Mastercard Incorporated — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; balance-sheet comparisons are with December 31, 2013. The interim financial statements are unaudited and were reviewed, not audited, by the independent accountant.
Business context
Mastercard operates a global payments network, processing authorization, clearing and settlement and providing related payment services. It does not issue cards or extend credit. Revenue principally comes from fees tied to payment volumes, transaction counts and related services.
Financial performance and liquidity
| Metric | Q1 2014 | Q1 2013 / prior balance date |
|---|---|---|
| Net revenue | $2.177 billion | $1.906 billion |
| Operating income / margin | $1.285 billion / 59.0% | $1.107 billion / 58.1% |
| Net income | $870 million | $766 million |
| Diluted EPS | $0.73 | $0.62 |
| Operating cash flow | $568 million | $872 million |
| Cash and cash equivalents | $4.019 billion | $3.599 billion |
| Available-for-sale securities | $2.543 billion | $2.696 billion |
| Long-term debt | $1.494 billion | None |
| Total equity | $6.578 billion | $7.495 billion |
- Net revenue rose 14%; gross revenue increased 14% to $2.910 billion, while rebates and incentives rose 12% to $733 million.
- Revenue drivers included cross-border volume fees of $695 million (+18%), transaction processing fees of $936 million (+14%), domestic assessments of $938 million (+7%), and other revenue of $341 million (+22%).
- Local-currency gross dollar volume and processed transactions each grew 14%. Cross-border volume grew 17%.
- Operating expenses increased 12% to $892 million, slower than revenue growth. General and administrative expense rose 10%, advertising and marketing 15%, and depreciation and amortization 19%.
- Effective tax rate was 32.0%, versus 30.5%, primarily due to a less favorable geographic mix of taxable earnings.
- Operating cash flow fell to $568 million, mainly reflecting changes in customer settlement balances; 2013 operating cash flow benefited from collection of income-tax receivables. Investing activities provided $130 million, while financing activities used $279 million.
- Cash, cash equivalents and available-for-sale securities totaled $6.6 billion, excluding restricted litigation cash. The company also had an undrawn $3.0 billion revolving credit facility.
- Current assets were $11.342 billion and current liabilities $5.994 billion. Liquidity includes settlement-related balances and restricted customer deposits; the filing states that available resources and borrowing capacity are expected to meet operating and other needs.
Material changes and capital allocation
- In March, Mastercard issued $500 million of 2.000% notes due 2019 and $1.0 billion of 3.375% notes due 2024; net proceeds were $1.484 billion. The notes have no financial covenants. No revolving-facility borrowings were outstanding.
- The company repurchased 21.3 million shares for $1.669 billion during the quarter, at an average $78.20 per share. Approximately $1.992 billion remained under the authorization at March 31; by April 24, approximately $1.5 billion remained.
- Cash dividends paid were $131 million; a quarterly dividend of $0.11 per share was declared for payment in May.
- Two businesses were acquired for aggregate consideration of $224 million, primarily in cash. The filing says their pro forma impact was not material.
Outlook, risks and contingencies
- No specific earnings or revenue guidance is provided. Management describes continued priorities of growing core payments, expanding into new markets and payment uses, and developing digital, analytics, loyalty and security services.
- Management cites uncertain global economic conditions, customer and merchant concentration, foreign-exchange movements, competition, cyber and operational threats, and regulatory change as risks. U.S. revenue represented 40% of total revenue in the quarter. A hypothetical 10% adverse currency move could produce an estimated $216 million fair-value loss on outstanding currency derivatives.
- Interchange-related litigation and regulation remain significant uncertainties. Mastercard had accrued $799 million for the U.S. merchant class litigation and filed or anticipated opt-out cases; the filing says the opt-out accrual is not an estimate of ultimate litigation exposure. Accrued litigation on the balance sheet was $859 million, including a separate $60 million timing-related item.
- The U.S. merchant settlement was approved in December 2013 but appealed by objectors; merchants representing slightly more than 25% of relevant Mastercard and Visa purchase volume opted out, and more than 30 related complaints had been filed. The company states it cannot estimate potential liability if these matters proceed to final judgment.
- The European Court of Justice was expected to decide in 2014 on Mastercard’s appeal of the European Commission’s cross-border interchange decision. A non-binding Advocate General opinion recommended rejecting the appeal. Proposed EU legislation would cap interchange fees and alter certain network rules, but remained subject to further debate and possible amendment.
- Other proceedings include U.K. merchant claims alleging damages exceeding $2 billion, Canadian merchant class actions, and regulatory inquiries in multiple jurisdictions. Outcomes and potential losses are generally uncertain and may adversely affect business practices, revenue, costs or cash flows.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether transaction and volume growth continues and translates into revenue growth after rebates and incentives.
- Whether operating cash flow recovers, given its decline and the impact of settlement-balance movements.
- Developments in U.S. opt-out merchant litigation, appeals of the class settlement and the adequacy of related reserves.
- Final EU interchange legislation and the outcome of the European Court of Justice appeal, including potential effects on fees and customer behavior.
- Cash deployment, remaining repurchase authorization, debt costs and the balance of foreign-held liquidity relative to potential U.S. funding needs.