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)
 
 
3
 
4
 
5
 
6
Item 2.
24
Item 3.
33
Item 4.
34
     
Part II:  OTHER INFORMATION
 
     
Item 1.
35
Item 1A.
35
Item 2.
35
Item 3.
35
Item 4.
35
Item 5.
35
Item 6.
36
38

 
2

 
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.
 
 
3

 
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.
 
 
4

 
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.
 
 
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 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.
 
 
6

 
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.
 
 
7

 
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.
 
 
8

 
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.
 
 
9

 
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.
 
 
10

 
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.
 
 
11

 
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
 
 
 
12

 
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
 
 
 
13

 
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.
 
 
14

 
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.”
 
 
15

 
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.
 
 
16

 
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.
 
 
17

 
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
 
 
 
18

 
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.
 
 
19

 
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
 
 
 
20

 
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.
 
 
21

 
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