Edgar Filing: ALLIANCE DATA SYSTEMS CORP

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, 2011

OR

£	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

	For the transition period from to

Commission File Number: 001-15749

ALLIANCE DATA SYSTEMS CORPORATION

(Exact Name of Registrant as Specified in its Charter)

Delaware	31-1429215
(State or Other Jurisdiction of Incorporation or Organization)	(I.R.S. Employer Identification No.)

7500 Dallas Parkway, Suite 700

Plano, Texas 75024

(Address of Principal Executive Office, Including Zip Code)

(214) 494-3000

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes R No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes R No £

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes £ No R

As of April 29, 2011, 51,022,398 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 March 31, 2011 and December 31, 2010	3
	Condensed Consolidated Statements of Income for the three months ended March 31, 2011 and 2010	4
	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2011 and 2010	5
	Notes to Condensed Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	33
Item 4.	Controls and Procedures	34

Part II: OTHER INFORMATION

Item 1.	Legal Proceedings	35
Item 1A.	Risk Factors	35
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	35
Item 3.	Defaults Upon Senior Securities	35
Item 4.	(Removed and Reserved)	35
Item 5.	Other Information	35
Item 6.	Exhibits	36
SIGNATURES		38

Index

PART I

Item 1. Financial Statements.

ALLIANCE DATA SYSTEMS CORPORATION

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

	March 31, 2011			December 31, 2010
	(In thousands)
ASSETS
Cash and cash equivalents	$	300,362		$	139,114
Trade receivables, less allowance for doubtful accounts ($3,731 and $4,350 at March 31, 2011 and December 31, 2010, respectively)		228,270			260,945
Credit card receivables:
Credit card receivables – restricted for securitization investors		4,287,821			4,795,753
Other credit card receivables		576,739			560,670
Total credit card receivables		4,864,560			5,356,423
Allowance for loan loss		(489,620	)		(518,069	)
Credit card receivables, net		4,374,940			4,838,354
Deferred tax asset, net		272,225			279,752
Other current assets		111,522			127,022
Redemption settlement assets, restricted		483,924			472,428
Assets of discontinued operations		8,721			11,920
Total current assets		5,779,964			6,129,535
Property and equipment, net		170,375			170,627
Deferred tax asset, net		47,725			46,218
Cash collateral, restricted		318,333			185,754
Intangible assets, net		302,048			314,391
Goodwill		1,228,982			1,221,823
Other non-current assets		182,023			203,804
Total assets	$	8,029,450		$	8,272,152
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable	$	113,349		$	121,856
Accrued expenses		119,965			168,578
Certificates of deposit		380,500			442,600
Asset-backed securities debt – owed to securitization investors		1,383,103			1,743,827
Current debt		1,074,372			255,679
Other current liabilities		102,409			85,179
Deferred revenue		1,053,931			1,044,469
Total current liabilities		4,227,629			3,862,188
Deferred revenue		184,405			176,773
Deferred tax liability, net		80,037			82,637
Certificates of deposit		450,200			416,500
Asset-backed securities debt – owed to securitization investors		1,916,315			1,916,315
Long-term and other debt		934,782			1,614,093
Other liabilities		185,089			180,552
Total liabilities		7,978,457			8,249,058
Commitments and contingencies (Note 16)
Stockholders’ equity:
Common stock, $0.01 par value; authorized, 200,000 shares; issued, 93,708 shares and 92,797 shares at March 31, 2011 and December 31, 2010, respectively		937			928
Additional paid-in capital		1,331,287			1,320,767
Treasury stock, at cost, 42,282 shares and 41,426 shares at March 31, 2011 and December 31, 2010, respectively		(2,141,254	)		(2,079,819	)
Retained earnings		902,094			815,718
Accumulated other comprehensive loss		(42,071	)		(34,500	)
Total stockholders’ equity		50,993			23,094
Total liabilities and stockholders’ equity	$	8,029,450		$	8,272,152

See accompanying notes to unaudited condensed consolidated financial statements.

Index

ALLIANCE DATA SYSTEMS CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME

	Three Months Ended March 31,
	2011		2010
	(In thousands, except per share amounts)
Revenues
Transaction	$	76,771	$	76,601
Redemption		149,760		138,677
Finance charges, net		342,142		306,357
Database marketing fees and direct marketing services		152,710		125,191
Other revenue		19,053		16,711
Total revenue		740,436		663,537
Operating expenses
Cost of operations		404,525		361,003
Provision for loan loss		67,666		88,001
General and administrative		20,939		22,164
Depreciation and other amortization		16,754		16,325
Amortization of purchased intangibles		18,644		17,846
Total operating expenses		528,528		505,339
Operating income		211,908		158,198
Interest expense
Securitization funding costs		30,986		41,619
Interest expense on certificates of deposit		5,693		7,527
Interest expense on long-term and other debt, net		34,780		33,560
Total interest expense, net		71,459		82,706
Income before income tax	$	140,449	$	75,492
Provision for income taxes		54,073		28,838
Net income	$	86,376	$	46,654

Basic income per share	$	1.69	$	0.89
Diluted income per share	$	1.56	$	0.84

Weighted average shares:
Basic		51,122		52,441
Diluted		55,412		55,419

See accompanying notes to unaudited condensed consolidated financial statements.

Index

ALLIANCE DATA SYSTEMS CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

	Three Months Ended March 31,
	2011			2010
	(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	86,376		$	46,654
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization		35,398			34,171
Deferred income taxes		7,782			18,272
Provision for loan loss		67,666			88,001
Non-cash stock compensation		9,084			10,606
Fair value (gain) loss on interest-rate derivatives		(9,892	)		2,181
Amortization of discount on convertible senior notes		17,695			15,861
Change in operating assets and liabilities, net of acquisitions:
Change in trade accounts receivable		14,434			26,819
Change in other assets		24,539			15,200
Change in accounts payable and accrued expenses		(46,160	)		(15,849	)
Change in deferred revenue		(16,375	)		(15,665	)
Change in other liabilities		30,521			(7,847	)
Excess tax benefits from stock-based compensation		(9,473	)		(3,763	)
Other		(1,207	)		(8,088	)
Net cash provided by operating activities		210,388			206,553

CASH FLOWS FROM INVESTING ACTIVITIES:
Change in redemption settlement assets		4,410			7,097
Change in restricted cash		20,180			28,245
Change in credit card receivables		432,997			397,525
Purchase of credit card receivables		(42,696	)		—
Change in cash collateral, restricted		(132,575	)		26,211
Capital expenditures		(18,631	)		(15,428	)
Investments in the stock of an investee		(5,019	)		—
Other		(7	)		(528	)
Net cash provided by investing activities		258,659			443,122

CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under debt agreements		202,000			346,000
Repayments of borrowings		(77,318	)		(288,155	)
Issuances of certificates of deposit		75,000			31,400
Repayments of certificates of deposit		(103,400	)		(346,000	)
Borrowings from asset-backed securities		174,500			100,965
Repayments/maturities of asset-backed securities		(535,224	)		(557,400	)
Payment of capital lease obligations		(3,013	)		(5,753	)
Payment of deferred financing costs		(730	)		(121	)
Excess tax benefits from stock-based compensation		9,473			3,763
Proceeds from issuance of common stock		12,509			6,639
Purchase of treasury shares		(61,435	)		(14,520	)
Net cash used in financing activities		(307,638	)		(723,182	)

Effect of exchange rate changes on cash and cash equivalents		(161	)		(860	)
Change in cash and cash equivalents		161,248			(74,367	)

Cash effect on adoption of ASC 860 and ASC 810		—			81,553
Cash and cash equivalent at beginning of period		139,114			213,378
Cash and cash equivalents at end of period	$	300,362		$	220,564

SUPPLEMENTAL CASH FLOW INFORMATION:
Interest paid	$	54,594		$	47,655
Income taxes paid (refund), net	$	31,692		$	(2,915	)

See accompanying notes to unaudited condensed consolidated financial statements.

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

The unaudited condensed consolidated financial statements included herein have been prepared by Alliance Data Systems Corporation (“ADSC” or, including its wholly owned subsidiaries and its consolidated variable interest entities, the “Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report filed on Form 10-K for the year ended December 31, 2010, filed with the SEC on February 28, 2011. With respect to information concerning principal geographic areas, revenues are attributed to respective countries based on the location of the subsidiary, which generally correlates with the location of the customer.

The unaudited condensed consolidated financial statements included herein reflect all adjustments (consisting of normal, recurring adjustments) which are, in the opinion of management, necessary to state fairly the results for the interim periods presented. The results of operations for the interim periods presented are not necessarily indicative of the operating results to be expected for any subsequent interim period or for the fiscal year.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect (1) the reported amounts of assets; (2) liabilities and disclosure of contingent assets and liabilities at the date of the financial statements; and (3) the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. For purposes of comparability, fraud losses of $0.9 million have been reclassified from provision for loan loss to cost of operations in the prior period financial statements to conform to the current year presentation. Such reclassifications have no impact on previously reported net income.

2. RECENT ACCOUNTING PRONOUNCEMENTS

In October 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2009-13, “Multiple-Deliverable Revenue Arrangements,” which supersedes certain guidance in Accounting Standards Codification (“ASC”) 605-25, “Revenue Recognition — Multiple-Element Arrangements,” and requires an entity to allocate arrangement consideration at the inception of an arrangement to all of its deliverables based on their relative selling prices (the relative-selling-price method). ASU 2009-13 eliminates the use of the residual method of allocation in which the undelivered element is measured at its estimated selling price and the delivered element is measured as the residual of the arrangement consideration, and requires the relative-selling-price method in all circumstances in which an entity recognizes revenue for an arrangement with multiple deliverables subject to ASU 2009-13. ASU 2009-13 is effective for revenue arrangements entered into or materially modified beginning on or after January 1, 2011. The Company elected to adopt this ASU prospectively. Revenue associated with the service element of the Company’s AIR MILES® Reward Program has historically been determined using the residual method. Based on the sponsor contracts expected to be signed, renewed or materially modified in 2011, the adoption of ASU 2009-13 did not and is not expected to have a material impact on the Company’s unaudited condensed consolidated financial statements for 2011. Should one of the AIR MILES Reward Program’s top five sponsors materially modify its agreement with the Company in 2011, it could significantly shift the allocation of deferred revenue between the service element and redemption element. This change in allocation between the deferred revenue elements could impact the timing of revenue recognition, as the redemption element is recognized as AIR MILES reward miles are redeemed while the service element is recognized on a pro-rata basis over the estimated life of an AIR MILES reward mile, or 42 months.

In July 2010, the FASB issued ASU 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses,” which amends ASC 310, “Receivables,” to require further disaggregated disclosures that improve financial statement users’ understanding of (1) the nature of an entity’s credit risk associated with its financing receivables and (2) the entity’s assessment of that risk in estimating its allowance for credit losses as well as changes in the allowance and the reasons for those changes. The adoption of ASU 2010-20 only impacted disclosures and did not have a material impact on the Company’s unaudited condensed consolidated financial statements. ASU 2010-20 also requires enhanced disclosures for troubled debt restructurings (“TDR”), but the effective date of these disclosures was deferred.

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

In April 2011, the FASB issued ASU 2011-02, “Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” The ASU provides additional guidance to creditors for evaluating on whether a modification or restructuring of a receivable is a TDR by clarifying the existing guidance whether (1) the creditor has granted a concession and (2) whether the debtor is experiencing financial difficulties. The amendments in the ASU will be effective for the first interim or annual period beginning on or after June 15, 2011, and are to be applied retrospectively to the beginning of the annual period of adoption. Early adoption is permitted. For purposes of measuring impairment of receivables that are newly considered impaired as a result of this ASU, the amendments are to be applied prospectively for the first interim or annual period beginning on or after June 15, 2011. In addition, the ASU will also require additional disclosures about TDR activities along with the disclosures required by ASU 2010-20 but were previously deferred in the period of adoption. The Company does not expect the adoption of this statement to have a material impact on the Company's financial condition, results of operations, or cash flows.

3. SHARES USED IN COMPUTING NET INCOME PER SHARE

The following table sets forth the computation of basic and diluted net income per share for the periods indicated:

	Three Months Ended March 31,
	2011		2010
	(In thousands, except per share amounts)
Numerator:
Net Income	$	86,376	$	46,654
Denominator:
Weighted average shares, basic		51,122		52,441
Weighted average effect of dilutive securities:
Shares from assumed conversion of convertible senior notes		2,789		1,605
Shares from assumed conversion of convertible note warrants		633		—
Net effect of dilutive stock options and unvested restricted stock		868		1,373
Denominator for diluted calculations		55,412		55,419

Basic net income per share	$	1.69	$	0.89
Diluted net income per share	$	1.56	$	0.84

The Company calculates the effect of its convertible senior notes, consisting of $805.0 million aggregate principal amount of convertible senior notes due 2013 (the “Convertible Senior Notes 2013”) and $345.0 million aggregate principal amount of convertible senior notes due 2014 (the “Convertible Senior Notes 2014”), which can be settled in cash or shares of common stock, on diluted net income per share as if they will be settled in cash as the Company has the intent to settle the convertible senior notes in cash.

The Company is also party to prepaid forward contracts to purchase 1,857,400 shares of its common stock that are to be delivered over a settlement period in 2014. The number of shares to be delivered under the prepaid forward contracts is used to reduce weighted-average basic and diluted shares outstanding.

For the three months ended March 31, 2011 and 2010, the Company excluded 16.9 million warrants and 17.5 million warrants, respectively, from the calculation of net income per share as the effect was anti-dilutive.

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

4. CREDIT CARD RECEIVABLES

The Company’s credit card receivables are the only portfolio segment or class of financing receivables. Quantitative information about the components of total credit card receivables and delinquencies is presented in the table below:

	March 31, 2011		December 31, 2010
	(In thousands)
Principal receivables	$	4,642,290	$	5,116,111
Billed and accrued finance charges		191,423		214,643
Other receivables		30,847		25,669
Total credit card receivables		4,864,560		5,356,423
Less credit card receivables – restricted for securitization investors		4,287,821		4,795,753
Other credit card receivables	$	576,739	$	560,670
Principal amount of credit card receivables 90 days or more past due	$	109,953	$	130,538

Allowance for Loan Loss

The Company maintains an allowance for loan loss at a level that is adequate to absorb probable losses inherent in credit card receivables. The allowance for loan loss covers forecasted uncollectable principal as well as unpaid interest and fees. In estimating the allowance covering principal loan losses, management utilizes a migration analysis of delinquent and current credit card receivables. Migration analysis is a technique used to estimate the likelihood that a credit card receivable will progress through the various stages of delinquency and to charge-off. In estimating the allowance covering uncollectable interest and fees, management utilizes historical charge-off trends. Management also considers factors that may impact loan loss experience, including seasoning, loan volume and amounts, payment rates and forecasting uncertainties.

The allowance for loan loss is evaluated monthly for adequacy and is maintained through an adjustment to the provision for loan loss. Additions to the allowance are made through charges to the provision for loan loss. Principal charge-offs, net of recoveries, are deducted from the allowance, while unpaid interest and fees are reversed against finance charges, net upon charge-off.

	March 31, 2011			March 31, 2010
	(In thousands)
Balance at beginning of period	$	518,069		$	54,884
Adoption of ASC 860 and ASC 810		—			523,950
Provision for loan loss		67,666			88,001
Recoveries		25,866			21,738
Principal charge-offs		(123,896	)		(144,004	)
Other		1,915			—
Balance at end of period	$	489,620		$	544,569

Net Charge-Offs

Net charge-offs include the principal amount of losses from credit cardholders unwilling or unable to pay their account balances, as well as bankrupt and deceased credit cardholders, less recoveries and exclude charged-off interest, fees and fraud losses. Charged-off interest and fees are recorded in finance charges, net while fraud losses are recorded as an expense. Credit card receivables, including unpaid interest and fees, are charged-off at the end of the month during which an account becomes 180 days contractually past due, except in the case of customer bankruptcies or death. Credit card receivables, including unpaid interest and fees, associated with customer bankruptcies or death are charged-off at the end of each month subsequent to 60 days after the receipt of notification of the bankruptcy or death, but in any case, not later than the 180-day contractual time frame.

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The net charge-off rate is calculated by dividing net charge-offs of principal receivables for the period by the average credit card receivables for the period. Average credit card receivables represent the average balance of the cardholder receivables at the beginning of each month in the years indicated. The following table presents the Company’s net charge-offs for the periods indicated:

	Three Months Ended March 31,
	2011			2010
	(In thousands, except percentages)
Average credit card receivables	$	4,968,459		$	5,185,147
Net charge-offs of principal receivables		98,030			122,266
Net charge-offs as a percentage of average credit card receivables		7.9	%		9.4	%

Delinquencies

A credit card account is contractually delinquent if the Company does not receive the minimum payment by the specified due date on the cardholder’s statement. When an account becomes delinquent, a message is printed on the credit cardholder’s billing statement requesting payment. After an account becomes 30 days past due, a proprietary collection scoring algorithm automatically scores the risk of the account becoming further delinquent. The collection system then recommends a collection strategy for the past due account based on the collection score and account balance and dictates the contact schedule and collections priority for the account. If the Company is unable to make a collection after exhausting all in-house collection efforts, the Company will engage collection agencies and outside attorneys to continue those efforts.

The following table presents the delinquency trends of the Company’s credit card portfolio:

	March 31, 2011		% of Total			December 31, 2010		% of Total
	(In thousands, except percentages)
Receivables outstanding – principal	$	4,642,290		100	%	$	5,116,111		100	%
Principal receivables balances contractually delinquent:
31 to 60 days		68,180		1.5	%		87,252		1.7	%
61 to 90 days		50,477		1.1			59,564		1.2
91 or more days		109,953		2.3			130,538		2.5
Total	$	228,610		4.9	%	$	277,354		5.4	%

Modified Credit Card Receivables

The Company does hold certain credit card receivables for which the terms have been modified. The Company’s modified credit card loans include loans for which temporary hardship concessions have been granted and loans in permanent workout programs. These modified loans include concessions consisting primarily of a reduced minimum payment and an interest rate reduction. The temporary programs’ concessions remain in place for a period no longer than twelve months, while the permanent programs remain in place through the payoff of the loan if the credit cardholder complies with the terms of the program. These concessions do not include the forgiveness of unpaid principal, but may involve the reversal of certain unpaid interest or fee assessments. In the case of the temporary programs, at the end of the concession period, loan terms revert to standard rates. These arrangements are automatically terminated if the customer fails to make payments in accordance with the terms of the program, at which time their account reverts back to its original terms. In assessing the appropriate allowance for loan loss, these loans are included in the general pool of credit cards with the allowance determined under the contingent loss model of ASC 450-20, “Loss Contingencies.” If the Company applied accounting under ASC 310-40, “Troubled Debt Restructurings by Creditors,” to loans in these programs, there would not be a significant difference in the allowance for loan loss. Credit card receivables for which temporary hardship and permanent concessions were granted comprised less than 3% of the Company’s total credit card receivables at each of March 31, 2011 and December 31, 2010.

