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1. Business and Basis of Presentation
Business
The Western Union Company (“Western Union” or the “Company”) is a leader in global money transfer, providing people with fast, reliable and convenient ways to send money around the world. The Western Union® brand is globally recognized. The Company’s services are available through a network of agent locations in more than 200 countries and territories. Each location in the Company’s agent network is capable of providing one or more of the Company’s services.
The Western Union business consists of the following segments:
| • |
Consumer-to-consumer—money transfer services between consumers, primarily through a global network of third-party agents using the Company’s multi-currency, real-time money transfer processing systems. This service is available for international cross-border transfers—that is, the transfer of funds from one country to another—and, in certain countries, intra-country transfers—that is, money transfers from one location to another in the same country. |
| • |
Global business payments (formerly consumer-to-business)—the processing of payments from consumers or businesses to other businesses. The Company’s business payments are available to be made to a variety of organizations including utilities, auto finance companies, mortgage servicers, financial service providers, government agencies and other businesses. As described further in Note 3, “Acquisitions,” the Company acquired Canada-based Custom House, Ltd. (“Custom House”), a provider of international business-to-business payment services, which is included in this segment. Custom House facilitates cross-border, cross-currency payment transactions. While the Company continues to pursue further international expansion of its offerings in this segment, the segment’s revenue was primarily generated in the United States during all periods presented. |
All businesses that have not been classified into the consumer-to-consumer or global business payments segments are reported as “Other” and include the Company’s money order and prepaid services businesses. Prior to October 1, 2009, the Company’s money orders were issued by Integrated Payment Systems Inc. (“IPS”), a subsidiary of First Data Corporation (“First Data”), to consumers at retail locations primarily in the United States and Canada. Effective October 1, 2009, the Company assumed the responsibility for issuing money orders as discussed further in Note 9, “Settlement Assets and Settlement Obligations.” The Company also offers Western Union branded Visa® and Mastercard® prepaid cards and provides certain prepaid services for third parties.
There are legal or regulatory limitations on transferring certain assets of the Company outside of the countries where these assets are located, or which constitute undistributed earnings of affiliates of the Company accounted for under the equity method of accounting. However, there are generally no limitations on the use of these assets within those countries. As of September 30, 2009, the amount of net assets subject to these limitations totaled approximately $170 million.
Various aspects of the Company’s services and businesses are subject to United States federal, state and local regulation, as well as regulation by foreign jurisdictions, including certain banking and other financial services regulations.
Basis of Presentation
The accompanying condensed consolidated financial statements are unaudited and were prepared in accordance with the instructions for Form 10-Q and Article 10 of Regulation S-X. In compliance with those instructions, certain information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) have been condensed or omitted.
The unaudited condensed consolidated financial statements in this quarterly report are presented on a consolidated basis and include the accounts of the Company and its majority-owned subsidiaries. Results of operations and cash flows for the interim periods are not necessarily indicative of the results that may be expected for the entire year in part due to seasonality of the business. All significant intercompany transactions and accounts have been eliminated.
In the opinion of management, these condensed consolidated financial statements include all the normal recurring adjustments necessary to fairly present the Company’s condensed consolidated results of operations, financial position and cash flows as of September 30, 2009 and for all periods presented. These condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements within the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.
Consistent with industry practice, the accompanying Condensed Consolidated Balance Sheets are unclassified due to the short-term nature of Western Union’s settlement obligations contrasted with the Company’s ability to invest cash awaiting settlement in long-term investment securities.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates.
Fair Value Measurements
On January 1, 2009, the Company began disclosing the fair value level classification in accordance with the valuation hierarchy for certain non-financial assets and liabilities that are recognized or disclosed at fair value on a non-recurring basis. This policy is most applicable to the Company’s business combinations, where the values of the intangible assets and goodwill acquired in a purchase are derived utilizing one of the three recognized approaches: the market approach, the income approach or the cost approach. These valuation techniques use primarily unobservable Level 3 inputs which require significant management judgment and estimation. The remaining assets and liabilities are also valued using one of the three approaches, however, fair value for these assets and liabilities often approximates carrying value. Refer to Note 3, “Acquisitions.”
The Company monitors its investments in debt securities to determine if these securities are in an other-than-temporary impairment position. Factors that could indicate an impairment exists include, but are not limited to: earnings performance, changes in credit rating or adverse changes in the regulatory or economic environment of the asset. If potential impairments exist, the Company assesses whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The Company had no material other-than-temporary impairments for both the three and nine months ended September 30, 2009 and 2008.
Business Combinations
Effective January 1, 2009, the Company accounts for business combinations achieved in stages by re-measuring any noncontrolling equity investments in the acquiree to fair value as of the acquisition date immediately before obtaining control. All re-measurement gains and losses are recognized in earnings and the total fair values of the identifiable assets, liabilities and any noncontrolling interests are recorded in the consolidated balance sheet. Also effective January 1, 2009, the Company expenses all costs as incurred related to or involved with an acquisition in “Selling, general and administrative” expenses. Any contingent consideration related to the acquisition is recognized at its acquisition date fair value with subsequent changes in fair value generally reflected in earnings. Any adjustments to the assessed fair values of the assets, liabilities and any noncontrolling interests made subsequent to the acquisition date but within the measurement period, due to facts that existed at the acquisition date, are recorded as an adjustment to goodwill. All other adjustments are recorded in income, including changes in tax contingencies. Refer also to Note 3, “Acquisitions.”
Subsequent Events Review
The Company has evaluated subsequent events through the date of the submission of filing of this Form 10-Q, October 30, 2009.
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3. Acquisitions
Custom House, Ltd.
On September 1, 2009, the Company acquired Canada-based Custom House, a provider of international business-to-business payment services, for $371.0 million. The acquisition of Custom House will allow the Company to enter the international business-to-business payments market. Custom House facilitates cross-border, cross-currency payment transactions. These payment transactions are conducted through various channels including the telephone and internet. The significant majority of Custom House’s revenue is from exchanges of currency at the spot rate enabling customers to make cross-currency payments. The credit risk arising from these spot foreign currency exchange contracts is largely mitigated, as in most cases Custom House requires the receipt of funds from customers before releasing the associated cross-currency payment. In addition, this business writes foreign currency forward and option contracts for their customers to facilitate future payments. The duration of these derivatives contracts is generally nine months or less. The significant majority of Custom House’s revenue is generated from transactions involving different currencies, in which Custom House generates revenue based on the difference between the exchange rate set by Custom House to the customer and the rate at which Custom House is able to acquire currency or forward and option contracts. This foreign exchange revenue is recorded at the time the customer initiates a trade with Custom House. The results of operations for Custom House have been included in the Company’s consolidated financial statements from the date of acquisition, September 1, 2009.
The Company recorded the assets and liabilities of Custom House at fair value. The following table summarizes the preliminary allocation of purchase price:
|
Assets: |
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Cash acquired |
$ | 2.5 | |
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Settlement assets |
152.5 | ||
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Property and equipment |
6.5 | ||
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Goodwill |
274.3 | ||
|
Other intangible assets |
118.1 | ||
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Other assets |
75.8 | ||
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Total assets |
$ | 629.7 | |
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Liabilities: |
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Accounts payable and accrued liabilities |
$ | 23.1 | |
|
Settlement obligations |
152.5 | ||
|
Deferred tax liability, net |
31.9 | ||
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Other liabilities |
51.2 | ||
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Total liabilities |
258.7 | ||
|
Total consideration, including cash acquired |
$ | 371.0 | |
The valuation of assets acquired resulted in $118.1 million of identifiable intangible assets, $99.8 million of which were attributable to customer and other contractual relationships and were valued using an income approach and $18.3 million of other intangibles, which were valued using both income and cost approaches. These fair values were derived using primarily unobservable Level 3 inputs which require significant management judgment and estimation. For the remaining assets and liabilities, fair value approximated carrying value. The intangible assets related to customer and other contractual relationships are being amortized over 10 to 12 years. The remaining intangibles are being amortized over three to five years. The goodwill recognized of $274.3 million is attributable to the projected long-term business growth in current and new markets. All goodwill relates entirely to the global business payments segment. The preliminary assessment of goodwill expected to be deductible for United States income tax purposes is approximately $225.1 million. The net deferred tax liability of $31.9 million and the resulting impacts on goodwill are preliminary and will be completed once the Company finalizes its tax review for this acquisition. In addition, the Company will finalize the accounts associated with the working capital settlement required by the purchase agreement, which may also result in an adjustment to goodwill.
FEXCO
On February 24, 2009, the Company acquired the money transfer business of European-based FEXCO, one of the Company’s largest agents providing services in a number of European countries, primarily the United Kingdom, Spain, Sweden and Ireland. The acquisition of FEXCO’s money transfer business will assist the Company in the implementation of the Payment Services Directive (“PSD”) in the European Union by providing an initial operating infrastructure platform. The PSD will allow the Company to operate under a single license in the 27 European Union countries and, in those European Union countries where the Company has been limited to working with banks, post-banks and foreign exchange houses, to expand its network to additional classes of trade. The acquisition does not impact the Company’s revenue, because the Company was already recording 100% of the revenue arising from money transfers originating at FEXCO’s subagents. As of the acquisition date, the Company no longer incurs commission costs for transactions related to FEXCO; rather, the Company now pays commissions directly to former FEXCO subagents, resulting in lower overall commission expense. The Company’s operating expenses include costs attributable to FEXCO’s operations subsequent to the acquisition date.
Prior to the acquisition, the Company held a 24.65% interest in FEXCO Group Holdings (“FEXCO Group”), which was a holding company for both the money transfer business as well as various unrelated businesses. The Company surrendered its 24.65% interest in FEXCO Group as non-cash consideration, which had an estimated fair value of $86.2 million on the acquisition date, and paid €123.1 million ($157.4 million) as additional consideration for 100% of the common shares of the money transfer business, resulting in a total purchase price of $243.6 million. The Company recognized no gain or loss in connection with the disposition of its equity interest in the FEXCO Group, because its estimated fair value approximated its carrying value. The Company recorded the assets and liabilities of FEXCO at fair value. The following table summarizes the allocation of purchase price for this acquisition:
|
Assets: |
|||
|
Cash acquired |
$ | 11.8 | |
|
Settlement assets |
43.0 | ||
|
Property and equipment |
3.1 | ||
|
Goodwill |
190.6 | ||
|
Other intangible assets |
74.9 | ||
|
Other assets |
2.3 | ||
|
Total assets |
$ | 325.7 | |
|
Liabilities: |
|||
|
Accounts payable and accrued liabilities |
$ | 2.7 | |
|
Settlement obligations |
43.0 | ||
|
Income taxes payable |
0.2 | ||
|
Deferred tax liability, net |
19.2 | ||
|
Other liabilities |
17.0 | ||
|
Total liabilities |
82.1 | ||
|
Total consideration, including cash acquired |
$ | 243.6 | |
The valuation of assets acquired resulted in $74.9 million of identifiable intangible assets, $64.8 million of which were attributable to the network of subagents, which were valued using an income approach, and $10.1 million relating to other intangibles, which were valued using both income and cost approaches. These fair values, along with the fair value of the Company’s 24.65% interest in FEXCO Group, were derived using primarily unobservable Level 3 inputs which require significant management judgment and estimation. For the remaining assets and liabilities, fair value approximated carrying value. The subagent network intangible assets are being amortized over 10 to 15 years. The remaining intangibles are being amortized over two to three years. The goodwill recognized of $190.6 million is attributable to growth opportunities that will arise from the Company directly managing its agent relationships via a dedicated sales force, expected synergies, projected long-term business growth and an assembled workforce. All goodwill relates entirely to the consumer-to-consumer segment and $91.1 million is expected to be deductible for income tax purposes.
Other acquisitions
In December 2008, the Company acquired 80% of its existing money transfer agent in Peru for a purchase price of $35.0 million. The aggregate consideration paid was $29.7 million, net of a holdback reserve of $3.0 million. The Company acquired cash of $2.3 million as part of the acquisition. The $3.0 million holdback reserve will be paid in annual $1.0 million increments beginning December 2009, subject to the terms of the agreement. The results of operations of the acquiree have been included in the Company’s consolidated financial statements since the acquisition date. The purchase price allocation resulted in $10.1 million of identifiable intangible assets, a significant portion of which were attributable to the network of subagents acquired by the Company. The identifiable intangible assets are being amortized over three to 10 years and goodwill of $27.1 million was recorded, most of which is expected to be deductible for income tax purposes. In addition, the Company has the option to acquire the remaining 20% of the money transfer agent and the money transfer agent has the option to sell the remaining 20% to the Company within 12 months after December 2013 at fair value.
In August 2008, the Company acquired the money transfer assets from its then-existing money transfer agent in Panama for a purchase price of $18.3 million. The consideration paid was $14.3 million, net of a holdback reserve of $4.0 million. In 2009, $1.7 million of the holdback reserve was paid and the remainder is scheduled to be paid in approximately equal installments in August 2010 and 2011, subject to the terms of the agreement. The results of operations of the acquiree have been included in the Company’s consolidated financial statements since the acquisition date. The purchase price allocation resulted in $5.6 million of identifiable intangible assets, a significant portion of which were attributable to the network of subagents acquired by the Company. The identifiable intangible assets are being amortized over three to seven years and goodwill of $14.2 million was recorded, which is not expected to be deductible for income tax purposes.
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4. Receivable for Securities Sold
On September 15, 2008, Western Union requested redemption of its shares in the Reserve International Liquidity Fund, Ltd. (the “Fund”), a money market fund, totaling $298.1 million. Western Union included the value of the receivable in “Other assets” in the Condensed Consolidated Balance Sheet as of December 31, 2008. At the time the redemption request was made, the Company was informed by the Reserve Management Company, the Fund’s investment advisor (the “Manager”), that the Company’s redemption trades would be honored at a $1.00 per share net asset value. In 2009, the Company received partial distributions totaling $234.9 million from the Fund ($193.6 million and $41.3 million in January and June 2009, respectively). The Company continues to vigorously pursue collection of the remaining balance and believes it has a right to full payment of the remaining amount based on the written and verbal representations from the Manager and the Company’s legal position. However, given the increased uncertainty surrounding the numerous third-party legal claims associated with the Fund, the Company reserved $12 million representing the estimated impact of a pro-rata distribution of the Fund during the three months ended June 30, 2009. As of September 30, 2009, the Company had a remaining receivable balance of $51.2 million, net of the related reserve, which is included in “Other assets” in the Condensed Consolidated Balance Sheet. If further deterioration occurs in the underlying assets in the Fund, or if the Fund incurs legal and/or administrative costs during the distribution process, the Company may record additional reserves related to the remaining receivable balance, which could negatively affect its financial position, results of operations and cash flows.
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5. Restructuring and Related Expenses
Missouri and Texas Closures
During 2008, the Company closed substantially all of its facilities in Missouri and Texas and did not renew the Company’s collective bargaining agreement with the unionized workers employed at these locations. The decision also resulted in the elimination of certain management positions in these same facilities and resulted, along with other actions, in the Company no longer having employees working in the United States under a collective bargaining agreement.
The Company incurred severance and employee related benefit expenses for all union and certain affected management employees, facility closure expenses and other expenses associated with the relocation of these operations to existing Company facilities and third-party providers, including costs related to hiring, training, relocation, travel and professional fees.
The Company incurred cumulative total expenses of $46.3 million comprised of $13.1 million, $7.3 million, $7.8 million and $18.1 million in severance and other employee related costs, asset write-offs and incremental depreciation, lease terminations and other restructurings expenses, respectively, through December 31, 2008. No additional restructuring and related expenses were incurred in the three and nine months ended September 30, 2009.
Other Reorganizations
Also during 2008, in addition to the Missouri and Texas closures, the Company restructured some of its operations and relocated or eliminated certain shared service and call center positions. The relocated positions were moved to the Company’s existing facilities or outsourced service providers in 2008.
The Company incurred cumulative total expenses of $36.6 million comprised of $31.2 million, $0.6 million and $4.8 million in severance and other employee related costs, asset write-offs and incremental depreciation and other restructuring expenses, respectively, through December 31, 2008. No additional restructuring and related expenses were incurred in the three and nine months ended September 30, 2009.
Total Plans
The following table summarizes the activity for the related restructuring accrual balances for the nine months ended September 30, 2009 (in millions):
| Restructuring accrual balances at December 31, 2008 |
Cash Payments | Restructuring accrual balances at September 30, 2009 |
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|
Missouri and Texas Closures: |
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|
Severance and employee related |
$ | 2.7 | $ | (2.5 | ) | $ | 0.2 | |||
|
Other |
0.3 | (0.3 | ) | — | ||||||
|
Total |
$ | 3.0 | $ | (2.8 | ) | $ | 0.2 | |||
|
Other Reorganizations: |
||||||||||
|
Severance and employee related |
$ | 22.1 | $ | (18.5 | ) | $ | 3.6 | |||
|
Other |
0.7 | (0.6 | ) | 0.1 | ||||||
|
Total |
$ | 22.8 | $ | (19.1 | ) | $ | 3.7 | |||
For the year ended December 31, 2008, the Company recognized cumulative expenses of $62.8 million and $20.1 million in “Cost of services” and “Selling, general and administrative,” respectively. The Company did not incur any material restructuring and related expenses in the three and nine months ended September 30, 2009. Restructuring and related expenses reflected in the Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2008 were as follows (in millions):
| Three Months Ended September 30, 2008 |
Nine Months Ended September 30, 2008 |
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|
Cost of services |
$ | 1.1 | $ | 43.0 | ||
|
Selling, general and administrative |
2.1 | 7.3 | ||||
|
Total restructuring and related expenses, pre-tax |
$ | 3.2 | $ | 50.3 | ||
|
Total restructuring and related expenses, net of tax |
$ | 2.5 | $ | 30.3 | ||
The following table summarizes the restructuring and related expenses, including expenses recorded through September 30, 2008, along with the additional expenses incurred through December 31, 2008, by reportable segment (in millions). While these items were identifiable to the Company’s segments, these expenses were excluded from the measurement of segment operating profit provided to the chief operating decision maker (“CODM”) for purposes of assessing segment performance and decision making with respect to resource allocation.
| Consumer-to- Consumer |
Global Business Payments |
Other | Total | |||||||||
|
First quarter 2008 |
$ | 18.5 | $ | 4.5 | $ | 1.2 | $ | 24.2 | ||||
|
Second quarter 2008 |
13.5 | 8.7 | 0.7 | 22.9 | ||||||||
|
Third quarter 2008 |
0.8 | 2.2 | 0.2 | 3.2 | ||||||||
|
Expenses incurred through September 30, 2008 |
32.8 | 15.4 | 2.1 | 50.3 | ||||||||
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Expenses incurred from October 1, 2008 through December 31, 2008 |
23.3 | 8.0 | 1.3 | 32.6 | ||||||||
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Total cumulative expenses through December 31, 2008 |
$ | 56.1 | $ | 23.4 | $ | 3.4 | $ | 82.9 | ||||
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6. Fair Value Measurements
Fair value, as defined by the relevant accounting standards, represents the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. For additional information on how Western Union measures fair value, refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2008.
