Edgar Filing: ALLIANCE DATA SYSTEMS CORP

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, 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 July 30, 2014, 55,528,310 shares of common stock were outstanding.

ALLIANCE DATA SYSTEMS CORPORATION

INDEX

		Page Number
Part I: FINANCIAL INFORMATION
Item 1.	Financial Statements (unaudited)
	Condensed Consolidated Balance Sheets as of June 30, 2014 and December 31, 2013	3
	Condensed Consolidated Statements of Income for the three and six months ended June 30, 2014 and 2013	4
	Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2014 and 2013	5
	Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and 2013	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	31
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	45
Item 4.	Controls and Procedures	45

Part II: OTHER INFORMATION

Item 1.	Legal Proceedings	47
Item 1A.	Risk Factors	47
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	47
Item 3.	Defaults Upon Senior Securities	47
Item 4.	Mine Safety Disclosures	47
Item 5.	Other Information	47
Item 6.	Exhibits	48
SIGNATURES		49

Index

PART I

Item 1.

Financial Statements.

ALLIANCE DATA SYSTEMS CORPORATION

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

	June 30, 2014			December 31, 2013
	(In thousands, except per share amounts)
ASSETS
Cash and cash equivalents	$	631,167		$	969,822
Trade receivables, less allowance for doubtful accounts ($3,868 and $2,262 at June 30, 2014 and December 31, 2013, respectively)		394,681			394,822
Credit card and loan receivables:
Credit card receivables – restricted for securitization investors		6,737,440			7,080,014
Other credit card and loan receivables		1,796,454			1,492,868
Total credit card and loan receivables		8,533,894			8,572,882
Allowance for loan loss		(483,580	)		(503,169	)
Credit card and loan receivables, net		8,050,314			8,069,713
Loan receivables held for sale		63,425			62,082
Deferred tax asset, net		196,145			216,195
Other current assets		444,042			177,859
Redemption settlement assets, restricted		565,158			510,349
Total current assets		10,344,932			10,400,842
Property and equipment, net		337,151			299,188
Deferred tax asset, net		2,185			2,454
Cash collateral, restricted		34,710			34,124
Intangible assets, net		791,186			460,404
Goodwill		2,301,305			1,735,703
Other non-current assets		403,429			311,542
Total assets	$	14,214,898		$	13,244,257
LIABILITIES AND EQUITY
Accounts payable	$	320,678		$	210,019
Accrued expenses		506,231			262,307
Deposits		1,752,641			1,544,059
Non-recourse borrowings of consolidated securitization entities		643,750			1,025,000
Current debt		65,480			364,489
Other current liabilities		186,734			140,186
Deferred revenue		923,122			966,438
Deferred tax liability, net		298			—
Total current liabilities		4,398,934			4,512,498
Deferred revenue		166,707			170,748
Deferred tax liability, net		371,604			275,757
Deposits		1,257,384			1,272,302
Non-recourse borrowings of consolidated securitization entities		3,668,166			3,566,916
Long-term and other debt		2,895,933			2,435,792
Other liabilities		166,162			154,483
Total liabilities		12,924,890			12,388,496
Commitments and contingencies
Redeemable non-controlling interest		342,687			—
Stockholders' equity:
Common stock, $0.01 par value; authorized, 200,000 shares; issued, 101,600 shares and 98,302 shares at June 30, 2014 and December 31, 2013, respectively		1,016			983
Additional paid-in capital		1,527,167			1,512,752
Treasury stock, at cost, 47,566 shares and 46,752 shares at June 30, 2014 and December 31, 2013, respectively		(2,890,936	)		(2,689,177	)
Retained earnings		2,324,269			2,049,430
Accumulated other comprehensive loss		(14,195	)		(18,227	)
Total stockholders' equity		947,321			855,761
Total liabilities and equity	$	14,214,898		$	13,244,257

See accompanying notes to unaudited condensed consolidated financial statements.

