Mastercard Incorporated — Q1 2010 Form 10-Q
Reporting period: Three months ended March 31, 2010. Financial statements are unaudited; the independent accountant performed a review, not an audit. Mastercard provides payment-network, transaction-processing and related services and generally does not issue cards or extend credit to cardholders.
Financial performance
| Metric | Q1 2010 | Q1 2009 | Change |
|---|---|---|---|
| Net revenue | $1.308 billion | $1.156 billion | +13.1% |
| Operating expenses | $608 million | $595 million | +2.2% |
| Operating income | $700 million | $561 million | +24.6% |
| Operating margin | 53.5% | 48.6% | +4.9 percentage points |
| Net income attributable to Mastercard | $455 million | $367 million | +23.8% |
| Diluted EPS | $3.46 | $2.80 | +23.6% |
| Operating cash flow | $95 million | $416 million | Down $321 million |
Net revenue growth reflected higher activity, pricing and favorable foreign exchange. Gross dollar volume was $631 billion, up 14.8% in U.S.-dollar terms and 8.3% in local-currency terms; processed transactions increased 4.6% to 5.373 billion. Cross-border volume fees rose 39.0%, transaction-processing fees 16.7%, and domestic assessments 6.1%.
Pricing actions contributed approximately 5 percentage points to net revenue growth; favorable currency translation contributed about 2.9 percentage points. Rebates and incentives rose 30.7% to $440 million and increased from 22.6% to 25.2% of gross revenue, partly offsetting gross growth. The filing attributes slower transaction growth in part to debit portfolio losses.
Cash flow, balance sheet and liquidity
- Cash and cash equivalents were $2.119 billion at March 31, 2010; cash plus current available-for-sale securities totaled approximately $3.0 billion. Total assets were $7.286 billion, equity $3.832 billion and current liabilities $2.822 billion.
- Operating cash flow was $95 million, down from $416 million. The company cites litigation payments, lower accrued expenses and stock units withheld for taxes as significant factors. Investing activities used $23 million; financing activities provided $77 million, including a $91 million tax benefit for share-based compensation. Cash ended the quarter at $2.119 billion.
- Reported long-term debt was $21 million. The company had no borrowings under its $2.5 billion revolving credit facility at quarter-end and reported compliance with its covenants. The facility was scheduled to decrease to $2.0 billion after April 27, 2010.
- Litigation-settlement liabilities were $731 million at quarter-end. Future obligations listed total $1.398 billion, including $759 million of settlement payments; five quarterly American Express settlement payments of up to $150 million remained.
- The company declared a $0.15-per-share quarterly dividend, totaling approximately $20 million. Management said cash, operating cash generation and borrowing capacity were sufficient for expected operating needs and settlement obligations.
Material changes and unusual items
- Net income increased 23.8%, while operating cash flow fell substantially year over year. A $122 million cash-flow adjustment for stock units withheld for taxes, versus $7 million in the prior-year quarter, was a notable factor.
- Interest expense declined to $15 million from $36 million, primarily because accretion on litigation settlements decreased as payments were made. Investment income declined to $10 million from $17 million, principally due to lower interest rates.
- Other comprehensive loss was $106 million, mainly from $105 million of foreign-currency translation losses; this reduced accumulated other comprehensive income to $88 million from $194 million at year-end.
- The $172 million auction-rate securities portfolio remained illiquid and was valued using Level 3 assumptions at a 15% discount to par. Management considered the unrealized loss liquidity-related rather than credit-related and did not deem it other-than-temporary. A 100-basis-point increase in the discount rate would have increased estimated impairment by $18 million at quarter-end.
- In February, the board authorized Class B share-conversion programs expected to begin after May 31, 2010. The filing does not provide a numerical earnings or share-count impact.
Outlook, commentary and principal risks
No specific numerical earnings or revenue guidance is provided. Management described the longer-term shift from cash and checks to electronic payments as an opportunity and outlined priorities including deeper customer penetration, geographic and segment expansion, processing opportunities, e-commerce, payment innovation and brand investment. It noted some improving U.S. indicators but said the pace and extent of economic recovery remained uncertain. Depreciation and amortization was expected to increase as the company continued investing in equipment, software and facilities.
Key risks include consumer-spending and cross-border travel weakness, foreign-exchange movements, customer financial distress or consolidation, reduced card issuance or marketing, and regulatory intervention affecting interchange fees or network rules. The company also warns that adverse legal outcomes could materially affect results, cash flows and financial condition.
- Litigation and regulation: U.S. merchant interchange litigation seeks treble damages and injunctive relief; plaintiffs’ expert reports alleged damages in the tens of billions of dollars. Class-certification and other motions remained pending, and no trial date was set. The company said the outcome and liability could not be estimated and had not recorded a provision for these claims.
- European interchange: Mastercard appealed the European Commission’s 2007 decision. Under undertakings, effective July 2009, weighted-average cross-border consumer interchange fees were capped at 30 basis points for credit and 20 basis points for debit. Noncompliance or an adverse outcome could lead to fines, private claims or business impacts.
- Settlement guarantees: Gross MasterCard-branded settlement exposure was $25.669 billion, with $3.444 billion of collateral and $22.225 billion net uncollateralized exposure; $195 million related to members deemed non-compliant or under review. These are guarantee exposures, not reported debt. Mastercard also estimated $378 million of travelers-cheque guarantee exposure, substantially covered by third-party guarantees.
- Other proceedings: Appeals and investigations remained active in several jurisdictions, including Poland, Hungary, Italy, the U.K. and Australia. Management said potential effects in some matters could be significant but generally could not estimate outcomes or liabilities.
Investor verification points
- Check whether revenue growth persists after separating pricing and currency effects from underlying volume and transaction growth, and track the rising rebates-and-incentives burden.
- Assess why operating cash flow lagged earnings, including settlement payments, accrued-liability movements and share-based tax withholding.
- Monitor U.S. interchange litigation and European regulatory proceedings for rulings, settlements, fines or changes to pricing and network rules.
- Review the liquidity assumptions and valuation sensitivity of the illiquid auction-rate securities portfolio.
- Track customer settlement risk, collateral coverage, travelers-cheque guarantees and the timing of remaining litigation payments.
- Consider that the quarter’s results may not indicate full-year performance; the filing cites seasonality and other factors.