form10q.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
     
     
FORM 10-Q

(Mark One)
 
R
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the quarterly period ended March 31, 2014
   
OR
 
£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the transition period from to

Commission File Number: 001-15749
 
     
     
ALLIANCE DATA SYSTEMS CORPORATION
(Exact name of registrant as specified in its charter)

Delaware
31-1429215
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)

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

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

 
Indicate by check mark whether the registrant: (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes R No £
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes R No £

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No R
 
As of April 30, 2014, 54,207,979 shares of common stock were outstanding.
 
 
 
 
 
ALLIANCE DATA SYSTEMS CORPORATION
 
INDEX
 
 
 
 
 
Page
Number
Part I:  FINANCIAL INFORMATION
   
Item 1.
Financial Statements (unaudited)
  
 
3
 
4
 
5
 
6
 
7
Item 2.
28
Item 3.
38
Item 4.
38
     
Part II:  OTHER INFORMATION
 
Item 1.
40
Item 1A.
40
Item 2.
40
Item 3.
40
Item 4.
40
Item 5.
40
Item 6.
41
42
 
 
 
 
 
2
 
PART I
 
Item 1. Financial Statements.
 
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
 
   
March 31,
2014
    
December 31,
2013
  
  (In thousands, except per share amounts)
ASSETS
Cash and cash equivalents
   $ 706,642     $ 969,822  
Trade receivables, less allowance for doubtful accounts ($3,290 and $2,262 at March 31, 2014 and December 31, 2013, respectively)
     374,483       394,822  
Credit card and loan receivables:
                
Credit card receivables – restricted for securitization investors
     6,486,702       7,080,014  
Other credit card and loan receivables
     1,602,096       1,492,868  
Total credit card and loan receivables
     8,088,798       8,572,882  
Allowance for loan loss
     (482,658 )     (503,169 )
Credit card and loan receivables, net
     7,606,140       8,069,713  
Loan receivables held for sale
     62,472       62,082  
Deferred tax asset, net
     201,237       216,195  
Other current assets
     418,487       177,859  
Redemption settlement assets, restricted
     568,564       510,349  
Total current assets
     9,938,025       10,400,842  
Property and equipment, net
     326,421       299,188  
Deferred tax asset, net
     2,355       2,454  
Cash collateral, restricted
     34,425       34,124  
Intangible assets, net
     840,059       460,404  
Goodwill
     2,296,349       1,735,703  
Other non-current assets
     319,636       311,542  
Total assets
   $ 13,757,270     $ 13,244,257  
LIABILITIES AND EQUITY
Accounts payable
   $ 362,901     $ 210,019  
Accrued expenses
     492,426       262,307  
Deposits
     1,381,079       1,544,059  
Non-recourse borrowings of consolidated securitization entities
     250,000       1,025,000  
Current debt
     384,940       364,489  
Other current liabilities
     186,128       140,186  
Deferred revenue
     907,716       966,438  
Deferred tax liability, net
     62       —  
Total current liabilities
     3,965,252       4,512,498  
Deferred revenue
     158,515       170,748  
Deferred tax liability, net
     390,530       275,757  
Deposits
     1,292,792       1,272,302  
Non-recourse borrowings of consolidated securitization entities
     3,921,916       3,566,916  
Long-term and other debt
     2,575,270       2,435,792  
Other liabilities
     160,289       154,483  
Total liabilities
     12,464,564       12,388,496  
Commitments and contingencies
                
Redeemable non-controlling interest
     342,797       —  
Stockholders’ equity:
                
Common stock, $0.01 par value; authorized, 200,000 shares; issued, 101,573 shares and 98,302 shares at March 31, 2014 and December 31, 2013, respectively
     1,016       983  
Additional paid-in capital
     1,508,456       1,512,752  
Treasury stock, at cost, 46,954 shares and 46,752 shares at March 31, 2014 and December 31, 2013, respectively
     (2,737,979 )     (2,689,177 )
Retained earnings
     2,186,825       2,049,430  
Accumulated other comprehensive loss
     (8,409 )     (18,227 )
Total stockholders’ equity
     949,909       855,761  
Total liabilities and equity
   $ 13,757,270     $ 13,244,257  
 
 
See accompanying notes to unaudited condensed consolidated financial statements.
 
 
3
 
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
 
   
Three Months Ended
March 31,
  
   
2014
    
2013
  
  (In thousands, except per share amounts)
Revenues
  
Transaction                                                                                                                   
  
$
83,980
    
$
82,348
  
Redemption                                                                                                                   
    
243,690
      
160,012
  
Finance charges, net                                                                                                                   
    
536,261
      
477,404
  
Database marketing fees and direct marketing services                                                                                                                   
    
328,469
      
295,606
  
Other revenue                                                                                                                   
    
40,500
      
38,067
  
Total revenue
    
1,232,900
      
1,053,437
  
Operating expenses
  
Cost of operations (exclusive of depreciation and amortization disclosed separately below)
    
772,426
      
620,422
  
Provision for loan loss                                                                                                                   
    
70,582
      
66,648
  
General and administrative                                                                                                                   
    
34,027
      
22,292
  
Depreciation and other amortization                                                                                                                   
    
25,512
      
19,560
  
Amortization of purchased intangibles                                                                                                                   
    
48,561
      
33,290
  
Total operating expenses
    
951,108
      
762,212
  
Operating income
    
281,792
      
291,225
  
Interest expense
  
Securitization funding costs                                                                                                                   
    
22,911
      
24,485
  
Interest expense on deposits                                                                                                                   
    
8,234
      
7,007
  
Interest expense on long-term and other debt, net                                                                                                                   
    
36,602
      
51,052
  
Total interest expense, net
    
67,747
      
82,544
  
Income before income tax
  
$
214,045
    
$
208,681
  
Provision for income taxes
    
78,298
      
79,702
  
Net income                                                                                                                      
  
$
135,747
    
$
128,979
  
Less: Net loss attributable to non-controlling interest
    
(1,648
)
    
—
  
Net income attributable to Alliance Data Systems Corporation stockholders
  
$
137,395
    
$
128,979
  
   
Net income attributable to Alliance Data Systems Corporation stockholders per share:
  
Basic                                                                                                                   
  
$
2.59
    
$
2.59
  
Diluted                                                                                                                   
  
$
2.08
    
$
1.92
  
   
Weighted average shares:
  
Basic                                                                                                                   
    
53,033
      
49,762
  
Diluted                                                                                                                   
    
66,065
      
67,328
  
 
 
See accompanying notes to unaudited condensed consolidated financial statements.
 
 
4
 
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
   
Three Months Ended
March 31,
  
   
2014
    
2013
  
   
(In thousands)
  
   
Net income                                                                                                                      
  
$
135,747
    
$
128,979
  
Other comprehensive income, net of tax:
  
Net unrealized gain on securities available-for-sale, net of tax expense (benefit) of $402 and $(152) for the three months ended March 31, 2014 and 2013, respectively
    
485
      
1,096
  
Foreign currency translation adjustments                                                                                                                   
    
9,333
      
3,327
  
Other comprehensive income                                                                                                                      
    
9,818
      
4,423
  
Total comprehensive income, net of tax                                                                                                                      
  
$
145,565
    
$
133,402
  
Less: Comprehensive loss attributable to non-controlling interest                                                                                                                      
    
(1,583
)
    
—
  
Comprehensive income attributable to Alliance Data Systems Corporation stockholders
  
$
147,148
    
$
133,402
  
 
 
See accompanying notes to unaudited condensed consolidated financial statements.
 
