UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

 

 

Form 10-K

 

 

Commission File Number: 1-31950

 

MONEYGRAM INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code
(952) 591-3000

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 

 

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes o     No þ

 

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 þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

The market value of common stock held by non-affiliates of the registrant, computed by reference to the last sales price as reported on the New York Stock Exchange as of June 29, 2007, the last business day of the registrant’s most recently completed second fiscal quarter, was $2,295.3 million.

 

82,598,034 shares of common stock were outstanding as of March 14, 2008.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Certain information required by Part III of this report is incorporated by reference from the registrant’s proxy statement for the 2008 Annual Meeting or Form 10-K/A.

 

 

TABLE OF CONTENTS

 

 

 

 

MoneyGram International, Inc. (“MoneyGram,” the “Company,” “we,” “us” and “our”) is a leading global payment services company. Our core purpose is to provide consumers with affordable, reliable and convenient payment services. We offer our products and services to consumers and businesses primarily through our network of agents and our financial institution customers. The diverse array of products and services we offer enables consumers, many of whom are not fully served by traditional financial institutions, to make payments and to transfer money around the world, helping them meet the financial demands of their daily lives.

 

Our business is conducted through our wholly owned subsidiary formerly known as Travelers Express Company, Inc. (“Travelers”), which has been in operation since 1940. In June 1998, we acquired MoneyGram Payment Systems, Inc. (“MPSI”), adding the MoneyGram^® branded international money transfer services to our group of services. We were incorporated in Delaware on December 18, 2003 in connection with the June 30, 2004 spin-off from our parent company, Viad Corp (“Viad”) (referred to hereafter as the “spin-off”). In the spin-off, Travelers was merged with our wholly owned subsidiary and Viad distributed all of our issued and outstanding shares of common stock to Viad stockholders in a tax-free distribution.

 

In April 2005, we acquired substantially all of the assets of ACH Commerce, LLC (“ACH Commerce”), an automated clearing house (“ACH”) payment processor. The acquisition provided the technology and systems platform to expand our bill payment services.

 

In 2005, we consolidated the operations of Travelers with MPSI to eliminate duplication and overlapping costs of operating the two businesses under separate corporate entities, and to complete the transition of our business from the Travelers Express brand to the MoneyGram brand. Effective December 31, 2005, the entity that was formerly Travelers merged with and into MPSI, with MPSI remaining as the surviving corporation and our primary operating subsidiary.

 

In May 2006, we completed the acquisition of Money Express S.r.l. (“Money Express”), a former super agent of our money transfer business in Italy. The acquisition of Money Express provides us with the opportunity for further network expansion and more control of marketing and promotional activities in the region. MoneyGram Payment Systems Italy, S.r.l. was established, which manages the former Money Express network comprised of approximately 900 active Italian agents.

 

In October 2007, we completed the acquisition of PropertyBridge, Inc., a provider of electronic payment processing services for the real estate management industry. The acquisition provides a solution in a new payment vertical and fits strategically with our build out of bill payment services.

 

During 2007, we continued to develop our retail strategy in Western Europe. Due to licensing requirements and marketing constraints in certain European countries, our preferred method of expanding the number of locations offering our services is through Company owned retail stores and kiosks in addition to our typical agent model. In May 2006, we formed a licensed financial institution entity in France, MoneyGram France S.A. We were granted the license in September 2006 and opened our first store in France shortly thereafter. As of the end of 2007, we are operating 16 Company owned retail stores or kiosks in France and 30 in Germany. We expect to open additional locations in these and other markets on a targeted basis.

 

During September 2007, the asset-backed securities market and broader credit markets began to experience significant disruption, with a general lack of liquidity in the markets and deterioration in fair value of mortgage-backed securities triggered by concerns surrounding sub-prime mortgages. In response to these concerns, the rating agencies undertook extensive reviews of asset-backed securities, particularly mortgage-backed securities. In late November and December 2007, the asset-backed securities and credit markets experienced further substantial

deterioration under increasing concerns over defaults on mortgages and debt in general, as well as an increasingly negative view towards all structured investments and the credit market. In addition, the rating agencies continued their review of securities, issuing broad rating downgrades based on high levels of assumed future defaults. Under the terms of certain of our asset-backed securities, ratings downgrades of collateral securities can reduce the cash flows to all but the most senior investors even if there have been no actual losses incurred by the collateral securities. In December 2007, we began to experience adverse changes to the cash flows from some of our asset-backed investments as a result of the accumulating rating downgrades of the underlying collateral securities. As the market continued its substantial deterioration, we identified a need for additional capital. Through meetings with potential investors in late December 2007 and early January 2008, it became evident that we would need to divest certain investments in connection with any recapitalization to significantly reduce the risk of any further deterioration in the investment portfolio. We commenced a plan in January 2008 to realign our investment portfolio away from asset-backed securities and into highly liquid assets through the sale of a substantial portion of our investment portfolio. As a result of these developments, we recognized $1.2 billion of other-than-temporary impairments as a charge to earnings in December 2007.

 

On March 25, 2008, we completed a recapitalization transaction pursuant to which we received a substantial infusion of both equity and debt capital (the “Capital Transaction”) to support the long-term needs of the business and to provide necessary capital due to the investment portfolio losses. The equity component of the Capital Transaction consisted of the sale to affiliates of Thomas H. Lee Partners, L.P. (“THL”) and affiliates of Goldman, Sachs & Co. (“Goldman Sachs” and together with THL, the “Investors”) in a private placement of 760,000 shares of Series B Participating Convertible Preferred Stock of the Company (the “Series B Preferred Stock”) and shares of Series B-1 Participating Convertible Preferred Stock of the Company (the “Series B-1 Preferred Stock,” and together the “Series B Stock”) for an aggregate purchase price of $760.0 million. The issuance of the Series B Stock gave THL and Goldman Sachs an initial equity interest of approximately 79%. Furthermore, in connection with the Capital Transaction, we paid Goldman Sachs an investment banking advisory fee equal to $7.5 million in the form of 7,500 shares of Series B-1 Preferred Stock. For a description of the terms of the Series B Stock, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Sale of Investments and Capital Transaction” and Note 18 — Subsequent Events of the Notes to Consolidated Financial Statements.

 

As part of the Capital Transaction, we amended our Rights Agreement with Wells Fargo Bank, N.A., as rights agent, to exempt the issuance of the Series B Stock and stock into which the Series B Stock is convertible from the Rights Agreement. We also entered into a Registration Rights Agreement with the Investors which requires us to promptly file a shelf registration statement with the SEC relating to the Series B Stock issued to the Investors after a specified holding period. We are generally obligated to keep the shelf registration statement effective for up to 15 years or, if earlier, until all the securities owned by the Investors have been sold. The Investors are also entitled to five demand registrations and unlimited piggyback registrations.

 

As part of the Capital Transaction, MoneyGram Payment Systems Worldwide, Inc. (“Worldwide”), a wholly owned subsidiary of the Company, issued Goldman Sachs $500.0 million of senior secured second lien notes (the “Notes”) with a ten year maturity. For a description of the terms of the Notes, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Sale of Investments and Capital Transaction” and Note 18 — Subsequent Events of the Notes to Consolidated Financial Statements. Additionally, Worldwide, as borrower, and the Company entered into a senior secured amended and restated credit agreement amending the Company’s existing $350.0 million debt facility, adding $250.0 million of term loans to bring the total facility to $600.0 million. The new facility includes $350.0 million in two term loan tranches and a $250.0 million revolving credit facility. For a description of the terms of the amended and restated credit facility, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Sale of Investments and Capital Transaction” and Note 18 — Subsequent Events of the Notes to Consolidated Financial Statements.

 

For additional information regarding our business, including our financial results, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Our Segments

 

We conduct our business through two segments: Global Funds Transfer and Payment Systems. In 2006, the sales, marketing and product development teams for the two segments were combined to take advantage of the overlap and synergies between the products and services offered by the two segments. However, management continues to review financial results and evaluate the performance of the Company based on these two segments. For financial information regarding our segments, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations — Segment Performance” and Note 16 — Segment Information of the Notes to Consolidated Financial Statements. Following is a description of each segment.

 

Our Global Funds Transfer segment provides money transfer services, money orders and bill payment services to consumers. Our primary consumers are “unbanked,” “underbanked” and “convenience users.” “Unbanked consumers” are those consumers who do not have a traditional relationship with a financial institution. “Underbanked consumers” are consumers who, while they may have a savings account with a financial institution, do not have a checking account. “Convenience users” are consumers who, while they may have a checking account, prefer to use our products and services on the basis of convenience or value.

 

In 2007, the Global Funds Transfer segment had revenue of $771.0 million and an operating loss of $60.4 million, including net securities losses of $234.2 million primarily attributable to our money order product line. During 2007, 2006 and 2005, our international operations generated 21 percent, 20 percent and 19 percent, respectively, of our total fee and investment revenue, and 29 percent, 28 percent and 29 percent, respectively of our Global Funds Transfer segment fee and investment revenue.

 

We conduct our Global Funds Transfer operations primarily through a worldwide network of agents. Our largest agent, Wal-Mart Stores, Inc. (“Wal-Mart”), accounted for 20 percent, 17 percent and 13 percent of our total fee and investment revenue and 27 percent, 24 percent and 19 percent of the fee and investment revenue of our Global Funds Transfer segment in 2007, 2006 and 2005, respectively. Wal-Mart is the only customer that accounts for more than 10 percent of our total fee and investment revenue. Our contract with Wal-Mart in the U.S. provides for the sale by Wal-Mart of our money orders, money transfer services and real-time, urgent bill payment services on an exclusive basis. In conjunction with our Capital Transaction, we extended the term of the current agreement with Wal-Mart through January 2013, agreed to certain commission increases over the term of the contract and agreed to create a trust for the benefit of consumers who purchase money transfers and money orders at Wal-Mart locations.

 

During 2007, our largest agent in the United Kingdom increased the number of locations offering money transfers as they completed the installation of the AgentConnect^® platform. Domestically, we had two new significant national retail agent signings and one significant agent renewal during 2007. During the first quarter of 2008, we extended the terms of the contracts with ACE Cash Express, Inc., in addition to Wal-Mart (two of our largest agents). During 2007, 2006 and 2005, our ten largest agents accounted for 36 percent, 34 percent, and 28 percent, respectively, of our total fee and investment revenue and 49 percent, 48 percent and 42 percent, respectively, of the fee and investment revenue of our Global Funds Transfer segment.

 

We provide Global Funds Transfer products and services utilizing a variety of proprietary point-of-sale platforms. We also operate two customer service call centers in the United States and contract for additional call center services in Bulgaria and, starting in late 2007, the Dominican Republic. These call centers provide multi-lingual customer service for both agents and consumers 24 hours per day, 365 days per year.

 

Money Transfers:  During 2007, 94 percent of our Global Funds Transfer segment fee and other revenue was generated by our money transfer services (including bill payment). Money transfers are transfers of funds between consumers from one location to another. Money transfers are used by consumers who want to transfer funds quickly, safely and efficiently to another individual within a country or internationally. As of December 31, 2007, we provided money transfer services through approximately 143,000 money transfer agent locations in approximately 180 countries and territories worldwide. These agent locations are located in the following geographic regions: 33,300 locations in North America; 22,200 locations in Latin America (including Mexico which represents 10,600 locations); 44,200 locations in Western Europe and the Middle East; 10,800 locations in the Indian subcontinent;

13,600 locations in Asia Pacific; 13,700 locations in Eastern Europe; and 5,200 locations in Africa. As of the date of this filing, our money transfer agent locations have grown to 150,000.

 

We also offer our money transfer services on the internet via our rapidly growing MoneyGram eMoneyTransfer service that allows customers to send a money transfer at www.emoneygram.com using a credit card, debit card or a debit from a bank account. Finally, we offer our money transfer services through Company-owned retail locations. In the United States, we have Company-owned retail locations in New York and Florida. In 2007, we continued to open retail locations and kiosks in France and Germany. We plan to continue this strategy, as expanding our global network by increasing our agent locations and opening new Company-owned locations in select markets is a core growth strategy of the Company.

 

Our money transfer revenues are derived primarily from consumer transaction fees and revenues from currency exchange on international money transfers. In a typical money transfer, a consumer goes to an agent location, completes a form and pays the agent the money to be transferred, together with a fee. The agent enters the transaction data into a point-of-sale money transfer platform, which connects to our central data processing system. Our platforms include AgentConnect^®, which is integrated onto the agent’s point-of-sale system, and DeltaWorks^® and Delta T3^®, which are separate software and stand-alone device platforms. Through our FormFree service, customers may contact our call center and a representative will collect the information over the telephone and enter it directly into our central data processing system. The funds are made available for payment to the designated recipient in various currencies throughout our agent network. The fee paid by the sender is based on the amount to be transferred and the location at which the funds are to be received. Both the “send” and “receive” agents receive a commission from the transaction. In some instances, we offer our agents a tiered commission structure, rewarding the agent with a higher commission as the volume of its money transfer transactions increases.

 

We have corridor pricing capabilities that enable us to establish different consumer prices and foreign exchange rates for our money transfer services by location, for a broader segment such as defined zip code regions or for a widespread direct marketing area. We also have multi-currency technology that allows us to execute our money transfers directly between and among several different currencies. Where implemented, these capabilities allow our agents to settle with us in local currency and allow consumers to know the exact amount that will be received in the local currency of the receiving nation, or in U.S. dollars or Euros in certain countries.

 

During 2007, the gap between total revenue growth and money transfer transaction growth narrowed as we lapped the first year of implementation of the simplified pricing initiatives and the Euro strengthened against the U.S. dollar. Our simplified pricing structure reduced the number of pricing tiers, or bands, and allows our agents to more effectively communicate our value proposition to our customers. Our pricing philosophy generally is to maintain a price point below our higher priced competitor, but above the niche players in the market.

 

Money Orders:  Money orders, much like checks, can be presented by the consumer to make a payment or for cash. Our Global Funds Transfer segment has its roots in the sale of money orders, a business we have been engaged in since 1940. Based on the number of money orders issued in 2007, we are the nation’s leading issuer of money orders. In 2007, we issued approximately 246 million money orders through our network of almost 59,000 retail agent locations in the United States and Puerto Rico.

 

Our money orders are sold under the MoneyGram brand, as well as on a private label basis or co-branded with retail agents. In most cases, we receive transaction fees from our agents for each money order sold. In many cases, we receive additional monthly dispenser service fees from our agents for the money order dispenser equipment we provide. Furthermore, we generate income from the investment of funds that are remitted from our agents and which we invest until the money orders are cleared through the banking system, or escheat to the applicable states. Generally, a money order will remain outstanding for fewer than ten days. As discussed above, we experienced significant other-than-temporary impairments in our investment portfolio in 2007 and 19 percent of the losses are allocable to the money order product.

 

Bill Payment Services:  Our bill payment suite of services allows consumers to make urgent payments or pay routine bills. Our bill payment services are divided into two categories: walk-in payments and electronic payments. These options enable convenience payers, just-in-time payers and delinquent debtors to pay bills through our network to certain creditors, or “billers.” Our billers include credit card companies, mortgage companies, auto

finance companies, telecom companies, satellite companies, property management companies and third-party bill collectors. We work closely with our agents to identify billers in their service areas to target for our services. Generally, our bill payment services generate revenue from transaction fees charged to consumers for each bill payment transaction completed.

 

The largest portion of walk-in payments consists of our ExpressPayment^® urgent bill payment service. Our ExpressPayment bill payment service, which is offered through our money transfer agent locations in the United States and select Caribbean countries, continues to grow as we add new billers to our network. As of December 31, 2007, we provide our ExpressPayment bill payment services to over 1,900 billers. The ExpressPayment bill payment service provides customers with same-day notification of credit to their account pursuant to our contract with the biller. Customers can also use the ExpressPayment service to load prepaid cards. Our ExpressPayment bill payment service is available for select billers for internet transactions at www.emoneygram.com.

 

Walk-in payments also include a new utility bill payment platform. Our FlashPay^® and BuyPay^® routine utility bill payment services are in the process of being converted to the new utility platform, implemented in 2007. Our utility payment product allows customers to make in-person payments of non-urgent bills at a low cost for credit to a biller typically within two to three days.

 

The acquisition of ACH Commerce in 2005 allowed us to enhance our electronic bill payment business and create a multi-faceted, full-suite of payment services. The acquisition of PropertyBridge in 2007 further expands our electronic bill payment suite of services. PropertyBridge offers a complete solution to the resident payment cycle, including the ability to electronically accept deposits and rent payments. The electronic payment portion of our bill payment services offers payment products by phone, IVR, web, and ACH processing along with check conversion. Consumers may select one-time or recurring ACH, credit or debit card payments to our contracted billers.

