Mastercard Incorporated — Q3 2009 Form 10-Q
Reporting period: Three and nine months ended September 30, 2009. Financial statement amounts below are in millions of U.S. dollars unless otherwise noted. Mastercard provides payment-network processing and related services; it does not issue cards or extend credit to cardholders.
Financial performance and position
| Metric | Q3 2009 | Q3 2008 | Nine months 2009 | Nine months 2008 |
|---|---|---|---|---|
| Net revenue | $1,364 | $1,338 | $3,800 | $3,767 |
| Operating income (loss) | $674 | ($279) | $1,792 | ($997) |
| Net income (loss) attributable to Mastercard | $452 | ($194) | $1,169 | ($493) |
| Diluted EPS | $3.45 | ($1.48) | $8.92 | ($3.76) |
| Operating margin, reported | 49.4% | (20.9%) | 47.2% | (26.5%) |
- Net revenue rose 2.0% in Q3 and 0.9% year to date. Transaction processing fees increased 16.4% and 12.9%, respectively, while cross-border volume fees declined 9.6% and 10.1%.
- Gross dollar volume declined 4.7% in Q3 and 7.9% year to date on a U.S.-dollar-converted basis; on a local-currency basis it rose 0.3% in Q3 and declined 0.1% year to date. Processed transactions increased 7.6% and 7.0%, respectively.
- Reported operating expenses fell 57.3% in Q3 and 57.8% year to date, largely because 2008 included major litigation charges. Excluding litigation settlement expenses, operating expenses declined 13.3% and 12.5%, respectively. Management reported adjusted operating margins of 49.8% in Q3 and 47.3% year to date, versus 41.0% and 39.3% in 2008.
- Cash from operating activities was $1,094 for the nine months, compared with $931 in 2008. Investing activities used $140; financing activities used $175. Cash and cash equivalents were $2,316 at September 30, 2009.
- Current assets were $4,753 and current liabilities $2,791. Mastercard reported $2.9 billion of cash and current available-for-sale securities and $3.2 billion of equity. Short-term debt was zero; long-term debt was $22.
- Litigation settlement liabilities totaled $1,010, including $614 current and $396 long term. Future litigation settlement payments were scheduled at approximately $1,064. Total future obligations listed for leases, sponsorships and other commitments, settlements, and debt were $1,767.
Changes versus the prior comparable period
- The return to substantial profit chiefly reflects the absence of 2008’s Discover and American Express settlement charges, rather than a comparable increase in revenue. Litigation settlement expense was $6 in Q3 and $7 year to date in 2009, versus $828 and $2,477 in 2008.
- Pricing and transaction growth supported revenue, but weaker spending volumes and unfavorable foreign exchange weighed on results. The stronger U.S. dollar reduced reported revenue growth by 1.9 percentage points in Q3 and 3.5 points year to date.
- Cost controls reduced general and administrative and advertising expenses, although depreciation and amortization rose with investment in technology and facilities. Severance costs were $31 in Q3 and $101 year to date, as Mastercard realigned resources.
- Operating cash flow increased year over year, while cash rose to $2,316 from $1,505 at December 31, 2008. The company repaid $149 of debt during the period.
Outlook, risks and unusual items
- No quantified full-year revenue or earnings guidance is provided. Management cited continued opportunities from the shift to electronic payments and plans to expand in targeted geographies and higher-growth payment segments. It expected rebates and incentives to be significantly higher in Q4 2009 than a year earlier, and marketing activity to increase during the remainder of 2009. Depreciation and amortization was expected to rise with ongoing investment.
- Management described the global economic downturn as a risk to spending, cross-border travel, card issuance, customer pricing and incentives, and customer settlement capacity. The United States represented 46.5% of Q3 revenue and 47.9% year-to-date revenue.
- Competition and regulation of interchange fees remain significant risks. In Europe, Mastercard undertook to set cross-border consumer interchange fees with weighted averages no higher than 30 basis points for credit and 20 basis points for debit, among other commitments, pending the EU court decision. Regulatory or legal proceedings were also disclosed in the U.S., U.K., Australia, Hungary, Italy and other jurisdictions. Mastercard recorded a roughly $2.6 million Hungarian fine and intended to appeal.
- Settlement exposure net of collateral was $20.9 billion, with $335 million attributable to members deemed non-compliant or under review, up from $57 million at year-end 2008. The filing notes heightened risk from customer financial-sector distress, while reporting no settlement losses in recent years.
- Auction-rate securities remained illiquid: $231 million par value was carried at $196 million fair value, with a $34.7 million unrealized loss. Management did not consider the loss other-than-temporary and expected to hold the securities until recovery; valuation depends on significant unobservable inputs.
- Mastercard prepaid $335 million to settle $400 million of remaining U.S. merchant litigation payments, recording a $14 million gain. American Express settlement payments continued; the related obligation depends partly on American Express billings.
- The company stated that liquidity and capital were sufficient for operating needs and settlement obligations. Moody’s assigned A3/P-2 ratings with stable outlook; S&P assigned BBB+/A-2 ratings with stable outlook. Management reported effective disclosure controls, and the independent accountant’s interim review was not an audit.
Important facts for investors to verify
- How much of reported earnings improvement reflects the absence of 2008 litigation charges, and how sustainable are revenue growth and expense savings?
- Whether transaction growth can offset continued weakness in dollar volumes, cross-border activity and foreign-exchange effects.
- The development and cash-flow timing of the American Express settlement, remaining merchant settlement obligations, and other legal or regulatory cases.
- Whether the elevated uncollateralized exposure to non-compliant members and broader customer financial-sector risks lead to losses or additional collateral needs.
- The eventual liquidity and recoverability of auction-rate securities, given their long maturities and Level 3 valuation assumptions.
- The effect of higher expected incentives and marketing spending, and continued investment-related depreciation, on future margins.