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Visa 10-Q 2008 Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
FORM 10-Q
For the quarterly period ended March 31, 2008 OR
For the transition period from to Commission file number 001-33977
VISA INC. (Exact name of Registrant as specified in its charter)
Registrant’s telephone number, including area code: (415) 932-2100
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 ¨ No þ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer þ Smaller Reporting Company ¨ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ As of May 12, 2008, there were 447,889,462 shares of class A, 369,038,802 shares of class B and 267,014,729 shares of class C common stock of Visa Inc. issued and outstanding.
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Unless the context requires otherwise, reference to “Company,” “Visa,” “we,” “us” or “our” refers to Visa Inc. and its subsidiaries. The registered trademarks of Visa Inc. and its subsidiaries include: “All It Takes;” “Bands Design—Blue, White & Gold;” “Dove” Design; “Interlink;” “Life Takes Visa;” “PLUS;” “Verified by Visa;” “Visa;” “Visa Classic;” “Visa Corporate;” “Porque La Vida es Ahora;” “The World’s Best Way to Pay;” “Visa Electron;” “Visa Europe;” “Visa Fleet;” “Visa Infinite;” “Visa Mobile;” “VisaNet;” “Visa Platinum;” “Visa Purchasing;” “Visa Resolve OnLine;” “Visa ReadyLink;” “Visa Signature;” “Visa Signature Business;” “Visa Vale;” and “Winged V” Design. Other trademarks used in this report are the property of their respective owners.
Table of Contents
CONSOLIDATED BALANCE SHEETS (Unaudited)
See accompanying notes, which are an integral part of these unaudited consolidated financial statements.
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Table of ContentsVISA INC. CONSOLIDATED BALANCE SHEETS—(Continued) (Unaudited)
See accompanying notes, which are an integral part of these unaudited consolidated financial statements.
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Table of ContentsCONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
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Table of ContentsVISA INC. CONSOLIDATED STATEMENTS OF OPERATIONS—(Continued) (Unaudited)
See accompanying notes, which are an integral part of these unaudited consolidated financial statements.
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Table of ContentsCONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)
See accompanying notes, which are an integral part of these unaudited consolidated financial statements.
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Table of ContentsCONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
See accompanying notes, which are an integral part of these unaudited consolidated financial statements.
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Table of ContentsCONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
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Table of ContentsVISA INC. CONSOLIDATED STATEMENTS OF CASH FLOWS—(Continued) (Unaudited)
See accompanying notes, which are an integral part of these unaudited consolidated financial statements.
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Table of ContentsNOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 2008 (unaudited) (In millions, except as noted) Note 1—Organization Visa Inc. (“Visa” or “the Company”) is a stock corporation incorporated under the laws of the state of Delaware, United States of America. Visa Inc. and its consolidated subsidiaries, including Visa U.S.A. Inc. (“Visa U.S.A.”), Visa International Service Association (“Visa International”), Visa Canada Inc. (“Visa Canada”) and Inovant LLC (“Inovant”) (hereafter referred to as the “Company”) operate the world’s largest retail electronic payments network. Visa Inc. facilitates global commerce through the transfer of value and information among financial institutions, merchants, consumers, businesses and government entities. Visa Inc. provides financial institutions, its primary customers, with product platforms encompassing consumer credit, debit, prepaid and commercial payments. VisaNet, a secure, centralized, global processing platform, enables Visa Inc. to provide financial institutions and merchants with a wide range of product platform, transaction processing and related value added-services. The Company does not issue cards, set fees, or determine the interest rates consumers will be charged on Visa-branded cards. The Company’s issuing customers have the independent responsibility to individually determine these and most other competitive card features. These functions are performed by the Company’s customer financial institutions in competition with one another. Prior to the October 2007 Reorganization Prior to the October 2007 reorganization, Visa operated as five corporate entities related by ownership and membership: Visa U.S.A., Visa International (comprising the operating regions of Asia Pacific (“AP”), Latin America and Caribbean (“LAC”), and Central and Eastern Europe, Middle East and Africa (“CEMEA”)), Visa Canada, Visa Europe Limited (“Visa Europe”) and Inovant, a majority owned subsidiary of Visa U.S.A., which operated the VisaNet transaction processing system and other related processing systems. Each of Visa U.S.A., Visa Canada, Visa Europe, Visa AP, Visa LAC and Visa CEMEA operated as a separate geographic region, serving its member financial institutions and administering Visa programs in its respective region. October 2007 Reorganization In order to respond to industry dynamics and enhance Visa’s ability to compete, in a series of transactions occurring from October 1 to October 3, 2007, Visa undertook a reorganization, as more fully described in Note 3—The Reorganization, in which Visa U.S.A., Visa International, Visa Canada and Inovant became direct or indirect subsidiaries of Visa Inc. For financial accounting and reporting purposes, the Company has reflected the reorganization as a single transaction occurring on October 1, 2007 (the “reorganization date”), the date all contractual conditions to the closing, other than those of a perfunctory nature, were met. Visa Europe did not become a subsidiary of Visa Inc., but rather remained owned and governed by its European member financial institutions and entered into a set of contractual arrangements with the Company in connection with the reorganization. In the reorganization, the Company issued different classes and series of common stock reflecting the different rights and obligations of the Visa financial institution members and Visa Europe based on the geographic region in which they are located. In addition to common stock, the Company provided other consideration to Visa Europe, as more fully described in Note 4—Visa Europe, in exchange for its ownership interest in Visa International and Inovant. Prior to the reorganization, at September 30, 2007, Visa U.S.A. held a 69% ownership interest in its consolidated subsidiary, Inovant, and an estimated 26% membership interest in Visa International. The remaining 31% ownership interest in Inovant was held by Visa International, Visa Canada and Visa Europe. The remaining
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Table of ContentsVISA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
estimated 74% membership interest in Visa International was held by the financial institution members of the unincorporated regions (consisting of Visa AP, Visa LAC, and Visa CEMEA), Visa Europe and Visa Canada. The reorganization was accounted for using the purchase method of accounting under the guidelines of Statement of Financial Accounting Standards (“SFAS”) No. 141, Business Combinations, (“SFAS No. 141”) with Visa U.S.A. deemed to be the accounting acquirer of Visa Canada and the remaining ownership interest in Visa International and Inovant not previously held (the “acquired interests”). The net assets underlying the acquired interests were recorded at fair value at the reorganization date with the excess purchase price over this value attributed to goodwill. The results of operations of Visa International and Visa Canada have been included in the consolidated statements of operations of the Company beginning October 1, 2007. Initial Public Offering In March 2008, the Company executed its initial public offering (the “IPO”), issuing 446,600,000 shares of Class A common stock at an IPO price of $44 per share. The Company closed the transaction on March 25, 2008. The Company received $19.1 billion in net proceeds from the offering which reflects underwriting discounts and commissions of $1.23 per share. The Company used $13.4 billion of the net proceeds to redeem 154,738,487 shares of class B common stock and 159,657,751 shares of class C (series I) common stock. In October 2008, the Company intends to use $1.5 billion of the proceeds for the required redemption of 35,263,585 shares of class C (series III) common stock and intends to use $1.146 billion of the proceeds to redeem all shares of class C (series II) common stock outstanding. See further discussion at Note 4—Visa Europe and Note 10—Stockholders’ Equity and Redeemable Shares. As determined by the litigation committee and under the Retrospective Responsibility Plan, the Company deposited $3.0 billion of the net IPO proceeds into an escrow account from which settlements of, or judgments in, the covered litigation will be payable, see Note 5—Retrospective Responsibility Plan. The Company has one operating and reportable segment, “Payment Services.” The Company’s activities are interrelated and each activity is dependent upon and supportive of the other. Accordingly all significant operating decisions are based on analysis of Visa Inc. as a single global business. Note 2—Summary of Significant Accounting Policies Basis of presentation—The accompanying unaudited interim consolidated financial statements are presented in accordance with accounting principles generally accepted in the United States of America and reflect all normal recurring adjustments that, in the opinion of management, are necessary to present fairly the results for the interim periods presented. Certain information and footnote disclosures normally included in annual financial statements have been omitted. Accordingly these unaudited interim consolidated financial statements should be read in conjunction with the financial statements included in the Company’s final prospectus filed with the Securities and Exchange Commission under Rule 424(b)(4) on March 19, 2008, including Visa Inc.’s audited consolidated balance sheet and related footnotes at October 1, 2007, unaudited consolidated financial statements and related notes for the three months ended December 31, 2007 and the audited consolidated financial statements and related notes of Visa U.S.A. for the fiscal year ended September 30, 2007. Comparative consolidated balance sheet information at September 30, 2007 and consolidated statements of operations information for the three and six months ended March 31, 2007 is that of Visa U.S.A., the accounting acquirer in the reorganization, as further described in Note 3—The Reorganization and is presented in accordance with accounting principles generally accepted in the United States of America. Revenues, expenses, assets, and liabilities can vary during each quarter of the year. Therefore, the results and trends in these unaudited interim consolidated financial statements may not be indicative of results for any other interim period or for the entire year.
