First Data 2007 Annual Report Download - page 76

FIRST DATA CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Continued)
The majority of the TeleCheck business involves the guarantee of checks received by merchants. If the check is returned, TeleCheck is required to
purchase the check from the merchant at its face value and pursue collection from the check writer. A provision for estimated check returns, net of anticipated
recoveries, is recorded at the transaction inception based on recent history. At December 31, 2007 and 2006, the Company had accrued warranty balances of
$16.4 million and $18.1 million, and accrued recovery balances of $38.1 million and $37.4 million, respectively. Accrued warranties are included in
"Accounts payable and other liabilities" and accrued recoveries are included in "Accounts receivable" in the Consolidated Balance Sheets.
The Company establishes an incremental liability (and deferred revenue) for the fair value of the check guarantee. The liability is relieved and revenue
is recognized when the check clears, is presented to TeleCheck, or the guarantee period expires. The majority of the guarantees are settled within 30 days. The
incremental liability was approximately $2.4 million and $2.7 million at December 31, 2007 and 2006, respectively.
The following table details the check guarantees of TeleCheck for the successor period from September 25, 2007 through December 31, 2007, the
predecessor period from January 1, 2007 through September 24, 2007 and the years ended December 31, 2006 and 2005.
Successor Predecessor
Period from September 25
through December 31,
2007
Period from January 1
through September 24,
2007
Year ended December 31,
2006 2005
Aggregate face value of guaranteed checks (in billions) $ 12.7 $ 30.4 $ 25.7 $ 23.2
Aggregate amount of checks presented for warranty (in millions) $ 128.2 $ 303.6 $ 295.1 $ 262.8
Warranty losses net of recoveries (in millions) $ 35.8 $ 80.0 $ 73.9 $ 62.9
The maximum potential future payments under the guarantees were estimated by the Company to be approximately $1.6 billion at December 31, 2007.
Derivative Financial Instruments
From time to time, the Company uses derivative instruments to mitigate (i) cash flow risks with respect to changes in interest rates (forecasted interest
payments on variable rate debt), foreign currency rates (forecasted transactions denominated in foreign currency) and market price risk related to an equity
security, and (ii) to protect the initial net investment in certain foreign subsidiaries and/or affiliates with respect to changes in foreign currency rates. As
required, such instruments are recognized in the Company's Consolidated Balance Sheets at their fair value. Not all of these derivatives qualify for hedge
accounting. Although certain transactions do not qualify for hedge accounting, they are entered into for economic hedging purposes and are not considered
speculative. The Company does not believe that its derivative financial instruments expose it to more than a nominal amount of credit risk, as the
counterparties are established, well-capitalized financial institutions.
The estimated fair value of derivative financial instruments is modeled in Bloomberg software using the Bloomberg reported market data based on mid-
market prices and the actual terms of the derivative contracts. 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 as of December 31, 2007 or that will be
realized in the future.
Capitalized Costs
FDC capitalizes initial payments for new contracts, contract renewals and conversion costs associated with customer contracts and system development
costs. Capitalization of such costs is subject to strict accounting policy criteria and requires management judgment as to the appropriate time to initiate
capitalization. Capitalization of initial payments for contracts and conversion costs only occurs when management is satisfied that such costs are recoverable
through future operations, contractual minimums and/or penalties in case of early termination.
The Company develops software that is used in providing processing services to customers. To a lesser extent, the Company also develops software to
be sold or licensed to customers. Capitalization of internally developed software, primarily associated with operating platforms, occurs only upon
management's estimation that the likelihood of successful development and implementation reaches a probable level. Currently unforeseen circumstances in
software development could require the Company to implement alternative plans with respect to a particular effort, which could result in the impairment of
previously capitalized software development costs.
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