MASTERCARD INCORPORATED
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
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þ
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the quarterly period ended June 30, 2005 |
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Or |
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o
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
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For the transition period from to |
Commission file number: 000-50250
MasterCard Incorporated
(Exact name of registrant as specified in its charter)
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Delaware
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13-4172551 |
(State or other jurisdiction of
incorporation or organization)
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(IRS Employer
Identification Number) |
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2000 Purchase Street
Purchase, NY
(Address of principal executive offices)
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10577
(Zip Code) |
(914) 249-2000
(Registrants telephone number, including area code)
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 whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act). Yes o No þ
Indicate the number of shares outstanding of each of the issuers classes of common stock, as
of the latest practicable date.
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Class
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Outstanding at July 29, 2005 |
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Class A redeemable common stock,
par value $.01 per share
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100,000,348 |
Class B convertible common stock,
par value $.01 per share
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None |
MASTERCARD INCORPORATED
FORM 10-Q
TABLE OF CONTENTS
2
MASTERCARD INCORPORATED
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
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June 30, |
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December 31, |
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2005 |
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2004 |
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(In thousands, except share data) |
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ASSETS |
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Cash and cash equivalents |
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$ |
520,081 |
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$ |
328,996 |
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Investment securities, at fair value: |
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Trading |
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23,395 |
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27,407 |
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Available-for-sale |
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719,262 |
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781,486 |
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Accounts receivable |
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324,589 |
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293,292 |
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Settlement due from members |
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205,705 |
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223,738 |
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Restricted security deposits held for members |
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104,892 |
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87,300 |
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Prepaid expenses |
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106,293 |
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124,595 |
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Other current assets |
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34,484 |
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35,982 |
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Total Current Assets |
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2,038,701 |
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1,902,796 |
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Property, plant and equipment, at cost (less accumulated depreciation of $349,105
and $329,877) |
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230,720 |
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242,358 |
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Deferred income taxes |
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249,156 |
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235,023 |
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Goodwill |
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196,224 |
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217,654 |
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Other intangible assets (less accumulated amortization of $252,446 and $227,738) |
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293,354 |
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328,984 |
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Municipal bonds held-to-maturity |
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194,855 |
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195,295 |
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Other assets |
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144,914 |
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142,560 |
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Total Assets |
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$ |
3,347,924 |
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$ |
3,264,670 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Accounts payable |
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$ |
177,891 |
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$ |
187,035 |
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Settlement due to members |
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169,198 |
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186,858 |
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Restricted security deposits held for members |
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104,892 |
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87,300 |
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Obligations under U.S. merchant lawsuit and other legal settlements current (Notes
8 and 10) |
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114,222 |
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129,047 |
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Accrued expenses |
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598,369 |
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648,019 |
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Other current liabilities |
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57,006 |
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63,103 |
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Total Current Liabilities |
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1,221,578 |
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1,301,362 |
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Deferred income taxes |
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63,548 |
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73,227 |
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Obligations under U.S. merchant lawsuit and other legal settlements (Notes 8 and 10) |
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491,559 |
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468,547 |
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Long-term debt |
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229,476 |
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229,569 |
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Other liabilities |
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208,615 |
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212,393 |
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Total Liabilities |
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2,214,776 |
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2,285,098 |
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Commitments and Contingencies (Notes 7 and 10) |
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Minority interest |
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4,620 |
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4,620 |
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Stockholders Equity |
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Class A redeemable common stock, $.01 par value; authorized 275,000,000 shares,
issued and outstanding 84,000,000 shares |
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840 |
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840 |
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Class B convertible common stock, $.01 par value; authorized 25,000,000 shares,
issued and outstanding 16,000,000 shares |
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160 |
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160 |
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Additional paid-in capital |
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967,368 |
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967,368 |
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Retained earnings (accumulated deficit) |
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92,338 |
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(121,204 |
) |
Accumulated other comprehensive income, net of tax: |
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Cumulative foreign currency translation adjustments |
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64,781 |
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127,481 |
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Net unrealized gain on investment securities available-for-sale |
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1,214 |
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3,804 |
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Net unrealized gain (loss) on derivatives accounted for as hedges |
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1,827 |
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(3,497 |
) |
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Total accumulated other comprehensive income, net of tax |
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67,822 |
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127,788 |
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Total Stockholders Equity |
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1,128,528 |
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974,952 |
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Total Liabilities and Stockholders Equity |
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$ |
3,347,924 |
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$ |
3,264,670 |
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The accompanying notes are an integral part of these consolidated financial statements.
3
MASTERCARD INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
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Three Months |
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Six Months |
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Ended June 30, |
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Ended June 30, |
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2005 |
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2004 |
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2005 |
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2004 |
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(In thousands, except per share data) |
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Revenues, net |
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$ |
771,867 |
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$ |
647,275 |
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$ |
1,430,105 |
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$ |
1,241,585 |
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Operating Expenses |
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General and administrative |
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319,187 |
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284,660 |
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625,803 |
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561,494 |
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Advertising and market development |
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231,578 |
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228,824 |
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403,257 |
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396,320 |
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U.S. merchant lawsuit and other legal settlements
(Notes 8 and 10) |
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3,896 |
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3,896 |
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Depreciation |
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11,997 |
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13,076 |
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24,191 |
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26,437 |
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Amortization |
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16,669 |
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18,358 |
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32,905 |
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36,505 |
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Total operating expenses |
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579,431 |
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548,814 |
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1,086,156 |
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1,024,652 |
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Operating income |
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192,436 |
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|
98,461 |
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|
343,949 |
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216,933 |
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Other Income (Expense) |
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Investment income, net |
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13,479 |
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|
9,290 |
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|
23,528 |
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|
21,609 |
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Interest expense |
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(17,477 |
) |
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|
(16,684 |
) |
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|
(34,333 |
) |
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|
(34,413 |
) |
Minority interest in (earnings) losses of subsidiaries |
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(55 |
) |
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(27 |
) |
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(76 |
) |
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17 |
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Other (expense) income, net |
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(989 |
) |
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(865 |
) |
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(1,479 |
) |
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(191 |
) |
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Total other income (expense) |
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(5,042 |
) |
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(8,286 |
) |
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(12,360 |
) |
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(12,978 |
) |
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Income before income taxes |
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|
187,394 |
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|
90,175 |
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331,589 |
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|
203,955 |
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Income tax expense |
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|
67,146 |
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|
|
24,468 |
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|
|
118,047 |
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|
|
64,680 |
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Net Income |
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$ |
120,248 |
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|
$ |
65,707 |
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$ |
213,542 |
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$ |
139,275 |
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Net Income per Share (Basic and Diluted) |
|
$ |
1.20 |
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$ |
.66 |
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$ |
2.14 |
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$ |
1.39 |
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Weighted average shares outstanding
(Basic and Diluted) |
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100,000 |
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|
100,000 |
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|
100,000 |
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|
100,000 |
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The accompanying notes are an integral part of these consolidated financial statements.
4
MASTERCARD INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
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Six Months |
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Ended June 30, |
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2005 |
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2004 |
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(In thousands) |
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Operating Activities |
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Net income |
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$ |
213,542 |
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|
$ |
139,275 |
|
Adjustments to reconcile net income to net cash provided by operating activities: |
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|
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Depreciation |
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|
24,191 |
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|
|
26,437 |
|
Amortization |
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|
32,905 |
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|
|
36,505 |
|
Deferred income taxes |
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|
(12,156 |
) |
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|
1,513 |
|
Other |
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|
5,785 |
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|
|
2,061 |
|
Changes in operating assets and liabilities: |
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Trading securities |
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|
4,012 |
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|
|
2,267 |
|
Accounts receivable |
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|
(39,854 |
) |
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|
9,152 |
|
Settlement due from members |
|
|
(4,648 |
) |
|
|
12,720 |
|
Prepaid expenses and other current assets |
|
|
13,496 |
|
|
|
11,146 |
|
Accounts payable |
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|
(3,538 |
) |
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|
(72,439 |
) |
Settlement due to members |
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|
1,086 |
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|
|
(16,248 |
) |
Legal settlement accruals, including accretion of imputed interest |
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|
8,187 |
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|
17,641 |
|
Accrued expenses |
|
|
(37,643 |
) |
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|
(40,169 |
) |
Net change in other assets and liabilities |
|
|
(8,086 |
) |
|
|
15,068 |
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|
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|
|
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|
Net cash provided by operating activities |
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|
197,279 |
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|
|
144,929 |
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Investing Activities |
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Purchases of property, plant and equipment |
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|
(18,925 |
) |
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|
(5,681 |
) |
Capitalized software |
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|
(22,024 |
) |
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|
(19,416 |
) |
Purchases of investment securities available-for-sale |
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|
(1,265,993 |
) |
|
|
(585,821 |
) |
Proceeds from sales and maturities of investment securities available-for-sale |
|
|
1,320,205 |
|
|
|
569,435 |
|
Acquisition of businesses, net of cash acquired |
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|
|
|
|
(29,861 |
) |
Other investing activities |
|
|
(265 |
) |
|
|
(5,007 |
) |
|
|
|
|
|
|
|
|
|
Net cash provided by (used in) investing activities |
|
|
12,998 |
|
|
|
(76,351 |
) |
|
|
|
|
|
|
|
|
|
Effect of exchange rate changes on cash and cash equivalents |
|
|
(19,192 |
) |
|
|
(1,822 |
) |
|
|
|
|
|
|
|
|
|
Net increase in cash and cash equivalents |
|
|
191,085 |
|
|
|
66,756 |
|
Cash and cash equivalents beginning of period |
|
|
328,996 |
|
|
|
248,119 |
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents end of period |
|
$ |
520,081 |
|
|
$ |
314,875 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental Cash Flows: |
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|
|
|
Cash paid for income taxes |
|
$ |
70,807 |
|
|
$ |
27,014 |
|
Cash paid for interest |
|
|
8,477 |
|
|
|
8,517 |
|
The accompanying notes are an integral part of these consolidated financial statements.
5
MASTERCARD INCORPORATED
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS EQUITY (UNAUDITED)
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Accumulated |
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|
|
|
|
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Retained |
|
Other |
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|
|
|
|
|
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|
|
|
Earnings |
|
Comprehensive |
|
Common Shares |
|
Additional |
|
|
|
|
|
|
(Accumulated |
|
Income (Loss), |
|
|
|
|
|
|
|
|
|
Paid-in |
|
|
Total |
|
Deficit) |
|
Net of Tax |
|
Class A |
|
Class B |
|
Capital |
|
|
|
|
|
|
|
|
|
|
(In thousands) |
|
|
|
|
|
|
|
|
|
|
|
|
Balance at January 1, 2005 |
|
$ |
974,952 |
|
|
$ |
(121,204 |
) |
|
$ |
127,788 |
|
|
$ |
840 |
|
|
$ |
160 |
|
|
$ |
967,368 |
|
Net income |
|
|
213,542 |
|
|
|
213,542 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive loss, net of tax |
|
|
(59,966 |
) |
|
|
|
|
|
|
(59,966 |
) |
|
|
|
|
|
|
|
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|
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|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at June 30, 2005 |
|
$ |
1,128,528 |
|
|
$ |
92,338 |
|
|
$ |
67,822 |
|
|
$ |
840 |
|
|
$ |
160 |
|
|
$ |
967,368 |
|
|
|
|
|
|
|
|
|
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|
|
|
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|
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|
MASTERCARD INCORPORATED
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
Six Months |
|
|
Ended June 30, |
|
Ended June 30, |
|
|
2005 |
|
2004 |
|
2005 |
|
2004 |
|
|
|
|
|
|
(In thousands) |
|
|
|
|
Net Income |
|
$ |
120,248 |
|
|
$ |
65,707 |
|
|
$ |
213,542 |
|
|
$ |
139,275 |
|
Other comprehensive income (loss), net of tax: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign currency translation adjustments |
|
|
(35,524 |
) |
|
|
1,242 |
|
|
|
(62,700 |
) |
|
|
(10,606 |
) |
Net unrealized gain (loss) on investment
securities available-for-sale |
|
|
2,720 |
|
|
|
(7,494 |
) |
|
|
(2,590 |
) |
|
|
(8,017 |
) |
Net unrealized gain (loss) on derivatives
accounted for as hedges |
|
|
2,957 |
|
|
|
(681 |
) |
|
|
5,324 |
|
|
|
1,555 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income (loss), net of tax |
|
|
(29,847 |
) |
|
|
(6,933 |
) |
|
|
(59,966 |
) |
|
|
(17,068 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive Income |
|
$ |
90,401 |
|
|
$ |
58,774 |
|
|
$ |
153,576 |
|
|
$ |
122,207 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The accompanying notes are an integral part of these consolidated financial statements.
6
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share and percent data)
Note 1. Summary of Significant Accounting Policies
Organization MasterCard Incorporated and its consolidated subsidiaries, including MasterCard
International Incorporated (MasterCard International) and MasterCard Europe sprl (MasterCard
Europe) (together, MasterCard or the Company), provide transaction processing and related
services to customers principally in support of their credit, deposit access (debit), electronic
cash and automated teller machine payment programs, and travelers cheque programs. The common
stock of MasterCard Incorporated is privately owned by certain of the Companys customers.
MasterCard enters into transactions with its customers in the normal course of business and
operates a system for payment processing among its customers.
Consolidation and basis of presentation The consolidated financial statements include the
accounts of MasterCard and its majority-owned and controlled entities, including the Companys
variable interest entity. Intercompany transactions are eliminated in consolidation. Minority
interest is recorded for consolidated entities in which the Company owns less than 100% of the
interest. Minority interest represents the equity interest not owned by the Company. The Company
follows accounting principles generally accepted in the United States of America. Certain prior
period amounts have been reclassified to conform to 2005 classifications.
