Mastercard Incorporated — FY 2014 Form 10-K
Business context and reporting period. This is Mastercard’s annual report for the fiscal year ended December 31, 2014. Mastercard operates a global payments network and earns fees from transaction processing, payment-related services and assessments based primarily on activity on its branded cards and devices. It does not issue cards or earn interchange fees. The filing also reports fourth-quarter results.
Financial results and liquidity
| Metric | FY 2014 | FY 2013 | Change |
|---|---|---|---|
| Net revenue | $9.473 billion | $8.346 billion | +14% |
| Operating income | $5.106 billion | $4.503 billion | +13% |
| Operating margin | 53.9% | 54.0% | Down 0.1 percentage point |
| Net income | $3.617 billion | $3.116 billion | +16% |
| Diluted EPS | $3.10 | $2.56 | +21% |
| Cash flow from operations | $3.407 billion | $4.135 billion | Down $728 million |
- FY 2014 revenue growth reflected increased volume, transactions and other payment-related services, plus acquisitions; acquisitions contributed 2 percentage points to net revenue growth. Processed transactions increased 12%, and GDV grew 13% in local currency (9% translated into U.S. dollars).
- Revenue by category: domestic assessments $3.967 billion (+8%); cross-border volume fees $3.054 billion (+12%); transaction processing fees $4.035 billion (+14%); and other revenues $1.688 billion (+27%). Rebates and incentives, recorded as contra-revenue, rose 11% to $3.271 billion.
- Operating expenses rose 14% to $4.367 billion. Excluding U.S. merchant-litigation provisions in prior years, expenses increased 17% in 2014; acquisitions contributed 6 percentage points to reported expense growth. Fourth-quarter results included an $87 million restructuring charge.
- Fourth-quarter 2014 net revenue was $2.416 billion, operating income $1.018 billion and net income $801 million, compared with $2.126 billion, $920 million and $623 million, respectively, in Q4 2013.
- At year-end, cash and cash equivalents were $5.137 billion and available-for-sale investments were $1.168 billion. Cash, cash equivalents, time deposits and investments totaled approximately $6.4 billion; the company also had a $3.0 billion unused revolving credit facility. Current assets were $10.997 billion and current liabilities $6.222 billion.
- Long-term debt was $1.494 billion, following the 2014 issuance of $500 million of 2.000% notes due 2019 and $1 billion of 3.375% notes due 2024. Mastercard reported no borrowings under its revolving facility at year-end.
- Net cash used in financing was $2.339 billion, including $3.386 billion of share repurchases and $515 million of dividends, partly offset by debt proceeds. The company repurchased 44.5 million shares during 2014.
Material changes, outlook and risks
- Net income growth was supported by higher revenue and a lower effective tax rate (28.8%, versus 30.8% in 2013), partly offset by higher operating expenses. The lower tax rate included a larger foreign-repatriation tax benefit; management also cited a one-time tax gain associated with an intellectual-property transfer as part of a tax and legal-entity reorganization intended to improve cash deployment and provide ongoing tax-rate benefits.
- Cash from operations declined, primarily because of prepaid income taxes associated with the reorganization. The company’s cash held by foreign subsidiaries fell to $2.6 billion from $3.6 billion, and it stated that undistributed foreign earnings were intended to remain permanently reinvested outside the U.S.
- Mastercard acquired eight businesses for total cash consideration of $575 million, principally to expand processing, digital/mobile and loyalty capabilities. The filing does not provide quantified forward revenue or earnings guidance. Management said existing cash, operating cash generation, borrowing capacity and capital-market access should be sufficient for operating needs, investment and potential obligations.
- Key regulatory and legal exposures include interchange-fee regulation and litigation. The European Court of Justice upheld the European Commission’s cross-border interchange decision in September 2014; proposed EU rules included consumer interchange caps and restrictions on certain network rules, with final legislation expected in 2015. U.S. merchant-settlement approval remained under appeal, and opt-out merchant claims continued. Mastercard reported a $771 million accrued liability for the U.S. merchant litigation and related opt-out cases.
- Settlement guarantees are a material contingent liquidity risk: gross settlement exposure was $41.729 billion at year-end, offset by $3.415 billion collateral, leaving $38.314 billion net uncollateralized exposure. The filing says guarantee term and amount are unlimited, although exposure is generally short term.
- Other prominent risks include competitive and pricing pressure, customer concentration (the five largest customers represented about 24% of 2014 net revenue), foreign exchange, cybersecurity and processing disruption, data breaches, and changing regulation. Russia’s requirement to route domestic transactions through a government-owned switch was expected to increase operating costs modestly from 2015.
Important facts for investors to verify
- Track whether EU interchange legislation is enacted as proposed and how it affects fees, customer incentives, transaction volumes and Mastercard’s results.
- Review developments in the U.S. merchant-settlement appeal and opt-out litigation, including whether the $771 million reserve remains adequate.
- Monitor growth in rebates and incentives relative to revenue, and whether transaction and GDV growth translate into sustainable margin expansion.
- Assess the recurring cash-flow impact of the tax reorganization and the degree to which foreign cash is available for U.S. needs.
- Evaluate settlement exposure, collateral coverage and the company’s capacity to withstand multiple customer failures or a major operational/security disruption.