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 September 30, 2011
   
OR
 
£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the transition period from          to          

Commission File Number: 001-15749
 
________________
 
ALLIANCE DATA SYSTEMS CORPORATION
(Exact Name of Registrant as Specified in its Charter)

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

7500 Dallas Parkway, Suite 700
Plano, Texas 75024
(Address of Principal Executive Office, Including Zip Code)

(214) 494-3000
(Registrant’s Telephone Number, Including Area Code)
 
________________
 

 

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

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

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

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

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

As of November 2, 2011, 49,968,460 shares of common stock were outstanding.
 


 
 
 
 
ALLIANCE DATA SYSTEMS CORPORATION
 
INDEX
 
 
 
 
 
Page
Number
Part I: FINANCIAL INFORMATION
 
Item 1.
Financial Statements (unaudited)
 
 
3
 
4
 
5
 
6
Item 2.
27
Item 3.
42
Item 4.
42
Part II: OTHER INFORMATION
 
Item 1.
43
Item 1A.
43
Item 2.
43
Item 3.
43
Item 4.
43
Item 5.
43
Item 6.
44
46
 
 
2
 
 
PART I
 
Item 1.    Financial Statements.
 
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
 
   
September 30,
2011
   
December 31,
2010
 
   
(In thousands)
 
ASSETS
 
Cash and cash equivalents
 
$
239,570
   
$
139,114
 
Trade receivables, less allowance for doubtful accounts ($3,835 and $4,350 at September 30, 2011 and
December 31, 2010, respectively)
   
265,156
     
260,945
 
Credit card receivables:
               
Credit card receivables – restricted for securitization investors
   
4,342,167
     
4,795,753
 
Other credit card receivables
   
632,660
     
560,670
 
Total credit card receivables
   
4,974,827
     
5,356,423
 
Allowance for loan loss
   
(448,665
)
   
(518,069
)
Credit card receivables, net
   
4,526,162
     
4,838,354
 
Deferred tax asset, net
   
251,820
     
279,752
 
Other current assets
   
166,125
     
127,022
 
Redemption settlement assets, restricted
   
448,634
     
472,428
 
Assets of discontinued operations
   
3,851
     
11,920
 
Total current assets
   
5,901,318
     
6,129,535
 
Property and equipment, net
   
182,069
     
170,627
 
Deferred tax asset, net
   
44,737
     
46,218
 
Cash collateral, restricted
   
654,705
     
185,754
 
Intangible assets, net
   
403,269
     
314,391
 
Goodwill
   
1,442,696
     
1,221,823
 
Other non-current assets
   
141,126
     
203,804
 
Total assets
 
$
8,769,920
   
$
8,272,152
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
Accounts payable
 
$
122,055
   
$
121,856
 
Accrued expenses
   
223,449
     
168,578
 
Certificates of deposit
   
752,532
     
442,600
 
Asset-backed securities debt – owed to securitization investors
   
1,769,122
     
1,743,827
 
Current debt
   
19,834
     
255,679
 
Other current liabilities
   
99,836
     
85,179
 
Deferred revenue
   
995,122
     
1,044,469
 
Total current liabilities
   
3,981,950
     
3,862,188
 
Deferred revenue
   
179,195
     
176,773
 
Deferred tax liability, net
   
112,216
     
82,637
 
Certificates of deposit
   
616,473
     
416,500
 
Asset-backed securities debt – owed to securitization investors
   
1,314,165
     
1,916,315
 
Long-term and other debt
   
2,234,386
     
1,614,093
 
Other liabilities
   
185,520
     
180,552
 
Total liabilities
   
8,623,905
     
8,249,058
 
Commitments and contingencies (Note 17)
               
Stockholders’ equity:
               
Common stock, $0.01 par value; authorized, 200,000 shares; issued, 93,977 shares and 92,797 shares at September 30, 2011 and December 31, 2010, respectively
   
940
     
928
 
Additional paid-in capital
   
1,365,235
     
1,320,767
 
Treasury stock, at cost, 43,739 shares and 41,426 shares at September 30, 2011 and December 31, 2010, respectively
   
(2,267,553
)
   
(2,079,819
)
Retained earnings
   
1,065,098
     
815,718
 
Accumulated other comprehensive loss
   
(17,705
)
   
(34,500
)
Total stockholders’ equity
   
146,015
     
23,094
 
Total liabilities and stockholders’ equity
 
$
8,769,920
   
$
8,272,152
 
 
See accompanying notes to unaudited condensed consolidated financial statements.

 
3
 
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
 
   
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
   
2011
   
2010
 
2011
   
2010
 
   
(In thousands, except per share amounts)
 
Revenues
                         
Transaction
 
$
74,712
   
$
68,150
 
$
221,352
   
$
214,092
 
Redemption
   
141,152
     
120,424
   
424,254
     
386,810
 
Finance charges, net
   
365,925
     
327,677
   
1,040,339
     
953,303
 
Database marketing fees and direct marketing services
   
230,350
     
167,083
   
565,324
     
427,246
 
Other revenue
   
32,705
     
19,109
   
74,469
     
54,247
 
Total revenue
   
844,844
     
702,443
   
2,325,738
     
2,035,698
 
Operating expenses
                     
Cost of operations
   
476,993
     
385,201
   
1,312,768
     
1,104,913
 
Provision for loan loss
   
70,697
     
89,559
   
198,739
     
272,259
 
General and administrative
   
26,242
     
19,767
   
68,202
     
63,440
 
Depreciation and other amortization
   
20,304
     
17,196
   
53,908
     
50,101
 
Amortization of purchased intangibles
   
22,929
     
20,711
   
60,743
     
56,398
 
Total operating expenses
   
617,165
     
532,434
   
1,694,360
     
1,547,111
 
Operating income
   
227,679
     
170,009
   
631,378
     
488,587
 
Interest expense
               
Securitization funding costs
   
30,233
     
43,026
   
96,281
     
128,251
 
Interest expense on certificates of deposit
   
5,645
     
7,317
   
16,832
     
23,519
 
Interest expense on long-term and other debt, net
   
38,478
     
33,776
   
111,496
     
98,903
 
Total interest expense, net
   
74,356
     
84,119
   
224,609
     
250,673
 
Income before income tax
 
$
153,323
   
$
85,890
 
$
406,769
   
$
237,914
 
Provision for income taxes
   
59,342
     
32,831
   
157,389
     
90,881
 
Net income
 
$
93,981
   
$
53,059
 
$
249,380
   
$
147,033
 
                               
Basic income per share
 
$
1.86
   
$
1.01
 
$
4.89
   
$
2.79
 
Diluted income per share
 
$
1.60
   
$
0.96
 
$
4.35
   
$
2.63
 
                               
Weighted average shares
               
Basic
   
50,644
     
52,584
   
50,948
     
52,743
 
Diluted
   
58,579
     
55,218
   
57,377
     
55,820
 
                               
 
See accompanying notes to unaudited condensed consolidated financial statements.

