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MASTERCARD INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis supplements management's discussion and analysis of MasterCard Incorporated for the year ended December 31, 2013 as contained in the Company's Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission on February 14, 2014. It also should be read in conjunction with the consolidated financial statements and notes of MasterCard Incorporated and its consolidated subsidiaries, including MasterCard International Incorporated ("MasterCard International") (together, "MasterCard" or the "Company"), included elsewhere in this Report. Certain prior period amounts have been reclassified to conform to the 2014 presentation. Percentage changes provided throughout "Management's Discussion and Analysis of Financial Condition and Results of Operations" were calculated on amounts rounded to the nearest thousand. Overview MasterCard is a technology company in the global payments industry that connects consumers, financial institutions, merchants, governments and businesses worldwide, enabling them to use electronic forms of payment instead of cash and checks. As the operator of the world's fastest payments network, we facilitate the processing of payment transactions, including authorization, clearing and settlement, and deliver related products and services. We make payments easier and more efficient by creating a wide range of payment solutions and services using our family of well-known brands, including MasterCard®, Maestro® and Cirrus®. We also provide value-added offerings such as loyalty and reward programs, information services and consulting. Our network is designed to ensure safety and security for the global payments system. A typical transaction on our network involves four participants in addition to us: cardholder, merchant, issuer (the cardholder's financial institution) and acquirer (the merchant's financial institution). We do not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to cardholders by issuers, or establish the "merchant discount" rate charged in connection with the acceptance of cards and other payment devices that carry our brands. In most cases, cardholder relationships belong to, and are managed by, our financial institution customers. Our ability to grow is influenced by personal consumption expenditure growth, driving paper-based forms of payment toward electronic forms of payment and increasing our share in electronic payments and providing other value-added products and services. We continue to drive growth by: • Growing our core businesses globally, both as to our products - credit, debit, prepaid and commercial - and increasing the number of payment transactions we process; • Diversifying our business by seeking new areas of growth in markets around the world by focusing on: • Existing and new markets; • Encouraging consumers and businesses to use MasterCard products for new payment areas, such as transit, parking, person-to-person transfers and paying bills; • Small merchants and merchants who have not historically accepted MasterCard products; and • Financial inclusion for the unbanked and underbanked; and • Building our business by: • Taking advantage of the opportunities presented by the ongoing convergence of the physical and digital worlds; and • Using our data analytics, loyalty solutions and fraudprotection and detection services to add value. Our technology, expertise and data make payments safe, simple and fast. We work with merchants to help them enable new sales channels, create better purchase experiences, increase revenues and fight fraud. We help national, state and local governments drive increased financial inclusion and efficiency, reduce costs, increase transparency to reduce crime and corruption and advance social programs. For consumers, we provide better, safer and more convenient ways to pay. We provide financial institutions with solutions to help them increase revenue and increase preference for their MasterCard-branded products. We generate revenue by charging fees to issuers and acquirers for providing transaction processing and other payment-related products and services, as well as by assessing these customers based, primarily, on the dollar volume of activity, or gross dollar volume ("GDV"), on the cards and other devices that carry our brands. 24-------------------------------------------------------------------------------- Table of Contents See "-Business Environment" for a discussion of considerations related to our long-term strategic objectives. We recorded net income of $931 million, or $0.80 per diluted share, and $1.8 billion, or $1.53 per diluted share, for the three and six months ended June 30, 2014, respectively, versus net income of $848 million, or $0.70 per diluted share, and $1.6 billion, or $1.32 per diluted share, for the three and six months ended June 30, 2013, respectively. Our net revenue increased 13% and 14% for the three and six months ended June 30, 2014, respectively, versus the comparable periods in 2013, driven by increases across our revenue categories, partially offset by higher rebates and incentives. For the three and six months ended June 30, 2014, our processed transactions increased 12% and 13%, respectively, versus the comparable periods in 2013. Our volumes also increased 13% for the three and six months ended June 30, 2014, on a local currency basis, versus the comparable periods in 2013. Rebates and incentives as a percentage of gross revenue were 24% for the three months ended June 30, 2014 and 2013 and 25% for the six months ended June 30, 2014 and 2013, respectively. Operating expenses increased 15% and 13% for the three and six months ended June 30, 2014, respectively, versus the comparable periods in 