Mastercard Incorporated — Q2 2009 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2009. The interim financial statements are unaudited; the independent accountant performed a review, not an audit. Mastercard operates a global payments network and earns fees primarily from card activity and transaction processing; it does not issue cards or extend credit to cardholders.
Financial results
| Metric | Q2 2009 | Q2 2008 | Six months 2009 | Six months 2008 |
|---|---|---|---|---|
| Net revenue | $1.280bn (+2.7%) | $1.247bn | $2.436bn (+0.3%) | $2.429bn |
| Operating income (loss) | $557m | $(1.233)bn | $1.118bn | $(718)m |
| Net income (loss) attributable to Mastercard | $349m | $(747)m | $716m | $(300)m |
| Diluted EPS | $2.67 | $(5.70) | $5.47 | $(2.28) |
| Operating margin | 43.5% | (98.9)% | 45.9% | (29.5)% |
The sharp year-over-year profit improvement mainly reflects the absence of the $1.649bn litigation-settlement charge recorded in 2008, rather than a comparable increase in revenue. Excluding litigation settlements, operating expenses fell 13.0% in Q2 and 12.0% year to date; adjusted operating margins were 43.6% and 45.9%, respectively.
- Revenue mix: Q2 domestic assessments were $586m (down 2.2%); cross-border volume fees $348m (down 9.4%); transaction processing fees $503m (up 14.6%); and other revenue $187m (down 1.6%). Pricing and transaction growth supported revenue, while weaker volumes and foreign exchange weighed on it.
- Activity: Gross dollar volume in U.S.-dollar terms fell 9.3% in Q2 and 9.5% year to date; on a local-currency basis it fell 0.6% and 0.2%. Processed transactions rose 7.9% in Q2 and 6.9% year to date. The company reported lower average transaction amounts alongside generally rising purchase-transaction counts.
- Costs and other income: Q2 advertising and marketing expense declined 35.8%; general and administrative expense declined 2.9%, despite higher severance costs. Investment income fell, and interest expense increased, partly due to accretion on the American Express settlement liability.
- Cash flow: Six-month operating cash flow was $778m, versus $543m in 2008. Investing activities used $88m; financing activities used $166m. Cash and cash equivalents increased to $2.048bn from $1.505bn at year-end.
- Balance sheet and liquidity: Total assets were $6.984bn and total equity $2.674bn at June 30. Current assets were $4.690bn against current liabilities of $2.982bn. Mastercard reported $2.7bn of cash, cash equivalents and current available-for-sale securities. Short-term debt was nil; long-term debt was $20.6m.
Material changes and unusual items
- Q2 and six-month 2008 results included a $1.649bn American Express litigation-settlement charge. The 2009 periods included only $0.5m of litigation-settlement expense.
- Mastercard recorded $1.4826bn of litigation-settlement liabilities at June 30, including obligations under the American Express and U.S. merchant settlements. It paid $300m under the American Express settlement in the first half of 2009.
- On July 1, 2009, after quarter-end, Mastercard agreed to prepay the remaining $400m under the U.S. Merchant Lawsuit Settlement for $335m on September 30, subject to court approval. The June 30 liability remained classified under the original payment terms.
- The company repaid $164.6m to terminate the Winghaven synthetic-lease financing in March and entered a new capital lease; related bonds and lease obligation were offset on the balance sheet.
- Shareholders’ equity rose from $1.932bn at year-end to $2.674bn, principally reflecting first-half earnings. Mastercard also converted approximately 10.9m Class B shares into Class A shares and sold or transferred them to investors.
Outlook, risks and contingencies
- Outlook: No specific numerical earnings or revenue guidance is provided. Management described long-term growth opportunities in electronic payments, customer penetration, targeted geographies and higher-growth segments. It said it was realigning resources and pursuing cost containment; it expected depreciation and amortization to rise with continued investment in technology and facilities.
- Economic and currency exposure: Recession, reduced consumer spending, lower cross-border travel, customer credit restrictions or consolidation, and pressure for greater customer incentives could constrain growth. A stronger U.S. dollar reduced reported revenue; management cited currency effects of 4.3 percentage points in Q2 and 4.2 points year to date.
- Interchange regulation: The European Commission’s 2007 decision and Mastercard’s 2009 undertakings require, among other terms, weighted-average cross-border consumer interchange fees not exceeding 30 basis points for credit and 20 basis points for debit, effective July 1, 2009. The company also repealed October 2008 pricing changes. The undertakings are interim, and litigation and regulatory challenges continue across multiple jurisdictions.
- Legal exposure: U.S. merchant interchange litigation remained active; plaintiffs’ expert reports alleged damages in the tens of billions of dollars. Mastercard said outcomes and losses could not be estimated and recorded no reserve for these proceedings. The filing warns that adverse legal or regulatory outcomes could materially affect results, liquidity or financial condition.
- Settlement and guarantee risk: Net uncollateralized settlement exposure for Mastercard-branded transactions was $20.670bn, including $166.8m attributable to members deemed non-compliant or under review. The company also guarantees travelers’ cheques; estimated exposure was $416.2m. Management noted that financial-market stress increases the possibility of having to perform under guarantees, although historical losses from customer failures had been low.
- Investment valuation: $187m of auction-rate securities remained illiquid and were valued using a discounted-cash-flow estimate; the recorded temporary impairment was $46.8m. A 100-basis-point increase in the discount rate would have increased impairment by $24m, according to the filing.
- Management said liquidity and capital remained strong and believed operating cash flow, borrowing capacity and capital access would cover operating needs and settlement obligations. It cautioned that adverse legal or regulatory outcomes could impair liquidity or access to capital.
Important facts for investors to verify
- How much of reported earnings improvement reflects the absence of the 2008 settlement charge versus underlying operating performance; compare results excluding litigation items.
- Whether transaction growth and pricing can offset declining dollar volumes, weaker cross-border activity and foreign-exchange headwinds.
- The effect on revenue and customer behavior of the European interchange undertakings and subsequent legal or regulatory decisions.
- Final court approval and completion of the $335m merchant-settlement prepayment, and the timing and amount of remaining litigation payments.
- Changes in uncollateralized settlement exposure, member credit quality, travelers’ cheque guarantees and the valuation or liquidity of auction-rate securities.