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