Mastercard Incorporated — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Financial statements are unaudited; the independent accountant performed a review, not an audit.
Business context
Mastercard operates a global payments network, processing transactions and providing related services. It earns fees from issuers and acquirers, largely based on payment volume and transaction activity; it does not issue cards or extend credit to cardholders.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net revenue | $2.377bn | $2.096bn | $4.554bn | $4.002bn |
| Operating income | $1.383bn | $1.228bn | $2.668bn | $2.335bn |
| Operating margin | 58.2% | 58.6% | 58.6% | 58.4% |
| Net income | $931m | $848m | $1.801bn | $1.614bn |
| Diluted EPS | $0.80 | $0.70 | $1.53 | $1.32 |
- Q2 net revenue rose 13%; gross revenue increased 14%, partly offset by rebates and incentives, which rose 17%. Six-month net revenue rose 14%.
- Q2 local-currency gross dollar volume grew 13% and processed transactions grew 12%; for the six-month period they increased 13% each.
- Operating expenses rose 15% in Q2 and 13% for the half, mainly due to higher general and administrative expense. Q2 G&A increased 20%, including higher personnel costs; depreciation and amortization rose 30%.
- Effective tax rates increased to 32.2% in Q2 and 32.1% for the half, primarily due to a less favorable geographic mix of taxable earnings.
- Six-month operating cash flow was $1.297bn, down from $1.614bn. Investing cash outflow was $432m, including business acquisitions; financing cash outflow was $1.585bn.
Balance sheet, debt and liquidity
- At June 30, cash and cash equivalents were $2.878bn and available-for-sale investments were $2.836bn. The company reported $5.7bn of cash, cash equivalents and available-for-sale securities, excluding restricted litigation cash.
- Long-term debt was $1.494bn, versus none at year-end 2013. In March, Mastercard issued $500m of 2.000% notes due 2019 and $1bn of 3.375% notes due 2024. It had no borrowings on its $3bn revolving credit facility.
- Management said existing liquidity, cash generation, borrowing capacity and capital-market access were sufficient for anticipated operating needs and obligations.
- Mastercard repurchased $2.827bn of shares in the first half and paid $260m in dividends. Equity declined to $6.314bn from $7.495bn at year-end, principally reflecting repurchases and dividends, partly offset by earnings.
Changes, outlook and material risks
- Growth and mix: Revenue grew across all reported categories. Q2 cross-border volume fees rose 14%, transaction processing fees 15%, and other revenues 24%. Currency translation reduced reported volume growth versus local-currency growth.
- Acquisitions: The company acquired five businesses during the first half for total consideration of $389m; preliminary goodwill recorded was $377m. Pro forma results were not presented because management considered the effect immaterial.
- Litigation: Mastercard had accrued $799m for U.S. merchant litigation and filed or anticipated opt-out cases; the company said the opt-out portion was not an estimate of the ultimate loss and that potential liability could not be estimated. The class settlement remained subject to appeal, and the court denied a motion to dismiss opt-out complaints in July 2014. Restricted cash for the settlement was $540m.
- Regulatory matters: A European Court of Justice decision on the company’s appeal of the European Commission interchange-fee decision was expected in September 2014. The filing describes potential damages, fines, business-practice changes and effects on customer activity across multiple jurisdictions; many outcomes and losses could not be estimated.
- Settlement exposure: Estimated gross settlement exposure was $40.881bn, with $3.486bn collateral and $37.395bn net uncollateralized exposure. The guarantee is generally short-term, but losses could rise if customers fail, particularly amid adverse economic or political conditions.
- Other risks: Competition and pricing pressure, customer concentration, economic weakness, foreign-exchange movements, cybersecurity and service disruption, and regulatory changes could affect results. A hypothetical 10% adverse currency move could cause an estimated $206m fair-value loss on outstanding foreign-exchange derivatives.
- Guidance: The filing provides no quantified financial guidance. Management described strategic priorities including growing core payment products, expanding into new markets and payment use cases, and developing digital, analytics, loyalty and fraud solutions.
Important facts for investors to verify
- Developments in U.S. merchant litigation, settlement appeals and opt-out cases, including whether the $799m accrual remains adequate.
- European and other regulatory decisions on interchange fees, and any resulting effects on pricing, customer agreements, transaction volumes or revenue.
- Whether revenue and transaction growth can continue to outpace expense growth, especially personnel, acquisition-related amortization and strategic investment costs.
- Cash generation and liquidity after substantial repurchases, acquisitions and the addition of long-term debt; note that a significant share of liquidity was held by foreign subsidiaries.
- Trends in settlement guarantee exposure, customer collateral and counterparty risk, as well as cybersecurity and foreign-exchange exposures.