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1. Formation of the Entity and Basis of Presentation
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 and to pay bills. 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 both international transfers—that is, the transfer of funds from one country to another and intra-country transfers—that is, money transfers from one location to another in the same country. |
| • | Consumer-to-business—the processing of payments from consumers to businesses and other organizations that receive consumer payments, including utilities, auto finance companies, mortgage servicers, financial service providers and government agencies, referred to as “billers,” through Western Union’s network of third-party agents and various electronic channels. 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 consumer-to-business segments are reported as “Other” and include the Company’s money order and prepaid services businesses. The Company’s money order business markets Western Union branded money orders issued by Integrated Payment Systems Inc. (“IPS”), a subsidiary of First Data Corporation (“First Data”), to consumers at non-bank retail locations primarily in the United States and Canada. Western Union also markets a Western Union branded prepaid MasterCard® card, a Western Union branded prepaid Visa® card, and provides top-up services for third parties that allow consumers to pay in advance for mobile phone and other services. Also included in “Other” are certain expenses incurred by Western Union to effect its spin-off from First Data, as described below, and expenses incurred in connection with the development of certain new service offerings, including costs to develop mobile money transfer and micro-lending services.
The primary entities providing the services described above are Western Union Financial Services, Inc. and its subsidiaries (“WUFSI”), Vigo Remittance Corp. (“Vigo”), Orlandi Valuta, E Commerce Group, Paymap, Inc. and Servicio Electrónico de Pago S.A. and its subsidiaries (“SEPSA” or “Pago Fácil”). There are additional legal entities included in the consolidated financial statements of The Western Union Company, including First Financial Management Corporation (“FFMC”), WUFSI’s immediate parent company.
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. In addition, 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 December 31, 2007, the amount of net assets subject to these limitations totaled approximately $200 million.
As of December 31, 2007, Western Union has two four-year labor contracts (both expiring August 6, 2008) with the Communications Workers of America, AFL-CIO representing approximately 845 employees located primarily in Texas and Missouri. The Company’s United States-based employees are not otherwise represented by any labor organization.
Spin-off from First Data
On January 26, 2006, the First Data Board of Directors announced its intention to pursue the distribution of 100% of its money transfer and consumer payments businesses and its interest in a Western Union money transfer agent, as well as related assets, including real estate, through a tax-free distribution to First Data shareholders (the “Separation” or “Spin-off”). Effective on September 29, 2006, First Data completed the separation and the distribution of these businesses by distributing The Western Union Company common stock to First Data shareholders (the “Distribution”). Prior to the Distribution, the Company had been a segment of First Data.
In connection with the Spin-off, the Company reported a $4.1 billion dividend to First Data in the accompanying consolidated statements of stockholders’ equity/(deficiency)/net investment in The Western Union Company, consisting of a promissory note from FFMC in an aggregate principal amount of $2.4 billion, the issuance of $1.0 billion in Western Union notes, and a cash payment to First Data of $100.0 million. The remaining dividend was comprised of cash, consideration for an ownership interest held by a First Data subsidiary in a Western Union agent which had already been reflected as part of the Company, settlement of net intercompany receivables (exclusive of certain intercompany notes as described in the following paragraph), and transfers of certain liabilities, net of assets. Since the amount of the dividend exceeded the historical cost of the Company’s net assets at the time of the Spin-off, a capital deficiency resulted.
The Company also settled certain intercompany notes receivable and payable with First Data along with related interest and currency swap agreements associated with such notes as part of the Spin-off. The net settlement of the principal and related swaps resulted in a net cash inflow of $724.0 million to the Company’s cash flows from financing activities. The net settlement of interest on such notes receivable and payable of $40.7 million was reflected in cash flows from operating activities in the Company’s Consolidated Statement of Cash Flows.
As part of the Spin-off, the Company also executed several non-cash transactions, including the issuance of $1.0 billion in notes to First Data in partial consideration for the contribution by First Data to the Company of its money transfer and consumer payments businesses (Note 13). The Company did not receive any proceeds from the subsequent private offering of the notes. In addition, First Data transferred to the Company its headquarters in Englewood, Colorado and certain other fixed assets with a net book value of $66.5 million, the Company transferred to First Data certain investments with a net book value of $20.9 million, and reclassified certain tax and employee-related obligations from intercompany liabilities totaling $193.8 million. First Data also distributed 765.3 million shares of Western Union’s common stock to holders of First Data common stock.
Basis of Presentation
The financial statements in this Annual Report on Form 10-K for periods ending on or after the Distribution are presented on a consolidated basis and include the accounts of the Company and its majority-owned subsidiaries. The financial statements for the periods presented prior to the Distribution are presented on a combined basis and represent those entities that were ultimately transferred to the Company as part of the Spin-off. The assets and liabilities presented have been reflected on a historical basis, as prior to the Distribution such assets and liabilities presented were 100% owned by First Data. The historical Consolidated Statements of Income include expense allocations for certain corporate functions historically provided to Western Union by First Data, including treasury, tax, accounting and reporting, mergers and acquisitions, risk management, legal, internal audit, procurement, human resources, investor relations and information technology. If possible, these allocations were made on a specific identification basis. Otherwise, the expenses related to services provided to Western Union by First Data were allocated to Western Union based on the relative percentages, as compared to First Data’s other businesses, of headcount or other appropriate methods depending on the nature of each item of cost to be allocated. However, the financial statements for the periods presented prior to the Distribution do not include all of the actual expenses that would have been incurred had Western Union been a stand-alone entity during the periods presented and do not reflect Western Union’s combined results of operations, financial position and cash flows had Western Union been a stand-alone company during the periods presented.
All significant intercompany transactions and accounts have been eliminated.
The accompanying Consolidated Balance Sheets are unclassified consistent with industry practice and due to the short-term nature of Western Union’s settlement obligations, contrasted with its ability to invest cash awaiting settlement in long-term investment securities.
2. Summary of Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“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.
Principles of Consolidation
Western Union consolidates financial results when it will absorb a majority of an entity’s expected losses or residual returns or when it has the ability to exert control over the entity. Control is normally established when ownership interests exceed 50% in an entity. However, when Western Union does not have the ability to exercise control over a majority-owned entity as a result of other investors having contractual rights over the management and operations of the entity, it accounts for the entity under the equity method. As of December 31, 2007 and 2006, there were no greater-than-50%-owned affiliates whose financial statements were not consolidated. Western Union utilizes the equity method of accounting when it is able to exercise significant influence over the entity’s operations, which generally occurs when Western Union has an ownership interest of between 20% and 50% in an entity.
Earnings Per Share
The calculation of basic earnings per share is computed by dividing net income available to common stockholders by the weighted-average number of shares of common stock outstanding for the period. Prior to September 29, 2006, all outstanding shares of Western Union were owned by First Data. Accordingly, for all periods prior to the completion of the Distribution on September 29, 2006, basic and diluted earnings per share are computed using Western Union’s shares outstanding as of that date.
Unvested shares of restricted stock are excluded from basic shares outstanding. Diluted earnings per share subsequent to September 29, 2006 reflects the potential dilution that could occur if outstanding stock options at the presented date are exercised and shares of restricted stock have vested and shares have been transferred in settlement of stock unit awards.
As of December 31, 2007 and 2006, there were 10.4 million and 4.9 million, respectively, outstanding options to purchase shares of Western Union stock excluded from the diluted earnings per share calculation under the treasury stock method as their effect is anti-dilutive. Prior to the September 29, 2006 spin-off date, there were no potentially dilutive instruments outstanding. The treasury stock method assumes proceeds from the exercise price of stock options, the unamortized compensation expense and assumed tax benefits are available to reduce the dilutive effect upon exercise. Of the 59.4 million outstanding options to purchase shares of common stock of the Company, approximately 58% are held by employees of First Data.
The following table provides the calculation of diluted weighted-average shares outstanding, and only considers the potential dilution for stock options, restricted stock awards and restricted stock units for the period subsequent to the spin-off date of September 29, 2006 (in millions):
| For the Year Ended December 31, | ||||||
| 2007 | 2006 | 2005 | ||||
| Basic weighted-average shares |
760.2 | 764.5 | 763.9 | |||
| Common stock equivalents | 12.7 | 4.1 | — | |||
| Diluted weighted-average shares outstanding |
772.9 | 768.6 | 763.9 | |||
Fair Value of Financial Instruments
Carrying amounts for Western Union financial instruments, including cash and cash equivalents, settlement assets (other than investment securities), settlement obligations, borrowings under the commercial paper program, revolving credit facility and other short-term notes payable, approximate fair value due to their short maturities. Investment securities, included in settlement assets, are carried at fair market value and are considered available for sale (Note 6). Fixed and floating rate notes are carried at their discounted notional amounts, except for portions of notes hedged by interest rate swap agreements as disclosed in Note 13. The fair market values of fixed and floating rate notes are also disclosed in Note 13 and are based on market quotations. For discussion of foreign currency forward contracts and interest rate swaps, refer to “Derivative Financial Instruments” within this Note 2.
Cash and Cash Equivalents
Highly liquid investments (other than those included in settlement assets) with maturities of three months or less at the date of purchase (that are readily convertible to cash), are considered to be cash equivalents and are stated at cost, which approximates market value.
Western Union maintains cash and cash equivalent balances with various financial institutions, including a substantial portion in money market funds which all have ratings of “AAA” from a major credit rating agency. Western Union limits the concentration of its cash and cash equivalents with any one institution; however, such balances often exceed United States federal deposit insurance limits. Western Union periodically evaluates the credit worthiness of these institutions to minimize risk.
Allowance for Doubtful Accounts
Western Union records an allowance for doubtful accounts when it is probable that the related receivable balance will not be collected based on its history of collection experience, known collection issues, such as agent suspensions and bankruptcies, and other matters the Company identifies in its routine collection monitoring. The allowance for doubtful accounts was $13.8 million and $14.8 million at December 31, 2007 and 2006, respectively. During the years ended December 31, 2007, 2006 and 2005, the provision for doubtful accounts reflected in the Consolidated Statements of Income was $23.5 million, $24.4 million and $16.1 million, respectively.
Settlement Assets and 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. Any difference in the aggregate amount of settlement assets and obligations is due to cumulative unrealized net investment gains.
Settlement assets are comprised of cash and cash equivalents, receivables from selling agents and investment securities. Cash received by Western Union agents generally becomes available to Western Union within one week after initial receipt by the agent. Cash equivalents consist of short-term time deposits, commercial paper and other highly liquid investments. Receivables from selling agents represent funds collected by such agents, but in transit to Western Union. Western Union has a large and diverse agent base, thereby reducing the credit risk of the Company from any one agent. In addition, Western Union performs ongoing credit evaluations of its agents’ financial condition and credit worthiness. See Note 6 for information concerning the Company’s investment securities.
Settlement obligations consist of money transfer and payment service payables and payables to agents. Money transfer payables represent amounts to be paid to transferees when they request their funds. Most agents typically settle with transferees first and then obtain reimbursement from Western Union. Due to the agent funding and settlement process, payables to agents represent amounts due to agents for money transfers that have been settled with transferees. Payment service payables represent amounts to be paid to utility companies, collection agencies, auto finance companies, mortgage servicers, financial service providers, government entities and others.
Settlement assets and obligations are comprised of the following (in millions):
| December 31, | ||||||
| 2007 | 2006 | |||||
| Settlement assets: | ||||||
| Cash and cash equivalents |
$ | 203.5 | $ | 348.8 | ||
|
Receivables from selling agents | 921.9 | 781.2 | ||||
|
Investment securities | 193.8 | 154.2 | ||||
| $ | 1,319.2 | $ | 1,284.2 | |||
| Settlement obligations: |
||||||
| Money transfer and payment service payables |
$ | 870.8 | $ | 714.5 | ||
| Payables to agents |
448.4 | 568.0 | ||||
| $ | 1,319.2 | $ | 1,282.5 | |||
Property and Equipment
Property and equipment are stated at cost, except for acquired assets which are recorded at fair market value under purchase accounting rules. Depreciation is computed using the straight-line method over the lesser of the estimated life of the related assets (generally three to 10 years, for equipment, furniture and fixtures, and 30 years for buildings) or the lease term. Maintenance and repairs, which do not extend the useful life of the respective assets, are charged to expense as incurred.
Property and equipment consists of the following (in millions):
| December 31, | ||||||||
| 2007 | 2006 | |||||||
| Equipment | $ | 289.1 | $ | 245.8 | ||||
| Leasehold improvements | 37.4 | 32.4 | ||||||
|
Furniture and fixtures | 29.0 | 23.9 | ||||||
| Land and improvements |
16.9 | 12.9 | ||||||
|
Buildings | 70.6 | 71.5 | ||||||
|
Projects in process | 8.8 | 2.7 | ||||||
| 451.8 | 389.2 | |||||||
|
Less accumulated depreciation | (251.5 | ) | (213.1 | ) | ||||
| Property and equipment, net |
$ | 200.3 | $ | 176.1 | ||||
Amounts charged to expense for depreciation of property and equipment were $49.1 million, $34.8 million and $32.0 million during the years ended December 31, 2007, 2006 and 2005, respectively.
Deferred Customer Set Up Costs
The Company capitalizes direct incremental costs not to exceed related deferred revenues associated with the enrollment of customers in the Equity Accelerator program, a service that allows consumers to complete automated clearing house (“ACH”) transactions to make recurring mortgage payments. Deferred customer set up costs, included in “Other assets” in the Consolidated Balance Sheets, are amortized to “Cost of services” in the Consolidated Statements of Income over the length of the customer’s expected participation in the program, generally five to seven years. Actual customer attrition data is assessed at least annually and the amortization period is adjusted prospectively.
