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, 2013
   
OR
 
£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the transition period from          to          

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

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

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

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

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

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes £     No R
 
As of October 30, 2013, 48,712,675 shares of common stock were outstanding.
 


 
 
 

ALLIANCE DATA SYSTEMS CORPORATION
 
INDEX
 
 
 
 
 
Page
Number
 
Part I:  FINANCIAL INFORMATION
 
Item 1.
Financial Statements (unaudited)
 
 
3
 
4
 
5
 
6
 
7
Item 2.
27
Item 3.
40
Item 4.
40
 
Part II:  OTHER INFORMATION
 
Item 1.
42
Item 1A.
42
Item 2.
42
Item 3.
42
Item 4.
42
Item 5.
42
Item 6.
43
44


 
2


PART I
 
Item 1. Financial Statements.
 
ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
 
 
       
   
September 30,
2013
 
December 31,
2012
 
   
(In thousands, except per share amounts)
 
ASSETS
Cash and cash equivalents
 
$
784,042
 
$
893,352
 
Trade receivables, less allowance for doubtful accounts ($2,505 and $3,919 at September 30, 2013 and December 31, 2012, respectively)
   
337,332
   
370,110
 
Credit card receivables:
             
Credit card receivables – restricted for securitization investors
   
6,185,497
   
6,597,120
 
Other credit card receivables
   
1,271,848
   
852,512
 
Loan receivables held for sale
   
50,950
   
 
Total credit card receivables
   
7,508,295
   
7,449,632
 
Allowance for loan loss
   
(462,041
)
 
(481,958
)
Credit card receivables, net
   
7,046,254
   
6,967,674
 
Deferred tax asset, net
   
221,293
   
237,268
 
Other current assets
   
175,500
   
171,049
 
Redemption settlement assets, restricted
   
545,939
   
492,690
 
Total current assets
   
9,110,360
   
9,132,143
 
Property and equipment, net
   
276,097
   
253,028
 
Deferred tax asset, net
   
27,600
   
30,027
 
Cash collateral, restricted
   
33,842
   
65,160
 
Intangible assets, net
   
489,640
   
582,874
 
Goodwill
   
1,741,979
   
1,751,053
 
Other non-current assets
   
285,145
   
185,854
 
Total assets
 
$
11,964,663
 
$
12,000,139
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable
 
$
258,254
 
$
215,470
 
Accrued expenses
   
302,417
   
274,625
 
Deposits
   
1,138,905
   
1,092,753
 
Non-recourse borrowings of consolidated securitization entities
   
315,000
   
1,474,054
 
Current debt
   
355,499
   
803,269
 
Other current liabilities
   
132,598
   
117,283
 
Deferred revenue
   
1,001,582
   
1,055,323
 
Total current liabilities
   
3,504,255
   
5,032,777
 
Deferred revenue
   
178,743
   
193,738
 
Deferred tax liability, net
   
265,922
   
277,354
 
Deposits
   
1,171,602
   
1,135,658
 
Non-recourse borrowings of consolidated securitization entities
   
3,666,916
   
2,656,916
 
Long-term and other debt
   
2,327,813
   
2,051,570
 
Other liabilities
   
137,993
   
123,639
 
Total liabilities
   
11,253,244
   
11,471,652
 
Commitments and contingencies
             
Stockholders’ equity:
             
Common stock, $0.01 par value; authorized, 200,000 shares; issued, 95,418 shares and 94,963 shares at September 30, 2013 and
December 31, 2012, respectively
   
954
   
950
 
Additional paid-in capital
   
1,487,332
   
1,454,230
 
Treasury stock, at cost, 46,752 shares and 45,360 shares at September 30, 2013 and December 31, 2012, respectively
   
(2,689,177
)
 
(2,458,092
)
Retained earnings
   
1,931,557
   
1,553,260
 
Accumulated other comprehensive loss
   
(19,247
)
 
(21,861
)
Total stockholders’ equity
   
711,419
   
528,487
 
Total liabilities and stockholders’ equity
 
$
11,964,663
 
$
12,000,139
 
 
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,
 
   
2013
 
2012
 
2013
 
2012
 
   
(In thousands, except per share amounts)
 
Revenues
                     
Transaction
 
$
84,264
 
$
74,904
 
$
246,185
 
$
235,150
 
Redemption
   
131,985
   
144,144
   
430,339
   
491,795
 
Finance charges, net
   
507,828
   
434,824
   
1,447,971
   
1,188,933
 
Database marketing fees and direct marketing services
   
334,720
   
225,303
   
939,821
   
658,429
 
Other revenue
   
37,650
   
32,317
   
113,660
   
95,239
 
Total revenue
   
1,096,447
   
911,492
   
3,177,976
   
2,669,546
 
Operating expenses
                 
Cost of operations (exclusive of depreciation and amortization disclosed separately below)
   
628,386
   
499,455
   
1,868,093
   
1,532,815
 
Provision for loan loss
   
90,976
   
81,250
   
215,420
   
183,129
 
General and administrative
   
33,845
   
24,584
   
84,392
   
76,115
 
Depreciation and other amortization
   
21,395
   
18,745
   
61,401
   
54,845
 
Amortization of purchased intangibles
   
33,077
   
22,987
   
99,497
   
65,009
 
Total operating expenses
   
807,679
   
647,021
   
2,328,803
   
1,911,913
 
Operating income
   
288,768
   
264,471
   
849,173
   
757,633
 
Interest expense
             
Securitization funding costs
   
22,914
   
23,296
   
72,093
   
68,143
 
Interest expense on deposits
   
7,287
   
6,753
   
21,296
   
18,719
 
Interest expense on long-term and other debt, net
   
43,814
   
44,316
   
146,636
   
126,222
 
Total interest expense, net
   
74,015
   
74,365
   
240,025
   
213,084
 
Income before income tax
 
$
214,753
 
$
190,106
 
$
609,148
 
$
544,549
 
Provision for income taxes
   
81,875
   
70,561
   
230,851
   
205,954
 
Net income
 
$
132,878
 
$
119,545
 
$
378,297
 
$
338,595
 
                           
Basic income per share
 
$
2.73
 
$
2.39
 
$
7.69
 
$
6.76
 
Diluted income per share
 
$
2.01
 
$
1.84
 
$
5.63
 
$
5.33
 
                           
Weighted average shares
             
Basic
   
48,710
   
49,939
   
49,199
   
50,086
 
Diluted
   
66,019
   
65,038
   
67,168
   
63,539
 
                           

 
See accompanying notes to unaudited condensed consolidated financial statements.

