10-Q 1 form10q.htm ALLIANCE DATA SYSTEMS CORPORATION 10-Q 3-31-2013 form10q.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 March 31, 2013
   
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 R     No  £
 
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 May 1, 2013, 49,186,398 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.
 
25
Item 3.
 
34
Item 4.
 
34
 
Part II:  OTHER INFORMATION
 
Item 1.
 
36
Item 1A.
 
36
Item 2.
 
36
Item 3.
 
36
Item 4.
 
36
Item 5.
 
36
Item 6.
 
37
 
39

 

 
2

 
PART I
 
Financial Statements.
  
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
 
   
March 31,
2013
   
December 31,
2012
 
 
(In thousands, except per share amounts)
ASSETS
Cash and cash equivalents
  $ 764,149     $ 893,352  
Trade receivables, less allowance for doubtful accounts ($4,558 and $3,919 at March 31, 2013 and December 31, 2012, respectively)
    331,608       370,110  
Credit card receivables:
               
Credit card receivables – restricted for securitization investors
    5,960,423       6,597,120  
Other credit card receivables
    1,066,260       852,512  
Total credit card receivables
    7,026,683       7,449,632  
Allowance for loan loss
    (471,016 )     (481,958 )
Credit card receivables, net
    6,555,667       6,967,674  
Deferred tax asset, net
    228,354       237,268  
Other current assets
    670,223       171,049  
Redemption settlement assets, restricted
    537,825       492,690  
Total current assets
    9,087,826       9,132,143  
Property and equipment, net
    255,905       253,028  
Deferred tax asset, net
    27,573       30,027  
Cash collateral, restricted
    67,191       65,160  
Intangible assets, net
    552,708       582,874  
Goodwill
    1,743,683       1,751,053  
Other non-current assets
    191,625       185,854  
Total assets
  $ 11,926,511     $ 12,000,139  
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable
  $ 258,278     $ 215,470  
Accrued expenses
    221,981       274,625  
Deposits
    1,056,086       1,092,753  
Asset-backed securities debt – owed to securitization investors
    1,581,719       1,474,054  
Current debt
    823,889       803,269  
Other current liabilities
    112,641       117,283  
Deferred revenue
    997,136       1,055,323  
Total current liabilities
    5,051,730       5,032,777  
Deferred revenue
    186,328       193,738  
Deferred tax liability, net
    282,614       277,354  
Deposits
    1,120,991       1,135,658  
Asset-backed securities debt – owed to securitization investors
    2,501,916       2,656,916  
Long-term and other debt
    2,047,098       2,051,570  
Other liabilities
    131,308       123,639  
Total liabilities
    11,321,985       11,471,652  
Commitments and contingencies
               
Stockholders’ equity:
               
Common stock, $0.01 par value; authorized, 200,000 shares; issued, 95,320 shares and 94,963 shares at March 31, 2013 and December 31, 2012, respectively
    953       950  
Additional paid-in capital
    1,448,574       1,454,230  
Treasury stock, at cost, 45,692 shares and 45,360 shares at March 31, 2013 and December 31, 2012, respectively
    (2,509,802 )     (2,458,092 )
Retained earnings
    1,682,239       1,553,260  
Accumulated other comprehensive loss
    (17,438 )     (21,861 )
Total stockholders’ equity
    604,526       528,487  
Total liabilities and stockholders’ equity
  $ 11,926,511     $ 12,000,139  
 
See accompanying notes to unaudited condensed consolidated financial statements.

 
3


UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
 
   
Three Months Ended
March 31,
 
   
2013
   
2012
 
 
(In thousands, except per share amounts)
Revenues
 
Transaction                                                                                                                   
 
$
82,348
   
$
82,744
 
Redemption                                                                                                                   
   
160,012
     
188,466
 
Finance charges, net                                                                                                                   
   
477,404
     
376,315
 
Database marketing fees and direct marketing services                                                                                                                   
   
295,606
     
213,596
 
Other revenue                                                                                                                   
   
38,067
     
30,448
 
Total revenue
   
1,053,437
     
891,569
 
Operating expenses
 
Cost of operations (exclusive of depreciation and amortization disclosed separately below)
   
620,422
     
526,905
 
Provision for loan loss                                                                                                                   
   
66,648
     
49,327
 
General and administrative                                                                                                                   
   
22,292
     
23,999
 
Depreciation and other amortization                                                                                                                   
   
19,560
     
17,604
 
Amortization of purchased intangibles                                                                                                                   
   
33,290
     
21,115
 
Total operating expenses
   
762,212
     
638,950
 
Operating income
   
291,225
     
252,619
 
Interest expense
 
Securitization funding costs                                                                                                                   
   
24,485
     
22,329
 
Interest expense on deposits                                                                                                                   
   
7,007
     
5,963
 
Interest expense on long-term and other debt, net                                                                                                                   
   
51,052
     
37,360
 
Total interest expense, net
   
82,544
     
65,652
 
Income before income tax
 
$
208,681
   
$
186,967
 
Provision for income taxes
   
79,702
     
71,738
 
Net income                                                                                                                      
 
$
128,979
   
$
115,229
 
   
Basic income per share                                                                                                                      
 
$
2.59
   
$
2.30
 
Diluted income per share                                                                                                                      
 
$
1.92
   
$
1.86
 
   
Weighted average shares:
 
Basic                                                                                                                   
   
49,762
     
50,147
 
Diluted                                                                                                                   
   
67,328
     
61,849
 
   
 
See accompanying notes to unaudited condensed consolidated financial statements.

 
4


UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
   
Three Months Ended
March 31,
 
   
2013
   
2012
 
   
(In thousands)
 
   
Net income                                                                                                                      
 
$
128,979
   
$
115,229
 
Other comprehensive income, net of tax:
 
Net unrealized gain on securities available-for-sale, net of tax benefit of $(152) and $(26) for the three months ended March 31, 2013 and 2012, respectively
   
1,096
     
1,484
 
Foreign currency translation adjustments                                                                                                                   
   
3,327
     
(3,066
)
Other comprehensive income (loss)                                                                                                                      
   
4,423
     
(1,582
)
Total comprehensive income, net of tax                                                                                                                      
 
$
133,402
   
$
113,647
 
 
 
See accompanying notes to unaudited condensed consolidated financial statements.

 
5


UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
   
Three Months Ended
March 31,
 
   
2013
   
2012
 
   
(In thousands)
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
Net income                                                                                                                      
 
$
128,979
   
$
115,229
 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
Depreciation and amortization                                                                                                                   
   
52,850
     
38,719
 
Deferred income taxes                                                                                                                   
   
14,597
     
8,026
 
Provision for loan loss                                                                                                                   
   
66,648
     
49,327
 
Non-cash stock compensation                                                                                                                   
   
13,024
     
12,306
 
Fair value gain on interest-rate derivatives                                                                                                                   
   
(6,311
)
   
(7,012
)
Amortization of discount on debt                                                                                                                   
   
22,241
     
19,750
 
Change in operating assets and liabilities, net of acquisitions:
 
Change in trade accounts receivable                                                                                                                   
   
5,605
     
33,947
 
Change in other assets                                                                                                                   
   
2,903
     
18,269
 
Change in accounts payable and accrued expenses                                                                                                                   
   
5,440
     
9,205
 
Change in deferred revenue                                                                                                                   
   
(34,918
   
(39,157
Change in other liabilities                                                                                                                   
   
10,065
     
(5,947
)
Excess tax benefits from stock-based compensation                                                                                                                      
   
(9,596
)
   
(11,713
)
Other                                                                                                                      
   
7,475
     
(1,326
)
Net cash provided by operating activities
   
279,002
     
239,623
 
   
CASH FLOWS FROM INVESTING ACTIVITIES:
 
Change in redemption settlement assets                                                                                                                      
   
(52,863
   
34,585
 
Change in restricted cash                                                                                                                      
   
(463,058
)
   
(44,763
Change in credit card receivables                                                                                                                      
   
371,421
     
257,512
 
Purchase of credit card portfolios                                                                                                                      
   
(37,061
)
   
(97,653
)
Change in cash collateral, restricted                                                                                                                      
   
(1,551
   
16,024
 
Capital expenditures                                                                                                                      
   
(28,282
)
   
(31,366
)
Purchases of marketable securities                                                                                                                      
   
(45,720
)
   
 
Maturities/sales of marketable securities                                                                                                                      
   
476
     
452
 
Other                                                                                                                      
   
(1,250
)
   
44
 
Net cash (used in) provided by investing activities
   
(257,888
)
   
134,835
 
   
CASH FLOWS FROM FINANCING ACTIVITIES:
 
Borrowings under debt agreements                                                                                                                      
   
     
699,500
 
Repayments of borrowings                                                                                                                      
   
(6,088
)
   
(473,953
)
Issuances of deposits                                                                                                                      
   
326,881
     
136,760
 
Repayments of deposits                                                                                                                      
   
(378,215
)
   
(202,741
)
Borrowings from asset-backed securities                                                                                                                      
   
500,004
     
 
Repayments/maturities of asset-backed securities                                                                                                                      
   
(547,339
)
   
(350,483
)
Payment of capital lease obligations                                                                                                                      
   
(6
)
   
(5
)
Payment of deferred financing costs                                                                                                                      
   
(2,506
)
   
(18,098
)
Excess tax benefits from stock-based compensation                                                                                                                      
   
9,596
     
11,713
 
Proceeds from issuance of common stock                                                                                                                      
   
2,093
     
6,928
 
Purchase of treasury shares                                                                                                                      
   
(51,710
)
   
(2,521
)
Net cash used in financing activities
   
(147,290
   
(192,900
)
   
Effect of exchange rate changes on cash and cash equivalents
   
(3,027
)
   
1,273
 
Change in cash and cash equivalents
   
(129,203
   
182,831
 
Cash and cash equivalents at beginning of period
   
893,352
     
216,213
 
Cash and cash equivalents at end of period                                                                                                                
 
$
764,149
   
$
399,044
 
   
SUPPLEMENTAL CASH FLOW INFORMATION:
 
Interest paid                                                                                                                      
 
$
47,951
   
$
49,466
 
Income taxes paid, net                                                                                                                      
 
$
37,724
   
$
34,685
 
 
See accompanying 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, 2012, filed with the SEC on February 28, 2013.
 
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.
 
 
Recently Issued Accounting Standards
 
In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-02, “Reporting Amounts Reclassified Out of Accumulated Other Comprehensive Income,” which expands the disclosure requirements for items reclassified from accumulated other comprehensive income to net income by requiring the total changes of each component of other comprehensive income to be disaggregated and separately presenting current period reclassification adjustments from the remainder of other comprehensive income for the period. ASU 2013-02 is effective for interim and annual periods beginning after December 15, 2012 and requires prospective application. ASU 2013-02 had no impact on the Company’s financial condition, results of operations or cash flows.
 
 
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 March 31,
 
   
2013
   
2012
 
   
(In thousands, except per share amounts)
 
Numerator:
           
Net Income
 
$
128,979
   
$
115,229
 
Denominator:
           
Weighted average shares, basic
   
49,762
     
50,147
 
Weighted average effect of dilutive securities:
     
Shares from assumed conversion of convertible senior notes
   
10,133
     
7,667
 
Shares from assumed conversion of convertible note warrants
   
6,854
     
3,289
 
Net effect of dilutive stock options and unvested restricted stock
   
579
     
746
 
Denominator for diluted calculations
   
67,328
     
61,849
 
                 
Basic net income per share
 
$
2.59
   
$
2.30
 
Diluted net income per share
 
$
1.92
   
$
1.86
 
 
 
7

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

 
The Company calculates the effect of its convertible senior notes, 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 its convertible senior notes, 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.
 
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.
 
 
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:
 
   
March 31,
2013
   
December 31,
2012
 
   
(In thousands)
 
Principal receivables
 
$
6,680,812
   
$
7,097,951
 
Billed and accrued finance charges
   
270,436
     
291,476
 
Other receivables
   
75,435
     
60,205
 
Total credit card receivables
   
7,026,683
     
7,449,632
 
Less credit card receivables – restricted for securitization investors
   
5,960,423
     
6,597,120
 
Other credit card receivables
 
$
1,066,260
   
$
852,512
 
 
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 uncollectible 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 loss. 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 $58.7 million and $48.9 million for the three months ended March 31, 2013 and 2012, respectively. In estimating the allowance for uncollectible 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 March 31,
 
   
2013
   
2012
 
   
(In thousands)
 
Balance at beginning of period
 
$
481,958
   
$
468,321
 
Provision for loan loss
   
66,648
     
49,327
 
Recoveries
   
30,785
     
28,850
 
Principal charge-offs
   
(108,375
)
   
(99,015
)
Balance at end of period
 
$
471,016
   
$
447,483
 
 
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 may engage collection agencies and outside attorneys to continue those efforts.
 
The following table presents the delinquency trends of the Company’s credit card portfolio:
 
   
March 31,
2013
   
% of
Total
   
December 31,
2012
   
% of
Total
 
           
(In thousands, except percentages)
         
Receivables outstanding – principal
 
$
6,680,812
     
100.0
%
 
$
7,097,951
     
100.0
%
Principal receivables balances contractually delinquent:
                               
31 to 60 days
   
83,929
     
1.2
%
   
100,479
     
1.4
%
61 to 90 days
   
57,609
     
0.9
     
62,546
     
0.9
 
91 or more days
   
112,916
     
1.7
     
120,163
     
1.7
 
Total
 
$
254,454
     
3.8
%
 
$
283,188
     
4.0
%
 
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 both considered troubled debt restructurings and 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 material difference in the allowance for loan loss.
 
 
9

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

 
The Company had $118.2 million and $117.0 million, respectively, as a recorded investment in impaired credit card receivables with an associated allowance for loan loss of $40.9 million and $39.7 million, respectively, as of March 31, 2013 and December 31, 2012. These modified credit card receivables represented less than 3% of the Company’s total credit card receivables as of March 31, 2013 and December 31, 2012, respectively.
 
The average recorded investment in the impaired credit card receivables was $117.6 million and $119.4 million for the three months ended March 31, 2013 and 2012, 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 $3.2 million for the three months ended March 31, 2013 and 2012, 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 are considered troubled debt restructurings as described above, which entered into a modification program during the specified periods:
 
 
Three Months Ended March 31, 2013
 
 
Number of Restructurings
 
Pre-modification
Outstanding
Balance
 
Post-modification
Outstanding
Balance
 
 
(Dollars in thousands)
 
Troubled debt restructurings – credit card receivables
37,795   $ 33,966   $ 33,942  
                     
                     
 
Three Months Ended March 31, 2012
 
 
Number of Restructurings
 
Pre-modification
Outstanding
Balance
 
Post-modification
Outstanding
Balance
 
 
(Dollars in thousands)
 
Troubled debt restructurings – credit card receivables
 31,540   $ 28,238    $ 28,229  
 
 
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 March 31, 2013
 
 
Number of
Restructurings
 
Outstanding
Balance
 
 
(Dollars in thousands)
 
Troubled debt restructurings that subsequently defaulted – credit card receivables
15,495
 
$
14,483
 
           
           
 
Three Months Ended March 31, 2012
 
 
Number of
Restructurings
 
Outstanding
Balance
 
 
(Dollars in thousands)
 
Troubled debt restructurings that subsequently defaulted – credit card receivables
16,020
 
$
15,462
 
           
 
 
10

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

 
Age of Credit Card Receivables
 
The following tables set forth, as of March 31, 2013 and 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:
 
   
March 31, 2013
 
Age of Accounts Since Origination
 
Number of
Active Accounts
with Balances
   
Percentage of
Active Accounts
with Balances
   
Principal
Receivables
Outstanding
   
Percentage of
Principal
Receivables
Outstanding
 
   
(In thousands, except percentages)
 
0-12 Months
   
3,919
     
25.8
%
 
$
1,489,425
     
22.3
%
13-24 Months
   
2,013
     
13.3
     
823,748
     
12.3
 
25-36 Months
   
1,415
     
9.3
     
634,826
     
9.5
 
37-48 Months
   
1,161
     
7.7
     
576,524
     
8.6
 
49-60 Months
   
920
     
6.1
     
467,542
     
7.0
 
Over 60 Months
   
5,726
     
37.8
     
2,688,747
     
40.3
 
Total
   
15,154
     
100.0
%
 
$
6,680,812
     
100.0
%
 

   
March 31, 2012
 
Age of Accounts Since Origination
 
Number of
Active Accounts
with Balances
   
Percentage of
Active Accounts
with Balances
   
Principal
Receivables
Outstanding
   
Percentage of
Principal
Receivables
Outstanding
 
   
(In thousands, except percentages)
 
0-12 Months
   
3,210
     
25.9
%
 
$
1,096,991
     
21.1
%
13-24 Months
   
1,603
     
12.9
     
622,278
     
12.0
 
25-36 Months
   
1,298
     
10.5
     
602,557
     
11.6
 
37-48 Months
   
984
     
7.9
     
473,416
     
9.1
 
49-60 Months
   
808
     
6.5
     
379,070
     
7.3
 
Over 60 Months
   
4,496
     
36.3
     
2,015,820
     
38.9
 
Total
   
12,399
     
100.0
%
 
$
5,190,132
     
100.0
%
 
Credit Quality
 
The Company uses proprietary scoring models developed specifically for the purpose of monitoring the Company’s obligor credit quality. The proprietary scoring models are used as a tool in the underwriting process and for making credit decisions. The proprietary scoring models are based on historical data and require 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 March 31, 2013 and 2012:
 
   
March 31, 2013
   
March 31, 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
   
Total Principal
Receivables
Outstanding
   
Percentage of
Principal
Receivables
Outstanding
 
           
(In thousands, except percentages)
         
No Score
 
$
182,777
     
2.7
%
 
$
186,242
     
3.6
%
27.1% and higher
   
302,099
     
4.5
     
214,738
     
4.1
 
17.1% - 27.0%    
615,789
     
9.2
     
424,710
     
8.2
 
12.6% - 17.0%    
725,147
     
10.9
     
508,390
     
9.8
 
3.7% - 12.5%    
2,662,963
     
39.9
     
2,088,922
     
40.2
 
1.9% - 3.6%    
1,414,222
     
21.2
     
1,166,685
     
22.5
 
Lower than 1.9%
   
777,815
     
11.6
     
600,445
     
11.6
 
Total
 
$
6,680,812
     
100.0
%
  $
5,190,132
     
100.0
%
 
 
11

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

 
Credit Card Portfolio Acquisition
 
In March 2013, the Company acquired the existing private label credit card portfolio of Barneys New York. The purchase price was $37.1 million, which is subject to customary purchase price adjustments, and consisted of $35.3 million of credit card receivables and $1.8 million of intangible assets that are included in the March 31, 2013 unaudited condensed consolidated balance sheet.
 
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 (“Master Trust I”) and World Financial Network Credit Card Master Trust III (“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 uncollectible receivables. These fees are eliminated and therefore are not reflected in the unaudited condensed consolidated statements of income for the three months ended March 31, 2013 and 2012.
 
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.
 
The tables below present quantitative information about the components of total securitized credit card receivables, delinquencies and net charge-offs:
 
   
March 31,
2013
   
December 31,
2012
 
   
(In thousands)
 
Total credit card receivables – restricted for securitization investors
 
$
5,960,423
   
$
6,597,120
 
Principal amount of credit card receivables – restricted for securitization investors, 90 days or more past due
 
$
98,729
   
$
112,203
 
 
 
   
Three Months Ended March 31,
 
   
2013
   
2012
 
   
(In thousands)
 
Net charge-offs of securitized principal
 
$
74,094
   
$
62,805
 
 
 
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. There were no realized gains or losses from the sale of investment securities for the three months ended March 31, 2013 and the twelve months ended December 31, 2012. The principal components of redemption settlement assets, which are carried at fair value, are as follows:
 
   
March 31, 2013
   
December 31, 2012
 
   
Cost
   
Unrealized Gains
   
Unrealized Losses
   
Fair Value
   
Cost
   
Unrealized Gains
   
Unrealized Losses
   
Fair Value
 
   
(In thousands)
 
Cash and cash equivalents
 
$
54,709
   
$
   
$
   
$
54,709
   
$
40,266
   
$
   
$
   
$
40,266
 
Government bonds
   
4,983
     
21
     
     
5,004
     
5,064
     
53
     
     
5,117
 
Corporate bonds
   
466,272
     
11,913
     
(73
)
   
478,112
     
436,846
     
10,560
     
(99
)
   
447,307
 
Total
 
$
525,964
   
$
11,934
   
$
(73
)
 
$
537,825
   
$
482,176
   
$
10,613
   
$
(99
)
 
$
492,690
 
 
 
12

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

 
The following tables show the gross unrealized losses and fair value for those investments that were in an unrealized loss position as of March 31, 2013 and December 31, 2012, aggregated by investment category and the length of time that individual securities have been in a continuous loss position:
 
   
Less than 12 months
   
March 31, 2013
12 Months or Greater
   
Total
 
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
 
   
(In thousands)
 
Corporate bonds
 
$
18,060
   
$
(73
)
 
$
   
$
   
$
18,060
   
$
(73
)
Total
 
$
18,060
   
$
(73
)
 
$
   
$
   
$
18,060
   
$
(73
)
 
 
   
Less than 12 months
   
December 31, 2012
12 Months or Greater
   
Total
 
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
 
   
(In thousands)
 
Corporate bonds
 
$
36,518
   
$
(99
)
 
$
   
$
   
$
36,518
   
$
(99
)
Total
 
$
36,518
   
$
(99
)
 
$
   
$
   
$
36,518
   
$
(99
)
 
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 March 31, 2013, 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 March 31, 2013 by contractual maturity are as follows:
 
   
Amortized
Cost
   
Estimated
Fair Value
 
   
(In thousands)
 
Due in one year or less
 
$
134,599
   
$
135,464
 
Due after one year through five years
   
391,365
     
402,361
 
Total
 
$
525,964
   
$
537,825
 
 
 
5. INTANGIBLE ASSETS AND GOODWILL
 
Intangible Assets
 
Intangible assets consist of the following:
 
   
March 31, 2013
   
   
Gross
Assets
   
Accumulated
Amortization
   
Net
 
Amortization Life and Method
   
(In thousands)
   
Finite Lived Assets
                   
Customer contracts and lists
 
$
440,200
   
$
(140,106
)
 
$
300,094
 
3-12 years—straight line
Premium on purchased credit card portfolios
   
239,561
     
(117,275
)
   
122,286
 
5-10 years—straight line, accelerated
Customer database
   
161,700
     
(107,587
)
   
54,113
 
4-10 years—straight line
Collector database
   
68,799
     
(62,658
)
   
6,141
 
30 years—15% declining balance
Tradenames
   
59,056
     
(11,576
)
   
47,480
 
4-15 years—straight line
Purchased data lists
   
15,339
     
(9,463
)
   
5,876
 
1-5 years—straight line, accelerated
Favorable lease
   
3,291
     
(115
)
   
3,176
 
10 years—straight line
Noncompete agreements
   
1,300
     
(108
)
   
1,192
 
3 years—straight line
   
$
989,246
   
$
(448,888
)
 
$
540,358
   
Indefinite Lived Assets
                         
Tradenames
   
12,350
     
     
12,350
 
Indefinite life
Total intangible assets
 
$
1,001,596
   
$
(448,888
)
 
$
552,708
   
 
 
13

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


   
December 31, 2012
   
   
Gross
Assets
   
Accumulated
Amortization
   
Net
 
Amortization Life and Method
   
(In thousands)
   
Finite Lived Assets
                   
Customer contracts and lists
 
$
440,200
   
$
(124,351
)
 
$
315,849
 
3-12 years—straight line
Premium on purchased credit card portfolios
   
237,800
     
(108,227
)
   
129,573
 
5-10 years—straight line, accelerated
Customer database
   
161,700
     
(102,706
)
   
58,994
 
4-10 years—straight line
Collector database
   
70,550
     
(63,980
)
   
6,570
 
30 years—15% declining balance
Tradenames
   
59,102
     
(10,139
)
   
48,963
 
4-15 years—straight line
Purchased data lists
   
14,540
     
(8,527
)
   
6,013
 
1-5 years—straight line, accelerated
Favorable lease
   
3,291
     
(29
)
   
3,262
 
10 years—straight line
Noncompete agreements
   
1,300
     
     
1,300
 
3 years—straight line
   
$
988,483
   
$
(417,959
)
 
$
570,524
   
Indefinite Lived Assets
                         
Tradenames
   
12,350
     
     
12,350
 
Indefinite life
Total intangible assets
 
$
1,000,833
   
$
(417,959
)
 
$
582,874
   
 
Goodwill
 
The changes in the carrying amount of goodwill for the three months ended March 31, 2013 are as follows:
 
   
LoyaltyOne®
   
Epsilon®
   
Private Label
Services and
Credit
   
Corporate/
Other
   
Total
 
   
(In thousands)
 
December 31, 2012
 
$
248,070
   
$
1,241,251
   
$
261,732
   
$
   
$
1,751,053
 
Effects of foreign currency translation
   
(5,875
)
   
(1,495
)
   
     
     
(7,370
)
March 31, 2013
 
$
242,195
   
$
1,239,756
   
$
261,732
   
$
   
$
1,743,683
 
 
 
14

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


6. DEBT
 
Debt consists of the following:
 
Description
 
March 31,
2013
   
December 31,
2012
 
Maturity
 
Interest Rate
 
   
(Dollars in thousands)
         
                     
Long-term and other debt:
                   
2011 credit facility
 
$
   
$
 
May 2016
 
 
2011 term loan
   
880,191
     
885,928
 
May 2016 or May 2017
 
(1)
 
Convertible senior notes due 2013
   
783,718
     
768,831
 
August 2013
 
1.75%
 
Convertible senior notes due 2014
   
311,146
     
304,333
 
May 2014
 
4.75%
 
Senior notes due 2017
   
395,924
     
395,734
 
December 2017
 
5.250%
 
Senior notes due 2020
   
500,000
     
500,000
 
April 2020
 
6.375%
 
Capital lease obligations and other debt
   
8
     
13
 
July 2013
 
7.10%
 
Total long-term and other debt
   
2,870,987
     
2,854,839
         
Less: current portion
   
(823,889
)
   
(803,269
)
       
Long-term portion
 
$
2,047,098
   
$
2,051,570
         
                     
Deposits:
                   
Certificates of deposit
 
$
1,862,797
   
$
1,974,158
 
Various – April 2013 – March 2020
 
0.20% to 5.25%
 
Money market deposits
   
314,280
     
254,253
 
On demand
 
0.01% to 0.25%
 
Total deposits
   
2,177,077
     
2,228,411
         
Less: current portion
   
(1,056,086
)
   
(1,092,753
)
       
Long-term portion
 
$
1,120,991
   
$
1,135,658
         
                     
Asset-backed securities debt – owed to securitization investors:
                       
Fixed rate asset-backed term note securities
 
$
2,746,916
   
$
2,403,555
 
Various – July 2013 – June 2019
 
1.61% to 6.75%
 
Floating rate asset-backed term note securities
   
500,000
     
545,700
 
April 2013
 
(2)
 
Conduit asset-backed securities
   
836,719
     
1,181,715
 
Various – May 2013 – March 2014
 
1.19% to 1.69%
 
Total asset-backed securities – owed to securitization investors
   
4,083,635
     
4,130,970
         
Less: current portion
   
(1,581,719
)
   
(1,474,054
)
       
Long-term portion
 
$
2,501,916
   
$
2,656,916
         
                           
 
(1)
At March 31, 2013, the weighted average interest rate for the 2011 Term Loan was 2.21%.
 
(2)
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 0.6%, each as defined in the respective agreements. The weighted average interest rate of the fixed rate achieved through interest rate swap agreements is 5.53% at March 31, 2013.
 
      At March 31, 2013, the Company was in compliance with its covenants.
 
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, Comenity Servicing LLC and Alliance Data FHC, Inc., as guarantors, are party to a credit agreement that provides for a $903.1 million term loan (the “2011 Term Loan”) with certain principal repayments and a $917.5 million revolving line of credit (the “2011 Credit Facility”).
 
Total availability under the 2011 Credit Facility at March 31, 2013 was $915.7 million.

 
15

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

 
Convertible Senior Notes
 
The Company has outstanding $1.15 billion of convertible senior notes, consisting of $804.6 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:
 
   
March 31,
2013
   
December 31,
2012
 
   
(In millions)
 
Carrying amount of equity component
 
$
368.7
   
$
368.7
 
                 
Principal amount of liability component
 
$
1,149.6
   
$
1,150.0
 
Unamortized discount
   
(54.7
)
   
(76.8
)
Net carrying value of liability component
 
$
1,094.9
   
$
1,073.2
 
                 
If-converted value of common stock
 
$
2,833.6
   
$
2,534.4
 
 
The discount on the liability component will be amortized as interest expense over the remaining life of the convertible senior notes which, at March 31, 2013, is a weighted average period of 0.6 years.
 
Interest expense on the convertible senior notes recognized in the Company’s unaudited condensed consolidated statements of income for the three months ended March 31, 2013 and 2012 is as follows:
 
   
Three Months Ended March 31,
 
   
2013
   
2012
 
   
(Dollars in thousands)
 
Interest expense calculated on contractual interest rate
 
$
7,528
   
$
7,619
 
Amortization of discount on liability component
   
22,050
     
19,750
 
Total interest expense on convertible senior notes
 
$
29,578
   
$
27,369
 
                 
Effective interest rate (annualized)
   
11.0
%
   
11.0
%
 
Both the convertible senior notes due 2013 (the “Convertible Senior Notes due 2013”) and the convertible senior notes due 2014 (the “Convertible Senior Notes due 2014”) are convertible at the option of the holder based on the condition that the common stock trading price exceeded 130% of the applicable conversion price. Through March 2013, certain of the convertible senior notes were surrendered for conversion and, in each case, either have been or will be settled in cash following the completion of the applicable cash settlement averaging period. The amounts settled during the period were not material.
 
In addition, pursuant to the indenture governing the Convertible Senior Notes due 2013, the Company has provided notice that it intends to satisfy conversions occurring on or after April 2, 2013 by paying solely cash.
 
Senior Notes Due 2017
 
In November 2012, the Company issued and sold $400 million aggregate principal amount of 5.250% senior notes due December 1, 2017 (the “Senior Notes due 2017”) at an issue price of 98.912% of the aggregate principal amount. The unamortized discount at the time of issuance was $4.3 million. The discount is being amortized using the effective interest method over the remaining life of the Senior Notes due 2017 which, at March 31, 2013, is a period of 4.7 years at an effective annual interest rate of 5.5%.
 
Deposits
 
As of March 31, 2013, Comenity Bank and Comenity Capital Bank had issued $314.3 million in money market deposits. Money market deposits are redeemable on demand by the customer and, as such, have no scheduled maturity date.

 
16

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

 
Asset-backed Securities – Owed to Securitization Investors
 
Asset-backed Term Notes
 
In February 2013, Master Trust I issued $500.0 million of term asset-backed securities to investors, which matures February 2018. The offering consisted of $375.0 million of Class A Series 2013-A asset-backed notes with a fixed interest rate of 1.61% per year and an aggregate of $125.0 million of subordinated classes of the term asset-backed notes that were retained by the Company and are eliminated from the unaudited condensed consolidated financial statements.
 
In April 2006, Master Trust I issued $500.0 million of term asset-backed securities to investors. These notes matured in April 2013. Pursuant to the indenture supplement applicable to these securities, as of March 31, 2013, the Company collected $500.0 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 balance sheet as of March 31, 2013.
 
Conduit Facilities
 
The Company has access to committed undrawn capacity through three conduit facilities to support the funding of its credit card receivables through Master Trust I, Master Trust III and the WFC Trust. As of March 31, 2013, total capacity under the conduit facilities was $1.9 billion, of which $0.8 billion had been drawn and was included in asset-backed securities debt in the unaudited condensed consolidated balance sheet. Borrowings outstanding under each facility bear interest at a margin above LIBOR or the asset-backed commercial paper costs of each individual conduit provider. The conduits have varying maturities from May 2013 to March 2014 with variable interest rates ranging from 1.19% to 1.69% as of March 31, 2013.
 
Derivative Instruments
 
As part of its interest rate risk management program, the Company may enter into derivative contracts with institutions that are established dealers to manage its exposure to changes in interest rates for certain obligations.
 
The credit card securitization trusts enter into derivative instruments, which include both interest rate swaps and an interest rate cap, to mitigate their interest rate risk on related financial instruments or to lock the interest rate on a portion of their variable asset-backed securities debt.
 
These interest rate derivative instruments 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 derivative instruments are not designated as hedges. Such instruments 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.”
 
The following tables identify the notional amount, fair value and classification of the Company’s outstanding interest rate derivatives at March 31, 2013 and December 31, 2012 in the unaudited condensed consolidated balance sheets:
 
   
March 31, 2013
 
December 31, 2012
 
   
Notional Amount
   
Weighted Average
Years to Maturity
 
Notional Amount
   
Weighted Average
Years to Maturity
 
   
(Dollars in thousands)
Interest rate derivatives not designated as hedging instruments
 
$
500,000
     
0.04
   
$
545,700
     
0.51
 
 
 
17

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

 
 
March 31, 2013
 
December 31, 2012
 
 
Balance Sheet Location
 
Fair Value
 
Balance Sheet Location
 
Fair Value
 
 
(In thousands)
Interest rate derivatives not designated as hedging instruments
Other assets
 
$
 
Other assets
 
$
4
 
Interest rate derivatives not designated as hedging instruments
Other current liabilities
 
$
2,200
 
Other current liabilities
 
$
8,515
 
                     
 
During the three months ended March 31, 2013 and 2012, gains on derivative instruments of $6.3 million and $7.0 million, respectively, were recognized in securitization funding costs within the unaudited condensed consolidated statements of income.
 
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 March 31, 2013, the Company does not maintain any derivative instruments 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 March 31, 2013, these thresholds were not breached and no amounts were held as collateral by the Company.
 
 
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 fees received is deferred. 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.
 
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.
 
A reconciliation of deferred revenue for the AIR MILES Reward Program is as follows:
 
   
Deferred Revenue
 
   
Service
   
Redemption
   
Total
 
   
(In thousands)
 
December 31, 2012
 
$
380,013
   
$
869,048
   
$
1,249,061
 
Cash proceeds
   
46,441
     
122,268
     
168,709
 
Revenue recognized
   
(53,994
)
   
(149,754
)
   
(203,748
)
Other
   
 
   
70
 
   
70
 
Effects of foreign currency translation
   
(9,363
)
   
(21,265
)
   
(30,628
)
March 31, 2013
 
$
363,097
   
$
820,367
   
$
1,183,464
 
Amounts recognized in the unaudited condensed consolidated balance sheets:
                       
Current liabilities
 
$
176,769
   
$
820,367
   
$
997,136
 
Non-current liabilities
 
$
186,328
   
$
   
$
186,328
 
 
 
8. STOCKHOLDERS’ EQUITY
 
Stock Repurchase Program
 
On January 2, 2013, 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 2, 2013 through December 31, 2013, subject to any restrictions pursuant to the terms of the Company’s credit agreements, indentures, applicable securities laws or otherwise.
 
 
18

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

 
For the three months ended March 31, 2013, the Company acquired a total of 332,000 shares of its common stock for $51.7 million. As of March 31, 2013, the Company has $348.3 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 months ended March 31, 2013 and 2012 is as follows:
 
   
Three Months Ended March 31,
 
   
2013
   
2012
 
   
(In thousands)
 
Cost of operations                                                                                             
 
$
8,942
   
$
7,567
 
General and administrative                                                                                             
   
4,082
     
4,739
 
Total
 
$
13,024
   
$
12,306
 
 
During the three months ended March 31, 2013, the Company awarded 257,212 performance-based restricted stock units with a weighted average grant date fair value per share of $152.05 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, 2013 to December 31, 2013 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, 2014, an additional 33% of the award on February 23, 2015 and the final 34% of the award on February 22, 2016, provided that the participant is employed by the Company on each such vesting date.
 
During the three months ended March 31, 2013, the Company awarded 68,460 service-based restricted stock units with a weighted average grant date fair value per share of $152.31 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. ACCUMULATED OTHER COMPREHENSIVE INCOME
 
The changes in each component of accumulated comprehensive income (loss), net of tax effects, are as follows:
 
 
Net Unrealized
Gains (Losses)
on Securities
 
Foreign Currency Translation
Adjustments (1)
 
Accumulated
Other
Comprehensive
Income (Loss)
 
 
(In thousands)
 
Balance as of December 31, 2012
$ 10,321   $ (32,182 ) $ (21,861 )
Changes in other comprehensive income
  1,096     3,327     4,423  
Balance as of March 31, 2013
$ 11,417   $ (28,855 ) $ (17,438 )
 
A de minimis amount of items were reclassified out of accumulated other comprehensive income (loss) for the three months ended March 31, 2013.
 
 
Net Unrealized
Gains (Losses)
on Securities
 
Foreign Currency Translation
Adjustments (1)
 
Accumulated
Other
Comprehensive
Income (Loss)
 
 
(In thousands)
 
Balance as of December 31, 2011
$ 6,953   $ (30,009 ) $ (23,056 )
Changes in other comprehensive income (loss)
  1,484     (3,066 )   (1,582 )
Balance as of March 31, 2012
$ 8,437   $ (33,075 ) $ (24,638 )
                           
 
(1)
Primarily related to the impact of changes in the Canadian currency exchange rate.

 
19

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


10. 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.
 
Fair Value of Financial Instruments The estimated fair values of the Company’s financial instruments are as follows:
 
   
March 31, 2013
   
December 31, 2012
 
   
Carrying
Amount
   
Fair
Value
   
Carrying
Amount
   
Fair
Value
 
   
(In thousands)
 
Financial assets
                       
Cash and cash equivalents
 
$
764,149
   
$
764,149
   
$
893,352
   
$
893,352
 
Trade receivables, net
   
331,608
     
331,608
     
370,110
     
370,110
 
Credit card receivables, net
   
6,555,667
     
6,555,667
     
6,967,674
     
6,967,674
 
Redemption settlement assets, restricted
   
537,825
     
537,825
     
492,690
     
492,690
 
Cash collateral, restricted
   
67,191
     
67,191
     
65,160
     
65,160
 
Other investment securities
   
600,018
     
600,018
     
91,972
     
91,972
 
Derivative instruments
   
     
     
4
     
4
 
Financial liabilities
                               
Accounts payable
   
258,278
     
258,278
     
215,470
     
215,470
 
Deposits
   
2,177,077
     
2,208,124
     
2,228,411
     
2,255,089
 
Asset-backed securities debt – owed to securitization investors
   
4,083,635
     
4,175,016
     
4,130,970
     
4,225,745
 
Long-term and other debt
   
2,870,987
     
4,661,801
     
2,854,839
     
4,358,379
 
Derivative instruments
   
2,200
     
2,200
     
8,515
     
8,515
 
 
Fair Value of Assets and Liabilities Held at March 31, 2013 and December 31, 2012
 
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.
 
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 March 31, 2013, the Company does not consider the investments to be other-than-temporarily impaired.

 
20

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

 
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 for the same transaction.
 
Long-term and other debt — 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 for the same transaction.
 
Derivative instruments —The valuation of these instruments is determined using a discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and option volatility.
 
Financial Assets and Financial Liabilities Fair Value Hierarchy
 
ASC 825 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include:
 
 
·
Level 1, defined as observable inputs such as quoted prices in active markets;
 
 
·
Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and
 
 
·
Level 3, defined as unobservable inputs where little or no market data exists, therefore requiring an entity to develop its own assumptions.
 
Financial instruments are considered Level 3 when their values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable. Level 3 financial instruments also include those for which the determination of fair value requires significant management judgment or estimation. The use of different techniques to determine fair value of these financial instruments could result in different estimates of fair value at the reporting date.
 
The following tables provide information for the assets and liabilities carried at fair value measured on a recurring basis as of March 31, 2013 and December 31, 2012:
 
         
Fair Value Measurements at
March 31, 2013 Using
 
   
Balance at
March 31,
2013
   
Level 1
   
Level 2
   
Level 3
 
   
(In thousands)
 
Government bonds (1) 
  $ 5,004     $     $ 5,004     $  
Corporate bonds (1) 
    478,112             478,112