The consolidated financial statements for the three and six months ended June 30, 2005 and
2004 and as of June 30, 2005 are unaudited, and in the opinion of management include normal
recurring adjustments that are necessary to present fairly the results for interim periods. The
balance sheet as of December 31, 2004 was derived from the audited consolidated financial
statements as of December 31, 2004. Due to seasonal fluctuations and other factors, the results of
operations for the three and six months ended June 30, 2005 are not necessarily indicative of the
results to be expected for the full year.
The accompanying unaudited consolidated financial statements are presented in accordance with
the requirements of Quarterly Reports on Form 10-Q and, consequently, do not include all of the
disclosures required by accounting principles generally accepted in the United States of America.
Reference should be made to the Companys 2004 Annual Report on Form 10-K for additional
disclosures, including a summary of the Companys significant accounting policies.
Note 2. Goodwill and Other Intangible Assets
The carrying amount of goodwill as of June 30, 2005 was $196,224 compared to $217,654 as of
December 31, 2004. The change in the balance is primarily related to the foreign currency
translation of the goodwill relating to the acquisition of MasterCard Europe.
The following table sets forth net intangible assets, other than goodwill:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2005 |
|
December 31, 2004 |
|
|
Gross |
|
|
|
|
|
Net |
|
Gross |
|
|
|
|
|
Net |
|
|
Carrying |
|
Accumulated |
|
Carrying |
|
Carrying |
|
Accumulated |
|
Carrying |
|
|
Amount |
|
Amortization |
|
Amount |
|
Amount |
|
Amortization |
|
Amount |
Amortized intangible assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capitalized software |
|
$ |
339,878 |
|
|
$ |
(231,749 |
) |
|
$ |
108,129 |
|
|
$ |
327,733 |
|
|
$ |
(207,371 |
) |
|
$ |
120,362 |
|
Trademarks and tradenames |
|
|
22,449 |
|
|
|
(16,766 |
) |
|
|
5,683 |
|
|
|
24,061 |
|
|
|
(17,728 |
) |
|
|
6,333 |
|
Other |
|
|
6,442 |
|
|
|
(3,931 |
) |
|
|
2,511 |
|
|
|
6,442 |
|
|
|
(2,639 |
) |
|
|
3,803 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
|
368,769 |
|
|
|
(252,446 |
) |
|
|
116,323 |
|
|
|
358,236 |
|
|
|
(227,738 |
) |
|
|
130,498 |
|
Unamortized intangible
assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Customer relationships |
|
|
177,031 |
|
|
|
|
|
|
|
177,031 |
|
|
|
198,486 |
|
|
|
|
|
|
|
198,486 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
545,800 |
|
|
$ |
(252,446 |
) |
|
$ |
293,354 |
|
|
$ |
556,722 |
|
|
$ |
(227,738 |
) |
|
$ |
328,984 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
7
MASTERCARD INCORPORATED
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
(In thousands, except per share and percent data)
A portion of the Companys intangible assets are denominated in foreign currencies. As such,
a component of the net change in these intangible assets is attributable to foreign currency
translation. For example, the change in the value of euro relative to the U.S. dollar resulted in
a decrease of $21,455 from December 31, 2004 to June 30, 2005 in the unamortized customer
relationships relating to the acquisition of MasterCard Europe.
Amortization expense on the assets above was $16,669 and $18,358 for the three months ended
June 30, 2005 and 2004, respectively, and $32,905 and $36,505 for the six months ended June 30,
2005 and 2004, respectively. Impairment charges of $1,205 and $282 for the three months ended June
30, 2005 and 2004, respectively, and $1,348 and $467 for the six months ended June 30, 2005 and
2004, respectively, were recorded primarily in connection with managements decision to discontinue
the use of various technologies with associated capitalized software balances. The following
table sets forth the estimated future amortization expense of amortizable intangible assets
existing as of June 30, 2005 for the periods ending:
|
|
|
|
|
Remainder of 2005 |
|
$ |
28,989 |
|
December 31, 2006 |
|
$ |
46,890 |
|
December 31, 2007 |
|
$ |
28,757 |
|
December 31, 2008 |
|
$ |
8,613 |
|
December 31, 2009 and thereafter |
|
$ |
3,074 |
|
Note 3. Pension Plans
The Company maintains a noncontributory defined benefit pension plan with a cash balance
feature covering substantially all of its U.S. employees. Additionally, the Company has an unfunded
nonqualified supplemental executive retirement plan that provides certain key employees with
supplemental retirement benefits in excess of limits imposed on qualified plans by U.S. tax laws.
For both plans, net periodic pension cost is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
Six Months |
|
|
Ended June 30, |
|
Ended June 30, |
|
|
2005 |
|
2004 |
|
2005 |
|
2004 |
Service cost |
|
$ |
4,580 |
|
|
$ |
4,038 |
|
|
$ |
9,159 |
|
|
$ |
8,076 |
|
Interest cost |
|
|
2,584 |
|
|
|
2,449 |
|
|
|
5,168 |
|
|
|
4,898 |
|
Expected return on plan assets |
|
|
(3,192 |
) |
|
|
(2,580 |
) |
|
|
(6,384 |
) |
|
|
(5,160 |
) |
Amortization of prior service cost |
|
|
(63 |
) |
|
|
(79 |
) |
|
|
(127 |
) |
|
|
(158 |
) |
Recognized actuarial loss |
|
|
332 |
|
|
|
318 |
|
|
|
665 |
|
|
|
636 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net periodic pension cost |
|
$ |
4,241 |
|
|
$ |
4,146 |
|
|
$ |
8,481 |
|
|
$ |
8,292 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The funded status of the qualified plan exceeds minimum funding requirements. In December
2004, the Company committed to make voluntary contributions of $40,000 to its qualified plan before
September 15, 2005. Through June 30, 2005, the Company contributed $30,000 of this commitment, of
which $15,000 was made in December 2004, and expects to make further voluntary contributions of
$10,000 before September 15, 2005.
8
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
(In thousands, except per share and percent data)
Note 4. Postretirement Health and Life Insurance Benefits
The Company maintains a postretirement plan providing health coverage and life insurance
benefits for substantially all of its U.S. employees and retirees. Net periodic postretirement
benefit cost is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
Six Months |
|
|
Ended June 30, |
|
Ended June 30, |
|
|
2005 |
|
2004 |
|
2005 |
|
2004 |
Service cost |
|
$ |
797 |
|
|
$ |
774 |
|
|
$ |
1,594 |
|
|
$ |
1,548 |
|
Interest cost |
|
|
858 |
|
|
|
741 |
|
|
|
1,716 |
|
|
|
1,482 |
|
Amortization of prior service cost |
|
|
17 |
|
|
|
17 |
|
|
|
34 |
|
|
|
34 |
|
Amortization of transition obligation |
|
|
145 |
|
|
|
145 |
|
|
|
290 |
|
|
|
290 |
|
Recognized actuarial loss |
|
|
65 |
|
|
|
|
|
|
|
130 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net periodic postretirement benefit cost |
|
$ |
1,882 |
|
|
$ |
1,677 |
|
|
$ |
3,764 |
|
|
$ |
3,354 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company funds its postretirement benefits as payments are required through cash flows from
operations.
Note 5. Accrued Expenses
Accrued expenses consist of the following :
|
|
|
|
|
|
|
|
|
|
|
June 30, |
|
December 31, |
|
|
2005 |
|
2004 |
Customer incentives |
|
$ |
153,608 |
|
|
$ |
163,278 |
|
Personnel costs |
|
|
137,368 |
|
|
|
190,114 |
|
Taxes |
|
|
115,719 |
|
|
|
63,940 |
|
Advertising |
|
|
98,702 |
|
|
|
136,107 |
|
Other |
|
|
92,972 |
|
|
|
94,580 |
|
|
|
|
|
|
|
|
|
|
|
|
$ |
598,369 |
|
|
$ |
648,019 |
|
|
|
|
|
|
|
|
|
|
Note 6. Credit Facility
On June 17, 2005, the Company entered into a committed unsecured $2,250,000 revolving credit
facility (the Credit Facility) with certain financial institutions. The Credit Facility, which
expires on June 16, 2006, replaced MasterCard Incorporateds prior $1,950,000 credit facility which
expired on June 17, 2005. Borrowings under the facility are available to provide liquidity in the
event of one or more settlement failures by MasterCard International members and, subject to a
limit of $300,000, for general corporate purposes. Interest on borrowings under the Credit Facility
would be charged at the London Interbank Offered Rate (LIBOR) plus 28 basis points or an
alternative base rate. An additional 10 basis points would be applied if the aggregate borrowings
under the Credit Facility exceed 33% of the commitments. MasterCard agreed to pay a facility fee
which varies based on MasterCards credit rating and is currently equal to 7 basis points on the
total commitment. MasterCard was in compliance with the Credit Facility covenants as of June 30,
2005. There were no borrowings under the Credit Facility at June 30, 2005. The majority of Credit
Facility lenders are members or affiliates of members of MasterCard International.
9
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
(In thousands, except per share and percent data)
Note 7. Commitments and Contingent Liabilities
The future minimum payments under non-cancelable leases for office buildings and equipment,
sponsorships, licensing and other agreements at June 30, 2005 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Sponsorship, |
|
|
|
|
|
|
Capital |
|
Operating |
|
Licensing and |
|
|
Total |
|
Leases |
|
Leases |
|
Other |
The remainder of 2005 |
|
$ |
226,333 |
|
|
$ |
4,660 |
|
|
$ |
22,415 |
|
|
$ |
199,258 |
|
2006 |
|
|
212,600 |
|
|
|
4,877 |
|
|
|
30,124 |
|
|
|
177,599 |
|
2007 |
|
|
126,092 |
|
|
|
4,008 |
|
|
|
25,286 |
|
|
|
96,798 |
|
2008 |
|
|
67,728 |
|
|
|
2,386 |
|
|
|
17,824 |
|
|
|
47,518 |
|
2009 |
|
|
31,462 |
|
|
|
1,959 |
|
|
|
11,405 |
|
|
|
18,098 |
|
Thereafter |
|
|
50,626 |
|
|
|
42,294 |
|
|
|
1,768 |
|
|
|
6,564 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
714,841 |
|
|
$ |
60,184 |
|
|
$ |
108,822 |
|
|
$ |
545,835 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The table above excludes obligations from performance based agreements with our customers and
merchants due to their contingent nature. Included in the table above are capital leases with
imputed interest expense of $15,348 and a net present value of minimum lease payments of $44,836.
At June 30, 2005, $27,439 of the future minimum payments in the table above for leases,
sponsorship, licensing and other agreements was included in accounts payable or accrued expenses.
Consolidated rental expense for the Companys office space was approximately $7,784 and $8,042 for
the three months ended June 30, 2005 and 2004, respectively, and $15,589 and $15,917 for the six
months ended June 30, 2005 and 2004, respectively. Consolidated lease expense for automobiles,
computer equipment and office equipment was $4,043 and $2,722 for the three months ended June 30,
2005 and 2004, respectively, and $7,876 and $5,266 for the six months ended June 30, 2005 and 2004,
respectively.
MasterCard licenses certain software to its customers. The license agreements contain
guarantees under which the Company indemnifies licensees from any adverse judgments arising from
claims of intellectual property infringement by third parties. The terms of the guarantees are
equal to the terms of the license to which they relate. The amount of the guarantees are limited to
damages, losses, costs, expenses or other liabilities incurred by the licensee as a result of any
intellectual property rights claims. The Company does not generate significant revenues from
software licensing. The fair value of the guarantees is estimated to be negligible.
Note 8. U.S. Merchant Lawsuit and Other Legal Settlements
In 2003, MasterCard settled the U.S. merchant lawsuit described in Note 10 herein and contract
disputes with certain customers. On June 4, 2003, MasterCard International and plaintiffs signed a
settlement agreement (the Settlement Agreement) which required the Company to pay $125,000 in
2003 and pay $100,000 annually each December from 2004 through 2012. In addition, the Company
adopted rules which permit U.S. merchants to elect not to accept MasterCard branded debit or credit
cards, implemented programs to allow merchants to identify debit cards, provided signage to
merchants and established a separate debit interchange rate for a required period. For a
description of interchange, see the text under the heading Global Interchange Proceedings in Note
10 herein. Also in 2003, several other lawsuits were initiated by merchants who opted not to
participate in the plaintiff class in the U.S. merchant lawsuit. The opt-out merchant lawsuits
are not covered by the terms of the Settlement Agreement and were settled in 2005. In addition,
during 2003 and 2004 MasterCard accrued for settlements and resolutions with MasterCards customers
and employees, a portion of which were paid in 2005. During the six months ended June 30, 2005,
total liabilities for the U.S. merchant lawsuit and other legal settlements changed as follows:
|
|
|
|
|
Balance as of December 31, 2004 |
|
$ |
597,594 |
|
Interest accretion |
|
|
23,122 |
|
Payments |
|
|
(14,935 |
) |
|
|
|
|
|
Balance as of June 30, 2005 |
|
$ |
605,781 |
|
|
|
|
|
|
10
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Continued
(In thousands, except per share and percent data)
Note 9. Income Tax
The effective tax rate for the three and six months ended June 30, 2005 was 35.8% and 35.6%,
respectively, compared to 27.1% and 31.7% for the three and six months ended June 30, 2004,
respectively. The rate in 2004 was lower than 2005 primarily due to the settlement and
reassessment of various tax audit matters, the filing and recognition of refund claims and
revaluation of the Companys deferred state tax assets due to a higher effective state tax rate.
Note 10. Legal and Regulatory Proceedings
MasterCard is a party to legal proceedings with respect to a variety of matters in the
ordinary course of business. Except as described below, MasterCard does not believe that any legal
proceedings to which it is a party would have a material impact on its results of operations,
financial position, or cash flows.
Department of Justice Antitrust Litigation and Related Private Litigations
In October 1998, the United States Department of Justice (DOJ) filed suit against MasterCard
International, Visa U.S.A., Inc. and Visa International Corp. in the U.S. District Court for the
Southern District of New York alleging that both MasterCards and Visas governance structure and
policies violated U.S. federal antitrust laws. First, the DOJ claimed that dual governance the
situation where a financial institution has a representative on the board of directors of
MasterCard or Visa while a portion of its card portfolio is issued under the brand of the other
association was anti-competitive and acted to limit innovation within the payment card industry.