 
4


ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
 
   
Three Months Ended
September 30,
 
Nine Months Ended
 September 30,
 
   
2013
 
2012
 
2013
 
2012
 
   
(In thousands)
 
                       
Net income
 
$
132,878
 
$
119,545
 
$
378,297
 
$
338,595
 
Other comprehensive income, net of tax
                         
Net unrealized gain (loss) on securities available-for-sale, net of tax expense of $167, tax expense of $142, tax benefit of $(913) and tax expense of $26 for the three and nine months ended September 30, 2013 and 2012, respectively
   
50
   
3,044
   
(5,404
)
 
4,880
 
Foreign currency translation adjustments
   
(247
 
(2,107
 
8,018
   
(3,767
Other comprehensive (loss) income
   
(197
 
937
   
2,614
   
1,113
 
Total comprehensive income, net of tax
 
$
132,681
 
$
120,482
 
$
380,911
 
$
339,708
 
                           

 
See accompanying notes to unaudited condensed consolidated financial statements.

 
5


ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
 
   
Nine Months Ended
September 30,
 
   
2013
   
2012
 
   
(In thousands)
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
Net income                                                                                                                      
 
$
378,297
   
$
338,595
 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
Depreciation and amortization                                                                                                                   
   
160,898
     
119,854
 
Deferred income taxes                                                                                                                   
   
4,668
     
76,356
 
Provision for loan loss                                                                                                                   
   
215,420
     
183,129
 
Non-cash stock compensation                                                                                                                   
   
43,428
     
37,605
 
Fair value gain on interest-rate derivatives                                                                                                                   
   
(8,511
)
   
(22,672
)
Amortization of discount on debt                                                                                                                   
   
57,900
     
60,915
 
Change in deferred revenue                                                                                                                      
   
(21,951
   
(36,364
Change in other operating assets and liabilities                                                                                                                      
   
19,691
     
120,091
 
Originations of loan receivables held for sale                                                                                                                      
   
(361,151
   
 
Sales of loan receivables held for sale                                                                                                                      
   
310,201
     
 
Excess tax benefits from stock-based compensation                                                                                                                      
   
(12,492
)
   
(15,237
)
Other                                                                                                                      
   
12,440
     
(211
)
Net cash provided by operating activities
   
798,838
     
862,061
 
   
CASH FLOWS FROM INVESTING ACTIVITIES:
 
Change in redemption settlement assets                                                                                                                      
   
(73,803
   
41,885
 
Change in cash collateral, restricted                                                                                                                      
   
32,405
     
101,536
 
Change in restricted cash                                                                                                                      
   
39,827
     
(43,892
Change in credit card and loan receivables                                                                                                                      
   
(220,571
)
   
(418,514
Purchase of credit card portfolios                                                                                                                      
   
(37,056
)
   
(780,153
)
Capital expenditures                                                                                                                      
   
(91,759
)
   
(77,340
)
Purchases of marketable securities                                                                                                                      
   
(23,632
)
   
(4,719
)
Maturities/sales of marketable securities                                                                                                                      
   
1,639
     
3,227
 
Other                                                                                                                      
   
(1,383
)
   
(10,587
)
Net cash used in investing activities
   
(374,333
)
   
(1,188,557
)
   
CASH FLOWS FROM FINANCING ACTIVITIES:
 
Borrowings under debt agreements                                                                                                                      
   
1,747,000
     
699,500
 
Repayments of borrowings                                                                                                                      
   
(1,171,428
)
   
(500,428
)
Proceeds from convertible note hedge counterparties                                                                                                                      
   
1,056,268
     
 
Repayments of convertible note borrowings                                                                                                                      
   
(1,861,239
   
 
Issuances of deposits                                                                                                                      
   
1,278,687
     
1,185,049
 
Repayments of deposits                                                                                                                      
   
(1,196,591
)
   
(703,173
)
Non-recourse borrowings of consolidated securitization entities                                                                                                                      
   
1,633,285
     
1,672,962
 
Repayments/maturities of non-recourse borrowings of consolidated securitization entities
   
(1,782,339
)
   
(1,418,133
)
Payment of capital lease obligations                                                                                                                      
   
(13
)
   
(16
)
Payment of deferred financing costs                                                                                                                      
   
(22,371
)
   
(30,930
)
Excess tax benefits from stock-based compensation                                                                                                                      
   
12,492
     
15,237
 
Proceeds from issuance of common stock                                                                                                                      
   
8,539
     
15,119
 
Purchase of treasury shares                                                                                                                      
   
(231,085
)
   
(65,358
)
Net cash (used in) provided by financing activities
   
(528,795
   
869,829
 
   
Effect of exchange rate changes on cash and cash equivalents
   
(5,020
)
   
6,771
 
Change in cash and cash equivalents
   
(109,310
   
550,104
 
Cash and cash equivalents at beginning of period
   
893,352
     
216,213
 
Cash and cash equivalents at end of period                                                                                                                
 
$
784,042
   
$
766,317
 
   
SUPPLEMENTAL CASH FLOW INFORMATION:
 
Interest paid                                                                                                                      
 
$
167,729
   
$
149,076
 
Income taxes paid, net                                                                                                                      
 
$
158,294
   
$
91,055
 
 
 
See accompanying notes to unaudited condensed consolidated financial statements.
 
 
6

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Basis of Presentation
 
The unaudited condensed consolidated financial statements included herein have been prepared by Alliance Data Systems Corporation (“ADSC” or, including its 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, 2012, filed with the SEC on February 28, 2013.
 
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.
 
Recently Issued Accounting Standards
 
In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-02, “Reporting Amounts Reclassified Out of Accumulated Other Comprehensive Income,” which expands the disclosure requirements for items reclassified from accumulated other comprehensive income to net income by requiring the total changes of each component of other comprehensive income to be disaggregated and separately presenting current period reclassification adjustments from the remainder of other comprehensive income for the period. ASU 2013-02 is effective for interim and annual periods beginning after December 15, 2012 and requires prospective application. ASU 2013-02 had no impact on the Company’s financial condition, results of operations or cash flows, but did add certain disclosure requirements. The related disclosures are presented in Note 9, “Accumulated Other Comprehensive Income.”
 
In July 2013, the FASB issued ASU 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists,” which provides guidance on financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss or a tax credit carryforward exists. ASU 2013-11 requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward when settlement in this manner is available under the governing tax law. ASU 2013-11 is effective for interim and annual periods beginning after December 15, 2013 and requires prospective application. The Company does not expect the adoption of ASU 2013-11 to have a material impact on the Company’s financial condition, results of operations or cash flows.

 
7

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
2. 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,
 
   
2013
 
2012
 
2013
 
2012
 
       
(In thousands, except per share amounts)
     
Numerator:
                     
Net income
 
$
132,878
 
$
119,545
 
$
378,297
 
$
338,595
 
Denominator:
                 
Weighted average shares, basic
   
48,710
   
49,939
   
49,199
   
50,086
 
Weighted average effect of dilutive securities:
             
Shares from assumed conversion of convertible senior notes
   
7,512
   
9,033
   
9,419
   
8,378
 
Shares from assumed conversion of convertible note warrants
   
9,141
   
5,263
   
7,937
   
4,317
 
Net effect of dilutive stock options and unvested restricted stock units
   
656
   
803
   
613
   
758
 
Denominator for diluted calculations
   
66,019
   
65,038
   
67,168
   
63,539
 
                           
Basic net income per share
 
$
2.73
 
$
2.39
 
$
7.69
 
$
6.76
 
Diluted net income per share
 
$
2.01
 
$
1.84
 
$
5.63
 
$
5.33
 
 
The Company calculates the effect of its convertible senior notes, which can be settled in cash or shares of common stock, on diluted net income per share as if they will be settled in cash as the Company has the intent to settle the convertible senior notes for cash.
 
Concurrently with the issuance of its convertible senior notes, the Company entered into hedge transactions that are generally expected to offset the potential dilution of the shares from assumed conversion of convertible senior notes.
 
The Company is also party to prepaid forward contracts to purchase 1,857,400 shares of its common stock that are to be delivered over a settlement period in 2014. The number of shares to be delivered under the prepaid forward contracts is used to reduce weighted-average basic and diluted shares outstanding.
 
 
3. 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,
2013
 
December 31,
2012
 
   
(In thousands)
 
Principal receivables
 
$
7,107,983
 
$
7,097,951
 
Billed and accrued finance charges
   
313,195
   
291,476
 
Other receivables
   
87,117
   
60,205
 
Total credit card receivables
   
7,508,295
   
7,449,632
 
Less credit card receivables – restricted for securitization investors
   
6,185,497
   
6,597,120
 
Less loan receivables held for sale
   
50,950
   
 
Other credit card receivables
 
$
1,271,848
 
$
852,512
 
 
 
8

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
In August 2013, under agreements with subsidiaries of eBay, Inc., including PayPal, Inc. and Bill Me Later, Inc. (collectively, “eBay”), the Company became an issuer for eBay’s Bill Me Later® credit products. After issuance, these loan receivables are transferred to eBay at par value plus accrued interest. These transfers qualify for sale treatment as they meet the conditions established in Accounting Standards Codification (“ASC”) 860-10, “Transfers and Servicing.” Following the sale, eBay owns the loan receivables, bears the risk of loss in the event of loan defaults and is responsible for all servicing functions related to the amounts. The loan receivables originated by the Company that have not yet been sold to eBay are included in loan receivables held for sale in the Company’s unaudited condensed consolidated balance sheet at September 30, 2013 and carried at the lower of cost or fair value. The carrying value of these loan receivables approximates fair value due to the short duration between origination and sale. Purchases and sales of these loan receivables held for sale are reflected as operating activities in the Company’s unaudited condensed consolidated statement of cash flow for the nine months ended September 30, 2013.
 
Upon eBay’s purchase of the Bill Me Later loan receivables, the Company is obligated to purchase a participating interest in a pool of loan receivables that includes the Bill Me Later loan receivables originated by the Company. Such interest participates on a pro rata basis in the cash flows of the underlying pool of loan receivables, including principal repayments, finance charges, losses, recoveries, and servicing costs. The Company bears the risk of loss related to its participation interest in this pool. Through September 30, 2013, the Company had purchased $15.5 million of these loan receivables, of which $14.5 million was outstanding at September 30, 2013 and included in other credit card receivables in the Company’s unaudited condensed consolidated balance sheet.
 
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 uncollectible principal as well as unpaid interest and fees. The allowance for loan loss is evaluated monthly for appropriateness.
 
In estimating the allowance for principal loan losses, management utilizes a migration analysis of delinquent and current credit card 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 loss. Charge-offs of principal amounts, net of recoveries are deducted from the allowance. In estimating the allowance for uncollectible unpaid interest and fees, the Company utilizes historical charge-off trends, analyzing actual charge-offs for the prior three months. The allowance is maintained through an adjustment to finance charges, net. In evaluating the allowance for loan loss for both principal and unpaid interest and fees, management also considers factors that may impact loan loss experience, including seasoning, loan volume and amounts, seasonality, payment rates and forecasting uncertainties.
 
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. Actual charge-offs for unpaid interest and fees were $54.1 million and $44.3 million for the three months ended September 30, 2013 and 2012, respectively, and $167.8 million and $137.5 million for the nine months ended September 30, 2013 and 2012, respectively.

 
9

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
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,
 
   
2013
 
2012
 
2013
 
2012
 
   
(In thousands)
 
Balance at beginning of period
 
$
448,396
 
$
432,521
 
$
481,958
 
$
468,321
 
Provision for loan loss
   
90,976
   
81,250
   
215,420
   
183,129
 
Recoveries
   
26,204
   
22,088
   
84,152
   
74,802
 
Principal charge-offs
   
(103,535
)
 
(87,309
)
 
(319,489
)
 
(277,702
)
Other
   
   
(8
)
 
   
(8
)
Balance at end of period
 
$
462,041
 
$
448,542
 
$
462,041
 
$
448,542
 
 
Delinquencies
 
A credit card account is contractually delinquent if the Company does not receive the minimum payment by the specified due date on the cardholder’s statement. It is the Company’s policy to continue to accrue interest and fee income on all credit card accounts beyond 90 days, except in limited circumstances, until the credit card account balance and all related interest and other fees are paid or charged off, typically at 180 days delinquent. When an account becomes delinquent, a message is printed on the credit cardholder’s billing statement requesting payment. After an account becomes 30 days past due, a proprietary collection scoring algorithm automatically scores the risk of the account becoming further delinquent. The collection system then recommends a collection strategy for the past due account based on the collection score and account balance and dictates the contact schedule and collections priority for the account. If the Company is unable to make a collection after exhausting all in-house collection efforts, the Company may engage collection agencies and outside attorneys to continue those efforts. At September 30, 2013, the more than 30 and more than 90 days delinquency rates were 4.5% and 1.9%, respectively. At December 31, 2012, the more than 30 and more than 90 days delinquency rates were 4.0% and 1.7%, respectively.
 
Modified Credit Card Receivables
 
The Company holds certain credit card receivables for which the terms have been modified. The Company’s modified credit card receivables include credit card receivables for which temporary hardship concessions have been granted and credit card receivables in permanent workout programs. These modified credit card receivables include concessions consisting primarily of a reduced minimum payment and an interest rate reduction. The temporary programs’ concessions remain in place for a period no longer than twelve months, while the permanent programs remain in place through the payoff of the credit card receivables if the credit cardholder complies with the terms of the program. These concessions do not include the forgiveness of unpaid principal, but may involve the reversal of certain unpaid interest or fee assessments. In the case of the temporary programs, at the end of the concession period, credit card receivable terms revert to standard rates. These arrangements are automatically terminated if the customer fails to make payments in accordance with the terms of the program, at which time their account reverts back to its original terms.
 
Credit card receivables for which temporary hardship and permanent concessions were granted are both considered troubled debt restructurings and are collectively evaluated for impairment. Modified credit card receivables are evaluated at their present value with impairment measured as the difference between the credit card receivable balance and the discounted present value of cash flows expected to be collected. Consistent with the Company’s measurement of impairment of modified credit card receivables on a pooled basis, the discount rate used for credit card receivables is the average current annual percentage rate the Company applies to non-impaired credit card receivables, which approximates what would have been applied to the pool of modified credit card receivables prior to impairment. In assessing the appropriate allowance for loan loss, these modified credit card receivables are included in the general pool of credit card receivables 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 the modified credit card receivables in these programs, there would not be a material difference in the allowance for loan loss.
 
The Company had $117.3 million and $117.0 million, respectively, as a recorded investment in impaired credit card receivables with an associated allowance for loan loss of $37.3 million and $39.7 million, respectively, as of September 30, 2013 and December 31, 2012. These modified credit card receivables represented less than 3% of the Company’s total credit card receivables as of September 30, 2013 and December 31, 2012, respectively.

 
10

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
The average recorded investment in the impaired credit card receivables was $116.7 million and $111.7 million for the three months ended September 30, 2013 and 2012, respectively, and $117.2 million and $114.3 million for the nine months ended September 30, 2013 and 2012, respectively.
 
Interest income on these modified credit card receivables is accounted for in the same manner as other accruing credit card receivables. Cash collections on these modified credit card receivables are allocated according to the same payment hierarchy methodology applied to credit card receivables that are not in such programs. The Company recognized $3.2 million and $3.0 million for the three months ended September 30, 2013 and 2012, respectively, and $9.5 million and $9.1 million for the nine months ended September 30, 2013 and 2012, respectively, in interest income associated with modified credit card receivables during the period that such credit card receivables were impaired.
 
The following tables provide information on credit card receivables that are considered troubled debt restructurings as described above, which entered into a modification program during the specified periods:
 
   
Three Months Ended September 30, 2013
 
Nine Months Ended September 30, 2013
 
   
Number of
Restructurings
 
Pre-
modification
Outstanding
Balance
 
Post-
modification
Outstanding
Balance
 
Number of
Restructurings
 
Pre-
modification
Outstanding
Balance
 
Post-
modification
Outstanding
Balance
 
     
(Dollars in thousands)
 
Troubled debt restructurings – credit card receivables
   
37,032
 
$
34,169
 
$
34,147
   
109,927
 
$
100,270
 
$
100,209
 
                                       

   
Three Months Ended September 30, 2012
 
Nine Months Ended September 30, 2012
 
   
Number of
Restructurings
 
Pre-
modification
Outstanding
Balance
 
Post-
modification
Outstanding
Balance
 
Number of
Restructurings
 
Pre-
modification
Outstanding
Balance
 
Post-
modification
Outstanding
Balance
 
     
(Dollars in thousands)
 
Troubled debt restructurings – credit card receivables
   
35,000
 
$
31,267
 
$
31,248
   
95,039
 
$
85,422
 
$
85,316
 
                                       
 
The tables below summarize troubled debt restructurings that have defaulted in the specified periods where the default occurred within 12 months of their modification date:
 
   
Three Months Ended
September 30, 2013
 
Nine Months Ended
September 30, 2013 
 
   
Number of
Restructurings
 
Outstanding
Balance
 
Number of
Restructurings
 
Outstanding
Balance
 
   
(Dollars in thousands)
 
Troubled debt restructurings that subsequently defaulted – credit card receivables
   
15,536
 
$
14,874
   
46,729
 
$
44,295
 
                           

   
Three Months Ended
September 30, 2012 
 
Nine Months Ended
September 30, 2012 
 
   
Number of
Restructurings
 
Outstanding
Balance
 
Number of
Restructurings
 
Outstanding
Balance
 
   
(Dollars in thousands)
 
Troubled debt restructurings that subsequently defaulted – credit card receivables
   
12,764
 
$
12,363
   
41,971
 
$
40,524
 
                           

 
11

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
Age of Credit Card Receivables
 
The following tables set forth, as of September 30, 2013 and 2012, 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:
 
   
September 30, 2013
 
Age of Accounts Since Origination
 
Number of Active Accounts with Balances
   
Percentage of Active Accounts with Balances
   
Principal Receivables Outstanding (1)
   
Percentage of Principal Receivables Outstanding
 
   
(In thousands, except percentages)
 
0-12 Months
   
4,233
     
27.0
%
 
$
1,660,718
     
23.5
%
13-24 Months
   
2,187
     
13.9
     
930,082
     
13.2
 
25-36 Months
   
1,514
     
9.7
     
684,463
     
9.7
 
37-48 Months
   
1,136
     
7.2
     
553,471
     
7.8
 
49-60 Months
   
931
     
5.9
     
500,259
     
7.1
 
Over 60 Months
   
5,694
     
36.3
     
2,728,040
     
38.7
 
Total
   
15,695
     
100.0
%
 
$
7,057,033
     
100.0
%
                                   
 
(1)
Excludes $51.0 million of loan receivables held for sale.
 
   
September 30, 2012
 
Age of Accounts Since Origination
 
Number of Active Accounts with Balances
   
Percentage of Active Accounts with Balances
   
Principal Receivables Outstanding
   
Percentage of Principal Receivables Outstanding
 
   
(In thousands, except percentages)
 
0-12 Months
   
3,838
     
25.7
%
 
$
1,388,049
     
22.2
%
13-24 Months
   
1,944
     
13.0
     
733,807
     
11.7
 
25-36 Months
   
1,424
     
9.5
     
621,926
     
9.9
 
37-48 Months
   
1,139
     
7.6
     
565,294
     
9.0
 
49-60 Months
   
944
     
6.3
     
436,518
     
7.0
 
Over 60 Months
   
5,668
     
37.9
     
2,514,645
     
40.2
 
Total
   
14,957
     
100.0
%
 
$
6,260,239
     
100.0
%
                                   
 
 
12

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
Credit Quality
 
The Company uses proprietary scoring models developed specifically for the purpose of monitoring the Company’s obligor credit quality. The proprietary scoring models are used as a tool in the underwriting process and for making credit decisions. The proprietary scoring models are based on historical data and require various assumptions about future performance. Information regarding customer performance is factored into these proprietary scoring models to determine the probability of an account becoming 90 or more days past due at any time within the next 12 months. Obligor credit quality is monitored at least monthly during the life of an account. The following table reflects composition of the Company’s credit card receivables by obligor credit quality as of September 30, 2013 and 2012:
 
   
September 30, 2013
   
September 30, 2012
 
Probability of an Account Becoming 90 or More Days Past
Due or Becoming Charged-off (within the next 12 months)
 
Total Principal Receivables Outstanding (1)
   
Percentage of Principal Receivables Outstanding
   
Total Principal Receivables Outstanding
   
Percentage of Principal Receivables Outstanding
 
           
(In thousands, except percentages)
         
No Score
 
$
144,336
     
2.0
%
 
$
290,008
     
4.6
%
27.1% and higher
   
330,802
     
4.7
     
257,032
     
4.1
 
17.1% - 27.0%
   
669,535
     
9.5
     
545,755
     
8.7
 
12.6% - 17.0%
   
746,424
     
10.6
     
625,436
     
10.0
 
3.7% - 12.5%
   
2,819,112
     
39.9
     
2,521,231
     
40.3
 
1.9% - 3.6%
   
1,487,871
     
21.1
     
1,322,943
     
21.1
 
Lower than 1.9%
   
858,953
     
12.2
     
697,834
     
11.2
 
Total
 
$
7,057,033
     
100.0
%
 
$
6,260,239
     
100.0
%
                                   
 
(1)
Excludes $51.0 million of loan receivables held for sale.
 
 
Credit Card Portfolio Acquisition
 
In March 2013, the Company acquired the existing private label credit card portfolio of Barneys New York. The total purchase price was $37.1 million and consisted of $35.3 million of credit card receivables and $1.8 million of intangible assets that are included in the September 30, 2013 unaudited condensed consolidated balance sheet.
 
Securitized Credit Card Receivables
 
The Company regularly securitizes its credit card receivables through its credit card securitization trusts. As of September 30, 2013, these trusts consisted of World Financial Network Credit Card Master Trust, World Financial Network Credit Card Master Note Trust (“Master Trust I”) and World Financial Network Credit Card Master Trust III (“Master Trust III”) (collectively, the “WFN Trusts”), and World Financial Capital Credit Card Master Note Trust (the “WFC Trust”). The Company continues to own and service the accounts that generate credit card receivables held by the WFN Trusts and the WFC Trust. In its capacity as a servicer, each of the respective banks earns a fee from the WFN Trusts and the WFC Trust to service and administer the credit card receivables, collect payments, and charge-off uncollectible receivables. These fees are eliminated and therefore are not reflected in the unaudited condensed consolidated statements of income for the three and nine months ended September 30, 2013 and 2012.
 
The WFN Trusts and the WFC Trust are variable interest entities (“VIEs”), and the Company is deemed to be the primary beneficiary for the WFN Trusts and the WFC Trust, as it is the servicer for each of the trusts and is a holder of the residual interest. The Company, through its involvement in the activities of the trusts, has the power to direct the activities that most significantly impact the economic performance of the trust, and the obligation (or right) to absorb losses (or receive benefits) of the trust that could potentially be significant. The assets of these consolidated VIEs include certain credit card receivables that are restricted to settle the obligations of those entities and are not expected to be available to the Company or its creditors. The liabilities of the consolidated VIEs include non-recourse secured borrowings and other liabilities for which creditors or beneficial interest holders do not have recourse to the general credit of the Company.

 
13

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
The tables below present quantitative information about the components of total securitized credit card receivables, delinquencies and net charge-offs:
 
   
September 30,
2013
 
December 31,
2012
 
   
(In thousands)
 
Total credit card receivables – restricted for securitization investors
 
$
6,185,497
 
$
6,597,120
 
Principal amount of credit card receivables – restricted for securitization investors, 90 days or more past due
 
$
120,210
 
$
112,203
 

   
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
   
2013
 
2012
 
2013
 
2012
 
   
(In thousands)
 
Net charge-offs of securitized principal
 
$
70,752
 
$
61,441
 
$
219,441
 
$
184,886
 
 
 
4.  REDEMPTION SETTLEMENT ASSETS
 
Redemption settlement assets consist of cash and cash equivalents and securities available-for-sale and are designated for settling redemptions by collectors of the AIR MILES® Reward Program in Canada under certain contractual relationships with sponsors of the AIR MILES Reward Program. These assets are primarily denominated in Canadian dollars. There were no realized gains or losses from the sale of investment securities for the three and nine months ended September 30, 2013 and 2012. The principal components of redemption settlement assets, which are carried at fair value, are as follows:
 
   
September 30, 2013
   
December 31, 2012
 
   
Cost
   
Unrealized Gains
   
Unrealized Losses
   
Fair Value
   
Cost
   
Unrealized Gains
   
Unrealized Losses
   
Fair Value
 
   
(In thousands)
 
Cash and cash equivalents
 
$
58,579
   
$
   
$
   
$
58,579
   
$
40,266
   
$
   
$
   
$
40,266
 
Government bonds
   
     
     
     
     
5,064
     
53
     
     
5,117
 
Corporate bonds
   
480,761
     
7,504
     
(905
)
   
487,360
     
436,846
     
10,560
     
(99
)
   
447,307
 
Total
 
$
539,340
   
$
7,504
   
$
(905
)
 
$
545,939
   
$
482,176
   
$
10,613
   
$
(99
)
 
$
492,690
 
 
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, 2013 and December 31, 2012, 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, 2013
12 Months or Greater
   
Total
 
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
 
   
(In thousands)
 
Corporate bonds
 
$
98,868
   
$
(905
)
 
$
   
$
   
$
98,868
   
$
(905
)
Total
 
$
98,868
   
$
(905
)
 
$
   
$
   
$
98,868
   
$
(905
)

   
Less than 12 months
   
December 31, 2012
12 Months or Greater
   
Total
 
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
   
Fair Value
   
Unrealized
Losses
 
   
(In thousands)
 
Corporate bonds
 
$
36,518
   
$
(99
)
 
$
   
$
   
$
36,518
   
$
(99
)
Total
 
$
36,518
   
$
(99
)
 
$
   
$
   
$
36,518
   
$
(99
)
 
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, 2013, the Company does not consider the investments to be other-than-temporarily impaired.

 
14

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
The amortized cost and estimated fair value of the securities at September 30, 2013 by contractual maturity are as follows:
 
   
Amortized
Cost
   
Estimated Fair Value
 
   
(In thousands)
 
Due in one year or less
 
$
141,764
   
$
142,273
 
Due after one year through five years
   
397,576
     
403,666
 
Total
 
$
539,340
   
$
545,939
 
 
 
5. INTANGIBLE ASSETS AND GOODWILL
 
Intangible Assets
 
Intangible assets consist of the following:
 
   
September 30, 2013
   
   
Gross
Assets
 
Accumulated
Amortization
 
Net
 
Amortization Life and Method
   
(In thousands)
   
Finite Lived Assets
               
Customer contracts and lists
 
$
440,200
 
$
(171,600
)
$
268,600
 
3-12 years—straight line
Premium on purchased credit card portfolios
   
214,337
   
(109,837
)
 
104,500
 
5-10 years—straight line, accelerated
Customer database
   
161,700
   
(117,349
)
 
44,351
 
4-10 years—straight line
Collector database
   
67,899
   
(62,335
)
 
5,564
 
30 years—15% declining balance
Tradenames
   
58,555
   
(13,992
)
 
44,563
 
4-15 years—straight line
Purchased data lists
   
16,834
   
(11,099
)
 
5,735
 
1-5 years—straight line, accelerated
Favorable lease
   
3,291
   
(289
)
 
3,002
 
10 years—straight line
Noncompete agreements
   
1,300
   
(325
)
 