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Age of Credit Card Receivables

The following table sets forth, as of March 31, 2011, the number of active credit card accounts with balances and the related principal balances outstanding, based upon the age of the active credit card accounts from origination:

Age Since Origination	Number of Active Accounts with Balances		Percentage of Active Accounts with Balances			Principal Receivables Outstanding		Percentage of Receivables Outstanding
	(In thousands, except percentages)
0-12 Months		2,703		23.4	%	$	876,492		18.9	%
13-24 Months		1,578		13.7			654,138		14.1
25-36 Months		1,174		10.2			522,678		11.3
37-48 Months		965		8.3			419,685		9.0
49-60 Months		830		7.2			364,228		7.8
Over 60 Months		4,297		37.2			1,805,069		38.9
Total		11,547		100.0	%	$	4,642,290		100.0	%

Credit Quality

The Company uses proprietary scoring models developed specifically for the purpose of monitoring the Company’s obligor credit quality. The proprietary scoring model is used as a tool in the underwriting process and for making credit decisions. The proprietary scoring model is based on historical data and requires various assumptions about future performance. Information regarding customer performance is factored into these proprietary scoring models to determine the probability of an account becoming 90 or more days past due at any time within the next 12 months. Obligor credit quality is monitored at least monthly during the life of an account. The following table reflects composition by obligor credit quality as of March 31, 2011:

Probability of an Account Becoming 90 or More Days Past Due or Becoming Charged off (within the next 12 months)	Total Principal Receivables Outstanding		Percentage of Principal Receivables Outstanding
	(In thousands, except percentages)
No Score	$	88,576		1.9	%
27.1% and higher		274,777		5.9
17.1% - 27.0%		453,154		9.8
12.6% - 17.0%		557,762		12.0
3.7% - 12.6%		1,916,149		41.3
1.9% - 3.7%		895,608		19.3
Lower than 1.9%		456,264		9.8
Total	$	4,642,290		100.0	%

Securitized Credit Card Receivables

The Company regularly securitizes its credit card receivables through its credit card securitization trusts, consisting of World Financial Network Credit Card Master Trust, World Financial Network Credit Card Master Note Trust, World Financial Network Credit Card Master Note Trust II and World Financial Network Credit Card Master Trust III (collectively, the “WFN Trusts”), and World Financial Capital Credit Card Master Note Trust (the “WFC Trust”). The Company continues to own and service the accounts that generate credit card receivables held by the WFN Trusts and the WFC Trust. In its capacity as a servicer, each of the respective banks earns a fee from the WFN Trusts and the WFC Trust to service and administer the credit card receivables, collect payments, and charge-off uncollectable receivables. These fees are eliminated and therefore are not reflected in the unaudited condensed consolidated statements of income for the three months ended March 31, 2011 and 2010.

The WFN Trusts and the WFC Trust are variable interest entities (“VIEs”) and the assets of these consolidated VIEs include certain credit card receivables that are restricted to settle the obligations of those entities and are not expected to be available to the Company or its creditors. The liabilities of the consolidated VIEs include asset-backed secured borrowings and other liabilities for which creditors or beneficial interest holders do not have recourse to the general credit of the Company.

Index

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, 2011		December 31, 2010
	(In thousands)
Total credit card receivables – restricted for securitization investors	$	4,287,821	$	4,795,753
Principal amount of credit card receivables – restricted for securitization investors, 90 days or more past due	$	99,293	$	117,594

	Three Months Ended March 31,
	2011		2010
	(In thousands)
Net charge-offs of securitized principal	$	87,303	$	108,109

Portfolio Acquisition

In February 2011, World Financial Capital Bank, one of the Company’s wholly-owned subsidiaries, acquired an existing private label credit card portfolio of J.Jill and entered into a multi-year agreement to provide private label credit card services. The total purchase price was approximately $42.7 million, which was comprised of $37.9 million of credit card receivables and $4.8 million of intangible assets and are included in the unaudited condensed consolidated balance sheets as of March 31, 2011.

5. REDEMPTION SETTLEMENT ASSETS

Redemption settlement assets consist of cash and cash equivalents and securities available-for-sale and are designated for settling redemptions by collectors of the AIR MILES Reward Program in Canada under certain contractual relationships with sponsors of the AIR MILES Reward Program. These assets are primarily denominated in Canadian dollars. Realized gains and losses from the sale of investment securities were not material. The principal components of redemption settlement assets, which are carried at fair value, are as follows:

	March 31, 2011									December 31, 2010
	Cost		Unrealized Gains		Unrealized Losses			Fair Value		Cost		Unrealized Gains		Unrealized Losses			Fair Value
	(In thousands)
Cash and cash equivalents	$	60,578	$	—	$	—		$	60,578	$	74,612	$	—	$	—		$	74,612
Government bonds		15,755		168		—			15,923		15,235		161		(34	)		15,362
Corporate bonds (1)		407,053		2,487		(2,117	)		407,423		380,605		3,212		(1,363	)		382,454
Total	$	483,386	$	2,655	$	(2,117	)	$	483,924	$	470,452	$	3,373	$	(1,397	)	$	472,428

(1)

At each of March 31, 2011 and December 31, 2010, LoyaltyOne® had investments in retained interests in the WFN Trusts with a fair value of $64.9 million. These amounts are eliminated and therefore not reflected in the unaudited condensed consolidated financial statements and notes thereof as of March 31, 2011 and December 31, 2010.

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The following tables show the gross unrealized losses and fair value for those investments that were in an unrealized loss position as of March 31, 2011 and December 31, 2010, aggregated by investment category and the length of time that individual securities have been in a continuous loss position:

	Less than 12 months					March 31, 2011 12 Months or Greater					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
	(In thousands)
Government bonds	$	—	$	—		$	—	$	—		$	—	$	—
Corporate bonds		181,770		(2,112	)		10,612		(5	)		192,382		(2,117	)
Total	$	181,770	$	(2,112	)	$	10,612	$	(5	)	$	192,382	$	(2,117	)

	Less than 12 months					December 31, 2010 12 Months or Greater				Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(In thousands)
Government bonds	$	10,119	$	(34	)	$	—	$	—	$	10,119	$	(34	)
Corporate bonds		128,349		(1,363	)		—		—		128,349		(1,363	)
Total	$	138,468	$	(1,397	)	$	—	$	—	$	138,468	$	(1,397	)

Market values were determined for each individual security in the investment portfolio. When evaluating the investments for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the security’s issuer, and the Company’s intent to sell the security and whether it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis. The Company typically invests in highly-rated securities with low probabilities of default and has the ability to hold the investments until maturity. As of March 31, 2011, the Company does not consider the investments to be other-than-temporarily impaired.

The net carrying value and estimated fair value of the securities at March 31, 2011 by contractual maturity are as follows:

	Amortized Cost		Estimated Fair Value
	(In thousands)
Due in one year or less	$	102,402	$	102,336
Due after one year through five years		380,984		381,588
Total	$	483,386	$	483,924

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

6. INTANGIBLE ASSETS AND GOODWILL

Intangible Assets

Intangible assets consist of the following:

	March 31, 2011
	Gross Assets		Accumulated Amortization			Net		Amortization Life and Method
	(In thousands)
Finite Lived Assets
Customer contracts and lists	$	200,245	$	(119,127	)	$	81,118	5-10 years—straight line
Premium on purchased credit card portfolios		156,203		(68,035	)		88,168	3-10 years—straight line, accelerated
Collector database		72,150		(63,146	)		9,004	30 years—15% declining balance
Customer database		175,526		(81,194	)		94,332	4-10 years—straight line
Noncompete agreements		1,083		(787	)		296	2-3 years—straight line
Tradenames		14,197		(5,438	)		8,759	5-10 years—straight line
Purchased data lists		21,380		(13,359	)		8,021	1-5 years—straight line, accelerated
	$	640,784	$	(351,086	)	$	289,698
Indefinite Lived Assets
Tradenames		12,350		—			12,350	Indefinite life
Total intangible assets	$	653,134	$	(351,086	)	$	302,048

	December 31, 2010
	Gross Assets		Accumulated Amortization			Net		Amortization Life and Method
	(In thousands)
Finite Lived Assets
Customer contracts and lists	$	211,413	$	(123,932	)	$	87,481	5-10 years—straight line
Premium on purchased credit card portfolios		151,430		(63,115	)		88,315	3-10 years—straight line, accelerated
Collector database		70,211		(61,075	)		9,136	30 years—15% declining balance
Customer database		175,397		(76,002	)		99,395	4-10 years—straight line
Noncompete agreements		1,062		(668	)		394	2-3 years—straight line
Tradenames		14,169		(5,070	)		9,099	5-10 years—straight line
Purchased data lists		20,506		(12,285	)		8,221	1-5 years—straight line, accelerated
	$	644,188	$	(342,147	)	$	302,041
Indefinite Lived Assets
Tradenames		12,350		—			12,350	Indefinite life
Total intangible assets	$	656,538	$	(342,147	)	$	314,391

With the J.Jill portfolio acquisition, the Company acquired $4.8 million of intangible assets consisting of a customer relationship of $2.6 million and a marketing relationship of $2.2 million, which are being amortized, in each case, over a weighted average life of 7.0 years.

Goodwill

The changes in the carrying amount of goodwill for the three months ended March 31, 2011 are as follows:

	LoyaltyOne		Epsilon®		Private Label Services and Credit		Corporate/ Other		Total
	(In thousands)
December 31, 2010	$	246,930	$	713,161	$	261,732	$	—	$	1,221,823
Effects of foreign currency translation		6,507		652		—		—		7,159
March 31, 2011	$	253,437	$	713,813	$	261,732	$	—	$	1,228,982

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

7. DEBT

Debt consists of the following:

Description	March 31, 2011			December 31, 2010			Maturity	Interest Rate
	(Dollars in thousands)

Certificates of deposit:
Certificates of deposit	$	830,700		$	859,100		Six months to five years	0.30% to 5.25%
Less: current portion		(380,500	)		(442,600	)
Long-term portion	$	450,200		$	416,500

Asset-backed securities debt – owed to securitization investors:
Fixed rate asset-backed term note securities	$	1,772,815		$	1,772,815		Various - Nov 2011 – Jun 2015	3.79% to 7.00%
Floating rate asset-backed term note securities		1,153,500			1,153,500		Various - Sept 2011 – Apr 2013	(1)
Conduit asset-backed securities		373,103			733,827		Various - Jun 2011 – Sept 2011	1.51% to 2.60%
Total asset-backed securities – owed to securitization investors		3,299,418			3,660,142
Less: current portion		(1,383,103	)		(1,743,827	)
Long-term portion	$	1,916,315		$	1,916,315

Long-term and other debt:
Credit facility	$	426,000		$	300,000		March 2012	(2)
Series B senior notes		250,000			250,000		May 2011	6.14%
2009 term loan		161,000			161,000		March 2012	(3)
2010 term loan		236,000			236,000		March 2012	(4)
Convertible senior notes due 2013		671,931			659,371		August 2013	1.75%
Convertible senior notes due 2014		262,822			257,687		May 2014	4.75%
Capital lease obligations and other debt		1,401			5,714		Various - Apr 2011 – Jul 2013(5)	5.20% to 8.10%(5)
Total long-term and other debt		2,009,154			1,869,772
Less: current portion		(1,074,372	)		(255,679	)
Long-term portion	$	934,782		$	1,614,093

(1)

Interest rates include those for certain of the Company’s asset-backed securities – owed to securitization investors where floating rate debt is fixed through interest rate swap agreements. The interest rate for the floating rate debt is equal to the London Interbank Offered Rate (“LIBOR”) as defined in the respective agreements plus a margin of 0.1% to 2.5% as defined in the respective agreements. The weighted average interest rate of the fixed rate achieved through interest rate swap agreements is 4.16% at March 31, 2011.

(2)

The Company maintains a $750.0 million unsecured revolving credit facility (the “Credit Facility,”) where advances are in the form of either base rate loans or Eurodollar loans and may be denominated in Canadian dollars, subject to a sublimit, or U.S. dollars. The interest rate for base loans is the higher of (a) the Bank of Montreal’s prime rate, (b) the Federal funds rate plus 0.5%, and (c) the quoted LIBOR as defined in the credit agreement plus 1.0%. The interest rate for Eurodollar loans denominated in U.S. or Canadian dollars fluctuates based on the rate at which deposits of U.S. dollars or Canadian dollars, respectively, in the London interbank market are quoted plus a margin of 0.4% to 0.8% based upon the Company’s senior leverage ratio as defined in the Credit Facility. Total availability under the Credit Facility at March 31, 2011 was $324.0 million. At March 31, 2011, the weighted average interest rate was 1.02%.

(3)

Advances under the term loan agreement, dated May 15, 2009 (the “2009 Term Loan”), are in the form of either base rate loans or Eurodollar loans. The interest rate for base rate loans fluctuates and is equal to the highest of (a) Bank of Montreal’s prime rate; (b) the Federal funds rate plus 0.5%; and (c) LIBOR as defined in the 2009 Term Loan agreement plus 1.0%, in each case plus a margin of 2.0% to 3.0% based upon the Company’s senior leverage ratio as defined in the 2009 Term Loan agreement. The interest rate for Eurodollar loans fluctuates based on the rate at which deposits of U.S. dollars in the London interbank market are quoted plus a margin of 3.0% to 4.0% based on the Company’s senior leverage ratio as defined in the 2009 Term Loan. At March 31, 2011, the weighted average interest rate was 3.25%.

(4)

Advances under the term loan agreement, dated August 6, 2010 (the “2010 Term Loan”), are in the form of either base rate loans or Eurodollar loans. The interest rate for base rate loans fluctuates and is equal to the highest of (a) Bank of Montreal’s prime rate; (b) the Federal funds rate plus 0.5%; and (c) LIBOR as defined in the 2010 Term Loan agreement plus 1.0%, in each case plus a margin of 1.5% to 2.5% based upon the Company’s senior leverage ratio as defined in the 2010 Term Loan agreement. The interest rate for Eurodollar loans fluctuates based on the rate at which deposits of U.S. dollars in the London interbank market are quoted plus a margin of 2.5% to 3.5% based on the Company’s senior leverage ratio as defined in the 2010 Term Loan. At March 31, 2011, the weighted average interest rate was 2.76%.

(5)	The Company has other minor borrowings, primarily capital leases, with varying interest rates and maturities.

At March 31, 2011, the Company was in compliance with its covenants.

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Convertible Senior Notes

In the third quarter of 2008, the Company issued $805.0 million aggregate principal amount of Convertible Senior Notes 2013. In the second quarter of 2009, the Company issued $345.0 million aggregate principal amount of Convertible Senior Notes 2014. The table below summarizes the carrying value of the components of the convertible senior notes:

	March 31, 2011			December 31, 2010
	(In thousands)
Carrying amount of equity component	$	368,678		$	368,678

Principal amount of liability component	$	1,150,000		$	1,150,000
Unamortized discount		(215,247	)		(232,942	)
Net carrying value of liability component	$	934,753		$	917,058

If-converted value of common stock	$	1,503,776		$	1,243,605

The discount on the liability component will be amortized as interest expense over the remaining life of the convertible senior notes which, at March 31, 2011, is a weighted average period of 2.6 years.

Interest expense on the convertible senior notes recognized in the Company’s unaudited condensed consolidated statements of income for the three months ended March 31, 2011 and 2010 is as follows:

	Three Months Ended March 31,
	2011			2010
	(Dollars in thousands)
Interest expense calculated on contractual interest rate	$	7,619		$	7,619
Amortization of discount on liability component		17,695			15,861
Total interest expense on convertible senior notes	$	25,314		$	23,480
Effective interest rate (annualized)		11.0	%		11.0	%

Derivative Financial Instruments

As part of its interest rate risk management program, the Company may enter into derivative financial instruments with institutions that are established dealers and manage its exposure to changes in fair value of certain obligations attributable to changes in LIBOR.

The credit card securitization trusts enter into derivative financial instruments, which include both interest rate swaps and an interest rate cap, to mitigate their interest rate risk on a related financial instrument or to lock the interest rate on a portion of their variable asset-backed securities debt.

These interest rate contracts involve the receipt of variable rate amounts from counterparties in exchange for the Company making fixed rate payments over the life of the agreement without the exchange of the underlying notional amount. These interest rate contracts are not designated as hedges. Such contracts are not speculative and are used to manage interest rate risk, but do not meet the specific hedge accounting requirements of ASC 815, “Derivatives and Hedging.”

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The following tables identify the notional amount, fair value and classification of the Company’s outstanding interest rate contracts at March 31, 2011 and December 31, 2010 in the unaudited condensed consolidated balance sheets:

	March 31, 2011				December 31, 2010
	Notional Amount		Weighted Average Years to Maturity		Notional Amount		Weighted Average Years to Maturity
	(Dollars in thousands)

Interest rate contracts not designated as hedging instruments	$	1,153,500		1.48	$	1,153,500		1.72

	March 31, 2011			December 31, 2010
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
	(In thousands)
Interest rate contracts not designated as hedging instruments	Other current liabilities	$	2,595	Other current liabilities	$	4,574
Interest rate contracts not designated as hedging instruments	Other liabilities	$	57,344	Other liabilities	$	65,257

The following table summarizes activity related to and identifies the location of the Company’s outstanding interest rate contracts for the three months ended March 31, 2011 and March 31, 2010 recognized in the unaudited condensed consolidated statements of income:

	March 31, 2011			March 31, 2010
	Income Statement Location	Gain on Derivative Contracts		Income Statement Location	Loss on Derivative Contracts
	(In thousands)
Interest rate contracts not designated as hedging instruments	Securitization funding costs	$	9,892	Securitization funding costs	$	2,181

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, 2011, the Company does not maintain any derivative contracts subject to master agreements that would require the Company to post collateral or that contain any credit-risk related contingent features. The Company has provisions in certain of the master agreements that require counterparties to post collateral to the Company when their credit ratings fall below certain thresholds. At March 31, 2011, these thresholds were not breached and no amounts were held as collateral by the Company.

8. DEFERRED REVENUE

Because management has determined that the earnings process is not complete at the time an AIR MILES reward mile is issued, the recognition of revenue on all fees received at issuance is deferred. The Company allocates the proceeds from the issuance of AIR MILES reward miles into two components as follows:

Redemption element. The redemption element is the larger of the two components. Revenue related to the redemption element is based on the estimated fair value. For this component, revenue is recognized at the time an AIR MILES reward mile is redeemed, or for those AIR MILES reward miles that are estimated to go unredeemed by the collector base, known as “breakage,” over the estimated life of an AIR MILES reward mile. The Company’s estimate of breakage is 28%.

Service element. The service element consists of marketing and administrative services provided to sponsors. Revenue related to the service element has been determined in accordance with ASU 2009-13. It is initially deferred and then amortized pro rata over the estimated life of an AIR MILES reward mile. With the adoption of ASU 2009-13, the residual method will no longer be utilized for new sponsor agreements entered into on or after January 1, 2011 or existing sponsor agreements that are materially modified subsequent to that date; for these agreements, the Company will measure the service element at its estimated selling price.

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Under certain of the Company’s contracts, a portion of the proceeds is paid to the Company upon the issuance of an AIR MILES reward mile and a portion is paid at the time of redemption and therefore, the Company does not have a redemption obligation related to these contracts. Revenue is recognized at the time of redemption and is not reflected in the reconciliation of the redemption obligation detailed below. Under such contracts, the proceeds received at issuance are initially deferred as service revenue and revenue is recognized pro rata over the estimated life of an AIR MILES reward mile. Amounts for revenue related to the redemption element and service element are recorded in redemption revenue and transaction revenue, respectively, in the unaudited condensed consolidated statements of income.

