Western Union 2007 Annual Report Download - page 29

Management’s Discussion and Analysis of Financial Condition and Results of Operations
27
Foreign exchange effect on notes receivable
from First Data, net
All euro denominated notes receivable with First Data, and
related foreign currency swap agreements were settled in con-
nection with the spin-off on September 29, 2006. Accordingly,
no amounts related to the revaluation of such notes or related
swaps were recorded during the year ended December 31, 2007,
explaining the decrease from the year ended December 31, 2006.
No such amounts will be recognized in future periods.
Prior to the spin-off, the revaluation to fair market value of
these euro denominated notes receivable from First Data and
the related foreign currency swap arrangements benefi ted income
before income taxes for the year ended December 31, 2006 by
$10.1 million compared to a reduction to income before income
taxes for the year ended December 31, 2005 of $5.9 million. Such
fl uctuations corresponded to changes in the value of the euro.
Interest income from First Data, net
Interest income from First Data, net consists of interest income
earned on notes receivable from First Data, partially offset by
interest incurred on notes payable to First Data. All notes receiv-
able and payable were settled in connection with the spin-off on
September 29, 2006, and accordingly, no such amounts were
recognized during the year ended December 31, 2007.
Interest income from First Data, net increased for the year
ended December 31, 2006 compared to the year ended Decem-
ber 31, 2005 due to increased average net borrowings by First
Data from Western Union affi liates.
Other income, net
Changes in other income, net during the years ended December
31, 2007 and 2006 compared to the previous corresponding
years were primarily attributable to fl uctuations in equity earnings
from equity method investments.
Income taxes
Our effective tax rates on pretax income were 29.9%, 31.5%
and 31.0% for the years ended December 31, 2007, 2006 and
2005, respectively. The effective tax rate over the three periods
remained relatively constant. The decrease in the effective tax
rate for the year ended December 31, 2007 compared to the
prior year is primarily the result of a higher proportion of foreign
derived profi ts compared to United States derived profi ts (our
foreign derived profi ts are taxed at lower rates than our United
States derived profi ts) and the favorable resolution of certain
income tax matters.
We have established contingency reserves for material, known
tax exposures, including potential tax audit adjustments with
respect to our international operations restructured in 2003,
whereby our income from certain foreign-to-foreign money
transfer transactions has been taxed at relatively low foreign tax
rates compared to our combined federal and state tax rates in
the United States. As of December 31, 2007, the total amount of
unrecognized tax benefi ts is a liability of $276.2 million, including
accrued interest and penalties. Our reserves refl ect our judgment
as to the resolution of the issues involved if subject to judicial
review. While we believe that our reserves are adequate to cover
reasonably expected tax risks, there can be no assurance that,
in all instances, an issue raised by a tax authority will be resolved
at a fi nancial cost that does not exceed our related reserve. With
respect to these reserves, our income tax expense would include
(i) any changes in tax reserves arising from material changes
during the period in facts and circumstances (i.e. new informa-
tion) surrounding a tax issue, and (ii) any difference from our tax
position as recorded in the fi nancial statements and the fi nal
resolution of a tax issue during the period. Such resolution could
materially increase or decrease income tax expense in our con-
solidated fi nancial statements in future periods.
Earnings per share
During the years ended December 31, 2007, 2006 and 2005,
basic earnings per share were $1.13, $1.20 and $1.21, respectively,
and diluted earnings per share were $1.11, $1.19 and $1.21,
respectively. All issued and outstanding shares of Western Union
common stock until the spin-off on September 29, 2006, consist-
ing of 100 shares, were held by First Data. Accordingly, for all
periods presented prior to the spin-off date of September 29,
2006, basic and diluted earnings per share were computed using
our basic shares outstanding as of the spin-off date.
Unvested shares of restricted stock are excluded from basic
shares outstanding. Diluted earnings per share subsequent to
September 29, 2006 refl ects the potential dilution that could
occur if outstanding stock options on the presented dates are
exercised and shares of restricted stock have vested. As of
December 31, 2007 and 2006, there were 10.4 million and 4.9
million, respectively, outstanding options to purchase shares of
Western Union stock excluded from the diluted earnings per
share calculation under the treasury stock method as their effect
is anti-dilutive. The treasury stock method assumes proceeds
from the exercise price of stock options, the unamortized com-
pensation expense and assumed tax benefi ts are available to
reduce the dilutive effect upon exercise. Of the 59.4 million
outstanding options to purchase shares of our common stock
as of December 31, 2007, approximately 58% are held by employ-
ees of First Data.
Diluted earnings per share decreased during the year ended
December 31, 2007 and 2006 compared to the previous periods
due to the decrease in net income as a result of the previously
described factors and the increase in diluted shares outstanding,
because, as described above, prior to the September 29, 2006
spin-off date, there were no potentially dilutive instruments
outstanding. Accordingly, the potentially dilutive shares arising
in connection with the spin-off had no impact to 2005 and minimal
impact to 2006 due to the impact of weighting. In 2007, the dilu-
tive shares outstanding were outstanding for a full year.