Index

ALLIANCE DATA SYSTEMS CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME

	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
	(In thousands, except per share amounts)
Revenues
Transaction	$	80,248	$	79,573	$	164,228	$	161,921
Redemption		268,504		138,342		512,194		298,354
Finance charges, net		538,186		462,739		1,074,447		940,143
Database marketing fees and direct marketing services		339,819		309,495		668,288		605,101
Other revenue		38,401		37,943		78,901		76,010
Total revenue		1,265,158		1,028,092		2,498,058		2,081,529
Operating expenses
Cost of operations (exclusive of depreciation and amortization disclosed separately below)		783,369		619,285		1,555,795		1,239,707
Provision for loan loss		96,652		57,796		167,234		124,444
General and administrative		28,302		28,255		62,329		50,547
Depreciation and other amortization		25,973		20,446		51,485		40,006
Amortization of purchased intangibles		48,322		33,130		96,883		66,420
Total operating expenses		982,618		758,912		1,933,726		1,521,124
Operating income		282,540		269,180		564,332		560,405
Interest expense
Securitization funding costs		22,300		24,694		45,211		49,179
Interest expense on deposits		8,228		7,002		16,462		14,009
Interest expense on long-term and other debt, net		32,404		51,770		69,006		102,822
Total interest expense, net		62,932		83,466		130,679		166,010
Income before income tax		219,608		185,714		433,653		394,395
Provision for income taxes		80,419		69,274		158,717		148,976
Net income	$	139,189	$	116,440	$	274,936	$	245,419
Less: Net income attributable to non-controlling interest		1,745		—		97		—
Net income attributable to Alliance Data Systems Corporation stockholders	$	137,444	$	116,440	$	274,839	$	245,419

Net income attributable to Alliance Data Systems Corporation stockholders per share:
Basic	$	2.54	$	2.37	$	5.13	$	4.96
Diluted	$	2.19	$	1.71	$	4.27	$	3.62

Weighted average shares
Basic		54,154		49,123		53,600		49,444
Diluted		62,637		68,167		64,354		67,746

See accompanying notes to unaudited condensed consolidated financial statements.

Index

ALLIANCE DATA SYSTEMS CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

	Three Months Ended June 30,						Six Months Ended June 30,
	2014			2013			2014		2013
	(In thousands)

Net income	$	139,189		$	116,440		$	274,936	$	245,419
Other comprehensive income, net of tax
Net unrealized gain (loss) on securities available-for-sale, net of tax expense (benefit) of $514, $(928), $916 and $(1,080) for the three and six months ended June 30, 2014 and 2013, respectively		71			(6,550	)		556		(5,454	)
Foreign currency translation adjustments		(5,857	)		4,938			3,476		8,265
Other comprehensive (loss) income		(5,786	)		(1,612	)		4,032		2,811
Total comprehensive income, net of tax	$	133,403		$	114,828		$	278,968	$	248,230
Less: Comprehensive income attributable to non-controlling interest		1,846			—			263		—
Comprehensive income attributable to Alliance Data Systems Corporation stockholders	$	131,557		$	114,828		$	278,705	$	248,230

See accompanying notes to unaudited condensed consolidated financial statements.

Index

ALLIANCE DATA SYSTEMS CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

	Six Months Ended June 30,
	2014			2013
	(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	274,936		$	245,419
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization		148,368			106,426
Deferred income taxes		13,221			1,594
Provision for loan loss		167,234			124,444
Non-cash stock compensation		31,497			28,015
Fair value gain on interest-rate derivatives		(113	)		(8,511	)
Amortization of discount on debt		12,293			45,102
Amortization of deferred financing costs		11,301			13,319
Change in deferred revenue		(41,175	)		(37,269	)
Change in other operating assets and liabilities, net of acquisitions		(8,292	)		9,207
Originations of loan receivables held for sale		(2,343,434	)		—
Sales of loan receivables held for sale		2,342,091			—
Excess tax benefits from stock-based compensation		(26,926	)		(10,103	)
Other		6,797			12,822
Net cash provided by operating activities		587,798			530,465

CASH FLOWS FROM INVESTING ACTIVITIES:
Change in redemption settlement assets		(57,530	)		(47,671	)
Change in cash collateral, restricted		—			18,450
Change in restricted cash		(58	)		(271,132	)
Change in credit card and loan receivables		(151,078	)		83,403
Purchase of credit card portfolios		—			(37,061	)
Payment for acquired business, net of cash		(259,514	)		—
Capital expenditures		(77,260	)		(58,995	)
Purchases of other investments		(105,911	)		(18,339	)
Maturities/sales of other investments		3,209			1,002
Other		(4,000	)		(1,383	)
Net cash used in investing activities		(652,142	)		(331,726	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under debt agreements		1,121,834			—
Repayments of borrowings		(788,805	)		(11,475	)
Proceeds from convertible note hedge counterparties		1,519,833			32,671
Settlement of convertible note borrowings		(1,864,803	)		(65,083	)
Issuances of deposits		1,194,448			732,754
Repayments of deposits		(1,000,783	)		(705,799	)
Non-recourse borrowings of consolidated securitization entities		760,000			1,268,285
Repayments/maturities of non-recourse borrowings of consolidated securitization entities		(1,040,000	)		(1,387,339	)
Payment of deferred financing costs		(6,671	)		(5,971	)
Excess tax benefits from stock-based compensation		26,926			10,103
Proceeds from issuance of common stock		8,202			5,534
Purchase of treasury shares		(201,759	)		(207,974	)
Other		(1,461	)		(11	)
Net cash used in financing activities		(273,039	)		(334,305	)

Effect of exchange rate changes on cash and cash equivalents		(1,272	)		(7,965	)
Change in cash and cash equivalents		(338,655	)		(143,531	)
Cash and cash equivalents at beginning of period		969,822			893,352
Cash and cash equivalents at end of period	$	631,167		$	749,821

SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid	$	114,986		$	111,633
Income taxes paid, net	$	69,028		$	95,108

See accompanying notes to unaudited condensed consolidated financial statements.

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The unaudited condensed consolidated financial statements included herein have been prepared by Alliance Data Systems Corporation ("ADSC" or, including its 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 Issued Accounting Standards

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, "Revenue from Contracts with Customers," which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for interim and annual reporting periods beginning after December 15, 2016. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures.

Recently Adopted Accounting Standards

In July 2013, the FASB issued 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.

Index

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 June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
	(In thousands, except per share amounts)
Numerator:
Net income attributable to Alliance Data Systems Corporation stockholders	$	137,444	$	116,440	$	274,839	$	245,419
Denominator:
Weighted average shares, basic		54,154		49,123		53,600		49,444
Weighted average effect of dilutive securities:
Shares from assumed conversion of convertible senior notes		2,715		10,611		4,224		10,372
Shares from assumed conversion of convertible note warrants		5,247		7,818		6,009		7,336
Net effect of dilutive stock options and unvested restricted stock		521		615		521		594
Denominator for diluted calculations		62,637		68,167		64,354		67,746

Net income attributable to Alliance Data Systems Corporation stockholders per share:
Basic	$	2.54	$	2.37	$	5.13	$	4.96
Diluted	$	2.19	$	1.71	$	4.27	$	3.62

The Company calculated the effect of its convertible senior notes on diluted net income per share as if they would be settled in cash as the Company had the intent to settle the convertible senior notes for cash. The convertible senior notes were settled with cash upon maturity in August 2013 and May 2014, respectively.

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 beginning in August 2014 and completing in December 2014. The number of shares to be delivered under the prepaid forward contracts has reduced weighted-average basic and diluted shares outstanding for the three and six months ended June 30, 2014 and 2013.

3. ACQUISITION

On January 2, 2014, the Company acquired a 60% ownership interest in BrandLoyalty Group B.V. ("BrandLoyalty"), 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 as of January 2, 2014, 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.

Index

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

Pursuant to the BrandLoyalty share purchase agreement, the Company may 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 their 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:

	June 30, 2014		December 31, 2013
	(In thousands)
Principal receivables	$	8,096,112	$	8,166,961
Billed and accrued finance charges		336,440		343,521
Other credit card and loan receivables		101,342		62,400
Total credit card and loan receivables		8,533,894		8,572,882
Less credit card receivables – restricted for securitization investors		6,737,440		7,080,014
Other credit card and loan receivables	$	1,796,454	$	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.

Index

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 $68.5 million and $55.0 million for the three months ended June 30, 2014 and 2013, respectively, and $144.0 million and $113.7 million for the six months ended June 30, 2014 and 2013, respectively.

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,
	2014			2013			2014			2013
	(In thousands)
Balance at beginning of period	$	482,658		$	471,016		$	503,169		$	481,958
Provision for loan loss		96,652			57,796			167,234			124,444
Change in estimate for uncollectible unpaid interest and fees		(5,000	)		—			500			—
Recoveries		38,066			27,163			76,474			57,948
Principal charge-offs		(128,796	)		(107,579	)		(263,797	)		(215,954	)
Balance at end of period	$	483,580		$	448,396		$	483,580		$	448,396

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:

	June 30, 2014		% of Total			December 31, 2013		% of Total
			(In thousands, except percentages)
Receivables outstanding – principal	$	8,096,112		100.0	%	$	8,166,961		100.0	%
Principal receivables balances contractually delinquent:
31 to 60 days		115,647		1.5	%		114,430		1.4	%
61 to 90 days		74,923		0.9			74,700		0.9
91 or more days		129,309		1.6			150,425		1.9
Total	$	319,879		4.0	%	$	339,555		4.2	%

Index

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 $110.3 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 $30.4 million and $33.9 million, respectively, as of June 30, 2014 and December 31, 2013. These modified credit card and loan receivables represented less than 2% of the Company's total credit card and loan receivables as of June 30, 2014 and December 31, 2013, respectively.

The average recorded investment in the impaired credit card receivables was $112.4 million and $117.5 million for the three months ended June 30, 2014 and 2013, respectively, and $114.3 million and $117.5 million for the six months ended June 30, 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 $3.1 million and $3.2 million for the three months ended June 30, 2014 and 2013, respectively, and $6.3 million for each of the six months ended June 30, 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 June 30, 2014						Six Months Ended June 30, 2014
	Number of Restructurings		Pre-modification Outstanding Balance		Post-modification Outstanding Balance		Number of Restructurings		Pre-modification Outstanding Balance		Post-modification Outstanding Balance
	(Dollars in thousands)
Troubled debt restructurings – credit card receivables		28,602	$	28,922	$	28,896		65,154	$	64,708	$	64,651

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)

	Three Months Ended June 30, 2013						Six Months Ended June 30, 2013
	Number of Restructurings		Pre-modification Outstanding Balance		Post-modification Outstanding Balance		Number of Restructurings		Pre-modification Outstanding Balance		Post-modification Outstanding Balance
	(Dollars in thousands)
Troubled debt restructurings – credit card receivables		35,100	$	32,135	$	32,120		72,895	$	66,101	$	66,062

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 June 30, 2014				Six Months Ended June 30, 2014
	Number of Restructurings		Outstanding Balance		Number of Restructurings		Outstanding Balance
	(Dollars in thousands)
Troubled debt restructurings that subsequently defaulted – credit card receivables		13,770	$	13,831		30,498	$	29,972

	Three Months Ended June 30, 2013				Six Months Ended June 30, 2013
	Number of Restructurings		Outstanding Balance		Number of Restructurings		Outstanding Balance
	(Dollars in thousands)
Troubled debt restructurings that subsequently defaulted – credit card receivables		15,698	$	14,938		31,193	$	29,421

Age of Credit Card and Loan Receivable Accounts

The following tables set forth, as of June 30, 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:

	June 30, 2014
Age of Accounts Since Origination	Number of Active Accounts with Balances		Percentage of Active Accounts with Balances			Total Principal Receivables Outstanding		Percentage of Principal Receivables Outstanding
	(In thousands, except percentages)
0-12 Months		4,750		27.8	%	$	2,031,774		25.1	%
13-24 Months		2,467		14.5			1,148,807		14.2
25-36 Months		1,714		10.0			838,573		10.4
37-48 Months		1,245		7.3			623,665		7.7
49-60 Months		988		5.8			520,428		6.4
Over 60 Months		5,915		34.6			2,932,865		36.2
Total		17,079		100.0	%	$	8,096,112		100.0	%

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)

	June 30, 2013
Age of Accounts Since Origination	Number of Active Accounts with Balances		Percentage of Active Accounts with Balances			Total Principal Receivables Outstanding		Percentage of Principal Receivables Outstanding
	(In thousands, except percentages)
0-12 Months		4,162		26.3	%	$	1,567,355		22.8	%
13-24 Months		2,132		13.5			868,822		12.7
25-36 Months		1,492		9.4			656,544		9.6
37-48 Months		1,188		7.5			570,969		8.3
49-60 Months		939		5.9			481,828		7.0
Over 60 Months		5,920		37.4			2,721,437		39.6
Total		15,833		100.0	%	$	6,866,955		100.0	%

Credit Quality

The Company uses proprietary scoring models developed specifically for the purpose of monitoring the Company's obligor credit quality. The proprietary scoring models are used as a tool in the underwriting process and for making credit decisions. The proprietary scoring models are based on historical data and require various assumptions about future performance. Information regarding customer performance is factored into these proprietary scoring models to determine the probability of an account becoming 90 or more days past due at any time within the next 12 months. Obligor credit quality is monitored at least monthly during the life of an account. The following table reflects composition of the Company's credit card and loan receivables by obligor credit quality as of June 30, 2014 and 2013:

	June 30, 2014					June 30, 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	$	144,270		1.8	%	$	143,497		2.1	%
27.1% and higher		391,005		4.8			304,557		4.4
17.1% - 27.0%		748,356		9.2			618,805		9.0
12.6% - 17.0%		886,078		11.0			718,748		10.5
3.7% - 12.5%		3,298,009		40.7			2,782,404		40.5
1.9% - 3.6%		1,681,968		20.8			1,483,852		21.6
Lower than 1.9%		946,426		11.7			815,092		11.9
Total	$	8,096,112		100.0	%	$	6,866,955		100.0	%

Transfer of Financial Assets

The Company originates loans under an agreement with one of its 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 $63.4 million and $62.1 million at June 30, 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.

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)

During the six months ended June 30, 2014, the Company purchased $117.1 million of loan receivables under these agreements. The outstanding balance of these loan receivables was $108.4 million and $61.6 million as of June 30, 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 and six months ended June 30, 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.

The tables below present quantitative information about the components of total securitized credit card receivables, delinquencies and net charge-offs:

	June 30, 2014		December 31, 2013
	(In thousands)
Total credit card receivables – restricted for securitization investors	$	6,737,440	$	7,080,014
Principal amount of credit card receivables – restricted for securitization investors, 90 days or more past due	$	109,383	$	131,659

	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
	(In thousands)
Net charge-offs of securitized principal	$	79,947	$	74,595	$	165,661	$	148,689

5. INVENTORIES

Inventories of $222.2 million and $14.6 million at June 30, 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. We acquired $198.9 million of finished goods inventory in the BrandLoyalty acquisition on January 2, 2014.

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.

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)

6. OTHER INVESTMENTS

Other investments consist of restricted cash, marketable securities and U.S. Treasury bonds and are included in other current assets and other assets in the unaudited condensed consolidated balance sheets. The principal components of other investments, which are carried at fair value, are as follows:

	June 30, 2014									December 31, 2013
	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value		Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
	(In thousands)
Restricted cash	$	30,548	$	—	$	—		$	30,548	$	25,988	$	—	$	—		$	25,988
Marketable securities		79,963		269		(1,977	)		78,255		77,351		62		(4,180	)		73,233
U.S. Treasury bonds		100,086		—		—			100,086		—		—		—			—
Total	$	210,597	$	269	$	(1,977	)	$	208,889	$	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 June 30, 2014 and December 31, 2013, aggregated by investment category and the length of time that individual securities have been in a continuous loss position:

	June 30, 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	$	19,810	$	(138	)	$	45,149	$	(1,839	)	$	64,959	$	(1,977	)

	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	)

The amortized cost and estimated fair value of the marketable securities and U.S. Treasury bonds at June 30, 2014 by contractual maturity are as follows:

	Amortized Cost		Fair Value
	(In thousands)
Due in one year or less	$	6,674	$	6,623
Due after one year through five years		100,086		100,086
Due after five years through ten years		4,440		4,608
Due after ten years		68,849		67,024
Total	$	180,049	$	178,341

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, 2014, the Company does not consider the investments to be other-than-temporarily impaired.

There were no realized gains or losses from the sale of investment securities for the three and six months ended June 30, 2014 and 2013.

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)

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. The principal components of redemption settlement assets, which are carried at fair value, are as follows:

	June 30, 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	$	153,794	$	—	$	—		$	153,794	$	73,984	$	—	$	—		$	73,984
Government bonds		4,788		—		(1	)		4,787		—		—		—			—
Corporate bonds		400,741		5,844		(8	)		406,577		429,592		7,083		(310	)		436,365
Total	$	559,323	$	5,844	$	(9	)	$	565,158	$	503,576	$	7,083	$	(310	)	$	510,349

	June 30, 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	$	4,787	$	(1	)	$	—	$	—	$	4,787	$	(1	)
Corporate bonds		12,818		(8	)		—		—		12,818		(8	)
Total	$	17,605	$	(9	)	$	—	$	—	$	17,605	$	(9	)

	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	)

The amortized cost and estimated fair value of the securities at June 30, 2014 by contractual maturity are as follows:

	Amortized Cost		Fair Value
	(In thousands)
Due in one year or less	$	156,621	$	157,994
Due after one year through five years		248,908		253,370
Total	$	405,529	$	411,364

There were no realized gains or losses from the sale of investment securities for the three and six months ended June 30, 2014 and 2013.

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)

8. INTANGIBLE ASSETS AND GOODWILL

Intangible Assets

Intangible assets consist of the following:

	June 30, 2014
	Gross Assets		Accumulated Amortization			Net		Amortization Life and Method
	(In thousands)
Finite Lived Assets
Customer contracts and lists	$	837,270	$	(247,017	)	$	590,253	3-12 years—straight line
Premium on purchased credit card portfolios		176,088		(93,860	)		82,228	5-10 years—straight line, accelerated
Customer database		161,700		(131,992	)		29,708	4-10 years—straight line
Collector database		65,601		(60,870	)		4,731	30 years—15% declining balance
Tradenames		85,968		(22,905	)		63,063	3-15 years—straight line
Purchased data lists		11,876		(6,415	)		5,461	1-5 years—straight line, accelerated
Favorable lease		3,291		(549	)		2,742	10 years—straight line
Noncompete agreements		1,300		(650	)		650	3 years—straight line
	$	1,343,094	$	(564,258	)	$	778,836
Indefinite Lived Assets
Tradenames		12,350		—			12,350	Indefinite life
Total intangible assets	$	1,355,444	$	(564,258	)	$	791,186

	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 weighted average lives of 7.0 years and 3.0 years, respectively.

The estimated amortization expense related to intangible assets for the next five years and thereafter is as follows:

	For Years Ending December 31,
	(In thousands)
2014 (excluding the six months ended June 30, 2014)	$	89,393
2015		161,487
2016		143,894
2017		109,342
2018		99,217
2019 & thereafter		175,503

Index

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, 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		(155	)		742		—		—		587
June 30, 2014	$	797,309		$	1,242,264	$	261,732	$	—	$	2,301,305

See Note 3, "Acquisition," for more information regarding the BrandLoyalty acquisition.

9. DEBT

Debt consists of the following:

Description	June 30, 2014			December 31, 2013			Maturity	Interest Rate
	(Dollars in thousands)
Long-term and other debt:
2013 credit facility	$	720,000		$	336,000		July 2018	⁽¹⁾
2013 term loan		1,218,750			1,234,688		July 2018	⁽¹⁾
BrandLoyalty credit facility		125,747			—		December 2015	⁽²⁾
Convertible senior notes due 2014		—			333,082		—	—
Senior notes due 2017		396,916			396,511		December 2017	5.250%
Senior notes due 2020		500,000			500,000		April 2020	6.375%
Total long-term and other debt		2,961,413			2,800,281
Less: current portion		(65,480	)		(364,489	)
Long-term portion	$	2,895,933		$	2,435,792

Deposits:
Certificates of deposit	$	2,437,647		$	2,486,533		Various – July 2014 – January 2021	0.15% to 3.30%
Money market deposits		572,378			329,828		On demand	0.01% to 0.14%
Total deposits		3,010,025			2,816,361
Less: current portion		(1,752,641	)		(1,544,059	)
Long-term portion	$	1,257,384		$	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		860,000			1,590,000		Various – September 2015 – May 2016	⁽⁴⁾
Total non-recourse borrowings of consolidated securitization entities		4,311,916			4,591,916
Less: current portion		(643,750	)		(1,025,000	)
Long-term portion	$	3,668,166		$	3,566,916

⁽¹⁾		The interest rate is based upon the London Interbank Offered Rate ("LIBOR") plus an applicable margin. At June 30, 2014, the weighted average interest rate was 1.90% 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 June 30, 2014, the weighted average interest rate was 3.61%.

⁽³⁾		The interest rate is based upon LIBOR plus an applicable margin. At June 30, 2014, the interest rate was 0.53%.

⁽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 June 30, 2014, the interest rates ranged from 1.05% to 1.70%.

At June 30, 2014, the Company was in compliance with its covenants.

Credit Agreement

The Company, as borrower, and ADS Alliance Data Systems, Inc., ADS Foreign Holdings, Inc., Alliance Data Foreign Holdings, Inc., Epsilon 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").

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)

Total availability under the 2013 Credit Facility at June 30, 2014 was $530.0 million.

In July 2014, the Company exercised in part the accordion feature of the 2013 Credit Agreement and increased the capacity under the 2013 Credit Facility by $50.0 million to $1.3 billion. Also in July 2014, HMI Holding LLC became an additional guarantor under the 2013 Credit Agreement, the Indenture governing the Senior Notes due 2017 and the Indenture governing the Senior Notes due 2020.

BrandLoyalty Credit Agreement

As part of the BrandLoyalty acquisition, 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 June 30, 2014, amounts outstanding under the term loans and revolving line of credit were €44.3 million and €47.6 million ($60.6 million and $65.2 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 aggregate principal amount of convertible senior notes that matured and were repaid on May 15, 2014 (the "Convertible Senior Notes due 2014"). On or prior to May 15, 2014, the Company settled in cash the Convertible Senior Notes due 2014, which were surrendered for conversion for $1,864.8 million. The Company applied $1,519.8 million of cash from the counterparties in settlement of the related convertible note hedge transactions, including Bank of America, N.A., J.P. Morgan Securities LLC, as agent for JPMorgan Chase Bank, National Association, London Branch, and Barclays Bank PLC (such parties collectively, the "2014 Hedge Counterparties").

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, 2014 and 2013 is as follows:

	Three Months Ended June 30,							Six Months Ended June 30,
	2014				2013			2014			2013
	(In thousands, except percentages)
Interest expense calculated on contractual interest rate		$	1,920		$	7,471		$	5,630		$	14,999
Amortization of discount on liability component			4,036			22,669			11,888			44,719
Total interest expense on convertible senior notes		$	5,956		$	30,140		$	17,518		$	59,718

Effective interest rate (annualized)			14.2	%		11.0	%		14.2	%		11.0	%

In June 2014, the Company entered into amendments to the warrant agreements with the 2014 Hedge Counterparties for the approximately 7.3 million warrants associated with the Convertible Senior Notes due 2014. The amendments, among other things, amend the dates on which the warrants are exercisable and will expire to June 16, 2014 and continuing each business day through August 11, 2014. On July 3, 2014, the Company net settled 2.0 million warrants associated with the Convertible Senior Notes due 2014 by issuing 1.5 million shares of its common stock.

In the first quarter of 2014, the Company completed the settlement of the final 5.1 million of warrants associated with the convertible senior notes that matured on August 1, 2013 by issuing 2.9 million shares of its common stock.

Index

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 $3.1 million and $3.5 million at June 30, 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 June 30, 2014, is a period of 3.4 years at an effective annual interest rate of 5.5%.

Senior Notes Due 2022

In July 2014, the Company issued and sold $600.0 million aggregate principal amount of 5.375% senior notes due August 1, 2022 (the "Senior Notes due 2022"). The Senior Notes due 2022 accrue interest on the principal amount at the rate of 5.375% per annum from July 29, 2014, payable semi-annually in arrears, on February 1 and August 1 of each year, beginning on February 1, 2015. The Senior Notes due 2022 are unsecured and are guaranteed on a senior unsecured basis by each of the existing and future domestic restricted subsidiaries that becomes liable for any debt under the domestic credit facilities, including the 2013 Credit Agreement.

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%.

In July 2014, Master Trust I issued $394.7 million of asset-backed term securities, $94.7 million of which was retained by the Company and will be eliminated from the unaudited condensed consolidated financial statements. These securities mature in September 2015 and have a fixed interest rate of 0.61%.

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 renewed its 2009-VFN conduit facility, extending the maturity to February 29, 2016, with a total capacity of $700.0 million.

In May 2014, the WFC Trust renewed its 2009-VFN conduit facility, extending the maturity to May 31, 2016, with a total capacity of $450.0 million.

As of June 30, 2014, total capacity under the conduit facilities was $1.6 billion, of which $860.0 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 June 30, 2014 the notional amount of the Company's outstanding interest rate derivatives was €59.3 million ($81.2 million), with a weighted average years to maturity of 0.9 years.

The fair value of the Company's outstanding interest rate derivatives at June 30, 2014 was $0.5 million, of which $0.2 million was included in other current liabilities and $0.3 million was included in other liabilities in the unaudited condensed consolidated balance sheets.

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ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)

During the three and six months ended June 30, 2014, a de minimis amount of gains on derivative instruments was recognized in interest expense on long-term and other debt, net within the unaudited condensed consolidated statements of income. During the three and six months ended June 30, 2013, gains on interest rate swaps on securitized borrowings that matured in 2013 of $2.2 million and $8.5 million, respectively, were recognized in securitization funding costs within the unaudited condensed consolidated statements of income.

The Company limits its exposure on derivatives by entering into contracts with institutions that are established dealers who maintain certain minimum credit criteria established by the Company. At June 30, 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.

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		96,377			211,608			307,985
Revenue recognized		(99,975	)		(248,940	)		(348,915	)
Other		—			(257	)		(257	)
Effects of foreign currency translation		(1,640	)		(4,530	)		(6,170	)
June 30, 2014	$	341,393		$	748,436		$	1,089,829
Amounts recognized in the unaudited condensed consolidated balance sheets:
Current liabilities	$	174,686		$	748,436		$	923,122
Non-current liabilities	$	166,707		$	—		$	166,707

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. Pursuant to the BrandLoyalty share purchase agreement, the Company may 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 their 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:

	Redeemable Non-Controlling Interest
	(In thousands)
Balance at January 2, 2014	$	341,907
Net income attributable to non-controlling interest		97
Other comprehensive income attributable to non-controlling interest		166
Foreign currency translation adjustments		517
Balance at June 30, 2014	$	342,687

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ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)

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 six months ended June 30, 2014, the Company acquired a total of 813,317 shares of its common stock for $201.8 million. As of June 30, 2014, the Company had $198.2 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, 2014 and 2013 is as follows:

	Three Months Ended June 30,				Six Months Ended June 30,
	2014		2013		2014		2013
	(In thousands)
Cost of operations	$	11,230	$	10,600	$	22,212	$	19,542
General and administrative		4,643		4,391		9,285		8,473
Total	$	15,873	$	14,991	$	31,497	$	28,015

During the six months ended June 30, 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 six months ended June 30, 2014, the Company awarded 52,472 service-based restricted stock units with a weighted average grant date fair value per share of $280.87 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:

Three Months Ended June 30, 2014	Net Unrealized Gains (Losses) on Securities		Foreign Currency Translation Adjustments⁽¹⁾			Accumulated Other Comprehensive Income (Loss)
	(In thousands)
Balance as of March 31, 2014	$	4,674	$	(13,083	)	$	(8,409	)
Changes in other comprehensive income (loss)		71		(5,857	)		(5,786	)
Balance as of June 30, 2014	$	4,745	$	(18,940	)	$	(14,195	)

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ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)

Three Months Ended June 30, 2013

Net

Unrealized

Gains (Losses)

on Securities

Foreign Currency Translation Adjustments⁽¹⁾

Accumulated

Other Comprehensive Income (Loss)

(In thousands)

Balance as of March 31, 2013

11,417