The following table reflects assets and liabilities that were measured and carried at fair value on a recurring basis (in millions):
| September 30, 2009 | ||||||||||||
| Fair Value Measurement Using | Assets/ Liabilities at Fair Value |
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| Level 1 | Level 2 | Level 3 | ||||||||||
|
Assets: |
||||||||||||
|
State and municipal debt instruments |
$ | — | $ | 316.5 | $ | — | $ | 316.5 | ||||
|
Debt securities issued by foreign governments |
0.1 | 1.6 | — | 1.7 | ||||||||
|
Derivatives |
— | 124.4 | 1.4 | 125.8 | ||||||||
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Total assets |
$ | 0.1 | $ | 442.5 | $ | 1.4 | $ | 444.0 | ||||
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Liabilities: |
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|
Derivatives |
$ | — | $ | 100.3 | $ | — | $ | 100.3 | ||||
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Total liabilities |
$ | — | $ | 100.3 | $ | — | $ | 100.3 | ||||
The Level 3 assets above represent an immaterial portion of the derivatives portfolio related to the Custom House acquisition for which credit judgments are deemed to be a significant input to the determination of fair value.
No non-recurring fair value adjustments were recorded in the three and nine months ended September 30, 2009, except those associated with the acquisitions as disclosed in Note 3, “Acquisitions.”
Other Fair Value Measurements
The carrying amounts for Western Union financial instruments, including cash and cash equivalents, settlement cash and cash equivalents, settlement receivables and settlement obligations approximate fair value due to their short maturities.
Fixed and floating rate notes are carried at their discounted notional amounts, except for portions of notes hedged by interest rate swap agreements. The fair market values of fixed and floating rate notes are based on market quotations as of September 30, 2009. The Company’s borrowings had a carrying value and fair value of $3,052.4 million and $3,243.4 million, respectively, at September 30, 2009 and had a carrying value and fair value of $3,143.5 million and $2,846.7 million, respectively, at December 31, 2008 (see Note 13).
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7. Commitments and Contingencies
In the normal course of business, Western Union is subject to claims and litigation. Management of Western Union believes such matters involving a reasonably possible chance of loss will not, individually or in the aggregate, result in a material adverse effect on Western Union’s financial position, results of operations and cash flows. Western Union accrues for loss contingencies as they become probable and estimable.
During the three and nine months ended September 30, 2009, the Company recorded an accrual of $71.0 million for an anticipated agreement and settlement with the State of Arizona. The anticipated agreement and settlement includes resolution of all outstanding legal issues and claims with the State and a multi-state agreement to fund a not-for-profit organization promoting safety and security along the United States and Mexico border. The accrual includes amounts for reimbursement to the State of Arizona for its costs associated with this matter. As part of the anticipated agreement, the Company expects to make certain investments in its compliance programs of approximately $23 million to be incurred over the next two to three years. While the $71.0 million in charges were identifiable to the Company’s consumer-to-consumer segment, they were not included in the measurement of segment operating profit provided to the CODM for purposes of assessing segment performance and decision making with respect to resource allocation. As the agreement has not yet been finalized, the accrual and related amounts are subject to change.
The United States Department of Justice (“DOJ”) served one of the Company’s subsidiaries with a grand jury subpoena requesting documents in connection with an investigation into money transfers from the United States to the Dominican Republic during the last several years. The Company is cooperating fully with the DOJ investigation. Due to the stage of the DOJ investigation, the Company is unable to predict the outcome of the investigation or the possible loss or range of loss, if any, associated with the resolution of any charges that may be brought against the Company.
The Company had $85.5 million in outstanding letters of credit and bank guarantees at September 30, 2009 with expiration dates through 2015, certain of which contain a one-year renewal option. The letters of credit and bank guarantees are primarily held in connection with lease arrangements and certain agent agreements. The Company expects to renew the letters of credit and bank guarantees prior to expiration in most circumstances.
In May 2007, the Company initiated litigation against MoneyGram Payment Systems, Inc. (“MoneyGram”) for infringement of the Company’s Money Transfer by Phone patents by MoneyGram’s FormFree service. On September 24, 2009, a jury found that MoneyGram was liable for patent infringement and awarded the Company $16.5 million in damages. In accordance with its policies, the Company does not recognize gain contingencies in earnings until realization and collectability are assured and, therefore, due to MoneyGram’s challenges to the verdict, the Company has not recognized any amounts in its Consolidated Statement of Income through September 30, 2009.
Pursuant to the separation and distribution agreement with First Data in connection with Western Union’s spin-off from First Data on September 29, 2006 (“Spin-off”), First Data and the Company are each liable for, and agreed to perform, all liabilities with respect to their respective businesses. In addition, the separation and distribution agreement also provides for cross-indemnities principally designed to place financial responsibility for the obligations and liabilities of the Company’s business with the Company and financial responsibility for the obligations and liabilities of First Data’s retained businesses with First Data. The Company also entered into a tax allocation agreement that sets forth the rights and obligations of First Data and the Company with respect to taxes imposed on their respective businesses both prior to and after the Spin-off as well as potential tax obligations for which the Company may be liable in conjunction with the Spin-off (see Note 14).
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8. Related Party Transactions
The Company has ownership interests in certain of its agents accounted for under the equity method of accounting. The Company pays these agents, as it does its other agents, commissions for money transfer and other services provided on the Company’s behalf. Commission expense recognized for these agents for the three months ended September 30, 2009 and 2008 totaled $52.2 million and $80.4 million, respectively, and $151.9 million and $233.4 million for the nine months ended September 30, 2009 and 2008, respectively. Commission expense recognized for FEXCO prior to February 24, 2009, the date of the acquisition, were considered related party transactions.
In July 2009, the Company appointed a director who is also a director for a company holding significant investments in two of the Company’s existing agents. These agents had been agents of the Company prior to the director being appointed to the board. The Company recognized commission expense of $13.8 million and $39.4 million, respectively, for the three and nine months ended September 30, 2009 related to these agents.
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9. Settlement Assets and Settlement Obligations
Settlement assets represent funds received or to be received from agents for unsettled money transfers and consumer payments. Western Union records corresponding settlement obligations relating to amounts payable under money transfer and payment service arrangements. Settlement assets and obligations also include amounts receivable from and payable to businesses for the value of customer cross-currency payment transactions related to the global business payments segment.
Settlement assets and obligations were comprised of the following (in millions):
| September 30, 2009 |
December 31, 2008 |
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|
Settlement assets: |
||||||
|
Cash and cash equivalents |
$ | 192.0 | $ | 42.3 | ||
|
Receivables from selling agents and business-to-business customers |
745.9 | 759.6 | ||||
|
Investment securities |
318.2 | 405.6 | ||||
| $ | 1,256.1 | $ | 1,207.5 | |||
|
Settlement obligations: |
||||||
|
Money transfer and payment service payables |
$ | 854.6 | $ | 799.5 | ||
|
Payables to agents |
401.5 | 408.0 | ||||
| $ | 1,256.1 | $ | 1,207.5 | |||
Receivables from international business-to-business customers arise from cross-currency payment transactions in the global business payments segment. Receivables (for currency to be received) and payables (for the cross-currency payment to be made) are recognized at trade date for these transactions. The credit risk arising from these spot foreign currency exchange contracts is largely mitigated, as in most cases Custom House requires the receipt of funds from customers before releasing the associated cross-currency payment.
Investment securities consist primarily of high-quality state and municipal debt instruments. Substantially all of the Company’s investment securities were marketable securities during the periods presented. The Company is required to maintain specific high-quality, investment grade securities and such investments are restricted to satisfy outstanding settlement obligations in accordance with applicable state regulations. Western Union does not hold investment securities for trading purposes. All investment securities are classified as available-for-sale and recorded at fair value. Investment securities are exposed to market risk due to changes in interest rates and credit risk. Western Union regularly monitors credit risk and attempts to mitigate its exposure by making high-quality investments. At September 30, 2009, the majority of the Company’s investment securities had credit ratings of “AA-” or better from a major credit rating agency.
Unrealized gains and losses on available-for-sale securities are excluded from earnings and presented as a component of accumulated other comprehensive income or loss, net of related deferred taxes. Gains and losses on investments are calculated using the specific-identification method and are recognized during the period the investment is sold or when an investment experiences an other-than-temporary decline in value. Proceeds from the sale and maturity of available-for-sale securities during the nine months ended September 30, 2009 and 2008 were $4.9 billion and $1.5 billion, respectively.
During 2008, the Company increased its investment securities primarily through the addition of various state and municipal variable rate demand note securities which can be put (sold at par) typically on a daily basis with settlement periods ranging from the same day to one week, but that have varying maturity dates through 2047. Generally, these securities are used by the Company for short-term liquidity needs and are held for short periods of time, typically less than 30 days. As a result, this has increased the frequency of purchases and proceeds received by the Company.
The components of investment securities, all of which are classified as available-for-sale, were as follows (in millions):
|
September 30, 2009 |
Amortized Cost |
Fair Value |
Gross Unrealized Gains |
Gross Unrealized Losses |
Net Unrealized Gains |
||||||||||||
|
State and municipal obligations |
$ | 311.5 | $ | 316.5 | $ | 5.0 | $ | — | $ | 5.0 | |||||||
|
Debt securities issued by foreign governments |
1.7 | 1.7 | — | — | — | ||||||||||||
| $ | 313.2 | $ | 318.2 | $ | 5.0 | $ | — | $ | 5.0 | ||||||||
|
December 31, 2008 |
Amortized Cost |
Fair Value |
Gross Unrealized Gains |
Gross Unrealized Losses |
Net Unrealized Gains/ (Losses) |
||||||||||||
|
State and municipal obligations |
$ | 400.1 | $ | 401.7 | $ | 2.5 | $ | (0.9 | ) | $ | 1.6 | ||||||
|
Debt securities issued by foreign governments |
4.0 | 3.9 | — | (0.1 | ) | (0.1 | ) | ||||||||||
| $ | 404.1 | $ | 405.6 | $ | 2.5 | $ | (1.0 | ) | $ | 1.5 | |||||||
The following summarizes contractual maturities of investment securities as of September 30, 2009 (in millions):
| Fair Value |
|||
|
Due within 1 year |
$ | 34.0 | |
|
Due after 1 year through 5 years |
187.9 | ||
|
Due after 5 years through 10 years |
13.8 | ||
|
Due after 10 years |
82.5 | ||
| $ | 318.2 | ||
Actual maturities may differ from contractual maturities because issuers may have the right to call or prepay the obligations or the Company may have the right to put the obligation back to the issuer prior to its contractual maturity.
Effective October 1, 2009 (the “Transition Date”), in accordance with the agreement signed on July 18, 2008, Integrated Payment Systems Inc. (“IPS”), a subsidiary of First Data Corporation (“First Data”), assigned and transferred to the Company certain operating assets used by IPS to issue Western Union branded money orders and approximately $860 million of cash sufficient to satisfy all outstanding money order liabilities. On the Transition Date, the Company assumed IPS’s role as issuer of the money orders, including its obligation to pay outstanding money orders, and terminated the existing agreement whereby IPS paid Western Union a fixed return on the outstanding money order balances. Following the Transition Date, Western Union invested the cash received from IPS in high-quality, investment grade securities, primarily tax exempt United States state and municipal securities, in accordance with applicable regulations, which are the same as those currently governing the investment of the Company’s United States originated money transfer principal. Prior to the Transition Date, the Company had entered into interest rate swaps on certain of its fixed rate notes to reduce its exposure to fluctuations in interest rates. Through a combination of the revenue generated from these investment securities and the anticipated interest expense savings resulting from the interest rate swaps, the Company estimates that it should be able to retain, subsequent to the Transition Date, a comparable after-tax rate of return through 2011 as it was receiving under its agreement with IPS. Refer to Note 12 for additional information on the interest rate swaps.
Subsequent to the Transition Date, all revenue generated from the investment portfolio is being retained by the Company. IPS will continue to provide to the Company clearing services necessary for payment of the money orders in exchange for the payment by the Company to IPS of a per-item administrative fee. The Company will no longer provide to IPS the services required under the original money order agreement or receive from IPS the fee for such services.
|
|||
10. Comprehensive Income
The components of other comprehensive income, net of tax, were as follows (in millions):
| Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||||
| 2009 | 2008 | 2009 | 2008 | |||||||||||||
|
Net income |
$ | 181.0 | $ | 240.8 | $ | 625.1 | $ | 679.4 | ||||||||
|
Unrealized gains/(losses) on investments securities: |
||||||||||||||||
|
Unrealized gains/(losses) |
3.1 | (3.4 | ) | 6.1 | (3.8 | ) | ||||||||||
|
Tax (expense)/benefit |
(1.2 | ) | 1.3 | (2.3 | ) | 1.4 | ||||||||||
|
Reclassification adjustment for (gains)/losses |
(0.9 | ) | 2.6 | (2.6 | ) | 4.3 | ||||||||||
|
Tax expense/(benefit) |
0.4 | (1.0 | ) | 1.0 | (1.6 | ) | ||||||||||
|
Net unrealized gains/(losses) on investment securities |
1.4 | (0.5 | ) | 2.2 | 0.3 | |||||||||||
|
Unrealized (losses)/gains on hedging activities: |
||||||||||||||||
|
Unrealized (losses)/gains |
(32.2 | ) | 86.7 | (52.8 | ) | 41.5 | ||||||||||
|
Tax benefit/(expense) |
6.0 | (12.2 | ) | 9.8 | (7.2 | ) | ||||||||||
|
Reclassification adjustment for (gains)/losses |
(5.7 | ) | 11.5 | (38.6 | ) | 38.7 | ||||||||||
|
Tax expense/(benefit) |
0.8 | (1.3 | ) | 5.8 | (5.2 | ) | ||||||||||
|
Net unrealized (losses)/gains on hedging activities (a) |
(31.1 | ) | 84.7 | (75.8 | ) | 67.8 | ||||||||||
|
Foreign currency translation adjustments: |
||||||||||||||||
|
Foreign currency translation adjustments |
4.9 | (13.1 | ) | (17.4 | ) | (2.2 | ) | |||||||||
|
Tax (expense)/benefit |
(1.5 | ) | 4.6 | 6.3 | 0.8 | |||||||||||
|
Reclassification adjustment for disposal of investment (b) |
— | — | (23.1 | ) | — | |||||||||||
|
Tax expense (b) |
— | — | 8.1 | — | ||||||||||||
|
Net foreign currency translation adjustments |
3.4 | (8.5 | ) | (26.1 | ) | (1.4 | ) | |||||||||
|
Unrealized gains/(losses) on pension liability: |
||||||||||||||||
|
Unrealized loss |
— | — | — | (1.0 | ) | |||||||||||
|
Tax benefit |
— | — | — | 0.1 | ||||||||||||
|
Reclassification adjustment for losses |
0.9 | 4.4 | 2.7 | 5.8 | ||||||||||||
|
Tax benefit |
(0.3 | ) | (1.6 | ) | (1.1 | ) | (2.1 | ) | ||||||||
|
Net unrealized gains on pension liability |
0.6 | 2.8 | 1.6 | 2.8 | ||||||||||||
|
Total other comprehensive income |
$ | 155.3 | $ | 319.3 | $ | 527.0 | $ | 748.9 | ||||||||
| (a) | The beginning balance in “Accumulated other comprehensive loss” in the Condensed Consolidated Balance Sheet at January 1, 2009 related to hedging activities was a gain of $45.5 million and the ending balance at September 30, 2009 was a loss of $30.3 million. See Note 12, “Derivatives-Cash Flow Hedges” for more information on the unrealized (losses)/gains on hedging activities. |
| (b) | The nine months ended September 30, 2009 includes the impact to the foreign currency translation account of the surrender of the Company’s interest in the FEXCO Group. See Note 3, “Acquisitions.” |
|
|||
11. Employee Benefit Plans
Defined Benefit Plans
The Company has two frozen defined benefit pension plans for which it has a recorded unfunded pension obligation of $102.1 million and $107.1 million as of September 30, 2009 and December 31, 2008, respectively, which were included in “Other liabilities” in the Condensed Consolidated Balance Sheets. No contributions were made to these plans by the Company in 2008. Due to the closure of one of its facilities in Missouri (see Note 5) and a recent agreement with the Pension Benefit Guaranty Corporation, the Company funded $4.1 million into one of its subsidiary’s pension plans during the third quarter of 2009. Pursuant to final guidance issued by the Internal Revenue Service (“IRS”) in September 2009, the Company made certain interest rate elections under the Pension Protection Act which will require it to fund approximately $15 million to the plans in 2010, which is less than was previously anticipated.
The following table provides the components of net periodic benefit cost/(income) for the defined benefit pension plans (in millions):
| Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||||
| 2009 | 2008 | 2009 | 2008 | |||||||||||||
|
Interest cost |
$ | 5.9 | $ | 6.1 | $ | 17.7 | $ | 18.2 | ||||||||
|
Expected return on plan assets |
(6.2 | ) | (6.8 | ) | (18.5 | ) | (20.6 | ) | ||||||||
|
Amortization of actuarial loss |
0.9 | 0.6 | 2.7 | 2.0 | ||||||||||||
|
Employee termination costs |
— | — | — | 2.8 | ||||||||||||
|
Net periodic benefit cost/(income) |
$ | 0.6 | $ | (0.1 | ) | $ | 1.9 | $ | 2.4 | |||||||
During the second quarter of 2008, the Company recorded $2.8 million of expenses related to the termination of certain retirement eligible union and management plan participants in connection with the restructuring and related activities, as disclosed in Note 5.
|
|||
12. Derivatives
The Company is exposed to foreign currency risk resulting from fluctuations in exchange rates, primarily the euro, and to a lesser degree the British pound, Canadian dollar and other currencies, related to forecasted money transfer revenues and on money transfer settlement assets and obligations. Subsequent to the acquisition of Custom House, the Company is also exposed to risk from derivative contracts written to its customers arising from its cross-currency business-to-business payments operations. Additionally, the Company is exposed to interest rate risk related to changes in market rates both prior to and subsequent to the issuance of debt. The Company uses derivatives to (a) minimize its exposures related to changes in foreign currency exchange rates and interest rates and to (b) facilitate cross-currency business-to-business payments by writing derivatives to customers and entering into offsetting derivatives with established financial institution counterparties, or by holding sufficient foreign currency positions to cover those transactions, to mitigate the derivative risk. Foreign currency forward and option contracts and interest rate swaps of varying maturities are used in these activities.
Foreign Currency—Consumer-to-Consumer
The Company’s policy is to use longer-term foreign currency forward contracts, with maturities of up to 36 months at inception and a targeted weighted-average maturity of approximately one year, to mitigate some of the risk that changes in foreign currency exchange rates compared to the United States dollar could have on forecasted revenues denominated in other currencies related to its consumer-to-consumer business. At September 30, 2009, the Company’s longer-term foreign currency forward contracts had maturities of a maximum of 24 months with a weighted-average maturity of approximately one year. The Company assesses the effectiveness of these foreign currency forward contracts based on changes in the spot rate of the affected currencies during the period of designation. Accordingly, all changes in the fair value of the hedges not considered effective or portions of the hedge that are excluded from the measure of effectiveness are recognized immediately in “Derivative gains/(losses), net” within the Company’s Condensed Consolidated Statements of Income.
The Company also uses short duration foreign currency forward contracts, generally with maturities from a few days up to one month, to offset foreign exchange rate fluctuations on settlement assets and obligations between initiation and settlement related to its consumer-to-consumer business. In addition, forward contracts, typically with maturities of less than one year, are utilized to offset foreign exchange rate fluctuations on certain foreign currency denominated cash positions. None of these contracts are designated as accounting hedges.
The Company executes these derivatives with established financial institutions. The substantial majority of these financial institutions have credit ratings of “A-” or better from a major credit rating agency. The credit risk inherent in these agreements represents the possibility that a loss may occur from the nonperformance of a counterparty to the agreements. The Company performs a review of the credit risk of these counterparties at the inception of the hedge, on a quarterly basis and as circumstances warrant. The Company also monitors the concentration of its contracts with any individual counterparty. The Company anticipates that the counterparties will be able to fully satisfy their obligations under the agreements, but takes action (including termination of contracts) when doubt arises about the counterparties’ ability to perform. The Company’s hedged foreign currency exposures are in liquid currencies, consequently there is minimal risk that appropriate derivatives to maintain the hedging program would not be available in the future.
The aggregate United States dollar notional amounts of foreign currency forward contracts held by the Company as of September 30, 2009 were as follows (in millions):
|
Contracts not designated as hedges: |
|||
|
Euro |
$ | 288.4 | |
|
British pound |
37.4 | ||
|
Other |
60.2 | ||
|
Contracts designated as hedges: |
|||
|
Euro |
$ | 498.7 | |
|
Canadian dollar |
98.1 | ||
|
British pound |
89.7 | ||
|
Other |
78.8 |
Foreign Currency—Global Business Payments
As a result of the acquisition of Custom House, the Company writes derivatives, primarily foreign currency forward contracts and, to a much smaller degree, option contracts, mostly with small and medium size enterprises (customer contracts) and derives a currency spread from this activity as part of its global business payments operations. In this capacity, the Company facilitates cross-currency payout transactions for its customers but hedges the foreign currency risk arising from these contracts by entering into offsetting contracts with established financial institution counterparties (economic hedge contracts), or by holding sufficient foreign currency positions to cover those transactions. The derivatives written are part of the broader portfolio of foreign currency positions arising from its cross-currency business-to-business payments operation, which includes significant spot exchanges of currency in addition to forwards and options. None of these contracts are designated as accounting hedges. The duration of these derivative contracts is generally nine months or less. To mitigate credit risk, the Company performs credit reviews of the customer contracts on an ongoing basis.
The aggregate United States dollar notional amounts of foreign currency customer forward contracts held by the Company as of September 30, 2009 were approximately $1.0 billion. The significant majority of customer contracts are written in major currencies such as the Canadian dollar, euro, Australian dollar and the British pound.
The Company also entered into a forward contract, with a notional amount of approximately 230 million Canadian dollars ($210 million), to offset foreign exchange rate fluctuations on a Canadian dollar denominated position in connection with the purchase of Custom House. This contract is not designated as an accounting hedge.
Interest Rate Hedging—Corporate
The Company utilizes interest rate swaps to effectively change the interest rate payments on a portion of its notes from fixed-rate payments to short-term LIBOR-based variable rate payments in order to manage its overall exposure to interest rates. The Company designates these derivatives as fair value hedges utilizing the short-cut method, which permits an assumption of no ineffectiveness if certain criteria are met. The change in fair value of the interest rate swaps is offset by a change in the balance of the debt being hedged within the Company’s “Borrowings” in the Condensed Consolidated Balance Sheets and “Interest expense” in the Condensed Consolidated Statements of Income has been adjusted to include the effects of interest accrued on the swaps.
At September 30, 2009, the Company held interest rate swaps in an aggregate notional amount of $750 million on its 5.400% notes due 2011. The notional amounts outstanding at September 30, 2009 included interest rate swaps entered into by the Company to reduce the economic exposure from fluctuations in interest rates as a result of the Company assuming IPS’s role as issuer of the Company’s money orders (see Note 9).
During the first quarter of 2009, the Company terminated an interest rate swap with a notional amount of $110 million and received cash, excluding interest, of $14.6 million related to this swap, the offset of which was recognized in “Borrowings” and will be reclassified as a reduction to “Interest expense” over the life of the related 5.930% notes due 2016.
Balance Sheet
The following table summarizes the fair value of derivatives reported in the Condensed Consolidated Balance Sheets as of September 30, 2009 and December 31, 2008 (in millions):
|
Derivative Assets |
Derivative Liabilities |
|||||||||||||||
|
Balance Sheet |
Fair Value |
Balance
Sheet |
Fair Value | |||||||||||||
| September 30, 2009 |
December 31, 2008 |
September 30, 2009 |
December 31, 2008 |
|||||||||||||
|
Derivatives—hedges: |
||||||||||||||||
|
Interest rate fair value hedges – Corporate |
Other assets | $ | 43.7 | $ | 48.9 | Other liabilities | $ | — | $ | — | ||||||
|
Foreign currency cash flow hedges – Consumer-to-consumer |
Other assets | 11.2 | 65.0 | Other liabilities | 42.8 | 6.7 | ||||||||||
|
Total |
$ | 54.9 | $ | 113.9 | $ | 42.8 | $ | 6.7 | ||||||||
|
Derivatives—undesignated: |
||||||||||||||||
|
Foreign currency – Global business payments |
Other assets | $ | 69.8 | $ | — | Other liabilities | $ | 52.3 | $ | — | ||||||
|
Foreign currency – Consumer-to-consumer |
Other assets | 1.1 | 2.9 | Other liabilities | 5.2 | 4.1 | ||||||||||
|
Total |
$ | 70.9 | $ | 2.9 | $ | 57.5 | $ | 4.1 | ||||||||
|
Total derivatives |
$ | 125.8 | $ | 116.8 | $ | 100.3 | $ | 10.8 | ||||||||
Income Statement
The following tables summarize the location and amount of gains and losses of derivatives in the Condensed Consolidated Statements of Income segregated by designated, qualifying hedging instruments and those that are not, for the three and nine months ended September 30, 2009 and 2008 (in millions):
Fair Value Hedges
The following table presents the location and amount of gains/(losses) from fair value hedges for the three months ended September 30, 2009 and 2008 (in millions):
|
Gain
Recognized in Income on |
Hedged Items |
Loss
Recognized in Income on |
||||||||||||||||||
|
Income Statement |
Amount |
Income Statement |
Amount | |||||||||||||||||
|
Derivatives |
September 30, 2009 |
September 30, 2008 |
September 30, 2009 |
September 30, 2008 |
||||||||||||||||
|
Interest rate contracts |
Interest expense | $ | 9.0 | $ | 1.5 | Fixed-rate debt | Interest expense | $ | (3.9 | ) | $ | (0.7 | ) | |||||||
|
Total gain/(loss) |
$ | 9.0 | $ | 1.5 | $ | (3.9 | ) | $ | (0.7 | ) | ||||||||||
The following table presents the location and amount of gains/(losses) from fair value hedges for the nine months ended September 30, 2009 and 2008 (in millions):
|
Gain Recognized in Income on Derivatives (b) |
Hedged Items |
Gain/(Loss)
Recognized in Income on |
|||||||||||||||||
|
Income Statement |
Amount |
Income
Statement |
Amount | ||||||||||||||||
|
Derivatives |
September 30, 2009 |
September 30, 2008 |
September 30, 2009 |
September 30, 2008 |
|||||||||||||||
|
Interest rate contracts |
Interest expense | $ | 10.0 | $ | 1.9 | Fixed-rate debt | Interest expense | $ | 2.8 | $ | (0.4 | ) | |||||||
|
Total gain/(loss) |
$ | 10.0 | $ | 1.9 | $ | 2.8 | $ | (0.4 | ) | ||||||||||
Cash Flow Hedges
The following table presents the location and amount of gains/(losses) from cash value hedges for the three months ended September 30, 2009 and 2008 (in millions):
| Amount of (Loss)/Gain Recognized in OCI on Derivatives (Effective Portion) |
Gain/(Loss) Reclassified from Accumulated OCI into Income (Effective Portion) |
Gain/(Loss) Recognized in Income on |
||||||||||||||||||||||||
|
Income Statement |
Amount |
Income Statement |
Amount | |||||||||||||||||||||||
|
Derivatives |
September 30, 2009 |
September 30, 2008 |
September 30, 2009 |
September 30, 2008 |
September 30, 2009 |
September 30, 2008 |
||||||||||||||||||||
|
Foreign currency contracts |
$ | (32.2 | ) | $ | 86.7 | Revenue | $ | 6.1 | $ | (11.1 | ) | Derivative gains/(losses), net | $ | 1.0 | $ | (16.6 | ) | |||||||||
|
Interest rate contracts (d) |
— | — | Interest expense | (0.4 | ) | (0.4 | ) | Derivative gains/(losses), net | — | — | ||||||||||||||||
|
Total (loss)/gain |
$ | (32.2 | ) | $ | 86.7 | $ | 5.7 | $ | (11.5 | ) | $ | 1.0 | $ | (16.6 | ) | |||||||||||
The following table presents the location and amount of gains/(losses) from cash value hedges for the nine months ended September 30, 2009 and 2008 (in millions):
| Amount of (Loss)/Gain Recognized in OCI on Derivatives (Effective Portion) |
Gain/(Loss)
Reclassified from |
Loss Recognized in Income on |
|||||||||||||||||||||||||
|
Income Statement |
Amount |
Income Statement |
Amount | ||||||||||||||||||||||||
|
Derivatives |
September 30, 2009 |
September 30, 2008 |
September 30, 2009 |
September 30, 2008 |
September 30, 2009 |
September 30, 2008 |
|||||||||||||||||||||
|
Foreign currency contracts |
$ | (52.8 | ) | $ | 41.5 | Revenue | $ | 39.8 | $ | (37.5 | ) | Derivative gains/(losses), net | $ | (0.7 | ) | $ | (11.6 | ) | |||||||||
|
Interest rate contracts (d) |
— | — | Interest expense | (1.2 | ) | (1.2 | ) | Derivative gains/(losses), net | — | — | |||||||||||||||||
|
Total (loss)/gain |
$ | (52.8 | ) | $ | 41.5 | $ | 38.6 | $ | (38.7 | ) | $ | (0.7 | ) | $ | (11.6 | ) | |||||||||||
Undesignated Hedges
The following table presents the location and amount of net gains/(losses) from undesignated hedges for the three and nine months ended September 30, 2009 and 2008 (in millions):
|
Gain/(Loss) Recognized in Income on Derivatives |
||||||||||||||||
|
Income Statement Location |
Amount | |||||||||||||||
| Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||||
|
Derivatives |
2009 | 2008 | 2009 | 2008 | ||||||||||||
|
Foreign currency contracts (f) |
Foreign exchange revenue | $ | 1.4 | $ | — | $ | 1.4 | $ | — | |||||||
|
Foreign currency contracts (a) |
Selling, general and administrative | (23.0 | ) | 33.5 | (9.5 | ) | 6.5 | |||||||||
|
Foreign currency contracts (e) |
Derivative gains/(losses), net | (1.7 | ) | 4.1 | (3.6 | ) | 1.6 | |||||||||
|
Total (loss)/gain |
$ | (23.3 | ) | $ | 37.6 | $ | (11.7 | ) | $ | 8.1 | ||||||
| (a) | The Company uses foreign currency forward contracts to offset foreign exchange rate fluctuations on settlement assets and obligations as well as certain foreign currency denominated positions. The loss of $23.0 million and $9.5 million generated by the undesignated foreign currency contracts for the three and nine months ended September 30, 2009, respectively, was offset by a foreign exchange gain on settlement assets and obligations and cash balances of $20.6 million and $3.0 million, respectively. The foreign exchange gain of $33.5 million and $6.5 million generated by the undesignated foreign currency contracts for the three and nine months ended September 30, 2008, respectively, was offset by a foreign exchange loss on settlement assets and obligations and cash balances of $36.3 million and $10.3 million, respectively. |
| (b) | The net gain of $5.1 million and $0.8 million in interest expense in the three months ended September 30, 2009 and 2008, respectively, and the net gain of $12.8 million and $1.5 million in interest expense in the nine months ended September 30, 2009 and 2008, respectively, from the fair value hedges represents the net interest benefit accrued on the swaps during the period. The fair value of all future receipts and payments on the swaps are completely offset by changes in the value of the hedged debt. |
| (c) | The portion of the change in fair value of a derivative excluded from the effectiveness assessment for foreign currency forward contracts designated as cash flow hedges represents the difference between changes in forward rates and spot rates. |
| (d) | The Company incurred an $18.0 million loss on the termination of these swaps in 2006 which is included in “Accumulated other comprehensive loss” in the Condensed Consolidated Balance Sheets and is reclassified as an increase to “Interest expense” over the life of the related notes. |
| (e) | The derivative contracts used in the Company’s revenue hedging program are not designated as hedges in the final month of the contract. |
| (f) | The Company uses foreign currency forward and option contracts as part of its international business-to-business payments operation. The derivative contracts are managed as part of a broader currency portfolio that includes non-derivative currency exposures. However, the Company hedges the foreign currency risk arising from these contracts by entering into offsetting contracts with established financial institution counterparties, or by holding sufficient foreign currency positions to cover those transactions. |
An accumulated other comprehensive pre-tax loss of $8.0 million related to the foreign currency forward contracts is expected to be reclassified into revenue within the next 12 months as of September 30, 2009. Approximately $1.7 million of losses on the forecasted debt issuance hedges are expected to be recognized in interest expense within the next 12 months as of September 30, 2009. No amounts have been reclassified into earnings as a result of the underlying transaction being considered probable of not occurring within the specified time period.
|
|||
13. Borrowings
The Company’s outstanding borrowings consisted of the following (in millions):
| September 30, 2009 | December 31, 2008 | |||||||||||
| Carrying Value | Fair Value (e) | Carrying Value | Fair Value (e) | |||||||||
|
Due in less than one year: |
||||||||||||
|
Commercial paper |
$ | — | $ | — | $ | 82.9 | $ | 82.9 | ||||
|
Term loan (a) |
— | — | 500.0 | 500.0 | ||||||||
|
Due in greater than one year: |
||||||||||||
|
5.400% notes, net of discount, due 2011 (b) |
1,037.5 | 1,066.6 | 1,042.8 | 962.9 | ||||||||
|
6.500% notes, net of discount, due 2014 (c) |
498.5 | 557.1 | — | — | ||||||||
|
5.930% notes, net of discount, due 2016 (d) |
1,012.9 | 1,088.5 | 1,014.4 | 903.5 | ||||||||
|
6.200% notes, net of discount, due 2036 |
497.5 | 525.2 | 497.4 | 391.4 | ||||||||
|
Other borrowings |
6.0 | 6.0 | 6.0 | 6.0 | ||||||||
|
Total borrowings |
$ | 3,052.4 | $ | 3,243.4 | $ | 3,143.5 | $ | 2,846.7 | ||||
| (a) | The term loan due in December 2009 (“Term Loan”) was paid and financed with the issuance of the 6.500% notes due 2014 (“2014 Notes”) on February 26, 2009. |
| (b) | At September 30, 2009 and December 31, 2008, the Company held interest rate swaps related to the 5.400% notes due 2011 (“2011 Notes”) with an aggregate notional amount of $750 million and $550 million, respectively. During 2008, the Company terminated an aggregate notional amount of $195 million of interest rate swaps. The Company received cash, excluding interest, of $10.7 million on the termination of these swaps, the offset of which is reflected in “Borrowings” and will be reclassified as a reduction to “Interest expense” over the life of the 2011 Notes. |
| (c) | The 2014 Notes were issued on February 26, 2009 and the proceeds were used to redeem the Term Loan. |
| (d) | At December 31, 2008, the Company held an interest rate swap related to the 5.930% notes due 2016 (“2016 Notes”) with an aggregate notional amount of $110 million. During the first quarter of 2009, the Company terminated the swap. The Company received cash, excluding interest, of $14.6 million on the termination of this swap, the offset of which is reflected in “Borrowings” and will be reclassified as a reduction to “Interest expense” over the life of the 2016 Notes. For further information regarding the interest rate swap, refer to Note 12, “Derivatives.” |
| (e) | At December 31, 2008, the fair value of commercial paper approximated its carrying value due to the short term nature of the obligations. The fair value of the Term Loan approximated its carrying value as it was a variable rate loan and Western Union credit spreads did not move significantly between the date of the borrowing (December 5, 2008) and December 31, 2008. The fair value of the fixed rate notes is determined by obtaining quotes from multiple independent banks and excludes the impact of discounts and related interest rate swaps. |
Exclusive of discounts and the fair value of the interest rate swaps, maturities of borrowings as of September 30, 2009 are $1.0 billion in 2011, $500 million in 2014 and $1.5 billion thereafter.
The Company’s obligations with respect to its outstanding borrowings as described above rank equally.
2014 Notes
On February 26, 2009, the Company issued $500 million of aggregate principal amount of 2014 Notes to repay the balance of the Term Loan which was scheduled to mature in December 2009. Interest with respect to the 2014 Notes is payable semiannually on February 26 and August 26 each year based on the fixed per annum interest rate of 6.500%. The 2014 Notes contain covenants that, among other things, limit or restrict the ability of the Company and certain of its subsidiaries to grant certain types of security interests or enter into sale and leaseback transactions. The Company may redeem the 2014 Notes at any time prior to maturity at the greater of par or the applicable make whole premium.
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14. Income Taxes
The Company’s effective tax rates on pre-tax income for the three months ended September 30, 2009 and 2008 were 26.6% and 27.7%, respectively, and 26.2% and 27.2% for the nine months ended September 30, 2009 and 2008, respectively. The Company continues to benefit from an increasing proportion of profits being foreign-derived and therefore taxed at lower rates than its combined federal and state tax rates in the United States. In addition, in the second quarter of 2008, the Company implemented additional foreign tax efficient strategies consistent with its overall tax planning which impacted its effective tax rate for all subsequent periods.
Uncertain Tax Positions
The Company has established contingency reserves for material, known tax exposures, including potential tax audit adjustments with respect to its international operations, which were restructured in 2003. The Company’s tax reserves reflect management’s judgment as to the resolution of the issues involved if subject to judicial review. While the Company believes its reserves are adequate to cover reasonably expected tax risks, there can be no assurance that, in all instances, an issue raised by a tax authority will be resolved at a financial cost that does not exceed its related reserve. With respect to these reserves, the Company’s income tax expense would include (i) any changes in tax reserves arising from material changes during the period in the facts and circumstances (i.e. new information) surrounding a tax issue, and (ii) any difference from the Company’s tax position as recorded in the financial statements and the final resolution of a tax issue during the period.
Unrecognized tax benefits represent the aggregate tax effect of differences between tax return positions and the amounts otherwise recognized in the Company’s financial statements, and are reflected in “Income taxes payable” in the Condensed Consolidated Balance Sheets. The total amount of unrecognized tax benefits as of September 30, 2009 and December 31, 2008, was $456.0 million and $361.2 million, respectively, excluding interest and penalties. A substantial portion of the Company’s unrecognized tax benefits relate to the 2003 restructuring of the Company’s international operations whereby the Company’s income from certain foreign-to-foreign money transfer transactions has been taxed at relatively low foreign tax rates compared to the Company’s combined federal and state tax rates in the United States. The total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was $447.4 million and $352.4 million as of September 30, 2009 and December 31, 2008, respectively, excluding interest and penalties.
The Company recognizes interest and penalties with respect to unrecognized tax benefits in “Provision for income taxes” in its Condensed Consolidated Statements of Income, and records the associated liability in “Income taxes payable” in its Condensed Consolidated Balance Sheets. The Company recognized $3.9 million and $2.8 million in interest and penalties during the three months ended September 30, 2009 and 2008, respectively, and $10.4 million and $9.3 million during the nine months ended September 30, 2009 and 2008, respectively. The Company has accrued $45.9 million and $35.8 million for the payment of interest and penalties at September 30, 2009 and December 31, 2008, respectively.
Subject to the matter referenced in the paragraph below, the Company has identified no other uncertain tax position for which it is reasonably possible that the total amount of unrecognized tax benefits will significantly increase or decrease within 12 months, except for recurring accruals on existing uncertain tax positions. The change in unrecognized tax benefits during the nine months ended September 30, 2009 is substantially attributable to such recurring accruals.
The Company and its subsidiaries file tax returns for the United States, for multiple states and localities, and for various non-United States jurisdictions, and the Company has identified the United States and Ireland as its two major tax jurisdictions. The United States federal income tax returns of First Data, which include the Company, are eligible to be examined for the years 2002 through 2006. The Company’s United States federal income tax returns since the Spin-off are also eligible to be examined. The IRS has issued a report of the results of its examination of the United States federal consolidated income tax return of First Data for 2002, and the Company believes that the resolution of the adjustments that affect the Company proposed in the report will not result in a material change to the Company’s financial position. In addition, the IRS completed its examination of the United States federal consolidated income tax returns of First Data for 2003 and 2004, which included the Company, and issued a Notice of Deficiency in December 2008. The Notice of Deficiency alleges significant additional taxes, interest and penalties owed with respect to a variety of adjustments involving the Company and its subsidiaries, and the Company generally has responsibility for taxes associated with these potential Company-related adjustments under the tax allocation agreement with First Data executed at the time of the Spin-off. The Company agrees with a number of the adjustments in the Notice of Deficiency; however, the Company does not agree with the Notice of Deficiency regarding several substantial adjustments representing total alleged additional tax and penalties due of approximately $114 million. As of September 30, 2009, interest on the alleged amounts due for unagreed adjustments would be approximately $28 million. A substantial part of the alleged amounts due for these unagreed adjustments relates to the Company’s international restructuring, which took effect in the fourth quarter 2003, and, accordingly, the alleged amounts due related to such restructuring largely are attributable to 2004. On March 20, 2009, the Company filed a petition in the United States Tax Court contesting those adjustments with which it does not agree. The Company believes its overall reserves are adequate, including those associated with the adjustments alleged in the Notice of Deficiency. If the IRS’ position in the Notice of Deficiency is sustained, the Company’s tax provision related to 2003 and later years would materially increase. The Irish income tax returns of certain subsidiaries for the years 2004 and forward are eligible to be examined by the Irish tax authorities, although no examinations have commenced.
At September 30, 2009, no provision had been made for United States federal and state income taxes on foreign earnings of approximately $1.9 billion, which are expected to be reinvested outside the United States indefinitely. Upon distribution of those earnings to the United States in the form of actual or constructive dividends, the Company would be subject to United States income taxes (subject to an adjustment for foreign tax credits), state income taxes and possible withholding taxes payable to various foreign countries. Determination of this amount of unrecognized deferred United States tax liability is not practicable because of the complexities associated with its hypothetical calculation.
Tax Allocation Agreement with First Data
The Company and First Data each are liable for taxes imposed on their respective businesses both prior to and after the Spin-off. If such taxes have not been appropriately apportioned between First Data and the Company, subsequent adjustments may occur that may impact the Company’s financial position or results of operations.
Also under the tax allocation agreement, with respect to taxes and other liabilities that result from a final determination that is inconsistent with the anticipated tax consequences of the Spin-off (as set forth in the private letter ruling and relevant tax opinion) (“Spin-off Related Taxes”), the Company will be liable to First Data for any such Spin-off Related Taxes attributable solely to actions taken by or with respect to the Company. In addition, the Company will also be liable for 50% of any Spin-off Related Taxes (i) that would not have been imposed but for the existence of both an action by the Company and an action by First Data or (ii) where the Company and First Data each take actions that, standing alone, would have resulted in the imposition of such Spin-off Related Taxes. The Company may be similarly liable if it breaches certain representations or covenants set forth in the tax allocation agreement. If the Company is required to indemnify First Data for taxes incurred as a result of the Spin-off being taxable to First Data, it likely would have a material adverse effect on the Company’s business, financial position and results of operations. First Data generally will be liable for all Spin-off Related Taxes, other than those described above.
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15. Stock Compensation Plans
2006 LTIP
In February 2009, the Compensation Committee of the Company’s board of directors granted the Company’s executives long-term incentive awards under the 2006 Long-Term Incentive Plan (“2006 LTIP”) which consisted of one-third restricted stock units, one-third stock option awards and one-third performance-based cash awards. The performance-based cash awards are based on strategic performance objectives for the next two years and are payable in equal installments on the second and third anniversaries of the award, assuming the applicable performance objectives are satisfied. Based on their contributions to the Company and additional assumed responsibilities, certain executives received an incremental grant of restricted stock units which fully vest on the fourth anniversary of the grant date. Additionally, non-executive employees of the Company participating in the 2006 LTIP received annual equity grants of 50% stock option awards and 50% restricted stock units, representing a change from the 75% stock option awards and 25% restricted stock awards or units previously granted under the 2006 LTIP. The employee stock option awards vest in 25% increments on each of the first through fourth anniversaries of the grant date and restricted stock units vest in full on the third anniversary of the grant date.
