MA

Mastercard Inc. 10-Q Summary: Quarter Ended September 30, 2004

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended September 30, 2004, for Mastercard Incorporated. The company provides transaction processing and related services for credit, debit, electronic cash, ATM, and travelers cheque programs globally. The financial statements are unaudited but include all adjustments necessary for a fair presentation of interim results.

Key Financial Metrics

Note: All figures in millions unless otherwise noted. Nine-month Net Income represents a significant turnaround from a net loss of $318.7 million in the same period in 2003, which included a $721 million pre-tax charge for the U.S. merchant lawsuit settlement.

Material Changes vs. Prior Period

• Revenue Growth: Net revenues increased 12% for the quarter and 15% for the nine-month period compared to 2003. Growth was driven by increased Gross Dollar Volume (GDV) and transaction counts, aided by a recovery in cross-border travel and a favorable foreign currency translation effect (2% impact).
• Expense Management: Excluding the U.S. merchant lawsuit charges, operating expenses as a percentage of revenue declined to 76% for the quarter (from 79%) and 80% for the nine months (from 86%).
• Legal Settlements: The nine-month period in 2003 included a massive $729.8 million charge for the U.S. merchant lawsuit. In contrast, the 2004 nine-month period recorded only $18.0 million in related expenses, primarily for legal costs in unrelated currency conversion cases.
• Profitability: Operating income turned from a loss of $498.9 million in the prior nine-month period to a profit of $366.5 million.

Guidance, Outlook, and Risks

Management Commentary: Management attributes growth to economic recovery in key markets and the normalization of international travel following the disruptions of 2003 (Iraq conflict, SARS, terrorism threats). Cost control initiatives are yielding results, and the company remains committed to expanding customer-focused strategies and brand development.

Legal and Regulatory Risks:

• DOJ Antitrust Litigation: The U.S. Supreme Court denied Mastercard's petition for certiorari regarding the Competitive Programs Policy (CPP). Mastercard must repeal the CPP, which previously prohibited members from issuing competing proprietary cards (e.g., American Express, Discover). This may lead to reduced card volumes as members can now terminate agreements to switch networks.
• Interchange Fees: Regulatory challenges to Multilateral Interchange Fees (MIF) are ongoing in the European Union and the United Kingdom. Unfavorable rulings could force changes to fee structures, potentially impacting revenue.
• Currency Conversion Litigation: Ongoing lawsuits in California and federal courts allege unlawful currency conversion fees. While Mastercard believes it will prevail on appeal regarding restitution, it accrued $14.1 million in legal fees in Q3 2004.
• Merchant Opt-Outs: Several major merchants (e.g., Best Buy, Home Depot) opted out of the 2003 class action settlement. While some have settled, others remain in litigation regarding interchange fees and the CPP.

Liquidity: The company maintains $1.1 billion in liquid investments and a $1.95 billion committed revolving credit facility (unutilized as of Sept 30, 2004) to manage settlement risks and operational needs.

Investor Verification Checklist

• Verify the impact of the repealed Competitive Programs Policy on member retention and transaction volumes in the coming quarters.
• Monitor the status of the European Commission and UK Office of Fair Trading investigations into interchange fees.
• Review the resolution of the "opt-out" merchant lawsuits and potential liability exposure beyond the 2003 settlement.
• Assess the sustainability of the 12-15% revenue growth rate given the one-time nature of the 2003 legal charge comparison.
• Confirm the adequacy of reserves for the $688.8 million liability related to the U.S. merchant lawsuit and other legal settlements.