectors and sponsors of the Air Miles reward miles program.
The new supply agreement with Air Canada contains reductions in the
guarantee related to the number of tickets available at contractual rates on
certain routes after December 31, 2002. Once these capacity guarantees on
certain routes are reduced in 2003, we may be required to meet the demands of
collectors by purchasing tickets from other carriers. These tickets could be
more expensive than a comparable ticket under the Air Canada agreement, and the
routes offered by the other airlines may be inconvenient or undesirable to the
redeeming collectors. As a result, we may experience higher air travel
redemption costs in 2003 and 2004 than we are currently experiencing, while at
the same time collector satisfaction with the Air Miles reward miles program may
be adversely affected by requiring travel on other carriers on certain routes.
IF ACTUAL REDEMPTIONS BY COLLECTORS OF AIR MILES REWARD MILES ARE GREATER THAN
EXPECTED, OUR REVENUES AND PROFITABILITY COULD BE ADVERSELY AFFECTED.
A portion of our revenue is based on our estimate of the number of Air Miles
reward miles that will go unused by the collector base. 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.
If actual redemptions are greater than our estimates, our revenues and
profitability could be adversely affected.
THE LOSS OF OUR MOST ACTIVE AIR MILES REWARD MILES COLLECTORS COULD NEGATIVELY
IMPACT OUR GROWTH AND PROFITABILITY.
Our most active Air Miles reward miles collectors represent a
disproportionately large percentage of our Air Miles reward program revenue.
Over the past year, we estimate that over half of the Air Miles reward program
revenues came from our most active Air Miles reward miles collectors. The loss
of a significant portion of these collectors, for any reason, could impact our
ability to generate significant revenue from sponsors and loyalty partners. The
continued attractiveness of our loyalty and
15
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.
LEGISLATION RELATING TO CONSUMER PRIVACY MAY AFFECT OUR ABILITY TO COLLECT DATA
THAT WE USE IN PROVIDING OUR MARKETING SERVICES, WHICH COULD NEGATIVELY AFFECT
OUR ABILITY TO SATISFY OUR CLIENTS' NEEDS.
The enactment of legislation or industry regulations arising from public
concern over consumer privacy issues could have a material adverse impact on our
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.
The Gramm-Leach-Bliley Act, which became law in November 1999, makes it more
difficult to collect and use information that has been legally available and may
increase our costs of collecting some data. New regulations under this act that
take effect in July 2001 will give cardholders the ability to "opt out" of
having information generated by their credit card purchases shared with other
parties or the public. Our ability to gather and utilize this data will be
adversely affected if a significant percentage of the consumers whose purchasing
behavior we track elect to "opt out," thereby precluding us from using their
data. Once the regulations take effect, we will need to refrain from using data
generated by our existing cardholders and new cardholders until such cardholders
are given the opportunity to opt out.
Similarly, the Personal Information Protection and Electronic Documents Act
enacted in Canada requires organizations to obtain a consumer's consent to
collect, use or disclose personal information. Under this act, which took effect
on January 1, 2001, the nature of the required consent depends on the
sensitivity of the personal information, and the act permits personal
information to be used only for the purposes for which it was collected. The
Loyalty Group allows its customers to voluntarily "opt out" from either
promotional mail or electronic mail. Heightened consumer awareness of, and
concern about, privacy may encourage more customers to "opt out" at higher rates
than they have historically. This would mean that a reduced number of customers
would receive bonus mile offers and therefore would collect fewer Air Miles
reward miles.
RISKS RELATED TO OUR COMPANY
SOME OF OUR STOCKHOLDERS CURRENTLY OWN, AND AFTER THE OFFERING WILL CONTINUE TO
OWN, A SIGNIFICANT AMOUNT OF OUR COMMON STOCK. THESE STOCKHOLDERS MAY HAVE
INTERESTS THAT CONFLICT WITH YOURS AND WOULD BE ABLE TO CONTROL THE ELECTION
OF DIRECTORS AND THE APPROVAL OF SIGNIFICANT CORPORATE TRANSACTIONS, INCLUDING
A CHANGE IN CONTROL.
Immediately prior to this offering, Limited Commerce Corp. and the
affiliated entities of Welsh, Carson, Anderson & Stowe in the aggregate
beneficially owned approximately 99.6% of our outstanding common stock and would
have owned approximately 81.6% of our common stock as of that date after giving
pro forma effect to this offering. Through a stockholders agreement, Limited
Commerce Corp. has the right to designate up to two members of our board of
directors and Welsh Carson has the ability to designate up to three members of
our board of directors. 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, changes to our
charter documents and significant corporate transactions. This concentration of
ownership makes it unlikely that any other holder or group of holders of common
stock will be able to affect the way we are managed or the direction of our
business. Limited Commerce Corp. and Welsh Carson may have interests that
conflict with the interests of our company or other stockholders. Their
continued concentrated ownership after the offering will make it impossible for
another company to acquire us and for you to receive any related takeover
premium for your shares unless they approve the acquisition.
16
DELAWARE LAW AND OUR CHARTER DOCUMENTS COULD PREVENT A CHANGE OF CONTROL 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.
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 our common stock has been approved for listing 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 have determined 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.
The stock market has experienced extreme price and volume fluctuations in
recent years that have significantly affected the quoted prices of the
securities of many companies, including companies in our industry. The changes
often appear to occur without regard to specific operating performance. The
price of our common stock could fluctuate based upon factors that have little or
nothing to do with our company and these fluctuations could materially reduce
our stock price.
FUTURE SALES OF OUR COMMON STOCK MAY ADVERSELY AFFECT OUR COMMON STOCK PRICE.
If a large number of shares of our common stock are sold in the open market
after this offering, the trading price of our common stock could decrease. In
addition, the sale of these shares could impair our ability to raise capital
through the sale of additional common stock. After this offering, we will have
an aggregate of 117,885,514 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
17
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 71,861,486 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 58,861,486 shares, 72,013 shares will be freely transferable
and 58,789,473 shares will be "restricted securities" as that term is defined in
Rule 144 under the Securities Act.
We have reserved 1,500,000 shares of common stock for issuance under our
employee stock purchase plan. We have also reserved 8,753,000 shares of our
common stock for issuance under our stock option and restricted stock plan, of
which 4,351,105 shares are issuable upon exercise of options granted as of
April 30, 2001, including options to purchase 1,731,787 shares exercisable as of
April 30, 2001 or that will become exercisable within 60 days after April 30,
2001. The sale of shares issued upon the exercise of currently outstanding stock
options could further dilute your investment in our common stock and adversely
affect our stock price.
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains forward-looking statements. Such statements may use
words such as "anticipate," "believe," "estimate," "expect," "intend,"
"predict," "project" and similar expressions as they relate to us or our
management. When we make forward-looking statements, we are basing them on our
management's beliefs and assumptions, using information currently available to
us. Although we believe that the expectations reflected in the forward-looking
statements are reasonable, these forward-looking statements are subject to
risks, uncertainties and assumptions, including those discussed in "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. You should
specifically consider the factors identified under "Risk Factors" and elsewhere
in this prospectus which could cause actual results to differ before making an
investment decision.
18
USE OF PROCEEDS
The net proceeds from our sale of 13,000,000 shares of our common stock in
this offering will be approximately $142.0 million, or $163.8 million if the
underwriters exercise their over-allotment option in full, after deducting
underwriting discounts and commissions and estimated offering expenses. We
intend to use the net proceeds as follows:
- approximately $100.8 million to repay debt outstanding under our
$330.0 million credit facility, which we entered into in July 1998,
consisting of approximately $90.8 million to repay in full the outstanding
balance of a term loan and $10.0 million to repay the outstanding balance
of the revolving loan commitment;
- approximately $500,000 to repurchase from JCP Telecom Systems, Inc. a
warrant for 167,084 shares of our common stock at an exercise price of
$9.00 per share; and
- the balance, approximately $40.7 million, for potential acquisitions and
general corporate purposes, including working capital and capital
expenditures.
Pending such uses, 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 U.S. government agencies.
The term loan and the revolving loan commitment to be repaid bear interest
at floating rates based on the prime rate, the Federal funds rate for a base
rate loan plus 50 basis points, or LIBOR plus the applicable Euro-dollar margin,
as selected by us from time to time. At March 31, 2001, the effective interest
rate on the term loan was 7.6% and the effective interest rate on the
outstanding amount of the revolving loan commitment was 9.1%. The term loan
matures in installments through July 25, 2003, and the revolving loan commitment
matures on July 25, 2003.
Although we are currently considering acquisition candidates in the
transaction services field and we continue to monitor and evaluate acquisition
opportunities on an ongoing basis, we have no present agreements, commitments or
understandings with respect to the acquisition of any business at this time. The
amounts and timing of our expenditures for general corporate purposes will vary
depending on a number of factors, including the amount of cash generated or used
by our operations, competitive and technological developments and the rate of
growth of our business. As a result, we will retain broad discretion in the
allocation of the net proceeds of this offering.
DIVIDEND POLICY
We have never declared or paid any dividends on our common stock, and we do
not anticipate paying any cash dividends on our common stock 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 on our common stock 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 common stockholders, nor can we authorize or
make any other distribution, payment or delivery of property or cash to our
common stockholders.
19
DILUTION
Our pro forma net deficit in tangible book value as of March 31, 2001 was
approximately $92.3 million, or approximately $1.57 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 13,000,000
shares of common stock in this offering at the initial public offering price of
$12.00 per share and after deduction of the underwriting discounts and
commissions and estimated offering expenses payable by us, our pro forma net
tangible book value as of March 31, 2001 would have been approximately
$48.3 million, or $0.67 per share. This represents an immediate increase in pro
forma net tangible book value to existing stockholders attributable to new
investors of $2.24 per share and the immediate dilution of $11.33 per share to
new investors.
Initial public offering price per share..................... $12.00
Pro forma net deficit in tangible book value per share
before offering......................................... $(1.57)
Increase per share attributable to new investors.......... 2.24
------
Pro forma as adjusted net tangible book value per share
after the offering........................................ 0.67
------
Dilution per share to new investors......................... $11.33
======
The following table sets forth as of March 31, 2001, 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 underwriting
discounts and commissions and estimated offering expenses payable by us at the
initial public offering price of $12.00 per share.
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
------------------- ------------------- PRICE PER
NUMBER PERCENT AMOUNT PERCENT SHARE
-------- -------- -------- -------- ---------
(AMOUNTS IN THOUSANDS)
Existing stockholders.......................... 58,861 81.9% $346,115 68.9% $ 5.88
New investors.................................. 13,000 18.1 156,000 31.1 12.00
------ ----- -------- -----
Total........................................ 71,861 100.0% $502,115 100.0%
====== ===== ======== =====
This table does not reflect shares issued upon the exercise of stock options
after March 31, 2001. As of March 31, 2001, there were outstanding options to
purchase a total of 4,384,576 shares of common stock at a weighted average
exercise price of $12.43 per share and 8,753,000 shares of common stock reserved
for issuance under our stock option and restricted stock plan. If all options
outstanding as of March 31, 2001 were exercised on the date of the closing of
the offering, new investors purchasing shares in this offering would suffer
dilution per share of $11.37.
20
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, 2001:
- 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
13,000,000 shares of our common stock offered by this prospectus at the
initial public offering price of $12.00 per share and the application of
the net proceeds from the sale, having deducted 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 in this prospectus.
AS OF MARCH 31, 2001
-------------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
--------- ---------- ------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Cash and cash equivalents................................... $ 58,756 $ 58,756 $ 99,410
======== ======== ========
Certificates of deposit..................................... $ 99,400 $ 99,400 $ 99,400
Current portion of term debt and revolving loan
commitment................................................ 44,125 44,125 4,125
-------- -------- --------
Total short-term debt..................................... $143,525 $143,525 $103,525
======== ======== ========
Long-term debt, excluding current portion:
Certificates of deposit................................... $ 20,300 $ 20,300 $ 20,300
Term debt................................................. 148,450 148,450 87,625
Subordinated notes........................................ 102,000 102,000 102,000
-------- -------- --------
Total long-term debt.................................... 270,750 270,750 209,925
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;
47,662 shares issued and outstanding, actual;
58,861 shares issued and outstanding, pro forma;
71,861 shares issued and outstanding, pro forma as
adjusted................................................ 477 589 719
Additional paid-in capital................................ 227,829 347,117 488,466
Retained earnings......................................... 16,423 16,423 14,923
Accumulated other comprehensive loss...................... (11,906) (11,906) (11,906)
-------- -------- --------
Total stockholders' equity.............................. 232,823 352,223 492,202
-------- -------- --------
Total capitalization.................................. $622,973 $622,973 $702,127
======== ======== ========
At the closing of this offering, as set forth in an agreement between us and
JCP Telecom Systems, Inc., a holder of a warrant to purchase 167,084 shares of
our common stock, we will purchase the unexercised warrant from JCP Telecom
Systems 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,
resulting in a payment to JCP Telecom Systems at closing of approximately
$500,000. There are no other warrants outstanding to purchase our common stock.
We estimate that there will be 71,861,486 shares of common stock outstanding
immediately 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.
21
UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION
The following unaudited pro forma consolidated financial information is
based on the historical financial statements of Alliance Data Systems
Corporation and Utilipro, Inc. 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 and Utilipro, Inc., 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 Utilipro
acquisition, accounted for under the purchase method of accounting, as if that
acquisition had been consummated on January 1, 2000.
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.
22
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2000
(IN THOUSANDS, EXCEPT PER SHARE DATA)
YEAR ENDED DECEMBER 31, 2000
--------------------------------------------------
PRO
ADSC UTILIPRO(1) ADJUSTMENTS FORMA
-------- ----------- -------------- --------
Total revenue........................................... $678,195 $ 17,732 $ -- $695,927
Cost of operations...................................... 547,985 24,620 -- 572,605
General and administrative.............................. 32,201 -- -- 32,201
Depreciation and other amortization..................... 26,265 1,261 -- 27,526
Amortization of purchased intangibles................... 49,879 -- 1,681 (2) 51,560
-------- -------- -------- --------
Total operating expenses.............................. 656,330 25,881 1,681 683,892
-------- -------- -------- --------
Operating income (loss)................................. 21,865 (8,149) (1,681) 12,035
Other non-operating expense............................. 2,477 -- -- 2,477
Interest expense........................................ 38,870 1,122 650 (3)(4) 40,642
Income tax expense (benefit)............................ 1,841 (3,539) (464)(5) (2,162)
-------- -------- -------- --------
Loss from continuing operations......................... $(21,323) $ (5,732) $ (1,867) $(28,922)
======== ======== ======== ========
Loss per share from continuing operations--basic and
diluted............................................... $ (0.60) $ (0.76)
======== ========
Weighted average shares used in computing per share
amounts--basic and diluted............................ 47,538 47,538
======== ========
See the accompanying notes on page 25.
23
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2001
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED MARCH 31, 2001
-----------------------------------------------------------
ADSC UTILIPRO(1) SUBTOTAL ADJUSTMENTS PRO FORMA
-------- ----------- -------- ----------- ---------
Total revenue.................................. $180,692 $4,140 $184,832 $ -- $184,832
Cost of operations............................. 143,258 4,017 147,275 -- 147,275
General and administrative..................... 9,333 -- 9,333 -- 9,333
Depreciation and other amortization............ 6,367 374 6,741 -- 6,741
Amortization of purchased intangibles.......... 11,113 -- 11,113 280 (2) 11,393
-------- ------ -------- ----- --------
Total operating expenses..................... 170,071 4,391 174,462 280 174,742
-------- ------ -------- ----- --------
Operating income (loss)........................ 10,621 (251) 10,370 (280) 10,090
Interest expense............................... 9,635 437 10,072 (142)(3)(4) 9,930
Income tax benefit (expense)................... 933 (260) 673 (62)(5) 611
-------- ------ -------- ----- --------
Income (loss) from continuing operations....... $ 53 $ (428) $ (375) $ (76) $ (451)
======== ====== ======== ===== ========
Earnings (loss) per share from continuing
operations--basic and diluted................ $ (0.04) $ (0.05)
======== ========
Weighted average shares used in computing per
share amounts--basic......................... 47,568 47,568
======== ========
See the accompanying notes on page 25.
24
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED PRO FORMA CONSOLIDATED
FINANCIAL STATEMENTS
The Unaudited Pro Forma Consolidated Statements of Operations for the year
ended December 31, 2000 and the three months ended March 31, 2001 reflect the
following adjustments:
(1) Represents operating activity for Utilipro for the year ended September 30,
2000 and the three months ended December 31, 2000. Prior to its acquisition
Utilipro had no significant transactions other than normal operations.
(2) Represents pro forma adjustments to goodwill and amortization of other
purchased intangibles' resulting from the preliminary purchase accounting
treatment of the Utilipro acquisition. The preliminary amortization period
for Utilipro is 10 years.
(3) Represents the elimination of interest expense from debt we are not assuming
as part of the acquisition.
(4) Represents the pro forma interest expense at an assumed 8.75% from the
incremental borrowing for the purchase price.
(5) Represents the tax effect of pro forma adjustments for the Utilipro
acquisition.
25
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. Full-year information is derived from financial statements that were
audited by Deloitte & Touche LLP. The selected consolidated financial data for
the three months ended March 31, 2000 and 2001 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, 2001 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.
FOR THE THREE MONTHS ENDED
FISCAL MARCH 31,
---------------------------------------------------------------------- ---------------------------
1996(1) 1997(2) 1998(3) 1999(4) 2000(5) 2000 2001
----------- ----------- ------------ ------------ ------------ ------------ ------------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
INCOME STATEMENT DATA
Total revenue............ $ 280,935 $ 353,399 $ 410,913 $ 583,082 $ 678,195 $ 165,547 $ 180,692
Cost of operations....... 221,511 273,145 335,804 466,856 547,985 134,571 143,258
General and
administrative
expenses............... 12,080 15,302 17,589 35,971 32,201 7,505 9,333
Depreciation and other
amortization........... 6,318 7,402 8,270 16,183 26,265 5,997 6,367
Amortization of purchased
intangibles............ 15,900 28,159 43,766 61,617 49,879 13,795 11,113
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total operating
expenses........... 255,809 324,008 405,429 580,627 656,330 161,868 170,071
---------- ---------- ---------- ---------- ---------- ---------- ----------
Operating income......... 25,126 29,391 5,484 2,455 21,865 3,679 10,621
Other non-operating
expenses(6)............ -- -- -- -- 2,477 2,476 --
Interest expense......... 5,649 15,459 27,884 42,785 38,870 8,776 9,635
---------- ---------- ---------- ---------- ---------- ---------- ----------
Income (loss) from
continuing operations
before income taxes.... 19,477 13,932 (22,400) (40,330) (19,482) (7,573) 986
Income tax expense
(benefit).............. 5,704 5,236 (4,708) (6,538) 1,841 716 933
---------- ---------- ---------- ---------- ---------- ---------- ----------
Income (loss) from
continuing
operations............. 13,773 8,696 (17,692) (33,792) (21,323) (8,289) 53
Income (loss) from
discontinued
operations, net of
taxes.................. (3,823) (8,247) (300) 7,688 -- -- --
Loss on disposal of
discontinued
operations, net of
taxes.................. -- -- -- (3,737) -- -- --
---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income (loss)........ $ 9,950 $ 449 $ (17,992) $ (29,841) $ (21,323) $ (8,289) $ 53
========== ========== ========== ========== ========== ========== ==========
Earnings (loss) per share
from continuing
operations--basic and
diluted................ $ 0.38 $ 0.24 $ (0.42) $ (0.78) $ (0.60) $ (0.21) $ (0.04)
========== ========== ========== ========== ========== ========== ==========
Earnings (loss) per
share--basic and
diluted................ $ 0.27 $ 0.01 $ (0.43) $ (0.70) $ (0.60) $ (0.21) $ (0.04)
========== ========== ========== ========== ========== ========== ==========
Weighted average shares
used in computing per
share amounts--basic
and diluted............ 36,521 36,612 41,729 47,498 47,538 47,529 47,568
========== ========== ========== ========== ========== ========== ==========
26
FOR THE THREE MONTHS ENDED
FISCAL MARCH 31,
---------------------------------------------------------------------- ---------------------------
1996(1) 1997(2) 1998(3) 1999(4) 2000(5) 2000 2001
----------- ----------- ------------ ------------ ------------ ------------ ------------
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
OTHER FINANCIAL DATA
Calculation of operating
EBITDA:
Operating income....... $ 25,126 $ 29,391 $ 5,484 $ 2,455 $ 21,865 3,679 10,621
Depreciation and other
amortization......... 6,318 7,402 8,270 16,183 26,265 5,997 6,367
Amortization of
purchased
intangibles.......... 15,900 28,159 43,766 61,617 49,879 13,795 11,113
---------- ---------- ---------- ---------- ---------- ---------- ----------
EBITDA................. 47,344 64,952 57,520 80,255 98,009 23,471 28,101
Plus change in deferred
revenue.............. -- -- 20,729 91,149 40,845 10,794 13,244
Less change in
redemption settlement
assets............... -- -- 11,838 63,472 18,357 3,337 6,163
---------- ---------- ---------- ---------- ---------- ---------- ----------
Operating EBITDA(7)...... $ 47,344 $ 64,952 $ 66,411 $ 107,932 $ 120,497 $ 30,928 $ 35,182
========== ========== ========== ========== ========== ========== ==========
Operating EBITDA as a
percentage of
revenue................ 16.9% 18.4% 16.2% 18.5% 17.8% 18.7% 19.5%
Cash flows from operating
activities............. $ 67,696 $ (30,678) $ 9,311 $ 251,638 $ 87,183 $ 14,872 $ 10,997
Cash flows from investing
activities............. (148,721) (103,746) (145,386) (309,451) (24,457) 15,194 (37,175)
Cash flows from financing
activities............. 82,011 104,870 163,282 74,929 1,144 (18,351) (20,278)
SEGMENT OPERATING DATA
Transactions processed... 881,316 929,274 1,073,040 1,839,857 2,519,535 566,275 629,131
Statements
generated(8)........... 126,114 113,940 117,672 132,817 127,217 34,333 31,921
Average securitized
portfolio.............. $1,261,833 $1,615,196 $1,905,927 $2,004,827 $2,073,574 $2,139,647 $2,214,044
Credit sales............. $2,402,881 $3,001,029 $2,866,062 $3,132,520 $3,685,069 $ 755,114 $ 780,429
Air Miles reward miles
issued................. -- -- 611,824 1,594,594 1,927,016 432,252 524,237
Air Miles reward miles
redeemed............... -- -- 158,281 529,327 781,823 162,312 192,023
AS OF
------------------------------------------------------------------------------------
FEBRUARY 1, JANUARY 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, MARCH 31,
1997 1998 1998 1999 2000 2001
----------- ----------- ------------ ------------ ------------ -----------
(AMOUNTS IN THOUSANDS) (UNAUDITED)
BALANCE SHEET DATA
Cash and cash equivalents.............. $ 50,149 $ 20,595 $ 47,036 $ 56,546 $ 116,941 $ 58,756
Credit card receivables and seller's
interest............................. 161,686 144,440 139,458 150,804 137,865 125,013
Redemption settlement assets,
restricted........................... -- -- 70,178 133,650 152,007 158,171
Intangibles and goodwill, net.......... 103,261 93,909 362,797 493,609 444,549 457,011
Total assets........................... 498,355 619,901 1,091,008 1,301,263 1,420,606 1,304,832
Deferred revenue--service and
redemption........................... -- -- 158,192 249,341 290,186 303,430
Certificates of deposit and other
receivables funding debt............. 68,400 50,900 49,500 116,900 139,400 119,700
Short-term debt........................ 80,811 82,800 98,484 -- -- --
Long-term and subordinated debt........ 50,000 180,000 332,000 318,236 296,660 294,575
Total liabilities...................... 294,144 415,145 796,203 921,791 1,058,215 952,609
Series A preferred stock............... -- -- -- 119,400 119,400 119,400
Total stockholders' equity............. 204,211 204,756 294,805 260,072 242,991 232,823
27
------------------------------
(1) 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.
(2) 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.
(3) 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.
(4) 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.
(5) Fiscal 2000 represents the operating results for the year ended
December 31, 2000.
(6) Other expenses represent a non-operating loss on disposal of equity
securities.
(7) Operating EBITDA is equal to operating income plus depreciation and
amortization and the change in deferred revenue less the change in
redemption settlement assets. We have presented operating EBITDA because we
use it to monitor compliance with the financial covenants in our amended
credit agreement, such as debt-to-operating EBITDA, interest coverage ratios
and minimum operating EBITDA. We also use operating EBITDA as an integral
part of our internal reporting to measure the performance and liquidity of
our reportable segments. In addition, operating 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. Operating 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, operating 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 operating 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 the cardholder and customer accounts we service.
28
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 & 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 significant acquisitions, each accounted for as a purchase, with the
results of operations of the acquired businesses included from their respective
closing dates:
- in July 1998, we acquired Loyalty Management Group Canada Inc.;
- in September 1998, we acquired Harmonic Systems Incorporated; and
- in July 1999, we acquired the network services business of SPS Payment
Systems, Inc., a wholly owned subsidiary of Associates First Capital
Corporation.
RECENT DEVELOPMENTS
Effective February 28, 2001, we acquired substantially all of the operating
assets of Utilipro, Inc., a subsidiary of AGL Resources, Inc., for
$20.3 million in cash. Utilipro is an account processing and servicing provider
to the de-regulated utility sector. Utilipro provides these services to three
clients serving approximately 500,000 utility customers.
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 1998 represents the 11 months ended
December 31, 1998, fiscal 1999 represents the year ended December 31, 1999 and
fiscal 2000 represents the year ended December 31, 2000. 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 recast basis for the
year ended December 31, 1998 compared to the year ended December 31, 1999.
REVENUE AND EXPENSES
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,
telecommunications, and equipment lease expense.
CREDIT SERVICES. We utilize a securitization program to finance
substantially all of the credit card receivables that we underwrite. Our
securitization trusts allow us to sell credit card receivables to the trusts on
a daily basis. As a result, our Credit Services segment derives its revenue from
the servicing fees and net financing income it receives from the securitization
trusts.
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 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
29
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.
Credit Services also receives merchant discount fees from clients, which are
determined based on a percentage of credit sales charged to our private label
card accounts.
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.
MARKETING SERVICES. Our Marketing Services segment generates the majority
of its revenue from our Air Miles reward miles program. Under this program, we
receive proceeds from our sponsors based on the number of Air Miles reward miles
issued to collectors. The proceeds from issuances of Air Miles reward miles are
allocated into two components based on the relative fair value of the related
element: the redemption element and the service element.
- Redemption element: the redemption element is the larger of the two
components. For this component, we recognize revenue at the time an Air
Mile reward mile is redeemed, or, for those miles that we estimate will go
unredeemed by the collector base, known as "breakage," over the estimated
life of an Air Miles reward mile.
- Service element: For this component, which consists of direct marketing
and administrative services provided to sponsors, we recognize revenue
ratably over the estimated life of an Air Miles reward mile.
On certain of our contracts, a portion of the proceeds is paid at the
issuance of Air Miles reward miles and a portion is paid at the time of
redemption. The proceeds received at issuance are initially deferred as service
revenue and the revenue is recognized ratably over the estimated life of an Air
Miles reward mile.
In addition to our Air Miles reward miles 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 for this segment include salaries and employee benefits,
redemption costs of the Air Miles reward program, marketing, data processing and
postage.
INTER-SEGMENT SALES. Our Transaction Services segment performs card
processing and servicing activities related to our Credit Services segment. For
this, our Transaction Services segment receives a fee equal to its direct costs
before corporate overhead plus a margin. The margin is based on current market
rates for similar services. This fee represents an operating cost to our Credit
Services segment and a corresponding revenue for Transaction Services.
USE OF EBITDA. We evaluate operating performance based on several factors
of which the primary financial measure is operating income plus depreciation and
amortization, or "EBITDA." EBITDA is presented because it is an integral part of
our internal reporting and performance evaluation for senior management. EBITDA
eliminates the uneven effect across all segments of considerable amounts of
non-cash amortization of purchased intangibles recognized in business
combinations accounted for under the purchase method. In addition, we use
operating EBITDA to monitor compliance with the financial covenants in our
amended credit agreement such as debt-to-operating EBITDA, interest coverage
ratios and minimum operating EBITDA. We also use operating EBITDA to measure the
performance and liquidity of our reportable segments. EBITDA and operating
EBITDA are not intended to be a performance measure that should be regarded as
an alternative to, or more meaningful than, either operating income or net
income as an indicator of operating performance or to the statement of cash
flows as a measure of liquidity. In addition, EBITDA and
30
operating EBITDA are not intended to represent funds available for dividends,
reinvestment or other discretionary uses, and should not be considered in
isolation or as a substitute for measures of performance prepared in accordance
with generally accepted accounting principles. The EBITDA and operating EBITDA
measures presented in this prospectus may not be comparable to similarly titled
measures presented by other companies.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2000 (UNAUDITED) COMPARED TO THE THREE MONTHS ENDED
MARCH 31, 2001 (UNAUDITED)
THREE MONTHS ENDED MARCH 31,
------------------------------------------------------------------
REVENUE EBITDA OPERATING INCOME
---------------------- ------------------- -------------------
2000 2001 2000 2001 2000 2001
-------- -------- -------- -------- -------- --------
(AMOUNTS IN THOUSANDS)
Transaction Services............... $108,748 $118,168 $13,558 $14,512 $ 3,277 $ 4,540
Credit Services.................... 69,903 73,810 8,601 8,363 8,286 7,961
Marketing Services................. 39,451 44,291 1,312 5,226 (7,884) (1,880)
Other and eliminations............. (52,555) (55,577) -- -- -- --
-------- -------- ------- ------- ------- -------
Total............................ $165,547 $180,692 $23,471 $28,101 $ 3,679 $10,621
======== ======== ======= ======= ======= =======
THREE MONTHS ENDED MARCH 31,
------------------------------------------------------------------
PERCENTAGE OF REVENUE EBITDA MARGIN OPERATING MARGIN
---------------------- ------------------- -------------------
2000 2001 2000 2001 2000 2001
-------- -------- -------- -------- -------- --------
(AMOUNTS IN THOUSANDS)
Transaction Services............... 65.7% 65.4% 12.5% 12.3% 3.0% 3.8%
Credit Services.................... 42.2 40.9 12.3 11.3 11.9 10.8
Marketing Services................. 23.8 24.5 3.3 11.8 (20.0) (4.2)
Other and eliminations............. (31.7) (30.8) -- -- -- --
-------- --------
Total............................ 100.0% 100.0% 14.2% 15.6% 2.2% 5.9%
======== ========
REVENUE. Total revenue increased $15.2 million, or 9.1%, to $180.7 million
for the three months ended March 31, 2001 from $165.5 million for the comparable
period in 2000. The increase was principally due to an 8.7% increase in
Transaction Services revenue, a 5.6% increase in Credit Services revenue and a
12.3% increase in Marketing Services revenue as follows:
- TRANSACTION SERVICES. Transaction Services revenue increased
$9.4 million, or 8.7%, due primarily to an increase in the number of
transactions processed. Revenue related to transactions processed
increased approximately $4.4 million as a result of an 11.1% increase in
the number of transactions processed with a significant portion of the
increase occurring among our large volume petroleum clients. Fees related
to account processing and servicing increased $6.3 million during the
three months ended March 31, 2001 over the comparable period in 2000 due
to increased inter-segment sales of $2.2 million during 2001 as a result
of increased account processing and servicing for our Credit Services
segment, which resulted from an increase in the number of private label
cardholders. The remaining portion of the increase resulted from sales
related to our utilities sector offset by a decrease in the number of
statements generated as a result of a lost client in the petroleum sector.
Our utilities sector benefited from the recently acquired Utilipro
business, which added approximately 500,000 customer accounts.
- CREDIT SERVICES. Credit Services revenue increased $3.9 million, or 5.6%,
due to increases in servicing fees and finance charges, net. Servicing fee
income increased by $1.0 million, or 8.8%, during the three months ended
March 31, 2001 over the comparable 2000 period due to an
31
increase in the average outstanding credit card receivables in the
securitization trust. Finance charge, net increased $3.7 million during
the three months ended March 31, 2001 over the comparable period in 2000
as a result of a 3.5% higher average outstanding securitized portfolio.
The yield remained relatively constant between the periods.
- MARKETING SERVICES. Marketing Services revenue increased $4.8 million, or
12.3%, primarily due to an increase in reward revenue related to an 18.3%
increase in the redemption of Air Miles reward miles. Additionally,
services revenue increased 3.4% as a result of a 21.3% increase in the
issuance of Air Miles reward miles and the recognition of deferred revenue
balances. As a result of the increased issuance activity, our deferred
revenue balance increased 4.6% to $303.4 million at March 31, 2001 from
the balance at December 31, 2000.
OPERATING EXPENSES. Total operating expenses, excluding depreciation and
amortization, increased $10.5 million, or 7.4%, to $152.6 million during the
three months ended March 31, 2001 from $142.1 million during the comparable
period in 2000. Total EBITDA margin increased to 15.6% for the three months
ended March 31, 2001 from 14.2% for the comparable period in 2000. The increase
in EBITDA margin is due to an increase in the Marketing Services margin,
partially offset by a decrease in the Credit Services margin.
- TRANSACTION SERVICES. Transaction Services operating expenses, excluding
depreciation and amortization, increased $8.5 million, or 8.9%, to
$103.7 million for the three months ended March 31, 2001 from
$95.2 million for the comparable period in 2000, and EBITDA margin
decreased to 12.3% for the three months ended March 31, 2001 from 12.5%
during the comparable period in 2000. The EBITDA margin decrease is
primarily related to increased overhead allocation, offset by improved
margins at the operating unit level.
- CREDIT SERVICES. Credit Services operating expenses, excluding
depreciation and amortization, increased $4.1 million, or 6.8%, to
$65.4 million for the three months ended March 31, 2001 from
$61.3 million for the comparable period in 2000, and EBITDA margin
decreased to 11.3% for the three months ended March 31, 2001 from 12.3%
during the comparable period in 2000. The decrease in EBITDA margin is the
result of increased processing costs from our Transaction Services segment
of $2.2 million associated with our larger securitized portfolio and the
decrease in yield on the securitized portfolio.
- MARKETING SERVICES. Marketing Services operating expenses, excluding
depreciation and amortization, increased $1.0 million, or 2.4%, to
$39.1 million for the three months ended March 31, 2001 from
$38.1 million for the comparable period in 2000, and EBITDA margin
increased to 11.8% for the three months ended March 31, 2001 from 3.3% for
the comparable period in 2000. The EBITDA margin in the 2000 period was
adversely impacted by the $3.1 million in non-recurring redemption related
costs incurred as a result of the transition from Canadian Airlines to Air
Canada as a primary reward supplier following their merger. Normally, we
are able to purchase airline tickets at a contractually determined
discount. Prior to the Air Canada merger, we had a long-term supply
contract with Canadian Airlines. During the second quarter of 2000, we
entered into 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. Prior to signing our supply agreement with Air Canada, our supply
of seats was constrained due to the reduction or elimination of some of
Canadian Airlines' routes. Based on our new supply agreement and other
factors, we do not anticipate incurring redemption costs in 2001 at a
level greater than what we have historically experienced. Excluding the
$3.1 million of additional redemption costs, EBITDA margin for the three
months ended March 31, 2000 would have been 11.2%.
- DEPRECIATION AND AMORTIZATION. Depreciation and amortization decreased
$2.3 million, or 11.7%, to $17.5 million for the three months ended March
31, 2001 from $19.8 million for the comparable period in 2000 due to
increases in capital expenditures in 2001. Amortization of purchased
intangibles decreased $2.7 million as a result of a decrease in
amortization expense.
32
OPERATING INCOME. Operating income increased $6.9 million, or 188.7%, to
$10.6 million for the three months ended March 31, 2001 from $3.7 million during
the comparable period in 2000. Operating income increased from revenue gains,
improved EBITDA margins and a decrease in depreciation and amortization.
INTEREST EXPENSE. Interest expense increased $0.9 million, or 9.8%, to
$9.7 million for the three months ended March 31, 2001 from $8.8 million for the
comparable period in 2000 due to an increase in average debt outstanding.
TAXES. Income tax expense increased $0.2 million, or 30.4%, to
$0.9 million for the three months ended March 31, 2001 from $0.7 million in 2000
due to an increase in taxable income.
TRANSACTIONS WITH THE LIMITED. Revenue from The Limited and its affiliates,
which includes merchant and database marketing fees, decreased $300,000, or
3.5%, to $9.6 million for the three months ended March 31, 2001 from
$9.9 million for the comparable period in 2000.
YEAR ENDED DECEMBER 31, 1999 COMPARED TO THE YEAR ENDED DECEMBER 31, 2000
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
REVENUE EBITDA OPERATING INCOME
------------------------ ------------------- -------------------
1999 2000 1999 2000 1999 2000
--------- --------- -------- -------- -------- --------
(AMOUNTS IN THOUSANDS)
Transaction Services............ $ 381,027 $ 437,980 $41,828 $54,764 $ 13,014 $ 13,017
Credit Services................. 247,824 268,183 29,803 25,318 17,743 24,059
Marketing Services.............. 138,310 178,214 8,624 17,927 (28,302) (15,211)
Other and eliminations.......... (184,079) (206,182) -- -- -- --
--------- --------- ------- ------- -------- --------
Total......................... $ 583,082 $ 678,195 $80,255 $98,009 $ 2,455 $ 21,865
========= ========= ======= ======= ======== ========
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
PERCENTAGE OF REVENUE EBITDA MARGIN OPERATING MARGIN
------------------------ ------------------- -------------------
1999 2000 1999 2000 1999 2000
--------- --------- -------- -------- -------- --------
Transaction Services............ 65.4% 64.6% 11.0% 12.5% 3.4% 3.0%
Credit Services................. 42.5 39.5 12.0 9.4 7.2 9.0
Marketing Services.............. 23.7 26.3 6.2 10.1 (20.5) (8.5)
Other and eliminations.......... (31.6) (30.4) -- -- -- --
--------- ---------
Total......................... 100.0% 100.0% 13.8% 14.5% 0.4% 3.2%
========= =========
REVENUE. Total revenue increased $95.1 million, or 16.3%, to
$678.2 million for 2000 from $583.1 million for 1999. The increase was due to a
14.9% increase in Transaction Services revenue, an 8.2% increase in Credit
Services revenue and a 28.9% increase in Marketing Services revenue as follows:
- TRANSACTION SERVICES. Transaction Services revenue increased
$57.0 million, or 14.9%, due primarily to an increase in the number of
transactions processed. Revenue related to transactions processed
increased approximately $30.0 million as a result of a 36.9% increase in
the number of transactions processed, 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 increase resulting from an increase in the number of
transactions processed for existing customers. A significant portion of
the increase in transactions processed occurred among the large volume
clients in the petroleum industry with a lower price per transaction. Fees
related to account processing and servicing increased $26.0 million during
2000 from 1999 primarily due to increased inter-segment sales of
33
$23.1 million during 2000 as a result of increased account processing and
servicing for our Credit Services segment due to an increase in the number
of private label cardholders. The remaining portion of the increase
resulted from new sales related to our utilities sector offset by a
decrease in the number of statements generated as a result of a lost
client in the petroleum sector.
- CREDIT SERVICES. Credit Services revenue increased $20.4 million, or
8.2%, due to increases in merchant discount fees, servicing fees and
finance charges, net. Servicing fee income increased by $3.5 million, or
10.4%, during 2000 due to an increase in the average outstanding balance
of the securitized credit card receivables we service. Finance charges,
net, increased $14.3 million, or 10.0%, during 2000 as a result of a 3.4%
higher average outstanding securitized portfolio. A liquidating portfolio
adversely impacted the average outstanding securitized portfolio.
Excluding the effect of the liquidating portfolio, the average outstanding
securitized portfolio would have grown by 11.7% in 2000. The net yield for
2000 was 45 basis points higher than in 1999. Private label merchant
discount fee income increased by $3.2 million, or 4.7%, during 2000 as a
result of increased charge volumes. This increase was offset by a change
in a specific program for one of our clients, where merchant discount fee
revenue from this client is now recorded as finance charge income.
- MARKETING SERVICES. Marketing Services revenue increased $39.9 million,
or 28.9%, primarily due to an increase in reward revenue related to a
39.2% increase in the redemption of Air Miles reward miles. Additionally,
services revenue increased 15.5% as a result of a 19.4% increase in the
number of Air Miles reward miles issued and the recognition of deferred
revenue balances. As a result of the increased issuance activity, our
deferred revenue balance increased 16.4% to $290.2 million at
December 31, 2000 from the balance at December 31, 1999.
OPERATING EXPENSES. Total operating expenses, excluding depreciation and
amortization, increased $77.4 million, or 15.4%, to $580.2 million for 2000 from
$502.8 million for 1999. Total EBITDA margin increased to 14.5% for 2000 from
13.8% for 1999. The increase in EBITDA margin is due to increases in Transaction
Services and Marketing Services margins, partially offset by a decrease in the
Credit Services margin.
- TRANSACTION SERVICES. Transaction Services operating expenses, excluding
depreciation and amortization, increased $44.0 million, or 13.0%, to
$383.2 million for 2000 from $339.2 million for 1999, and EBITDA margin
increased to 12.5% for 2000 from 11.0% for 1999. The increase in EBITDA
margin is primarily the result of operational efficiencies achieved in our
network business related to the SPS acquisition.
- CREDIT SERVICES. Credit Services operating expenses, excluding
depreciation and amortization, increased $24.9 million, or 11.4%, to
$242.9 million for 2000 from $218.0 million for 1999, and EBITDA margin
decreased to 9.4% for 2000 from 12.0% for 1999. The decrease in EBITDA
margin is the result of increased processing costs from our Transaction
Services segment of $22.1 million associated with a higher number of
private label cardholders. Additionally, the EBITDA margin was adversely
impacted by the previously mentioned change in a client's program. The new
program is financed off-balance sheet in a securitization trust, which
generates lower EBITDA margin than the previous program.
- MARKETING SERVICES. Marketing Services operating expenses, excluding
depreciation and amortization, increased $30.6 million, or 23.6%, to
$160.3 million for 2000 from $129.7 million for 1999, and EBITDA margin
increased to 10.1% for 2000 from 6.2% for 1999. The increase in the margin
is attributable to increased revenue and the leveraging of the marketing,
payroll and other operating costs in 2000. Non-redemption expenses
decreased to 47.8% of revenue for 2000 from 52.9% for 1999. The EBITDA
margin increase was offset by the approximate $7.0 million in
non-recurring redemption related costs as a result of the transition of
primary reward suppliers from Canadian Airlines to Air Canada following
their merger. Normally, we are able
34
to purchase airline tickets at a contractually determined discount. Prior
to the Air Canada merger, we had a long-term supply contract with Canadian
Airlines. During the second quarter of 2000, we entered into 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. Prior to signing our
supply agreement with Air Canada, our supply of seats was constrained due
to the reduction and/or elimination of some of Canadian Airlines' routes.
Based on our new supply agreement and other factors, we do not anticipate
incurring redemption costs in 2001 at a level greater than what we have
historically experienced. Excluding the $7.0 million of additional
redemption costs, EBITDA margin for 2000 would have been 14.0%.
In January 2000, we increased 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's
value to collectors.
EBITDA margin for 1999 was affected by approximately $3.3 million of
marketing and payroll costs associated with the start-up of a new
business-to-business loyalty program in Canada.
- DEPRECIATION AND AMORTIZATION. Depreciation and amortization decreased
$1.7 million, or 2.2%, to $76.1 million for 2000 from $77.8 million for
1999 due to a decrease in amortization of purchased intangibles of
$11.7 million. This decrease resulted from 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 was fully amortized, partially offset by amortization
related to the SPS acquisition and an increase in capital expenditures in
1999, especially software development costs that have relatively short
amortization periods.
OPERATING INCOME. Operating income increased $19.4 million, or 776.0%, to
$21.9 million for 2000 from $2.5 million for 1999. Operating income increased
primarily from revenue gains with modest expansion of EBITDA margins and a
decrease in depreciation and amortization.
INTEREST EXPENSE. Interest expense decreased $3.9 million, or 9.1%, to
$38.9 million for 2000 from $42.8 million for 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 $8.3 million to a $1.8 million income
tax expense for 2000 from a $6.5 million income tax benefit 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 1999, discontinued operations had income of
$4.0 million, net of income tax.
TRANSACTIONS WITH THE LIMITED. Revenue from The Limited and its affiliates,
which includes merchant and database marketing fees, increased $100,000 to
$46.7 million for 2000 from $46.6 million for 1999. The increase was primarily
the result of increased database marketing fees offset by a small decrease in
merchant discount fees.
35
RECAST YEAR ENDED DECEMBER 31, 1998 (UNAUDITED) COMPARED TO THE YEAR ENDED
DECEMBER 31, 1999
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
REVENUE EBITDA OPERATING INCOME
------------------------ ------------------- -------------------
1998 1999 1998 1999 1998 1999
--------- --------- -------- -------- -------- --------
(AMOUNTS IN THOUSANDS)
Transaction Services........... $ 325,944 $ 381,027 $26,116 $ 41,828 $ (1,641) $ 13,014
Credit Services................ 242,377 247,824 37,841 29,803 25,041 17,743
Marketing Services............. 62,824 138,310 3,341 8,624 (11,861) (28,302)
Other and eliminations......... (179,608) (184,079) -- -- -- --
--------- --------- ------- -------- -------- --------
Total........................ $ 451,537 $ 583,082 $67,298 $ 80,255 $ 11,539 $ 2,455
========= ========= ======= ======== ======== ========
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
PERCENTAGE OF REVENUE EBITDA MARGIN OPERATING MARGIN
------------------------ ------------------- -------------------
1998 1999 1998 1999 1998 1999
--------- --------- -------- -------- -------- --------
Transaction Services............ 72.2 % 65.4 % 8.0% 11.0% (0.5)% 3.4 %
Credit Services................. 53.7 42.5 15.6 12.0 10.3 7.2
Marketing Services.............. 13.9 23.7 5.3 6.2 (18.9) (20.5)
Other and eliminations.......... (39.8) (31.6) -- -- -- --
--------- ---------
Total......................... 100.0 % 100.0 % 14.9% 13.8% 2.6 % 0.4 %
========= =========
REVENUE. Total revenue increased $131.6 million, or 29.1%, to
$583.1 million for 1999 from $451.5 million for 1998. The increase was
principally due to a 16.9% increase in Transaction Services revenue, a 2.2%
increase in Credit Services revenue and a 120.2% increase in Marketing Services
revenue as follows:
- TRANSACTION SERVICES. Transaction Services revenue increased
$55.1 million, or 16.9%, 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 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 the average outstanding balance of the securitized
credit card receivables we service. Finance charges, net, increased
$600,000 during 1999. 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. Finance charges, net,
increased $16.8 million, or 13.5%, during 1999, excluding the
$16.2 million gain on sale of receivables, as a result of a 4.6% higher
average outstanding securitized portfolio and an approximate 75 basis
point increase in yield.
- MARKETING SERVICES. Marketing Services revenue increased $75.5 million, or
120.2%, 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 $40.9 million. The remaining increase is primarily
related to an increase in Air Miles reward miles issuance and redemption
activity, which increased 17.2% and 40.7%, respectively, on a pro forma
basis in 1999 compared to 1998.
36
OPERATING EXPENSES. Total operating expenses, excluding depreciation and
amortization, increased $118.6 million, or 30.9%, to $502.8 million for 1999
from $384.2 million for 1998. Total EBITDA margin decreased to 13.8% for 1999
from 14.9% for 1998. The decrease in EBITDA margin is due to a decrease in
Credit Services margins, partially offset by increases in Marketing Services and
Transaction Services margins.
- TRANSACTION SERVICES. Transaction Services operating expenses, excluding
depreciation and amortization, increased $39.4 million, or 13.1%, to
$339.2 million for 1999 from $299.8 million for 1998, and EBITDA margin
increased to 11.0% for 1999 from 8.0% for 1998. 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 6.6%, to
$218.0 million for 1999 from $204.5 million for 1998, and EBITDA margin
decreased to 12.0% for 1999 from 15.6% for 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.
- MARKETING SERVICES. Marketing Services operating expenses, excluding
depreciation and amortization, increased $70.2 million, or 118.0%, to
$129.7 million for 1999 from $59.5 million for 1998, and EBITDA margin
increased to 6.2% for 1999 from 5.3% 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 amortization increased
$22.0 million, or 39.4%, to $77.8 million for 1999 from $55.8 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 $14.9 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 decreased $9.0 million, or 78.3%, to
$2.5 million for 1999 from $11.5 million for 1998. Operating income decreased
primarily from a lower consolidated EBITDA 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 benefit increased $3.9 million to $6.5 million for 1999
from $2.6 million for 1998 due to an increase in pre-tax loss.
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 for 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 discount and database marketing fees, increased
$3.4 million, or 7.9%, to $46.6 million for 1999 from $43.2 million for 1998.
The increase was primarily the result of increased merchant discount fees from
increased credit sales activity.
37
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.
HISTORICAL FISCAL PERIODS
--------------------------------------------------------------------
REVENUE EBITDA OPERATING INCOME
------------------------ ------------------- -------------------
1998 1999 1998 1999 1998 1999
--------- --------- -------- -------- -------- --------
(AMOUNTS IN THOUSANDS)
Transaction Services........... $ 303,186 $ 381,027 $29,825 $ 41,828 $ 4,405 $ 13,014
Credit Services................ 212,663 247,824 24,297 29,803 12,883 17,743
Marketing Services............. 60,892 138,310 3,398 8,624 (11,804) (28,302)
Other and eliminations......... (165,828) (184,079) -- -- -- --
--------- --------- ------- -------- -------- --------
Total........................ $ 410,913 $ 583,082 $57,520 $ 80,255 $ 5,484 $ 2,455
========= ========= ======= ======== ======== ========
HISTORICAL FISCAL PERIODS
--------------------------------------------------------------------
PERCENTAGE OF REVENUE EBITDA MARGIN OPERATING MARGIN
------------------------ ------------------- -------------------
1998 1999 1998 1999 1998 1999
--------- --------- -------- -------- -------- --------
Transaction Services........... 73.8 % 65.4 % 9.8% 11.0% 1.5 % 3.4 %
Credit Services................ 51.8 42.5 11.4 12.0 6.1 7.2
Marketing Services............. 14.8 23.7 5.6 6.2 (19.4) (20.5)
Other and eliminations......... (40.4) (31.6) -- -- -- --
--------- ---------
Total........................ 100.0 % 100.0 % 14.0% 13.8% 1.3 % 0.4 %
========= =========
REVENUE. Total revenue increased $172.2 million, or 41.9%, to
$583.1 million for fiscal 1999 from $410.9 million for fiscal 1998. The increase
was principally due to a 25.7% increase in Transaction Services revenue, a 16.5%
increase in Credit Services revenue and a 127.1% increase in Marketing Services
revenue as follows:
- TRANSACTION SERVICES. Transaction Services revenue increased
$77.8 million, or 25.7%, due to the acquisitions of Harmonic Systems in
1998 and SPS in 1999. Fees related to servicing of private label credit
card statements increased $15.7 million during fiscal 1999 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 the average outstanding balance of the
securitized credit card receivables we service and fiscal 1998 being one
month shorter than fiscal 1999. Finance charges, net, increased
$22.6 million during fiscal 1999. 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.