Goodwill
Goodwill represents the excess of purchase price over the fair value of tangible and other intangible assets acquired, less liabilities assumed arising from business combinations. The Company’s annual goodwill impairment test did not identify any goodwill impairment in 2007 or 2006; however, Western Union recorded a goodwill impairment charge of $8.7 million in 2005 due to a change in strategic direction relating to one of its majority owned prepaid businesses (Note 3). The majority of goodwill on Western Union’s Consolidated Balance Sheets arose in connection with FFMC’s acquisition of WUFSI in November 1994. FFMC was acquired by First Data in October 1995.
Other Intangible Assets
Other intangible assets primarily consist of contract costs (primarily amounts paid to agents in connection with establishing and renewing long-term contracts) and software. Other intangible assets are amortized on a straight-line basis over the length of the contract or benefit periods. Included in “Cost of services” in the Consolidated Statements of Income is amortization expense of approximately $74.8 million, $68.7 million and $47.5 million for the years ended December 31, 2007, 2006 and 2005, respectively.
The Company capitalizes initial payments for new and renewed agent contracts to the extent recoverable through future operations, contractual minimums and/or penalties in the case of early termination. The Company’s accounting policy is to limit the amount of capitalized costs for a given contract to the lesser of the estimated future cash flows from the contract or the termination fees the Company would receive in the event of early termination of the contract.
The Company develops software that is used in providing services. Software development costs are capitalized once technological feasibility of the software has been established. Costs incurred prior to establishing technological feasibility are expensed as incurred. Technological feasibility is established when the Company has completed all planning, designing, coding and testing activities that are necessary to determine that a product can be produced to meet its design specifications, including functions, features and technical performance requirements. Capitalization of costs ceases when the product is available for general use. Software development costs and purchased software are amortized over a term of three to five years.
The following table provides the components of other intangible assets (in millions):
| December 31, 2007 | December 31, 2006 | |||||||||||||
| Weighted- Average Amortization Period (in years) |
Initial Cost | Net of Accumulated Amortization |
Initial Cost | Net of Accumulated Amortization | ||||||||||
| Capitalized contract costs |
6.6 | $ | 274.0 | $ | 193.1 | $ | 242.3 | $ | 155.6 | |||||
| Acquired contracts |
9.2 | 74.1 | 42.8 | 74.1 | 49.7 | |||||||||
| Acquired trademarks | 24.7 | 44.7 | 41.0 | 40.7 | 38.8 | |||||||||
|
Developed software | 3.3 | 74.6 | 15.2 | 66.0 | 12.6 | |||||||||
| Purchased or acquired software |
3.2 | 74.9 | 32.5 | 50.4 | 18.8 | |||||||||
|
Other intangibles | 6.8 | 28.6 | 9.5 | 25.6 | 12.2 | |||||||||
| Total other intangibles | 7.5 | $ | 570.9 | $ | 334.1 | $ | 499.1 | $ | 287.7 | |||||
The estimated future aggregate amortization expense for existing other intangible assets as of December 31, 2007 is expected to be $84.5 million in 2008, $57.7 million in 2009, $50.9 million in 2010, $39.7 million in 2011, $25.2 million in 2012 and $76.1 million thereafter.
Other intangible assets are reviewed for impairment on an annual basis and whenever events indicate that their carrying amount may not be recoverable. In such reviews, estimated undiscounted cash flows associated with these assets or operations are compared with their carrying values to determine if a write-down to fair value (normally measured by the present value technique) is required. Western Union did not record any impairment related to other intangible assets during the years ended December 31, 2007, 2006 and 2005.
Revenue Recognition
The majority of the Company’s revenues are comprised of consumer money transfer transaction fees that are based on the principal amount of the money transfer and the locations from and to which funds are transferred. Consumer money transfer transaction fees are set by the Company and recorded as revenue at the time of sale. In certain consumer money transfer transactions involving different send and receive currencies, the Company generates revenue based on the difference between the exchange rate set by Western Union to the consumer and the rate at which Western Union or its agents are able to acquire currency. This foreign exchange revenue is recorded at the time the related transaction fee revenue is recognized.
The Company also offers several consumer-to-business payment services, including payments from consumers to billers. Revenues for these services are primarily derived from transaction fees, which are recorded as revenue when payments are sent to the intended recipients.
The Company’s Equity Accelerator service requires a consumer to pay an upfront enrollment fee to participate in this mortgage payment service. These enrollment fees are deferred and recognized into income over the length of the customer’s expected participation in the program, generally five to seven years. Actual customer attrition data is assessed at least annually and the period over which revenue is recognized is adjusted prospectively. Many factors impact the duration of the expected customer relationship, including interest rates, refinance activity and trends in consumer behavior.
The Company sells money orders issued by IPS under the Western Union brand and manages the agent network through which such money orders are sold. Western Union recognizes monthly commissions from IPS based on a fixed investment yield on the average investable balance resulting from the sale of money orders. Western Union also recognizes transaction fees collected from the Company’s agents at the time a money order is issued to the consumer.
Loyalty Program
Western Union operates a loyalty program which consists of points that are awarded to program participants. Such points may be redeemed for either a discount on future money transfers or merchandise. The Company estimates the distribution between awards of merchandise and discounts based on recent redemption history and trends, measured on a quarterly basis. Revenue is deferred for the portion of points expected to be ultimately redeemed for discounts in a manner that reflects the consumer’s progress toward earning such discounts. Costs associated with the redemption of merchandise are reflected in operating expenses in the Consolidated Statements of Income.
Cost of Services
Cost of services consists of costs directly associated with providing services to consumers, and is primarily comprised of commissions paid to agents, which are recognized at the time of sale. Most agents outside the U.S. also receive additional commissions based on a portion of the foreign exchange revenue associated with money transfer transactions. Other costs included in costs of services include personnel, software, equipment, telecommunications, bank fees, depreciation and amortization, and other operating expenses incurred in connection with providing money transfers and other payment services.
Advertising Costs
Advertising costs are charged to operating expenses as incurred or at the time the advertising first takes place. Advertising costs for the years ended December 31, 2007, 2006 and 2005 were $264.2 million, $261.4 million and $243.3 million, respectively.
Income Taxes
For periods subsequent to the Spin-off, Western Union files its own U.S. federal and state income tax returns. Western Union files its own separate tax returns in foreign jurisdictions for periods prior to and subsequent to the Spin-off, and foreign taxes are paid in each respective jurisdiction locally.
Prior to the Spin-off, Western Union’s taxable income was included in the consolidated U.S. federal income tax return of First Data and also in a number of state income tax returns filed with First Data on a combined or unitary basis. Western Union’s provision for income taxes was computed as if it were a separate tax-paying entity for periods prior to the Spin-off, and federal and state income taxes payable were remitted to First Data prior to the Spin-off.
Western Union accounts for income taxes under the liability method, which requires that deferred tax assets and liabilities be determined based on the expected future income tax consequences of events that have been recognized in the consolidated financial statements. Deferred tax assets and liabilities are recognized based on temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the temporary differences are expected to reverse.
The Company adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), on January 1, 2007. FIN 48 addresses the determination of how tax benefits claimed or expected to be claimed on a tax return should be recorded in the consolidated financial statements. Under FIN 48, the Company recognizes the tax benefits from an uncertain tax position only when it is more likely than not, based on the technical merits of the position, that the tax position will be sustained upon examination, including the resolution of any related appeals or litigation. The tax benefits recognized in the consolidated financial statements from such a position are measured as the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution. As a result of the implementation of FIN 48, the Company recognized an increase in the liability for unrecognized tax benefits plus associated accrued interest and penalties of $0.6 million, which was accounted for as a reduction to the January 1, 2007 balance of retained earnings.
Foreign Currency Translation
The U.S. dollar is the functional currency for all of Western Union’s businesses except certain investments and subsidiaries located primarily in Ireland and Argentina. Foreign currency denominated assets and liabilities for those entities for which the local currency is the functional currency are translated into United States dollars based on exchange rates prevailing at the end of the period. Revenues and expenses are translated at average exchange rates prevailing during the period. The effects of foreign exchange gains and losses arising from the translation of assets and liabilities of those entities where the functional currency is not the United States dollar are included as a component of “Accumulated other comprehensive loss.” Foreign currency translation gains and losses on assets and liabilities of foreign operations in which the United States dollar is the functional currency are recognized in operations.
Derivative Financial Instruments
Western Union utilizes derivative instruments to mitigate foreign currency and interest rate risk. The Company recognizes all derivative instruments in the “Other assets” and “Other liabilities” captions in the accompanying Consolidated Balance Sheets at their fair value. All cash flows associated with derivatives are included in cash flows from operating activities in the Consolidated Statements of Cash Flows other than those previously designated as cash flow hedges that were determined to not qualify for hedge accounting as described in Note 12.
| • | Cash Flow hedges—Changes in the fair value of derivatives that are designated and qualify as cash flow hedges in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended and interpreted (“SFAS No. 133”) are recorded in “Accumulated other comprehensive loss.” Cash flow hedges consist of foreign currency hedging of forecasted sales, as well as, from time to time, hedges of anticipated fixed rate debt issuances. Derivative fair value changes that are captured in Accumulated other comprehensive loss are reclassified to earnings in the same period or periods the hedged item affects earnings, to the extent the change in the fair value of the instrument is effective in offsetting the change in fair value of the hedged item. The portion of the change in fair value that is either considered ineffective or is excluded from the measure of effectiveness is recognized immediately in “Derivative gains/(losses), net.” |
| • | Fair Value hedges—Changes in the fair value of derivatives that are designated as fair value hedges of fixed rate debt in accordance with SFAS No. 133 are recorded in interest expense. The offsetting change in value attributable to changes in the benchmark interest rate of the related debt instrument is also recorded in interest expense consistent with the related derivative’s change. |
| • | Undesignated—Derivative contracts entered into to reduce the variability related to (a) settlement assets and obligations, generally with terms of a few days up to three weeks, and (b) certain foreign currency denominated cash positions, generally with maturities of less than one year, are not designated as hedges for accounting purposes and, as such, changes in their fair value are included in operating expenses consistent with foreign exchange rate fluctuations on the related settlement assets and obligations or cash positions. |
The Company also had certain other foreign currency swap arrangements with First Data, prior to September 29, 2006, to mitigate the foreign exchange impact on certain euro denominated notes receivable with First Data. These foreign currency swaps did not qualify for hedge accounting and, accordingly, the fair value changes of these agreements were reported in the accompanying Consolidated Statements of Income as “Foreign exchange effect on notes receivable from First Data, net.” The fair value of these swaps were settled in cash along with the related notes receivable in connection with the Spin-off.
The fair value of the Company’s derivative financial instruments is derived from standardized models that use market based inputs (e.g., forward prices for foreign currency).
Stock-Based Compensation
The Company currently has a stock-based compensation plan that grants Western Union stock options, restricted stock awards and restricted stock units to employees and other key individuals who perform services for the Company. In addition, the Company has a stock-based compensation plan that provides for grants of Western Union stock options and stock unit awards to non-employee directors of the Company. Prior to the Spin-off, employees of Western Union participated in First Data’s stock-based compensation plans.
Effective January 1, 2006, the Company adopted SFAS No. 123R, “Share-Based Payment” (“SFAS No. 123R”), using the modified prospective method. SFAS No. 123R requires all stock-based compensation to employees be measured at fair value and expensed over the requisite service period and also requires an estimate of forfeitures when calculating compensation expense. The Company recognizes compensation expense on awards on a straight-line basis over the requisite service period for the entire award. In accordance with the Company’s chosen method of adoption, results for prior periods have not been adjusted. Prior to the adoption of SFAS No. 123R, the Company followed Accounting Principles Board (“APB”) Opinion No. 25 which accounts for share-based payments to employees using the intrinsic value method and, as such, generally recognized no compensation expense for employee stock options. Refer to Note 14 for additional discussion regarding details of the Company’s stock-based compensation plans and the adoption of SFAS No. 123R.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year presentation. These reclassifications had no impact on the Company’s consolidated financial position, results of operations or cash flows as previously reported.
New Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value under GAAP and expands disclosures about fair value measurements. SFAS No. 157 applies to other accounting pronouncements that require or permit fair value measurements. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2007, and for interim periods within those fiscal years. The Company adopted the provisions of SFAS No. 157 on January 1, 2008. The Company believes the impact of adoption will not be significant to the Company’s consolidated financial position, results of operations and cash flows as it has, in most cases, historically reported assets and liabilities required to be reported at fair value using the methods prescribed by SFAS No. 157.
On September 29, 2006, the FASB issued SFAS No. 158, “Employers Accounting for Defined Benefit Pension and Other Postretirement Plans—An Amendment of SFAS No. 87, 88, 106 and 132(R)” (“SFAS No. 158”). The remaining provisions that the Company will adopt under SFAS No. 158 require a plan’s funded status to be measured at the employer’s fiscal year end. The Company will change its measurement date from September 30 to December 31 during 2008.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Liabilities” (“SFAS No. 159”), which provides companies with an option to report selected financial assets and liabilities at fair value, and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The new guidance is effective for fiscal years beginning after November 15, 2007. The Company adopted the provisions of SFAS No. 159 on January 1, 2008. The Company believes the impact of adoption will not be significant as the Company will not elect to measure any financial instruments or other items at fair value that are not currently required to be measured at fair value.
In December 2007, the FASB issued SFAS No. 141R, “Business Combinations” (“SFAS No. 141R”). This statement establishes a framework to disclose and account for business combinations. The adoption of the requirements of SFAS No. 141R applies prospectively to business combinations for which the acquisition date is on or after fiscal years beginning after December 15, 2008 and may not be early adopted. The Company is currently evaluating the potential impact of the adoption of SFAS No. 141R.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51” (“SFAS No. 160”). The statement establishes accounting and reporting standards for a noncontrolling interest in a subsidiary. The adoption of the requirements of SFAS No. 160 is effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2008 and may not be early adopted. The Company is currently evaluating the potential impact of the adoption of SFAS No. 160. However, we do not expect the impact to be significant on the financial position, results of operations and cash flows, as the Company’s current non-controlling interests are immaterial.
3. Acquisitions and Disposals
In October 2007, the Company entered into agreements totaling $18.3 million to convert its non-participating interest in an agent in Singapore to a fully participating 49% equity interest and to extend the agent relationship at more favorable commission rates to Western Union. As a result, the Company will now earn a pro-rata share of profits and will have enhanced voting rights. The Company also has the right to add additional agent relationships in Singapore. In addition, in October 2007, the Company completed an agreement to acquire a 25% ownership interest in an agent in Jamaica and to extend the term of the agent relationship for $29.0 million. The aggregate consideration paid resulted in $20.2 million of identifiable intangible assets, which are being amortized over seven to 10 years. Western Union’s investments in these agents are accounted for under the equity method of accounting.
In December 2006, the Company acquired SEPSA, which operates under the brand name Pago FácilSM, for a total purchase price of $69.8 million, less cash acquired of $3.0 million. Pago Fácil provides consumer-to-business payments and prepaid mobile phone top-up services in Argentina. Previously, the Company held a 25% interest in Pago Fácil, which was treated as an equity method investment. As a result of acquiring the additional 75% ownership, the Company’s entire investment in and results of operations of Pago Fácil have been included in the consolidated financial statements since the acquisition date. The purchase price allocation resulted in $28.1 million of identifiable intangible assets, a significant portion of which were attributable to the Pago Fácil service mark and acquired agent and biller relationships. The identifiable intangible assets were calculated based on the additional 75% ownership interest acquired, and are being amortized over two to 25 years. After adjusting the additional acquired net assets to fair value, goodwill of $44.5 million was recorded, substantially all of which is eligible for amortization for tax purposes across various jurisdictions.
In October 2005, First Data acquired 100% of GMT Group, Inc. (“GMT”), the owner of Vigo, a provider of consumer-to-consumer money transfer services to various countries, for approximately $369.2 million, including cash acquired of $20.1 million. GMT was contributed to Western Union in connection with the Spin-off. The results of Vigo’s operations have been included in the consolidated financial statements since the acquisition date. The purchase price allocation resulted in $83.6 million of identifiable intangible assets, which are being amortized over 3.5 to 11 years, except for acquired trademarks aggregating $28.6 million, which are being amortized over 25 years. Goodwill of $284.4 million was recorded in connection with the acquisition of GMT, none of which is deductible for tax purposes.
In the fourth quarter of 2005, Western Union recorded a goodwill impairment charge of $8.7 million due to a change in strategic direction related to its 51% ownership interest in EPOSS Limited (“EPOSS”). In the second quarter 2006, the Company sold its majority interest in EPOSS. The fair value of net assets on disposition approximated the net book value subsequent to the recognition of the goodwill impairment charge noted above.
The pro forma impact of all acquisitions on net income in 2007, 2006 and 2005 was immaterial.
The following table presents changes to goodwill for the years ended December 31, 2007 and 2006 (in millions):
| Consumer-to- Consumer |
Consumer-to- Business |
Other | Total | |||||||||||||
| January 1, 2006 balance | $ | 1,390.7 | $ | 195.1 | $ | 32.2 | $ | 1,618.0 | ||||||||
|
Acquisitions | — | 48.0 | — | 48.0 | ||||||||||||
|
Purchase price adjustments | 1.3 | — | — | 1.3 | ||||||||||||
| Disposals |
— | — | (19.3 | ) | (19.3 | ) | ||||||||||
| December 31, 2006 balance |
$ | 1,392.0 | $ | 243.1 | $ | 12.9 | $ | 1,648.0 | ||||||||
|
Purchase price adjustments | (3.0 | ) | (5.9 | ) | 1.7 | (7.2 | ) | |||||||||
|
Currency translation | — | (1.3 | ) | — | (1.3 | ) | ||||||||||
| December 31, 2007 balance |
$ | 1,389.0 | $ | 235.9 | $ | 14.6 | $ | 1,639.5 | ||||||||
4. Related Party Transactions
Related Party Transactions with First Data
The Consolidated Statements of Income prior to the Spin-off include expense allocations for certain corporate functions historically provided to Western Union by First Data. If possible, these allocations were made on a specific identification basis. Otherwise, the expenses related to services provided to Western Union by First Data were allocated to Western Union based on relative percentages, as compared to First Data’s other businesses, of headcount or other appropriate methods depending on the nature of each item or cost to be allocated.
Charges for functions historically provided to Western Union by First Data are primarily attributable to First Data’s performance of many shared services that the Company utilized prior to the Spin-off. First Data continued to provide certain of these services subsequent to the Spin-off through a transition services agreement until September 29, 2007. In addition, prior to the Spin-off, the Company participated in certain First Data insurance, benefit and incentive plans, and it received services directly related to the operations of its businesses such as call center services, credit card processing, printing and mailing. The Consolidated Statements of Income reflect charges incurred prior to the spin-off from First Data and its affiliates for these services of $152.4 million and $166.3 million for the years ended December 31, 2006 and 2005, respectively. Included in these charges are amounts recognized for stock-based compensation expense, as well as net periodic benefit income associated with the Company’s pension plans.
Included in “Interest income from First Data, net” in the Consolidated Statements of Income for the years ended December 31, 2006 and 2005 was interest income of $37.4 million and $28.8 million, respectively, earned on notes receivable from First Data subsidiaries and interest expense of $1.7 million and $4.5 million, respectively, incurred on notes payable to First Data which were settled in connection with the Spin-off. Certain of the notes receivable were euro denominated, and as such, the Company had related foreign currency swap agreements to mitigate the foreign exchange impact to the Company on such notes. Included in “Foreign exchange effect on notes receivable from First Data, net” in the Consolidated Statements of Income during the years ended December 31, 2006 and 2005 are foreign exchange gains/(losses) of $10.1 million and $(5.9) million, respectively, from the revaluation of these euro denominated notes receivable and related foreign currency swap agreements.
During the period from January 1, 2006 through September 29, 2006 and the year ended December 31, 2005, the Company recognized commission revenues from a First Data subsidiary in connection with its money order business of $23.6 million and $29.6 million, respectively. Subsequent to the Spin-off, the Company continues to recognize commission revenue from this First Data subsidiary.
Other Related Party Transactions
The Company has ownership interests in certain of its agents, all of which are 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. Commissions paid to these agents for the years ended December 31, 2007, 2006 and 2005 totaled $256.6 million, $212.2 million and $177.7 million, respectively. For those agents where an ownership interest was acquired during the year, only amounts paid subsequent to the investment date have been reflected as a related party transaction.
5. 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 or cash flows. Western Union accrues for loss contingencies as they become probable and estimable.
On August 21, 2006, the Interregional Inspectorate No. 50 of the Federal Tax Service of the Russian Federation for the City of Moscow (“Tax Inspectorate”) issued a tax audit report to OOO Western Union MT East (“Western Union MT East”), an indirect wholly-owned subsidiary of the Company, asserting claims for the underpayment of Russian Value Added Taxes (“VAT”) related to the money transfer activities of Western Union MT East in Russia during 2003 and 2004. On October 24, 2006, the Tax Inspectorate issued its final decision for tax assessment and tax demand notices to Western Union MT East for approximately $20 million, including a 20% penalty and applicable interest to date. The assessment was challenged at successive levels within the Russian courts, and all such courts have ruled in favor of Western Union MT East, holding that the services provided in Russia by Western Union MT East qualify as banking services which are not subject to VAT. The Tax Inspectorate requested a hearing by the Presidium of the Supreme Arbitrazh Court of the Russian Federation, the highest court in Russia, which request was denied on December 26, 2007, and, accordingly no further appeals are available to the Tax Inspectorate with respect to this matter. However, the Tax Inspectorate has the ability to assert the same position in subsequent tax years since decisions of Russian courts are not viewed as binding precedents by the Russian tax authorities. As of December 31, 2007, the Company has not accrued any potential loss or associated penalties and interest for this matter.
Western Union is subject to unclaimed or abandoned property (escheat) laws in the United States and abroad. These laws require the Company to remit to certain government authorities the property of others held by the Company that has been unclaimed for a specified period of time, such as unpaid money transfers. The Company holds property subject to escheat laws and the Company has an ongoing program to comply with such laws. The Company is subject to audits with regard to its escheatment practices.
The Company has $62.0 million in outstanding letters of credit and bank guarantees at December 31, 2007 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 prior to expiration in most circumstances.
Pursuant to the separation and distribution agreement with First Data in connection with the Spin-off (see Note 1), 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 8).
6. Investment Securities
Investment securities, classified within “Settlement assets” in the Consolidated Balance Sheets, consist primarily of high-quality state and municipal debt instruments. All of the Company’s investment securities were marketable securities during all 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 financial instruments for trading purposes. All investment securities are classified as available-for-sale and recorded at fair value, which are based on market quotations. 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 December 31, 2007, substantially all 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. There were no significant realized gains or losses transferred out of “Accumulated other comprehensive loss” during the periods presented. Proceeds from the sale and maturity of available-for-sale securities during the years ended December 31, 2007, 2006 and 2005 were $177.7 million, $62.6 million and $49.0 million, respectively.
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 below cost or amortized cost. When an investment is deemed to have an other-than-temporary decline in value it is reduced to its fair value, which becomes the new cost basis of the investment. Western Union considers both qualitative and quantitative indicators when judging whether a decline in value of an investment is other-than-temporary in nature, including, but not limited to, the length of time the investment has been in an unrealized loss position, the significance of the unrealized loss relative to the carrying amount of the investment and our intent and ability to hold the investment until a forecasted recovery.
The components of investment securities, all of which are classified as available-for-sale, are as follows (in millions):
| December 31, 2007 | Amortized Cost | Fair Value | Gross Unrealized Gains | Gross Unrealized Losses | Net Unrealized Gains/(Losses) | ||||||||||||
|
State and municipal obligations | $ | 187.3 | $ | 188.0 | $ | 0.7 | $ | — | $ | 0.7 | |||||||
| Preferred stock of a government sponsored enterprise | 6.9 | 5.8 | — | (1.1 | ) | (1.1 | ) | ||||||||||
| $ | 194.2 | $ | 193.8 | $ | 0.7 | $ | (1.1 | ) | $ | (0.4 | ) | ||||||
| December 31, 2006 | Amortized Cost | Fair Value | Gross Unrealized Gains | Gross Unrealized Losses | Net Unrealized Gains | ||||||||||||
|
State and municipal obligations | $ | 145.5 | $ | 146.4 | $ | 1.0 | $ | (0.1 | ) | $ | 0.9 | ||||||
| Preferred stock of a government sponsored enterprise | 6.9 | 7.8 | 0.9 | — | 0.9 | ||||||||||||
| $ | 152.4 | $ | 154.2 | $ | 1.9 | $ | (0.1 | ) | $ | 1.8 | |||||||
No individual investment balance included within investment securities represents greater than 10% of total investment securities as of December 31, 2007 and 2006.
The following summarizes contractual maturities of state and municipal obligations as of December 31, 2007 (in millions):
| Amortized Cost |
Fair Value | |||||
| Due within 1 year | $ | 32.8 | $ | 33.0 | ||
| Due after 1 year through 5 years |
35.1 | 35.6 | ||||
| Due after 5 years through 10 years |
— | — | ||||
| Due after 10 years | 119.4 | 119.4 | ||||
| $ | 187.3 | $ | 188.0 | |||
Preferred stock with a fair value of $5.8 million as of December 31, 2007 is not included above because the securities do not have fixed maturities. 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.
Aggregate unrealized losses on the Company’s investment securities as of December 31, 2007 and 2006 were $1.1 million and $0.1 million, respectively. The unrealized losses on such investments as of December 31, 2007 were deemed to be temporary as the duration of the loss has been short, and the Company has the intent and ability to hold these securities until a recovery.
7. Other Assets and Other Liabilities
The following table summarizes the components of other assets and other liabilities (in millions):
| December 31, | ||||||
| 2007 | 2006 | |||||
| Other assets: | ||||||
| Equity method investments |
$ | 211.3 | $ | 165.1 | ||
|
Amounts advanced to agents, net of discounts | 93.1 | 112.4 | ||||
|
Deferred customer set up costs | 41.9 | 45.5 | ||||
| Prepaid commissions | 22.5 | 37.8 | ||||
|
Accounts receivable, net | 22.5 | 24.3 | ||||
| Prepaid expenses | 19.8 | 16.6 | ||||
|
Debt issue costs | 13.5 | 14.6 | ||||
| Derivative financial instruments |
8.1 | 0.6 | ||||
|
Other | 65.3 | 86.5 | ||||
| Total other assets | $ | 498.0 | $ | 503.4 | ||
| Other liabilities: |
||||||
| Deferred revenue | $ | 74.2 | $ | 83.3 | ||
| Derivative financial instruments |
37.2 | 12.8 | ||||
| Pension obligations | 27.6 | 52.9 | ||||
|
Other | 43.9 | 51.3 | ||||
| Total other liabilities | $ | 182.9 | $ | 200.3 | ||
Amounts advanced to agents
From time to time, the Company makes advances and loans to agents. In 2006, the Company signed a six year agreement with one of its existing agents which included a four year loan of $140.0 million to the agent. The terms of the loan agreement require that a percentage of commissions earned by the agent (61% in 2008 and 64% in 2009) be withheld by us as repayment of the loan and the agent remains obligated to repay the loan if commissions earned are not sufficient. The Company imputes interest on this below-market rate note receivable, and has recorded the note net of a discount of $22.5 million and $37.8 million as of December 31, 2007 and 2006, respectively. The remaining loan receivable balance relating to this agent as of December 31, 2007 and 2006, net of discount, was $67.5 million and $82.2 million, respectively. Other advances and loans outstanding as of December 31, 2007 and 2006 were $25.6 million and $30.2 million, respectively.
8. Income Taxes
The components of pretax income, generally based on the jurisdiction of the legal entity, are as follows (in millions):
| Year Ended December 31, | |||||||||
| 2007 | 2006 | 2005 | |||||||
| Components of pretax income: |
|||||||||
| Domestic | $ | 529.3 | $ | 707.1 | $ | 801.9 | |||
| Foreign | 693.1 | 628.0 | 542.2 | ||||||
| $ | 1,222.4 | $ | 1,335.1 | $ | 1,344.1 | ||||
The provision for income taxes is as follows (in millions):
| Year Ended December 31, | |||||||||
| 2007 | 2006 | 2005 | |||||||
| Federal | $ | 287.7 | $ | 331.1 | $ | 338.0 | |||
|
State and local | 26.3 | 34.5 | 29.1 | ||||||
| Foreign | 51.1 | 55.5 | 49.6 | ||||||
| $ | 365.1 | $ | 421.1 | $ | 416.7 | ||||
Domestic taxes have been incurred on certain pre-tax income amounts that were generated by the Company’s foreign operations. Accordingly, the percentage obtained by dividing the total federal, state and local tax provision by the domestic pretax income, all as shown in the preceding tables, may be higher than the statutory tax rates in the United States.
The Company’s effective tax rates differ from statutory rates as follows:
| Year Ended December 31, | |||||||||
| 2007 | 2006 | 2005 | |||||||
|
Federal statutory rate | 35.0 | % | 35.0 | % | 35.0 | % | |||
| State income taxes, net of federal income tax benefits | 1.7 | % | 2.0 | % | 2.0 | % | |||
|
Foreign rate differential | (7.7 | )% | (6.3 | )% | (5.8 | )% | |||
| Federal tax credits |
— | % | (0.3 | )% | (0.4 | )% | |||
| Other | 0.9 | % | 1.1 | % | 0.2 | % | |||
| Effective tax rate | 29.9 | % | 31.5 | % | 31.0 | % | |||
Western Union’s provision for income taxes consists of the following components (in millions):
| Year Ended December 31, | ||||||||||
| 2007 | 2006 | 2005 | ||||||||
| Current: | ||||||||||
|
Federal | $ | 284.9 | $ | 314.0 | $ | 326.4 | ||||
|
State and local | 25.5 | 33.1 | 26.0 | |||||||
| Foreign |
50.5 | 61.1 | 39.4 | |||||||
| Total current taxes | 360.9 | 408.2 | 391.8 | |||||||
| Deferred: | ||||||||||
| Federal | 2.8 | 17.1 | 11.6 | |||||||
| State and local |
0.8 | 1.4 | 3.1 | |||||||
|
Foreign | 0.6 | (5.6 | ) | 10.2 | ||||||
|
Total deferred taxes | 4.2 | 12.9 | 24.9 | |||||||
| $ | 365.1 | $ | 421.1 | $ | 416.7 | |||||
Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the book and tax bases of Western Union’s assets and liabilities. The following table outlines the principal components of deferred tax items (in millions):
| December 31, | ||||||
| 2007 | 2006 | |||||
| Deferred tax assets related to: | ||||||
| Reserves and accrued expenses | $ | 40.2 | $ | 24.0 | ||
| Pension obligations | 11.8 | 21.6 | ||||
|
Deferred revenue | 4.4 | 6.2 | ||||
| Other | 14.3 | 8.3 | ||||
| Total deferred tax assets | 70.7 | 60.1 | ||||
| Deferred tax liabilities related to: | ||||||
| Property, equipment and intangibles | 321.8 | 325.2 | ||||
| Other | 12.5 | 9.7 | ||||
| Total deferred tax liabilities | 334.3 | 334.9 | ||||
| Net deferred tax liability | $ | 263.6 | $ | 274.8 | ||
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 that 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.
The Company adopted the provisions of FIN 48 on January 1, 2007. The cumulative effect of applying this interpretation resulted in a reduction of $0.6 million to the January 1, 2007 balance of retained earnings.
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 Consolidated Balance Sheets. A reconciliation of the beginning and ending amount of unrecognized tax benefits, excluding interest and penalties, is as follows (in millions):
| Total | ||||
| Balance at January 1, 2007 |
$ | 166.0 | ||
|
Increases—positions taken in current period (a) |
78.0 | |||
| Increases—positions taken in prior periods (b) | 12.8 | |||
| Decreases—settlements with taxing authorities |
(0.7 | ) | ||
| Decreases—lapse of applicable statute of limitations | (4.7 | ) | ||
| Balance at December 31, 2007 |
$ | 251.4 | ||
| (a) | Includes recurring accruals for issues which initially arose in previous periods. |
| (b) | Changes to positions taken in prior periods relate to changes in estimates used to calculate prior period unrecognized tax benefits. |
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 $243.2 million and $156.2 million as of December 31, 2007 and January 1, 2007, respectively.
The Company recognizes interest and penalties with respect to unrecognized tax benefits in income tax expense and records the associated liability in “Income taxes payable” in its Consolidated Balance Sheets. During the years ended December 31, 2007, 2006 and 2005, the Company recognized $13.5 million, $5.6 million and $1.9 million, respectively, in interest and penalties. The Company had $24.8 million and $12.3 million for the payment of interest and penalties accrued at December 31, 2007 and 2006, respectively.
Except for increases for recurring accruals on existing uncertain tax positions, 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.
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 which include the Company are eligible to be examined for the years 2002 and forward. The Internal Revenue Service (“IRS”) currently is conducting audits of the United States federal consolidated income tax returns of First Data for the years 2002 through 2004, which returns include the taxable results of the Company and its subsidiaries. The Company currently contemplates that the IRS will complete the examination phase of its audits for these years during 2008. The Irish income tax returns of certain subsidiaries for the years 2003 and forward are eligible to be examined by the Irish tax authorities, although no examinations have commenced.
At December 31, 2007, no provision had been made for United States federal and state income taxes on foreign earnings of approximately $1.2 billion, which are expected to be reinvested outside the United States indefinitely. Upon distribution of those earnings in the form of dividends or otherwise, 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.
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), (“Restructuring Taxes”), the Company will be liable to First Data for any such Restructuring 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 Restructuring 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 Restructuring 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 Restructuring Taxes, other than those described above.
9. Employee Benefit Plans
Defined Contribution Plans
The Company’s Board of Directors approved The Western Union Company Incentive Savings Plan (“401(k)”) as of September 29, 2006, covering eligible non-union employees on the United States payroll of Western Union after the spin-off date. Employees that make voluntary contributions to this plan receive up to a 4% Western Union matching contribution. All matching contributions are immediately 100% vested.
The Company also has a 401(k) plan covering its union employees. Western Union contributes 4% of eligible employee compensation. Union employees who make voluntary contributions receive up to a 1.5% Western Union matching contribution in addition to a $650 per employee lump-sum contribution per year.
The Company also administers 15 defined contribution plans in various countries globally on behalf of approximately 500 employee participants as of December 31, 2007. Such plans have vesting and employer contribution provisions that vary by country.
In addition, Western Union’s Board of Directors adopted a non-qualified deferred compensation plan for highly compensated employees. The plan provides tax-deferred contributions, matching and the restoration of Company matching contributions otherwise limited under the 401(k).
Prior to the spin-off from First Data, eligible full-time non-union employees of the Company were covered under a First Data sponsored defined contribution incentive savings plan. Employees who made voluntary contributions to this plan, received up to a 3% Western Union matching contribution, service related contributions of 1.5% to 3% of eligible employee compensation, certain other additional employer contributions, and additional discretionary Company contributions. In addition, First Data provided non-qualified deferred compensation plans for certain highly compensated employees. These plans provided tax-deferred contributions, matching and the restoration of Company contributions under the defined contribution plans otherwise limited by IRS or plan limits.
The aggregate amount charged to expense in connection with all of the above plans was $11.6 million, $10.8 million and $9.7 million during the years ended December 31, 2007, 2006 and 2005, respectively.
Defined Benefit Plans
The Company has two frozen defined benefit pension plans. No contributions were made by First Data or Western Union during the years ended December 31, 2007, 2006 and 2005. As part of the Distribution, Western Union is responsible for any remaining underfunded pension obligations. Western Union is not required to contribute to the plans in 2008. A September 30 measurement date is used for the Company’s plans. Thus, during the third quarter of each year, management reviews and if necessary, adjusts the assumptions associated with its pension plans. During 2008, in connection with the adoption of SFAS No. 158, the measurement dates for the Company’s pension plans will be changed to December 31.
On December 31, 2006, the Company adopted the recognition and disclosure provisions of SFAS No. 158, which requires the Company to recognize the funded status of its pension plans in its Consolidated Balance Sheets as of December 31, 2006 with a corresponding adjustment to “Accumulated other comprehensive loss,” net of tax. Due to the frozen status of the Company’s pension plans, the Company’s funded status of its pension plans was already reflected in its Consolidated Balance Sheets, and therefore, no such adjustment was required to “Other liabilities,” “Deferred tax liability, net” or “Accumulated other comprehensive loss” on adoption of SFAS No. 158.
The following table provides a reconciliation of the changes in the pension plans’ benefit obligations and fair value of assets for the plan years ended September 30, 2007 and 2006, and a statement of the funded status of the plans as of September 30, 2007 and 2006 (in millions):
| September 30, | ||||||||
| 2007 | 2006 | |||||||
| Change in benefit obligation |
||||||||
| Projected benefit obligation at October 1, | $ | 459.0 | $ | 494.1 | ||||
| Interest costs | 24.6 | 24.8 | ||||||
| Actuarial gain |
(12.5 | ) | (13.5 | ) | ||||
| Benefits paid | (45.1 | ) | (46.4 | ) | ||||
| Projected benefit obligation at September 30, |
426.0 | 459.0 | ||||||
| Change in plan assets |
||||||||
| Fair value of plan assets at October 1, | 406.1 | 424.3 | ||||||
| Actual return on plan assets |
37.4 | 28.2 | ||||||
| Benefits paid |
(45.1 | ) | (46.4 | ) | ||||
| Fair value of plan assets at September 30, |
398.4 | 406.1 | ||||||
| Funded status of the plan |
(27.6 | ) | (52.9 | ) | ||||
| Unrecognized amounts, principally unrecognized actuarial loss | 73.1 | 98.1 | ||||||
| Total recognized | $ | 45.5 | $ | 45.2 | ||||
|
Accumulated benefit obligation | 426.0 | 459.0 | ||||||
Differences in expected returns on plan assets estimated at the beginning of the year versus actual returns, and assumptions used to estimate the beginning of year projected benefit obligation versus the end of year obligation (principally discount rate and mortality assumptions) are, on a combined basis, considered actuarial gains and losses. Such actuarial gains and losses are recognized as a component of “Comprehensive income” over the average remaining life expectancy of the plan participants. Included in “Accumulated other comprehensive loss” at December 31, 2007 is $2.7 million ($1.7 million, net of tax) of unrecognized actuarial losses that are expected to be recognized in net periodic pension cost during the year ended December 31, 2008.
The following table provides the amounts recognized in the Consolidated Balance Sheets (in millions):
| December 31, | ||||||||
| 2007 | 2006 | |||||||
| Accrued benefit liability |
$ | (27.6 | ) | $ | (52.9 | ) | ||
| Accumulated other comprehensive loss |
73.1 | 98.1 | ||||||
| Net amount recognized | $ | 45.5 | $ | 45.2 | ||||
The following table provides the components of net periodic benefit income for the plans (in millions):
| December 31, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
| Interest cost | $ | 24.6 | $ | 24.8 | $ | 25.6 | ||||||
|
Expected return on plan assets | (28.4 | ) | (29.9 | ) | (33.8 | ) | ||||||
| Amortization of unrecognized actuarial loss |
3.6 | 4.2 | 2.7 | |||||||||
| Net periodic benefit income |
$ | (0.2 | ) | $ | (0.9 | ) | $ | (5.5 | ) | |||
The pension liability included in other comprehensive income/(loss), net of tax, decreased $15.3 million, $10.8 million and $4.9 million in 2007, 2006 and 2005, respectively.