975
 
3 years—straight line
   
$
964,116
 
$
(486,826
)
$
477,290
   
Indefinite Lived Assets
                     
Tradenames
   
12,350
   
   
12,350
 
Indefinite life
Total intangible assets
 
$
976,466
 
$
(486,826
)
$
489,640
   
 

 
   
December 31, 2012
   
   
Gross
Assets
 
Accumulated
Amortization
 
Net
 
Amortization Life and Method
   
(In thousands)
   
Finite Lived Assets
               
Customer contracts and lists
 
$
440,200
 
$
(124,351
)
$
315,849
 
3-12 years—straight line
Premium on purchased credit card portfolios
   
237,800
   
(108,227
)
 
129,573
 
5-10 years—straight line, accelerated
Customer database
   
161,700
   
(102,706
)
 
58,994
 
4-10 years—straight line
Collector database
   
70,550
   
(63,980
)
 
6,570
 
30 years—15% declining balance
Tradenames
   
59,102
   
(10,139
)
 
48,963
 
4-15 years—straight line
Purchased data lists
   
14,540
   
(8,527
)
 
6,013
 
1-5 years—straight line, accelerated
Favorable lease
   
3,291
   
(29
)
 
3,262
 
10 years—straight line
Noncompete agreements
   
1,300
   
   
1,300
 
3 years—straight line
   
$
988,483
 
$
(417,959
)
$
570,524
   
Indefinite Lived Assets
                     
Tradenames
   
12,350
   
   
12,350
 
Indefinite life
Total intangible assets
 
$
1,000,833
 
$
(417,959
)
$
582,874
   
 
 
15

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, 2013 are as follows:
 
   
LoyaltyOne®
   
Epsilon®
   
Private Label Services and Credit
   
Corporate/
Other
   
Total
 
   
(In thousands)
 
December 31, 2012
 
$
248,070
   
$
1,241,251
   
$
261,732
   
$
   
$
1,751,053
 
Effects of foreign currency translation
   
(8,898
)
   
(176
)
   
     
     
(9,074
)
September 30, 2013
 
$
239,172
   
$
1,241,075
   
$
261,732
   
$
   
$
1,741,979
 
 
 
6. DEBT
 
Debt consists of the following:
 
Description
 
September 30,
2013
   
December 31,
2012
 
Maturity
 
Interest Rate
 
   
(Dollars in thousands)
         
                     
Long-term and other debt:
                   
2013 credit facility
 
$
269,000
   
$
 
July 2018
 
(1)
 
2013 term loan
   
1,192,500
     
 
July 2018
 
(1)
 
2011 term loan
   
     
885,928
 
 
 
Convertible senior notes due 2013
   
     
768,831
 
 
 
Convertible senior notes due 2014
   
325,499
     
304,333
 
May 2014
 
4.75%
 
Senior notes due 2017
   
396,313
     
395,734
 
December 2017
 
5.250%
 
Senior notes due 2020
   
500,000
     
500,000
 
April 2020
 
6.375%
 
Capital lease obligations and other debt
   
     
13
 
 
 
Total long-term and other debt                                                            
   
2,683,312
     
2,854,839
         
Less: current portion
   
(355,499
)
   
(803,269
)
       
Long-term portion
 
$
2,327,813
   
$
2,051,570
         
                     
Deposits:
                   
Certificates of deposit
 
$
2,050,504
   
$
1,974,158
 
Various – October 2013 – May 2020
 
0.15% to 5.25%
 
Money market deposits
   
260,003
     
254,253
 
On demand
 
0.01% to 0.18%
 
Total deposits
   
2,310,507
     
2,228,411
         
Less: current portion
   
(1,138,905
)
   
(1,092,753
)
       
Long-term portion
 
$
1,171,602
   
$
1,135,658
         
                     
Non-recourse borrowings of consolidated securitization entities:
                       
Fixed rate asset-backed term note securities
 
$
3,001,916
   
$
2,403,555
 
Various – October 2014 – June 2019
 
0.91% to 6.75%
 
Floating rate asset-backed term note securities
   
     
545,700
 
 
 
Conduit asset-backed securities
   
980,000
     
1,181,715
 
Various – March 2014 – September 2015
 
1.18% to 1.71%
 
Total non-recourse borrowings of consolidated securitization entities
   
3,981,916
     
4,130,970
         
Less: current portion
   
(315,000
)
   
(1,474,054
)
       
Long-term portion
 
$
3,666,916
   
$
2,656,916
         
                           
 
(1)
At September 30, 2013, the weighted average interest rate was 2.18% for both the 2013 Credit Facility and 2013 Term Loan.
 
At September 30, 2013, the Company was in compliance with its covenants.
 
Credit Agreements
 
In July 2013, the Company, as borrower, and ADS Alliance Data Systems, Inc., ADS Foreign Holdings, Inc., Alliance Data Foreign Holdings, Inc., Epsilon Data Management, LLC, Comenity LLC, Comenity Servicing LLC and Aspen Marketing Services, LLC, as guarantors, entered into a credit agreement with various agents and lenders dated July 10, 2013 (the “2013 Credit Agreement”), replacing the Company’s credit agreement dated May 24, 2011 (the “2011 Credit Agreement”). The 2011 Credit Agreement provided for a $903.1 million term loan subject to certain principal repayments and a $917.5 million revolving line of credit. Upon entering into the 2013 Credit Agreement, the 2011 Credit Agreement was terminated.

 
16

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
Wells Fargo Bank, N.A. is the administrative agent and letter of credit issuer under the 2013 Credit Agreement. The 2013 Credit Agreement provides for a $1,142.5 million term loan (the “2013 Term Loan”) with certain principal repayments and a $1,142.5 million revolving line of credit (the “2013 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 2013 Credit Agreement includes an uncommitted accordion feature of up to $500.0 million (in certain circumstances, up to $615.0 million) in the aggregate allowing for future incremental borrowings, subject to certain conditions.
 
In September 2013, the Company exercised in part the accordion feature of the 2013 Credit Agreement, and increased the borrowings under the 2013 Term Loan by $57.5 million to $1.2 billion and increased the capacity under the 2013 Credit Facility by $57.5 million to $1.2 billion.
 
Total availability under the 2013 Credit Facility at September 30, 2013 was $931.0 million.
 
In October 2013, the Company exercised in part the accordion feature of the 2013 Credit Agreement, and increased the borrowings under the 2013 Term Loan and the capacity under the 2013 Credit Facility, each by $25.0 million.
 
The loans under the 2013 Credit Agreement are scheduled to mature on July 10, 2018. The 2013 Term Loan provides for aggregate principal payments of 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, payable in equal quarterly installments beginning on September 30, 2013. The 2013 Credit Agreement is unsecured.
 
Advances under the 2013 Credit Agreement are in the form of either U.S. dollar-denominated or Canadian dollar-denominated base rate loans or U.S. dollar-denominated eurodollar loans. The interest rate for base rate loans denominated in U.S. dollars fluctuates and is equal to the highest of (i) Wells Fargo’s prime rate (ii) the Federal funds rate plus 0.5% and (iii) the London Interbank Offered Rate (“LIBOR”) as defined in the 2013 Credit Agreement plus 1.0%, in each case plus a margin of 0.25% to 1.0% based upon the Company’s total leverage ratio as defined in the 2013 Credit Agreement. The interest rate for base rate loans denominated in Canadian dollars fluctuates and is equal to the higher of (i) Wells Fargo’s prime rate for Canadian dollar loans and (ii) the Canadian Dollar Offered Rate (“CDOR”) plus 1.0%, in each case plus a margin of 0.25% to 1.0% based upon the Company’s total leverage ratio as defined in the 2013 Credit 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 1.25% to 2.0% based on the Company’s total leverage ratio as defined in the 2013 Credit Agreement.
 
The 2013 Credit Agreement contains the usual and customary negative covenants for transactions of this type, including, but not limited to, restrictions on the Company’s ability and in certain instances, its subsidiaries’ ability to consolidate or merge; substantially change the nature of its business; sell, lease, or otherwise transfer any substantial part of its assets; create or incur indebtedness; create liens; pay dividends; and make acquisitions. The negative covenants are subject to certain exceptions as specified in the 2013 Credit Agreement. The 2013 Credit Agreement also requires the Company to satisfy certain financial covenants, including a maximum total leverage ratio as determined in accordance with the 2013 Credit Agreement and a minimum ratio of consolidated operating EBITDA to consolidated interest expense as determined in accordance with the 2013 Credit Agreement. The 2013 Credit Agreement also includes customary events of default.
 
Convertible Senior Notes
 
At September 30, 2013, the Company had outstanding $345.0 million of convertible senior notes scheduled to mature on May 15, 2014 (the “Convertible Senior Notes due 2014”). On August 1, 2013, the Company settled in cash the remaining $772.6 million of convertible senior notes due August 1, 2013, of which $772.5 million was surrendered for conversion for $1,790.3 million, with the remaining principal paid at maturity. The Company received $1,017.7 million of cash from the counterparties in settlement of the related convertible note hedge transactions.

 
17

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
The table below summarizes the carrying value of the components of the convertible senior notes:
 
   
September 30,
2013
   
December 31,
2012
 
   
(In millions)
 
Carrying amount of equity component
 
$
115.9
   
$
368.7
 
                 
Principal amount of liability component
 
$
345.0
   
$
1,150.0
 
Unamortized discount
   
(19.5
)
   
(76.8
)
Net carrying value of liability component
 
$
325.5
   
$
1,073.2
 
                 
If-converted value of common stock
 
$
1,533.7
   
$
2,534.4
 
 
The discount on the liability component will be amortized as interest expense over the remaining life of the Convertible Senior Notes due 2014 which, at September 30, 2013, is a period of 0.6 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, 2013 and 2012 is as follows:
 
   
Three Months Ended
September 30,
   
Nine Months Ended
September 30,
 
   
2013
   
2012
   
2013
   
2012
 
   
(In thousands, except percentages)
 
Interest expense calculated on contractual interest rate
 
$
5,074
   
$
7,619
   
$
20,073
   
$
22,856
 
Amortization of discount on liability component
   
12,602
     
20,865
     
57,321
     
60,915
 
Total interest expense on convertible senior notes
 
$
17,676
   
$
28,484
   
$
77,394
   
$
83,771
 
                                 
Effective interest rate (annualized)
   
13.2
%
   
11.0
%
   
11.8
%
   
11.0
%
 
The Convertible Senior Notes due 2014 are convertible at the option of the holder based on the condition that the common stock trading price exceeded 130% of the applicable conversion price. Through September 30, 2013, a de minimis amount of the Convertible Senior Notes due 2014 were surrendered for conversion and, in each case, either have been or will be settled in cash following the completion of the applicable cash settlement averaging period.
 
Senior Notes Due 2017
 
In November 2012, the Company issued and sold $400 million aggregate principal amount of 5.250% senior notes due December 1, 2017 (the “Senior Notes due 2017”) at an issue price of 98.912% of the aggregate principal amount. The unamortized discount was $3.7 million and $4.3 million at September 30, 2013 and December 31, 2012, respectively. The discount is being amortized using the effective interest method over the remaining life of the Senior Notes due 2017 which, at September 30, 2013, is a period of 4.2 years at an effective annual interest rate of 5.5%.
 
Deposits
 
As of September 30, 2013, Comenity Bank and Comenity Capital Bank had issued $260.0 million in money market deposits. Money market deposits are redeemable on demand by the customer and, as such, have no scheduled maturity date.
 
Non-Recourse Borrowings of Consolidated Securitization Entities
 
Asset-Backed Term Notes
 
In February 2013, Master Trust I issued $500.0 million of asset-backed term securities to investors, which will mature in February 2018. The offering consisted of $375.0 million of Class A Series 2013-A asset-backed notes with a fixed interest rate of 1.61% per year and an aggregate of $125.0 million of subordinated classes of the asset-backed term notes that were retained by the Company and are eliminated from the unaudited condensed consolidated financial statements.
 
In April 2013, $500.0 million of floating rate Series 2006-A asset-backed term notes matured and were repaid by the Company.

 
18

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
In May 2013, Master Trust I issued $657.9 million of asset-backed term securities to investors, which will mature in May 2016. The offering consisted of $500.0 million of Class A Series 2013-B asset-backed notes with a fixed interest rate of 0.91% per year and an aggregate of $157.9 million of subordinated classes of the asset-backed term notes that were retained by the Company and are eliminated from the unaudited condensed consolidated financial statements.
 
In July 2013, $245.0 million of fixed rate Series 2009-D asset-backed term notes matured and were repaid by the Company.
 
Conduit Facilities
 
The Company has access to committed undrawn capacity through three conduit facilities to support the funding of its credit card receivables through Master Trust I, Master Trust III and the WFC Trust. As of September 30, 2013, total capacity under the conduit facilities was $2.1 billion, of which $980.0 million had been drawn and was included in non-recourse borrowings of consolidated securitization entities in the unaudited condensed consolidated balance sheet. Borrowings outstanding under each facility bear interest at a margin above LIBOR or the asset-backed commercial paper costs of each individual conduit provider. The conduits have varying maturities from March 2014 to September 2015 with variable interest rates ranging from 1.18% to 1.71% as of September 30, 2013.
 
In May 2013, the Company renewed its 2009-VFN conduit facility under World Financial Capital Master Note Trust, extending the maturity to May 31, 2015 and increasing the total capacity from $375.0 million to $450.0 million.
 
In September 2013, the Company renewed its 2009-VFC1 conduit facility under World Financial Network Credit Card Master Note Trust III, extending the maturity to September 24, 2015 and increasing the total capacity from $330.0 million to $440.0 million.
 
Derivative Instruments
 
As part of its interest rate risk management program, the Company may enter into derivative contracts with institutions that are established dealers to manage its exposure to changes in interest rates for certain obligations.
 
The credit card securitization trusts entered into certain interest rate derivative instruments that involved the receipt of variable rate amounts from counterparties in exchange for the Company making fixed rate payments over the life of the agreement without the exchange of the underlying notional amount. These interest rate derivative instruments were not designated as hedges. Such instruments were not speculative and were used to manage interest rate risk, but did not meet the specific hedge accounting requirements of ASC 815, “Derivatives and Hedging.”
 
The Company’s outstanding interest rate derivative instruments matured in April 2013. The Company was not a party to any derivative instruments as of September 30, 2013.
 
There were no gains on derivative instruments for the three months ended September 30, 2013. Gains on derivative instruments of $7.5 million for the three months ended
September 30, 2012, and $8.5 million and $22.7 million for the nine months ended September 30, 2013 and 2012, respectively, were recognized in securitization funding costs within the unaudited condensed consolidated statements of income.
 
The following tables identify the notional amount, fair value and classification of the Company’s outstanding interest rate derivatives at December 31, 2012 in the unaudited condensed consolidated balance sheets:
 
   
December 31, 2012
 
   
Notional Amount
   
Weighted Average Years to Maturity
 
   
(Dollars in thousands)
 
Interest rate derivatives not designated as hedging instruments
 
$
545,700
     
0.51
 
 
 
     
December 31, 2012
 
   
Balance Sheet Location
   
Fair Value
 
     
(In thousands)
 
Interest rate derivatives not designated as hedging instruments
 
Other assets
   
$
4
 
Interest rate derivatives not designated as hedging instruments
 
Other current liabilities
   
$
8,515
 
 
 
19

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
7. 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 redemption and service revenue is deferred. 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.
 
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 on its unaudited condensed consolidated balance sheets. 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.
 
A reconciliation of deferred revenue for the AIR MILES Reward Program is as follows:
 
   
Deferred Revenue
 
   
Service
   
Redemption
   
Total
 
   
(In thousands)
 
December 31, 2012
 
$
380,013
   
$
869,048
   
$
1,249,061
 
Cash proceeds
   
153,669
     
386,101
     
539,770
 
Revenue recognized
   
(158,381
)
   
(403,754
)
   
(562,135
)
Other
   
 
   
386
     
386
 
Effects of foreign currency translation
   
(14,248
)
   
(32,509
)
   
(46,757
)
September 30, 2013
 
$
361,053
   
$
819,272
   
$
1,180,325
 
Amounts recognized in the unaudited condensed consolidated balance sheets:
                       
Current liabilities
 
$
182,310
   
$
819,272
   
$
1,001,582
 
Non-current liabilities
 
$
178,743
   
$
   
$
178,743
 
 
 
8. STOCKHOLDERS’ EQUITY
 
Stock Repurchase Program
 
On January 2, 2013, 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 January 2, 2013 through December 31, 2013, subject to any restrictions pursuant to the terms of the Company’s credit agreements, indentures, applicable securities laws or otherwise.
 
For the nine months ended September 30, 2013, the Company acquired a total of 1,392,000 shares of its common stock for $231.1 million. As of September 30, 2013, the Company has $168.9 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, 2013 and 2012 is as follows:
 
   
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
   
2013
   
2012
 
2013
   
2012
 
   
(In thousands)
 
Cost of operations
 
$
9,812
   
$
8,343
 
$
29,354
   
$
23,864
 
General and administrative
   
5,601
     
4,076
   
14,074
     
13,741
 
Total
 
$
15,413
   
$
12,419
 
$
43,428
   
$
37,605
 
 
During the nine months ended September 30, 2013, the Company awarded 257,212 performance-based restricted stock units with a weighted average grant date fair value per share of $152.05 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, 2013 to December 31, 2013 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, 2014, an additional 33% of the award on February 23, 2015 and the final 34% of the award on February 22, 2016, provided that the participant is employed by the Company on each such vesting date.

 
20

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)

 
During the nine months ended September 30, 2013, the Company awarded 86,234 service-based restricted stock units with a weighted average grant date fair value per share of $158.40 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.
 
 
9. ACCUMULATED OTHER COMPREHENSIVE INCOME
 
The changes in each component of accumulated comprehensive income (loss), net of tax effects, are as follows:
 
Three Months Ended September 30, 2013
 
Net Unrealized
Gains (Losses)
on Securities
   
Foreign
Currency
Translation Adjustments (1)
   
Accumulated
Other
Comprehensive
Income (Loss)
 
   
(In thousands)
 
Balance as of June 30, 2013
 
$
4,867
   
$
(23,917
)
 
$
(19,050
)
Changes in other comprehensive income (loss)
   
50
     
(247
)
   
(197
)
Balance as of September 30, 2013
 
$
4,917
   
$
(24,164
)
 
$
(19,247
)
                           


Three Months Ended September 30, 2012
 
Net Unrealized
Gains (Losses)
on Securities
   
Foreign
Currency
Translation
Adjustments (1)
   
Accumulated
Other
Comprehensive
Income (Loss)
 
   
(In thousands)
 
Balance as of June 30, 2012
 
$
8,789
   
$
(31,669
)
 
$
(22,880
)
Changes in other comprehensive income (loss)
   
3,044
     
(2,107
)
   
937
 
Balance as of September 30, 2012
 
$
11,833
   
$
(33,776
)
 
$
(21,943
)
                           


Nine Months Ended September 30, 2013
 
Net Unrealized
Gains (Losses)
on Securities
   
Foreign
Currency
Translation
Adjustments (1)
   
Accumulated
Other
Comprehensive
Income (Loss)
 
   
(In thousands)
 
Balance as of December 31, 2012
 
$
10,321
   
$
(32,182
)
 
$
(21,861
)
Changes in other comprehensive income (loss)
   
(5,404
)
   
8,018
     
2,614
 
Balance as of September 30, 2013
 
$
4,917
   
$
(24,164
)
 
$
(19,247
)
                           


Nine Months Ended September 30, 2012
 
Net Unrealized
Gains (Losses)
on Securities
   
Foreign
Currency
Translation
Adjustments (1)
   
Accumulated
Other
Comprehensive
Income (Loss)
 
   
(In thousands)
 
Balance as of December 31, 2011
 
$
6,953
   
$
(30,009
)
 
$
(23,056
)
Changes in other comprehensive income (loss)
   
4,880
     
(3,767
)
   
1,113
 
Balance as of September 30, 2012
 
$
11,833
   
$
(33,776
)
 
$
(21,943
)
                           
 
(1)
Primarily related to the impact of changes in the Canadian currency exchange rate.
 
A de minimis amount was reclassified out of accumulated other comprehensive income (loss) for the nine months ended September 30, 2013.

 
21

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
10. 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:
 
   
September 30, 2013
   
December 31, 2012
 
   
Carrying
Amount
 
Fair
Value
   
Carrying
Amount
 
Fair
Value
 
   
(In thousands)
 
Financial assets
                   
Cash and cash equivalents
 
$
784,042
 
$
784,042