 
4
 
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
   
Nine Months Ended
September 30,
 
   
2011
   
2010
 
   
(In thousands)
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
Net income                                                                                                                      
 
$
249,380
   
$
147,033
 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
Depreciation and amortization                                                                                                                   
   
114,651
     
106,499
 
Deferred income taxes                                                                                                                   
   
(221
)
   
24,044
 
Provision for loan loss                                                                                                                   
   
198,739
     
272,259
 
Non-cash stock compensation                                                                                                                   
   
32,471
     
33,996
 
Fair value (gain) loss on interest-rate derivatives                                                                                                                   
   
(23,146
)
   
5,443
 
Amortization of discount on convertible senior notes                                                                                                                   
   
54,574
     
48,914
 
Change in operating assets and liabilities, net of acquisitions:
 
Change in trade accounts receivable                                                                                                                   
   
1,188
     
(20,927
)
Change in other assets                                                                                                                   
   
43,402
     
36,975
 
Change in accounts payable and accrued expenses                                                                                                                   
   
44,739
     
33,220
 
Change in deferred revenue                                                                                                                   
   
15,869
     
9,079
 
Change in other liabilities                                                                                                                   
   
37,411
     
13,551
 
Excess tax benefits from stock-based compensation                                                                                                                      
   
(12,103
)
   
(12,713
)
Other                                                                                                                      
   
5,546
     
(3,869
)
Net cash provided by operating activities
   
762,500
     
693,504
 
   
CASH FLOWS FROM INVESTING ACTIVITIES:
 
Change in redemption settlement assets                                                                                                                      
   
4,353
     
21,964
 
Payments for acquired businesses, net of cash                                                                                                                      
   
(359,076
)
   
(117,000
)
Change in cash collateral, restricted                                                                                                                      
   
(468,690
)
   
12,530
 
Change in credit card receivables                                                                                                                      
   
160,592
     
273,925
 
Change in restricted cash                                                                                                                      
   
98,408
     
24,064
 
Purchase of credit card receivables                                                                                                                      
   
(42,696
)
   
 
Capital expenditures                                                                                                                      
   
(48,536
)
   
(48,296
)
Investments in marketable securities, net                                                                                                                      
   
(68,191
)
   
(4,950
)
Investments in the stock of investees                                                                                                                      
   
(17,974
)
   
 
Other                                                                                                                      
   
     
1,918
 
Net cash (used in) provided by investing activities
   
(741,810
)
   
164,155
 
   
CASH FLOWS FROM FINANCING ACTIVITIES:
 
Borrowings under debt agreements                                                                                                                      
   
2,858,500
     
1,205,000
 
Repayments of borrowings                                                                                                                      
   
(2,524,729
)
   
(1,089,549
)
Issuances of certificates of deposit                                                                                                                      
   
842,505
     
94,000
 
Repayments of certificates of deposit                                                                                                                      
   
(332,600
)
   
(592,200
)
Borrowings from asset-backed securities                                                                                                                      
   
1,126,921
     
833,126
 
Repayments/maturities of asset-backed securities                                                                                                                      
   
(1,703,776
)
   
(1,157,235
)
Payment of capital lease obligations                                                                                                                      
   
(3,920
)
   
(17,272
)
Payment of deferred financing costs                                                                                                                      
   
(27,366
)
   
(3,025
)
Excess tax benefits from stock-based compensation                                                                                                                      
   
12,103
     
12,713
 
Proceeds from issuance of common stock                                                                                                                      
   
22,942
     
31,848
 
Purchase of treasury shares                                                                                                                      
   
(186,320
)
   
(76,742
)
Net cash provided by (used in) financing activities
   
84,260
     
(759,336
)
   
Effect of exchange rate changes on cash and cash equivalents
   
(4,494
)
   
(2,028
)
Change in cash and cash equivalents
   
100,456
     
96,295
 
   
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                                                                                                                
 
$
239,570
   
$
391,226
 
   
SUPPLEMENTAL CASH FLOW INFORMATION:
 
Interest paid                                                                                                                      
 
$
177,301
   
$
176,335
 
Income taxes paid, net                                                                                                                      
 
$
87,185
   
$
26,497
 
   
 
See accompanying notes to unaudited condensed consolidated financial statements.
 
 
5
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
1. BASIS OF PRESENTATION
 
The unaudited condensed consolidated financial statements included herein have been prepared by Alliance Data Systems Corporation (“ADSC” or, including its wholly owned subsidiaries and its consolidated variable interest entities, the “Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report filed on Form 10-K for the year ended December 31, 2010, filed with the SEC on February 28, 2011. With respect to information concerning principal geographic areas, revenues are attributed to respective countries based on the location of the subsidiary, which generally correlates with the location of the customer.
 
The unaudited condensed consolidated financial statements included herein reflect all adjustments (consisting of normal, recurring adjustments) which are, in the opinion of management, necessary to state fairly the results for the interim periods presented. The results of operations for the interim periods presented are not necessarily indicative of the operating results to be expected for any subsequent interim period or for the fiscal year.
 
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect (1) the reported amounts of assets; (2) liabilities and disclosure of contingent assets and liabilities at the date of the financial statements; and (3) the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. For purposes of comparability, fraud losses of $0.9 million and $2.8 million for the three and nine months ended September 30, 2010, respectively, have been reclassified from provision for loan loss to cost of operations in the prior period financial statements to conform to the current year presentation. Such reclassifications have no impact on previously reported net income.
 
2. RECENT ACCOUNTING PRONOUNCEMENTS
 
In October 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2009-13, “Multiple-Deliverable Revenue Arrangements,” which supersedes certain guidance in Accounting Standards Codification (“ASC”) 605-25, “Revenue Recognition — Multiple-Element Arrangements,” and requires an entity to allocate arrangement consideration at the inception of an arrangement to all of its deliverables based on their relative selling prices (the relative-selling-price method). ASU 2009-13 eliminates the use of the residual method of allocation and requires the relative-selling-price method in all circumstances in which an entity recognizes revenue for an arrangement with multiple deliverables subject to ASU 2009-13. ASU 2009-13 is effective for revenue arrangements entered into or materially modified beginning on or after January 1, 2011. The Company elected to adopt this ASU prospectively. Revenue associated with the service element of the Company’s AIR MILES® Reward Program has historically been determined using the residual method. Based on the sponsor contracts expected to be signed, renewed or materially modified in 2011, the adoption of ASU 2009-13 did not and is not expected to have a material impact on the Company’s unaudited condensed consolidated financial statements for 2011. Should one of the AIR MILES Reward Program’s top five sponsors materially modify its agreement with the Company in 2011, it could significantly shift the allocation of deferred revenue between the service element and redemption element. This change in allocation between the deferred revenue elements could impact the timing of revenue recognition, as the redemption element is recognized as AIR MILES reward miles are redeemed while the service element is recognized on a pro-rata basis over the estimated life of an AIR MILES reward mile, or 42 months.
 
In April 2011, the FASB issued ASU 2011-02, “Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” ASU 2011-02 provides additional guidance to creditors for evaluating whether a modification or restructuring of a receivable is a Troubled Debt Restructuring (“TDR”) and also requires additional disclosures about TDR activities along with the disclosures required by ASU 2010-20, “Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses,” that were previously deferred. The amendments in ASU 2011-02 were effective for the first interim or annual period beginning on or after June 15, 2011 and are applied retrospectively to the beginning of the annual period of adoption. For purposes of measuring impairment of receivables that are newly considered impaired as a
 
 
6
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
result of ASU 2011-02, the amendments are applied prospectively for the first interim or annual period beginning on or after June 15, 2011. The adoption of ASU 2011-02 did not have a material impact on the Company’s financial condition, results of operations or cash flows.
 
In May 2011, the FASB issued ASU 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”)”, which amends ASC 820, “Fair Value Measurement.” ASU 2011-04 revises the application of the valuation premise of highest and best use of an asset. It also enhances disclosure requirements and will require entities to disclose, for their recurring Level 3 fair value measurements, quantitative information about unobservable inputs used, a description of the valuation processes used by the entity and a qualitative discussion about the sensitivity of the measurements. ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011 and will require prospective application. The Company does not expect the adoption of ASU 2011-04 to have a material impact on the Company’s financial condition, results of operations or cash flows.
 
In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220): Presentation of Comprehensive Income.” ASU 2011-05 eliminates the current option to report other comprehensive income and its components in the statement of changes in equity and requires the presentation of net income and other comprehensive income in one continuous statement or in two separate, but consecutive, statements. ASU 2011-05 is effective for interim and annual periods beginning after December 31, 2011. Early adoption is permitted but full retrospective application is required. ASU 2011-05 only impacts financial statement presentation; accordingly, it will have no impact on the Company’s financial condition, results of operations or cash flows.
 
In September 2011, the FASB issued ASU 2011-08, “Intangibles – Goodwill and Other (Topic 350): Testing Goodwill for Impairment,” which amends ASC 350, “Intangibles – Goodwill and Other.” ASU 2011-08 adds a qualitative assessment to the annual goodwill impairment test, providing the option of first performing a qualitative assessment in testing goodwill for impairment before calculating the fair value of the reporting unit. A company will be required to perform the current quantitative two-step impairment test if, based on the qualitative assessment, it determines that more likely than not, the fair value of the reporting unit is not less than the carrying value. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. ASU 2011-08 only impacts the process of testing goodwill for impairment; accordingly, it will have no impact on the Company’s financial condition, results of operations or cash flows.

3. SHARES USED IN COMPUTING NET INCOME PER SHARE
 
The following table sets forth the computation of basic and diluted net income per share for the periods indicated:
 
   
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
   
2011
   
2010
 
2011
   
2010
 
       
(In thousands, except per share amounts)
     
Numerator:
                         
Net Income
 
$
93,981
   
$
53,059
 
$
249,380
   
$
147,033
 
Denominator:
                     
Weighted average shares, basic
   
50,644
     
52,584
   
50,948
     
52,743
 
Weighted average effect of dilutive securities:
               
Shares from assumed conversion of convertible senior notes
   
5,138
     
1,454
   
4,195
     
1,785
 
Shares from assumed conversion of convertible note warrants
   
1,750
     
   
1,306
     
 
Net effect of dilutive stock options and unvested restricted stock
   
1,047
     
1,180
   
928
     
1,292
 
Denominator for diluted calculations
   
58,579
     
55,218
   
57,377
     
55,820
 
                               
Basic net income per share
 
$
1.86
   
$
1.01
 
$
4.89
   
$
2.79
 
Diluted net income per share
 
$
1.60
   
$
0.96
 
$
4.35
   
$
2.63
 

 
7
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
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.
 
Concurrently with the issuance of the Convertible Senior Notes 2013 and the Convertible Senior Notes 2014, the Company entered into hedge transactions which are generally expected to offset the potential dilution of the shares from assumed conversion of convertible senior notes.
 
The Company is also party to prepaid forward contracts to purchase 1,857,400 shares of its common stock that are to be delivered over a settlement period in 2014. The number of shares to be delivered under the prepaid forward contracts is used to reduce weighted-average basic and diluted shares outstanding.
 
For the three and nine months ended September 30, 2011, the Company excluded 10.3 million warrants, respectively, from the calculation of net income per share as the effect was anti-dilutive. For the three and nine months ended September 30, 2010, the Company excluded 17.5 million warrants, respectively, from the calculation of net income per share as the effect was anti-dilutive.
 
4. ACQUISITION
 
On May 31, 2011, the Company acquired all of the stock of Aspen Marketing Holdings, Inc. (“Aspen”). Aspen specializes in a full range of digital and direct marketing services, including the use of advanced analytics to perform data-driven customer acquisition and retention campaigns. Aspen is also a leading provider of marketing agency services, with expertise in the automotive and telecommunications industries. The results of Aspen have been included since the date of acquisition and are reflected in the Company’s Epsilon® segment. The acquisition enhances Epsilon’s core capabilities, strengthens its competitive advantage, expands Epsilon into new industry verticals and adds a strong, talented team of marketing professionals.
 
The final purchase price for Aspen was $359.1 million, net of $13.5 million of cash and cash equivalents acquired. The purchase was subject to customary working capital adjustments, which were finalized in August 2011, resulting in a $0.9 million increase to goodwill. The goodwill resulting from the acquisition is not deductible for tax purposes. The following table summarizes the allocation of the consideration and the respective fair values of the assets acquired and liabilities assumed in the Aspen acquisition as of the date of purchase:
 
   
As of May 31, 2011
 
   
(In thousands)
 
Current assets
 
$
39,924
 
Property and equipment
   
4,829
 
Other assets
   
1,600
 
Capitalized software                                                                                                        
   
24,000
 
Intangible assets
   
140,000
 
Goodwill
   
232,910
 
Total assets acquired
   
443,263
 
       
Current liabilities
   
30,099
 
Other liabilities
   
3,904
 
Deferred tax liabilities
   
50,184
 
Total liabilities assumed
   
84,187
 
       
Net assets acquired
 
$
359,076
 
 
As part of the acquisition, the Company assumed two interest rate caps with a notional amount of $42.5 million that were to mature November 2012. The derivatives did not qualify for hedge accounting treatment and were terminated in July 2011. The fair value of the derivatives from May 31, 2011 through termination was de minimis.
 
Additionally, at the date of the acquisition, Aspen had a tax net operating loss carryforward totaling approximately $140 million resulting from a previous merger. This potential tax benefit is contingent on the prior merger qualifying as a reorganization under Internal Revenue Code section 368. At this time, the potential tax benefits from the tax net operating loss carryforward have not been recognized in the Company’s unaudited condensed consolidated financial statements.

