UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2015
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 001-11073
FIRST DATA CORPORATION
(Exact name of registrant as specified in its charter)
www.firstdata.com
DELAWARE | 47-0731996 | |
(State or other jurisdiction of | (I.R.S. Employer | |
incorporation or organization) | Identification No.) | |
225 LIBERTY STREET 29th FLOOR | ||
NEW YORK, NEW YORK | 10281 | |
(Address of principal executive offices) | (Zip Code) | |
Registrant’s telephone number, including area code (800) 735-3362
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes o No ý
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o | Accelerated filer o | |
Non-accelerated filer x | Smaller reporting company o | |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No ý
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class | Outstanding at October 30, 2015 | |
Class A Common Stock, $0.01 par value per share | 179,873,244 shares | |
Class B Common Stock, $0.01 par value per share | 719,330,114 shares | |
INDEX
PAGE NUMBER | |||
Unless otherwise indicated or the context otherwise requires, financial data in this Form 10-Q reflects the consolidated business and operations of First Data Corporation and its consolidated subsidiaries. Unless the context otherwise requires, all references herein to “First Data,” “FDC,” the “Company,” “we,” “our,” or “us” refer to First Data Corporation and its consolidated subsidiaries.
Amounts in this Form 10-Q and the consolidated financial statements included in this Form 10-Q are presented in U.S. Dollars rounded to the nearest million, unless otherwise noted. The audited consolidated financial statements contained in our Prospectus filed with the Securities and Exchange Commission on October 15, 2015 pursuant to Rule 424(b) that are referenced throughout this Form 10-Q have been updated to reflect the Company's segment realignment and debt extinguishment adjustments in the second quarter of 2015. The accounting policies set out in the audited consolidated financial statements have been consistently applied to all periods presented.
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FORWARD LOOKING STATEMENTS
Certain matters we discuss in this Quarterly Report on Form 10-Q and in other public statements may constitute forward-looking statements. You can identify forward-looking statements because they contain words such as “believes,” “expects,” “may,” “will,” “should,” “seeks,” “intends,” “plans,” “estimates,” or “anticipates” or similar expressions which concern our strategy, plans, projections or intentions. Examples of forward-looking statements include, but are not limited to, all statements we make relating to revenue, earnings before net interest expense, income taxes, depreciation, and amortization (EBITDA), earnings, margins, growth rates and other financial results for future periods. By their nature, forward-looking statements speak only as of the date they are made; are not statements of historical fact or guarantees of future performance; and are subject to risks, uncertainties, assumptions or changes in circumstances that are difficult to predict or quantify. Actual results could differ materially and adversely from our forward-looking statements due to a variety of factors, including the following: (1) adverse impacts from global economic, political, and other conditions affecting trends in consumer, business, and government spending; (2) our ability to anticipate and respond to changing industry trends, including technological changes and increasing competition; (3) our ability to successfully renew existing client contracts on favorable terms and obtain new clients; (4) our ability to prevent a material breach of security of any of our systems; (5) our ability to implement and improve processing systems to provide new products, improve functionality, and increase efficiencies; (6) our merchant alliance program which involves several alliances not under our sole control and each of which acts independently of the others; (7) credit and fraud risks in our business units and merchant alliances, particularly in the context of eCommerce and mobile markets; (8) consolidation among financial institution clients or other client groups that impacts our client relationships; (9) our ability to improve our profitability and maintain flexibility in our capital resources through the implementation of cost savings initiatives; (10) our ability to successfully value and integrate acquired businesses, including those outside of the United States; (11) our high degree of leverage; (12) adverse impacts from currency exchange rates or currency controls imposed by any government or otherwise; (13) changes in the interest rate environment that increase interest on our borrowings or the interest rate at which we can refinance our borrowings; (14) the impact of new laws, regulations, credit card association rules, or other industry standards; and (15) new lawsuits, investigations, or proceedings, or changes to our potential exposure in connection with pending lawsuits, investigations or proceedings, or changes to our potential exposure in connection with pending lawsuits, investigations or proceedings, and various other factors set forth in Risk Factors in our Prospectus filed with the Securities and Exchange Commission on October 15, 2015 pursuant to Rule 424(b). Except as required by law, we do not intend to revise or update any forward-looking statement as a result of new information, future developments or otherwise.
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FIRST DATA CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(in millions, except per share and share amounts) | 2015 | 2014 | 2015 | 2014 | ||||||||||||
Revenues: | ||||||||||||||||
Transaction and processing service fees (a) | $ | 1,673 | $ | 1,652 | $ | 4,906 | $ | 4,864 | ||||||||
Product sales and other (a) | 309 | 252 | 844 | 712 | ||||||||||||
Total revenues (excluding reimbursable items) | 1,982 | 1,904 | 5,750 | 5,576 | ||||||||||||
Reimbursable PIN debit fees, postage, and other | 938 | 888 | 2,737 | 2,693 | ||||||||||||
Total revenues | 2,920 | 2,792 | 8,487 | 8,269 | ||||||||||||
Expenses: | ||||||||||||||||
Cost of services (exclusive of items shown below) | 686 | 671 | 2,055 | 1,971 | ||||||||||||
Cost of products sold | 96 | 80 | 257 | 240 | ||||||||||||
Selling, general, and administrative | 521 | 528 | 1,567 | 1,538 | ||||||||||||
Depreciation and amortization | 257 | 268 | 760 | 796 | ||||||||||||
Other operating expenses: | ||||||||||||||||
Restructuring, net | 20 | 4 | 40 | 11 | ||||||||||||
Total expenses (excluding reimbursable items) | 1,580 | 1,551 | 4,679 | 4,556 | ||||||||||||
Reimbursable PIN debit fees, postage, and other | 938 | 888 | 2,737 | 2,693 | ||||||||||||
Total expenses | 2,518 | 2,439 | 7,416 | 7,249 | ||||||||||||
Operating profit | 402 | 353 | 1,071 | 1,020 | ||||||||||||
Interest income | 1 | 2 | 3 | 9 | ||||||||||||
Interest expense | (389 | ) | (407 | ) | (1,202 | ) | (1,334 | ) | ||||||||
Loss on debt extinguishment | (108 | ) | (271 | ) | (108 | ) | (274 | ) | ||||||||
Other income (expense) | (10 | ) | 57 | 1 | 140 | |||||||||||
(506 | ) | (619 | ) | (1,306 | ) | (1,459 | ) | |||||||||
Loss before income taxes and equity earnings in affiliates | (104 | ) | (266 | ) | (235 | ) | (439 | ) | ||||||||
Income tax expense (benefit) | 32 | (23 | ) | 45 | 54 | |||||||||||
Equity earnings in affiliates | 61 | 55 | 175 | 163 | ||||||||||||
Net loss | (75 | ) | (188 | ) | (105 | ) | (330 | ) | ||||||||
Less: Net income attributable to noncontrolling interests and redeemable noncontrolling interest | 51 | 47 | 159 | 140 | ||||||||||||
Net loss attributable to First Data Corporation | $ | (126 | ) | $ | (235 | ) | $ | (264 | ) | $ | (470 | ) | ||||
Net loss per share, basic and diluted | $ | (126,000 | ) | $ | (235,000 | ) | $ | (264,000 | ) | $ | (470,000 | ) | ||||
Weighted-average shares used to compute basic and diluted net loss per share | 1,000 | 1,000 | 1,000 | 1,000 | ||||||||||||
(a) | Includes processing fees, administrative service fees, and other fees charged to merchant alliances accounted for under the equity method of $55 million and $153 million for the three and nine months ended September 30, 2015, respectively, and $45 million and $135 million for the comparable periods in 2014. |
See notes to unaudited consolidated financial statements.
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FIRST DATA CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(in millions) | 2015 | 2014 | 2015 | 2014 | ||||||||||||
Net loss | $ | (75 | ) | $ | (188 | ) | $ | (105 | ) | $ | (330 | ) | ||||
Other comprehensive income (loss), net of tax: | ||||||||||||||||
Net change in unrealized (gains) losses on securities, net of reclassifications | (2 | ) | 2 | 3 | 2 | |||||||||||
Foreign currency translation adjustment | (85 | ) | (152 | ) | (221 | ) | (168 | ) | ||||||||
Pension liability adjustments | — | — | 2 | 1 | ||||||||||||
Total other comprehensive income (loss), net of tax | (87 | ) | (150 | ) | (216 | ) | (165 | ) | ||||||||
Comprehensive income (loss) | (162 | ) | (338 | ) | (321 | ) | (495 | ) | ||||||||
Less: Comprehensive income attributable to noncontrolling interests and redeemable noncontrolling interest | 51 | 40 | 151 | 133 | ||||||||||||
Comprehensive income (loss) attributable to First Data Corporation | $ | (213 | ) | $ | (378 | ) | $ | (472 | ) | $ | (628 | ) | ||||
See notes to unaudited consolidated financial statements.
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FIRST DATA CORPORATION
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(in millions, except common stock share amounts) | As of September 30, 2015 | As of December 31, 2014 | ||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 368 | $ | 358 | ||||
Accounts receivable, net of allowance for doubtful accounts of $57 and $51 | 1,741 | 1,752 | ||||||
Settlement assets | 7,114 | 7,555 | ||||||
Other current assets | 439 | 289 | ||||||
Total current assets | 9,662 | 9,954 | ||||||
Property and equipment, net of accumulated depreciation of $1,377 and $1,233 | 932 | 930 | ||||||
Goodwill | 16,892 | 17,017 | ||||||
Customer relationships, net of accumulated amortization of $5,190 and $4,871 | 2,259 | 2,604 | ||||||
Other intangibles, net of accumulated amortization of $2,070 and $1,965 | 1,778 | 1,745 | ||||||
Investment in affiliates | 1,058 | 1,101 | ||||||
Other long-term assets | 859 | 849 | ||||||
Total assets | $ | 33,440 | $ | 34,200 | ||||
LIABILITIES AND EQUITY | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 243 | $ | 280 | ||||
Short-term and current portion of long-term borrowings | 361 | 161 | ||||||
Settlement obligations | 7,115 | 7,557 | ||||||
Other current liabilities | 1,517 | 1,533 | ||||||
Total current liabilities | 9,236 | 9,531 | ||||||
Long-term borrowings | 20,816 | 20,760 | ||||||
Long-term deferred tax liabilities | 544 | 521 | ||||||
Other long-term liabilities | 780 | 788 | ||||||
Total liabilities | 31,376 | 31,600 | ||||||
Commitments and contingencies (See note 8) | ||||||||
Redeemable noncontrolling interest | 78 | 70 | ||||||
First Data Corporation shareholder's deficit: | ||||||||
Common stock, $0.01 par value; 1,000 shares authorized and issued (2015 and 2014) | — | — | ||||||
Additional paid-in capital | 9,919 | 9,906 | ||||||
Accumulated loss | (9,815 | ) | (9,547 | ) | ||||
Accumulated other comprehensive loss | (1,137 | ) | (929 | ) | ||||
Total First Data Corporation shareholder's deficit | (1,033 | ) | (570 | ) | ||||
Noncontrolling interests | 3,019 | 3,100 | ||||||
Total equity | 1,986 | 2,530 | ||||||
Total liabilities and equity | $ | 33,440 | $ | 34,200 | ||||
See notes to unaudited consolidated financial statements.
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FIRST DATA CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine months ended September 30, | ||||||||
(in millions) | 2015 | 2014 | ||||||
CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||
Net loss | $ | (105 | ) | $ | (330 | ) | ||
Adjustments to reconcile to net cash provided by operating activities: | ||||||||
Depreciation and amortization (including amortization netted against equity earnings in affiliates and revenues) | 843 | 878 | ||||||
Charges related to other operating expenses and other income | 147 | 145 | ||||||
Other non-cash and non-operating items, net | (13 | ) | (8 | ) | ||||
(Decrease) increase in cash, excluding the effects of acquisitions and dispositions, resulting from changes in: | ||||||||
Accounts receivable, current and long-term | (66 | ) | 53 | |||||
Other assets, current and long-term | (16 | ) | 64 | |||||
Accounts payable and other liabilities, current and long-term | (71 | ) | (180 | ) | ||||
Income tax accounts | (32 | ) | (23 | ) | ||||
Net cash provided by operating activities | 687 | 599 | ||||||
CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||
Proceeds from dispositions, net of expenses paid | 4 | 270 | ||||||
Additions to property and equipment | (213 | ) | (214 | ) | ||||
Payments to secure customer service contracts, including outlays for conversion, and capitalized systems development costs | (244 | ) | (196 | ) | ||||
Acquisitions, net of cash acquired | (89 | ) | (30 | ) | ||||
Proceeds from sale of property and equipment | 3 | 3 | ||||||
Purchase of investments | (17 | ) | — | |||||
Other investing activities | 2 | 2 | ||||||
Net cash used in investing activities | (554 | ) | (165 | ) | ||||
CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||
Short-term borrowings, net | 219 | (35 | ) | |||||
Proceeds from issuance of long-term debt | 2,206 | 1,830 | ||||||
Payment of debt issuance cost | (104 | ) | (355 | ) | ||||
Principal payments on long-term debt | (2,185 | ) | (3,725 | ) | ||||
Distributions and dividends paid to noncontrolling interests and redeemable noncontrolling interest | (232 | ) | (201 | ) | ||||
Purchase of noncontrolling interest | — | (1 | ) | |||||
Capital transactions with parent, net | (13 | ) | 2,035 | |||||
Net cash used in financing activities | (109 | ) | (452 | ) | ||||
Effect of exchange rate changes on cash and cash equivalents | (14 | ) | (21 | ) | ||||
Change in cash and cash equivalents | 10 | (39 | ) | |||||
Cash and cash equivalents at beginning of period | 358 | 425 | ||||||
Cash and cash equivalents at end of period | $ | 368 | $ | 386 | ||||
NON-CASH TRANSACTIONS: | ||||||||
Capital leases, net of trade-ins | $ | 33 | $ | 101 | ||||
See notes to unaudited consolidated financial statements.
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FIRST DATA CORPORATION
CONSOLIDATED STATEMENTS OF EQUITY
(Unaudited)
First Data Corporation Shareholder | |||||||||||||||||||||||
(in millions, except common share amounts) | Common Shares | Accumulated Loss | Accumulated Other Comprehensive Loss | Paid-In Capital | Noncontrolling Interests | Total | |||||||||||||||||
Balance, December 31, 2014 | 1,000 | $ | (9,547 | ) | $ | (929 | ) | $ | 9,906 | $ | 3,100 | $ | 2,530 | ||||||||||
Dividends and distributions paid to noncontrolling interests | — | — | — | — | (206 | ) | (206 | ) | |||||||||||||||
Net (loss) income (a) | — | (264 | ) | — | — | 133 | (131 | ) | |||||||||||||||
Other comprehensive loss | — | — | (208 | ) | — | (8 | ) | (216 | ) | ||||||||||||||
Adjustment to redemption value of redeemable noncontrolling interest | — | — | — | (8 | ) | — | (8 | ) | |||||||||||||||
Stock compensation expense and other | — | — | — | 21 | — | 21 | |||||||||||||||||
Cash dividends paid by First Data Corporation to Parent | — | (4 | ) | — | — | — | (4 | ) | |||||||||||||||
Balance, September 30, 2015 | 1,000 | $ | (9,815 | ) | $ | (1,137 | ) | $ | 9,919 | $ | 3,019 | $ | 1,986 | ||||||||||
First Data Corporation Shareholder | |||||||||||||||||||||||
(in millions, except common share amounts) | Common Shares | Accumulated Loss | Accumulated Other Comprehensive Loss | Paid-In Capital | Noncontrolling Interests | Total | |||||||||||||||||
Balance, December 31, 2013 | 1,000 | $ | (8,403 | ) | $ | (589 | ) | $ | 7,384 | $ | 3,183 | $ | 1,575 | ||||||||||
Dividends and distributions paid to noncontrolling interests | — | — | — | — | (175 | ) | (175 | ) | |||||||||||||||
Net (loss) income (a) | — | (470 | ) | — | — | 115 | (355 | ) | |||||||||||||||
Other comprehensive loss | — | — | (158 | ) | — | (7 | ) | (165 | ) | ||||||||||||||
Adjustment to noncontrolling interest and redemption value of redeemable noncontrolling interest | — | — | — | (3 | ) | — | (3 | ) | |||||||||||||||
Stock compensation expense and other | — | — | — | 39 | — | 39 | |||||||||||||||||
Capital Contribution from First Data Holdings | — | — | — | 2,482 | — | 2,482 | |||||||||||||||||
Cash dividends paid by First Data Corporation to Parent | — | (440 | ) | — | — | — | (440 | ) | |||||||||||||||
Balance, September 30, 2014 | 1,000 | $ | (9,313 | ) | $ | (747 | ) | $ | 9,902 | $ | 3,116 | $ | 2,958 | ||||||||||
(a) | The total net loss presented in the unaudited consolidated statements of equity for the nine months ended September 30, 2015 and 2014 is $26 million and $25 million, respectively, greater than the amount presented in the unaudited consolidated statements of operations due to the net income attributable to the redeemable noncontrolling interest not included in equity. |
See notes to unaudited consolidated financial statements.
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FIRST DATA CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1: Basis of Presentation and Summary of Significant Accounting Policies
Business Description
First Data Corporation (FDC or the Company) is a global leader in commerce-enabling technology and solutions, for merchants, financial institutions, and card issuers. The services the Company provides include merchant transaction processing and acquiring; credit, retail, and debit card issuing and processing; prepaid services; and check verification, settlement and guarantee services.
On October 15, 2015, the Company filed its Prospectus with the Securities and Exchange Commission pursuant to Rule 424(b). The Company issued 176,076,869 shares of Class A common stock and began trading on the New York Stock Exchange under the symbol "FDC". The net proceeds to the Company from the offering, after deducting underwriting discounts, commissions, and Kohlberg Kravis Roberts & Co. L.P. (KKR) termination fees was $2.6 billion. On November 2, 2015, the Company used proceeds to redeem all $510 million aggregate principal amount of its 11.25% senior unsecured notes due 2021 and intends to use the remaining proceeds to redeem approximately $1.8 billion aggregate principal amount of its 12.625% senior unsecured notes due 2021, to pay applicable premiums and related fees and expenses, and for general corporate purposes.
On October 13, 2015, First Data Holdings Inc. (FDH), the Company's direct parent company, merged with and into First Data Corporation, with First Data Corporation being the surviving entity (HoldCo Merger). All outstanding shares of FDH were converted into Class B common stock, which are entitled to ten votes per share. All outstanding common stock of FDC were eliminated upon the merger. The Company will account for the HoldCo Merger as a transfer of assets between entities under common control and will reflect the transaction in its financial statements on a prospective basis beginning with the Company's 2015 consolidated financial statements on Form 10-K.
On October 13, 2015, the Company amended its certificate of incorporation which affected a reverse stock split of the Company’s authorized, issued and outstanding Class B common stock, on the basis of 1 new share of Class B common stock for each 3.16091 old shares of common stock. Note 9 “Stock Compensation Plans” within these consolidated financial statements has been retrospectively adjusted to reflect the impact of the reverse stock split. The shares on the Company’s consolidated balance sheet have not been adjusted because the shares of FDC stock were not subject to the stock split.
Basis of Presentation
The accompanying unaudited consolidated financial statements of the Company should be read in conjunction with the Company’s audited consolidated financial statements for the year ended December 31, 2014 included in the Company's Prospectus filed with the Securities and Exchange Commission on October 15, 2015 pursuant to Rule 424(b). Significant accounting policies disclosed therein have not changed.
The accompanying consolidated financial statements are unaudited; however, in the opinion of management, they include all normal recurring adjustments necessary for a fair presentation of the consolidated financial position of the Company as of September 30, 2015 and the consolidated results of its operations and comprehensive income (loss) for the three and nine months ended September 30, 2015 and 2014 and the consolidated cash flows and changes in equity for the nine months ended September 30, 2015 and 2014. Results of operations reported for interim periods are not necessarily indicative of results for the entire year due in part to the seasonality of certain business units.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the unaudited consolidated financial statements and accompanying notes. Actual results could differ from those estimates.
Presentation
Depreciation and amortization presented as a separate line item on the Company’s unaudited consolidated statements of operations does not include amortization of initial payments for new contracts which is recorded as a contra-revenue within “Transaction and
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processing service fees.” Also not included is amortization related to equity method investments which is netted within the “Equity earnings in affiliates” line. The following table presents the amounts associated with such amortization:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(in millions) | 2015 | 2014 | 2015 | 2014 | ||||||||||||
Amortization of initial payments for new contracts | $ | 14 | $ | 13 | $ | 38 | $ | 35 | ||||||||
Amortization related to equity method investments | 15 | 15 | 45 | 47 | ||||||||||||
Revenue Recognition
The majority of the Company’s revenues are comprised of: 1) transaction-based fees, which typically constitute a percentage of dollar volume processed; 2) fees per transaction processed; 3) fees per account on file during the period; or 4) some combination thereof.
In multiple-element transactions, revenue is allocated to the separate units of accounting provided each element has stand-alone value to the customer. Stand-alone value is based on the relative selling price of any undelivered items for which delivery is probable and substantially within the Company’s control.
In the case of contracts that the Company owns and manages, revenue is comprised of fees charged to the client, net of interchange fees and assessments charged by the credit card associations, and is recognized at the time the client accepts a point of sale transaction. The fees charged to the client are a percentage of the credit card and signature based debit card transaction’s dollar value, a fixed amount or a combination of the two. Personal identification number based debit (PIN-debit) network fees are recognized in “Reimbursable PIN debit fees, postage, and other” revenues and expenses in the unaudited consolidated statements of operations. STAR Network access fees charged to clients are assessed on a per transaction basis. Interchange fees and assessments charged by credit card associations to the Company’s consolidated subsidiaries and network fees related to PIN-debit transactions charged by debit networks are as follows:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(in millions) | 2015 | 2014 | 2015 | 2014 | ||||||||||||
Interchange fees and assessments | $ | 5,598 | $ | 5,218 | $ | 16,089 | $ | 15,091 | ||||||||
Debit network fees | 757 | 729 | 2,227 | 2,221 | ||||||||||||
The Company records deferred revenue when it receives payments or invoices in advance of the delivery of products or the performance of services. The deferred revenue is recognized into earnings when underlying performance obligations are achieved. As of September 30, 2015 and December 31, 2014, current deferred revenue included within "Other current liabilities" in the Company's unaudited consolidated balance sheets was $108 million and $84 million, respectively. As of September 30, 2015 and December 31, 2014, noncurrent deferred revenue included within "Other long-term liabilities" in the Company's unaudited consolidated balance sheets was $137 million and $118 million, respectively.
Net Loss Per Share
Basic net loss per share is calculated by dividing net loss attributable to First Data Corporation by the weighted-average shares outstanding during the period, without consideration for any potential dilutive shares. Dilutive loss per share is the same as basic loss per share for all periods presented because there are no dilutive or potentially dilutive securities.
New Accounting Guidance
In May 2014, the Financial Accounting Standards Board (FASB) issued guidance that requires companies to recognize revenue to depict the transfer of goods or services to customers in amounts that reflect the consideration to which the company expects to be entitled in an exchange for those goods or services. It also requires enhanced disclosures about revenue, provides guidance for transactions that were not previously addressed comprehensively, and improves guidance for multiple-element arrangements. The
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guidance applies to any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. As amended in August 2015, the guidance is effective for public companies for annual periods beginning after December 15, 2017 as well as interim periods within those annual periods using either the full retrospective approach or modified retrospective approach. The FASB also permitted early adoption of the standard, but not before December 15, 2016. The Company is currently evaluating the impacts of the new guidance on its consolidated financial statements.
In April 2015, the FASB issued guidance that requires companies to present debt issuance costs related to a recognized debt liability on the balance sheet as a direct deduction from the debt liability, similar to the presentation of debt discounts. Debt issuance costs will continue to be amortized to interest expense using the effective interest method. The guidance is effective for public companies for annual periods beginning after December 15, 2015 as well as interim periods within those annual periods using the retrospective approach. The adoption of this standard is not expected to have a material impact on the Company's consolidated financial statements.
Note 2: Supplemental Financial Information
Supplemental Unaudited Consolidated Statements of Operations Information
The following table details the components of “Other income (expense)” on the unaudited consolidated statements of operations:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(in millions) | 2015 | 2014 | 2015 | 2014 | ||||||||||||
Investment gains | $ | — | $ | 11 | $ | — | $ | 100 | ||||||||
Derivative financial instruments gains and (losses) | (9 | ) | 6 | (25 | ) | 2 | ||||||||||
Divestitures, net gains | — | 1 | 3 | 2 | ||||||||||||
Non-operating foreign currency gains and (losses) | (1 | ) | 39 | 23 | 36 | |||||||||||
Other income (expense) | $ | (10 | ) | $ | 57 | $ | 1 | $ | 140 | |||||||
Note 3: Restructuring
The Company recorded restructuring charges during the three and nine months ended September 30, 2015 and 2014, in connection with management’s alignment of the business with strategic objectives, cost savings initiatives, the departure of certain executive officers, and refinements of estimates.
On May 4, 2015, the Company announced a strategic expense management initiative to optimize its annualized expense base by mid-2016. Anticipated restructuring costs will be approximately $75 million, mainly cash, and began being recognized in the second quarter of 2015. The net charge is expected to include costs for severance, retention, and transition, asset impairments, professional services fees, and gains/losses on the sale of facilities. The vast majority of the net charge will be related to personnel (severance, retention and transition).
A summary of net pretax benefits (charges), incurred by segment, for each period is as follows:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(in millions) | 2015 | 2014 | 2015 | 2014 | ||||||||||||
Global Business Solutions | $ | (9 | ) | $ | (1 | ) | $ | (14 | ) | $ | (1 | ) | ||||
Global Financial Solutions | (5 | ) | (1 | ) | (9 | ) | — | |||||||||
Network & Security Solutions | (1 | ) | — | (1 | ) | (1 | ) | |||||||||
Corporate | (5 | ) | (2 | ) | (16 | ) | (9 | ) | ||||||||
Restructuring, net | $ | (20 | ) | $ | (4 | ) | $ | (40 | ) | $ | (11 | ) | ||||
11
The following table summarizes the Company’s utilization of restructuring accruals for the period presented:
(in millions) | Employee Severance | Other | ||||||
Remaining accrual as of January 1, 2015 | $ | 12 | $ | 1 | ||||
Restructuring, net | 37 | 3 | ||||||
Cash payments and other | (16 | ) | (3 | ) | ||||
Remaining accrual as of September 30, 2015 | $ | 33 | $ | 1 | ||||
Note 4: Acquisitions
On June 9, 2015, the Company acquired Transaction Wireless, Inc. (TWI) a provider of digital stored value products that offer gift card programs, loyalty incentives, and integrated marketing solutions for retailers, partners, and consumers. The purchase price was approximately $62 million in cash and $3 million in equity. The acquisition is reported as part of the Network & Security Solutions segment.
In addition to TWI, the Company also completed an acquisition of a webstore builder as well as an acquisition of a wholesale independent sales organization, both of which are reported in the Company's Global Business Solutions segment.
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Note 5: Borrowings
(in millions) | As of September 30, 2015 | As of December 31, 2014 | ||||||
Short-term borrowings: | ||||||||
Foreign lines of credit and other arrangements | $ | 33 | $ | 68 | ||||
Senior secured revolving credit facility | 260 | 10 | ||||||
Total short-term borrowings | 293 | 78 | ||||||
Current portion of long-term borrowings: | ||||||||
4.95% Unsecured notes due 2015 | — | 10 | ||||||
Capital lease obligations | 68 | 73 | ||||||
Total current portion of long-term borrowings | 68 | 83 | ||||||
Total Short-term and current portion of long-term borrowings | 361 | 161 | ||||||
Long-term borrowings: | ||||||||
Senior secured term loan facility due March 2017, net of unamortized discount of $3 and $4 | 1,456 | 1,457 | ||||||
Senior secured term loan facility due March 2018, net of unamortized discount of $29 and $38 | 4,918 | 4,939 | ||||||
Senior secured term loan facility due September 2018, net of unamortized discount of $16 and $21 | 992 | 987 | ||||||
Senior secured term loan facility due March 2021, net of unamortized discount of $9 and $11 | 1,167 | 1,180 | ||||||
Senior secured term loan facility due July 2022, net of unamortized discount of $16 | 988 | — | ||||||
7.375% Senior secured first lien notes due 2019, net of unamortized discount of $0 and $19 | — | 1,576 | ||||||
8.875% Senior secured first lien notes due 2020, net of unamortized discount of $0 and $10 | — | 500 | ||||||
6.75% Senior secured first lien notes due 2020, net of unamortized discount of $12 and $14 | 1,385 | 1,383 | ||||||
5.375% Senior secured first lien notes due 2023, net of unamortized discount of $12 | 1,198 | — | ||||||
8.25% Senior secured second lien notes due 2021, net of unamortized discount of $10 and $11 | 1,990 | 1,989 | ||||||
8.75% Senior secured second lien notes due 2022, net of unamortized discount of $5 and $6 | 995 | 994 | ||||||
12.625% Senior unsecured notes due 2021, net of unamortized discount of $14 and $16 | 2,986 | 2,984 | ||||||
10.625% Senior unsecured notes due 2021, net of unamortized discount of $1 and $1 | 529 | 529 | ||||||
11.25% Senior unsecured notes due 2021, net of unamortized discount of $8 and $10 | 502 | 500 | ||||||
11.75% Senior unsecured subordinated notes due 2021, net of unamortized discount of $1 and $1 | 1,608 | 1,608 | ||||||
Capital lease obligations | 102 | 134 | ||||||
Total long-term borrowings | 20,816 | 20,760 | ||||||
Total borrowings | $ | 21,177 | $ | 20,921 | ||||
Lines of Credit and Other Arrangements
As of September 30, 2015 and December 31, 2014, the Company had $289 million and $349 million, respectively, available under short-term lines of credit and other arrangements with foreign banks and alliance partners primarily to fund settlement activity. As of September 30, 2015, the Company had a $150 million committed line of credit for one of the Company's U.S. alliances. The remainder of these arrangements are primarily associated with international operations and are in various functional currencies, the most significant of which are the Australian dollar, the Polish zloty, and the euro. Of the amounts outstanding as of September 30, 2015 and December 31, 2014, $20 million and $67 million, respectively, were uncommitted.
13
Senior Secured Revolving Credit Facility
On June 2, 2015, the Company terminated and replaced its previous $1.0 billion senior secured revolving credit facility maturing September 24, 2016 with a new $1.25 billion senior secured revolving credit facility maturing on June 2, 2020 subject to certain earlier springing maturity provisions in certain circumstances. The Company had $260 million and $10 million outstanding against these facilities as of September 30, 2015 and December 31, 2014, respectively. Up to $250 million of the new senior secured revolving credit facility is available for letters of credit, of which $46 million and $43 million of letters of credit were issued under these facilities as of September 30, 2015 and December 31, 2014, respectively. As of September 30, 2015, $944 million remained available.
Recent Events
On July 10, 2015, the Company entered into an amendment to its senior secured credit facilities providing for incremental term loans of $725 million and €250 million ($276 million), the proceeds of which were used to redeem $955 million of the Company's 7.375% senior secured first lien notes due 2019. Associated with the redemption, the Company incurred $45 million in loss on debt extinguishment.
On August 11, 2015, the Company issued $1.2 billion of 5.375% senior secured first lien notes due 2023. Proceeds from this offering are being used to redeem and/or repurchase outstanding amounts under the Company's 7.375% senior secured first lien notes due 2019 and the Company's 8.875% senior secured first lien notes due 2020. Associated with this transaction, the Company incurred $63 million in loss on debt extinguishment.
Fair Value Measurement
As of September 30, 2015, the fair value of the Company's long-term borrowings was $21.7 billion. The estimated fair value of the Company's long-term borrowings was primarily based on market trading prices and is considered to be a Level 2 measurement.
Note 6: Segment Information
During the second quarter, the Company realigned its operating segments into three reportable segments: Global Business Solutions, Global Financial Solutions, and Network & Security Solutions. Following the realignment, the Company retroactively adjusted all segment related disclosures included within the notes to the unaudited consolidated financial statements. For a detailed discussion of the Company’s principles and detailed discussions regarding its operating segments refer to note 13 “Segment Information” in the Company’s audited consolidated financial statements for the year ended December 31, 2014 included in the Company's Prospectus filed with the Securities and Exchange Commission on October 15, 2015 pursuant to Rule 424(b), which reflects the Company's realigned operating segments.
The following tables present the Company’s operating segment results for the periods presented:
Three months ended September 30, 2015 | ||||||||||||||||||||
(in millions) | Global Business Solutions | Global Financial Solutions | Network & Security Solutions | Corporate | Totals | |||||||||||||||
Revenues: | ||||||||||||||||||||
Transaction and processing service fees | $ | 801 | $ | 341 | $ | 339 | $ | — | $ | 1,481 | ||||||||||
Product sales and other | 223 | 50 | 35 | — | 308 | |||||||||||||||
Equity earnings in affiliates | 8 | — | — | — | 8 | |||||||||||||||
Total segment revenues | $ | 1,032 | $ | 391 | $ | 374 | $ | — | $ | 1,797 | ||||||||||
Depreciation and amortization | $ | 124 | $ | 98 | $ | 22 | $ | 8 | $ | 252 | ||||||||||
Segment EBITDA (a) | 431 | 145 | 162 | (35 | ) | 703 | ||||||||||||||
Other operating expenses and other income (expense) excluding divestitures | 34 | (7 | ) | (1 | ) | (56 | ) | (30 | ) | |||||||||||
(a) | Earnings before net interest expense, income taxes, depreciation, and amortization (EBITDA). Refer to Item 2. Management's Discussion and Analysis - Segment Results where Segment EBITDA is defined. |
14
Three months ended September 30, 2014 | ||||||||||||||||||||
(in millions) | Global Business Solutions | Global Financial Solutions | Network & Security Solutions | Corporate | Totals | |||||||||||||||
Revenues: | ||||||||||||||||||||
Transaction and processing service fees | $ | 818 | $ | 334 | $ | 321 | $ | — | $ | 1,473 | ||||||||||
Product sales and other | 188 | 44 | 22 | — | 254 | |||||||||||||||
Equity earnings in affiliates | 7 | — | — | — | 7 | |||||||||||||||
Total segment revenues | $ | 1,013 | $ | 378 | $ | 343 | $ | — | $ | 1,734 | ||||||||||
Depreciation and amortization | $ | 130 | $ | 107 | $ | 23 | $ | 1 | $ | 261 | ||||||||||
Segment EBITDA | 415 | 133 | 151 | (43 | ) | 656 | ||||||||||||||
Other operating expenses and other income (expense) excluding divestitures | 50 | (1 | ) | 8 | (5 | ) | 52 | |||||||||||||
Nine months ended September 30, 2015 | ||||||||||||||||||||
(in millions) | Global Business Solutions | Global Financial Solutions | Network & Security Solutions | Corporate | Totals | |||||||||||||||
Revenues: | ||||||||||||||||||||
Transaction and processing service fees | $ | 2,413 | $ | 974 | $ | 965 | $ | — | $ | 4,352 | ||||||||||
Product sales and other | 613 | 127 | 101 | — | 841 | |||||||||||||||
Equity earnings in affiliates | 24 | — | — | — | 24 | |||||||||||||||
Total segment revenues | $ | 3,050 | $ | 1,101 | $ | 1,066 | $ | — | $ | 5,217 | ||||||||||
Depreciation and amortization | $ | 365 | $ | 293 | $ | 65 | $ | 20 | $ | 743 | ||||||||||
Segment EBITDA | 1,245 | 388 | 448 | (113 | ) | 1,968 | ||||||||||||||
Other operating expenses and other income (expense) excluding divestitures | 55 | (14 | ) | (1 | ) | (82 | ) | (42 | ) | |||||||||||
Nine months ended September 30, 2014 | ||||||||||||||||||||
(in millions) | Global Business Solutions | Global Financial Solutions | Network & Security Solutions | Corporate | Totals | |||||||||||||||
Revenues: | ||||||||||||||||||||
Transaction and processing service fees | $ | 2,440 | $ | 977 | $ | 946 | $ | — | $ | 4,363 | ||||||||||
Product sales and other | 535 | 121 | 64 | — | 720 | |||||||||||||||
Equity earnings in affiliates | 22 | — | — | — | 22 | |||||||||||||||
Total segment revenues | $ | 2,997 | $ | 1,098 | $ | 1,010 | $ | — | $ | 5,105 | ||||||||||
Depreciation and amortization | $ | 387 | $ | 306 | $ | 70 | $ | 17 | $ | 780 | ||||||||||
Segment EBITDA | 1,252 | 379 | 448 | (128 | ) | 1,951 | ||||||||||||||
Other operating expenses and other income (expense) excluding divestitures | 11 | — | 96 | 20 | 127 | |||||||||||||||
15
A reconciliation of reportable segment amounts to the Company’s consolidated balances is as follows:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(in millions) | 2015 | 2014 | 2015 | 2014 | ||||||||||||
Total segment revenues | $ | 1,797 | $ | 1,734 | $ | 5,217 | $ | 5,105 | ||||||||
Adjustments to reconcile to total revenues: | ||||||||||||||||
Adjustments for non-wholly-owned entities (a) | 18 | 15 | 58 | 31 | ||||||||||||
Independent sales organizations (ISO) commission expense | 167 | 155 | 475 | 440 | ||||||||||||
Reimbursable PIN debit fees, postage, and other | 938 | 888 | 2,737 | 2,693 | ||||||||||||
Total revenues | $ | 2,920 | $ | 2,792 | $ | 8,487 | $ | 8,269 | ||||||||
Segment EBITDA: | ||||||||||||||||
Global Business Solutions | $ | 431 | $ | 415 | $ | 1,245 | $ | 1,252 | ||||||||
Global Financial Solutions | 145 | 133 | 388 | 379 | ||||||||||||
Network & Security Solutions | 162 | 151 | 448 | 448 | ||||||||||||
Total reported segments | 738 | 699 | 2,081 | 2,079 | ||||||||||||
Corporate | (35 | ) | (43 | ) | (113 | ) | (128 | ) | ||||||||
Adjusted EBITDA | 703 | 656 | 1,968 | 1,951 | ||||||||||||
Adjustments to reconcile to Net loss attributable to First Data Corporation: | ||||||||||||||||
Adjustments for non-wholly-owned entities (a) | 6 | 7 | 19 | 17 | ||||||||||||
Depreciation and amortization | (257 | ) | (268 | ) | (760 | ) | (796 | ) | ||||||||
Interest expense | (389 | ) | (407 | ) | (1,202 | ) | (1,334 | ) | ||||||||
Interest income | 1 | 2 | 3 | 9 | ||||||||||||
Loss on debt extinguishment | (108 | ) | (271 | ) | (108 | ) | (274 | ) | ||||||||
Other items (b) | (32 | ) | 44 | (82 | ) | 96 | ||||||||||
Income tax expense | (32 | ) | 23 | (45 | ) | (54 | ) | |||||||||
Stock-based compensation | (8 | ) | (11 | ) | (31 | ) | (45 | ) | ||||||||
Costs of alliance conversions | — | (4 | ) | (5 | ) | (17 | ) | |||||||||
KKR related items | (6 | ) | (6 | ) | (17 | ) | (20 | ) | ||||||||
Debt issuance costs | (4 | ) | — | (4 | ) | (3 | ) | |||||||||
Net loss attributable to First Data Corporation | $ | (126 | ) | $ | (235 | ) | $ | (264 | ) | $ | (470 | ) | ||||
(a) | Net adjustment to reflect the Company’s proportionate share of alliance revenue and EBITDA and amortization related to equity method investments not included in segment EBITDA. |
(b) | Includes adjustments to exclude the official check and money order businesses due to the Company's wind down of these businesses, restructuring, non-normal course litigation and regulatory settlements, and “Other income (expense)” as presented in the unaudited consolidated statements of operations, which includes divestitures, impairments, derivative gains and (losses), and non-operating foreign currency gains and (losses). |
16
A reconciliation of reportable segment depreciation and amortization amounts to the Company’s consolidated balances in the unaudited consolidated statements of cash flows and unaudited consolidated statements of operations is as follows:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(in millions) | 2015 | 2014 | 2015 | 2014 | ||||||||||||
Segment depreciation and amortization | $ | 252 | $ | 261 | $ | 743 | $ | 780 | ||||||||
Adjustments for non-wholly owned entities | 20 | 22 | 62 | 63 | ||||||||||||
Amortization of initial payments for new contracts (a) | 14 | 13 | 38 | 35 | ||||||||||||
Total consolidated depreciation and amortization per unaudited consolidated statements of cash flows | 286 | 296 | 843 | 878 | ||||||||||||
Amortization of equity method investments (b) | (15 | ) | (15 | ) | (45 | ) | (47 | ) | ||||||||
Amortization of initial payments for new contracts (a) | (14 | ) | (13 | ) | (38 | ) | (35 | ) | ||||||||
Total consolidated depreciation and amortization per unaudited consolidated statements of operations | $ | 257 | $ | 268 | $ | 760 | $ | 796 | ||||||||
(a) | Included in "Transaction and processing service fees" as contra-revenue in the Company's unaudited consolidated statements of operations. |
(b) | Included in "Equity earnings in affiliates" in the Company's unaudited consolidated statements of operations. |
Note 7: Redeemable Noncontrolling Interest
One of the Company's noncontrolling interests is redeemable at the option of the holder and is presented outside of equity and carried at its estimated redemption value.
The following table presents a summary of the redeemable noncontrolling interest activity during the periods presented:
(in millions) | 2015 | 2014 | ||||||
Balance as of January 1, | $ | 70 | $ | 69 | ||||
Distributions | (26 | ) | (26 | ) | ||||
Share of income | 26 | 25 | ||||||
Adjustment to redemption value of redeemable noncontrolling interest | 8 | 2 | ||||||
Balance as of September 30, | $ | 78 | $ | 70 | ||||
Note 8: Commitments and Contingencies
The Company is involved in various legal proceedings. Accruals have been made with respect to these matters, where appropriate, which are reflected in the Company’s unaudited consolidated financial statements. The Company may enter into discussions regarding settlement of these matters, and may enter into settlement agreements, if it believes settlement is in the best interest of the Company. The matters discussed below, if decided adversely to or settled by the Company, individually or in the aggregate, may result in liability material to the Company’s financial condition and/or results of operations.
Legal
There are asserted claims against the Company where an unfavorable outcome is considered to be reasonably possible. These claims can generally be categorized in the following areas: (1) patent infringement which results from claims that the Company is using technology that has been patented by another party; (2) merchant customer matters often associated with alleged processing errors or disclosure issues and claims that one of the subsidiaries of the Company has violated a federal or state requirement regarding credit reporting or collection in connection with its check verification guarantee, and collection activities; and (3) other matters which may include issues such as employment. The Company’s estimates of the possible ranges of losses in excess of any amounts accrued are $0 to $20 million for patent infringement, $0 to $50 million for merchant customer matters, and $0 to $30 million for other matters, resulting in a total estimated range of possible losses of $0 to $100 million for all of the matters described above.
17
The estimated range of reasonably possible losses is based on information currently available and involves elements of judgment and significant uncertainties. As additional information becomes available and the resolution of the uncertainties becomes more apparent, it is possible that actual losses may exceed even the high end of the estimated range.
Other
In the normal course of business, the Company is subject to claims and litigation, including indemnification obligations to purchasers of former subsidiaries. Management of the Company believes that such matters will not have a material adverse effect on the Company’s results of operations, liquidity or financial condition.
Contingent Consideration
Over the past three years, the Company completed acquisitions in which contingent consideration was recorded. The transactions called for cash consideration as well as contingent payments for achievement of certain milestones. As part of the purchase price, the Company recorded a $29 million liability for the contingent consideration, of which $1 million was paid during the nine months ended September 30, 2015. During the three months ended September 30, 2015, the Company evaluated the liability and decreased the fair value of the liability by $10 million, $18 million remained accrued as of September 30, 2015. This fair value measurement represents a Level 3 measurement as it is based on significant inputs not observable in the market. Significant judgment is employed in determining the appropriateness of these assumptions as of the acquisition date. The primary assumption is the estimated number of client locations that will be using the software or technology in the next three years.
Note 9: Stock Compensation Plans
The Company’s parent, FDH, has a stock incentive plan for employees of the Company and its affiliates (stock plan). This plan transferred to the Company as part of the merger with FDH on October 13, 2015. Stock compensation expense associated with this stock plan is recorded by the Company. Stock compensation expense for certain awards is only recognized upon liquidity or an employment termination event which triggers vesting. For the remaining awards that vest based solely on service conditions, expense is recognized over the requisite service period. As discussed in note 1 "Basis of Presentation and Summary of Significant Accounting Policies", on October 15, 2015 the Company filed its Prospectus with the Securities and Exchange Commission pursuant to Rule 424(b) and started trading on the New York Stock Exchange.
Total stock-based compensation expense recognized in the unaudited consolidated statements of operations was as follows for the periods presented:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(in millions) | 2015 | 2014 | 2015 | 2014 | ||||||||||||
Total stock-based compensation expense (pretax) | $ | 8 | $ | 11 | $ | 31 | $ | 45 | ||||||||
During the nine months ended September 30, 2015 and 2014, $12 million and $35 million, respectively, of stock-based compensation expense was recognized as a result of the departure of certain executive officers.
Beginning in 2014, substantially all of the Company's employees are granted restricted stock awards or units on an annual basis and during the nine months ended September 30, 2015, 14 million restricted stock awards and units were granted at a weighted average price per share of $14.73. The restrictions on a majority of these awards will lapse after three years or upon certain employment termination events. For the remainder of these awards, the restrictions will lapse after the 180-day lock-up period following the Company's initial public offering or upon certain employment termination events.
On September 28, 2015, the Company authorized the grant of restricted stock awards, restricted stock units, and options to certain executives in connection with the consummation of its initial public offering. These awards are valued at approximately $120 million based on the initial public offering price of $16.00 per share, resulting in incremental unrecognized compensation expense. Two thirds of these grants will be subject to time-based vesting conditions over the next five years and one third will be subject to a performance-based vesting condition.
18
As of September 30, 2015, there was $157 million and $356 million of total unrecognized compensation expense related to non-vested stock options and restricted stock, respectively, of which $195 million will be recognized in connection with the Company's initial public offering over the 180-day lock-up period and $95 million was recognized upon the initial public offering.
For additional information on the Company’s Stock Compensation Plans refer to note 11 “Stock Compensation Plans” in the Company’s audited consolidated financial statements for the year ended December 31, 2014 included in the Company's Prospectus filed with the Securities and Exchange Commission on October 15, 2015 pursuant to Rule 424(b).
Note 10: Derivative Financial Instruments
The Company enters into the following types of derivatives:
Interest rate contracts:
• | Interest rate swaps: The Company uses interest rate swaps to mitigate its exposure to interest rate fluctuations on interest payments related to variable rate debt. The Company uses these contracts in non-qualifying hedging relationships. |
• | Fixed to floating interest rate swaps: The Company uses fixed to floating interest rate swaps to maintain a desired ratio of fixed rate and floating rate debt. The Company uses these contracts in non-qualifying hedging relationships. |
Foreign exchange contracts: The Company uses cross-currency swaps to protect the net investment in certain foreign subsidiaries and/or affiliates with respect to changes in foreign currency exchange rates. The Company uses these contracts in both qualifying and non-qualifying hedging relationships.
The Company held the following derivative instruments as of the dates indicated:
As of September 30, 2015 | As of December 31, 2014 | |||||||||||||||||||||||
(in millions) | Notional Currency | Notional Value | Assets (a) (b) | Liabilities (a) (c) | Notional Value | Assets (a) (b) | Liabilities (a) (c) | |||||||||||||||||
Derivatives designated as hedges of net investments in foreign operations: | ||||||||||||||||||||||||
Foreign exchange contracts | AUD | 260 | $ | 71 | $ | — | 260 | $ | 41 | $ | — | |||||||||||||
Foreign exchange contracts | EUR | 200 | 45 | — | 200 | 27 | — | |||||||||||||||||
Foreign exchange contracts | GBP | 250 | 29 | — | 250 | 18 | — | |||||||||||||||||
Foreign exchange contracts | CAD | 110 | 22 | — | 110 | 9 | — | |||||||||||||||||
167 | — | 95 | — | |||||||||||||||||||||
Derivatives not designated as hedging instruments: | ||||||||||||||||||||||||
Interest rate contracts | USD | 5,000 | — | (84 | ) | 5,750 | 47 | (105 | ) | |||||||||||||||
Foreign exchange contracts | EUR | — | — | — | 22 | 1 | — | |||||||||||||||||
— | (84 | ) | 48 | (105 | ) | |||||||||||||||||||
$ | 167 | $ | (84 | ) | $ | 143 | $ | (105 | ) | |||||||||||||||
(a) | Of the balances included in the table above, in aggregate, $167 million of assets and $77 million of liabilities, net $90 million, as of September 30, 2015 and $142 million of assets and $96 million of liabilities, net $46 million, as of December 31, 2014 are subject to master netting agreements to the extent that the swaps are with the same counterparty. The terms of those agreements require that the Company net settle the outstanding positions at the option of the counterparty upon certain events of default. |
(b) | Derivative assets are included in “Other current assets” and “Other long-term assets” in the unaudited consolidated balance sheets. |
(c) | Derivative liabilities are included in “Other current liabilities” and “Other long-term liabilities” in the unaudited consolidated balance sheets. |
The maximum length of time over which the Company is hedging its exposure to the variability in future cash flows for forecasted transactions excluding those forecasted transactions related to the payment of variable interest on existing financial instruments is through January 2018.
19
Fair Value Measurement
The carrying amounts for the Company's derivative financial instruments are the estimated fair value of the financial instruments. The Company’s derivatives are not exchange listed and therefore the fair value is estimated under an income approach using Bloomberg analytics models that are based on readily observable market inputs. These models reflect the contractual terms of the derivatives, such as notional value and expiration date, as well as market-based observables including interest and foreign currency exchange rates, yield curves, and the credit quality of the counterparties. The models also incorporate the Company’s creditworthiness in order to appropriately reflect non-performance risk. Inputs to the derivative pricing models are generally observable and do not contain a high level of subjectivity and, accordingly, the Company’s derivatives are classified within Level 2 of the fair value hierarchy. While the Company believes its estimates result in a reasonable reflection of the fair value of these instruments, the estimated values may not be representative of actual values that could have been realized or that will be realized in the near future.
Effect of Derivative Instruments on the Unaudited Consolidated Financial Statements
Derivative gains and (losses) were as follows for the periods indicated:
Three months ended September 30, | ||||||||||||||||
2015 | 2014 | |||||||||||||||
(in millions, pretax) | Interest Rate Contracts | Foreign Exchange Contracts | Interest Rate Contracts | Foreign Exchange Contracts | ||||||||||||
Derivatives in net investment hedging relationships: | ||||||||||||||||
Gain (loss) recognized in other comprehensive income (loss) (effective portion) | $ | — | $ | 36 | $ | — | $ | 62 | ||||||||
Derivatives not designated as hedging instruments: | ||||||||||||||||
Gain (loss) recognized in Other income (expense) in the unaudited consolidated statements of operations | (9 | ) | — | 4 | 2 | |||||||||||
Nine months ended September 30, | ||||||||||||||||
2015 | 2014 | |||||||||||||||
(in millions, pretax) | Interest Rate Contracts | Foreign Exchange Contracts | Interest Rate Contracts | Foreign Exchange Contracts | ||||||||||||
Derivatives in net investment hedging relationships: | ||||||||||||||||
Gain (loss) recognized in other comprehensive income (loss) (effective portion) | $ | — | $ | 68 | $ | — | $ | 37 | ||||||||
Derivatives not designated as hedging instruments: | ||||||||||||||||
Gain (loss) recognized in Other income (expense) in the unaudited consolidated statements of operations | (27 | ) | 2 | — | 2 | |||||||||||
20
Accumulated Derivative Gains and Losses
The following table summarizes activity in other comprehensive income for the periods indicated related to derivative instruments classified as cash flow hedges and a net investment hedge held by the Company:
(in millions, after tax) | Three months ended September 30, | Nine months ended September 30, | ||||||||||||||
2015 | 2014 | 2015 | 2014 | |||||||||||||
Accumulated gain (loss) included in other comprehensive income (loss) at beginning of the period | $ | 57 | $ | (29 | ) | $ | 37 | $ | (12 | ) | ||||||
Less: Reclassifications into earnings from other comprehensive income (loss), net of tax | — | — | — | — | ||||||||||||
Increase (decrease) in fair value of derivatives that qualify for hedge accounting (a) | 22 | 39 | 42 | 22 | ||||||||||||
Accumulated gain included in other comprehensive income (loss) at end of the period | $ | 79 | $ | 10 | $ | 79 | $ | 10 | ||||||||
(a) | Gains and (losses) are included in “Unrealized gains on hedging activities” and in “Foreign currency translation adjustment” in the unaudited consolidated statements of comprehensive income (loss). |
Note 11: Income Taxes
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(in millions) | 2015 | 2014 | 2015 | 2014 | ||||||||||||
Income tax expense (benefit) | $ | 32 | $ | (23 | ) | $ | 45 | $ | 54 | |||||||
Effective income tax rate | (74 | )% | 11 | % | (75 | )% | (20 | )% | ||||||||
The effective tax rates for the three and nine months ended September 30, 2015 and 2014 were different from the statutory rate as a result of the Company's inability to recognize tax benefits attributable to its domestic losses while at the same time recording tax expense on its foreign earnings. The Company's tax expense was also impacted by the Company not recording tax expense on noncontrolling interests from pass through entities. The effective tax rates for the three and nine months ended September 30, 2014 were positively impacted by a valuation allowance release in certain foreign jurisdictions due to improved financial performance.
The Company's liability for unrecognized tax benefits was approximately $237 million as of September 30, 2015. The Company anticipates it is reasonably possible that the liability for unrecognized tax benefits may decrease by up to $124 million over the next twelve months beginning September 30, 2015 as a result of the possible closure of federal tax audits, potential settlements with certain states and foreign countries and the lapse of the statute of limitations in various state and foreign jurisdictions.
Note 12: Investment in Affiliates
Segment results include the Company’s proportionate share of income from affiliates, which consist of unconsolidated investments accounted for under the equity method of accounting. The most significant of these affiliates are related to the Company’s merchant bank alliance programs.
21
As of September 30, 2015, the Company has an unconsolidated significant subsidiary that is not required to be consolidated, but represents more than 20% of the Company’s pretax loss. This affiliate became significant during the second quarter of 2014 and its summarized financial information is presented below for the periods indicated:
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(in millions) | 2015 | 2014 | 2015 | 2014 | ||||||||||||
Net operating revenues | $ | 228 | $ | 207 | $ | 668 | $ | 604 | ||||||||
Operating expenses | 97 | 86 | 281 | 255 | ||||||||||||
Operating income | $ | 131 | $ | 121 | $ | 387 | $ | 349 | ||||||||
Net income | $ | 131 | $ | 121 | $ | 387 | $ | 350 | ||||||||
FDC equity earnings | 42 | |||||||||||||||