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Table of ContentsVISA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Principles of consolidation—The Company consolidates all entities that are controlled by ownership of a majority voting interest as well as variable interest entities for which the Company is the primary beneficiary. All significant intercompany accounts and transactions are eliminated in consolidation. Reclassifications—Certain reclassifications, not affecting net income, have been made to prior period information to conform to the current period presentation format. Use of estimates—The preparation of the accompanying unaudited interim consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated balance sheets. Such estimates include purchase consideration, valuation of goodwill and intangible assets, valuation of the Visa Europe put option, legal contingencies, assumptions used to determine share based compensation expense, guarantees and indemnifications, and assumptions used in the calculation of income taxes, among others. These estimates and assumptions are based on management’s best estimates and judgment. Actual results could differ from these estimates. Share Based Compensation—In March 2008, the Company granted non-qualified stock options, restricted stock awards and restricted stock units to its employees and non-employee directors. Upon granting the awards, the Company applied Statement of Financial Accounting Standards (SFAS) Statement No. 123 (revised 2004), “Share-Based Payment” (SFAS 123R). SFAS 123R requires that the fair value of all share-based payments to employees be recognized in the financial statements. See Note 12—Share-based Compensation. Restricted Cash—Litigation Escrow—In accordance with the Retrospective Responsibility Plan (See Note 5—Retrospective Responsibility Plan) and following the Company’s IPO, the Company deposited $3.0 billion of the proceeds of the offering into an escrow account from which settlements of, or judgments in, the covered litigation will be paid. The escrow funds are held in money market investments with the income earned, less the applicable taxes, classified as restricted cash on the Company’s consolidated balance sheet. The amount of the escrow funds equivalent to the actual, undiscounted amount of payments expected to be made beyond one year from the balance sheet date is classified as a non-current asset. Interest earned on escrow funds is included in investment income, net, on the Company’s consolidated statement of operations. Accrued Litigation—Accrued litigation associated with settled obligations to be paid over periods longer than one year is accounted for using the present value of actual and estimable future payment obligations, discounted at the estimated rate of sources of credit that could be used to finance the payment of such obligations with similar terms. The current portion of accrued litigation represents the present value of payments to be made over the next twelve months. See Note 16—Legal Matters. Recently Adopted Accounting Pronouncements On October 1, 2007, the Company adopted Financial Accounting Standards Board (FASB) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (FIN 48). FIN 48 clarifies the accounting and reporting for income taxes where interpretation of the tax law may be uncertain. FIN 48 prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of income tax uncertainties with respect to positions taken or expected to be taken in income tax returns. The initial adoption of FIN 48 resulted in a decrease in accumulated deficit of approximately $8 million and a decrease in goodwill of approximately $6 million at October 1, 2007.
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Table of ContentsVISA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Note 3—The Reorganization Description of the Reorganization In a series of transactions from October 1 to October 3, 2007, Visa undertook a reorganization in which Visa U.S.A., Visa International, Visa Canada and Inovant became direct or indirect subsidiaries of Visa Inc. and the retrospective responsibility plan was established (see Note 5—Retrospective Responsibility Plan). For financial accounting and reporting purposes, the Company has reflected the reorganization as a single transaction occurring on the reorganization date. Visa Europe did not become a subsidiary of Visa Inc., but rather remained owned and governed by its European member financial institutions and entered into a set of contractual arrangements with the Company in connection with the reorganization. In the reorganization, the Company issued different classes and series of common stock reflecting the different rights and obligations of the Visa financial institution members and Visa Europe based on the geographic region in which they are located. In addition to common stock, the Company provided other consideration, as more fully described in Note 4—Visa Europe, to Visa Europe in exchange for its ownership interest in Visa International and Inovant. At September 30, 2007, Visa U.S.A. held a 69% ownership interest in its consolidated subsidiary, Inovant, and an estimated 26% membership interest in Visa International. The remaining 31% ownership interest in Inovant was held by Visa International, Visa Canada and Visa Europe. The remaining estimated 74% membership interest in Visa International was held by Visa Europe, Visa Canada and the financial institution members of Visa AP, Visa LAC, and Visa CEMEA. The reorganization was accounted for using the purchase method of accounting under the guidelines of SFAS No. 141 with Visa U.S.A. deemed to be the accounting acquirer of the acquired interests. The net assets underlying the acquired interests were recorded at fair value at the reorganization date with the excess purchase price over this value attributed to goodwill. At the time of the reorganization, the allocation of the Company’s common stock to each of Visa AP, Visa LAC, Visa CEMEA, Visa Canada (collectively the “acquired regions”) and Visa U.S.A. (collectively “the participating regions”) was based on each entity’s relative contribution to the Company’s projected net income estimated for fiscal 2008, after giving effect to negotiated adjustments. The allocation of Company common stock and other consideration conveyed to Visa Europe in exchange for its membership interest in Visa International and its ownership interest in Inovant was determined based on the fair value of each element exchanged in the reorganization. To effect the reorganization and in exchange for the interests held in Visa U.S.A., Visa International, Visa Canada and Inovant, the Company authorized and issued to Visa Europe and the financial institution member groups of the participating regions the following shares of common stock (in whole numbers):
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Table of ContentsVISA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Purchase Consideration Total purchase consideration of approximately $17.3 billion was exchanged in October 2007 for the acquired interests. The consideration was comprised of the following:
See Note 4—Visa Europe for more information related to the Visa Europe put option and the liability under framework agreement. Visa Inc. Common Stock Issued in Exchange for the Acquired Regions The value of the purchase consideration conveyed to each of the member groups of the acquired regions was determined by valuing the underlying businesses contributed by each, after giving effect to negotiated adjustments. The value of the purchase consideration, consisting of all outstanding shares of class Canada, class AP, class LAC and class CEMEA common stock, was measured at June 15, 2007 (the “measurement date”), the date on which all parties entered into the global restructuring agreement, and was determined to have a fair value of approximately $12.6 billion. The Company primarily relied upon the analysis of comparable companies with similar industry, business model and financial profiles. This analysis considered a range of metrics including the forward multiples of revenue; earnings before interest, depreciation and amortization; and net income of comparable companies. Ultimately, the Company determined that the forward net income multiple was the most appropriate measure to value the acquired regions and reflect anticipated changes in the Company’s financial profile prospectively. This multiple was applied to the corresponding forward net income of the acquired regions to calculate their value. The most comparable company identified was MasterCard Inc. Therefore, the most significant input into this analysis was MasterCard’s forward net income multiple of 27 times net income at the measurement date. The Company additionally performed discounted cash flow analyses for each region. This analysis considered the Company’s forecast by region and incorporated market participant assumptions for growth and profitability. The cash flows were discounted using rates ranging from 12-16%, reflecting returns for investments times EBITDA to ascribe value to periods beyond the Company’s forecast, consistent with recent payment processing, financial exchange and credit card precedent transactions. True-Up of Purchase Consideration Under the terms of the reorganization, on March 17, 2008 each regional class and series of common stock was converted into class C common stock (except in the case of class USA common stock which was converted into class B common stock) resulting in a reallocation of ownership among the participating regions (the “true-up”). The conversion rate was based on each participating region’s relative under- or over-achievement of its net revenue targets during the four quarters ended December 31, 2007. The shares held by Visa Europe were not subject to the true-up. As a result of the true-up the ownership interest of the Visa U.S.A. member group in the Company was reduced by approximately 7%, with a corresponding increase in the collective ownership interest of the other
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Table of ContentsVISA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
stockholders in the form of 26 million additional shares of class C (series I) common stock received net in the conversion. Under the guidelines of SFAS 141 the additional shares issued to these members was recorded as additional purchase consideration. These shares were recorded at the true-up date at their fair value of $44 per share resulting in the recognition of $1.2 billion of additional purchase consideration as an increase to goodwill and additional paid-in capital. The fair value of these shares was determined based on the price per share in the IPO. See Note 10—Stockholders’ Equity and Redeemable Shares. Visa Inc. Common Stock Issued to Visa Europe Visa Europe remained a separate entity owned and governed by its European member banks. Under the terms of the reorganization, Visa Europe exchanged its membership interest in Visa International and Inovant for a put-call option agreement, a framework agreement (as described below) and the following consideration:
Visa Europe Put-Call Option Agreement Under the put-call option agreement between the Company and Visa Europe, the Company has granted Visa Europe a put option under which the Company is required to purchase from its members all of the share capital of Visa Europe. This option is exercisable beginning on March 25, 2009. The Company is required to repurchase the shares of Visa Europe no later than 285 days after exercise of the put option. The purchase price of the Visa Europe shares under the put option is based upon a formula that, subject to certain adjustments, applies the 12-month forward price-to-earnings multiple applicable to the Company’s common stock at the time the option is
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Table of ContentsVISA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
exercised to Visa Europe’s projected sustainable adjusted net operating income for the same 12-month period. At the date of reorganization and at March 31, 2008, the fair value of the put option was approximately $346 million. Refer to Note 4—Visa Europe for more information related to the Visa Europe put-call option agreement. Liability Under Framework Agreement The relationship between the Company and Visa Europe subsequent to the reorganization is governed by the framework agreement, which provides for trademark and technology licenses and bilateral services. Visa Inc., Visa U.S.A., Visa International and Inovant, as licensors, granted Visa Europe exclusive, irrevocable and perpetual licenses to use the Visa trademarks and technology intellectual property owned by the licensors and certain affiliates within the Visa Europe region for use in the field of financial services, payments, related information technology and information processing services and participation in the Visa system. The Company determined that the base license fee (the “fee”), as adjusted in future periods based on the growth of the gross domestic product of the European Union, approximated fair value. The Company made this determination through an analysis of the fee rates implied by the economics of the licenses. The first and second fee reduction components, as more fully described in Note 4—Visa Europe, reduce this base fee by an amount and for a period of time dependent on the timing and results of the IPO. At October 1, 2007, the Company calculated its liability to provide these licenses at below fair value to be approximately $132 million, based on the Company’s initial registration statement filing on November 9, 2007, an assumed offering closing date of March 31, 2008 and the applicable three-month LIBOR rate at September 30, 2007 of 5.23%. Refer to Note 4—Visa Europe for more information related to the liability under the framework agreement. Fair Value of Assets Acquired and Liabilities Assumed Total purchase consideration has been allocated to the tangible and identifiable intangible assets and liabilities assumed underlying the acquired interests based on their fair value on the date of the reorganization. The excess of purchase consideration over the tangible and identifiable intangible assets and liabilities assumed was recorded as goodwill. The following table summarizes the allocation of total purchase consideration to tangible and intangible assets acquired, liabilities assumed and goodwill at October 1, 2007:
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Table of ContentsVISA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The following table reflects activity related to Goodwill from September 30, 2007 to March 31, 2008:
As discussed above under “True-Up of Purchase Consideration,” under the guidelines of SFAS No. 141 the ownership interest of the Visa U.S.A. member group in the Company was reduced as a result of the true-up, with a corresponding increase in the collective ownership interest of the other stockholders, resulting in additional purchase consideration. The additional purchase consideration of $1.15 billion was recorded as an increase in additional paid-in capital and goodwill. Goodwill was adjusted by $90 million due to the release of the deferred tax liability related to Visa U.S.A.’s historical equity ownership interest in Visa International, a $7 million adjustment to the liability under the framework agreement and $4 million due to the adoption of FIN 48 and other tax adjustments. The purchased intangibles and goodwill are not deductible for tax purposes. Substantially all of the identifiable intangible assets have an indefinite life and accordingly are not subject to amortization. The Company has determined that all goodwill is attributable to its single reportable segment. Pro Forma Results of Operations The following Visa Inc. pro forma results of operations for the three and six months ended March 31, 2007 have been prepared to give effect to the reorganization described above assuming it occurred on October 1, 2006, the beginning of the periods presented. The pro forma results of operations are presented for illustrative purposes only and are not necessarily indicative of the results of operations that would have been obtained had these events actually occurred on October 1, 2006, nor do they intend to be a projection of future results of operations. The pro forma results of operations have been prepared by applying adjustments to the historical unaudited consolidated statements of operations of Visa U.S.A., Visa International and Visa Canada for the three and six months ended March 31, 2007.
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Table of ContentsVISA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
California Special Deduction The pro forma statements of operations presented above reflect the Company’s continuing eligibility to claim the special deduction afforded to companies that operate on a cooperative or mutual basis under California Revenue and Taxation Code §24405 (referred to hereafter as “the special deduction”). The State of California, where both Visa U.S.A. and Visa International are headquartered, historically has not taxed a substantial portion of the reported income of these companies on the basis that both operate on a cooperative or mutual basis and are therefore eligible for the special deduction. As taxpayers eligible for the special deduction, Visa U.S.A. and Visa International were generally only subject to California taxation on interest and investment income. Therefore, the majority of each company’s income has not historically been taxed in California. Upon the Company’s completion of an IPO and the consequent ownership by parties other than the Company’s financial institution customers, the Company is no longer eligible to claim the special deduction and is subject to California taxation as a traditional, for-profit business enterprise. Had ineligibility for the special deduction been reflected at October 1, 2006 in the pro forma condensed combined statements of operations, pro forma income tax expense would increase and pro forma net income would decrease by approximately $13 million and $22 million for the three and six months ended March 31, 2007, respectively. The Company’s tax provision for the three and six months ended March 31, 2008 was updated to reflect the loss of the special deduction in the quarter ended March 31, 2008. See Note 15—Income Taxes.
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Table of ContentsVISA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Other Contingencies The Company has not identified any material unrecorded pre-acquisition contingencies other than future adjustments to the liability under the framework agreement where the related asset, liability or impairment is probable and the amount can be reasonably estimated. Prior to the end of the one-year purchase price allocation period, if information becomes available that would indicate it is probable that such events had occurred and the amounts can be reasonably estimated, such items will be included in the final purchase price allocation and may adjust goodwill. Note 4—Visa Europe As discussed in Note 1—Organization, Visa Europe remained a separate entity owned and governed by its European member banks after the reorganization. Under the terms of the reorganization, Visa Europe exchanged its ownership interest in Visa International and Inovant for the following consideration: (i) an 8.1% ownership interest in the form of class EU (series I) and class EU (series III) common stock (see Note 3—The Reorganization), (ii) a 3.6% ownership interest in the form of class EU (series II) common stock, (iii) a put-call option agreement, and (iv) a framework agreement. Class EU (Series II) Common Stock and Class C (Series II) Common Stock At the date of reorganization, Visa Europe received a 3.6% ownership interest in Visa Inc. in the form of class EU (series II) common stock. On March 17, 2008, the class EU (series II) common stock converted on a one-to-one basis into shares of class C (series II) common stock. On March 19, 2008, the Company issued 51,844,393 additional shares of class C (series II) stock at a price of $44 per share in exchange for a subscription receivable from Visa Europe. This issuance and subscription receivable were recorded as offsetting entries in temporary equity on the Company’s consolidated balance sheet at March 31, 2008. See Note 10—Stockholders’ Equity and Redeemable Shares for a description of the true-up. The Company intends to redeem all outstanding shares of class C (series II) common stock in October 2008 at a price of $1.146 billion adjusted for dividends and certain other adjustments and the extinguishment of the subscription receivable. Visa Europe also has the option to require the Company to redeem all outstanding shares of class C (series II) common stock any time after December 4, 2008. Fair Value of Class C (Series II) Common Stock The Company determined the fair value of the class C (series II) common stock, which is the equivalent of class EU (series II common stock), to be $1.104 billion at October 1, 2007. The Company determined fair value by discounting the redemption price using a risk-free rate based on the probability and timing of the successful completion of an IPO and its intention to redeem these shares in October 2008. Upon completion of the Company’s IPO, the redemption feature of this stock was triggered. The fair value of the class C (series II) common shares was determined to be $1.125 billion and was classified as temporary or mezzanine level equity on the Company’s consolidated balance sheet in accordance with EITF Topic D-98, “Classification and Measurement of Redeemable Securities.” The Company determined fair value at this date by discounting the redemption price using a risk-free interest rate based on its intention to redeem these shares in October 2008. (See Note 10—Stockholders’ Equity and Redeemable Shares). Visa Europe Put-Call Option Agreement Visa Inc. and Visa Europe have entered into a put-call option agreement under which Visa Inc. granted Visa Europe a perpetual put option to require Visa Inc. to purchase from the Visa Europe members all of the issued
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Table of ContentsVISA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
shares of capital stock of Visa Europe. The put option may be exercised by Visa Europe at any time after March 25, 2009. The Company is required to purchase the shares of Visa Europe no later than 285 days after exercise of the put option. In addition, Visa Europe granted to Visa Inc. a call option under which the Company will be entitled to purchase all of the share capital of Visa Europe. The Company may exercise the call option, subject to certain conditions, at any time following certain triggering events. At the date of reorganization or October 1, 2007 and at March 31, 2008, the fair value of the put option was approximately $346 million and is recorded within other liabilities on the Company’s consolidated balance sheet. Fair Value of the Put and Call Options The Company determined the fair value of the put option, approximately $346 million at March 31, 2008 and October 1, 2007, using probability-weighted models designed to estimate the Company’s liability assuming various possible exercise decisions that Visa Europe could make under different economic conditions in the future, including the possibility that Visa Europe will never exercise its option. This liability is carried at fair value in other liabilities on the Company’s consolidated balance sheet with changes in fair value included in the Company’s statement of operations similar to the treatment required by SFAS No. 133 and reclassified as a short-term liability when it becomes payable within a year. The key assumptions used in these models are dictated by the various elements of the put option strike price calculation and the Company’s estimation of the fair value of Visa Europe at the assumed date of exercise. Significant key inputs used in the determination of the fair value of the put option include the estimated probability of exercise and various assumptions used in the estimation of the Company’s obligation in the event of exercise. These include the estimated differential between the 12-month forward price-to-earnings multiple applicable to the Company’s common stock and that applicable to Visa Europe on a stand alone basis at the time of exercise and the estimated growth of Visa Europe’s sustainable net operating income. These key inputs are unobservable. The Company determined that the call option contained in the put-call option agreement has nominal value at March 31, 2008 as the conditions under which it is exercisable are deemed remote. The Framework Agreement The relationship between Visa Inc. and Visa Europe is governed by a framework agreement, which provides for trademark and technology licenses and bilateral services. Trademark and Technology Licenses Visa Inc., Visa U.S.A., Visa International and Inovant, as the licensors, granted to Visa Europe exclusive, irrevocable and perpetual licenses to use the Visa trademarks and technology intellectual property owned by the licensors and certain affiliates within the Visa Europe region for use in the field of financial services, payments, related information technology and information processing services and participation in the Visa system. Visa Europe may sublicense the Visa trademarks and technology intellectual property to its members and other sublicensees, such as processors, for use within Visa Europe’s region and, in certain limited circumstances, outside the Visa Europe region. First Fee Reduction Component From the period October 1, 2007 through November 8, 2007, the fee payable for the licenses is $6 million per quarter. Thereafter until October 5, 2008, the fee payable for the licenses will be approximately $143 million
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Table of ContentsVISA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
per year, payable quarterly, which is referred to as the quarterly base fee, reduced by an amount equal to $1.146 billion multiplied by the three-month LIBOR rate plus 100 to 200 basis points (the “LIBOR rate”). Thereafter, the fee payable for the licenses will be the quarterly base fee. Beginning November 9, 2010, this fee will be increased annually based on the annual growth of the gross domestic product of the European Union. Second Fee Reduction Component The quarterly base fee will be reduced between March 19, 2008 (the date the Company’s shares commenced trading on the New York Stock Exchange) and October 5, 2008 by an amount equal to the product of the following: (i) Visa Inc.’s IPO price per share net of any underwriting discounts and commissions or $42.77 per share (“net IPO price”); (ii) 35,263,585, the number of shares of Visa Inc. held by Visa Europe (other than class C (series II) common stock) that would have been redeemed immediately, but for provisions that delay the redemption of shares held by Visa Europe until one year following the date of the reorganization; and (iii) the LIBOR rate. The Company determined through an analysis of the fee rates implied by the economics of the agreement that the quarterly base fee, as adjusted in future periods based on the growth of the gross domestic product of the European Union, approximates fair value. As a result of the first and second fee reduction components, the trademark and technology license agreement represents a contract that is below fair value. Calculation of Liability under the Framework Agreement At October 1, 2007, the Company recorded a liability of approximately $132 million, consisting of $113 million recorded in accrued liabilities and $19 million recorded in other long-term liabilities on the Company’s consolidated balance sheet, to reflect the Company’s obligation to provide this license at below fair value. The application of the LIBOR rate in determining the first and second fee reduction components represents a variable interest element embedded within the framework agreement, which the Company has treated as an embedded derivative with changes in fair value reflected in Visa Inc.’s consolidated statement of operations under the guidelines of SFAS No. 133. Subsequent to October 1, 2007, the Company made adjustments to its liability under the framework agreement as follows:
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Other Obligations under Trademark and Technology Licenses Visa Europe must comply with certain agreed upon global rules governing the use and interoperability of the Visa trademarks and interoperability of Visa Inc.’s systems with the systems of Visa Europe. In addition, the parties will guarantee the obligations of their respective customers and members to settle transactions between such customers and members, service global customers, participate in certain global sponsorships, manage certain global programs, establish rules for servicing global merchants, ensure that their customers and members require acceptance of globally accepted cards, maintain adequate capital levels to support their ongoing business operations and establish and comply with rules relating to the operation of the Visa enterprise. The Company will indemnify Visa Europe for any claims arising from activities within the field brought outside Visa Europe’s region and Visa Europe will indemnify Visa Inc. for any claims arising from activities within the field brought within Visa Europe’s region. The Company has not recorded liabilities associated with these obligations as the fair value of such obligations was determined to be nominal at March 31, 2008. Bilateral Services Visa Inc. and Visa Europe provide each other with transitional and ongoing services similar to those services previously provided among Visa U.S.A., Visa International, Inovant, Visa Canada and Visa Europe. Visa Inc. provides Visa Europe, on an ongoing basis, with authorization services for cross-border transactions involving Visa Europe’s region and the rest of the world, as well as clearing and settlement system services between Visa Europe’s region and the rest of the world. Until Visa Europe’s regional clearing and settlement system is deployed, Visa Inc. also provides clearing and settlement system services within Visa Europe’s region. In addition, the parties share foreign exchange revenues related to currency conversion for transactions involving European cardholders as well as other cross-border transactions that take place in Visa Europe’s region until Visa Europe’s regional clearing and settlement system is deployed, at which time this arrangement will cease. The parties also use each others’ switching and processing services. Visa Europe indemnifies Visa Inc. for any claims arising out of the provision of the services brought by Visa Europe’s member banks against Visa Inc., while Visa Inc. indemnifies Visa Europe for any claims arising out of the provision of the services brought against Visa Europe by Visa Inc.’s customer financial institutions. The Company has determined that no material value was exchanged in the bilateral services agreement above or below fair value as a result of agreeing to receive or perform services at specified rates. The Company made this determination by comparing the pricing specified in the agreement to those routinely charged by comparable third party service providers. As a result, the Company has not recorded an asset or liability to reflect an obligation to provide or receive services at above or below fair value. Note 5—Retrospective Responsibility Plan As part of the reorganization, the Company entered into several related mechanisms, including a series of agreements designed to address potential liability under certain litigation referred to as the “covered litigation.” These mechanisms are referred to as the retrospective responsibility plan and consist of an escrow agreement, a loss sharing agreement, an interchange judgment sharing agreement, the conversion feature of the Company’s shares of class B common stock and the indemnification obligations of the Visa U.S.A. members pursuant to Visa U.S.A.’s certificate of incorporation and bylaws and in accordance with their membership agreements. In accordance with the escrow agreement, following the Company’s IPO, the Company deposited $3.0 billion of the proceeds of the offering in an escrow account from which settlements of, or judgments in, the covered litigation will be paid. The escrow funds are held in money market investments with the income earned, less the applicable taxes, classified as short term and long term restricted cash on the Company’s consolidated
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balance sheet. The amount of the escrow funds equivalent to the actual, undiscounted amount of covered litigation payments expected to be made beyond one year from the balance sheet date is classified as a non-current asset. The amount of the escrow was determined by the litigation committee. The litigation committee was established pursuant to a litigation management agreement among Visa Inc., Visa U.S.A., Visa International, and the members of the litigation committee, all of whom are affiliated with, or act for, certain Visa U.S.A. members. The litigation committee: (i) determined the amount of the proceeds from the IPO to be deposited in the escrow account; (ii) may request the issuance of a follow-on offering of class A common stock to increase the size of the escrow account, subject to Visa Inc.’s right to delay the filing or effectiveness of a registration statement under certain circumstances; and (iii) may recommend or refer the cash payment portion of a proposed settlement of any covered litigation to the Visa Inc. board of directors. Visa Inc. has entered into a loss sharing agreement with Visa U.S.A., Visa International and certain Visa U.S.A. members. The loss sharing agreement provides for the indemnification of Visa U.S.A., Visa International and, in certain circumstances, Visa Inc. with respect to: (i) the amount of a final judgment paid by Visa U.S.A. or Visa International in the covered litigation after the operation of the interchange judgment sharing agreement, plus any amounts reimbursable to the interchange judgment sharing agreement signatories; or (ii) the damages portion of a settlement of a covered litigation that is approved as required under Visa U.S.A.’s certificate of incorporation by the vote of Visa U.S.A.’s members. The several obligation of each bank that is a party to the loss sharing agreement will equal the amount of any final judgment enforceable against Visa U.S.A., Visa International or any other signatory to the interchange judgment sharing agreement, or the amount of any approved settlement of a covered litigation, multiplied by such bank’s then-current membership proportion as calculated in accordance with Visa U.S.A.’s certificate of incorporation. Visa U.S.A. and Visa International also entered into an interchange judgment sharing agreement with certain Visa U.S.A. members that have been named as defendants in the interchange litigation. Under this judgment sharing agreement, the Visa U.S.A. members that are signatories will pay their membership proportion of the amount of a final judgment not allocated to the conduct of MasterCard. Visa Inc., Visa U.S.A. and Visa International entered into a settlement agreement with American Express that became effective on November 9, 2007. Under the settlement agreement, American Express will receive maximum payment of $2.25 billion, including up to $2.07 billion from the Company, which will be funded through the litigation escrow account, and $185 million from five co-defendant banks. An initial payment of $1.13 billion was made during the three months ended March 31, 2008, including $945 million from the Company, which reduced the litigation escrow account. Beginning with the quarter ended March 31, 2008, the Company will pay American Express an additional amount of up to $70 million each quarter for 16 quarters, for a maximum total of $1.12 billion. The initial quarterly payment was made in April 2008. The present value of total future payments, discounted at 4.72%, or $1.9 billion, was included in litigation provision in the Company’s consolidated statement of operations during fiscal 2007. Accrued litigation of $1.0 billion and $1.9 billion was included in current and long-term accrued litigation on the Company’s consolidated balance sheets at March 31, 2008 and September 30, 2007, respectively. The Company recorded $23 million and $46 million in accretion on this obligation, included in interest expense on the Company’s consolidated statements of operations for the three and six months ended March 31, 2008, respectively. Visa Inc. intends to fund its payment obligations under the American Express settlement with amounts in the escrow account, in accordance with the terms of the retrospective responsibility plan.
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The following table sets forth the change in the escrow account during the six months ended March 31, 2008:
To the extent that amounts available under the escrow arrangement and agreements in the retrospective responsibility plan are insufficient to fully resolve the covered litigation, the Company will use commercially reasonable efforts to enforce the indemnification obligations of Visa U.S.A.’s members for such excess amount, including but not limited to enforcing indemnification obligations pursuant to Visa U.S.A.’s certificate of incorporation and bylaws and in accordance with their membership agreements. During the quarter ended March 31, 2008, the Company recorded an additional litigation provision of approximately $285 million related to the covered litigation. See Note 16—Legal Matters for further information regarding pending litigation. Note 6—Investments Available-for-Sale Investments Available-for-sale investment securities, which are recorded at fair value, consist of debt securities issued by governments and government-sponsored entities, tax-exempt municipal bonds, auction rate securities issued by corporations and mutual fund investments in equity securities and other marketable equity securities. The amortized cost, unrealized gains and losses, and fair value of available-for-sale securities are as follows:
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The contractual maturity of available-for-sale debt securities regardless of their balance sheet classification is as follows:
At March 31, 2008, equity securities with a fair value and unrealized losses of $67 million and $10 million, respectively, were in an unrealized loss position for less than one year. At March 31, 2008, there were no investments which had been in a significant unrealized loss position for a period of greater than one year. Equity securities primarily consist of mutual fund investments related to various employee compensation plans. For these plans, employees bear the risk of market fluctuations over the term of their participation in the compensation plan. Losses experienced on these equity investments are offset by reductions in personnel expense. Unrealized losses on equity securities were caused by changes in market conditions. At March 31, 2008, a total of 22 mutual fund investments are in an unrealized loss position. Based on an evaluation of the near-term prospects of these investments and management’s ability and intent to hold these investments for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company does not consider these investments to be other-than-temporarily impaired at March 31, 2008. During the three months ended March 31, 2008, the Company recognized losses on auction rate securities of $7 million. There were no other investments that realized significant losses during the three and six months ended March 31, 2008. Other Investments At March 31, 2008, investments accounted for under the cost and equity methods totaled $572 million, of which $565 million were acquired in the reorganization from Visa International and were recorded at their fair value at the date of acquisition. At September 30, 2007, investments accounted for under the cost and equity methods, excluding Visa U.S.A.’s investment in Visa International and Visa U.S.A.’s investments in real estate
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ventures owned jointly by itself and Visa International, totaled $4 million. Investments accounted for under the cost and equity methods are included in other assets on the consolidated balance sheets, except for Visa U.S.A.’s investment in Visa International, which is shown as a separate line on the September 30, 2007 consolidated balance sheet. Note 7—Property, Equipment and Technology Property, Equipment and Technology consisted of the following:
Furniture, equipment and leasehold improvements include certain transportation assets acquired during the three months ended March 31, 2008, with an original cost of $56 million. Construction-in-progress primarily reflects cost related to the ongoing construction of the Company’s east coast data center which is expected to commence operations in 2010. Technology consists of both purchased and internally developed software. Internally developed software represents software utilized by the VisaNet electronic payment network. At March 31, 2008, and September 30, 2007, accumulated amortization for technology was $244 million and $176 million, respectively. At March 31, 2008, estimated future amortization expense on technology was as follows:
Depreciation and amortization expenses related to property, equipment and technology was $59 million and $28 million for the three months ended March 31, 2008 and 2007, and $121 million and $57 million for the six months ended March 31, 2008 and 2007, respectively. Included in those amounts are amortization expense on technology of $34 million and $9 million for the three months ended March 31, 2008 and 2007, and $67 million and $19 million for the six months ended March 31, 2008 and 2007, respectively.
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Note 8—Pension, Postretirement and Other Benefits United States Plans The Company sponsors various qualified and non-qualified defined benefit pension and postretirement benefit plans which provide retirement and medical benefits for substantially all employees residing in the United States. Components of Net Periodic Benefit Costs The components of net periodic benefit costs of the United States pension and other postretirement plans for the three and six months ended March 31, 2008 and 2007 are as follows:
For the three months ended March 31, 2008, the Company contributed $3 million and $1 million to each of the pension and postretirement plans, respectively. For the six months ended March 31, 2008, the Company contributed $4 million and $2 million to the pension and postretirement plans, respectively. The expected
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contributions from employer assets to the pension plans and postretirement plan for fiscal 2008 are expected to be at least $62 million and $5 million, respectively. The Company will continue to monitor the performance of pension plan assets and market conditions in evaluating its contribution to the pension plans in fiscal 2008. Net settlement losses on plan assets, included in personnel expense in the accompanying consolidated statements of operations, are as follows:
Note 9—Debt 2002 Senior Secured Notes In December 2002, Visa U.S.A. issued $200 million in senior secured notes with maturity dates of five and ten years. The series A senior secured notes were paid at December 31, 2007. The net carrying amount of the series B senior secured notes at March 31, 2008, is $32 million. As a result of the American Express settlement described in Note 16—Legal Matters, the Company was in default of certain financial performance covenants on its series B senior secured notes and the debt was classified as a current liability at September 30, 2007. In March 2008, the Company executed the second waiver to Note Purchase Agreements and the Series B Noteholders agreed to waive the default through May 31, 2008, to allow the Company to complete and execute an Amended and Restated Note Purchase Agreement prior to the waiver termination date. The Company expects to execute the amendment by May 31, 2008, and will continue to classify related debt as a current liability until the amendment is executed. Note Purchase Agreement In September 1994, a real estate partnership owned jointly by Visa U.S.A. and Visa International issued notes that are secured by certain office properties and facilities in California which are used by the Company. Series B of these notes, totaling $26 million, were issued with an interest rate of 8.28% and a stated maturity of September 23, 2014, and are payable monthly with interest-only payments for the first ten years and payments of interest and principal for the remainder of the term. Series B issuance costs of $0.5 million are being amortized on a straight-line basis over the life of the term. The net carrying amount of the Series B notes at March 31, 2008, is $19 million. In September 1995, a separate real estate partnership owned jointly by Visa U.S.A. and Visa International issued notes that are secured by certain office properties and facilities in California which are used by the Company. Series B of these notes, totaling $27 million, were issued with an interest rate of 7.83% and a stated maturity of September 15, 2015, and are payable monthly with interest-only payments for the first ten years and payments of interest and principal for the remainder of the term. Series B debt issuance costs of $0.3 million and
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a $0.8 million loss on termination of a forward contract are being amortized on a straight-line basis over the life of the notes. The net carrying amount of the series B notes at March 31, 2008, is $22 million. As a result of the American Express settlement, described in Note 16—Legal Matters, the 1994 partnership was in default of certain performance covenants under the terms of the debt agreement. As compliance of this debt agreement is a financial covenant for the 1995 partnership’s debt agreement, the settlement triggered a cross-default, and the related debt was classified as a current liability at September 30, 2007. In March 2008, Visa U.S.A. and Visa International executed the second waiver to the 1994 note purchase agreement and the Series B Noteholders agreed to waive the default through May 31, 2008. The Company expects to execute an amendment by May 31, 2008, and will continue to classify related debt as a current liability until the amendment is executed. As of March 31, 2008, Visa U.S.A. and Visa International were in default of certain financial covenants under the 1995 note purchase agreement. Visa U.S.A. and Visa International executed a waiver to the 1995 note purchase agreement in April 2008 in which the Series B noteholders agreed to waive the default. Since the default was not cured by March 31, 2008, the net carrying amount, or $22 million, remained classified as a current liability at March 31, 2008. Note 10—Stockholders’ Equity and Redeemable Shares Pursuant to the amended and restated certificate of incorporation, the Company has the following shares of preferred and common stock authorized, issued and outstanding at March 31, 2008 (in whole numbers):
No shares were outstanding at September 30, 2007 as Visa U.S.A. was a non-stock corporation at September 30, 2007. The preferred stock may be issued as redeemable or non-redeemable, and it has preference over any class or series of common stock with respect to the payment of dividends and distribution of the Company’s assets in the event of a liquidation or dissolution. The shares of common stock participate ratably on an as-converted basis, as discussed below, in dividends or distributions paid by the Company on the common stock, regardless of class or series. Conversion True-Up In accordance with the terms of the restructuring agreement, dated as of June 15, 2007 and amended as of August 24, 2007, on March 17, 2008 all of the Company’s regional classes and series of common stock were
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converted into either class B or class C common stock. In connection with this conversion, ownership was reallocated in order to reflect the relative contribution of the participating regions to the Company’s financial performance for the four quarters ended December 31, 2007. The conversion rates applied were based on the relative under- or over-achievement (beyond certain percentage limits) of each participating region’s net revenue targets for that period. The shares held by Visa Europe were not subject to the true-up, but were converted on a one-to-one basis from class EU (series I, II, III) common stock to class C (series III, II, and IV) common stock concurrent with the true-up. The results of the true-up are reflected in the table below. Fractional shares resulting from the conversion of the shares of each individual stockholder have been rounded down. These fractional shares were paid in cash to stockholders as part of the initial redemption of class B common stock and class C common stock following the IPO.
Also, the Company issued 51,844,393 additional shares of class C (series II) common stock at a price of $44 per share in exchange for a subscription receivable from Visa Europe. This issuance and subscription receivable were recorded as offsetting entries in temporary equity on the Company’s consolidated balance sheet at March 31, 2008. Initial Public Offering In March , 2008, the Company completed its IPO with the issuance of 446,600,000 shares of class A common stock at a net offering price of $42.77 (the IPO price of $44.00 per share of class A common stock, less underwriting discounts and commissions of $1.23 per share). The Company received net proceeds of $19.1 billion as a result of the IPO. Redemption Class B Common Stock and Class C Common Stock Other than Class C (Series II) Common Stock On March 28, 2008, the Company completed the required redemption of a portion of the class B common stock and class C (series I) common stock. The Company used $13.4 billion of net proceeds from the IPO to redeem 154,738,487 shares of class B common stock and 159,657,751 shares of class C (series I) common stock
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at a redemption price of $42.77 per share. Immediately after giving effect to the redemption and subject to the restrictions set forth in the Company’s Amended and Restated Certificate of Incorporation (the “Certificate”) and the conversion and transfer restrictions below, all outstanding shares of class B common stock will be convertible into 175,367,482 shares of class A common stock and 152,002,287 shares of class C (series I, III and IV) common stock will be convertible into shares of Class A common stock on a one-to-one basis. The number of shares of class C (series I, III and IV) common stock convertible into shares of class A common stock excludes those class C (series III) common shares subject to redemption in October 2008, as further described below. Further, as required by the Certificate, the Company intends to use $1.508 billion of net proceeds from the IPO to redeem 35,263,585 shares of class C (series III) common stock at a redemption price of $42.77 per share in October 2008. Following this October 2008 redemption, the remaining 27,499,203 shares of class C (series III) and class C (series IV) common stock outstanding will automatically convert into shares of class C (series I) common stock on a one-to-one basis. Class C (Series II) Common Stock The Company intends to use $1.146 billion of the net proceeds from the IPO to fund the redemption of all class C (series II) common stock in October 2008. Upon execution of the IPO, Visa Europe has the option to require the Company to redeem all class C (series II) common stock at any time after December 4, 2008. As a result, in March 2008, the Company reclassified all class C (series II) common stock at its then fair value of $1.125 billion to temporary equity on the Company’s consolidated balance sheet with a corresponding reduction in additional paid-in-capital of $1.104 billion and accumulated income (deficit) of $21 million. The Company will accrete this stock to its redemption price of $1.146 billion, adjusted for dividends and certain other adjustments, on a straight-line basis, from March 2008 to October 2008 through accumulated income or in the absence of accumulated income, through additional paid in capital. Concurrent with the true-up discussed above, the Company issued 51,844,393 additional shares of class C (series II) stock at a price of $44 per share in exchange for a subscription receivable from Visa Europe. This issuance and subscription receivable were recorded as offsetting entries in temporary equity on the Company’s consolidated balance sheet at March 31, 2008. Conversion and Transfer Restrictions Class B Common Stock The class B common stock is not convertible or transferable until the later of March 25, 2011 and the date on which all of the covered litigation has been finally resolved, although the Company’s board of directors may make exceptions to this transfer restriction after resolution of all covered litigation. This transfer restriction is subject to limited exceptions, including transfers to other class B shareholders. After termination of the restrictions, the class B common stock will be convertible into class A common stock if transferred to a person that was not, a Visa member or similar person or affiliate of a Visa member or similar person, as defined in the Certificate. Upon such transfer, each common share will automatically convert into a number of shares of class A common stock based upon the applicable conversion rate in effect at the time of such transfer. Immediately following the IPO, the conversion rate applicable to class B common stock was reduced to 0.71 shares of class A common stock for each share of class B common stock. The conversion rate was adjusted to reflect the initial deposit of $3.0 billion, as determined by the litigation committee, into the litigation escrow account. Settlements of, or judgments in, the covered litigation will be paid using the litigation escrow account. Further adjustment to the conversion rate applicable to class B shares will occur upon: (i) the completion of any
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follow-on offering of class A common stock completed in order to increase the size of the litigation escrow account; or (ii) the final resolution of the covered litigation and the release of funds remaining on deposit in the litigation escrow account. No conversion of class B common stock will be effected until all applicable restrictions on the transfer of class B common stock have expired. See Note 5—Retrospective Responsibility Plan. Class C Common Stock The class C common stock, other then class C (series II) common stock and class C (series III) redemption shares, is not convertible into class A common stock or transferable until March 25, 2011, although the Company’s board of directors may make exceptions to this transfer restriction. This transfer restriction is subject to limited exceptions, including transfers to other class stockholders. After termination of the restrictions, the class C common stock will be convertible into class A common stock if transferred to a person that was not, immediately after the reorganization, a Visa member, Upon such transfer, each common share will automatically convert into a number of shares of class A common stock based upon the applicable conversion rate in effect at the time of such transfer. The conversion rate of the class C common stock, other then class C (series II) common stock and class C (series III) redemption shares, into class A common stock is on a one-to-one basis, subject to adjustments for stock splits, recapitalizations and similar transactions. Class C (series II) common stock and class C (series III) redemption shares are not convertible into class A common stock. Immediately after the completion of the partial redemption of the class C (series III) common stock in October 2008 described above, each outstanding share of class C (series III) common stock and class C (series IV) common stock will automatically be converted into class C (series I) common stock. No conversion into class A common stock of class C common stock will be effected until all applicable restrictions on such transfers have expired. Voting Rights The holders of class A common stock have the right to vote on all matters on which stockholders generally are entitled to vote. All holders of class B and class C common stock have no right to vote on any matters, except for certain defined matters, including any consolidation, merger, combination or any decision to exit the core payments business, in which the holders of class B and class C common stock (other than class C (series II) common stock) are entitled to cast a number of votes equal to the number of shares of class B or C common stock held multiplied by the applicable conversion rate in effect on the record date. Note 11—Net Income Per Share For the three and six months ended March 31, 2007, Visa U.S.A. was a non-stock corporation and therefore there was no comparable measure for net income per share. For the three and six months ended March 31, 2008, the Company calculated earnings per share in accordance with Statement of Financial Accounting Standards 128, Earnings Per Share (“SFAS No. 128”). Prior to the Company’s IPO, the stockholders of each regional class of common stock were entitled to equal per share distributions of earnings whether through dividends or upon liquidation. The Company therefore presented a single earnings per share amount applicable to all outstanding classes of common stock for periods presented ending prior to the IPO. Following the IPO, the Company calculated net income per share using the two-class method under the guidelines of SFAS No. 128 to reflect the different rights of each class and series of outstanding common stock. Calculation of Basic Earnings Per Share Under the provisions of SFAS No. 128, basic net income per share is computed for each class and series of common stock outstanding during the period by dividing net income available to each class and series by the weighted average number of common shares outstanding during the period.
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Earnings Allocation to Each Class and Series of Common Stock Prior to the IPO, each class and series of common stock was legally entitled to pro rata per share distributions whether through dividends or upon liquidation. As a result, net income was allocated to each class and series of common stock for this period based on each class’ proportionate ownership. Following the Company’s IPO, net income is ascribed to each class and series of common stock as follows:
Weighted Average Number of Shares Outstanding During the three and six months ended March 31, 2008, the weighted average number of shares of each class and series of common stock outstanding reflects changes in ownership over the periods as follows:
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See Note 10—Stockholders’ Equity and Redeemable Shares and the Consolidated Statement of Changes in Stockholders’ Equity and Accumulated Income (Deficit) reflecting these ownership changes over the period and for additional information regarding redeemable common shares. Calculation of the Numerator—Basic Earnings Per Share The following tables calculate net income allocated to each series and class of common stock in the calculation of basic earnings per share for the three and six months ended March 31, 2008. For the three months ended March 31, 2008:
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For the six months ended March 31, 2008:
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Calculation of the Denominator—Basic Earnings Per Share The following tables present proportional ownership of each class and series of common stock, prior and subsequent to the true-up, IPO, and initial redemptions, applied to calculate income allocated to each class and series of common stock in the calculation of basic earnings per share for the three and six months ended March 31, 2008. For the three months ended March 31, 2008:
For the six months ended March 31, 2008:
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Calculation of Diluted Earnings Per Share Diluted net income per share for each class and series of common stock is computed by dividing net income available by the weighted average number of common shares and, if dilutive, potential common shares outstanding during the period. The calculation of class A common stock diluted earnings per share assumes potential common shares outstanding, which consist of the incremental Class A common shares issuable upon:
The dilutive effect of outstanding stock options, restricted shares, and restricted share units is reflected in diluted earnings per share by application of the treasury stock method under the guidelines of SFAS No. 128. No potential common shares existed for any other class or series of common stock other then class A common stock. The calculation of diluted earnings per share for all classes and series of common stock other then class A common stock assumes no conversion of any class B or class C common stock into class A common stock during the period. Net income attributable to each class and series of common stock other then class A common stock in the calculation of diluted earnings per share is reduced proportionately by the number of potential class A common shares underlying employee stock options, restricted share and restricted share units. Calculation of the Numerator—Diluted Earnings Per Share The following tables calculate net income allocated to each series and class of common stock in the calculation of diluted earnings per share for the three and six months ended March 31, 2008. For the three months ended March 31, 2008:
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For the six months ended March 31, 2008:
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Calculation of the Denominator—Diluted Earnings Per Share The following tables present proportional ownership of each class and series, prior and subsequent to the true-up, IPO, and initial redemptions, applied to calculate income available to each class and series of common stock in the calculation of diluted earnings per share for the three and six months ended March 31, 2008. Upon the pricing of the IPO, which was deemed to have occurred, for the purpose of presenting earnings per share, on March 19, 2008, the Company granted to certain of its directors and employees options to purchase 8,971,783 shares of Class A common stock at $44 per share, 622,126 restricted stock units, and 1,289,803 shares of restricted stock. The dilutive effect of these instruments was minimal during the three and six months ended March 31, 2008 due to the limited number of days these instruments were outstanding in the periods presented. For the three months ended March 31, 2008:
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For the six months ended March 31, 2008:
Note 12—Share-based Compensation Prior to the Company’s IPO in March 2008, the Company had not granted share-based compensation awards. During 2007 in anticipation of the IPO, the Company adopted the 2007 Equity Incentive Compensation Plan (the “EIP”). The EIP was adopted to award long-term compensation following the reorganization and is designed to align management interests with those of stockholders, provide opportunities for wealth creation and ownership, encourage a long-term focus, and promote retention. The EIP is a stockholder-approved omnibus plan that permits the grant or award of stock options, stock appreciation rights, restricted stock awards, restricted stock units, performance unit awards, performance share awards, cash-based awards and other equity-based awards to eligible persons, and covers a total of up to 59,000,000 shares of class A common stock. Shares available for award may be either authorized and unissued or previously issued shares subsequently acquired by the Company. The EIP became effective in October 2007 upon the completion of the reorganization. The EIP will continue in effect until all of the common stock available under the EIP is delivered and all restrictions on those shares have lapsed, unless the plan is terminated earlier by the Company’s board of directors. No awards may be granted under the plan on or after 10 years from its effective date. The compensation committee of the board of directors administers the equity incentive plan and determines the non-employee directors, employees and consultants that may be granted awards under the EIP, the size and types of awards, the terms and conditions of awards, the timing of awards and the form and content of the award agreements. In March 2008, in connection with the IPO, the Company granted non-qualified stock options (“options”), restricted stock awards (“RSA’s”) and restricted stock units (“RSUs”) to its employees and non-employee directors. The Company accounted for these awards under the guidance of SFAS 123R, “Share-Based Payment” (“SFAS 123R”). The Company uses the straight-line method of attribution for expensing equity awards. Compensation expense is recorded net of estimated forfeitures. Estimates are adjusted as appropriate.
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Options The options issued during the three months ended March 31, 2008 have an exercise price equal to the Company’s IPO price or $44.00 per share and expire ten years from the date of grant. The options vest in three equal installments on each of the first three anniversaries of the date of grant, subject to earlier vesting in full under certain conditions including death, disability or retirement. The fair value of each stock option was estimated on the date of grant using a Black-Scholes option pricing model. The following table presents the assumptions used in the valuation and resulting fair value per option granted during the three months ended March 31, 2008:
The expected term of options represents the weighted-average period the options are expected to remain outstanding and was based on a set of peer companies who had share based payment awards with terms similar to that of Visa. The expected term of options impacts all underlying assumptions used in the Company’s Black-Scholes option-pricing model, including the period applicable for the risk-free rate of return and expected volatility. The risk-free rate of return assumption is based upon the zero coupon U.S. treasury bond rate over the expected term of the Company’s options. As the Company did not have publicly traded stock historically, the expected volatility was based on the average of the historical and implied volatility of a group of peer companies that management believes is generally comparable to Visa. The expected dividends were based on the Company’s expected annual dividend rate on the date of grant. The following table summarizes the Company’s option activity for the three months ended March 31, 2008:
The weighted-average grant-date fair value per share of options granted during the three months ended March 31, 2008 was $15.30. As of March 31, 2008, there was $130 million of total unrecognized compensation cost related to non-vested options. The cost is expected to be recognized over a weighted average period of approximately 3 years.
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Table of ContentsVISA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Restricted Stock Awards and Restricted Stock Units In fiscal 2007, the Company instituted a special broad-based bonus program (“special bonus”) for all eligible employees to reward performance during the Company’s reorganization. Half of the special bonus was paid through RSA and RSU awards which vest one year after the completion of the IPO and may be subject to earlier vesting under certain conditions including death, disability or retirement. In connection with the IPO, the Company also granted RSA and RSU awards to employees. These awards share the same terms and conditions as awards granted in connection with the special bonus. The RSA and RSU awards granted to the Company’s non-employee directors vest on the first anniversary of the Company’s IPO, subject to earlier vesting in full under certain conditions specified in the award agreement and EIP. Upon vesting, the RSA awards are settled in class A common stock on a one-for-one basis. During the vesting period, RSA award recipients are eligible to receive dividends and participate in the same voting rights as those granted to the holders of the underlying class A common stock. Upon vesting, RSU awards can be settled in Class A common stock on a one-for-one basis or in cash, or a combination thereof at the Company’s option. The Company does not currently intend to settle any RSU awards in cash. During the vesting period, RSU award recipients are eligible to receive dividend equivalents but do not participate in the voting rights as those granted to the holders of the underlying class A common stock. Compensation expense associated with RSA’s and RSU’s issued in connection with the IPO is measured based on the IPO share price or $44.00 per share. Future RSA and RSU awards will be valued using the closing stock price of the Class A common stock price as listed on the New York Stock Exchange on the date of grant. The following table summarizes the Company’s RSA activity for the three months ended March 31, 2008:
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The following table summarizes the Company’s RSU activity for the three months ended March 31, 2008:
At March 31, 2008, there was $44 million and $18 million of total unrecognized compensation cost related to non-vested RSA’s and RSU’s, respectively. The cost is expected to be recognized over a weighted average period of approximately one year. The following table summarizes remaining equity instruments available for grant under the EIP:
The components of share-based compensation expense during the three months ended March 31, 2008 are summarized below:
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Table of ContentsVISA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
The Company recorded its share-based compensation in Personnel on its consolidated statements of operations for the three and six months ended March 31, 2008. The Company did not capitalize any portion of its share-based compensation expense during the three months ended March 31, 2008. Note 13—Related Parties Visa Inc. is a stock corporation and certain of its customers are also its stockholders. The Company considers an entity to be a related party if the entity owns more than 10% of the Company’s total voting common stock or if an officer or employee of the entity also serves on the Company’s board of directors. The Company also considers an investee to be a related party if the Company’s ownership interest in the entity is greater than or equal to 10% or if the investment is accounted for under the equity method of accounting. An affiliate of one of the Company’s customers with an officer who serves on the Company’s board of directors was engaged as one of the Company’s underwriters for the Company’s IPO. This customer was offered and purchased 113 million shares of class A common stock at a price of $42.77 per share, a discount of $1.23 per share based on the IPO price of $44.00 per share. This customer received total underwriter fees from the Company of $139 million during the three months ended March 31, 2008. Note 14—Commitments and Contingencies Stock Redemptions The Company intends to redeem all outstanding shares of class C (series II) common stock in October 2008 at a price of $1.146 billion adjusted for dividends and certain other adjustments and the return to Visa Europe of any subscription receivable outstanding. Visa Europe also has the option to require the Company to redeem all outstanding shares of class C (series II) common stock any time after December 4, 2008. Pursuant to the Amended and Restated Global Restructuring Agreement executed in August 2007, and the Company’s Certificate of Incorporation, the Company is required to redeem 35,263,585 shares of class C (series III) common stock for an aggregate redemption price of $1.5 billion in October 2008. Dividends Dividends may be paid on Visa Inc. common stock when, as, and if declared by the Board of Directors out of amounts available for dividends under applicable law. The declaration and payment of dividends will be at the sole discretion of the Board of Directors after taking into account various factors, including our financial condition, operating results, capital requirements, covenants in our debt instruments and other factors that the Board of Directors deems relevant. The Company intends to pay a quarterly dividend in cash, at an annual rate initially equal to $0.42 per share of class A common stock (representing a quarterly rate initially equal to $0.105 per share) commencing with the quarter ended June 30, 2008. Class B and class C common stock will share ratably on an as-converted basis in such dividends. Any dividends received by the class C (series II) shareholders will reduce the redemption price. Volume and Support Incentives The Company has agreements with customers for various programs designed to build sales volume and increase the acceptance of its payment products. These agreements, with original terms ranging from one to thirteen years, provide card issuance, marketing and program support based on specific performance requirements. These agreements are designed to encourage customer business and to increase overall Visa-
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branded payment volume, thereby reducing unit transaction processing costs and increasing brand awareness for all Visa customers. Payments made and obligations incurred under these programs are included on the Company’s consolidated balance sheets. The Company’s obligation under these customer agreements are generally amortized as a reduction to revenue in the same period as the related revenues are earned, based on management’s estimate of the customer’s performance compared to the terms of the incentive agreement. The agreements may or may not limit the amount of customer incentive payments. The Company entered into new volume and support incentive agreements during the three months ended March 31, 2008, increasing the Company’s total volume and support incentive commitment. Excluding anticipated revenue to be earned from higher payments and transaction volumes in connection with these agreements, the Company’s potential exposure under agreements that limit the incentive payments, coupled with the Company’s estimate for incentive agreements with no limit, is estimated as follows:
The ultimate amounts to be paid under these agreements may be greater than or less than the estimates above. Based on these agreements, increases in the incentive payments are generally driven by increased payment and transaction volume, and as a result, in the event incentive payments exceed this estimate such payments are not expected to have a material negative effect on the Company’s financial condition, results of operations or cash flows. Note 15—Income Taxes Effective Tax Rate The Company’s effective income tax rates for the three months and six months ended March 31, 2008 and 2007 are as follows:
The effective income tax rates for the three months and six months ended March 31, 2008 differ from those of 2007 primarily due to the loss of a California special deduction, the change in state tax apportionment, and a one-time tax benefit attributable to the remeasurement of our deferred taxes. The State of California, where the Company is headquartered, historically has not taxed a substantial portion of the reported income on the basis that the Company operated on a cooperative or mutual basis and therefore was eligible for a special deduction. As a result of the Company’s IPO and consequent ownership by parties other than its financial institution customers, the Company is no longer eligible to claim the special deduction,
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Table of ContentsVISA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
resulting in a tax increase. The tax increase is partially offset by a tax decrease resulting from a change in the Company’s state tax apportionment. In addition, the change in state tax apportionment resulted in an estimated $107 million one-time tax benefit in the current fiscal quarter, due to the remeasurement of the Company’s deferred taxes. The income tax expense differs from the amount of income tax determined by applying the applicable U.S. federal statutory rate of 35% to pretax income, as a result of the following:
FIN 48 On October 1, 2007, the Company adopted FASB Interpretation No. 48 (“FIN 48”), Accounting of Uncertainty in Income Taxes. At the date of adoption, the Company’s total unrecognized tax benefits were approximately $320 million, $247 million of which, if recognized, would affect the effective tax rate. Following adoption of FIN 48, in the three and six months ended March 31, 2008 the Company’s total unrecognized tax benefits increased by $7 million and $19 million, respectively, relating to tax positions taken in the current year. If these unrecognized tax benefits would be recognized, substantially all amounts would impact the Company’s effective tax rate. It is the Company’s policy to account for interest expense and penalties related to uncertain tax position as interest expense and penalties in its statement of operations. At October 1, 2007, the Company had $4 million and $1 million of accrued interest and penalties, respectively, related to uncertain tax positions. For the three months and six months ended March 31, 2008, there were no significant changes in interest and penalties related to uncertain tax positions. The Company is in the advanced stage of negotiating a resolution with the California Franchise Tax Board regarding certain 1990 to 2003 audit issues, which include the eligibility to claim certain items as special deductions, apportionment computation and research and development credits. The Company believes that it is reasonably possible that the unrecognized tax benefits related to these state audit issues could decrease (whether by settlement, release, or a combination of both) in the next 12 months by as much as $62 million ($34 million related to rate benefit and $28 million related to reduction to goodwill). The Company is subject to examination by the Internal Revenue Service and various state and foreign tax authorities. The Company has concluded all U.S. federal income tax matters for years through 2002. All material state and foreign tax matters have been concluded for years through 1989. Note 16—Legal Matters The Company is party to various legal and regulatory proceedings. Some of these proceedings involve complex claims that are subject to substantial uncertainties and unascertainable damages. Accordingly, except as
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disclosed, the Company has not established reserves or ranges of possible loss related to these proceedings, as at this time in the proceedings, the matters do not relate to a probable loss and/or amounts are not reasonably estimable. Although the Company believes that it has strong defenses for the litigation and regulatory proceedings described below, it could in the future incur judgments or fines or enter into settlements of claims that could have a material adverse effect on the Company’s results of operations, financial position, or cash flows. The Company’s litigation provision includes provisions of $292 million and $13 million for the three months ended March 31, 2008 and 2007, respectively, and $292 million and $15 million for the six months ended March 31, 2008 and 2007, respectively. The litigation accrual is an estimate and is based on management’s understanding of its litigation profile, the specifics of each case, advice of counsel to the extent appropriate and management’s best estimate of incurred loss at the balance sheet date. The Company is presently involved in the matters described below and other legal actions, except for those disclosed below as resolved or settled. From time to time we may engage in settlement discussions or mediations with respect to one or more of our outstanding litigation matters, either on our own behalf or collectively with other parties. The Company will continue to review the litigation accrual and, if necessary, future refinements to the accrual will be made. The following table summarizes the activity related to accrued litigation for the six months ended March 31, 2008 and 2007:
Covered Litigation The following table summarizes the activity related to covered litigation matters for the six months ended March 31, 2008 and 2007:
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Table of ContentsVISA INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Set forth below are updates on proceedings previously reported by the Company in its final prospectus, filed with the Securities and Exchange Commission under Rule 424(b)(4) on March 19, 2008, including Visa Inc.’s audited consolidated balance sheet and related footnotes at October 1, 2007, unaudited consolidated financial statements and related footnotes for the three months ended December 31, 2007, and the audited consolidated financial statements and related notes of Visa U.S.A. for the fiscal year ended September 30, 2007. The updates should be read in conjunction with the description in the prospectus. The Discover Litigation On February 15, 2008, Visa U.S.A. and Visa International filed motions for partial summary judgment, challenging aspects of Discover’s damages theory and its debit monopolization claims and asserting that the statute of limitations barred Discover’s suit. Discover also filed a motion for partial summary judgment, renewing its request that the court give collateral estoppel effect to certain findings in the DOJ litigation. Briefing on these motions was complete on April 25, 2008. On April 18, 2008, the district court ordered Visa U.S.A., Visa International, MasterCard, and Discover to confer and stipulate to terms for non-binding mediation of this dispute. The American Express Litigation On March 31, 2008, the initial payment to American Express of $1.13 billion described in the settlement agreement was made by Visa Inc. Of this amount, $945 million was funded through the litigation escrow account established under the Retrospective Responsibility Plan, see Note 5—Retrospective Responsibility Plan, and $185 million was funded by the five co-defendant banks. The Interchange Litigation Kendall. On March 7, 2008, the Ninth Circuit affirmed the district court’s dismissal of the complaint. The court concluded that the plaintiffs had failed to plead facts sufficient to establish a conspiracy, and that no amendment could cure the pleading defect. In doing so, the Ninth Circuit also held that the plaintiffs were “indirect purchasers” of Visa U.S.A. and could not recover antitrust damages for their claims. Multidistrict Litigation Proceedings (MDL). The court entered a revised case management schedule on March 13, 2008, setting deadlines for class certification briefing, expert discovery and dispositive motions and extending fact discovery to October 15, 2008. On May 8, 2008, putative class plaintiffs served on defendants a motion seeking to certify a class of merchants. Once briefing on the class certification issue is complete, all briefs will be filed with the court. Retailers’ Litigation Retailers’ “Opt-Outs” GMRI, Inc. and Visa U.S.A. participated in the binding mediation session in March 2008 and are now negotiating the terms of a settlement agreement. Department of Justice Antitrust Case and Related Litigation
Settlement Service Fee Litigation The Second Circuit Court of Appeals has proposed that oral argument on Visa’s appeal take place the week of June 23, 2008. New Zealand Interchange Proceedings In March 2008, the court set a trial date in October 2009 for this matter. Currency Conversion Litigation On February 14, 2008, the United States Department of Justice filed an objection on behalf of the United States to the settlement. Among other things, the objection states that the United States is not a member of the
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class covered by the settlement. Thus, any claims that the United States may have against Visa or its member banks relating to foreign transactions will not be released by the settlement. On March 31, 2008, the court held a hearing on whether to approve the settlement and enter the Final Judgment and Order of Dismissal. The court took the matter under submission. U.S. Department of Justice Civil Investigative Demands On February 26, 2008, the Division issued a third CID to Visa U.S.A., seeking information regarding a potential violation of the Final Judgment, dated November 26, 2001, in United States v. Visa U.S.A. Inc. et al., 163 F.Supp.2d 322 (S.D.N.Y. 2001). The CID seeks documents, data and narrative responses to several interrogatories and document requests, which focus on alleged termination and waiver provisions in certain agreements between Visa U.S.A. and Visa issuers. Visa U.S.A. is cooperating with the Division in connection with this CID. AAA Antiques Mall On February 1, 2008, Visa U.S.A. filed a motion for summary judgment, or, in the alternative, motion to dismiss all claims brought against it. Intellectual Property Litigation Cryptography Research CRI filed its Third Amended Complaint on March 14, 2008. On March 27, 2008, CRI sought leave to file a supplemental complaint, in which it would add Visa Inc. as an additional defendant to the claims of patent infringement, unfair competition, and antitrust violations that were alleged against Visa International in the Third Amended Complaint. On May 8, 2008 the court granted CRI leave to file the supplemental complaint. Vale Canjeable On March 14, 2008, Visa International filed an extraordinary appeal of the preliminary injunction ruling with the Commercial Chamber of the Supreme Court.
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Forward-Looking Statements This management’s discussion and analysis of historical and pro forma financial condition and results of operations contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements can be identified by the terms “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “should,” “will,” and similar expressions, which are intended to identify forward-looking statements. In addition, any underlying assumptions are forward-looking statements. By their nature, forward-looking statements are not guarantees of future performance or results and are subject to risks, uncertainties and assumptions that are difficult to predict or quantify. Therefore, actual results could differ materially and adversely from these forward-looking statements as a result of a variety of factors, including all the risks discussed in Part I, Item 1A—“Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended September 30, 2007, filed with the SEC on December 21, 2007, and under the heading “Risk Factors” in our final prospectus filed with the Securities and Exchange Commission under Rule 424(b)(4) on March 19, 2008. You are cautioned not to place undue reliance on such statements, which are made only at the date of this report. Unless we are required to do so under U.S. federal securities laws or other applicable laws, we do not intend to update or revise any forward-looking statements. Overview This management’s discussion and analysis provides a review of the results of operations, financial condition and the liquidity and capital resources of Visa Inc. and its subsidiaries (“Visa”) on a historical and pro forma basis and outlines the factors that have affected recent earnings, as well as those factors that may affect future earnings. The following discussion and analysis should be read in conjunction with Visa Inc.’s unaudited consolidated financial statements and related notes included elsewhere in this report. Visa operates the world’s largest retail electronic payments network and manages the world’s most recognized global financial services brand. We provide financial institutions with platforms that encompass consumer credit, debit, prepaid and commercial payments. We facilitate global commerce through the transfer of value and information among financial institutions, merchants, consumers, businesses and government entities. Each of these constituencies has played a key role in the ongoing worldwide migration from paper-based to electronic forms of payment, and we believe that this transformation will continue to yield significant growth opportunities in the electronic payments industry. We will continue to explore additional opportunities to enhance our competitive position by expanding the scope of payment solutions to benefit our existing customers and to position Visa to serve more and different constituencies. In order to respond to industry dynamics and enhance Visa’s ability to compete, Visa consummated a reorganization in October 2007 in which Visa U.S.A., Visa International, Visa Canada and Inovant became direct or indirect subsidiaries of Visa Inc., a Delaware stock corporation. Visa Europe did not become a subsidiary of Visa Inc., but rather remained owned by its member financial institutions and entered into a set of contractual arrangements with Visa Inc. In connection with the reorganization, we issued different classes and series of shares reflecting the different rights and obligations of Visa financial institution members and Visa Europe based on the geographic region in which they are located. To further enhance our competitive position, in March 2008 we successfully completed an IPO and sold 446.6 million shares of class A common stock to the public, raising $19.1 billion in net proceeds. We used $13.4 billion of the net proceeds from the IPO to redeem a portion of the shares of Visa’s financial institution members and as a result Visa is now majority owned by the public. Pursuant to our retrospective responsibility plan, we established an escrow account with $3.0 billion of the net proceeds. Our retrospective responsibility plan is a central component of the reorganization and is designed to address potential liabilities arising from certain
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Table of Contentslitigation that we refer to as covered litigation. Future settlements of, or judgments in, the covered litigation will be payable from the escrow account. Our capital structure was designed to implement a key principle of the retrospective responsibility plan, which is that liability for the covered litigation would remain with the holders of our class B common stock, all of which are members or affiliates of members of Visa U.S.A. See further discussion in Note 5—Retrospective Liability Plan. The remaining net proceeds of $2.7 billion were retained and will be used to fund the redemption of all of the class C (series II) shares and a portion of the class C (series III) shares in October 2008. See Note 1—Organization and Part II, Item 2—“Unregistered Sales of Equity Securities and Use of Proceeds” elsewhere in this report. There is no historical combined statement of operations of Visa Inc. prior to October 1, 2007, because Visa Inc. did not have any operations prior to the reorganization. In order to provide insight into our operating results and trends affecting our business, this management’s discussion and analysis of our operating results includes a comparison of the results of operations for the three and six months ended March 31, 2008, to the pro forma results of operations for the three and six months ended March 31, 2007, as if the reorganization had occurred on October 1, 2006. This pro forma information is derived from our unaudited consolidated financial statements, and presented in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations.” See Note 3—The Reorganization. In addition, this management’s discussion and analysis includes a comparison of our operating results for the three and six months ended March 31, 2008, to the operating results of Visa Inc.’s accounting acquirer, Visa U.S.A., for the three and six months ended March 31, 2007. The following table sets forth our actual and pro forma operating revenues for the periods presented:
Our non-U.S. operating revenues for each of the three and six month periods ended March 31, 2008, represented 39% of total operating revenues. Our non-U.S. operating revenues for the comparable periods in fiscal 2007 represented 33% and 32%, respectively, of our total pro forma operating revenues for those periods. Growth in operating revenues outside of the United States accounted for 66% of the increase in total operating revenues for the three months ended March 31, 2008, compared to the same period in 2007, and 64% of the increase in total operating revenues for the six months ended March 31, 2008, compared to the same period in 2007. As anticipated, during the three months ended March 31, 2008, revenue growth in the United States was impacted by a significant increase in volume and support incentives, which reduce our operating revenue. See additional discussion in “Results of Operations” below. A significant portion of the revenues we earn outside the United States results from cross-border business and leisure travel. Revenues from processing foreign currency transactions for our customers fluctuate with cross-border travel and our customers’ need for transactions to be converted into their base currency. We believe that payments volume and transactions are key drivers of our business. Payments volume is the basis for card service fees and transactions are the basis for data processing fees. Current period card service fees are generated from payments volume on Visa-branded cards for goods and services in the preceding quarter, exclusive of PIN-based debit volume. Payments volume and revenues are impacted by changes in currency rates. Payments volume and revenues increased, reflecting in part the impact of the weaker U.S. dollar, during the three and six months ended December 31, 2007, compared to comparable periods in the prior fiscal year. Payments volume increased 19%, to $681 billion, and 17%, to $1.3 trillion,
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Table of Contentsduring the three and six months ended December 31, 2007, with double-digit growth in all product categories. Growth outside the United States was 29% and 27% during the three and six months ended December 31, 2007. The following tables set forth product payments volumes for the periods presented:
Transactions processed increased by 1.2 billion, or 15%, to 8.8 billion during the three months ended March 31, 2008, from 7.6 billion in the prior year comparable period. Growth in transactions processed in the United States accounted for 943 million transactions, or 82%, of the growth in transactions processed. Transactions processed increased by 2.2 billion, or 14%, to 17.9 billion during the six months ended March 31, 2008, from 15.7 billion in the prior year comparable period. Growth in transactions processed in the United States accounted for 1.8 billion, or 81%, of the growth in transactions processed.
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Table of ContentsThe following table sets forth transaction volumes for the periods presented:
Growth in operating revenues exceeded growth in payments and transactions volumes reflecting the continued impact of new service fees and changes in pricing for various services in regions outside the United States as those regions transition to a business model seeking to increase profitability. While we believe that these pricing changes will generate ongoing benefits, we do not believe that the rates of growth in operating revenues during the three and six months ended March 31, 2008, are representative of sustainable future revenue growth because they include the impacts of the new service fees and pricing changes introduced in the second half of fiscal 2007. We expect future price increases to correlate more closely with innovations in our product line and improvements in our service model. Our business is affected by overall economic conditions and consumer spending patterns. We expect that the impacts of the softening housing market, declining mortgage credit quality, and recent economic trends in the United States will moderate our rate of growth during the remainder of fiscal 2008. Operating income as a percentage of operating revenue, or operating margin, was 24% and 35% for the three and six months ended March 31, 2008, respectively, compared with pro forma operating margin of 33% in each of the prior year comparable periods. The decline in our operating margin during the three months ended March 31, 2008 compared with the prior year comparable period reflects a litigation provision made during the quarter as discussed further in Note 16—Legal Matters. The Reorganization and IPO The reorganization and IPO will impact our business, results of operations and financial condition currently and in future periods in a number of significant ways:
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Results of Operations Operating Revenues and Expenses Operating Revenues Our operating revenues consist of gross operating revenues reduced by payments made to customers and merchants under volume and support incentive arrangements. Gross operating revenues consist of service fees, data processing fees, international transaction fees and other revenues. Our operating revenues are based upon aggregate payments volume reported by our customers or transa | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||