Stock Option Activity
A summary of Western Union stock option activity for the nine months ended September 30, 2009 was as follows (options and aggregate intrinsic value in millions):
| Nine Months Ended September 30, 2009 | |||||||||||
| Options | Weighted-Average Exercise Price |
Weighted-Average Remaining Contractual Term (Years) |
Aggregate Intrinsic Value |
||||||||
|
Outstanding at January 1, |
43.6 | $ | 19.11 | ||||||||
|
Granted |
3.7 | 12.27 | |||||||||
|
Exercised |
(1.1 | ) | 13.08 | ||||||||
|
Cancelled/forfeited |
(1.9 | ) | 18.98 | ||||||||
|
Outstanding at September 30, |
44.3 | $ | 18.69 | 5.1 | $ | 59.4 | |||||
|
Options exercisable at September 30, |
37.1 | $ | 19.10 | 4.5 | $ | 35.2 | |||||
As of September 30, 2009 and 2008, approximately 42% and 48%, respectively, of outstanding options to purchase shares of common stock of the Company were held by employees of First Data.
The total intrinsic value of stock options exercised during the nine months ended September 30, 2009 and 2008 were $3.7 million and $132.2 million, respectively.
Restricted Stock Awards and Restricted Stock Units
A summary of Western Union activity for restricted stock awards and units for the nine months ended September 30, 2009 is listed below (awards/units in millions):
| Nine Months Ended September 30, 2009 |
||||||
| Number Outstanding |
Weighted-Average Grant-Date Fair Value |
|||||
|
Non-vested at January 1, |
1.2 | $ | 20.32 | |||
|
Granted |
1.7 | 12.35 | ||||
|
Vested |
(0.6 | ) | 18.94 | |||
|
Forfeited |
(0.1 | ) | 17.95 | |||
|
Non-vested at September 30, |
2.2 | $ | 14.59 | |||
Stock-Based Compensation
The following table sets forth the total impact on earnings for stock-based compensation expense recognized in the Condensed Consolidated Statements of Income resulting from stock options, restricted stock awards and restricted stock units for the three and nine months ended September 30, 2009 and 2008 (in millions, except per share data).
| Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||||
| 2009 | 2008 | 2009 | 2008 | |||||||||||||
|
Stock-based compensation expense |
$ | (8.7 | ) | $ | (6.3 | ) | $ | (24.9 | ) | $ | (19.8 | ) | ||||
|
Income tax benefit from stock-based compensation expense |
2.8 | 1.9 | 7.7 | 6.1 | ||||||||||||
|
Net income impact |
$ | (5.9 | ) | $ | (4.4 | ) | $ | (17.2 | ) | $ | (13.7 | ) | ||||
|
Earnings per share: |
||||||||||||||||
|
Basic |
$ | (0.01 | ) | $ | (0.01 | ) | $ | (0.02 | ) | $ | (0.02 | ) | ||||
|
Diluted |
$ | (0.01 | ) | $ | (0.01 | ) | $ | (0.02 | ) | $ | (0.02 | ) | ||||
The Company used the following assumptions for the Black-Scholes option pricing model to determine the value of Western Union options granted.
| Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||||
| 2009 | 2008 | 2009 | 2008 | |||||||||||||
|
Stock options granted: |
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|
Weighted-average risk-free interest rate |
2.8 | % | 3.5 | % | 2.0 | % | 3.0 | % | ||||||||
|
Weighted-average dividend yield |
0.2 | % | 0.2 | % | 0.2 | % | 0.2 | % | ||||||||
|
Volatility |
38.2 | % | 32.3 | % | 46.6 | % | 31.3 | % | ||||||||
|
Expected term (in years) |
5.8 | 5.8 | 5.6 | 5.9 | ||||||||||||
|
Weighted-average fair value |
$ | 7.47 | $ | 10.01 | $ | 5.38 | $ | 7.68 | ||||||||
All assumptions used to calculate the fair market value of Western Union’s stock options granted during the nine months ended September 30, 2009 were determined on a consistent basis with those assumptions disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008, except for changes in the volatility calculation. The Company updated the historical portion of its volatility assumption to include a blend of Western Union and First Data stock data instead of peer group historical volatility which was used prior to 2009.
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16. Segments
As previously described in Note 1, the Company classifies its businesses into two reportable segments: consumer-to-consumer and global business payments. Operating segments are defined as components of an enterprise which constitute businesses, about which separate financial information is available that is evaluated regularly by the Company’s chief operating decision maker (“CODM”) in deciding where to allocate resources and in assessing performance.
The consumer-to-consumer reporting segment is viewed as one global network where a money transfer can be sent from one location to another, anywhere in the world. The segment, which consists of three regions, is now managed as two areas, primarily to coordinate agent network management and marketing activities. The CODM makes decisions regarding resource allocation and monitors performance based on specific corridors within and across these regions, but also reviews total revenue and operating profit of each region. These regions frequently interact on transactions with consumers and share processes, systems and licenses, thereby constituting one global consumer-to-consumer money transfer network. The regions and corridors generally offer the same services distributed by the same agent network, have the same types of customers, are subject to similar regulatory requirements, are processed on the same system and have similar economic characteristics, allowing the geographic regions to be aggregated into one reporting segment.
The global business payments (formerly consumer-to-business) segment processes payments from consumers or businesses to other businesses. The results of the Company’s existing consumer-to-business operations as well as the newly acquired Custom House business have been combined in this segment as both are focused on facilitating payments. For further information on Custom House, see Note 3, “Acquisitions.”
All businesses that have not been classified into consumer-to-consumer or global business payments are reported as “Other.” These businesses primarily include the Company’s money order and prepaid services businesses. Expenses incurred in connection with the development of certain new service offerings, including costs to develop mobile money transfer services, new prepaid service offerings and costs incurred in connection with mergers and acquisitions are included in “Other.”
During the three and nine months ended September 30, 2009, the Company recorded an accrual of $71.0 million for an anticipated agreement and settlement with the State of Arizona. The anticipated agreement and settlement includes resolution of all outstanding legal issues and claims with the State and a multi-state agreement to fund a not-for-profit organization promoting safety and security along the United States and Mexico border. While this item was identifiable to the Company’s consumer-to-consumer segment, it was not included in the measurement of segment operating profit provided to the CODM for purposes of assessing segment performance and decision making with respect to resource allocation. For additional information on the settlement accrual, refer to Note 7.
During the three and nine months ended September 30, 2008, the Company incurred expenses of $3.2 million and $50.3 million, respectively, for restructuring and related activities, which were not allocated to the segments. While these items were identifiable to the Company’s segments, they were not included in the measurement of segment operating profit provided to the CODM for purposes of assessing segment performance and decision making with respect to resource allocation. For additional information on restructuring and related activities, refer to Note 5.
The following table presents the Company’s reportable segment results for the three and nine months ended September 30, 2009 and 2008 (in millions):
| Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||||
| 2009 | 2008 | 2009 | 2008 | |||||||||||||
|
Revenues: |
||||||||||||||||
|
Consumer-to-consumer: |
||||||||||||||||
|
Transaction fees |
$ | 875.9 | $ | 925.2 | $ | 2,497.1 | $ | 2,664.8 | ||||||||
|
Foreign exchange revenue |
229.3 | 237.8 | 650.1 | 678.6 | ||||||||||||
|
Other revenues |
12.6 | 15.1 | 39.8 | 33.9 | ||||||||||||
| 1,117.8 | 1,178.1 | 3,187.0 | 3,377.3 | |||||||||||||
|
Global business payments: |
||||||||||||||||
|
Transaction fees |
153.8 | 163.1 | 471.0 | 506.1 | ||||||||||||
|
Foreign exchange revenue |
8.3 | 0.9 | 9.8 | 2.4 | ||||||||||||
|
Other revenues |
9.2 | 12.4 | 29.1 | 37.1 | ||||||||||||
| 171.3 | 176.4 | 509.9 | 545.6 | |||||||||||||
|
Other: |
||||||||||||||||
|
Transaction fees |
10.3 | 10.3 | 30.3 | 29.8 | ||||||||||||
|
Commission and other revenues |
14.7 | 12.6 | 42.4 | 37.7 | ||||||||||||
| 25.0 | 22.9 | 72.7 | 67.5 | |||||||||||||
|
Total consolidated revenues |
$ | 1,314.1 | $ | 1,377.4 | $ | 3,769.6 | $ | 3,990.4 | ||||||||
|
Operating income: |
||||||||||||||||
|
Consumer-to-consumer |
$ | 308.9 | $ | 327.7 | $ | 889.2 | $ | 906.8 | ||||||||
|
Global business payments |
41.6 | 46.6 | 136.2 | 152.5 | ||||||||||||
|
Other |
2.0 | 4.1 | 9.7 | 11.7 | ||||||||||||
|
Total segment operating income |
352.5 | 378.4 | 1,035.1 | 1,071.0 | ||||||||||||
|
Anticipated agreement and settlement (see Note 7) |
(71.0 | ) | — | (71.0 | ) | — | ||||||||||
|
Restructuring and related expenses |
— | (3.2 | ) | — | (50.3 | ) | ||||||||||
|
Total consolidated operating income |
$ | 281.5 | $ | 375.2 | $ | 964.1 | $ | 1,020.7 | ||||||||
|
|