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 March 31, 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 May 1, 2012, 50,354,665 shares of common stock were outstanding.
 


 
 
 
 
 
ALLIANCE DATA SYSTEMS CORPORATION
 
INDEX
 
 
 
 
 
Page
Number 
Part I:  FINANCIAL INFORMATION
Item 1.
Financial Statements (unaudited)
 
 
3
 
4
 
5
 
6
 
7
Item 2.
25
Item 3.
35
Item 4.
35
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.
 
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
 
   
March 31,
2012
   
December 31,
2011
 
   
(In thousands)
 
ASSETS
 
Cash and cash equivalents
 
$
399,044
   
$
216,213
 
Trade receivables, less allowance for doubtful accounts ($4,255 and $2,406 at March 31, 2012 and December 31, 2011, respectively)
   
245,011
     
300,895
 
Credit card receivables:
               
Credit card receivables – restricted for securitization investors
   
4,540,464
     
4,886,168
 
Other credit card receivables
   
893,676
     
779,843
 
Total credit card receivables
   
5,434,140
     
5,666,011
 
Allowance for loan loss
   
(447,483
)
   
(468,321
)
Credit card receivables, net
   
4,986,657
     
5,197,690
 
Deferred tax asset, net
   
248,128
     
252,303
 
Other current assets
   
155,143
     
121,589
 
Redemption settlement assets, restricted
   
494,753
     
515,838
 
Assets of discontinued operations
   
830
     
2,439
 
Total current assets
   
6,529,566
     
6,606,967
 
Property and equipment, net
   
206,569
     
195,397
 
Deferred tax asset, net
   
46,862
     
43,408
 
Cash collateral, restricted
   
144,366
     
158,727
 
Intangible assets, net
   
365,779
     
383,646
 
Goodwill
   
1,455,084
     
1,449,363
 
Other non-current assets
   
154,090
     
142,741
 
Total assets
 
$
8,902,316
   
$
8,980,249
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
Accounts payable
 
$
171,353
   
$
149,812
 
Accrued expenses
   
181,393
     
206,621
 
Deposits
   
619,504
     
642,567
 
Asset-backed securities debt – owed to securitization investors
   
1,421,054
     
1,694,198
 
Current debt
   
22,972
     
19,834
 
Other current liabilities
   
99,265
     
105,888
 
Deferred revenue
   
1,017,122
     
1,036,251
 
Total current liabilities
   
3,532,663
     
3,855,171
 
Deferred revenue
   
196,764
     
190,185
 
Deferred tax liability, net
   
155,714
     
151,746
 
Deposits
   
668,290
     
711,208
 
Asset-backed securities debt – owed to securitization investors
   
1,488,750
     
1,566,089
 
Long-term and other debt
   
2,405,793
     
2,163,640
 
Other liabilities
   
160,769
     
166,244
 
Total liabilities
   
8,608,743
     
8,804,283
 
Commitments and contingencies
               
Stockholders’ equity:
               
Common stock, $0.01 par value; authorized, 200,000 shares; issued, 94,660 shares and 94,141 shares at March 31, 2012 and December 31, 2011, respectively
   
947
     
941
 
Additional paid-in capital
   
1,394,248
     
1,387,773
 
Treasury stock, at cost, 44,336 shares and 44,311 shares at March 31, 2012 and December 31, 2011, respectively
   
(2,323,217
)
   
(2,320,696
)
Retained earnings
   
1,246,233
     
1,131,004
 
Accumulated other comprehensive loss                                                                                                                      
   
(24,638
)
   
(23,056
)
Total stockholders’ equity
   
293,573
     
175,966
 
Total liabilities and stockholders’ equity
 
$
8,902,316
   
$
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
March 31,
 
   
2012
   
2011
 
   
(In thousands, except per share amounts)
 
Revenues
 
Transaction                                                                                                                   
 
$
82,744
   
$
76,771
 
Redemption                                                                                                                   
   
188,466
     
149,760
 
Finance charges, net                                                                                                                   
   
376,315
     
342,142
 
Database marketing fees and direct marketing services                                                                                                                   
   
213,596
     
152,710
 
Other revenue                                                                                                                   
   
30,448
     
19,053
 
Total revenue
   
891,569
     
740,436
 
Operating expenses
 
Cost of operations (exclusive of depreciation and amortization disclosed separately below)
   
526,905
     
404,525
 
Provision for loan loss                                                                                                                   
   
49,327
     
67,666
 
General and administrative                                                                                                                   
   
23,999
     
20,939
 
Depreciation and other amortization                                                                                                                   
   
17,604
     
16,754
 
Amortization of purchased intangibles                                                                                                                   
   
21,115
     
18,644
 
Total operating expenses
   
638,950
     
528,528
 
Operating income
   
252,619
     
211,908
 
Interest expense
 
Securitization funding costs                                                                                                                   
   
22,329
     
30,986
 
Interest expense on deposits                                                                                                                   
   
5,963
     
5,693
 
Interest expense on long-term and other debt, net                                                                                                                   
   
37,360
     
34,780
 
Total interest expense, net
   
65,652
     
71,459
 
Income before income tax
 
$
186,967
   
$
140,449
 
Provision for income taxes
   
71,738
     
54,073
 
Net income                                                                                                                      
 
$
115,229
   
$
86,376
 
   
Basic income per share                                                                                                                      
 
$
2.30
   
$
1.69
 
Diluted income per share                                                                                                                      
 
$
1.86
   
$
1.56
 
   
Weighted average shares:
 
Basic                                                                                                                   
   
50,147
     
51,122
 
Diluted                                                                                                                   
   
61,849
     
55,412
 
 
See accompanying notes to unaudited condensed consolidated financial statements.
 
 
4

 
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
   
Three Months Ended
March 31,
 
   
2012
   
2011
 
   
(In thousands)
 
   
Net income                                                                                                                      
 
$
115,229
   
$
86,376
 
Other comprehensive income, net of tax:
 
Net unrealized gain (loss) on securities available-for-sale, net of tax benefit of $(26) and tax expense of $4 for the three months ended March 31, 2012 and 2011, respectively
   
1,484
     
(4,428
)
Foreign currency translation adjustments                                                                                                                   
   
(3,066
)
   
(3,144
)
Total comprehensive income, net of tax                                                                                                                      
 
$
113,647
   
$
78,804
 
 
See accompanying notes to unaudited condensed consolidated financial statements.
 
 
5

 
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
   
Three Months Ended
March 31,
 
   
2012
   
2011
 
   
(In thousands)
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
Net income                                                                                                                      
 
$
115,229
   
$
86,376
 
Adjustments to reconcile net income to net cash provided by operating activities:
 
Depreciation and amortization                                                                                                                   
   
38,719
     
35,398
 
Deferred income taxes                                                                                                                   
   
8,026
     
7,782
 
Provision for loan loss                                                                                                                   
   
49,327
     
67,666
 
Non-cash stock compensation                                                                                                                   
   
12,306
     
9,084
 
Fair value gain on interest-rate derivatives                                                                                                                   
   
(7,012
)
   
(9,892
)
Amortization of discount on convertible senior notes                                                                                                                   
   
19,750
     
17,695
 
Change in operating assets and liabilities, net of acquisitions:
 
Change in trade accounts receivable                                                                                                                   
   
33,947
     
14,434
 
Change in other assets                                                                                                                   
   
18,269
     
24,539
 
Change in accounts payable and accrued expenses                                                                                                                   
   
9,205
     
(46,160
)
Change in deferred revenue                                                                                                                   
   
(39,157
)
   
(16,375
)
Change in other liabilities                                                                                                                   
   
(5,947
)
   
30,521
 
Excess tax benefits from stock-based compensation                                                                                                                      
   
(11,713
)
   
(9,473
)
Other                                                                                                                      
   
(1,326
)
   
(1,207
)
Net cash provided by operating activities
   
239,623
     
210,388
 
   
CASH FLOWS FROM INVESTING ACTIVITIES:
 
Change in redemption settlement assets                                                                                                                      
   
34,585
     
4,410
 
Change in restricted cash                                                                                                                      
   
(44,763
)
   
20,180
 
Change in credit card receivables                                                                                                                      
   
257,512
     
432,997
 
Purchase of credit card receivables                                                                                                                      
   
(97,653
)
   
(42,696
)
Change in cash collateral, restricted                                                                                                                      
   
16,024
     
(132,575
)
Capital expenditures                                                                                                                      
   
(31,366
)
   
(18,631
)
Investments in the stock of an investee                                                                                                                      
   
     
(5,019
)
Other                                                                                                                      
   
496
     
(7
)
Net cash provided by investing activities
   
134,835
     
258,659
 
   
CASH FLOWS FROM FINANCING ACTIVITIES:
 
Borrowings under debt agreements                                                                                                                      
   
699,500
     
202,000
 
Repayments of borrowings                                                                                                                      
   
(473,953
)
   
(77,318
)
Issuances of deposits                                                                                                                      
   
136,760
     
75,000
 
Repayments of deposits                                                                                                                      
   
(202,741
)
   
(103,400
)
Borrowings from asset-backed securities                                                                                                                      
   
     
174,500
 
Repayments/maturities of asset-backed securities                                                                                                                      
   
(350,483
)
   
(535,224
)
Payment of capital lease obligations                                                                                                                      
   
(5
)
   
(3,013
)
Payment of deferred financing costs                                                                                                                      
   
(18,098
)
   
(730
)
Excess tax benefits from stock-based compensation                                                                                                                      
   
11,713
     
9,473
 
Proceeds from issuance of common stock                                                                                                                      
   
6,928
     
12,509
 
Purchase of treasury shares                                                                                                                      
   
(2,521
)
   
(61,435
)
Net cash used in financing activities
   
(192,900
)
   
(307,638
)
   
Effect of exchange rate changes on cash and cash equivalents
   
1,273
     
(161
)
Change in cash and cash equivalents
   
182,831
     
161,248
 
Cash and cash equivalent at beginning of period
   
216,213
     
139,114
 
Cash and cash equivalents at end of period                                                                                                                
 
$
399,044
   
$
300,362
 
   
SUPPLEMENTAL CASH FLOW INFORMATION:
 
Interest paid                                                                                                                      
 
$
49,466
   
$
54,594
 
Income taxes paid, net                                                                                                                      
 
$
34,685
   
$
31,692
 
 
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.
 
Recently Adopted Accounting Standards
 
In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”),” which amends Accounting Standards Codification (“ASC”) 820, “Fair Value Measurement.” ASU 2011-04 revises the application of the valuation premise of highest and best use of an asset. It also enhances disclosure requirements and requires entities to disclose, for their recurring Level 3 fair value measurements, quantitative information about unobservable inputs used, a description of the valuation processes used by the entity, and a qualitative discussion about the sensitivity of the measurements. ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011 and requires prospective application. The adoption of ASU 2011-04 did not have a material impact on the Company’s financial condition, results of operations, or cash flows. See Note 9, “Financial Instruments,” for the Company’s required disclosures.
 
In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income.” ASU 2011-05 eliminates the option to report other comprehensive income (“OCI”) and its components in the statement of changes in equity and requires the presentation of net income and OCI in one continuous statement or in two separate, but consecutive, statements. In December 2011, the FASB issued ASU 2011-12, “Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.” ASU 2011-12 indefinitely defers the provision in ASU 2011-05 under which entities must present reclassification adjustments out of accumulated OCI by component in both the statement where net income is presented and the statement where OCI is presented. ASU 2011-05 is effective for interim and annual periods beginning after December 31, 2011 and requires retrospective application. The adoption of ASU 2011-05 only impacted financial statement presentation and did not have an impact on the Company’s financial condition, results of operations, or cash flows. See the Company’s unaudited condensed consolidated statements of comprehensive income for the requisite interim disclosures.
 
 
7

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
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,
 
   
2012
   
2011
 
   
(In thousands, except
per share amounts)
 
Numerator:
           
Net Income
 
$
115,229
   
$
86,376
 
Denominator:
           
Weighted average shares, basic
   
50,147
     
51,122
 
Weighted average effect of dilutive securities:
     
Shares from assumed conversion of convertible senior notes
   
7,667
     
2,789
 
Shares from assumed conversion of convertible note warrants
   
3,289
     
633
 
Net effect of dilutive stock options and unvested restricted stock
   
746
     
868
 
Denominator for diluted calculations
   
61,849
     
55,412
 
                 
Basic net income per share
 
$
2.30
   
$
1.69
 
Diluted net income per share
 
$
1.86
   
$
1.56
 
 
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 the 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.
 
For the three months ended March 31, 2011, the Company excluded 16.9 million warrants 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:
 
   
March 31,
2012
   
December 31,
2011
 
   
(In thousands)
 
Principal receivables
 
$
5,190,132
   
$
5,408,862
 
Billed and accrued finance charges
   
210,180
     
221,357
 
Other receivables
   
33,828
     
35,792
 
Total credit card receivables
   
5,434,140
     
5,666,011
 
Less credit card receivables – restricted for securitization investors
   
4,540,464
     
4,886,168
 
Other credit card receivables
 
$
893,676
   
$
779,843
 
 
 
8

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
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. For the three months ended March 31, 2012 and 2011, actual charge-offs for unpaid interest and fees were $48.9 million and $56.2 million, 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.
 
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:
 
   
March 31,
2012
   
March 31,
2011
 
   
(In thousands)
 
Balance at beginning of period
 
$
468,321
   
$
518,069
 
Provision for loan loss
   
49,327
     
67,666
 
Recoveries
   
28,850
     
25,866
 
Principal charge-offs
   
(99,015
)
   
(123,896
)
Other
   
     
1,915
 
Balance at end of period
 
$
447,483
   
$
489,620
 
 
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.
 
 
9

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
The following table presents the delinquency trends of the Company’s credit card portfolio:
 
   
March 31,
2012
   
% of
Total
   
December 31,
2011
   
% of
Total
 
   
(In thousands, except percentages)
 
Receivables outstanding – principal
 
$
5,190,132
     
100
%
 
$
5,408,862
     
100
%
Principal receivables balances contractually delinquent:
                               
31 to 60 days
   
66,769
     
1.3
%
   
78,272
     
1.4
%
61 to 90 days
   
46,958
     
0.9
     
51,709
     
1.0
 
91 or more days
   
92,499
     
1.8
     
105,626
     
2.0
 
Total
 
$
206,226
     
4.0
%
 
$
235,607
     
4.4
%
 
Modified Credit Card Receivables
 
The Company holds certain credit card receivables for which the terms have been modified. Cash collections on these modified loans are allocated according to the same payment hierarchy methodology applied to loans that are not in such programs. The Company’s modified credit card loans include loans for which temporary hardship concessions have been granted and loans in permanent workout programs. These modified loans 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 loan 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, loan 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. In assessing the appropriate allowance for loan loss, these loans are included in the general pool of credit cards with the allowance determined under the contingent loss model of ASC 450-20, “Loss Contingencies.” If the Company applied accounting under ASC 310-40, “Troubled Debt Restructurings by Creditors,” to loans in these programs, there would not be a significant difference in the allowance for loan loss. Credit card receivables for which temporary hardship and permanent concessions were granted comprised $116.3 million  and $122.2 million, respectively, or less than 3%, of the Company’s total credit card receivables at each of March 31, 2012 and December 31, 2011.
 
The following tables provide information on credit card receivables that entered into a modification program during the specified periods:
 
 
Three Months Ended March 31, 2012
 
 
Number of Restructurings
 
Pre-modification Outstanding Principal Balance
 
Post-modification
Outstanding Principal Balance
 
 
(Dollars in thousands)
 
Troubled debt restructurings – credit card receivables
  31,540   $ 28,238   $ 28,229  
                   
 
 
 
Three Months Ended March 31, 2011
 
 
Number of Restructurings
 
Pre-modification Outstanding Principal Balance
 
Post-modification Outstanding Principal Balance
 
 
(Dollars in thousands)
 
Troubled debt restructurings – credit card receivables
  44,072   $ 37,429   $ 35,383  
                   
 
 
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
March 31, 2012
 
 
Number of Restructurings
 
Outstanding Balance
 
 
(Dollars in thousands)
 
Troubled debt restructurings, defaulted – credit card receivables
16,020
 
$
15,462
 
           
 
 
 
Three Months Ended
March 31, 2011
 
 
Number of Restructurings
 
Outstanding Balance
 
 
(Dollars in thousands)
 
Troubled debt restructurings, defaulted – credit card receivables
18,800
 
$
19,003
 
           
 
Age of Credit Card Receivables
 
The following table sets forth, as of March 31, 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
   
3,210
     
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
%
 
 
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 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
 
   
(In thousands, except percentages)
 
No Score
 
$
186,242
     
3.6
%
27.1% and higher
   
214,738
     
4.1
 
17.1% - 27.0%
   
424,710
     
8.2
 
12.6% - 17.0%
   
508,390
     
9.8
 
3.7% - 12.5%
   
2,088,922
     
40.2
 
1.9% - 3.6%
   
1,166,685
     
22.5
 
Lower than 1.9%
   
600,445
     
11.6
 
Total
 
$
5,190,132
     
100.0
%
 
Portfolio Acquisitions
 
In March 2012, World Financial Network Bank acquired the existing private label credit card portfolio of Pier 1 Imports. The preliminary total purchase price was $97.7 million, which is subject to customary purchase price adjustments, and 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 March 31, 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 months ended March 31, 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:
 
   
March 31,
2012
   
December 31,
2011
 
   
(In thousands)
 
Total credit card receivables – restricted for securitization investors
 
$
4,540,464
   
$
4,886,168
 
Principal amount of credit card receivables – restricted for securitization investors, 90 days or more past due
 
$
80,554
   
$
94,981
 
 

 
   
Three Months Ended March 31,
 
   
2012
   
2011
 
   
(In thousands)
 
Net charge-offs of securitized principal
 
$
62,805
   
$
87,303
 
 
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:
 
   
March 31, 2012
   
December 31, 2011
 
   
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair Value
   
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair Value
 
   
(In thousands)
 
Cash and cash equivalents
 
$
8,552
   
$
   
$
   
$
8,552
   
$
35,465
   
$
   
$
   
$
35,465
 
Government bonds
   
5,102
     
127
     
     
5,229
     
4,948
     
152
     
     
5,100
 
Corporate bonds
   
473,043
     
8,532
     
(603
)
   
480,972
     
468,894
     
7,416
     
(1,037
)
   
475,273
 
Total
 
$
486,697
   
$
8,659
   
$
(603
)
 
$
494,753
   
$
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 March 31, 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
   
March 31, 2012
12 Months or Greater
   
Total
 
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
 
   
(In thousands)
 
Government bonds
 
$
   
$
   
$
   
$
   
$
   
$
 
Corporate bonds
   
     
     
18,656
     
(603
)
   
18,656
     
(603
)
Total
 
$
   
$
   
$
18,656
   
$
(603
)
 
$
18,656
   
$
(603
)
 

 
   
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
)
 
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, 2012, the Company does not consider the investments to be other-than-temporarily impaired.
 
 
13

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
The net carrying value and estimated fair value of the securities at March 31, 2012 by contractual maturity are as follows:
 
   
Amortized
Cost
   
Estimated
Fair Value
 
   
(In thousands)
 
Due in one year or less
 
$
74,684
   
$
74,573
 
Due after one year through five years
   
412,013
     
420,180
 
Total
 
$
486,697
   
$
494,753
 
 
5. INTANGIBLE ASSETS AND GOODWILL
 
Intangible Assets
 
Intangible assets consist of the following:
 
   
March 31, 2012
   
   
Gross
Assets
   
Accumulated
Amortization
   
Net
 
Amortization Life and Method
   
(In thousands)
   
Finite Lived Assets
                   
Customer contracts and lists
 
$
314,245
   
$
(148,859
)
 
$
165,386
 
3-12 years—straight line
Premium on purchased credit card portfolios
   
157,711
     
(87,670
)
   
70,041
 
5-10 years—straight line, accelerated
Customer database
   
175,520
     
(101,590
)
   
73,930
 
4-10 years—straight line
Collector database
   
70,147
     
(62,741
)
   
7,406
 
30 years—15% declining balance
Tradenames
   
38,181
     
(8,180
)
   
30,001
 
5-15 years—straight line
Purchased data lists
   
19,925
     
(13,298
)
   
6,627
 
1-5 years—straight line, accelerated
Noncompete agreements
   
1,062
     
(1,024
)
   
38
 
2 years—straight line
   
$
776,791
   
$
(423,362
)
 
$
353,429
   
Indefinite Lived Assets
                         
Tradenames
   
12,350
     
     
12,350
 
Indefinite life
Total intangible assets
 
$
789,141
   
$
(423,362
)
 
$
365,779
   
 

   
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 three months ended March 31, 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
   
5,021
     
700
     
     
     
5,721
 
March 31, 2012
 
$
246,718
   
$
946,634
   
$
261,732
   
$
   
$
1,455,084
 
 
6. DEBT
 
Debt consists of the following:
 
Description
 
March 31,
2012
   
December 31,
2011
 
Maturity
 
Interest Rate
   
(Dollars in thousands)
       
                   
Deposits:
                     
Deposits
 
$
1,287,794
   
$
1,353,775
 
Various - April 2012 – January 2019
 
0.15% to 5.25%
Less: current portion
   
(619,504
)
   
(642,567
)
     
Long-term portion
 
$
668,290
   
$
711,208
       
                   
Asset-backed securities debt – owed to securitization investors:
                     
Fixed rate asset-backed term note securities
 
$
1,562,815
   
$
1,562,815
 
Various - April 2012 – October 2016
 
1.68% to 7.00%
Floating rate asset-backed term note securities
   
703,500
     
703,500
 
Various - April 2012 – April 2013
 
(1)
Conduit asset-backed securities
   
643,489
     
993,972
 
Various - June 2012 – September 2012
 
1.27% to 1.97%
Total asset-backed securities – owed to securitization investors
   
2,909,804
     
3,260,287
       
Less: current portion
   
(1,421,054
)
   
(1,694,198
)
     
Long-term portion
 
$
1,488,750
   
$
1,566,089
       
                   
Long-term and other debt:
                 
2011 credit facility
 
$
15,000
   
$
410,000
 
May 2016
 
(2)
2011 term loan
   
903,141
     
782,594
 
May 2016 or May 2017
 
(2)
Senior notes due 2020
   
500,000
     
 
April 2020
 
6.38%
Convertible senior notes due 2013
   
725,313
     
711,480
 
August 2013
 
1.75%
Convertible senior notes due 2014
   
285,282
     
279,365
 
May 2014
 
4.75%
Capital lease obligations
   
29
     
35
 
July 2013
 
7.10%
Total long-term and other debt
   
2,428,765
     
2,183,474
       
Less: current portion
   
(22,972
)
   
(19,834
)
     
Long-term portion
 
$
2,405,793
   
$
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 5.75% at March 31, 2012.
 
(2)  
At March 31, 2012, the weighted average interest rate for the 2011 Credit Facility and 2011 Term Loan, in each case, was 2.25%.
 
At March 31, 2012, 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 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”).
 
On March 30, 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, the Company borrowed additional term loans in the aggregate principal amount of $125.5 million, increasing the 2011 Term Loan to $903.1 million as of March 30, 2012.
 
 
15

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
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 March 31, 2012 was $902.5 million.
 
Senior Notes Due 2020
 
In March 2012, the Company entered into a purchase agreement and 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:
 
   
March 31,
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
   
(139,405
)
   
(159,155
)
Net carrying value of liability component
 
$
1,010,595
   
$
990,845
 
                 
If-converted value of common stock
 
$
2,205,328
   
$
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 March 31, 2012, is a weighted average period of 1.6 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, 2012 and 2011 is as follows:
 
   
Three Months Ended March 31,
 
   
2012
   
2011
 
   
(Dollars in thousands)
 
Interest expense calculated on contractual interest rate
 
$
7,619
   
$
7,619
 
Amortization of discount on liability component
   
19,750
     
17,695
 
Total interest expense on convertible senior notes
 
$
27,369
   
$
25,314
 
Effective interest rate (annualized)
   
11.0
%
   
11.0
%
 
 
16

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
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.”
 
The following tables identify the notional amount, fair value and classification of the Company’s outstanding interest rate contracts at March 31, 2012 and December 31, 2011 in the unaudited condensed consolidated balance sheets:
 
   
March 31, 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
 
$
703,500
     
1.12
   
$
703,500
     
1.37
 
 
 
   
March 31, 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 current liabilities
   
$
3,665
     
Other current liabilities
   
$
4,739
 
Interest rate contracts not designated as hedging instruments
   
Other liabilities
   
$
27,426
     
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 months ended March 31, 2012 and March 31, 2011 recognized in the unaudited condensed consolidated statements of income:
 
   
March 31, 2012
     
March 31, 2011
 
   
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
   
$
7,012
     
Securitization
funding costs
   
$
9,892
 
                                 
 
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, 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 March 31, 2012, these thresholds were not breached and no amounts were held as collateral by the Company.
 
 
17

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 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
   
55,064
     
129,728
     
184,792
 
Revenue recognized
   
(49,397
)
   
(174,641
)
   
(224,038
)
Other
   
     
118
     
118
 
Effects of foreign currency translation
   
7,844
     
18,734
     
26,578
 
March 31, 2012
 
$
372,484
   
$
841,402
   
$
1,213,886
 
Amounts recognized in the unaudited condensed consolidated balance sheets:
                       
Current liabilities
 
$
175,720
   
$
841,402
   
$
1,017,122
 
Non-current liabilities
 
$
196,764
   
$
   
$
196,764
 
 
Effective 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, at the beginning of 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 in-store towards purchases at participating sponsors.
 
 
18

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 three months ended March 31, 2012, the Company acquired a total of 25,000 shares of its common stock for $2.5 million. As of March 31, 2012, the Company has $397.5 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, 2012 and 2011 is as follows:
 
   
Three Months Ended March 31,
 
   
2012
   
2011
 
   
(In thousands)
 
Cost of operations                                                                                             
 
$
7,567
   
$
5,903
 
General and administrative                                                                                             
   
4,739
     
3,181
 
Total
 
$
12,306
   
$
9,084
 
 
During the three months ended March 31, 2012, the Company awarded 323,685 performance-based restricted stock units with a weighted average grant date fair value per share of $119.97 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 three months ended March 31, 2012, the Company awarded 88,799 service-based restricted stock units with a weighted average grant date fair value per share of $119.80 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.
 
 
19

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:
 
   
March 31, 2012
   
December 31, 2011
 
   
Carrying
Amount
   
Fair
Value
   
Carrying
Amount
   
Fair
Value
 
   
(In thousands)
 
Financial assets
                       
Cash and cash equivalents
 
$
399,044
   
$
399,044
   
$
216,213
   
$
216,213
 
Trade receivables, net
   
245,011
     
245,011
     
300,895
     
300,895
 
Credit card receivables, net
   
4,986,657
     
4,986,657
     
5,197,690
     
5,197,690
 
Redemption settlement assets, restricted
   
494,753
     
494,753
     
515,838
     
515,838
 
Cash collateral, restricted
   
144,366
     
144,366
     
158,727
     
158,727
 
Other investment securities
   
71,246
     
71,246
     
26,772
     
26,772
 
Financial liabilities
                               
Accounts payable
   
171,353
     
171,353
     
149,812
     
149,812
 
Deposits
   
1,287,794
     
1,311,358
     
1,353,775
     
1,372,670
 
Asset-backed securities debt – owed to securitization investors
   
2,909,804
     
2,956,128
     
3,260,287
     
3,302,687
 
Long-term and other debt
   
2,428,765
     
3,652,272
     
2,183,474
     
3,071,661
 
Derivative financial instruments
   
31,091
     
31,091
     
38,103
     
38,103
 
 
Fair Value of Assets and Liabilities Held at March 31, 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 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.
 
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.
 
Derivative financial 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.
 
 
20

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
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 the assets and liabilities carried at fair value measured on a recurring basis as of March 31, 2012 and December 31, 2011:
 
         
Fair Value Measurements at
March 31, 2012 Using
 
   
Balance at
March 31,
2012
   
Level 1
   
Level 2
   
Level 3
 
   
(In thousands)
 
Government bonds (1) 
 
$
5,229
   
$
   
$
5,229
   
$
 
Corporate bonds (1) 
   
480,972
     
14,357
     
466,615
     
 
Cash collateral, restricted
   
144,366
     
2,500
     
     
141,866
 
Other investment securities (2) 
   
71,246
     
47,969
     
23,277
     
 
Total assets measured at fair value
 
$
701,813
   
$
64,826
   
$
495,121
   
$
141,866
 
                                 
Derivative financial instruments (3) 
 
$
31,091
   
$
   
$
31,091
   
$
 
Total liabilities measured at fair value
 
$
31,091
   
$
   
$
31,091
   
$
 
 
 
         
Fair Value Measurements at
December 31, 2011 Using
 
   
Balance at
December 31,
2011
   
Level 1
   
Level 2
   
Level 3
 
   
(In thousands)
 
Government bonds (1) 
 
$
5,100
   
$
   
$
5,100
   
$
 
Corporate bonds (1) 
   
475,273
     
21,346
     
453,927
     
 
Cash collateral, restricted
   
158,727
     
     
     
158,727
 
Other investment securities (2) 
   
26,772
     
3,043
     
23,729
     
 
Total assets measured at fair value
 
$
665,872
   
$
24,389
   
$
482,756
   
$
158,727
 
                                 
Derivative financial instruments (3) 
 
$
38,103
   
$
   
$
38,103
   
$
 
Total liabilities measured at fair value
 
$
38,103
   
$
   
$
38,103
   
$
 
                                   
 
(1)  
Amounts are included in redemption settlement assets in the unaudited condensed consolidated balance sheets.
 
(2)  
Amounts are included in other current assets and other non-current assets in the unaudited condensed consolidated balance sheets.
 
(3)  
Amounts are included in other current liabilities and other liabilities in the unaudited condensed consolidated balance sheets.
 
 
21

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
The following tables summarize the changes in fair value of the Company’s assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as defined in ASC 825 as of March 31, 2012 and 2011:
 
   
Cash Collateral, Restricted
 
   
(In thousands)
 
December 31, 2011
 
$
158,727
 
Total gains (realized or unrealized):
       
Included in earnings
   
1,689
 
Purchases
   
 
Settlements
   
(18,550
)
Transfers in or out of Level 3
   
 
March 31, 2012
 
$
141,866
 
         
Gains for the period included in earnings related to assets still held at March 31, 2012
 
$
1,689
 
 
 
   
Cash Collateral, Restricted
 
   
(In thousands)
 
December 31, 2010
 
$
185,754
 
Total gains (realized or unrealized):
       
Included in earnings
   
332
 
Purchases
   
2,291
 
Settlements
   
(9,044
)
Transfers in or out of Level 3
   
 
March 31, 2011
 
$
179,333
 
         
Gains for the period included in earnings related to assets still held at March 31, 2011
 
$
332
 
 
The spread deposits included in cash collateral, restricted are recorded at their fair value based on discounted cash flow models, utilizing the respective term of each instrument which ranged from 3 to 55 months. The unobservable input used to calculate the fair value was the discount rate of 3.3%, which was based on an interest rate curve that is observable in the market as adjusted for a credit spread. Significant increases (decreases) in the term or the discount rate would result in a lower (higher) fair value.
 
For the three months ended March 31, 2012 and 2011, gains included in earnings attributable to cash collateral, restricted are included in interest in the unaudited condensed consolidated statements of income.
 
 
22

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
Financial Instruments Disclosed but Not Carried at Fair Value
 
The following table provides assets and liabilities disclosed but not carried at fair value as of March 31, 2012:
 
   
Fair Value Measurements at
March 31, 2012
 
   
Total
   
Level 1
   
Level 2
   
Level 3
 
   
(In thousands)
 
Cash and cash equivalents
 
$
399,044
   
$
399,044
   
$
   
$
 
Credit card receivables, net
   
4,986,657
     
     
     
4,986,657
 
Total assets
 
$
5,385,701
   
$
399,044
   
$
   
$
4,986,657
 
                                 
Deposits
 
$
1,311,358
   
$
   
$
1,311,358
   
$
 
Asset-backed securities debt - owed to securitization investors 
   
2,956,128
     
     
2,956,128
     
 
Long-term and other debt
   
3,652,272
     
     
3,652,272