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

5. CREDIT CARD RECEIVABLES
 
The Company’s credit card receivables are the only portfolio segment or class of financing receivables. Quantitative information about the components of total credit card receivables is presented in the table below:
 
   
September 30,
2011
   
December 31,
2010
 
   
(In thousands)
 
Principal receivables
 
$
4,741,569
   
$
5,116,111
 
Billed and accrued finance charges
   
205,412
     
214,643
 
Other receivables
   
27,846
     
25,669
 
Total credit card receivables
   
4,974,827
     
5,356,423
 
Less credit card receivables – restricted for securitization investors
   
4,342,167
     
4,795,753
 
Other credit card receivables
 
$
632,660
   
$
560,670
 
 
Allowance for Loan Loss
 
The Company maintains an allowance for loan loss at a level that is appropriate to absorb probable losses inherent in credit card receivables. The allowance for loan loss covers forecasted uncollectable principal as well as unpaid interest and fees. The allowance for loan loss is evaluated monthly for adequacy.
 
In estimating the allowance for principal loan losses, management utilizes a migration analysis of delinquent and current credit card receivables. Migration analysis is a technique used to estimate the likelihood that a credit card receivable will progress through the various stages of delinquency and to charge-off. The allowance is maintained through an adjustment to the provision for loan losses. Charge-offs of principal amounts, net of recoveries are deducted from the allowance.
 
Net charge-offs include the principal amount of losses from credit cardholders unwilling or unable to pay their account balances, as well as bankrupt and deceased credit cardholders, less recoveries and exclude charged-off interest, fees and fraud losses. Charged-off interest and fees reduce finance charges, net while fraud losses are recorded as an expense. Credit card receivables, including unpaid interest and fees, are charged-off at the end of the month during which an account becomes 180 days contractually past due, except in the case of customer bankruptcies or death. Credit card receivables, including unpaid interest and fees, associated with customer bankruptcies or death are charged-off at the end of each month subsequent to 60 days after the receipt of notification of the bankruptcy or death, but in any case, not later than the 180-day contractual time frame.
 
The Company records the actual charge-offs for unpaid interest and fees as a reduction to finance charges, net. For the three and nine months ended September 30, 2011 and 2010, actual charge-offs for unpaid interest and fees were $43.3 million, $147.8 million and $49.3 million, $163.8 million, respectively. In estimating the allowance for uncollectable unpaid interest and fees, the Company utilizes historical charge-off trends, analyzing actual charge-offs for the prior three months. The allowance is maintained through an adjustment to finance charges, net.
 
 
9
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
In evaluating the allowance for loan loss for both principal and unpaid interest and fees, management also considers factors that may impact loan loss experience, including seasoning, loan volume and amounts, payment rates and forecasting uncertainties. The following table presents the Company’s allowance for loan loss for the periods indicated:
 
   
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
   
2011
   
2010
 
2011
   
2010
 
   
(In thousands)
 
Balance at beginning of period
 
$
461,015
   
$
526,845
 
$
518,069
   
$
54,884
 
Adoption of ASC 860 and ASC 810
   
     
   
     
523,950
 
Provision for loan loss
   
70,697
     
89,559
   
198,739
     
272,259
 
Change in estimate for uncollectible unpaid interest and fees
   
(5,000
)
   
   
(5,000
)
   
 
Recoveries
   
20,858
     
18,762
   
68,600
     
61,546
 
Principal charge-offs
   
(93,905
)
   
(120,870
)
 
(326,743
)
   
(398,343
)
Other
   
(5,000
)
   
   
(5,000
)
   
 
Balance at end of period
 
$
448,665
   
$
514,296
 
$
448,665
   
$
514,296
 
 
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 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:
 
   
September 30,
2011
   
% of
Total
   
December 31,
2010
   
% of
Total
 
           
(In thousands, except percentages)
         
Receivables outstanding – principal
 
$
4,741,569
     
100
%
 
$
5,116,111
     
100
%
Principal receivables balances contractually delinquent:
                               
31 to 60 days
   
79,154
     
1.6
%
   
87,252
     
1.7
%
61 to 90 days
   
50,624
     
1.1
     
59,564
     
1.2
 
91 or more days
   
103,230
     
2.2
     
130,538
     
2.5
 
Total
 
$
233,008
     
4.9
%
 
$
277,354
     
5.4
%
 
Modified Credit Card Receivables
 
The Company holds certain credit card receivables for which the terms have been modified. Interest income on these modified loans is accounted for in the same manner as other accruing loans. Cash collections on these modified loans are allocated according to the same payment hierarchy methodology applied to loans that are not in such programs. 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
 
 
10
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
cards with the allowance determined under the contingent loss model of ASC 450-20, “Loss Contingencies.” If the Company applied accounting standards under ASC 310-40, “Troubled Debt Restructurings by Creditors,” to loans in these programs, there would not be a significant difference in the allowance for loan loss. Credit card receivables for which temporary and permanent concessions were granted comprised $126.2 million, or less than 3%, of the Company’s total credit card receivables at September 30, 2011.
 
The following tables indicate the modifications related to troubled debt restructurings within credit card receivables as of the three and nine months ended September 30, 2011:
 
   
Three Months Ended September 30, 2011
     
Nine Months Ended September 30, 2011
 
   
Number of Restructurings
   
Pre-modification Outstanding Principal Balance
   
Post-modification Outstanding Principal Balance
     
Number of Restructurings
   
Pre-modification Outstanding Principal Balance
   
Post-modification Outstanding Principal Balance
 
     
(Dollars in thousands)
 
Troubled debt restructurings – credit card receivables
   
36,576
   
$
32,665
   
$
31,398
       
119,614
   
$
104,483
   
$
101,019
 
                                                   
 

 
   
Three Months Ended September 30, 2011 
   
Nine Months Ended September 30, 2011 
 
   
Number of Restructurings
   
Outstanding Balance
   
Number of Restructurings
   
Outstanding Balance
 
   
(Dollars in thousands)
 
Troubled debt restructurings that subsequently defaulted – credit card receivables(1)
   
12,627
   
$
11,413
     
20,899
   
$
18,953
 
                                 
 
(1)
Represents those troubled debt restructurings that occurred since January 1, 2011 that have defaulted during the reporting period.
 
