Note 1: Summary of Significant Accounting Policies

Consolidation and Basis of Preparation

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from these estimates.

Presentation

Business Description

The Company derives a substantial portion of its operating revenues from its services, which are based on the number of accounts or transactions processed, a percentage of dollar volume processed, or a combination thereof. The balance of FDC's operating revenues consists of investment earnings (primarily on certain settlement assets) and ancillary product sales (primarily sales and rentals of terminals enabling customers to receive the Company's services). FDC has made numerous acquisitions, primarily to expand its service offerings, to enter new markets, and to supplement internal growth.

FDC's operations in the United States provide the vast majority of the Company's transaction processing services, including the processing for almost all of the money transfers and credit card transactions that are ultimately settled outside of the U.S. Currently, FDC's processing centers in the United Kingdom and Australia are the only foreign operations of any significance. These units, collectively, accounted for 4% of FDC's total operating revenues in 1996 (compared with 5% in 1995 and 6% in 1994) and a comparable portion of FDC's assets and earnings (prior to the merger, integration and impairment charges).

Cash and Cash Equivalents

Investment Securities

Off-Balance Sheet Financial Instruments

Property and Equipment

Goodwill and Other Intangibles

Goodwill and other intangible assets are reviewed for impairment whenever events indicate that their carrying amount may not be recoverable. In such reviews, estimated undiscounted future cash flows associated with these assets are compared with their carrying value to determine if a write-down to fair value (normally measured by discounting estimated future cash flows) is required.

Revenue Recognition

Earnings (Loss) Per Common Share

Earnings per common share computations for 1996 and 1994 were computed based on weighted average shares outstanding including the dilutive impact of common stock equivalents which consist of outstanding stock options, warrants and convertible debt. The after tax interest expense and issue cost amortization on convertible debt is added back to net income when common stock equivalents are included in computing earnings per common share. The loss per common share in 1995 was computed based on FDC's simple weighted average shares outstanding for the year, as the impact of common stock equivalents is anti-dilutive. In computing the per share impact of the 1995 merger, integration and impairment charge, common stock equivalents were included since their impact would be dilutive on operating results before this charge.

Foreign Currency Translation

Stock Based Compensation

Note 2: FFMC Business Combination and Merger, Integration and Impairment Charge

FFMC Business Combination

Operating results of FFMC included with FDC's consolidated results for the nine months ended September 30, 1995 and the year ended December 31, 1994, adjusted for conformity of accounting policies utilized by FDC and FFMC, are as follows (in millions):

Merger, Integration and Impairment Charge

Transaction costs related to the merger and consisted primarily of payments pursuant to preexisting change in control agreements with FFMC management totaling $174.7 million, with the remainder comprised of professional fees and other expenses incurred in connection with the transaction. A large portion of these expenditures were not deductible for income tax purposes.

As a result of the FFMC merger, the Company conducted a strategic reevaluation of its businesses, reviewing overall trends and developments in relation to its business investments and industry concentrations. In addition to identifying duplicate and overlapping operations, this process identified certain insignificant business lines for disposition or discontinuance and highlighted other business lines and customer relationships which had diminished future value. As a result, the Company recorded restructuring and integration costs and impairment charges.

Restructuring and integration costs in 1995 and 1996 consist of accruals for personnel severance, lease termination costs for facilities and equipment, contract termination and modification costs for exit activities related to duplicate or overlapping operations and incurred employee relocations. Through December 31, 1996, cash expenditures of $85.2 million were charged against the accruals. Personnel severance in 1995 and 1996 included in the costs aggregated $34.8 million and involved approximately 1,900 employees in the card issuing, merchant processing, collections, and corporate groups. In addition, asset write-downs in connection with these activities were recorded as a part of the impairment charges.

The Company measures the need for a reduction in the carrying amount of long-lived assets using Statement of Financial Accounting Standards No. 121 ("SFAS 121"). A discount rate of 15% is utilized for discounting estimated future cash flows for purposes of measuring fair market value. This process resulted in the substantial portion of the $283.6 million charge in 1995 for impairment. The charge included $136.1 million for goodwill, principally related to the ENVOY acquisition (see Note 3); $77.0 million for other long-lived assets, principally systems development and conversion costs and other intangibles; $30.3 million for other assets and $40.2 million for assets which were substantially disposed of during 1996.

On October 12, 1995, the Company exercised its prepayment option with respect to certain notes payable. The prepayment premium, plus the write-off of related deferred issue costs resulted in an early extinguishment of debt cost of $19.2 million before income taxes ($12.5 million after tax). This was not reflected as an extraordinary item due to its immaterial effect.

Note 3: Other Business Combinations and Asset Acquisitions

(a) Other consideration, not separately listed in the table or described above, consists of promissory notes and other amounts payable of $95.9 million in 1996, $21.2 million in 1995 and $7.3 million in 1994.

(b) Includes amounts infused to prepay CES debt obligations of $215.0 million.

(c) Deferred cash consideration of $300 million was paid in January 1995. FDC also assumed pension obligations of $304 million as part of the Western Union acquisition (see Note 14).

(d) Does not include the assumption of stock options.

Donnelley provides marketing database and information based services and Elektra represents the balance of Western Union-Mexico money transfer services not owned by FDC. The Company continues to develop bank alliance programs (joint ventures) in the domestic merchant credit card processing area. EBP is a health care claims processor and plan administrator (with a life insurance subsidiary selling insurance products ancillary to its processing area), and ENVOY and CES are merchant payment transaction processors. Western Union is a provider of nonbank money transfer and bill payment services in over 130 countries. GENEX provides workers' compensation cost containment and management services (see Note 4). Other acquisitions expanded the Company's markets and service offerings in various FDC business categories.

The merger with GENEX was accounted for as a pooling of interests. Substantially all other business combinations and asset acquisitions have been accounted for as purchases, and their results have been included in the results of the Company's operations from the effective dates of acquisition. The following table outlines the assets acquired and liabilities assumed (at the date of acquisition) for FDC business combinations and asset acquisitions accounted for as purchases.

The fair value of net assets acquired includes initial goodwill and other intangible amounts aggregating $560 million in 1996, $1.1 billion in 1995 and $1.3 billion in 1994.

The terms of certain of the Company's acquisition agreements provide for additional consideration to be paid if the acquired entity's results of operations exceed certain targeted levels. Targeted levels are generally set substantially above the historical experience of the acquired entity at the time of acquisition. Such additional consideration is paid in cash and with shares of the Company's common stock, and is recorded when earned as additional purchase price. Additional consideration was paid totaling $26.6 million in 1996 (including 0.5 million shares of common stock valued at $21.0 million), $10.0 million in 1995 and $9.3 million in 1994. The maximum amount of other remaining contingent consideration is $13 million (payable through 2008).

The agreement to acquire ENVOY in August 1994 (almost one year prior to completion of the transaction in June 1995) was viewed at such time as a strategic expansion of FDC's merchant card processing area. The subsequent additions of CES and FFMC's merchant card processing operations, combined with industry trends toward consolidation, caused the Company not to pursue the ENVOY business plan. Accordingly, the Company recorded a $114.7 million impairment charge in the fourth quarter of 1995 to reduce the carrying amount of goodwill to its current estimated fair value under SFAS 121.

Note 4: Dispositions

Operating revenues from these businesses were approximately 3% of the Company's consolidated operating revenues in 1996, compared with 5% in 1995 and 10% in 1994, and a comparable percentage of FDC's earnings in each of the years (measured prior to the impact of the merger, integration and impairment charge in the case of 1995).

In December 1996, the Company divested of its MoneyGram operation through an initial public offering of 100% of its common stock. Since the merger with FFMC required the divestiture of MoneyGram pursuant to an order by the Federal Trade Commission, the gain on the divestiture of MoneyGram has been reflected as a component of the 1996 merger, integration and impairment amount.

The pretax gains on the 1995 and 1994 dispositions have been included in "other income" in the Company's consolidated statements of operations. The aggregate pretax gain in 1995 on the sale of the health systems business (which included a $24.0 million pretax gain on the September 1995 sale of the buyer's stock received as consideration in the sale) was substantially offset by income taxes related to the sale totaling $76.9 million. The Company also recorded pretax gains in 1995 resulting from the favorable resolution of certain indemnification issues related to the 1994 sale of the cable services business. In 1994, FDC also received $10.0 million in contingent proceeds from a business sold in 1993.

In February 1997, FDC completed the sale of its GENEX subsidiary (see Note 3). The transaction will produce a gain to the Company.

Note 5: Settlement Assets and Obligations

Cash equivalents consist of short-term time deposits, reverse repurchase agreements, commercial paper and other highly liquid investments. See Note 6 for information concerning the Company's investment securities.

FDC generates operating revenues from its investment of certain settlement assets, a substantial majority of which are cash equivalents and investment securities within the Company's payment instruments business. Payment instrument investment portfolio balances averaged $4.5 billion in 1996, $3.3 billion in 1995 and $1.9 billion in 1994. Investment revenues (before commissions to certain selling agents) from payment instrument portfolios totaled $285.9 million in 1996, $244.0 million in 1995 and $192.6 million in 1994.

A significant but declining percentage of FDC's payment instruments services is generated from official checks, money orders and money transfers issued under an agreement with an entity affiliated with American Express Company ("American Express"), the state-licensed issuer of the instruments. Settlement assets (primarily cash equivalents, investment securities and amounts due from selling agents) resulting from payment instruments issued under the agreement with American Express represented approximately 24% of FDC's total settlement assets at December 31, 1996 compared with 38% at December 31, 1995. FDC began issuing payment instruments under its own name in 1994, and plans to phase out those issued under the American Express name prior to the end of the current agreement in April 1997.

FDC manages this business and indemnifies American Express against any losses in connection with this business, thus assuming the risks and rewards of ownership. Accordingly, the assets and liabilities related to these transactions are included with settlement assets and obligations on the Company's consolidated balance sheets. Under the agreement, the Company earns transaction fees paid by selling agents and net earnings on the investment securities, with such amounts totaling approximately 5% of FDC's operating revenues in 1996, 6% in 1995 and 7% in 1994.

Note 6: Investment Securities

Virtually all of FDC's investment securities are debt securities, all of which have maturities greater than one year. At December 31, 1996, 65% of these debt securities mature within five years and 90% within 10 years. Realized gains and losses from the sale of investment securities were not material. The principal components of investment securities, which are carried at fair value, classified as available-for-sale, are as follows:

Note 7: Financial Instruments

Concentration of Credit Risk

Management of Investment Risks

Off-Balance Sheet Financial Instruments

Fair Value of Financial Instruments

The estimated fair values of balance sheet financial instruments are based primarily on market quotations, whereas the estimated fair values of off-balance sheet arrangements are based on dealer quotations. These estimated values may not be representative of actual values that could have been realized as of the year-end dates or that will be realized in the future.

Note 8: Income Taxes

The Company's effective tax rates differ from statutory rates as follows (1995 differences are calculated by excluding the impact of merger, integration and impairment charges, the impact of which is separately disclosed):

FDC's income tax provisions consist of the following components:

Income tax payments of $77.6 million in 1996, $144.6 million in 1995 and $205.6 million in 1994 are less than current expense due primarily to tax benefits recorded directly to equity and reductions of goodwill. Deferred tax assets and liabilities are recognized for the expected tax consequences of temporary differences between the book and tax bases of the Company's assets and liabilities. There was no valuation allowance in 1996 or 1995. Net deferred tax assets are included in other assets and net deferred tax liabilities are included in accounts payable and other liabilities in FDC's consolidated balance sheets. The following table outlines the principal components of deferred tax items.

Note 9: Borrowings

The Company's commercial paper borrowings at December 31, 1996 and 1995 had weighted average interest rates of 5.6% and 5.9%, respectively.

In October 1995, FDC revised its short-term borrowing arrangement by establishing two revolving credit facilities ("the Facilities") to support a newly instituted commercial paper program with maximum borrowings of $1 billion. The maximum amount of borrowings possible under the Facilities, which consist of a $500 million 364-day facility and a $500 million five-year facility at December 31, 1996, is reduced by outstanding commercial paper amounts. Interest rates for borrowings under the Facilities are based on market rates. FDC plans to increase the maximum borrowings under its existing commercial paper program and its Facilities to $1.5 billion. The Facilities contain customary covenants, none of which are expected to significantly affect FDC's operations. At December 31, 1996, the Company was in compliance with all of these covenants. Also, the Company obtained new uncommitted credit lines of $250 million from several financial institutions during 1996. The interest rates for borrowings under the credit lines are based on market rates.

In 1996, FDC issued $350 million in Medium-Term Notes with maturities ranging from two to five years. The interest rates on the Medium-Term Notes are between 6.19% and 6.82%. Interest on the 63/4% and 65/8% term notes, which are public debt offerings, is payable semi-annually in arrears. These notes do not have sinking fund obligations, and they are not redeemable prior to maturity. Aggregate annual maturities of long-term debt are $33.9 million in 1997, $151.5 million in 1998, $151.6 million in 1999, $0.3 million in 2000, $49.9 in 2001 and $398.3 million in all periods thereafter. The Company paid interest amounts totaling $95.6 million in 1996, $92.7 million in 1995 and $45.1 million in 1994.

Note 10: Supplemental

Balance Sheet Information

Note 11: Commitments and Contingencies

In the normal course of business, the Company is subject to claims and litigation, including indemnification obligations to purchasers of former subsidiaries. Management of the Company believes that such matters involving a reasonably possible chance of loss would not, individually or in the aggregate, result in a materially adverse effect on the Company's results of operations, liquidity or financial condition.

Note 12: Stockholders' Equity and Senior Convertible Debentures

Other adjustments, net of income taxes, that increase (decrease) stockholders' equity are as follows (in millions):

FDC has guaranteed the $447.1 million of 5% senior convertible debentures issued by FFMC in December 1994. The debentures are convertible into 20.6 million shares of FDC common stock on or before December 15, 1999 based upon a conversion rate of $21.755 per share (subject to adjustment in certain events). The debentures are redeemable on at least 30 days' notice at the option of the Company (in whole or in part) at 102% during the 12-month period beginning December 15, 1997, at 101% during the 12-month period beginning December 15, 1998 and at 100% if redeemed at maturity.

FFMC is not required to file periodic reports with the Securities and Exchange Commission with respect to the outstanding senior convertible debentures so long as such reports for the Company contain summarized financial information concerning FFMC. Subsequent to the merger, certain FDC businesses were merged into certain FFMC subsidiaries; therefore, the current year results are not comparable with the prior years. The summarized financial information for FFMC and its consolidated subsidiaries is as follows:

Other Stockholders' Equity Transactions

Note 13: Stock Compensation Plans

In October 1996, the Company instituted an employee stock purchase plan for which a total of six million shares have been reserved for issuance. Monies accumulated through payroll deductions elected by eligible employees are used to effect quarterly purchases of FDC common stock at a 15% discount from the lower of the market price at the beginning or end of the quarter.

In addition, the Company maintains other stock option plans which were assumed in connection with the Company's business combinations. These options were converted to options to purchase shares of FDC common stock (at prices ranging from $0.005 to amounts substantially above current market prices for the Company's common stock) and are exercisable on specified conditions and at specified times not later than ten years from the date of grant.

The Company has elected to follow APB 25 for its employee stock options because, as discussed below, the alternative fair value accounting under SFAS 123 requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized.

Pro forma information regarding net income and earnings per share is required by SFAS 123, assuming the Company has accounted for its employee stock options granted subsequent to December 31, 1994 under the fair value method of SFAS 123. The fair value for options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for 1995 and 1996, respectively: risk-free interest rate of 5.29% and 6.28%; a dividend yield of 0.22%; volatility factor of the expected market price of the Company's common stock of 17.6% and 16.9%; and an expected option life of five years. The weighted average fair value of these options granted are approximately $11 and $8 for the period ending December 31, 1996 and 1995, respectively. Assumptions for the stock purchase plan rights are as follows: dividend yield of 0.22%; an expected life of 0.25 years; expected volatility of 16.9%; and risk-free interest rate of 5.04%. The weighted average fair value of those purchase rights granted during the fourth quarter of 1996 is approximately $7. The Company's pro forma information, amortizing the fair value of the options over their vesting period and the stock purchase rights, is as follows (because SFAS 123 is applicable only to options granted subsequent to December 31, 1994, its pro forma effect will not be fully reflected until 1998):

Because the Company's employee stock options have characteristics significantly different from those of traded options for which the Black-Scholes model was developed, and because changes in the subjective input assumptions can materially affect the fair value estimate, the existing models, in management's opinion, do not necessarily provide a reliable single measure of the fair value of its employee stock options.

A summary of stock option activity is as follows (options in millions):

The following summarizes information about stock options outstanding (options in millions):

FFMC had plans that provided for the granting of restricted stock awards to certain officers, employees and nonemployee members of its board of directors. The value of these awards was determined using closing prices of FFMC common stock on the grant dates, and was amortized to expense on a straight-line basis over the restriction periods of two to five years (with the unamortized portion of such awards reported as a reduction in paid-in capital). All remaining restrictions on these stock awards expired effective with the merger, and the unamortized value of the awards at the merger date ($62.4 million) was included in the 1995 merger, integration and impairment charge.

Note 14: Employee Benefit Plans

Defined Contribution Plans

Defined Benefit Plans

A summary of the Company's defined benefit plans is as follows:

Net periodic pension costs consisted of the following components:

Reconciliations of the funded status of FDC's defined benefit plans to obligations recognized in the Company's consolidated balance sheets are as follows:

The primary assumptions used in computing amounts for FDC's defined benefit plans are as follows:

Changes in interest rates are the primary factor behind year-to-year fluctuations in discount rates.

The Company does not offer post-retirement health care or other insurance benefits for retired employees; however, the Company is required to continue such plans that were in effect when FFMC acquired Western Union. Generally, retiring Western Union employees bear the entire cost of the premiums and Western Union's former owner is obligated by agreement through 1997 to pay FDC for its administrative services in continuing these coverages.

Note 15: Quarterly Financial Results (Unaudited)

(a) Revenues in 1995's second quarter include a gain on the sale of FDC's health systems business of $68.9 million, and income tax expense in the quarter includes $67.7 million in income taxes associated with this gain. (b) The Company recorded income tax benefits totaling $105.8 million related to the merger, integration and impairment charge. (c) The fourth quarter 1995 loss per common share was computed based on FDC's simple weighted average shares outstanding, as the impact of common stock equivalents is anti-dilutive. Earnings per common share computations for all other quarters were computed based on weighted average shares outstanding which include the dilutive impact of common stock equivalents (see Note 1).