First Data 2007 Annual Report Download - page 78

FIRST DATA CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
If the Company has majority ownership and management control over an alliance, then the alliance's financial statements are consolidated with those of
the Company and the related processing fees are treated as an intercompany transaction and eliminated upon consolidation. If the Company does not have a
controlling ownership interest in an alliance, it uses the equity method of accounting to account for its investment in the alliance. As a result, the Company's
consolidated revenues include processing fees charged to alliances accounted for under the equity method.
The Company negotiated all agreements with the alliance banks. Therefore, all transactions between the Company and its alliances were conducted at
arm's length; nevertheless, SFAS No. 57, "Related Party Disclosures," defines a transaction between the Company and an entity for which investments are
accounted for under the equity method by the Company as a related party transaction requiring separate disclosure in the financial statements provided by the
Company. Accordingly, the revenue associated with these related party transactions are presented on the face of the Consolidated Statements of Income.
The investments held by the Company in investment funds managed by a member of its Board of Directors prior to the merger are no longer a related
party transaction since subsequent to the merger this individual is not affiliated with FDC. Subsequent to the merger, certain members of the Company's new
Board of Directors are affiliated with KKR.
In connection with the consummation of the merger, First Data entered into a management agreement with affiliates of KKR pursuant to which such
entities or their affiliates will provide management services to the Company. Pursuant to such agreement, the Company will pay an aggregate annual
management fee of $20 million, which amount is expected to increase annually by 5% beginning in October 2008, and will reimburse out-of-pocket expenses
incurred in connection with the provision of services pursuant to the agreement. In addition and pursuant to such agreement, the Company paid aggregate
transaction fees of approximately $260 million in connection with services provided by such entities in connection with the merger. The agreement also
provides that the Company will pay fees in connection with certain subsequent financing, acquisition, disposition and change of control transactions, as well
as a termination fee based on the net present value of future payment obligations under the management agreement, in the event of an initial public offering or
under certain other circumstances. The agreement also includes customary exculpation and indemnification provisions in favor of KKR and its affiliates.
Income Taxes
The determination of the Company's provision for income taxes requires management's judgment in the use of estimates and the interpretation and
application of complex tax laws. Judgment is also required in assessing the timing and amounts of deductible and taxable items. The Company believes its tax
return positions are fully supportable; however, the Company establishes contingency reserves for material tax exposures relating to deductions, transactions
and other matters involving some uncertainty as to the proper tax treatment of the item. Issues raised by a tax authority may be finally resolved at an amount
different than the related reserve. When facts and circumstances change (including a resolution of an issue or statute of limitations expiration), these reserves
are adjusted through the provision for income taxes in the period of change. As the result of the additional interest and amortization expenses that the
Company incurs due to the merger, the Company is currently in a net loss position. Judgment will be required to determine whether or not some portion or all
of the deferred tax assets will not be realized. To the extent the Company determines that it will not realize the benefit of some or all of its deferred tax assets,
then these deferred tax assets will be adjusted through the Company's provision for income taxes in the period in which this determination is made.
Goodwill
Due to the merger, the Company recorded all assets and liabilities at their estimated fair value on the acquisition date. This has resulted in a significant
amount of goodwill due to purchase accounting. Goodwill represents the excess of cost over the fair value of net assets acquired, including identifiable
intangible assets, and will be allocated to reporting units upon finalization of the intangible valuation being completed due to the merger. The Company's
reporting units are businesses one level below the operating segment level for which discrete financial information is prepared and regularly reviewed by
management.
The Company tests goodwill annually for impairment, as well as upon an indicator of impairment, using a fair value approach at the reporting unit
level. If it is determined that the fair value of the reporting unit is less than its carrying value, an impairment charge of the reporting unit's goodwill would be
recognized which could have a material adverse effect on the Company's financial results.
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