- MARKETING SERVICES. Marketing Services revenue increased $77.4 million, or
127.1%, 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 $35.6 million. The remaining increase is primarily
related to an increase in Air Miles reward miles activity and fiscal 1998
being one month shorter than fiscal 1999. The increase in Air Miles
activity is primarily related to an increase in the number of reward miles
collectors.
38
OPERATING EXPENSES. Total operating expenses, excluding depreciation and
amortization, increased $149.4 million, or 42.3%, to $502.8 million during
fiscal 1999 from $353.4 million for fiscal 1998. Total EBITDA margin decreased
to 13.8% for fiscal 1999 from 14.0% for fiscal 1998.
- TRANSACTION SERVICES. Transaction Services operating expenses, excluding
depreciation and amortization, increased $65.8 million, or 24.1%, to
$339.2 million for fiscal 1999 from $273.4 million for fiscal 1998, and
EBITDA margin increased to 11.0% for fiscal 1999 from 9.8% for fiscal
1998. EBITDA margin increased due to the newly acquired SPS network
services business which carries a higher margin than our historical
processing business, as well as 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 $29.6 million, or 15.7%, to
$218.0 million for fiscal 1999 from $188.4 million for fiscal 1998, and
EBITDA margin increased to 12.0% for fiscal 1999 from 11.4% 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.
- MARKETING SERVICES. Marketing Services operating expenses, excluding
depreciation and amortization, increased $72.2 million, or 125.6%, to
$129.7 million for fiscal 1999 from $57.5 million for fiscal 1998, and
EBITDA margin increased to 6.2% for fiscal 1999 from 5.6% 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 amortization increased
$25.8 million, or 49.6%, to $77.8 million for fiscal 1999 from
$52.0 million for fiscal 1998 due to increases in capital expenditures for
fiscal 1998 and fiscal 1999, especially software development costs that
have relatively short amortization periods. Amortization of purchased
intangibles increased $17.9 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 decreased $3.0 million, or 54.5%, to
$2.5 million for fiscal 1999 from $5.5 million during fiscal 1998. Operating
income declined primarily due to lower margins as the result of increased
inter-segment charges and 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 benefit increased $1.8 million, or 38.3%, to
$6.5 million for fiscal 1999 from $4.7 million for fiscal 1998 due to an
increase in taxable loss.
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 for 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 discount and database marketing fees, increased
$6.0 million, or 14.8%, to $46.6 million for fiscal 1999 from $40.6 million for
fiscal 1998. The increase was primarily the result of increased volume of credit
sales and database marketing fees.
39
ASSET QUALITY
Our delinquency and net charge-off rates reflect, among other factors, the
credit risk of credit card receivables, the average age of our various credit
card account portfolios, the success of our collection and recovery efforts, and
general economic conditions. The average age of our credit card portfolio
affects the stability of delinquency and loss rates of the portfolio. We
continue to focus our resources on refining our credit underwriting standards
for new accounts, and on collections and post charge-off recovery efforts to
minimize net losses. At March 31, 2001, 19.2% of securitized accounts and 38.6%
of securitized loans were less than 24 months old. Accordingly, we believe that
our credit card portfolio will experience increasing levels of delinquency and
loan losses as the average age of our accounts increases.
DELINQUENCIES. A credit card account is contractually delinquent if we do
not receive the minimum payment by the specified due date on the cardholder's
statement. It is our policy to continue to accrue interest and fee income on all
credit card accounts, except in limited circumstances, until the account balance
and all related interest and other fees are charged off or paid. When an account
becomes delinquent, we print a message requesting payment on the cardholder's
billing statement. After an account becomes 30 days past due, a proprietary
collection scoring algorithm automatically scores the risk of the account
rolling to a more delinquent status. The collection system then recommends a
collection strategy for the past-due account based on the collection score and
account balance, and dictates the contact schedule and collections priority for
the account. If we are unable to make a collection after exhausting all in-house
efforts, we engage collection agencies and outside attorneys to continue those
efforts.
The following table presents the delinquency trends of our securitized
credit card portfolio:
DECEMBER 31, % OF DECEMBER 31, % OF DECEMBER 31,
1998 TOTAL 1999 TOTAL 2000
------------ -------- ------------- -------- -------------
(DOLLARS IN THOUSANDS)
Receivables outstanding................ $2,135,340 100% $2,232,375 100% $2,319,703
Loan balances contractually delinquent:
31 to 60 days........................ 52,581 2.5% 59,840 2.7% 62,040
61 to 90 days........................ 29,925 1.4 35,394 1.6 36,095
91 or more days...................... 53,885 2.5 60,025 2.7 64,473
---------- --- ---------- --- ----------
Total.............................. $ 136,391 6.4% $ 155,259 7.0% $ 162,608
========== === ========== === ==========
% OF MARCH 31, % OF
TOTAL 2001 TOTAL
-------- ---------- --------
(DOLLARS IN THOUSANDS)
Receivables outstanding................ 100% $2,145,500 100%
Loan balances contractually delinquent:
31 to 60 days........................ 2.7% 54,005 2.5%
61 to 90 days........................ 1.5 33,472 1.6
91 or more days...................... 2.8 62,125 2.9
--- ---------- ---
Total.............................. 7.0% $ 149,602 7.0%
=== ========== ===
NET CHARGE-OFFS. Net charge-offs comprise the principal amount of losses
from cardholders unwilling or unable to pay their account balances, as well as
bankrupt and deceased cardholders, less current period recoveries. Net
charge-offs exclude accrued finance charges and fees. The following table
presents our net charge-offs for the periods indicated on a securitized basis.
Average credit card portfolio outstanding represents the average balance of the
securitized receivables at the beginning of each month in the period indicated.
THREE MONTHS ENDED
FISCAL MARCH 31,
------------------------------------ -----------------------
1998 1999 2000 2000 2001
---------- ---------- ---------- ---------- ----------
(DOLLARS IN THOUSANDS)
Average credit card portfolio
outstanding.............................. $1,905,927 $2,004,827 $2,073,574 $2,139,647 $2,214,044
Net charge-offs............................ 135,478 143,370 157,351 40,742 43,708
Net charge-offs as a percentage of average
loans outstanding (annualized)........... 7.8% 7.2% 7.6% 7.6% 7.9%
40
We believe, consistent with our statistical models and other credit
analyses, that our securitized net charge-off ratio will continue to fluctuate
but generally rise.
AGE OF PORTFOLIO. The following table sets forth, as of March 31, 2001, the
number of total accounts and amount of outstanding loans, based upon the age of
the securitized accounts:
PERCENTAGE
NUMBER OF PERCENTAGE OF BALANCES OF BALANCES
AGE SINCE ORIGINATION ACCOUNTS ACCOUNTS OUTSTANDING OUTSTANDING
--------------------- --------- ------------- ----------- -----------
(AMOUNTS IN THOUSANDS)
0-5 Months...................................... 3,197 5.4% $ 278,967 13.0%
6-11 Months..................................... 2,724 4.6 188,839 8.8
12-17 Months.................................... 3,079 5.2 208,152 9.7
18-23 Months.................................... 2,368 4.0 150,213 7.0
24-35 Months.................................... 5,329 9.0 281,113 13.1
36+ Months...................................... 42,511 71.8 1,038,616 48.4
------ ----- ---------- -----
Total..................................... 59,208 100.0% $2,145,900 100.0%
====== ===== ========== =====
LIQUIDITY AND CAPITAL RESOURCES
OPERATING ACTIVITIES. We generated cash flow from operating activities of
$11.0 million for the three months ended March 31, 2001 compared to
$14.9 million for the comparable period in 2000. We generated cash flow from
operating activities of $87.2 million for 2000 compared to $251.6 million for
1999 and $9.3 million for fiscal 1998. Operating cash flow in 2000 decreased
compared to 1999 primarily due to changes in working capital. Working capital
changes for 2000 were $54.2 million compared to $250.8 million in 1999. Working
capital in 1999 was positively influenced by a large decrease in trade accounts
receivable associated with a change in a specific program for one of our
clients, whereby the receivables were moved off-balance sheet to a
securitization trust. Our operating cash flow is seasonal with cash utilization
peaking at the end of December due to increased activity in our Credit Services
segment related to the holidays. We utilize our operating cash flow for ongoing
business operations and to pay interest expense.
INVESTING ACTIVITIES. We utilized cash flow from investing activities of
$37.2 million for the three months ended March 31, 2001 compared to providing
$15.2 million for the comparable period in 2000. We utilized cash flow from
investing activities of $24.5 million for 2000 compared to $309.5 million for
1999 and $145.4 million for fiscal 1998. Three significant components of
investing activities are as follows:
- ACQUISITIONS. Net cash outlays for acquisitions for the three months ended
March 31, 2001 was $18.8 million compared to zero in the comparable period
in 2000. Net cash outlays for acquisitions in 2000 was zero compared to
$171.4 million for 1999 and $138.8 million for fiscal 1998.
- SECURITIZATIONS AND 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, 2001, we had over $2.1 billion of securitized credit card
receivables. Securitizations require credit enhancements in the form of
cash, spread accounts and additional receivables. The credit enhancement
is principally based on the outstanding balances of the private label
credit cards in the securitization trust and their related performance.
During the period from November to January, we are required to maintain a
credit enhancement level of 6% as compared to 4% for the remainder of the
year. Accordingly, at December 31, we typically have our highest balance
of credit enhancement assets. We intend to utilize our securitization
program for the foreseeable future.
41
- RESERVE FUND. Redemption settlement assets on our balance sheet at
March 31, 2001 are related to a reserve fund we established in connection
with funding future redemptions by collectors under the Air Miles reward
program. We believe the reserve fund is sufficient to meet redemptions 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 was $18.8 million for the three
months ended March 31, 2001 compared to $18.4 million for the comparable period
in 2000. Net cash borrowings was $1.0 million for 2000 compared to net cash
payments on borrowings of $44.8 million for 1999 and net cash borrowings of
$56.2 million for fiscal 1998. Our financing activities relate primarily to
funding working capital requirements and the securitization program. We issued
$119.4 million of preferred stock to finance a portion of our acquisition of SPS
in 1999 and $107.0 million of common stock to fund a portion of our acquisition
of the Loyalty Group during fiscal 1998.
LIQUIDITY SOURCES. We have two main sources of liquidity to finance working
capital and securitization requirements: certificates of deposit and a credit
agreement.
CERTIFICATES OF DEPOSIT. We utilize certificates of deposit to finance the
operating activities of our credit card bank subsidiary, World Financial, and to
fund securitization requirements. Securitization requirements are generally in
the form of credit enhancements and interests in the principal balance of the
credit card receivables. 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.
World Financial issues certificates of deposit in denominations of $100,000
in various maturities ranging between three months and two years and with
effective annual fixed rates ranging from 5.45% to 7.45%. As of March 31, 2001,
we had $119.7 million of certificates of deposit outstanding. World Financial is
limited in the amounts that it can dividend to us. Certificate of deposit
borrowings are subject to regulatory capital requirements.
CREDIT AGREEMENT. At March 31, 2001, we had $192.6 million outstanding
under our credit facility, consisting of $182.6 million of term loans and
$10.0 million under the revolving loan commitment. During 2000, the highest
outstanding balance on the revolving loan commitment was $69.0 million.
Approximately $34.0 million is due under our term loans on July 1, 2001. Of the
amount due on July 1, 2001, approximately $30.0 million relates to the term loan
that we will repay in full with the net proceeds from the offering. Interest on
our loans is generally payable quarterly. With the exception of a $44.0 million
term loan that matures on July 25, 2005, all of our other obligations under the
credit facility mature on July 25, 2003.
The credit facility prohibits us from borrowing in excess of four times our
operating EBITDA. Based on this covenant, our borrowing capacity at March 31,
2001 was approximately $500.0 million. With outstanding borrowings of
$414.5 million at that date, we had additional borrowing capacity of
$85.5 million under the revolver. In addition, we had $58.8 million of cash and
cash equivalents as of March 31, 2001.
On September 29, 2000 and January 10, 2001, we amended our credit agreement
to change the administrative agent and to adjust certain covenants related to
consolidated EBITDA, the senior secured leverage ratio, adjusted consolidated
net worth and the interest coverage ratio.
Following the $100.8 million debt repayment with the proceeds of this
offering, we will record an extraordinary loss on early extinguishment of debt
of approximately $1.5 million, net of tax.
42
We believe that our current level of cash and financing capacity, along with
future cash flows from operations, will provide sufficient liquidity to meet the
needs of our existing businesses for the foreseeable future. However, we may
from time to time seek longer-term financing to support additional cash needs,
reduce short-term borrowings or raise funds for acquisitions.
ACQUISITION FINANCING. 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. Additionally, we issued
$107.0 million in common stock to fund the Loyalty acquisition.
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.
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.
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 trigger 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 regulations 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, 2001, World Financial's Tier 1 capital ratio
was 15.8%, total capital ratio was 16.0% and leverage ratio was 52.7%, and World
Financial was not subject to a capital directive order.
43
MARKET RISK
Market risk is the risk of loss from adverse changes in market prices and
rates. Our primary market risks include off-balance sheet risk, interest rate
risk, credit risk, foreign currency exchange rate risk and redemption reward
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
$161.8 million for 2000. Of this total, $38.9 million of the interest expense
for 2000 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 obtainable with such arrangements. In
addition, we enter into derivative financial instruments such as interest rate
swaps and treasury locks to mitigate our interest rate risk on a related
financial instrument or to 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, 2001, approximately 9.2% of our
outstanding debt was subject to fixed rates with a weighted average interest
rate of 8.3%. An additional 55.3% of our outstanding debt at March 31, 2001 was
locked at an effective interest rate of 6.7% through interest rate swap
agreements and treasury locks with notional amounts totaling $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 $8.6 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.
44
REDEMPTION REWARD RISK. We are exposed to potentially increasing reward
costs associated primarily with travel rewards. To minimize the risk of rising
travel reward costs, we:
- have a supply agreement with Air Canada;
- are seeking new supply agreements with additional airlines in Canada;
- alter the total mix of rewards available to collectors with the
introduction of new merchandise rewards, which are typically lower cost
per Air Mile reward mile than air travel; and
- periodically adjust the number of miles required to redeem a reward.
RECENT ACCOUNTING PRONOUNCEMENTS
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 is effective for all
fiscal years beginning after June 15, 2000. SFAS No. 133, as amended and
interpreted, establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, and for hedging activities, and requires companies to recognize all
derivatives as either assets or liabilities in the balance sheet and measure
such instruments at fair value. If the derivative is designated in a fair-value
hedge, the changes in the fair value of the derivative and the hedged item will
be recognized in earnings. If the derivative is designated in a cash flow hedge,
changes in the fair value of the derivative will be recorded in other
comprehensive income and will be recognized in the income statement when the
hedged item affects earnings.
SFAS No. 133 defines new requirements for designation and documentation of
hedging relationships as well as ongoing effectiveness assessments in order to
use hedge accounting. For a derivative that does not qualify as a hedge, changes
in fair value will be recognized in earnings. In January 2001, we recorded
$882,000 in other comprehensive income as a cumulative translation adjustment
for derivatives designated in cash flow-type hedges prior to adopting SFAS
No. 133, primarily related to interest rate swaps.
In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities", which
replaced SFAS No. 125 and revises the standards for accounting for
securitizations and other transfers of financial assets and collateral and
requires certain disclosures. SFAS No. 140 is effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring after
March 31, 2001. Disclosures relating to securitization transactions are required
for fiscal years ending after December 15, 2000. Management is currently
evaluating the impact on our financial position and results of operations when
SFAS No. 140 is adopted, but does not anticipate any material changes.
The Emerging Issues Task Force ("EITF") is reviewing an issue, Issue
No. 00-22, "Accounting for 'Point' and Other Loyalty Programs," that is closely
related to our Air Miles reward program and the way revenue is recognized for
these types of programs. We understand that the EITF will provide guidance on
this issue sometime in 2001, but a specific date has not been set. When Issue
00-22 is issued, if it requires 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 00-22 at
this time.
45
BUSINESS
GENERAL
We are a leading provider of transaction services, credit services and
marketing services to retail companies in North America. We focus on
facilitating and managing electronic transactions between our clients and their
customers through multiple distribution channels including in-store, catalog and
the Internet. Our credit and marketing services assist our clients in
identifying and acquiring new customers as well as helping to increase the
loyalty and profitability of their existing customers.
We target select market sectors that typically involve companies who sell
products and services to individual consumers. The market sectors include
specialty retailers, petroleum retailers, supermarkets and financial services
companies. Additionally, we target markets where there is an increasing
acceptance of electronic payments--mass transit, tollways and parking--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 the demand increases for products and services that help them
compete in a newly de-regulated market.
Our client base includes over 300 companies. We generally have long-term
relationships with our clients, with contracts typically ranging from three to
five years in duration. Our top five clients, based on their contribution to our
2000 consolidated revenue, are:
- the retail affiliates of The Limited, including Victoria's Secret Stores,
Victoria's Secret Catalogue, Express, Lane Bryant, Bath and 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.; and
- CITGO.
OUR HISTORY
We are the result of the 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 Network National Bank.
In July 1998, we acquired The Loyalty Management Group Canada Inc., which
developed and operates the Air Miles reward miles program in Canada. The
acquisition expanded our Marketing Services capabilities to include loyalty
marketing. In September 1998, we acquired Harmonic Systems Incorporated, which
provides network services, on-line loyalty and stored value products to
specialty retailers. This acquisition enabled us to expand our transaction
services to include specialty retailers. In July 1999, we acquired the network
services business of SPS Payment Systems, Inc., a wholly owned subsidiary of
Associates First Capital Corporation. This acquisition increased our processing
scale and added an additional 180 clients, many in market sectors with an
increasing acceptance of electronic payments, such as mass transit, tollway and
parking.
PROGRAMS AND PRODUCTS
Our program and product offerings are centered around three core
offerings--Transaction Services, Credit Services and Marketing Services.
46
TRANSACTION SERVICES
Transaction Services is our largest segment representing 49.5% of our 2000
revenue. Primary services within this segment are transaction processing,
representing 34.5% of this segment's 2000 revenue, and account processing and
servicing, representing 64.3% of this segment's 2000 revenue.
We facilitate and manage transactions between our clients and their
customers through our scalable processing systems. Our services include
transaction processing and account processing and servicing. Transaction
processing is the electronic authorization, capture and financial settlement of
sales transactions at the point of sale. Account processing and servicing is the
processing of consumer accounts--both private label credit card and utility
accounts; billing and payment processing; and the handling of customer service
and collection calls associated with those accounts. Through our predecessor
company, we have provided transaction services since 1983. Our clients within
this segment are made up of specialty retailers and petroleum retailers. Our
largest clients within this segment include The Limited and its retail
affiliates, representing approximately 28% of this segment's 2000 revenue, and
Brylane, representing approximately 10% of this segment's 2000 revenue.
TRANSACTION PROCESSING. We are a leading provider of transaction
processing, processing 2.5 billion transactions in 2000 through approximately
138,000 of our point-of-sale terminals. According to the Faulkner and Gray Card
Industry report, we were ranked fifth among third-party U.S. payment processors
in 1999. We believe that we are the largest transaction processor to the U.S.
retail petroleum industry, and we have a significant presence in the specialty
retail and transportation industries.
NETWORK SERVICES. We have built a network that enables us to process an
array of electronic payment types including credit card, debit card, prepaid
card, electronic benefits and fleet and check transactions. Our acquisitions of
Harmonic Systems and SPS's network transaction processing business have enabled
us to offer our existing products to new market segments, as well as provide
additional products to existing clients. In addition to authorization and
settlement of transactions, we also provide merchants with on-line, two-way mail
messaging between our clients and their individual locations by broadcasting and
receiving messages through their terminal devices. We provide clients with a
comprehensive help desk, operating 24 hours per day and seven days per week, as
well as terminal deployment and servicing.
MERCHANT BANKCARD SERVICES. Our merchant bankcard services include
financial settlement of MasterCard, Visa, Discover, American Express and other
electronic card transactions, including credit, debit and stored value cards.
Through our merchant bankcard services our clients can maintain their current
settlement provider or use us as a single processor to streamline their
end-to-end transaction processing.
ACCOUNT PROCESSING AND SERVICING. As reported in the Nilson Report, based
on the number of accounts on file we were the second largest outsourcer of
retail private label card programs in the United States in 1999, with
52.5 million accounts on file. We assist clients in issuing private label 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 Transaction Services
segment performs account processing and servicing for the Credit Services
segment in connection with that segment's private label card programs. These
intersegment services accounted for 47.1% of Transaction Services revenue in
2000. 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. We
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also provide billing and payment processing and customer care services in new
markets, such as for regulated and de-regulated utility companies.
CARD PROCESSING. We have developed a proprietary private label credit card
system designed specifically for retailers with the flexibility to make changes
to accommodate our clients' specific needs. We have also built into the system
marketing tools to assist our clients in increasing sales. We utilize our Quick
Credit and On-Line Pre-Screen products to originate new private label credit
card accounts. We believe that these products provide an effective marketing
advantage over competing services.
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,
register devices or web sites.
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.
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 9.5 million new cards in
2000.
BILLING AND PAYMENT PROCESSING. We use 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 127.2 million statements in 2000. In addition, we also
process customer payments using image processing technology to maximize
efficiency. By doing so, we improve the funds availability for both our clients
and for those private label receivables that we own or securitize.
CUSTOMER CARE. Our customer care operations are influenced by our retail
heritage. We focus our training programs in all areas on achieving the highest
possible standards. We monitor our performance by conducting surveys with our
clients and their customers. We have over 5,000 call center seats in 11
locations, and we handled over 115 million customer inquiries in 2000. Our call
centers are equipped to handle phone, mail, fax and Internet inquiries. We also
provide collection activities on delinquent accounts to support our retail
private label credit card programs.
CREDIT SERVICES
Through our Credit Services segment we provide a program that allows our
clients to make private label credit cards available for their customers without
having to commit financial resources to the funding of the receivables. We are
able to finance and operate private label programs more effectively than a
typical retailer can operate a stand-alone program, as we are able to fund
receivables through our securitization program to achieve lower borrowing costs
while having the infrastructure to support a variety of portfolio types and a
large number of account holders.
Through World Financial, we underwrite the accounts and fund purchases at
45 private label credit clients, representing 56.2 million cardholders and
$2.1 billion of receivables as of March 31, 2001. Tracing back to our
predecessor company, we have experience and expertise in successfully managing
private label portfolios since 1986. Clients who utilize our credit services are
predominantly specialty retailers. Our largest clients within this segment
include The Limited and its retail affiliates, representing 59.2% of this
segment's 2000 revenue, and Brylane, representing 21.1% of this segment's 2000
revenue.
ACCOUNT UNDERWRITING AND RISK MANAGEMENT. We believe that an effective risk
management process is important in both account underwriting and servicing. We
use risk-based pricing in establishing
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pricing arrangements with our clients. We also use a risk analysis in
establishing initial credit limits with cardholders. Because we process a large
number of credit applications each year, we use automated proprietary scoring
technology and verification procedures to process these applications. 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 proprietary scorecards that have been refined to
reflect performance of the various retail programs. Credit scoring is based on
several factors including delinquency history, number of recent credit inquiries
and the amount of credit used and available. We continuously validate, monitor
and maintain the scorecards, and we use resulting data to ensure optimal risk
performance.
We utilize the capabilities of our Marketing Services segment to develop and
execute new account acquisition strategies that support our underwriting
guidelines.
We monitor and control the quality of our portfolio on a continuous basis 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 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.
MERCHANT PROCESSING. We receive a merchant fee for processing each sales
transaction charged to a private label credit card program for which we provide
receivables funding. Processing includes authorization and settlement of the
funds to the retailer, net of our merchant discount fee.
RECEIVABLES FUNDING. We utilize a securitization program as our primary
funding vehicle for private label credit card receivables. Securitizations
involve the packaging and selling of both current and future receivable balances
of credit card accounts to a master trust. Our Transaction Services segment
retains rights to service the securitized accounts. Our securitizations are
treated as sales for accounting purposes and, accordingly, the receivable is
removed from the balance sheet. We retain an ownership interest in the
receivables, which is commonly referred to as a seller's interest, and a
residual interest in the trust, which is commonly referred to as an interest
only strip.
We securitize our receivables by selling them to a master trust. The master
trust funds itself by issuing publicly traded bonds or selling notes to
bank-sponsored multi-seller conduits who in turn issue commercial paper. The
bonds and notes represent undivided interests in all of the receivables in the
related master trust and may be split into separate series and classes that have
different terms or maturities. The different classes of an individual series are
structured to obtain specific credit ratings. Our seller's interest ranks
equally in the right to repayment of principal with the most senior bondholders.
Generally, each series involves an initial reinvestment period, which we
refer to as a revolving period, in which the principal payments on receivables
allocated to such series are returned to us and we reinvest in the trust new
receivables from customer accounts. After the revolving period ends, principal
payments allocated to the series are used to repay the investors. This period is
referred to as the controlled amortization period. We currently have one series
that has entered its controlled amortization period. The controlled amortization
period is determined by the agreements governing each series. All series set
forth early amortization events, which are deemed to occur if portfolio
collections, less net charge-offs for bad debt, financing costs and servicing
fees, drop below a minimum threshold. Because new receivables in designated
accounts cannot be funded by the trust while a series is in early amortization,
early amortization would require us to fund any new receivables or establish a
new securitization vehicle. We do not have any series in early amortization.
49
Each month, each series is allocated its share of finance charge collections
which is used to pay investors interest on their securities, to reimburse them
for their share of losses due to charge-offs and to pay their share of servicing
fees. Amounts remaining may be deposited in cash accounts of the trust as
additional protection for future losses. Once each of these obligations is fully
met, remaining finance charge collections, if any, are returned to us.
We also maintain flexibility in our current securitization program by
negotiating with bank-sponsored conduits. These conduits purchase an interest in
receivables arising in designated accounts. These transactions also feature a
revolving period in which principal payments on receivables allocated to the
conduits are returned to us and reinvested in new receivables. These agreements
also have early amortization triggers. Finance charge collections are used to
pay certain obligations, including servicing fees, interest on the principal
amount of the conduit's investment in the applicable receivables, and recouping
charge-offs. After such allocation, remaining finance charge collections, if
any, are returned to us.
INTEREST ONLY STRIP. We retain a residual interest in the receivables that
essentially represents an interest only strip. The fair value of the interest
only strip is determined by the present value of the anticipated cash flows over
the estimated outstanding period of the receivables. This anticipated excess
cash flow consists of the excess of finance charges and past-due fees net of the
sum of the return paid to bondholders, contractual servicing fees and credit
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 in the rate 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.
MARKETING SERVICES
Our clients are focused on targeting, acquiring and retaining loyal and
profitable customers. We create and manage marketing programs that result in
securing more frequent and sustained customer purchasing. We utilize the
information gathered through our loyalty programs to help our clients design and
implement effective marketing programs. Our primary service for this segment is
the Air Miles reward miles program, representing 72.2% of this segment's 2000
revenue. Our clients within this segment are specialty retailers, petroleum
retailers, supermarkets and financial services providers. Our largest clients
are Bank of Montreal, representing approximately 26.8% of this segment's 2000
revenue, and Canada Safeway, representing approximately 10% of this segment's
2000 revenue.
AIR MILES REWARD MILES PROGRAM. We operate what we believe to be the
largest loyalty program in Canada. 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
miles 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 program
members, known as collectors,
50
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. We make these reward opportunities available through over 180
rewards suppliers, including Canadian Airlines and Air Canada, the Toronto Blue
Jays, Marine Land and A&P Canada. The Air Miles reward miles program has enabled
sponsors to use this tool to increase revenues by bringing 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 58% of all Canadian households. We have issued
over seven 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
miles program:
- sponsors--our clients who enter the Air Miles reward miles program to
build their customers' loyalty and increase sales from those customers;
- collectors--customers of sponsors who enroll in the Air Miles reward miles
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 miles program and prospective sponsors to join
the Air Miles reward miles 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. Over a
number of years, we have been able to develop a membership, or a collector base,
of 6.5 million active collectors.
COLLECTORS
The major benefits of the Air Miles reward miles 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 miles program offers a reward structure that provides a
quick and easy way to earn a broad selection of travel, entertainment and other
lifestyle rewards 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, grocery and department store purchases to bank deposits. To
increase the program's attractiveness to collectors and potential collectors, we
have developed a variety of rewards and continue to add suppliers to the
program.
SUPPLIERS
We enter into supply agreements with suppliers of rewards to the program
such as airlines, movie theaters and manufacturers of consumer electronics.
These supply agreements allow us to purchase goods at a set price from the
suppliers. We make payments to suppliers pursuant to the contractual supply
arrangement when a collector redeems the Air Miles reward miles.
DATABASE MARKETING SERVICES. We have built and manage a large database
containing information on approximately 85.7 million U.S. consumers. This
database contains nearly five years of purchase information as well as details
and results of marketing programs conducted over the last five years. In
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addition, we provide database management services for our Air Miles reward miles
program. This database contains Air Miles collection information for over
6.5 million Canadian households and the results of marketing programs conducted
over the last seven years. Using this database, we have developed a suite of
data mining and profiling products that enable our clients to better understand
their customers and optimize opportunities for developing customer
relationships.
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. These services include
sourcing, promoting and fulfillment of products. These products do not compete
with the clients' merchandise offerings and include merchandise, travel clubs
and credit life insurance programs.
DIRECT MARKETING. 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, cash
register devices or web sites. We view this product as a competitive
advantage for 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 target a particular segment of
the customer base and promote specific products and services to them based
on customer profiles. 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.
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.
OUR MARKET OPPORTUNITY AND GROWTH STRATEGY
The increasing acceptance of electronic payment systems, including credit,
debit and stored value cards, generates transaction data on individual
consumers, while the dramatic proliferation of technology has enabled companies
to capture, access and easily use this information.
While companies recognize the 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 card operations,
including the extension of credit. In addition, many companies look externally
for the expertise to develop and manage their marketing services. Thus,
companies that provide the infrastructure to create, manage and facilitate
electronic payment systems can create a
52
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 will capitalize on our market opportunities by:
INCREASING THE PENETRATION OF OUR PRODUCTS AND SERVICES TO EXISTING
CLIENTS. We plan to further increase the number and types of products and
services we provide to our existing client base.
EXPANDING OUR CLIENT BASE IN OUR EXISTING MARKET SECTORS. We plan to
acquire new clients in our traditional markets by continuing to distinguish
ourselves as a provider of integrated transaction services, credit services
and marketing services. We will 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.
CONTINUING TO EXPAND OUR SERVICES AND CAPABILITIES TO HELP OUR CLIENTS
SUCCEED IN MULTI-CHANNEL COMMERCE. We plan to help our clients in all
channels they choose for distribution--whether in-store, catalog or the
Internet. Our current client base is comprised predominantly of traditional
storefront and catalog distribution channels. We can apply the systems and
marketing programs we have built to support our store and catalog clients
using the Internet.
CONSIDERING FOCUSED, STRATEGIC ACQUISITIONS AND ALLIANCES. As we
identify new opportunities or product gaps, we may consider focused
acquisitions and alliances to enhance our competencies or increase our
scale.
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
marketing services to Victoria's Secret. The Victoria's Secret private label
credit card that we issue allows us to capture a customer's name and address, as
well as transaction data in any channel the customer 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 that we collect and manage for the private label credit
card program to enhance our billing, payment processing and customer care
services.
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. 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.
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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 used in each segment of our business. 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 United States 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 United States and Canada. We believe that our trademarks are
important for our branding and corporate identification and marketing of our
services in each segment.
COMPETITION
The markets for our products and services are highly competitive. We compete
with data processing companies, credit card issuers and traditional and online
marketing companies, as well as with the in-house staffs of our current and
potential clients.
TRANSACTION SERVICES. The payment processing industry is highly
competitive, especially among the five largest payment processors in the United
States, which processed approximately 17.0 billion transactions during 1999. We
are a leading provider of transaction services, processing 2.5 billion
transactions in 2000 through approximately 138,000 of our point-of-sale
terminals. According to the Faulkner and Gray Card Industry report, we were
ranked fifth among U.S. payment processors in 1999. 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, detail-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. Our credit services business competes primarily with
financial institutions whose marketing focus has been on developing credit card
programs with large revolving balances. These competitors further drive 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 payment
methods, primarily general-purpose credit cards like Visa, MasterCard and
American Express, as well as cash, checks and debit cards.
MARKETING SERVICES. As a provider of marketing 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 marketing 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
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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.
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 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.
The Gramm-Leach-Bliley Act, which became law in November 1999, 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. This law also
requires us to disclose our privacy policies and practices to consumers. New
regulations under the Gramm-Leach-Bliley Act that take effect in July 2001 will
give credit card customers the ability to opt out of having information
generated by their credit card purchases shared with other parties or the
public.
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 became effective on January 1, 2001, comprises
comprehensive private sector privacy legislation that applies to organizations
engaged in any commercial activities in Canada. It enacted into law 10 privacy
principles from the Canadian Standards Association's Model Privacy Code. This
act requires 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. We have taken steps with the Air Miles reward miles program
to comply with the new law.
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 a consumer reporting agency under the Fair Credit
Reporting Act. If we were deemed to be a consumer
55
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 the
enforceability of such legislation, prior court decisions and the volume of
business we conduct in states that have passed this 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 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.
56
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 cumulatively in the last
two years and 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.
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
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, 2001, World Financial's Tier 1 capital ratio
was 15.8%, total capital ratio was 16.0% and leverage ratio was 52.7%, 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
57
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 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, 2001,
World Financial was in full compliance with its 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, 2001, we had approximately 6,500 employees in the
United States, Canada and New Zealand.
58
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.
Service Merchandise, Inc., which is in voluntary Chapter 11 bankruptcy, and
its subsidiary Service Credit Corp., as plaintiffs, have filed an action against
World Financial in U.S. Bankruptcy Court for the Middle District of Tennessee.
The plaintiffs are alleging claims of breach of contract, anticipatory breach of
contract, and violations of the automatic stay provisions of the U.S. Bankruptcy
Code. The action centers around claims that World Financial violated various
contractual provisions of a private label credit card program agreement for
Service Merchandise that World Financial entered into with Service Merchandise
and Service Credit Corp. Plaintiffs allege that World Financial violated the
agreement, by among other things, unilaterally revising the credit standards
applicable to existing cardholders and withholding monthly program payments from
Service Credit Corp. In April 2000, we moved to dismiss the amended complaint.
On November 9, 2000, the Bankruptcy Court issued an order dismissing a portion
of the counts of the amended complaint, but allowing plaintiffs to go forward
with other claims for breach of contract, anticipatory breach of contract and
violation of the automatic stay. On January 5, 2001, we answered the plaintiffs'
complaint, denying their material allegations and asserting affirmative
defenses. We were granted leave by the Bankruptcy Court to file counterclaims
against both plaintiffs. Through these counterclaims, we are seeking to recover
from Service Merchandise and Service Credit various amounts, cumulatively
exceeding $30.0 million, that we contend are due and owing to us. Service
Merchandise and Service Credit Corp. filed a joint answer with affirmative
defenses on April 26, 2001. Neither Service Merchandise nor Service Credit Corp.
have specified the amount of damages that they are seeking from us but do claim,
among other things, that World Financial's conduct caused the plaintiffs to
suspend, and later terminate, the private label card program agreement. The
plaintiffs generally claim they suffered damages through unpaid amounts that
they allege World Financial owes them, lost sales and profits, the loss of the
economic benefits of the World Financial credit card program, and a loss of
enterprise value. Given the early stage of the litigation, we are unable to
determine whether the ultimate resolution of the claims by and against World
Financial will have a material effect on our business, financial condition or
operating results. We intend to defend World Financial's interests vigorously.
On November 16, 2000, in the United States District Court, Southern District
of Florida, Miami Division, a group of World Financial cardholders filed a
putative class action complaint against World Financial. The plaintiffs,
individually and on behalf of all others similarly situated, commenced the
action alleging that World Financial engaged in a systematic program of false,
misleading, and deceptive practices to improperly bill and collect consumer
debts from thousands of cardholders. The suit stems from World Financial's
practices involved in calculating finance charges and in crediting cardholder
payments on the next business day if received after 6:30 a.m. The plaintiffs
contend that such practices are deceptive and result in the imposition of
excessive finance charges and other penalties to cardholders. The plaintiffs
allege that World Financial, through such practices, has violated several
federal and Florida state consumer protection statutes and breached cardholder
contracts. The plaintiffs have not specified an amount of damages, but have
requested, individually and on behalf of a putative class, monetary and punitive
damages for the alleged stated claims and permanent injunctions for alleged
statutory violations. This complaint was subsequently amended to include our
subsidiary, ADS Alliance Data Systems, Inc., as a defendant. We believe these
allegations are without merit and intend to defend this matter vigorously.
59
PROPERTIES
The following table sets forth information with respect to our principal
facilities.
CURRENT
MONTHLY APPROXIMATE LEASE
BASE LEASE SQUARE EXPIRATION
LOCATION SEGMENT RENT FOOTAGE DATE
-------- ---------------------------- ---------- ----------- ------------------
Northglenn, Colorado........ Transaction Services $ 37,104 65,000 August 31, 2007
Kennesaw, Georgia........... Transaction Services $ 22,560 20,068 October 8, 2006
Buffalo Grove, Illinois..... Transaction Services $ 35,669 24,320 February 29, 2010
Lenexa, Kansas.............. Transaction Services $ 45,244 65,000 January 31, 2008
Minneapolis, Minnesota...... Marketing Services and $ 31,997 28,442 August 31, 2004
Transaction Services
Voorhees, New Jersey........ Transaction Services $ 75,431 67,050 January 1, 2005
Columbus, Ohio.............. Transaction Services $ 36,536 103,161 January 31, 2008
Columbus, Ohio.............. Transaction Services and $ 74,928 100,800 May 31, 2006
Credit Services
Columbus, Ohio.............. Transaction Services $ 14,400 57,600 August 31, 2004
Columbus, Ohio.............. Marketing Services, $ 40,733 54,615 August 31, 2007
Transaction Services and
Credit Services
Reno, Ohio.................. Credit Services $ 11,128 12,140 April 30, 2002
Zanesville, Ohio............ Credit Services $ 5,850 5,400 April 1, 2006
Johnson City, Tennessee..... Transaction Services $ 44,925 45,000 October 19, 2010
Dallas, Texas............... Marketing Services and $ 114,228 114,419 November 30, 2009
Transaction Services
Dallas, Texas............... Transaction Services and $ 121,000 114,419 October 10, 2010
Credit Services
Dallas, Texas............... Marketing Services, $ 57,479 61,750 July 31, 2007
Transaction Services and
Credit Services
Dallas, Texas............... Transaction Services $ 18,224 72,897 April 30, 2006
San Antonio, Texas.......... Transaction Services $ 47,692 67,540 January 31, 2002
Mississauga, Ontario, $ 36,850 39,027 August 31, 2009
Canada.................... Marketing Services
Toronto, Ontario, Canada.... Marketing Services $ 228,700 137,411 September 16, 2007
Montreal, Quebec, $ 5,846 6,093
Canada.................... Marketing Services June 30, 2009
Calgary, Alberta, Canada.... Marketing Services $ 9,313 8,120 December 31, 2004
Auckland, New Zealand....... Transaction Services $ 12,041 11,700 September 13, 2005
---------- ---------
Total..................... $1,127,878 1,281,972
========== =========
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.
60
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth the name, age and positions of each of our
executive officers, business unit presidents and directors as of the date of
this prospectus:
NAME AGE POSITION
---- --------------------- ------------------------------------------
J. Michael Parks.......................... 50 Chairman of the Board of Directors,
Chief Executive Officer and President
Ivan M. Szeftel........................... 47 Executive Vice President and President,
Retail Credit Services
John W. Scullion.......................... 44 President and Chief Executive Officer,
The Loyalty Group
Michael A. Beltz.......................... 45 Executive Vice President and President,
Transaction Services Group
Edward J. Heffernan....................... 38 Executive Vice President and
Chief Financial Officer
Dwayne H. Tucker.......................... 44 Executive Vice President and
Chief Administrative Officer
Steven T. Walensky........................ 43 Executive Vice President and
Chief Information Officer
Carolyn S. Melvin......................... 48 Senior Vice President, Secretary and
General Counsel
Robert P. Armiak.......................... 39 Vice President and Treasurer
Michael D. Kubic.......................... 45 Vice President, Corporate Controller and
Chief Accounting Officer
Richard E. Schumacher, Jr................. 34 Vice President, Tax
Bruce K. Anderson......................... 61 Director
Roger H. Ballou........................... 50 Director
Anthony J. deNicola....................... 36 Director
Daniel P. Finkelman....................... 45 Director
Kenneth R. Jensen......................... 57 Director
Robert A. Minicucci....................... 49 Director
Bruce A. Soll............................. 43 Director
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 M. SZEFTEL, executive vice president and president of our Retail Credit
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 a director and 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.
61
JOHN W. 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 financial officer for The Loyalty Group.
Prior to that, he served as chief financial officer of The Rider Group from
September 1988 to October 1993. Mr. Scullion holds a Bachelor's degree from the
University of Toronto.
MICHAEL A. BELTZ, executive vice president and president of our Transaction
Services Group, joined us in May 1997. From May 1997 to January 2001, he served
as executive vice president and then president of business development and
planning. He is responsible for transaction services, U.S. based marketing
services, new market identification and acquisitions. 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 J. HEFFERNAN, executive vice president and chief financial officer,
joined us in May 1998. Before joining us, he served as vice president, mergers
and acquisitions for First Data Corporation from October 1994 to May 1998. Prior
to that he served as vice president, mergers and acquisitions for Citicorp from
July 1990 to October 1994, and prior to that he served in corporate finance at
Credit Suisse First Boston Corporation from June 1986 until July 1990. He holds
a Bachelor's degree from Wesleyan University and an MBA from Columbia Business
School.
DWAYNE H. TUCKER, executive vice president and chief administrative officer,
joined us in June 1999. He is responsible for human resources, facilities, legal
services, corporate communications and corporate marketing. 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, executive 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.
CAROLYN S. MELVIN, senior 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, internal audit
and compliance. Before joining us, she served as vice president and counsel for
National City Corporation from December 1982 until September 1995. Ms. Melvin
holds a Bachelor's degree from Dickinson College and a J.D. from Ohio State
University College of Law.
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.
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.
62
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 & 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.
ROGER H. BALLOU has served as a director since February 2001. Mr. Ballou has
been a self-employed consultant since October 2000. Before that time,
Mr. Ballou had served as chairman and chief executive officer of Global Vacation
Group, Inc. from April 1998 to September 2000. Prior to that, he was a senior
advisor for Thayer Capital Partners from September 1997 to April 1998. From
April 1995 to August 1997, he served as vice chairman and chief marketing
officer, then as president and chief operating officer, of Alamo
Rent-a-Car, Inc. Mr. Ballou is currently chairman of the U.S. National Tourism
Organization, and served as chairman of the Government Affairs Council from 1995
to 1997. Mr. Ballou is currently a director of American Medical Security Group,
Inc. Mr. Ballou holds a Bachelor's degree from the Wharton School of the
University of Pennsylvania and an MBA from the Tuck School of Business at
Dartmouth.
ANTHONY J. DENICOLA has served as a director since our merger in
August 1996. Mr. deNicola is a partner with Welsh, Carson, Anderson & 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 Corp. and
NTELOS Inc. 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.
KENNETH R. JENSEN became a director in February 2001. 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.
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 & 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.
63
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 eight members.
Kenneth R. Jensen and Roger H. Ballou were elected as independent directors in
February 2001, and we intend to designate one additional independent director
after consummation of this offering. Our board is divided into three classes
that serve staggered three-year terms, as follows:
CLASS EXPIRATION OF TERM MEMBERS
----- ------------------ -----------------------
Class I............................. 2004 Anthony J. deNicola,
Bruce A. Soll,
Kenneth R. Jensen
Class II............................ 2002 Bruce K. Anderson,
Daniel P. Finkelman
Roger H. Ballou
Class III........................... 2003 Robert A. Minicucci,
J. Michael Parks
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 board of directors presently has three committees, consisting of the
audit committee, the compensation committee and the capital budget committee.
The audit committee, which consists of Kenneth R. Jensen, Roger H. Ballou
and Anthony J. deNicola, will review the scope and approach of the annual audit,
our financial statements and related auditors' report and the auditors' comments
relative to the adequacy of our system of internal controls and financial
reporting. The audit committee will also recommend to our board of directors the
appointment of independent public accountants for the following year. In
accordance with New York Stock Exchange regulations, the members of the audit
committee are independent directors who are financially literate, at least one
of whom has significant experience in accounting or finance matters. Our audit
committee has adopted and will periodically review a written charter that will
specify the scope of its responsibilities.
The compensation committee, which consists of Robert A. Minicucci and
Daniel P. Finkelman and will include a third nonemployee director, 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 administer specific matters with
respect to our stock option plan.
The capital budget committee, which currently consists of Anthony J.
deNicola and Bruce A. Soll, has the power and authority of the board of
directors to adopt our capital expenditure budget and to evaluate and authorize
any and all capital expenditures that exceed $1 million.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
Prior to this offering, our board of directors or the compensation committee
made decisions relating to the compensation of Mr. 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
64
compensation 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 closing date of this offering will have a choice
of receiving either (1) a nonqualified stock option to purchase 42,000 shares of
our common stock at an exercise price equal to the initial public offering price
or (2) a nonqualified stock option to purchase 28,500 shares of our common
stock, at an exercise price equal to the fair market value at the date of grant,
plus cash compensation of $15,000 annually, $1,000 for each board meeting
attended and $500 for each committee meeting attended. Non-employee directors
who are elected after this offering will make this choice of compensation
alternatives upon becoming directors and will receive the nonqualified stock
options on the date that they first become directors.
65
EXECUTIVE COMPENSATION
The following table sets forth the annual and long-term compensation for the
year ended December 31, 2000 for our chief executive officer, our four other
most highly compensated executive officers and one additional executive officer
who would have been one of our four most highly compensated executive officers
if he had continued to be employed with us as of December 31, 2000. These six
individuals are referred to as the named executive officers.
ANNUAL LONG-TERM
COMPENSATION COMPENSATION
--------------------- --------------------------------------
SECURITIES
RESTRICTED UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION SALARY ($) BONUS(1) STOCK AWARDS($)(2) OPTIONS, SARS (#) COMPENSATION
--------------------------- ---------- -------- ------------------ ----------------- --------------
J. Michael Parks....................... $475,000 $372,000 $1,800,000 230,000 $ 33,482
Chairman of the Board,
Chief Executive Officer and President
Ivan M. Szeftel........................ $335,000 $179,800 $ 525,000 80,000 $ 21,135
Executive Vice President and
President, Retail Credit Services
Michael A. Beltz....................... $260,000 $198,200 $ 525,000 80,000 $ 15,503
Executive Vice President and
President, Transaction Services Group
John W. Scullion(3).................... $255,104 $134,006 $ 525,000 80,000 $ 11,993
President and Chief Executive
Officer, The Loyalty Group
Edward K. Mims(4)...................... $214,077 $113,377 $ 525,000 80,000 $290,787
Executive Vice President
and Chief Financial Officer
James E. Anderson(5)................... $233,692 $117,500 $ 525,000 80,000 $ 17,176
Executive Vice President and
President, Utilities Services
------------------------
(1) Bonuses represent amounts earned by each executive officer during the
referenced year, although paid in the following year. Bonuses are determined
based upon the achievement of operating income, various financial and
operational objectives and individual objectives.
(2) Amounts in this column represent the value of the following
performance-based restricted stock awards issued in September 2000 at $15.00
per share: 120,000 shares to Mr. Parks and 35,000 shares to each of
Messrs. Szeftel, Beltz, Scullion, Mims and Anderson. The value of the
restricted stock awards, based upon the initial public offering price of
$12.00 per share, is $1,440,000 for Mr. Parks and $420,000 for each of
Messrs. Szeftel, Beltz, Scullion, Mims and Anderson. These awards will not
vest unless specific performance measures tied to either EBITDA or return on
stockholders' equity are met. If these performance measures are met, some of
these restricted shares will vest at the end of a five year period, but some
can vest on a more accelerated basis if certain annual EBITDA performance
targets are met. Twenty percent of each participant's award vested on
February 6, 2001 based on our EBITDA in 2000.
(3) Mr. Scullion's salary, bonus and all other compensation are paid in Canadian
dollars. Amounts reflected are converted to U.S. dollars at an average
conversion rate for the year of $0.67.
(4) Mr. Mims commenced employment with us in February 1998 and resigned
effective October 11, 2000. All other compensation includes the lump-sum
payment of $269,923 received in 2000 by Mr. Mims as part of his severance
agreement.
(5) Mr. Anderson commenced employment with us in May 1997 and resigned effective
December 31, 2000.
66
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 and
long-term disability expenses as follows:
LIFE INSURANCE LONG-TERM
401(K) PLAN PREMIUMS SERP DISABILITY SEVERANCE
----------- -------------- -------- ---------- ---------
J. Michael Parks.............................. $11,580 $ 172 $21,730 $ -- $ --
Ivan M. Szeftel............................... $11,580 $ 149 $ 9,406 $ -- $ --
Michael A. Beltz.............................. $ 9,980 $ 115 $ 5,408 $ -- $ --
John W. Scullion.............................. $ -- $4,221 $ -- $7,722 $ --
Edward K. Mims................................ $13,180 $ 108 $ 7,577 $ -- $269,923
James E. Anderson............................. $11,580 $ 103 $ 5,493 $ -- $ --
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth certain information concerning option grants
made to the named executive officers during 2000 pursuant to our stock option
plan.
