10-Q 1 form_10q.htm ALLIANCE DATA SYSTEMS CORPORATION 10-Q 6-30-2012 form_10q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
     
 
FORM 10-Q

(Mark One)
 
R
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the quarterly period ended June 30, 2012
   
OR
 
£
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.)

7500 Dallas Parkway, Suite 700
Plano, Texas 75024
(Address of principal executive office, including zip code)

(214) 494-3000
(Registrant’s telephone number, including area code)
 
     
 
 

 
Indicate by check mark whether the registrant: (1) has filed all reports required 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 (2) has been subject to such filing requirements for the past 90 days.  Yes £     No R
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes R     No  £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 
Large accelerated filer R     
Accelerated filer  £     
 
Non-accelerated filer £ (Do not check if a smaller reporting company)
Smaller reporting company £

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes £     No R

As of August 1, 2012, 49,906,953 shares of common stock were outstanding.
 


 
 
 
 
 
 
INDEX
 
 
 
 
 
Page
Number
Part I:  FINANCIAL INFORMATION
Item 1.
Financial Statements (unaudited)
 
 
3
 
4
 
5
 
6
 
7
Item 2.
27
Item 3.
41
Item 4.
41
Part II:  OTHER INFORMATION
Item 1.
42
Item 1A.
42
Item 2.
42
Item 3.
42
Item 4.
43
Item 5.
43
Item 6.
44
45


 
2


PART I
 
Item 1. Financial Statements.
 
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
 
   
June 30,
2012
   
December 31,
2011
 
   
(In thousands)
 
ASSETS
 
Cash and cash equivalents
 
$
642,199
   
$
216,213
 
Trade receivables, less allowance for doubtful accounts ($4,718 and $2,406 at June 30, 2012 and December 31, 2011, respectively)
   
319,292
     
300,895
 
Credit card receivables:
               
Credit card receivables – restricted for securitization investors
   
4,891,816
     
4,886,168
 
Other credit card receivables
   
818,885
     
779,843
 
Total credit card receivables
   
5,710,701
     
5,666,011
 
Allowance for loan loss
   
(432,521
)
   
(468,321
)
Credit card receivables, net
   
5,278,180
     
5,197,690
 
Deferred tax asset, net
   
208,022
     
252,303
 
Other current assets
   
553,541
     
121,589
 
Redemption settlement assets, restricted
   
476,234
     
515,838
 
Assets of discontinued operations
   
     
2,439
 
Total current assets
   
7,477,468
     
6,606,967
 
Property and equipment, net
   
218,938
     
195,397
 
Deferred tax asset, net
   
54,974
     
43,408
 
Cash collateral, restricted
   
124,895
     
158,727
 
Intangible assets, net
   
347,601
     
383,646
 
Goodwill
   
1,450,284
     
1,449,363
 
Other non-current assets
   
152,754
     
142,741
 
Total assets
 
$
9,826,914
   
$
8,980,249
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
Accounts payable
 
$
169,938
   
$
149,812
 
Accrued expenses
   
160,983
     
206,621
 
Deposits
   
809,547
     
642,567
 
Asset-backed securities debt – owed to securitization investors
   
1,634,517
     
1,694,198
 
Current debt
   
22,972
     
19,834
 
Other current liabilities
   
106,202
     
105,888
 
Deferred revenue
   
994,526
     
1,036,251
 
Total current liabilities
   
3,898,685
     
3,855,171
 
Deferred revenue
   
196,634
     
190,185
 
Deferred tax liability, net
   
187,246
     
151,746
 
Deposits
   
843,405
     
711,208
 
Asset-backed securities debt – owed to securitization investors
   
1,803,250
     
1,566,089
 
Long-term and other debt
   
2,405,350
     
2,163,640
 
Other liabilities
   
131,352
     
166,244
 
Total liabilities
   
9,465,922
     
8,804,283
 
Commitments and contingencies
               
Stockholders’ equity:
               
Common stock, $0.01 par value; authorized, 200,000 shares; issued, 94,752 shares and 94,141 shares at June 30, 2012 and December 31, 2011, respectively
   
948
     
941
 
Additional paid-in capital
   
1,412,598
     
1,387,773
 
Treasury stock, at cost, 44,797 shares and 44,311 shares at June 30, 2012 and December 31, 2011, respectively
   
(2,379,728
)
   
(2,320,696
)
Retained earnings
   
1,350,054
     
1,131,004
 
Accumulated other comprehensive loss
   
(22,880
)
   
(23,056
)
Total stockholders’ equity
   
360,992
     
175,966
 
Total liabilities and stockholders’ equity
 
$
9,826,914
   
$
8,980,249
 
 
See accompanying notes to unaudited condensed consolidated financial statements.

 
3


ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
 
   
Three Months Ended
June 30,
 
Six Months Ended
 June 30,
 
   
2012
 
2011
 
2012
 
2011
 
   
(In thousands, except per share amounts)
 
Revenues
                     
Transaction
 
$
77,502
 
$
69,869
 
$
160,246
 
$
146,640
 
Redemption
   
159,185
   
133,342
   
347,651
   
283,102
 
Finance charges, net
   
377,794
   
332,272
   
754,109
   
674,414
 
Database marketing fees and direct marketing services
   
219,530
   
182,264
   
433,126
   
334,974
 
Other revenue
   
32,474
   
22,711
   
62,922
   
41,764
 
Total revenue
   
866,485
   
740,458
   
1,758,054
   
1,480,894
 
Operating expenses
                 
Cost of operations (exclusive of depreciation and amortization disclosed separately below)
   
506,455
   
431,250
   
1,033,360
   
835,775
 
Provision for loan loss
   
52,552
   
60,376
   
101,879
   
128,042
 
General and administrative
   
27,532
   
21,021
   
51,531
   
41,960
 
Depreciation and other amortization
   
18,496
   
16,850
   
36,100
   
33,604
 
Amortization of purchased intangibles
   
20,907
   
19,170
   
42,022
   
37,814
 
Total operating expenses
   
625,942
   
548,667
   
1,264,892
   
1,077,195
 
Operating income
   
240,543
   
191,791
   
493,162
   
403,699
 
Interest expense
             
Securitization funding costs
   
22,518
   
35,062
   
44,847
   
66,048
 
Interest expense on deposits
   
6,003
   
5,494
   
11,966
   
11,187
 
Interest expense on long-term and other debt, net
   
44,546
   
38,238
   
81,906
   
73,018
 
Total interest expense, net
   
73,067
   
78,794
   
138,719
   
150,253
 
Income before income tax
 
$
167,476
 
$
112,997
 
$
354,443
 
$
253,446
 
Provision for income taxes
   
63,655
   
43,974
   
135,393
   
98,047
 
Net income
 
$
103,821
 
$
69,023
 
$
219,050
 
$
155,399
 
                           
Basic income per share
 
$
2.07
 
$
1.35
 
$
4.37
 
$
3.04
 
Diluted income per share
 
$
1.63
 
$
1.19
 
$
3.49
 
$
2.74
 
                           
Weighted average shares
             
Basic
   
50,161
   
51,070
   
50,157
   
51,099
 
Diluted
   
63,731
   
58,145
   
62,790
   
56,778
 
                           
 
See accompanying notes to unaudited condensed consolidated financial statements.

 
4


ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME
 
   
Three Months Ended
June 30,
   
Six Months Ended
 June 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
(In thousands)
 
                             
Net income
 
$
103,821
   
$
69,023
   
$
219,050
   
$
155,399
 
Other comprehensive income, net of tax
                               
Net unrealized gain (loss) on securities available-for-sale, net of tax benefit of $(90), tax expense of $146 and tax benefit of $(116), tax expense of $150 for the three and six months ended June 30, 2012 and 2011, respectively
   
352
     
3,484
     
1,836
     
(944
Foreign currency translation adjustments
   
1,406
     
(387
   
(1,660
   
(3,531
Total comprehensive income, net of tax
 
$
105,579
   
$
72,120
   
$
219,226
   
$
150,924
 
                                 
 
See accompanying notes to unaudited condensed consolidated financial statements.

 
5


ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
   
Six Months Ended
June 30,
 
   
2012
   
2011
 
   
(In thousands)
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
Net income                                                                                                                      
 
$
219,050
   
$
155,399
 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
Depreciation and amortization                                                                                                                   
   
78,122
     
71,418
 
Deferred income taxes                                                                                                                   
   
68,865
     
9,960
 
Provision for loan loss                                                                                                                   
   
101,879
     
128,042
 
Non-cash stock compensation                                                                                                                   
   
25,186
     
20,190
 
Fair value gain on interest-rate derivatives                                                                                                                   
   
(15,184
)
   
(14,603
)
Amortization of discount on convertible senior notes                                                                                                                   
   
40,050
     
35,882
 
Change in operating assets and liabilities, net of acquisitions:
 
Change in trade accounts receivable                                                                                                                   
   
(43,872
)
   
(19,321
)
Change in other assets                                                                                                                   
   
26,684
     
10,941
 
Change in accounts payable and accrued expenses                                                                                                                   
   
(8,570
)
   
(21,599
)
Change in deferred revenue                                                                                                                   
   
(39,323
)
   
5,113
 
Change in other liabilities                                                                                                                   
   
(19,638
)
   
36,253
 
Excess tax benefits from stock-based compensation                                                                                                                      
   
(13,564
)
   
(11,590
)
Other                                                                                                                      
   
(2,247
)
   
1,782
 
Net cash provided by operating activities
   
417,438
     
407,867
 
   
CASH FLOWS FROM INVESTING ACTIVITIES:
 
Change in redemption settlement assets                                                                                                                      
   
41,440
     
15,513
 
Change in restricted cash                                                                                                                      
   
(438,665
)
   
16,842
 
Change in credit card receivables                                                                                                                      
   
(61,375
)
   
270,586
 
Purchase of credit card portfolios                                                                                                                      
   
(122,237
)
   
(42,696
)
Change in cash collateral, restricted                                                                                                                      
   
37,735
     
(131,172
)
Payments for acquired businesses, net of cash                                                                                                                      
   
     
(359,076
)
Capital expenditures                                                                                                                      
   
(55,541
)
   
(33,935
)
Investments in the stock of investees                                                                                                                      
   
(921
)
   
(13,591
)
Other                                                                                                                      
   
(13,417
)
   
222
 
Net cash used in investing activities
   
(612,981
)
   
(277,307
)
   
CASH FLOWS FROM FINANCING ACTIVITIES:
 
Borrowings under debt agreements                                                                                                                      
   
699,500
     
2,336,500
 
Repayments of borrowings                                                                                                                      
   
(494,691
)
   
(1,876,776
)
Issuances of deposits                                                                                                                      
   
659,227
     
138,061
 
Repayments of deposits                                                                                                                      
   
(360,050
)
   
(169,480
)
Borrowings from asset-backed securities                                                                                                                      
   
897,038
     
636,500
 
Repayments/maturities of asset-backed securities                                                                                                                      
   
(719,558
)
   
(989,757
)
Payment of capital lease obligations                                                                                                                      
   
(11
)
   
(3,791
)
Payment of deferred financing costs                                                                                                                      
   
(25,624
)
   
(24,564
)
Excess tax benefits from stock-based compensation                                                                                                                      
   
13,564
     
11,590
 
Proceeds from issuance of common stock                                                                                                                      
   
11,411
     
20,533
 
Purchase of treasury shares                                                                                                                      
   
(59,032
)
   
(116,661
)
Net cash provided by (used in) financing activities
   
621,774
     
(37,845
)
   
Effect of exchange rate changes on cash and cash equivalents
   
(245
)
   
992
 
Change in cash and cash equivalents
   
425,986
     
93,707
 
Cash and cash equivalent at beginning of period
   
216,213
     
139,114
 
Cash and cash equivalents at end of period                                                                                                                
 
$
642,199
   
$
232,821
 
   
SUPPLEMENTAL CASH FLOW INFORMATION:
 
Interest paid                                                                                                                      
 
$
99,257
   
$
118,971
 
Income taxes paid, net                                                                                                                      
 
$
98,243
   
$
58,371
 
 
See accompanying notes to unaudited condensed consolidated financial statements.

 
6

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
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 and its consolidated variable interest entities, 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, 2011, filed with the SEC on February 27, 2012.
 
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 (1) the reported amounts of assets; (2) liabilities and disclosure of contingent assets and liabilities at the date of the financial statements; and (3) the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
 
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
June 30,
   
Six Months Ended
June 30,
 
   
2012
 
2011
   
2012
 
2011
 
       
(In thousands, except per share amounts)
     
Numerator:
                       
Net Income
 
$
103,821
 
$
69,023
   
$
219,050
 
$
155,399
 
Denominator:
                   
Weighted average shares, basic
   
50,161
   
51,070
     
50,157
   
51,099
 
Weighted average effect of dilutive securities:
               
Shares from assumed conversion of convertible senior notes
   
8,435
   
4,659
     
8,051
   
3,724
 
Shares from assumed conversion of convertible note warrants
   
4,399
   
1,537
     
3,844
   
1,085
 
Net effect of dilutive stock options and unvested restricted stock
   
736
   
879
     
738
   
870
 
Denominator for diluted calculations
   
63,731
   
58,145
     
62,790
   
56,778
 
                             
Basic net income per share
 
$
2.07
 
$
1.35
   
$
4.37
 
$
3.04
 
Diluted net income per share
 
$
1.63
 
$
1.19
   
$
3.49
 
$
2.74
 
 
The Company calculates the effect of its convertible senior notes, consisting of $805.0 million aggregate principal amount of convertible senior notes due 2013 (the “Convertible Senior Notes 2013”) and $345.0 million aggregate principal amount of convertible senior notes due 2014 (the “Convertible Senior Notes 2014”), which can be settled in cash or shares of common stock, on diluted net income per share as if they will be settled in cash as the Company has the intent to settle the convertible senior notes for cash.
 
Concurrently with the issuance of the Convertible Senior Notes 2013 and the Convertible Senior Notes 2014, the Company entered into hedge transactions that are generally expected to offset the potential dilution of the shares from assumed conversion of convertible senior notes.

 
7

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
The Company is also party to prepaid forward contracts to purchase 1,857,400 shares of its common stock that are to be delivered over a settlement period in 2014. The number of shares to be delivered under the prepaid forward contracts is used to reduce weighted-average basic and diluted shares outstanding.
 
For the three and six months ended June 30, 2011, the Company excluded 10.3 million warrants, respectively, from the calculation of net income per share as the effect was anti-dilutive.
 
3. CREDIT CARD RECEIVABLES
 
The Company’s credit card receivables are the only portfolio segment or class of financing receivables. Quantitative information about the components of total credit card receivables is presented in the table below:
 
   
June 30,
2012
   
December 31,
2011
 
   
(In thousands)
 
Principal receivables
 
$
5,451,277
   
$
5,408,862
 
Billed and accrued finance charges
   
222,735
     
221,357
 
Other receivables
   
36,689
     
35,792
 
Total credit card receivables
   
5,710,701
     
5,666,011
 
Less credit card receivables – restricted for securitization investors
   
4,891,816
     
4,886,168
 
Other credit card receivables
 
$
818,885
   
$
779,843
 
 
Allowance for Loan Loss
 
The Company maintains an allowance for loan loss at a level that is appropriate to absorb probable losses inherent in credit card receivables. The allowance for loan loss covers forecasted uncollectable principal as well as unpaid interest and fees. The allowance for loan loss is evaluated monthly for adequacy.
 
In estimating the allowance for principal loan losses, management utilizes a migration analysis of delinquent and current credit card receivables. Migration analysis is a technique used to estimate the likelihood that a credit card receivable will progress through the various stages of delinquency and to charge-off. The allowance is maintained through an adjustment to the provision for loan losses. Charge-offs of principal amounts, net of recoveries are deducted from the allowance.
 
Net charge-offs include the principal amount of losses from credit cardholders unwilling or unable to pay their account balances, as well as bankrupt and deceased credit cardholders, less recoveries and exclude charged-off interest, fees and fraud losses. Charged-off interest and fees reduce finance charges, net while fraud losses are recorded as an expense. Credit card receivables, including unpaid interest and fees, are charged-off at the end of the month during which an account becomes 180 days contractually past due, except in the case of customer bankruptcies or death. Credit card receivables, including unpaid interest and fees, associated with customer bankruptcies or death are charged-off at the end of each month subsequent to 60 days after the receipt of notification of the bankruptcy or death, but in any case, not later than the 180-day contractual time frame.
 
The Company records the actual charge-offs for unpaid interest and fees as a reduction to finance charges, net. Actual charge-offs for unpaid interest and fees were $44.3 million and $48.3 million for the three months ended June 30, 2012 and 2011, respectively, and $93.2 million and $104.5 million for the six months ended June 30, 2012 and 2011, respectively. In estimating the allowance for uncollectable unpaid interest and fees, the Company utilizes historical charge-off trends, analyzing actual charge-offs for the prior three months. The allowance is maintained through an adjustment to finance charges, net.

 
8

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
In evaluating the allowance for loan loss for both principal and unpaid interest and fees, management also considers factors that may impact loan loss experience, including seasoning, loan volume and amounts, payment rates and forecasting uncertainties. The following table presents the Company’s allowance for loan loss for the periods indicated:
 
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
(In thousands)
 
Balance at beginning of period
 
$
447,483
   
$
489,620
   
$
468,321
   
$
518,069
 
Provision for loan loss
   
52,552
     
60,376
     
101,879
     
128,042
 
Recoveries
   
23,864
     
21,876
     
52,714
     
47,742
 
Principal charge-offs
   
(91,378
)
   
(108,942
)
   
(190,393
)
   
(232,838
)
Other
   
     
(1,915
)
   
     
 
Balance at end of period
 
$
432,521
   
$
461,015
   
$
432,521
   
$
461,015
 
 
Delinquencies
 
A credit card account is contractually delinquent if the Company does not receive the minimum payment by the specified due date on the cardholder’s statement. It is the Company’s policy to continue to accrue interest and fee income on all credit card accounts beyond 90 days, except in limited circumstances, until the credit card account balance and all related interest and other fees are paid or charged off, typically at 180 days delinquent. When an account becomes delinquent, a message is printed on the credit 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 becoming further delinquent. 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 the Company is unable to make a collection after exhausting all in-house collection efforts, the Company will engage collection agencies and outside attorneys to continue those efforts.
 
The following table presents the delinquency trends of the Company’s credit card portfolio:
 
   
June 30,
2012
   
% of
Total
   
December 31,
2011
   
% of
Total
 
           
(In thousands, except percentages)
         
Receivables outstanding – principal
 
$
5,451,277
     
100
%
 
$
5,408,862
     
100
%
Principal receivables balances contractually delinquent:
                               
31 to 60 days
   
77,212
     
1.4
%
   
78,272
     
1.4
%
61 to 90 days
   
49,842
     
0.9
     
51,709
     
1.0
 
91 or more days
   
87,346
     
1.6
     
105,626
     
2.0
 
Total
 
$
214,400
     
3.9
%
 
$
235,607
     
4.4
%
 
Modified Credit Card Receivables
 
The Company holds certain credit card receivables for which the terms have been modified. The Company’s modified credit card receivables include credit card receivables for which temporary hardship concessions have been granted and credit card receivables in permanent workout programs. These modified credit card receivables include concessions consisting primarily of a reduced minimum payment and an interest rate reduction. The temporary programs’ concessions remain in place for a period no longer than twelve months, while the permanent programs remain in place through the payoff of the credit card receivables if the credit cardholder complies with the terms of the program. These concessions do not include the forgiveness of unpaid principal, but may involve the reversal of certain unpaid interest or fee assessments. In the case of the temporary programs, at the end of the concession period, credit card receivable terms revert to standard rates. These arrangements are automatically terminated if the customer fails to make payments in accordance with the terms of the program, at which time their account reverts back to its original terms.
 
Credit card receivables for which temporary hardship and permanent concessions were granted are collectively evaluated for impairment. Modified credit card receivables are evaluated at their present value with impairment measured as the difference between the credit card receivable balance and the discounted present value of cash flows expected to be collected. Consistent with the Company’s measurement of impairment of modified credit card receivables on a pooled basis, the discount rate used for credit card receivables is the average current annual percentage rate the Company applies to non-impaired credit card receivables, which approximates what would have been applied to the pool of modified credit card receivables prior to impairment. In assessing the appropriate allowance for loan loss, these modified credit card receivables are included in the general pool of credit cards with the allowance determined under the contingent loss model of Accounting Standards Codification (“ASC”) 450-20, “Loss Contingencies.” If the Company applied accounting under ASC 310-40, “Troubled Debt Restructurings by Creditors,” to the modified credit card receivables in these programs, there would not be a significant difference in the allowance for loan loss.

 
9

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
The Company had $107.9 million and $122.2 million, respectively, as a recorded investment in impaired credit card receivables with an associated allowance for loan loss of $40.7 million and $45.3 million, respectively, as of June 30, 2012 and December 31, 2011. These modified credit card receivables represented less than 3% of the Company’s total credit card receivables at each of June 30, 2012 and December 31, 2011.
 
The average recorded investment in the impaired credit card receivables was $111.8 million and $135.0 million for the three months ended June 30, 2012 and 2011, respectively, and $115.6 million and $135.3 million for the six months ended June 30, 2012 and 2011, respectively.
 
Interest income on these modified credit card receivables is accounted for in the same manner as other accruing credit card receivables. Cash collections on these modified credit card receivables are allocated according to the same payment hierarchy methodology applied to credit card receivables that are not in such programs. The Company recognized $2.9 million and $3.5 million for the three months ended June 30, 2012 and 2011, respectively, and $6.1 million and $7.1 million for the six months ended June 30, 2012 and 2011, respectively, in interest income associated with modified credit card receivables during the period that such credit card receivables were impaired.
 
The following tables provide information on credit card receivables that entered into a modification program during the specified periods:
 
   
Three Months Ended June 30, 2012
   
Six Months Ended June 30, 2012
 
   
Number of Restructurings
   
Pre-modification Outstanding Principal Balance
   
Post-modification
Outstanding Principal Balance
   
Number of Restructurings
   
Pre-modification Outstanding Principal Balance
   
Post-modification
Outstanding Principal Balance
 
     
(Dollars in thousands)
 
Troubled debt restructurings – credit card receivables
   
28,499
   
$
25,917
   
$
25,839
     
60,039
   
$
54,155
   
$
54,068
 
                                                 
 
 
   
Three Months Ended June 30, 2011
   
Six Months Ended June 30, 2011
 
   
Number of Restructurings
   
Pre-modification Outstanding Principal Balance
   
Post-modification
Outstanding Principal Balance
   
Number of Restructurings
   
Pre-modification Outstanding Principal Balance
   
Post-modification Outstanding Principal Balance
 
     
(Dollars in thousands)
 
Troubled debt restructurings – credit card receivables
   
38,966
   
$
34,389
   
$
34,381
     
83,038
   
$
71,818
   
$
69,764
 
                                                 
 
 
10

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
The tables below summarize troubled debt restructurings that have defaulted in the specified periods where the default occurred within 12 months of their modification date:
 
   
Three Months Ended
June 30, 2012
   
Six Months Ended
June 30, 2012
 
   
Number of Restructurings
   
Outstanding Balance
   
Number of Restructurings
   
Outstanding Balance
 
   
(Dollars in thousands)
 
Troubled debt restructurings, defaulted – credit card receivables
   
13,187
   
$
12,699
     
29,207
   
$
28,161
 
                                 
 
 
   
Three Months Ended
June 30, 2011
   
Six Months Ended
June 30, 2011
 
   
Number of Restructurings
   
Outstanding Balance
   
Number of Restructurings
   
Outstanding Balance
 
   
(Dollars in thousands)
 
Troubled debt restructurings, defaulted – credit card receivables
   
19,595
   
$
19,414
     
38,395
   
$
38,417
 
                                 
 
Age of Credit Card Receivables
 
The following table sets forth, as of June 30, 2012, the number of active credit card accounts with balances and the related principal balances outstanding, based upon the age of the active credit card accounts from origination:
 
Age Since Origination
 
Number of
Active Accounts
with Balances
   
Percentage of
Active Accounts
with Balances
   
Principal
Receivables
Outstanding
   
Percentage of Receivables
Outstanding
 
   
(In thousands, except percentages)
 
0-12 Months
   
3,469
     
26.5
%
 
$
1,198,107
     
22.0
%
13-24 Months
   
1,728
     
13.2
     
660,098
     
12.1
 
25-36 Months
   
1,335
     
10.2
     
605,357
     
11.1
 
37-48 Months
   
1,023
     
7.8
     
504,946
     
9.2
 
49-60 Months
   
851
     
6.5
     
396,614
     
7.3
 
Over 60 Months
   
4,683
     
35.8
     
2,086,155
     
38.3
 
Total
   
13,089
     
100.0
%
 
$
5,451,277
     
100.0
%
 
 
11

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
Credit Quality
 
The Company uses proprietary scoring models developed specifically for the purpose of monitoring the Company’s obligor credit quality. The proprietary scoring model is used as a tool in the underwriting process and for making credit decisions. The proprietary scoring model is based on historical data and requires various assumptions about future performance. Information regarding customer performance is factored into these proprietary scoring models to determine the probability of an account becoming 90 or more days past due at any time within the next 12 months. Obligor credit quality is monitored at least monthly during the life of an account. The following table reflects composition of the Company’s credit card receivables by obligor credit quality as of June 30, 2012:
 
Probability of an Account Becoming 90 or More Days Past
Due or Becoming Charged off (within the next 12 months)
 
Total Principal Receivables Outstanding
   
Percentage of Principal Receivables Outstanding
 
   
(In thousands, except percentages)
 
No Score
 
$
112,731
     
2.1
%
27.1% and higher
   
232,278
     
4.2
 
17.1% - 27.0%
   
478,551
     
8.8
 
12.6% - 17.0%
   
551,539
     
10.1
 
3.7% - 12.5%
   
2,197,155
     
40.3
 
1.9% - 3.6%
   
1,236,673
     
22.7
 
Lower than 1.9%
   
642,350
     
11.8
 
Total
 
$
5,451,277
     
100.0
%
 
Portfolio Acquisitions
 
In March 2012, World Financial Network Bank (“WFNB”) acquired the existing private label credit card portfolio of Pier 1 Imports. The total purchase price was $97.7 million, which consisted of $96.2 million of credit card receivables and $1.5 million of intangible assets that are included in the unaudited condensed consolidated balance sheets as of June 30, 2012.
 
In May 2012, World Financial Capital Bank (“WFCB”) acquired the existing private label credit card portfolio of Premier Designs, Inc. The preliminary total purchase price, which is subject to customary purchase price adjustments, was $24.5 million and consisted of $22.8 million of credit card receivables and $1.7 million of intangible assets that are included in the unaudited condensed consolidated balance sheets as of June 30, 2012.
 
Securitized Credit Card Receivables
 
The Company regularly securitizes its credit card receivables through its credit card securitization trusts, consisting of World Financial Network Credit Card Master Trust, World Financial Network Credit Card Master Note Trust, World Financial Network Credit Card Master Note Trust II and World Financial Network Credit Card Master Trust III (collectively, the “WFN Trusts”), and World Financial Capital Credit Card Master Note Trust (the “WFC Trust”). The Company continues to own and service the accounts that generate credit card receivables held by the WFN Trusts and the WFC Trust. In its capacity as a servicer, each of the respective banks earns a fee from the WFN Trusts and the WFC Trust to service and administer the credit card receivables, collect payments, and charge-off uncollectable receivables. These fees are eliminated and therefore are not reflected in the unaudited condensed consolidated statements of income for the three and six months ended June 30, 2012 and 2011.
 
The WFN Trusts and the WFC Trust are variable interest entities (“VIEs”) and the assets of these consolidated VIEs include certain credit card receivables that are restricted to settle the obligations of those entities and are not expected to be available to the Company or its creditors. The liabilities of the consolidated VIEs include asset-backed secured borrowings and other liabilities for which creditors or beneficial interest holders do not have recourse to the general credit of the Company.

 
12

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
The tables below present quantitative information about the components of total securitized credit card receivables, delinquencies and net charge-offs:
 
   
June 30,
2012
   
December 31,
2011
 
   
(In thousands)
 
Total credit card receivables – restricted for securitization investors
 
$
4,891,816
   
$
4,886,168
 
Principal amount of credit card receivables – restricted for securitization investors, 90 days or more past due
 
$
78,104
   
$
94,981
 
 
 
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
(In thousands)
 
Net charge-offs of securitized principal
 
$
60,640
   
$
78,623
   
$
123,445
   
$
165,926
 
                                 
 
4. REDEMPTION SETTLEMENT ASSETS
 
Redemption settlement assets consist of cash and cash equivalents and securities available-for-sale and are designated for settling redemptions by collectors of the AIR MILES® Reward Program in Canada under certain contractual relationships with sponsors of the AIR MILES Reward Program. These assets are primarily denominated in Canadian dollars. Realized gains and losses from the sale of investment securities were not material. The principal components of redemption settlement assets, which are carried at fair value, are as follows:
 
   
June 30, 2012
   
December 31, 2011
 
   
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair Value
   
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair Value
 
   
(In thousands)
 
Cash and cash equivalents
 
$
6,379
   
$
   
$
   
$
6,379
   
$
35,465
   
$
   
$
   
$
35,465
 
Government bonds
   
4,954
     
104
     
     
5,058
     
4,948
     
152
     
     
5,100
 
Corporate bonds
   
456,346
     
8,869
     
(418
)
   
464,797
     
468,894
     
7,416
     
(1,037
)
   
475,273
 
Total
 
$
467,679
   
$
8,973
   
$
(418
)
 
$
476,234
   
$
509,307
   
$
7,568
   
$
(1,037
)
 
$
515,838
 
 
The following tables show the gross unrealized losses and fair value for those investments that were in an unrealized loss position as of June 30, 2012 and December 31, 2011, aggregated by investment category and the length of time that individual securities have been in a continuous loss position:
 
   
Less than 12 months
   
June 30, 2012
12 Months or Greater
   
Total
 
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
 
   
(In thousands)
 
Government bonds
 
$
   
$
   
$
   
$
   
$
   
$
 
Corporate bonds
   
     
     
4,507
     
(418
)
   
4,507
     
(418
)
Total
 
$
   
$
   
$
4,507
   
$
(418
)
 
$
4,507
   
$
(418
)
 
 
   
Less than 12 months
   
December 31, 2011
12 Months or Greater
   
Total
 
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
 
   
(In thousands)
 
Government bonds
 
$
   
$
   
$
   
$
   
$
   
$
 
Corporate bonds
   
65,043
     
(444
)
   
18,124
     
(593
)
   
83,167
     
(1,037
)
Total
 
$
65,043
   
$
(444
)
 
$
18,124
   
$
(593
)
 
$
83,167
   
$
(1,037
)
 

 
13

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
Market values were determined for each individual security in the investment portfolio. When evaluating the investments for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the security’s issuer, and the Company’s intent to sell the security and whether it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis. The Company typically invests in highly-rated securities with low probabilities of default and has the ability to hold the investments until maturity. As of June 30, 2012, the Company does not consider the investments to be other-than-temporarily impaired.
 
The net carrying value and estimated fair value of the securities at June 30, 2012 by contractual maturity are as follows:
 
   
Amortized
Cost
   
Estimated
Fair Value
 
   
(In thousands)
 
Due in one year or less
 
$
93,723
   
$
93,831
 
Due after one year through five years
   
373,956
     
382,403
 
Total
 
$
467,679
   
$
476,234
 
       
 
5. INTANGIBLE ASSETS AND GOODWILL
 
Intangible Assets
 
Intangible assets consist of the following:
 
   
June 30, 2012
   
   
Gross
Assets
   
Accumulated
Amortization
   
Net
 
Amortization Life and Method
   
(In thousands)
   
Finite Lived Assets
                   
Customer contracts and lists
 
$
314,245
   
$
(157,096
)
 
$
157,149
 
3-12 years—straight line
Premium on purchased credit card portfolios
   
159,395
     
(92,462
)
   
66,933
 
5-10 years—straight line, accelerated
Customer database
   
175,429
     
(106,600
)
   
68,829
 
4-10 years—straight line
Collector database
   
68,854
     
(61,896
)
   
6,958
 
30 years—15% declining balance
Tradenames
   
38,162
     
(8,922
)
   
29,240
 
5-15 years—straight line
Purchased data lists
   
20,639
     
(14,497
)
   
6,142
 
1-5 years—straight line, accelerated
Noncompete agreements
   
300
     
(300
)
   
 
2 years—straight line
   
$
777,024
   
$
(441,773
)
 
$
335,251
   
Indefinite Lived Assets
                         
Tradenames
   
12,350
     
     
12,350
 
Indefinite life
Total intangible assets
 
$
789,374
   
$
(441,773
)
 
$
347,601
   
 
 
   
December 31, 2011
   
   
Gross
Assets
   
Accumulated
Amortization
   
Net
 
Amortization Life and Method
   
(In thousands)
   
Finite Lived Assets
                   
Customer contracts and lists
 
$
314,245
   
$
(140,622
)
 
$
173,623
 
3-12 years—straight line
Premium on purchased credit card portfolios
   
156,203
     
(82,988
)
   
73,215
 
5-10 years—straight line, accelerated
Customer database
   
175,377
     
(96,363
)
   
79,014
 
4-10 years—straight line
Collector database
   
68,652
     
(61,091
)
   
7,561
 
30 years—15% declining balance
Tradenames
   
38,155
     
(7,411
)
   
30,744
 
5-15 years—straight line
Purchased data lists
   
23,776
     
(16,712
)
   
7,064
 
1-5 years—straight line, accelerated
Noncompete agreements
   
1,045
     
(970
)
   
75
 
2 years—straight line
   
$
777,453
   
$
(406,157
)
 
$
371,296
   
Indefinite Lived Assets
                         
Tradenames
   
12,350
     
     
12,350
 
Indefinite life
Total intangible assets
 
$
789,803
   
$
(406,157
)
 
$
383,646
   

 
14

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
Goodwill
 
The changes in the carrying amount of goodwill for the six months ended June 30, 2012 are as follows:
 
   
LoyaltyOne®
   
Epsilon®
   
Private Label
Services and
Credit
   
Corporate/
Other
   
Total
 
   
(In thousands)
 
December 31, 2011
 
$
241,697
   
$
945,934
   
$
261,732
   
$
   
$
1,449,363
 
Effects of foreign currency translation
   
680
     
241
     
     
     
921
 
June 30, 2012
 
$
242,377
   
$
946,175
   
$
261,732
   
$
   
$
1,450,284
 
 
6. DEBT
 
Debt consists of the following:
 
Description
 
June 30,
2012
   
December 31,
2011
 
Maturity
 
Interest Rate
   
(Dollars in thousands)
       
                   
Deposits:
                     
Certificates of deposit
 
$
1,514,944
   
$
1,353,775
 
Various - July 2012 – April 2019
 
0.20% to 5.25%
Money market deposits
   
138,008
     
 
On demand
 
0.01% to 0.26%
Total deposits
   
1,652,952
     
1,353,775
       
Less: current portion
   
(809,547
)
   
(642,567
)
     
Long-term portion
 
$
843,405
   
$
711,208
       
                   
Asset-backed securities debt – owed to securitization investors:
                     
Fixed rate asset-backed term note securities
 
$
1,929,415
   
$
1,562,815
 
Various - July 2012 – March 2019
 
1.68% to 7.00%
Floating rate asset-backed term note securities
   
645,825
     
703,500
 
Various - July 2012 – April 2013
 
(1)
Conduit asset-backed securities
   
862,527
     
993,972
 
Various - September 2012 – March 2014
 
1.20% to 1.70%
Total asset-backed securities – owed to securitization investors
   
3,437,767
     
3,260,287
       
Less: current portion
   
(1,634,517
)
   
(1,694,198
)
     
Long-term portion
 
$
1,803,250
   
$
1,566,089
       
                   
Long-term and other debt:
                 
2011 credit facility
 
$
   
$
410,000
 
May 2016
 
—%
2011 term loan
   
897,403
     
782,594
 
May 2016 or May 2017
 
(2)
Senior notes due 2020
   
500,000
     
 
April 2020
 
6.38%
Convertible senior notes due 2013
   
739,484
     
711,480
 
August 2013
 
1.75%
Convertible senior notes due 2014
   
291,411
     
279,365
 
May 2014
 
4.75%
Capital lease obligations
   
24
     
35
 
July 2013
 
7.10%
Total long-term and other debt
   
2,428,322
     
2,183,474
       
Less: current portion
   
(22,972
)
   
(19,834
)
     
Long-term portion
 
$
2,405,350
   
$
2,163,640
       
                         
 
(1)
Interest rates include those for certain of the Company’s asset-backed securities – owed to securitization investors where floating rate debt is fixed through interest rate swap agreements. The interest rate for the floating rate debt is equal to the London Interbank Offered Rate (“LIBOR”) plus a margin of 0.1% to 2.5%, each as defined in the respective agreements. The weighted average interest rate of the fixed rate achieved through interest rate swap agreements is 5.70% at June 30, 2012.
 
(2)
At June 30, 2012, the weighted average interest rate for the 2011 Term Loan was 2.25%.
 
At June 30, 2012, the Company was in compliance with its covenants.
 
Deposits
 
Beginning January 1, 2012, World Financial Network Bank and World Financial Capital Bank, subsidiaries of the Company, offered a demand deposit program through contractual arrangements with securities brokerage firms. As of June 30, 2012, WFNB and WFCB had issued $138.0 million in money market deposits. Money market deposits are redeemable on demand by the customer and, as such, have no scheduled maturity date.

 
15

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
Credit Agreement
 
The Company, as borrower, and ADS Alliance Data Systems, Inc., ADS Foreign Holdings, Inc., Alliance Data Foreign Holdings, Inc., Epsilon Marketing Services, LLC, Epsilon Data Management LLC, Comenity LLC and Alliance Data FHC, Inc., as guarantors, is party to a credit agreement that originally provided for a $792.5 million term loan (the “2011 Term Loan”) and a $792.5 million revolving line of credit (the “2011 Credit Facility”).
 
In March 2012, the Company entered into a second amendment (the “Second Amendment”) to its credit agreement, dated May 24, 2011 (the “Credit Agreement”), through which the Company increased its 2011 Credit Facility by $125.0 million to $917.5 million. In addition, in March 2012, the Company borrowed additional term loans in the aggregate principal amount of $125.5 million, increasing the 2011 Term Loan to $903.1 million.
 
The Second Amendment, among other things, (i) extends the maturity date of certain term loans under the Credit Agreement from May 24, 2016 to May 24, 2017, (ii) creates a mechanism by which in the future non-extending term loan lenders may extend their term loans to May 24, 2017, (iii) reflects the additional term loans and the increase in the revolving credit commitments and (iv) provides for aggregate principal payments equal to 5% of the extended term loan amount in the additional year of the extended term loans, payable in equal quarterly installments. Total availability under the 2011 Credit Facility at June 30, 2012 was $917.5 million.
 
Senior Notes Due 2020
 
In March 2012, the Company issued and sold $500 million aggregate principal amount of 6.375% senior notes due April 1, 2020 (the “Senior Notes due 2020”). The Senior Notes due 2020 accrue interest on the principal amount at the rate of 6.375% per annum from March 29, 2012, payable semiannually in arrears, on April 1 and October 1 of each year, beginning on October 1, 2012.
 
The payment obligations under the Senior Notes due 2020 are governed by an indenture dated March 29, 2012 with Wells Fargo Bank, N.A., as trustee. The Senior Notes due 2020 are unsecured and are guaranteed on a senior unsecured basis by certain of the Company’s existing and future domestic subsidiaries that guarantee its Credit Agreement, initially ADS Alliance Data Systems, Inc., ADS Foreign Holdings, Inc., Alliance Data Foreign Holdings, Inc., Epsilon Marketing Services, LLC, Epsilon Data Management LLC, Comenity LLC and Alliance Data FHC, Inc. The indenture includes usual and customary negative covenants and events of default for transactions of this type.
 
Convertible Senior Notes
 
The Company has outstanding $1.15 billion of convertible senior notes, consisting of $805.0 million scheduled to mature on August 1, 2013 and $345.0 million scheduled to mature on May 15, 2014. The table below summarizes the carrying value of the components of the convertible senior notes:
 
   
June 30,
2012
   
December 31,
2011
 
   
(In thousands)
 
Carrying amount of equity component
 
$
368,678
   
$
368,678
 
                 
Principal amount of liability component
 
$
1,150,000
   
$
1,150,000
 
Unamortized discount
   
(119,105
)
   
(159,155
)
Net carrying value of liability component
 
$
1,030,895
   
$
990,845
 
                 
If-converted value of common stock
 
$
2,363,602
   
$
1,818,048
 
 
The discount on the liability component will be amortized as interest expense over the remaining life of the convertible senior notes which, at June 30, 2012, is a weighted average period of 1.3 years.

 
16

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
Interest expense on the convertible senior notes recognized in the Company’s unaudited condensed consolidated statements of income for the three and six months ended June 30, 2012 and 2011 is as follows:
 
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
(In thousands, except percentages)
 
Interest expense calculated on contractual interest rate
 
$
7,618
   
$
7,618
   
$
15,237
   
$
15,237
 
Amortization of discount on liability component
   
20,300
     
18,187
     
40,050
     
35,882
 
Total interest expense on convertible senior notes
 
$
27,918
   
$
25,805
   
$
55,287
   
$
51,119
 
                                 
Effective interest rate (annualized)
   
11.0
%
   
11.0
%
   
11.0
%
   
11.0
%
 
Asset-backed Securities – Owed to Securitization Investors
 
Asset-backed Term Notes
 
In April 2012, World Financial Network Credit Card Master Note Trust issued $550.0 million of term asset-backed securities to investors. The offering consisted of $412.5 million of Class A Series 2012-A asset-backed term notes that have a fixed interest rate of 3.14% per year and mature in March 2019. In addition, the Company retained an aggregate of $137.5 million of subordinated classes of the term asset-backed notes which have been eliminated from the Company’s unaudited condensed consolidated financial statements.
 
In August 2009, World Financial Network Credit Card Master Note Trust issued $395.0 million of Class A Series 2009-B asset-backed term notes that have a fixed interest rate of 3.79% per year and mature in July 2012. Pursuant to the indenture supplement applicable to these securities, as of June 30, 2012, the Company has collected $395.0 million of principal payments made by its credit cardholders during the accumulation period. The cash is restricted to the securitization investors and is reflected in other current assets in the Company’s unaudited condensed consolidated financial statements as of June 30, 2012.
 
Conduit Facilities
 
In June 2012, the Company renewed its $1.2 billion 2009-VFN conduit facility under World Financial Network Credit Card Master Note Trust, extending its maturity to March 5, 2014. Also, in June 2012, the Company renewed its 2009-VFN conduit facility under World Financial Capital Master Note Trust, extending the maturity to May 31, 2013 and increasing the total capacity from $275.0 million to $375.0 million.
 
Derivative Financial Instruments
 
As part of its interest rate risk management program, the Company may enter into derivative financial instruments with institutions that are established dealers and manage its exposure to changes in fair value of certain obligations attributable to changes in LIBOR.
 
The credit card securitization trusts enter into derivative financial instruments, which include both interest rate swaps and an interest rate cap, to mitigate their interest rate risk on a related financial instrument or to lock the interest rate on a portion of their variable asset-backed securities debt.
 
These interest rate contracts involve the receipt of variable rate amounts from counterparties in exchange for the Company making fixed rate payments over the life of the agreement without the exchange of the underlying notional amount. These interest rate contracts are not designated as hedges. Such contracts are not speculative and are used to manage interest rate risk, but do not meet the specific hedge accounting requirements of ASC 815, “Derivatives and Hedging.”

 
17

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
The following tables identify the notional amount, fair value and classification of the Company’s outstanding interest rate contracts at June 30, 2012 and December 31, 2011 in the unaudited condensed consolidated balance sheets:
 
   
June 30, 2012
 
December 31, 2011
 
   
Notional Amount
   
Weighted Average Years to Maturity
 
Notional Amount
   
Weighted Average Years to Maturity
 
   
(Dollars in thousands)
Interest rate contracts not designated as hedging instruments
 
$
645,825
   
0.92
   
703,500
   
1.37
 
 

 
   
June 30, 2012
 
December 31, 2011
 
   
Balance Sheet
Location
   
Fair Value
 
Balance Sheet
Location
   
Fair Value
 
   
(In thousands)
Interest rate contracts not designated as hedging instruments
 
Other assets
   
$
8
   
Other assets
   
$
 
Interest rate contracts not designated as hedging instruments
 
Other current liabilities
   
$
22,927
   
Other current liabilities
   
$
4,739
 
Interest rate contracts not designated as hedging instruments
 
Other liabilities
   
$
   
Other liabilities
   
$
33,364
 
 
The following table summarizes activity related to and identifies the location of the Company’s outstanding interest rate contracts for the three and six months ended June 30, 2012 and 2011 recognized in the unaudited condensed consolidated statements of income:
 
   
2012
 
2011
 
For the three months ended June 30,
 
Income Statement
Location
   
Gain on Derivative
Contracts
 
Income Statement
Location
   
Gain on Derivative
Contracts
 
   
(In thousands)
Interest rate contracts not designated as hedging instruments
 
Securitization
funding costs
   
$
8,172
   
Securitization
funding costs
   
$
4,711
 
                               
For the six months ended June 30,
                             
Interest rate contracts not designated as hedging instruments
 
Securitization
funding costs
   
$
15,184
   
Securitization
funding costs
   
$
14,603
 
 
The Company limits its exposure on derivatives by entering into contracts with institutions that are established dealers who maintain certain minimum credit criteria established by the Company. At June 30, 2012, the Company does not maintain any derivative contracts subject to master agreements that would require the Company to post collateral or that contain any credit-risk related contingent features. The Company has provisions in certain of the master agreements that require counterparties to post collateral to the Company when their credit ratings fall below certain thresholds. At June 30, 2012, these thresholds were not breached and no amounts were held as collateral by the Company.

 
18

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
7. DEFERRED REVENUE
 
Because management has determined that the earnings process is not complete at the time an AIR MILES reward mile is issued, the recognition of revenue on all fees received at issuance is deferred. The Company allocates the proceeds from the issuance of AIR MILES reward miles into two components as follows:
 
 
Redemption element. The redemption element is the larger of the two components. Revenue related to the redemption element is based on the estimated fair value. For this component, revenue is recognized at the time an AIR MILES reward mile is redeemed, or for those AIR MILES reward miles that are estimated to go unredeemed by the collector base, known as “breakage,” over the estimated life of an AIR MILES reward mile, or a period of 42 months. The Company’s estimate of breakage is 28%.
 
 
Service element. The service element consists of marketing and administrative services. Revenue related to the service element is determined in accordance with Accounting Standards Update (“ASU”) 2009-13, “Multiple Deliverable Revenue Arrangements.” It is initially deferred and then amortized pro rata over the estimated life of an AIR MILES reward mile. With the adoption of ASU 2009-13, the residual method will no longer be utilized for new sponsor agreements entered into on or after January 1, 2011 or existing sponsor agreements that are materially modified subsequent to that date; for these agreements, the Company will measure the service element at its estimated selling price.
 
Under certain of the Company’s contracts, a portion of the proceeds is paid to the Company upon the issuance of an AIR MILES reward mile and a portion is paid at the time of redemption and therefore, the Company does not have a redemption obligation related to these contracts. Revenue is recognized at the time of redemption and is not reflected in the reconciliation of the redemption obligation detailed below. Under such contracts, the proceeds received at issuance are initially deferred as service revenue and revenue is recognized pro rata over the estimated life of an AIR MILES reward mile. Amounts for revenue related to the redemption element and service element are recorded in redemption revenue and transaction revenue, respectively, in the unaudited condensed consolidated statements of income.
 
A reconciliation of deferred revenue for the AIR MILES Reward Program is as follows:
 
   
Deferred Revenue
 
   
Service
   
Redemption
   
Total
 
   
(In thousands)
 
December 31, 2011
 
$
358,973
   
$
867,463
   
$
1,226,436
 
Cash proceeds
   
113,589
     
269,083
     
382,672
 
Revenue recognized
   
(99,323
)
   
(323,062
)
   
(422,385
)
Other
   
     
385
     
385
 
Effects of foreign currency translation
   
907
     
3,145
     
4,052
 
June 30, 2012
 
$
374,146
   
$
817,014
   
$
1,191,160
 
Amounts recognized in the unaudited condensed consolidated balance sheets:
                       
Current liabilities
 
$
177,512
   
$
817,014
   
$
994,526
 
Non-current liabilities
 
$
196,634
   
$
   
$
196,634
 
 
Effective from December 31, 2011, LoyaltyOne implemented an expiry policy, with all existing and future AIR MILES reward miles having an expiry of five years.
 
In December 2011, LoyaltyOne introduced a new program option, AIR MILES Cash, to which collectors, beginning in the first quarter of 2012, can allocate some or all of their future AIR MILES reward miles collected. Effective March 2012, AIR MILES Cash enabled collectors to instantly redeem their AIR MILES reward miles collected in this new program in-store towards purchases at participating sponsors.

 
19

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
8. STOCKHOLDERS’ EQUITY
 
Stock Repurchase Program
 
On December 13, 2011, the Company’s Board of Directors authorized a stock repurchase program to acquire up to $400.0 million of the Company’s outstanding common stock from January 1, 2012 through December 31, 2012, subject to any restrictions pursuant to the terms of the Company’s credit agreements or otherwise.
 
For the six months ended June 30, 2012, the Company acquired a total of 486,241 shares of its common stock for $59.0 million. As of June 30, 2012, the Company has $341.0 million available under the stock repurchase program.
 
Stock Compensation Expense
 
Total stock-based compensation expense recognized in the Company’s unaudited condensed consolidated statements of income for the three and six months ended June 30, 2012 and 2011 is as follows:
 
   
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2012
   
2011
   
2012
   
2011
 
   
(In thousands)
 
Cost of operations
 
$
7,954
   
$
6,007
   
$
15,521
   
$
11,910
 
General and administrative
   
4,926
     
5,099
     
9,665
     
8,280
 
Total
 
$
12,880
   
$
11,106
   
$
25,186
   
$
20,190
 
 
During the six months ended June 30, 2012, the Company awarded 328,759 performance-based restricted stock units with a weighted average grant date fair value per share of $120.00 as determined on the date of grant. The performance restriction on the awards will lapse upon determination by the Board of Directors or the Compensation Committee of the Board of Directors that the Company’s earnings before taxes for the period from January 1, 2012 to December 31, 2012 met certain pre-defined vesting criteria that permit a range from 50% to 150% of such performance-based restricted stock units to vest. Upon such determination, the restrictions will lapse with respect to 33% of the award on February 21, 2013, an additional 33% of the award on February 21, 2014 and the final 34% of the award on February 23, 2015, provided that the participant is employed by the Company on each such vesting date.
 
During the six months ended June 30, 2012, the Company awarded 94,626 service-based restricted stock units with a weighted average grant date fair value per share of $120.16 as determined on the date of grant. Service-based restricted stock units typically vest ratably over three years provided that the participant is employed by the Company on each such vesting date.
 
9. FINANCIAL INSTRUMENTS
 
In accordance with ASC 825, “Financial Instruments,” the Company is required to disclose the fair value of financial instruments for which it is practical to estimate fair value. To obtain fair values, observable market prices are used if available. In some instances, observable market prices are not readily available and fair value is determined using present value or other techniques appropriate for a particular financial instrument. These techniques involve judgment and as a result are not necessarily indicative of the amounts the Company would realize in a current market exchange. The use of different assumptions or estimation techniques may have a material effect on the estimated fair value amounts.

 
20

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
 
Fair Value of Financial Instruments The estimated fair values of the Company’s financial instruments are as follows:
 
   
June 30, 2012
   
December 31, 2011
 
   
Carrying
Amount
   
Fair
Value
   
Carrying
Amount
   
Fair
Value
 
   
(In thousands)
 
Financial assets
                       
Cash and cash equivalents
 
$
642,199
   
$
642,199
   
$
216,213
   
$
216,213
 
Trade receivables, net
   
319,292
     
319,292
     
300,895
     
300,895
 
Credit card receivables, net
   
5,278,180
     
5,278,180
     
5,197,690
     
5,197,690
 
Redemption settlement assets, restricted
   
476,234
     
476,234
     
515,838
     
515,838
 
Cash collateral, restricted
   
124,895
     
124,895
     
158,727
     
158,727
 
Other investment securities
   
469,215
     
469,215
     
26,772
     
26,772
 
Derivative financial instruments
   
8
     
8
     
     
 
Financial liabilities
                               
Accounts payable
   
169,938
     
169,938
     
149,812
     
149,812
 
Deposits
   
1,652,952
     
1,670,748
     
1,353,775
     
1,372,670
 
Asset-backed securities debt – owed to securitization investors
   
3,437,767
     
3,502,028
     
3,260,287
     
3,302,687
 
Long-term and other debt
   
2,428,322
     
3,779,796
     
2,183,474
     
3,071,661
 
Derivative financial instruments
   
22,927
     
22,927
     
38,103
     
38,103
 
 
Fair Value of Assets and Liabilities Held at June 30, 2012 and December 31, 2011
 
The following techniques and assumptions were used by the Company in estimating fair values of financial instruments as disclosed herein:
 
Cash and cash equivalents, trade receivables, net and accounts payable The carrying amount approximates fair value due to the short maturity and the relatively liquid nature of these assets and liabilities.
 
Credit card receivables, net — The carrying amount of credit card receivables, net approximates fair value due to the short maturity, and the average interest rates approximate current market origination rates.
 
Redemption settlement assets, restricted — Redemption settlement assets, restricted consists of cash and cash equivalents and marketable securities. The fair value for securities is based on quoted market prices for the same or similar securities.
 
Cash collateral, restricted — The spread deposits are recorded at their fair value based on discounted cash flow models. The Company uses a valuation model that calculates the present value of estimated cash flows for each asset. The fair value is based on the term of the underlying securities and a discount rate. The carrying amount of excess funding deposits approximates its fair value due to the relatively short maturity period and average interest rates, which approximate current market rates.
 
Other investment securities — Other investment securities consist primarily of restricted cash and marketable securities. The fair value is based on quoted market prices for the same or similar securities.
 
Deposits — The fair value is estimated based on the current observable market rates available to the Company for similar deposits with similar remaining maturities.
 
Asset-backed securities debt – owed to securitization investors — The fair value is estimated based on the current observable market rates available to the Company for similar debt instruments with similar remaining maturities or quoted market prices of the same transaction.
 
Long-term and other debt — The fair value is estimated based on the current observable market rates av