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EX-31.2 - EXHIBIT 31.2 - ALLIANCE DATA SYSTEMS CORPexhibit_31-2.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 June 30, 2014
OR
 
£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from to

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

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

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

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

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

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No R
 
As of July 30, 2014, 55,528,310 shares of common stock were outstanding.
 



 
ALLIANCE DATA SYSTEMS CORPORATION
 
INDEX
 
 
 
 
 
Page
Number
Part I:   FINANCIAL INFORMATION
 
Item 1.
Financial Statements (unaudited)
 
 
3
 
4
 
5
 
6
 
7
Item 2.
31
Item 3.
45
Item 4.
45
 
Part II:   OTHER INFORMATION
 
 
Item 1.
47
Item 1A.
47
Item 2.
47
Item 3.
47
Item 4.
47
Item 5.
47
Item 6.
48
49

2

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

ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2014
 
2013
 
2014
 
2013
 
 
(In thousands, except per share amounts)
 
Revenues
 
 
 
 
Transaction  
$
80,248
 
$
79,573
 
$
164,228
 
$
161,921
 
Redemption  
 
268,504
   
138,342
   
512,194
   
298,354
 
Finance charges, net  
 
538,186
   
462,739
   
1,074,447
   
940,143
 
Database marketing fees and direct marketing services  
 
339,819
   
309,495
   
668,288
   
605,101
 
Other revenue  
 
38,401
   
37,943
   
78,901
   
76,010
 
Total revenue  
 
1,265,158
   
1,028,092
   
2,498,058
   
2,081,529
 
Operating expenses
                   
Cost of operations (exclusive of depreciation and amortization disclosed separately below)
 
783,369
   
619,285
   
1,555,795
   
1,239,707
 
Provision for loan loss  
 
96,652
   
57,796
   
167,234
   
124,444
 
General and administrative  
 
28,302
   
28,255
   
62,329
   
50,547
 
Depreciation and other amortization  
 
25,973
   
20,446
   
51,485
   
40,006
 
Amortization of purchased intangibles  
 
48,322
   
33,130
   
96,883
   
66,420
 
Total operating expenses  
 
982,618
   
758,912
   
1,933,726
   
1,521,124
 
Operating income  
 
282,540
   
269,180
   
564,332
   
560,405
 
Interest expense
         
Securitization funding costs  
 
22,300
   
24,694
   
45,211
   
49,179
 
Interest expense on deposits  
 
8,228
   
7,002
   
16,462
   
14,009
 
Interest expense on long-term and other debt, net  
 
32,404
   
51,770
   
69,006
   
102,822
 
Total interest expense, net  
 
62,932
   
83,466
   
130,679
   
166,010
 
Income before income tax  
 
219,608
 
 
185,714
 
 
433,653
 
 
394,395
 
Provision for income taxes  
 
80,419
   
69,274
   
158,717
   
148,976
 
Net income  
139,189
 
116,440
 
274,936
 
245,419
 
Less: Net income attributable to non-controlling interest  
 
1,745
   
   
97
   
 
Net income attributable to Alliance Data Systems Corporation stockholders  
$
137,444
 
$
116,440
 
$
274,839
 
$
245,419
 
 
                       
Net income attributable to Alliance Data Systems Corporation stockholders per share:  
                       
Basic  
$
2.54
 
$
2.37
 
$
5.13
 
$
4.96
 
Diluted  
$
2.19
 
$
1.71
 
$
4.27
 
$
3.62
 
 
                       
Weighted average shares
         
Basic  
 
54,154
   
49,123
   
53,600
   
49,444
 
Diluted  
 
62,637
   
68,167
   
64,354
   
67,746
 
 
 
See accompanying notes to unaudited condensed consolidated financial statements.
 
4

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


See accompanying notes to unaudited condensed consolidated financial statements.
 
5

ALLIANCE DATA SYSTEMS CORPORATION
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
 
 
Six Months Ended
June 30,
 
 
 
2014
   
2013
 
 
 
(In thousands)
 
CASH FLOWS FROM OPERATING ACTIVITIES:
 
Net income                                                                                                                                                            
 
$
274,936
   
$
245,419
 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
Depreciation and amortization                                                                                                                                                        
   
148,368
     
106,426
 
Deferred income taxes                                                                                                                                                        
   
13,221
     
1,594
 
Provision for loan loss                                                                                                                                                        
   
167,234
     
124,444
 
Non-cash stock compensation                                                                                                                                                        
   
31,497
     
28,015
 
Fair value gain on interest-rate derivatives                                                                                                                                                        
   
(113
)
   
(8,511
)
Amortization of discount on debt                                                                                                                                                        
   
12,293
     
45,102
 
Amortization of deferred financing costs                                                                                                                                                        
   
11,301
     
13,319
 
Change in deferred revenue                                                                                                                                                            
   
(41,175
)
   
(37,269
)
Change in other operating assets and liabilities, net of acquisitions                                                                                                                                                            
   
(8,292
)
   
9,207
 
Originations of loan receivables held for sale                                                                                                                                                            
   
(2,343,434
)
   
 
Sales of loan receivables held for sale                                                                                                                                                            
   
2,342,091
     
 
Excess tax benefits from stock-based compensation                                                                                                                                                            
   
(26,926
)
   
(10,103
)
Other                                                                                                                                                            
   
6,797
     
12,822
 
Net cash provided by operating activities                                                                                                                                                    
   
587,798
     
530,465
 
 
CASH FLOWS FROM INVESTING ACTIVITIES:
 
Change in redemption settlement assets                                                                                                                                                            
   
(57,530
)
   
(47,671
)
Change in cash collateral, restricted                                                                                                                                                            
   
     
18,450
 
Change in restricted cash                                                                                                                                                            
   
(58
)
   
(271,132
)
Change in credit card and loan receivables                                                                                                                                                            
   
(151,078
)
   
83,403
 
Purchase of credit card portfolios                                                                                                                                                            
   
     
(37,061
)
Payment for acquired business, net of cash                                                                                                                                                            
   
(259,514
)
   
 
Capital expenditures                                                                                                                                                            
   
(77,260
)
   
(58,995
)
Purchases of other investments                                                                                                                                                            
   
(105,911
)
   
(18,339
)
Maturities/sales of other investments                                                                                                                                                            
   
3,209
     
1,002
 
Other                                                                                                                                                            
   
(4,000
)
   
(1,383
)
Net cash used in investing activities                                                                                                                                                    
   
(652,142
)
   
(331,726
)
 
CASH FLOWS FROM FINANCING ACTIVITIES:
 
Borrowings under debt agreements                                                                                                                                                            
   
1,121,834
     
 
Repayments of borrowings                                                                                                                                                            
   
(788,805
)
   
(11,475
)
Proceeds from convertible note hedge counterparties                                                                                                                                                            
   
1,519,833
     
32,671
 
Settlement of convertible note borrowings                                                                                                                                                            
   
(1,864,803
)
   
(65,083
)
Issuances of deposits                                                                                                                                                            
   
1,194,448
     
732,754
 
Repayments of deposits                                                                                                                                                            
   
(1,000,783
)
   