INDIVIDUAL GRANTS
--------------------------------------------------
PERCENTAGE OF POTENTIAL REALIZABLE VALUE AT
NUMBER OF TOTAL OPTIONS ASSUMED ANNUAL RATES OF
SECURITIES GRANTED TO STOCK PRICE APPRECIATION FOR
UNDERLYING EMPLOYEES IN EXERCISE OPTION TERM ($)(2)
OPTIONS FISCAL PRICE EXPIRATION -----------------------------
GRANTED(#) YEAR(1) ($/SH) DATE 5% 10%
---------- ------------- -------- ---------- ------------- -------------
J. Michael Parks............ 230,000 8.7% $15.00 9/1/10 $2,169,686 $5,498,411
Ivan M. Szeftel............. 80,000 3.0% $15.00 9/1/10 $ 754,674 $1,912,491
Michael A. Beltz............ 80,000 3.0% $15.00 9/1/10 $ 754,674 $1,912,491
John W. Scullion............ 80,000 3.0% $15.00 9/1/10 $ 754,674 $1,912,491
Edward K. Mims(3)........... 80,000 3.0% $15.00 9/1/10 $ 754,674 $1,912,491
James E. Anderson(4)........ 80,000 3.0% $15.00 9/1/10 $ 754,674 $1,912,491
------------------------
(1) In 2000, we granted options to purchase a total of 19,331 shares of common
stock at an exercise price of $11.25 per share and options to purchase a
total of 2,629,145 shares of common stock at an exercise price of $15.00 per
share.
(2) In accordance with SEC rules, the amounts shown on this table represent
hypothetical gains that could be achieved for the respective options if
exercised at the end of the option term. These gains are based on the
assumed rates of stock appreciation of 5% and 10% compounded annually from
the date the respective options were granted to their expiration date and do
not reflect our estimates or projections of the future price of our common
stock. The gains shown are net of the option exercise price, but do not
include deductions for taxes or other expenses associated with the exercise.
Actual gains, if any, on stock option exercises will depend on the future
performance of our common stock, the option holder's continued employment
through the option period, and the date on which the options are exercised.
(3) Under Mr. Mims' severance agreement, options that were vested as of the date
of his resignation may be exercised by Mr. Mims for a period of up to six
months after that date. One-third of Mr. Mims' unvested options will vest on
August 31, 2001 and be exercisable thereafter for a period of six months.
(4) Under Mr. Anderson's severance agreement, options that were vested as of the
date of his resignation may be exercised through February 2002. One-third of
Mr. Anderson's unvested options will vest on August 31, 2001 and be
exercisable thereafter for a period of six months.
67
OPTION EXERCISES IN LAST FISCAL YEAR
The following table sets forth certain information concerning all
unexercised options held by the named executive officers as of December 31,
2000. No options were exercised by the named executive officers during 2000.
NUMBER OF UNEXERCISED VALUE OF UNEXERCISED IN-THE-
OPTIONS AT MONEY OPTIONS AT
FISCAL YEAR-END(#) FISCAL YEAR-END($)(1)
--------------------------- -----------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ------------- ------------ --------------
J. Michael Parks............................... 298,609 348,056 $877,077 $297,918
Ivan M. Szeftel................................ 61,111 152,222 $178,333 $201,677
Michael A. Beltz............................... 72,221 141,110 $199,163 $155,831
John W. Scullion............................... 41,667 121,666 $ 87,501 $ 87,498
Edward K. Mims(2).............................. 36,111 132,777 $ 95,833 $130,832
James E. Anderson(3)........................... 43,055 125,832 $116,665 $109,997
------------------------
(1) Value for "in-the-money" options represents the positive spread between the
respective exercise prices of outstanding options and the initial public
offering price of $12.00 per share.
(2) Under Mr. Mims' severance agreement, options that were vested as of the date
of his resignation may be exercised by Mr. Mims for a period of up to six
months after that date. One-third of Mr. Mims' unvested options will vest on
August 31, 2001 and be exercisable thereafter for a period of six months.
(3) Under Mr. Anderson's severance agreement, options that were vested as of the
date of his resignation may be exercised through February 2002. One-third of
Mr. Anderson's unvested options will vest on August 31, 2001 and be
exercisable thereafter for a period of six months.
EMPLOYMENT, SEVERANCE 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 annual
base salary of $475,000. Mr. Parks is entitled to an annual 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, all of which have vested.
Additionally, Mr. Parks was granted options to purchase 83,333 shares of our
common stock at an exercise price of $9.90 per share in 1999. Of these options,
options to purchase 41,666 shares are vested. Mr. Parks was also granted options
to purchase 230,000 shares of our common stock at an exercise price of $15.00
per share in 2000, none of which are vested. Additionally, Mr. Parks is entitled
to participate in our 401(k) and Retirement Savings Plan, our Incentive
Compensation Plan and any other employee benefits as provided to other senior
executives. Mr. Parks is entitled to 18 months base salary if terminated.
IVAN M. 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 annual base
salary of $325,000, subject to increases based on annual reviews. Mr. Szeftel is
entitled to an annual incentive bonus of $200,000 based on the achievement of
our annual financial goals. Under the agreement, we granted Mr. Szeftel options
to purchase 111,111 shares of our common stock at an exercise price of $9.00 per
share. Of these options, options to purchase
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83,332 shares have vested. Mr. Szeftel was also granted options to purchase
22,222 shares of our common stock at an exercise price of $9.90 per share in
1999. Of these options, options to purchase 5,556 shares are currently vested.
Mr. Szeftel was also granted options to purchase 80,000 shares of our common
stock at an exercise price of $15.00 per share in 2000, none of which are
vested. Mr. Szeftel is entitled to participate in our 401(k) and Retirement
Savings Plan, our 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 12 months base salary.
EDWARD K. MIMS. In connection with Mr. Mims' resignation as Chief Financial
Officer effective as of October 11, 2000 and his resignation as an employee
effective as of October 31, 2000, we entered into a severance agreement under
which we paid Mr. Mims a lump sum severance payment of $269,923. The severance
agreement provides that Mr. Mims is entitled to outplacement benefits,
reimbursement of continuing professional educational expenses and professional
fees through 2001. The severance agreement also provided that Mr. Mims was
entitled to a payment under the 2000 Incentive Compensation Plan, the amount of
which was later set at $113,377. In addition, options that were vested as of the
date of Mr. Mims' resignation may be exercised by Mr. Mims for a period of up to
six months after that date. One-third of Mr. Mims' unvested options will vest on
August 31, 2001 and be exercisable thereafter for a period of six months.
Mr. Mims received a lump sum cash payment pursuant to restricted stock awards
that vested on February 6, 2001.
JAMES E. ANDERSON. In connection with the resignation of Mr. Anderson as an
officer and an employee effective December 31, 2000, we entered into a severance
agreement with Mr. Anderson that provides for severance pay equal to 52 weeks of
his former annual base salary payable in 26 equal installments. The severance
agreement provides that Mr. Anderson is entitled to an incentive compensation
payment pursuant to the 2000 Incentive Compensation Plan in the amount of
$117,500 and a relocation payment of up to $80,000 if he is relocated and such
costs of relocation are not paid in full by a subsequent employer. In addition,
options that were vested as of the date of Mr. Anderson's resignation may be
exercised through February 2002. One-third of Mr. Anderson's unvested options
will vest on August 31, 2001 and be exercisable thereafter for a period of six
months. Mr. Anderson received a lump sum cash payment pursuant to restricted
stock awards that vested on February 6, 2001.
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 2001. 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. We have reserved
a total of 8,753,000 shares of common stock for issuance pursuant to this plan.
As of March 31, 2001, there were 4,384,576 shares of common stock subject to
outstanding options at a weighted average exercise price of $12.43 per share.
Our board has approved the grant on the offering date to certain of our officers
of options to purchase approximately 666,000 shares of our common stock at an
exercise price equal to $12.00 per share, the initial public offering price.
Under the plan, we may grant incentive stock options to any person employed
by us or any of our subsidiaries. We may grant nonqualified stock options and
restricted stock awards 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
69
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 options granted under both the current plan and our prior plan
terminate on the tenth anniversary of the date of grant.
The plan also provides for the granting of performance-based restricted
stock awards to our chief executive officer, officers that report directly to
him and certain other officers. The plan gives our committee administering the
plan the sole discretion to determine the vesting provisions for
performance-based restricted stock awards. As of March 31, 2001
performance-based restricted awards representing an aggregate of 570,000 shares
had been granted to 28 officers. The restricted shares subject to these grants
will not vest unless specified performance measures tied to either EBITDA or
return on stockholders' equity are met. If these performance targets are met,
some of these restricted shares will vest over a five year period. However, some
of the restricted shares will vest on a more accelerated basis if certain annual
EBITDA performance targets are met. Our board of directors accepted the
2000 EBITDA results and accelerated vesting for 114,000 shares based on strong
contributions from management to our company in 2000.
We implemented a program whereby we make loans available to recipients of
restricted stock awards in amounts sufficient to cover any tax liability
resulting from the vesting of those awards. The amount that any participant can
borrow under the program is limited to 50% of the value of the vested shares.
Participants in the program are required to pledge their vested restricted
shares to us as collateral, until the loans are repaid.
The plan provides that our board of directors will administer the plan. Our
board of directors may delegate all or a portion of its authority under the plan
to the compensation committee. The board of directors or the compensation
committee may further delegate all or a portion of its authority under the plan
to our chief executive officer, except with respect to grants of options or
awards to officers and directors who are subject to Section 16(b) of the
Securities Exchange Act of 1934.
The plan gives our board of directors discretion to determine the vesting
provisions of each individual stock option. In the event of a change of control,
our plan provides that our board of directors may provide for accelerated
vesting of options. Options granted on or after September 1, 2000 vest over a
three year period from the date of grant. The normal vesting provision for
options granted under our prior plan provides for vesting of 33 1/3% of the
options each year over a three-year period, beginning on the first day of
February of the eighth year after the options have been awarded. 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 6,700 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. 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
70
employees who are at least 21 years old and who we have employed for at least
30 days 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.
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.
2001 INCENTIVE COMPENSATION PLAN
The Alliance Data Systems 2001 Incentive Compensation Plan provides an
opportunity for certain U.S. employees to be eligible for a cash bonus based on
achieving certain performance targets. To be eligible under the plan, employees
must meet certain eligibility requirements outlined in the plan document.
Under the plan, each participant has an incentive compensation target that
is expressed as a percentage of his or her annualized base salary as of
October 1, 2001. The participant's incentive compensation target is based on
various objectives that are weighted to reflect the participant's contribution
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, as well as associate satisfaction scores, and the individual
objectives are items of importance to us that the individual can impact. Our
executive committee members and chairman have their incentive compensation
target tied to our operating income, revenue
71
(either at the company level or at the business unit level), and associate
satisfaction. The amount of compensation a participant receives depends on the
percentage of objectives that were achieved. For all objectives except associate
satisfaction, 80% of the objectives must be achieved before a participant is
eligible for any payout and the maximum payout is equal to 150% of the
participant's incentive compensation target. For associate satisfaction, 90% of
the target must be achieved before a participant is eligible for any payout,
plus there must be improvement from the 2000 base score before a participant is
eligible for any payout.
EMPLOYEE STOCK PURCHASE PLAN
We adopted the Alliance Data Systems Corporation and its Subsidiaries
Employee Stock Purchase Plan in February 2001. We intend for the plan to qualify
under section 423 of the Internal Revenue Code. The plan permits our eligible
employees and those of our designated subsidiaries to purchase our common stock
at a discount to the market price through payroll deductions. No employee may
purchase more than $25,000 in stock under the plan in any calendar year, and no
employee may purchase stock under the plan if such purchase would cause the
employee to own more than 5% of the voting power or value of our common stock.
We have authorized the issuance of up to 1,500,000 shares of common stock under
the plan.
The plan provides for three month offering periods, beginning on each
January 1, April 1, July 1 and October 1. We anticipate that October 1, 2001
will begin the first offering period, but the plan allows the board of directors
to change this date as well as the date, duration and frequency of any future
offering period. The plan has a term of ten years, unless terminated sooner by
our board of directors pursuant to the provisions of the plan.
On the offering date at the beginning of each offering period, each eligible
employee is granted an option to purchase a number shares of common stock, which
option is exercised automatically on the purchase date at the end of the
offering period. The purchase price of the common stock upon exercise of the
options will be 85% of its fair market value on the offering date or purchase
date, whichever is lower.
72
PRINCIPAL STOCKHOLDERS
The following table sets forth information with respect to the beneficial
ownership of our common stock as of April 30, 2001 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 58,861,486 shares of our
common stock outstanding before this offering, and 71,861,486 shares of our
common stock outstanding immediately after this offering, both of which reflect
the conversion of all outstanding shares of Series A preferred stock into common
shares.
PERCENT OF SHARES
BENEFICIALLY
OWNED(1)
SHARES BENEFICIALLY -------------------
OWNED BEFORE AND BEFORE AFTER
NAME OF BENEFICIAL OWNER AFTER OFFERING(1) OFFERING OFFERING
------------------------ ---------------------------- -------- --------
Welsh, Carson, Anderson & Stowe(2) ......................... 43,950,958 74.7% 61.2%
320 Park Avenue, Suite 2500
New York, New York 10022-6815
Limited Commerce Corp. ..................................... 14,663,376 24.9% 20.4%
Three Limited Parkway
Columbus, Ohio 43230
J. Michael Parks(3)......................................... 398,998 * *
Ivan M. Szeftel(4).......................................... 101,443 * *
Michael A. Beltz(5)......................................... 112,553 * *
John W. Scullion(6)......................................... 69,500 * *
Edward K. Mims(7)........................................... 58,331 * *
James E. Anderson(8)........................................ 65,275 * *
Bruce K. Anderson(9)........................................ 368,176 * *
Anthony J. deNicola(9)...................................... 35,336 * *
Robert A. Minicucci(9)...................................... 121,488 * *
Roger H. Ballou............................................. -- * *
Daniel P. Finkelman......................................... -- * *
Kenneth R. Jensen........................................... -- * *
Bruce A. Soll............................................... -- * *
All directors and executive officers as a group
(20 individuals)(10)...................................... 1,478,218 2.5% 2.0%
------------------------
* 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
73
convertible within 60 days of April 30, 2001, 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 11,199,340 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,
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,
- 102,630 shares of common stock held by Thomas E. McInerney,
- 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,
74
- 10,101 shares of common stock held by Rudolph Rupert, and
- 2,525 shares of common stock held by D. Scott Mackesy.
(3) Includes options to purchase 374,998 shares of common stock which are
exercisable within 60 days of April 30, 2001.
(4) Includes options to purchase 94,443 shares of common stock which are
exercisable within 60 days of April 30, 2001.
(5) Includes options to purchase 105,553 shares of common stock which are
exercisable within 60 days of April 30, 2001.
(6) Includes options to purchase 62,500 shares of common stock which are
exercisable within 60 days of April 30, 2001.
(7) Includes options to purchase 58,331 shares of common stock which are
exercisable within 60 days of April 30, 2001.
(8) Includes options to purchase 65,275 shares of common stock which are
exercisable within 60 days of April 30, 2001.
(9) The number of shares beneficially owned by Messrs. Bruce K. Anderson,
deNicola and Minicucci includes 122,137, 11,659 and 40,437 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.
(10) Includes options to purchase an aggregate of 877,618 shares of common stock
which are exercisable within 60 days of April 30, 2001 held by Messrs.
Parks, Szeftel, Beltz, Mims, James E. Anderson, Armiak, Heffernan, Kubic,
Melvin, Schumacher, Scullion, Tucker and Walensky and 174,233 shares
issuable upon conversion of Series A preferred stock.
75
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 74.7% of our
outstanding common stock immediately prior to this offering. 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. These preferred shares are convertible
into 11,199,340 shares of common stock. Upon consummation of the offering, all
of the outstanding shares of Series A preferred stock will be converted into
shares of 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., one of our wholly
owned subsidiaries.
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, which now operates as part of ADS
Alliance Data Systems. 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.
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 24.9% of our common
stock immediately prior to this offering. Limited Commerce Corp. is indirectly
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 designate two members of 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, Henri Bendel, Victoria's
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Secret Catalogue, Victoria's Secret Stores, 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 December 31, 2000.
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. World Financial is obligated to issue credit cards
to any customer of a Limited affiliate who applies for a credit card, meets
World Financial's credit standards, and agrees to the terms and conditions of
World Financial's standard form of credit card agreement. World Financial is
allowed to change its applicable credit standards and standard form of credit
card agreement with the consent of the relevant Limited affiliate. Furthermore,
these agreements obligate World Financial to consider, in good faith, requests
by a Limited affiliate for variances from World Financial's credit standards and
standard form of credit agreement. 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 for special
programs and reimbursement of certain costs.
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 any third party 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, with the revenue to be
shared between World Financial, The Limited and its affiliated businesses as
agreed on a program by program basis.
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.
In September 2000, our subsidiary, ADS Alliance Data Systems, Inc., entered
into a marketing database services agreement with The Limited, Inc. and one of
its affiliates, Intimate Brands, Inc., which wholly owns Victoria's Secret and
Bath & Body Works. In this agreement, ADS agreed to provide an information
database system capable of capturing certain consumer information when a
consumer makes a purchase, excluding purchases for credit or financial products,
at Bath & Body Works, The Limited Stores, Structure, Victoria's Secret Stores,
Lerner New York, Lane Bryant and Express, and to provide database marketing
services. Under the agreement, ADS has the right to sell data provided to ADS by
affiliates of The Limited under the agreement, subject to the privacy policies
of The Limited and Intimate Brands and their consent. However, ADS is prohibited
from disclosing or selling any of this information to third parties who, in the
sole judgement of The Limited and Intimate Brands, compete with affiliates or
subsidiaries of The Limited. ADS is required to share revenues generated by the
sale of such data with The Limited and Intimate Brands. This agreement expires
in 2003, but can be terminated earlier by The Limited and Intimate Brands if we
fail to meet specified service standards.
We received total revenues directly from The Limited and its retail
affiliates of $40.6 million during fiscal 1998, $46.6 million during 1999 and
$46.7 million during 2000.
77
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.
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
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
"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 at any time after the consummation of this initial public offering,
subject to the 180-day lock-up agreement these entities have entered into in
connection with this 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 United States
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. Instead, stockholders have independently funded the program through
a separate company called U.S. Loyalty Corp., which they have funded. We do not
and 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.
The stockholders of U.S. Loyalty Corp. include Welsh Carson, Limited
Commerce Corp. and our officers and directors who received stock in U.S. Loyalty
as a result of their participation in funding U.S. Loyalty Corp. Robert A.
Minicucci, who is a stockholder and one of our directors, is a director,
78
officer and a stockholder of U.S. Loyalty Corp. 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.
AMOUNT OF PRINCIPAL
OUTSTANDING AS OF
CREDIT LINE MARCH 31, 2001
------------ ------------------------------
World Financial Network National Bank note.................. $100,000,000 $ --
ADS Alliance Data Systems, Inc. note........................ 300,000,000 265,000,000
Alliance Data Systems (New Zealand) Limited note............ 11,250,000 9,750,000
Loyalty Management Group Canada Inc. note................... 20,000,000 --
79
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 71,861,486 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. The shares of Series A
preferred stock will convert into a number of common shares equal to the per
share dividend preference amount plus accrued dividends, divided by the lesser
of (1) $13.50 and (2) the initial public offering price.
EFFECTS OF AUTHORIZED BUT UNISSUED STOCK
Upon consummation of the offering there will be 200,000,000 authorized
shares of our common stock, 128,138,514 of which will be unissued, and
20,000,000 shares of preferred stock available for our
80
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 plan and 1,500,000 shares have been
reserved for issuance under our employee stock purchase plan.
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
and restricted stock plan and our employee stock purchase 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. 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.
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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.
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; and
- 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.
82
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. Prior to this offering, principal stockholders held 58,614,334 shares,
representing 99.6% of the outstanding shares of our common stock. Immediately
after this offering, we will have 71,861,486 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 58,861,486 shares, 72,013 shares will be freely transferable and
58,789,473 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 58,566,067 shares of our common stock and options to
purchase approximately 2,819,635 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, the underwriters, in their
sole discretion, may release any of these stockholders from the lock-up
agreements prior to expiration of the 180-day period 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 our affiliate at
any time during the three months 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 and restricted stock 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 and restricted stock
plan. This registration statement would permit the resale of shares issued under
the stock option and restricted stock plan and the employee stock purchase plan
by non-affiliates in the public market without restriction, subject to the
lock-up agreements.
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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 Credit Suisse First Boston 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:
NUMBER OF
UNDERWRITER SHARES
----------- ----------
Bear, Stearns & Co. Inc..................................... 3,600,000
Merrill Lynch, Pierce, Fenner & Smith
Incorporated...................................... 3,600,000
Credit Suisse First Boston Corporation...................... 2,400,000
Banc of America Securities LLC.............................. 200,000
Deutsche Banc Alex. Brown................................... 200,000
First Union Securities, Inc................................. 200,000
Lazard Freres & Co. LLC..................................... 200,000
Lehman Brothers Inc......................................... 200,000
J.P. Morgan Securities Inc.................................. 200,000
Robertson Stephens, Inc..................................... 200,000
SG Cowen Securities Corporation............................. 200,000
UBS Warburg LLC............................................. 200,000
Wit SoundView Corporation................................... 200,000
Adams, Harkness & Hill, Inc................................. 100,000
William Blair & Company, L.L.C.............................. 100,000
Blaylock & Partners L.P..................................... 100,000
Chatsworth Securities LLC................................... 100,000
Fox-Pitt, Kelton Inc........................................ 100,000
Gaines, Berland Inc......................................... 100,000
Gerard Klauer Mattison & Co., LLC........................... 100,000
Hoak Breedlove Wesneski & Co................................ 100,000
Josephthal & Co. Inc........................................ 100,000
McDonald Investments Inc., a KeyCorp Company................ 100,000
Nesbitt Burns Securities Inc................................ 100,000
Raymond James & Associates, Inc............................. 100,000
Sanders Morris Harris....................................... 100,000
C.E. Unterberg, Towbin...................................... 100,000
----------
Total.................................................. 13,000,000
==========
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.
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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 $0.50 per share. The underwriters may allow, and these dealers
may reallow, concessions not in excess of $0.10 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 1,950,000 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.
UNDERWRITING COMPENSATION. The following table summarizes the compensation
to be paid to the underwriters by us in connection with this offering:
TOTAL
------------------------------------------
WITHOUT EXERCISE OF WITH EXERCISE OF THE
THE OVER-ALLOTMENT OVER-ALLOTMENT
PER SHARE OPTION OPTION
--------- ------------------- --------------------
Underwriting discounts........... $0.84 $10,920,000 $12,558,000
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 58,566,067 shares of our common stock, and options
to purchase approximately 2,819,635 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 has been determined by negotiations 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;
85
- 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.
Our common stock has been approved for listing 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 650,000 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 or, with regard to sales made in
Canada, through accounts at Merrill Lynch Canada Inc., in accordance with their
procedures for opening accounts and effecting transactions 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. CSFBDIRECT Inc., an affiliate of Credit
Suisse First Boston Corporation, is making a prospectus in electronic format
available on its Internet Web site. The underwriters have agreed to allocate
shares to CSFBDIRECT Inc. 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 or endorsed by us or any
underwriter in such capacity and should not be relied on by prospective
investors.
STABILIZATION AND OTHER TRANSACTIONS. In connection with the offering, the
underwriters may engage in stabilizing transactions, over-allotment
transactions, syndicate covering transactions and penalty bids.
- Stabilizing transactions permit bids to purchase the underlying security
so long as the stabilizing bids do not exceed a specified maximum price.
- Over-allotment involves sales by the underwriters of shares in excess of
the number of shares the underwriters are obligated to purchase, which
creates a syndicate short position. The short position may be either a
covered short position or a naked short position. In a covered short
position, the number of shares over-allotted by the underwriters is not
greater than the number of shares that they may purchase in the
over-allotment option. In a naked short position, the number of shares
involved is greater than the number of shares in the over-allotment
option. The underwriters may close out any short position by either
exercising their over-allotment option and/or purchasing shares in the
open market.
- Syndicate covering transactions involve purchases of the common stock in
the open market after the distribution has been completed in order to
cover syndicate short positions. In determining the source of shares to
close out the short position, the underwriters will consider, among other
things, the price of shares available for purchase in the open market as
compared to the price at which they may purchase shares through the
over-allotment option. If the underwriters sell more shares than could be
covered by the over-allotment option, a naked short position, the position
can only be closed out by buying shares in the open market. A naked short
position is more likely to be created if the underwriters are concerned
that there could be downward pressure on the price of the shares in the
open market after pricing that could adversely affect investors who
purchase in the offering.
86
- Penalty bids permit the representatives to reclaim a selling concession
from a syndicate member when the common stock originally sold by the
syndicate member is purchased in a stabilizing or syndicate covering
transaction to cover syndicate short positions.
These stabilizing transactions, syndicate covering transactions and penalty bids
may have the effect of raising or maintaining the market price of our common
stock or preventing or retarding a decline in the market price of the common
stock. As a result, the price of our common stock may be higher than the price
that might otherwise exist in the open market. 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 at least 1.1 million shares outstanding and a minimum public market
value of $60.0 million.
87
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, 1999 and 2000 and for the eleven months
ended December 31, 1998 and the years ended December 31, 1999 and 2000, 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 and have been so included in reliance
upon the reports of such firm given upon their authority as experts in
accounting and auditing.
The consolidated financial statements of Utilipro, Inc. and subsidiaries as
of September 30, 1999 and September 30, 2000 and for the years ended
September 30, 1999 and September 30, 2000, 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 report
of such firm given upon their authority as experts in accounting and auditing.
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.
88
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
ALLIANCE DATA SYSTEMS CORPORATION
PAGE
--------
ALLIANCE DATA SYSTEMS CORPORATION AND SUBSIDIARIES
Independent Auditors' Report................................ F-2
Consolidated Statements of Operations for the eleven months
ended December 31, 1998 and the years ended December 31,
1999 and 2000............................................. F-3
Consolidated Balance Sheets as of December 31, 1999 and
2000...................................................... F-4
Consolidated Statements of Stockholders' Equity for the
eleven months ended December 31, 1998 and the years ended
December 31, 1999 and 2000................................ F-5
Consolidated Statements of Cash Flows for the eleven months
ended December 31, 1998 and the years ended December 31,
1999 and 2000............................................. F-6
Notes to Consolidated Financial Statements.................. F-7
Unaudited Condensed Consolidated Statements of Operations
for the three months ended March 31, 2000 and 2001........ F-31
Consolidated Balance Sheets as of December 31, 2000
(audited) and March 31, 2001 (unaudited).................. F-32
Unaudited Condensed Consolidated Statements of Cash Flows
for the three months ended March 31, 2000 and 2001........ F-33
Notes to Unaudited Condensed Consolidated Financial
Statements................................................ F-34
UTILIPRO, INC. AND SUBSIDIARIES
Independent Auditors' Report................................ F-37
Consolidated Balance Sheets as of September 30, 1999 and
2000 and December 31, 2000 (unaudited).................... F-38
Consolidated Statements of Operations for the years ended
September 30, 1999 and 2000
and the three months ended December 31, 1999 and 2000
(unaudited)............................................... F-39
Consolidated Statements of Stockholders' Equity for the
years ended September 30, 1999 and 2000 and the three
months ended December 31, 2000 (unaudited)................ F-40
Consolidated Statements of Cash Flows for the years ended
September 30, 1999 and 2000
and the three months ended December 31, 1999 and 2000
(unaudited)............................................... F-41
Notes to Consolidated Financial Statements.................. F-42
F-1
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, 1999 and 2000, and
the related consolidated statements of operations, stockholders' equity, and
cash flows for the eleven months ended December 31, 1998 and the years ended
December 31, 1999 and 2000. Our audits also include the financial statement
schedule listed in the Index at Item 16. These financial statements and the
financial statement schedule are the responsibility of the Company's management.
Our responsibility is to express an opinion on the financial statements and the
financial statement schedule 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, 1999 and 2000, 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. Also, in our opinion, such
financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
Columbus, Ohio
February 2, 2001 (February 28, 2001 as to Note 21)
F-2
ALLIANCE DATA SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
11 MONTHS
ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1998 DECEMBER 31, 1999 DECEMBER 31, 2000
----------------- ------------------ ------------------
Revenues
Transaction and marketing services....... $264,928 $368,026 $415,792
Redemption revenue....................... 17,000 59,017 87,509
Financing charges, net................... 119,352 141,947 156,349
Other income............................. 9,633 14,092 18,545
-------- -------- --------
Total revenue........................ 410,913 583,082 678,195
-------- -------- --------
Operating expenses
Cost of operations....................... 335,804 466,856 547,985
General and administrative............... 17,589 35,971 32,201
Depreciation and other amortization...... 8,270 16,183 26,265
Amortization of purchased intangibles.... 43,766 61,617 49,879
-------- -------- --------
Total operating expenses............. 405,429 580,627 656,330
-------- -------- --------
Operating income............................. 5,484 2,455 21,865
Other non-operating expense.................. -- -- 2,477
Interest expense............................. 27,884 42,785 38,870
-------- -------- --------
Loss from continuing operations before income
taxes...................................... (22,400) (40,330) (19,482)
Income tax expense (benefit)................. (4,708) (6,538) 1,841
-------- -------- --------
Loss from continuing operations.............. (17,692) (33,792) (21,323)
Income (loss) from discontinued operations,
net of income taxes........................ (300) 7,688 --
Loss on disposal of discontinued operations,
net of income taxes........................ -- (3,737) --
-------- -------- --------
Net loss..................................... $(17,992) $(29,841) $(21,323)
======== ======== ========
Loss per share from continuing
operations--basic and diluted.............. $ (0.42) $ (0.78) $ (0.60)
======== ======== ========
Loss per share--basic and diluted............ $ (0.43) $ (0.70) $ (0.60)
======== ======== ========
Weighted average shares--basic and diluted... 41,729 47,498 47,538
======== ======== ========
See accompanying notes to consolidated financial statements.
F-3
ALLIANCE DATA SYSTEMS CORPORATION
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
DECEMBER 31,
-----------------------
1999 2000
---------- ----------
ASSETS
Cash and cash equivalents................................... $ 56,546 $ 116,941
Due from card associations.................................. 44,919 125,083
Trade receivables less allowance for doubtful accounts
($1,079
and $3,876 at December 31, 1999 and 2000, respectively)... 46,724 86,153
Credit card receivables and seller's interest less allowance
for
doubtful accounts ($3,657 and $3,657 at December 31, 1999
and 2000, respectively)................................... 150,804 137,865
Deferred tax asset, net..................................... 26,416 22,365
Other current assets........................................ 45,209 35,368
---------- ----------
Total current assets................................ 370,618 523,775
Redemption settlement assets, restricted.................... 133,650 152,007
Property and equipment, net................................. 89,231 92,178
Deferred tax asset, net..................................... 38,201 55,366
Other non-current assets.................................... 31,470 18,753
Due from securitizations.................................... 144,484 133,978
Intangible assets and goodwill, net......................... 493,609 444,549
---------- ----------
Total assets........................................ $1,301,263 $1,420,606
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable............................................ $ 55,921 $ 63,570
Accrued expenses............................................ 75,646 80,547
Merchant settlement obligations............................. 61,674 149,271
Other liabilities........................................... 11,321 36,725
Debt, current portion....................................... 118,225 161,725
---------- ----------
Total current liabilities........................... 322,787 491,838
Other liabilities........................................... 32,752 1,856
Deferred revenue--service................................... 84,474 88,931
Deferred revenue--redemption................................ 164,867 201,255
Long-term and subordinated debt............................. 316,911 274,335
---------- ----------
Total liabilities................................... 921,791 1,058,215
---------- ----------
Commitments and contingencies
Series A cumulative convertible preferred stock, $0.01 par
value;
120 shares authorized, issued and outstanding............. 119,400 119,400
Stockholders' equity:
Common stock, $0.01 par value; authorized 66,667 shares
(December 31, 1999), and 200,000 shares (December 31,
2000),
issued and outstanding, 47,529 shares (December 31, 1999)
and 47,545 shares (December 31, 2000)..................... 475 475
Additional paid-in capital.................................. 226,174 226,323
Retained earnings........................................... 37,693 16,370
Accumulated other comprehensive income (loss)............... (4,270) (177)
---------- ----------
Total stockholders' equity.......................... 260,072 242,991
---------- ----------
Total liabilities and stockholders' equity.......... $1,301,263 $1,420,606
========== ==========
See accompanying notes to consolidated financial statements.
F-4
ALLIANCE DATA SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(AMOUNTS IN THOUSANDS)
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER TOTAL TOTAL
------------------- PAID-IN RETAINED COMPREHENSIVE COMPREHENSIVE STOCKHOLDERS'
SHARES AMOUNT CAPITAL EARNINGS INCOME (LOSS) LOSS EQUITY
-------- -------- ---------- -------- ------------- ------------- -------------
JANUARY 31, 1998............ 36,619 $ 366 $118,864 $ 85,526 $ -- $204,756
Net loss.................... (17,992) $(17,992) (17,992)
Other comprehensive
income, net of tax:
Unrealized gain on
securities
available-for-sale,
net................... 1,207 1,207 1,207
Foreign currency
translation
adjustments........... (208) (208) (208)
-------
Other comprehensive
income.................... 999
--------
Total comprehensive loss.... $(16,993)
========
Common stock issued......... 10,868 109 106,933 107,042
------- ------ -------- -------- ------- --------
DECEMBER 31, 1998........... 47,487 475 225,797 67,534 999 294,805
Net loss.................... (29,841) $(29,841) (29,841)
Other comprehensive loss,
net of tax:
Unrealized loss on
securities
available-for-sale,
net................... (4,684) (4,684) (4,684)
Foreign currency
translation
adjustments........... (585) (585) (585)
-------
Other comprehensive loss.... (5,269)
--------
Total comprehensive loss.... $(35,110)
========
Common stock issued......... 42 -- 377 377
------- ------ -------- -------- ------- --------
DECEMBER 31, 1999........... 47,529 475 226,174 37,693 (4,270) 260,072
Net loss.................... (21,323) $(21,323) (21,323)
Other comprehensive
income, net of tax:
Unrealized gain on
securities available
for sale, net......... 3,774 3,774 3,774
Foreign currency
translation
adjustments........... 319 319 319
-------
Other comprehensive
income.................... 4,093
--------
Total comprehensive loss.... $(17,230)
========
Common stock issued......... 16 -- 149 149
------- ------ -------- -------- ------- --------
DECEMBER 31, 2000........... 47,545 $ 475 $226,323 $ 16,370 $ (177) $242,991
======= ====== ======== ======== ======= ========
See accompanying notes to consolidated financial statements.
F-5
ALLIANCE DATA SYSTEMS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
11 MONTHS
ENDED YEAR ENDED YEAR ENDED
DECEMBER 31, 1998 DECEMBER 31, 1999 DECEMBER 31, 2000
----------------- ----------------- -----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Loss from continuing operations................ $ (17,692) $ (33,792) $ (21,323)
Adjustments to reconcile loss from continuing
operations to net cash provided by operating
activities:
Income (loss) from discontinued operations..... (300) 7,688 --
Loss on disposal of discontinued operations.... -- (3,737) --
Depreciation and amortization.................. 52,036 77,800 76,144
Deferred income taxes.......................... (12,372) (37,600) (13,114)
Impairment of assets........................... 4,000 -- --
Accretion of deferred income................... (9,395) (5,950) (5,967)
Provision (credit) for doubtful accounts....... (3,383) (3,540) (2,797)
Change in operating assets and liabilities, net
of acquisitions:
Change in trade accounts receivables......... (20,868) 81,276 (43,845)
Change in merchant settlement activity....... -- 10,480 17,148
Change in other assets....................... (16,686) 33,449 20,056
Change in accounts payable and accrued
expenses................................... 6,076 37,187 12,550
Change in deferred revenue................... 15,520 91,149 40,845
Change in other liabilities.................. 12,099 11,621 475
Other operating activities................... 276 (14,393) 7,011
--------- --------- ---------
Net cash provided by operating
activities............................... 9,311 251,638 87,183
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Increase in redemption settlement assets....... (14,704) (63,976) (18,357)
Purchase of credit card receivables............ -- (33,817) --
Change in due from securitizations............. 5,470 (26,404) 14,280
Net cash paid for corporate acquisition........ (138,825) (171,423) --
Proceeds from sale of credit card receivable
portfolios................................... 94,091 -- --
Change in seller's interest.................... (76,975) 22,471 12,703
Capital expenditures........................... (14,443) (36,302) (33,083)
--------- --------- ---------
Net cash used in investing activities...... (145,386) (309,451) (24,457)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under debt agreements............... 382,043 249,625 148,546
Repayment of borrowings........................ (325,803) (294,473) (147,551)
Proceeds from issuance of preferred stock...... -- 119,400 --
Proceeds from issuance of common stock......... 107,042 377 149
--------- --------- ---------
Net cash provided by financing
activities............................... 163,282 74,929 1,144
--------- --------- ---------
Effect of exchange rate changes.................. (766) (7,606) (3,475)
--------- --------- ---------
Change in cash and cash equivalents.............. 26,441 9,510 60,395
Cash and cash equivalents at beginning of
period......................................... 20,595 47,036 56,546
--------- --------- ---------
Cash and cash equivalents at end of period....... $ 47,036 $ 56,546 $ 116,941
========= ========= =========
SUPPLEMENTAL CASH FLOW DISCLOSURE:
Interest paid.................................. $ 33,695 $ 43,215 $ 38,078
========= ========= =========
Income taxes paid.............................. $ 12,406 $ 25,242 $ 14,498
========= ========= =========
See accompanying notes to consolidated financial statements.
F-6
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
transaction services, credit services and marketing services in the United
States and Canada. The Company facilitates and manages transactions between its
clients and their customers through multiple distribution channels including
in-store, catalog and the Internet. Through the Credit Services and Marketing
Services segments, the Company assists its clients in identifying and acquiring
new customers, and helps to increase the loyalty and profitability of its
clients' existing customers.
The Company operates in three reportable segments: Transaction Services,
Credit Services and Marketing Services. Transaction Services encompasses
transaction processing, including network services and bank card settlement and
account processing and servicing, such as card processing, billing and payment
processing and customer care. Credit Services provides private label receivables
financing. Credit Services generally securitizes the credit card receivables
that it underwrites from its private label programs. Marketing Services provides
for loyalty programs, such as Air Miles reward miles, database marketing, direct
marketing and enhancement services.
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 1998 represents the 11 months ended December 31, 1998,
fiscal 1999 represents the year ended December 31, 1999 and fiscal 2000
represents the year ended December 31, 2000.
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 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 $182.0 million, was allocated to
goodwill and is being 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.
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,
F-7
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
1. DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION AND ACQUISITIONS (CONTINUED)
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.
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.
DUE FROM CARD ASSOCIATIONS AND MERCHANT SETTLEMENT OBLIGATIONS--Due from
card associations and merchant settlement obligations result from the Company's
network servicing and associated settlement activities. Due from card
associations is generated from credit card transactions, such as Mastercard,
Visa and American Express, at merchant locations. The Company records
corresponding settlement obligations for amounts payable to merchants.
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.
REDEMPTION SETTLEMENT ASSETS--These securities relate to the redemption fund
for the Air Miles reward miles program and are held in trust for the benefit of
funding redemptions by collectors. 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. 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.
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
TRANSACTION AND MARKETING SERVICES--The Company earns transaction fees,
which are principally based on the number of transactions processed and
statements generated and are recognized as such services are performed.
AIR MILES REWARD MILES PROGRAM--The Company allocates the proceeds received
from sponsors for the issuance of Air Miles reward miles based on relative fair
values between the redemption element of the award ultimately provided to the
collector (the "Redemption element") and its service elements.
F-8
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT POLICIES (CONTINUED)
This service element consists of direct marketing and support services provided
to sponsors (the "Service element").
The fair value of the Service element is based on the estimated fair value
of providing the services on a third-party basis. The revenue related to the
Service element of the Air Miles reward miles is initially deferred and
amortized over the period of time beginning with the issuance of the Air Miles
reward miles and ending upon their expected redemption (the estimated life of an
Air Miles reward mile).
The fair value of the Redemption element of the Air Miles reward miles
issued is determined based on separate pricing offered by the Company as well as
other objective evidence. The revenue related to the Redemption element is
deferred until the collector redeems the Air Miles reward miles or over the
estimated life of an Air Miles reward mile in the case of reward miles that the
Company estimates will go unused by the collector base ("breakage").
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 $(3.4 million),
$(3.7 million) and $(4.9 million) and related interest expense of $8.4 million,
$10.4 million and $6.2 million for fiscal 1998, 1999 and 2000, 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 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.
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.
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-9
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 loss
per share for the periods indicated (in thousands, except per share data):
FISCAL
------------------------------
1998 1999 2000
-------- -------- --------
NUMERATOR
Loss from continuing operations........................... $(17,692) $(33,792) $(21,323)
Preferred stock dividends................................. -- (3,377) (7,200)
-------- -------- --------
Loss from continuing operations available to common
stockholders............................................ (17,692) (37,169) (28,523)
Income (loss) from discontinued operations................ (300) 7,688 --
Loss on disposal of discontinued operations............... -- (3,737) --
-------- -------- --------
Net loss available to common stockholders................. $(17,992) $(33,218) $(28,523)
======== ======== ========
DENOMINATOR
Weighted average shares................................... 41,729 47,498 47,538
Weighted average effect of dilutive securities:
Net effect of dilutive stock options.................... -- -- --
Net effect of dilutive stock warrants................... -- -- --
-------- -------- --------
Denominator for diluted calculation....................... 41,729 47,498 47,538
======== ======== ========
Loss per share from continuing operations--basic and
diluted................................................... $ (0.42) $ (0.78) $ (0.60)
Income (loss) per share from discontinued operations--basic
and diluted............................................... (0.01) 0.08 --
-------- -------- --------
Net loss per share--basic and diluted....................... $ (0.43) $ (0.70) $ (0.60)
======== ======== ========
MANAGEMENT ESTIMATES--The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
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-10
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, 1999 and 2000, the related amount
payable to counterparties was $1.5 million and $1.4 million, respectively.
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.
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 is effective for all fiscal years
beginning after June 15, 2000. SFAS No. 133, as amended and interpreted,
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities, and requires companies to recognize all derivatives as
either assets or liabilities in the balance sheet and measure such instruments
at fair value. If the derivative is designated in a fair-value hedge, the
changes in the fair value of the derivative and the hedged item will be
recognized in earnings. If the derivative is designated in a cash flow hedge,
changes in the fair value of the derivative will be recorded in other
comprehensive income ("OCI") and will be recognized in the income statement when
the hedged item affects earnings. SFAS No. 133 defines new requirements for
designation and documentation of hedging
F-11
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT POLICIES (CONTINUED)
relationships as well as ongoing effectiveness assessments in order to use hedge
accounting. For a derivative that does not qualify as a hedge, changes in fair
value will be recognized in earnings. In January 2001 the Company recorded
$882,000 in OCI as a cumulative translation adjustment for derivatives
designated in cash flow-type hedges prior to adopting SFAS No. 133, primarily
related to interest rate swaps.
In September 2000, the FASB issued SFAS No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities", which
replaced SFAS No. 125 and revises the standards for accounting for
securitizations and other transfers of financial assets and collateral and
requires certain disclosures. SFAS No. 140 is effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring after
March 31, 2001. Disclosures relating to securitization transactions are required
for fiscal years ending after December 15, 2000. Management is currently
evaluating the impact on its financial position and results of operations when
SFAS No. 140 is adopted, but does not anticipate any material changes.
The Emerging Issues Task Force ("EITF") is reviewing an issue, Issue
No. 00-22, "Accounting for 'Point' and Other Loyalty Programs," that is closely
related to our Air Miles reward program and the way revenue is recognized for
these types of programs. We understand that the EITF will provide guidance on
this issue sometime in 2001, but a specific date has not been set. When Issue
00-22 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 00-22 at
this time.
RECLASSIFICATIONS--For purposes of comparability, certain prior period
amounts have been reclassified to conform with the current year presentation.
F-12
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
3. REDEMPTION SETTLEMENT ASSETS
Redemption settlement assets consist of cash and cash equivalents and
securities available-for-sale and are designated for settling the Company's
redemptions by collectors under its Air Miles reward program in Canada under
certain contractual relationships with its sponsors. These assets are primarily
denominated in Canadian dollars. Realized gains and losses from the sale of
investment securities were not material. The principal components of redemption
settlement assets, which are carried at fair value, are as follows:
DECEMBER 31, 1999 DECEMBER 31, 2000
-------------------------------------------- -------------------------------------------
UNREALIZED UNREALIZED
------------------- -------------------
COST GAINS LOSSES FAIR VALUE COST GAINS LOSSES FAIR VALUE
-------- -------- -------- ----------- -------- -------- -------- ----------
(IN THOUSANDS)
Cash and cash
equivalents............ $ 69,571 $ -- $ -- $ 69,571 $115,309 $-- $ -- $115,309
Government............... 29,981 -- (1,368) 28,613 16,278 35 (457) 15,856
Corporate................ 11,884 9 (540) 11,353 21,134 18 (355) 20,797
Equity securities........ 25,385 3,171 (4,443) 24,113 35 10 -- 45
-------- ------ ------- -------- -------- --- ----- --------
Total.................... $136,821 $3,180 $(6,351) $133,650 $152,756 $63 $(812) $152,007
======== ====== ======= ======== ======== === ===== ========
4. PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
DECEMBER 31,
-------------------
1999 2000
-------- --------
(IN THOUSANDS)
Software development and conversion costs............... $ 55,156 $ 75,450
Computer equipment and purchased software............... 28,236 30,131
Furniture and fixtures.................................. 40,632 47,127
Leasehold improvements.................................. 31,593 34,455
Construction in progress................................ 6,624 4,542
-------- --------
Total................................................. 162,241 191,705
Accumulated depreciation................................ (73,010) (99,527)
-------- --------
Property and equipment, net............................. $ 89,231 $ 92,178
======== ========
During fiscal 1998, the Company recorded an impairment of $4.0 million on
computer equipment and software related to the 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.
F-13
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
5. SECURITIZATION OF CREDIT CARD RECEIVABLES
The Company regularly securitizes its credit card receivables. 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. We currently have one series that has entered its controlled
amortization period. We do not have any series in early amortization. The
receivables associated with the customer accounts 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
2001 and 2003.
"Due from securitizations" consists of spread deposits, I/O strips and
excess funding deposits as shown in the table below:
DECEMBER 31,
-------------------
1999 2000
-------- --------
(IN THOUSANDS)
Spread deposits......................................... $104,222 $100,807
I/O strips.............................................. 20,289 33,171
Excess funding deposits................................. 19,973 --
-------- --------
$144,484 $133,978
======== ========
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.
F-14
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
5. SECURITIZATION OF CREDIT CARD RECEIVABLES (CONTINUED)
At December 31, 2000, key economic assumptions and the sensitivity of the
current fair value of residual cash flows to immediate 10 percent and
20 percent adverse changes in the assumptions are as follows:
IMPACT ON FAIR VALUE IMPACT ON FAIR VALUE
ASSUMPTION OF 10% CHANGE OF 20% CHANGE
---------- ---------------------- --------------------
(DOLLARS IN THOUSANDS)
Fair value of retained interest............... $ 31,971
Weighted average life......................... 7 months
Discount rate................................. 14.0% $ 998 $ 1,112
Expected yield, net of dilution............... 21.6% 14,729 25,089
Interest expense.............................. 7.0% 4,648 8,272
Net charge-offs rate.......................... 7.0% 5,620 10,234
These sensitivities are hypothetical and should be used with caution. As the
figures indicate, changes in fair value based on a 10 percent variation in
assumptions generally cannot be extrapolated because the relationship of the
change in assumption to the change in fair value may not be linear. Also, in
this table, the effect of a variation in a particular assumption on the fair
value of the retained interest is calculated without changing any other
assumption; in reality, changes in one factor may result in changes in another,
which might magnify or counteract the sensitivities.
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 weighted average life of the underlying
securities and the discount rate. The discount rate is based on a risk adjusted
rate paid on the series. 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,
2000.
The table below summarizes certain cash flows received from and paid to
securitization trusts:
FISCAL
-------------------
1999 2000
-------- --------
(IN MILLIONS)
Proceeds from collections reinvested in previous credit
card securitizations................................... $4,070.0 $4,235.7
======== ========
Servicing fees received.................................. $ 37.4 $ 39.6
======== ========
Other cash flows received on retained interests.......... $ 124.1 $ 146.8
======== ========
F-15
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
5. SECURITIZATION OF CREDIT CARD RECEIVABLES (CONTINUED)
The table below presents quantitative information about the components of
total credit card receivables managed, delinquencies and net charge-offs:
AT DECEMBER 31,
-------------------
1999 2000
-------- --------
(IN MILLIONS)
Total principal of credit card receivables managed...... $2,258.6 $2,331.0
Less credit card receivables securitized................ 2,232.4 2,319.7
-------- --------
Credit card receivables held............................ $ 26.2 $ 11.3
======== ========
Principal amount of credit card receivables 90 days or
more past due......................................... $ 60.0 $ 64.5
======== ========
YEAR ENDED
DECEMBER 31,
-------------------
1999 2000
-------- --------
(IN THOUSANDS)
Net charge-offs......................................... $143,370 $157,351
======== ========
The Company is required to maintain minimum interests ranging from 3% to 6%
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:
AMORTIZATION LIFE
DECEMBER 31, AND METHOD
--------------------- --------------------------
1999 2000
--------- ---------
(IN THOUSANDS)
Premium on purchased 3 years--straight line
credit card portfolio... $ 38,536 $ 1,936
Customer contracts and 3-20 years--straight line
lists................... 46,700 46,700
Noncompete agreement...... 2,300 2,300 5 years--straight line
Goodwill.................. 411,009 407,833 20-25 years--straight line
Deferred incentives....... 11,086 10,753 27 months--straight line
Sponsor contracts......... 39,495 38,306 5 years--declining balance
Collector database........ 48,503 47,043 15%--declining balance
--------- ---------
Total................... 597,629 554,871
Accumulated
amortization............ (104,020) (110,322)
--------- ---------
Intangible assets and
goodwill, net........... $ 493,609 $ 444,549
========= =========
F-16
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
7. DEFERRED REVENUE
A reconciliation of deferred revenue--service, and deferred
revenue--redemption, for the Air Miles program is as follows:
FISCAL
-------------------
1999 2000
-------- --------
(IN THOUSANDS)
DEFERRED REVENUE--SERVICE
Beginning balance..................................... $ 64,609 $ 84,474
Cash proceeds......................................... 51,916 55,091
Revenue recognized.................................... (36,409) (47,098)
Other................................................. 4,358 (3,536)
-------- --------
Ending balance........................................ $ 84,474 $ 88,931
======== ========
DEFERRED REVENUE--REDEMPTION
Beginning balance..................................... $ 93,583 $164,867
Cash proceeds......................................... 94,620 90,889
Revenue recognized.................................... (30,911) (49,597)
Other................................................. 7,575 (4,904)
-------- --------
Ending balance........................................ $164,867 $201,255
======== ========
The Company currently estimates breakage to be one-third of miles issued.
8. DEBT
Debt consists of the following:
DECEMBER 31,
---------------------
1999 2000
--------- ---------
(IN THOUSANDS)
Certificates of deposit............................... $ 116,900 $ 139,400
Subordinated notes.................................... 102,000 102,000
Credit agreement...................................... 120,361 92,910
Term loans............................................ 95,875 91,750
Line of credit........................................ -- 10,000
--------- ---------
435,136 436,060
Less: current portion................................. (118,225) (161,725)
--------- ---------
Long term portion..................................... $ 316,911 $ 274,335
========= =========
CERTIFICATES OF DEPOSIT--Terms of the certificates of deposit range from
three months to 24 months with annual interest rates ranging from 5.4% to 6.9%
at December 31, 1999 and from 5.5% to 7.5% at December 31, 2000. Interest is
paid monthly and at maturity.
SUBORDINATED NOTES--The Company has outstanding subordinated notes with its
two largest stockholders in the aggregate principal amount of $50.0 million.
Such notes bear interest at 10% payable semiannually. These notes were issued at
an aggregate discount of approximately $3.6 million, and such discount is
accreted into interest expense using the effective rate of approximately 12%
over
F-17
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
8. DEBT (CONTINUED)
the life of the notes. The notes are to be repaid on October 25, 2005. The
Company may, at its option, prepay the notes at their 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 8.0% and 8.8% at December 31, 1999 and 2000, 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.
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 8.1% and 9.3%, respectively,
at December 31, 2000.
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. The effective interest rate was 10.6% at
December 31, 2000.
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.
F-18
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
8. DEBT (CONTINUED)
Debt at December 31, 2000 matures as follows (in thousands):
2001.............................................. $161,725
2002.............................................. 67,925
2003.............................................. 59,410
2004.............................................. 1,000
2005.............................................. 94,000
Thereafter........................................ 52,000
--------
$436,060
========
9. INCOME TAXES
The Company files a consolidated Federal income tax return. Components of
the provision (credit) for income taxes are as follows:
FISCAL
------------------------------
1998 1999 2000
-------- -------- --------
(IN THOUSANDS)
CURRENT
Federal...................................... $ 5,789 $ 18,827 $ (1,100)
State........................................ 98 483 2,424
Foreign...................................... 1,777 9,610 13,631
-------- -------- --------
Total current.............................. 7,664 28,920 14,955
-------- -------- --------
DEFERRED
Federal...................................... (4,839) (15,081) 7,227
State........................................ (808) 1,182 (669)
Foreign...................................... (6,725) (21,559) (19,672)
-------- -------- --------
Total deferred............................. (12,372) (35,458) (13,114)
-------- -------- --------
Tax (benefit) expense related to continuing
operations................................... (4,708) (6,538) 1,841
Tax (benefit) expense related to discontinued
operations................................... (159) 2,127 --
-------- -------- --------
Total income tax provision (benefit)........... $ (4,867) $ (4,411) $ 1,841
======== ======== ========
F-19
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
9. INCOME TAXES (CONTINUED)
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 from continuing operations before income taxes is as follows:
FISCAL
------------------------------
1998 1999 2000
-------- -------- --------
(IN THOUSANDS)
Expected (benefit) expense at statutory rate..... $(7,840) $(14,115) $(6,819)
Increase (decrease) in income taxes resulting
from:
State and foreign income taxes................. 63 296 1,552
Non-deductible foreign losses.................. 832 623 1,339
Non-deductible acquired goodwill and other
intangibles.................................. 2,134 11,254 3,187
Change in valuation allowance.................. -- (3,266) 2,635
Other--net..................................... 103 (1,330) (53)
------- -------- -------
Total........................................ $(4,708) $ (6,538) $ 1,841
======= ======== =======
Deferred tax assets and liabilities consist of the following:
DECEMBER 31,
----------------------
1999 2000
---------- ---------
(IN THOUSANDS)
DEFERRED TAX ASSETS
Deferred income.................................... $13,410 $ 9,506
Deferred revenue................................... 23,299 42,955
Allowance for doubtful accounts.................... 1,405 2,380
Intangible assets.................................. 20,008 18,506
Net operating loss carryforwards................... 11,966 13,458
Depreciation....................................... 2,875 3,046
Discontinued operations............................ 2,186 826
Other.............................................. 3,935 5,836
------- -------
Total deferred tax assets........................ 79,084 96,513
------- -------
DEFERRED TAX LIABILITIES
Servicing rights................................... 8,120 10,990
Accrued expenses................................... 468 (400)
Other.............................................. 348 26
------- -------
Total deferred tax liabilities................... 8,936 10,616
------- -------
Net deferred tax asset......................... 70,148 85,897
Valuation allowance................................ (5,531) (8,166)
------- -------
Net deferred tax asset............................. $64,617 $77,731
======= =======
F-20
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
9. INCOME TAXES (CONTINUED)
At December 31, 2000, the Company had approximately $15.6 million of Federal
net operating loss carryforwards, which expire at various times through 2013. In
addition, the Company has approximately $196 million of state net operating loss
carryforwards, which expire at various times through 2016. 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 benefit associated with their respective
unrealizable federal and state NOL's. In 2000, the Company increased the
valuation allowance by $2.6 million. 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.
10. 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, 2000 were approximately $11.0 million.
- Each share is convertible into common shares at a conversion rate based on
the lesser of $13.50 or the initial public offering price, 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.
11. STOCKHOLDERS' EQUITY
As part of consideration for the BSI acquisition, the seller received
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 Company assigned a fair value
of $9.00 per warrant or $1,503,756 which was included in the acquisition
purchase price. The warrants expire in January 2008. The fair value of the
warrants was determined based on the fair value of the Company at the time of
acquisition.
During July 1999, the stockholders approved an increase in the number of
authorized shares from 50,000,000 shares to 66,666,667 shares.
During March 2000, the stockholders approved an increase in the number of
authorized shares from 66,666,667 shares to 200,000,000 shares.
F-21
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
12. 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"), as
amended and restated. 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:
FISCAL
------------------------------
1998 1999 2000
-------- -------- --------
Expected dividend yield............................. -- -- --
Risk-free interest rate............................. 6.0% 7.0% 7.0%
Expected life of options (years).................... 4.0 yrs 4.0 yrs 4.0 yrs
Assumed volatility.................................. 0.01% 0.01% 0.01%
Weighted average fair value......................... $ 2.79 $ 2.43 $ 6.68
The following table summarizes stock option activity under the Plan:
OPTIONS WEIGHTED AVERAGE
OUTSTANDING EXERCISE PRICE
------------ -----------------
(IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
BALANCE AT JANUARY 31, 1998....................... 1,156 $ 9.00
Granted......................................... 912 9.45
Exercised....................................... (57) 9.00
Cancelled....................................... (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
Granted......................................... 2,648 14.98
Exercised....................................... (17) 9.09
Cancelled....................................... (96) 10.39
-----
BALANCE AT DECEMBER 31, 2000...................... 4,883 $12.45
=====
The following table summarizes information concerning currently outstanding
and exercisable stock options at December 31, 2000 (in thousands, except per
share amounts):
OUTSTANDING EXERCISABLE
---------------------------------------- -------------------------
REMAINING WEIGHTED WEIGHTED
RANGE OF EXERCISE CONTRACTUAL AVERAGE AVERAGE
PRICES OPTIONS LIFE (YEARS) EXERCISE PRICE OPTIONS EXERCISE PRICE
----------------- -------- ------------ -------------- -------- --------------
$9.00 to $12.00 2,257 7.39 $ 9.52 1,232 $9.31
$12.01 to $15.00 2,626 9.68 $15.00 -- --
F-22
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
12. STOCK COMPENSATION PLANS (CONTINUED)
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 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):
FISCAL
------------------------------
1998 1999 2000
-------- -------- --------
Pro forma net income (loss).................... $(18,629) $(30,331) $(25,708)
======== ======== ========
Basic and diluted pro forma earnings per
share........................................ $ (0.45) $ (0.71) $ (0.69)
======== ======== ========
13. 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.
14. 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
$53.4 million at December 31, 2000, which exceeds the estimated amount of the
obligation to provide travel and other rewards.
The Company currently has an obligation to fund redemption of Air Miles
reward miles as they are redeemed by collectors. The Company believes that the
redemption settlement assets are sufficient to meet that obligation.
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, 2000 are (in thousands):
YEAR:
-----
2001.............................................. $ 38,846
2002.............................................. 23,570
2003.............................................. 14,595
2004.............................................. 11,707
2005.............................................. 9,775
Thereafter........................................ 29,320
--------
Total............................................. $127,813
========
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
F-23
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
14. COMMITMENTS AND CONTINGENCIES (CONTINUED)
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 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 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, WFNNB is considered well
capitalized. As of December 31, 2000, WFNNB's Tier 1 capital ratio was 14.1%,
total capital ratio was 14.4% and leverage ratio was 44.8%, 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, 2000, WFNNB had approximately 29.2 million active
accountholders, having an unused line of credit averaging $673 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, 2000, 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.
15. 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
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
15. FINANCIAL INSTRUMENTS (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS--The estimated fair values of the
Company's financial instruments were as follows:
DECEMBER 31
-----------------------------------------------------------
1999 2000
---------------------------- ----------------------------
CARRYING AMOUNT FAIR VALUE CARRYING AMOUNT FAIR VALUE
--------------- ---------- --------------- ----------
(IN THOUSANDS)
FINANCIAL ASSETS
Cash and cash equivalents................ $ 56,546 $ 56,546 $116,941 $116,941
Redemption settlement assets............. 133,650 133,650 152,007 152,007
Trade receivables........................ 69,085 69,085 115,727 115,727
Credit card receivables and seller's
interest, net.......................... 150,804 150,804 137,865 137,865
Due from securitizations................. 144,484 144,484 133,978 133,978
FINANCIAL LIABILITIES
Accounts payable......................... 55,921 55,921 63,570 63,570
Debt..................................... 435,136 447,861 436,060 427,125
NOTIONAL AMOUNT FAIR VALUE NOTIONAL AMOUNT FAIR VALUE
--------------- ---------- --------------- ----------
Interest swaps............................. $725,000 $ (6,083) $351,750 $ (5,478)
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.
REDEMPTION SETTLEMENT ASSETS--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.
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
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
16. INTEREST SWAPS
INTEREST SWAPS--In March 1997, WFNNB entered into an interest rate swap
agreement with J.P. Morgan Company ("Morgan") with a notional amount totaling
$200.0 million. This interest rate swap effectively changed WFNNB's interest
rate exposure on $200.0 million of securitized credit card receivables to a
fixed rate of approximately 6.72%. 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, $60 million at
December 31, 2000, 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. One of the interest rate swaps effectively changed
Loyalty's interest rate exposure on $50 million of notes payable (decreasing
with principal payments) from a variable rate based on Canadian Bankers
Acceptance to a fixed rate of 9.3%. The other interest rate swap effectively
changed Loyalty's interest rate exposure on $50 million of notes payable
(decreasing with principal payments) from a variable rate based on Canadian
Bankers Acceptance to a variable rate based on LIBOR. The following briefly
outlines the terms of each swap agreement:
FIXED/VARIABLE FIXED/VARIABLE
NOTIONAL AMOUNT SWAP PERIOD RATE RECEIVED RATE PAID
----------------------- --------------------------------------- ------------------------ ------------------------
$200,000,000........... May 15, 1997 through May 15, 2004 USD-LIBOR-BBA 6.720%
$60,000,000............ January 30, 1998 through March 15, 2003 5.67% USD-LIBOR-BBA
$43,750,000............ October 26, 1998 through July 25, 2003 USD-LIBOR-BBA+2.00% CAD-BA-CDOR+2.26%
$48,000,000............ October 26, 1998 through July 25, 2005 USD-LIBOR-BBA+3.25% 9.265%
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
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
17. PARENT ONLY FINANCIAL STATEMENTS
ALLIANCE DATA SYSTEMS CORPORATION
(PARENT COMPANY ONLY)
CONDENSED FINANCIAL INFORMATION
DECEMBER 31,
-------------------
1999 2000
BALANCE SHEETS -------- --------
(IN THOUSANDS)
Assets:
Cash and cash equivalents................................... $ -- $ 7
Investment in subsidiaries.................................. 350,285 351,270
Loans to subsidiaries....................................... 181,750 274,750
Receivables from subsidiaries............................... 66,179
Trade receivables........................................... -- --
Other....................................................... 12,867 3,976
-------- --------
Total assets.............................................. $611,081 $630,003
======== ========
Liabilities:
Long-term and subordinated debt............................. $222,361 $195,975
Borrowings from subsidiaries................................ -- 6,659
Other....................................................... 10,432 6,180
-------- --------
Total liabilities......................................... 232,793 208,814
Stockholders' equity........................................ 378,288 421,189
-------- --------
Total liabilities and stockholders' equity................ $611,081 $630,003
======== ========
FISCAL
------------------------------
1998 1999 2000
STATEMENTS OF INCOME -------- -------- --------
(IN THOUSANDS)
Interest from loans to subsidiaries......................... $17,907 $23,962 $24,648
Dividends from subsidiary................................... -- 40,000 32,000
Processing and servicing fees............................... 4,457 3,404 --
Other income................................................ 156 149 --
------- ------- -------
Total revenue............................................. 22,520 67,515 56,648
Interest expense............................................ 21,165 25,981 24,296
Other expense............................................... 153 256 970
------- ------- -------
Total expense............................................. 21,318 26,237 25,266
------- ------- -------
Income before income taxes.................................. 1,202 41,278 31,382
Income tax expense.......................................... 486 720 540
------- ------- -------
Net income.................................................. $ 716 $40,558 $30,842
======= ======= =======
Note: Alliance Data Systems Corporation accounts for its investments in
subsidiaries under the cost method.
F-27
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
17. PARENT ONLY FINANCIAL STATEMENTS (CONTINUED)
FISCAL
---------------------------------
1998 1999 2000
STATEMENTS OF CASH FLOWS --------- --------- ---------
(IN THOUSANDS)
Net cash provided by (used in) operating activities......... $ (78,260) $ 115,555 $ 99,338
Investing activities:
Net cash paid for corporate acquisitions.................... (151,500) (169,322) 10,925
Loans to subsidiaries....................................... -- -- (93,000)
--------- --------- ---------
Net cash used in investing activities....................... (151,500) (169,322) (82,075)
Financing Activities:
Borrowings from subsidiaries................................ 17,490 41,331 --
Issuance of long-term and subordinated debt................. 327,159 320,624 391,000
Repayment of long-term and subordinated debt................ (221,676) (428,854) (408,405)
Net proceeds from preferred stock........................... -- 119,400 --
Net proceeds from issuances of common stock................. 107,042 377 149
--------- --------- ---------
Net cash provided by (used in) financing activities......... 230,015 52,878 (17,256)
--------- --------- ---------
Increase (decrease) in cash and cash equivalents............ 255 (889) 7
Cash and cash equivalents at beginning of period............ 634 889 --
--------- --------- ---------
Cash and cash equivalents at end of period.................. $ 889 $ -- $ 7
========= ========= =========
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; and Executive Vice Presidents. 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. The margin is based on
F-28
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
18. SEGMENT INFORMATION (CONTINUED)
current market rates for similar services. Revenues are attributed to geographic
areas based on the location of the unit processing the underlying transactions.
TRANSACTION CREDIT MARKETING OTHER/
SERVICES SERVICES SERVICES ELIMINATION TOTAL
FISCAL 1998 ----------- -------- --------- ----------- --------
(IN THOUSANDS)
Revenues................................ $303,186 $212,663 $ 60,892 $(165,828) $410,913
Depreciation and amortization........... 25,419 11,763 14,854 -- 52,036
Operating profit........................ 4,405 12,883 (11,804) -- 5,484
TRANSACTION CREDIT MARKETING OTHER/
SERVICES SERVICES SERVICES ELIMINATION TOTAL
FISCAL 1999 ----------- -------- --------- ----------- --------
(IN THOUSANDS)
Revenues................................. $381,027 $247,824 $138,310 $(184,079) $583,082
Depreciation and amortization............ 28,814 12,060 36,926 -- 77,800
Operating profit......................... 13,014 17,743 (28,302) -- 2,455
TRANSACTION CREDIT MARKETING OTHER/
SERVICES SERVICES SERVICES ELIMINATION TOTAL
FISCAL 2000 ----------- -------- --------- ----------- --------
(IN THOUSANDS)
Revenues................................. $437,980 $268,183 $178,214 $(206,182) $678,195
Depreciation and amortization............ 41,747 1,259 33,138 -- 76,144
Operating profit......................... 13,017 24,059 (15,211) -- 21,865
Information concerning principal geographic areas is as follows:
UNITED STATES REST OF WORLD(1) TOTAL
------------- ---------------- ----------
(IN THOUSANDS)
Revenues
Fiscal 1998......................... $367,588 $ 43,325 $ 410,913
Fiscal 1999......................... 467,629 115,453 583,082
Fiscal 2000......................... 518,839 159,356 678,195
Total assets
December 31, 1999................... 834,838 466,425 1,301,263
December 31, 2000................... 936,849 483,757 1,420,606
------------------------
(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
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
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 and a database marketing agreement with several affiliates
of The Limited. The Company has received fees from The Limited and its
affiliates of $40.6 million for fiscal 1998, $46.6 million for fiscal 1999, and
$46.7 million for fiscal 2000.
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 had revenues of approximately $44.9 million and
$43.1 million in fiscal 1998 and 1999, respectively. The net assets of the
business were immaterial.
21. SUBSEQUENT EVENTS
Effective February 28, 2001, the Company acquired substantially all of the
operating assets of Utilipro, Inc., a subsidiary of AGL Resources, Inc., for
$20.3 million in cash. Utilipro is an account processing and servicing provider
to the deregulated utility sector. Utilipro provides these services to three
clients serving approximately 500,000 customers.
F-30
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR THE THREE MONTHS
ENDED MARCH 31,
---------------------
2000 2001
--------- ---------
Revenues
Transaction and marketing services........................ $ 98,770 $107,142
Redemption revenue........................................ 18,656 22,343
Financing charges, net.................................... 44,359 45,478
Other income.............................................. 3,762 5,729
-------- --------
Total revenue........................................... 165,547 180,692
Operating expenses
Cost of operations........................................ 134,571 143,258
General and administrative................................ 7,505 9,333
Depreciation and other amortization....................... 5,997 6,367
Amortization of purchased intangibles..................... 13,795 11,113
-------- --------
Total operating expenses................................ 161,868 170,071
Operating income............................................ 3,679 10,621
Other non-operating expense................................. 2,476 --
Interest expense............................................ 8,776 9,635
-------- --------
Loss before income taxes.................................... (7,573) 986
Income tax expense (benefit)................................ 716 933
-------- --------
Net income (loss)........................................... $ (8,289) $ 53
======== ========
Loss per share--basic and diluted........................... $ (0.21) $ (0.04)
======== ========
Weighted average shares--basic and diluted.................. 47,529 47,568
======== ========
See accompanying notes to consolidated financial statements.
F-31
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
MARCH 31, 2001
--------------------------
PRO FORMA
STOCKHOLDERS'
DECEMBER 31, 2000 ACTUAL EQUITY
----------------- ---------- -------------
(AUDITED) (UNAUDITED)
ASSETS
Cash and cash equivalents............................ $ 116,941 $ 58,756
Due from card associations........................... 125,083 60,563
Trade receivables.................................... 86,153 66,008
Credit card receivables and seller's interest........ 137,865 125,013
Other current assets................................. 57,733 56,650
---------- ----------
Total current assets............................... 523,775 366,990
Redemption settlement assets, restricted............. 152,007 158,171
Property and equipment, net.......................... 92,178 95,972
Other non-current assets............................. 74,119 79,913
Due from securitizations............................. 133,978 146,775
Intangible assets and goodwill, net.................. 444,549 457,011
---------- ----------
Total assets....................................... $1,420,606 $1,304,832
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable..................................... $ 63,570 $ 56,438
Accrued expenses..................................... 80,547 64,998
Merchant settlement obligations...................... 149,271 76,777
Other liabilities.................................... 36,725 28,733
Debt, current portion................................ 161,725 143,525
---------- ----------
Total current liabilities.......................... 491,838 370,471
Other liabilities.................................... 1,856 7,958
Deferred revenue--service............................ 88,931 96,805
Deferred revenue--redemption......................... 201,255 206,625
Long-term and subordinated debt...................... 274,335 270,750
---------- ----------
Total liabilities.................................. 1,058,215 952,609
Commitments and contingencies
Series A cumulative convertible preferred stock,
$0.01 par value; 120 shares authorized, issued and
outstanding........................................ 119,400 119,400 $ --
Stockholders' equity:
Common stock, $0.01 par value; authorized 200,000
shares (December 31, 2000 and March 31, 2001),
issued and outstanding, 47,545 shares (December 31,
2000), 47,662 shares (March 31, 2001), and 57,886
shares (pro forma)................................. 475 477 579
Additional paid-in capital........................... 226,323 227,829 347,127
Retained earnings.................................... 16,370 16,423 16,423
Accumulated other comprehensive income (loss)........ (177) (11,906) (11,906)
---------- ---------- ----------
Total stockholders' equity........................... 242,991 232,823 352,223
---------- ---------- ----------
Total liabilities and stockholders' equity........... $1,420,606 $1,304,832 $1,304,832
========== ========== ==========
See accompanying notes to consolidated financial statements.
F-32
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
---------------------
2000 2001
--------- ---------
(UNAUDITED)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)......................................... $ (8,289) $ 52
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization............................. 19,792 17,480
Deferred income taxes..................................... (2,257) (1,789)
Loss on sale of equity securities......................... 2,467 --
Accretion of deferred income.............................. -- --
Provision (credit) for doubtful accounts.................. 2,074 573
Change in operating assets and liabilities, net of
acquisitions:
Change in trade accounts receivables.................... (1,385) 22,739
Change in merchant settlement activity.................. 26,288 (7,974)
Change in other assets.................................. 10,385 (2,856)
Change in accounts payable and accrued expenses......... (44,866) (27,330)
Change in deferred revenue.............................. 10,794 13,244
Change in other liabilities............................. (1,938) (1,889)
Other operating activities.............................. 1,807 (1,253)
--------- ---------
Net cash provided by operating activities............. 14,872 10,997
CASH FLOWS FROM INVESTING ACTIVITIES
Increase in redemption settlement assets.................. (5,804) (6,164)
Net cash paid for corporate acquisition................... -- (18,750)
Purchase of credit card receivables....................... -- (76,487)
Proceeds from sale of credit card receivable portfolios... -- 74,258
Change in seller's interest............................... 14,326 11,914
Change in due from securitizations........................ 15,038 (12,797)
Capital expenditures...................................... (8,366) (9,149)
--------- ---------
Net cash provided by (used in) investing activities... 15,194 (37,175)
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under debt agreements.......................... 122,700 171,200
Repayment of borrowings................................... (141,051) (192,986)
Proceeds from issuance of preferred stock................. -- --
Proceeds from issuance of common stock.................... -- 1,508
--------- ---------
Net cash used in financing activities................. (18,351) (20,278)
Effect of exchange rate changes............................. (1,192) (11,729)
--------- ---------
Change in cash and cash equivalents......................... 10,523 (58,185)
Cash and cash equivalents at beginning of period............ 56,546 116,941
--------- ---------
Cash and cash equivalents at end of period.................. $ 67,069 $ 58,756
========= =========
SUPPLEMENTAL CASH FLOW DISCLOSURE:
Interest paid............................................. $ 13,110 $ 9,635
========= =========
Income taxes paid......................................... $ 4,695 $ 10,156
========= =========
See accompanying notes to consolidated financial statements.
F-33
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, 2000 and 2001 have
been prepared in accordance with accounting principles generally accepted in the
United States of America and 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 11
months ended December 31, 1998 and at and for the years ended December 31, 1999
and 2000 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 (in thousands):
THREE MONTHS ENDED
MARCH 31,
---------------------
2000 2001
--------- ---------
Net income (loss).......................................... $ (8,289) $ 53
Unrealized gains on securities available-for-sale.......... 2,106 --
Currency translation adjustment............................ (338) (11,729)
--------- ---------
Total comprehensive loss................................... $ (6,521) $ (11,676)
========= =========
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. The following table sets
F-34
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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):
THREE MONTHS ENDED
MARCH 31,
---------------------
2000 2001
--------- ---------
NUMERATOR
Net income (loss)......................................... $ (8,289) $ 53
Preferred stock dividends................................. 1,800 1,800
--------- ---------
Numerator for basic and diluted earnings per share--loss
attributable to common stockholders..................... $ (10,089) $ (1,747)
========= =========
DENOMINATOR
Weighted average shares................................... 47,529 47,568
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...................... 47,529 47,568
========= =========
NET (LOSS) PER SHARE
Basic and diluted......................................... $ (0.21) $ (0.04)
========= =========
RECENTLY ISSUED ACCOUNTING STANDARDS
Effective January 1, 2001, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 133 "Accounting for Derivative Instruments and
Hedging Activities." This statement, as amended and interpreted, establishes
accounting and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging activities.
SFAS No. 133 requires a company to recognize all derivatives as either assets or
liabilities in the balance sheet and measure such instruments at fair value.
Derivatives that are not hedges must be adjusted to fair value through income.
If the derivative is a hedge, depending on the nature of the hedge, changes in
the fair value of derivatives are either offset against the change in fair value
of assets, liabilities or firm commitments through earnings or recognized in
other comprehensive income until the hedged item is recognized in earnings. The
ineffective portion of a derivative's change in fair value will be immediately
recognized in earnings. The cumulative effect of the change in accounting
principle due to the adoption of SFAS No. 133 resulted in the recognition of
$882,000 (net of tax) in other comprehensive income. During the three months
ended March 31, 2001, the amount recorded in earnings (a) related to cash flow
hedge ineffectiveness and (b) as a result of the discontinuance of cash flow
hedges because it is probable that the original transactions will not occur by
the end of the originally specified period, was immaterial.
The Company currently uses derivative financial instruments primarily to
reduce its exposure to adverse fluctuations in interest rates. When entered
into, the Company formally designates and documents the financial instrument as
a hedge of a specific underlying exposure, as well as the risk-management
objectives and strategies for undertaking the hedge transaction. Because of the
high degree of effectiveness between the hedging instrument and the underlying
exposure being hedged, fluctuations in the value of the derivative instruments
are generally offset by changes in the cash flows of the underlying exposures
being hedged. Derivatives are recorded in the condensed consolidated balance
sheet at fair value in other assets or other liabilities, depending on whether
the amount is an
F-35
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION (CONTINUED)
asset or liability. The earnings impact resulting from the Company's derivative
instruments is recorded in the same line item within the condensed consolidated
statement of operations as the underlying exposure being hedged. The Company
also formally assesses, both at the inception and at least quarterly thereafter,
whether the financial instruments that are used in hedging transactions are
effective at offsetting changes in either the fair value or cash flows of the
related underlying exposures. Any ineffective portion of a financial
instrument's change in fair value is immediately recognized in earnings.
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, 2001 reflects the conversion of all
outstanding convertible preferred stock at March 31, 2001 into 10,223,572 shares
of common stock.
2. SEGMENT INFORMATION
The Company classifies its businesses into three segments: Transaction
Services, Credit Services and Marketing Services.
TRANSACTION CREDIT MARKETING OTHER/
SERVICES SERVICES SERVICES ELIMINATION TOTAL
THREE MONTHS ENDED MARCH 31, 2000 ----------- -------- --------- ----------- --------
(IN THOUSANDS)
Revenues.................................. $108,748 $69,903 $39,451 $(52,555) $165,547
Depreciation and amortization............. 10,282 315 9,195 -- 19,972
Operating profit.......................... 3,277 8,286 (7,884) -- 3,679
TRANSACTION CREDIT MARKETING OTHER/
SERVICES SERVICES SERVICES ELIMINATION TOTAL
THREE MONTHS ENDED MARCH 31, 2001 ----------- -------- --------- ----------- --------
(IN THOUSANDS)
Revenues.................................. $118,168 $73,810 $44,291 $(55,577) $180,692
Depreciation and amortization............. 9,972 401 7,107 -- 17,480
Operating profit.......................... 4,540 7,961 (1,880) -- 10,621
3. ACQUISITIONS
Effective February 28, 2001, the Company acquired substantially all of the
operating assets of Utilipro, Inc., a subsidiary of AGL Resources, Inc., for
$20.3 million in cash. Utilipro is an account processing and servicing provider
to the deregulated utility sector. Utilipro provides these services to three
clients serving aproximately 500,000 customers.
F-36
INDEPENDENT AUDITORS' REPORT
Board of Directors of Utilipro, Inc.:
We have audited the accompanying consolidated balance sheets of
Utilipro, Inc. and subsidiaries (the "Company") as of September 30, 1999 and
2000, and the related consolidated statements of operations and comprehensive
loss, changes in stockholders' equity, 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 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, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of the Company
as of September 30, 1999 and 2000, and the results of its operations and its
cash flows for the years then ended in conformity with accounting principles
generally accepted in the United States of America.
/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
Atlanta, Georgia
February 28, 2001
F-37
UTILIPRO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30,
-------------------------- DECEMBER 31,
1999 2000 2000
----------- ------------ -------------
(UNAUDITED)
ASSETS
Cash.................................................. $ 194,405 $ 270,190 $ 521,101
Accounts receivable--affiliate........................ 1,537,259 5,843,621 1,981,022
Accounts receivable--nonaffiliates, net of allowance
for doubtful accounts of $957,226, $3,311,590 and
$3,505,387 at September 30, 1999 and 2000 and
December 31, 2000, respectively..................... 1,372,044 500,000 500,000
Prepaid expenses and other current assets............. 114,943 283,391 225,764
Current deferred tax asset............................ 575,253 1,316,590 1,360,848
----------- ------------ -----------
Total current assets.............................. 3,793,904 8,213,792 4,588,735
Property and equipment, net........................... 3,770,395 3,443,606 3,485,298
Deferred tax asset.................................... 170,962 136,227
Tax receivable from affiliate......................... 1,073,960 3,508,565 3,758,374
Other assets.......................................... 68,444 118,716 118,716
----------- ------------ -----------
$ 8,706,703 $ 15,455,641 $12,087,350
=========== ============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable...................................... $ 1,648,602 $ 313,935 $ 405,154
Accrued salaries and benefits......................... 763,745 673,631 241,643
Other accrued expenses................................ 314,976 1,729,330 691,305
Notes payable to affiliates........................... 4,162,011 16,104,399 14,787,159
Current portion of long-term debt..................... 420,825 850,488 705,171
----------- ------------ -----------
Total current liabilities......................... 7,310,159 19,671,783 16,830,432
Long-term debt........................................ 574,351 1,067,256 968,891
Deferred tax liability................................ 191,848 -- --
----------- ------------ -----------
Total liabilities................................. 8,076,358 20,739,039 17,799,323
----------- ------------ -----------
Commitments and contingencies (Notes 3, 8 and 9)
Redeemable Preferred Stock, Series A Convertible,
$1.00 par value 4,200,000 shares authorized, 700,000
issued and outstanding.............................. 700,000 700,000 700,000
Stockholders' equity (deficit):
Common stock, $1.00 par value, 10,000,000 shares
authorized, 123,529 shares issued and outstanding as
of September 30, 1999 and 62,999 shares issued and
outstanding as of September 30, 2000 and
December 31, 2000 (unaudited)....................... 123,529 62,999 62,999
Additional paid-in capital............................ 3,500,000 3,378,940 3,378,940
Accumulated other comprehensive loss.................. (109) -- --
Accumulated deficit................................... (3,693,075) (9,425,337) (9,853,912)
----------- ------------ -----------
Total stockholders' equity (deficit).............. (69,655) (5,983,398) (6,411,973)
----------- ------------ -----------
Total liabilities and stockholders' equity........ $ 8,706,703 $ 15,455,641 $12,087,350
=========== ============ ===========
See accompanying notes to consolidated financial statements.
F-38
UTILIPRO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
THREE MONTHS ENDED
YEAR ENDED SEPTEMBER 30, DECEMBER 31,
----------------------------- ---------------------------
1999 2000 1999 2000
----------- ------------ ----------- ----------
(UNAUDITED)
Revenues
Affiliate............................ $ 5,289,008 $ 13,648,089 $ 1,830,195 $4,048,323
Nonaffiliate......................... 3,310,702 4,083,554 1,161,433 91,952
----------- ------------ ----------- ----------
Total revenues..................... 8,599,710 17,731,643 2,991,628 4,140,275
----------- ------------ ----------- ----------
Expenses
Payroll and employee benefits........ 5,686,438 12,158,138 2,329,458 2,039,523
Other operating expenses............. 6,992,762 12,654,070 2,588,909 1,982,309
Depreciation......................... 638,794 1,260,697 273,675 373,989
----------- ------------ ----------- ----------
Total expenses..................... 13,317,994 26,072,905 5,192,042 4,395,821
----------- ------------ ----------- ----------
Operating loss......................... (4,718,284) (8,341,262) (2,200,414) (255,546)
Interest expense....................... 103,242 1,121,671 182,083 437,243
Other income, net...................... (58,639) (191,919) (70,491) (4,883)
----------- ------------ ----------- ----------
Loss before income taxes............... (4,762,887) (9,271,014) (2,312,006) (687,906)
Income tax benefit..................... 1,842,285 3,538,752 887,500 259,331
----------- ------------ ----------- ----------
Net loss............................... $(2,920,602) $ (5,732,262) $(1,424,506) $ (428,575)
=========== ============ =========== ==========
Foreign currency translation
adjustment........................... (109) 109 -- --
----------- ------------ ----------- ----------
Comprehensive loss..................... $(2,920,711) $ (5,732,153) $(1,424,506) $ (428,575)
=========== ============ =========== ==========
See accompanying notes to consolidated financial statements.
F-39
UTILIPRO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
COMMON STOCK ACCUMULATED
---------------------- ADDITIONAL OTHER
SHARES PAID-IN COMPREHENSIVE ACCUMULATED
OUTSTANDING AMOUNT CAPITAL (LOSS) DEFICIT TOTAL
----------- -------- ---------- ------------- ----------- -----------
September 30, 1998............... 123,529 $123,529 $ 700,000 $ -- $ (772,473) $ 51,056
Capital contribution........... 2,800,000 2,800,000
Foreign currency translation
adjustment................... (109) (109)
Net loss....................... (2,920,602) (2,920,602)
------- -------- ---------- ----- ----------- -----------
September 30, 1999............... 123,529 123,529 3,500,000 (109) (3,693,075) (69,655)
Repurchase of common stock..... (60,530) (60,530) (121,060) (181,590)
Foreign currency translation
adjustment................... 109 109
Net loss......................... (5,732,262) (5,732,262)
------- -------- ---------- ----- ----------- -----------
September 30, 2000............... 62,999 62,999 3,378,940 -- (9,425,337) (5,983,398)
Net loss (unaudited)........... (428,575) (428,575)
------- -------- ---------- ----- ----------- -----------
December 31, 2000 (unaudited).... 62,999 $ 62,999 $3,378,940 $ -- $(9,853,912) $(6,411,973)
======= ======== ========== ===== =========== ===========
See accompanying notes to consolidated financial statements.
F-40
UTILIPRO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED
YEAR ENDED SEPTEMBER 30, DECEMBER 31,
-------------------------- ------------------------
1999 2000 1999 2000
----------- ------------ ----------- ----------
(UNAUDITED)
OPERATING ACTIVITIES:
Net loss................................. $(2,920,602) $ (5,732,262) $(1,424,506) $ (428,575)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depreciation........................... 638,794 1,260,697 273,675 373,989
Bad debt expense....................... 957,226 2,354,364
Deferred taxes......................... (424,928) (1,104,147) (105,817) (259,332)
Changes in assets and liabilities:
Accounts receivable.................... (3,505,233) (5,788,682) (536,779) 3,862,599
Prepaid expenses and other current
assets................................. (11,506) (168,448) (326,489) 57,627
Other assets........................... (61,327) (50,272)
Accounts payable and accrued
expenses............................... 2,220,155 (10,427) 267,185 (1,378,794)
Tax receivable from affiliate.......... (626,856) (2,434,605) -- --
----------- ------------ ----------- ----------
Net cash used in operating
activities........................... (3,734,277) (11,673,782) (1,852,731) 2,227,514
----------- ------------ ----------- ----------
INVESTING ACTIVITY--Capital expenditures... (2,785,163) (933,799) (207,255) (415,681)
----------- ------------ ----------- ----------
FINANCING ACTIVITIES
Increases in note payable to affiliate... 4,162,011 11,942,388 1,713,398 (1,317,240)
Borrowings on long-term debt............. -- 1,798,940 368,115 --
Payments on long-term debt............... (298,852) (876,372) -- (243,682)
Common stock repurchase.................. -- (181,590) -- --
Capital contribution..................... 2,800,000 -- -- --
----------- ------------ ----------- ----------
Net cash provided by financing
activities........................... 6,663,159 12,683,366 2,081,513 (1,560,922)
----------- ------------ ----------- ----------
INCREASE IN CASH........................... 143,719 75,785 21,527 250,911
CASH:
Beginning of period...................... 50,686 194,405 194,405 270,190
----------- ------------ ----------- ----------
End of period............................ $ 194,405 $ 270,190 $ 215,932 $ 521,101
=========== ============ =========== ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOWS
INFORMATION:
Interest paid............................ -- $ 350,694 -- $ 318,288
=========== ============ =========== ==========
NONCASH ACTIVITY
Property, plant, and equipment acquired
under capital leases..................... $ 1,099,137 $ 2,028,013 $ 1,799,245 $ --
=========== ============ =========== ==========
See accompanying notes to consolidated financial statements.
F-41
UTILIPRO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION
The accompanying consolidated financial statements include the accounts of
Utilipro, Inc. and its wholly owned subsidiaries, which are collectively
referred to as the "Company." All significant intercompany accounts and
transactions have been eliminated.
The Company engages in the sale of integrated customer care solutions and
billing services to energy marketers. The Company was formed on June 17, 1997
and on December 10, 1997 AGL Investments, Inc. ("AGL Investments"), a wholly
owned subsidiary of AGL Resources, Inc. ("AGL Resources"), acquired 700,000
shares of the Company's convertible preferred stock. The Company is based in
Atlanta, Georgia.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
INTERIM FINANCIAL DATA (UNAUDITED)--The financial statements as of
December 31, 2000 and for the three months ended December 31, 1999 and 2000 are
unaudited. In the opinion of management, these financial statements reflect all
adjustments necessary for a fair presentation of the financial statements for
such periods. These adjustments consist of normal, recurring items. The results
of operations for the three months ended December 31, 2000 are not necessarily
indicative of the results of operations that may be expected for the full year.
USE OF ESTIMATES--The preparation of financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the amounts
reported in the financial statements and accompanying notes. Actual results
could differ from those estimates.
PROPERTY AND EQUIPMENT--Purchases of property and equipment are recorded at
cost. Depreciation on property is computed on a straight-line basis using the
following estimated useful lives:
Computer and telecommunications equipment................... 5 years
Computer software........................................... 4 to 5 years
Furniture and fixtures...................................... 5 to 7 years
Leasehold improvements...................................... The life of the lease
IMPAIRMENT OF LONG-LIVED ASSETS--The Company reviews long-lived assets and
certain intangibles for impairment when events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable and any
impairment losses are reported in the period in which the recognition criteria
are first applied based on the fair value of the asset.
INCOME TAXES--Deferred tax assets and liabilities are recorded for all
significant temporary differences between the carrying amounts and the tax bases
of assets and liabilities. The operating results of the Company are included in
the consolidated federal income tax return of AGL Resources and income taxes are
allocated to the Company for the tax effects of its income and deductions
included in the consolidated return.
DERIVATIVE INSTRUMENTS--In June 1998, the Financial Accounting Standards
Board issued Statement of Financial Accounting Standards ("SFAS") No. 133,
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES. SFAS No. 133, as
amended by SFAS No. 138, ACCOUNTING FOR CERTAIN DERIVATIVE INSTRUMENTS AND
CERTAIN HEDGING ACTIVITIES, establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities. It
F-42
UTILIPRO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
requires that an entity record all derivatives as either assets or liabilities
in the balance sheet measured at fair value. The Company adopted SFAS No. 133 on
October 1, 2000. The impact of the adoption of SFAS No. 133 on the Company's
consolidated financial statements at October 1, 2000 was immaterial.
REVENUE RECOGNITION--The Company recognizes revenues using the accrual
method. As services are performed, they are billed to the Company's customers
and recorded as revenue.
RECLASSIFICATIONS--Certain prior year amounts have been reclassified for
comparative purposes. Those reclassifications did not affect consolidated net
loss for the years presented.
3. CONCENTRATION OF CREDIT RISK
At September 30, 2000, one nonaffiliated customer comprised all of the
Company's accounts receivable--nonaffiliates, and at September 30, 1999, three
nonaffiliated customers comprised 73%, 12%, and 11%, respectively of the
Company's accounts receivable--non-affiliate balance. For the year ended
September 30, 2000, no nonaffiliate customer represented more than 10% of
nonaffiliate revenues. For the year ended September 30, 1999, three
nonaffiliated customers comprised 24%, 8%, and 4% of nonaffiliate revenues,
respectively.
On October 26, 1999, Peachtree Natural Gas, LLC ("Peachtree"), one of the
Company's nonaffiliated customers, filed for bankruptcy protection under
Chapter 11 of the United States Bankruptcy Code. As of the date of Peachtree's
bankruptcy filing, Peachtree owed the Company $2,063,769. The amount owed to the
Company as of September 30, 2000 was fully reserved for in the accompanying
balance sheet.
4. PROPERTY AND EQUIPMENT
Property and equipment are as follows:
AS OF
SEPTEMBER 30,
------------------------
1999 2000
---------- -----------
Computer and telecommunications equipment................... $3,347,907 $ 3,425,108
Computer software........................................... 697,350 1,215,750
Furniture and fixtures...................................... 350,056 385,323
Leasehold improvements...................................... 65,034 341,044
---------- -----------
4,460,347 5,367,225
Accumulated depreciation.................................... (689,952) (1,923,619)
---------- -----------
$3,770,395 $ 3,443,606
========== ===========
5. LONG-TERM DEBT
Long-term debt as of September 30, 1999 and 2000 consists of capital lease
obligations related to computer equipment, telephone equipment, and computer
software with interest rates of 8%, maturing at various dates through 2003. The
cost of the assets recorded under the capital lease obligations is $3,151,765.
Accumulated amortization related to assets recorded under capital leases is
$242,026 and
F-43
UTILIPRO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. LONG-TERM DEBT (CONTINUED)
$490,441 at September 30, 1999 and 2000, respectively. The balance of the
capital lease obligations as of September 30, 1999 and 2000 was $995,176 and
$1,917,744, respectively.
Total aggregate minimum lease payments under capital leases at
September 30, 2000 are as follows:
2001........................................................ $1,008,682
2002........................................................ 1,114,684
2003........................................................ 35,472
----------
2,158,838
Less: amounts representing interest......................... (241,094)
----------
$1,917,744
==========
6. INCOME TAXES
The components of income tax benefit are as follows:
YEAR ENDED
SEPTEMBER 30,
-----------------------
1999 2000
---------- ----------
Current:
Federal................................................... $1,209,957 $2,078,320
State..................................................... 207,400 356,285
---------- ----------
1,417,357 2,434,605
Deferred:
Federal................................................... 362,749 942,564
State..................................................... 62,179 161,583
---------- ----------
424,928 1,104,147
---------- ----------
Income tax benefit.......................................... $1,842,285 $3,538,752
========== ==========
The reconciliation of the Company's effective tax rate to the statutory tax
rate is as follows:
YEAR ENDED SEPTEMBER 30,
-----------------------------------------------------
1999 2000
------------------------- -------------------------
RATE AMOUNT RATE AMOUNT
-------- ----------- -------- -----------
Computed tax expense benefit................. 35.0% $(1,667,059) 35.0% $(3,244,894)
State taxes, net of federal benefit.......... 3.7 (175,226) 3.6 (336,614)
Other........................................ (0.4) 42,756
---- ----------- ---- -----------
Income tax benefit........................... 38.7% $(1,842,285) 38.2% $(3,538,752)
==== =========== ==== ===========
F-44
UTILIPRO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. INCOME TAXES (CONTINUED)
On a pro forma basis, had the Company used the separate return basis for its
income tax provision, no income tax benefit would have been recorded in the
years ended September 30, 1999 and 2000.
The tax effects of temporary differences comprising the net deferred tax
asset are as follows (a valuation reserve was not considered necessary):
AS OF SEPTEMBER 30,
----------------------
1999 2000
--------- ----------
Allowance for doubtful accounts............................. $ 370,255 $1,280,899
Property.................................................... (191,848) 131,138
Accrued bonus and vacation.................................. 185,658 35,691
Other....................................................... 19,340 39,824
--------- ----------
Net deferred tax asset...................................... $ 383,405 $1,487,552
========= ==========
7. STOCKHOLDERS' EQUITY
On December 10, 1997, Utilipro entered into a Series A Convertible Preferred
Stock Purchase Agreement whereby 700,000 shares of Convertible Series A
Preferred Stock ("Preferred Stock") were issued to AGL Investments for $700,000.
Concurrently with the issuance of the Preferred Stock, 123,529 shares of common
stock were issued to certain shareholders. The Preferred Stock is convertible
into common stock at the option of AGL Investments at a conversion price of $1
per share. Furthermore, AGL Investments has the option to require the Company to
redeem any or all outstanding shares of the Preferred Stock on December 10, 2004
at an amount equal to the sum of the original purchase price per share plus any
declared and accrued but unpaid dividends on the shares. If the Company fails to
redeem the Preferred Stock on December 10, 2004, the conversion price of the
Preferred Stock will decrease at the rate of 10% per quarter. As of September
30, 1999 and 2000, no dividends had been declared.
During the year ended September 30, 2000, the Company acquired common stock
held by two shareholders. The shares, which were acquired for $181,590, were
retired.
On May 22, 1998, the Company entered into a Capital Contribution Agreement
with AGL Resources whereby AGL Investments agreed to contribute up to a maximum
of $3,500,000 in additional capital to the Company. As of September 30, 2000,
AGL Investments had contributed $3,500,000 in additional capital.
8. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES--The Company leases certain buildings and equipment under
noncancelable operating leases which expire at various dates through 2006.
F-45
UTILIPRO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. COMMITMENTS AND CONTINGENCIES (CONTINUED)
The following is a schedule of future minimum lease payments under operating
leases as of September 30, 2000:
2001........................................................ $1,407,130
2002........................................................ 1,229,051
2003........................................................ 801,158
2004........................................................ 572,214
2005........................................................ 319,959
Thereafter.................................................. 354,306
----------
$4,683,818
==========
Rent expense for the years ended September 30, 1999 and 2000 was $418,052
and $1,418,324, respectively.
9. LITIGATION
During the year ended September 30, 2000, Peachtree commenced litigation
against the Company seeking damages in excess of $50 million as a result of an
alleged breach of contract by the Company. If the Company were to suffer an
adverse outcome in this litigation, it could have a material adverse effect on
the Company's consolidated financial statements. While management believes that
the Company has valid defenses to this litigation, management cannot predict the
outcome of the litigation.
The Company is involved in litigation arising in the normal course of
business. Management believes that the ultimate resolution of that litigation
will not have a material adverse effect on the Company's consolidated financial
statements.
10. RELATED PARTY TRANSACTIONS
ACCOUNTS RECEIVABLE-AFFILIATE--Accounts receivable-affiliate at
September 30, 1999 and 2000 of $1,537,259 and $5,843,621, respectively, consists
of amounts due from SouthStar Energy Services, LLC ("SouthStar"), a joint
venture in which AGL Resources is a member, for services rendered by the
Company.
REVENUE-AFFILIATE--Revenue-affiliate consists of revenue from SouthStar for
services rendered by the Company.
TAX RECEIVABLE FROM AFFILIATE--The receivable from affiliate at
September 30, 1999 and 2000 of $1,073,960 and $3,508,565, respectively, consists
primarily of amounts due from AGL Resources for income tax benefits.
NOTES PAYABLE TO AFFILIATE--The notes payable to affiliates at
September 30, 1999 of $4,162,000 included $2,947,000 owed to AGL Investments and
$1,215,000 owed to AGL Propane, Inc., a wholly owned subsidiary of AGL
Resources Inc. in accordance with a Note Agreement dated April 16, 1999 (the
"AGL Propane Note"). Interest accrues at rates from 8.075% to 8.105% annually
with a maturity date of June 1, 2000. The AGL Propane Note was repaid during the
year ended September 30, 2000.
F-46
UTILIPRO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. RELATED PARTY TRANSACTIONS (CONTINUED)
The amount payable to AGL Investments is pursuant to a Note Agreement dated
August 13, 1999, as amended (the "Original AGL Investments Note"), with interest
accruing at LIBOR plus 250 basis points. The Company and AGL Investments entered
into a Note Agreement dated January 1, 2000, with interest accruing at LIBOR
plus 300 basis points, whereby the outstanding balance as of January 1, 2000 of
the Original AGL Investments Note was refinanced. During the year ended
September 30, 1999, interest rates ranged from 7.7% to 7.9%. During the year
ended September 30, 2000, interest rates ranged from 8.8% to 9.7%. At
September 30, 2000, notes payable to AGL Investments totaled $16,104,399.
Interest expense recognized during the years ended September 30, 1999 and 2000
was $47,011 and $882,822, respectively. Accrued and unpaid interest at
September 30, 1999 and 2000 was $47,011 and $532,128, respectively.
11. SUBSEQUENT EVENTS
In January 2001, the Company acquired and retired all of the outstanding
common stock held by the Company's minority shareholder for $188,997. As a
result, all of the capital stock of the Company is now held by AGL Investments.
On February 28, 2001, the Company extinguished its capital lease obligations
in the amount of $2,094,999.
Effective February 28, 2001, Alliance Data Systems, Inc. purchased from AGL
Investments the property and equipment and assumed certain working capital
related liabilities of the Company.
F-47
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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
------------------------
PAGE
--------
Prospectus Summary............................. 1
Risk Factors................................... 7
Special Note Regarding Forward-Looking
Statements................................... 18
Use of Proceeds................................ 19
Dividend Policy................................ 19
Dilution....................................... 20
Capitalization................................. 21
Unaudited Pro Forma Consolidated Financial
Information.................................. 22
Selected Historical Consolidated Financial and
Operating Information........................ 26
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................... 29
Business....................................... 46
Management..................................... 61
Principal Stockholders......................... 73
Certain Relationships and Related
Transactions................................. 76
Description of Capital Stock................... 80
Shares Eligible for Future Sale................ 83
Underwriting................................... 84
Legal Matters.................................. 88
Experts........................................ 88
Where You Can Find More Information............ 88
Index to Consolidated Financial Statements..... F-1
------------------------------
Dealer Prospectus Delivery Obligation:
Until July 2, 2001 (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.
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[LOGO]
13,000,000 SHARES
COMMON STOCK
---------------------
PROSPECTUS
---------------------
BEAR, STEARNS & CO. INC.
MERRILL LYNCH & CO.
CREDIT SUISSE FIRST BOSTON
JUNE 7, 2001
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