Age of Credit Card Receivables
 
The following table sets forth, as of September 30, 2011, the number of active credit card accounts with balances and the related principal balances outstanding based upon the age of the active credit card accounts from origination:
 
Age Since Origination
 
Number of Active Accounts with Balances
   
Percentage of Active Accounts with Balances
   
Principal Receivables Outstanding
   
Percentage of Receivables Outstanding
 
   
(Dollars in thousands)
 
0-12 Months
   
2,883,748
     
24.8
%
 
$
929,383
     
19.6
%
13-24 Months
   
1,516,285
     
13.1
     
603,421
     
12.7
 
25-36 Months
   
1,198,243
     
10.3
     
573,477
     
12.1
 
37-48 Months
   
957,825
     
8.2
     
427,124
     
9.0
 
49-60 Months
   
793,908
     
6.8
     
358,624
     
7.6
 
Over 60 Months
   
4,269,538
     
36.8
     
1,849,540
     
39.0
 
Total
   
11,619,547
     
100.0
%
 
$
4,741,569
     
100.0
%
 
 
11
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
Credit Quality
 
The Company uses proprietary scoring models developed specifically for the purpose of monitoring the Company’s obligor credit quality. The proprietary scoring 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 September 30, 2011:
 
Probability of an Account Becoming 90 or More Days Past Due or Becoming Charged off (within the next 12 months)
 
Total Principal Receivables Outstanding
   
Percentage of Principal Receivables Outstanding
 
   
(In thousands, except percentages)
 
No Score
 
$
80,233
     
1.7
%
27.1% and higher
   
274,486
     
5.8
 
17.1% - 27.0%
   
467,977
     
9.9
 
12.6% - 17.0%
   
561,270
     
11.8
 
3.7% - 12.5%
   
1,951,653
     
41.2
 
1.9% - 3.6%
   
916,800
     
19.3
 
Lower than 1.9%
   
489,150
     
10.3
 
Total
 
$
4,741,569
     
100.0
%
 
Securitized Credit Card Receivables
 
The Company regularly securitizes its credit card receivables through its credit card securitization trusts, consisting of World Financial Network Credit Card Master Trust, World Financial Network Credit Card Master Note Trust, World Financial Network Credit Card Master Note Trust II and World Financial Network Credit Card Master Trust III (collectively, the “WFN Trusts”), and World Financial Capital Credit Card Master Note Trust (the “WFC Trust”). The Company continues to own and service the accounts that generate credit card receivables held by the WFN Trusts and the WFC Trust. In its capacity as a servicer, each of the respective banks earns a fee from the WFN Trusts and the WFC Trust to service and administer the credit card receivables, collect payments, and charge-off uncollectable receivables. These fees are eliminated and therefore are not reflected in the unaudited condensed consolidated statements of income for the three and nine months ended September 30, 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.
 
The tables below present quantitative information about the components of total securitized credit card receivables, delinquencies and net charge-offs:
 
   
September 30,
2011
   
December 31,
2010
 
   
(In thousands)
 
Total credit card receivables – restricted for securitization investors
 
$
4,342,167
   
$
4,795,753
 
Principal amount of credit card receivables – restricted for securitization investors, 90 days or more past due
 
$
93,820
   
$
117,594
 
 
 
   
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
   
2011
   
2010
 
2011
   
2010
 
   
(In thousands)
 
Net charge-offs of securitized principal
 
$
65,993
   
$
91,467
 
$
231,919
   
$
297,476
 
                               
 
 
12
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
Portfolio Acquisition
 
In February 2011, World Financial Capital Bank, one of the Company’s wholly-owned subsidiaries, acquired the existing private label credit card portfolio of J.Jill and entered into a multi-year agreement to provide private label credit card services. The total purchase price was approximately $42.7 million, which consisted of $37.9 million of credit card receivables and $4.8 million of intangible assets that are included in the unaudited condensed consolidated balance sheets as of September 30, 2011.
 
6. REDEMPTION SETTLEMENT ASSETS
 
Redemption settlement assets consist of cash and cash equivalents and securities available-for-sale and are designated for settling redemptions by collectors of the AIR MILES Reward Program in Canada under certain contractual relationships with sponsors of the AIR MILES Reward Program. These assets are primarily denominated in Canadian dollars. Realized gains and losses from the sale of investment securities were not material. The principal components of redemption settlement assets, which are carried at fair value, are as follows:
 
   
September 30, 2011
   
December 31, 2010
 
   
Cost
   
Unrealized Gains
   
Unrealized Losses
   
Fair Value
   
Cost
   
Unrealized Gains
   
Unrealized Losses
   
Fair Value
 
   
(In thousands)
 
Cash and cash equivalents
 
$
38,770
   
$
   
$
   
$
38,770
   
$
74,612
   
$
   
$
   
$
74,612
 
Government bonds
   
4,858
     
178
     
     
5,036
     
15,235
     
161
     
(34
)
   
15,362
 
Corporate bonds (1)
   
397,072
     
8,790
     
(1,034
)
   
404,828
     
380,605
     
3,212
     
(1,363
)
   
382,454
 
Total
 
$
440,700
   
$
8,968
   
$
(1,034
)
 
$
448,634
   
$
470,452
   
$
3,373
   
$
(1,397
)
 
$
472,428
 
                                                                 
 
(1)
As of September 30, 2011 and December 31, 2010, LoyaltyOne® had investments in retained interests in the WFN Trusts with a fair value of $64.9 million in each case. These amounts are eliminated and therefore not reflected in the unaudited condensed consolidated financial statements and notes thereof as of September 30, 2011 and December 31, 2010.
 
The following tables show the gross unrealized losses and fair value for those investments that were in an unrealized loss position as of September 30, 2011 and December 31, 2010, aggregated by investment category and the length of time that individual securities have been in a continuous loss position:
 
   
Less than 12 months
   
September 30, 2011
12 Months or Greater
   
Total
 
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
 
   
(In thousands)
 
Corporate bonds
 
$
10,753
   
$
(1,023
)
 
$
13,533
   
$
(11
)
 
$
24,286
   
$
(1,034
)
Total
 
$
10,753
   
$
(1,023
)
 
$
13,533
   
$
(11
)
 
$
24,286
   
$
(1,034
)
 

   
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 September 30, 2011, the Company does not consider the investments to be other-than-temporarily impaired.

 
13
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
The net carrying value and estimated fair value of the redemption settlement assets at September 30, 2011 by contractual maturity are as follows:
 
   
Amortized
Cost
   
Estimated Fair Value
 
   
(In thousands)
 
Due in one year or less
 
$
65,546
   
$
65,151
 
Due after one year through five years
   
375,154
     
383,483
 
Total
 
$
440,700
   
$
448,634
 
       
 
7. INTANGIBLE ASSETS AND GOODWILL
 
Intangible Assets
 
Intangible assets consist of the following:
 
   
September 30, 2011
   
   
Gross
Assets
   
Accumulated
Amortization
   
Net
 
Amortization Life and Method
   
(In thousands)
   
Finite Lived Assets
                   
Customer contracts and lists
 
$
316,245
   
$
(134,361
)
 
$
181,884
 
3-12 years—straight line
Premium on purchased credit card portfolios
   
156,203
     
(78,087
)
   
78,116
 
3-10 years—straight line, accelerated
Collector database
   
66,664
     
(59,020
)
   
7,644
 
30 years—15% declining balance
Customer database
   
175,391
     
(91,281
)
   
84,110
 
4-10 years—straight line
Noncompete agreements
   
1,024
     
(911
)
   
113
 
2-3 years—straight line
Tradenames
   
38,141
     
(6,649
)
   
31,492
 
5-15 years—straight line
Purchased data lists
   
23,119
     
(15,559
)
   
7,560
 
1-5 years—straight line, accelerated
   
$
776,787
   
$
(385,868
)
 
$
390,919
   
Indefinite Lived Assets
                         
Tradenames
   
12,350
     
     
12,350
 
Indefinite life
Total intangible assets
 
$
789,137
   
$
(385,868
)
 
$
403,269
   
 
 
   
December 31, 2010
   
   
Gross
Assets
   
Accumulated
Amortization
   
Net
 
Amortization Life and Method
   
(In thousands)
   
Finite Lived Assets
                   
Customer contracts and lists
 
$
211,413
   
$
(123,932
)
 
$
87,481
 
5-10 years—straight line
Premium on purchased credit card portfolios
   
151,430
     
(63,115
)
   
88,315
 
3-10 years—straight line, accelerated
Collector database
   
70,211
     
(61,075
)
   
9,136
 
30 years—15% declining balance
Customer database
   
175,397
     
(76,002
)
   
99,395
 
4-10 years—straight line
Noncompete agreements
   
1,062
     
(668
)
   
394
 
2-3 years—straight line
Tradenames
   
14,169
     
(5,070
)
   
9,099
 
5-10 years—straight line
Purchased data lists
   
20,506
     
(12,285
)
   
8,221
 
1-5 years—straight line, accelerated
   
$
644,188
   
$
(342,147
)
 
$
302,041
   
Indefinite Lived Assets
                         
Tradenames
   
12,350
     
     
12,350
 
Indefinite life
Total intangible assets
 
$
656,538
   
$
(342,147
)
 
$
314,391
   
 
With the J.Jill portfolio acquisition in February 2011, the Company acquired $4.8 million of intangible assets, consisting of a customer relationship of $2.6 million and a marketing relationship of $2.2 million, which are being amortized, in each case, over a weighted average life of 7.0 years. See Note 5, “Credit Card Receivables,” for more information regarding the J.Jill portfolio acquisition.
 
With the Aspen acquisition on May 31, 2011, the Company acquired $140.0 million of intangible assets, consisting of $116.0 million of customer relationships and $24.0 million of trade names, which are being amortized over a weighted average life of 8.3 years and 15 years, respectively. See Note 4, “Acquisition,” for more information regarding the Aspen acquisition.

 
14
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
Goodwill
 
The changes in the carrying amount of goodwill for the nine months ended September 30, 2011 are as follows:
 
   
LoyaltyOne
   
Epsilon
   
Private Label Services and Credit
   
Corporate/
Other
   
Total
 
   
(In thousands)
 
December 31, 2010
 
$
246,930
   
$
713,161
   
$
261,732
   
$
   
$
1,221,823
 
Effects of foreign currency translation
   
(11,902
)
   
(135
)
   
     
     
(12,037
)
Goodwill acquired during the year
   
     
232,910
     
     
     
232,910
 
September 30, 2011
 
$
235,028
   
$
945,936
   
$
261,732
   
$
   
$
1,442,696
 
 
8. DEBT
 
Debt consists of the following:
 
Description
 
September 30,
2011
   
December 31,
2010
 
Maturity
 
Interest Rate
   
(Dollars in thousands)
       
                   
Certificates of deposit:
                     
Certificates of deposit
 
$
1,369,005
   
$
859,100
 
Three months to five years
 
0.10% to 5.25%
Less: current portion
   
(752,532
)
   
(442,600
)
     
Long-term portion
 
$
616,473
   
$
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
   
703,500
     
1,153,500
 
Various - Apr 2012 – Apr 2013
 
(1)
Conduit asset-backed securities
   
606,972
     
733,827
 
Various - Jun 2012 – Sept 2012
 
1.26% to 1.97%
Total asset-backed securities – owed to securitization investors
   
3,083,287
     
3,660,142
       
Less: current portion
   
(1,769,122
)
   
(1,743,827
)
     
Long-term portion
 
$
1,314,165
   
$
1,916,315
       
                   
Long-term and other debt:
                 
2011 credit facility
 
$
495,000
   
$
 
May 2016
 
(2)
2011 term loan
   
787,547
     
 
May 2016
 
(2)
2006 credit facility
   
     
300,000
 
 
Series B senior notes
   
     
250,000
 
 
2009 term loan
   
     
161,000
 
 
2010 term loan
   
     
236,000
 
 
Convertible senior notes due 2013
   
697,977
     
659,371
 
August 2013
 
1.75%
Convertible senior notes due 2014
   
273,655
     
257,687
 
May 2014
 
4.75%
Capital lease obligations and other debt
   
41
     
5,714
 
July 2013(3)
 
7.10%(3)
Total long-term and other debt
   
2,254,220
     
1,869,772
       
Less: current portion
   
(19,834
)
   
(255,679
)
     
Long-term portion
 
$
2,234,386
   
$
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 5.75% at September 30, 2011.
 
(2)
At September 30, 2011, the weighted average interest rate for the 2011 Credit Facility and 2011 Term Loan was 2.51% and 2.49%, respectively.
 
(3)
The Company has other minor borrowings, primarily capital leases.
 
At September 30, 2011, the Company was in compliance with its covenants.

 
15
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
2011 Credit Agreement
 
The Company is party to a credit agreement, among the Company as borrower, and ADS Alliance Data Systems, Inc., ADS Foreign Holdings, Inc., Alliance Data Foreign Holdings, Inc., Epsilon Marketing Services, LLC, Epsilon Data Management LLC, Comenity LLC and Alliance Data FHC, Inc., as guarantors, SunTrust Bank and Bank of Montreal, as co-administrative agents, and Bank of Montreal as letter of credit issuer, and various other agents and banks, dated May 24, 2011 (the “2011 Credit Agreement”). The 2011 Credit Agreement provides for a $792.5 million term loan (the “2011 Term Loan”) and a $792.5 million revolving line of credit (the “2011 Credit Facility”) with a U.S. $65.0 million sublimit for Canadian dollar borrowings and a $65.0 million sublimit for swing line loans. The 2011 Credit Agreement includes an uncommitted accordion feature of up to $415.0 million in the aggregate allowing for future incremental borrowings, subject to certain conditions, for a maximum total facility size of $2.0 billion, both of which were increased by a subsequent amendment.
 
The loans under the 2011 Credit Agreement are scheduled to mature on May 24, 2016. The 2011 Term Loan provides for aggregate principal payments equal to 2.5% of the initial term loan amount in each of the first and second year and 5% of the initial term loan amount in each of the third, fourth and fifth year of the term loan, payable in equal quarterly installments beginning September 30, 2011. The 2011 Credit Agreement is unsecured.
 
Advances under the 2011 Credit Agreement are in the form of either base rate loans or Eurodollar loans and may be denominated in U.S. dollars or Canadian dollars. The interest rate for base rate loans denominated in U.S. dollars fluctuates and is equal to the highest of (i) the Bank of Montreal’s prime rate; (ii) the Federal funds rate plus 0.5% and (iii) the LIBOR rate as defined in the 2011 Credit Agreement plus 1.0%, in each case plus a margin of 0.75% to 1.25% based upon the Company’s senior leverage ratio as defined in the 2011 Credit Agreement. The interest rate for base rate loans denominated in Canadian dollars fluctuates and is equal to the higher of (i) the Bank of Montreal’s prime rate for Canadian dollar loans and (ii) the Canadian Dollar Offered Rate (“CDOR”) plus 1%, in each case plus a margin of 0.75% to 1.25% based upon the Company’s senior leverage ratio as defined in the 2011 Credit Agreement. The interest rate for Eurodollar loans denominated in U.S. or Canadian dollars fluctuates based on the rate at which deposits of U.S. dollars or Canadian dollars, respectively, in the London interbank market are quoted plus a margin of 1.75% to 2.25% based upon the Company’s senior leverage ratio as defined in the 2011 Credit Agreement.
 
Concurrently with entering into the 2011 Credit Agreement, the Company terminated the following credit facilities: (i) a credit agreement, dated September 29, 2006, which consisted of a $750.0 million unsecured revolving credit facility (the “2006 Credit Facility”); (ii) a term loan agreement, dated May 15, 2009 (the “2009 Term Loan”); and (iii) a term loan agreement, dated August 6, 2010 (the “2010 Term Loan”). The 2006 Credit Facility, the 2009 Term Loan and the 2010 Term Loan were scheduled to expire on March 30, 2012.
 
On September 20, 2011, the Company entered into a First Amendment to the 2011 Credit Agreement (the “First Amendment”). The First Amendment, among other things, (a) increases the uncommitted accordion feature to up to $915.0 million in the aggregate to allow a maximum total facility size of $2.5 billion, up from $2.0 billion, (b) permits any incremental term loans to be secured in such collateral as may be agreed to by the Company and the banks advancing the incremental term loans, with the existing loans to be equally and ratably secured in the same collateral, (c) except with respect to terms relating to amortization and pricing of the incremental term loans, requires that the incremental term loans may not otherwise have terms and conditions materially different from those of the existing loans and (d) permits the co-administrative agents, the Company and the banks advancing the incremental term loans to amend the 2011 Credit Agreement, without further consent of any other banks, as necessary to allow the issuance of the incremental term loans.
 
Total availability under the 2011 Credit Facility at September 30, 2011 was $297.5 million.
 
Series B Senior Notes
 
The Company repaid the $250.0 million aggregate principal amount of the 6.14% Series B senior notes at their scheduled maturity of May 16, 2011.

 
16
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
Convertible Senior Notes
 
The Company has outstanding $1.15 billion of convertible senior notes, consisting of $805.0 million scheduled to mature on August 1, 2013 and $345.0 million scheduled to mature on May 15, 2014. The table below summarizes the carrying value of the components of the convertible senior notes:
 
   
September 30,
2011
   
December 31,
2010
 
   
(In thousands)
 
Carrying amount of equity component
 
$
368,678
   
$
368,678
 
                 
Principal amount of liability component
 
$
1,150,000
   
$
1,150,000
 
Unamortized discount
   
(178,368
)
   
(232,942
)
Net carrying value of liability component
 
$
971,632
   
$
917,058
 
                 
If-converted value of common stock
 
$
1,623,007
   
$
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 September 30, 2011, is a weighted average period of 2.1 years.
 
Interest expense on the convertible senior notes recognized in the Company’s unaudited condensed consolidated statements of income for the three and nine months ended September 30, 2011 and 2010 is as follows:
 
   
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
   
2011
   
2010
 
2011
   
2010
 
   
(In thousands, except percentages)
 
Interest expense calculated on contractual interest rate
 
$
7,619
   
$
7,619
 
$
22,856
   
$
22,856
 
Amortization of discount on liability component
   
18,692
     
16,752
   
54,574
     
48,914
 
Total interest expense on convertible senior notes
 
$
26,311
   
$
24,371
 
$
77,430
   
$
71,770
 
                               
Effective interest rate (annualized)
   
11.0
%
   
11.0
%
 
11.0
%
   
11.0
%
 
Asset-backed Securities – Owed to Securitization Investors
 
Conduit Facilities
 
During the second quarter of 2011, the Company renewed its $1.2 billion 2009-VFN conduit facility under World Financial Network Credit Card Master Note Trust and its $275.0 million 2009-VFN conduit facility under World Financial Capital Credit Card Master Note Trust, extending their maturities to June 13, 2012 and June 1, 2012, respectively.
 
In September 2011, the Company renewed its 2009-VFC1 conduit facility under World Financial Network Credit Card Master Trust III, extending the maturity to September 28, 2012 and reducing the total capacity from $550.0 million to $400.0 million.
 
Derivative Financial Instruments
 
As part of its interest rate risk management program, the Company may enter into derivative financial instruments with institutions that are established dealers and manage its exposure to changes in fair value of certain obligations attributable to changes in LIBOR.
 
The credit card securitization trusts enter into derivative financial instruments, which include both interest rate swaps and an interest rate cap, to mitigate their interest rate risk on a related financial instrument or to lock the interest rate on a portion of their variable asset-backed securities debt.
 
These interest rate contracts involve the receipt of variable rate amounts from counterparties in exchange for the Company making fixed rate payments over the life of the agreement without the exchange of the underlying notional amount. These interest rate contracts are not designated as hedges. Such contracts are not speculative and are used to manage interest rate risk, but do not meet the specific hedge accounting requirements of ASC 815, “Derivatives and Hedging.”

 
17
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
The following tables identify the notional amount, fair value and classification of the Company’s outstanding interest rate contracts for the credit card securitization trusts at September 30, 2011 and December 31, 2010 in the unaudited condensed consolidated balance sheets:
 
   
September 30, 2011
 
December 31, 2010
 
   
Notional Amount
   
Weighted Average Years to Maturity
 
Notional Amount
   
Weighted Average Years
to Maturity
 
   
(Dollars in thousands)
Interest rate contracts not designated as hedging instruments
 
$
703,500
     
1.63
   
1,153,500
     
1.72
 
                               
 
 
   
September 30, 2011
 
December 31, 2010
 
   
Balance Sheet Location
   
Fair Value
 
Balance Sheet Location
   
Fair Value
 
   
(In thousands)
Interest rate contracts not designated as hedging instruments
   
Other current liabilities
   
$
   
Other current liabilities
   
$
4,574
 
Interest rate contracts not designated as hedging instruments
   
Other liabilities
   
$
46,685
   
Other liabilities
   
$
65,257
 
                               
 
The following table summarizes activity related to and identifies the location of the Company’s outstanding interest rate contracts for the credit card securitization trusts for the three and nine months ended September 30, 2011 and 2010 recognized in the unaudited condensed consolidated statements of income:
 
   
2011
 
2010
 
For the three months ended September 30,
 
Income Statement Location
   
Gain on Derivative Contracts
 
Income Statement Location
   
Loss on Derivative Contracts
 
   
(In thousands)
 
Interest rate contracts not designated as hedging instruments
   
Securitization funding costs
   
$
8,543
   
Securitization funding costs
   
$
59
 
                               
For the nine months ended September 30,
                             
Interest rate contracts not designated as hedging instruments
   
Securitization funding costs
   
$
23,146
   
Securitization funding costs
   
$
5,443
 
                               
 
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 September 30, 2011, the Company does not maintain any derivative contracts subject to master agreements that would require the Company to post collateral or that contain any credit-risk related contingent features. The Company has provisions in certain of the master agreements that require counterparties to post collateral to the Company when their credit ratings fall below certain thresholds. At September 30, 2011, these thresholds were not breached and no amounts were held as collateral by the Company.
 
9. DEFERRED REVENUE
 
Because management has determined that the earnings process is not complete at the time an AIR MILES reward mile is issued, the recognition of revenue on all fees received at issuance is deferred. The Company allocates the proceeds from the issuance of AIR MILES reward miles into two components as follows:
 
 
·
Redemption element. The redemption element is the larger of the two components. Revenue related to the redemption element is based on the estimated fair value. For this component, revenue is recognized at the time an AIR MILES reward mile is redeemed, or for those AIR MILES reward miles that are estimated to go unredeemed by the collector base, known as “breakage,” over the estimated life of an AIR MILES reward mile. The Company’s estimate of breakage is 28%.
 
 
·
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.

 
18
 
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
   
163,534
     
395,201
     
558,735
 
Revenue recognized
   
(144,610
)
   
(399,437
)
   
(544,047
)
Other
   
     
1,184
     
1,184
 
Effects of foreign currency translation
   
(18,461
)
   
(44,336
)
   
(62,797
)
September 30, 2011
 
$
339,977
   
$
834,340
   
$
1,174,317
 
Amounts recognized in the unaudited condensed consolidated balance sheets:
                       
Current liabilities
 
$
160,782
   
$
834,340
   
$
995,122
 
Non-current liabilities
 
$
179,195
   
$
   
$
179,195
 
 
10. STOCKHOLDERS’ EQUITY
 
Stock Repurchase Program
 
On September 13, 2010, the Company’s Board of Directors authorized a stock repurchase program to acquire up to $400.0 million of the Company’s outstanding common stock from September 13, 2010 through December 31, 2011, subject to any restrictions pursuant to the terms of the Company’s credit agreements or otherwise.
 
For the nine months ended September 30, 2011, the Company acquired a total of 2,313,078 shares of its common stock for $187.7 million. As of September 30, 2011, the Company has $140.3 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 nine months ended September 30, 2011 and 2010 is as follows:
 
   
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
   
2011
   
2010
 
2011
   
2010
 
   
(In thousands)
 
Cost of operations
 
$
7,762
   
$
6,598
 
$
19,672
   
$
18,801
 
General and administrative
   
4,519
     
4,377
   
12,799
     
15,195
 
Total
 
$
12,281
   
$
10,975
 
$
32,471
   
$
33,996
 

 
19
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
During the nine months ended September 30, 2011, the Company awarded 425,328 performance-based restricted stock units with a weighted average grant date fair value per share of $83.72 as determined on the date of grant. The performance restriction on the awards will lapse upon determination by the Board of Directors or the Compensation Committee of the Board of Directors that the Company’s earnings before taxes for the period from January 1, 2011 to December 31, 2011 met certain pre-defined vesting criteria that permit a range from 50% to 150% of such performance-based restricted stock units to vest. Upon such determination, the restrictions will lapse with respect to 33% of the award on February 21, 2012, an additional 33% of the award on February 21, 2013 and the final 34% of the award on February 21, 2014, provided that the participant is employed by the Company on each such vesting date.
 
During the nine months ended September 30, 2011, the Company awarded 149,324 service-based restricted stock units with a weighted average grant date fair value per share of $85.52 as determined on the date of grant. Service-based restricted stock units typically vest ratably over three years provided that the participant is employed by the Company on each such vesting date.
 
11. COMPREHENSIVE INCOME
 
The components of comprehensive income, net of tax effect, are as follows:
 
   
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
   
2011
   
2010
 
2011
   
2010
 
   
(In thousands)
 
Net income
 
$
93,981
   
$
53,059
 
$
249,380
   
$
147,033
 
Adoption of ASC 860 and ASC 810 (1) 
   
     
   
     
55,881
 
Unrealized gain (loss) on securities available-for-sale
   
13,989
     
(1,535
)
 
13,045
     
(3,283
)
Foreign currency translation adjustments (2) 
   
7,281
     
(3,909
)
 
3,750
     
(5,791
)
Total comprehensive income, net of tax
 
$
115,251
   
$
47,615
 
$
266,175
   
$
193,840
 
         
 
(1)
These amounts related to retained interests in the WFN Trusts and the WFC Trust were previously reflected in accumulated other comprehensive income. Upon the adoption of ASC 860, “Transfers and Servicing,” and ASC 810, “Consolidation,” which was effective January 1, 2010, these interests and related accumulated other comprehensive income have been reclassified, derecognized or eliminated upon consolidation.
 
(2)
Primarily related to the impact of changes in the Canadian currency exchange rate.
 
12. FINANCIAL INSTRUMENTS
 
In accordance with ASC 825, “Financial Instruments,” the Company is required to disclose the fair value of financial instruments for which it is practical to estimate fair value. To obtain fair values, observable market prices are used if available. In some instances, observable market prices are not readily available and fair value is determined using present value or other techniques appropriate for a particular financial instrument. These techniques involve judgment and as a result are not necessarily indicative of the amounts the Company would realize in a current market exchange. The use of different assumptions or estimation techniques may have a material effect on the estimated fair value amounts.

 
20
 
ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 
Fair Value of Financial Instruments The estimated fair values of the Company’s financial instruments are as follows:
 
   
September 30, 2011
   
December 31, 2010
 
   
Carrying
Amount
   
Fair
Value
   
Carrying
Amount
   
Fair
Value
 
   
(In thousands)
 
Financial assets
                       
Cash and cash equivalents
 
$
239,570
   
$
239,570
   
$
139,114
   
$
139,114
 
Trade receivables, net
   
265,156
     
265,156
     
260,945
     
260,945
 
Credit card receivables, net
   
4,526,162
     
4,526,162
     
4,838,354
     
4,838,354
 
Redemption settlement assets, restricted
   
448,634
     
448,634
     
472,428
     
472,428
 
Cash collateral, restricted
   
654,705
     
654,705
     
185,754
     
185,754
 
Other investment securities
   
80,160
     
80,160
     
104,916
     
104,916
 
Financial liabilities
                               
Accounts payable
   
122,055
     
122,055
     
121,856
     
121,856
 
Certificates of deposit
   
1,369,005
     
1,390,828
     
859,100
     
883,405
 
Asset-backed securities debt – owed to securitization investors
   
3,083,287
     
3,140,758
     
3,660,142
     
3,711,263
 
Long-term and other debt
   
2,254,220
     
2,999,681
     
1,869,772
     
2,393,124
 
Derivative financial instruments
   
46,685
     
46,685
     
69,831
     
69,831