2013, primarily due to higher general and administrative expenses. We generated net cash flows from operations of $1.3 billion for the six months ended June 30, 2014, compared to $1.6 billion for the comparable period in 2013. The following table provides a summary of our operating results for the three and six months ended June 30, 2014 and 2013: Three Months Ended Percent Six Months Ended Percent June 30, Increase June 30, Increase 2014 2013 (Decrease) 2014 2013 (Decrease) (in millions, except per share data and percentages) Net revenue $ 2,377 $ 2,096 13% $ 4,554 $ 4,002 14% Operating expenses 994 868 15% 1,886 1,667 13% Operating income 1,383 1,228 13% 2,668 2,335 14% Operating margin 58.2 % 58.6 % ** 58.6 % 58.4 % ** Income tax expense 442 385 15% 853 721 18% Effective income tax rate 32.2 % 31.2 % ** 32.1 % 30.9 % ** Net income $ 931 $ 848 10% $ 1,801 $ 1,614 12% Diluted earnings per share $ 0.80 $ 0.70 14% $ 1.53 $ 1.32 16% Diluted weighted-average shares outstanding 1,169 1,217 (4)% 1,179 1,223 (4)% ** Not meaningful Business Environment We process transactions from more than 210 countries and territories and in more than 150 currencies. Net revenue generated in the United States was 39% and 41% of total revenue for the three months ended June 30, 2014 and 2013, respectively, and 39% and 40% for the six months ended June 30, 2014 and 2013, respectively. No individual country, other than the United States, generated more than 10% of total revenue in any such period, but differences in market growth, economic health and foreign exchange fluctuations in certain countries can have an impact on the proportion of revenue generated outside the United States over time. While the global nature of our business helps protect our operating results from adverse economic conditions in a single or a few countries, the significant concentration of our revenue generated in the United States makes our business particularly susceptible to adverse economic conditions in the United States. The competitive and evolving nature of the global payments industry provides both challenges to and opportunities for the continued growth of our business. Adverse economic events (including continued distress in the credit environment, continued equity market volatility and additional government intervention) have impacted the financial markets around the world. The economies of the United States and numerous countries around the world have been significantly impacted by this economic turmoil. Countries have experienced credit ratings actions by ratings agencies, including several in Europe as well as the United States. In addition, some existing customers have been placed in receivership or administration or have a significant amount of their stock owned by 25-------------------------------------------------------------------------------- Table of Contents their governments. Many financial institutions are facing increased regulatory and governmental influence, including potential further changes in laws and regulations. Many of our financial institution customers, merchants that accept our brands and cardholders who use our brands have been directly and adversely impacted. MasterCard's financial results may be negatively impacted by actions taken by individual financial institutions or by governmental or regulatory bodies. In addition, further political instability or a decline in economic conditions in the countries in which the Company operates may accelerate the timing of or increase the impact of risks to our financial performance. As a result, our revenue may be negatively impacted, or the Company may be impacted in several ways. MasterCard continues to monitor political and economic conditions around the world to identify opportunities for the continued growth of our business and to evaluate the evolution of the global payments industry. The extent and pace of economic recovery in various regions remains uncertain and the overall business environment may present challenges for MasterCard to grow its business. For further discussion see, "Risk Factors - Business Risks" in Part I, Item 1A of the Company's Annual Report on Form 10-K for the year ended December 31, 2013. In addition, our business and our customers' businesses are subject to regulation in many countries. Regulatory bodies may seek to impose rules and price controls on certain aspects of our business and the payments industry. For further discussion, see Note 12 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part I, Item 1 and our risk factors in "Risk Factors - Legal and Regulatory Risks" in Part I, Item 1A (Risk Factors) of the Company's Annual Report on Form 10-K for the year ended December 31, 2013 and in Part II, Item 1A (Risk Factors) of this Report. Further, information security risks for global payments and technology companies such as MasterCard have significantly increased in recent years. Although to date we have not experienced any material impacts relating to cyber-attacks or other information security breaches, there can be no assurance that we will be immune to these risks and not suffer such losses in the future. See our risk factor in "Risk Factors - Business Risks" in Part I, Item 1A of the Company's Annual Report on Form 10-K for the year ended December 31, 2013 related to a failure or breach of our security systems or infrastructure as a result of cyber-attacks. Impact of Foreign Currency Rates Our overall operating results can be impacted by changes in foreign currency exchange rates, especially the strengthening or weakening of the U.S. dollar versus the euro and Brazilian real. The functional currency of MasterCard Europe, our principal European operating subsidiary, is the euro, and the functional currency of our Brazilian subsidiary is the Brazilian real. