SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

Or

Commission file number: 000-50250

MasterCard Incorporated

(914) 249-2000
(Registrant’s 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 [X] No [   ]

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [   ] No [X]

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

MASTERCARD INCORPORATED

FORM 10-Q

TABLE OF CONTENTS

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CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)

MASTERCARD INCORPORATED

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 (“ATM”) payment programs, and travelers cheque programs.

     Consolidation and basis of presentation— The Company follows accounting principles generally accepted in the United States of America. Certain prior period amounts have been reclassified to conform to 2004 classifications. The consolidated financial statements include the accounts of MasterCard and its majority-owned or controlled entities. Intercompany transactions are eliminated in consolidation.

     The Company consolidates majority-owned or controlled entities, including variable interest entities. 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 consolidated financial statements for the three and six months ended March 31,June 30, 2004 and 2003 and as of March 31,June 30, 2004 are unaudited, and in the opinion of management include all adjustments (consisting only of normal recurring adjustments) that are necessary to present fairly the results for a fair statement of the Company’s balance sheet, statement of operations and cash flows.interim periods. Due to seasonal fluctuations and other factors, the results of operations for the three and six months ended March 31,June 30, 2004 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 generally accepted accounting principles in the United States of America. Reference should be made to the Company’s 2003 Annual Report on Form 10-K for additional disclosures, including a summary of the Company’s significant accounting policies.

Note 2. Supplemental Cash Flows

     The following table includes supplemental cash flow disclosures for the periods:

MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share and percent data)

International executedhas a guarantee of 85.15 percent offor the Secured Notes outstanding totaling $127,197 at March 31,June 30, 2004. Additionally, upon the occurrence of specific events of default, MasterCard International guarantees repayment of the total outstanding principal and interest on the Secured Notes and would hold ownership of the facility.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
(In thousands, except per share and percent data)

     Included in the liabilities assumed in the acquisition was a liability for exit costs relating to the integration of the Company and EPI (now MasterCard Europe). The changes in the liability for exit costs are summarized as follows:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
(In thousands, except per share and percent data)

     Amortization expense on the assets above was $18,358 and $16,887 for the three months ended June 30, 2004 and 2003, respectively, and $36,505 and $33,735 for the six months ended June 30, 2004 and 2003, respectively. Impairment losses on capitalized software were nominal in both periods.

     The following table sets forth the estimated future amortization expense on amortizable intangible assets:

MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share and percent data)

Net periodic postretirement benefit cost is as follows for the three months ended March 31:follows:

MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share and percent data)

     Consolidated rental expense for the Company’s office space was approximately $7,875$8,042 and $7,164$7,157, respectively, for the three months ended March 31,June 30, 2004 and 2003 and $15,917 and $14,321 for the six months ended June 30, 2004 and 2003, respectively. Consolidated lease expense for automobiles, computer equipment and office equipment was $2,544$2,722 and $2,319$2,286 for the three months ended March 31,June 30, 2004 and 2003, respectively, and $5,266 and $4,605, respectively, for the six months ended June 30, 2004 and 2003, 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 10.11. U.S. Merchant Lawsuit and Other Legal Settlements

     During 2003, MasterCard settled the U.S. merchant lawsuit described in Note 1113 herein and contract disputes with certain customers. MasterCard International signed a Memorandum of Understanding (“MOU”) with plaintiffs in the U.S. merchant lawsuit on April 30, 2003. On June 4, 2003, MasterCard International and plaintiffs signed a settlement agreement (the “Settlement Agreement”) embodying the terms originally set forth in the MOU. The Settlement Agreement required the Company to pay $125,000 in 2003 and requires it to pay $100,000 annually in December from 2004 through 2012. In addition, the Company agreed to adoptadopted rules which permit U.S. merchants to elect not to accept MasterCard branded debit or credit(or credit) cards, implementimplemented programs to allow merchants to identify debit cards, provide signage to merchants and for the period of August 1, 2003 to December 31, 2003, establishestablished a separate debit interchange rate.rate for a required period. For a description of interchange, see the text under the heading “Global Interchange Proceedings” in Note 11.13.

     For the year ended December 31, 2003, the total pre-tax charge recorded for the U.S. merchant lawsuit and other legal settlements was $763,460. The primary component of this charge was made in connection with the signing of the MOU, for which MasterCard recorded a pre-tax charge of $721,000 ($469,000 after-tax) in the three month periodsix months ended March 31,June 30, 2003, consisting of (i) the monetary amount of the U.S. merchant lawsuit settlement (discounted at 8 percent over the payment term), (ii) certain additional costs in connection with, and in order to comply with, other requirements of the U.S. merchant lawsuit settlement, and (iii) costs to address the merchants who opted not to participate in the plaintiff class in the U.S. merchant lawsuit. This amount was an estimate, which was revised during the three months ended December 31, 2003 based on approval of the settlement agreementSettlement Agreement by the court and other factors. The Company will continuecontinued to review these estimates and ifmade an additional charge of $3,896 during the three months ended June 30, 2004. If necessary, future refinements to the charge will also be made. RelatingPayments relating to these settlements cash paymentsand costs of $6,101$5,250 and $11,351 were made during the three and six months ended March 31, 2004.June 30, 2004, respectively. Included in interest expense for the three months ended March 31, 2004 is $12,422 of imputed interest on the U.S. merchant lawsuit settlement.

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MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share and percent data)

Note 11.13. Legal 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

     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 MasterCard’s and Visa’s 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. At the same time, the DOJ conceded that “dual issuance” — a term describing the structure of the bank card industry in the United States in which a single financial institution can issue both MasterCard and Visa-branded cards — was pro-competitive. Second, the DOJ challenged MasterCard’s 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 MasterCard’s CPP and Visa’s bylaw provision acted to restrain competition.

     MasterCard denied the DOJ’s allegations. MasterCard believes that both “dual governance” and the CPP are pro-competitive and fully consistent with U.S. federal antitrust law.

     A bench trial concerning the DOJ’s allegations was concluded on August 22, 2000. On October 9, 2001, the District Court judge issued an opinion upholding the legality and pro-competitive nature of dual governance. In so doing, the judge specifically found that MasterCard and Visa have competed vigorously over the years, that prices to consumers have dropped dramatically, and that MasterCard has fostered rapid innovations in systems, product offerings and services.

     However, the judge also held that MasterCard’s CPP and the Visa bylaw constitute unlawful restraints of trade under the federal antitrust laws. The judge found that the CPP and Visa bylaw weakened competition and harmed consumers by preventing competing proprietary payment card networks such as American Express and Discover from entering into agreements with banks to issue cards on their networks. In reaching this decision, the judge found that two distinct markets — a credit and charge card issuing market and a network services market — existed in the United States, and that both MasterCard and Visa had market power in the network market. MasterCard strongly disputes these findings and believes that the DOJ failed, among other things, to demonstrate that U.S. consumers have been harmed by the CPP.

     On November 26, 2001, the judge issued a final judgment that orders MasterCard to repeal the CPP insofar as it applies to issuers and enjoins 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 judge also concluded that during the period in which the CPP was in effect, MasterCard was able to “lock up” certain members by entering into long-term agreements with them pursuant to which the members committed to maintain a certain percentage of their general purpose card volume, new card issuance or total number of cards in force in the United States on MasterCard’s network. Accordingly, the final judgment provides that there will be a period (commencing on the effective date of the judgment and ending on the later of two years from that date or two years from the resolution of any final appeal) during which MasterCard will be 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. MasterCard would be free to apply to the District Court to recover funds paid but not yet earned under any terminated agreement. The final judgment imposes parallel requirements on Visa. The judge explicitly provided that MasterCard and Visa would be free to enter into new partnership or member business agreements in the future.

     MasterCard appealed the judge’s ruling with respect to the CPP and on February 6, 2002, the judge issued an order granting MasterCard’s and Visa’s motion to stay the final judgment pending appeal. On September 17, 2003 a three-judge panel of the Second

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MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share and percent data)

     In addition, on September 18, 2003, MasterCard filed a motion before the District Court judge in this case seeking to enjoin Visa, pending completion of the appellate process, from enforcing a newly-enacted bylaw requiring Visa’s 100 largest issuers of debit cards in the United States to pay a so calledso-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 Opt Out and Consumer Litigations” below. MasterCard believes that this bylaw is punitive and inconsistent with the status quo that the District Court judge in the DOJ case sought to preserve in her decision to stay her final judgment pending appeal, and would be inconsistent with the final judgment if it is preserved on appeal. On December 8, 2003, the District Court judge ruled that the District Court lacked jurisdiction to issue an injunction, but held that the court would have the authority to rescind contracts entered into by issuers with Visa because ofduring the time that the settlement service fee was in effect if the court’s final judgment is upheld on appeal and the court finds that the settlement service fee violates the final judgment. At this time it is not possible to determine the ultimate resolution of this matter.

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 Int’l 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 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. Plaintiffs seek to prevent defendants from continuing to engage in, use or employ the alleged practice of charging and collecting the asserted one percent currency conversion “fee” and from charging any type of purported currency conversion “fee” without providing a clear, obvious and comprehensive notice that a fee will be charged. Plaintiffs also request an order (1) requiring defendants to fund a corrective advertising campaign; and (2) awarding restitution of the monies allegedly wrongfully acquired by imposing the purported currency conversion “fee”. 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 MasterCard’s 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 state 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. MasterCard cannot determine the outcome of the restitution process at this time. The court issued its final judgment on October 31, 2003. On2003 and on December 29, 2003, MasterCard appealed the judgment. MasterCard’s appeal brief was filed a notice of appealon July 28, 2004. The final judgment and its opening brief on the appeal is due July 2, 2004. On January 20, 2004, plaintiffs filed an application for an award of attorneys’ fees and reimbursement of expenses.restitution process have been stayed pending MasterCard’s appeal. With respect to restitution, MasterCard believes that it is likely to prevail on such appeal.

     In addition, MasterCard has been served with complaints in state courts in New York, Arizona, Texas, Florida, Arkansas, Kentucky, Illinois and Tennessee seeking to, in effect, extend the judge’s 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 December 12, 2003, the action in Kentucky was dismissed; however, plaintiff in that case has moved fordismissed. On July 28, 2004, a rehearing.New York state action was dismissed without prejudice.

     MasterCard International, Visa U.S.A., Inc., Visa International Corp., several member banks including Citibank (South Dakota), N.A., Citibank (Nevada), N.A., Chase Manhattan Bank USA, N.A., Bank of America, N.A. (USA), MBNA, and Diners Club are also defendants in a number of federal putative class actions that allege, among other things, violations of federal antitrust laws based on the asserted one percent currency conversion “fee”.

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MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share and percent data)

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.

     Defendants have moved to dismiss the MDL Complaint. On July 3, 2003, Judge Pauley issued a decision granting MasterCard’s 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. Discovery in this matter is expected to continue. On November 12, 2003 plaintiffs filed a motion for class certification. Oral argument on the motion was held on May 7, 2004. A trial date has been set for October 10, 2005. At this time, it is not possible to determine the ultimate resolution of this matter.

     For the reasons set forth above, no provision for losses has been provided in connection with these currency conversion litigations.

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. MasterCard has assessedThe complaint’s allegations focused on MasterCard’s past and potential future assessments on the plaintiff’s merchant bank (acquirer) for exceeding excessive chargeback standards in connection with the plaintiff’s transaction activity.activity as well as the effect of MasterCard’s chargeback rules 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’s motionMasterCard moved to dismiss all of the claims in the complaint is currently scheduledfor failure to be fully briefed by June 16, 2004.state a cause of action. The Court has yet to schedule oral argument on the motion.

     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 MasterCard’s (and Visa’s) 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 August 13, 2003, MasterCard made motions seeking to dismiss the complaint in its entirety or, in the alternative, to narrow the scope of the proceeding and add necessary parties. Oral argument on the motions was held on October 27, 2003. The Court denied the motions. Initial, but limited, discovery is now proceeding in this matter.

     At this time it is not possible to determine the outcome of the merchant chargeback-related litigations. Consequently,For reasons set forth above, no provision for losses is necessary at this timehas been provided in connection with respect to these litigations.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share and percent data)

suppressing the growth of regional networks such as ATM payment systems. Plaintiffs alleged that the plaintiff class had been forced to pay unlawfully high prices for debit and credit card transactions as a result of the alleged tying arrangement and monopolization practices. 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 court’s approval of the settlement to the Second Circuit Court of Appeals. These appeals are largely focused on the court’s attorneys’ fees award as well on the court’s ruling on the scope of the release. The Second Circuit has scheduled oral argument on these appeals for August 25, 2004. For a further description of the U.S. merchant lawsuit settlement, see Note 10.11.

     Several lawsuits have been commenced by merchants who have opted not to participate in the plaintiff class in the U.S. merchant lawsuit, including Best Buy Stores, CVS, Giant Eagle, Home Depot, Toys “R” Us and Darden Restaurants. The majority of these cases were filed in the U.S. District Court for the Eastern District of New York and we expect that all of these cases will be tried in that Court for, at a minimum, pretrial issues. On December 31, 2003, MasterCard entered into an agreement to settle claims brought by an “opt out” merchant. On or about March 19, 2004, the opt out merchants amended their complaints to include allegations, among other things: (i) that MasterCard’s (and Visa’s) interchange fees contravene the Sherman Act and (ii) that the opt out merchants were harmed by MasterCard’s CPP. MasterCard filed its response to the amended complaints on April 21, 2004. The parties are currentlyOn July 1, 2004, MasterCard and CVS entered into a settlement and release resolving CVS’s claims against MasterCard. On July 9, 2004, the District Court entered an order dismissing with prejudice CVS’s complaint against MasterCard. MasterCard continues to be involved in court-ordered mediation butwith the remaining opt out merchant plaintiffs while discovery continues to proceed.

     In addition, there are currently related actions against MasterCard International in 19 different state courts and the District of Columbia. In a number of state courts there are multiple complaints against MasterCard International brought under state unfair competition statutes on behalf of putative classes of consumers. The claims in these actions 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. On or about April 21, 2004, theThe Supreme Court ofin the State of New York and the Circuit Court for the State of Michigan have granted MasterCard’s motion to dismiss the complaint for failure to state a claim in that court with prejudice. Plaintiff’sOn June 21, 2004, the plaintiffs in the New York case filed a notice of appeal. The plaintiffs’ time in which to file an appeal this decision has not yet expired.of the Michigan court’s ruling is currently running. MasterCard is still awaiting decisions on its motions to dismiss in the other state courts. At this time, it is not possible to determine the outcome of these consumer cases. Neither the consumer class actions nor the “opt out” merchant litigations are 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 MasterCard’s. Generally, interchange fees are paid by the merchant bank (the “acquirer”) to the cardholder bank (the “issuer”) in connection with transactions initiated with the payment system’s 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 establishes 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, MIFs are subject to regulatory or legal review and/or challenges in a number of jurisdictions.

     European Union.In September 2000, the European Commission issued a “Statement of Objections” challenging Visa International’s 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

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MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share and percent data)

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 Europe’s operations, changes to it could significantly impact MasterCard International’s European members and the MasterCard business in Europe. At this time, it is not possible to determine the ultimate resolution of this matter.

     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. The MIF and MSF are 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, and an oral hearing concerning the matter was held on February 5, 2002.notice. On February 11, 2003, the OFT issued a supplemental notice, which also contained preliminary conclusions challenging MasterCard’s U.K. MIF under the Competition Act. On May 2, 2003, MasterCard and MMF responded to the supplemental notice,notice.

     MasterCard Europe and a hearing was held on May 21, 2003. TheMMF are engaged in discussions with the OFT has informed MasterCard that it willin order to determine under what conditions, if any, the OFT would issue a further notice, thereby delaying anyfavorable ruling regarding the MasterCard U.K. MIF. If MasterCard and MMF are unsuccessful in obtaining a favorable ruling, the OFT could issue a prohibition decision byordering MasterCard to change the OFT.

manner in which it calculates its U.K. MIF. Because the MIF and MSF constituteconstitutes an essential elementselement of MasterCard’s U.K. operations, a negative decision by the OFT could have a significant adverse impact on MasterCard’s U.K. members and on MasterCard’s competitive position and overall business in the U.K. In the event of a negative decision by the OFT, MasterCard mayintends to appeal to the relevant competition tribunal in the U.K.Competition Appeals Tribunal and to seek interim relief if the negative decision adversely impacts MasterCard’s U.K. business.relief. At this time, it is not possible to determine the ultimate resolution of this matter.

     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 (collectively “defendants”) alleging, among other things, that MasterCard’s and Visa’s interchange fees contravene the Sherman Act. The suit seeks treble damages in an unspecified amount, attorney’s fees and injunctive relief, including the divestiture of bank ownership of MasterCard and Visa, and the elimination of MasterCard and Visa marketing activities. On April 21, 2003, the court issued a decision that dismissed several of plaintiffs’ claims and significantly narrowed the scope of the remaining claims in the case. Plaintiffs filed an amended complaint shortly thereafter. 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 York’s approval of the U.S. merchant settlement and release to the Second Circuit Court of Appeals and have also filed a notice of their intention to appealappealed the U.S. District Court for the Northern District of California’s dismissal of the present lawsuit to the Ninth Circuit Court of Appeals. At this time it is not possible to determine the outcome of this proceeding.

     Other Jurisdictions.MasterCard is aware that regulatory authorities in certain other jurisdictions, including Poland, Spain, New Zealand, Portugal and Switzerland are reviewing MasterCard’s and/or its members’ interchange feefees and/or related practices and may seek to regulate the establishment of such fees.fees and/or such practices. At this time it is not possible to determine the outcome of these proceedings.

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MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share and percent data)

     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 Company’s risk standards 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.

     Estimated settlement exposure, and the portion of the Company’s 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 Company’s risk management standards, at March 31,June 30, 2004 and December 31, 2003 was as follows:

MASTERCARD INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except per share and percent data)

     Based on the Company’s ability to assess its members for settlement and travelers cheque losses, the effectiveness of the Company’s 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 may change, which wouldthey may require the Company 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.

Note 13.15. Foreign Exchange Risk Management

     The Company enters into foreign exchange contracts to minimize the risk associated with anticipated receipts and disbursements and assets and liabilities denominated in foreign currencies and thecurrencies. We also enter into contracts to offset possible changes in value due to foreign exchange fluctuations of assets and liabilities denominated in foreign currencies. MasterCard’s forward contracts are listed below, classified by functional currency:currency and summarized below:

U.S. Dollar Functional Currency

Item 2.Management’s 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,” “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 thatthese could cause actual results to differ from our expectations. Please see a complete discussion of these risk factors under the caption “Risk Factors” in Item 1 — Business of the Annual Report on Form 10-K of MasterCard for the year ended December 31, 2003.

Overview

     Our focus on strengthening customer relationships continues to drive increases in our revenues. Revenues increased by 16% in the firstsecond quarter of 2004 and for the six months ended June 30, 2004 from the comparable periodperiods in 2003. Of this increase, 3%1% and 2%, respectively, was due to the weakening of the U.S. dollar against the euro in 2004 versus the comparable periods in 2003, which created a favorable foreign currency translation. Revenues are growing due to increases in the number of transactions processed and related volumes. We continue to experience favorable transaction and volume growth on cards carrying our brands due to consumers’ increasing preference for making electronic payments globally and as a result of our strategy to win incremental business from our key customers. In addition, the conflict in Iraq, the threat of terrorism and SARS negatively impacted cross border travel in the beginning of 2003. In 2004, our cross border transactions have increased significantly as international travel returns to more normal levels.

     We are also managingcontinue to focus on cost containment. Accordingly, operating expenses declined as a percentage of total revenues during 2004 from the comparable periods in 2003. We have focused our cost management efforts on our general and administrative expenses and improving productivity. Exclusive ofresulting in only a 1% increase from 2003. Excluding the impact of the U.S. merchant lawsuit and other legal settlements, our operating expenses only increased 4%8% in the firstsecond quarter of 2004 and 6% for the six months ended June 30, 2004 from the comparable periodperiods in 2003, of which 3%1% and 2%, respectively, was due to the weakening of the U.S. dollar against the euro creating an unfavorable currency translation. In addition, each category of operating expenses declined as a percentage of total revenues during the first quarter of 2004 from the comparable period in 2003. Although we are focusing on cost management, weWe realize the importance of building brand recognition, promoting brand acceptance, and enhancing the development of our programs and services. Therefore, in certain markets weadvertising and marketing spending continue to expand our investment in advertising and market development initiatives.increase.

     The payments industry is undergoing changes due to increased competition, consolidation and globalization. We are, and will continue to be, significantly dependent on our relationships with our issuers and acquirers and their further relationships with cardholders and merchants to support our programs and services. Most of our relationships with our customers are not exclusive and may be terminated at the convenience of our customers. 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. In addition,

     Our consolidated balance sheets reflect significant amounts of goodwill and intangible assets related to acquisitions we have made. Impairment charges could be incurred if operating results of these acquired entities do not meet our expectations.

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Legal and Regulatory Impact on our Business

     Our financial results have been and will continue to be significantly influenced by the legal and regulatory environment in which we operate our business. MasterCard is a party to several legal and regulatory proceedings, as discussed in Note 13 to the Consolidated Financial Statements included herein, which could have a material adverse impact on our business. In particular, any of the following outcomes to our legal and regulatory proceedings could adversely affect our results of operations and liquidity:

     Our balance sheet reflects significant amounts

     LegalSee Note 13 to the Consolidated Financial Statements included herein for a discussion of these and Regulatory Impact on our Businessother legal and regulatory proceedings to which we are a party.

     We earn a portion of our revenues in connection with MasterCard-branded offline debit cards issued in the United States. Following the settlement of the U.S. merchant lawsuit in 2003, Visa U.S.A., Inc. implemented a bylaw requiring Visa’s 100 largest issuers of debit cards in the United States to pay a fee if they reduce their debit volume by more than 10%. If Visa is permitted to enforce this bylaw, it would penalize Visa members seeking to do debit business with MasterCard and effectively prevent them from converting their debit cards to the MasterCard brand. MasterCard has challenged the validity of this bylaw provision. In addition, under the settlement agreementSettlement Agreement in the U.S. merchant lawsuit, merchants have the right to reject MasterCard-branded debit cards in the United States, while still accepting other MasterCard-branded cards and vice versa. A small number of merchants, including Walmart, have announced that they will no longer accept MasterCard-branded debit cards. These scenarios aremay be detrimental to MasterCard’s ability to maintain and grow its debit card business in the United States.

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     In addition, if we ultimately are unsuccessful in our litigation with the U.S. Department of Justice concerning our Competitive Programs Policy, some of our customers may choose to do business with American Express or Discover, which would adversely affect our business. Finally, we are being sued in several state and federal courts because of our currency conversion practices. The outcome of these lawsuits potentially could require us to change our currency conversion practices, which may have a negative impact on our business. See Note 11 to the Consolidated Financial Statements included herein for a discussion of these and other legal and regulatory proceedings to which we are a party.

     We establish multilateral interchange fees on behalf of certain customers. While we do not receive or record interchange fees as revenue, the impact of the global interchange proceedings described in Note 11 to the Consolidated Financial Statements included herein could impact our customers’ use of payment programs carrying our brands, thereby negatively impacting our future revenues.

Results of Operations

     Key selected financial and operating data for the three and six months ended March 31,June 30, 2004 and 2003 is included in the table below:

for determining these and most other competitive card features. Our revenues are based upon transactional information accumulated by our systems and/or reported by our customers. Certain revenues are estimated based upon aggregate transaction information and historical and projected customer performance.

     The U.S. market remains our largest geographic market.market based on revenues, however, international revenues are growing at a faster rate than U.S. revenues for the three and six months ended June 30, 2004. Revenue generated in the U.S. accounted for approximately 56%59% and 64% of our total revenue for the three months ended March 31,June 30, 2004 and 2003, respectively. The United Kingdom accounted for approximately 6%respectively, and 5%was 58% and 64% of our total revenue for the threesix months ended March 31, 2004 and March 31, 2003, respectively. No other country accounted for more than 5% of the Company’s revenue for the three months ended March 31,June 30, 2004 and 2003, respectively.

     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 $57$44 million or 18%13% and $101 million or 15% in the first three and six months ofended June 30, 2004, respectively, compared to the same periodperiods in 2003. The significant changes in operations fees were as follows: