1.  Business and Basis of Presentation

Business

The Western Union Company (“Western Union” or the “Company”) is a leader in global money movement and payment services, providing people and businesses with fast, reliable and convenient ways to send money and make payments around the world. The Western Union^® brand is globally recognized. The Company’s services are available through a network of agent locations in more than 200 countries and territories. Each location in the Company’s agent network is capable of providing one or more of the Company’s services.

The Western Union business consists of the following segments:

 

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Consumer-to-consumer — money transfer services between consumers, primarily through a global network of third-party agents using the Company’s multi-currency, real-time money transfer processing systems. This service is available for international cross-border transfers — that is, the transfer of funds from one country to another — and, in certain countries, intra-country transfers — that is, money transfers from one location to another in the same country.

 

•

Global business payments — the processing of payments from consumers or businesses to other businesses. The Company’s business payments services allow consumers to make payments to a variety of organizations including utilities, auto finance companies, mortgage servicers, financial service providers, government agencies and other businesses. Western Union Business Solutions (“Business Solutions”), which is also included in this segment, facilitates cross-border, cross-currency business-to-business payment transactions. The majority of the segment’s revenue was generated in the United States during all periods presented. However, international expansion and other key strategic initiatives have resulted in international revenue continuing to increase in this segment.

All businesses that have not been classified into the consumer-to-consumer or global business payments segments are reported as “Other” and primarily include the Company’s money order and prepaid services businesses.

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. Additionally, the Company must meet minimum capital requirements in some countries in order to maintain operating licenses. As of September 30, 2011, the amount of net assets subject to these limitations totaled approximately $230 million.

Various aspects of the Company’s services and businesses are subject to United States federal, state and local regulation, as well as regulation by foreign jurisdictions, including certain banking and other financial services regulations.

Basis of Presentation

The accompanying condensed consolidated financial statements are unaudited and were prepared in accordance with the instructions for Form 10-Q and Article 10 of Regulation S-X. In compliance with those instructions, certain information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) have been condensed or omitted.

 

The unaudited condensed consolidated financial statements in this quarterly report are presented on a consolidated basis and include the accounts of the Company and its majority-owned subsidiaries. Results of operations and cash flows for the interim periods are not necessarily indicative of the results that may be expected for the entire year. All significant intercompany transactions and accounts have been eliminated.

In the opinion of management, these condensed consolidated financial statements include all the normal recurring adjustments necessary to fairly present the Company’s condensed consolidated results of operations, financial position and cash flows as of September 30, 2011 and for all periods presented. These condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements within the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

Consistent with industry practice, the accompanying Condensed Consolidated Balance Sheets are unclassified due to the short-term nature of the Company’s settlement obligations contrasted with the Company’s ability to invest cash awaiting settlement in long-term investment securities.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates.

2.  Earnings Per Share and Dividends

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. Unvested shares of restricted stock are excluded from basic shares outstanding. Diluted earnings per share reflects the potential dilution that could occur if outstanding stock options at the presented dates are exercised and shares of restricted stock have vested, using the treasury stock method. The treasury stock method assumes proceeds from the exercise price of stock options, the unamortized compensation expense and assumed tax benefits of options and restricted stock are available to acquire shares at an average market price throughout the period, and therefore, reduce the dilutive effect.

For the three months ended September 30, 2011 and 2010, there were 26.4 million and 36.0 million, respectively, of outstanding options to purchase shares of Western Union stock excluded from the diluted earnings per share calculation as their effect was anti-dilutive. For the nine months ended September 30, 2011 and 2010, there were 14.1 million and 36.1 million, respectively, of outstanding options to purchase shares of Western Union stock excluded from the diluted earnings per share calculation as their effect was anti-dilutive.

The following table provides the calculation of diluted weighted-average shares outstanding (in millions):

		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
Basic weighted-average shares outstanding			624.9				659.1				634.3				670.1
Common stock equivalents			2.2				2.2				4.0				2.3
Diluted weighted-average shares outstanding			627.1				661.3				638.3				672.4

Cash Dividends Paid

The Company’s Board of Directors declared quarterly cash dividends of $0.08 per common share in both the second and third quarters of 2011, and $0.07 per common share in the first quarter of 2011, representing $144.6 million in total dividends. Of this amount, $49.6 million was paid on October 7, 2011, $50.3 million was paid on June 30, 2011 and $44.7 million was paid on March 31, 2011. During the nine months ended September 30, 2010, the Company’s Board of Directors declared quarterly cash dividends of $0.06 per common share, representing $119.5 million in total dividends. Of this amount, $39.4 million was paid on October 14, 2010, $39.6 million was paid on June 30, 2010 and $40.5 million was paid on March 31, 2010.

3.  Acquisitions

Travelex Global Business Payments

In July 2011, the Company entered into an agreement with Travelex Holdings Limited to acquire its business-to-business payment operations known as Travelex Global Business Payments (“TGBP”) for cash consideration of £606 million (approximately $945 million based on currency exchange rates at September 30, 2011), subject to a working capital adjustment. With the acquisition of TGBP and the Company’s existing Business Solutions business, the Company will have a presence in 18 countries and the ability to leverage TGBP’s international business-to-business payments market expertise, distribution, product and capabilities with Western Union’s brand, existing Business Solutions operations, global infrastructure and relationships, and financial strength. The acquisition is expected to close in the fourth quarter of 2011, subject to regulatory approval and satisfaction of closing conditions.

Finint, S.r.l.

On October 31, 2011, the Company acquired the remaining 70% interest in Finint S.r.l. (“Finint”), one of the Company’s largest money transfer agents in Europe, for cash consideration of approximately €100 million (approximately $140 million based on currency exchange rates at October 31, 2011), subject to a working capital adjustment. The Company previously held a 30% equity interest in Finint. The Company expects the acquisition of Finint will help accelerate the introduction of additional Western Union products and services, and will leverage its existing European infrastructure to build new opportunities across the European Union. The acquisition will be recognized at 100% of the fair value of Finint due to the revaluation of the Company’s 30% interest to fair value. The acquisition will not impact the Company’s revenue, because the Company is already recording all of the revenue arising from money transfers originating at Finint subagents. As of the acquisition date, the Company no longer incurs commission costs for transactions related to Finint; rather the Company now pays commissions to Finint subagents, resulting in lower overall commission expense. The Company’s operating expenses include costs attributable to Finint’s operations subsequent to the acquisition date.

Angelo Costa, S.r.l.

On April 20, 2011, the Company acquired the remaining 70% interest in European-based Angelo Costa S.r.l. (“Costa”), one of the Company’s largest agents providing services in a number of European countries, primarily Italy, the United Kingdom, Belgium, Romania and the Netherlands. The Company previously held a 30% equity interest in Costa. The Company expects the acquisition of Costa will help accelerate the introduction of additional Western Union products and services, and will leverage its existing European infrastructure to build new opportunities across the European Union. The acquisition does not impact the Company’s money transfer revenue, because the Company was already recording all of the revenue arising from money transfers originating at Costa subagents. As of the acquisition date, the Company no longer incurs commission costs for transactions related to Costa; rather the Company now pays commissions to Costa subagents, resulting in lower overall commission expense. The Company’s operating expenses include costs attributable to Costa’s operations subsequent to the acquisition date.

The Company acquired the remaining 70% interest in Costa for cash consideration of €95 million ($135.7 million) which included a reduction of €5 million ($7.1 million) for an initial working capital adjustment pursuant to the terms of the purchase agreement. The final consideration and the final purchase price allocation are subject to an additional working capital adjustment. The Company revalued its previous 30% equity interest to fair value of approximately $46.2 million on the acquisition date, resulting in total value of $181.9 million. In conjunction with the revaluation, the Company recognized a gain of $29.4 million, recorded in “Other income, net” in the Company’s Condensed Consolidated Statements of Income for the amount by which the fair value of the 30% equity interest exceeded its previous carrying value. All assets and liabilities of Costa have been recorded at fair value, excluding the deferred tax liability. The following table summarizes the preliminary allocation of total value (in millions):

Assets:
Settlement assets		$	51.2
Property and equipment			3.0
Goodwill			171.9
Other intangible assets			49.6
Other assets			4.1
Total assets		$	279.8
Liabilities:
Accounts payable and accrued liabilities		$	10.2
Settlement obligations			55.5
Income taxes payable			10.5
Deferred tax liability, net			15.0
Other liabilities			6.7
Total liabilities			97.9
Total value		$	181.9

The preliminary valuation of assets acquired resulted in $49.6 million of identifiable intangible assets, $42.7 million of which were attributable to the network of subagents and were valued using an income approach, and $6.9 million of other intangibles which were valued using both income and cost approaches. For the remaining assets and liabilities excluding goodwill and the deferred tax liability, fair value approximated carrying values. The intangible assets related to the network of subagents are being amortized over 11 years, subject to valuation completion. The remaining intangibles are being amortized over one to four years. The goodwill recognized of $171.9 million is attributable to growth opportunities that will arise from the Company directly managing its agent relationships through a dedicated sales force, expected synergies, projected long-term business growth and an assembled workforce. All goodwill relates entirely to the consumer-to-consumer segment. Goodwill expected to be deductible for income tax purposes is approximately $92.7 million.

4.  Restructuring and Related Expenses

On May 25, 2010 and as subsequently revised, the Company’s Board of Directors approved a restructuring plan (the “Restructuring Plan”) designed to reduce the Company’s overall headcount and migrate positions from various facilities, primarily within North America and Europe, to regional operating centers. Details of the expenses incurred are included in the tables below. Included in these expenses are approximately $2 million of non-cash expenses related to fixed asset and leasehold improvement write-offs and accelerated depreciation at impacted facilities. As of September 30, 2011, the Company has incurred all of the expenses related to the Restructuring Plan.

 

The following table summarizes the activity for the restructuring and related expenses discussed above for the nine months ended September 30, 2011 and the related restructuring accruals at September 30, 2011 and December 31, 2010 (in millions):

		Severance, Outplacement and Related Benefits				Fixed Asset Write-Offs  and Accelerated Depreciation				Lease Terminations				Other(b)				Total
Balance, December 31, 2010		$	34.3			$	—			$	—			$	1.1			$	35.4
Expenses (a)			26.1				1.3				3.5				15.9				46.8
Cash payments			(36.4	)			—				(3.5	)			(16.0	)			(55.9	)
Non-cash charges (a)			1.4				(1.3	)			—				—				0.1
Balance, September 30, 2011		$	25.4			$	—			$	—			$	1.0			$	26.4
Total expenses		$	74.8			$	2.2			$	3.5			$	25.8			$	106.3

 

(a)	Expenses include non-cash write-offs and accelerated depreciation of fixed assets and leasehold improvements. However, these amounts were recognized outside of the restructuring accrual.

 

(b)	Other expenses related to the relocation of various operations to new and existing Company facilities including expenses for hiring, training, relocation, travel and professional fees. All such expenses will be recorded when incurred.

Restructuring and related expenses are reflected in the Condensed Consolidated Statements of Income as follows (in millions):

		Three Months  Ended September 30,								Nine Months  Ended September 30,
		2011				2010				2011				2010
Cost of services		$	3.2			$	4.6			$	10.6			$	14.0
Selling, general and administrative			10.7				9.4				36.2				34.5
Total restructuring and related expenses, pre-tax		$	13.9			$	14.0			$	46.8			$	48.5
Total restructuring and related expenses, net of tax		$	9.7			$	9.5			$	32.0			$	31.9

The following table summarizes the restructuring and related expenses by reportable segment (in millions). These expenses have not been allocated to the Company’s segments disclosed in Note 15. While these items are identifiable to the Company’s segments, these expenses have been excluded from the measurement of segment operating profit provided to the chief operating decision maker (“CODM”) for purposes of assessing segment performance and decision making with respect to resource allocation.

		Consumer-to- Consumer				Global Business Payments				Other				Total
2010 expenses		$	44.7			$	12.8			$	2.0			$	59.5
First quarter 2011			19.1				3.5				1.4				24.0
Second quarter 2011			6.8				1.8				0.3				8.9
Third quarter 2011			7.8				5.9				0.2				13.9
Total expenses		$	78.4			$	24.0			$	3.9			$	106.3

During the three months ended September 30, 2010, $12.0 million, $1.4 million, and $0.6 million of the restructuring expenses incurred were attributable to the consumer-to-consumer, global business payments, and other segments, respectively, for a total of $14.0 million. During the nine months ended September 30, 2010, $38.2 million, $8.3 million, and $2.0 million of the restructuring expenses incurred were attributable to the consumer-to-consumer, global business payments, and other segments, respectively, for a total of $48.5 million.

 

5.  Fair Value Measurements

Fair value, as defined by the relevant accounting standards, represents the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. For additional information on how the Company measures fair value, refer to the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

The following tables reflect assets and liabilities that were measured and carried at fair value on a recurring basis (in millions):

		Fair Value Measurement Using												Assets/ Liabilities at Fair Value
September 30, 2011		Level 1				Level 2				Level 3
Assets:
State and municipal debt securities		$	—			$	834.8			$	—			$	834.8
State and municipal variable rate demand notes			—				560.9				—				560.9
Corporate debt and other			0.1				101.2				—				101.3
Derivatives			—				130.3				—				130.3
Total assets		$	0.1			$	1,627.2			$	—			$	1,627.3
Liabilities:
Derivatives		$	—			$	82.8			$	—			$	82.8
Total liabilities		$	—			$	82.8			$	—			$	82.8
		Fair Value Measurement Using												Assets/ Liabilities at Fair Value
December 31, 2010		Level 1				Level 2				Level 3
Assets:
State and municipal debt securities		$	—			$	849.1			$	—			$	849.1
State and municipal variable rate demand notes			—				490.0				—				490.0
Agency mortgage-backed securities and other			0.1				29.9				—				30.0
Derivatives			—				69.8				—				69.8
Total assets		$	0.1			$	1,438.8			$	—			$	1,438.9
Liabilities:
Derivatives		$	—			$	80.9			$	—			$	80.9
Total liabilities		$	—			$	80.9			$	—			$	80.9

No non-recurring fair value adjustments were recorded during the three and nine months ended September 30, 2011, except those associated with the Costa acquisition in the nine months ended September 30, 2011, as disclosed in Note 3.

Other Fair Value Measurements

The carrying amounts for Western Union financial instruments, including cash and cash equivalents, settlement cash and cash equivalents, settlement receivables and settlement obligations approximate fair value due to their short-term maturities. The Company’s borrowings had a carrying value and fair value of $3,982.8 million and $4,246.5 million, respectively, at September 30, 2011 and had a carrying value and fair value of $3,289.9 million and $3,473.6 million, respectively, at December 31, 2010 (see Note 12).

 

6.  Commitments and Contingencies

Letters of Credit and Bank Guarantees

The Company had approximately $90 million in outstanding letters of credit and bank guarantees at September 30, 2011 with expiration dates through 2015, the majority of which contain a one-year renewal option. The letters of credit and bank guarantees are primarily held in connection with lease arrangements and certain agent agreements. The Company expects to renew the letters of credit and bank guarantees prior to expiration in most circumstances.

Litigation and Related Contingencies

In the second quarter of 2009, the Antitrust Division of the United States Department of Justice (“DOJ”) served one of the Company’s subsidiaries with a grand jury subpoena requesting documents in connection with an investigation into money transfers, including related foreign exchange rates, from the United States to the Dominican Republic from 2004 through the date of subpoena. The Company is cooperating fully with the DOJ investigation. Due to the stage of the investigation, the Company is unable to predict the outcome of the investigation, or the possible loss or range of loss, if any, which could be associated with the resolution of any possible criminal charges or civil claims that may be brought against the Company. Should such charges or claims be brought, the Company could face significant fines, damage awards or regulatory consequences which could have a material adverse effect on the Company’s business, financial position and results of operations.

The Company and one of its subsidiaries are defendants in two purported class action lawsuits: James P. Tennille v. The Western Union Company and Robert P. Smet v. The Western Union Company, both of which are pending in the United States District Court for the District of Colorado. The original complaints asserted claims for violation of various consumer protection laws, unjust enrichment, conversion and declaratory relief, based on allegations that the Company waits too long to inform consumers if their money transfers are not redeemed by the recipients and that the Company uses the unredeemed funds to generate income until the funds are escheated to state governments. The Tennille complaint was served on the Company on April 27, 2009. The Smet complaint was served on the Company on April 6, 2010. On September 21, 2009, the Court granted the Company’s motion to dismiss the Tennille complaint and gave the plaintiff leave to file an amended complaint. On October 21, 2009, Tennille filed an amended complaint. The Company moved to dismiss the Tennille amended complaint and the Smet complaint. On November 8, 2010, the Court denied the Company’s motion to dismiss as to the plaintiffs’ unjust enrichment and conversion claims. On February 4, 2011, the Court dismissed plaintiffs’ consumer protection claims. On March 11, 2011, the plaintiffs filed an amended complaint that adds a claim for breach of fiduciary duty, various elements to its declaratory relief claim and Western Union Financial Services, Inc. as a defendant. On April 25, 2011, the Company and Western Union Financial Services, Inc. filed a motion to dismiss the breach of fiduciary duty and declaratory relief claims. Western Union Financial Services, Inc. has also moved to compel arbitration of the plaintiffs’ claims. The plaintiffs have not sought and the Court has not granted class certification. The Company and Western Union Financial Services, Inc. intend to vigorously defend themselves against both lawsuits. However, due to the preliminary stages of these lawsuits, the fact the plaintiffs have not quantified their damage demands, and the uncertainty as to whether they will ever be certified as class actions, the potential outcome cannot be determined.

On February 11, 2010, the Company signed an agreement and settlement, which resolved all outstanding legal issues and claims with the State of Arizona and requires the Company to fund a multi-state not-for-profit organization promoting safety and security along the United States and Mexico border, in which California, Texas and New Mexico are participating with Arizona. The accrual includes amounts for reimbursement to the State of Arizona for its costs associated with this matter. In addition, as part of the agreement and settlement, the Company has made and expects to make certain investments in its compliance programs along the United States and Mexico border and has engaged a monitor for those programs, which are expected to cost up to $23 million over the period from signing to 2013.

 

In the normal course of business, the Company is subject to claims and litigation. Management of the Company believes such matters involving a reasonably possible chance of loss will not, individually or in the aggregate, result in a material adverse effect on the Company’s financial position, results of operations and cash flows. The Company accrues for loss contingencies as they become probable and estimable.

On January 26, 2006, the First Data Corporation (“First Data”) Board of Directors announced its intention to pursue the distribution of all of its money transfer and consumer payments business and its interest in a Western Union money transfer agent, as well as its related assets, including real estate, through a tax-free distribution to First Data shareholders (the “Spin-off”). The Spin-off resulted in the formation of the Company and these assets and businesses no longer being part of First Data. Pursuant to the separation and distribution agreement with First Data in connection with the Spin-off, First Data and the Company are each liable for, and agreed to perform, all liabilities with respect to their respective businesses. In addition, the separation and distribution agreement also provides for cross-indemnities principally designed to place financial responsibility for the obligations and liabilities of the Company’s business with the Company and financial responsibility for the obligations and liabilities of First Data’s retained businesses with First Data. The Company also entered into a tax allocation agreement that sets forth the rights and obligations of First Data and the Company with respect to taxes imposed on their respective businesses both prior to and after the Spin-off as well as potential tax obligations for which the Company may be liable in conjunction with the Spin-off (see Note 13).

7.  Related Party Transactions

The Company has ownership interests in certain of its agents accounted for under the equity method of accounting. The Company pays these agents, as it does its other agents, commissions for money transfer and other services provided on the Company’s behalf. Commission expense recognized for these agents for the three months ended September 30, 2011 and 2010 totaled $31.3 million and $46.6 million, respectively, and $110.3 million and $135.8 million for the nine months ended September 30, 2011 and 2010, respectively. Commission expense recognized for Costa prior to April 20, 2011, the date of the acquisition (see Note 3), was considered a related party transaction.

