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 June 30, 2011
   
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 Act).  Yes £     No R

As of August 3, 2011, 50,917,709 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
Item 2.
27
Item 3.
43
Item 4.
43
Part II:  OTHER INFORMATION
  
Item 1.
44
Item 1A.
44
Item 2.
44
Item 3.
44
Item 4.
44
Item 5.
44
Item 6.
45
47


 
2
 
PART I
 
Item 1.  Financial Statements.
 
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
 
   
June 30,
2011
    
December 31,
2010
  
   
(In thousands)
  
ASSETS
  
Cash and cash equivalents
  
$
232,821
    
$
139,114
  
Trade receivables, less allowance for doubtful accounts ($3,832 and $4,350 at June 30, 2011 and December 31, 2010, respectively)
    
296,271
      
260,945
  
Credit card receivables:
                
Credit card receivables – restricted for securitization investors
    
4,338,016
      
4,795,753
  
Other credit card receivables
    
601,201
      
560,670
  
Total credit card receivables
    
4,939,217
      
5,356,423
  
Allowance for loan loss
    
(461,015
)
    
(518,069
)
Credit card receivables, net
    
4,478,202
      
4,838,354
  
Deferred tax asset, net
    
252,816
      
279,752
  
Other current assets
    
132,266
      
127,022
  
Redemption settlement assets, restricted
    
479,210
      
472,428
  
Assets of discontinued operations
    
5,898
      
11,920
  
Total current assets
    
5,877,484
      
6,129,535
  
Property and equipment, net
    
195,850
      
170,627
  
Deferred tax asset, net
    
53,815
      
46,218
  
Cash collateral, restricted
    
317,076
      
185,754
  
Intangible assets, net
    
424,567
      
314,391
  
Goodwill
    
1,462,716
      
1,221,823
  
Other non-current assets
    
216,939
      
203,804
  
Total assets
  
$
8,548,447
    
$
8,272,152
  
LIABILITIES AND STOCKHOLDERS’ EQUITY
  
Accounts payable
  
$
111,543
    
$
121,856
  
Accrued expenses
    
170,562
      
168,578
  
Certificates of deposit
    
357,409
      
442,600
  
Asset-backed securities debt – owed to securitization investors
    
1,494,146
      
1,743,827
  
Current debt
    
19,957
      
255,679
  
Other current liabilities
    
107,252
      
85,179
  
Deferred revenue
    
1,078,038
      
1,044,469
  
Total current liabilities
    
3,338,907
      
3,862,188
  
Deferred revenue
    
190,980
      
176,773
  
Deferred tax liability, net
    
118,068
      
82,637
  
Certificates of deposit
    
470,272
      
416,500
  
Asset-backed securities debt – owed to securitization investors
    
1,812,740
      
1,916,315
  
Long-term and other debt
    
2,341,651
      
1,614,093
  
Other liabilities
    
188,698
      
180,552
  
Total liabilities
    
8,461,316
      
8,249,058
  
Commitments and contingencies (Note 17)
                
Stockholders’ equity:
                
Common stock, $0.01 par value; authorized, 200,000 shares; issued, 93,924 shares and 92,797 shares at June 30, 2011 and December 31, 2010, respectively
    
939
      
928
  
Additional paid-in capital
    
1,350,530
      
1,320,767
  
Treasury stock, at cost, 42,931 shares and 41,426 shares at June 30, 2011 and December 31, 2010, respectively
    
(2,196,480
)
    
(2,079,819
)
Retained earnings
    
971,117
      
815,718
  
Accumulated other comprehensive loss
    
(38,975
)
    
(34,500
)
Total stockholders’ equity
    
87,131
      
23,094
  
Total liabilities and stockholders’ equity
  
$
8,548,447
    
$
8,272,152
  
 
See accompanying notes to unaudited condensed consolidated financial statements.

 
3
 
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
 
   
Three Months Ended June 30,
  
Six Months Ended June 30,
  
   
2011
    
2010
  
2011
    
2010
  
   
(In thousands, except per share amounts)
  
Revenues
                          
Transaction
  
$
69,869
    
$
69,341
  
$
146,640
    
$
145,942
  
Redemption
    
133,342
      
127,709
    
283,102
      
266,386
  
Finance charges, net
    
332,272
      
319,269
    
674,414
      
625,626
  
Database marketing fees and direct marketing services
    
182,264
      
134,972
    
334,974
      
260,163
  
Other revenue
    
22,711
      
18,427
    
41,764
      
35,138
  
Total revenue
    
740,458
      
669,718
    
1,480,894
      
1,333,255
  
Operating expenses
                      
Cost of operations
    
431,250
      
358,708
    
835,775
      
719,711
  
Provision for loan loss
    
60,376
      
94,700
    
128,042
      
182,701
  
General and administrative
    
21,021
      
21,509
    
41,960
      
43,673
  
Depreciation and other amortization
    
16,850
      
16,580
    
33,604
      
32,905
  
Amortization of purchased intangibles
    
19,170
      
17,841
    
37,814
      
35,687
  
Total operating expenses
    
548,667
      
509,338
    
1,077,195
      
1,014,677
  
Operating income
    
191,791
      
160,380
    
403,699
      
318,578
  
Interest expense
                
Securitization funding costs
    
35,062
      
43,606
    
66,048
      
85,225
  
Interest expense on certificates of deposit
    
5,494
      
7,604
    
11,187
      
16,202
  
Interest expense on long-term and other debt, net
    
38,238
      
32,638
    
73,018
      
65,127
  
Total interest expense, net
    
78,794
      
83,848
    
150,253
      
166,554
  
Income before income tax
  
$
112,997
    
$
76,532
  
$
253,446
    
$
152,024
  
Provision for income taxes
    
43,974
      
29,212
    
98,047
      
58,050
  
Net income
  
$
69,023
    
$
47,320
  
$
155,399
    
$
93,974
  
                               
Basic income per share
  
$
1.35
    
$
0.89
  
$
3.04
    
$
1.78
  
Diluted income per share
  
$
1.19
    
$
0.83
  
$
2.74
    
$
1.67
  
                               
Weighted average shares
                
Basic
    
51,070
      
53,188
    
51,099
      
52,820
  
Diluted
    
58,145
      
56,821
    
56,778
      
56,122
  
                               
 
See accompanying notes to unaudited condensed consolidated financial statements.

 
4
 
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
   
Six Months Ended
June 30,
  
   
2011
    
2010
  
   
(In thousands)
  
CASH FLOWS FROM OPERATING ACTIVITIES:
  
Net income                                                                                                                      
  
$
155,399
    
$
93,974
  
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
  
Depreciation and amortization                                                                                                                   
    
71,418
      
68,592
  
Deferred income taxes                                                                                                                   
    
9,960
      
19,973
  
Provision for loan loss                                                                                                                   
    
128,042
      
182,701
  
Non-cash stock compensation                                                                                                                   
    
20,190
      
23,021
  
Fair value (gain) loss on interest-rate derivatives                                                                                                                   
    
(14,603
)
    
5,384
  
Amortization of discount on convertible senior notes                                                                                                                   
    
35,882
      
32,162
  
Change in operating assets and liabilities, net of acquisitions:
  
Change in trade accounts receivable                                                                                                                   
    
(20,245
)
    
2,619
  
Change in other assets                                                                                                                   
    
10,941
      
24,833
  
Change in accounts payable and accrued expenses                                                                                                                   
    
(21,599
)
    
(668
)
Change in deferred revenue                                                                                                                   
    
5,113
      
(5,169
)
Change in other liabilities                                                                                                                   
    
36,253
      
11,865
  
Excess tax benefits from stock-based compensation                                                                                                                      
    
(11,590
)
    
(11,416
)
Other                                                                                                                      
    
1,782
      
(1,376
)
Net cash provided by operating activities
    
406,943
      
446,495
  
   
CASH FLOWS FROM INVESTING ACTIVITIES:
  
Change in redemption settlement assets                                                                                                                      
    
15,513
      
16,927
  
Payments for acquired businesses, net of cash                                                                                                                      
    
(358,152
)
    
—
  
Change in restricted cash                                                                                                                      
    
16,842
      
21,802
  
Change in credit card receivables                                                                                                                      
    
270,586
      
276,446
  
Purchase of credit card receivables                                                                                                                      
    
(42,696
)
    
—
  
Change in cash collateral, restricted                                                                                                                      
    
(131,172
)
    
(95,053
)
Capital expenditures                                                                                                                      
    
(33,935
)
    
(31,512
)
Investments in the stock of investees                                                                                                                      
    
(13,591
)
    
—
  
Other                                                                                                                      
    
222
      
(3,699
)
Net cash (used in) provided by investing activities
    
(276,383
)
    
184,911
  
   
CASH FLOWS FROM FINANCING ACTIVITIES:
  
Borrowings under debt agreements                                                                                                                      
    
2,336,500
      
555,000
  
Repayments of borrowings                                                                                                                      
    
(1,876,776
)
    
(544,346
)
Issuances of certificates of deposit                                                                                                                      
    
138,061
      
94,000
  
Repayments of certificates of deposit                                                                                                                      
    
(169,480
)
    
(460,100
)
Borrowings from asset-backed securities                                                                                                                      
    
636,500
      
411,945
  
Repayments/maturities of asset-backed securities                                                                                                                      
    
(989,757
)
    
(745,120
)
Payment of capital lease obligations                                                                                                                      
    
(3,791
)
    
(11,476
)
Payment of deferred financing costs                                                                                                                      
    
(24,564
)
    
(730
)
Excess tax benefits from stock-based compensation                                                                                                                      
    
11,590
      
11,416
  
Proceeds from issuance of common stock                                                                                                                      
    
20,533
      
29,631
  
Purchase of treasury shares                                                                                                                      
    
(116,661
)
    
(14,520
)
Net cash used in financing activities
    
(37,845
)
    
(674,300
)
   
Effect of exchange rate changes on cash and cash equivalents
    
992
      
(1,702
)
Change in cash and cash equivalents
    
93,707
      
(44,596
)
   
Cash effect on adoption of ASC 860 and ASC 810
    
—
      
81,553
  
Cash and cash equivalent at beginning of period
    
139,114
      
213,378
  
Cash and cash equivalents at end of period                                                                                                                
  
$
232,821
    
$
250,335
  
   
SUPPLEMENTAL CASH FLOW INFORMATION:
  
Interest paid                                                                                                                      
  
$
118,971
    
$
119,290
  
Income taxes paid, net                                                                                                                      
  
$
58,371
    
$
16,897
  
   
 
See accompanying notes to unaudited condensed consolidated financial statements.

 
5
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


1. BASIS OF PRESENTATION
 
The unaudited condensed consolidated financial statements included herein have been prepared by Alliance Data Systems Corporation (“ADSC” or, including its wholly owned subsidiaries 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, 2010, filed with the SEC on February 28, 2011. With respect to information concerning principal geographic areas, revenues are attributed to respective countries based on the location of the subsidiary, which generally correlates with the location of the customer.
 
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. For purposes of comparability, fraud losses of $1.0 million and $1.9 million for the three and six months ended June 30, 2010, respectively, have been reclassified from provision for loan loss to cost of operations in the prior period financial statements to conform to the current year presentation. Such reclassifications have no impact on previously reported net income.
 
2. RECENT ACCOUNTING PRONOUNCEMENTS
 
In October 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2009-13, “Multiple-Deliverable Revenue Arrangements,” which supersedes certain guidance in Accounting Standards Codification (“ASC”) 605-25, “Revenue Recognition — Multiple-Element Arrangements,” and requires an entity to allocate arrangement consideration at the inception of an arrangement to all of its deliverables based on their relative selling prices (the relative-selling-price method). ASU 2009-13 eliminates the use of the residual method of allocation in which the undelivered element is measured at its estimated selling price and the delivered element is measured as the residual of the arrangement consideration, and requires the relative-selling-price method in all circumstances in which an entity recognizes revenue for an arrangement with multiple deliverables subject to ASU 2009-13. ASU 2009-13 is effective for revenue arrangements entered into or materially modified beginning on or after January 1, 2011. The Company elected to adopt this ASU prospectively. Revenue associated with the service element of the Company’s AIR MILES® Reward Program has historically been determined using the residual method. Based on the sponsor contracts expected to be signed, renewed or materially modified in 2011, the adoption of ASU 2009-13 did not and is not expected to have a material impact on the Company’s unaudited condensed consolidated financial statements for 2011. Should one of the AIR MILES Reward Program’s top five sponsors materially modify its agreement with the Company in 2011, it could significantly shift the allocation of deferred revenue between the service element and redemption element. This change in allocation between the deferred revenue elements could impact the timing of revenue recognition, as the redemption element is recognized as AIR MILES reward miles are redeemed while the service element is recognized on a pro-rata basis over the estimated life of an AIR MILES reward mile, or 42 months.
 
In April 2011, the FASB issued ASU 2011-02, “Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” ASU 2011-02 provides additional guidance to creditors for evaluating whether a modification or restructuring of a receivable is a TDR by clarifying the existing guidance with respect to whether (1) the creditor has granted a concession and (2) the debtor is experiencing financial difficulties. The amendments in ASU 2011-02 will be effective for the first interim or annual period beginning on or after June 15, 2011, and are to be applied retrospectively to the beginning of the annual period of adoption. Early adoption is permitted. For purposes of measuring impairment of receivables that are newly considered impaired as a result of ASU 2011-02, the amendments are to be applied prospectively for the first interim or annual period

 
6
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


beginning on or after June 15, 2011. ASU 2011-02 will also require additional disclosures about TDR activities along with the disclosures required by ASU 2010-20, “Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses,” that were previously deferred. The Company does not expect the adoption of ASU 2011-02 to have a material impact on the Company’s financial condition, results of operations, or cash flows.
 
In May 2011, the FASB issued 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 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 will require 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, with early adoption prohibited. ASU 2011-04 will require prospective application. The Company does not expect the adoption of
ASU 2011-04 to have a material impact on the Company’s financial condition, results of operations, or cash flows.
 
In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income.” ASU 2011-05 eliminates the current option to report other comprehensive income and its components in the statement of changes in equity and requires the presentation of net income and other comprehensive income in one continuous statement or in two separate, but consecutive, statements. ASU 2011-05 does not change the items that must be reported in other comprehensive income, how such items are measured or when they must be reclassified to net income. ASU 2011-05 is effective for interim and annual periods beginning after December 31, 2011. Early adoption is permitted, but full retrospective application is required. ASU 2011-05 impacts financial statement presentation only; accordingly, it will have no impact on the Company’s financial condition, results of operations, or cash flows.
 
3. SHARES USED IN COMPUTING NET INCOME PER SHARE
 
The following table sets forth the computation of basic and diluted net income per share for the periods indicated:
 
   
Three Months Ended June 30,
  
Six Months Ended June 30,
  
   
2011
    
2010
  
2011
    
2010
  
       
(In thousands, except per share amounts)
      
Numerator:
                          
Net Income
  
$
69,023
    
$
47,320
  
$
155,399
    
$
93,974
  
Denominator:
                      
Weighted average shares, basic
    
51,070
      
53,188
    
51,099
      
52,820
  
Weighted average effect of dilutive securities:
                
Shares from assumed conversion of convertible senior notes
    
4,659
      
2,295
    
3,724
      
1,950
  
Shares from assumed conversion of convertible note warrants
    
1,537
      
—
    
1,085
      
—
  
Net effect of dilutive stock options and unvested restricted stock
    
879
      
1,338
    
870
      
1,352
  
Denominator for diluted calculations
    
58,145
      
56,821
    
56,778
      
56,122
  
                               
Basic net income per share
  
$
1.35
    
$
0.89
  
$
3.04
    
$
1.78
  
Diluted net income per share
  
$
1.19
    
$
0.83
  
$
2.74
    
$
1.67
  
 
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 in cash.
 
 
7
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
The Company is also party to prepaid forward contracts to purchase 1,857,400 shares of its common stock that are to be delivered over a settlement period in 2014. The number of shares to be delivered under the prepaid forward contracts is used to reduce weighted-average basic and diluted shares outstanding.
 
For the three and six months ended June 30, 2011, the Company excluded 10.3 million warrants, respectively, from the calculation of net income per share as the effect was anti-dilutive. For the three and six months ended June 30, 2010, the Company excluded 17.5 million warrants, respectively, from the calculation of net income per share as the effect was anti-dilutive.
 
4. ACQUISITION
 
On May 31, 2011, the Company acquired all of the stock of Aspen Marketing Holdings, Inc. (“Aspen”) for a purchase price of $345.0 million, plus a working capital adjustment. Aspen specializes in a full range of digital and direct marketing services, including the use of advanced analytics to perform data-driven customer acquisition and retention campaigns. Aspen is also a leading provider of marketing agency services, with expertise in the automotive and telecommunications industries. The results of Aspen have been included since the date of acquisition and are reflected in the Company’s Epsilon® segment. The acquisition enhances Epsilon’s core capabilities, strengthens its competitive advantage, expands Epsilon into new industry verticals and adds a strong, talented team of marketing professionals.
 
The total purchase price for Aspen was $358.2 million, net of $13.5 million of cash and cash equivalents acquired. The purchase price is subject to customary working capital adjustments. The goodwill resulting from the acquisition is not deductible for tax purposes. The following table summarizes the preliminary allocation of the consideration and the respective fair values of the assets acquired and liabilities assumed in the Aspen acquisition as of the date of purchase:
 
   
As of May 31,
2011
  
   
(In thousands)
  
Current assets
  
$
39,924
  
Property and equipment
    
4,829
  
Other assets
    
1,600
  
Capitalized software                                                                                                        
    
24,000
  
Intangible assets
    
140,000
  
Goodwill
    
231,986
  
Total assets acquired
    
442,339
  
       
Current liabilities
    
30,099
  
Other liabilities
    
3,904
  
Deferred tax liabilities
    
50,184
  
Total liabilities assumed
    
84,187
  
       
Net assets acquired
  
$
358,152
  
 
As part of the acquisition, the Company assumed two interest rate caps with a notional amount of $42.5 million that mature November 2012. The derivatives did not qualify for hedge accounting treatment and were terminated in July 2011. The fair value of the derivatives from May 31, 2011 through termination was de minimis.
 
Additionally, at the date of the acquisition, Aspen had a tax net operating loss carryforward totaling approximately $140 million resulting from a previous merger. This potential tax benefit is contingent on the prior merger qualifying as a reorganization under Internal Revenue Code (“IRC”) section 368. At this time, the potential tax benefits from the tax net operating loss carryforward have not been recognized in the Company’s unaudited condensed consolidated financial statements.

 
8
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
5. 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 and delinquencies is presented in the table below:
 
   
June 30,
2011
    
December 31,
2010
  
   
(In thousands)
  
Principal receivables
  
$
4,716,196
    
$
5,116,111
  
Billed and accrued finance charges
    
192,173
      
214,643
  
Other receivables
    
30,848
      
25,669
  
Total credit card receivables
    
4,939,217
      
5,356,423
  
Less credit card receivables – restricted for securitization investors
    
4,338,016
      
4,795,753
  
Other credit card receivables
  
$
601,201
    
$
560,670
  
Principal amount of credit card receivables 90 days or more past due
  
$
91,977
    
$
130,538
  
 
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.
 
The Company records the actual charge-offs for unpaid interest and fees as a reduction to finance charges, net. For the three and six months ended June 30, 2011 and 2010, actual charge-offs for unpaid interest and fees were $48.3 million, $104.5 million and $53.6 million, $114.5 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 quantitative and qualitative factors as set forth below, including the relatively consistent levels of unpaid interest and fees included in credit card receivables for each of the quarterly periods in 2010 and 2011, there has been no change in the allowance for loan loss attributable to unpaid interest and fees. However, if trends continue to improve, the Company would expect to reduce the allowance for loan loss attributable to unpaid interest and fees.
 
In evaluating the allowance for loan loss for both principal and unpaid interest and fees, management also considers factors that may impact loan loss experience, including seasoning, loan volume and amounts, payment rates and forecasting uncertainties. The following table presents the Company’s allowance for loan loss for the periods indicated:
 
   
Three Months Ended June 30,
  
Six Months Ended June 30,
  
   
2011
    
2010
  
2011
    
2010
  
   
(In thousands)
  
Balance at beginning of period
  
$
489,620
    
$
544,569
  
$
518,069
    
$
54,884
  
Adoption of ASC 860 and ASC 810
    
—
      
—
    
—
      
523,950
  
Provision for loan loss
    
60,376
      
94,700
    
128,042
      
182,701
  
Recoveries
    
21,876
      
21,046
    
47,742
      
42,784
  
Principal charge-offs
    
(108,942
)
    
(133,470
)
  
(232,838
)
    
(277,474
)
Other
    
(1,915
)
    
—
    
—
      
—
  
Balance at end of period
  
$
461,015
    
$
526,845
  
$
461,015
    
$
526,845
  

 
9
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)


Net Charge-Offs
 
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 net charge-off rate is calculated by dividing net charge-offs of principal receivables for the period by the average credit card receivables for the period. Average credit card receivables represent the average balance of the cardholder receivables at the beginning of each month in the years indicated. The following table presents the Company’s net charge-offs for the periods indicated:
 
   
Three Months Ended June 30,
  
Six Months Ended June 30,
  
   
2011
    
2010
  
2011
    
2010
  
   
(In thousands, except percentages)
  
Average credit card receivables
  
$
4,848,715
    
$
4,992,034
  
$
4,908,587
    
$
5,088,590
  
Net charge-offs of principal receivables
    
87,066
      
112,424
    
185,096
      
234,690
  
Net charge-offs as a percentage of average credit card receivables
    
7.2
%
    
9.0
%
  
7.5
%
    
9.2
%
 
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. When an account becomes delinquent, a message is printed on the credit cardholder’s billing statement requesting payment. After an account becomes 30 days past due, a proprietary collection scoring algorithm automatically scores the risk of the account becoming further delinquent. The collection system then recommends a collection strategy for the past due account based on the collection score and account balance and dictates the contact schedule and collections priority for the account. If the Company is unable to make a collection after exhausting all in-house collection efforts, the Company will engage collection agencies and outside attorneys to continue those efforts.
 
The following table presents the delinquency trends of the Company’s credit card portfolio:
 
   
June 30,
2011
    
% of
Total
    
December 31,
2010
    
% of
Total
  
           
(In thousands, except percentages)
          
Receivables outstanding – principal
  
$
4,716,196
      
100
%
  
$
5,116,111
      
100
%
Principal receivables balances contractually delinquent:
                                
31 to 60 days
    
73,982
      
1.5
%
    
87,252
      
1.7
%
61 to 90 days
    
48,408
      
1.0
      
59,564
      
1.2
  
91 or more days
    
91,977
      
2.0
      
130,538
      
2.5
  
Total
  
$
214,367
      
4.5
%
  
$
277,354
      
5.4
%
 
Modified Credit Card Receivables
 
The Company does hold certain credit card receivables for which the terms have been modified. 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
 
 
10
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
Contingencies.” If the Company applied accounting standards 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 less than 3% of the Company’s total credit card receivables at each of June 30, 2011 and December 31, 2010.
 
Age of Credit Card Receivables
 
The following table sets forth, as of June 30, 2011, 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
    
2,890
      
24.1
%
  
$
890,067
      
18.9
%
13-24 Months
    
1,605
      
13.4
      
637,793
      
13.5
  
25-36 Months
    
1,206
      
10.1
      
546,198
      
11.6
  
37-48 Months
    
992
      
8.3
      
427,875
      
9.1
  
49-60 Months
    
838
      
7.0
      
365,110
      
7.7
  
Over 60 Months
    
4,446
      
37.1
      
1,849,153
      
39.2
  
Total
    
11,977
      
100.0
%
  
$
4,716,196
      
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 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 by obligor credit quality as of June 30, 2011:
 
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
  
$
79,173
      
1.7
%
27.1% and higher
    
266,134
      
5.6
  
17.1% - 27.0%
    
447,442
      
9.5
  
12.6% - 17.0%
    
550,006
      
11.7
  
3.7% - 12.5%
    
1,962,204
      
41.6
  
1.9% - 3.6%
    
925,257
      
19.6
  
Lower than 1.9%
    
485,980
      
10.3
  
Total
  
$
4,716,196
      
100.0
%
 
Securitized Credit Card Receivables
 
The Company regularly securitizes its credit card receivables through its credit card securitization trusts, consisting of World Financial Network Credit Card Master Trust, World Financial Network Credit Card Master Note Trust, World Financial Network Credit Card Master Note Trust II and World Financial Network Credit Card Master Trust III (collectively, the “WFN Trusts”), and World Financial Capital Credit Card Master Note Trust (the “WFC Trust”). The Company continues to own and service the accounts that generate credit card receivables held by the WFN Trusts and the WFC Trust. In its capacity as a servicer, each of the respective banks earns a fee from the WFN Trusts and the WFC Trust to service and administer the credit card receivables, collect payments, and charge-off uncollectable receivables. These fees are eliminated and therefore are not reflected in the unaudited condensed consolidated statements of income for the three and six months ended June 30, 2011 and 2010.
 
 
11
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
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:
 
   
June 30,
2011
    
December 31,
2010
  
   
(In thousands)
  
Total credit card receivables – restricted for securitization investors
  
$
4,338,016
    
$
4,795,753
  
Principal amount of credit card receivables – restricted for securitization investors, 90 days or more past due
  
$
82,769
    
$
117,594
  
 
   
Three Months Ended June 30,
  
Six Months Ended June 30,
  
   
2011
    
2010
  
2011
    
2010
  
   
(In thousands)
  
Net charge-offs of securitized principal
  
$
78,623
    
$
97,899
  
$
165,926
    
$
206,008
  
                               
 
Portfolio Acquisition
 
In February 2011, World Financial Capital Bank, one of the Company’s wholly-owned subsidiaries, acquired the existing private label credit card portfolio of J.Jill and entered into a multi-year agreement to provide private label credit card services. The total purchase price was approximately $42.7 million, which consisted of $37.9 million of credit card receivables and $4.8 million of intangible assets that are included in the unaudited condensed consolidated balance sheets as of June 30, 2011.
 
6. REDEMPTION SETTLEMENT ASSETS
 
Redemption settlement assets consist of cash and cash equivalents and securities available-for-sale and are designated for settling redemptions by collectors of the AIR MILES Reward Program in Canada under certain contractual relationships with sponsors of the AIR MILES Reward Program. These assets are primarily denominated in Canadian dollars. Realized gains and losses from the sale of investment securities were not material. The principal components of redemption settlement assets, which are carried at fair value, are as follows:
 
   
June 30, 2011
    
December 31, 2010
  
   
Cost
    
Unrealized Gains
    
Unrealized Losses
    
Fair Value
    
Cost
    
Unrealized Gains
    
Unrealized Losses
    
Fair Value
  
   
(In thousands)
  
Cash and cash equivalents
  
$
36,759
    
$
—
    
$
—
    
$
36,759
    
$
74,612
    
$
—
    
$
—
    
$
74,612
  
Government bonds
    
5,247
      
163
      
—
      
5,410
      
15,235
      
161
      
(34
)
    
15,362
  
Corporate bonds (1)
    
432,745
      
4,885
      
(589
)
    
437,041
      
380,605
      
3,212
      
(1,363
)
    
382,454
  
Total
  
$
474,751
    
$
5,048
    
$
(589
)
  
$
479,210
    
$
470,452
    
$
3,373
    
$
(1,397
)
  
$
472,428
  
                                                                 
 
(1)
As of June 30, 2011 and December 31, 2010, LoyaltyOne® had investments in retained interests in the WFN Trusts with a fair value of $64.9 million in each case. These amounts are eliminated and therefore not reflected in the unaudited condensed consolidated financial statements and notes thereof as of June 30, 2011 and December 31, 2010.

 
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 June 30, 2011 and December 31, 2010, aggregated by investment category and the length of time that individual securities have been in a continuous loss position:
 
   
Less than 12 months
    
June 30, 2011
12 Months or Greater
    
Total
  
   
Fair Value
    
Unrealized
Losses
    
Fair Value
    
Unrealized
Losses
    
Fair Value
    
Unrealized
Losses
  
   
(In thousands)
  
Corporate bonds
  
$
59,582
    
$
(589
)
  
$
—
    
$
—
    
$
59,582
    
$
(589
)
Total
  
$
59,582
    
$
(589
)
  
$
—
    
$
—
    
$
59,582
    
$
(589
)
 

   
Less than 12 months
    
December 31, 2010
12 Months or Greater
    
Total
  
   
Fair Value
    
Unrealized
Losses
    
Fair Value
    
Unrealized
Losses
    
Fair Value
    
Unrealized
Losses
  
   
(In thousands)
  
Government bonds
  
$
10,119
    
$
(34
)
  
$
—
    
$
—
    
$
10,119
    
$
(34
)
Corporate bonds
    
128,349
      
(1,363
)
    
—
      
—
      
128,349
      
(1,363
)
Total
  
$
138,468
    
$
(1,397
)
  
$
—
    
$
—
    
$
138,468
    
$
(1,397
)
 
Market values were determined for each individual security in the investment portfolio. When evaluating the investments for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the security’s issuer, and the Company’s intent to sell the security and whether it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis. The Company typically invests in highly-rated securities with low probabilities of default and has the ability to hold the investments until maturity. As of June 30, 2011, the Company does not consider the investments to be other-than-temporarily impaired.
 
The net carrying value and estimated fair value of the redemption settlement assets at June 30, 2011 by contractual maturity are as follows:
 
   
Amortized
Cost
    
Estimated Fair Value
  
   
(In thousands)
  
Due in one year or less
  
$
58,010
    
$
57,909
  
Due after one year through five years
    
416,741
      
421,301
  
Total
  
$
474,751
    
$
479,210
  
       
 
 
13
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
7. INTANGIBLE ASSETS AND GOODWILL
 
Intangible Assets
 
Intangible assets consist of the following:
 
   
June 30, 2011
    
   
Gross
Assets
    
Accumulated
Amortization
    
Net
  
Amortization Life and Method
   
(In thousands)
    
Finite Lived Assets
                    
Customer contracts and lists
  
$
316,245
    
$
(125,357
)
  
$
190,888
  
3-12 years—straight line
Premium on purchased credit card portfolios
    
156,203
      
(73,068
)
    
83,135
  
3-10 years—straight line, accelerated
Collector database
    
72,659
      
(63,980
)
    
8,679
  
30 years—15% declining balance
Customer database
    
175,531
      
(86,299
)
    
89,232
  
4-10 years—straight line
Noncompete agreements
    
1,089
      
(895
)
    
194
  
2-3 years—straight line
Tradenames
    
38,202
      
(5,929
)
    
32,273
  
5-15 years—straight line
Purchased data lists
    
22,244
      
(14,428
)
    
7,816
  
1-5 years—straight line, accelerated
   
$
782,173
    
$
(369,956
)
  
$
412,217
    
Indefinite Lived Assets
                          
Tradenames
    
12,350
      
—
      
12,350
  
Indefinite life
Total intangible assets
  
$
794,523
    
$
(369,956
)
  
$
424,567
    
 

   
December 31, 2010
    
   
Gross
Assets
    
Accumulated
Amortization
    
Net
  
Amortization Life and Method
   
(In thousands)
    
Finite Lived Assets
                    
Customer contracts and lists
  
$
211,413
    
$
(123,932
)
  
$
87,481
  
5-10 years—straight line
Premium on purchased credit card portfolios
    
151,430
      
(63,115
)
    
88,315
  
3-10 years—straight line, accelerated
Collector database
    
70,211
      
(61,075
)
    
9,136
  
30 years—15% declining balance
Customer database
    
175,397
      
(76,002
)
    
99,395
  
4-10 years—straight line
Noncompete agreements
    
1,062
      
(668
)
    
394
  
2-3 years—straight line
Tradenames
    
14,169
      
(5,070
)
    
9,099
  
5-10 years—straight line
Purchased data lists
    
20,506
      
(12,285
)
    
8,221
  
1-5 years—straight line, accelerated
   
$
644,188
    
$
(342,147
)
  
$
302,041
    
Indefinite Lived Assets
                          
Tradenames
    
12,350
      
—
      
12,350
  
Indefinite life
Total intangible assets
  
$
656,538
    
$
(342,147
)
  
$
314,391
    
 
With the J.Jill portfolio acquisition in February 2011, the Company acquired $4.8 million of intangible assets consisting of a customer relationship of $2.6 million and a marketing relationship of $2.2 million, which are being amortized, in each case, over a weighted average life of 7.0 years.
 
With the Aspen acquisition on May 31, 2011, the Company acquired $140.0 million of intangible assets, consisting of $116.0 million of customer relationships and $24.0 million of trade names, which are being amortized over a weighted average life of 8.3 years and 15 years, respectively. See Note 4, “Acquisition,” for more information regarding the Aspen acquisition.

 
14
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
Goodwill
 
The changes in the carrying amount of goodwill for the six months ended June 30, 2011 are as follows:
 
   
LoyaltyOne
    
Epsilon
    
Private Label Services and Credit
    
Corporate/
Other
    
Total
  
   
(In thousands)
  
December 31, 2010
  
$
246,930
    
$
713,161
    
$
261,732
    
$
—
    
$
1,221,823
  
Effects of foreign currency translation
    
8,216
      
691
      
—
      
—
      
8,907
  
Goodwill acquired during the year
    
—
      
231,986
      
—
      
—
      
231,986
  
June 30, 2011
  
$
255,146
    
$
945,838
    
$
261,732
    
$
—
    
$
1,462,716
  
 
8. DEBT
 
Debt consists of the following:
 
Description
  
June 30,
2011
    
December 31,
2010
  
Maturity
  
Interest Rate
   
(Dollars in thousands)
        
                   
Certificates of deposit:
                      
Certificates of deposit
  
$
827,681
    
$
859,100
  
Six months to five years
  
0.20% to 5.25%
Less: current portion
    
(357,409
)
    
(442,600
)
      
Long-term portion
  
$
470,272
    
$
416,500
        
                   
Asset-backed securities debt – owed to securitization investors:
                      
Fixed rate asset-backed term note securities
  
$
1,772,815
    
$
1,772,815
  
Various - Nov 2011 – Jun 2015
  
3.79% to 7.00%
Floating rate asset-backed term note securities
    
1,153,500
      
1,153,500
  
Various - Sept 2011 – Apr 2013
  
(1)
Conduit asset-backed securities
    
380,571
      
733,827
  
Various - Sept 2011 – Jun 2012
  
1.39% to 2.07%
Total asset-backed securities – owed to securitization investors
    
3,306,886
      
3,660,142
        
Less: current portion
    
(1,494,146
)
    
(1,743,827
)
      
Long-term portion
  
$
1,812,740
    
$
1,916,315
        
                   
Long-term and other debt:
                  
2011 credit facility
  
$
616,000
    
$
—
  
May 2016
  
(2)
2011 term loan
    
792,500
      
—
  
May 2016
  
(2)
2006 credit facility
    
—
      
300,000
  
—
  
—
Series B senior notes
    
—
      
250,000
  
—
  
—
2009 term loan
    
—
      
161,000
  
—
  
—
2010 term loan
    
—
      
236,000
  
—
  
—
Convertible senior notes due 2013
    
684,797
      
659,371
  
August 2013
  
1.75%
Convertible senior notes due 2014
    
268,143
      
257,687
  
May 2014
  
4.75%
Capital lease obligations and other debt
    
168
      
5,714
  
Various - Aug 2011 – Jul 2013(3)
  
5.25% to 7.10%(3)
Total long-term and other debt
    
2,361,608
      
1,869,772
        
Less: current portion
    
(19,957
)
    
(255,679
)
      
Long-term portion
  
$
2,341,651
    
$
1,614,093
        
                       
 
(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”) as defined in the respective agreements plus a margin of 0.1% to 2.5% as defined in the respective agreements. The weighted average interest rate of the fixed rate achieved through interest rate swap agreements is 4.16% at June 30, 2011.
 
(2)
On May 24, 2011, the Company entered into a credit agreement (the “2011 Credit Agreement”) which consists of a $792.5 million unsecured revolving credit facility (the “2011 Credit Facility”) and a $792.5 million term loan (the “2011 Term Loan”) where advances are in the form of either base rate loans or Eurodollar loans and may be denominated in Canadian dollars, subject to a sublimit, or U.S. dollars. At June 30, 2011, the weighted average interest rate for the 2011 Credit Facility and 2011 Term Loan was 2.59% and 2.44%, respectively.
 
(3)
The Company has other minor borrowings, primarily capital leases, with varying interest rates and maturities.
 
At June 30, 2011, the Company was in compliance with its covenants.

 
15
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
2011 Credit Agreement
 
The Company is party to a credit agreement, among 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, SunTrust Bank and Bank of Montreal, as co-administrative agents, and Bank of Montreal as letter of credit issuer, and various other agents and banks, dated May 24, 2011 (the “2011 Credit Agreement”). The 2011 Credit Agreement provides for a $792.5 million term loan (the “2011 Term Loan”) and a $792.5 million revolving line of credit (the “2011 Credit Facility”) with a U.S. $65.0 million sublimit for Canadian dollar borrowings and a $65.0 million sublimit for swing line loans. The 2011 Credit Agreement includes an uncommitted accordion feature of up to $415.0 million in the aggregate allowing for future incremental borrowings, subject to certain conditions.
 
The loans under the 2011 Credit Agreement are scheduled to mature on May 24, 2016. The 2011 Term Loan provides for aggregate principal payments equal to 2.5% of the initial term loan amount in each of the first and second year and 5% of the initial term loan amount in each of the third, fourth and fifth year of the term loan, payable in equal quarterly installments beginning September 30, 2011. The 2011 Credit Agreement is unsecured.
 
Advances under the 2011 Credit Agreement are in the form of either base rate loans or Eurodollar loans and may be denominated in U.S. dollars or Canadian dollars. The interest rate for base rate loans denominated in U.S. dollars fluctuates and is equal to the highest of (i) the Bank of Montreal’s prime rate; (ii) the Federal funds rate plus 0.5% and (iii) the London Interbank Offered Rate (“LIBOR”) as defined in the 2011 Credit Agreement plus 1.0%, in each case plus a margin of 0.75% to 1.25% based upon the Company’s senior leverage ratio as defined in the 2011 Credit Agreement. The interest rate for base rate loans denominated in Canadian dollars fluctuates and is equal to the higher of (i) the Bank of Montreal’s prime rate for Canadian dollar loans and (ii) the Canadian Dollar Offered Rate (“CDOR”) plus 1%, in each case plus a margin of 0.75% to 1.25% based upon the Company’s senior leverage ratio as defined in the 2011 Credit Agreement. The interest rate for Eurodollar loans denominated in U.S. or Canadian dollars fluctuates based on the rate at which deposits of U.S. dollars or Canadian dollars, respectively, in the London interbank market are quoted plus a margin of 1.75% to 2.25% based upon the Company’s senior leverage ratio as defined in the 2011 Credit Agreement.
 
The 2011 Credit Agreement contains usual and customary negative covenants for transactions of this type, including, but not limited to, restrictions on the Company’s ability, and in certain instances, its subsidiaries’ ability, to consolidate or merge; substantially change the nature of its business; sell, lease or otherwise transfer any substantial part of its assets; create or incur indebtedness; create liens; pay dividends; and make investments or acquisitions. The negative covenants are subject to certain exceptions as specified in the 2011 Credit Agreement. The 2011 Credit Agreement also requires the Company to satisfy certain financial covenants, including maximum ratios of total leverage and senior leverage as determined in accordance with the 2011 Credit Agreement and a minimum ratio of consolidated operating EBITDA to consolidated interest expense as determined in accordance with the 2011 Credit Agreement.
 
Concurrently with entering into the 2011 Credit Agreement, the Company terminated the following credit facilities: (i) a credit agreement, dated September 29, 2006, which consisted of a $750.0 million unsecured revolving credit facility (the “2006 Credit Facility”); (ii) a term loan agreement, dated May 15, 2009 (the “2009 Term Loan”); and (iii) a term loan agreement, dated August 6, 2010 (the “2010 Term Loan”). The 2006 Credit Facility, the 2009 Term Loan and the 2010 Term Loan were scheduled to expire on March 30, 2012.
 
Total availability under the 2011 Credit Facility at June 30, 2011 was $176.5 million.
 
Series B Senior Notes
 
The Company repaid the $250.0 million aggregate principal amount of the 6.14% Series B senior notes at their scheduled maturity of May 16, 2011.

 
16
 
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 $805.0 million scheduled to mature on August 1, 2013 and $345.0 million scheduled to mature on May 15, 2014. The table below summarizes the carrying value of the components of the convertible senior notes:
 
   
June 30,
2011
    
December 31,
2010
  
   
(In thousands)
  
Carrying amount of equity component
  
$
368,678
    
$
368,678
  
                 
Principal amount of liability component
  
$
1,150,000
    
$
1,150,000
  
Unamortized discount
    
(197,060
)
    
(232,942
)
Net carrying value of liability component
  
$
952,940
    
$
917,058
  
                 
If-converted value of common stock
  
$
1,646,993
    
$
1,243,605
  
 
The discount on the liability component will be amortized as interest expense over the remaining life of the convertible senior notes which, at June 30, 2011, is a weighted average period of 2.3 years.
 
Interest expense on the convertible senior notes recognized in the Company’s unaudited condensed consolidated statements of income for the three and six months ended June 30, 2011 and 2010 is as follows:
 
   
Three Months Ended June 30,
  
Six Months Ended June 30,
  
   
2011
    
2010
  
2011
    
2010
  
   
(In thousands, except percentages)
  
Interest expense calculated on contractual interest rate
  
$
7,618
    
$
7,618
  
$
15,237
    
$
15,237
  
Amortization of discount on liability component
    
18,187
      
16,301
    
35,882
      
32,162
  
Total interest expense on convertible senior notes
  
$
25,805
    
$
23,919
  
$
51,119
    
$
47,399
  
                               
Effective interest rate (annualized)
    
11.0
%
    
11.0
%
  
11.0
%
    
11.0
%
 
Asset-backed Securities – Owed to Securitization Investors
 
Conduit Facilities
 
During the second quarter of 2011, the Company renewed its $1.2 billion 2009-VFN conduit facility under World Financial Network Credit Card Master Note Trust and its $275.0 million 2009-VFN conduit facility under World Financial Capital Credit Card Master Note Trust, extending their maturities to June 13, 2012 and June 1, 2012, respectively.
 
Derivative Financial Instruments
 
As part of its interest rate risk management program, the Company may enter into derivative financial instruments with institutions that are established dealers and manage its exposure to changes in fair value of certain obligations attributable to changes in LIBOR.
 
The credit card securitization trusts enter into derivative financial instruments, which include both interest rate swaps and an interest rate cap, to mitigate their interest rate risk on a related financial instrument or to lock the interest rate on a portion of their variable asset-backed securities debt.
 
These interest rate contracts involve the receipt of variable rate amounts from counterparties in exchange for the Company making fixed rate payments over the life of the agreement without the exchange of the underlying notional amount. These interest rate contracts are not designated as hedges. Such contracts are not speculative and are used to manage interest rate risk, but do not meet the specific hedge accounting requirements of ASC 815, “Derivatives and Hedging.”
 
 
17
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
The following tables identify the notional amount, fair value and classification of the Company’s outstanding interest rate contracts for the credit card securitization trusts at June 30, 2011 and December 31, 2010 in the unaudited condensed consolidated balance sheets:
 
   
June 30, 2011
  
December 31, 2010
  
   
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
  
$
1,153,500
      
1.23
  
 
 $ 
1,153,500
      
1.72
  
                               
 
 
   
June 30, 2011
  
December 31, 2010
  
   
Balance Sheet Location
    
Fair Value
  
Balance Sheet Location
    
Fair Value
  
   
(In thousands)
Interest rate contracts not designated as hedging instruments     Other current liabilities      $ 1,400     Other current liabilities      $ 4,574  
Interest rate contracts not designated as hedging instruments         
Other liabilities
     $  53,828    
Other liabilities  
     $  65,257  
                               
 
The following table summarizes activity related to and identifies the location of the Company’s outstanding interest rate contracts for the credit card securitization trusts for the three and six months ended June 30, 2011 and 2010 recognized in the unaudited condensed consolidated statements of income:
 
   
2011
  
2010
  
For the three months ended June 30,
  
Income Statement Location
    
Gain on Derivative Contracts
  
Income Statement Location
    
Loss on Derivative Contracts
  
   
(In thousands)
Interest rate contracts not designated as hedging instruments
    
Securitization
funding costs
    
$
4,711
    
Securitization
funding costs
    
$
3,203
  
                               
For the six months ended June 30,
                              
Interest rate contracts not designated as hedging instruments
    
Securitization
funding costs
    
$
14,603
    
Securitization
funding costs
    
$
5,384
  
                               
 
The Company limits its exposure on derivatives by entering into contracts with institutions that are established dealers who maintain certain minimum credit criteria established by the Company. At June 30, 2011, the Company does not maintain any derivative contracts subject to master agreements that would require the Company to post collateral or that contain any credit-risk related contingent features. The Company has provisions in certain of the master agreements that require counterparties to post collateral to the Company when their credit ratings fall below certain thresholds. At June 30, 2011, these thresholds were not breached and no amounts were held as collateral by the Company.
 
9. 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. The Company’s estimate of breakage is 28%.
 
 
18
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
 
·
Service element. The service element consists of marketing and administrative services provided to sponsors. Revenue related to the service element has been determined in accordance with ASU 2009-13. 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, 2010
  
$
339,514
    
$
881,728
    
$
1,221,242
  
Cash proceeds
    
108,189
      
258,078
      
366,267
  
Revenue recognized
    
(95,743
)
    
(266,500
)
    
(362,243
)
Other
    
—
      
1,094
      
1,094
  
Effects of foreign currency translation
    
12,009
      
30,649
      
42,658
  
June 30, 2011
  
$
363,969
    
$
905,049
    
$
1,269,018
  
Amounts recognized in the unaudited condensed consolidated balance sheets:
                        
Current liabilities
  
$
172,989
    
$
905,049
    
$
1,078,038
  
Non-current liabilities
  
$
190,980
    
$
—
    
$
190,980
  
 
10. STOCKHOLDERS’ EQUITY
 
Stock Repurchase Program
 
On September 13, 2010, 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 September 13, 2010 through December 31, 2011, subject to any restrictions pursuant to the terms of the Company’s credit agreements or otherwise.
 
For the six months ended June 30, 2011, the Company acquired a total of 1,505,252 shares of its common stock for $116.7 million. As of June 30, 2011, the Company has $211.4 million available under the stock repurchase program.
 
Stock Compensation Expense
 
Total stock-based compensation expense recognized in the Company’s unaudited condensed consolidated statements of income for the three and six months ended June 30, 2011 and 2010 is as follows:
 
   
Three Months Ended June 30,
  
Six Months Ended June 30,
  
   
2011
    
2010
  
2011
    
2010
  
   
(In thousands)
  
Cost of operations
  
$
6,007
    
$
6,308
  
$
11,910
    
$
12,203
  
General and administrative
    
5,099
      
6,107
    
8,280
      
10,818
  
Total
  
$
11,106
    
$
12,415
  
$
20,190
    
$
23,021
  
 
During the six months ended June 30, 2011, the Company awarded 425,328 performance-based restricted stock units with a weighted average grant date fair value per share of $83.72 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, 2011 to December 31, 2011 met certain pre-defined vesting criteria that permit a range from 50% to
 
 
19
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
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, 2012, an additional 33% of the award on February 21, 2013 and the final 34% of the award on February 21, 2014, provided that the participant is employed by the Company on each such vesting date.
 
During the six months ended June 30, 2011, the Company awarded 125,959 service-based restricted stock units with a weighted average grant date fair value per share of $84.45 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.
 
11. COMPREHENSIVE INCOME
 
The components of comprehensive income, net of tax effect, are as follows:
 
   
Three Months Ended June 30,
  
Six Months Ended June 30,
  
   
2011
    
2010
  
2011
    
2010
  
   
(In thousands)
  
Net income
  
$
69,023
    
$
47,320
  
$
155,399
    
$
93,974
  
Adoption of ASC 860 and ASC 810 (1) 
    
—
      
—
    
—
      
55,881
  
Unrealized gain (loss) on securities available-for-sale
    
3,484
      
3,953
    
(944
)
    
(1,748
)
Foreign currency translation adjustments (2) 
    
(387
)
    
5,757
    
(3,531
)
    
(1,881
)
Total comprehensive income, net of tax
  
$
72,120
    
$
57,030
  
$
150,924
    
$
146,226
  
         
 
(1)
These amounts related to retained interests in the WFN Trusts and the WFC Trust were previously reflected in accumulated other comprehensive income. Upon the adoption of ASC 860, “Transfers and Servicing,” and ASC 810, “Consolidation,” which was effective January 1, 2010, these interests and related accumulated other comprehensive income have been reclassified, derecognized or eliminated upon consolidation.
 
(2)
Primarily related to the impact of changes in the Canadian currency exchange rate.
 
12. FINANCIAL INSTRUMENTS
 
In accordance with ASC 825, “Financial Instruments,” the Company is required to disclose the fair value of financial instruments for which it is practical to estimate fair value. To obtain fair values, observable market prices are used if available. In some instances, observable market prices are not readily available and fair value is determined using present value or other techniques appropriate for a particular financial instrument. These techniques involve judgment and as a result are not necessarily indicative of the amounts the Company would realize in a current market exchange. The use of different assumptions or estimation techniques may have a material effect on the estimated fair value amounts.

 
20
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
Fair Value of Financial Instruments — The estimated fair values of the Company’s financial instruments are as follows:
 
   
June 30, 2011
    
December 31, 2010
  
   
Carrying
Amount
    
Fair
Value
    
Carrying
Amount
    
Fair
Value
  
   
(In thousands)
  
Financial assets
                        
Cash and cash equivalents
  
$
232,821
    
$
232,821
    
$
139,114
    
$
139,114
  
Trade receivables, net
    
296,271
      
296,271
      
260,945
      
260,945
  
Credit card receivables, net
    
4,478,202
      
4,478,202
      
4,838,354
      
4,838,354
  
Redemption settlement assets, restricted
    
479,210
      
479,210
      
472,428
      
472,428
  
Cash collateral, restricted
    
317,076
      
317,076
      
185,754
      
185,754
  
Other investment securities
    
89,214
      
89,214
      
104,916
      
104,916
  
Financial liabilities
                                
Accounts payable
    
111,543
      
111,543
      
121,856
      
121,856
  
Certificates of deposit
    
827,681
      
849,521
      
859,100
      
883,405
  
Asset-backed securities debt – owed to securitization investors
    
3,306,886
      
3,368,719
      
3,660,142
      
3,711,263
  
Long-term and other debt
    
2,361,608
      
3,152,040
      
1,869,772
      
2,393,124
  
Derivative financial instruments
    
55,228
      
55,228
      
69,831
      
69,831
  
 
Fair Value of Assets and Liabilities Held at June 30, 2011 and December 31, 2010