First Data 2007 Annual Report Download - page 43

FIRST DATA CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
Investment income, net – The loss was reduced in the 2007 predecessor and successor periods due to benefits from decreased interest rates which resulted in
lower commissions compared to 2006.
During the pro forma 2007 period, the Company recognized a gain of $0.5 million on the repositioning of portfolio investments, net of the impact of
terminating the associated interest rate swaps. The Company further repositioned the portfolio from short-term tax-exempt variable rate demand notes held at
December 31, 2007 to short-term taxable investment securities in January 2008.
The decrease in investment income in 2006 from 2005 was driven by the official check business. Rising interest rates caused commissions paid to
official check agents to increase which was partially offset by increases in investment earnings resulting from rate increases. In addition, investment earnings
growth in Commercial Services in 2006 over 2005 resulted mostly from increased interest rates.
Product sales and other – The 2007 predecessor and successor periods were positively impacted by acquisitions, royalty income and contract termination fees.
Product sales and other increased in 2006 compared to 2005 due to increased terminal sales and leasing revenue, the impact of acquisitions, an increase in
merchant portfolio sales in 2006 as well as an increase in royalty income partially offset by a decrease resulting from contract termination fees received in
2005.
Reimbursable debit network fees, postage and other – Increases in debit network fees resulting from the continued growth of PIN-debit transaction volumes as
well as rate increases imposed by the debit networks benefited the 2007 predecessor and successor periods. Postage revenue increased due to new business
and an increase in postage rates in May 2007, offset partially by lost business. The increases in 2006 compared to 2005 were due to increases in debit network
fees resulting from higher PIN-debit transaction volumes and rate increases imposed by the debit networks. Postage revenue increased in 2006 due to new
business and a postage rate increase in January 2006 partially offset by lost business.
Operating expenses overview
Cost of services – In the 2007 predecessor period, cost of services increased significantly due to an increase in employee related expenses, the impact of
acquisitions, increased net warranty expense and increased outside professional services. The employee related expenses resulted most significantly from the
accelerated vesting of stock options, restricted stock awards and units upon the change of control (see "Merger" above). The impact from the accelerated
vesting of stock options, restricted stock awards and units was approximately $106 million, the majority which was recorded in All Other and Corporate.
There was also an increase due to the presentation of certain independent sales organizations ("ISO") commission payments on a gross basis in the 2007
predecessor period versus a net presentation against transaction and processing service fee revenue in 2006. The successor period had a significant increase in
cost of services mostly due to the amortization of identifiable intangible assets recorded in purchase accounting from the merger. Purchase accounting, mostly
amortization of identifiable intangible assets, impacted earnings by approximately $189 million in the successor period. The growth rate for the pro forma
2007 period was negatively impacted by 21 percentage points due to purchase accounting.
Cost of services, as a percentage of transaction and processing service fee revenue, increased for the 2007 predecessor and successor periods compared
to 2006 as a result of the items noted above.
The majority of the increase in cost of services for 2006 over 2005 was attributable to the first year results of international acquisitions. Also
contributing to the increase was compensation expense related to stock options and the employee stock purchase plan ("ESPP") recognized since the adoption
of SFAS 123R on January 1, 2006. Additionally, the Company recorded higher incentive compensation accruals in 2006 compared to 2005 due to achieving
certain financial targets. Partially offsetting these increases were lower costs due to 2005 restructuring activities resulting from client deconversions. Cost of
services, as a percentage of transaction and processing service fee revenue, decreased slightly for 2006 compared to 2005 as a result of the items noted above.
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