The Company has a director who is also a director for a company holding significant investments in two of the Company’s existing agents. These agents had been agents of the Company prior to the director being appointed to the board. The Company recognized commission expense of $15.1 million and $14.0 million for the three months ended September 30, 2011 and 2010, respectively, and $43.5 million and $40.3 million for the nine months ended September 30, 2011 and 2010, respectively, related to these agents.

8.  Settlement Assets and Obligations

Settlement assets represent funds received or to be received from agents for unsettled money transfers, money orders and consumer payments. Western Union records corresponding settlement obligations relating to amounts payable under money transfers, money orders and consumer payment service arrangements. Settlement assets and obligations also include amounts receivable from and payable to businesses for the value of customer cross-currency payment transactions related to the global business payments segment.

 

Settlement assets and obligations consisted of the following (in millions):

		September 30, 2011				December 31, 2010
Settlement assets:
Cash and cash equivalents		$	288.9			$	133.8
Receivables from selling agents and business-to-business customers			971.1				1,132.3
Investment securities			1,497.0				1,369.1
		$	2,757.0			$	2,635.2
Settlement obligations:
Money transfer, money order and payment service payables		$	2,159.2			$	2,170.0
Payables to agents			597.8				465.2
		$	2,757.0			$	2,635.2

Investment securities consist primarily of high-quality state and municipal debt securities, including variable rate demand notes. Variable rate demand note securities can be put (sold at par) typically on a daily basis with settlement periods ranging from the same day to one week, but that have varying maturities through 2043. Generally, these securities are used by the Company for short-term liquidity needs and are held for short periods of time, typically less than 30 days. The Company is required to hold specific high-quality, investment grade securities and such investments are restricted to satisfy outstanding settlement obligations in accordance with applicable state and foreign country requirements. The substantial majority of the Company’s investment securities are classified as available-for-sale and recorded at fair value. Investment securities are exposed to market risk due to changes in interest rates and credit risk. Western Union regularly monitors credit risk and attempts to mitigate its exposure by making high-quality investments and through investment diversification. As of September 30, 2011, the majority of the Company’s investment securities had credit ratings of “AA–” or better from a major credit rating agency.

Unrealized gains and losses on available-for-sale securities are excluded from earnings and presented as a component of accumulated other comprehensive income or loss, net of related deferred taxes. Gains and losses on investments are calculated using the specific-identification method and are recognized during the period the investment is sold or when an investment experiences an other-than-temporary decline in value. Proceeds from the sale and maturity of available-for-sale securities during the nine months ended September 30, 2011 and 2010 were $10.5 billion and $10.8 billion, respectively.

The components of investment securities, all of which are classified as available-for-sale, were as follows (in millions):

September 30, 2011		Amortized Cost				Fair Value				Gross Unrealized Gains				Gross Unrealized Losses				Net Unrealized Gains/ (Losses)
State and municipal debt securities (a)		$	822.9			$	834.8			$	12.5			$	(0.6	)		$	11.9
State and municipal variable rate demand notes			560.9				560.9				—				—				—
Corporate debt and other			101.1				101.3				0.9				(0.7	)			0.2
		$	1,484.9			$	1,497.0			$	13.4			$	(1.3	)		$	12.1

 

December 31, 2010		Amortized Cost				Fair Value				Gross Unrealized Gains				Gross Unrealized Losses				Net Unrealized Gains/ (Losses)
State and municipal debt securities (a)		$	844.1			$	849.1			$	7.0			$	(2.0	)		$	5.0
State and municipal variable rate demand notes			490.0				490.0				—				—				—
Agency mortgage-backed securities and other			29.9				30.0				0.1				—				0.1
		$	1,364.0			$	1,369.1			$	7.1			$	(2.0	)		$	5.1

 

(a)	The majority of these securities are fixed-rate instruments.

The following summarizes the contractual maturities of investment securities as of September 30, 2011 (in millions):

		Fair Value
Due within 1 year		$	150.5
Due after 1 year through 5 years			699.7
Due after 5 years through 10 years			140.7
Due after 10 years			506.1
		$	1,497.0

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 prior to its contractual maturity, as with variable rate demand notes. Variable rate demand notes, having a fair value of $4.0 million, $38.9 million, $49.3 million and $468.7 million, are included in the “Due within 1 year,” “Due after 1 year through 5 years,” “Due after 5 years through 10 years” and “Due after 10 years” categories, respectively, in the table above.

 

9.  Comprehensive Income

The components of other comprehensive income, net of tax, were as follows (in millions):

		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
Net income		$	239.7			$	238.4			$	713.1			$	667.3
Unrealized gains on investment securities:
Unrealized gains			5.2				5.6				12.2				6.3
Tax expense			(2.0	)			(2.2	)			(4.6	)			(2.4	)
Reclassification of gains into earnings			(4.1	)			(1.3	)			(5.2	)			(2.4	)
Tax expense			1.6				0.5				2.0				0.9
Net unrealized gains on investment securities			0.7				2.6				4.4				2.4
Unrealized gains/(losses) on hedging activities:
Unrealized gains/(losses)			41.4				(69.6	)			(16.2	)			14.6
Tax (expense)/benefit			(2.8	)			9.6				6.0				(0.2	)
Reclassification of gains/(losses) into earnings			12.7				(13.6	)			33.9				(23.4	)
Tax (expense)/benefit			(2.2	)			1.6				(6.2	)			2.2
Net unrealized gains/(losses) on hedging activities			49.1				(72.0	)			17.5				(6.8	)
Foreign currency translation adjustments:
Foreign currency translation adjustments			12.8				(10.8	)			15.2				8.7
Tax (expense)/benefit			(2.0	)			2.4				(2.6	)			(1.7	)
Net foreign currency translation adjustments			10.8				(8.4	)			12.6				7.0
Pension liability adjustments:
Reclassification of losses into earnings			2.0				1.5				6.1				4.6
Tax benefit			(0.8	)			(0.5	)			(2.5	)			(1.7	)
Net pension liability adjustments			1.2				1.0				3.6				2.9
Total comprehensive income		$	301.5			$	161.6			$	751.2			$	672.8

10.  Employee Benefit Plan

The Company has a frozen defined benefit pension plan (the “Plan”) for which it had a recorded unfunded pension obligation of $89.4 million and $112.8 million as of September 30, 2011 and December 31, 2010, respectively, included in “Other liabilities” in the Condensed Consolidated Balance Sheets. The Company is required to fund $22 million to the Plan in 2011. Through September 2011, the Company has made contributions of approximately $21 million to the Plan, including a discretionary contribution of $3 million.

The following table provides the components of net periodic benefit cost for the Plan (in millions):

		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
Interest cost		$	4.5			$	5.1			$	13.5			$	15.1
Expected return on plan assets			(5.3	)			(5.1	)			(16.0	)			(15.3	)
Amortization of actuarial loss			2.0				1.5				6.1				4.6
Net periodic benefit cost		$	1.2			$	1.5			$	3.6			$	4.4

 

11.  Derivatives

The Company is exposed to foreign currency exchange risk resulting from fluctuations in exchange rates, primarily the euro, and to a lesser degree the British pound, Canadian dollar and other currencies, related to forecasted money transfer revenues and on money transfer settlement assets and obligations. The Company is also exposed to risk from derivative contracts written to its customers arising from its cross-currency business-to-business payments operations. Additionally, the Company is exposed to interest rate risk related to changes in market rates both prior to and subsequent to the issuance of debt. The Company uses derivatives to (a) minimize its exposures related to changes in foreign currency exchange rates and interest rates and (b) facilitate cross-currency business-to-business payments by writing derivatives to customers.

The Company executes derivatives with established financial institutions, with the substantial majority of these financial institutions having credit ratings of “A–” or better from a major credit rating agency. The Company also executes global business payments derivatives mostly with small and medium size enterprises. The primary credit risk inherent in derivative 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 contract and on an ongoing basis. The Company also monitors the concentration of its contracts with any individual counterparty. The Company anticipates that the counterparties will be able to fully satisfy their obligations under the agreements, but takes action (including termination of contracts) when doubt arises about the counterparties’ ability to perform. The Company’s hedged foreign currency exposures are in liquid currencies, consequently there is minimal risk that appropriate derivatives to maintain the hedging program would not be available in the future.

Foreign Currency — Consumer-to-Consumer

The Company’s policy is to use longer-term foreign currency forward contracts, with maturities of up to 36 months at inception and a targeted weighted-average maturity of approximately one year, to mitigate some of the risk that changes in foreign currency exchange rates compared to the United States dollar could have on forecasted revenues denominated in other currencies related to its business. At September 30, 2011, the Company’s longer-term foreign currency forward contracts had maturities of a maximum of 24 months with a weighted-average maturity of approximately one year. These contracts are accounted for as cash flow hedges of forecasted revenue, with effectiveness assessed based on changes in the spot rate of the affected currencies during the period of designation. Accordingly, all changes in the fair value of the hedges not considered effective or portions of the hedge that are excluded from the measure of effectiveness are recognized immediately in “Derivative gains/(losses), net” within the Company’s Condensed Consolidated Statements of Income.

The Company also uses short duration foreign currency forward contracts, generally with maturities from a few days up to one month, to offset foreign exchange rate fluctuations on settlement assets and obligations between initiation and settlement. In addition, forward contracts, typically with maturities of less than one year, are utilized to offset foreign exchange rate fluctuations on certain foreign currency denominated cash positions. None of these contracts are designated as accounting hedges.

The aggregate equivalent United States dollar notional amounts of foreign currency forward contracts as of September 30, 2011 were as follows (in millions):

Contracts not designated as hedges:
Euro		$	165.5
British pound			43.3
Other			101.7
Contracts designated as hedges:
Euro		$	497.5
Canadian dollar			115.1
British pound			107.0
Other			109.8

 

Foreign Currency — Global Business Payments

The Company writes derivatives, primarily foreign currency forward contracts and, to a much smaller degree, option contracts, mostly with small and medium size enterprises (customer contracts) and derives a currency spread from this activity as part of its global business payments operations. In this capacity, the Company facilitates cross-currency payment transactions for its customers but aggregates its global business payments foreign currency exposures arising from customer contracts, including the derivative contracts described above, and hedges the resulting net currency risks by entering into offsetting contracts with established financial institution counterparties (economic hedge contracts). The derivatives written are part of the broader portfolio of foreign currency positions arising from its cross-currency business-to-business payments operations, which primarily include spot exchanges of currency in addition to forwards and options. Foreign exchange revenues from the total portfolio of positions were $32.8 million and $25.4 million in the three months ended September 30, 2011 and 2010, respectively, and $89.8 million and $77.0 million in the nine months ended September 30, 2011 and 2010, respectively. None of the derivative contracts used in global business payments operations are designated as accounting hedges. The duration of these derivative contracts is generally nine months or less.

The aggregate equivalent United States dollar notional amounts of foreign currency derivative customer contracts held by the Company as of September 30, 2011 were approximately $1.8 billion. The significant majority of customer contracts are written in major currencies such as the Canadian dollar, euro, Australian dollar and the British pound.

The Company has forward contracts to offset foreign exchange rate fluctuations on a Canadian dollar denominated intercompany loan. These contracts, which are not designated as accounting hedges, had a notional amount of approximately 230 million and 245 million Canadian dollars at September 30, 2011 and December 31, 2010, respectively.

Interest Rate Hedging — Corporate

The Company utilizes interest rate swaps to effectively change the interest rate payments on a portion of its notes from fixed-rate payments to short-term LIBOR-based variable rate payments in order to manage its overall exposure to interest rates. The Company designates these derivatives as fair value hedges utilizing the short-cut method, which permits an assumption of no ineffectiveness if certain criteria are met. The change in fair value of the interest rate swaps is offset by a change in the carrying value of the debt being hedged within the Company’s “Borrowings” in the Condensed Consolidated Balance Sheets and “Interest expense” in the Condensed Consolidated Statements of Income has been adjusted to include the effects of interest accrued on the swaps.

The Company, at times, utilizes derivatives to hedge the forecasted issuance of fixed-rate debt. These derivatives are designated as cash flow hedges of the variability in the fixed-rate coupon of the debt expected to be issued. The effective portion of the change in fair value of the derivatives is recorded in “Accumulated other comprehensive loss.”

At September 30, 2011 and December 31, 2010, the Company held interest rate swaps in an aggregate notional amount of $695 million and $1,195 million, respectively. The aggregate notional amount held at September 30, 2011 related to notes due in November 2011.

 

Balance Sheet

The following table summarizes the fair value of derivatives reported in the Condensed Consolidated Balance Sheets as of September 30, 2011 and December 31, 2010 (in millions):

		Derivative Assets												Derivative Liabilities
						Fair Value												Fair Value
		Balance  Sheet Location				September 30, 2011				December 31, 2010				Balance  Sheet Location				September 30, 2011				December 31, 2010
Derivatives — hedges:
Interest rate hedges — Corporate			Other assets			$	10.4			$	8.0				Other liabilities			$	—			$	1.6
Foreign currency cash flow hedges — Consumer-to-consumer			Other assets				31.5				14.7				Other liabilities				10.3				31.1
Total						$	41.9			$	22.7							$	10.3			$	32.7
Derivatives — undesignated:
Foreign currency — Global business payments			Other assets			$	81.7			$	46.9				Other liabilities			$	71.3			$	36.2
Foreign currency —Consumer-to-consumer			Other assets				6.7				0.2				Other liabilities				1.2				12.0
Total						$	88.4			$	47.1							$	72.5			$	48.2
Total derivatives						$	130.3			$	69.8							$	82.8			$	80.9

Income Statement

The following tables summarize the location and amount of gains and losses of derivatives in the Condensed Consolidated Statements of Income segregated by designated, qualifying hedging instruments and those that are not, for the three and nine months ended September 30, 2011 and 2010 (in millions):

Fair Value Hedges

The following table presents the location and amount of gains/(losses) from fair value hedges for the three months ended September 30, 2011 and 2010 (in millions):

		Gain/(Loss) Recognized in Income on Derivatives														Gain/(Loss) Recognized in Income on Related Hedged Item (a)
		Income Statement Location		Amount												Income Statement Location		Amount
Derivatives				September 30, 2011				September 30, 2010				Hedged Items						September 30, 2011				September 30, 2010
Interest rate contracts		Interest expense		$	3.4			$	4.9				Fixed-rate debt			Interest expense		$	3.0			$	0.7
Total gain				$	3.4			$	4.9									$	3.0			$	0.7

The following table presents the location and amount of gains/(losses) from fair value hedges for the nine months ended September 30, 2011 and 2010 (in millions):

 

		Gain/(Loss) Recognized in Income on Derivatives														Gain/(Loss) Recognized in Income on Related Hedged Item (a)
		Income Statement Location		Amount												Income Statement Location		Amount
Derivatives				September 30, 2011				September 30, 2010				Hedged Items						September 30, 2011				September 30, 2010
Interest rate contracts		Interest expense		$	11.6			$	14.8				Fixed-rate debt			Interest expense		$	8.7			$	3.3
Total gain				$	11.6			$	14.8									$	8.7			$	3.3

 

Cash Flow Hedges

The following table presents the location and amount of gains/(losses) from cash flow hedges for the three months ended September 30, 2011 and 2010 (in millions):

		Amount of Gain/(Loss) Recognized in OCI on Derivatives (Effective Portion)								Gain/(Loss) Reclassified from Accumulated OCI into Income (Effective Portion)										Gain/(Loss) Recognized in Income on Derivatives (Ineffective Portion and Amount Excluded from Effectiveness Testing) (b)
										Income Statement		Amount								Income Statement		Amount
		September 30,				September 30,						September 30,				September 30,						September 30,				September 30,
Derivatives		2011				2010				Location		2011				2010				Location		2011				2010
Foreign currency contracts		$	60.6			$	(69.6	)		Revenue		$	(11.8	)		$	13.9			Derivative gains/ (losses), net		$	(8.0	)		$	3.6
Interest rate contracts (c)			(19.2	)			—			Interest expense			(0.9	)			(0.3	)		Interest expense			—				—
Total gain/(loss)		$	41.4			$	(69.6	)				$	(12.7	)		$	13.6					$	(8.0	)		$	3.6

The following table presents the location and amount of gains/(losses) from cash flow hedges for the nine months ended September 30, 2011 and 2010 (in millions):

 

		Amount of Gain/(Loss) Recognized in OCI on Derivatives (Effective Portion)								Gain/(Loss) Reclassified from Accumulated OCI into Income (Effective Portion)										Gain/(Loss) Recognized in Income on Derivatives (Ineffective Portion and Amount Excluded from Effectiveness Testing) (b)
										Income Statement		Amount								Income Statement		Amount
		September 30,				September 30,						September 30,				September 30,						September 30,				September 30,
Derivatives		2011				2010				Location		2011				2010				Location		2011				2010
Foreign currency contracts		$	5.4			$	18.8			Revenue		$	(32.2	)		$	24.5			Derivative gains/(losses), net		$	(7.5	)		$	0.6
Interest rate contracts (c)			(21.6	)			(4.2	)		Interest expense			(1.7	)			(1.1	)		Interest expense			—				(0.1	)
Total gain/(loss)		$	(16.2	)		$	14.6					$	(33.9	)		$	23.4					$	(7.5	)		$	0.5

Undesignated Hedges

The following table presents the location and amount of net gains/(losses) from undesignated hedges for the three and nine months ended September 30, 2011 and 2010 (in millions):

		Gain/(Loss) Recognized in Income on Derivatives (d)
		Income Statement Location		Amount
				Three Months Ended September 30,								Nine Months Ended September 30,
Derivatives				2011				2010				2011				2010
Foreign currency contracts (e)		Selling, general and administrative		$	44.8				$    (36.0	)		$	11.5			$	12.3
Foreign currency contracts (f)		Derivative gains/(losses), net			3.6				(4.1	)			0.5				0.9
Total gain/(loss)				$	48.4			$	(40.1	)		$	12.0			$	13.2

 

 

(a)

The net gain of $3.0 million and $0.7 million in the three months ended September 30, 2011 and 2010, respectively, was comprised of a loss in value on the debt of $3.4 million and $4.9 million, respectively, and amortization of hedge accounting adjustments of $6.4 million and $5.6 million, respectively. The net gain of $8.7 million and $3.3 million in the nine months ended September 30, 2011 and 2010, respectively, was comprised of a loss in value on the debt of $11.6 million and $14.8 million, respectively, and amortization of hedge accounting adjustments of $20.3 million and $18.1 million, respectively.

 

(b)	The portion of the change in fair value of a derivative excluded from the effectiveness assessment for foreign currency forward contracts designated as cash flow hedges represents the difference between changes in forward rates and spot rates.

 

(c)

The Company uses derivatives to hedge the forecasted issuance of fixed-rate debt and records the effective portion of the derivative’s fair value in “Accumulated other comprehensive loss” in the Condensed Consolidated Balance Sheets. These amounts are reclassified to “Interest expense” over the life of the related notes.

 

(d)

The Company uses foreign currency forward and option contracts as part of its international business-to-business payments operations. These derivative contracts are excluded from this table as they are managed as part of a broader currency portfolio that includes non-derivative currency exposures. The gains and losses on these derivatives are included as part of the broader disclosure of portfolio revenue for this business discussed above.

 

(e)

The Company uses foreign currency forward contracts to offset foreign exchange rate fluctuations on settlement assets and obligations as well as certain foreign currency denominated positions. Foreign exchange loss on settlement assets and obligations and cash balances for the three and nine months ended September 30, 2011, were $46.5 million and $20.9 million, respectively. Foreign exchange gain/(loss) on settlement assets and obligations and cash balances for the three and nine months ended September 30, 2010, were $34.3 million and $(15.1) million, respectively.

 

(f)	The derivative contracts used in the Company’s revenue hedging program are not designated as hedges in the final month of the contract.

An accumulated other comprehensive pre-tax loss of $11.3 million related to the foreign currency forward contracts is expected to be reclassified into revenue within the next 12 months as of September 30, 2011. Approximately $3.8 million of net losses on the forecasted debt issuance hedges are expected to be recognized in interest expense within the next 12 months as of September 30, 2011. 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.