 
5
 
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
   
Three Months Ended
March 31,
  
   
2014
    
2013
  
   
(In thousands)
  
CASH FLOWS FROM OPERATING ACTIVITIES:
  
Net income                                                                                                                      
  
$
135,747
    
$
128,979
  
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
  
Depreciation and amortization                                                                                                                   
    
74,073
      
52,850
  
Deferred income taxes                                                                                                                   
    
25,324
      
14,597
  
Provision for loan loss                                                                                                                   
    
70,582
      
66,648
  
Non-cash stock compensation                                                                                                                   
    
15,624
      
13,024
  
Fair value gain on interest-rate derivatives                                                                                                                   
    
(75
)
    
(6,311
)
Amortization of discount on debt                                                                                                                   
    
8,053
      
22,241
  
Amortization of deferred financing costs                                                                                                                   
    
5,828
      
6,764
  
Change in deferred revenue                                                                                                                      
    
(27,131
) 
    
(34,918
) 
Change in other operating assets and liabilities, net of acquisitions                                                                                                                      
    
37,702
      
17,249
  
Originations of loan receivables held for sale                                                                                                                      
    
(1,114,635
)
    
—
  
Sales of loan receivables held for sale                                                                                                                      
    
1,114,245
      
—
  
Excess tax benefits from stock-based compensation                                                                                                                      
    
(24,805
)
    
(9,596
)
Other                                                                                                                      
    
12,579
      
7,475
  
Net cash provided by operating activities
    
333,111
      
279,002
  
   
CASH FLOWS FROM INVESTING ACTIVITIES:
  
Change in redemption settlement assets                                                                                                                      
    
(77,765
) 
    
(52,863
) 
Change in cash collateral, restricted                                                                                                                      
    
—
      
(1,551
)
Change in restricted cash                                                                                                                      
    
346
      
(463,058
) 
Change in credit card and loan receivables                                                                                                                      
    
384,037
      
371,421
  
Purchase of credit card portfolios                                                                                                                      
    
—
      
(37,061
)
Payment for acquired business, net of cash                                                                                                                      
    
(259,514
)
    
—
  
Capital expenditures                                                                                                                      
    
(43,488
)
    
(28,282
)
Purchases of marketable securities                                                                                                                      
    
(1,657
)
    
(45,720
)
Maturities/sales of marketable securities                                                                                                                      
    
1,691
      
476
  
Other                                                                                                                      
    
(4,000
)
    
(1,250
)
Net cash used in investing activities
    
(350
)
    
(257,888
)
   
CASH FLOWS FROM FINANCING ACTIVITIES:
  
Borrowings under debt agreements                                                                                                                      
    
496,822
      
—
  
Repayments of borrowings                                                                                                                      
    
(484,874
)
    
(6,088
)
Proceeds from convertible note hedge counterparties                                                                                                                      
    
93,380
      
—
  
Settlement of convertible note borrowings                                                                                                                      
    
(115,053
)
    
—
  
Issuances of deposits                                                                                                                      
    
341,308
      
326,881
  
Repayments of deposits                                                                                                                      
    
(483,797
)
    
(378,215
)
Non-recourse borrowings of consolidated securitization entities                                                                                                                      
    
530,000
      
500,004
  
Repayments/maturities of non-recourse borrowings of consolidated securitization entities
    
(950,000
)
    
(547,339
)
Payment of deferred financing costs                                                                                                                      
    
(4,958
)
    
(2,506
)
Excess tax benefits from stock-based compensation                                                                                                                      
    
24,805
      
9,596
  
Proceeds from issuance of common stock                                                                                                                      
    
4,603
      
2,093
  
Purchase of treasury shares                                                                                                                      
    
(44,605
)
    
(51,710
)
Other                                                                                                                      
    
(10
)
    
(6
)
Net cash used in financing activities
    
(592,379
) 
    
(147,290
)
   
Effect of exchange rate changes on cash and cash equivalents
    
(3,562
)
    
(3,027
)
Change in cash and cash equivalents
    
(263,180
) 
    
(129,203
) 
Cash and cash equivalents at beginning of period
    
969,822
      
893,352
  
Cash and cash equivalents at end of period                                                                                                                
  
$
706,642
    
$
764,149
  
   
SUPPLEMENTAL CASH FLOW INFORMATION:
  
Interest paid                                                                                                                      
  
$
40,104
    
$
47,951
  
Income taxes paid, net                                                                                                                      
  
$
17,459
    
$
37,724
  
 
 
See accompanying notes to unaudited condensed consolidated financial statements.
 
 
6
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Basis of Presentation
 
The unaudited condensed consolidated financial statements included herein have been prepared by Alliance Data Systems Corporation (“ADSC” or, including its consolidated subsidiaries and 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, 2013, filed with the SEC on February 28, 2014.
 
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, certain prior period amounts have been reclassified to conform to the current year presentation in accordance with GAAP.
 
Recently Adopted Accounting Standards
 
In July 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists,” which provides guidance on financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss or a tax credit carryforward exists. ASU 2013-11 requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward when settlement in this manner is available under the governing tax law. ASU 2013-11 was effective for interim and annual periods beginning after December 15, 2013 and required prospective application. The adoption of ASU 2013-11 did not have a material impact on the Company’s financial condition, results of operations or cash flows.
 
 
7
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
 
2. EARNINGS PER SHARE
 
The following table sets forth the computation of basic and diluted net income per share for the periods indicated:
 
   
Three Months Ended March 31,
  
   
2014
    
2013
  
   
(In thousands, except
per share amounts)
  
Numerator:
            
Net income attributable to Alliance Data Systems Corporation stockholders
  
$
137,395
    
$
128,979
  
Denominator:
            
Weighted average shares, basic
    
53,033
      
49,762
  
Weighted average effect of dilutive securities:
      
Shares from assumed conversion of convertible senior notes
    
5,734
      
10,133
  
Shares from assumed conversion of convertible note warrants
    
6,771
      
6,854
  
Net effect of dilutive stock options and unvested restricted stock
    
527
      
579
  
Denominator for diluted calculations
    
66,065
      
67,328
  
                 
Net income attributable to Alliance Data Systems Corporation stockholders per share:
                
Basic
  
$
2.59
    
$
2.59
  
Diluted
  
$
2.08
    
$
1.92
  
 
The Company calculates the effect of its convertible senior notes, which can be settled in cash or shares of common stock, on diluted net income per share as if they will be settled in cash as the Company had the intent and has elected to settle the convertible senior notes for cash.
 
Concurrently with the issuance of its convertible senior notes, the Company entered into hedge transactions that are generally expected to offset the potential dilution of the shares from assumed conversion of convertible senior notes.
 
The Company is also party to prepaid forward contracts to purchase 1,857,400 shares of its common stock that are to be delivered over a settlement period in 2014. The number of shares to be delivered under the prepaid forward contracts has reduced weighted-average basic and diluted shares outstanding.
 
 
3. ACQUISITION
 
On January 2, 2014, the Company acquired a 60% ownership interest in BrandLoyalty Group B.V. (“Brand Loyalty”), a Netherlands-based, data-driven loyalty marketer. BrandLoyalty designs, organizes, implements and evaluates innovative and tailor-made loyalty programs for food retailers worldwide. The acquisition expands the Company’s presence across Europe, Asia and Latin America. The results of BrandLoyalty have been included since the date of acquisition and are reflected in the Company’s LoyaltyOne segment. The initial cash consideration was approximately $259.5 million in addition to the assumption of debt. The goodwill resulting from the acquisition is not deductible for tax purposes.
 
The Company also recorded a contingent liability for the earn-out provisions included in the share purchase agreement of approximately $248.7 million, which is included in accrued expenses in the Company’s unaudited condensed consolidated balance sheet. The contingent liability was measured at fair value on the date of purchase and any subsequent changes in the fair value of the liability are recorded through earnings.
 
 
8
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
 
The following table summarizes the allocation of consideration and the respective fair values of the assets acquired and liabilities assumed in the BrandLoyalty acquisition as of the date of purchase:
 
   
As of
January 2, 2014
  
   
(In thousands)
  
Current assets, net of cash acquired
  
$
246,769
  
Deferred tax asset
    
3,509
  
Property and equipment
    
19,719
  
Other non-current assets
    
3,994
  
Intangible assets
    
423,832
  
Goodwill
    
565,015
  
Total assets acquired
    
1,262,838
  
       
Current liabilities
    
146,559
  
Current portion of long-term debt
    
34,180
  
Deferred tax liability
    
105,512
  
Long-term debt (net of current portion)
    
126,323
  
Other liabilities
    
142
  
Total liabilities assumed
    
412,716
  
       
Redeemable non-controlling interest
    
341,907
  
       
Net assets acquired
  
$
508,215
  
 
The Company also has the right to acquire the remaining 40% ownership interest in BrandLoyalty over a four-year period, 10% per year at predetermined valuation multiples. If specified annual earnings targets are met by BrandLoyalty, the Company must acquire the additional 10% interest for the year achieved; otherwise, the sellers have a put option to sell the Company its 10% interest for the respective year. See Note 11, “Redeemable Non-Controlling Interest,” for more information.
 
 
4. CREDIT CARD AND LOAN RECEIVABLES
 
The Company’s credit card and loan receivables are the only portfolio segment or class of financing receivables. Quantitative information about the components of total credit card and loan receivables is presented in the table below:
 
   
March 31,
2014
    
December 31,
2013
  
   
(In thousands)
  
Principal receivables
  
$
7,674,407
    
$
8,166,961
  
Billed and accrued finance charges
    
317,857
      
343,521
  
Other credit card and loan receivables
    
96,534
      
62,400
  
Total credit card and loan receivables
    
8,088,798
      
8,572,882
  
Less credit card receivables – restricted for securitization investors
    
6,486,702
      
7,080,014
  
Other credit card and loan receivables
  
$
1,602,096
    
$
1,492,868
  
 
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 and loan receivables. The allowance for loan loss covers forecasted uncollectible principal as well as unpaid interest and fees. The allowance for loan loss is evaluated monthly for appropriateness.
 
In estimating the allowance for principal loan losses, management utilizes a migration analysis of delinquent and current credit card and loan receivables. Migration analysis is a technique used to estimate the likelihood that a credit card or loan receivable will progress through the various stages of delinquency and to charge-off. The allowance is maintained through an adjustment to the provision for loan loss. Charge-offs of principal amounts, net of recoveries are deducted from the allowance. In estimating the allowance for uncollectible unpaid interest and fees, the Company utilizes historical charge-off trends, analyzing actual charge-offs for the prior three months. The allowance is maintained through an adjustment to finance charges, net. 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, seasonality, payment rates and forecasting uncertainties.

 
9
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
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 and loan 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 and loan receivables, including unpaid interest and fees, associated with customer bankruptcies or death are charged-off at the end of each month subsequent to 60 days after the receipt of notification of the bankruptcy or death, but in any case, not later than the 180-day contractual time frame. The Company records the actual charge-offs for unpaid interest and fees as a reduction to finance charges, net. Actual charge-offs for unpaid interest and fees were $75.6 million and $58.7 million for the three months ended March 31, 2014 and 2013, respectively.
 
In evaluating the allowance for loan loss for both principal and unpaid interest and fees, management also considers factors that may impact loan loss experience, including seasoning, loan volume and amounts, payment rates and forecasting uncertainties. The following table presents the Company’s allowance for loan loss for the periods indicated:
 
   
Three Months Ended March 31,
  
   
2014
    
2013
  
   
(In thousands)
  
Balance at beginning of period
  
$
503,169
    
$
481,958
  
Provision for loan loss
    
70,582
      
66,648
  
Change in estimate for uncollectible unpaid interest and fees
    
5,500
      
—
  
Recoveries
    
38,408
      
30,785
  
Principal charge-offs
    
(135,001
)
    
(108,375
)
Balance at end of period
  
$
482,658
    
$
471,016
  
 
Delinquencies
 
A credit card account is contractually delinquent if the Company does not receive the minimum payment by the specified due date on the cardholder’s statement. It is the Company’s policy to continue to accrue interest and fee income on all credit card accounts beyond 90 days, except in limited circumstances, until the credit card account balance and all related interest and other fees are paid or charged off, typically at 180 days delinquent. When an account becomes delinquent, a message is printed on the credit cardholder’s billing statement requesting payment. After an account becomes 30 days past due, a proprietary collection scoring algorithm automatically scores the risk of the account becoming further delinquent. The collection system then recommends a collection strategy for the past due account based on the collection score and account balance and dictates the contact schedule and collections priority for the account. If the Company is unable to make a collection after exhausting all in-house collection efforts, the Company may engage collection agencies and outside attorneys to continue those efforts.
 
The following table presents the delinquency trends of the Company’s credit card and loan receivables portfolio:
 
   
March 31,
2014
    
% of
Total
    
December 31,
2013
    
% of
Total
  
           
(In thousands, except percentages)
          
Receivables outstanding – principal
  
$
7,674,407
      
100.0
%
  
$
8,166,961
      
100.0
%
Principal receivables balances contractually delinquent:
                                
31 to 60 days
    
95,018
      
1.2
%
    
114,430
      
1.4
%
61 to 90 days
    
68,136
      
0.9
      
74,700
      
0.9
  
91 or more days
    
134,175
      
1.8
      
150,425
      
1.9
  
Total
  
$
297,329
      
3.9
%
  
$
339,555
      
4.2
%

 
10
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
  
Modified Credit Card and Loan Receivables
 
The Company holds certain credit card and loan receivables for which the terms have been modified. The Company’s modified credit card and loan receivables include credit card and loan receivables for which temporary hardship concessions have been granted and credit card and loan receivables in permanent workout programs. These modified credit card and loan receivables include concessions consisting primarily of a reduced minimum payment and an interest rate reduction. The temporary programs’ concessions remain in place for a period no longer than twelve months, while the permanent programs remain in place through the payoff of the credit card and loan receivables if the credit cardholder complies with the terms of the program. These concessions do not include the forgiveness of unpaid principal, but may involve the reversal of certain unpaid interest or fee assessments. In the case of the temporary programs, at the end of the concession period, credit card and loan receivable terms revert to standard rates. These arrangements are automatically terminated if the customer fails to make payments in accordance with the terms of the program, at which time their account reverts back to its original terms.
 