Second, the DOJ challenged MasterCards Competitive Programs Policy (CPP) and a Visa bylaw
provision that prohibit financial institutions participating in the respective associations from
issuing competing proprietary payment cards (such as American Express or Discover). The DOJ alleged
that MasterCards CPP and Visas bylaw provision acted to restrain competition.
On October 9, 2001, the District Court judge issued an opinion upholding the legality and
pro-competitive nature of dual governance. However, the judge also held that MasterCards CPP and
the Visa bylaw constitute unlawful restraints of trade under the federal antitrust laws. On
November 26, 2001, the judge issued a final judgment that ordered MasterCard to repeal the CPP
insofar as it applies to issuers and enjoined MasterCard from enacting or enforcing any bylaw,
rule, policy or practice that prohibits its issuers from issuing general purpose credit or debit
cards in the United States on any other general purpose card network. The final judgment also
provides that from the effective date of the final judgment until October 15, 2006, MasterCard is
required to permit any issuer with which it entered into such an agreement prior to the effective
date of the final judgment to terminate that agreement without penalty, provided that the reason
for the termination is to permit the issuer to enter into an agreement with American Express or
Discover. The final judgment imposes parallel requirements on Visa.
MasterCard appealed the judges ruling with respect to the CPP. On September 17, 2003 a
three-judge panel of the Second Circuit issued its decision upholding the District Courts
decision. On October 4, 2004, the Supreme Court denied MasterCards petition for certiorari,
thereby exhausting all avenues for further appeal in this case. Thereafter, the parties agreed that
October 15, 2004 would serve as the effective date of the final judgment.
On September 18, 2003, MasterCard filed a motion before the District Court judge in the DOJ
litigation seeking to enjoin Visa, pending completion of the appellate process, from enforcing a
newly-enacted bylaw requiring Visas 100 largest issuers of debit cards in the United States to pay
a so-called settlement service fee if they reduce their Visa debit volume by more than 10%. This
bylaw was later modified to clarify that the settlement service fee would only be imposed if an
issuer shifted its portfolio of debit cards to MasterCard. Visa implemented this bylaw provision
following the settlement of the U.S. merchant lawsuit described under the heading U.S. Merchant
and Consumer Litigations below. MasterCard believes that this bylaw is punitive and inconsistent
with the final judgment in the DOJ litigation. As a result of the Supreme Courts denial of
certiorari, the District Court now has jurisdiction over issues related to the final judgment in
the DOJ litigation. On January 10, 2005, MasterCard moved before the District Court to enforce the
terms of the final judgment and sought an order enjoining Visa from enforcing or maintaining its
settlement service fee bylaw. In addition, MasterCard requested that the Court permit Visas
largest 100 debit issuers to rescind any debit issuance agreements they entered into with Visa
while the
11
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Continued
(In thousands, except per share and percent data)
settlement service fee was in effect. The motion was fully briefed on June 3, 2005, and no
date for a hearing has been scheduled. At this time it is not possible to determine the ultimate
resolution of this matter.
On October 4, 2004, Discover Financial Services, Inc. filed a complaint against MasterCard,
Visa U.S.A., Inc. and Visa International Incorporated. The complaint was filed in the U.S. District
Court for the Southern District of New York and was designated as a related case to the DOJ
litigation, and preliminarily assigned to the same judge. The complaint alleges that the
implementation and enforcement of MasterCards CPP and Visas bylaw provision as well as
MasterCards Honor All Cards rule (and a similar Visa rule), which require merchants who accept
MasterCard cards to accept for payment every validly presented MasterCard card, violated Sections 1
and 2 of the Sherman Act as well as Californias Unfair Competition Act. The complaint also
challenged MasterCards no surcharge rule (and a similar Visa rule) under the same statutes. On
December 10, 2004, MasterCard moved to dismiss the complaint in its entirety for failure to state a
claim. In lieu of filing its opposition papers to MasterCards motion, Discover filed an amended
complaint on January 7, 2005. In the amended complaint, Discover dropped some of its claims,
including its challenge against the no surcharge rule and its claims under Californias Unfair
Competition Act, but continued to allege that the implementation and enforcement of the Companys
CPP, Visas bylaw provision and the Honor All Cards rules are in violation of Sections 1 and 2 of
the Sherman Act. Discover requested that the District Court apply collateral estoppel with respect
to its final judgment in the DOJ litigation and enter an order that the CPP and Visas bylaw
provision have injured competition and caused injury to Discover. Discover seeks treble damages in
an amount to be proved at trial along with attorneys fees and costs. On February 7, 2005,
MasterCard moved to dismiss Discovers amended complaint in its entirety for failure to state a
claim. On April 14, 2005, the Court denied, at this stage in the litigation, Discovers request to
give collateral estoppel effect to the findings in the DOJ litigation. In addition, the Court
denied MasterCards motion to dismiss a number of Discovers claims. However, the Court reserved
ruling with respect to MasterCards motion to dismiss those portions of Discovers claims that are
based on MasterCards Honor All Cards rule as well those claims under Section 2 of the Sherman Act.
On June 30, 2005, the Court found that MasterCards motion to dismiss Discovers Honor All Cards
claims was moot since Discovers counsel acknowledged that Discover was not bringing a tying claim
based on the Honor All Cards Rules. The parties are still awaiting the Courts ruling on the
motion to dismiss Discovers claims brought under Section 2 of the Sherman Act. Discovery will
commence after the Court issues this ruling. At this time it is not possible to determine the
ultimate resolution of this matter. No provision for losses has been provided in connection with
the Discover litigation.
On November 15, 2004, American Express filed a complaint against MasterCard, Visa and eight
member banks, including JPMorgan Chase & Co., Bank of America Corp., Capital One Financial Corp.,
U.S. Bancorp, Household International Inc., Wells Fargo & Co., Providian Financial Corp. and USAA
Federal Savings Bank. The complaint, which was filed in the U.S. District Court for the Southern
District of New York, was designated as a related case to the DOJ litigation and was assigned to
the same judge. The complaint alleges that the implementation and enforcement of MasterCards CPP
and Visas bylaw provision violated Sections 1 and 2 of the Sherman Act. American Express seeks
treble damages in an amount to be proved at trial, along with attorneys fees and costs. On
January 14, 2005, MasterCard filed a motion to dismiss the complaint for failure to state a claim.
On April 14, 2005, the District Court denied, at this stage in the litigation, American Express
request to give collateral estoppel effect to the findings in the DOJ litigation. In addition, the
Court denied MasterCards motion to dismiss a number of American Express claims. However, the
Court reserved ruling with respect to MasterCards motion to dismiss those portions of American
Express claims that were brought under Section 2 of the Sherman Act. Discovery will commence
after the Court issues this ruling. At this time it is not possible to determine the ultimate
resolution of this matter. No provision for losses has been provided in connection with the
American Express litigation.
Currency Conversion Litigations
MasterCard International, together with Visa U.S.A., Inc. and Visa International Corp., are
defendants in a state court lawsuit in California. The lawsuit alleges that MasterCard and Visa
wrongfully imposed an asserted one percent currency conversion fee on every credit card
transaction by U.S. MasterCard and Visa cardholders involving the purchase of goods or services in
a foreign country, and that such alleged fee is unlawful. This action, titled Schwartz v. Visa
Intl Corp., et al., was brought in the Superior Court of California in February 2000, purportedly
on behalf of the general public. Trial of the Schwartz matter commenced on May 20, 2002 and
concluded on November 27, 2002. The Schwartz action claims that the alleged fee grossly exceeds
any costs the
12
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Continued
(In thousands, except per share and percent data)
defendants might incur in connection with currency conversions relating to credit card
purchase transactions made in foreign countries and is not properly disclosed to cardholders.
MasterCard denies these allegations.
On April 8, 2003, the trial court judge issued a final decision in the Schwartz matter. In his
decision, the trial judge found that MasterCards currency conversion process does not violate the
Truth in Lending Act or regulations, nor is it unconscionably priced under California law. However,
the judge found that the practice is deceptive under California law, and ordered that MasterCard
mandate that members disclose the currency conversion process to cardholders in cardholder
agreements, applications, solicitations and monthly billing statements. As to MasterCard, the judge
also ordered restitution to California cardholders. The judge issued a decision on restitution on
September 19, 2003, which requires a traditional notice and claims process in which consumers have
approximately six months to submit their claims. The court issued its final judgment on October 31,
2003. On December 29, 2003, MasterCard appealed the judgment. The final judgment and restitution
process have been stayed pending MasterCards appeal. On August 6, 2004 the court awarded
plaintiffs attorneys fees in the amount of $28,224 to be paid equally by MasterCard and Visa.
Accordingly, during the three months ended September 30, 2004, MasterCard accrued amounts totaling
$14,112 which are included in U.S. Merchant Lawsuit and Other Legal Settlements in the Consolidated
Statements of Operations (see Note 8). MasterCard subsequently filed a notice of appeal on the
attorneys fee award on October 1, 2004. With respect to restitution, MasterCard believes that it
is likely to prevail on appeal. In February 2005, MasterCard filed an appeal regarding
applicability of Proposition 64, which amended sections 17203 and 17204 of the California Business
and Professions Code, to this action. Oral argument on the appeal took place on July 18, 2005 on
this issue. At this time it is not possible to determine the ultimate resolution of this matter.
Other than as set forth above, no provision for losses has been provided in connection with this
matter.
In addition, MasterCard has been served with complaints in state courts in New York, Arizona,
Texas, Florida, Arkansas, Illinois, Tennessee, Michigan, Pennsylvania, Ohio, Minnesota and Missouri
seeking to, in effect, extend the judges decision in the Schwartz matter to MasterCard cardholders
outside of California. Some of these cases have been transferred to the U.S. District Court for the
Southern District of New York and combined with the federal complaints in MDL No. 1409 discussed
below. In other state court cases, MasterCard has moved to dismiss the claims. On February 1,
2005, a Michigan action was dismissed with prejudice and on April 12, 2005, the plaintiff agreed to
withdraw his appeal of that decision. On June 24, 2005, a Minnesota action was dismissed with
prejudice. The time has not yet run for the plaintiff to file an
appeal. On July 13, 2005, an Illinois court dismissed plaintiffs
consumer fraud act claims. MasterCard has also been
served with complaints in state courts in California, Texas and New York alleging it wrongfully
imposed an asserted one percent currency conversion fee in every debit card transaction by U.S.
MasterCard cardholders involving the purchase of goods or services in a foreign country and that
such alleged fee is unlawful. Visa USA, Inc. and Visa International Corp. have been named as
co-defendants in the California cases. One such Texas case was dismissed voluntarily by plaintiffs.
At this time, it is not possible to determine the ultimate resolution of these matters and no
provision for losses has been provided in connection with them.
MasterCard International, Visa U.S.A., Inc., Visa International Corp., several member banks
including Citibank (South Dakota), N.A., Citibank (Nevada), N.A., Chase Bank USA, N.A., Bank of
America, N.A. (USA), MBNA, and Diners Club are also defendants in a number of federal class actions
that allege, among other things, violations of federal antitrust laws based on the asserted one
percent currency conversion fee. Pursuant to an order of the Judicial Panel on Multidistrict
Litigation, the federal complaints have been consolidated in MDL No. 1409 before Judge William H.
Pauley III in the U.S. District Court for the Southern District of New York. In January 2002, the
federal plaintiffs filed a Consolidated Amended Complaint (MDL Complaint) adding MBNA Corporation
and MBNA America Bank, N.A. as defendants. This pleading asserts two theories of antitrust
conspiracy under Section 1 of the Sherman Act: (i) an alleged inter-association conspiracy among
MasterCard (together with its members), Visa (together with its members) and Diners Club to fix
currency conversion fees allegedly charged to cardholders of no less than 1% of the transaction
amount and frequently more; and (ii) two alleged intra-association conspiracies, whereby each of
Visa and MasterCard is claimed separately to have conspired with its members to fix currency
conversion fees allegedly charged to cardholders of no less than 1% of the transaction amount
and to facilitate and encourage institution and collection of second tier currency conversion
surcharges. The MDL Complaint also asserts that the alleged currency conversion fees have not
been disclosed as required by the Truth in Lending Act and Regulation Z.
13
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Continued
(In thousands, except per share and percent data)
Defendants have moved to dismiss the MDL Complaint. On July 3, 2003, Judge Pauley issued a
decision granting MasterCards motion to dismiss in part. Judge Pauley dismissed the Truth in
Lending claims in their entirety as against MasterCard, Visa and several of the member bank
defendants. Judge Pauley did not dismiss the antitrust claims. Fact and expert discovery in this
matter have closed. On November 12, 2003 plaintiffs filed a motion for class certification, which
was granted on October 15, 2004. On March 9, 2005, Judge Pauley issued a decision on defendants
motion to reconsider the class certification decision. The Judge ruled that the arbitration
provisions in the cardholder agreements of member bank defendants, Bank One, MBNA, Providian,
Household and Bank of America are valid as to those respective banks and MasterCard and,
consequently, cardholders of those banks can no longer participate in the class action certified in
his earlier decision and must pursue any claims through arbitration. Plaintiffs moved for further
reconsideration, which was denied by Judge Pauley on June 16, 2005. In addition, Judge Pauley
declined to give effect to the arbitration clauses in the Citibank and Chase cardholder agreements;
both banks have noticed an appeal of that decision. The trial date which has been set for May 15,
2006. At this time, it is not possible to determine the ultimate resolution of this matter and no
provision for losses has been provided in connection with it.
Merchant Chargeback-Related Litigations
On May 12, 2003, a complaint alleging violations of federal and state antitrust laws, breach
of contract, fraud and other theories was filed in the U.S. District Court for the Central District
of California (Los Angeles) against MasterCard by a merchant aggregator whose customers include
businesses selling adult entertainment content over the Internet. The complaints allegations
focus on MasterCards past and potential future assessments on the plaintiffs merchant bank
(acquirer) for exceeding excessive chargeback standards in connection with the plaintiffs
transaction activity as well as the effect of MasterCards chargeback rules and other practices on
card-not-present merchants. Chargebacks refer to a situation where a transaction is returned, or
charged back, to an acquirer by an issuer at the request of cardholders or for other reasons. Prior
to MasterCard filing any motion or responsive pleading, the plaintiff filed a voluntary notice of
dismissal without prejudice on December 5, 2003. On the same date, the plaintiff filed a complaint
in the U.S. District Court for the Eastern District of New York making similar allegations to those
made in its initial California complaint. MasterCard moved to dismiss all of the claims in the
complaint for failure to state a cause of action. On March 30, 2005 the judge granted MasterCards
motion and dismissed all of the claims in the complaint. On April 11, 2005, the plaintiff filed a
notice of appeal of the district courts order. On June 30, 2005, the plaintiff filed its brief in
support of its appeal. MasterCards opposition brief is currently due to be filed on August 30,
2005.
In addition, on June 6, 2003, an action titled California Law Institute v. Visa U.S.A, et al.
was initiated against MasterCard and Visa U.S.A., Inc. in the Superior Court of California,
purportedly on behalf of the general public. Plaintiffs seek disgorgement, restitution and
injunctive relief for unlawful and unfair business practices in violation of California Unfair
Trade Practices Act Section 17200, et. seq. Plaintiffs purportedly allege that MasterCards (and
Visas) chargeback fees are unfair and punitive in nature. Plaintiffs seek injunctive relief
preventing MasterCard from continuing to engage in its chargeback practices and requiring
MasterCard to provide restitution and/or disgorgement for monies improperly obtained by virtue of
them. On June 10, 2005, MasterCard filed a motion requesting that the Court bifurcate certain
dispositive issues to be tried separately. The parties are waiting for a ruling on that motion.
Initial, but limited, discovery is now proceeding in this matter.
On September 20, 2004, MasterCard was served with a complaint titled PSW Inc. v. Visa U.S.A,
Inc., MasterCard International Incorporated, et. al., No. 04-347, in the District Court of Rhode
Island. The plaintiff, as alleged in the complaint, provided credit card billing services
primarily for adult content web sites. The plaintiff alleges defendants excessive chargeback
standards, exclusionary rules, merchant registration programs, cross-border acquiring rules and
interchange pricing to internet merchants violate federal and state antitrust laws as well as state
contract and tort law. The plaintiff seeks $60,000 in compensatory damages as well as $180,000 in
punitive damages. On November 24, 2004, MasterCard moved to dismiss the complaint. Prior to the
Court ruling on MasterCards motion to dismiss, plaintiffs filed an amended complaint on April 6,
2005. This complaint generally mirrors the original complaint but includes additional causes of
action based on the purported deprivation of plaintiffs rights under the First Amendment of the
U.S. Constitution. On May 20, 2005, MasterCard moved to dismiss all of PSWs claims in the
complaint for failure to state a claim. The plaintiff filed its opposition to MasterCards motion
on July 7, 2005. The Court has not yet scheduled oral argument on the motion.
14
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Continued
(In thousands, except per share and percent data)
At this time it is not possible to determine the outcome of the merchant chargeback-related
litigations. No provision for losses has been provided in connection with these litigations.
U.S. Merchant and Consumer Litigations
Commencing in October 1996, several class action suits were brought by a number of U.S.
merchants against MasterCard International and Visa U.S.A., Inc. challenging certain aspects of the
payment card industry under U.S. federal antitrust law. Those suits were later consolidated in the
U.S. District Court for the Eastern District of New York. The plaintiffs challenged MasterCards
Honor All Cards rule and a similar Visa rule. Plaintiffs claimed that MasterCard and Visa
unlawfully tied acceptance of debit cards to acceptance of credit cards. The plaintiffs also
claimed that MasterCard and Visa conspired to monopolize what they characterized as the
point-of-sale debit card market, thereby suppressing the growth of regional networks such as ATM
payment systems. On June 4, 2003, MasterCard International signed the Settlement Agreement to
settle the claims brought by the plaintiffs in this matter, which the Court approved on December
19, 2003. A number of class members have appealed the District Courts approval of the settlement.
These appeals are largely focused on the Courts attorneys fees award as well on the Courts
ruling on the scope of the release set forth in the Settlement Agreement. On January 4, 2005, the
Second Circuit Court of Appeals issued an order affirming the District Courts approval of the U.S.
merchant Settlement Agreement. The settlement is now final as no class members filed a petition
for certiorari with the Supreme Court regarding the Second Circuits affirmation of the district
courts approval of the settlement. For a further description of the U.S. merchant lawsuit
settlement and its impact on MasterCards financial results, see Note 8.
In addition, individual or multiple complaints have been brought in 19 different states and
the District of Columbia under state unfair competition statutes against MasterCard International
(and Visa) on behalf of putative classes of consumers. The claims in these actions largely mirror
the allegations made in the U.S. merchant lawsuit and assert that merchants, faced with excessive
merchant discount fees, have passed these overcharges to consumers in the form of higher prices on
goods and services sold. While these actions are in their early stages, MasterCard has filed
motions to dismiss the complaints in a number of state courts for failure to state a cause of
action. Courts in Arizona, Iowa, New York, Michigan, Minnesota, Nebraska, Maine, North Dakota,
Kansas, North Carolina, South Dakota, Vermont, Wisconsin and the District of Columbia have granted
MasterCards motions and dismissed the complaints with prejudice. Plaintiffs have appealed several
of these decisions. The plaintiffs in Minnesota have filed a revised complaint on behalf of a
purported class of Minnesota consumers who made purchases with debit cards rather than on behalf of
all consumers. On July 12, 2005, the court granted MasterCards motion to dismiss the Minnesota
complaint for failure to state a claim and dismissed the complaint with prejudice. The time in
which plaintiffs may appeal this decision is currently running. In addition, the courts in
Tennessee and California have granted MasterCards motion to dismiss the respective state unfair
competition claims but have denied MasterCards motions with respect to unjust enrichment claims in
Tennessee and Section 17200 claims for unlawful, unfair, and/or fraudulent business practices in
California. Both parties have appealed the Tennessee decisions. MasterCard is awaiting decisions
on its motions to dismiss in the other state courts.
On March 14, 2005, MasterCard was served with a complaint that was filed in Ohio state court
on behalf of a putative class of consumers under Ohio state unfair competition law. The claims in
this action mirror those in the consumer actions described above but also name as co-defendants a
purported class of merchants who were class members in the U.S. merchant lawsuit. Plaintiffs
allege that Visa, MasterCard and the class members of the U.S. merchant lawsuit conspired to
attempt to monopolize the debit card market by tying debit card acceptance to credit card
acceptance. MasterCards time in which to respond to the complaint is currently running.
At this time, it is not possible to determine the outcome of these consumer cases and no
provision for losses has been provided in connection with them. The consumer class actions are not
covered by the terms of the Settlement Agreement in the U.S. merchant lawsuit.
Global Interchange Proceedings
Interchange fees represent a sharing of payment system costs among the financial institutions
participating in a four-party payment card system such as MasterCards. Typically, interchange
fees are paid by the merchant bank
15
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Continued
(In thousands, except per share and percent data)
(the acquirer) to the cardholder bank (the issuer) in connection with transactions
initiated with the payment systems cards. These fees reimburse the issuer for a portion of the
costs incurred by it in providing services which are of benefit to all participants in the system,
including acquirers and merchants. MasterCard or its members establish a multilateral interchange
fee (MIF) in certain circumstances as a default fee that applies when there is no other
interchange fee arrangement between the issuer and the acquirer. MasterCard establishes a variety
of MIF rates depending on such considerations as the location and the type of transaction, and
collects the MIF on behalf of the institutions entitled to receive it. As described more fully
below, MasterCards or its members MIFs are subject to regulatory or legal review and/or
challenges in a number of jurisdictions. At this time, it is not possible to determine the
ultimate resolution of any of the interchange proceedings described below. Accordingly, no
provision for losses has been provided in connection with them.
European Union. In September 2000, the European Commission issued a Statement of Objections
challenging Visa Internationals cross-border MIF under European Community competition rules. On
July 24, 2002, the European Commission announced its decision to exempt the Visa MIF from these
rules based on certain changes proposed by Visa to its MIF. Among other things, in connection with
the exemption order, Visa agreed to adopt a cost-based methodology for calculating its MIF similar
to the methodology employed by MasterCard, which considers the costs of certain specified services
provided by issuers, and to reduce its MIF rates for debit and credit transactions to amounts at or
below certain specified levels.
On September 25, 2003, the European Commission issued a Statement of Objections challenging
MasterCard Europes cross-border MIF. MasterCard Europe filed its response to this Statement of
Objections on January 5, 2004. MasterCard Europe is engaged in discussions with the European
Commission in order to determine under what conditions, if any, the European Commission would issue
a favorable ruling regarding MasterCard Europes MIF. If MasterCard is unsuccessful in obtaining a
favorable ruling, the European Commission could issue a prohibition decision ordering MasterCard to
change the manner in which it calculates its cross-border MIF. MasterCard could appeal such a
decision to the European Court of Justice. Because the cross-border MIF constitutes an essential
element of MasterCard Europes operations, changes to it could significantly impact MasterCard
Internationals European members and the MasterCard business in Europe. In addition, a negative
decision by the European Commission could lead to the filing of private actions against MasterCard
by merchants seeking substantial damages.
United Kingdom Office of Fair Trading. On September 25, 2001, the Office of Fair Trading of
the United Kingdom (OFT) issued a Rule 14 Notice under the U.K. Competition Act 1998 challenging
the MasterCard MIF, the fee paid by acquirers to issuers in connection with point of sale
transactions, and multilateral service fee (MSF), the fee paid by issuers to acquirers when a
customer uses a MasterCard-branded card in the United Kingdom either at an ATM or over the counter
to obtain a cash advance. Until November 2004 (see below), the MIF and MSF were established by
MasterCard U.K. Members Forum Limited (formerly MEPUK) (MMF) for domestic credit card
transactions in the United Kingdom. The notice contained preliminary conclusions to the effect
that the MasterCard U.K. MIF and MSF may infringe U.K. competition law and do not qualify for an
exemption in their present forms. In January 2002, MasterCard, MEPUK and several MasterCard U.K.
members responded to the notice. On February 11, 2003, the OFT issued a supplemental Rule 14
Notice, which also contained preliminary conclusions challenging MasterCards U.K. MIF under the
Competition Act. On May 2, 2003, MasterCard and MMF responded to the supplemental notice. On
November 10, 2004, the OFT issued a third notice (now called a Statement of Objections) claiming
that the MIF infringes U.K. and European Union competition law. In February 2005, MasterCard and
MMF responded to the Statement of Objections. An oral hearing was held on March 2, 2005. The OFT
is expected to reach a decision later this year.
On November 18, 2004, MasterCards board of directors adopted a resolution withdrawing the
authority of the U.K. members to set domestic MasterCard MIFs and MSFs and conferring such
authority exclusively on MasterCards President and Chief Executive Officer. As a result, if
MasterCard and MMF are unsuccessful in obtaining a favorable ruling in the current proceeding, the
OFT would have to commence a new proceeding for the purpose of ordering MasterCard to change the
manner in which it calculates its U.K. MIF. The OFT has informed MasterCard that, if it issues a
prohibition decision in the current proceedings, it is likely to commence a new proceeding
challenging MasterCards setting of MIFs. Because the MIF constitutes an essential element of
MasterCards U.K. operations, negative decisions by the OFT in the current or any future
proceedings could have a
16
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Continued
(In thousands, except per share and percent data)
significant adverse impact on MasterCards U.K. members and on MasterCards competitive
position and overall business in the U.K. In addition, a negative decision by the OFT could lead
to the filing of private actions against MasterCard by merchants seeking substantial damages. In
the event of a negative decision by the OFT in the current proceeding, MasterCard and MMF intend to
appeal to the Competition Appeals Tribunal and possibly to seek interim relief. Similarly, it is
likely that MasterCard would appeal a negative decision by the OFT in any future proceeding to the
Competition Appeals Tribunal and would seek interim relief.
United States. In July 2002, a purported class action lawsuit was filed by a group of
merchants in the U.S. District Court for the Northern District of California against MasterCard
International, Visa U.S.A., Inc., Visa International Corp. and several member banks in California
alleging, among other things, that MasterCards and Visas interchange fees contravene the Sherman
Act. The suit seeks treble damages in an unspecified amount, attorneys fees and injunctive
relief, including the divestiture of bank ownership of MasterCard and Visa, and the elimination of
MasterCard and Visa marketing activities. On March 4, 2004, the court dismissed the lawsuit with
prejudice in reliance upon the approval of the Settlement Agreement in the U.S. merchant lawsuit by
the U.S. District Court for the Eastern District of New York, which held that the settlement and
release in that case extinguished the claims brought by the merchant group in the present case.
The plaintiffs have appealed the U.S. District Court for the Eastern District of New Yorks
approval of the U.S. merchant lawsuit settlement and release to the Second Circuit Court of Appeals
and have also appealed the U.S. District Court for the Northern District of Californias dismissal
of the present lawsuit to the Ninth Circuit Court of Appeals. On January 4, 2005, the Second
Circuit Court of Appeals issued an order affirming the District Courts approval of the U.S.
merchant lawsuit settlement agreement, including the District Courts finding that the settlement
and release extinguished such claims. Plaintiffs did not seek certiorari of the Second Circuits
decision with the U.S. Supreme Court. The appeal to the Ninth Circuit is currently pending.
On October 8, 2004, a new purported class action lawsuit was filed by a group of merchants in
the U.S. District Court for the Northern District of California against MasterCard International,
Visa U.S.A., Inc., Visa International Corp. and several member banks in California alleging, among
other things, that MasterCards and Visas interchange fees contravene the Sherman Act and the
Clayton Act. The complaint contains similar allegations to those brought in the interchange case
described in the preceding paragraph, and plaintiffs have designated it as a related case. The
plaintiffs seek damages and an injunction against MasterCard (and Visa) setting interchange and
engaging in joint marketing activities, which plaintiffs allege include the purported negotiation
of merchant discount rates with certain merchants. On November 19, 2004, MasterCard filed an answer
to the complaint. The plaintiff filed an amended complaint on April 25, 2005. MasterCard moved
to dismiss the claims in the complaint for failure to state a claim and, in the alternative, also
moved for summary judgment with respect to certain of the claims. The Court heard oral argument on
MasterCards motion to dismiss on July 8, 2005. On July 25, 2005, the Court issued an order
granting MasterCards motion to dismiss and dismissed the plaintiffs compliant with prejudice.
The time in which the plaintiff can appeal this decision is currently running.
On June 22, 2005, a purported class action lawsuit was filed by a group of merchants in the
U.S. District Court of Connecticut against MasterCard International Incorporated, Visa U.S.A., Inc.
Visa International Service Association and a number of member banks alleging, among other things,
that MasterCards and Visas purported setting of interchange fees violates Section 1 of the
Sherman Act. In addition, the complaint alleges MasterCards and Visas purported tying and
bundling of transaction fees also constitutes a violation of Section 1 of the Sherman Act. The
suit seeks treble damages in an unspecified amount, attorneys fees and injunctive relief.
MasterCards time in which to respond to the complaint is currently running. In addition, on June
28, 2005, a second class action lawsuit was filed on behalf of a purported class of merchants in
the Southern District of New York against MasterCard, Visa U.S.A., Inc. and Visa International.
This suit alleges that MasterCard and Visas interchange fees violate Section 1 of the Sherman Act.
The suit also alleges that MasterCard and Visa have enacted various rules, including the no
surcharge rule, which purportedly constitute unlawful restraints of trade. The suit seeks treble
damages, attorneys fees and injunctive relief. There has been a number of additional class action
lawsuits on behalf of merchants filed in the Southern District of New York generally mirroring the
allegations contained in the lawsuits described above. Likewise, there have been a number of
complaints containing similar allegations filed in the Northern
District of California, the
District of Connecticut and the Eastern District of Wisconsin. MasterCard has yet to be served with the complaints in the majority of
these actions, and its time in which to respond to the complaints with which it has been served is
currently running.
17
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Continued
(In thousands, except per share and percent data)
At this time it is not possible to determine the outcome of these interchange-related
litigations. No provisions for losses have been provided in connection with these litigations.
Other Jurisdictions.
In Spain, the Competition Tribunal issued a decision in April 2005 denying the interchange fee
exemption applications of two of the three domestic credit and debit card processing systems and
beginning the process to revoke the exemption it had previously granted to the third such system.
The interchange fees set by these three processors apply to MasterCard transactions in Spain and
consequently, MasterCard has appealed this decision. In addition, the Tribunal expressed views as
to the appropriate manner for setting domestic interchange fees which, if implemented, would result
in substantial reductions in credit and debit card interchange fees in Spain. This could have a
material impact on MasterCards business in Spain.
MasterCard is aware that regulatory authorities and/or central banks in certain other
jurisdictions, including Poland, New Zealand, Portugal, Mexico, Colombia, South Africa, Hungary and
Switzerland are reviewing MasterCards and/or its members interchange fees and/or related
practices and may seek to regulate the establishment of such fees and/or such practices.
Note 11. Settlement and Travelers Cheque Risk Management
Settlement risk is the legal exposure due to the difference in timing between the payment
transaction date and subsequent settlement. Settlement risk is estimated using the average daily
card charges during the quarter multiplied by the estimated number of days to settle. The Company
has global risk management policies and procedures, which include risk standards to provide a
framework for managing the Companys settlement exposure. MasterCard Internationals rules
generally guarantee the payment of MasterCard transactions and certain Cirrus and Maestro
transactions between principal members. The term and amount of the guarantee are unlimited.
Member-reported transaction data and the transaction clearing data underlying the settlement risk
exposure calculation may be revised in subsequent reporting periods.
In the event that MasterCard International effects a payment on behalf of a failed member,
MasterCard International may seek an assignment of the underlying receivables. Subject to approval
by the Board of Directors, members may be assessed for the amount of any settlement loss.
MasterCard requires certain members that are not in compliance with the Companys risk
standards in effect at the time of review to post collateral, typically in the form of letters of
credit and bank guarantees. This requirement is based on management review of the individual risk
circumstances for each member that is out of compliance. In addition to these amounts, MasterCard
holds collateral to cover variability and future growth in member programs; the possibility that it
may choose to pay merchants to protect brand integrity in the event of merchant bank/acquirer
failure, although it is not contractually obligated to do so; and Cirrus and Maestro related risk.
MasterCard monitors its credit risk portfolio on a regular basis to estimate potential
concentration risks and the adequacy of collateral on hand. Additionally, from time to time, the
Company reviews its risk management methodology and standards. As such, the amounts of estimated
settlement exposure are revised as necessary.
18
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Continued
(In thousands, except per share and percent data)
Estimated settlement exposure, and the portion of the Companys uncollateralized settlement
exposure for MasterCard-branded transactions that relates to members that are deemed not to be in
compliance with, or that are under review in connection with, the Companys risk management
standards were as follows:
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|
|
June 30 , 2005 |
|
December 31, 2004 |
MasterCard-branded transactions: |
|
|
|
|
|
|
|
|
Gross legal settlement exposure |
|
$ |
13,898,001 |
|
|
$ |
14,055,973 |
|
Collateral held for legal settlement exposure |
|
|
(1,295,809 |
) |
|
|
(1,482,319 |
) |
|
|
|
|
|
|
|
|
|
Net uncollateralized settlement exposure |
|
$ |
12,602,192 |
|
|
$ |
12,573,654 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Uncollateralized settlement exposure
attributable to non-compliant members |
|
$ |
314,806 |
|
|
$ |
299,995 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cirrus and Maestro transactions: |
|
|
|
|
|
|
|
|
Gross legal settlement exposure |
|
$ |
1,553,481 |
|
|
$ |
1,294,145 |
|
|
|
|
|
|
|
|
|
|
Although MasterCard holds collateral at the member level, the Cirrus and Maestro estimated
settlement exposures are calculated at the regional level. Therefore, these settlement exposures
are reported on a gross basis, rather than net of collateral.
Of the total estimated settlement exposure under the MasterCard brand, net of collateral, the
U.S. generated approximately 51% and 52% at June 30, 2005 and December 31, 2004, respectively. No
individual country, other than the U.S. generated more than 10% of this exposure. Of the total
uncollateralized settlement exposure attributable to non-compliant members, five members
represented approximately 69% and 65% at June 30, 2005 and December 31, 2004, respectively.
MasterCard guarantees the payment of MasterCard-branded travelers cheques in the event of
issuer default. The guarantee estimate is based on all outstanding MasterCard-branded travelers
cheques, reduced by an actuarial determination of cheques that are not anticipated to be presented
for payment. The term and amount of the guarantee are unlimited. MasterCard calculated its
MasterCard-branded travelers cheques exposure under this guarantee as $1,074,957 and $1,172,533 at
June 30, 2005 and December 31, 2004, respectively.
A significant portion of the Companys travelers cheque credit risk is concentrated in one
MasterCard travelers cheque issuer. MasterCard has obtained an unlimited guarantee estimated at
$882,281 and $969,593 at June 30, 2005 and December 31, 2004, respectively, from a financial
institution that is a member, to cover all of the exposure of outstanding travelers cheques with
respect to that issuer. In addition, MasterCard has obtained guarantees estimated at $27,915 and
$28,592 at June 30, 2005 and December 31, 2004, respectively, from financial institutions that are
members in order to cover the exposure of outstanding travelers cheques with respect to another
issuer. These guarantee amounts have also been reduced by an actuarial determination of cheques
that are not anticipated to be presented for payment.
Based on the Companys ability to assess its members for settlement and travelers cheque
losses, the effectiveness of the Companys global risk management policies and procedures, and the
historically low level of losses that the Company has experienced, management believes the
probability of future payments for settlement and travelers cheque losses in excess of existing
reserves is negligible. However, if circumstances in the future change, the Company may need to
reassess whether it would be necessary to record an obligation for the fair value of some or all of
its settlement and travelers cheque guarantees.
19
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Continued
(In thousands, except per share and percent data)
Note 12. Foreign Exchange Risk Management
The Company enters into foreign currency forward contracts to minimize risk associated with
anticipated receipts and disbursements denominated in foreign currencies and the possible changes
in value due to foreign exchange fluctuations of assets and liabilities denominated in foreign
currencies. MasterCards forward contracts are classified by functional currency as summarized
below:
U.S. Dollar Functional Currency
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2005 |
|
December 31, 2004 |
|
|
|
|
|
|
Estimated |
|
|
|
|
|
Estimated |
Forward Contracts |
|
Notional |
|
Fair Value |
|
Notional |
|
Fair Value |
Commitments to purchase foreign currency |
|
$ |
61,278 |
|
|
$ |
(365 |
) |
|
$ |
40,981 |
|
|
$ |
1,854 |
|
Commitments to sell foreign currency |
|
|
40,760 |
|
|
|
(147 |
) |
|
|
20,226 |
|
|
|
(655 |
) |
Euro Functional Currency
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2005 |
|
December 31, 2004 |
|
|
|
|
|
|
Estimated |
|
|
|
|
|
Estimated |
Forward Contracts |
|
Notional |
|
Fair Value |
|
Notional |
|
Fair Value |
Commitments to purchase foreign currency |
|
$ |
90,213 |
|
|
$ |
3,423 |
|
|
$ |
128,253 |
|
|
$ |
(6,494 |
) |
Commitments to sell foreign currency |
|
|
50,488 |
|
|
|
(780 |
) |
|
|
|
|
|
|
|
|
The currencies underlying the foreign currency forward contracts consist primarily of euro,
U.K. pounds sterling, Swiss francs, Japanese yen and Australian dollars. The fair value of the
foreign currency forward contracts generally reflects the estimated amounts that the Company would
receive or (pay), on a pre-tax basis, to terminate the contracts at the reporting date based on
broker quotes for the same or similar instruments. The terms of the foreign currency forward
contracts are generally less than 18 months. The Company has deferred $1,827 of net gains and
$3,497 of net losses, after tax, in accumulated other comprehensive income as of June 30, 2005 and
December 31, 2004, respectively, all of which is expected to be reclassified to earnings within the
next six months to provide an economic offset to the earnings impact of the anticipated cash flows
hedged.
The Companys derivative financial instruments are subject to both credit and market risk.
Credit risk is the risk of loss due to failure of the counterparty to perform its obligations in
accordance with contractual terms. Market risk is the potential change in an investments value
caused by fluctuations in interest and currency exchange rates, credit spreads or other variables.
Credit and market risk related to derivative instruments were not material at June 30, 2005 and
December 31, 2004.
Generally, the Company does not obtain collateral related to forward contracts because of the
high credit ratings of the counterparties that are members. The amount of accounting loss the
Company would incur if the counterparties failed to perform according to the terms of the contracts
is not considered material.
20
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Continued
(In thousands, except per share and percent data)
Note 13. Stockholders Equity
MasterCards capital stock is privately held by certain of the Companys customers which are
principal members of MasterCard International. Each principal member of MasterCard International
also has a class A membership interest in MasterCard International, representing that members
continued rights as a licensee to use MasterCards brands, programs, products and services.
MasterCard Incorporated owns the sole class B membership interest in MasterCard International,
entitling MasterCard Incorporated to exercise all economic rights and substantially all voting
rights in MasterCard International. MasterCard International is the Companys principal operating
subsidiary.
The authorized capital stock of MasterCard Incorporated at June 30, 2005 consists of 275,000
shares of class A redeemable common stock, par value $.01 per share (of which 84,000 shares are
issued and outstanding); 25,000 shares of class B convertible common stock, par value $.01 per
share (of which 16,000 shares are issued and outstanding); and 75,000 shares of class C common
stock, par value $.01 per share (of which no shares are issued or outstanding). Class C common
stock may be issued from time to time with voting powers, designations, preferences and other
rights to be determined by the MasterCard board of directors, in compliance with certain
limitations, as set forth in the certificate of incorporation of MasterCard.
The class A and B shares were issued on June 28, 2002, pursuant to an Agreement and Plan of
Merger dated as of February 13, 2002, in which MasterCard International merged with a subsidiary of
MasterCard Incorporated (the Conversion) and the Integration Agreement pursuant to which
MasterCard Incorporated acquired all of the outstanding shares of Europay International S.A. (now
MasterCard Europe) (the Integration). In the Conversion and Integration, each principal member
of MasterCard International received shares of class A redeemable common stock and class B
convertible common stock of MasterCard, representing each members existing equity interest in the
Company.
Pursuant to the Companys bylaws (the bylaws), on July 1, 2005 all of the Companys class B
convertible common stock converted to class A redeemable common stock. Thereafter, all class A
redeemable common stock will be reallocated among the Companys stockholders (the reallocation)
based on a global proxy calculation set forth in the Companys bylaws. The global proxy
calculation is based on the stockholders business contribution to MasterCard Incorporated during
the twelve months ended June 30, 2005. MasterCard Incorporated intends to redeem and issue shares
in order to facilitate the reallocation, which is anticipated to be finalized no later than the
fourth quarter of 2005. The global proxy calculation will occur annually after July 1, 2005 based
on each stockholders business contribution to MasterCard Incorporated during the previous twelve
months. Transfers of shares of common stock and assignment of the right to receive shares were not
permitted until July 1, 2005. After July 1, 2005, no reallocation will occur however each
stockholder must maintain an ownership percentage of common stock that is no less than 75% and no
more than 125% of the shares determined in the most recent global proxy calculation. Stockholders
may be required to purchase or sell shares of MasterCard, in accordance with procedures established
by the Company, in order to satisfy these requirements.
The bylaws also set forth that customers that became principal members of MasterCard
International subsequent to January 1, 2001, would be eligible to participate in the reallocation.
To permit this to occur, the Company will issue one share to principal members that qualify to
participate in the reallocation as of July 1, 2005 but did not receive shares on June 28, 2002.
Accordingly, MasterCard issued 348 shares to such principal members on July 1, 2005. The issuance
of this common stock will be recorded at par in the three months ended September 30, 2005 by
reclassifying a portion of retained earnings to common stock. All shares received by these new
members, both issued and as a result of the reallocation, will be restricted for resale under
applicable U.S. securities laws.
After July 1, 2005, MasterCard Incorporated may, at its option, redeem the common stock of a
stockholder that ceases to be a principal member of MasterCard International for the book value of
the shares, based on MasterCards financial statements most recently filed with the Securities and
Exchange Commission. If MasterCard Incorporated does not redeem the stockholders shares, a
stockholder ceasing to be a member of MasterCard International after July 1, 2005 will be required
to offer the unredeemed shares to the other stockholders of MasterCard in accordance with
procedures to be established by the Company.
21
MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) Continued
(In thousands, except per share and percent data)
Note 14. Acquisition of MasterCard Europe
On June 28, 2002, MasterCard Incorporated issued 23,760 shares of its common stock to the
shareholders of Europay International (EPI), now MasterCard Europe, and MasterCard Europay U.K.
Limited (MEPUK), in return for directly and indirectly acquiring 100% of the shares of EPI not
previously owned by MasterCard International. Of the 23,760 shares attributable to the exchange of
EPI and MEPUK shares, 6,150 shares are conditional shares subject to reallocation as of July 1,
2005, as described in Note 13 herein.
Each shareholder of EPI (other than MasterCard International and MEPUK) entered into a
separate share exchange agreement pursuant to which it exchanged its EPI shares for shares of class
A redeemable and class B convertible common stock of MasterCard Incorporated. The shareholders of
MEPUK entered into an agreement pursuant to which they exchanged their MEPUK shares for class A
redeemable and class B convertible common stock of MasterCard Incorporated. As a result, EPI and
MEPUK became wholly-owned subsidiaries of MasterCard Incorporated. MEPUKs sole asset was shares of
EPI (now MasterCard Europe). In addition, class B convertible common stock automatically converted
into class A redeemable common stock on July 1, 2005.
In calculating the purchase price of EPI, the Company considered only the unconditional shares
issued to the former shareholders of EPI and MEPUK. Since former EPI and MEPUK shareholders will
retain or receive additional shares without remitting any additional consideration, any conditional
shares retained or received by them will constitute a part of the purchase price. Any conditional
shares issued will be valued based upon the estimated fair value of the stock of MasterCard
Incorporated as of July 1, 2005 and will result in an increase to the purchase price for EPI, the
amount of goodwill and additional paid-in capital initially recorded. The Company began the
process of determining the reallocation of the shares among its stockholders as of July 1, 2005.
The reallocation of the shares and the determination of the amount of EPI conditional shares, if
any, to be issued to the former shareholders of EPI and MEPUK are anticipated to be finalized no
later than the fourth quarter of 2005. Based on preliminary estimates of the performance of the
Companys shareholders and other pertinent data utilized in the reallocation formula, the Company
anticipates the purchase price for EPI and accordingly the amount of goodwill recorded will
increase. Subsequent to the determination of the incremental purchase price, the total amount of
goodwill relating to the acquisition of MasterCard Europe will be tested for impairment.
22
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the consolidated financial
statements and notes of MasterCard Incorporated and its consolidated subsidiaries, including
MasterCard International Incorporated (MasterCard International) and MasterCard Europe sprl
(MasterCard Europe)(together, MasterCard or the Company) included elsewhere in this report.
References to we, our and similar terms in the following discussion are references to the
Company.
Forward-Looking Statements
This Report on Form 10-Q contains forward-looking statements pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. When used in this Report, the
words believe, expect, could, may, would, will and similar words are intended to
identify forward-looking statements. These statements relate to our future prospects, developments
and business strategies. Many factors and uncertainties relating to our operations and business
environment, all of which are difficult to predict and many of which are outside of our control,
influence whether any forward-looking statements can or will be achieved. Any one of those factors
could cause our actual results to differ materially from those expressed or implied in writing in
any forward-looking statements made by MasterCard or on its behalf. We believe there are certain
risk factors that are important to our business, and these could cause actual results to differ
from our expectations. Reference should be made to the Companys 2004 Annual Report on Form 10-K
for a complete discussion of these risk factors under the caption Risk Factors in Item 1
Business.
Overview
The strength of our business is evident from our financial results for the three and six
months ended June 30, 2005. Revenue growth was 19% and 15% in the three and six months ended June
30, 2005, respectively, from the comparable periods in 2004. In addition to strong revenue growth,
there were modest 6% increases in operating expenses in each of the three and six months ended June
30, 2005 versus the same periods in the prior year, resulting in net income increases of 82% and
54%, respectively. The impact of favorable foreign currency fluctuation of the dollar against the
euro contributed 1% in each period to the increases in revenues and expenses.
Our liquidity and capital position is also strong. We have $1.2 billion in cash, cash
equivalents and available-for-sale securities, and $1.1 billion in stockholders equity as of June
30, 2005.
Revenue growth can be attributed to higher gross dollar volume (GDV), more transactions
being processed and certain pricing changes which went into effect in the three months ended June
30, 2005. Our revenue growth in 2005 is moderated by pricing arrangements and business agreements
for rebates and incentives with certain large customers and merchants. The number of agreements
and amount of support provided to our customers has been increasing due to enhanced competition in
the global payments industry and continued consolidation and globalization of key customers and
merchants. Rebates and incentives are generally based on GDV or other performance hurdles such as
card issuance. Rebates and incentives were 17% and 18% of our gross revenues in the three and six
months ended June 30, 2005, respectively.
We have begun to implement strategic initiatives by hiring additional resources and developing
sales personnel to enhance our relationships with our customers and the merchants that accept the
cards carrying our brands. We will seek to leverage our expertise in payment programs, brand
marketing, technology, processing and consulting services to expand the value-added services we
provide our customers. We expect our efforts will continue to drive our business growth;
strengthen our brands, technology and acceptance network; and differentiate MasterCard from our
competition by developing innovative payment solutions and customized services. In addition, we
intend to address proactively the legal, regulatory and other industry risks that impact our
business. We believe our resources are sufficient to fund our initiatives in 2005 and beyond.
23
Results of Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percent |
|
|
|
|
|
|
|
|
|
Percent |
|
|
Three Months |
|
Increase |
|
Six Months |
|
Increase |
|
|
Ended June 30, |
|
(Decrease) |
|
Ended June 30, |
|
(Decrease) |
|
|
|
|
|
|
|
|
|
|
2005 vs. |
|
|
|
|
|
|
|
|
|
2005 vs. |
|
|
2005 |
|
2004 |
|
2004 |
|
2005 |
|
2004 |
|
2004 |
|
|
(In millions, except per share and GDV amounts) |
Operations fees |
|
$ |
489 |
|
|
$ |
397 |
|
|
|
23 |
% |
|
$ |
901 |
|
|
$ |
769 |
|
|
|
17 |
% |
Assessments |
|
|
283 |
|
|
|
250 |
|
|
|
13 |
|
|
|
529 |
|
|
|
473 |
|
|
|
12 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
|
772 |
|
|
|
647 |
|
|
|
19 |
|
|
|
1,430 |
|
|
|
1,242 |
|
|
|
15 |
|
General and administrative |
|
|
319 |
|
|
|
285 |
|
|
|
12 |
|
|
|
626 |
|
|
|
562 |
|
|
|
11 |
|
Advertising and market development |
|
|
232 |
|
|
|
229 |
|
|
|
1 |
|
|
|
403 |
|
|
|
396 |
|
|
|
2 |
|
U.S. merchant lawsuit and other legal
settlements |
|
|
|
|
|
|
4 |
|
|
|
|
|
|
|
|
|
|
|
4 |
|
|
|
|
|
Depreciation and amortization |
|
|
29 |
|
|
|
31 |
|
|
|
(6 |
) |
|
|
57 |
|
|
|
63 |
|
|
|
(10 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses |
|
|
580 |
|
|
|
549 |
|
|
|
6 |
|
|
|
1,086 |
|
|
|
1,025 |
|
|
|
6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating income |
|
|
192 |
|
|
|
98 |
|
|
|
96 |
|
|
|
344 |
|
|
|
217 |
|
|
|
59 |
|
Total other income (expense) |
|
|
(5 |
) |
|
|
(8 |
) |
|
|
38 |
|
|
|
(12 |
) |
|
|
(13 |
) |
|
|
8 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before income tax expense |
|
|
187 |
|
|
|
90 |
|
|
|
107 |
|
|
|
332 |
|
|
|
204 |
|
|
|
63 |
|
Income tax expense |
|
|
67 |
|
|
|
24 |
|
|
|
179 |
|
|
|
118 |
|
|
|
65 |
|
|
|
82 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
$ |
120 |
|
|
$ |
66 |
|
|
|
82 |
|
|
$ |
214 |
|
|
$ |
139 |
|
|
|
54 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share (basic and diluted) |
|
$ |
1.20 |
|
|
$ |
.66 |
|
|
|
82 |
|
|
$ |
2.14 |
|
|
$ |
1.39 |
|
|
|
54 |
|
Weighted average shares outstanding
(basic and diluted) |
|
|
100 |
|
|
|
100 |
|
|
|
|
|
|
|
100 |
|
|
|
100 |
|
|
|
|
|
Effective income tax rate |
|
|
35.8 |
% |
|
|
27.1 |
% |
|
|
|
|
|
|
35.6 |
% |
|
|
31.7 |
% |
|
|
|
|
Gross dollar volume (GDV) on a U.S.
dollar converted basis (in
billions) |
|
$ |
408 |
|
|
$ |
354 |
|
|
|
15 |
|
|
$ |
791 |
|
|
$ |
691 |
|
|
|
14 |
|
Processed transactions |
|
|
3,462 |
|
|
|
3,034 |
|
|
|
14 |
|
|
|
6,574 |
|
|
|
5,829 |
|
|
|
13 |
|
Impact of Foreign Currency Rates
Our operations are impacted by changes in foreign currency exchange rates. Quarterly
assessment fees are calculated based on local currency volume which is converted to U.S. dollar
volume using average exchange rates for the quarter. In three and six months ended June 30, 2005,
GDV increased 15% and 14%, respectively, on a U.S. dollar converted basis, which exceeded local
currency GDV growth of 12% in each of these periods compared to the same periods in the prior year.
Accordingly, a portion of the increases in assessment revenue for these periods is attributable to
the devaluation of the U.S. dollar. In addition, consumer behavior, particularly international
transactions, may vary with changes in foreign currency exchange rates.
24
We are especially impacted by the movements of the euro to the U.S. dollar since MasterCard
Europes functional currency is the euro. The devaluation of the U.S. dollar against the euro and
the impact of the translation of MasterCard Europes operating results into U.S. dollars are
summarized below:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended |
|
Six Months Ended |
|
|
June 30, |
|
June 30, |
|
|
2005 |
|
2004 |
|
2005 |
|
2004 |
Euro to U.S. dollar average exchange rate |
|
$ |
1.26 |
|
|
$ |
1.20 |
|
|
$ |
1.28 |
|
|
$ |
1.22 |
|
Devaluation of U.S. dollar to euro |
|
|
5 |
% |
|
|
|
|
|
|
5 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue growth attributable to
translation of MasterCard Europe revenues
to U.S. dollars |
|
|
1 |
% |
|
|
|
|
|
|
1 |
% |
|
|
|
|
Operating expense growth attributable to
translation of MasterCard Europe expenses
to U.S. dollars |
|
|
1 |
% |
|
|
|
|
|
|
1 |
% |
|
|
|
|
Revenues
Our revenues are generated from the fees that we charge our customers for providing
transaction processing and other payment services, and from assessments calculated on the dollar
volume of activity on cards carrying our brands. Certain revenues are estimated based upon
aggregate transaction information and projected customer performance. A component of our revenue
growth in the three and six months ended June 30, 2005 was the result of implementing new fees and
the changes to existing fees charged to our customers during the three months ended June 30, 2005.
We believe revenue growth was positively impacted by the worldwide trend in which payments are
migrating from paper-based forms to electronic forms such as payment cards. This trend has helped
drive our volume and revenue growth for a number of years. However, this growth is being moderated
by the demand from our customers for better pricing arrangements and greater rebates and
incentives. The rebates and incentives are calculated on a monthly basis based upon estimated
performance and the terms of the related business agreements. Rebates and incentives are recorded
as a reduction of revenue in the same period as performance has occurred.
We establish standards and procedures for the acceptance and settlement of our customers
transactions on a global basis. Our revenues are based upon transactional information accumulated
by our systems or reported by our customers, who may choose to engage third parties for transaction
processing. Our customers are responsible to ensure these third parties comply with our standards.
We do not issue cards, set fees, or determine the interest rates consumers will be charged on cards
carrying our brands. Our issuing customers have the responsibility for determining these and most
other competitive card features.
The U.S. remains our largest geographic market representing 54% and 59% of total revenues in
the three months ended June 30, 2005 and 2004, respectively, and 55% and 58% of total revenues in
the six months ended June 30, 2005 and 2004, respectively. No individual country, other than the
U.S., generated more than 10% of total revenues in all periods.
25
Operations Fees
Operations fees primarily represent user fees for authorization, clearing, settlement and
other payment services that facilitate transaction and information management among our customers
on a global basis. Operations fees increased $92 million or 23% and $132 million or 17% in the
three and six months ended June 30, 2005, respectively, compared to the same periods in 2004. The
significant changes in operations fees were as follows:
|
|
|
|
|
|
|
|
|
|
|
Change in Revenue |
|
|
Increase (Decrease) |
|
|
Three Months |
|
Six Months Ended |
|
|
Ended June 30, |
|
June 30, |
|
|
2005 vs. 2004 |
|
2005 vs. 2004 |
|
|
(In millions) |
Authorization, settlement and switch |
|
$ |
39 |
|
|
$ |
60 |
|
Acceptance development fees |
|
|
23 |
|
|
|
32 |
|
Currency conversion |
|
|
13 |
|
|
|
22 |
|
Consulting fees and research subscriptions |
|
|
7 |
|
|
|
13 |
|
Connectivity |
|
|
8 |
|
|
|
8 |
|
Other operations fees |
|
|
8 |
|
|
|
19 |
|
|
|
|
|
|
|
|
|
|
Gross operations fees change |
|
|
98 |
|
|
|
154 |
|
Increase in rebates |
|
|
(6 |
) |
|
|
(22 |
) |
|
|
|
|
|
|
|
|
|
Net change in operations fees |
|
$ |
92 |
|
|
$ |
132 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Authorization, settlement and switch revenues increased $39 million, or 18% and $60
million or 14% in the three and six months ended June 30, 2005, respectively, compared to
the same periods in 2004. These revenues are driven by the number of transactions
processed through our systems, which increased 14% and 13% in the three and six months
ended June 30, 2005, respectively, compared to the same periods in 2004. In addition,
these revenues increased due to the pricing of a component of these revenues being
restructured during 2005. |
|
|
|
|
Acceptance development fees assessed to members have increased to support our focus on
developing merchant relationships and promote acceptance at the point of sale. New fees
were implemented and the pricing on existing fees was increased during 2005. |
|
|
|
|
Currency conversion revenues increased $13 million, or 19%, and $22 million, or 17%, in
the three and six months ended June 30, 2005, respectively, compared to the same periods in
2004. These revenues fluctuate with the level of cross-border transactions and our
customers need for transactions to be converted into their base currency. |
|
|
|
|
Consulting fees and research subscriptions are primarily generated by MasterCard
Advisors, our advisory services group. Consulting fees have increased due to new
engagements with our customers. Additionally, in the first quarter of 2004, MasterCard
acquired a consulting firm and revenues from this firm were greater in the three and six
months ended June 30, 2005 compared to the same periods in 2004. |
|
|
|
|
Our connectivity fee structure changed in the three months ended June 30, 2005 to be
based on the volume of information being transmitted through MasterCard systems and the
number of connections. Previously, connectivity fees were solely based on the number of
connections. This change resulted in incremental revenue. |
26
|
|
|
Other operations fees represent various revenue streams including system services, fees
for non-compliance with MasterCards standards, manuals and publications. The change in
any individual component of this revenue category is not considered material. |
|
|
|
|
Rebates are primarily based on transactions and volumes and, accordingly, increase as
these variables increase. Rebates have been increasing due to agreements with new
customers, renewals of existing agreements, ongoing consolidation of our customers and
competition. Rebates as a percentage of gross operations fees were 7% in each of the three
months ended June 30, 2005 and 2004 and 8% and 7% in the six months ended June 30, 2005 and
2004, respectively. |
Assessments
Assessments are revenues that are calculated based on our customers GDV. GDV represents gross
usage (purchases and cash disbursements) on cards carrying our brands for goods and services
including balance transfers and convenience checks. In the three and six months ended June 30,
2005, assessments revenue grew $33 million, or 13% and $56 million or 12%, respectively, versus the
comparable periods in 2004. In three and six months ended June 30, 2005, GDV increased 15% and
14%, respectively, on a U.S. dollar converted basis, which exceeded local currency GDV growth of
12% in each of these periods compared to the same periods in the prior year.
Specific countries in Europe and Latin America have separate marketing assessment fees based
on volume. These fees are used by MasterCard to expand new and existing market development
programs to promote the MasterCard brand in these countries. In addition to the increase in GDV,
assessments were greater due to new or higher regional marketing assessment fees.
Rebates and incentives provided to customers and merchants increased $40 million and $78
million in the three and six months ended June 30, 2005 versus the comparable periods in 2004.
These rebates and incentives reduce revenue, moderate assessments revenue growth and are generally
based on GDV, as well as a fixed component for the issuance of new cards or the launch of new
programs. Rebates and incentives as a percentage of gross assessments were 31% and 26% in each of
the three and six months ended June 30, 2005 and 2004, respectively. We entered into pricing arrangements
with certain large customers and merchants in 2004 that we expect will moderate net revenue growth
in 2005 and subsequent years.
Operating Expenses
Our operating expenses are comprised of general and administrative, advertising and market
development, and depreciation and amortization expenses. Operating expenses as a percentage of net
revenues declined to 75% from 85% in the three months ended June 30, 2005 and to 76% from 83% in
the six months ended June 30, 2005, in each case from the comparable period in 2004.
General and Administrative
General and administrative expenses consist primarily of personnel, professional fees,
telecommunications and travel. In the three and six months ended June 30, 2005 and 2004, general
and administrative expenses as a percentage of net revenues were approximately 41% and 44%,
respectively, compared to 44% and 45%, respectively, in the same periods in 2004. The major
components of changes in general and administrative expenses are as follows:
27
|
|
|
|
|
|
|
|
|
|
|
Change |
|
|
Increase (Decrease) |
|
|
Three months ended |
|
Six months ended |
|
|
June 30, |
|
June 30, |
|
|
2005 vs. 2004 |
|
2005 vs. 2004 |
|
|
(In millions) |
Personnel |
|
$ |
30 |
|
|
$ |
48 |
|
Professional fees |
|
|
1 |
|
|
|
9 |
|
Telecommunications |
|
|
|
|
|
|
(3 |
) |
Travel |
|
|
4 |
|
|
|
9 |
|
Other |
|
|
(1 |
) |
|
|
1 |
|
|
|
|
|
|
|
|
|
|
General and administrative expense change |
|
$ |
34 |
|
|
$ |
64 |
|
|
|
|
|
|
|
|
|
|
|
|
|
Personnel expense increased in 2005 primarily due to additional headcount to support
our strategic initiatives and the acquisition of the two consulting firms in the first and
second quarters of 2004. As we continue to expand our customer-focused approach and expand
our relationships with merchants, additional personnel are required. |
|
|
|
|
Professional fees increased in the three and six months ended June 30, 2005 primarily
due to legal fees and consulting services being utilized primarily to develop and implement
our strategic initiatives. |
|
|
|
|
Telecommunications expense in the six months ended June 30, 2005 decreased as a result
of our ongoing evaluation of telecommunication needs, including renegotiation of certain
contracts with service providers. |
|
|
|
|
Travel expenses are incurred primarily for travel to customer and regional meetings.
More travel in the three and six months ended June 30, 2005 than in the comparable period
in 2004 was necessary to maintain and enhance our relationships with customers and
merchants. |
|
|
|
|
Other includes rental expense for our facilities, foreign exchange gains and losses and
other miscellaneous administrative expenses. During the three and six months ended June
30, 2005, foreign exchange gains of $4 million and $3 million, respectively, offset
increases in other general and administrative expenses. |
Advertising and Market Development
Advertising and market development consists of expenses associated with advertising,
marketing, promotions and sponsorships, which promote our brand and assist our customers in
achieving their goals by raising consumer awareness and usage of cards carrying our brands.
Advertising and market development expenses increased $3 million or 1% and $7 million or 2% in the
three and six months ended June 30, 2005, respectively. In the three and six months ended June 30,
2005, advertising and market development expenses as a percentage of net revenues were
approximately 30% and 28%, respectively, of total revenues compared to 35% and 32%, respectively,
in the same periods in 2004.
Our brands, principally MasterCard, are valuable strategic assets which convey symbols that
can be readily identified by our customers, as well as their cardholders, creating value for our
business. Our advertising and marketing efforts are focused on ensuring that our services are
identified, communicated and marketed in a clear, efficient and consistent manner, not only on a
local level, but also on a global scale. We are committed to maintaining and enhancing our
MasterCard brand reputation and image. Our Priceless campaign has run in 105 countries and 48
languages and we continue to invest significantly in this campaign. In addition, we undertake
programs from time to time to focus our marketing efforts in order to build brand recognition, to
promote brand acceptance and enhance the development of our
28
programs and services in certain markets. MasterCard also has corporate sponsorships and
conducts promotions to generate usage of cards carrying our brands. Our sponsorships include the
World Cup, UEFA Champions League, certain National Football League teams, Major League Baseball,
the Professional Golf Association and Universal Studios.
Depreciation and Amortization
Depreciation and amortization expenses decreased $2 million and $6 million in the three and
six months ending June 30, 2005, respectively, versus the comparable period in 2004. This decrease
was primarily related to the maturity of certain capital leases and certain assets becoming fully
depreciated.
Income Taxes
The effective tax rate for the three and six months ended June 30, 2005 was 35.8% and 35.6%,
respectively, compared to 27.1% and 31.7% for the three and six months ended June 30, 2004,
respectively. The rate in 2004 was lower than 2005 primarily due to the settlement and
reassessment of various tax audit matters, the filing and recognition of refund claims and
revaluation of the Companys deferred state tax assets due to a higher effective state tax rate.
Liquidity
At June 30, 2005 and December 31, 2004, we had $1.2 billion and $1.1 billion, respectively, of
cash, cash equivalents and available-for-sale securities with which to manage operations. We
believe our ability to generate cash to reinvest in our business is one of our fundamental
financial strengths. We need capital resources and liquidity to fund our global development, to
provide for credit and settlement risk, to finance capital expenditures, future acquisitions, to
service the payments of principal and interest on our outstanding debt and the settlement of the
U.S. merchant lawsuit. We expect that the cash generated from operations and our borrowing
capacity will be sufficient to meet our operating, working capital and capital needs in 2005 and
thereafter. In addition, we believe that our resources are sufficient to fund our initiatives to
accelerate our profitable growth and to enhance the global position of MasterCard in 2005 and
beyond. However, our liquidity could be negatively impacted by the outcome of any of the legal or
regulatory proceedings to which we are a party. See Legal, Regulatory and Other Industry Risks.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Six Months |
|
Dollar Change |
|
|
Ended June 30, |
|
Increase |
|
|
2005 |
|
2004 |
|
2005 vs. 2004 |
|
|
(in millions) |
Cash flow data: |
|
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities |
|
$ |
197 |
|
|
$ |
145 |
|
|
$ |
52 |
|
Net cash provided by (used in) investing
activities |
|
|
13 |
|
|
|
(76 |
) |
|
|
89 |
|
|
|
|
|
|
|
|
|
|
|
|
June 30, 2005 |
|
December 31, 2004 |
|
|
(in millions, except ratio) |
Balance sheet data: |
|
|
|
|
|
|
|
|
Current assets |
|
$ |
2,039 |
|
|
$ |
1,903 |
|
Current liabilities |
|
|
1,222 |
|
|
|
1,301 |
|
Long-term liabilities |
|
|
993 |
|
|
|
984 |
|
Stockholders equity |
|
|
1,129 |
|
|
|
975 |
|
Working capital ratio |
|
|
1.67 |
|
|
|
1.46 |
|
Net cash provided by operating activities in the six months ended June 30, 2005 and 2004 was
$197 million and $145 million, respectively. The increase in cash from operations was principally
due to the increase in net income offset by an increase in accounts receivable in 2005 as compared
to 2004, as well as the timing of payment of accounts payable versus the prior period. We believe
that the liabilities related to the U.S. merchant lawsuit settlement and other legal settlements
discussed in Note 8 to the Consolidated
29
Financial Statements herein will be funded through existing cash and cash equivalents,
investments and cash generated from operations. The source of cash from investing activities in
the six months ended June 30, 2005 was primarily due to the sale or maturity of available-for-sale
securities compared to the same period last year. In addition, in the six months ended June 30,
2004, the acquisition of businesses was a use of cash from investing activities.
In addition to our liquid investments, on June 17, 2005, the Company entered into a committed
unsecured $2.25 billion revolving credit facility (the Credit Facility) with certain financial
institutions. The Credit Facility, which expires on June 16, 2006, replaced MasterCard
Incorporateds prior $1.95 billion credit facility which expired on June 17, 2005. Borrowings under
the facility are available to provide liquidity in the event of one or more settlement failures by
MasterCard International members and, subject to a limit of $300 million, for general corporate
purposes. Interest on borrowings under the Credit Facility is charged at the London Interbank
Offered Rate (LIBOR) plus 28 basis points or an alternative base rate. An additional 10 basis
points would be applied if the aggregate borrowings under the Credit Facility exceed 33% of the
commitments. MasterCard agreed to pay a facility fee which varies based on MasterCards credit
rating and is currently equal to 7 basis points on the total commitment. MasterCard was in
compliance with the Credit Facility covenants as of June 30, 2005. There were no borrowings under
the Credit Facility at June 30, 2005. The majority of Credit Facility lenders are members or
affiliates of members of MasterCard International.
Legal, Regulatory and Other Risks
Our business has many risks, most significantly the legal and regulatory environment in which
we operate. Reference should be made to the Companys 2004 Annual Report on Form 10-K for a
complete discussion of these risk factors under the caption Risk Factors in Item 1 Business.
In addition, the following risks, among others, can also have a material impact on our results of
operations or financial condition:
|
|
Legal and Regulatory Proceedings MasterCard is a party to
several legal and regulatory proceedings, as discussed in Note 10
to the Consolidated Financial Statements herein, which could have
a material adverse impact on our business. In addition, we have
been named in a lawsuit and may be subject to lawsuits in
connection with data security breaches involving payment cards
carrying our brands. Privacy and data use and security are also
issues of interest to regulators and legislators. Future legal and
regulatory proceedings or legislation related to breaches of
cardholder data could negatively impact our results of operations.
These risks have increased in recent years, although we are
proactively seeking to address them. |
|
|
Competition and Consolidation of Our Customers We are, and will
continue to be, significantly dependent on our relationships with
our issuers, acquirers and merchants. Most of our relationships
with our customers are not exclusive and may be terminated at the
convenience of our customers. In addition, the consolidation and
globalization of our customers has provided more intense
competition and greater demand for rebates, incentives and reduced
pricing for our services. The consolidation or merger of one or
more of our customers with financial institutions aligned with our
competitors could have a material adverse impact on our revenues. |
|
|
Economic Our business is dependent on certain world economies
and consumer behaviors. In the past, our revenues have been
impacted by specific events such as the war in Iraq, the SARS
outbreak, and the September 11, 2001 terrorist attack. Consumer
behavior can be impacted by a number of factors, including
confidence in the MasterCard brand. |
30
Future Obligations
The following table summarizes, as of June 30, 2005, our obligations that are expected to
impact liquidity and cash flow in future periods. We believe we will be able to fund these
obligations through cash generated from operations and our existing cash balances.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payments Due by Period |
|
|
|
|
|
|
Remaining |
|
2006 and |
|
2008 and |
|
|
|
|
Total |
|
of 2005 |
|
2007 |
|
2009 |
|
Thereafter |
|
|
(In millions) |
Capital leases (a) |
|
$ |
60 |
|
|
$ |
5 |
|
|
$ |
9 |
|
|
$ |
4 |
|
|
$ |
42 |
|
Operating leases (b) |
|
|
109 |
|
|
|
23 |
|
|
|
55 |
|
|
|
29 |
|
|
|
2 |
|
Sponsorship, licensing & other (c) |
|
|
546 |
|
|
|
199 |
|
|
|
275 |
|
|
|
65 |
|
|
|
7 |
|
U.S. merchant lawsuit and other legal settlements (d) |
|
|
814 |
|
|
|
114 |
|
|
|
200 |
|
|
|
200 |
|
|
|
300 |
|
Debt (e) |
|
|
248 |
|
|
|
3 |
|
|
|
11 |
|
|
|
234 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total |
|
$ |
1,777 |
|
|
$ |
344 |
|
|
$ |
550 |
|
|
$ |
532 |
|
|
$ |
351 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a) |
|
Most capital leases relate to certain property, plant and
equipment used in our business. Our largest capital lease relates
to our Kansas City, Missouri co-processing facility. |
|
(b) |
|
We enter into operating leases in the normal course of business,
including the lease on our facility in St. Louis, Missouri.
Substantially all lease agreements have fixed payment terms based
on the passage of time. Some lease agreements provide us with the
option to renew the lease or purchase the leased property. Our
future operating lease obligations would change if we exercised
these renewal options and if we entered into additional lease
agreements. |
|
(c) |
|
Amounts primarily relate to sponsorships with certain
organizations to promote the MasterCard brand. The amounts
included are fixed and non-cancelable. In addition, these amounts
include purchase obligations. Obligations which result from
performance based agreements with our members and merchants have
been excluded from the table due to their contingent nature. |
|
(d) |
|
Amounts due in accordance with legal settlements entered into
during 2003 and 2004, including the Settlement Agreement in the
U.S. merchant lawsuit. |
|
(e) |
|
Debt primarily represents principal and interest owed on our
subordinated notes due June 2008 and the principal owed on our
Series A Senior Secured Notes due September 2009. We also have
various credit facilities for which there were no outstanding
balances at June 30, 2005 that, among other things, would provide
liquidity in the event of settlement failures by our members. Our
debt obligations would change if one or more of our customers
failed to settle and we borrowed under these credit facilities to
settle on our members behalf or for other reasons. |
31
Item 3. Quantitative and Qualitative Disclosures About Market Risk
MasterCard has limited exposure to market risk or the potential for economic losses on market
risk sensitive instruments arising from adverse changes in market factors such as interest rates,
foreign currency exchange rates, and equity price risk. Management establishes and oversees the
implementation of policies, which have been approved by the Board of Directors, governing our
funding, investments, and use of derivative financial instruments. We monitor aggregate risk
exposures on an ongoing basis. There have been no material changes in our market risk exposures at
June 30, 2005 as compared to December 31, 2004.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
MasterCard Incorporateds management, including the President and Chief Executive Officer and
Chief Financial Officer, carried out an evaluation of the Companys disclosure controls and
procedures (as defined in Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended) as
of the end of the period covered by this Report. Based on that evaluation, the Companys President
and Chief Executive Officer and Chief Financial Officer concluded that MasterCard Incorporated had
effective disclosure controls and procedures for (i) recording, processing, summarizing and
reporting information that is required to be disclosed in its reports under the Securities Exchange
Act of 1934, as amended, within the time periods specified in the Securities and Exchange
Commissions rules and forms and (ii) ensuring that information required to be disclosed in such
reports is accumulated and communicated to MasterCard Incorporateds management, including its
President and Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely
decisions regarding disclosure.
Changes in Internal Control over Financial Reporting
In connection with the evaluation by the Companys President and Chief Executive Officer and
Chief Financial Officer of changes in internal control over financial reporting that occurred
during the Companys last fiscal quarter, no change in the Companys internal control over
financial reporting was identified that has materially affected, or is reasonably likely to
materially affect, the Companys internal control over financial reporting.
32
[PRICEWATERHOUSECOOPERS LETTERHEAD]
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
of MasterCard Incorporated:
We have reviewed the accompanying consolidated balance sheet of MasterCard Incorporated and its
subsidiaries as of June 30, 2005, and the related consolidated statements of operations and
consolidated condensed statements of comprehensive income for each of the three- and six-month
periods ended June 30, 2005 and 2004, and the consolidated statements of cash flows for each of the
six-month periods ended June 30, 2005 and 2004 and the consolidated statement of changes in
stockholders equity for the six-month period ended June 30, 2005. These interim financial
statements are the responsibility of the Companys management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight
Board (United States). A review of interim financial information consists principally of applying
analytical procedures and making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance with the
standards of the Public Company Accounting Oversight Board (United States), the objective of which
is the expression of an opinion regarding the financial statements taken as a whole. Accordingly,
we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the
accompanying consolidated interim financial statements for them to be in conformity with accounting
principles generally accepted in the United States of America.
We have previously audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheet as of December 31, 2004, and the
related consolidated statements of operations, of comprehensive income (loss), of changes in
stockholders/members equity, and of cash flows for the year then ended, managements assessment
of the effectiveness of the Companys internal control over financial reporting as of December 31,
2004 and the effectiveness of the Companys internal control over financial reporting as of
December 31, 2004; and in our report dated March 1, 2005, we expressed unqualified opinions
thereon. Our report contained an explanatory paragraph for a change in accounting principle and the
adoption of an accounting standard, as stated in the paragraph below. The consolidated financial
statements and managements assessment of the effectiveness of internal control over financial
reporting referred to above are not presented herein. In our opinion, the information set forth in
the accompanying consolidated balance sheet information as of December 31, 2004, is fairly stated
in all material respects in relation to the consolidated balance sheet from which it has been
derived.
The Company changed its method for calculating the market-related value of pension plan assets used
in determining the expected return on the assets component of annual pension cost in 2003 and the
Company adopted the provisions of Financial Accounting Standards Board Interpretation No. 46R,
Consolidation of Variable Interest Entities, which resulted in the consolidation of a special
purpose entity in 2003.
PricewaterhouseCoopers LLP
New York, New York
August 4, 2005
33
MASTERCARD INCORPORATED
FORM 10-Q
PART II OTHER INFORMATION
Item 1. Legal Proceedings
Refer to Notes 8 and 10 to the Consolidated Financial Statements included herein.
Item 4. Submission of Matters to a Vote of Security Holders
The annual meeting of stockholders of MasterCard Incorporated was held on May 9, 2005. A
total of 75,057,002 shares of common stock were represented by proxy at the meeting. The items on
the agenda for the annual meeting were the election of directors, approval of the MasterCard
International Incorporated Senior Executive Annual Incentive Compensation Plan and approval of the
MasterCard International Incorporated Senior Executive Incentive Plan.
Proposal 1 Election of Directors
The names of the nominees elected as directors and the number of votes for or withheld for
each nominee is listed below:
|
|
|
|
|
|
|
|
|
Director |
|
For |
|
|
Withheld |
|
|
William F. Aldinger |
|
|
67,401,002 |
|
|
|
2,921,476 |
|
Silvio Barzi |
|
|
70,311,884 |
|
|
|
10,594 |
|
Donald L. Boudreau |
|
|
70,158,450 |
|
|
|
164,028 |
|
Augusto M. Escalante |
|
|
70,158,450 |
|
|
|
164,028 |
|
Richard D. Fairbank |
|
|
70,169,176 |
|
|
|
153,302 |
|
Baldomero Falcones Jaquotot |
|
|
70,158,450 |
|
|
|
164,028 |
|
Bernd M. Fieseler |
|
|
70,169,176 |
|
|
|
153,302 |
|
Iwao Iijima |
|
|
70,158,450 |
|
|
|
164,028 |
|
Michel Lucas |
|
|
70,158,450 |
|
|
|
164,028 |
|
Norman C. McLuskie |
|
|
69,979,867 |
|
|
|
342,611 |
|
Siddharth N. Mehta |
|
|
70,158,450 |
|
|
|
164,028 |
|
Robert W. Pearce |
|
|
70,158,450 |
|
|
|
164,028 |
|
Michael T. Pratt |
|
|
70,158,450 |
|
|
|
164,028 |
|
Robert W. Selander |
|
|
70,172,957 |
|
|
|
149,521 |
|
Dato Tan Teong Hean |
|
|
70,158,450 |
|
|
|
164,028 |
|
Jac Verhaegen |
|
|
70,158,450 |
|
|
|
164,028 |
|
Lance L. Weaver |
|
|
70,158,450 |
|
|
|
164,028 |
|
Robert B. Willumstad |
|
|
70,169,176 |
|
|
|
153,302 |
|
34
There were no abstentions or broker non-votes.
Proposal 2 Approval of the MasterCard International Incorporated Senior Executive Annual
Incentive Compensation Plan.
Proposal 2 received 71,254,760 votes for, 426,152 votes against and 3,376,090 abstentions and
was adopted by the stockholders. There were no broker non-votes.
Proposal 3 Approval of the MasterCard International Incorporated Senior Executive Incentive Plan.
Proposal 3 received 68,660,078 votes for, 3,008,866 votes against and 3,388,058 abstentions and
was adopted by the stockholders. There were no broker non-votes.
Item 6. Exhibits
Refer to the Exhibit Index included herein.
35
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized.
|
|
|
|
|
Date: August 4, 2005 |
|
MASTERCARD INCORPORATED |
|
|
|
|
|
(Registrant) |
|
|
|
|
|
Date: August 4, 2005
|
|
By:
|
|
/s/ ROBERT W. SELANDER |
|
|
|
|
|
|
|
|
|
Robert W. Selander |
|
|
|
|
President and Chief Executive Officer |
|
|
|
|
(Principal Executive Officer) |
|
|
|
|
|
Date: August 4, 2005
|
|
By:
|
|
/s/ CHRIS A. MCWILTON |
|
|
|
|
|
|
|
|
|
Chris A. McWilton |
|
|
|
|
Chief Financial Officer |
|
|
|
|
(Principal Financial Officer) |
|
|
|
|
|
Date: August 4, 2005
|
|
By:
|
|
/s/ TARA MAGUIRE |
|
|
|
|
|
|
|
|
|
Tara Maguire |
|
|
|
|
Assistant Controller |
|
|
|
|
(Acting Principal Accounting Officer) |
36
EXHIBIT INDEX
|
|
|
Exhibit |
|
|
Number |
|
Exhibit Description |
3.1(a)
|
|
Amended and Restated Certificate of Incorporation of MasterCard
Incorporated (incorporated by reference to Exhibit 4.1 to the
Companys Current Report on Form 8-K dated June 28, 2002 and filed
July 12, 2002 (No. 333-67544)). |
|
|
|
3.1(b)
|
|
Amended and Restated Bylaws of MasterCard Incorporated
(incorporated by reference to Exhibit 3.1(b) to the Companys
Annual Report on Form 10-K filed March 2, 2005 (No. 333-67544)). |
|
|
|
3.2(a)
|
|
Amended and Restated Certificate of Incorporation of MasterCard
International Incorporated (incorporated by reference to Exhibit
3.2(a) to the Companys Quarterly Report on Form 10-Q filed August
14, 2002 (No. 333-67544)). |
|
|
|
3.2(b)
|
|
Amended and Restated Bylaws of MasterCard International
Incorporated (incorporated by reference to Exhibit 3.2(b) to the
Companys Quarterly Report on Form 10-Q filed August 14, 2002 (No.
333-67544)). |
|
|
|
10.1
|
|
$2,250,000,000 Credit Agreement, dated as of June 17, 2005, among
MasterCard Incorporated, MasterCard International Incorporated, the several
lenders, Citigroup Global Markets Inc., as sole lead arranger and sole book
manager, Citibank, N.A. , as co-administrative agent, JPMorgan Chase Bank,
N.A., as co-administrative agent, and J.P. Morgan Securities, Inc., as
co-arranger. |
|
|
|
10.2
|
|
MasterCard International Incorporated Senior Executive Annual Incentive
Compensation Plan, effective January 1, 2005. |
|
|
|
10.3
|
|
MasterCard International Incorporated Senior Executive Incentive Plan, effective
January 1, 2005. |
|
|
|
31.1
|
|
Certification of Robert W. Selander, President and Chief Executive
Officer, pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002. |
|
|
|
31.2
|
|
Certification of Chris A. McWilton, Chief Financial Officer,
pursuant to Rule 13a-14(a)/ 15d-14(a), as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002. |
|
|
|
32.1
|
|
Certification of Robert W. Selander, President and Chief Executive
Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002. |
|
|
|
32.2
|
|
Certification of Chris A. McWilton, Chief Financial Officer,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section
906 of the Sarbanes-Oxley Act of 2002. |
37