(705,799
)
Non-recourse borrowings of consolidated securitization entities                                                                                                                                                            
   
760,000
     
1,268,285
 
Repayments/maturities of non-recourse borrowings of consolidated securitization entities
   
(1,040,000
)
   
(1,387,339
)
Payment of deferred financing costs                                                                                                                                                            
   
(6,671
)
   
(5,971
)
Excess tax benefits from stock-based compensation                                                                                                                                                            
   
26,926
     
10,103
 
Proceeds from issuance of common stock                                                                                                                                                            
   
8,202
     
5,534
 
Purchase of treasury shares                                                                                                                                                            
   
(201,759
)
   
(207,974
)
Other                                                                                                                                                            
   
(1,461
)
   
(11
)
Net cash used in financing activities                                                                                                                                                    
   
(273,039
)
   
(334,305
)
 
Effect of exchange rate changes on cash and cash equivalents                                                                                                                                                            
   
(1,272
)
   
(7,965
)
Change in cash and cash equivalents                                                                                                                                                            
   
(338,655
)
   
(143,531
)
Cash and cash equivalents at beginning of period                                                                                                                                                            
   
969,822
     
893,352
 
Cash and cash equivalents at end of period                                                                                                                                                    
 
$
631,167
   
$
749,821
 
 
SUPPLEMENTAL CASH FLOW INFORMATION:
 
Interest paid                                                                                                                                                            
 
$
114,986
   
$
111,633
 
Income taxes paid, net                                                                                                                                                            
 
$
69,028
   
$
95,108
 
 
 
See accompanying notes to unaudited condensed consolidated financial statements.
 
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 consolidated subsidiaries and variable interest entities, the "Company"), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") have been condensed or omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's Annual Report filed on Form 10-K for the year ended December 31, 2013, filed with the SEC on February 28, 2014.
 
The unaudited condensed consolidated financial statements included herein reflect all adjustments (consisting of normal, recurring adjustments) which are, in the opinion of management, necessary to state fairly the results for the interim periods presented. The results of operations for the interim periods presented are not necessarily indicative of the operating results to be expected for any subsequent interim period or for the fiscal year.
 
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect (1) the reported amounts of assets; (2) liabilities and disclosure of contingent assets and liabilities at the date of the financial statements; and (3) the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
 
For purposes of comparability, certain prior period amounts have been reclassified to conform to the current year presentation in accordance with GAAP.
 
Recently Issued Accounting Standards
 
In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2014-09, "Revenue from Contracts with Customers," which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective. The new standard is effective for interim and annual reporting periods beginning after December 15, 2016. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures.
 
Recently Adopted Accounting Standards
 
In July 2013, the FASB issued ASU 2013-11, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists," which provides guidance on financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss or a tax credit carryforward exists. ASU 2013-11 requires an entity to present an unrecognized tax benefit, or a portion of an unrecognized tax benefit, as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward when settlement in this manner is available under the governing tax law. ASU 2013-11 was effective for interim and annual periods beginning after December 15, 2013 and required prospective application. The adoption of ASU 2013-11 did not have a material impact on the Company's financial condition, results of operations or cash flows.
7

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


2. EARNINGS PER SHARE
 
The following table sets forth the computation of basic and diluted net income per share for the periods indicated:
 
 
 
Three Months Ended
June 30,
Six Months Ended
June 30,
 
2014
2013
2014
2013
(In thousands, except per share amounts)
Numerator:
Net income attributable to Alliance Data Systems Corporation stockholders
 
$
137,444
   
$
116,440
   
$
274,839
   
$
245,419
 
Denominator:
                               
Weighted average shares, basic  
   
54,154
     
49,123
     
53,600
     
49,444
 
Weighted average effect of dilutive securities:
                 
Shares from assumed conversion of convertible senior notes  
   
2,715
     
10,611
     
4,224
     
10,372
 
Shares from assumed conversion of convertible note warrants  
   
5,247
     
7,818
     
6,009
     
7,336
 
Net effect of dilutive stock options and unvested restricted stock  
   
521
     
615
     
521
     
594
 
Denominator for diluted calculations  
   
62,637
     
68,167
     
64,354
     
67,746
 
 
                               
Net income attributable to Alliance Data Systems Corporation stockholders per share:
                               
Basic
 
$
2.54
   
$
2.37
   
$
5.13
   
$
4.96
 
Diluted 
  $ 2.19     $ 1.71     $ 4.27     $ 3.62  
 
 
The Company calculated the effect of its convertible senior notes on diluted net income per share as if they would be settled in cash as the Company had the intent to settle the convertible senior notes for cash. The convertible senior notes were settled with cash upon maturity in August 2013 and May 2014, respectively.
 
The Company is also party to prepaid forward contracts to purchase 1,857,400 shares of its common stock that are to be delivered over a settlement period beginning in August 2014 and completing in December 2014. The number of shares to be delivered under the prepaid forward contracts has reduced weighted-average basic and diluted shares outstanding for the three and six months ended June 30, 2014 and 2013.
 
 
3. ACQUISITION
 
On January 2, 2014, the Company acquired a 60% ownership interest in BrandLoyalty Group B.V. ("BrandLoyalty"), a Netherlands-based, data-driven loyalty marketer. BrandLoyalty designs, organizes, implements and evaluates innovative and tailor-made loyalty programs for food retailers worldwide. The acquisition expands the Company's presence across Europe, Asia and Latin America. The results of BrandLoyalty have been included since the date of acquisition and are reflected in the Company's LoyaltyOne segment. The initial cash consideration was approximately $259.5 million in addition to the assumption of debt. The goodwill resulting from the acquisition is not deductible for tax purposes.
 
The Company also recorded a contingent liability for the earn-out provisions included in the share purchase agreement of approximately $248.7 million as of January 2, 2014, which is included in accrued expenses in the Company's unaudited condensed consolidated balance sheet. The contingent liability was measured at fair value on the date of purchase and any subsequent changes in the fair value of the liability are recorded through earnings.

8

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
 
The following table summarizes the allocation of consideration and the respective fair values of the assets acquired and liabilities assumed in the BrandLoyalty acquisition as of the date of purchase:
 
 
 
As of
January 2, 2014
 
(In thousands)
Current assets, net of cash acquired                                                                                                                                          
$
246,769
 
Deferred tax asset                                                                                                                                          
 
3,509
 
Property and equipment                                                                                                                                          
 
19,719
 
Other non-current assets                                                                                                                                          
 
3,994
 
Intangible assets                                                                                                                                          
 
423,832
 
Goodwill                                                                                                                                          
 
565,015
 
Total assets acquired                                                                                                                                      
 
1,262,838
 
 
   
Current liabilities                                                                                                                                          
 
146,559
 
Current portion of long-term debt                                                                                                                                          
 
34,180
 
Deferred tax liability                                                                                                                                          
 
105,512
 
Long-term debt (net of current portion)                                                                                                                                          
 
126,323
 
Other liabilities                                                                                                                                          
 
142
 
Total liabilities assumed                                                                                                                                      
 
412,716
 
 
   
Redeemable non-controlling interest                                                                                                                                      
 
341,907
 
 
   
Net assets acquired                                                                                                                                      
$
508,215
 
 
Pursuant to the BrandLoyalty share purchase agreement, the Company may acquire the remaining 40% ownership interest in BrandLoyalty over a four-year period, 10% per year at predetermined valuation multiples. If specified annual earnings targets are met by BrandLoyalty, the Company must acquire the additional 10% interest for the year achieved; otherwise, the sellers have a put option to sell the Company their 10% interest for the respective year. See Note 11, "Redeemable Non-Controlling Interest," for more information.
 
 
4. CREDIT CARD AND LOAN RECEIVABLES
 
The Company's credit card and loan receivables are the only portfolio segment or class of financing receivables. Quantitative information about the components of total credit card and loan receivables is presented in the table below:
 
 
 
June 30,
2014
   
December 31,
2013
 
 
 
(In thousands)
 
Principal receivables  
 
$
8,096,112
   
$
8,166,961
 
Billed and accrued finance charges  
   
336,440
     
343,521
 
Other credit card and loan receivables  
   
101,342
     
62,400
 
Total credit card and loan receivables  
   
8,533,894
     
8,572,882
 
Less credit card receivables – restricted for securitization investors
   
6,737,440
     
7,080,014
 
Other credit card and loan receivables  
 
$
1,796,454
   
$
1,492,868
 
 
Allowance for Loan Loss
 
The Company maintains an allowance for loan loss at a level that is appropriate to absorb probable losses inherent in credit card and loan receivables. The allowance for loan loss covers forecasted uncollectible principal as well as unpaid interest and fees. The allowance for loan loss is evaluated monthly for appropriateness.
 
In estimating the allowance for principal loan losses, management utilizes a migration analysis of delinquent and current credit card and loan receivables. Migration analysis is a technique used to estimate the likelihood that a credit card or loan receivable will progress through the various stages of delinquency and to charge-off. The allowance is maintained through an adjustment to the provision for loan loss. Charge-offs of principal amounts, net of recoveries are deducted from the allowance. In estimating the allowance for uncollectible unpaid interest and fees, the Company utilizes historical charge-off trends, analyzing actual charge-offs for the prior three months. The allowance is maintained through an adjustment to finance charges, net. In evaluating the allowance for loan loss for both principal and unpaid interest and fees, management also considers factors that may impact loan loss experience, including seasoning, loan volume and amounts, seasonality, payment rates and forecasting uncertainties.

9

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
 
Net charge-offs include the principal amount of losses from credit cardholders unwilling or unable to pay their account balances, as well as bankrupt and deceased credit cardholders, less recoveries and exclude charged-off interest, fees and fraud losses. Charged‑off interest and fees reduce finance charges, net while fraud losses are recorded as an expense. Credit card and loan receivables, including unpaid interest and fees, are charged-off at the end of the month during which an account becomes 180 days contractually past due, except in the case of customer bankruptcies or death. Credit card and loan receivables, including unpaid interest and fees, associated with customer bankruptcies or death are charged-off at the end of each month subsequent to 60 days after the receipt of notification of the bankruptcy or death, but in any case, not later than the 180-day contractual time frame. The Company records the actual charge-offs for unpaid interest and fees as a reduction to finance charges, net. Actual charge-offs for unpaid interest and fees were $68.5 million and $55.0 million for the three months ended June 30, 2014 and 2013, respectively, and $144.0 million and $113.7 million for the six months ended June 30, 2014 and 2013, respectively.
 
The following table presents the Company's allowance for loan loss for the periods indicated:
 
 
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
 
 
2014
   
2013
   
2014
   
2013
 
 
 
(In thousands)
 
Balance at beginning of period  
 
$
482,658
   
$
471,016
   
$
503,169
   
$
481,958
 
Provision for loan loss  
   
96,652
     
57,796
     
167,234
     
124,444
 
Change in estimate for uncollectible unpaid interest and fees  
   
(5,000
)
   
     
500
     
 
Recoveries  
   
38,066
     
27,163
     
76,474
     
57,948
 
Principal charge-offs  
   
(128,796
)
   
(107,579
)
   
(263,797
)
   
(215,954
)
Balance at end of period  
 
$
483,580
   
$
448,396
   
$
483,580
   
$
448,396
 
 
Delinquencies
 
A credit card account is contractually delinquent if the Company does not receive the minimum payment by the specified due date on the cardholder's statement. It is the Company's policy to continue to accrue interest and fee income on all credit card accounts beyond 90 days, except in limited circumstances, until the credit card account balance and all related interest and other fees are paid or charged off, typically at 180 days delinquent. When an account becomes delinquent, a message is printed on the credit cardholder's billing statement requesting payment. After an account becomes 30 days past due, a proprietary collection scoring algorithm automatically scores the risk of the account becoming further delinquent. The collection system then recommends a collection strategy for the past due account based on the collection score and account balance and dictates the contact schedule and collections priority for the account. If the Company is unable to make a collection after exhausting all in-house collection efforts, the Company may engage collection agencies and outside attorneys to continue those efforts.
 
The following table presents the delinquency trends of the Company's credit card and loan receivables portfolio:
 
 
 
June 30,
2014
   
% of
Total
   
December 31,
2013
   
% of
Total
 
 
 
   
(In thousands, except percentages)
   
 
Receivables outstanding – principal  
 
$
8,096,112
     
100.0
%
 
$
8,166,961
     
100.0
%
Principal receivables balances contractually delinquent:
                               
31 to 60 days  
   
115,647
     
1.5
%
   
114,430
     
1.4
%
61 to 90 days  
   
74,923
     
0.9
     
74,700
     
0.9
 
91 or more days  
   
129,309
     
1.6
     
150,425
     
1.9
 
Total  
 
$
319,879
     
4.0
%
 
$
339,555
     
4.2
%

10

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
 
Modified Credit Card and Loan Receivables
 
The Company holds certain credit card and loan receivables for which the terms have been modified. The Company's modified credit card and loan receivables include credit card and loan receivables for which temporary hardship concessions have been granted and credit card and loan receivables in permanent workout programs. These modified credit card and loan receivables include concessions consisting primarily of a reduced minimum payment and an interest rate reduction. The temporary programs' concessions remain in place for a period no longer than twelve months, while the permanent programs remain in place through the payoff of the credit card and loan receivables if the credit cardholder complies with the terms of the program. These concessions do not include the forgiveness of unpaid principal, but may involve the reversal of certain unpaid interest or fee assessments. In the case of the temporary programs, at the end of the concession period, credit card and loan receivable terms revert to standard rates. These arrangements are automatically terminated if the customer fails to make payments in accordance with the terms of the program, at which time their account reverts back to its original terms.
 
Credit card and loan receivables for which temporary hardship and permanent concessions were granted are both considered troubled debt restructurings and are collectively evaluated for impairment. Modified credit card and loan receivables are evaluated at their present value with impairment measured as the difference between the credit card and loan receivable balance and the discounted present value of cash flows expected to be collected. Consistent with the Company's measurement of impairment of modified credit card and loan receivables on a pooled basis, the discount rate used for credit card and loan receivables is the average current annual percentage rate the Company applies to non-impaired credit card and loan receivables, which approximates what would have been applied to the pool of modified credit card and loan receivables prior to impairment. In assessing the appropriate allowance for loan loss, these modified credit card and loan receivables are included in the general pool of credit card and loan receivables with the allowance determined under the contingent loss model of Accounting Standards Codification ("ASC") 450-20, "Loss Contingencies." If the Company applied accounting under ASC 310-40, "Troubled Debt Restructurings by Creditors," to the modified credit card and loan receivables in these programs, there would not be a material difference in the allowance for loan loss.
 
The Company had $110.3 million and $118.1 million, respectively, as a recorded investment in impaired credit card and loan receivables with an associated allowance for loan loss of $30.4 million and $33.9 million, respectively, as of June 30, 2014 and December 31, 2013. These modified credit card and loan receivables represented less than 2% of the Company's total credit card and loan receivables as of June 30, 2014 and December 31, 2013, respectively.
 
The average recorded investment in the impaired credit card receivables was $112.4 million and $117.5 million for the three months ended June 30, 2014 and 2013, respectively, and $114.3 million and $117.5 million for the six months ended June 30, 2014 and 2013, respectively.
 
Interest income on these modified credit card and loan receivables is accounted for in the same manner as other accruing credit card and loan receivables. Cash collections on these modified credit card and loan receivables are allocated according to the same payment hierarchy methodology applied to credit card and loan receivables that are not in such programs. The Company recognized $3.1 million and $3.2 million for the three months ended June 30, 2014 and 2013, respectively, and $6.3 million for each of the six months ended June 30, 2014 and 2013, respectively, in interest income associated with modified credit card and loan receivables during the period that such credit card and loan receivables were impaired.
 
The following tables provide information on credit card and loan receivables that are considered troubled debt restructurings as described above, which entered into a modification program during the specified periods:
 
 
Three Months Ended June 30, 2014
Six Months Ended June 30, 2014
 
Number of Restructurings
Pre-modification Outstanding
Balance
Post-modification Outstanding
Balance
Number of Restructurings
Pre-modification Outstanding
Balance
Post-modification Outstanding
Balance
 
(Dollars in thousands)
Troubled debt restructurings – credit card receivables
   
28,602
   
$
28,922
   
$
28,896
     
65,154
   
$
64,708
   
$
64,651
 
 
                                               

11

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
 
 
Three Months Ended June 30, 2013
Six Months Ended June 30, 2013
 
Number of Restructurings
Pre-modification Outstanding
Balance
Post-modification Outstanding
Balance
Number of Restructurings
Pre-modification Outstanding
Balance
Post-modification Outstanding
Balance
 
(Dollars in thousands)
Troubled debt restructurings – credit card receivables
   
35,100
   
$
32,135
   
$
32,120
     
72,895
   
$
66,101
   
$
66,062
 
 
                                               
 
The tables below summarize troubled debt restructurings that have defaulted in the specified periods where the default occurred within 12 months of their modification date:
 
 
Three Months Ended
June 30, 2014
Six Months Ended
June 30, 2014
 
Number of Restructurings
Outstanding Balance
Number of Restructurings
Outstanding Balance
 
(Dollars in thousands)
Troubled debt restructurings that subsequently defaulted – credit card receivables
   
13,770
   
$
13,831
     
30,498
   
$
29,972
 
 
 
 
Three Months Ended
June 30, 2013
Six Months Ended
June 30, 2013
 
Number of Restructurings
Outstanding Balance
Number of Restructurings
Outstanding Balance
 
(Dollars in thousands)
Troubled debt restructurings that subsequently defaulted – credit card receivables
   
15,698
   
$
14,938
     
31,193
   
$
29,421
 
 
Age of Credit Card and Loan Receivable Accounts
 
The following tables set forth, as of June 30, 2014 and 2013, the number of active credit card and loan accounts with balances and the related principal balances outstanding, based upon the age of the active credit card and loan accounts from origination:
 
 
 
June 30, 2014
 
Age of Accounts Since Origination
 
Number of
Active Accounts
with Balances
   
Percentage of
Active Accounts
with Balances
   
Total
Principal
Receivables Outstanding
   
Percentage of
Principal
Receivables Outstanding
 
 
 
(In thousands, except percentages)
 
0-12 Months  
   
4,750
     
27.8
%
 
$
2,031,774
     
25.1
%
13-24 Months  
   
2,467
     
14.5
     
1,148,807
     
14.2
 
25-36 Months  
   
1,714
     
10.0
     
838,573
     
10.4
 
37-48 Months  
   
1,245
     
7.3
     
623,665
     
7.7
 
49-60 Months  
   
988
     
5.8
     
520,428
     
6.4
 
Over 60 Months  
   
5,915
     
34.6
     
2,932,865
     
36.2
 
Total  
   
17,079
     
100.0
%
 
$
8,096,112
     
100.0
%
 
 
12

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


 
 
June 30, 2013
 
Age of Accounts Since Origination
 
Number of
Active Accounts
with Balances
   
Percentage of
Active Accounts
with Balances
   
Total
Principal
Receivables Outstanding
   
Percentage of
Principal
Receivables Outstanding
 
 
 
(In thousands, except percentages)
 
0-12 Months  
   
4,162
     
26.3
%
 
$
1,567,355
     
22.8
%
13-24 Months  
   
2,132
     
13.5
     
868,822
     
12.7
 
25-36 Months  
   
1,492
     
9.4
     
656,544
     
9.6
 
37-48 Months  
   
1,188
     
7.5
     
570,969
     
8.3
 
49-60 Months  
   
939
     
5.9
     
481,828
     
7.0
 
Over 60 Months  
   
5,920
     
37.4
     
2,721,437
     
39.6
 
Total  
   
15,833
     
100.0
%
 
$
6,866,955
     
100.0
%
 
Credit Quality
 
The Company uses proprietary scoring models developed specifically for the purpose of monitoring the Company's obligor credit quality. The proprietary scoring models are used as a tool in the underwriting process and for making credit decisions. The proprietary scoring models are based on historical data and require various assumptions about future performance. Information regarding customer performance is factored into these proprietary scoring models to determine the probability of an account becoming 90 or more days past due at any time within the next 12 months. Obligor credit quality is monitored at least monthly during the life of an account. The following table reflects composition of the Company's credit card and loan receivables by obligor credit quality as of June 30, 2014 and 2013:
 
 
June 30, 2014
   
June 30, 2013
 
Probability of an Account Becoming 90 or More Days Past
Due or Becoming Charged-off (within the next 12 months)
 
Total
Principal
Receivables Outstanding
   
Percentage of
Principal
Receivables Outstanding
   
Total
Principal
Receivables Outstanding
   
Percentage of
Principal
Receivables Outstanding
 
 
   
(In thousands, except percentages)
   
 
No Score
 
$
144,270
     
1.8
%
 
$
143,497
     
2.1
%
27.1% and higher
   
391,005
     
4.8
     
304,557
     
4.4
 
17.1% - 27.0%
   
748,356
     
9.2
     
618,805
     
9.0
 
12.6% - 17.0%
   
886,078
     
11.0
     
718,748
     
10.5
 
3.7% - 12.5%
   
3,298,009
     
40.7
     
2,782,404
     
40.5
 
1.9% - 3.6%
   
1,681,968
     
20.8
     
1,483,852
     
21.6
 
Lower than 1.9%
   
946,426
     
11.7
     
815,092
     
11.9
 
Total
 
$
8,096,112
     
100.0
%
 
$
6,866,955
     
100.0
%
 
Transfer of Financial Assets
 
The Company originates loans under an agreement with one of its clients and after origination, these loan receivables are sold to the client at par value plus accrued interest. These transfers qualify for sale treatment as they meet the conditions established in ASC 860-10, "Transfers and Servicing." Following the sale, the client owns the loan receivables, bears the risk of loss in the event of loan defaults and is responsible for all servicing functions related to the receivables. The loan receivables originated by the Company that have not yet been sold to the client were $63.4 million and $62.1 million at June 30, 2014 and December 31, 2013, respectively, and are included in loan receivables held for sale in the Company's unaudited condensed consolidated balance sheets and carried at the lower of cost or fair value. The carrying value of these loan receivables approximates fair value due to the short duration between origination and sale. Purchases and sales of these loan receivables held for sale are reflected as operating activities in the Company's unaudited condensed consolidated statements of cash flows.
 
Upon the client's purchase of the originated loan receivables, the Company is obligated to purchase a participating interest in a pool of loan receivables that includes the loan receivables originated by the Company. Such interest participates on a pro rata basis in the cash flows of the underlying pool of loan receivables, including principal repayments, finance charges, losses, recoveries, and servicing costs. The Company bears the risk of loss related to its participation interest in this pool.
 
13

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
 
During the six months ended June 30, 2014, the Company purchased $117.1 million of loan receivables under these agreements. The outstanding balance of these loan receivables was $108.4 million and $61.6 million as of June 30, 2014 and December 31, 2013, respectively, and was included in other credit card and loan receivables in the Company's unaudited condensed consolidated balance sheets.
 
Securitized Credit Card Receivables
 
The Company regularly securitizes its credit card receivables through its credit card securitization trusts, consisting of World Financial Network Credit Card Master Trust, World Financial Network Credit Card Master Note Trust ("Master Trust I") and World Financial Network Credit Card Master Trust III ("Master Trust III") (collectively, the "WFN Trusts"), and World Financial Capital Credit Card Master Note Trust (the "WFC Trust"). The Company continues to own and service the accounts that generate credit card receivables held by the WFN Trusts and the WFC Trust. In its capacity as a servicer, each of the respective banks earns a fee from the WFN Trusts and the WFC Trust to service and administer the credit card receivables, collect payments and charge-off uncollectible receivables. These fees are eliminated and therefore are not reflected in the unaudited condensed consolidated statements of income for the three and six months ended June 30, 2014 and 2013.
 
The WFN Trusts and the WFC Trust are variable interest entities ("VIEs") and the assets of these consolidated VIEs include certain credit card receivables that are restricted to settle the obligations of those entities and are not expected to be available to the Company or its creditors. The liabilities of the consolidated VIEs include non-recourse secured borrowings and other liabilities for which creditors or beneficial interest holders do not have recourse to the general credit of the Company.
 
The tables below present quantitative information about the components of total securitized credit card receivables, delinquencies and net charge-offs:
 
 
June 30,
2014
December 31,
2013
 
(In thousands)
Total credit card receivables – restricted for securitization investors  
 
$
6,737,440
   
$
7,080,014
 
Principal amount of credit card receivables – restricted for securitization investors, 90 days or more past due
 
$
109,383
   
$
131,659
 

 
 
Three Months Ended
June 30,
Six Months Ended
June 30,
 
2014
2013
2014
2013
 
(In thousands)
Net charge-offs of securitized principal  
 
$
79,947
   
$
74,595
   
$
165,661
   
$
148,689
 
 
 
5. INVENTORIES
 
Inventories of $222.2 million and $14.6 million at June 30, 2014 and December 31, 2013, respectively, consist of finished goods primarily to be utilized as rewards in the Company's loyalty programs and are included in other current assets in the Company's unaudited condensed consolidated balance sheets. We acquired $198.9 million of finished goods inventory in the BrandLoyalty acquisition on January 2, 2014.
 
Inventories are stated at lower of cost or market and valued primarily on a first-in-first-out basis. The Company records valuation adjustments to its inventories if the cost of inventory exceeds the amount it expects to realize from the ultimate sale or disposal of the inventory. These estimates are based on management's judgment regarding future market conditions and analysis of historical experience.
 
14

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

6. OTHER INVESTMENTS
 
Other investments consist of restricted cash, marketable securities and U.S. Treasury bonds and are included in other current assets and other assets in the unaudited condensed consolidated balance sheets. The principal components of other investments, which are carried at fair value, are as follows:
 
 
June 30, 2014
December 31, 2013
 
Amortized Cost
Unrealized Gains
Unrealized Losses
Fair Value
Amortized Cost
Unrealized Gains
Unrealized Losses
Fair Value
 
(In thousands)
Restricted cash  
 
$
30,548
   
$
   
$
   
$
30,548
   
$
25,988
   
$
   
$
   
$
25,988
 
Marketable securities  
   
79,963
     
269
     
(1,977
)
   
78,255
     
77,351
     
62
     
(4,180
)
   
73,233
 
U.S. Treasury bonds  
   
100,086
     
     
     
100,086
     
     
     
     
 
Total                                  
 
$
210,597
   
$
269
   
$
(1,977
)
 
$
208,889
   
$
103,339
   
$
62
   
$
(4,180
)
 
$
99,221
 
 
The following tables show the unrealized losses and fair value for those investments that were in an unrealized loss position as of June 30, 2014 and December 31, 2013, aggregated by investment category and the length of time that individual securities have been in a continuous loss position:
 
 
June 30, 2014
 
Less than 12 months
12 Months or Greater
Total
 
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
 
(In thousands)
Marketable securities
 
19,810
   
$
(138
 
$
45,149
   
(1,839
 
$
64,959
   
$
(1,977
 
 
 
December 31, 2013
 
Less than 12 months
12 Months or Greater
Total
 
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
 
(In thousands)
Marketable securities
 
39,954
   
$
(2,206
)  
$
25,785
   
(1,974
)  
$
65,739
   
$
(4,180
 
The amortized cost and estimated fair value of the marketable securities and U.S. Treasury bonds at June 30, 2014 by contractual maturity are as follows:
 
 
 
Amortized
Cost
   
Fair Value
 
 
 
(In thousands)
 
Due in one year or less  
 
$
6,674
   
$
6,623
 
Due after one year through five years  
   
100,086
     
100,086
 
Due after five years through ten years  
   
4,440
     
4,608
 
Due after ten years  
   
68,849
     
67,024
 
Total  
 
$
180,049
   
$
178,341
 
 
Market values were determined for each individual security in the investment portfolio. When evaluating the investments for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the security's issuer, and the Company's intent to sell the security and whether it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis. The Company typically invests in highly-rated securities with low probabilities of default and has the ability to hold the investments until maturity. As of June 30, 2014, the Company does not consider the investments to be other-than-temporarily impaired.
 
There were no realized gains or losses from the sale of investment securities for the three and six months ended June 30, 2014 and 2013.
 
15

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
 
7. REDEMPTION SETTLEMENT ASSETS
 
Redemption settlement assets consist of cash and cash equivalents and securities available-for-sale and are designated for settling redemptions by collectors of the AIR MILES® Reward Program in Canada under certain contractual relationships with sponsors of the AIR MILES Reward Program. These assets are primarily denominated in Canadian dollars. The principal components of redemption settlement assets, which are carried at fair value, are as follows:
 
 
 
June 30, 2014
December 31, 2013
 
Amortized Cost
Unrealized Gains
Unrealized Losses
Fair Value
Amortized Cost
Unrealized Gains
Unrealized Losses
Fair Value
 
(In thousands)
Cash and cash equivalents
 
$
153,794
   
$
   
$
   
$
153,794
   
$
73,984
   
$
   
$
   
$
73,984
 
Government bonds
   
4,788
     
     
(1
)
   
4,787
     
     
     
 
   
 
Corporate bonds 
   
400,741
     
5,844
     
(8
   
406,577
     
429,592
     
7,083
     
(310
   
436,365
 
Total 
 
$
559,323
   
$
5,844
   
$
(9
)
 
$
565,158
   
$
503,576
   
$
7,083
   
$
(310
)
 
$
510,349
 
 
The following tables show the unrealized losses and fair value for those investments that were in an unrealized loss position as of June 30, 2014 and December 31, 2013, aggregated by investment category and the length of time that individual securities have been in a continuous loss position:
 
 
June 30, 2014
 
 
Less than 12 months
 
12 Months or Greater
 
Total
 
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
Fair Value
 
Unrealized
Losses
 
 
(In thousands)
 
Government bonds 
$
4,787
  $ (1 )
$
 
$
 
$
4,787
 
$
(1
)
Corporate bonds
 
12,818
    (8 )  
   
   
12,818
   
(8
)
Total 
$
17,605
 
$
(9
)
$
 
$
 
$
17,605
 
$
(9
)
 
 
 
December 31, 2013
 
Less than 12 months
12 Months or Greater
Total
 
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
 
(In thousands)
Corporate bonds
  $
80,493
   
$
(310
)  
$
    $
   
$
80,493
   
$
(310
)
 
The amortized cost and estimated fair value of the securities at June 30, 2014 by contractual maturity are as follows:
 
 
 
Amortized
Cost
   
Fair Value
 
 
 
(In thousands)
 
Due in one year or less 
 
$
156,621
   
$
157,994
 
Due after one year through five years 
   
248,908
     
253,370
 
Total 
 
$
405,529
   
$
411,364
 
 
Market values were determined for each individual security in the investment portfolio. When evaluating the investments for other-than-temporary impairment, the Company reviews factors such as the length of time and extent to which fair value has been below cost basis, the financial condition of the security's issuer, and the Company's intent to sell the security and whether it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis. The Company typically invests in highly-rated securities with low probabilities of default and has the ability to hold the investments until maturity. As of June 30, 2014, the Company does not consider the investments to be other-than-temporarily impaired.
 
There were no realized gains or losses from the sale of investment securities for the three and six months ended June 30, 2014 and 2013.
 
16

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

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

 
 
 
December 31, 2013
 
 
 
 
Gross
Assets
   
Accumulated
Amortization
   
Net
 
Amortization Life and Method
 
 
(In thousands)
 
 
Finite Lived Assets
 
   
   
 
       
Customer contracts and lists  
 
$
440,200
   
$
(187,350
)
 
$
252,850
 
3-12 years—straight line
Premium on purchased credit card portfolios
   
216,041
     
(118,006
)
   
98,035
 
5-10 years—straight line, accelerated
Customer database  
   
161,700
     
(122,230
)
   
39,470
 
4-10 years—straight line
Collector database  
   
65,895
     
(60,711
)
   
5,184
 
30 years—15% declining balance
Tradenames  
   
58,567
     
(15,443
)
   
43,124
 
4-15 years—straight line
Purchased data lists  
   
17,567
     
(11,959
)
   
5,608
 
1-5 years—straight line, accelerated
Favorable lease  
   
3,291
     
(375
)
   
2,916
 
10 years—straight line
Noncompete agreements  
   
1,300
     
(433
)
   
867
 
3 years—straight line
 
 
$
964,561
   
$
(516,507
)
 
$
448,054
 
 
Indefinite Lived Assets
                       
       
Tradenames  
   
12,350
     
     
12,350
 
Indefinite life
Total intangible assets  
 
$
976,911
   
$
(516,507
)
 
$
460,404
 
 
 
With the BrandLoyalty acquisition on January 2, 2014, the Company acquired $423.8 million of intangible assets, consisting of $396.5 million of customer contracts and a $27.3 million tradename, which are being amortized over weighted average lives of 7.0 years and 3.0 years, respectively.
 
The estimated amortization expense related to intangible assets for the next five years and thereafter is as follows:
 
 
 
For Years Ending
December 31,
 
 
 
(In thousands)
 
2014 (excluding the six months ended June 30, 2014)  
 
$
89,393
 
2015  
   
161,487
 
2016  
   
143,894
 
2017  
   
109,342
 
2018  
   
99,217
 
2019 & thereafter  
   
175,503
 

 
17

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

Goodwill
 
The changes in the carrying amount of goodwill for the six months ended June 30, 2014 are as follows:
 
 
 
LoyaltyOne®
   
Epsilon®
   
Private Label Services and Credit
   
Corporate/
Other
   
Total
 
 
 
(In thousands)
 
December 31, 2013  
 
$
232,449
   
$
1,241,522
   
$
261,732
   
$
   
$
1,735,703
 
Goodwill acquired during the year
   
565,015
     
     
     
     
565,015
 
Effects of foreign currency translation
   
(155
)
   
742
     
     
     
587
 
June 30, 2014  
 
$
797,309
   
$
1,242,264
   
$
261,732
   
$
   
$
2,301,305
 
 
See Note 3, "Acquisition," for more information regarding the BrandLoyalty acquisition.
 
 
9. DEBT
 
Debt consists of the following:
 
Description
 
June 30,
2014
   
December 31,
2013
 
Maturity
 
Interest Rate
 
 
(Dollars in thousands)
 
 
Long-term and other debt:
 
   
 
 
2013 credit facility  
 
$
720,000
   
$
336,000
 
July 2018
 
(1)
2013 term loan  
   
1,218,750
     
1,234,688
 
July 2018
 
(1)
BrandLoyalty credit facility  
   
125,747
     
 
December 2015
 
(2)
Convertible senior notes due 2014  
   
     
333,082
   
Senior notes due 2017  
   
396,916
     
396,511
 
December 2017
 
5.250%
Senior notes due 2020  
   
500,000
     
500,000
 
April 2020
 
6.375%
Total long-term and other debt  
   
2,961,413
     
2,800,281
       
Less: current portion  
   
(65,480
)
   
(364,489
)
     
Long-term portion  
 
$
2,895,933
   
$
2,435,792
       
 
                     
Deposits:
                     
Certificates of deposit  
 
$
2,437,647
   
$
2,486,533
 
Various – July 2014 – January 2021
 
0.15% to 3.30%
Money market deposits  
   
572,378
     
329,828
 
On demand
 
0.01% to 0.14%
Total deposits  
   
3,010,025
     
2,816,361
       
Less: current portion  
   
(1,752,641
)
   
(1,544,059
)
     
Long-term portion  
 
$
1,257,384
   
$
1,272,302
       
 
                     
Non-recourse borrowings of consolidated securitization entities:
                     
Fixed rate asset-backed term note securities
 
$
3,001,916
   
$
3,001,916
 
Various – October 2014 – June 2019
 
0.91% to 6.75%
Floating rate asset-backed term note securities
   
450,000
     
 
February 2016
 
(3)
Conduit asset-backed securities  
   
860,000
     
1,590,000
 
Various – September 2015 – May 2016
 
(4)
Total non-recourse borrowings of consolidated securitization entities
   
4,311,916
     
4,591,916
       
Less: current portion  
   
(643,750
)
   
(1,025,000
)
     
Long-term portion  
 
$
3,668,166
   
$
3,566,916
       
 
 
(1)
 
The interest rate is based upon the London Interbank Offered Rate ("LIBOR") plus an applicable margin. At June 30, 2014, the weighted average interest rate was 1.90% for both the 2013 Credit Facility and 2013 Term Loan.
 
(2)
The interest rate is based upon the Euro Interbank Offered Rate ("EURIBOR") plus an applicable margin. At June 30, 2014, the weighted average interest rate was 3.61%.
 
(3)
The interest rate is based upon LIBOR plus an applicable margin. At June 30, 2014, the interest rate was 0.53%.
 
(4)
 
The interest rate is based upon LIBOR or the asset-backed commercial paper costs of each individual conduit provider plus an applicable margin. At June 30, 2014, the interest rates ranged from 1.05% to 1.70%.
 
At June 30, 2014, the Company was in compliance with its covenants.
 
Credit Agreement
 
The Company, as borrower, and ADS Alliance Data Systems, Inc., ADS Foreign Holdings, Inc., Alliance Data Foreign Holdings, Inc., Epsilon Data Management, LLC, Comenity LLC, Comenity Servicing LLC and Aspen Marketing Services, LLC, as guarantors, are party to a credit agreement that provides for a $1.25 billion term loan (the "2013 Term Loan") with certain principal repayments and a $1.25 billion revolving line of credit (the "2013 Credit Facility").
 
18

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
 
Total availability under the 2013 Credit Facility at June 30, 2014 was $530.0 million.
 
In July 2014, the Company exercised in part the accordion feature of the 2013 Credit Agreement and increased the capacity under the 2013 Credit Facility by $50.0 million to $1.3 billion. Also in July 2014, HMI Holding LLC became an additional guarantor under the 2013 Credit Agreement, the Indenture governing the Senior Notes due 2017 and the Indenture governing the Senior Notes due 2020.
 
BrandLoyalty Credit Agreement
 
As part of the BrandLoyalty acquisition, the Company assumed the debt outstanding under BrandLoyalty's Amended and Restated Senior Facilities Agreement, as amended (the "BrandLoyalty Credit Agreement"). The BrandLoyalty Credit Agreement is secured by the accounts receivable, inventory, fixed assets, bank accounts and shares of BrandLoyalty Group B.V. and certain of its subsidiaries. The BrandLoyalty Credit Agreement consists of term loans of €63.0 million and a revolving line of credit of €87.0 million, both of which are scheduled to mature on December 31, 2015. The term loans provide for quarterly principal payments of €6.25 million through September 2015, with the remaining amount payable upon maturity. As of June 30, 2014, amounts outstanding under the term loans and revolving line of credit were €44.3 million and €47.6 million ($60.6 million and $65.2 million), respectively.
 
All advances under the BrandLoyalty Credit Agreement are denominated in Euros. The interest rate fluctuates and is equal to EURIBOR, as defined in the BrandLoyalty Credit Agreement, plus an applicable margin based on BrandLoyalty's senior net leverage ratio. The BrandLoyalty Credit Agreement contains financial covenants, including a senior net leverage ratio and a minimum annual EBITDA, as well as usual and customary negative covenants and customary events of default.
 
Convertible Senior Notes
 
In June 2009, the Company issued $345.0 million aggregate principal amount of convertible senior notes that matured and were repaid on May 15, 2014 (the "Convertible Senior Notes due 2014"). On or prior to May 15, 2014, the Company settled in cash the Convertible Senior Notes due 2014, which were surrendered for conversion for $1,864.8 million. The Company applied $1,519.8 million of cash from the counterparties in settlement of the related convertible note hedge transactions, including Bank of America, N.A., J.P. Morgan Securities LLC, as agent for JPMorgan Chase Bank, National Association, London Branch, and Barclays Bank PLC (such parties collectively, the "2014 Hedge Counterparties").
 
Interest expense on the convertible senior notes recognized in the Company's unaudited condensed consolidated statements of income for the three and six months ended June 30, 2014 and 2013 is as follows:
 
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
 
2014
   
2013
   
2014
   
2013
 
 
(In thousands, except percentages)
 
Interest expense calculated on contractual interest rate  
 
$
1,920
   
$
7,471
   
$
5,630
   
$
14,999
 
Amortization of discount on liability component  
   
4,036
     
22,669
     
11,888
     
44,719
 
Total interest expense on convertible senior notes  
 
$
5,956
   
$
30,140
   
$
17,518
   
$
59,718
 
 
                               
Effective interest rate (annualized)  
   
14.2
%
   
11.0
%
   
14.2
%
   
11.0
%
 
In June 2014, the Company entered into amendments to the warrant agreements with the 2014 Hedge Counterparties for the approximately 7.3 million warrants associated with the Convertible Senior Notes due 2014. The amendments, among other things, amend the dates on which the warrants are exercisable and will expire to June 16, 2014 and continuing each business day through August 11, 2014. On July 3, 2014, the Company net settled 2.0 million warrants associated with the Convertible Senior Notes due 2014 by issuing 1.5 million shares of its common stock.
 
In the first quarter of 2014, the Company completed the settlement of the final 5.1 million of warrants associated with the convertible senior notes that matured on August 1, 2013 by issuing 2.9 million shares of its common stock.
 
19

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

Senior Notes Due 2017
 
In November 2012, the Company issued and sold $400.0 million aggregate principal amount of 5.250% senior notes due December 1, 2017 (the "Senior Notes due 2017") at an issue price of 98.912% of the aggregate principal amount. The unamortized discount was $3.1 million and $3.5 million at June 30, 2014 and December 31, 2013, respectively. The discount is being amortized using the effective interest method over the remaining life of the Senior Notes due 2017 which, at June 30, 2014, is a period of 3.4 years at an effective annual interest rate of 5.5%.

Senior Notes Due 2022
 
In July 2014, the Company issued and sold $600.0 million aggregate principal amount of 5.375% senior notes due August 1, 2022 (the "Senior Notes due 2022"). The Senior Notes due 2022 accrue interest on the principal amount at the rate of 5.375% per annum from July 29, 2014, payable semi-annually in arrears, on February 1 and August 1 of each year, beginning on February 1, 2015. The Senior Notes due 2022 are unsecured and are guaranteed on a senior unsecured basis by each of the existing and future domestic restricted subsidiaries that becomes liable for any debt under the domestic credit facilities, including the 2013 Credit Agreement.
 
Non-Recourse Borrowings of Consolidated Securitization Entities
 
Asset-Backed Term Notes
 
In February 2014, Master Trust I issued $625.0 million of asset-backed term securities, $175.0 million of which was retained by the Company and eliminated from the unaudited condensed consolidated financial statements. These securities mature in February 2016 and have a variable interest rate equal to LIBOR plus a margin of 0.38%.
 
In July 2014, Master Trust I issued $394.7 million of asset-backed term securities, $94.7 million of which was retained by the Company and will be eliminated from the unaudited condensed consolidated financial statements. These securities mature in September 2015 and have a fixed interest rate of 0.61%.
 
Conduit Facilities
 
The Company has access to committed undrawn capacity through three conduit facilities to support the funding of its credit card receivables through Master Trust I, Master Trust III and the WFC Trust.
 
In February 2014, Master Trust I renewed its 2009-VFN conduit facility, extending the maturity to February 29, 2016, with a total capacity of $700.0 million.
 
In May 2014, the WFC Trust renewed its 2009-VFN conduit facility, extending the maturity to May 31, 2016, with a total capacity of $450.0 million.
 
As of June 30, 2014, total capacity under the conduit facilities was $1.6 billion, of which $860.0 million had been drawn and was included in non-recourse borrowings of consolidated securitization entities in the unaudited condensed consolidated balance sheets.
 
Derivative Instruments
 
As part of its interest rate risk management program, the Company may enter into derivative contracts with institutions that are established dealers to manage its exposure to changes in interest rates for certain obligations. The Company was not a party to any derivative instruments as of December 31, 2013. With the BrandLoyalty acquisition on January 2, 2014, the Company assumed certain derivative instruments.
 
These interest rate derivative instruments involve the receipt of variable rate amounts from counterparties in exchange for the Company making fixed rate payments over the life of the agreement without the exchange of the underlying notional amount. These interest rate derivative instruments are not designated as hedges. Such instruments are not speculative and are used to manage interest rate risk, but do not meet the specific hedge accounting requirements of ASC 815, "Derivatives and Hedging."
 
At June 30, 2014 the notional amount of the Company's outstanding interest rate derivatives was €59.3 million ($81.2 million), with a weighted average years to maturity of 0.9 years.
 
The fair value of the Company's outstanding interest rate derivatives at June 30, 2014 was $0.5 million, of which $0.2 million was included in other current liabilities and $0.3 million was included in other liabilities in the unaudited condensed consolidated balance sheets.

 
20

ALLIANCE DATA SYSTEMS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (CONTINUED)
 
 
During the three and six months ended June 30, 2014, a de minimis amount of gains on derivative instruments was recognized in interest expense on long-term and other debt, net within the unaudited condensed consolidated statements of income. During the three and six months ended June 30, 2013, gains on interest rate swaps on securitized borrowings that matured in 2013 of $2.2 million and $8.5 million, respectively, were recognized in securitization funding costs within the unaudited condensed consolidated statements of income.
 
The Company limits its exposure on derivatives by entering into contracts with institutions that are established dealers who maintain certain minimum credit criteria established by the Company. At June 30, 2014, the Company does not maintain any derivative instruments subject to master agreements that would require the Company to post collateral or that contain any credit-risk related contingent features.
 
 
10. DEFERRED REVENUE
 
The AIR MILES Reward Program collects fees from its sponsors based on the number of AIR MILES reward miles issued and, in limited circumstances, the number of AIR MILES reward miles redeemed. Because management has determined that the earnings process is not complete at the time an AIR MILES reward mile is issued, the recognition of redemption and service revenue is deferred.
 
A reconciliation of deferred revenue for the AIR MILES Reward Program is as follows:
 
 
 
Deferred Revenue
 
 
 
Service
   
Redemption
   
Total
 
 
 
(In thousands)
 
December 31, 2013  
 
$
346,631
   
$
790,555
   
$
1,137,186
 
Cash proceeds  
   
96,377
     
211,608
     
307,985
 
Revenue recognized  
   
(99,975
)
   
(248,940
)
   
(348,915
)
Other  
   
 
   
(257
)
   
(257
)
Effects of foreign currency translation  
   
(1,640
)
   
(4,530
)
   
(6,170
)
June 30, 2014  
 
$
341,393
   
$
748,436
   
$
1,089,829
 
Amounts recognized in the unaudited condensed consolidated balance sheets:
                       
Current liabilities  
 
$
174,686
   
$
748,436
   
$
923,122
 
Non-current liabilities  
 
$
166,707
   
$
   
$
166,707
 
 
 
11. REDEEMABLE NON-CONTROLLING INTEREST
 
On January 2, 2014, the Company acquired a 60% ownership interest in BrandLoyalty. The remaining 40% interest held by minority interest shareholders is considered a redeemable non-controlling interest. Pursuant to the BrandLoyalty share purchase agreement, the Company may acquire the remaining 40% ownership interest in BrandLoyalty over a four-year period, 10% per year at predetermined valuation multiples. If specified annual earnings targets are met by BrandLoyalty, the Company must acquire the additional 10% interest for the year achieved; otherwise, the sellers have a put option to sell the Company their 10% interest for the respective year. The Company recognized a redeemable non-controlling interest in the amount of $341.9 million, which was measured at fair value at the acquisition date. A reconciliation of the changes in the redeemable non-controlling interest is as follows:
 
 
 
Redeemable
Non-Controlling Interest
 
 
 
(In thousands)
 
Balance at January 2, 2014  
 
$
341,907
 
Net income attributable to non-controlling interest  
   
97
 
Other comprehensive income attributable to non-controlling interest  
   
166
 
Foreign currency translation adjustments  
   
517
 
Balance at June 30, 2014  
 
$
342,687
 

 
21

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

 
12. STOCKHOLDERS' EQUITY
 
Stock Repurchase Program
 
On December 5, 2013, the Company's Board of Directors authorized a stock repurchase program to acquire up to $400.0 million of our outstanding common stock from January 1, 2014 through December 31, 2014, subject to any restrictions pursuant to the terms of the Company's credit agreements, indentures, applicable securities laws or otherwise.
 
For the six months ended June 30, 2014, the Company acquired a total of 813,317 shares of its common stock for $201.8 million. As of June 30, 2014, the Company had $198.2 million available under the stock repurchase program.
 
Stock Compensation Expense
 
Total stock-based compensation expense recognized in the Company's unaudited condensed consolidated statements of income for the three and six months ended June 30, 2014 and 2013 is as follows:
 
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
 
2014
   
2013
   
2014
   
2013