Credit card and loan receivables for which temporary hardship and permanent concessions were granted are both considered troubled debt restructurings and are collectively evaluated for impairment. Modified credit card and loan receivables are evaluated at their present value with impairment measured as the difference between the credit card and loan receivable balance and the discounted present value of cash flows expected to be collected. Consistent with the Company’s measurement of impairment of modified credit card and loan receivables on a pooled basis, the discount rate used for credit card and loan receivables is the average current annual percentage rate the Company applies to non-impaired credit card and loan receivables, which approximates what would have been applied to the pool of modified credit card and loan receivables prior to impairment. In assessing the appropriate allowance for loan loss, these modified credit card and loan receivables are included in the general pool of credit card and loan receivables with the allowance determined under the contingent loss model of Accounting Standards Codification (“ASC”) 450-20, “Loss Contingencies.” If the Company applied accounting under ASC 310-40, “Troubled Debt Restructurings by Creditors,” to the modified credit card and loan receivables in these programs, there would not be a material difference in the allowance for loan loss.
 
The Company had $114.7 million and $118.1 million, respectively, as a recorded investment in impaired credit card and loan receivables with an associated allowance for loan loss of $32.1 million and $33.9 million, respectively, as of March 31, 2014 and December 31, 2013. These modified credit card and loan receivables represented less than 3% of the Company’s total credit card and loan receivables as of March 31, 2014 and December 31, 2013, respectively.
 
The average recorded investment in the impaired credit card receivables was $116.3 million and $117.6 million for the three months ended March 31, 2014 and 2013, respectively.
 
Interest income on these modified credit card and loan receivables is accounted for in the same manner as other accruing credit card and loan receivables. Cash collections on these modified credit card and loan receivables are allocated according to the same payment hierarchy methodology applied to credit card and loan receivables that are not in such programs. The Company recognized $3.2 million for each of the three months ended March 31, 2014 and 2013, respectively, in interest income associated with modified credit card and loan receivables during the period that such credit card and loan receivables were impaired.
 
The following tables provide information on credit card and loan receivables that are considered troubled debt restructurings as described above, which entered into a modification program during the specified periods:
 
 
Three Months Ended March 31, 2014
  
 
Number of Restructurings
  
Pre-modification
Outstanding
Balance
  
Post-modification
Outstanding
Balance
  
 
(Dollars in thousands)
  
Troubled debt restructurings – credit card and loan receivables
   36,552   $ 35,786   $ 35,755  
                   
                   
 
Three Months Ended March 31, 2013
  
 
Number of Restructurings
  
Pre-modification
Outstanding
Balance
  
Post-modification
Outstanding
Balance
  
 
(Dollars in thousands)
  
Troubled debt restructurings – credit card and loan receivables
   37,795   $ 33,966   $ 33,942  
                   
 
 
11
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
 
The tables below summarize troubled debt restructurings that have defaulted in the specified periods where the default occurred within 12 months of their modification date:
 
   
Three Months Ended
March 31, 2014
  
   
Number of Restructurings
  
Outstanding Balance
  
   
(Dollars in thousands)
  
Troubled debt restructurings that subsequently defaulted – credit card and loan receivables
    
16,728
  
$
16,141
  
                       
                       
   
Three Months Ended
March 31, 2013
  
   
Number of Restructurings
  
Outstanding Balance
  
   
(Dollars in thousands)
  
Troubled debt restructurings that subsequently defaulted – credit card and loan receivables
    
15,495
  
$
14,483
  
                       
 
Age of Credit Card and Loan Receivable Accounts
 
The following tables set forth, as of March 31, 2014 and 2013, the number of active credit card and loan accounts with balances and the related principal balances outstanding, based upon the age of the active credit card and loan accounts from origination:
 
   
March 31, 2014
  
Age of Accounts Since Origination
  
Number of Active Accounts with Balances
    
Percentage of Active Accounts with Balances
    
Principal Receivables Outstanding
    
Percentage of Principal Receivables Outstanding
  
   
(In thousands, except percentages)
  
0-12 Months
    
4,467
      
27.6
%
  
$
1,895,642
      
24.7
%
13-24 Months
    
2,325
      
14.4
      
1,049,930
      
13.7
  
25-36 Months
    
1,604
      
9.9
      
781,339
      
10.2
  
37-48 Months
    
1,163
      
7.2
      
588,152
      
7.6
  
49-60 Months
    
962
      
5.9
      
514,670
      
6.7
  
Over 60 Months
    
5,656
      
35.0
      
2,844,674
      
37.1
  
Total
    
16,177
      
100.0
%
  
$
7,674,407
      
100.0
%
 
 
   
March 31, 2013
  
Age of Accounts Since Origination
  
Number of Active Accounts with Balances
    
Percentage of Active Accounts with Balances
    
Principal Receivables Outstanding
    
Percentage of Principal Receivables Outstanding
  
   
(In thousands, except percentages)
  
0-12 Months
    
3,919
      
25.8
%
  
$
1,489,425
      
22.3
%
13-24 Months
    
2,013
      
13.3
      
823,748
      
12.3
  
25-36 Months
    
1,415
      
9.3
      
634,826
      
9.5
  
37-48 Months
    
1,161
      
7.7
      
576,524
      
8.6
  
49-60 Months
    
920
      
6.1
      
467,542
      
7.0
  
Over 60 Months
    
5,726
      
37.8
      
2,688,747
      
40.3
  
Total
    
15,154
      
100.0
%
  
$
6,680,812
      
100.0
%
 
 
12
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
 
Credit Quality
 
The Company uses proprietary scoring models developed specifically for the purpose of monitoring the Company’s obligor credit quality. The proprietary scoring models are used as a tool in the underwriting process and for making credit decisions. The proprietary scoring models are based on historical data and require various assumptions about future performance. Information regarding customer performance is factored into these proprietary scoring models to determine the probability of an account becoming 90 or more days past due at any time within the next 12 months. Obligor credit quality is monitored at least monthly during the life of an account. The following table reflects composition of the Company’s credit card and loan receivables by obligor credit quality as of March 31, 2014 and 2013:
 
   
March 31, 2014
    
March 31, 2013
  
Probability of an Account Becoming 90 or More Days Past
Due or Becoming Charged-off (within the next 12 months)
  
Total Principal Receivables Outstanding
    
Percentage of Principal Receivables Outstanding
    
Total Principal Receivables Outstanding
    
Percentage of Principal Receivables Outstanding
  
           
(In thousands, except percentages)
          
No Score
  
$
151,316
      
2.0
%
  
$
182,777
      
2.7
%
27.1% and higher
    
375,904
      
4.9
      
302,099
      
4.5
  
17.1% - 27.0%
    
714,925
      
9.3
      
615,789
      
9.2
  
12.6% - 17.0%
    
843,358
      
11.0
      
725,147
      
10.9
  
3.7% - 12.5%
    
3,117,732
      
40.6
      
2,662,963
      
39.9
  
1.9% - 3.6%
    
1,584,841
      
20.7
      
1,414,222
      
21.2
  
Lower than 1.9%
    
886,331
      
11.5
      
777,815
      
11.6
  
Total
  
$
7,674,407
      
100.0
%
  
$
6,680,812
      
100.0
%
 
Transfer of Financial Assets
 
We originate loans under an agreement with one of our clients and after origination, these loan receivables are sold to the client at par value plus accrued interest. These transfers qualify for sale treatment as they meet the conditions established in ASC 860-10, “Transfers and Servicing.” Following the sale, the client owns the loan receivables, bears the risk of loss in the event of loan defaults and is responsible for all servicing functions related to the receivables. The loan receivables originated by the Company that have not yet been sold to the client were $62.5 million and $62.1 million at March 31, 2014 and December 31, 2013, respectively, and are included in loan receivables held for sale in the Company’s unaudited condensed consolidated balance sheets and carried at the lower of cost or fair value. The carrying value of these loan receivables approximates fair value due to the short duration between origination and sale. Purchases and sales of these loan receivables held for sale are reflected as operating activities in the Company’s unaudited condensed consolidated statements of cash flows.
 
Upon the client’s purchase of the originated loan receivables, the Company is obligated to purchase a participating interest in a pool of loan receivables that includes the loan receivables originated by the Company. Such interest participates on a pro rata basis in the cash flows of the underlying pool of loan receivables, including principal repayments, finance charges, losses, recoveries, and servicing costs. The Company bears the risk of loss related to its participation interest in this pool.
 
During the three months ended March 31, 2014, the Company purchased $54.6 million of loan receivables under these agreements. The outstanding balance of these loan receivables was $85.5 million and $61.6 million as of March 31, 2014 and December 31, 2013, respectively, and was included in other credit card and loan receivables in the Company’s unaudited condensed consolidated balance sheets.
 
Securitized Credit Card Receivables
 
The Company regularly securitizes its credit card receivables through its credit card securitization trusts, consisting of World Financial Network Credit Card Master Trust, World Financial Network Credit Card Master Note Trust (“Master Trust I”) and World Financial Network Credit Card Master Trust III (“Master Trust III”) (collectively, the “WFN Trusts”), and World Financial Capital Credit Card Master Note Trust (the “WFC Trust”). The Company continues to own and service the accounts that generate credit card receivables held by the WFN Trusts and the WFC Trust. In its capacity as a servicer, each of the respective banks earns a fee from the WFN Trusts and the WFC Trust to service and administer the credit card receivables, collect payments and charge-off uncollectible receivables. These fees are eliminated and therefore are not reflected in the unaudited condensed consolidated statements of income for the three months ended March 31, 2014 and 2013.
 
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 non-recourse secured borrowings and other liabilities for which creditors or beneficial interest holders do not have recourse to the general credit of the Company.
 
 
13
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
 
The tables below present quantitative information about the components of total securitized credit card receivables, delinquencies and net charge-offs:
 
   
March 31,
2014
    
December 31,
2013
  
   
(In thousands)
  
Total credit card receivables – restricted for securitization investors
  
$
6,486,702
    
$
7,080,014
  
Principal amount of credit card receivables – restricted for securitization investors, 90 days or more past due
  
$
115,096
    
$
131,659
  
 
 
   
Three Months Ended March 31,
  
   
2014
    
2013
  
   
(In thousands)
  
Net charge-offs of securitized principal
  
$
85,714
    
$
74,094
  
 
 
5. INVENTORIES
 
Inventories of $226.1 million and $14.6 million at March 31, 2014 and December 31, 2013, respectively, consist of finished goods primarily to be utilized as rewards in the Company’s loyalty programs and are included in other current assets in the Company’s unaudited condensed consolidated balance sheets. The increase in inventories from December 31, 2013 to March 31, 2014 is attributable to the BrandLoyalty acquisition.
 
Inventories are stated at lower of cost or market and valued primarily on a first-in-first-out basis. The Company records valuation adjustments to its inventories if the cost of inventory exceeds the amount it expects to realize from the ultimate sale or disposal of the inventory. These estimates are based on management’s judgment regarding future market conditions and analysis of historical experience.
 
 
6. OTHER INVESTMENTS
 
Other investments consist of restricted cash and marketable securities and are included in other current assets and other assets in the unaudited condensed consolidated balance sheets. As of March 31, 2014 and December 31, 2013, other investments are comprised as follows:
 
   
March 31, 2014
    
December 31, 2013
  
   
Amortized
Cost
    
Unrealized
Gains
    
Unrealized
Losses
    
Fair
Value
    
Amortized
Cost
    
Unrealized
Gains
    
Unrealized
Losses
    
Fair
Value
  
   
(In thousands)
  
Restricted cash
  
$
27,770
    
$
—
    
$
—
    
$
27,770
    
$
25,988
    
$
—
    
$
—
    
$
25,988
  
Marketable securities
    
77,317
      
191
      
(3,255
)
    
74,253
      
77,351
      
62
      
(4,180
)
    
73,233
  
Total
  
$
105,087
    
$
191
    
$
(3,255
)
  
$
102,023
    
$
103,339
    
$
62
    
$
(4,180
)
  
$
99,221
  
 
The following tables show the unrealized losses and fair value for those investments that were in an unrealized loss position as of March 31, 2014 and December 31, 2013, aggregated by investment category and the length of time that individual securities have been in a continuous loss position:
 
   
March 31, 2014
  
   
Less than 12 months
    
12 Months or Greater
    
Total
  
   
Fair
Value
    
Unrealized
Losses
    
Fair
Value
    
Unrealized
Losses
    
Fair
Value
    
Unrealized
Losses
  
   
(In thousands)
  
Marketable securities
   $ 27,607     $ (1,239 )   $ 34,176     $ (2,016 )   $ 61,783     $ (3,255 )
 
 
   
December 31, 2013
  
   
Less than 12 months
    
12 Months or Greater
    
Total
  
   
Fair
Value
    
Unrealized
Losses
    
Fair
Value
    
Unrealized
Losses
    
Fair
Value
    
Unrealized
Losses
  
   
(In thousands)
  
Marketable securities
   $ 39,954     $ (2,206 )   $ 25,785     $ (1,974 )   $ 65,739     $ (4,180 )
 
 
14
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
 
The amortized cost and estimated fair value of the marketable securities at March 31, 2014 by contractual maturity are as follows:
 
   
Amortized
Cost
    
Fair
Value
  
   
(In thousands)
  
Due in one year or less
  
$
6,645
    
$
6,539
  
Due after five years through ten years
    
4,455
      
4,569
  
Due after ten years
    
66,217
      
63,145
  
Total
  
$
77,317
    
$
74,253
  
 
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. Realized gains and losses from the sale of investment securities were not material.
 
As of March 31, 2014, the Company does not consider the investments to be other-than-temporarily impaired.
 
 
7. REDEMPTION SETTLEMENT ASSETS
 
Redemption settlement assets consist of cash and cash equivalents and securities available-for-sale and are designated for settling redemptions by collectors of the AIR MILES® Reward Program in Canada under certain contractual relationships with sponsors of the AIR MILES Reward Program. These assets are primarily denominated in Canadian dollars. There were no realized gains or losses from the sale of investment securities for the three months ended March 31, 2014 and 2013, respectively. The principal components of redemption settlement assets, which are carried at fair value, are as follows:
 
   
March 31, 2014
    
December 31, 2013
  
   
Amortized
Cost
    
Unrealized
Gains
    
Unrealized
Losses
    
Fair
Value
    
Amortized
Cost
    
Unrealized
Gains
    
Unrealized
Losses
    
Fair
Value
  
   
(In thousands)
  
Cash and cash equivalents
  
$
157,610
    
$
—
    
$
—
    
$
157,610
    
$
73,984
    
$
—
    
$
—
    
$
73,984
  
Government bonds
    
4,724
      
—
      
(85
)
    
4,639
      
—
      
—
      
—
      
—
  
Corporate bonds
    
399,624
      
6,806
      
(115
)
    
406,315
      
429,592
      
7,083
      
(310
)
    
436,365
  
Total
  
$
561,958
    
$
6,806
    
$
(200
)
  
$
568,564
    
$
503,576
    
$
7,083
    
$
(310
)
  
$
510,349
  
 
The following tables show the unrealized losses and fair value for those investments that were in an unrealized loss position as of March 31, 2014 and December 31, 2013, aggregated by investment category and the length of time that individual securities have been in a continuous loss position:
 
   
March 31, 2014
  
   
Less than 12 months
    
12 Months or Greater
    
Total
  
   
Fair
Value
    
Unrealized
Losses
    
Fair
Value
    
Unrealized
Losses
    
Fair
Value
    
Unrealized
Losses
  
   
(In thousands)
  
Government bonds
   $ 4,639     $ (85 )   $ —     $ —     $ 4,639     $ (85 )
Corporate bonds
     9,198       (113 )     5,031       (2 )     14,229       (115 )
Total
   $ 13,837     $ (198 )   $ 5,031     $ (2 )   $ 18,868     $ (200 )
 
 
   
December 31, 2013
  
   
Less than 12 months
    
12 Months or Greater
    
Total
  
   
Fair
Value
    
Unrealized
Losses
    
Fair
Value
    
Unrealized
Losses
    
Fair
Value
    
Unrealized
Losses
  
   
(In thousands)
  
Corporate bonds
   $ 80,493     $ (310 )   $ —     $ —     $ 80,493     $ (310 )

 
15
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
 
 
Market values were determined for each individual security in the investment portfolio. When evaluating the investments for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the security’s issuer, and the Company’s intent to sell the security and whether it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis. The Company typically invests in highly-rated securities with low probabilities of default and has the ability to hold the investments until maturity. As of March 31, 2014, the Company does not consider the investments to be other-than-temporarily impaired.
 
The amortized cost and estimated fair value of the securities at March 31, 2014 by contractual maturity are as follows:
 
   
Amortized
Cost
    
Fair
Value
  
   
(In thousands)
  
Due in one year or less
  
$
126,542
    
$
127,624
  
Due after one year through five years
    
277,806
      
283,330
  
Total
  
$
404,348
    
$
410,954
  
 
 
8. INTANGIBLE ASSETS AND GOODWILL
 
Intangible Assets
 
Intangible assets consist of the following:
 
   
March 31, 2014
    
   
Gross
Assets
    
Accumulated
Amortization
    
Net
  
Amortization Life and Method
   
(In thousands)
    
Finite Lived Assets
                    
Customer contracts and lists
   $ 839,567     $ (217,363 )   $ 622,204  
3-12 years—straight line
Premium on purchased credit card portfolios
     176,088       (85,984 )     90,104  
5-10 years—straight line, accelerated
Customer database
     161,700       (127,111 )     34,589  
4-10 years—straight line
Collector database
     63,351       (58,575 )     4,776  
30 years—15% declining balance
Tradenames
     86,113       (19,183 )     66,930  
3-15 years—straight line
Purchased data lists
     13,784       (8,265 )     5,519  
1-5 years—straight line, accelerated
Favorable lease
     3,291       (462 )     2,829  
10 years—straight line
Noncompete agreements
     1,300       (542 )     758  
3 years—straight line
    $ 1,345,194     $ (517,485 )   $ 827,709    
Indefinite Lived Assets
                          
Tradenames
     12,350       —       12,350  
Indefinite life
Total intangible assets
   $ 1,357,544     $ (517,485 )   $ 840,059    
 
 
   
December 31, 2013
    
   
Gross
Assets
    
Accumulated
Amortization
    
Net
  
Amortization Life and Method
   
(In thousands)
    
Finite Lived Assets
                    
Customer contracts and lists
   $ 440,200     $ (187,350 )   $ 252,850  
3-12 years—straight line
Premium on purchased credit card portfolios
     216,041       (118,006 )     98,035  
5-10 years—straight line, accelerated
Customer database
     161,700       (122,230 )     39,470  
4-10 years—straight line
Collector database
     65,895       (60,711 )     5,184  
30 years—15% declining balance
Tradenames
     58,567       (15,443 )     43,124  
4-15 years—straight line
Purchased data lists
     17,567       (11,959 )     5,608  
1-5 years—straight line, accelerated
Favorable lease
     3,291       (375 )     2,916  
10 years—straight line
Noncompete agreements
     1,300       (433 )     867  
3 years—straight line
    $ 964,561     $ (516,507 )   $ 448,054    
Indefinite Lived Assets
                          
Tradenames
     12,350       —       12,350  
Indefinite life
Total intangible assets
   $ 976,911     $ (516,507 )   $ 460,404    
 
With the BrandLoyalty acquisition on January 2, 2014, the Company acquired $423.8 million of intangible assets, consisting of $396.5 million of customer contracts and a $27.3 million tradename, which are being amortized over a weighted average life of 7.0 years and 3.0 years, respectively.

 
16
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
 
Goodwill
 
The changes in the carrying amount of goodwill for the three months ended March 31, 2014 are as follows:
 
   
LoyaltyOne®
    
Epsilon®
    
Private Label
Services and Credit
    
Corporate/
Other
    
Total
  
   
(In thousands)
  
December 31, 2013
  
$
232,449
    
$
1,241,522
    
$
261,732
    
$
—
    
$
1,735,703
  
Goodwill acquired during the year
    
565,015
      
—
      
—
      
—
      
565,015
  
Effects of foreign currency translation
    
(4,432
)
    
63
      
—
      
—
      
(4,369
)
March 31, 2014
  
$
793,032
    
$
1,241,585
    
$
261,732
    
$
—
    
$
2,296,349
  
 
See Note 3, “Acquisition,” for more information regarding the BrandLoyalty acquisition.
 
 
9. DEBT
 
Debt consists of the following:
 
Description
  
March 31,
2014
    
December 31,
2013
  
Maturity
  
Interest Rate
   
(Dollars in thousands)
        
                   
Long-term and other debt:
                  
2013 credit facility
  
$
370,000
    
$
336,000
  
July 2018
  
(1)
2013 term loan
    
1,226,563
      
1,234,688
  
July 2018
  
(1)
BrandLoyalty credit facility
    
147,674
      
—
  
December 2015
  
(2)
Convertible senior notes due 2014
    
319,261
      
333,082
  
May 2014
  
4.75%
Senior notes due 2017
    
396,712
      
396,511
  
December 2017
  
5.250%
Senior notes due 2020
    
500,000
      
500,000
  
April 2020
  
6.375%
Total long-term and other debt
    
2,960,210
      
2,800,281
        
Less: current portion
    
(384,940
)
    
(364,489
)
      
Long-term portion
  
$
2,575,270
    
$
2,435,792
        
                   
Deposits:
                  
Certificates of deposit
  
$
2,267,906
    
$
2,486,533
  
Various – April 2014 – January 2021
  
0.20% to 3.30%
Money market deposits
    
405,965
      
329,828
  
On demand
  
0.01% to 0.12%
Total deposits
    
2,673,871
      
2,816,361
        
Less: current portion
    
(1,381,079
)
    
(1,544,059
)
      
Long-term portion
  
$
1,292,792
    
$
1,272,302
        
                   
Non-recourse borrowings of consolidated securitization entities:
                      
Fixed rate asset-backed term note securities
  
$
3,001,916
    
$
3,001,916
  
Various – October 2014 – June 2019
  
0.91% to 6.75%
Floating rate asset-backed term note securities
    
450,000
      
—
  
February 2016
  
(3)
Conduit asset-backed securities
    
720,000
      
1,590,000
  
Various – May 2015 – February 2016
  
(4)
Total non-recourse borrowings of consolidated securitization entities
    
4,171,916
      
4,591,916
        
Less: current portion
    
(250,000
)
    
(1,025,000
)
      
Long-term portion
  
$
3,921,916
    
$
3,566,916
        
                         
 
(1)
The interest rate is based upon the London Interbank Offered Rate (“LIBOR”) plus an applicable margin. At March 31, 2014, the weighted average interest rate was 1.91% for both the 2013 Credit Facility and 2013 Term Loan.
 
(2)
The interest rate is based upon the Euro Interbank Offered Rate (“EURIBOR”) plus an applicable margin. At March 31, 2014, the weighted average interest rate was 2.79%.
 
(3)
The interest rate is based upon LIBOR plus an applicable margin. At March 31, 2014, the interest rate was 0.57%.
 
(4)
The interest rate is based upon LIBOR or the asset-backed commercial paper costs of each individual conduit provider plus an applicable margin.  At March 31, 2014, the interest rates ranged from 1.00% to 1.69%.
 
Credit Agreement
 
The Company, as borrower, and ADS Alliance Data Systems, Inc., ADS Foreign Holdings, Inc., Alliance Data Foreign Holdings, Inc., Epsilon Data Management, LLC, Comenity LLC, Comenity Servicing LLC and Aspen Marketing Services, LLC, as guarantors, are party to a credit agreement that provides for a $1.25 billion term loan (the “2013 Term Loan”) with certain principal repayments and a $1.25 billion revolving line of credit (the “2013 Credit Facility”).
 
Total availability under the 2013 Credit Facility at March 31, 2014 was $880.0 million.

 
17
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
 
BrandLoyalty Credit Agreement
 
As part of the acquisition of BrandLoyalty, the Company assumed the debt outstanding under BrandLoyalty’s Amended and Restated Senior Facilities Agreement, as amended (the “BrandLoyalty Credit Agreement”). The BrandLoyalty Credit Agreement is secured by the accounts receivable, inventory, fixed assets, bank accounts and shares of BrandLoyalty Group B.V. and certain of its subsidiaries. The BrandLoyalty Credit Agreement consists of term loans of €63.0 million and a revolving line of credit of €87.0 million, both of which are scheduled to mature on December 31, 2015. The term loans provide for quarterly principal payments of €6.25 million through September 2015, with the remaining amount payable upon maturity. As of March 31, 2014, amounts outstanding under the term loans and revolving line of credit were €50.5 million and €56.7 million ($69.6 million and $78.1 million), respectively.
 
All advances under the BrandLoyalty Credit Agreement are denominated in Euros. The interest rate fluctuates and is equal to EURIBOR, as defined in the BrandLoyalty Credit Agreement, plus an applicable margin based on BrandLoyalty’s senior net leverage ratio. The BrandLoyalty Credit Agreement contains financial covenants, including a senior net leverage ratio and a minimum annual EBITDA, as well as usual and customary negative covenants and customary events of default.
 
Convertible Senior Notes
 
In June 2009, the Company issued $345.0 million of convertible senior notes scheduled to mature on May 15, 2014 (the “Convertible Senior Notes due 2014”). Through March 31, 2014, $21.7 million of the Convertible Senior Notes due 2014 were surrendered for conversion and were settled in cash. The table below summarizes the carrying value of the components of the convertible senior notes:
 
   
March 31,
2014
    
December 31,
2013
  
   
(In millions)
  
Carrying amount of equity component
  
$
115.9
    
$
115.9
  
                 
Principal amount of liability component
  
$
323.3
    
$
345.0
  
Unamortized discount
    
(4.0
)
    
(11.9
)
Net carrying value of liability component
  
$
319.3
    
$
333.1
  
                 
If-converted value of common stock
  
$
1,851.8
    
$
1,906.9
  
 
The discount on the liability component will be amortized as interest expense over the remaining life of the convertible senior notes which, at March 31, 2014, is a period of 0.1 years.
 
Interest expense on the convertible senior notes recognized in the Company’s unaudited condensed consolidated statements of income for the three months ended March 31, 2014 and 2013 is as follows:
 
   
Three Months Ended March 31,
  
   
2014
    
2013
  
   
(Dollars in thousands)
  
Interest expense calculated on contractual interest rate
  
$
3,710
    
$
7,528
  
Amortization of discount on liability component
    
7,852
      
22,050
  
Total interest expense on convertible senior notes
  
$
11,562
    
$
29,578
  
                 
Effective interest rate (annualized)
    
14.2
%
    
11.0
%
 
In the first quarter of 2014, the Company net settled the final 5.1 million of warrants associated with the convertible senior notes that matured on August 1, 2013 that were exercisable through February 25, 2014 by issuing 2.9 million shares of its common stock.

 
18
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
 
Senior Notes Due 2017
 
In November 2012, the Company issued and sold $400.0 million aggregate principal amount of 5.250% senior notes due December 1, 2017 (the “Senior Notes due 2017”) at an issue price of 98.912% of the aggregate principal amount. The unamortized discount was $3.3 million and $3.5 million at March 31, 2014 and December 31, 2013, respectively. The discount is being amortized using the effective interest method over the remaining life of the Senior Notes due 2017 which, at March 31, 2014, is a period of 3.7 years at an effective annual interest rate of 5.5%.
 
Non-Recourse Borrowings of Consolidated Securitization Entities
 
Asset-Backed Term Notes
 
In February 2014, Master Trust I issued $625.0 million of asset-backed term securities, $175.0 million of which was retained by the Company and eliminated from the unaudited condensed consolidated financial statements. These securities mature in February 2016 and have a variable interest rate equal to LIBOR plus a margin of 0.38%.
 
Conduit Facilities
 
The Company has access to committed undrawn capacity through three conduit facilities to support the funding of its credit card receivables through Master Trust I, Master Trust III and the WFC Trust.
 
In February 2014, Master Trust I reduced its capacity under its conduit facility from $1.2 billion to $800.0 million. In February 2014, Master Trust I subsequently renewed its 2009-VFN conduit facility, extending the maturity to February 29, 2016, with a total capacity of $700.0 million.
 
As of March 31, 2014, total capacity under the conduit facilities was $1.6 billion, of which $720.0 million had been drawn and was included in non-recourse borrowings of consolidated securitization entities in the unaudited condensed consolidated balance sheets.
 
Derivative Instruments
 
As part of its interest rate risk management program, the Company may enter into derivative contracts with institutions that are established dealers to manage its exposure to changes in interest rates for certain obligations. The Company was not a party to any derivative instruments as of December 31, 2013.With the BrandLoyalty acquisition on January 2, 2014, the Company assumed certain derivative instruments.
 
These interest rate derivative instruments involve the receipt of variable rate amounts from counterparties in exchange for the Company making fixed rate payments over the life of the agreement without the exchange of the underlying notional amount. These interest rate derivative instruments are not designated as hedges. Such instruments are not speculative and are used to manage interest rate risk, but do not meet the specific hedge accounting requirements of ASC 815, “Derivatives and Hedging.”
 
At March 31, 2014 the notional amount of the Company’s outstanding interest rate derivatives was €63.4 million ($87.3 million), with a weighted average years to maturity of 1.2 years.
 
The fair value of the Company’s outstanding interest rate derivatives at March 31, 2014 was $0.5 million, of which $0.3 million was included in other current liabilities and $0.2 million was included in other liabilities in the unaudited condensed consolidated balance sheets.
 
During the three months ended March 31, 2014, gains on derivative instruments of $0.1 million were recognized in interest expense on long-term and other debt, net within the unaudited condensed consolidated statements of income. During the three months ended March 31, 2013, gains on derivative instruments of $6.3 million were recognized in securitization funding costs within the unaudited condensed consolidated statements of income.
 
The Company limits its exposure on derivatives by entering into contracts with institutions that are established dealers who maintain certain minimum credit criteria established by the Company. At March 31, 2014, the Company does not maintain any derivative instruments subject to master agreements that would require the Company to post collateral or that contain any credit-risk related contingent features.
 
 
19
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
 
10. DEFERRED REVENUE
 
The AIR MILES Reward Program collects fees from its sponsors based on the number of AIR MILES reward miles issued and, in limited circumstances, the number of AIR MILES reward miles redeemed. Because management has determined that the earnings process is not complete at the time an AIR MILES reward mile is issued, the recognition of redemption and service revenue is deferred.
 
A reconciliation of deferred revenue for the AIR MILES Reward Program is as follows:
 
   
Deferred Revenue
  
   
Service
    
Redemption
    
Total
  
   
(In thousands)
  
December 31, 2013
  
$
346,631
    
$
790,555
    
$
1,137,186
  
Cash proceeds
    
42,175
      
104,764
      
146,939
  
Revenue recognized
    
(49,795
)
    
(124,139
)
    
(173,934
)
Other
    
—
 
    
(149
)
    
(149
)
Effects of foreign currency translation
    
(13,360
)
    
(30,451
)
    
(43,811
)
March 31, 2014
  
$
325,651
    
$
740,580
    
$
1,066,231
  
Amounts recognized in the unaudited condensed consolidated balance sheets:
                        
Current liabilities
  
$
167,136
    
$
740,580
    
$
907,716
  
Non-current liabilities
  
$
158,515
    
$
—
    
$
158,515
  
 
 
11. REDEEMABLE NON-CONTROLLING INTEREST
 
On January 2, 2014, the Company acquired a 60% ownership interest in BrandLoyalty. The remaining 40% interest held by minority interest shareholders is considered a redeemable non-controlling interest. The Company has the right to acquire the remaining 40% ownership interest in BrandLoyalty over a four-year period, 10% per year at predetermined valuation multiples. If specified annual earnings targets are met by BrandLoyalty, the Company must acquire the additional 10% interest for the year achieved; otherwise, the sellers have a put option to sell the Company its 10% interest for the respective year. The Company recognized a redeemable non-controlling interest in the amount of $341.9 million, which was measured at fair value at the acquisition date. A reconciliation of the changes in the redeemable non-controlling interest is as follows:
 
   
Three Months Ended
March 31, 2014
  
   
(In thousands)
  
Balance at January 2, 2014
  
$
341,907
  
Net loss attributable to non-controlling interest
    
(1,648
) 
Other comprehensive income attributable to non-controlling interest
    
65
  
Foreign currency translation adjustments
    
2,473
  
Balance at March 31, 2014
  
$
342,797
  
 
 
12. STOCKHOLDERS’ EQUITY
 
Stock Repurchase Program
 
On December 5, 2013, the Company’s Board of Directors authorized a stock repurchase program to acquire up to $400.0 million of our outstanding common stock from January 1, 2014 through December 31, 2014, subject to any restrictions pursuant to the terms of the Company’s credit agreements, indentures, applicable securities laws or otherwise.
 
For the three months ended March 31, 2014, the Company acquired a total of 201,445 shares of its common stock for $48.8 million, of which $4.2 million had not settled as of March 31, 2014. As of March 31, 2014, the Company had $351.2 million available under the stock repurchase program.
 
 
20
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
 
Stock Compensation Expense
 
Total stock-based compensation expense recognized in the Company’s unaudited condensed consolidated statements of income for the three months ended March 31, 2014 and 2013 is as follows:
 
   
Three Months Ended March 31,
  
   
2014
    
2013
  
   
(In thousands)
  
Cost of operations                                                                                             
  
$
10,982
    
$
8,942
  
General and administrative                                                                                             
    
4,642
      
4,082
  
Total
  
$
15,624
    
$
13,024
  
 
During the three months ended March 31, 2014, the Company awarded 174,590 performance-based restricted stock units with a weighted average grant date fair value per share of $283.93 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, 2014 to December 31, 2014 met certain pre-defined vesting criteria that permit a range from 50% to 150% of such performance-based restricted stock units to vest. Upon such determination, the restrictions will lapse with respect to 33% of the award on February 18, 2015, an additional 33% of the award on February 18, 2016 and the final 34% of the award on February 21, 2017, provided that the participant is employed by the Company on each such vesting date.
 
During the three months ended March 31, 2014, the Company awarded 48,634 service-based restricted stock units with a weighted average grant date fair value per share of $283.10 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.
 
 
13. ACCUMULATED OTHER COMPREHENSIVE INCOME
 
The changes in each component of accumulated comprehensive income (loss), net of tax effects, are as follows:
 
 
Net
Unrealized
Gains (Losses)
on Securities
    
Foreign Currency Translation
Adjustments (1)
    
Accumulated
Other
Comprehensive
Income (Loss)
  
 
(In thousands)
  
Balance as of December 31, 2013
 $ 4,189     $ (22,416 )   $ (18,227 )
Changes in other comprehensive income
   485       9,333       9,818  
Balance as of March 31, 2014
 $ 4,674     $ (13,083 )   $ (8,409 )
 
There were no reclassifications out of accumulated other comprehensive income (loss) into net income for the three months ended March 31, 2014.
 
 
Net
Unrealized
Gains (Losses)
on Securities
    
Foreign Currency Translation
Adjustments (1)
    
Accumulated
Other
Comprehensive
Income (Loss)
  
 
(In thousands)
  
Balance as of December 31, 2012
 $ 10,321     $ (32,182 )   $ (21,861 )
Changes in other comprehensive income (loss)
   1,096       3,327       4,423  
Balance as of March 31, 2013
 $ 11,417     $ (28,855 )   $ (17,438 )
                           
 
(1)
Primarily related to the impact of changes in the Canadian dollar and Euro exchange rates for the three months ended March 31, 2014 and to the impact of changes in the Canadian dollar exchange rate for the three months ended March 31, 2013.
 
A de minimis amount was reclassified out of accumulated other comprehensive income (loss) into net income for the three months ended March 31, 2013.
 
 
21
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)