e10vq
Table of Contents

 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
     
þ
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
    For the Quarterly Period Ended September 30, 2005
 
OR
 
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
    For the transition period from           to
Commission File Number: 001-15749
 
ALLIANCE DATA SYSTEMS CORPORATION
(Exact Name of Registrant as Specified in its Charter)
     
Delaware   31-1429215
(State or Other Jurisdiction of
Incorporation or Organization)
  (I.R.S. Employer
Identification No.)
17655 Waterview Parkway
Dallas, Texas 75252
(Address of Principal Executive Office, Including Zip Code)
(972) 348-5100
(Registrant’s Telephone Number, Including Area Code)
 
     Indicate by check mark whether the registrant (i) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (ii) has been subject to such filing requirements for the past 90 days.     Yes þ          No o
      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).     Yes þ          No o
      Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes o          No þ
      As of October 31, 2005, 82,036,045 shares of the registrant’s common stock, par value $0.01 per share, were outstanding.
 
 


ALLIANCE DATA SYSTEMS CORPORATION
INDEX
             
        Page
        Number
         
 Part I: FINANCIAL INFORMATION
   Financial Statements (unaudited)        
     Condensed Consolidated Balance Sheets as of December 31, 2004 and September 30, 2005     3  
     Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2004 and 2005     4  
     Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2005     5  
     Notes to Condensed Consolidated Financial Statements     6  
   Management’s Discussion and Analysis of Financial Condition and Results of Operations     14  
   Quantitative and Qualitative Disclosures about Market Risk     28  
   Controls and Procedures     28  
 Part II: OTHER INFORMATION
   Legal Proceedings     29  
   Unregistered Sales of Equity Securities and Use of Proceeds     29  
   Defaults Upon Senior Securities     29  
   Submission of Matters to a Vote of Security Holders     29  
   Other Information     29  
   Exhibits     30  
 SIGNATURES     31  
 Certification of CEO Pursuant to Rule 13a-14(a)
 Certification of CFO Pursuant to Rule 13a-14(a)
 Certification of CEO Pursuant to Rule 13a-14(b)
 Certification of CFO Pursuant to Rule 13a-14(b)

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PART I
Item 1. Financial Statements
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
                   
    December 31,   September 30,
    2004   2005
         
    (in thousands, except
    per share amounts)
ASSETS
Cash and cash equivalents
  $ 84,409     $ 157,797  
Due from card associations
    10,995       13,190  
Trade receivables, less allowance for doubtful accounts ($1,458 and $3,993 at December 31, 2004 and September 30, 2005, respectively)
    158,236       197,033  
Seller’s interest and credit card receivables, less allowance for doubtful accounts ($11,673 and $11,854 at December 31, 2004 and September 30, 2005, respectively)
    248,074       255,215  
Deferred tax asset, net
    49,606       48,727  
Other current assets
    66,026       78,501  
             
 
Total current assets
    617,346       750,463  
Redemption settlement assets, restricted
    243,492       257,321  
Property and equipment, net
    147,531       155,662  
Due from securitizations
    244,291       198,606  
Intangible assets, net
    233,779       239,316  
Goodwill
    709,146       826,997  
Other non-current assets
    43,495       40,688  
             
 
Total assets
  $ 2,239,080     $ 2,469,053  
             
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable
  $ 56,214     $ 65,843  
Accrued expenses
    141,534       140,405  
Merchant settlement obligations
    77,980       95,947  
Certificates of deposit, current
    94,700       130,500  
Credit facilities and other debt, current
    135,962       210,429  
Other current liabilities
    54,229       49,130  
             
 
Total current liabilities
    560,619       692,254  
Deferred tax liability, net
    49,283       48,948  
Deferred revenue—service
    158,026       178,550  
Deferred revenue—redemption
    389,097       419,764  
Certificates of deposit, long term
          36,500  
Credit facilities and other debt, long-term
    206,861       115,408  
Other liabilities
    4,674       14,664  
             
 
Total liabilities
    1,368,560       1,506,088  
Stockholders’ equity:
               
Common stock, $0.01 par value; authorized 200,000 shares; issued 82,765 shares as of December 31, 2004, 84,652 shares as of September 30, 2005
    828       847  
Unearned compensation
    (7,739 )     (19,700 )
Additional paid-in capital
    679,776       738,279  
Treasury stock, at cost, 418 shares as of December 31, 2004, 2,070 shares as of September 30, 2005
    (6,151 )     (71,385 )
Retained earnings
    199,336       306,752  
Accumulated other comprehensive income
    4,470       8,172  
             
 
Total stockholders’ equity
    870,520       962,965  
             
 
Total liabilities and stockholders’ equity
  $ 2,239,080     $ 2,469,053  
             
See accompanying notes to unaudited condensed consolidated financial statements.

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ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
                                     
    Three months ended   Nine months ended
    September 30,   September 30,
         
    2004   2005   2004   2005
                 
    (in thousands, except per share amounts)
Revenues
                               
 
Transaction services
  $ 151,232     $ 159,092     $ 445,225     $ 452,845  
 
Redemption
    55,339       66,221       160,316       196,745  
 
Securitization income
    80,643       98,441       268,160       306,390  
 
Database marketing fees and marketing services
    5,404       43,833       15,621       135,007  
 
Other revenue
    6,254       17,226       21,280       40,269  
                         
   
Total revenues
    298,872       384,813       910,602       1,131,256  
Operating expenses
                               
 
Cost of operations (exclusive of depreciation and amortization disclosed separately below)
    218,908       277,627       654,876       812,411  
 
General and administrative
    15,414       23,050       44,494       65,960  
 
Depreciation and other amortization
    15,236       13,972       47,025       43,182  
 
Amortization of purchased intangibles
    6,556       10,359       20,060       30,301  
                         
   
Total operating expenses
    256,114       325,008       766,455       951,854  
                         
Operating income
    42,758       59,805       144,147       179,402  
                         
Fair value loss on interest rate derivative
                808        
Interest expense, net
    1,029       2,422       4,727       7,537  
                         
Income before income taxes
    41,729       57,383       138,612       171,865  
Provision for income taxes
    15,732       21,532       52,258       64,449  
                         
Net income
  $ 25,997     $ 35,851     $ 86,354     $ 107,416  
                         
Net income per share — basic
  $ 0.32     $ 0.43     $ 1.07     $ 1.30  
                         
Net income per share — diluted
  $ 0.31     $ 0.42     $ 1.03     $ 1.26  
                         
Weighted average shares — basic
    81,387       82,755       80,861       82,612  
                         
Weighted average shares — diluted
    84,703       85,249       83,792       85,320  
                         
      See accompanying notes to unaudited condensed consolidated financial statements.

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ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
                       
    Nine months ended
    September 30,
     
    2004   2005
         
    (in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
               
 
Net income
  $ 86,354     $ 107,416  
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
   
Depreciation and other amortization
    47,025       43,182  
   
Amortization of purchased intangibles
    20,060       30,301  
   
Deferred income taxes
    12,868       (5,741 )
   
Fair value loss on interest rate derivative
    808        
   
(Recovery of) provision for doubtful accounts
    (661 )     13,705  
   
Non-cash compensation
          5,263  
 
Change in operating assets and liabilities, net of acquisitions:
               
     
Change in trade receivables
    (4,136 )     (30,023 )
     
Change in merchant settlement activity
    18,990       15,772  
     
Change in other assets
    3,135       8,762  
     
Change in accounts payable and accrued expenses
    16,700       (2,132 )
     
Change in deferred revenue
    21,053       31,016  
     
Change in other liabilities
    (15,370 )     (8,836 )
 
Purchase of credit card receivables
    (34,417 )     (20,527 )
 
Proceeds from sale of credit card receivable portfolios to securitization trusts
    105,538        
 
Other operating activities
    381       427  
             
 
Net cash provided by operating activities
    278,328       188,585  
CASH FLOWS FROM INVESTING ACTIVITIES:
               
 
Change in redemption settlement assets
    (6,434 )     (6,064 )
 
Payments for acquired businesses, net of cash acquired
    (780 )     (139,675 )
 
Change in seller’s interest
    (9,838 )     (3,622 )
 
Change in due from securitizations
    101,059       61,516  
 
Capital expenditures
    (35,244 )     (45,595 )
 
Other investing activities
    (530 )     (2,783 )
             
 
Net cash provided by (used in) investing activities
    48,233       (136,223 )
CASH FLOWS FROM FINANCING ACTIVITIES:
               
 
Borrowings under debt agreements
    339,273       577,172  
 
Repayment of borrowings
    (427,416 )     (591,418 )
 
CD issuance
    500       166,500  
 
Repayment of CD
    (168,300 )     (94,200 )
 
Payment of capital lease obligations
    (3,892 )     (5,471 )
 
Proceeds from issuances of common stock
    25,630       27,397  
 
Purchase of treasury shares
          (60,267 )
             
 
Net cash (used in) provided by financing activities
    (234,205 )     19,713  
 
Effect of exchange rate changes on cash and cash equivalents
    (1,111 )     1,313  
             
 
Change in cash and cash equivalents
    91,245       73,388  
 
Cash and cash equivalents at beginning of period
    67,745       84,409  
             
 
Cash and cash equivalents at end of period
  $ 158,990     $ 157,797  
             
SUPPLEMENTAL CASH FLOW INFORMATION:
               
Interest paid
  $ 6,719     $ 9,798  
             
Income taxes paid
  $ 15,106     $ 40,164  
             
See accompanying notes to unaudited condensed consolidated financial statements.

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ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
      The unaudited condensed consolidated financial statements included herein have been prepared by Alliance Data Systems Corporation (“ADSC” or, including its wholly owned subsidiaries, the “Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report filed on Form 10-K for the year ended December 31, 2004.
      The unaudited condensed consolidated financial statements included herein reflect all adjustments (consisting of normal, recurring adjustments) which are, in the opinion of management, necessary to state fairly the results for the interim periods presented. The results of operations for the interim periods presented are not necessarily indicative of the operating results to be expected for any subsequent interim period or for the fiscal year.
      The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
      For purposes of comparability, certain prior period amounts have been reclassified to conform with the current year presentation. Such reclassifications have no impact on previously reported net income.
2. SHARES USED IN COMPUTING NET INCOME PER SHARE
      The following table sets forth the computation of basic and diluted net income per share for the periods indicated:
                                     
    Three months ended   Nine months ended
    September 30,   September 30,
         
    2004   2005   2004   2005
                 
    (in thousands)
Numerator
                               
Net income available to common stockholders
  $ 25,997     $ 35,851     $ 86,354     $ 107,416  
                         
Denominator
                               
 
Weighted average shares, basic
    81,387       82,755       80,861       82,612  
 
Weighted average effect of dilutive securities:
                               
   
Net effect of dilutive stock options and unvested restricted stock
    3,316       2,494       2,931       2,708  
                         
 
Denominator for diluted calculation
    84,703       85,249       83,792       85,320  
                         
Basic
                               
Net income per share
  $ 0.32     $ 0.43     $ 1.07     $ 1.30  
                         
Diluted
                               
Net income per share
  $ 0.31     $ 0.42     $ 1.03     $ 1.26  
                         

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ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
3. ACQUISITIONS
      In November 2004, the Company acquired Capstone Consulting Partners, Inc. In connection with the acquisition, the Company is required to pay the seller additional consideration for exceeding certain revenue targets, as defined in the agreement. The contingent payment is limited to $15.0 million. As of September 30, 2005, the Company had met the initial threshold and recorded a purchase price adjustment of approximately $5.7 million. The Company believes that it has a potential liability in the range of $5.0 million to $9.3 million associated with this earn-out provision, which will be recorded in the fourth quarter when the amount can be reasonably estimated.
      In May 2005, the Company acquired the stock of Atrana Solutions Inc., a provider of point-of-sale technology services. Total consideration paid was approximately $13.1 million, including $1.5 million which was placed in escrow for a period of twelve to eighteen months to satisfy potential indemnification claims. The results of operations for Atrana have been included since the date of acquisition and are reflected in our Transaction Services segment.
      On September 30, 2005, Epsilon Data Management, Inc., one of the Company’s wholly-owned subsidiaries, acquired Bigfoot Interactive Inc., (“Epsilon Interactive”), a leading full-service provider of strategic ROI-focused email communications and marketing automation solutions. Total consideration paid was approximately $133.4 million, including $8.8 million which was placed in escrow for a period of six to eighteen months. The preliminary purchase price allocation is as follows:
         
Identifiable intangible assets
  $ 26,000  
Capitalized software
    3,600  
Goodwill
    92,827  
Net assets
    10,939  
       
Purchase price
  $ 133,366  
       
4. INTANGIBLE ASSETS AND GOODWILL
      Intangible assets consist of the following:
                                 
    September 30, 2005    
         
    Gross   Accumulated        
    Assets   Amortization   Net   Amortization Life and Method
                 
    (in thousands)    
Customer contracts and lists
  $ 243,908     $ (65,095 )   $ 178,813       2-20 years—straight line            
Collector database
    60,207       (41,583 )     18,624       15%—declining balance  
Premium on purchased credit card portfolios
    41,908       (14,354 )     27,554       5-10 years—straight line  
Tradename
    12,350             12,350       Indefinite life  
Noncompete agreements
    2,400       (1,425 )     975       1-5 years—straight line  
Favorable lease
    1,000             1,000       4 years—straight line  
                         
Total intangible assets
  $ 361,773     $ (122,457 )   $ 239,316          
                         

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ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
4. INTANGIBLE ASSETS AND GOODWILL — (Continued)
                                 
    December 31, 2004    
         
    Gross   Accumulated        
    Assets   Amortization   Net   Amortization Life and Method
                 
    (in thousands)    
Customer contracts and lists
  $ 216,277     $ (45,236 )   $ 171,041       2-20 years—straight line  
Collector database
    58,233       (37,831 )     20,402       15%—declining balance  
Premium on purchased credit card portfolios
    43,137       (12,299 )     30,838       5-10 years—straight line  
Tradename
    11,200             11,200       Indefinite life  
Noncompete agreements
    1,500       (1,202 )     298       1-5 years—straight line  
                         
Total intangible assets
  $ 330,347     $ (96,568 )   $ 233,779          
                         
      In connection with the Epsilon Interactive acquisition, the Company acquired $24.1 million in customer contracts and $1.9 million in other related intangible assets.
Goodwill
      The changes in the carrying amount of goodwill for the nine months ended September 30, 2005 are as follows:
                                   
    Transaction   Credit   Marketing    
    Services   Services   Services   Total
                 
        (in thousands)    
Beginning balance
  $ 303,874     $     $ 405,272     $ 709,146  
 
Goodwill acquired during period
    7,106             92,827       99,933  
 
Effects of foreign currency translation
    343             6,574       6,917  
 
Other, primarily final purchase price adjustments(1)
    12,110             (1,109 )     11,001  
                         
Ending balance
  $ 323,433     $     $ 503,564     $ 826,997  
                         
 
(1)  Represents recognition of a deferred payment, certain earn-out provisions, and other initial purchase price adjustments associated with the Company’s acquisitions.
5. DEBT
      Debt consists of the following:
                 
    December 31,   September 30,
    2004   2005
         
    (in thousands)
Certificates of deposit
  $ 94,700     $ 167,000  
Credit facilities
    324,629       310,000  
Other
    18,194       15,837  
             
      437,523       492,837  
Less: current portion
    (230,662 )     (340,929 )
             
Long term portion
  $ 206,861     $ 151,908  
             

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ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
5.     DEBT — (Continued)
      As of September 30, 2005, the certificates of deposit had effective annual fixed rates ranging from 4.1% to 4.8%, and the credit facilities had a weighted average interest rate of 5.6%.
      On April 7, 2005, the Company entered into amendments to its three credit facilities. The amendment to the 3-year credit facility extended the maturity date from April 10, 2006 to April 3, 2008. The amendment to the 364-day credit facility extended the maturity date from April 7, 2005 to April 6, 2006. The amendment to the Canadian credit facility extended the maturity date from April 10, 2006 to April 3, 2008 and reduced the aggregate amount of the commitments permitted thereunder by $15.0 million from $50.0 million to $35.0 million. The range of margins on the interest rate on eurodollar loans for each of the three facilities and the commitment fee percentages, both of which are based upon the ratio of total debt under the credit facilities to consolidated operating EBITDA, as each term is defined in the credit facilities, was revised from 1.0%-1.5% to 0.5%-1.0% and from 0.1%-0.3% to 0.1%-0.15%, respectively.
      On October 28, 2005, the Company entered into amendments to the Company’s three credit facilities to increase the amount of revolving commitments under the facilities and amend certain covenants. The amendment to the 3-year credit facility increased the amount of revolving commitments thereunder from $200.0 million to $250.0 million. The amendment to the 364-day credit facility increased the amount of revolving commitments thereunder from $205.0 million to $230.0 million. After giving effect to the three amendments, the aggregate amount of revolving commitments under the three credit facilities is $515.0 million. In addition, the amendments increased the aggregate amounts of commitments permitted under the three facilities from $500.0 million to $550.0 million. As a result, the Company has the right to obtain commitments under the three credit facilities for an additional $35.0 million in the aggregate without having to amend the credit facilities. In addition, the amendments increased the amount of restricted payments permitted under the credit facilities. Except as set forth above, the remaining terms of each credit facility remain unchanged.

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ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
6. DEFERRED REVENUE
      A reconciliation of deferred revenue for the AIR MILES®Reward Program is as follows (in thousands):
           
Deferred Revenue—Service
       
 
Beginning balance December 31, 2004
  $ 158,026  
 
Cash proceeds
    77,748  
 
Revenue recognized
    (63,334 )
 
Effects of foreign currency translation
    6,110  
       
 
Ending balance September 30, 2005
  $ 178,550  
       
Deferred Revenue—Redemption
       
 
Beginning balance December 31, 2004
  $ 389,097  
 
Cash proceeds
    136,183  
 
Revenue recognized
    (120,123 )
 
Effects of foreign currency translation
    14,607  
       
 
Ending balance September 30, 2005
  $ 419,764  
       
7. INCOME TAXES
      For the three and nine months ended September 30, 2005, the Company has utilized an effective tax rate of 37.5% to calculate its provision for income taxes. In accordance with Accounting Principles Board (“APB”) Opinion No. 28, Interim Financial Reporting, this effective tax rate is the Company’s expected annual effective tax rate for calendar year 2005 based on all known variables.
8. COMPREHENSIVE INCOME
      The components of comprehensive income, net of tax effect, are as follows:
                                 
    Three months ended   Nine months ended
    September 30,   September 30,
         
    2004   2005   2004   2005
                 
        (in thousands)    
Net income
  $ 25,997     $ 35,851     $ 86,354     $ 107,416  
Reclassifications into earnings
                482        
Unrealized gain (loss) on securities available-for-sale, net
    1,055       (583 )     (951 )     529  
Foreign currency translation adjustments(1)
    1,582       3,724       3,840       3,173  
                         
Total comprehensive income
  $ 28,634     $ 38,992     $ 89,725     $ 111,118  
                         
 
(1)  Primarily related to the impact of changes in the Canadian currency exchange rate.