A reconciliation of deferred revenue for the AIR MILES Reward Program is as follows:

	Deferred Revenue
	Service			Redemption			Total
	(In thousands)
December 31, 2010	$	339,514		$	881,728		$	1,221,242
Cash proceeds		51,787			119,169			170,956
Revenue recognized		(47,125	)		(140,650	)		(187,775	)
Other		—			451			451
Effects of foreign currency translation		9,453			24,009			33,462
March 31, 2011	$	353,629		$	884,707		$	1,238,336
Amounts recognized in the unaudited condensed consolidated balance sheets:
Current liabilities	$	169,224		$	884,707		$	1,053,931
Non-current liabilities	$	184,405		$	—		$	184,405

9. STOCKHOLDERS’ EQUITY

Stock Repurchase Program

On September 13, 2010, the Company’s Board of Directors authorized a stock repurchase program to acquire up to $400.0 million of the Company’s outstanding common stock from September 13, 2010 through December 31, 2011, subject to any restrictions pursuant to the terms of the Company’s credit agreements or otherwise.

For the three months ended March 31, 2011, the Company acquired a total of 856,363 shares of its common stock for $61.4 million. As of March 31, 2011, the Company has $266.6 million available under the stock repurchase program.

Stock Compensation Expense

Total stock-based compensation expense recognized in the Company’s unaudited condensed consolidated statements of income for the three months ended March 31, 2011 and 2010 is as follows:

	Three Months Ended March 31,
	2011		2010
	(In thousands)
Cost of operations	$	5,903	$	5,895
General and administrative		3,181		4,711
Total	$	9,084	$	10,606

During the three months ended March 31, 2011, the Company awarded 405,746 performance-based restricted stock units with a weighted average grant date fair value per share of $83.30 as determined on the date of grant. The performance restriction on the awards will lapse upon determination by the Board of Directors or the Compensation Committee of the Board of Directors that the Company’s earnings before taxes for the period from January 1, 2011 to December 31, 2011 met certain pre-defined vesting criteria that permit a range from 50% to 150% of such performance-based restricted stock units to vest. Upon such determination, the restrictions will lapse with respect to 33% of the award on February 21, 2012, an additional 33% of the award on February 21, 2013 and the final 34% of the award on February 21, 2014, provided that the participant is employed by the Company on each such vesting date.

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

During the three months ended March 31, 2011, the Company awarded 105,927 service-based restricted stock units with a weighted average grant date fair value per share of $83.07 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.

10. COMPREHENSIVE INCOME

The components of comprehensive income, net of tax effect, are as follows:

	Three Months Ended March 31,
	2011			2010
	(In thousands)
Net income	$	86,376		$	46,654
Adoption of ASC 860 and ASC 810 (1)		—			55,881
Unrealized loss on securities available-for-sale		(4,428	)		(5,701	)
Foreign currency translation adjustments (2)		(3,144	)		(7,638	)
Total comprehensive income, net of tax	$	78,804		$	89,196

(1)

These amounts related to retained interests in the WFN Trusts and the WFC Trust were previously reflected in accumulated other comprehensive income. Upon the adoption of ASC 860, “Transfers and Servicing,” and ASC 810, “Consolidation,” which was effective January 1, 2010, these interests and related accumulated other comprehensive income have been reclassified, derecognized or eliminated upon consolidation.

(2)	Primarily related to the impact of changes in the Canadian currency exchange rate.

11. FINANCIAL INSTRUMENTS

In accordance with ASC 825, “Financial Instruments,” the Company is required to disclose the fair value of financial instruments for which it is practical to estimate fair value. To obtain fair values, observable market prices are used if available. In some instances, observable market prices are not readily available and fair value is determined using present value or other techniques appropriate for a particular financial instrument. These techniques involve judgment and as a result are not necessarily indicative of the amounts the Company would realize in a current market exchange. The use of different assumptions or estimation techniques may have a material effect on the estimated fair value amounts.

Fair Value of Financial Instruments — The estimated fair values of the Company’s financial instruments are as follows:

	March 31, 2011				December 31, 2010
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
	(In thousands)
Financial assets
Cash and cash equivalents	$	300,362	$	300,362	$	139,114	$	139,114
Trade receivables, net		228,270		228,270		260,945		260,945
Credit card receivables, net		4,374,940		4,374,940		4,838,354		4,838,354
Redemption settlement assets, restricted		483,924		483,924		472,428		472,428
Cash collateral, restricted		318,333		318,333		185,754		185,754
Other investment securities		85,122		85,122		104,916		104,916
Financial liabilities
Accounts payable		113,349		113,349		121,856		121,856
Certificates of deposit		830,700		855,365		859,100		883,405
Asset-backed securities debt – owed to securitization investors		3,299,418		3,353,227		3,660,142		3,711,263
Long-term and other debt		2,009,154		2,713,578		1,869,772		2,393,124
Derivative financial instruments		59,939		59,939		69,831		69,831

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Fair Value of Assets and Liabilities Held at March 31, 2011 and December 31, 2010

The following techniques and assumptions were used by the Company in estimating fair values of financial instruments as disclosed herein:

Cash and cash equivalents, trade receivables, net and accounts payable — The carrying amount approximates fair value due to the short maturity.

Credit card receivables, net — The carrying amount of credit card receivables, net approximates fair value due to the short maturity, and the average interest rates approximate current market origination rates.

Redemption settlement assets, restricted — The fair value for securities is based on quoted market prices for the same or similar securities.

Cash collateral, restricted — The spread deposits are recorded at their fair value based on discounted cash flow models. The carrying amount of excess funding deposits approximates its fair value due to the relatively short maturity period and average interest rates, which approximate current market rates.

Other investment securities — Other investment securities consist primarily of U.S. Treasury and government securities. The fair value is based on quoted market prices for the same or similar securities.

Certificates of deposit — The fair value is estimated based on the current rates available to the Company for similar certificates of deposit with similar remaining maturities.

Asset-backed securities debt – owed to securitization investors — The fair value is estimated based on the current rates available to the Company for similar debt instruments with similar remaining maturities.

Long-term and other debt — The fair value is estimated based on the current rates available to the Company for similar debt instruments with similar remaining maturities.

Derivative financial instruments —The valuation of these instruments is determined using a discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and option volatility.

Assets and Liabilities Measured on a Recurring Basis

ASC 825 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include:

Level 1, defined as observable inputs such as quoted prices in active markets;

Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and

Level 3, defined as unobservable inputs where little or no market data exists, therefore requiring an entity to develop its own assumptions.

Financial instruments are considered Level 3 when their values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable. Level 3 financial instruments also include those for which the determination of fair value requires significant management judgment or estimation. The use of different techniques to determine fair value of these financial instruments could result in different estimates of fair value at the reporting date.

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The following tables provide the assets carried at fair value measured on a recurring basis as of March 31, 2011 and December 31, 2010:

			Fair Value Measurements at March 31, 2011 Using
	Balance at March 31, 2011		Level 1		Level 2		Level 3
	(In thousands)
Government bonds (1)	$	15,923	$	—	$	15,923	$	—
Corporate bonds (1)		407,423		99,345		308,078		—
Cash collateral, restricted		318,333		—		139,000		179,333
Other investment securities (2)		85,122		67,508		17,614		—
Total assets measured at fair value	$	826,801	$	166,853	$	480,615	$	179,333

Derivative financial instruments (3)	$	59,939	$	—	$	59,939	$	—
Total liabilities measured at fair value	$	59,939	$	—	$	59,939	$	—

			Fair Value Measurements at December 31, 2010 Using
	Balance at December 31, 2010		Level 1		Level 2		Level 3
	(In thousands)
Government bonds (1)	$	15,362	$	—	$	15,362	$	—
Corporate bonds (1)		382,454		164,706		217,748		—
Cash collateral, restricted		185,754		—		—		185,754
Other investment securities (2)		104,916		86,881		18,035		—
Total assets measured at fair value	$	688,486	$	251,587	$	251,145	$	185,754

Derivative financial instruments (3)	$	69,831	$	—	$	69,831	$	—
Total liabilities measured at fair value	$	69,831	$	—	$	69,831	$	—

(1)	Amounts are included in redemption settlement assets in the unaudited condensed consolidated balance sheets.

(2)	Amounts are included in other current assets and other non-current assets in the unaudited condensed consolidated balance sheets.

(3)	Amounts are included in other current liabilities and other liabilities in the unaudited condensed consolidated balance sheets.

The following tables summarize the changes in fair value of the Company’s assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as defined in ASC 825 as of March 31, 2011 and 2010:

	Cash Collateral, Restricted
	(In thousands)
December 31, 2010	$	185,754
Total gains (realized or unrealized):
Included in earnings		332
Purchases		2,291
Settlements		(9,044	)
Transfers in or out of Level 3		—
March 31, 2011	$	179,333

Gains for the period included in earnings attributable to the change in unrealized gains or losses related to assets still held at March 31, 2011	$	332

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

	Corporate Bonds			Seller’s Interest			Due from Securitizations			Cash Collateral, Restricted
	(In thousands)
December 31, 2009	$	73,866		$	297,108		$	775,570		$	206,678
Adoption of ASC 860 and ASC 810		(73,866	)		(297,108	)		(775,570	)		—
Total gains (realized or unrealized):
Included in earnings		—			—			—			33
Purchases, sales, issuances and settlements		—			—			—			(23,011	)
Transfers in or out of Level 3		—			—			—			—
March 31, 2010	$	—		$	—		$	—		$	183,700

Gains for the period included in earnings attributable to the change in unrealized gains or losses related to assets still held at March 31, 2010	$	—		$	—		$	—		$	33

For the three months ended March 31, 2011 and 2010, gains included in earnings attributable to cash collateral, restricted are included in revenue under finance charges, net in the unaudited condensed consolidated statements of income.

Assets and Liabilities Measured on a Non-Recurring Basis

The Company also has assets that under certain conditions are subject to measurement at fair value on a non-recurring basis. These assets include those associated with acquired businesses, including goodwill and other intangible assets. For these assets, measurement at fair value in periods subsequent to their initial recognition is applicable if one or more is determined to be impaired. During the three months ended March 31, 2011, the Company had no impairments related to these assets.

12. INCOME TAXES

For the three months ended March 31, 2011 and 2010, the Company utilized an effective tax rate of 38.5% and 38.2%, respectively, to calculate its provision for income taxes. In accordance with ASC 740-270, “Income taxes — Interim Reporting,” the Company’s expected annual effective tax rate for calendar year 2011 based on all known variables is 38.5%.

13. SEGMENT INFORMATION

The Company operates in three reportable segments: LoyaltyOne, Epsilon and Private Label Services and Credit.

LoyaltyOne includes the Company’s Canadian AIR MILES Reward Program;

Epsilon provides integrated direct marketing solutions that combine database marketing technology and analytics with a broad range of direct marketing services; and

Private Label Services and Credit provides risk management solutions, account origination, funding, transaction processing, customer care and collections services for the Company’s private label retail credit card programs.

Index

ALLIANCE DATA SYSTEMS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Additionally, corporate and all other immaterial businesses are reported collectively as an “all other” category labeled “Corporate/Other.” Total interest expense, net and income taxes are not allocated to the segments in the computation of segment operating profit for internal evaluation purposes and are included in “Corporate/Other.” Total assets are not allocated to the segments.

Three Months Ended March 31, 2011	LoyaltyOne		Epsilon		Private Label Services and Credit		Corporate/ Other			Eliminations			Total
	(In thousands)
Revenues	$	217,674	$	155,684	$	368,910	$	357		$	(2,189	)	$	740,436
Adjusted EBITDA (1)		58,251		33,666		183,330		(17,403	)		(1,454	)		256,390
Depreciation and amortization		5,183		19,899		9,010		1,306			—			35,398
Stock compensation expense		1,967		2,293		1,644		3,180			—			9,084
Operating income (loss)		51,101		11,474		172,676		(21,889	)		(1,454	)		211,908
Interest expense, net		—		—		—		71,459			—			71,459
Income (loss) before income taxes		51,101		11,474		172,676		(93,348	)		(1,454	)		140,449

Three Months Ended March 31, 2010	LoyaltyOne		Epsilon		Private Label Services and Credit		Corporate/ Other			Eliminations			Total
	(In thousands)
Revenues	$	199,670	$	126,307	$	339,204	$	765		$	(2,409	)	$	663,537
Adjusted EBITDA (1)		53,587		27,286		139,755		(15,940	)		(1,713	)		202,975
Depreciation and amortization		6,137		18,016		8,489		1,529			—			34,171
Stock compensation expense		2,163		1,970		1,762		4,711			—			10,606
Operating income (loss)		45,287		7,300