 

Our Payment Systems segment primarily provides financial institutions with payment processing services, which include official check outsourcing services and money orders for sale to their customers, as well as ACH processing services. Our customers are primarily comprised of financial institutions, thrifts and credit unions. As of December 31, 2007, we provide official check services to over 17,000 branch locations of over 1,900 financial institutions.

 

We primarily derive revenues in our Payment Systems segment from the investment of funds underlying the official check or financial institution money order. We invest funds from the official checks and money orders sold from the time the proceeds are remitted until the items are cleared. We also derive revenue from fees paid by our financial institution and corporate customers. In 2007, Payment Systems segment revenue was a loss of $614.4 million. As noted above, we experienced significant other-than-temporary impairments in our investment portfolio in 2007. Net securities losses of $955.6 million were allocated to the Payment Systems segment, which represents approximately 80 percent of the total losses recorded on our investment portfolio for 2007. The operating loss for 2007 was $920.1 million.

 

In the fourth quarter of 2007, we announced the strategic review of our official check business. As a result of the review, we have begun a restructuring of the official check business model by changing the commission structure and exiting certain large customer relationships. This restructuring will enable us to continue providing these essential services by focusing on small- to mid-sized institutions. We expect to exit contracts with most of our top ten official check customers, who together account for approximately $2 billion of our official check payment obligations. As of March 21, 2008, 45 of our over 1,900 financial institutions have provided some form of notification of intent to terminate their official check agreements with us. Outside of the top ten customers we planned to exit, these termination notifications represent $132.0 million of our average payment service obligations in 2007. Of the financial institutions that have provided notification, 32 financial institutions have stopped or reduced their issuance of official checks. We expect that most of our top ten official check financial institutions will stop issuing our official checks by the end of 2008. Also impacting the Payment Systems segment is the process commenced in January 2008 to realign our investment portfolio away from asset-backed securities into highly liquid assets. The realigned portfolio will consist primarily of cash equivalents, government and government agency securities. As a result, we anticipate that our profit margins in the official check business will be adversely affected

by the lower yields in our realigned portfolio. While we expect our commission re-pricing initiatives under the official check restructuring to substantially offset the impact of the lower yields from the realigned portfolio, we will not know the final results of the re-pricing initiatives for some time.

 

Official Check Outsourcing Services:  We provide official check outsourcing services through our PrimeLink^® service. Financial institutions provide official checks, which include bank checks, cashier checks, teller checks and agent checks, to consumers for use in transactions when the payee requires a check drawn on a bank or other third party. Official checks are commonly used in consumer loan closings, such as closings of home and car loans, and other critical situations where the payee requires assurance of payment and funds availability. Financial institutions also use official checks to pay their own obligations. Our PrimeLinkplus^® product is an internet-based check issuance platform that allows financial institutions and other businesses with multiple locations to securely print official checks at remote locations on a client-controlled basis, eliminating the need to overnight the checks from the main office or wire transfer the funds. We provide PrimeLink and PrimeLinkplus at a low cost to financial institutions and pay an agreed upon commission rate on the balance of funds underlying the official checks pending clearing of the items.

 

Money Orders:  The Payment Systems segment also offers money orders through financial institutions in a manner very similar to the way the services are offered through our retail agents in our Global Funds Transfer segment.

 

Check Processing:  Through our subsidiary FSMC, Inc. (“FSMC”), we offer high volume check processing and controlled disbursement processing. FSMC is a leading processor of promotional payments and rebates. Through FSMC, we also process checks issued under the Special Supplemental Nutrition Program to Women, Infants and Children administered by the U.S. Department of Agriculture through various states. Our revenues from this area are primarily derived from fees.

 

Our business involves the movement of money. On a daily basis, we move on average over $1.0 billion in cash to settle our payment instruments and related settlements with our agents and financial institutions. We receive a similar amount on a daily basis from our agents and financial institutions for the face amount and related fees of our payment instruments sold. We maintain contractual relationships with 13 clearing banks around the country in order to clear the official checks issued by our PrimeLink and PrimeLinkplus customers, as well as money orders and share drafts. These financial institutions serve as the drawee bank or payable through bank on official check, money order and share draft items. For the clearing of money orders, we rely on one primary clearing bank. In addition, we maintain contractual relationships with a variety of domestic and international cash management banks for ACH and wire transfer services to process agent remittances and payments. The relationships with these clearing banks and cash management banks are a critical component of our ability to timely move monies on a global basis.

 

We market our products and services through a number of dedicated sales and marketing teams. In the United States, we have a dedicated sales and marketing team that markets money transfer services, money orders and bill payment services on a regional basis to our two principal agent distribution channels: large national chain accounts and smaller chains and independent accounts. The agent locations consist of general merchandise, check cashing, grocery, drug and convenience store retailers and bank locations. We also have dedicated sales and marketing teams that market our bill payment services directly to billers. Finally, we have a dedicated team of sales and marketing professionals that market our PrimeLink official check services, money transfer services, PrimeLinkplus services, money orders and ACH services to financial institutions. Our international sales and marketing for money transfer services is conducted by dedicated regional sales and marketing teams that are generally located in or near their regions: Western Europe, including the United Kingdom; Eastern Europe; Asia; the Middle East; Africa; Canada; and Mexico, Latin America and the Caribbean.

 

Our sales and marketing efforts continue to be supported by a wide range of consumer advertising methods. A core focus of building our brand awareness is signage, particularly ensuring that our signs are displayed at agent locations, as well as maintaining consistency in our signage and image globally.

During 2007, we continued to focus on our brand positioning and customer loyalty programs. MoneyGram made a significant investment in 2007 to establish a new brand positioning strategy which was released in the first quarter of 2008 and will impact our marketing activities, as well as our overall product development strategies, for the coming years. Working with an outside research firm, we spent more than two years developing a new global brand position and message that differentiates MoneyGram from other payment services providers. Additionally, our new customer loyalty program entitled “MoneyGram Rewards” was developed to build loyalty and repeat usage with consumers around the world. The new loyalty program is part of a broader initiative at MoneyGram to build global brand awareness. The program includes features such as a new discount structure based on a customer’s use of MoneyGram’s services, notifications to the sender when the funds are picked up and less paperwork with an easier process. Consumers can enroll for the program through our call center or at www.mymoneygram.com

 

A variety of traditional media methods have been used in the past to reach our consumers, such as television, radio, print and event marketing. We will focus more heavily on national television ads during 2008 in conjunction with a new media campaign, and will also rely on radio and print advertising. Additionally, MoneyGram has initiated several research projects that are designed to measure the effectiveness of the new campaign and its impact on image, awareness and volume.

 

Our product development activities have focused on new ways to transfer money and pay bills through enhancements to our current services and the development of new products and services. Recent enhancements and new products supplement our Global Funds Transfer segment. We have also invested in new infrastructure to increase efficiencies and support our strategic initiatives. We believe new features, products and infrastructure will provide customers with added flexibility and convenience to help meet their financial services needs.

 

New Product and Product Enhancements:  We successfully transitioned our MoneyGram Prepaid MasterCard card program to a new processor during 2007, and are positioned to take advantage of the anticipated growth in the debit card arena. The cards are available for purchase and reload at designated MoneyGram agent locations throughout the United States. Throughout 2006 and 2007, we continued to implement a full suite of ACH and electronic bill payment services that provide consumers with pay-by-telephone, pay-by-IVR and pay-by-web options. Our new utility bill payment services were implemented across the United States in 2007. Furthermore, our internet-based money transfer service, eMoneyTransfer, grew rapidly during 2007 and significant enhancements of the eMoneyTransfer service are planned for release in 2008. The enhancements will provide better usability and efficiency in completing a transaction for our online customers, as well as more cost effective transaction processing.

 

Infrastructure Development:  In early 2007, we launched a new general ledger and accounts payable system. We continue to invest in improving our infrastructure, including settlement and commission processing, agent and customer data management and set-up and other important financial systems. The new system and associated processes are intended to increase the flexibility of our back office, thereby improving operating efficiencies and communications between our agents and our marketing, sales, customer service and accounting functions. This significant investment in technology and process re-engineering will allow us to create an infrastructure able to support our strategic initiatives. Other benefits to be derived from this investment include increased speed to market for new products, efficiencies in back office operations, enhancement of information repositories for regulatory and compliance reporting and better overall consumer and agent experience.

 

In 2007, we began a development effort to automate our agent on-boarding process. This effort is being undertaken to improve our speed to market with new agents, to improve departmental tracking and to increase accountability throughout the process. The primary component of this development effort is the implementation of a business process management tool, which allows us to automate a paper intensive process with strong work-flow processes.

 

The industries in which we operate are very competitive and we face a variety of competitors across our businesses. New competitors or alliances among established companies may emerge. Consolidation among payment services companies, and money transmitters in particular, has occurred and may continue. We compete for agents and

financial institution customers on the basis of value, service, quality, technical and operational differences, price and financial incentives paid to agents once they have entered into an agreement. In turn, we compete for consumers on the basis of number and location of outlets, price, convenience and technology.

 

Money transfer, money order and walk-in bill payment services within the Global Funds Transfer segment of our business compete in a concentrated industry, with a small number of large competitors and a large number of small, niche competitors. Our primary competition in Global Funds Transfer comes from The Western Union Company (“Western Union”), a former subsidiary of First Data Corporation, which has greater transaction volume, a larger agent base, a more established brand name and greater financial and marketing resources. Other competitors in this segment are other providers of money transfer services, such as banks and niche person-to-person money transfer service providers that serve select send and receive corridors, and other providers of money orders, including the U.S. Postal Service and a subsidiary of First Data Corporation. Walk-in and electronic bill payment services within the Global Funds Transfer segment of our business compete in a consumer-to-business payment industry, which includes competition from Western Union, CheckFree Corporation, a subsidiary of Fiserv Inc. and other niche players. Additional competitors in this area include financial institutions, third parties that host financial institution and bill payment services, third parties that offer payment services directly to consumers and billers offering their own bill payment services.

 

As new technologies for money transfer and bill payment services emerge allowing consumers to send and receive money in a variety of ways, we face increasing competition. These emerging technologies include online payment service providers, mobile telephone payment services and card-based options, such as ATM cards and stored-value cards.

 

The Payment Systems segment of our business competes in a concentrated industry with a small number of large competitors. Our competitors in this segment are federal home loan banks. We also compete with financial institutions that have developed internal processing capabilities or services similar to ours and do not outsource these services.

 

Compliance with legal requirements and government regulations is a highly complex and integral part of our day-to-day operations. Our operations are subject to a wide range of laws and regulations, both in the United States and abroad. These laws and regulations include: international, federal and state anti-money laundering laws and regulations; money transfer and payment instrument licensing laws; escheat laws; laws covering consumer privacy; data protection and information security and consumer disclosure and consumer protection laws.

 

If we were to fail to comply with any applicable laws and regulations, this failure could result in restrictions on our ability to provide our products and services, as well as the potential imposition of civil fines and possibly criminal penalties. See “Risk Factors.” We have added compliance managers and employees to our compliance team around the world as part of our efforts to ensure compliance with regulations of specific countries and regions. We have developed and are constantly enhancing our global compliance program to stay current with the most recent legal and regulatory changes.

 

Anti-Money Laundering Compliance.  Compliance with money transfer regulations, including but not limited to anti-money laundering laws and regulations, is a primary focus. Our money transfer services are subject to anti-money laundering laws and regulations of the United States, including the Bank Secrecy Act, as amended by the USA PATRIOT Act, as well as the anti-money laundering laws and regulations in many of the countries in which we operate, particularly in the European Union (the “EU”). Countries in which we operate may require one or more of the following:

 

 

 

Regulations impacting money transfers are constantly evolving and vary from country to country. We continue to implement policies and procedures and work to make our business practices flexible in order to help us comply with the most current legal requirements.

 

In most cases, our money transfer services are offered through third party agents with whom we contract and our ability to directly control our agents’ compliance is limited. As a money services business, the Company and its agents are required to establish anti-money laundering compliance programs that include: (i) internal policies and controls; (ii) designation of a compliance officer; (iii) ongoing employee training and (iv) an independent review function. We have developed an anti-money laundering training manual available in multiple languages and a program to assist with the education of our agents on the various rules and regulations. In 2007, we implemented a new online training system to supplement our compliance agent training program.

 

Certain economic and trade sanctions programs administered by OFAC prohibit or restrict transactions to or from, or dealings with, certain countries. Additionally, transactions in regions that are under the control of the Palestinian Authority are carefully monitored for compliance with OFAC requirements. The Company will continue to assess the relative regulatory requirements and risks as compared to the consumer demand for services in certain government identified high-risk countries.

 

Money Transfer and Payment Instrument Licensing.  In the United States, virtually all states, the District of Columbia and Puerto Rico require us to be licensed in order to conduct business within their jurisdiction. Requirements to be so licensed generally include minimum net worth, provision of surety bonds, compliance with operational procedures and reserves or “permissible investments” that must be maintained in an amount equivalent to outstanding payment obligations, as defined by the states. The types of securities that are considered “permissible investments” vary from state to state, but generally include U.S. government securities and other highly rated debt instruments. Most states require us to file reports on a quarterly or more frequent basis to verify our compliance with their requirements. Many states also subject us to periodic examinations and require that money transmitters and issuers of payment instruments, as well as their agents that offer these products and services, comply with federal and state anti-money laundering laws and regulations.

 

In connection with the Capital Transaction, we sold certain investments at a realized loss of $260.6 million. As a result of these portfolio sales, we were not in compliance for a brief period of time with the minimum net worth requirements of the states in which we are licensed to conduct our money transfer and other payment services businesses, as well as certain other requirements of one state. This failure to meet minimum net worth or other requirements may result in the states imposing certain fines and other penalties in the future. No state has taken any action or informed us of its intention to take any action at this time. Upon the closing of the Capital Transaction, we were again in compliance with the minimum net worth requirements and all other regulatory requirements.

 

Escheat Regulation.  Unclaimed property laws of every state, the District of Columbia and Puerto Rico require that we track the relevant information on each payment instrument and money transfer and, if unclaimed at the end of the statutory abandonment period, that we remit the proceeds of the unclaimed property to the appropriate jurisdiction. State abandonment periods for payment instruments and money transfers range from three to seven years. Certain foreign jurisdictions also may have unclaimed property laws, though we do not have material amounts subject to any such law.

Privacy Regulations.  In the ordinary course of our business, we collect certain types of data and thus are subject to certain privacy laws in the United States and abroad. In the United States, we are subject to the Gramm-Leach-Bliley Act of 1999 (the “GLB Act”), which requires that financial institutions have in place policies regarding the collection, processing, storage and disclosure of information considered nonpublic personal information. We comply with the GLB Act by posting a privacy notice on our website, posting a privacy notice on the forms completed by consumers in order to use services and maintaining an information safeguards program. In addition, we collect personal data from the European Union which is subject to the European Privacy Directive (the “Directive”). We abide by the U.S. Department of Commerce’s Safe Harbor framework principles to assist in compliance with the Directive. In some cases, the privacy laws of an EU member state may be more restrictive than the Directive and may impose additional duties, with which we must comply. We also have confidentiality/information security standards and procedures in place for our business activities and with our third-party vendors and service providers. Privacy and information security laws in various jurisdictions are evolving regularly and conflicting laws in various jurisdictions pose challenges.

 

In January 2007, we disclosed that we were the subject of an isolated unlawful data server attack and suffered potential improper data access by unauthorized persons. We notified appropriate authorities and customers and also took additional security measures to help ensure that such an incident does not occur again.

 

Other.  In the United States, we sell our MoneyGram-branded stored value card and also load stored value cards of other card issuers through our ExpressPayment system. Stored value services are generally subject to federal and state laws and regulations, including laws related to consumer protection, licensing, escheat, anti-money laundering and the payment of wages. These laws are evolving, unclear and sometimes inconsistent. The extent to which these laws are applicable to us is uncertain and we are currently unable to determine the impact that any future clarification, changes or interpretation of these laws will have on our services.

 

We rely on a combination of patent, trademark and copyright laws, and trade secret protection and confidentiality or license agreements to protect our proprietary rights in products, services, know-how and information. Intellectual property rights in processing equipment, computer systems, software and business processes held by us and our subsidiaries provide us with a competitive advantage. Even though not all of these assets are protectable, we attempt to take the measures necessary to protect as much of our intellectual property as current intellectual property laws will allow.

 

We own U.S. and foreign patents related to our money order and money transfer technology. Our U.S. patents have in the past given us competitive advantages in the marketplace, including a number of patents for automated money order dispensing systems and printing techniques, many of which have expired. We also have patent applications pending in the United States that relate to our money transfer, money order, PrimeLink and bill payment technologies and business methods. We anticipate that these applications, if granted, will give us continued competitive advantages in the marketplace. However, our competitors are also actively patenting their technology and business processes.

 

We register our trademarks in the U.S. and in a number of other countries where we do business. We maintain a portfolio of trademarks representing substantial goodwill in our businesses. Many of our trademarks, including the MoneyGram^®, ExpressPayment^®, our globe with arrows logo, PrimeLink^®, PrimeLinkplus^®, AgentConnect^®, DeltaWorks^®, and Delta T3^® marks have substantial importance and value to our business.

 

At December 31, 2007, we had approximately 1,887 full-time employees in the United States and 433 full-time employees internationally. In addition, we use contractors to support certain of our domestic and international sales and marketing efforts. None of our employees are represented by a labor union and we consider our employee relations to be good.

 

Philip W. Milne, age 48, has served as our President and Chief Executive Officer and as a Director of MoneyGram since June 2004. He was named Chairman of the Board effective January 1, 2007. He is also the President and Chief Executive Officer of MPSI and its predecessor, Travelers, our principal operating subsidiary, a position he has held since 1996. Mr. Milne joined Travelers in 1991 and served as General Manager of the official check business from 1991 until early 1992, as Vice President, General Manager of the Payment Systems segment from 1992 until early 1993, and as Vice President, General Manager of the Retail Payment Products group from 1993 to 1996.

 

David J. Parrin, age 53, has served as the Executive Vice President, Chief Financial Officer of MoneyGram since November 2005. Mr. Parrin previously served as the Vice President and Chief Financial Officer of MoneyGram since June 2004 and Travelers since joining the Company in June 2002. From 1998 to 2002, he was with the investment firm of Dain Rauscher Corporation (now RBC Dain Rauscher Corporation), serving since 1999 as Executive Vice President and Chief Financial Officer. From 1994 to 1998, he served as Senior Vice President and Corporate Controller of U.S. Bancorp. Prior to that, Mr. Parrin spent 17 years with the accounting firm of Ernst & Young LLP, serving most recently as audit partner.

 

Anthony P. Ryan, age 45, has served as Executive Vice President and Chief Operating Officer of MoneyGram since November 2007. Mr. Ryan previously served as Executive Vice President/President, MoneyGram Global Payment Products and Services from August 2006 to November 2007, Executive Vice President/ Division President Global Funds Transfer from November 2005 to August 2006 and Vice President of MoneyGram and General Manager of Global Funds Transfer from June 2004 to November 2005, a position he had held at Travelers since 2001. He previously served as Chief Financial Officer of Travelers from 1997 to 2001 and as Controller from 1996 to 1997. Prior to joining the Company, Mr. Ryan spent 10 years at First Data Corporation, serving most recently as Director of Finance.

 

Jean C. Benson, age 40, has served as the Senior Vice President, Controller of MoneyGram since May 2007. Ms. Benson previously served as Vice President, Controller of MoneyGram from June 2004 to May 2007 and as Vice President, Controller of Travelers since joining the Company in August 2001. From 1994 to 2001, Ms. Benson was at Metris Companies, Inc., a financial products and services company, serving as Corporate Controller and Executive Vice President of Finance since 1996. Ms. Benson began her career as an auditor with the accounting firm of Deloitte & Touche LLP from 1990 to 1994.

 

Mary A. Dutra, age 56, has served as Executive Vice President, Global Payment Processing and Settlement of MoneyGram since August 2006. Ms. Dutra previously served as Executive Vice President/Division President Payment Systems from November 2005 to August 2006, Vice President of MoneyGram and General Manager of Payment Systems from June 2004 to November 2005 and as General Manager and Vice President, Global Operations of Travelers from November 1994 to June 2004. Ms. Dutra joined the Company in 1988 as Manager of Payment Services of Travelers and has served in positions of increasing responsibility from 1988 to 1994.

 

Timothy J. Gallaher, age 40, has served as Vice President, Investor Relations of MoneyGram since April 2005. He was named Treasurer of MoneyGram in October 2006. Mr. Gallaher previously served as Director of Corporate Planning and Analysis from December 2002 to April 2005. Prior to joining the Company, Mr. Gallaher spent eight years with U.S. Bancorp working in planning, corporate development and commercial banking.

 

Thomas E. Haider, age 49, has served as Senior Vice President Government Affairs since May 2007 and Chief Compliance Officer of MoneyGram since November 2005. Mr. Haider joined the Company in 1992 as an Attorney and held various other positions, including Associate Corporate Counsel through May 2007. Prior to joining the Company, Mr. Haider spent seven years representing the Minnesota League of Credit Unions in both legislative and regulatory matters.

 

Teresa H. Johnson, age 56, has served as Executive Vice President, General Counsel and Secretary of MoneyGram since November 2005. Ms. Johnson previously served as Vice President, General Counsel and Secretary of MoneyGram since June 2004 and Chief Legal Counsel of Travelers since joining the Company in 1997. From 1992 to 1997, she was employed at SUPERVALU INC., a food retailer and distributor, serving most recently as Associate General Counsel and Corporate Secretary.

Daniel J. O’Malley, age 43, has served as Senior Vice President, Global Payment Systems/ President Americas of MoneyGram since April 2007. Mr. O’Malley previously served as Vice President, Global Payment Systems/Americas from April 2003 to April 2007, Vice President, Customer Service from June 1999 to April 2003, Director, Operations from October 1996 to June 1999, Regulatory Project Manager from September 1995 to October 1996, Manager of the Southeast Processing Center of Travelers from April 1989 to September 1995 and Coordinator of the Southeast Processing Center of Travelers since joining the Company in June 1988. Prior to joining the Company, Mr. O’Malley held various operations positions at NCNB National Bank and Southeast Bank N.A. from 1983 to 1988.

 

William J. Putney, age 45, has served as Executive Vice President, Chief Investment Officer of MoneyGram since November 2005. Mr. Putney previously served as Vice President, Chief Investment Officer of MoneyGram from June 2004 to November 2005 and as Vice President, Chief Investment Officer of Travelers from 1996 to 2004. Mr. Putney joined the Company in 1993, serving as Portfolio Manager. Prior to joining the Company, Mr. Putney held positions as a trader, investment analyst and portfolio manager.

 

Cindy J. Stemper, age 50, has served as Executive Vice President, Human Resources and Corporate Services of MoneyGram since November 2006. Ms. Stemper previously served as Executive Vice President, Human Resources and Facilities of MoneyGram from November 2005 to November 2006, Vice President of Human Resources and Facilities of MoneyGram from June 2004 to November 2005 and Vice President of Human Resources at Travelers from 1996 to June 2004. Ms. Stemper joined the Company in 1984 and served in positions of increasing responsibility from 1984 to 1996.

 

Our principal executive offices are located at 1550 Utica Avenue South, Minneapolis, Minnesota 55416 and our telephone number is (952) 591-3000. Our website address is www.moneygram.com. We make our reports on Forms 10-K, 10-Q and 8-K, Section 16 reports on Forms 3, 4 and 5, and all amendments to those reports, available electronically free of charge in the Investor Relations section of our website as soon as reasonably practicable after they are filed with or furnished to the Securities and Exchange Commission (the “SEC”).

 

Various risks and uncertainties could affect our business. Any of the risks described below or elsewhere in this Annual Report on Form 10-K or our other filings with the SEC could have a material impact on our business, financial condition or results of operations.

 

RISK FACTORS

 

The substantial dividends payable on our newly issued preferred stock and our increased debt service, together with significant debt covenant requirements, could impair our financial condition and adversely affect our ability to operate and grow our business.

 

On March 25, 2008, we closed a transaction with affiliates of Thomas H. Lee Partners, L.P. (“THL”) and affiliates of Goldman, Sachs & Co. (“Goldman Sachs”) (collectively, the “Investors”) pursuant to which we received a substantial infusion of both equity and debt capital (the “Capital Transaction”). The equity component consisted of the sale of 760,000 shares, in aggregate, of Series B Participating Convertible Preferred Stock to THL (the “Series B Preferred”) and non-voting Series B-1 Participating Convertible Preferred Stock to Goldman Sachs (the “Series B-1 Preferred”) (collectively, the “Series B Stock”) for an aggregate purchase price of $760.0 million. In addition, Goldman Sachs provided debt financing of $500.0 million at an annual interest rate of 13.25 percent, which increases to a rate of 15.25 percent if interest is accrued. This debt is non-redeemable for five years, except with substantial premiums, and thus we have only a limited opportunity to refinance this debt to obtain more favorable terms. In addition, the Company has secured additional term debt of $250.0 million under an amendment and restatement of our existing credit facility.

As a result of the Capital Transaction, we are highly leveraged and have substantial dividend and debt service obligations. Our indebtedness and dividends payable on our Preferred Stock could adversely affect our ability to operate our business and could have an adverse impact on our stockholders, including:

 

 

Our senior debt pursuant to our credit facility has been rated non-investment grade. Together with our leverage, this rating adversely affects our ability to obtain additional financing and increases our cost of borrowing. A non-investment grade rating may also affect our ability to attract and retain certain customers.

 

Our recent transaction with the Investors significantly dilutes the interests of the common stockholders and grants other important rights to the Investors.

 

The Series B Stock issued to the Investors is convertible into shares of common stock or common equivalent stock at the price of $2.50 per common share (subject to anti-dilution rights), giving the Investors an initial equity interest in us of approximately 79 percent. Dividends payable on Series B Stock are expected to be accrued and not be paid in cash for approximately five years, which will substantially increase the ownership interest of the Investors and dilute the interests of the common stockholders.

 

The Preferred Stock will initially have voting rights equivalent to 9.9% of the outstanding common shares on a fully converted basis. Upon receipt of all regulatory approvals, or upon receipt of notification from THL on or after June 15, 2008, the holders of the Preferred Stock would attain full voting rights. At that time, the holders of the Series B Preferred Stock will vote as a class with the common stock, and will have a number of votes equal to the number of shares of common stock issuable if all outstanding shares of Series B Preferred Stock were converted plus the number of shares of common stock issuable if all outstanding shares of Series B-1 Preferred Stock were converted into Series B Preferred Stock and subsequently converted into common stock. As a result, the Investors collectively are able to determine the outcome of matters put to a stockholder vote, including the election of our directors, determine our corporate and management policies and determine, without the consent of our other stockholders, the outcome of any corporate action submitted to our stockholders for approval, including potential mergers, acquisitions, asset sales and other significant corporate transactions. THL also has sufficient voting power to amend our organizational documents. We cannot provide assurance that the interests of the Investors will coincide with the interests of other holders of our common shares. This concentration of ownership may discourage, delay or prevent a change in control of our company, which could deprive our stockholders of an opportunity to receive a premium for their common shares as part of a sale of our company and might reduce our share price.

 

In view of their significant ownership stake in the Company, the Investors have appointed two members and two observers to our Board of Directors and the size of our Board has been reduced to six members, of which three

members are independent. As promptly as practicable, we are required under the terms of the Capital Transaction to seek to amend our Certificate of Incorporation, including the filing of a proxy statement with the SEC and use our best efforts to solicit proxies in favor of such amendment, which would grant directors appointed by the Investors voting rights proportionate to their ownership interest calculated on a fully converted basis. In addition, the Investors have the ability, at their discretion, to appoint the number of directors proportionate to their common stock ownership, calculated on a fully-converted basis, as well as to the proportionate committee membership.

 

If we lose key customers or are unable to maintain our Global Funds Transfer agent network, our business and results of operations could be adversely affected.

 

We may not be able to retain all of our current retail agents. The competition for retail agents is intense and larger customers in our Global Funds Transfer segment are increasingly demanding financial concessions and more information technology customization. The development, equipment and capital necessary to meet these demands could require substantial expenditures and there can be no assurance that we will have the available capital after paying dividends to the Investors and servicing our debt, or that we will be allowed to make such expenditures under the terms of our debt agreements. If we were unable to meet these demands, we could lose customers and our business and results of operations would be adversely affected. Additionally, as a result of the events leading to the Capital Transaction, agents have asked for certain funding arrangements and special remittance patterns for their benefit, which arrangements negatively impact our liquidity.

 

The reputational damage to our brand as a result of the events leading to the Capital Transaction may make it harder for us to retain existing agents or develop new agent relationships. If agents decide to leave our Global Funds Transfer network, or if we are unable to sign new agents to our network, our revenue would decline. Existing agents may generate fewer transactions or less revenue for various reasons, including increased competition. An agent may encounter business difficulties unrelated to its provision of our services, which could cause the agent to reduce its number of locations or hours of operation, or cease doing business altogether. Many of our high volume agents are in the check cashing industry. There are risks associated with the check cashing industry that could cause this portion of our agent base to decline. Any regulatory action that adversely affects check cashers could also cause this portion of our agent base to decline.

 

A substantial portion of our transaction volume is generated by a limited number of key agents. During 2007 and 2006, our ten largest agents accounted for 36 percent and 34 percent of our total fee and investment revenue and 49 percent and 48 percent of the total fee and investment revenue of our Global Funds Transfer segment, respectively. Our largest agent, Wal-Mart Stores, Inc. (“Wal-Mart”), accounted for 20 percent and 17 percent of our total fee and investment revenue and 27 percent and 24 percent of the fee and investment revenue of our Global Funds Transfer segment in 2007 and 2006, respectively. If any of these key agents were not to renew their contracts with us, or if such agents were to reduce the number of their locations, or cease doing business, we might not be able to replace the volume of business conducted through these agents, and our business and results of operations would be adversely affected.

 

We may be unable to operate our Payment Systems segment profitably as a result of our new official check strategy and the realignment of our investment portfolio.

 

Our earnings in the official check business are generated primarily by the investment of funds we receive from the sale of payment instruments. In turn, we pay commissions to our official check customers based on the outstanding balance produced by that customer’s sale of official checks, calculated at a rate based on short term financial indices, such as the federal funds rate. In the past our investments included long- and medium-term fixed income securities, a portion of which were asset-backed securities. In conjunction with the Capital Transaction and our new official check strategy, we have realigned our investment portfolio to focus on highly liquid, short-term securities that are expected to produce a lower rate of return. The success of our new official check strategy is dependent on our ability to reduce the commissions that we pay to our official check customers and to exit certain large customer relationships with high commission rates and costs, thereby continuing to generate a profit after the realignment of our investment portfolio into lower yielding investments. There can be no assurance that we will successfully reprice those official check customers that we wish to retain or that the timing of the exit of customers will not adversely affect our earnings and cash flow. Our exit from the largest official check relationships will reduce our revenue and operating income in the short term, with no initial replacement for such revenue.

Notwithstanding the realignment of our investment portfolio, fluctuations in interest rates will affect the value and amount of revenue produced by our investment portfolio, the amount of commissions that we pay and the amount we pay or receive under our swap agreements. There can be no assurance that we will be able to successfully manage interest rate exposure through the use of swaps or other arrangements or that interest rate fluctuation in our investments will align with the commission rates we pay to our official check customers.

 

Litigation or investigations involving MoneyGram or our agents, which could result in material settlements, fines or penalties, may adversely affect our business, financial condition and results of operations.

 

We have received a notice from the SEC that it is conducting an informal, non-public inquiry of our financial statements, reporting and disclosures related to our investment portfolio and offers and negotiations to sell the Company or our assets. While the SEC’s notice states that it has not determined that any violations of the securities laws have occurred, there can be no assurance of the outcome of the investigation. We are also currently the subject of stockholder litigation. While we believe the suits are without merit and intend to vigorously defend against such claims, the outcome of the lawsuits cannot be predicted at this time. The cost to defend the SEC inquiry and the stockholder litigation could be substantial, regardless of the outcome.

 

Regulatory and judicial proceedings, including risks associated with the SEC inquiry, our failure to comply with certain state regulatory requirements for a brief period of time, and potential adverse developments in connection with ongoing stockholder litigation, may adversely affect our business, financial condition and results of operations. There may also be adverse publicity associated with lawsuits and investigations that could decrease agent and customer acceptance of our services.

 

Additionally, our business has been in the past, and may be in the future, the subject of class action lawsuits, regulatory actions and investigations and other general litigation. The outcome of class action lawsuits, regulatory actions and investigations is difficult to assess or quantify. Plaintiffs or regulatory agencies in these lawsuits, actions or investigations may seek recovery of very large or indeterminate amounts, and the magnitude of these actions may remain unknown for substantial periods of time. The cost to defend or settle future lawsuits or investigations may be significant.

 

An inability of our agents or for the Company to maintain adequate banking relationships may adversely affect our financial condition.

 

Prior to the closing of the Capital Transaction, certain of our clearing and processing banks sought additional intra-day and other advance funding from us. While we believe the Capital Transaction will restore more ordinary funding protocols, it is possible that clearing and cash management banks will require advance funding or other security or even terminate their relationships with us. For the clearing of certain items, such as money orders, we rely on two clearing banks and thus have limited alternative resources. We may experience increased costs or significant disruption of our business if we should lose one of our existing clearing bank relationships.

 

We and our agents are considered Money Service Businesses, or “MSBs,” in the United States under the Bank Secrecy Act. The federal banking regulators are increasingly taking the stance that MSBs, as a class, are high risk. As a result, several financial institutions, which look to the federal regulators for guidance, have terminated their banking relationships with some of our agents and one depository bank has terminated its banking relationship with us. If agents are unable to maintain existing or establish new banking relationships, they may not be able to continue to offer our services. Any inability on our part to maintain existing or establish new banking relationships could adversely affect our business, results of operations and financial condition.

 

Loss of key employees could have a material adverse effect on our business, financial condition and results of operations.

 

Our success depends to a large extent upon the continued services of our executive management team and other key employees. The loss of key personnel could have a material adverse effect on our business, financial condition, results of operations and cash flows. Additionally, there are no assurances that we will be able to attract or retain other skilled personnel in the future.

Failure to maintain sufficient capital could adversely affect our results of operations and financial condition.

 

If we do not have sufficient capital, we may not be able to pursue our growth strategy and fund key strategic initiatives, such as product development and acquisitions. While we received substantial new capital in conjunction with the Capital Transaction, there can be no assurance that we will not need additional capital in the future. Given the leveraged nature of the Company and the significant restrictive covenants in our debt agreements, there can be no assurance that we will have access to additional capital. Failure to have such access could materially impact our results of operations and financial condition.

 

If we fail to successfully develop and timely introduce new and enhanced products and services or we make substantial investments in an unsuccessful new product or service or infrastructure change, our business, prospects, financial condition and results of operations could be adversely affected.

 

Our future growth will depend, in part, on our ability to continue to develop and successfully introduce new and enhanced methods of providing money transfer, money order, official check, bill payment and related services that keep pace with competitive introductions, technological changes and the demands and preferences of our agents, financial institution customers and consumers. Many of our competitors offer stored-value cards and other electronic payment mechanisms, including various internet-based and cellular phone payment services, that could be substituted for traditional forms of payment, such as the money order, bill payment and money transfer services that we offer. If these alternative payment mechanisms become widely substituted for our products and services, and we do not develop and ramp up similar alternative payment mechanisms successfully and on a timely basis, our business and prospects could be adversely affected. Additionally, we may make future investments or enter into strategic alliances to develop new technologies and services or to implement infrastructure change to further our strategic objectives, strengthen our existing businesses and remain competitive. Investments in new technologies and infrastructure and strategic alliances are inherently risky and we cannot guarantee that such investments will be successful or will not have a material adverse effect on our business, financial condition and results of operations.

 

If we are unable to adequately protect the intellectual property rights related to our existing and any new or enhanced products and services, or if we are unable to avoid infringing on the rights of others, our business, prospects, financial condition and results of operations could be adversely affected.

 

We rely on a combination of patent, trademark and copyright laws, trade secret protection and confidentiality and license agreements to protect the intellectual property rights related to our products and services. We also investigate the intellectual property rights of third parties to prevent our infringement of those rights. We may be subject to claims of third parties that we infringe or have misappropriated their proprietary rights. We may be required to spend resources to defend any such claims or to protect and police our own rights. Some of our intellectual property rights may not be protected by intellectual property laws, particularly in foreign jurisdictions. The loss of our intellectual property protection, the inability to secure or enforce intellectual property protection or to successfully defend against an intellectual property infringement action could harm our business and prospects.

 

We face intense competition, and if we are unable to continue to compete effectively, our business, financial condition and results of operations would be adversely affected.

 

The industries in which we compete are highly competitive, and we face a variety of competitors across our businesses. In addition, new competitors or alliances among established companies may emerge. Our primary competition comes from Western Union, which has substantially greater transaction volume than we do. Western Union has a larger agent base, a more established brand name and substantially greater financial and marketing resources than we do. We cannot anticipate every effect that actions taken by Western Union will have on our business, or the money transfer and bill payment industry in general.

 

Money transfer, money order and walk-in bill payment services within our Global Funds Transfer segment compete in a concentrated industry, with a small number of large competitors and a large number of small, niche competitors. Our large competitors are other providers of money orders and money transfer services, including Western Union and the U.S. Postal Service with respect to money orders. We also compete with banks and niche person-to-person

money transfer service providers that serve select send and receive corridors. The electronic bill payment services within our Global Funds Transfer segment compete in a highly fragmented consumer- to-business payment industry. Competitors in the electronic payments area include financial institutions, third parties that host financial institution and bill payment services, third parties that offer payment services directly to consumers and billers offering their own bill payment services. Competitors of PropertyBridge Inc. (“PropertyBridge”), our wholly owned subsidiary, include the providers of electronic bill payment services discussed above, as well as companies focusing solely on the rent payment vertical, companies focusing on multiple payment verticals, including rent payments, and providers of property management software.

 

Our Payment Systems segment competes in a concentrated industry with a small number of large competitors. Our competitors in this segment are federal home loan banks. We also compete with financial institutions that have developed internal processing capabilities or services similar to ours and do not outsource these services.

 

Recent levels of growth in consumer money transfer transactions, bill payment transactions and other payment products may not continue. In addition, consolidation among payment services companies has occurred and could continue. If we are unable to continue to grow our existing products, while also growing newly developed and acquired products, we will be unable to compete effectively in the changing marketplace, and our business, financial condition and results of operations would be adversely affected.

 

MoneyGram and our agents are subject to a number of risks relating to U.S. and International regulatory requirements which could result in material settlements, fines or penalties or changes in our or their business operations that may adversely affect our business, financial condition and results of operations.

 

Our business is subject to a wide range of laws and regulations which vary from country to country. The money transfer business is subject to a variety of regulations aimed at the prevention of money laundering and terrorism. We are subject to U.S. federal anti-money laundering laws, including the Bank Secrecy Act, as amended by the USA PATRIOT Act, the requirements of the Office of Foreign Assets Control (“OFAC”), which prohibit us from transmitting money to specified countries or on behalf of prohibited individuals and the anti-money laundering laws in many countries where we operate, particularly in the European Union. We are also subject to financial services regulations, money transfer and payment instrument licensing regulations, currency control regulations, escheat laws, laws covering consumer privacy, data protection and information security and consumer disclosure and consumer protection laws. Many of the laws to which we are subject are evolving, unclear and inconsistent across various jurisdictions, making compliance challenging.

 

Any intentional or negligent violation of the laws and regulations set forth above by our employees or our agents could lead to significant fines or penalties, and could limit our ability to conduct business in some jurisdictions. In addition to those direct costs, a failure by us or our agents to comply with applicable laws and regulations also could seriously damage our reputation and brands, and result in diminished revenue and profit and increased operating costs.

 

In connection with the Capital Transaction, we sold certain investments at a realized loss of $260.6 million. As a result of these portfolio sales, we were not in compliance for a brief period of time with the minimum net worth requirements of the states in which we are licensed to conduct our money transfer and other payment services businesses, as well as certain other requirements of one state. This failure to meet minimum net worth or other requirements may result in the states imposing certain fines and other penalties in the future.

 

Changes in laws, regulations or other industry practices and standards, or interpretations of legal or regulatory requirements may occur which could increase our compliance and other costs of doing business, require significant systems redevelopment, reduce the market for or value of our products or services or render our products or services less profitable or obsolete, and have an adverse effect on our results of operations. Changes in the laws affecting the kinds of entities that are permitted to act as money transfer agents (such as changes in requirements for capitalization or ownership) could adversely effect our ability to distribute our services and the cost of providing such services, both by us and our agents. If onerous regulatory requirements were imposed on our agents, the requirements could lead to a loss of agents, which, in turn, could lead to a loss of retail business.

 

Failure by us or our agents to comply with the laws and regulatory requirements of applicable regulatory authorities could result in, among other things, revocation of required licenses or registrations, loss of approved status,

termination of contracts with banks or retail representatives, administrative enforcement actions and fines, class action lawsuits, cease and desist orders and civil and criminal liability. The occurrence of one or more of these events could have a material adverse effect on our business, financial condition and results of operations.

 

We conduct money transfer transactions through agents in some regions that are politically volatile or, in a limited number of cases, are subject to certain OFAC restrictions.

 

We conduct money transfer transactions through agents in some regions that are politically volatile or, in a limited number of cases, are subject to certain OFAC restrictions. While we have instituted policies and procedures to protect against violations of law, it is possible that our money transfer service or other products could be used by wrong-doers in contravention of U.S. law or regulations. In addition to monetary fines or penalties that we could incur, we could be subject to reputational harm that could adversely impact the value of our stockholders’ investments.

 

We face security risks related to our electronic processing and transmission of confidential customer information. A material breach of security of our systems could adversely affect our business.

 

Any significant security or privacy breaches in our facilities, computer networks and databases could harm our business and reputation, cause inquiries and fines or penalties from regulatory or governmental authorities and cause a loss of customers. We discovered an unlawful data server attack and suffered potential improper data access by unauthorized persons in late 2006. We rely on encryption software and other technologies to provide security for processing and transmission of confidential customer information. Advances in computer capabilities, new discoveries in the field of cryptography or other events or developments, including improper acts by third parties, may result in a compromise or breach of the security measures we use to protect customer transaction data. We may be required to expend significant capital and other resources to protect against these security breaches or to alleviate problems caused by these breaches. Third-party contractors also may experience security breaches involving the storage and transmission of our confidential customer information. If users gain improper access to our or our contractor’s systems or databases, they may be able to steal, publish, delete or modify confidential customer information. A security breach could expose us to monetary liability, lead to reputational harm and make our customers less confident in our services.

 

Our business involves the movement of large sums of money, and, as a result, our business is particularly dependent on our ability to process and settle transactions accurately and on the efficient and uninterrupted operation of our computer network systems and data centers.

 

Our ability to provide reliable service largely depends on the efficient and uninterrupted operation of our computer network systems and data centers. Our business involves the movement of large sums of money. Our revenues consist primarily of transaction fees that we charge for the movement of this money and investment revenues. These transaction fees represent only a small fraction of the total amount of money that we move. Because we are responsible for large sums of money that are substantially greater than our revenues, the success of our business particularly depends upon the efficient and error-free handling of the money that is remitted to us and that is used to clear payment instruments or complete money transfers. We rely on the ability of our employees and our internal systems and processes to process these transactions in an efficient, uninterrupted and error-free manner. In addition, we rely on third-party vendors in our business, including clearing and processing banks that clear our money orders and official checks, and process automated clearing house (“ACH”) transactions and bank wires on our behalf and certain of our telecommunications providers.

 

In the event of a breakdown, catastrophic event (such as fire, natural disaster, power loss, telecommunications failure or physical break-in), security breach, improper operation or any other event impacting our systems or processes or our vendors’ systems or processes, or improper action by our employees, agents, customer financial institutions or third party vendors, we could suffer financial loss, loss of customers, regulatory sanctions and damage to our reputation. The measures we have enacted, such as the implementation of disaster recovery plans and redundant computer systems, may not be successful and we may experience problems other than system failures. We may also experience software defects, development delays and installation difficulties, which would harm our business and reputation and expose us to potential liability and increased operating expenses. Certain of our agent

contracts, including our contract with Wal-Mart, contain service level standards pertaining to the operation of our system, and give the agent a right to collect damages and in extreme situations a right of termination for system downtime exceeding agreed upon service levels. If we face system interruptions and system failures our business interruption insurance may not be adequate to compensate us for all losses or damages that we may incur.

 

If we are unable to effectively operate and scale our technology to match our business growth, our business, financial condition and results of operations could be adversely affected.

 

Our ability to continue to provide our services to a growing number of agents and consumers, as well as to enhance our existing services and offer new services is dependent on our information technology systems. If we are unable to effectively manage the technology associated with our business, we could experience increased costs, reductions in system availability and loss of agents or consumers. Any failure of our systems in scalability, reliability and functionality could adversely impact our business, financial condition and results of operations.

 

We face credit and fraud risks from our retail agents.

 

The vast majority of our Global Funds Transfer segment is conducted through independent agents that provide our products and services to consumers at their business locations. Our agents receive the proceeds from the sale of our payment instruments and money transfers and we must then collect these funds from the agents. As a result, we have credit exposure to our agents, which averages approximately $1.4 billion in the aggregate, representing a combination of money orders, money transfers and bill payment proceeds. During 2007, this credit exposure was spread across over 24,000 agents, of which 12 owed us in excess of $15.0 million each at any one time.

 

We are not insured against credit losses, except in circumstances of agent theft or fraud. If an agent becomes insolvent, files for bankruptcy, commits fraud or otherwise fails to remit money order or money transfer proceeds to us, we must nonetheless pay the money order or complete the money transfer on behalf of the consumer. Moreover, we have made, and may make in the future, secured or unsecured loans to retail agents under limited circumstances or allow agents to retain our funds for a period of time before remitting them to us. The failure of agents owing us large amounts to remit funds to us or to repay such amounts could have a material adverse effect on our business, results of operations and financial condition.

 

An increase in fraudulent activity using our services could lead to reputational damage to our brand and could reduce the use and acceptance of our services.

 

Criminals are using increasingly sophisticated methods to engage in illegal activities such as fraud and identity theft. As we make more of our services available over the internet we subject ourselves to new types of credit and fraud risk, because requirements relating to customer authentication are more complex with internet services. If fraud levels involving our services were to rise, it could lead to regulatory intervention and reputational and financial damage. This in turn could reduce the use and acceptance of our services or increase our compliance costs, and thereby have a material adverse impact on our business, financial condition and results of operations.

 

The opening of new retail locations and acquisition or start-up of businesses create risks and may adversely affect our operating results.

 

We have recently opened several Company-owned retail locations for the sale of our products and services. Operating such retail locations presents new risks for us. After substantial capital investment in such retail locations it is uncertain how such locations will be accepted in the market and how quickly transaction volume will increase to offset such investment. We may be subject to additional laws and regulations that are triggered by our ownership of the retail locations and our employment of the individuals staffing such retail locations. There are also certain risks inherent in operating any retail location, including theft, personal injury and property damage and risks associated with long-term lease obligations and employee matters.

 

Additionally, we may from time to time acquire or start up businesses both inside and outside of the U.S. The acquisition and integration of businesses, involve a number of risks. We may not be able to successfully integrate any businesses that we acquire or open, including their facilities, personnel, financial systems, distribution, operations and general operating procedures. If we fail to successfully integrate acquisitions, we could experience

increased costs and other operating inefficiencies, which could have an adverse effect on our results of operations. The diversion of capital and management’s attention from our core business that results from opening retail locations or acquiring or opening new businesses could adversely affect our business, financial condition and results of operations.

 

A material slow down or complete disruption in international migration patterns could adversely affect our business, financial condition and results of operations.

 

The money transfer business relies in part on migration patterns, as individuals move from their native country into countries with greater economic opportunities or a more stable political environment. A significant portion of money transfer transactions are initiated by immigrants or refugees sending money back to their native countries. Changes in immigration laws and economic development patterns that discourage international migration and political or other events (such as war, terrorism or health emergencies) that make it more difficult for individuals to migrate or work abroad could adversely affect our money transfer remittance volume or growth rate and could each have an adverse effect on our business, financial condition and results of operations.

 

There are a number of risks associated with our international sales and operations that could adversely affect our business.

 

We provided money transfer services between and among approximately 180 countries and territories at December 31, 2007, and our strategy is to expand our international business. Our ability to grow in international markets and our future results could be harmed by a number of factors, including:

 

 

Failure to maintain effective internal controls in accordance with Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on our business.

 

We are required to certify and report on our compliance with the requirements of Section 404 of the Sarbanes-Oxley Act, which requires annual management assessments of the effectiveness of our internal control over financial reporting and a report by our independent registered public accounting firm addressing the effectiveness of our internal control over financial reporting. If we fail to maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404. In order to achieve effective internal controls we may need to enhance our accounting systems or processes which could increase our cost of doing business. Any failure to achieve and maintain an effective internal control environment could have a material adverse effect on our business.

 

We have significant overhang of salable convertible preferred stock relative to float.

 

The trading market for our common stock was first established in June 2004. The float in that market now consists of approximately 82,000,000 shares out of a total of 82,598,034 shares issued and outstanding as of March 14, 2008. Under the Registration Rights Agreement entered into between the Company and the Investors at the closing of the

Capital Transaction, the Investors and other parties may require us to register for sale publicly (at times largely of their choosing) all of the Series B Stock that they hold, as well as any common stock or Series D Preferred Stock into which the Series B Stock may be converted. Sales of a substantial number of shares of our common stock, or the perception that significant sales could occur (particularly if sales are concentrated in time or amount), may depress the trading price of our common stock.

 

An agreement among the Investors and Wal-Mart could prevent an acquisition of the Company.

 

The Investors and Wal-Mart have entered into an agreement that, among other things, prevents the Investors, without the prior written consent of Wal-Mart, from voting in favor of, consenting to or selling or transferring their equity securities in a manner that would result in a change of control of the Company. This provision is effective until March 17, 2010. The Investors collectively have a majority of the voting stock of the Company and Wal-Mart, whose interests may differ from our stockholders’ interests, could prevent the Investors from agreeing to a sale of the Company under certain circumstances.

 

Our charter documents, our rights plan and Delaware law contain provisions that could delay or prevent an acquisition of the Company, which could inhibit your ability to receive a premium on your investment from a possible sale of the Company.

 

Our charter documents contain provisions that may discourage third parties from seeking to acquire the Company. In addition, we have adopted a rights plan which enables our Board of Directors to issue preferred share purchase rights that would be triggered by certain prescribed events. These provisions and specific provisions of Delaware law relating to business combinations with interested stockholders may have the effect of delaying, deterring or preventing a merger or change in control of the Company. Some of these provisions may discourage a future acquisition of the Company even if stockholders would receive an attractive value for their shares or if a significant number of our stockholders believed such a proposed transaction to be in their best interests. As a result, stockholders who desire to participate in such a transaction may not have the opportunity to do so.

 

If we cannot meet the New York Stock Exchange continued listing requirements, the NYSE may delist our common stock.

 

Our common stock is currently listed on the NYSE. In the future, we may not be able to meet the continued listing requirements of the NYSE, which require, among other things; (i) that the average closing price of our common stock be above $1.00 over 30 consecutive trading days; (ii) that the average market capitalization and stockholders’ equity be at least $75 million over 30 consecutive trading days; and (iii) that the average market capitalization be at least $25 million over 30 consecutive trading days. Our closing stock price on March 21, 2008 was $1.71, our market capitalization was approximately $141.2 million. Our stockholders’ deficit was $488.5 million at December 31, 2007.

 

If we are unable to satisfy the NYSE criteria for continued listing, our common stock would be subject to delisting. A delisting of our common stock could negatively impact us by, among other things, reducing the liquidity and market price of our common stock; reducing the number of investors willing to hold or acquire our common stock, which could negatively impact our ability to raise equity financing; decreasing the amount of news and analyst coverage for the Company; and limiting our ability to issue additional securities or obtain additional financing in the future.

 

We did not timely file with the SEC this Form 10-K for the fiscal year ended December 31, 2007. As a result of this delayed filing, we are currently ineligible to use Form S-3 to register securities with the SEC in capital-raising transactions, which may adversely affect our cost of future capital.

 

We did not timely file with the SEC our Form 10-K for the fiscal year ended December 31, 2007. Although the filing of this Annual Report on Form 10-K will bring us current in our filings with the SEC, because this Form 10-K was not filed within the deadline promulgated by the SEC, the filing was not timely under applicable SEC rules. As a result of the delayed filing of this Form 10-K, we are ineligible to use a “short form” registration statement on

Form S-3 to register securities for sale by us or for resale by other security holders, in capital raising transactions, until we have timely filed all periodic reports under the Securities Exchange Act of 1934 for at least 12 calendar months. In the meantime, for capital raising transactions, we would need to use Form S-1 to register securities with the SEC, or issue such securities in a private placement, which could increase the time and resources required to raise capital during this period.

 

 

 

None.

 

 

 

 

Information concerning our material properties, all of which are leased, including location, use, approximate area in square feet and lease terms, is set forth above. We also have a number of other smaller office locations in California, Florida, New York, Tennessee and in France, Germany, Italy and the United Kingdom, as well as small sales and marketing offices in Australia, China, Greece, Hong Kong, India, Netherlands, Nigeria, Russia, South Africa, Spain, Ukraine and United Arab Emirates. We believe that our properties are sufficient to meet our current and projected needs.

 

 

 

We are party to a variety of legal proceedings that arise in the normal course of our business. We accrue for legal proceedings as losses become probable and can be reasonably estimated. While the results of these legal proceedings cannot be predicted with certainty, management believes that the final outcome of these proceedings will not have a material adverse effect on our consolidated results of operations or financial position.

 

The Company and its officers and directors are parties to two stockholder lawsuits making various claims, including breach of fiduciary duty and unfair business practices relating to its disclosure of investments, the events leading to the Capital Transaction and the completion of the Capital Transaction without stockholder approval. In these actions, plaintiffs may request punitive or other damages that may not be covered by insurance.

 

SEC Inquiry — By letter dated February 4, 2008, we received a notice from the SEC that it is conducting an informal, non-public inquiry relating to the Company’s financial statements, reporting and disclosures related to the Company’s investment portfolio and offers and negotiations to sell the Company or its assets. The SEC’s notice states that it has not determined that any violations of the securities laws have occurred. On February 11, 2008, we received an additional letter from the SEC requesting certain information. We are cooperating with the SEC on a voluntary basis.

 

Not applicable.

 

Our stock is traded on the New York Stock Exchange under the symbol MGI. Our Board of Directors declared quarterly cash dividends totaling $0.20 and $0.17 per share of common stock during 2007 and 2006, respectively. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Stockholders’ Equity” and Note 12 — Pensions and Other Benefits of the Notes to Consolidated Financial Statements. As of March 14, 2008, there were approximately 15,114 stockholders of record of our common stock.

 

The high and low sales prices for our common stock for fiscal 2007 and 2006 were as follows:

 

 

On November 18, 2004, our Board of Directors authorized a plan to repurchase, at our discretion, up to 2,000,000 shares of MoneyGram common stock on the open market. On August 18, 2005, our Board of Directors increased its share buyback authorization by 5,000,000 shares to a total of 7,000,000 shares. On May 9, 2007, our Board of Directors increased its share buyback authorization by an additional 5,000,000 shares to a total of 12,000,000 shares. These authorizations were announced publicly in our press releases issued on November 18, 2004, August 18, 2005 and May 9, 2007, respectively. The repurchase authorization is effective until such time as the Company has repurchased 12,000,000 common shares. MoneyGram common stock tendered to the Company in connection with the exercise of stock options or vesting of restricted stock are not considered repurchased shares under the terms of the repurchase authorization. As of December 31, 2007, we have repurchased 6,795,000 shares of our common stock under this authorization and have remaining authorization to repurchase up to 5,205,000 shares. The Company has not repurchased any shares since July 2007, other than in connection with employees’ exercise of stock options.

 

The following table sets forth information in connection with repurchases of shares of our common stock during the quarterly period ended December 31, 2007.

 

We completed a Capital Transaction on March 25, 2008, as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Sale of Investments and Capital Transaction.” Under the terms of the equity securities and debt issued in connection with the Capital Transaction, our ability to declare or pay dividends or distributions to the stockholders of the Company’s common stock is severely limited.

 

STOCKHOLDER RETURN PERFORMANCE

 

The following graph compares the cumulative total return from June 22, 2004 to December 31, 2007 for our common stock, our peer group index of payment services companies used in 2006, our peer group index of payment services companies used in 2007 and the S&P 500 Index. Our common stock began trading on the New York Stock Exchange on June 22, 2004 on a when-issued basis in connection with the spin-off. The peer group index of payment services companies in 2007 consists of: CSG Systems International Inc., DST Systems, Inc., Euronet Worldwide Inc., Fidelity National Financial, Inc., Fiserv, Inc., Global Payments Inc., Jack Henry & Associates, Inc., Online Resources Corporation, The Western Union Company and Total System Services, Inc. (the “Peer Group Index 2007”). The peer group index of payment services companies in 2006 consists of: Ceridian Corporation, CheckFree Corporation, CSG Systems International Inc., DST Systems, Inc., eFunds Corporation, Euronet Worldwide Inc., First Data Corporation, Fiserv, Inc., Global Payments Inc., Jack Henry & Associates, Inc., The Western Union Company and Total System Services, Inc. (the “Peer Group Index 2006”). We changed our peer group in 2007 to delete companies which were purchased and are no longer stand alone public companies (Ceridian Corporation, eFunds Corporation, First Data Corporation, and CheckFree Corporation) and to add Fidelity National Financial, Inc. (title insurance/specialty insurance/claims management services) and Online Resources Corporation (payment services). The graph assumes the investment of $100 in each of our common stock, our peer group indexes and the S&P 500 Index on June 22, 2004, and the reinvestment of all dividends as and when distributed.

 

COMPARISON OF CUMULATIVE TOTAL RETURN
AMONG MONEYGRAM INTERNATIONAL, INC.,
S&P 500 INDEX AND PEER GROUP INDEX

 

 

 

 

The following table presents our selected consolidated financial data for the periods indicated. The information set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our Consolidated Financial Statements and notes thereto. For the basis of presentation of the information set forth below, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Basis of Presentation.”

 

 

 

The following discussion should be read in conjunction with MoneyGram International, Inc.’s Consolidated Financial Statements and related notes. This discussion contains forward-looking statements that involve risks and uncertainties. MoneyGram’s actual results could differ materially from those anticipated due to various factors discussed under “Cautionary Statements Regarding Forward-Looking Statements” and elsewhere in this Annual Report on Form 10-K.

 

Basis of Presentation

 

On December 18, 2003, MoneyGram International, Inc. (“MoneyGram”) was incorporated in the state of Delaware as a subsidiary of Viad Corp (“Viad”) to effect the spin off of Viad’s payment services business operated by Travelers Express Company, Inc. (“Travelers”) to its stockholders (the “spin-off”). On June 30, 2004, Travelers was merged with a subsidiary of MoneyGram and Viad then distributed 88,556,077 shares of MoneyGram common stock to Viad’s stockholders in a tax-free distribution. Effective December 31, 2005, the entity that was formerly Travelers was merged into MoneyGram Payment Systems, Inc. (“MPSI”), with MPSI remaining as the surviving corporation. References to “MoneyGram,” the “Company,” “we,” “us” and “our” are to MoneyGram International, Inc. and its subsidiaries and consolidated entities. The financial statements in this Annual Report on Form 10-K are presented on a consolidated basis and include the accounts of the Company and our majority-owned subsidiaries. Our Consolidated Financial Statements are prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”).

 

In 2005, we recorded a gain of $0.7 million (net of tax) due to the partial resolution of contingencies relating to the sale of Game Financial Corporation, which was completed in 2004. During 2007, we paid $3.3 million in connection with the settlement of a contingency arising from the Sale and Purchase Agreement related to the continued operations of Game Financial Corporation with one casino. We recognized a gain from discontinued operations of $0.3 million in the Consolidated Statements of (Loss) Income in 2007. The gain is comprised of the net of the reversal of the remaining liability and the recognition of a deferred tax asset valuation allowance. The following discussion of our results of operations is focused on our continuing businesses.

RESULTS OF OPERATIONS

 

Summary

 

Following are significant items affecting operating results from continuing operations in 2007:

 

 

During September 2007, the asset-backed securities market and broader credit markets began to experience significant disruption, with a general lack of liquidity in the markets and deterioration in fair value of mortgage-backed securities triggered by concerns surrounding sub-prime mortgages. In late November and December 2007, the asset-backed securities and credit markets experienced further substantial deterioration under increasing concerns over defaults on mortgages and debt in general, as well as an increasingly negative view towards all structured investments and the credit market. In December 2007, we began to experience adverse changes to the cash flows from some of our asset-backed investments. As the market continued its substantial deterioration, we identified a need for additional capital and commenced a plan in January 2008 to realign our investment portfolio away from asset-backed securities and into highly liquid assets through the sale of a substantial portion of the investment portfolio. As a result of these developments, we recognized $1.2 billion of other-than-temporary impairments in December 2007. See “Liquidity and Capital Resources — Impact of Credit Market Disruption” for further information. The declines in the portfolio did not have an immediate impact on our liquidity, but rather created a need for long-term capital.

 

In December 2007, we completed our strategic review of our Payment Systems segment. As a result of this review, we have begun to restructure our official check business model by changing our commission structure and exiting certain large customer relationships. This restructuring will enable us to continue providing these essential services by focusing on small- to mid-sized institutions. We expect to exit contracts with most of our top ten official check customers, who together account for approximately $2 billion of our official check payment service obligations. Included in the top ten official check customers are the financial institutions for which we maintain special purpose entities (“SPEs”). With the sale of investments and the Capital Transaction (defined below), we believe we have sufficient liquidity to manage the exiting of these customers without disruption to daily operating liquidity needs.

 

Capital Transaction

 

The Company completed a recapitalization transaction on March 25, 2008 pursuant to which the Company received a substantial infusion of both equity and debt capital (the “Capital Transaction”) to support the long term needs of the business and to provide necessary capital due to the investment portfolio losses. The equity component consisted of a $760.0 million private placement of participating convertible preferred stock. The debt component consisted of the issuance of $500.0 million of senior secured second lien notes with a ten year maturity. Additionally, we entered into a senior secured amended and restated credit agreement amending the Company’s existing $350.0 million debt facility to increase the facility by $250.0 million to a total facility size of $600.0 million. The new facility includes $350.0 million in two term loan tranches and a $250.0 million revolving credit facility. For a description of the terms of the equity and debt components of the Capital Transaction discussed below, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Sale of Investments and Capital Transaction” and Note 18 Subsequent Events of the Notes to Consolidated Financial Statements.

 

The net proceeds of the Capital Transaction were used to invest in cash equivalents to supplement our unrestricted assets.

Components of Net Revenue

 

Our net revenue consists of fee and other revenue, investment revenue and net securities gains and losses, less commission expense. We generate net revenue primarily by charging transaction fees in excess of third-party agent commissions, managing foreign currency exchange and managing our investments to provide returns in excess of commissions paid to financial institution customers.

 

We derive revenue primarily through service fees charged to consumers and through our investments. Fee and other revenue consist of transaction fees, foreign exchange and miscellaneous revenue. Transaction fees are fees earned on the sale of money transfers, retail money order and bill payment products and official check transactions. Money transfer transaction fees are fixed per transaction and may vary based upon the face value of the amount of the transaction and the location in which the money transfer originates and to which it is sent. Money order and bill payment transaction fees are fixed per transaction. Foreign exchange revenue is derived from the management of currency exchange spreads on international money transfer transactions. Miscellaneous revenue primarily consists of processing fees on rebate checks and controlled disbursements, service charges on aged outstanding money orders and money order dispenser fees.

 

Investment revenue consists of interest and dividends generated through the investment of cash balances received from the sale of official checks, money orders and other payment instruments. These cash balances are available to us for investment until the payment instrument is presented for payment. Investment revenue varies depending on the level of investment balances and the yield on our investments. Investment balances vary based on the number of payment instruments sold, the average face amount of those payment instruments and the average length of time that passes until the instruments are presented for payment. Net securities gains and losses consist of realized gains and losses on the sale of investments and other-than-temporary impairments of investments.

 

We incur commission expense on our money transfer products and our investments. We pay fee commissions to our third-party agents for money transfer services. In a money transfer transaction, both the agent initiating the transaction and the agent disbursing the funds receive a commission. The commission amount generally is based on a percentage of the fee charged to the consumers. We generally do not pay commissions to agents on the sale of money orders. Fee commissions also include the amortization of capitalized incentive payments to agents.

 

Investment commissions are amounts paid to financial institution customers based on the average outstanding cash balances generated by the sale of official checks, as well as costs associated with swaps and the sale of receivables program. In December 2007, the Company made a decision to cease selling receivables through a gradual reduction in the balances sold each period. As of January 2008, the Company did not have a sold receivables balance remaining (see further discussion on our sale of receivables program in Note 6 — Sale of Receivables of the Notes to Consolidated Financial Statements). In connection with our interest rate swaps, we pay a fixed amount to a counterparty and receive a variable rate payment in return. To the extent that the fixed rate exceeds the variable rate, we incur an expense related to the swap; conversely, if the variable rate exceeds the fixed rate, we receive income related to the swap. Under our receivables program, we sold our receivables at a discount to accelerate our cash flow; this discount was recorded as an expense. Commissions paid to financial institution customers generally are variable based on short-term interest rates. We utilize interest rate swaps, as described above, to convert a portion of our variable rate commission payments to fixed rate payments. These swaps assist us in managing the interest rate risk associated with the variable rate commissions paid to our financial institution customers.

Table 1 — Results of Operations

 

 

 

NM = Not meaningful

 

For the year ended December 31, 2007, total revenue decreased 86 percent from 2006 due to the net securities losses of $1.2 billion resulting from other-than-temporary impairments. See “Liquidity and Capital Resources — Impact of Credit Market Disruption” and Note 4 — Investments (Substantially Restricted) of the Notes to Consolidated Financial Statements for further information on our investments. Fee and other revenue increased 24 percent over 2006 due to continued growth in money transfer transaction volume. Total expenses, excluding commissions, increased 16 percent over 2006, reflecting increased infrastructure costs supporting the growth in our money transfer business and our global network, higher costs to support compliance activities and enhancements to our technology systems and additional headcount. Depreciation and amortization increased primarily due to our investment in agent equipment and signage, and our prior investments in computer hardware and capitalized software to enhance our support functions. Additionally, we recorded an impairment of goodwill related to a component of our Payment Systems segment. See further discussion of the impairment in Note 8 — Intangibles and Goodwill of the Notes to Consolidated Financial Statements.

 

A significant amount of our internationally originated transactions and settlements with international agents are conducted in the Euro. In addition, the operating expenses of most of our international subsidiaries are denominated in the Euro. In 2007, the Euro strengthened significantly against the U.S. Dollar. While the strong Euro benefits the internationally originated revenue in our Consolidated Statement of (Loss) Income, this benefit is significantly offset by the impact on commissions paid and operating expenses incurred in Euros. The impact of fluctuations in the Euro exchange rate on the Company’s consolidated net (loss) income has been minimal at approximately $3.2 million in 2007.

For the year ended December 31, 2006, total revenue and net revenue each grew by 19 percent over 2005 due to 41 percent growth in money transfer transaction volume. Total expenses, excluding commissions, increased 18 percent over 2005, which reflects additional headcount to support growth, increased marketing expenditures due to global brand initiatives and higher professional fees to support technology systems enhancements. These increased expenses were partially offset by lower agent credit losses.

 

Table 2 — Net Fee Revenue Analysis

 

 

Fee and other revenue consists of fees on money transfer, money orders and official check transactions. For 2007, fee and other revenue increased by $182.2 million, or 24 percent, from 2006, primarily driven by growth in the money transfer business (including bill payment services). Growth in money transfer fee and other revenue (including bill payment services) continued to be in line with growth in money transfer transaction volume, which increased 27 percent during the year as a result of our network expansion and targeted pricing initiatives. Transaction growth resulted in incremental fee and other revenue of $179.0 million. This transaction growth was offset slightly by a $9.9 million decrease in money transfer fees resulting from targeted pricing initiatives and changes in geographic and product mix (money transfer versus urgent bill payment). The change in the Euro exchange rate increased total fee and other revenue by $21.5 million in 2007 compared to 2006.

 

Our simplified pricing initiatives, which were initiated in the first half of 2005, included reducing the number of pricing tiers or bands, allowing us to manage our price-volume dynamic while streamlining the point of sale process for our agents and customers. While simplified pricing initiatives have contributed to a lower average per transaction fee, we believe that the initiatives have contributed to our volume growth as simpler pricing and lower overall fees attracts new customers. During 2007, the gap between total revenue growth and money transfer transaction growth narrowed primarily because we lapped the first year of implementation of simplified pricing initiatives. Our pricing philosophy continues to be to maintain a price point below our higher priced competitor but above the niche players in the market. We anticipate money transfer revenue and money transfer volume growth percentages to remain in line, subject to fluctuations in the Euro exchange rate, pricing initiatives and product mix.

 

For 2006 and 2005, fee and other revenue was 66 percent and 62 percent of total revenue, respectively. Compared to 2005, fee and other revenue grew $159.9 million, or 26 percent, in 2006, primarily driven by transaction growth in our money transfer and bill payment services, with volumes increasing 41 percent during the year. Transaction volume growth in money transfer and bill payment services increased fee and other revenue by $196.5 million. Average per transaction fees in money transfer and bill payment services were lower in 2006, reducing fee and other revenue by $56.7 million primarily as a result of our simplified pricing initiative and as a result of shifts in product and geographic origination mix. Money transfer and bill payment transactions continued to drive fee and other revenue growth in 2006, while money order transactions, which have higher margins, declined. Our domestic transactions, which contributed lower revenue per transaction, grew at a faster rate than internationally originated transactions. The gap between total revenue growth and money transfer transaction growth narrowed in the fourth quarter of 2006 as we began to lap the first year of implementation of simplified pricing initiatives. The change in the Euro exchange rate increased revenue by $3.2 million compared to 2005.

 

Fee commissions consist primarily of fees paid to our third-party agents for the money transfer service. We generally do not pay fee commissions on our money order products. Fee commissions expense grew at a faster pace than fee revenue, increasing $95.9 million, or 30 percent, for 2007 as compared to the prior year, driven by higher money transfer transaction volume, tiered commissions and a stronger Euro. Higher money transfer transaction volumes increased fee commissions expense by $79.0 million, while higher average commissions per transaction

increased commissions by $10.2 million, primarily from tiered commissions. Tiered commissions are commission rates that are adjusted upward, subject to certain caps, as an agent’s transaction volume grows. We use tiered commission rates as an incentive for select agents to grow transaction volume by paying our agents for performance and allowing them to participate in adding market share for MoneyGram. The change in the Euro exchange rate increased fee commissions by $9.7 million in 2007 compared to 2006. For 2006, fee commissions expense increased $83.2 million, or 36 percent, over 2005, primarily due to higher transaction volume and tiered commissions. Higher money transfer transaction volumes increased fee commissions expense by $61.2 million, while average commissions per transaction increased $13.0 million, primarily from tiered commissions. The change in the Euro exchange rate increased fee commissions by $1.3 million in 2006 compared to 2005.

 

Net fee revenue increased 19 percent in 2007 compared to 2006, driven primarily by the increase in money transfer transaction volume. Growth in net fee revenue was lower than fee and other revenue growth primarily due to tiered commissions. Net fee revenue increased 20 percent in 2006 compared to 2005, driven by the increase in volume of money transfer and bill payment transactions. Growth in net fee revenue was lower than fee and other revenue growth in 2006 compared to 2005, primarily due to a shift in product mix towards money transfer and tiered commissions.

 

Table 3 — Net Investment Revenue Analysis

 

 

 

 

Investment revenue in 2007 increased one percent over 2006 due to wider spreads earned in 2007 and higher average investable balances in 2007, but were partially offset by higher investment revenue in 2006 that benefited from $14.0 million in cash flows from previously impaired investments and income from limited partnership interests. During the last half of 2007, our cash investments and adjustable rate securities, which are primarily tied to LIBOR, earned a wider spread due to the disruption in the credit markets. Investment revenue in 2006 increased seven

percent over 2005 due to higher yields on the portfolio from rising short-term interest rates and the benefit from previously impaired investments and income from limited partnership interests, but was partially offset by lower average investable balances.

 

Investment commissions expense in 2007 increased two percent compared to the prior year, reflecting higher commissions paid to financial institution customers resulting from an increase of 5 basis points in the average federal funds rate over the prior year. Investment commissions expense in 2006 increased four percent compared to the prior year as rising short-term rates resulted in higher commissions paid to financial institution customers and increased the amount of the cost of receivables sold. The impact of rising rates in 2006 was significantly offset by lower swap costs. Lower swap costs are the result of maturing high rate swaps replaced by lower rate swaps, increases in short-term rates and lower notional swap balances.

 

The Company had $1.4 billion of outstanding swaps with an average fixed pay rate of 4.3 percent at December 31, 2007, compared to $2.6 billion with an average fixed pay rate of 4.3 percent at December 31, 2006. Approximately $1.4 billion of swaps matured during 2007. The run off of the lower priced swaps during 2007 increased investment commission expense over the same period in the prior year. Approximately seven percent of the notional value of our swaps will roll off during the first quarter of 2008. The remaining balance will roll off beginning in 2009 and continuing through 2012. In the first quarter of 2008, the Company terminated three outstanding swaps with a notional value of $32.0 million in connection with the sale of the investments related to these swaps.

 

Net investment revenue decreased 1 percent in 2007 compared to 2006 reflecting the benefit of pre-tax cash flow on previously impaired investments and income from limited partnerships recorded in 2006 and higher investment commission expense in 2007. Net investment margin decreased 3 basis points to 2.28 percent in 2007 compared to 2006, reflecting a decrease in net investment revenue and somewhat offset by an increase in average investable balances. During 2006, net investment revenue increased 14 percent compared to 2005, with the net investment margin increasing 40 basis points to 2.31 percent. During 2006, the average federal funds rate increased 175 basis points and the average 5-year U.S. Treasury Note increased 70 basis points. These changes in interest rates are representative of the flat yield curve environment in which we operated in 2006. During 2005, the average federal funds rate increased 187 basis points and the average 5-year U.S. Treasury Note increased 62 basis points. The 2006 and 2005 margins benefited from the investment revenue items discussed above, as well as the lower swap costs.

 

In January 2008, we commenced a process to realign our investment portfolio away from asset-backed securities into highly liquid assets. We anticipate the realigned portfolio will be comprised primarily of cash equivalents and government and government agency securities. In addition, the Company began a restructuring of its official check business model by changing its commission structure and exiting certain large customer relationships. As a result, we anticipate that our net investment margins will be adversely affected on a going forward basis by the lower yields in our realigned portfolio. While we expect our commission re-pricing initiatives under the official check restructuring to substantially offset the impact of the lower yields from the realigned portfolio, we will not know the final results of the re-pricing initiatives for some time.

 

Table 4 — Summary of Gains, Losses and Impairments

 

 

As shown in Table 4, the Company had a net securities losses of $1.2 billion in 2007 compared to net securities losses of $2.8 million in 2006. The increase in net securities losses is due to $1.2 billion of other-than-temporary impairments recorded in December 2007. See “Liquidity and Capital Resources — Impact of Credit Market Disruption” for further discussion of the other-than-temporary impairments.

Compared to the $2.8 million of net securities losses recorded in 2006, the Company had net securities losses of $3.7 million in 2005, primarily due to lower realized losses and lower impairments. Net securities losses of $2.8 million recorded in 2006 include impairments related to investments backed by automobile, aircraft, manufactured housing, bank loans and insurance securities collateral. Impairments in 2005 related primarily to investments backed by aircraft and manufactured housing collateral.

 

Expenses

 

Expenses represent operating expenses other than commissions. Following is a discussion of the operating expenses presented in Table 1.

 

Compensation and benefits — Compensation and benefits includes salaries and benefits, management incentive programs and other employee related costs. Compensation and benefits increased $15.8 million, or 9 percent, in 2007 compared to 2006, resulting primarily from an increase in salaries and benefits of $31.4 million, partially offset by a decrease of $16.7 million in incentive compensation accruals. The increase in salaries and benefits is primarily due to a $24.6 million increase in salaries due to higher headcount supporting the growth of the money transfer business, a $2.5 million increase in medical costs and a $2.4 million increase in payroll taxes. Incentive compensation decreased $18.6 million due to the Company’s 2007 performance and stock price decline, offset by a $2.0 million increase in stock-based compensation expense. The increase in stock based compensation expense is due primarily to the high value of the Company’s stock price at the date of the 2007 grants, partially offset by a lower number of awards being earned in the current year. The change in the Euro exchange rate, which is reflected in each of the amounts discussed above, increased compensation and benefits by approximately $1.4 million compared to 2006. As of December 31, 2007, the number of employees increased 10 percent over 2006 as we increased headcount for our support functions and continued to staff our retail locations in France and Germany. We expect to see a double-digit increase in headcount in 2008, resulting in continued increases to compensation and benefits.

 

Compensation and benefits increased $39.5 million, or 30 percent, in 2006 compared to 2005, primarily driven by the hiring of additional personnel, resulting in an increase in salary expense of $22.6 million, higher performance incentive accruals of $7.1 million and an increase of $1.6 million of stock-based compensation expense. In 2006, the number of employees increased by 21 percent over 2005 to drive and support money transfer growth.

 

Transaction and operations support — Transaction and operations support expenses include marketing costs, professional fees and other outside services costs, telecommunications and forms expense related to our products. Transaction and operations support costs increased $26.9 million, or 16 percent, in 2007 compared to 2006, primarily due to higher costs related to the expansion of the money transfer business and the global network, as well as an impairment of $6.4 million of goodwill related to a component of our Payment Systems segment. See further discussion of the impairment recorded in Note 8 — Intangibles and Goodwill of the Notes to Consolidated Financial Statements. Provision for loss increased in 2007 by $4.6 million over 2006, with no noticeable trends driving the increase. As our agent base and transaction volumes continue to grow, we expect that provision for loss will increase; however, we expect this growth to be much slower than agent base and transaction growth due to our underwriting and credit monitoring processes. Professional fees increased $5.3 million primarily due to increased contractor and consulting fees to support compliance activities and enhancements to our technology systems and increased credit servicing fees. Marketing costs increased $3.2 million, agent forms and supplies costs increased $2.7 million and licensing fees increased by $2.5 million, all primarily due to the increase in agent locations. These increases were offset by a decrease of $4.1 million in the directors deferred compensation accrual related to the decrease in the price of our common stock. The change in the Euro exchange rate, which is reflected in each of the amounts discussed above, increased transaction and operations support by approximately $6.0 million compared to 2006.

 

Transaction and operations support costs were up $14.1 million, or nine percent, in 2006 compared to 2005, primarily driven by an increase of $15.0 million in marketing expenditures as we continue to invest in our brand and support our agent growth and an increase of $9.0 million in professional fees to support enhancements to our technology systems. These increases were partially offset by a $9.0 million decline in provision for uncollectible receivables primarily resulting from the additional provision of $6.7 million in 2005 for one agent. In addition, in 2006, we recognized an impairment of $0.9 million due to the discontinuation of a software development project.

We continue to see a trend among state and federal regulators toward enhanced scrutiny of anti-money laundering compliance. As we continue to add staff resources and enhancements to our technology systems to address this trend, our transaction expenses will likely increase. In addition, we anticipate that our transaction expenses will increase due to marketing spend, investment in the agent network and development of our retail network in Western Europe. We anticipate these expenses will grow at a rate similar to 2007, excluding the goodwill impairment, based on our assumed agent network growth of 15 to 20 percent. We also will incur significant one-time charges for costs related to the Capital Transaction and strategic review of the Payment Systems segment. See Note 18 — Subsequent Events of the Notes to Consolidated Financial Statements for further information.

 

Depreciation and amortization — Depreciation and amortization expense includes depreciation on point of sale equipment, agent signage, computer hardware and software (including capitalized software development costs), office furniture, equipment and leasehold improvements and amortization of intangible assets. Depreciation and amortization expense increased $13.0 million, or 33 percent, in 2007 compared to 2006, primarily due to our investment in agent equipment and signage of $5.3 million, amortization of our investment in computer hardware and capitalized software in prior periods to enhance our support functions, as well as amortization of purchased software of $5.1 million. Our investments in computer hardware and software helped drive the growth in money transfer product. Additionally, amortization of acquired intangible assets increased by $1.2 million from 2006, primarily due to the acquisition of PropertyBridge, Inc (“PropertyBridge”) on October 1, 2007. We expect to see a further increase in amortization of intangible assets due to the intangible assets acquired in the acquisition of PropertyBridge. See further discussion in Note 8 — Intangibles and Goodwill of the Notes to Consolidated Financial Statements.

 

Depreciation and amortization expense increased $6.5 million, or 20 percent, in 2006 compared to 2005, primarily due to the amortization of our investment in computer hardware and capitalized software of $4.4 million to enhance the money transfer platform, the depreciation of agent equipment of $2.3 million and the amortization of leasehold improvements of $0.5 million (offset by a corresponding reduction in rent expense of $1.1 million).

