Mastercard Inc. 10-Q Summary: Period Ended September 30, 2002
Business Context and Reporting Period
This Form 10-Q covers the quarterly and nine-month periods ended September 30, 2002. A pivotal event during this period was the conversion of Mastercard International Incorporated (MCI) from a membership organization to a publicly traded stock company, Mastercard Incorporated, on June 28, 2002. Concurrently, the company completed the acquisition of Europay International SA (EPI), renamed Mastercard Europe, integrating it into the consolidated financial statements from the acquisition date. The company operates as a single reportable segment, "Payment Services," providing transaction processing and related services globally.
Key Financial Metrics
| Metric (in thousands) | 3 Months Ended Sep 30, 2002 | 3 Months Ended Sep 30, 2001 | 9 Months Ended Sep 30, 2002 | 9 Months Ended Sep 30, 2001 |
|---|---|---|---|---|
| Revenue | $539,435 | $403,425 | $1,382,576 | $1,198,884 |
| Operating Income | $126,527 | $74,017 | $257,600 | $228,315 |
| Net Income | $77,930 | $46,625 | $167,915 | $145,768 |
| Diluted EPS | $0.78 | $0.65 | $2.06 | $2.03 |
| Operating Cash Flow (9mo) | N/A | $174,436 | $196,069 | |
| Cash & Equivalents (Sep 30) | N/A | $269,939 | $176,143 (Dec 31, 2001) | |
| Long-Term Debt | N/A | $80,481 | $80,065 (Dec 31, 2001) |
Liquidity: Working capital was $581 million at September 30, 2002, with a working capital ratio of 1.7 to 1. The company maintains a $1.2 billion senior unsecured revolving credit facility, with no borrowings outstanding as of the reporting date.
Material Changes vs. Prior Period
- Revenue Growth: Revenue increased 34% year-over-year for the quarter and 15% for the nine-month period. This growth was driven primarily by the acquisition of Mastercard Europe (contributing approximately $36 million in operations fees and $48 million in assessments for the quarter) and a 15% increase in the number of transactions processed.
- Expense Increases: Operating expenses rose 25% for the quarter and 16% for the nine-month period. Increases were attributed to the EPI acquisition, higher personnel costs, and increased advertising and market development spending (including World Cup and Major League Baseball sponsorships).
- Amortization: Amortization expense increased significantly (108% for the quarter) due to the amortization of capitalized software and intangible assets acquired from EPI.
- Accounting Changes: The company implemented EITF 01-9 on January 1, 2002, reclassifying certain payments to members and merchants from advertising expense to a reduction of revenue. Additionally, the adoption of SFAS 142 eliminated goodwill amortization for existing goodwill, though new goodwill from EPI is subject to impairment testing.
Outlook, Risks, and Contingencies
Management Commentary: Management expects net income growth to potentially slow over the next several years due to significant planned expenditures in advertising and market support to build brand value. The company anticipates operating expenses will increase significantly as a result of these initiatives.
Legal Proceedings:
- DOJ Antitrust Litigation: A district court ruled that Mastercard's Competitive Programs Policy (CPP) was an unlawful restraint of trade. Mastercard has appealed this decision, and the judgment is stayed pending appeal. The outcome remains uncertain.
- Merchant Antitrust Litigation: Class action suits by merchants challenge the "Honor All Cards" rule and alleged tying of debit to credit cards. Plaintiffs have asserted damage claims ranging from $8 billion to over $100 billion. A trial date is set for April 2003.
- Currency Conversion Litigation: Lawsuits allege unlawful 1% currency conversion fees. Trials and motions are ongoing in California and federal courts.
- Global Interchange Proceedings: Regulatory challenges regarding Multilateral Interchange Fees (MIF) are active in the European Union, United Kingdom, and Australia, where new regulations may require fee reductions.
Settlement Risk: Mastercard guarantees settlement of transactions among members. Estimated settlement exposure net of collateral was approximately $9.1 billion as of September 30, 2002.
Key Facts for Investor Verification
- Verify the status and potential financial impact of the DOJ antitrust appeal and the merchant class action trial scheduled for April 2003.
- Monitor the outcome of regulatory reviews on interchange fees in the EU, UK, and Australia, which could materially affect revenue models.
- Assess the integration progress of Mastercard Europe and the realization of synergies versus the increased operating costs associated with the acquisition.
- Review the company's ability to maintain liquidity and meet covenants on its $1.2 billion credit facility and $80 million subordinated notes.
- Confirm the accuracy of transaction volume and Gross Dollar Volume (GDV) statistics provided by members, as these drive revenue assessments.