The weighted-average rate assumptions used in the measurement of the Company’s benefit obligation are as follows:
| 2007 | 2006 | |||||
| Discount rate | 6.02 | % | 5.61 | % |
The weighted-average rate assumptions used in the measurement of the Company’s net cost (income) are as follows:
| 2007 | 2006 | 2005 | |||||||
| Discount rate | 5.62 | % | 5.24 | % | 5.19 | % | |||
| Expected long-term return on plan assets | 7.50 | % | 7.50 | % | 7.75 | % |
SFAS No. 87 requires the sponsor of a defined benefit plan to measure the plan’s obligations and annual expense using assumptions that reflect best estimates and are consistent to the extent that each assumption reflects expectations of future economic conditions. As the bulk of the pension benefits will not be paid for many years, the computation of pension expenses and benefits is based on assumptions about future interest rates and expected rates of return on plan assets. In general, pension obligations are most sensitive to the discount rate assumption, and it is set based on the rate at which the pension benefits could be settled effectively. The discount rate is determined by matching the timing and amount of anticipated payouts under the plans to the rates from a AA spot rate yield curve. The curve is derived from AA bonds of varying maturities.
Western Union employs a building block approach in determining the long-term rate of return for plan assets. Historical markets are studied and long-term historical relationships between equities and fixed-income securities are preserved consistent with the widely accepted capital market principle that assets with higher volatility generate a greater return over the long run. Current market factors such as inflation and interest rates are evaluated before long-term capital market assumptions are determined. The long-term portfolio return is established using a building block approach with proper consideration of diversification and re-balancing. Peer data and historical returns are reviewed to check for reasonableness and appropriateness.
Pension plan asset allocation at September 30, 2007 and 2006, and target allocations based on investment policies, are as follows:
| Percentage of Plan Assets at Measurement Date |
||||||
| Asset Category | 2007 | 2006 | ||||
| Equity securities | 41 | % | 40 | % | ||
| Debt securities |
58 | % | 58 | % | ||
| Other | 1 | % | 2 | % | ||
| 100 | % | 100 | % | |||
| Target Allocation | |||
|
Equity securities | 30-50 | % | |
| Debt securities |
55-65 | % | |
| Other | 0-10 | % |
Certain members of the Company’s Board of Directors and management are affiliated with companies whose securities are held in Western Union’s pension trust, which is managed by independent asset managers. In addition, the pension trust holds securities in companies that provide services for the Company’s pension plans. Therefore, these affiliated companies are considered related parties. The following table details plan assets invested in these related party securities as of September 30, 2007 and 2006:
| 2007 | |||||||||
| Plan Corporate Bond Holdings |
Principal (in millions) | Fair Market Value (in millions) | % of Total Plan Assets | ||||||
|
Allstate Corporation corporate bond | $ | 0.8 | $ | 0.8 | 0.20 | % | |||
| Hasbro Inc. corporate bond |
$ | 0.2 | $ | 0.2 | 0.05 | % | |||
|
Mellon FDG corporate bond | $ | 0.3 | $ | 0.3 | 0.08 | % | |||
| New York Life Insurance Company corporate bond | $ | 0.4 | $ | 0.4 | 0.10 | % | |||
| 2006 | ||||||||
| Plan Common Stock Holdings |
Shares (in thousands) |
Fair Market Value (in millions) | % of Total Plan Assets |
|||||
| Altria Group, Inc. common stock |
11.4 | $ | 0.9 | 0.21 | % | |||
| First Data Corporation common stock * | 14.9 | $ | 0.3 | 0.08 | % | |||
| The Western Union Company common stock |
14.9 | $ | 0.3 | 0.07 | % | |||
| Bank of New York Company Inc. common stock | 23.6 | $ | 0.8 | 0.20 | % | |||
| Plan Corporate Bond Holdings |
Principal (in millions) | Fair Market Value (in millions) | % of Total Plan Assets | ||||||
|
Allstate Corporation corporate bond | $ | 0.5 | $ | 0.6 | 0.14 | % | |||
| Kraft Foods corporate bond |
$ | 0.6 | $ | 0.7 | 0.16 | % | |||
|
New York Life Insurance Company corporate bond | $ | 0.8 | $ | 0.8 | 0.19 | % | |||
| * | Western Union was a segment of First Data prior to the Spin-off, as discussed in Note 1. |
The maturities of debt securities at September 30, 2007 range from less than one year to 80 years with a weighted-average maturity of 14 years.
The assets of the Company’s defined benefit plans are managed in a third party master trust. The investment policy and allocation of the assets in the master trust are overseen by the Company’s Investment Council. Western Union employs a total return investment approach whereby a mix of equities and fixed income investments are used in an effort to maximize the long-term return of plan assets for a prudent level of risk. Risk tolerance is established through careful consideration of plan liabilities and plan funded status. The investment portfolio contains a diversified blend of equity and fixed-income investments. Furthermore, equity investments are diversified across U.S. and non-U.S. stocks, as well as securities deemed to be growth, value, and small and large capitalizations. Other assets, primarily private equity, are used judiciously in an effort to enhance long-term returns while improving portfolio diversification. Investment risk is measured and monitored on an ongoing basis through quarterly investment portfolio reviews, annual liability measurements, and periodic asset and liability studies.
The estimated future benefit payments are expected to be $44.3 million in 2008, $43.1 million in 2009, $41.9 million in 2010, $40.7 million in 2011, $39.5 million in 2012 and $175.9 million in 2013 through 2017.
Western Union administers a post-retirement health care plan to union employees that was in effect when First Data acquired FFMC. Generally, retired employees bear the entire cost of the premiums. Western Union also offers a short-term disability plan for union employees. The Company’s obligations pursuant to these plans are immaterial.
10. Operating Lease Commitments
Western Union leases certain real properties for use as customer service centers and administrative and sales offices. Western Union also leases data communications terminals, computers and office equipment. Certain of these leases contain renewal options and escalation provisions. Total rent expense under operating leases was $31.6 million, $29.2 million and $28.6 million during the years ended December 31, 2007, 2006 and 2005, respectively.
As of December 31, 2007, the minimum aggregate rental commitments under all noncancelable operating leases, net of sublease income commitments aggregating $8.0 million through 2012, are as follows (in millions):
| Year Ending December 31, | |||
| 2008 | $ | 22.7 | |
| 2009 |
15.4 | ||
| 2010 | 11.4 | ||
|
2011 | 8.6 | ||
| 2012 | 7.5 | ||
|
Thereafter | 19.5 | ||
| Total future minimum lease payments |
$ | 85.1 | |
11. Stockholders’ Equity
Accumulated other comprehensive loss
The income tax effects allocated to and the cumulative balance of each component of accumulated other comprehensive loss are as follows (in millions):
| December 31, 2007 | Beginning Balance | Pretax Gain (Loss) |
Tax Benefit (Expense) | Net of Tax Amount |
Ending Balance | |||||||||||||||
|
Unrealized gains (losses) on investment securities |
$ | 1.2 | $ | (2.3 | ) | $ | 0.8 | $ | (1.5 | ) | $ | (0.3 | ) | |||||||
| Unrealized gains (losses) on hedging activities |
(29.3 | ) | (24.6 | ) | 10.2 | (14.4 | ) | (43.7 | ) | |||||||||||
| Foreign currency translation adjustment |
18.0 | 8.1 | (2.8 | ) | 5.3 | 23.3 | ||||||||||||||
| Minimum pension liability | (63.4 | ) | 24.5 | (9.2 | ) | 15.3 | (48.1 | ) | ||||||||||||
| $ | (73.5 | ) | $ | 5.7 | $ | (1.0 | ) | $ | 4.7 | $ | (68.8 | ) | ||||||||
| December 31, 2006 | Beginning Balance | Pretax Gain (Loss) |
Tax Benefit (Expense) | Net of Tax Amount |
Ending Balance | |||||||||||||||
|
Unrealized gains (losses) on investment securities |
$ | 1.6 | $ | (0.7 | ) | $ | 0.3 | $ | (0.4 | ) | $ | 1.2 | ||||||||
| Unrealized gains (losses) on hedging activities |
— | (31.0 | ) | 1.7 | (29.3 | ) | (29.3 | ) | ||||||||||||
| Foreign currency translation adjustment |
10.5 | 11.7 | (4.2 | ) | 7.5 | 18.0 | ||||||||||||||
| Minimum pension liability | (74.2 | ) | 12.7 | (1.9 | ) | 10.8 | (63.4 | ) | ||||||||||||
| $ | (62.1 | ) | $ | (7.3 | ) | $ | (4.1 | ) | $ | (11.4 | ) | $ | (73.5 | ) | ||||||
| December 31, 2005 | Beginning Balance | Pretax Gain (Loss) |
Tax Benefit (Expense) | Net of Tax Amount |
Ending Balance | |||||||||||||||
|
Unrealized gains (losses) on investment securities |
$ | 3.8 | $ | (3.4 | ) | $ | 1.2 | $ | (2.2 | ) | $ | 1.6 | ||||||||
| Foreign currency translation adjustment |
15.3 | (7.2 | ) | 2.4 | (4.8 | ) | 10.5 | |||||||||||||
| Minimum pension liability | (79.1 | ) | 7.6 | (2.7 | ) | 4.9 | (74.2 | ) | ||||||||||||
| $ | (60.0 | ) | $ | (3.0 | ) | $ | 0.9 | $ | (2.1 | ) | $ | (62.1 | ) | |||||||
Cash Dividends Paid
During the fourth quarter of 2007, the Company’s Board of Directors declared a quarterly cash dividend of $0.04 per common share, representing $30.0 million which was paid on December 28, 2007 to shareholders of record on December 14, 2007.
During the fourth quarter of 2006, the Company’s Board of Directors declared a quarterly cash dividend of $0.01 per common share, representing $7.7 million which was paid in December 2006.
Share Repurchases
During December 2007, the Company’s Board of Directors adopted resolutions to retire all of its existing treasury stock, thereby restoring the status of the Company’s common stock held in treasury as “authorized but unissued”. The resulting impact to the Company’s Consolidated Balance Sheet was a decrease in “Treasury stock” of $462.0 million, “Common stock” of $0.2 million and “Retained earnings” of $461.8 million. There is no change to the Company’s overall equity position as a result of this retirement. All shares repurchased by the Company subsequent to this resolution will also be retired at the time such shares are reacquired.
In September 2006, the Company’s Board of Directors authorized the purchase of up to $1.0 billion of the Company’s common stock through December 31, 2008. In December, 2007, the Company’s Board of Directors authorized the purchase of up to an additional $1.0 billion of the Company’s common stock through December 31, 2009.
During the years ended December 31, 2007 and 2006, 34.7 million and 0.9 million shares, respectively, have been repurchased for $726.8 million and $19.9 million, respectively. As of December 31, 2007, $1.25 billion remains available for purchases under the Company’s two authorized share repurchase programs.
12. Derivative Financial Instruments
The Company is exposed to foreign currency risk resulting from fluctuations in exchange rates, primarily the euro, British pound and Canadian dollar related to forecasted revenues and also on settlement assets and obligations denominated in these and other currencies. 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’s policy is to minimize its exposures related to adverse changes in foreign currency exchange rates and interest rates, while prohibiting speculative derivative activities. The Company uses longer-term foreign currency forward contracts, generally with maturities of three years or less, to mitigate some of the risk related to changes in the exchange rate between forecasted revenues denominated in other currencies and the United States dollar. Short-term foreign currency forward contracts, generally with maturities from a few days up to three weeks, are utilized to offset foreign exchange rate fluctuations on settlement assets and settlement obligations between transaction initiation and settlement. Forward starting interest rate swaps were utilized in 2006 to reduce the risk of interest rate fluctuations on forecasted debt issuances. Interest rate swaps are also used to swap a portion of certain fixed rate debt instruments to a floating rate.
The Company does not believe its derivative financial instruments expose it to more than a nominal amount of credit risk as the counterparties are established, well-capitalized financial institutions with credit ratings of “A” or better from major rating agencies. 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. The Company’s 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 details of each designated hedging relationship are formally documented at the inception of the arrangement, including the risk management objective, hedging strategy, hedged item, specific risks being hedged, the derivative instrument, how effectiveness is being assessed and how ineffectiveness, if any, will be measured. The derivative must be highly effective in offsetting the changes in cash flows, and effectiveness is evaluated quarterly on a retrospective and prospective basis.
Foreign Currency Hedging
The Company assesses the effectiveness of its foreign currency forward contracts, used to mitigate some of the risks related to forecasted revenues, 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 are recognized immediately in “Derivative gains/(losses), net” within the Company’s Consolidated Statements of Income. Differences between changes in the forward rates and spot rates, along with all changes in the fair value during periods in which the instrument was not designated as a hedge, were excluded from the measure of effectiveness. Prior to September 29, 2006, the Company did not have derivatives that qualified for hedge accounting in accordance with SFAS No. 133. As such, the effect of the changes in the fair value of these hedges prior to September 29, 2006 is included in “Derivative gains/ (losses), net”. On September 29, 2006 and during the fourth quarter of 2006, the Company entered into new derivative contracts in accordance with its revised foreign currency derivatives and hedging processes, which were designated and qualify as cash flow hedges under SFAS No. 133.
As mentioned above, the Company also uses short duration foreign currency forward contracts, generally with maturities from a few days up to three weeks, to offset foreign exchange rate fluctuations on settlement assets and obligations between initiation and settlement. 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 hedges pursuant to SFAS No. 133.
The aggregate United States dollar equivalent notional amount of foreign currency forward contracts held by the Company with external third parties as of the balance sheet dates are as follows (in millions):
| December 31, | ||||||
| 2007 | 2006 | |||||
| Contracts not designated as hedges: | ||||||
|
Euro | $ | 358.9 | $ | 249.5 | ||
| British pound | 56.4 | 43.5 | ||||
|
Other | 46.4 | 51.1 | ||||
| Contracts designated as hedges: |
||||||
|
Euro | 585.3 | 333.9 | ||||
| British pound | 99.2 | 73.2 | ||||
|
Canadian dollar | 97.5 | — | ||||
Interest Rate Hedging
In October 2006, the Company executed forward starting interest rate swaps with a combined notional amount of $875 million to fix the interest rate in connection with an anticipated issuance of fixed rate debt securities expected to be issued between October 2006 and May 2007. The Company designated these derivatives as cash flow hedges of the variability in the cash outflows of interest payments on the first $875 million of the forecasted debt issuance due to changes in the benchmark interest rate. The swaps were expected to be highly effective in hedging the interest payments associated with the forecasted debt issuance as the terms of the hedges, including the life and notional amount, mirrored the probable issuance dates of the forecasted debt issuances, and statistical analyses of historical relationships indicated a high correlation between spot and forward swap rates for all possible issuance dates within the expected range of issuance dates.
In November 2006, the Company terminated these swaps in conjunction with the issuance of the 2011 and 2036 Notes described in Note 13, by paying cash of approximately $18.6 million to the counterparties. The difference in the actual issuance date and the probable issuance date as stated in the Company’s hedge designation documentation resulted in ineffectiveness of $0.6 million, which was immediately recognized in “Derivative gains/(losses), net” in the Consolidated Statements of Income. No amounts were excluded from the measure of effectiveness. The remaining $18.0 million loss on the hedges was included in “Accumulated other comprehensive loss” and will be reclassified to “Interest expense” over the life of the related notes.
In June 2007, the Company entered into an interest rate swap with a notional amount of $75.0 million to effectively change the interest rate payments on a portion of its notes due 2011 from fixed-rate payments to short-term LIBOR-based variable rate payments in order to manage the mix of fixed and floating rates in the Company’s debt portfolio. The interest rate swap has a termination date of November 17, 2011, matching the maturity date of the hedged instrument. Additionally, the payment dates and coupon of the fixed portion of the swap match the contractual terms specified in the notes being hedged, and the rate on the floating portion of the swap resets every three months. Accordingly, the Company designated this derivative as a fair value hedge utilizing the short-cut method in SFAS No. 133, which permits an assumption of no ineffectiveness if these and other criteria are met. The fair value of the hedge was a net asset of $3.6 million as of December 31, 2007. The offset to the change in fair value of the interest rate swap is reflected in the balance of the hedged instrument within the Company’s “Borrowings” in the Consolidated Balance Sheets and interest expense has been adjusted to include the effects of payments made and received under the swap.
Summary Impact of Derivatives
The following table summarizes activity in “Accumulated other comprehensive loss” related to all derivatives designated as cash flow hedges (in millions):
| 2007 | 2006 | 2005 | |||||||||
| Balance included in “Accumulated other comprehensive loss” at January 1, | $ | (29.3 | ) | $ | — | $ | — | ||||
| Total reclassification into earnings from “Accumulated other comprehensive loss” | 26.9 | (1.5 | ) | — | |||||||
| Changes in fair value of derivatives, net of tax | (41.3 | ) | (27.8 | ) | — | ||||||
|
Balance included in “Accumulated other comprehensive loss” at December 31, | $ | (43.7 | ) | $ | (29.3 | ) | $ | — | |||
“Accumulated other comprehensive loss” of $29.3 million related to the foreign currency forward contracts is expected to be reclassified into revenue within the next 12 months as of December 31, 2007. Approximately $1.7 million of losses on the forecasted debt issuance hedges are expected to be recognized in interest expense during the next 12 months as of December 31, 2007. 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.
The following table summarizes changes in the fair value of derivatives held during the respective years (in millions):
| 2007 | 2006 | 2005 | |||||||||
| Interest rate fair value hedges—effective portion (a) | $ | 3.6 | $ | — | $ | — | |||||
| Interest rate cash flow hedges—effective portion (b) | — | (18.0 | ) | — | |||||||
| Foreign currency cash flow hedges—effective portion (c) | (55.9 | ) | (11.4 | ) | — | ||||||
| Portion excluded from effectiveness assessment and ineffectiveness (d) | 8.3 | 0.9 | — | ||||||||
| Foreign currency undesignated (e) |
(21.1 | ) | (41.9 | ) | 71.2 | ||||||
|
Total increase/(decrease) in fair value | $ | (65.1 | ) | (70.4 | ) | $ | 71.2 | ||||
| (a) | Changes in the fair value of interest rate swaps designated as fair value hedges are offset by recognized changes in the fair value of the hedged borrowings. |
| (b) | The effective portion of changes in fair value of interest rate swaps designated as cash flow hedges are recorded in other comprehensive income or loss. This amount recognized in other comprehensive income or loss is subsequently amortized to interest expense over the life of the debt being hedged. |
| (c) | The change in spot value of foreign currency forward contracts designated as cash flow hedges is recognized in other comprehensive income or loss. Amounts classified within “Accumulated other comprehensive loss” are reclassified to revenue in the period that the hedged item effects earnings. |
| (d) | The portion of change in fair value of a derivative excluded from effectiveness assessment for foreign currency forward contracts designated as cash flow hedges represents the difference between changes in forward rates and spot rates, along with all changes in fair value during periods in which the instrument was not designated as a hedge. The ineffectiveness recognized in forecasted debt hedges is attributable to the timing of the debt issuance changing from original expectation. These changes were recognized in “Derivative gains/ (losses), net.” |
| (e) | Changes in the fair value of undesignated foreign currency forward contracts are recognized in “Cost of services.” Prior to September 29, 2006, the Company did not have derivatives that qualified for hedge accounting in accordance with SFAS No. 133. As such, the effect of the changes in the fair value of these derivatives prior to September 29, 2006 is included in “Derivative gains/(losses), net.” |
The following table summarizes the fair value of derivatives held at December 31, 2007 and their expected maturities (in millions):
| Total | 2008 | 2009 | 2010 | 2011 | ||||||||||||||
| Foreign currency hedges—cash flow |
$ | (33.1 | ) | $ | (25.8 | ) | $ | (7.3 | ) | $ | — | $ | — | |||||
| Foreign currency hedges—undesignated |
0.4 | 0.4 | — | — | — | |||||||||||||
| Interest rate hedges | 3.6 | 0.6 | 1.4 | 1.0 | 0.6 | |||||||||||||
|
Total | $ | (29.1 | ) | $ | (24.8 | ) | $ | (5.9 | ) | $ | 1.0 | $ | 0.6 | |||||
13. Borrowings
The Company’s outstanding borrowings at December 31, 2007 and 2006 consist of the following (in millions):
| December 31, 2007 | December 31, 2006 | |||||||||||
| Carrying Value | Fair Value | Carrying Value | Fair Value | |||||||||
| Due in less than one year: | ||||||||||||
|
Commercial paper | $ | 338.2 | $ | 338.2 | $ | 324.6 | $ | 324.6 | ||||
| Note payable due January 2007 |
— | — | 3.0 | 3.0 | ||||||||
|
Floating rate notes, due 2008 | 500.0 | 495.2 | — | — | ||||||||
| Due in greater than one year: | ||||||||||||
|
Floating rate notes, due 2008 | — | — | 500.0 | 499.8 | ||||||||
| 5.400% notes, net of discount, due 2011 (a) |
1,002.8 | 1,012.0 | 999.0 | 986.3 | ||||||||
|
5.930% notes, net of discount, due 2016 | 999.7 | 1,001.2 | 999.7 | 992.2 | ||||||||
| 6.200% notes, net of discount, due 2036 |
497.3 | 473.1 | 497.2 | 471.4 | ||||||||
| Total borrowings |
$ | 3,338.0 | $ | 3,319.7 | $ | 3,323.5 | $ | 3,277.3 | ||||
| (a) | During the second quarter 2007, the Company entered into a $75.0 million interest rate swap related to these notes. For further information regarding the interest rate swap, refer to Note 12, “Derivative Financial Instruments.” |
Exclusive of discounts and the fair value of the interest rate swap, maturities of borrowings as of December 31, 2007 are $838.2 million in 2008, $1.0 billion in 2011 and $1.5 billion thereafter. There are no contractual maturities on borrowings during 2009 and 2010.
The Company’s obligations with respect to its outstanding borrowings, as described below, rank equally.
Commercial Paper Program
On November 3, 2006, the Company established a commercial paper program pursuant to which the Company may issue unsecured commercial paper notes (the “Commercial Paper Notes”) in an amount not to exceed $1.5 billion outstanding at any time. The Commercial Paper Notes may have maturities of up to 397 days from date of issuance. Interest rates for borrowings are based on market rates at the time of issuance. The Company’s commercial paper borrowings at December 31, 2007 and 2006 had weighted-average interest rates of approximately 5.5% and 5.4%, respectively, and a weighted-average initial terms of 36 days and 17 days, respectively.
Revolving Credit Facility
On September 27, 2006, the Company entered into a five-year unsecured revolving credit facility, which includes a $1.5 billion revolving credit facility, a $250.0 million letter of credit sub-facility and a $150.0 million swing line sub-facility (the “Revolving Credit Facility”). The Revolving Credit Facility contains certain covenants that, among other things, limit or restrict the ability of the Company and other significant subsidiaries to grant certain types of security interests, incur debt or enter into sale and leaseback transactions. The Company is also required to maintain compliance with a consolidated interest coverage ratio covenant.
On September 28, 2007, the Company entered into an amended and restated credit agreement, the primary purpose of which was to extend the maturity by one year from its original five-year $1.5 billion facility entered into in 2006. No other material changes were made in the amended and restated facility. As of December 31, 2007, the Company had no outstanding borrowings and had approximately $1.2 billion available for borrowings under this agreement.
Interest due under the Revolving Credit Facility is fixed for the term of each borrowing and is payable according to the terms of that borrowing. Generally, interest is calculated using LIBOR plus an interest rate margin (19 basis points as of December 31, 2007 and 2006). A facility fee is also payable quarterly on the total facility, regardless of usage (6 basis points as of December 31, 2007 and 2006). The facility fee percentage is determined based on our credit rating assigned by Standard & Poor’s Ratings Services (“S&P”) and/or Moody’s Investor Services, Inc. (“Moody’s”). In addition, to the extent the aggregate outstanding borrowings under the Revolving Credit Facility exceed 50% of the related aggregate commitments, a utilization fee based upon such ratings is payable to the lenders on the aggregate outstanding borrowings (5 basis points as of December 31, 2007 and 2006).
Notes
On September 29, 2006, the Company issued to First Data $1.0 billion aggregate principal amount of unsecured notes maturing on October 1, 2016 (the “2016 Notes”) in partial consideration for the contribution by First Data to the Company of its money transfer and consumer payments businesses in connection with the Spin-off.
Interest on the 2016 Notes is payable semiannually on April 1 and October 1 each year based on a fixed per annum interest rate of 5.930%. The indenture governing the 2016 Notes contains covenants that, among other things, limit or restrict the ability of the Company and other significant subsidiaries to grant certain types of security interests, incur debt (in the case of significant subsidiaries) or enter into sale and leaseback transactions. The Company may redeem the 2016 Notes at any time prior to maturity at the applicable treasury rate plus 20 basis points.
On November 17, 2006, the Company issued $2 billion aggregate principal amount of the Company’s unsecured fixed and floating rate notes, comprised of $500 million aggregate principal amount of the Company’s Floating Rate Notes due 2008 (the “Floating Rate Notes”), $1 billion aggregate principal amount of 5.400% Notes due 2011 (the “2011 Notes”) and $500 million aggregate principal amount of 6.200% Notes due 2036 (the “2036 Notes”).
Interest with respect to the 2011 Notes and 2036 Notes is payable semiannually on May 17 and November 17 each year based on fixed per annum interest rates of 5.400% and 6.200%, respectively. Interest with respect to the Floating Rate Notes is payable quarterly in arrears on February 17, May 17, August 17, and November 17 each year at a per annum rate equal to the three month LIBOR plus 15 basis points, reset quarterly (5.06% and 5.52% at December 31, 2007 and 2006, respectively). The indenture governing the 2011 Notes, 2036 Notes and Floating Rate Notes contains covenants that, among other things, limit or restrict the ability of the Company and other significant subsidiaries to grant certain types of security interests, incur debt (in the case of significant subsidiaries), or enter into sale and leaseback transactions. The Company may redeem the 2011 Notes and the 2036 Notes at any time prior to maturity at the applicable treasury rate plus 15 basis points and 25 basis points, respectively. The Company may redeem the Floating Rate Notes at any time on or after May 17, 2007 at a redemption price equal to 100% of the principal amount of the Floating Rate Notes to be redeemed plus accrued interest thereon to the date of redemption.
The 2011 Notes, 2016 Notes, 2036 Notes and the Floating Rate Notes were all originally issued in reliance on exemptions from the registration requirements of the Securities Act of 1933, as amended. The Company exchanged all such notes for identical notes registered with the Securities and Exchange Commission pursuant to the terms of the original issuance.
14. Stock Compensation Plans
Stock Compensation Plans
The Western Union Company 2006 Long-Term Incentive Plan
The Western Union Company 2006 Long-Term Incentive Plan (“2006 LTIP”) provides for the granting of stock options, restricted stock awards and units, unrestricted stock awards, and other equity-based awards, to employees and other key individuals who perform services for the Company. A maximum of 120.0 million shares of common stock may be awarded under the 2006 LTIP. As of December 31, 2007, the Company has issued 80.2 million options and 3.1 million restricted stock awards and units (of which 73.1 million options and 1.9 million restricted stock awards and units were issued in connection with the spin-off from First Data as further described below) to certain employees of the Company under the 2006 LTIP.
Options granted under the 2006 LTIP are issued with exercise prices equal to the fair market value of Western Union common stock on the grant date, have 10-year terms, and vest over four equal annual increments beginning 12 months after the date of grant. Compensation expense related to stock options is recognized over the requisite service period. The requisite service period for stock options is the same as the vesting period, with the exception of retirement eligible employees, who have shorter requisite service periods ending when the employees become retirement eligible.
Restricted stock awards and units granted under the 2006 LTIP typically become 100% vested on the three year anniversary of the grant date. The fair value of the awards granted is measured based on the fair market value of the shares on the date of grant, and the related compensation expense is recognized over the requisite service period which is the same as the vesting period.
On September 29, 2006, the Company awarded a founders’ grant of either restricted stock awards or units to certain employees who are not otherwise eligible to receive stock-based awards under the 2006 LTIP. These awards vest in two equal annual increments on the first and second anniversary of the grant date. The fair value of the awards granted was measured based on the when-issued closing price of the Company’s common stock of $19.13 on the grant date and is being recognized ratably over the vesting period. Included in the 3.1 million restricted stock awards and units issued under the 2006 LTIP described in the preceding paragraph, were 0.3 million restricted stock awards or units issued in connection with the founders’ grant.
The Western Union Company 2006 Non-Employee Director Equity Compensation Plan
The Western Union Company 2006 non-employee director equity compensation plan (“2006 Director Plan”) provides for the granting of equity-based awards to non-employee directors of the Company. Options granted under the 2006 Director Plan are issued at prices equal to the fair market value of Western Union common stock at the grant date, have 10-year terms, and vest immediately. Since options and stock units under this plan vest immediately, compensation expense is recognized on the date of grant based on the fair market value of the awards when granted. Awards under the plan may be settled immediately unless the participant elects to defer the receipt of the common shares under applicable plan rules. A maximum of 1.5 million shares of common stock may be awarded under the 2006 Director Plan. As of December 31, 2007, the Company has issued 0.2 million options and 0.1 million unrestricted stock units to non-employee directors of the Company.
First Data Stock Options and Employee Stock Purchase Plan Rights
Prior to the Spin-off, Western Union participated in the First Data plans that provided for the granting of stock options to employees and other key individuals who performed services for the Company. Options granted under the First Data plans were issued with exercise prices equivalent to the fair market value of First Data common stock on the dates of grant, substantially all had 10-year terms and became exercisable in four equal annual increments beginning 12 months after the dates of grant. The requisite service period for stock options was the same as the vesting period, with the exception of retirement eligible employees who have shorter requisite service periods ending when the employees become retirement eligible. Compensation expense related to stock options was recognized over the requisite service period, except as discussed further under “Stock-Based Compensation” below for certain options granted prior to the adoption of SFAS No. 123R.
During the first quarter of 2006, First Data issued restricted stock awards or restricted stock units to certain employees which were contingent upon the achievement of certain performance criterion which were met on the date of Distribution. The awards had provisions to vest at a rate of 33% per year on the anniversary date of the grant. The fair value of the awards granted in February 2006 was measured based on the fair market value of the shares on the date of grant.
Prior to the Spin-off, employees of the Company were able to participate in a First Data instituted employee stock purchase plan (“ESPP”). Amounts accumulated through payroll deductions elected by eligible employees were used to make quarterly purchases of First Data common stock at a 15% discount from the lower of the market price at the beginning or end of the quarter. The fair value of these awards was recognized as compensation expense in the Consolidated Statements of Income for the year ended December 31, 2006 in accordance with the provisions of SFAS No. 123R. Western Union has not adopted an employee stock purchase plan.
First Data received all cash proceeds related to the exercise of stock options and ESPP shares sold by Western Union employees during all periods prior to the Spin-off.
Impact of Spin-Off to Stock–Based Awards Granted Under First Data Plans
At the time of the Spin-off, First Data converted stock options, restricted stock awards and restricted stock units (collectively, “Stock-Based Awards”) on First Data stock held by Western Union and First Data employees. For Western Union employees, outstanding First Data Stock-Based Awards were converted to new Western Union Stock-Based Awards at a conversion ratio of 2.1955 Western Union Stock-Based Awards for every First Data Stock-Based Award held prior to the Spin-off. The conversion was based on the pre-distribution First Data closing price with due bills of $42.00 relative to the Western Union when-issued closing price of $19.13 on September 29, 2006. For First Data employees, each First Data Stock-Based Award held prior to the Spin-off was converted into one replacement First Data Stock-Based Award and one Western Union Stock-Based Award. The new Western Union and First Data Stock-Based Awards maintained their pre-conversion aggregate intrinsic values, and, in the case of stock options, their ratio of the exercise price per share to their fair market value per share.
All converted Stock-Based Awards, which had not vested prior to September 24, 2007, were subject to the terms and conditions applicable to the original First Data Stock-Based Awards, including change of control provisions which required full vesting upon a change of control of First Data. Accordingly, upon the completion of the acquisition of First Data on September 24, 2007 by an affiliate of Kohlberg Kravis Roberts & Co.’s (“KKR”), all of these remaining converted unvested Western Union Stock-Based Awards vested. In connection with this accelerated vesting, the Company incurred a non-cash pre-tax charge of $22.3 million during year ended December 31, 2007 for such awards held by Western Union employees. Approximately one-third of this charge was recorded within “Cost of services” and two-thirds was recorded within “Selling, general and administrative expense” in the Consolidated Statements of Income. As a result of this accelerated vesting, there is no remaining unamortized compensation expense associated with such converted Stock-Based Awards.
The conversion of each stock option held by Western Union employees on the date of the Spin-off constituted a modification of those stock option awards under the provisions of SFAS No. 123R resulting in additional stock based compensation charges of $1.5 million and $1.9 million during the years ended December 31, 2007 and 2006, respectively.
After the Spin-off, the Company receives all cash proceeds related to the exercise of all Western Union stock options, and recognizes all stock compensation expense and retains the resulting tax benefits relating to Western Union awards held by Western Union employees. First Data recognizes all stock-based compensation expense and retains all associated tax benefits for Western Union Stock-Based Awards held by First Data employees.
Stock Option Activity
A summary of Western Union stock option activity relating to Western Union and First Data employees for the year ended December 31, 2007 is as follows (options and aggregate intrinsic value in millions):
| Year Ended December 31, 2007 | |||||||||||
| Options | Weighted-Average Exercise Price | Weighted-Average Remaining Contractual Term | Aggregate Intrinsic Value | ||||||||
| Outstanding at January 1, |
73.8 | $ | 17.84 | ||||||||
| Granted | 0.7 | 21.77 | |||||||||
| Exercised | (13.6 | ) | 15.62 | ||||||||
| Cancelled / forfeited |
(1.5 | ) | 21.05 | ||||||||
| Outstanding at December 31, |
59.4 | $ | 18.32 | 5.9 | $ | 377.1 | |||||
| Western Union options exercisable at December 31, | 54.7 | $ | 18.21 | 5.6 | $ | 354.7 | |||||
The Company received $211.8 million and $80.8 million in cash proceeds related to the exercise of stock options during the years ended December 31, 2007 and 2006, respectively. Upon the exercise of stock options, shares of common stock are issued from authorized common shares. The Company maintains a share repurchase program (Note 11).
The Company’s calculated pool of excess tax benefits available to absorb write-offs of deferred tax assets in subsequent periods was approximately $10.6 million as of December 31, 2007. The Company realized total tax benefits during the years ended December 31, 2007 and 2006 from stock option exercises of $10.7 million and $1.9 million, respectively.
The total intrinsic value of stock options exercised during the years ended December 31, 2007, 2006 and 2005 was $91.0 million, $42.1 million and $6.9 million, respectively.
Restricted Stock Awards and Restricted Stock Units
A summary of Western Union activity for restricted stock awards and units relating to Western Union and First Data employees for the year ended December 31, 2007 is listed below (awards/units in millions):
| Year
Ended December 31, 2007 | ||||||
| Number Outstanding |
Weighted-Average Grant-Date Fair Value | |||||
| Non-vested at January 1, 2007 |
3.0 | $ | 19.80 | |||
|
Granted | 0.1 | 21.86 | ||||
| Vested | (1.9 | ) | 19.94 | |||
| Forfeited | (0.2 | ) | 19.70 | |||
| Non-vested at December 31, 2007 |
1.0 | $ | 19.39 | |||
Stock-Based Compensation
The following table sets forth the total impact on earnings for stock-based compensation expense recognized in the Consolidated Statements of Income resulting from stock options, restricted stock awards, restricted stock units and ESPP rights for Western Union employees for the year ended December 31, 2007 and 2006 (in millions, except per share data). Although Western Union has not adopted an employee stock purchase plan, the Company’s employees were allowed to participate in First Data’s ESPP prior to the Spin-off. A benefit to earnings is reflected as a positive and a reduction to earnings is reflected as a negative.
| Year Ended December 31, |
||||||||
| 2007 | 2006 | |||||||
| Stock-based compensation expense impact on income before income taxes | $ | (50.2 | ) | $ | (30.1 | ) | ||
|
Income tax benefit from stock-based compensation expense |
15.1 | 9.7 | ||||||
| Net income impact | $ | (35.1 | ) | $ | (20.4 | ) | ||
| Earnings per share: |
||||||||
| Basic | $ | (0.05 | ) | $ | (0.03 | ) | ||
|
Diluted | $ | (0.05 | ) | $ | (0.03 | ) | ||
As discussed previously, the Company incurred a pre-tax charge of $22.3 million during the year ended December 31, 2007 upon the completion of the acquisition of First Data on September 24, 2007 by an affiliate of KKR. Also included in stock-based compensation expense above for the year ended December 31, 2006 is $6.8 million of allocated stock-based compensation related to employees of First Data providing administrative services to the Company prior to the Spin-off. There was no stock-based compensation capitalized during the years ended December 31, 2007 and 2006.
As of December 31, 2007, there was $28.4 million of total unrecognized compensation cost, net of assumed forfeitures, related to non-vested stock options which is expected to be recognized over a weighted-average period of 2.9 years, and there was $10.6 million of total unrecognized compensation cost, net of assumed forfeitures, related to non-vested restricted stock awards and restricted stock units which is expected to be recognized over a weighted-average period of 1.7 years.
Pro Forma SFAS No. 123 Stock-Based Compensation Information
For periods prior to the adoption of SFAS No. 123R, pro forma information regarding the Company’s net income is required by SFAS No. 123, “Accounting for Stock Based Compensation” (“SFAS No. 123”), as if the Company had accounted for its employee stock options in First Data stock under the fair value method prescribed by SFAS No. 123. The Company’s pro forma information for the year ended December 31, 2005, which reflects compensation expense equal to the fair value of the options, restricted stock awards and ESPP rights for Western Union employees recognized over their vesting periods, is as follows (in millions):
| Year Ended December 31, 2005 | ||||
|
Reported net income | $ | 927.4 | ||
| Restricted stock expense and effect of accelerated vesting included in reported net income, net of tax | 1.9 | |||
| SFAS No. 123 expense, net of tax |
(37.7 | ) | ||
| Pro forma net income | $ | 891.6 | ||
| Reported earnings per share—basic |
$ | 1.21 | ||
|
Reported earnings per share—diluted | $ | 1.21 | ||
|
Pro forma earnings per share—basic | $ | 1.17 | ||
| Pro forma earnings per share—diluted | $ | 1.17 | ||
In December 2005, First Data accelerated vesting of all outstanding unvested stock options granted by First Data to its officers and employees under First Data’s 2002 Long-Term Incentive Plan. The Company recognized compensation expense of $1.8 million during the fourth quarter of 2005 resulting from accelerated vesting.
Certain of the Company’s employee stock-based compensation awards have terms that provide for vesting to continue after retirement. Prior to the adoption of SFAS No. 123R, the Company accounted for this type of arrangement by recognizing pro forma compensation cost over the stated vesting period for the SFAS No. 123 pro forma disclosures. Upon adoption of SFAS No. 123R, compensation cost is being recognized over a shorter period that ends with retirement eligibility. The impact of applying SFAS No. 123R requirements for accelerated expense recognition would have impacted pro forma SFAS No. 123 compensation expense, net of tax, by a benefit of $1.7 million for the year ended December 31, 2005.
Fair Value Assumptions
The Company used the following assumptions for the Black-Scholes option pricing model to determine the value of First Data stock options and ESPP rights granted to Western Union employees before the Spin-off and the value of Western Union options granted to such employees after the Spin-off.
| Year Ended December 31, | ||||||||||||
| 2007 | 2006 | 2005 | ||||||||||
| Stock options granted (post-spin grants): |
||||||||||||
| Weighted-average risk-free interest rate |
4.53 | % | 4.64 | % | — | |||||||
| Weighted-average dividend yield |
0.18 | % | 0.21 | % | — | |||||||
| Volatility | 23.8 | % | 26.4 | % | — | |||||||
| Expected term (in years) | 6.2 | 6.6 | — | |||||||||
| Weighted-average fair value |
$ | 7 | $ | 7 | — | |||||||
| Stock options granted (pre-spin grants): |
||||||||||||
| Weighted-average risk-free interest rate |
— | 4.62 | % | 4.14 | % | |||||||
| Weighted-average dividend yield |
— | 0.58 | % | 0.58 | % | |||||||
| Volatility | — | 23.5 | % | 32.7 | % | |||||||
| Expected term (in years) | — | 5 | 6 | |||||||||
| Weighted-average fair value (pre-spin) | — | $ | 12 | $ | 15 | |||||||
| ESPP: |
||||||||||||
| Weighted-average risk-free interest rate |
— | 4.85 | % | 3.12 | % | |||||||
| Weighted-average dividend yield |
— | 0.56 | % | 0.58 | % | |||||||
| Volatility | — | 23.0 | % | 19.1 | % | |||||||
| Expected term (in years) | — | 0.25 | 0.25 | |||||||||
| Weighted-average fair value (pre-spin) | — | $ | 9 | $ | 8 | |||||||
For periods presented prior to the spin-off date of September 29, 2006, all stock-based compensation awards were made by First Data, and used First Data assumptions for volatility, dividend yield and term. Western Union assumptions, which are described in the paragraphs below, were utilized for grants made by Western Union on September 29, 2006 and subsequent thereto.
Expected volatility—Western Union’s expected weighted-average volatility of 23.8% was determined based on the calculated historical peer group volatility for companies in similar industries, stage of life cycle and market capitalization since there is not sufficient historical volatility data for Western Union common stock. Expected volatility for the Company’s 2007 grants, which varies by group based on the expected option term, was 26.9% for the Board of Directors and executives and 22.8% for non-executive employees. Beginning in 2006, First Data used the implied volatility method for estimating expected volatility for all stock options granted and ESPP rights. First Data calculated its implied volatility on a daily basis using a Black-Scholes option pricing model, incorporating the market prices of a variety of traded options, the market price of First Data stock, the exercise price and remaining term of the traded options, the expected dividends and the risk-free rate.
Expected dividend yield—The Company’s expected annual dividend yield is calculated based on Western Union’s average stock price on each respective grant date and an assumed annual dividend is $0.04 per common share. First Data’s dividend yield was the calculation of the annualized First Data dividend amount of $0.24 divided by a rolling 12 month average First Data stock price as of the most recent grant date for which First Data granted options to Western Union employees.
Expected term—Western Union’s expected term is 5.8 years for non-executive employees, and 7.5 years for the Board of Directors and executives. The Company’s expected term of options was based upon, among other things, historical exercises (including the exercise history of First Data’s awards), the vesting term of the Company’s options, the cancellation history of the Company’s employees options in First Data stock and the options’ contractual term of ten years. First Data has also aggregated stock option awards into classes. For each class, the expected term is primarily based on the results of a study performed on the historical exercise and post-vesting employment termination behavior for similar grants. First Data’s expected terms were as follows: 4.5 years for non-executive employees, 7 years for the Board of Directors and 7.5 years for its executives. The expected term of ESPP rights were determined to be 0.25 years as purchase rights are achieved over the course of the quarter in which the employee participated in the ESPP. Once the shares have been purchased, the employee can sell their respective shares.
Risk-free interest rate—The risk-free rate for stock options granted during the period is determined by using a U.S. Treasury rate for the period that coincided with the expected terms listed above.
The assumptions used to calculate the fair value of options granted will be evaluated and revised, as necessary, to reflect market conditions and the Company’s historical experience and future expectations. The calculated fair value is recognized as compensation cost in the Company’s financial statements over the requisite service period of the entire award. Compensation cost is recognized only for those options expected to vest, with forfeitures estimated at the date of grant and evaluated and adjusted periodically to reflect the Company’s historical experience and future expectations. Any change in the forfeiture assumption will be accounted for as a change in estimate, with the cumulative effect of the change on periods previously reported being reflected in the financial statements of the period in which the change is made. In the future, as more historical data is available to calculate the volatility of Western Union stock and the actual terms Western Union employees hold options, expected volatility and expected term may change which could substantially change the grant-date fair value of future stock option awards and, ultimately, the recorded compensation expense.
15. Segments
The Company classifies its businesses into two reportable segments: consumer-to-consumer and consumer-to-business. Operating segments are defined by SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information,” as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker (“CODM”) in deciding where to allocate resources and in assessing performance.
| • | The consumer-to-consumer reporting segment provides money transfer services between consumers, primarily through a global network of third-party agents using our multi-currency, real-time money transfer processing systems. |
| • | The consumer-to-business reporting segment provides payments from consumers to billers through a network of third-party agents and other various electronic channels, including the telephone and the internet. The segment’s revenue was primarily generated in the United States for all periods presented. |
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 is managed as four regions, primarily to coordinate agent network management and marketing activities. The Company’s 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. Each region and corridor 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. Consumer-to-consumer segment revenue typically increases sequentially from the first quarter to the fourth quarter each year and declines from the fourth quarter to the first quarter of the following year. This seasonal fluctuation is related to the holiday season in various countries in the fourth quarter.
All businesses that have not been classified into consumer-to-consumer or consumer-to-business, primarily the Company’s money order and prepaid services businesses, and certain expenses incurred in connection with the Spin-off are reported as “Other.” The Company previously operated internet auction payments, messaging and international prepaid cellular top-up businesses. These three businesses represented aggregated revenues in 2006 and 2005 of $4.1 million and $28.9 million, respectively. Aggregate operating income related to the shut down or disposed of businesses, including a gain on the sale of assets related to our internet auction payments business, for the year ended December 31, 2006 was $0.1 million. The aggregate operating loss associated with such businesses in the year ended December 31, 2005 was $(16.2) million. Due to the immaterial nature of these three businesses, they have not been presented separately as discontinued operations.
The Company’s reportable segments are reviewed separately below because each reportable segment represents a strategic business unit that offers different products and serves different markets. The business segment measurements provided to, and evaluated by, the Company’s CODM are computed in accordance with the following principles:
| • | The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. |
| • | Corporate and other overhead is allocated to the segments primarily based on a percentage of the segments’ revenue. |
| • | Expenses incurred in connection with the development of certain new service offerings, including costs to develop mobile money transfer and micro-lending services, and non-recurring costs incurred to effect the Spin-off are not allocated to the segments. |
| • | All items not included in operating income are excluded. |
The following table presents the Company’s reportable segment results for the years ended December 31, 2007, 2006 and 2005, respectively (in millions):
| Years Ended December 31, | |||||||||
| 2007 | 2006 | 2005 | |||||||
| Revenues: | |||||||||
|
Consumer-to-Consumer: | |||||||||
| Transaction fees | $ | 3,286.6 | $ | 3,059.0 | $ | 2,724.0 | |||
| Foreign exchange revenue | 769.3 | 652.4 | 529.6 | ||||||
| Other revenues | 37.2 | 33.5 | 25.6 | ||||||
| 4,093.1 | 3,744.9 | 3,279.2 | |||||||
| Consumer-to-Business: | |||||||||
| Transaction fees | 665.5 | 593.7 | 565.0 | ||||||
| Foreign exchange revenue | 2.0 | 1.5 | 1.4 | ||||||
|
Other revenues | 52.4 | 41.0 | 33.8 | ||||||
| 719.9 | 636.2 | 600.2 | |||||||
|
Other: | |||||||||
| Transaction fees | 37.7 | 43.9 | 65.8 | ||||||
|
Commission and other revenues | 49.5 | 45.2 | 42.7 | ||||||
| 87.2 | 89.1 | 108.5 | |||||||
| Total revenues |
$ | 4,900.2 | $ | 4,470.2 | $ | 3,987.9 | |||
| Operating income: | |||||||||
|
Consumer-to-Consumer | $ | 1,078.3 | $ | 1,069.7 | $ | 1,047.9 | |||
|
Consumer-to-Business | 223.7 | 223.3 | 220.4 | ||||||
|
Other | 20.0 | 18.4 | 0.9 | ||||||
| Total operating income | $ | 1,322.0 | $ | 1,311.4 | $ | 1,269.2 | |||
| Assets: |
|||||||||
| Consumer-to-Consumer | $ | 4,734.7 | $ | 4,456.0 | $ | 3,759.3 | |||
|
Consumer-to-Business | 885.6 | 740.2 | 587.0 | ||||||
| Other | 163.9 | 124.9 | 245.4 | ||||||
| Total assets |
$ | 5,784.2 | $ | 5,321.1 | $ | 4,591.7 | |||
| Depreciation and amortization: |
|||||||||
| Consumer-to-Consumer | $ | 98.5 | $ | 80.6 | $ | 54.0 | |||
| Consumer-to-Business | 21.8 | 18.1 | 19.8 | ||||||
|
Other | 3.6 | 4.8 | 5.7 | ||||||
| Total depreciation and amortization | $ | 123.9 | $ | 103.5 | $ | 79.5 | |||
| Capital expenditures: |
|||||||||
| Consumer-to-Consumer | $ | 155.7 | $ | 174.8 | $ | 48.3 | |||
|
Consumer-to-Business | 28.1 | 21.1 | 12.7 | ||||||
| Other | 8.3 | 6.4 | 4.0 | ||||||
| Total capital expenditures |
$ | 192.1 | $ | 202.3 | $ | 65.0 | |||
Information concerning principal geographic areas was as follows (in millions):
| Years Ended December 31, | |||||||||
| 2007 | 2006 | 2005 | |||||||
| Revenue: | |||||||||
|
United States | $ | 1,825.3 | $ | 1,889.3 | $ | 1,842.7 | |||
|
International | 3,074.9 | 2,580.9 | 2,145.2 | ||||||
| Total |
$ | 4,900.2 | $ | 4,470.2 | $ | 3,987.9 | |||
| Long-lived assets: | |||||||||
|
United States | $ | 172.3 | $ | 157.3 | $ | 70.5 | |||
|
International | 28.0 | 18.8 | 11.9 | ||||||
| Total |
$ | 200.3 | $ | 176.1 | $ | 82.4 | |||
The geographic split of revenue above has been determined based upon the country where a money transfer is initiated and the country where a money transfer is paid with revenue being split 50% between the two countries. Long-lived assets, consisting of “Property and equipment, net,” are presented based upon the location of the assets.
A majority of Western Union’s consumer-to-consumer transactions involve at least one non-United States location. Based on the method used to attribute revenue between countries described in the paragraph above, no individual country outside the United States accounted for more than 10% of segment revenue for the years ended December 31, 2007, 2006 and 2005. In addition, no individual agent or biller accounted for greater than 10% of consumer-to-consumer or consumer-to-business segment revenue, respectively, during these periods.
16. Quarterly Financial Information (Unaudited)
Summarized quarterly results for the years ended December 31, 2007 and 2006 are as follows (in millions):
| 2007 by Quarter: | Q1 | Q2 | Q3 | Q4 | Year Ended December 31, 2007 | |||||||||||||||
|
Revenues | $ | 1,131.0 | $ | 1,202.9 | $ | 1,257.2 | $ | 1,309.1 | $ | 4,900.2 | ||||||||||
|
Expenses | 826.4 | 880.2 | 927.1 | 944.5 | 3,578.2 | |||||||||||||||
| Other (expense)/income, net |
(22.5 | ) | (24.5 | ) | (23.2 | ) | (29.4 | ) | (99.6 | ) | ||||||||||
| Income before income taxes |
282.1 | 298.2 | 306.9 | 335.2 | 1,222.4 | |||||||||||||||
|
Income tax expense | 88.9 | 93.7 | 90.6 | 91.9 | 365.1 | |||||||||||||||
| Net income | $ | 193.2 | $ | 204.5 | $ | 216.3 | $ | 243.3 | $ | 857.3 | ||||||||||
|
Earnings per share: | ||||||||||||||||||||
|
Basic earnings per share | $ | 0.25 | $ | 0.27 | $ | 0.29 | $ | 0.32 | $ | 1.13 | ||||||||||
| Diluted earnings per share |
$ | 0.25 | $ | 0.26 | $ | 0.28 | $ | 0.32 | $ | 1.11 | ||||||||||
| Weighted-average shares outstanding: |
||||||||||||||||||||
| Basic | 768.2 | 764.8 | 757.5 | 749.5 | 760.2 | |||||||||||||||
|
Diluted | 783.3 | 779.0 | 767.4 | 761.7 | 772.9 | |||||||||||||||
| 2006 by Quarter: | Q1 | Q2 | Q3 | Q4 | Year Ended December 31, 2006 | ||||||||||||
| Revenues | $ | 1,043.0 | $ | 1,113.6 | $ | 1,140.4 | $ | 1,173.2 | $ | 4,470.2 | |||||||
| Expenses | 730.3 | 787.2 | 803.3 | 838.0 | 3,158.8 | ||||||||||||
| Other income/(expense), net |
12.2 | (2.6 | ) | 42.8 | (28.7 | ) | 23.7 | ||||||||||
|
Income before income taxes | 324.9 | 323.8 | 379.9 | 306.5 | 1,335.1 | ||||||||||||
| Income tax expense | 105.1 | 104.9 | 121.8 | 89.3 | 421.1 | ||||||||||||
|
Net income | $ | 219.8 | $ | 218.9 | $ | 258.1 | $ | 217.2 | $ | 914.0 | |||||||
| Earnings per share: |
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| Basic earnings per share | $ | 0.29 | $ | 0.29 | $ | 0.34 | $ | 0.28 | $ | 1.20 | |||||||
| Diluted earnings per share |
$ | 0.29 | $ | 0.29 | $ | 0.34 | $ | 0.28 | $ | 1.19 | |||||||
| Weighted-average shares outstanding: |
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| Basic | 763.9 | 763.9 | 763.9 | 766.2 | 764.5 | ||||||||||||
|
Diluted | 763.9 | 763.9 | 764.0 | 782.3 | 768.6 | ||||||||||||
|