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ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
9. SEGMENT INFORMATION
      Consistent with prior periods, the Company classifies its businesses into three segments: Transaction Services, Credit Services and Marketing Services.
                                         
    Transaction   Credit   Marketing   Other/    
    Services   Services   Services   Elimination   Total
                     
    (in thousands)
Three months ended September 30, 2004                                
Revenues
  $ 169,434     $ 121,398     $ 84,992     $ (76,952 )   $ 298,872  
Adjusted EBITDA(1)
    25,075       26,328       13,147             64,550  
Depreciation and amortization
    14,808       2,039       4,945             21,792  
Operating income
    10,267       24,289       8,202             42,758  
Interest expense, net
                      1,029       1,029  
Income before income taxes
    10,267       24,289       8,202       (1,029 )     41,729  
Three months ended September 30, 2005                                
Revenues
  $ 178,973     $ 137,049     $ 145,404     $ (76,613 )   $ 384,813  
Adjusted EBITDA(1)
    23,242       39,470       23,368             86,080  
Stock compensation expense
    648       648       648             1,944  
Depreciation and amortization
    13,810       1,894       8,627             24,331  
Operating income
    8,784       36,928       14,093             59,805  
Interest expense, net
                      2,422       2,422  
Income before income taxes
    8,784       36,928       14,093       (2,422 )     57,383  
                                         
    Transaction   Credit   Marketing   Other/    
    Services   Services   Services   Elimination   Total
                     
    (in thousands)
Nine months ended September 30, 2004                                
Revenues
  $ 511,531     $ 384,631     $ 249,449     $ (235,009 )   $ 910,602  
Adjusted EBITDA(1)
    76,528       92,790       41,914             211,232  
Depreciation and amortization
    46,907       6,039       14,139             67,085  
Operating income
    29,621       86,751       27,775             144,147  
Fair value loss on interest rate derivative
          808                   808  
Interest expense, net
                      4,727       4,727  
Income before income taxes
    29,621       85,943       27,775       (4,727 )     138,612  
Nine months ended September 30, 2005                                
Revenues
  $ 515,278     $ 419,229     $ 428,501     $ (231,752 )   $ 1,131,256  
Adjusted EBITDA(1)
    65,531       121,510       71,107             258,148  
Stock compensation expense
    1,754       1,755       1,754             5,263  
Depreciation and amortization
    42,100       5,717       25,666             73,483  
Operating income
    21,677       114,038       43,687             179,402  
Interest expense, net
                      7,537       7,537  
Income before income taxes
    21,677       114,038       43,687       (7,537 )     171,865  
 
(1)  Adjusted EBITDA is a non-GAAP financial measure equal to net income, the most directly comparable GAAP financial measure, plus stock compensation expense, provision for income taxes, interest expense, net, fair value loss on interest rate derivative, other expenses, depreciation and amortization. Adjusted EBITDA is presented in accordance with Statement of Financial Accounting Standard (“SFAS”) No. 131 as it is the primary performance metric by which senior management is evaluated.

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ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
10. STOCK COMPENSATION AND UNEARNED COMPENSATION
      At September 30, 2005, the Company had three stock-based employee compensation plans. The Company accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and related Interpretations. No stock-based employee compensation cost is reflected in net income for stock options, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”, to stock-based employee compensation.
      In the first quarter of 2005, the Company changed the valuation model used for estimating the fair value of options granted from a Black-Scholes option pricing model to a Binomial lattice pricing model. This change was made in order to provide a better estimate of fair value. The Binomial model can incorporate a range of possible outcomes over an option’s term and can be adjusted for changes in certain assumptions over time. The Black-Scholes model assumptions are more constant over time, which is not always consistent with an employee’s exercise behavior. In accordance with APB Opinion No. 20, “Accounting Changes,” this change was made for options granted to employees beginning in the first quarter of 2005. Options to purchase a total of 0.1 million shares of common stock were granted in the third quarter of 2005 at a weighted average fair value of $16.96 per share. The historical Black-Scholes model would have produced a pro forma stock compensation expense that was approximately 14% lower than that derived from the Binomial model. As a result of this change, the after-tax increase in pro forma stock-based employee compensation expense for the nine months ended September 30, 2005 was approximately $0.3 million.
                                 
    Three months ended   Nine months ended
    September 30,   September 30,
         
    2004   2005   2004   2005
                 
    (in thousands, except per share amounts)
Net income, as reported
  $ 25,997     $ 35,851     $ 86,354     $ 107,416  
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects
          1,215             3,289  
Deduct: Total stock-based employee compensation expense determined under fair value based method for all stock option awards, net of related tax effects
    (2,313 )     (4,899 )     (6,580 )     (13,587 )
                         
Net income, pro forma
  $ 23,684     $ 32,167     $ 79,774     $ 97,118  
                         
Net income per share:
                               
Basic — as reported
  $ 0.32     $ 0.43     $ 1.07     $ 1.30  
Diluted — as reported
  $ 0.31     $ 0.42     $ 1.03     $ 1.26  
Basic — pro forma
  $ 0.29     $ 0.39     $ 0.99     $ 1.18  
Diluted — pro forma
  $ 0.28     $ 0.38     $ 0.95     $ 1.14  
      During the nine months ended September 30, 2005, a total of 635,807 shares of restricted stock were granted under the 2003 Long Term Incentive Plan (“2003 LTIP”) and the 2005 Long Term Incentive Plan (“2005 LTIP”).

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ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — (Continued)
10.     STOCK COMPENSATION AND UNEARNED COMPENSATION — (Continued)
      Under the plans, 125,872 shares of performance based restricted stock were granted. The restrictions on the shares subject to these grants do not lapse unless specified performance measures tied to either cash earnings per share or total shareholder return are met. If these performance targets are met, the restrictions on some of these shares lapse at the end of a three-year period. However, the Company’s Board of Directors may accelerate the lapsing of such restrictions if certain annual cash earnings per share performance targets are met. As the performance targets have not been met, compensation has not been earned. The Company has recorded $4.9 million associated with the award as unearned compensation in the stockholders’ equity section of the accompanying balance sheet.
      Additionally, during the nine months ended September 30, 2005, the Company awarded 509,935 shares of time-based restricted stock under the plans, with vesting periods of two to three years. The Company recorded $12.0 million (the aggregate value of the common stock based on the market price at the date of the award) as unearned compensation in the stockholders’ equity section of the accompanying balance sheet. The Company recorded $1.9 million and $5.3 million of compensation expense for the three and nine months ended September 30, 2005, respectively, related to shares of time-based restricted stock outstanding.
11. STOCKHOLDERS’ EQUITY
      On June 8, 2005, the Company’s Board of Directors authorized a repurchase program to acquire up to an aggregate of $80.0 million of its outstanding common stock through June 2006. As of September 30, 2005, the Company has repurchased 1,652,400 shares of its common stock for approximately $65.2 million under this program.
      On October 27, 2005, the Company’s board of directors authorized a new stock repurchase program to acquire up to an additional $220.0 million of its outstanding common stock through October 2006.
12. EMPLOYEE BENEFIT PLANS
      On June 7, 2005, at the annual meeting of stockholders, the stockholders approved and adopted the Amended and Restated Employee Stock Purchase Plan (the “ESPP”), effective on July 1, 2005. No employee may purchase more than $25,000 in stock under the ESPP in any calendar year, and no employee may purchase stock under the ESPP if such purchase would cause the employee to own more than 5% of the voting power or value of the Company’s common stock. The ESPP provides for three month offering periods, commencing on the first trading day of each calendar quarter and ending on the last trading day of each calendar quarter. The purchase price of the common stock upon exercise shall be 85% of the fair market value of shares on the applicable purchase date as determined by averaging the high and low trading prices of the last trading day of each quarter. An employee may elect to pay the purchase price of such common stock through payroll deductions. The maximum number of shares that were reserved for issuance under the ESPP is 1,500,000 shares, and subject to adjustment as provided in the ESPP. Employees are required to hold any stock purchased through the ESPP for 180 days prior to any sale or withdrawal of shares.
      On June 7, 2005, the stockholders, at the annual meeting of stockholders, approved the Executive Annual Incentive Plan (the “Executive Incentive Plan”). Under the plan, the Company may grant to each eligible employee, including executive officers and other key employees, incentive awards to receive cash upon the achievement of pre-established performance goals. No participant may be granted performance awards in excess of $5.0 million in any calendar year.

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
      The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and related notes thereto presented in this quarterly report and the notes thereto included in our Annual Report filed on Form 10-K for the year ended December 31, 2004.
Year to Date in Review Highlights
      Our year to date 2005 results included significant new and renewed agreements:
  •  In February 2005, we signed a multi-year renewal to provide private label credit card services to Pacific Sunwear of California, Inc., a leading specialty retailer of everyday casual apparel, accessories and footwear.
 
  •  In March 2005, we entered into an agreement to provide marketing services to TruGreen ChemLawn, a leading provider of lawn care services.
 
  •  In March 2005, we signed a long-term agreement to provide private label credit card services for Z Gallerie, a leading retailer specializing in high-quality, distinctive furnishings and decorative accessories for the home.
 
  •  In April 2005, we signed a long-term agreement to provide a fully integrated private label credit card and co-brand bankcard solution for Hanover Direct, a leading catalog and Web retailer of home furnishings and accessories and men’s and women’s apparel.
 
  •  In April 2005, we signed an agreement to provide project management and systems integration services to Cobb Energy, one of the largest co-op electric utilities in the United States.
 
  •  In April 2005, we signed an agreement with Blair Corporation to purchase Blair’s private label credit portfolio and a 10-year agreement with Blair to provide a fully integrated private label credit program. Blair, through its Blair and Irvine Park brands, sells quality men’s and women’s business and casual fashion attire and home accessories. We expect this transaction to close in the fourth quarter of 2005.
 
  •  In May 2005, we signed a long-term agreement to provide private label credit card services for Crescent Jewelers, which operates 122 stores in California, Arizona and Nevada, and sells quality fine jewelry, including unique and exclusive jewelry collections targeted to mid- and upper-end consumers.
 
  •  In May 2005, we acquired Atrana Solutions Inc., a leading provider of point-of-sale technology solutions that will give us additional capabilities, product offerings and client relationships.
 
  •  In May 2005, Epsilon Data Management, Inc., one of our wholly-owned subsidiaries, signed a five-year extension with Hilton HHonors Worldwide, one of our top 15 clients, to provide integrated relationship management services, including database hosting and development, for the Hilton HHonors® Guest Rewards Program.
 
  •  In June 2005, Epsilon Data Management, Inc., one of our wholly-owned subsidiaries, completed the build of a comprehensive database system for Pfizer Inc. to manage and host Pfizer’s database solution geared toward enhancing Pfizer’s overall consumer outreach efforts.
 
  •  In July 2005, we signed a multi-year renewal agreement to continue providing private label credit card services for leading specialty retailers The Dress Barn, Inc. and Maurices Incorporated.
 
  •  In July 2005, we signed an agreement to provide a credit card program for Gander Mountain Company, one of the fastest-growing retailers in the outdoor lifestyle industry.

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  •  In July 2005, we signed a long-term contract renewal with Pepco Energy Services, Inc. to continue hosting the customer information system and to provide traditional and electronic billing, payment processing and other services related to the support and maintenance of the customer information system.
 
  •  In July 2005, Epsilon Data Management, Inc., one of our wholly-owned subsidiaries, signed a multi-year renewal and expanded agreement with Bank of America to complete the build of an enhanced consumer marketing database and to host and manage the system on behalf of Bank of America.
 
  •  In August 2005, we signed an agreement with Hampton Roads Sanitation District to provide consulting services related to CIS selection, improvement of business processes and project management.
 
  •  In August 2005, we signed a multi-year renewal with Sobeys Inc. to continue as a participating sponsor in the AIR MILES Reward Program.
 
  •  In August 2005, we signed a multi-year agreement with Gordmans, Inc., an existing private label credit card client, to also provide a comprehensive servicing solution for their gift card program.
 
  •  In August 2005, we signed an agreement to provide customer care maintenance and support services for Greenville Utilities Commission, a provider of electric, gas and water services in North Carolina.
 
  •  In September 2005, Epsilon Data Management, Inc., one of our wholly-owned subsidiaries, acquired Epsilon Interactive, a leading full-service provider of strategic ROI-focused email communications and marketing automation solutions.
 
  •  In September 2005, we signed a five-year agreement with Carter Lumber, one of the nation’s top building materials retailers operating 240 stores in 10 states, to provide integrated commercial and private label card services and payment processing services.
 
  •  In September 2005, we entered into an agreement with CompUSA, Inc., one of the nation’s leading retailers and resellers of technology products and services, to provide a full suite of loyalty marketing services for The CompUSA NetworkFor Business loyalty program.
Critical Accounting Policies and Estimates
      There have been no material changes to our critical accounting policies and estimates from the information provided in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2004.
Use of Non-GAAP Financial Measures
      Adjusted EBITDA is a non-GAAP financial measure equal to net income, the most directly comparable GAAP financial measure, plus stock compensation expense, provision for income taxes, interest expense, net, fair value loss on interest rate derivative, depreciation and other amortization and amortization of purchased intangibles. Operating EBITDA is a non-GAAP financial measure equal to adjusted EBITDA plus the change in deferred revenue less the change in redemption settlement assets. We have presented operating EBITDA because we use the financial measure as part of our monitoring of compliance with the financial covenants in our credit facilities. For the nine months ended September 30, 2005, senior debt-to-operating EBITDA was 0.8x compared to a maximum ratio of 2.0x and operating EBITDA to interest expense was 30.8x compared to a minimum ratio of 3.5x. As discussed in more detail in the liquidity section of the “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, our credit facilities together with cash flow from operations are the two main sources of funding for our acquisition strategy and for our future working capital needs and capital expenditures. As of September 30, 2005, we had borrowings of $310.0 million outstanding under these credit facilities and had approximately $130.0 million in unused borrowing capacity. We were in compliance with our covenants at September 30, 2005 and we expect to be in compliance with these covenants during the year ending December 31, 2005.

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      We use adjusted EBITDA as an integral part of our internal reporting to measure the performance of our reportable segments and to evaluate the performance of our senior management. Adjusted EBITDA is considered an important indicator of the operational strength of our businesses. Adjusted EBITDA eliminates the uneven effect across all business segments of considerable amounts of non-cash depreciation of tangible assets and amortization of certain intangible assets that were recognized in business combinations. A limitation of this measure, however, is that it does not reflect the periodic costs of certain capitalized tangible and intangible assets used in generating revenues in our businesses. Management evaluates the costs of such tangible and intangible assets, the impact of related impairments, as well as asset sales through other financial measures, such as capital expenditures, investment spending and return on capital. Adjusted EBITDA also eliminates the non-cash effect of stock compensation expense. Stock compensation expense is not included in the measurement of segment adjusted EBITDA provided to the chief operating decision maker for purposes of assessing segment performance and decision making with respect to resource allocations. Therefore, we believe that adjusted EBITDA provides useful information to our investors regarding our performance and overall results of operations. Adjusted EBITDA and operating EBITDA are not intended to be performance measures that should be regarded as an alternative to, or more meaningful than, either operating income or net income as an indicator of operating performance or to cash flows from operating activities as a measure of liquidity. In addition, adjusted EBITDA and operating EBITDA are not intended to represent funds available for dividends, reinvestment or other discretionary uses, and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP. The adjusted EBITDA and operating EBITDA measures presented in this Quarterly Report on Form 10-Q may not be comparable to similarly titled measures presented by other companies, and may not be identical to corresponding measures used in our various agreements.
                                   
    Three months ended   Nine months ended
    September 30,   September 30,
         
    2004   2005   2004   2005
                 
    (in thousands)
Net income
  $ 25,997     $ 35,851     $ 86,354     $ 107,416  
 
Stock compensation expense
          1,944             5,263  
 
Provision for income taxes
    15,732       21,532       52,258       64,449  
 
Interest expense, net
    1,029       2,422       4,727       7,537  
 
Fair value loss on interest rate derivative
                808        
 
Depreciation and other amortization
    15,236       13,972       47,025       43,182  
 
Amortization of purchased intangibles
    6,556       10,359       20,060       30,301  
                         
Adjusted EBITDA
    64,550       86,080       211,232       258,148  
 
Change in deferred revenue
    36,899       44,092       35,062       51,191  
 
Less change in redemption settlement assets
    16,537       18,265       15,195       13,829  
                         
Operating EBITDA
  $ 84,912     $ 111,907     $ 231,099     $ 295,510  
                         
 
Note:  Change in deferred revenue is affected by fluctuations in foreign exchange rates. Change in redemption settlement assets is affected by transfers of cash.

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Results of Operations
Three months ended September 30, 2004 compared to the three months ended September 30, 2005
                                     
    Three months ended    
    September 30,   Change
         
    2004   2005   $   %
                 
    (in thousands, except percentages)
Revenue:
                               
 
Transaction Services
  $ 169,434     $ 178,973     $ 9,539       5.6 %
 
Credit Services
    121,398       137,049       15,651       12.9  
 
Marketing Services
    84,992       145,404       60,412       71.1  
 
Other/ Eliminations
    (76,952 )     (76,613 )     339       0.4  
                         
   
Total
  $ 298,872     $ 384,813     $ 85,941       28.8 %
                         
Adjusted EBITDA:
                               
 
Transaction Services
  $ 25,075     $ 23,242     $ (1,833 )     (7.3 )%
 
Credit Services
    26,328       39,470       13,142       49.9  
 
Marketing Services
    13,147       23,368       10,221       77.7  
                         
   
Total
  $ 64,550     $ 86,080     $ 21,530       33.4 %
                         
Stock compensation expense:
                               
 
Transaction Services
  $     $ 648     $ 648        
 
Credit Services
          648       648        
 
Marketing Services
          648       648        
                         
   
Total
  $     $ 1,944     $ 1,944        
                         
Depreciation and amortization:
                               
 
Transaction Services
  $ 14,808     $ 13,810     $ (998 )     (6.7 )%
 
Credit Services
    2,039       1,894       (145 )     (7.1 )
 
Marketing Services
    4,945       8,627       3,682       74.5  
                         
   
Total
  $ 21,792     $ 24,331     $ 2,539       11.7 %
                         
Operating income:
                               
 
Transaction Services
  $ 10,267     $ 8,784     $ (1,483 )     (14.4 )%
 
Credit Services
    24,289       36,928       12,639       52.0  
 
Marketing Services
    8,202       14,093       5,891       71.8  
                         
   
Total
  $ 42,758     $ 59,805     $ 17,047       39.9 %
                         
Adjusted EBITDA margin(1):
                               
 
Transaction Services
    14.8 %     13.0 %     (1.8 )%        
 
Credit Services
    21.7       28.8       7.1          
 
Marketing Services
    15.5       16.1       0.6          
                         
   
Total
    21.6 %     22.4 %     0.8 %        
                         
Segment operating data:
                               
 
Statements generated
    47,410       47,523       113       0.2 %
 
Credit Sales
  $ 1,450,033     $ 1,508,123     $ 58,090       4.0 %
 
Average managed receivables(2)
  $ 2,960,628     $ 3,114,452     $ 153,824       5.2 %
 
AIR MILES reward miles issued
    733,279       830,604       97,325       13.3 %
 
AIR MILES reward miles redeemed
    435,069       475,400       40,331       9.3 %
 
(1)  Adjusted EBITDA margin is adjusted EBITDA divided by revenue. Management uses adjusted EBITDA margin to analyze the operating performance of the segments and the impact revenue growth has on operating expenses.
 
(2)  The Company will now report average managed receivables as it better reflects the Company’s future business strategy. The difference between the previously reported metric and the current one is private label credit card receivables which are not securitized will now also be included. Historically, this difference has not been meaningful but will be in the future as some private label credit card portfolios are not anticipated to be securitized for a period of time.

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      Revenue. Total revenue increased $85.9 million, or 28.8%, to $384.8 million for the three months ended September 30, 2005 from $298.9 million for the comparable period in 2004. The increase was due to a 5.6% increase in Transaction Services revenue, a 12.9% increase in Credit Services revenue and a 71.1% increase in Marketing Services revenue as follows:
  •  Transaction Services. Transaction Services revenue increased $9.5 million, or 5.6%, primarily due to customer ramp-ups in utility services and increased transaction volume from merchant services. Statements generated, the segment’s key driver, was flat due primarily to the reduced credit sales volume at one major client resulting in a lower corresponding statement volume for that client offset by growth from other clients.
 
  •  Credit Services. Credit Services revenue increased $15.7 million, or 12.9%, primarily due to a 22.3% increase in securitization income, offset in part by a small decrease in merchant discount. Securitization income increased $17.9 million primarily as a result of an increase in the net yield from the securitization trusts in addition to a 5.2% increase in average managed receivables. The net yield increased principally as a result of an approximate 130 basis point increase in the excess spread and an approximate 50 basis point decrease in cost of funds. Excess spread, which represents interest and late fees collected from cardholders, other trust-related fees, fair value changes related to the interest-only strips and charge-offs, increased due to lower charge-offs and higher collected fees from cardholders.
 
  •  Marketing Services. Marketing Services revenue increased $60.4 million, or 71.1%, primarily due to an increase in database marketing fees attributable to the acquisition of Epsilon Data Management, Inc., an increase in redemption revenue related to a 9.3% increase in the redemption of AIR MILES® reward miles and an increase in the amortization of deferred services revenue. Changes in the exchange rate of the Canadian dollar accounted for approximately $7.7 million of the $60.4 million increase in our Marketing Services revenue, or 12.7%. Deferred revenue-redemption is impacted by both the number of AIR MILES reward miles issued and redeemed, as well as foreign currency movements. Our deferred revenue balance increased 8.0% to $598.3 million at September 30, 2005 from $554.2 million at June 30, 2005 due to continued growth in the program for AIR MILES reward miles issued and a change in the exchange rate during the three months ended September 30, 2005. AIR MILES reward miles issued grew by 13.3% during the three months ended September 30, 2005 over the comparable period in 2004.
      Operating Expenses. Total operating expenses, excluding depreciation and amortization, increased $66.4 million, or 28.3%, to $300.7 million during the three months ended September 30, 2005 from $234.3 million during the comparable period in 2004. Total adjusted EBITDA margin increased to 22.4% for the three months ended September 30, 2005 from 21.6% for the comparable period in 2004, due to increases in the margins for Marketing Services and Credit Services, partially offset by a decreased margin for Transaction Services.
  •  Transaction Services. Transaction Services operating expenses, excluding depreciation and amortization, increased $12.0 million, or 8.3%, to $156.4 million for the three months ended September 30, 2005 from $144.4 million for the comparable period in 2004, and adjusted EBITDA margin decreased to 13.0% for the three months ended September 30, 2005 from 14.8% during the comparable period in 2004. The decrease in adjusted EBITDA margin was primarily the result of an increase in expenses related to higher expenses associated with corporate overhead and, to a smaller extent, new private label credit card clients.
 
  •  Credit Services. Credit Services operating expenses, excluding depreciation and amortization, increased $3.1 million, or 3.3%, to $98.2 million for the three months ended September 30, 2005 from $95.1 million for the comparable period in 2004, and adjusted EBITDA margin increased to 28.8% for the three months ended September 30, 2005 from 21.7% for the comparable period in 2004. The increased adjusted EBITDA margin is the result of favorable revenue trends from an increase in average managed receivables and lower cost of funds.

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  •  Marketing Services. Marketing Services operating expenses, excluding depreciation and amortization, increased $50.9 million, or 70.9%, to $122.7 million for the three months ended September 30, 2005 from $71.8 million for the comparable period in 2004, and adjusted EBITDA margin increased to 16.1% for the three months ended September 30, 2005 from 15.5% for the comparable period in 2004. Adjusted EBITDA margin increased due to increased revenue from the AIR MILES reward program and our Epsilon business unit.
 
  •  Depreciation and Amortization. Depreciation and amortization increased $2.5 million, or 11.7%, to $24.3 million for the three months ended September 30, 2005 from $21.8 million for the comparable period in 2004 due to a $3.8 million increase in the amortization of purchased intangibles, offset by a decrease in depreciation and other amortization of $1.3 million.
      Operating Income. Operating income increased $17.0 million, or 39.9%, to $59.8 million for the three months ended September 30, 2005 from $42.8 million during the comparable period in 2004, due to the revenue and expense factors discussed above.
      Interest Expense. Interest expense increased $1.4 million, or 140.0%, to $2.4 million for the three months ended September 30, 2005 from $1.0 million for the comparable period in 2004, due to higher average balances under our credit facilities.
      Taxes. Income tax expense increased $5.8 million to $21.5 million for the three months ended September 30, 2005 from $15.7 million in 2004 due to an increase in income before income taxes. Our effective tax rate of 37.5% in 2005 improved from the 37.7% effective tax rate in 2004.

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Nine months ended September 30, 2004 compared to the nine months ended September 30, 2005
                                     
    Nine months ended    
    September 30,   Change
         
    2004   2005   $   %
                 
    (in thousands, except percentages)
Revenue:
                               
 
Transaction Services
  $ 511,531     $ 515,278     $ 3,747       0.7 %
 
Credit Services
    384,631       419,229       34,598       9.0  
 
Marketing Services
    249,449       428,501       179,052       71.8  
 
Other/ Eliminations
    (235,009 )     (231,752 )     3,257       (1.4 )
                         
   
Total
  $ 910,602     $ 1,131,256     $ 220,654       24.2 %
                         
Adjusted EBITDA:
                               
 
Transaction Services
  $ 76,528     $ 65,531     $ (10,997 )     (14.4 )%
 
Credit Services
    92,790       121,510       28,720       31.0  
 
Marketing Services
    41,914       71,107       29,193       69.6  
                         
   
Total
  $ 211,232     $ 258,148     $ 46,916       22.2 %
                         
Stock compensation expense:
                               
 
Transaction Services
  $     $ 1,754     $ 1,754        
 
Credit Services
          1,755       1,755        
 
Marketing Services
          1,754       1,754        
                         
   
Total
  $     $ 5,263     $ 5,263        
                         
Depreciation and amortization:
                               
 
Transaction Services
  $ 46,907     $ 42,100     $ (4,807 )     (10.2 )%
 
Credit Services
    6,039       5,717       (322 )     (5.3 )
 
Marketing Services
    14,139       25,666       11,527       81.5  
                         
   
Total
  $ 67,085     $ 73,483     $ 6,398       9.5 %
                         
Operating income:
                               
 
Transaction Services
  $ 29,621     $ 21,677     $ (7,944 )     (26.8 )%
 
Credit Services
    86,751       114,038       27,287       31.5  
 
Marketing Services
    27,775       43,687       15,912       57.3  
                         
   
Total
  $ 144,147     $ 179,402     $ 35,255       24.5 %
                         
Adjusted EBITDA margin(1):
                               
 
Transaction Services
    15.0 %     12.7 %     (2.3 )%        
 
Credit Services
    24.1       29.0       4.9          
 
Marketing Services
    16.8       16.6       (0.2 )        
                         
   
Total
    23.2 %     22.8 %     (0.4 )%        
                         
Segment operating data:
                               
 
Statements generated
    142,946       141,839       (1,107 )     (0.8 )%
 
Credit Sales
  $ 4,309,364     $ 4,484,937     $ 175,573       4.1 %
 
Average managed receivables(2)
  $ 2,988,701     $ 3,107,603     $ 118,902       4.0 %
 
AIR MILES reward miles issued
    2,044,208       2,357,552       313,344       15.3 %
 
AIR MILES reward miles redeemed
    1,283,967       1,449,088       165,121       12.9 %
 
(1)  Adjusted EBITDA margin is adjusted EBITDA divided by revenue. Management uses adjusted EBITDA margin to analyze the operating performance of the segments and the impact revenue growth has on operating expenses.
 
(2)  The Company will now report average managed receivables as it better reflects the Company’s future business strategy. The difference between the previously reported metric and the current one is private label credit card receivables which are not securitized will now also be included. Historically, this difference has not been meaningful but will be in the future as some private label credit card portfolios are not anticipated to be securitized for a period of time.

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      Revenue. Total revenue increased $220.7 million, or 24.2%, to $1,131.3 million for the nine months ended September 30, 2005 from $910.6 million for the comparable period in 2004. The increase was due to a 0.7% increase in Transaction Services revenue, a 9.0% increase in Credit Services revenue and a 71.8% increase in Marketing Services revenue as follows:
  •  Transaction Services. Transaction Services revenue increased $3.7 million, or 0.7%, primarily due to customer ramp-ups in utility services and increased transaction volume for merchant services, partially offset by the loss of a call center client which ceased operations in the fourth quarter of 2004. Statements generated decreased by 0.8%. The decrease in the number of statements generated is primarily attributable to one private label client that experienced a significant reduction in private label credit sales, which resulted in a corresponding reduction in statements generated for private label clients.
 
  •  Credit Services. Credit Services revenue increased $34.6 million, or 9.0%, primarily due to a 14.5% increase in securitization income, offset by a small decrease in merchant discount. Securitization income increased $38.7 million primarily as a result of an increase in the net yield from the securitization trusts in addition to a 4.0% increase in our average managed receivables. The net yield increased principally as a result of an approximate 140 basis point increase in the excess spread partially offset by a 10 basis point increase in cost of funds. Excess spread, which represents interest and late fees collected from cardholders, other trust-related fees, fair value changes related to the interest-only strips and charge-offs, increased due to lower charge-offs and higher collected fees from cardholders.
 
  •  Marketing Services. Marketing Services revenue increased $179.1 million, or 71.8%, primarily due to an increase in database marketing fees attributable to the acquisition of Epsilon Data Management, Inc., an increase in redemption revenue related to a 12.9% increase in the redemption of AIR MILES reward miles and an increase in the amortization of deferred services revenue. Changes in the exchange rate of the Canadian dollar accounted for approximately $21.7 million of the $179.1 million increase in our Marketing Services revenue, or 12.1%. Deferred revenue-redemption is impacted by both the number of AIR MILES reward miles issued and redeemed, as well as foreign currency movements. Our deferred revenue balance increased 9.4% to $598.3 million at September 30, 2005 from $547.1 million at December 31, 2004 due to continued growth in the program, including a 15.3% increase in AIR MILES reward miles issued during the nine months ended September 30, 2005 over the comparable period in 2004.
      Operating Expenses. Total operating expenses, excluding depreciation and amortization, increased $179.0 million, or 25.6%, to $878.4 million during the nine months ended September 30, 2005 from $699.4 million during the comparable period in 2004. Total adjusted EBITDA margin decreased to 22.8% for the nine months ended September 30, 2005 from 23.2% for the comparable period in 2004, due to decreased margins in Transaction Services and Marketing Services, partially offset by an increased margin for Credit Services.
  •  Transaction Services. Transaction Services operating expenses, excluding depreciation and amortization, increased $16.5 million, or 3.8%, to $451.5 million for the nine months ended September 30, 2005 from $435.0 million for the comparable period in 2004, and adjusted EBITDA margin decreased to 12.7% for the nine months ended September 30, 2005 from 15.0% during the comparable period in 2004. The decrease in adjusted EBITDA margin was primarily the result of expenses related to streamlining efforts in utility services during the first half of 2005 and higher expenses associated with corporate overhead and, to a smaller extent, new private label credit card clients.

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  •  Credit Services. Credit Services operating expenses, excluding depreciation and amortization, increased $7.7 million, or 2.6%, to $299.5 million for the nine months ended September 30, 2005 from $291.8 million for the comparable period in 2004, and adjusted EBITDA margin increased to 29.0% for the nine months ended September 30, 2005 from 24.1% for the same period in 2004. The increased adjusted EBITDA margin is the result of favorable revenue trends from an increase in our average managed receivables and lower net charge-offs as well as leveraging existing infrastructure.
 
  •  Marketing Services. Marketing Services operating expenses, excluding depreciation and amortization, increased $151.6 million, or 73.1%, to $359.1 million for the nine months ended September 30, 2005 from $207.5 million for the comparable period in 2004, and adjusted EBITDA margin decreased to 16.6% for the nine months ended September 30, 2005 from 16.8% for the comparable period in 2004. The decrease in adjusted EBITDA margin is the result of additional overhead expense and an increase in marketing expenses as a result of a change in timing compared to the prior year, offset by increased higher-margin revenue from the AIR MILES reward program and our Epsilon business unit.
 
  •  Depreciation and Amortization. Depreciation and amortization increased $6.4 million, or 9.5%, to $73.5 million for the nine months ended September 30, 2005 from $67.1 million for the comparable period in 2004 due to a $10.2 million increase in the amortization of purchased intangibles, offset by a decrease in depreciation and other amortization of $3.8 million.
      Operating Income. Operating income increased $35.3 million, or 24.5%, to $179.4 million for the nine months ended September 30, 2005 from $144.1 million during the comparable period in 2004, due to the revenue and expense factors discussed above.
      Interest Expense. Interest expense increased $2.8 million, or 59.6%, to $7.5 million for the nine months ended September 30, 2005 from $4.7 million for the comparable period in 2004, due to higher average balances under our credit facilities.
      Taxes. Income tax expense increased $12.1 million to $64.4 million for the nine months ended September 30, 2005 from $52.3 million in 2004 due to an increase in income before income taxes. Our effective tax rate of 37.5% in 2005 improved from the 37.7% effective tax rate in 2004.

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Asset Quality
      Our delinquency and net charge-off rates reflect, among other factors, the credit risk of our private label credit card receivables, the average age of our various private label credit card account portfolios, the success of our collection and recovery efforts, and general economic conditions. The average age of our private label 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. An older private label credit card portfolio generally drives a more stable performance in the portfolio. The average age of our portfolio is consistent with our historical trends as shown at September 30, 2005 with 57.9% of securitized accounts with balances and 61.6% of securitized receivables being greater than 24 months old.
      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 beyond 90 days delinquent. When an account becomes delinquent, we print a message on the cardholder’s billing statement requesting payment. After an account becomes 30 days past due, a proprietary collection scoring algorithm automatically scores the risk of the account rolling to a more delinquent status. The collection system then recommends a collection strategy for the past due account based on the collection score and account balance and dictates the contact schedule and collections priority for the account. If we are unable to make a collection after exhausting all in-house efforts, we engage collection agencies and outside attorneys to continue those efforts.
      The following table presents the delinquency trends of our managed receivables credit card portfolio:
                                     
    December 31,   % of   September 30,   % of
    2004   total   2005   total
                 
        (dollars in thousands)    
Managed receivables outstanding
  $ 3,432,105       100.0 %   $ 3,193,726       100.0 %
Receivables balances contractually delinquent:
                               
 
31 to 60 days
    52,467       1.5       54,718       1.7  
 
61 to 90 days
    32,863       1.0       34,121       1.1  
 
91 or more days
    69,340       2.0       63,618       2.0  
                         
   
Total
  $ 154,670       4.5 %   $ 152,457       4.8 %
                         
      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 managed basis.
                                 
    Three months ended   Nine months ended
    September 30,   September 30,
         
    2004   2005   2004   2005
                 
        (dollars in thousands)    
Average managed receivables
  $ 2,960,628     $ 3,114,452     $ 2,988,701     $ 3,107,603  
Net charge-offs
    49,706       49,790       159,464       148,618  
Net charge-offs as a percentage of average receivables outstanding (annualized)
    6.7 %     6.4 %     7.1 %     6.4 %

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Liquidity and Capital Resources
      Operating Activities. We have historically generated cash flow from operating activities, as detailed in the table below, although that amount may vary based on fluctuations in working capital and the timing of merchant settlement activity.
                 
    Nine months ended
    September 30,
     
    2004   2005
         
    (in thousands)
Cash provided by operating activities before changes in credit card portfolio activity and merchant settlement activity
  $ 188,217     $ 193,340  
Purchase of credit card receivables
    (34,417 )     (20,527 )
Proceeds from sale of credit card receivable portfolios to securitization trusts
    105,538        
Net change in merchant settlement activity
    18,990       15,772  
             
Cash provided by operating activities
  $ 278,328     $ 188,585  
             
      We generated cash flow from operating activities before changes in credit card portfolio activity and merchant settlement activity of $193.3 million for the nine months ended September 30, 2005 compared to $188.2 million for the comparable period in 2004. The increase in operating cash flows before changes in credit card portfolio activity and merchant settlement activity is related to improved operating results for the nine months ended September 30, 2005, in addition to favorable working capital movements. Merchant settlement activity fluctuates significantly depending on the day in which the quarter ends. We utilize our cash flow from operations for ongoing business operations, acquisitions and capital expenditures.
      Investing Activities. We used cash for investing activities of $136.2 million for the nine months ended September 30, 2005 compared to $48.2 million of cash provided for the comparable period in 2004. Significant components of investing activities are as follows:
  •  Acquisitions. Cash outlays, net of cash received, for acquisitions for the nine months ended September 30, 2005 was $139.7 million compared to $0.8 million for the comparable period in 2004. The outlay for acquisitions in 2005 relates primarily to the purchases of Atrana Solutions Inc., a provider of point-of-sale technology services and Epsilon Interactive, a leading provider of strategic ROI-focused email communications and marketing automation solutions.
 
  •  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 September 30, 2005, we had over $3.0 billion of securitized credit card receivables. Securitizations require credit enhancements in the form of cash, spread accounts and additional receivables. The credit enhancement is partially funded through the use of certificates of deposit issued through our subsidiary, World Financial Network National Bank. Cash flow from securitization activity was $57.9 million for the nine months ended September 30, 2005 and $91.2 million for the comparable period in 2004. We intend to utilize our securitization program for the foreseeable future.
 
  •  Capital Expenditures. Our capital expenditures for the nine months ended September 30, 2005 were $45.6 million compared to $35.2 million for the comparable period in 2004. Such amounts are consistent with our normal level of capital expenditures. We have no expectation that this will change in the foreseeable future.
      Financing Activities. Net cash provided by financing activities was $19.7 million for the nine months ended September 30, 2005 compared to a use of cash of $234.2 million in the comparable period in 2004. Our financing activities during the nine months ended September 30, 2005 relate primarily to borrowings and repayments under our revolving credit facilities and the repurchase of 1,652,400 shares of our common stock.

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      Liquidity Sources. In addition to cash generated from operating activities, we have four main sources of liquidity: securitization program, certificates of deposit issued by World Financial Network National Bank and World Financial Capital Bank, our credit facilities and issuances of equity securities. We believe that internally generated funds and existing sources of liquidity are sufficient to meet current and anticipated financing requirements during the next 12 months.
      Securitization Program and Off-Balance Sheet Transactions. Since January 1996, we have sold, sometimes through WFN Credit Company, LLC and WFN Funding Company II, LLC, substantially all of the credit card receivables owned by our credit card bank, World Financial Network National Bank, to World Financial Network Credit Card Master Trust, World Financial Network Credit Card Master Note Trust and World Financial Network Credit Card Master Trust III, which we refer to as the WFN Trusts, as part of our securitization program. This securitization program is the primary vehicle through which we finance our private label credit card receivables.
      As public notes approach maturity, the notes will enter a controlled accumulation period, which typically lasts three months. During the controlled accumulation period, we will either need to arrange an additional private conduit facility or use our own balance sheet to finance the controlled accumulation until such time as we can issue a new public series in the public markets.
      As of September 30, 2005 the WFN Trusts had over $3.0 billion of securitized credit card receivables. Securitizations require credit enhancements in the form of cash, spread deposits and additional receivables. The credit enhancement is principally based on the outstanding balances of the series issued by the WFN Trusts and by the performance of the private label credit cards in the securitization trust. During the period from November to January, the WFN Trusts are required to maintain a credit enhancement level of between 6% and 10% of securitized credit card receivables. Certain of the WFN Trusts are required to maintain a level of between 4% and 9% for the remainder of the year. Accordingly, at December 31, the WFN Trusts typically have their highest balance of credit enhancement assets. We intend to utilize our securitization program for the foreseeable future.
      If World Financial Network National Bank 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 as we would be severely limited in our financing ability. World Financial Network National Bank’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; and
 
  •  conformity in the quality of credit card receivables to rating agency requirements and changes in those requirements; and
 
  •  our ability to fund required over collateralizations or credit enhancements, which we routinely utilize in order to achieve better credit ratings to lower our borrowing costs.
      We believe that the conditions to securitize private label credit card receivables are favorable for us. We plan to continue using our securitization program as our primary financing vehicle.
      Once World Financial Network National Bank 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 Network National Bank’s interest in the related receivables, along with the excess spread that would normally be paid to World Financial Network National Bank, until such time as the securitization investors are fully repaid. The occurrence of an early amortization event would significantly limit, or even negate, our ability to securitize additional receivables and would have a negative impact on the interest-only strip, which has ranged from approximately 2.0% to 2.5% of managed receivables. There have been no early amortization events as of September 30, 2005.

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      Certificates of Deposit. We utilize certificates of deposit to finance the operating activities and/or fund securitization enhancement requirements of our credit card bank subsidiaries, World Financial Network National Bank and World Financial Capital Bank. World Financial Network National Bank and World Financial Capital Bank issue 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 4.1 % to 4.8 %. As of September 30, 2005, we had $167.0 million of certificates of deposit outstanding. Certificate of deposit borrowings are subject to regulatory capital requirements.
      Credit Facilities. On April 7, 2005, we entered into amendments to our three credit facilities. The amendment to the 3-year credit facility extended the maturity date from April 10, 2006 to April 3, 2008. The amendment to the 364-day credit facility extended the maturity date from April 7, 2005 to April 6, 2006. The amendment to the Canadian credit facility extended the maturity date from April 10, 2006 to April 3, 2008 and reduced the aggregate amount of the commitments permitted thereunder by $15.0 million from $50.0 million to $35.0 million. The range of margins on the interest rate on eurodollar loans for each of the three facilities and the commitment fee percentages, both of which are based upon the ratio of total debt under the credit facilities to consolidated Operating EBITDA, as each term is defined in the credit facilities, was revised from 1.0%-1.5% to 0.5%-1.0% and from 0.1%-0.3% to 0.1%-0.15%, respectively.
      On October 28, 2005, we entered into amendments to our three credit facilities to increase the amount of revolving commitments under the facilities and amend certain covenants. The amendment to the 3-year credit facility increased the amount of revolving commitments thereunder from $200.0 million to $250.0 million. The amendment to the 364-day credit facility increased the amount of revolving commitments thereunder from $205.0 million to $230.0 million. After giving effect to the three amendments, the aggregate amount of revolving commitments under the three credit facilities is $515.0 million. In addition, the amendments increased the aggregate amounts of commitments permitted under the three facilities from $500.0 million to $550.0 million. As a result, we have the right to obtain commitments under the three credit facilities for an additional $35.0 million in the aggregate without having to amend the credit facilities. In addition, the amendments increased the amount of restricted payments permitted under the credit facilities. Except as set forth above, the remaining terms of each credit facility remain unchanged.
      Advances under the credit facilities are in the form of either base rate loans or eurodollar loans. The interest rate on base rate loans fluctuates based upon the higher of (1) the interest rate announced by the administrative agent as its “prime rate” and (2) the Federal funds rate plus 0.5%, in each case with no additional margin. The interest rate on eurodollar loans fluctuates based upon the rate at which eurodollar deposits in the London interbank market are quoted plus a margin of 0.5% to 1.0% based upon the ratio of total debt under the credit facilities to consolidated Operating EBITDA, as each term is defined in the credit facilities. The credit facilities are secured by pledges of stock of certain of our subsidiaries and pledges of certain intercompany promissory notes.
      At September 30, 2005, we had borrowings of $310.0 million outstanding under these credit facilities (with a weighted average interest rate of 5.6%), we issued no letters of credit, and we had available unused borrowing capacity of approximately $130.0 million. The credit facilities limit our aggregate outstanding letters of credit to $50.0 million.
      We utilize our credit facilities and cash flows from operations to support our acquisition strategy and to fund working capital and capital expenditures.

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Recent Accounting Pronouncements
      In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 123 (revised 2004), “Share-Based Payment”, which replaces SFAS No. 123 “Accounting for Stock-Based Compensation” and supersedes Accounting Principles Board (“APB”) Opinion No. 25. SFAS No. 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. In addition, SFAS No. 123(R) will cause unrecognized expense (based on the fair values determined for the pro forma footnote disclosure, adjusted for estimated forfeitures) related to options vesting after the date of initial adoption to be recognized as a charge to results of operations over the remaining vesting period. Under SFAS No. 123(R), we must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at the date of adoption. The transition alternatives include the modified prospective or the modified retrospective adoption methods. Under the modified retrospective method, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The modified prospective method requires that compensation expense be recorded for all unvested stock options and share awards at the beginning of the first quarter of adoption of SFAS No. 123(R), while the modified retrospective methods would record compensation expense for all unvested stock options and share awards beginning with the first period restated.
      In March 2005, the SEC released SAB 107, “Share-Based Payment”, which expresses views of the SEC Staff about the application of SFAS No. 123(R). SFAS No. 123(R) was to be effective for interim or annual reporting periods beginning on or after June 15, 2005, but in April 2005 the SEC issued a rule that SFAS No. 123(R) will be effective for annual reporting periods beginning on or after June 15, 2005. We are evaluating the requirements of SFAS No. 123(R) and we expect that the adoption of SFAS No. 123(R) will have a material impact on our statements of income and earnings per share. We have not determined the method of adoption.
      In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections — a replacement of APB Opinion No. 20 and FASB Statement No. 3”. Opinion 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. SFAS No. 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not expect the adoption of SFAS No. 154 to have an impact on the consolidated financial statements.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market Risk
      There has been no material change from our Annual Report on Form 10-K for the year ended December 31, 2004 related to our exposure to market risk from off-balance sheet risk, interest rate risk, credit risk, foreign currency exchange risk and redemption reward risk.
Item 4. Controls and Procedures
      As of September 30, 2005, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of September 30, 2005, our disclosure controls and procedures are effective. Disclosure controls and procedures are controls and procedures designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and include controls and procedures designed to ensure that information we are required to disclose in such reports is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
      Our evaluation of and conclusion on the effectiveness of internal control over financial reporting as of December 31, 2004 did not include the internal controls of Epsilon and Capstone Consulting Partners, Inc., entities we acquired during 2004, which are included in the 2004 consolidated financial statements, and that constituted $363.9 million of total assets as of December 31, 2004 and an immaterial amount of revenues and net income for the year then ended. We have not assessed the effectiveness of internal control over financial reporting at Epsilon or Capstone because of the timing of the acquisitions, which were completed in October 2004 and November 2004, respectively. In the fourth quarter of 2005, we will expand our evaluation of the effectiveness of the internal controls over financial reporting to include these two acquisitions. As part of our integration of Epsilon, we are in the process of converting their general ledger platform to the platform utilized by the majority of the Company.
      There have been no changes in our internal control over financial reporting that occurred during our last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
FORWARD-LOOKING STATEMENTS
      This Form 10-Q and the documents incorporated by reference herein contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements may use words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “predict,” “project” and similar expressions as they relate to us or our management. When we make forward-looking statements, we are basing them on our management’s beliefs and assumptions, using information currently available to us. Although we believe that the expectations reflected in the forward-looking statements are reasonable, these forward-looking statements are subject to risks, uncertainties and assumptions, including those discussed in the “Risk Factors” section in our Annual Report on Form 10-K for the year ended December 31, 2004.
      If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may vary materially from what we projected. Any forward-looking statements contained in this quarterly report reflect our current views with respect to future events and are subject to these and other risks, uncertainties and assumptions relating to our operations, results of operations, growth strategy and liquidity. We have no intention, and disclaim any obligation, to update or revise any forward-looking statements, whether as a result of new information, future results or otherwise.

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PART II
Item 1. Legal Proceedings.
      From time to time, we are involved in various claims and lawsuits arising in the ordinary course of our business that we believe will not have a material adverse affect on our business or financial condition, including claims and lawsuits alleging breaches of contractual obligations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
      On June 8, 2005, our Board of Directors authorized a stock repurchase program to acquire up to an aggregate of $80.0 million of our outstanding common stock through June 2006. As of September 30, 2005, we have repurchased 1,652,400 shares of our common stock for approximately $65.2 million under this program. On October 27, 2005, our Board of Directors authorized a new stock repurchase program to acquire up to an additional $220.0 million of our outstanding common stock through October 2006. Additionally, the administrator of our 401(k) and Retirement Savings Plan purchased shares of our common stock for the benefit of the employees who participated in that portion of the plan during the third quarter of 2005.
      The following table presents information with respect to those purchases of our common stock made during the three months ended September 30, 2005:
                                   
                Approximate Dollar Value of
    Total Number       Total Number of Shares Purchased as   Shares that May Yet Be
    of Shares   Average Price   Part of Publicly Announced   Purchased
Period   Purchased   Paid per Share   Plans or Programs   Under the Plans or Programs
                 
                (in millions)
During 2005:
                               
July
    2,704     $ 42.34           $ 282.9 (1,2)
August
    119,241       40.89       117,200 (1)     278.1 (1,2)
September
    1,082,834       40.19       1,078,500 (1)     234.8 (1,2)
                         
 
Total
    1,204,779     $ 40.26       1,195,700     $ 234.8  
                         
 
(1)  On June 8, 2005, our Board of Directors authorized a stock repurchase program to acquire up to an aggregate of $80.0 million of our outstanding common stock through June 2006.
 
(2)  On October 27, 2005, our Board of Directors authorized a new stock repurchase program to acquire up to an additional $220.0 million of our outstanding common stock through October 2006.
Item 3. Defaults Upon Senior Securities.
      None
Item 4. Submission of Matters to a Vote of Security Holders.
      None
Item 5. Other Information.
      (a) None
      (b) None

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Item 6. Exhibits.
      (a) Exhibits:
EXHIBIT INDEX
         
Exhibit    
No.   Description
     
  3 .1   Second Amended and Restated Certificate of Incorporation of the Registrant (incorporated by reference to Exhibit No. 3.1 to our Registration Statement on Form S-1 filed with the SEC on March 3, 2000, File No. 333-94623).
  3 .2   Second Amended and Restated Bylaws of the Registrant (incorporated by reference to Exhibit No. 3.2 to our Registration Statement on Form S-1 filed with the SEC on March 3, 2000, File No. 333-94623).
  3 .3   First Amendment to the Second Amended and Restated Bylaws of the Registrant (incorporated by reference to Exhibit No. 3.3 to our Registration Statement on Form S-1 filed with the SEC on May 4, 2001, File No. 333-94623).
  3 .4   Second Amendment to the Second Amended and Restated Bylaws of the Registrant (incorporated by reference to Exhibit No. 3.4 to our Annual Report on Form 10-K, filed with the SEC on April 1, 2002, File No. 001-15749).
  4     Specimen Certificate for shares of Common Stock of the Registrant (incorporated by reference to Exhibit No. 4 to our Quarterly Report on Form 10-Q filed with the SEC on August 8, 2003, File No. 001-15749).
  *31 .1   Certification of Chief Executive Officer of Alliance Data Systems Corporation pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended.
  *31 .2   Certification of Chief Financial Officer of Alliance Data Systems Corporation pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended.
  *32 .1   Certification of Chief Executive Officer of Alliance Data Systems Corporation pursuant to Rule 13a-14(b) promulgated under the Securities Exchange Act of 1934, as amended, and Section 1350 of Chapter 63 of Title 18 of the United States Code.
  *32 .2   Certification of Chief Financial Officer of Alliance Data Systems Corporation pursuant to Rule 13a-14(b) promulgated under the Securities Exchange Act of 1934, as amended, and Section 1350 of Chapter 63 of Title 18 of the United States Code.
 
Filed herewith

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SIGNATURES
      Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
  ALLIANCE DATA SYSTEMS CORPORATION
  By:  /s/ Edward J. Heffernan
 
 
  Edward J. Heffernan
  Executive Vice President and Chief Financial
  Officer (Principal Financial Officer)
Date: November 8, 2005
  By:  /s/ Michael D. Kubic
 
 
  Michael D. Kubic
  Senior Vice President and Corporate Controller
  (Principal Accounting Officer)
Date: November 8, 2005

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EXHIBIT INDEX
         
Exhibit    
No.   Description
     
  3 .1   Second Amended and Restated Certificate of Incorporation of the Registrant (incorporated by reference to Exhibit No. 3.1 to our Registration Statement on Form  S-1 filed with the SEC on March 3, 2000, File No. 333-94623).
  3 .2   Second Amended and Restated Bylaws of the Registrant (incorporated by reference to Exhibit No. 3.2 to our Registration Statement on Form S-1 filed with the SEC on March 3, 2000, File No. 333-94623).
  3 .3   First Amendment to the Second Amended and Restated Bylaws of the Registrant (incorporated by reference to Exhibit No. 3.3 to our Registration Statement on Form S-1 filed with the SEC on May 4, 2001, File No. 333-94623).
  3 .4   Second Amendment to the Second Amended and Restated Bylaws of the Registrant (incorporated by reference to Exhibit No. 3.4 to our Annual Report on Form 10-K, filed with the SEC on April 1, 2002, File No. 001-15749).
  4     Specimen Certificate for shares of Common Stock of the Registrant (incorporated by reference to Exhibit No. 4 to our Quarterly Report on Form 10-Q filed with the SEC on August 8, 2003, File No. 001-15749).
  *31 .1   Certification of Chief Executive Officer of Alliance Data Systems Corporation pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended.
  *31 .2   Certification of Chief Financial Officer of Alliance Data Systems Corporation pursuant to Rule 13a-14(a) promulgated under the Securities Exchange Act of 1934, as amended.
  *32 .1   Certification of Chief Executive Officer of Alliance Data Systems Corporation pursuant to Rule 13a-14(b) promulgated under the Securities Exchange Act of 1934, as amended, and Section 1350 of Chapter 63 of Title 18 of the United States Code.
  *32 .2   Certification of Chief Financial Officer of Alliance Data Systems Corporation pursuant to Rule 13a-14(b) promulgated under the Securities Exchange Act of 1934, as amended, and Section 1350 of Chapter 63 of Title 18 of the United States Code.
 
Filed herewith