 

The Company is currently implementing a new system to provide improved connections between our agents and our marketing, sales, customer service and accounting functions. The new system and associated processes are intended to increase the flexibility of our back office, thereby improving operating efficiencies. In 2007, we capitalized software costs of approximately $3.7 million related to the enhancements to our financial processing systems that will impact future depreciation and amortization. As we continue our investment in the infrastructure for future growth, we expect depreciation and amortization expense to increase.

 

Occupancy, equipment and supplies — Occupancy, equipment and supplies includes facilities rent and maintenance costs, software and equipment maintenance costs, freight and delivery costs and supplies. Occupancy, equipment and supplies expense increased $8.9 million, or 25 percent, in 2007 compared to 2006, primarily due to software expense and maintenance, delivery, freight and supplies expense and office rent. Software expense and maintenance increased $2.8 million due primarily to purchased licenses to support our growth and compliance initiatives. Delivery, freight and supplies expense increased $2.1 million in connection with the growth in our agent locations. Office rent increased $1.9 million due to annual rent increases and expanded retail locations.

 

Occupancy, equipment and supplies expense increased $4.3 million, or 14 percent, in 2006 compared to 2005, primarily due to normal increases in facilities rent of $1.9 million and higher software maintenance costs of $1.1 million, partially offset by gains on disposal of equipment of $1.0 million. Software expense and maintenance increases relate primarily to purchased licenses to support our growth and compliance initiatives, as well as licensing costs which were incurred by Viad prior to the spin-off.

 

Interest expense — Interest expense increased 39 percent in 2007 compared to 2006, primarily due to higher average interest rates and an increase in outstanding debt. The increase was partially offset by receipts under our cash flow hedges. During the second half of 2007, we borrowed an additional $195.0 million under the revolving credit facility. In connection with an amendment to waive certain covenants at December 31, 2007, the interest rates related to all outstanding balances increased as of January 1, 2008. We expect interest expense to increase in 2008 due to this increase in interest rates and the additional debt associated with the Capital Transaction. See further discussion of the credit facility in Note 9 — Debt of the Notes to Consolidated Financial Statements and further discussion of the Capital Transaction in Note 18 — Subsequent Events of the Notes to Consolidated Financial

Statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Sale of Investments and Capital Transaction”.

 

Interest expense increased four percent in 2006 as compared to 2005, primarily due to higher average interest rates, which were partially offset by receipts under our cash flow hedges. In connection with the amendment of our $350.0 million bank credit facility in the second quarter of 2005, we expensed $0.9 million of unamortized financing costs related to the original facility. Also see “Management’s Discussion and Analysis — Other Funding Sources and Requirements” for further information regarding our bank credit facility.

 

Income taxes — In 2007, we had $78.5 million of tax expense on a pre-tax loss of $993.3 million resulting in a negative effective tax rate of 7.9 percent. The effective tax rate was 29.8 percent in 2006 and 23.3 percent in 2005. The decrease in the effective tax rate in 2007 is primarily due to establishing a deferred tax asset valuation allowance of $417.6 million for the impairment of securities. Due to the amount and characterization of losses, as of December 31, 2007, we determined that it was not “more likely than not” that the deferred tax assets related to the losses will be realized. We are continuing to evaluate available tax positions related to the net securities losses, which may result in future tax benefits.

 

The corporate tax rate in 2006 and 2005 is lower than the statutory rate primarily due to income from tax-exempt bonds in our investment portfolio. The tax rate in 2005 benefited from a reduction in provision of $5.6 million due to reversal of tax reserves no longer needed due to the passage of time and changes in estimates of tax amounts. These benefits in 2006 were partially offset by the decline in tax-exempt investment income as a percentage of total pre-tax income.

 

Acquisitions and Discontinued Operations

 

PropertyBridge, Inc. — On October 1, 2007, the Company acquired PropertyBridge for $28.1 million, plus a potential earn-out payment of up to $10.0 million contingent on PropertyBridge’s performance during 2008. PropertyBridge is a provider of electronic payment processing services for the real estate management industry. PropertyBridge offers a complete solution to the resident payment cycle, including the ability to electronically accept deposits and rent payments. Residents can pay rent online, by phone or in person and set up recurring payments. PropertyBridge is a component of the Company’s Global Funds Transfer segment.

 

The Company has finalized its purchase price allocation, resulting in goodwill of $24.1 million and purchased intangible assets of $6.0 million, consisting primarily of customer lists, developed technology and a non-compete agreement. The intangible assets will be amortized over useful lives ranging from three to fifteen years. Goodwill was assigned to the Company’s Global Funds Transfer segment. The acquisition cost includes $0.2 million of transaction costs.

 

The operating results of PropertyBridge subsequent to October 1, 2007 are included in the Company’s Consolidated Statements of (Loss) Income.

 

Money Express — On May 31, 2006, MoneyGram completed the acquisition of Money Express S.r.l. (“Money Express”), the Company’s former money transfer super agent in Italy, for $15.0 million. In connection with the acquisition, the Company formed MoneyGram Payment Systems Italy, S.r.l., a wholly-owned subsidiary, to operate the former Money Express agent network. The acquisition provides the Company with the opportunity for further network expansion and more control of marketing and promotional activities in the region.

 

The Company finalized its purchase price allocation in 2007, resulting in a decrease of $0.3 million to goodwill. Purchased intangible assets of $7.7 million, consisting primarily of customer lists and a noncompetition agreement, will be amortized over useful lives ranging from three to five years. Goodwill of $16.7 million was recorded and assigned to the Company’s Global Funds Transfer segment. The acquisition cost includes $1.3 million of transaction costs and the forgiveness of $0.7 million of liabilities.

 

The operating results of Money Express subsequent to May 31, 2006 are included in the Company’s Consolidated Statements of (Loss) Income.

ACH Commerce — The Company purchased ACH Commerce, LLC (“ACH Commerce”) in April 2005 for $8.5 million, of which $1.1 million was to be paid upon the second anniversary of the acquisition. Based on the terms of the acquisition agreement, the Company paid this amount during the second quarter of 2007.

 

Game Financial Corporation — In 2005, the Company recorded a gain of $0.7 million (net of tax) due to the partial resolution of contingencies relating to the sale of Game Financial Corporation, (“Game Financial”) which was completed in 2004. During 2007, the Company paid $3.3 million in connection with the settlement of a contingency in the Sales and Purchase Agreement related to the continued operations of Game Financial with one casino. We recognized a loss from discontinued operations of $0.3 million in the Consolidated Statements of (Loss) Income in 2007, representing the recognition of a deferred tax asset valuation allowance partially offset by the reversal of the remaining liability.

 

Segment Performance

 

We measure financial performance by our two business segments:

 

Global Funds Transfer — this segment provides global money transfer services, money orders and bill payment services to consumers through a network of agents. Fee revenue is driven by transaction volume and fees per transaction. In addition, investment and related income is generated by investing funds received from the sale of money orders until the instruments are settled.

 

Payment Systems — this segment provides financial institutions with payment processing services, primarily official check outsourcing services and money orders for sale to their customers, and processes controlled disbursements. Investment and related income is generated by investing funds received from the sale of payment instruments until the instruments are settled. In addition, revenue is derived from per-item fees paid by our financial institution customers.

 

The business segments are determined based upon factors such as the type of customers, the nature of products and services provided and the distribution channels used to provide those services. Segment pre-tax operating income and segment operating margin are used to evaluate performance and allocate resources.

 

We manage our investment portfolio on a consolidated level and the specific investment securities are not identifiable to a particular segment. However, average investable balances are allocated to our segments based upon the average balances generated by that segment’s sale of payment instruments. The investment yield generally is allocated based upon the total average investment yield. Gains and losses are allocated based upon the allocation of average investable balances. Our derivatives portfolio is also managed on a consolidated level and the derivative instruments are not specifically identifiable to a particular segment. The total costs associated with our derivatives portfolio are allocated to each segment based upon the percentage of that segment’s average investable balances to the total average investable balances. Other unallocated expenses include pension and benefit obligation expense, director deferred compensation plan expense and other miscellaneous corporate expenses not allocated to the segments. Table 5 reconciles “Total segment operating (loss) income” to “(Loss) income from continuing operations before income taxes” as reported in the Consolidated Statements of (Loss) Income.

 

Table 5 — Segment Information

 

Table 6 — Global Funds Transfer Segment

 

 

 

NM = Not meaningful

 

Total revenue decreased $50.8 million, or six percent, in 2007 compared to 2006 due to net securities losses of $234.2 million that were recorded on our investment portfolio and allocated to this segment. See further discussion of the losses in Note 4 — Investments (Substantially Restricted) of the Notes to Consolidated Financial Statements. Total fee and other revenue for the Global Funds Transfer segment increased $183.8 million, or 25 percent, in 2007 compared to 2006 and continues to be driven by the growth in the money transfer business (including bill payment services). Growth in money transfer fee and other revenue (including bill payment services) increased 28 percent over the prior year and continued to be in line with growth in money transfer transaction volume, which increased 27 percent during the year as a result of our network expansion and targeted pricing initiatives. Transaction growth resulted in incremental fee and other revenue of $179.0 million. This increase was offset by $9.9 million of decreases in money transfer fees related to targeted pricing initiatives and changes in geographic and product mix (money transfer versus urgent bill payment). Our domestic transactions, which contribute lower revenue per transaction, grew at a faster rate of 38 percent, while internationally originated transactions (outside of North America) grew 34 percent from 2006. Transaction volume to Mexico grew 8 percent in 2007 compared to 2006. We believe economic conditions in the U.S. housing market and immigration concerns continued to dampen the growth in volume. Our Mexico volume represented 10 percent of our total transactions in 2007. The growth in money transfer is the result of our network expansion and continued targeted pricing initiatives to provide a strong consumer value proposition supported by targeted marketing efforts. The money transfer agent base expanded 30 percent over 2006, primarily in the international markets, to about 143,000 locations.

 

Our simplified pricing initiatives, which were initiated in the first half of 2005, included reducing the number of pricing tiers or bands, allowing us to manage our price-volume dynamic while streamlining the point of sale process

for our agents and customers. While simplified pricing initiatives have contributed to a lower average per transaction fee, we believe that the initiatives have contributed to our volume growth as a simpler pricing process and lower overall fees attracts new customers. During 2007, the gap between total revenue growth and money transfer transaction growth narrowed as we lapped the first year of implementation of simplified pricing initiatives.

 

Total revenue increased 26 percent in 2006 compared to 2005, primarily driven by the growth in the money transfer and bill payment services, as total transaction volume grew 41 percent. Transaction volume growth in money transfer and bill payment services increased fee and other revenue by $196.5 million. Average per transaction fees in money transfer and bill payment services were lower in 2006, reducing fee and other revenue by $56.7 million, primarily as a result of our simplified pricing initiative. In addition, average per transaction fees were lower in 2006 than 2005 as a result of shifts in product and geographic origination mix. Money transfer and bill payment transactions continued to drive fee and other revenue growth in 2006, while money order transactions, which have higher margins, declined. Domestic originated transactions (including bill payment) grew 46 percent with growth across all corridors, while international originated transactions grew 30 percent from 2005. Transaction volume to Mexico grew 29 percent in 2006 over 2005. Our Mexico volume represented 11 percent and 12 percent of our total transactions in 2006 and 2005, respectively. In 2006, the money transfer agent base expanded 24 percent over 2005, primarily in the international markets, to about 110,000 locations.

 

At December 31, 2007, money transfer agents are located in the following geographic regions: 33,300 locations in North America; 22,200 locations in Latin America (including Mexico, which represents 10,600 locations); 44,200 locations in Western Europe and the Middle East; 10,800 locations in the Indian subcontinent; 13,600 locations in Asia Pacific; 13,700 locations in Eastern Europe and 5,200 locations in Africa.

 

Fee and other revenue for retail money order decreased seven percent and two percent in 2007 and 2006, respectively, compared to the prior year. These decreases are in line with declines in volume for both years. The Company expects to see a decline in money order fee and other revenue of approximately 5 percent in 2008.

 

Investment revenue in the Global Funds Transfer segment decreased one percent in 2007 compared to 2006 due to lower average investable balances and as 2006 benefited from $3.1 million of pre-tax cash flow on previously impaired investments and income from limited partnership interests. Pre-tax cash flows in 2007 from previously impaired investments and income from limited partnership interests was nominal. Partially offsetting these decreases was the benefit from wider spreads earned on our cash investments and adjustable rate securities due to the disruption in the credit markets in the second half of 2007. Net securities losses in 2007 reflect other-than-temporary impairments of $234.2 million that were recorded on our investment portfolio and allocated to this segment. See further discussion of the losses in Note 4 — Investments (Substantially Restricted) and Note 18 — Subsequent Events of the Notes to Consolidated Financial Statements. Investment revenue increased 17 percent in 2006 compared to 2005 primarily due to higher average yields which were partially offset by lower average investable balances. Net securities losses were flat in 2006 compared to 2005.

 

Commissions expense in 2007 was up 29 percent compared to 2006, primarily driven by tiered commission rates paid to certain agents and increases in the Euro exchange rate. Tiered commissions are commission rates that are adjusted upward, subject to certain caps, as an agent’s transaction volume grows. We use tiered commission rates as an incentive for select agents to grow transaction volume by paying the agents for performance and allowing the agent to participate in adding market share for MoneyGram. Our largest agent, Wal-Mart, achieved new tiers in the third quarter of 2006 and the fourth quarter of 2007. In conjunction with our Capital Transaction, we extended the term of the current agreement with Wal-Mart through January 2013 and agreed to certain commission increases over the extended term of the contract. See further discussion of the Capital Transaction in Note 18 — Subsequent Events of the Notes to Consolidated Financial Statements and in “Liquidity and Capital Resources — Sale of Investments and Capital Transaction.” As compared to 2005, commissions expense in 2006 was up 34 percent, primarily driven by the 28 percent growth in fee and other revenue. Commissions expense as a percentage of revenue increased from 38.4 percent in 2005 to 40.6 percent in 2006, primarily due to tiered commission rates paid to certain agents and product mix (as growth in the money transfer business outpaced money orders).

 

Operating loss of $60.4 million and operating margin of (7.8) percent in 2007 reflect the net securities losses of $234.2 million that were recorded on our investment portfolio and allocated to this segment. The losses were partially offset by the growth in money transfer. Operating income in 2006 increased 25 percent over the previous

year due to the growth in money transfer and bill payment services and the higher investment revenue. The operating margin of 18.6 percent in 2006 was essentially flat compared to 2005. An additional provision for agent loss impacted the 2005 operating margin by (0.9) percentage points.

 

Table 7 — Payment Systems Segment

 

 

 

NM = Not meaningful

 

 

Total revenue includes investment revenue, net securities gains and losses, per-item fees charged to our official check financial institution customers and fees earned on our rebate processing business. Total net loss in the Payment Systems segment of $614.4 million for 2007 reflects net securities losses of $955.6 million that were recorded on our investment portfolio. See further discussion of the losses in “Liquidity and Capital Resources — Impact of Credit Market Disruption” and Note 4 — Investments (Substantially Restricted) of the Notes to Consolidated Financial Statements. Total revenue for 2006 includes $10.9 million of cash flows from previously impaired securities and income from limited partnership interests. Such cash flows were nominal for 2007. Total revenue increased five percent in 2006 compared to 2005 due primarily to higher investment revenue from higher yields earned on the portfolio from the increase in short-term interest rates.

 

Commissions expense includes payments made to financial institution customers based on official check average investable balances and short-term interest rate indices, as well as costs associated with swaps and the sale of receivables program. Commissions expense increased two percent in 2007, primarily due to higher commissions paid to financial institution customers resulting from an increase in the average federal funds rate over the prior year, as well as the run-off of interest rate swaps. Commissions expense increased four percent in 2006, primarily due to higher commissions paid to financial institutions as short-term interest rates increased. Commissions expense as a percentage of investment revenue was 77 percent for all years presented.

 

The operating loss for 2007 was $920.1 million, reflecting the net securities losses of $955.6 million resulting from other-than-temporary impairment charges recognized on the investment portfolio and a goodwill impairment charge of $6.4 million relating to one component of the Payment Systems segment. After considering the net securities losses and goodwill impairment charge, the operating margin for 2007 declined 70 basis points from 2006 due primarily to the run-off of interest rate swaps. The operating margin in 2006 decreased to 12.3 percent (16.7 percent on a taxable equivalent basis) as compared to 2005 operating margin of 13.2 percent (18.0 percent on a taxable equivalent basis), primarily due to lower average investable balances and a $0.9 million charge for the discontinuance of a development project. The cash flows from previously impaired securities, income from limited partnership interests and termination fee contributed a combined 2.6 percentage points and 4.9 percentage points, respectively, to the operating margin in each of 2006 and 2005.

 

In late 2007, MoneyGram conducted a comprehensive review of the Payment Systems segment. As a result of this review, the Company has begun to restructure its official check business model by changing its commission structure and exiting certain large customer relationships. This restructuring will enable the Company to continue providing these essential services by focusing on small- to mid-sized institutions. The Company expects to exit contracts with most of its top ten official check customers, who together account for approximately $2 billion of the Company’s official check payment obligations, thereby significantly reducing our official check business. Also impacting the Payment Systems segment is the process commenced in January 2008 to realign our investment portfolio away from asset-backed securities into highly liquid assets. We anticipate that the realigned portfolio will be comprised primarily of cash equivalents, government and government agency securities. As a result, we anticipate that our profit margins in the official check business will be adversely affected by the lower yields in our realigned portfolio. While we expect our commission re-pricing initiatives under the official check restructuring to fully offset the impact of the lower yields from the realigned portfolio, we will not know the final results of the re-pricing initiatives for some time.

 

LIQUIDITY AND CAPITAL RESOURCES

 

One of our primary financial goals is to maintain adequate liquidity to manage the fluctuations in the balances of payment service assets and obligations resulting from sales of official checks, money orders and other payment instruments, the timing of the collections of receivables and the timing of the presentment of such instruments for payment. In addition, we strive to maintain adequate liquidity for capital expenditures and other normal operating cash needs. Another primary financial goal is to maintain adequate capital to ensure the on-going compliance with regulatory and contractual requirements through the fluctuations in the balances of our payment service assets and obligations, particularly investments.

We have various resources available to us for purposes of managing liquidity and capital needs, including our cash, cash equivalents, investments, credit facilities, reverse repurchase agreements and letters of credit. For purposes of this discussion, we use the term “investments” to refer to our long-term investment portfolio, while the term “cash equivalents” refers to our short-term investment portfolio. Short-term investments are included in “Cash and cash equivalents” in the Consolidated Balance Sheets and are used in managing our daily operating liquidity needs. Long-term investments are classified as trading or available-for-sale as explained in Note 1 — Description of the Business of the Notes to Consolidated Financial Statements and are used in managing our capital needs.

 

Liquidity

 

We utilize our cash, cash equivalents and reverse repurchase agreements as the main tools to manage our daily operating liquidity needs. Our operating liquidity needs relate to the monies required to settle our payment instruments on a daily basis and fund the routine operating activities of the business. On a daily basis, we move on average over $1.0 billion to settle our payment instruments and make related settlements with our agents and financial institutions. We receive a similar amount on a daily basis from our agents and financial institutions for the face amount and related fees of our payment instruments sold. We have agreements with 13 clearing banks that provide clearing and processing functions for official checks, money orders and share drafts. For the clearing of money orders, we rely primarily on one clearing bank. In addition, we maintain contractual relationships with a variety of domestic and international cash management banks for ACH and wire transfer services to move customer funds and make agent payments. The relationships with these clearing banks and cash management banks are a critical component of the Company’s ability to move monies on a global and timely basis.

 

We rely on the funds from on-going sales of payment instruments and portfolio cash flows to settle our payment service obligations (“PSO”) as they are presented. Our daily net cash settlements tend to follow a pattern whereby certain days of the week are typically net cash inflow days, while other days are typically net cash outflow days. On the days with a net cash outflow, we have historically utilized our cash equivalents, as well as repurchase agreements, to fund the shortfall. On the next cash inflow day, excess cash is used to repay any amounts outstanding under the repurchase agreements, with the remaining excess cash reinvested in cash equivalents. The repurchase agreements are uncommitted facilities with various banks and require specific securities to be designated as collateral for borrowings under the agreements. The acceptance of securities as collateral is at the discretion of our counterparty. Beginning in the third quarter of 2007, we began investing more heavily in cash equivalents to enhance our liquidity. This shift was accomplished by reinvesting proceeds from normal maturities of our long-term investments into cash equivalents. As a result of this enhanced liquidity, we have reduced our use of repurchase agreements. At December 31, 2007, we had no amounts outstanding under repurchase agreements.

 

For certain of our financial institution customers, we established individual SPEs upon the origination of our relationship. Along with operational processes and certain financial covenants, these SPEs provide the financial institutions with additional assurance of our ability to clear their official checks. Under these relationships, the cash, cash equivalents, investments and PSO related to the financial institution customer are all held by the SPE. In most cases, the fair value of the cash, cash equivalents and investments must be maintained in excess of the PSO. As the financial institution customer sells our payment service instruments, the face amount of the instrument and any fees are paid into the SPE. As payment service instruments issued by the financial institution customer are presented for payment, the cash and cash equivalents within the SPE are used to settle the instrument. As a result, cash and cash equivalents within SPEs are generally not available for use outside of the SPE. We remain liable to satisfy the obligations, both contractually and under the Uniform Commercial Code, as the issuer and drawer of the official checks regardless of the existence of the SPEs. Accordingly, we consolidate all of the assets and liabilities of these SPEs in our Consolidated Balance Sheets, with the individual assets and liabilities of the SPEs classified in a manner similar to our other assets and liabilities. For further information relating to the SPEs, see Note 2 — Summary of Significant Accounting Policies of the Notes to Consolidated Financial Statements.

 

Contractual and Regulatory Capital

 

We use investments and credit facilities to manage our capital needs deriving from contractual and regulatory requirements. Due to the continuous nature of the sales and settlement of our payment instruments as described above, we are able to invest in securities with a longer term than the average life of our payment instruments to

provide for long-term capital needs. We strive to have cash, cash equivalents, receivables and investments in excess of our PSO in an amount which allows us to maintain compliance with all contractual and regulatory requirements during normal fluctuations in the value of our assets and liabilities. We refer to this excess as our unrestricted assets. Assets restricted for regulatory or contractual reasons are not available to satisfy working capital or other financing requirements.

 

In connection with our senior credit facility, one clearing bank contract and the SPEs, we have certain financial covenants that require us to maintain pre-defined ratios of certain assets to PSO as presented in the Consolidated Balance Sheets. As more fully described in Note 9 — Debt of the Notes to Consolidated Financial Statements, the financial covenants under our credit facilities relate to the maintenance of pre-defined ratios of interest coverage, leverage and consolidated total indebtedness (collectively, the “Debt Covenants”). One clearing bank contract has financial covenants that include the maintenance of total cash, cash equivalents, receivables and investments in an amount at least equal to total outstanding PSO (the “Total Company Ratio”), as well as the maintenance of a minimum 103 percent ratio of total assets held at that bank to instruments estimated to clear through that bank (the “Clearing Bank Ratio”). Financial covenants related to the SPEs include the maintenance of specified ratios, typically greater than 100 percent, of cash, cash equivalents and investments held in the SPE to outstanding payment instruments issued by the related financial institution. In addition, under limited circumstances, these financial institution customers with SPEs have the right to either demand liquidation of the assets in the SPEs or to replace us as the administrator of the SPE. Such limited circumstances consist of material, and in most cases continued, failure to uphold our warranties and obligations pursuant to the underlying agreements with the financial institutions.

 

In addition, we are regulated by various state agencies which generally require us to maintain a pool of liquid assets and investments with a rating of A or higher in an amount generally equal to the regulatory PSO measure, as defined by the state, for our regulated payment instruments, namely teller checks, agent checks, money orders and money transfers. The regulatory requirements are similar to, but less restrictive than, our unrestricted assets measure. The regulatory PSO measure varies by state, but in all cases is substantially lower than our PSO as disclosed in the Consolidated Balance Sheets as we are not regulated by state agencies for PSO resulting from outstanding cashier’s checks or for amounts payable to agents and brokers. All states also require MPSI, the licensed entity and our wholly-owned operating subsidiary, to maintain positive net worth, with one state also requiring MPSI to maintain positive tangible net worth.

 

The regulatory and contractual requirements do not require us to specify individual assets held to meet our PSOs, nor are we required to deposit specific assets into a trust, escrow or other special account. Rather, we must maintain a pool of liquid assets. No third party places limitations, legal or otherwise, on us regarding the use of our individual liquid assets. We are able to withdraw, deposit or sell our individual liquid assets at will, with no prior notice or penalty, provided we maintain a total pool of liquid assets sufficient to meet the regulatory and contractual requirements.

 

The Total Company Ratio is the most restrictive of our financial covenants under all contractual and regulatory requirements. We monitor compliance with the Total Company Ratio by monitoring the amount of our unrestricted assets.

 

Impact of the Credit Market Disruption

 

During September 2007, the asset-backed securities market and broader credit markets began to experience significant disruption, with a general lack of liquidity in the markets and deterioration in fair value of mortgage-backed securities triggered by concerns surrounding sub-prime mortgages. In response to these concerns, the rating agencies undertook extensive reviews of asset-backed securities, particularly mortgage-backed securities. As a result of these developments, we experienced a net decline of $230.5 million in the fair value of its investment portfolio from June 30, 2007 through September 30, 2007. As we monitored the deterioration in the market in September 2007, we decided to draw the $197.0 million available balance of our revolving credit facility to supplement our unrestricted assets to ensure that a sufficient cushion over the Total Company Ratio was maintained if there was any further market deterioration. As of October 30, 2007, we maintained compliance with all contractual and regulatory requirements, even without considering the proceeds of the $197.0 million draw on the revolver. In addition, preliminary valuations of the investment portfolio as of October 31, 2007 showed a

substantially lower rate of decline in fair value. We continued to closely monitor the performance of our investments, market developments and the impact of rating agency actions on our portfolio. With few exceptions, our investments continued to provide for all contractual cash flows and evidenced little, if any, actual losses from defaults through early November 2007. As a result, through early November 2007, we believed we had sufficient unrestricted assets to maintain compliance with all of our contractual and regulatory requirements through any further market deterioration. As the unrealized losses on the investment portfolio had no immediate impact on our cash flows, there was no disruption to our operating liquidity.

 

In late November and December 2007, the asset-backed securities and credit markets experienced further substantial deterioration under increasing concerns over defaults on mortgages and debt in general, as well as an increasingly negative view of all structured investments and the credit market in general. This deterioration caused the market to demand higher risk premiums and liquidity discounts on asset-backed securities, as well as assume higher rates of defaults than previously anticipated through October 2007. As a result of these market developments, the fair value for asset-backed securities as of November 30, 2007 substantially declined by an additional $571.2 million from September 30, 2007. In addition, the rating agencies continued their review of securities, issuing broad rating downgrades based on high levels of assumed future defaults. Under the terms of certain of our asset-backed securities, ratings downgrades of collateral securities can reduce the cash flows to all but the most senior investors even if there have been no actual losses incurred by the collateral securities. In December 2007, we began to experience adverse changes to the cash flows from some of our asset-backed investments as a result of the accumulating rating downgrades of the underlying collateral securities.

 

As the market continued its substantial deterioration in December 2007, we identified a need for additional capital as we anticipated that we would not be in compliance with our Total Company Ratio and our Debt Covenants as of December 31, 2007. Through meetings with potential investors in late December 2007 and early January 2008, it became evident that we would need to divest certain investments in connection with any recapitalization to substantially reduce the risk of any further deterioration in the investment portfolio. We commenced a plan in January 2008 to realign our investment portfolio away from asset-backed securities and into highly liquid assets through the sale of a substantial portion of the investment portfolio. Based on these developments, we determined that we no longer had the intent to “hold until maturity or call” substantially all of our investments classified as “Obligations of states and political subdivisions,” “Commercial mortgage-backed securities,” “Residential mortgage-backed securities,” “Other asset-backed securities,” “Corporate debt securities” and “Preferred and common stock.”

 

As a result of these developments, we recognized $1.2 billion of other-than-temporary impairments in December 2007, causing a shortfall in unrestricted assets. Following are the unrestricted assets as of:

 

Table 8 — Unrestricted Assets

 

Impact on Contractual and Regulatory Capital — The shortfall in unrestricted assets of $551.8 million was the direct result of the market developments in late November and December 2007, causing us to be out of compliance with the Total Company Ratio. As of December 31, 2007, our regulated subsidiary MPSI was in compliance with state regulatory requirements, with the exception of one state where MPSI was out of compliance with the tangible net worth requirement. Subsequent to December 31, 2007, we were out of compliance with certain other state regulatory requirements, including minimum net worth requirements. We have not received notice of any enforcement actions contemplated by the regulators, but the regulators reserve the right to take action in the future and could impose fines and penalties related to the compliance failure. With the completion of the Capital Transaction, as of March 25, 2008, we are in compliance with all regulatory requirements for all states.

 

We received waivers of default through May 1, 2008 from both the clearing bank and credit agreement lenders through amendments to their respective agreements. These waivers were superceded by amendments to these agreements made in conjunction with the Capital Transaction.

 

Impact on Liquidity — The declines in the investment portfolio through December 31, 2007 created a need for regulatory and contractual capital, but did not immediately impact our liquidity. Although we had a shortfall in our unrestricted assets, daily operating and short-term liquidity needs were not affected due to the nature of our business whereby daily remittances to us are used to pay the daily clearings of our instruments. In addition, approximately $800.0 million of our PSO at December 31, 2007 are greater than one year old. We have continued to meet our daily operating and short-term liquidity needs and believe that we will continue to do so with the completion of the Capital Transaction.

 

We have agreed with certain of our clearing banks to make funding changes, including providing additional intra-day funding, due to concerns over the impact of the market disruption on the Company. Additionally, we have revised the funding arrangements with a few agents, including changes to their remittance patterns, pre-funding by the Company and, in one case, creating a trust for the benefit of the agent’s consumers. These changes have altered our total liquidity needs and changed the timing of cash inflows and outflows. While we believe the Capital Transaction will restore more ordinary funding protocols with the clearing banks, it is possible that clearing banks will require advance funding or other security, or even terminate their relationships with us. We believe the requests for amendments to agent agreements will decrease as a result of the Capital Transaction.

 

Downgrade of Debt Rating — In January 2008, Moody’s Investor Service (“Moody’s”), Standard & Poors (“S&P”) and Fitch Ratings (“Fitch”) downgraded our senior unsecured debt rating to non-investment grade at Ba1, BB and BB-, respectively. In March 2008, S&P downgraded our senior unsecured debt rating to B+. Moody’s, S&P and Fitch have also placed us on watch for potential additional downgrades. The three major credit rating agencies have cited, among other factors, the reduction in our unrestricted assets caused by our net unrealized losses and other-than-temporary impairments as the rationale for these downgrades, despite the growth and profitability of our core money transfer business. A securities rating is not a recommendation to buy, sell or hold securities and is subject to revision at any time and each rating should be evaluated independently of any other rating. It is possible that one or more rating agencies will in the future downgrade our debt rating further, and that further downgrades could increase our cost of borrowing. It is important to note that state and federal regulatory authorities do not consider such ratings as criteria in determining licensing or regulatory compliance. Accordingly any change in debt ratings is not expected to directly affect our regulatory status as a money services business. The financial impact of any downgrade in our debt ratings will depend on the actual ratings, whether the ratings are split between investment and non-investment grade and which agency takes this action. It is also possible that ratings downgrades could affect our ability to attract and retain customers.

 

Sale of Investments and Capital Transaction

 

Subsequent to December 31, 2007, we sold substantially all of our investment portfolio for a realized loss of $260.6 million. This realized loss is incremental to the $1.2 billion other-than-temporary impairment charge we recognized in December 2007. On March 25, 2008, we completed the Capital Transaction, pursuant to which we received an infusion of $1.5 billion of both equity and debt capital to support the long-term needs of the business and provide necessary capital due to the investment portfolio losses. The terms of the Capital Transaction are set forth

below. The net proceeds of the Capital Transaction were used to invest in cash equivalents to supplement our unrestricted assets and to repay $100.0 million on our revolving credit facility.

 

With the Capital Transaction and sale of investments, we believe we have sufficient liquidity and capital to operate and grow our business for the next twelve months and the foreseeable future. We expect operating cash flows to be sufficient to finance our on-going business, pay interest expense on our outstanding debt, maintain adequate capital levels and meet debt and clearing agreement covenants. Should liquidity and capital needs exceed operating cash flows, we believe our external financing sources, including availability under the new senior credit facility, will be sufficient to meet any shortfalls.

 

Had the Capital Transaction and sale of investments occurred on December 31, 2007, the pro forma unrestricted assets would be as follows: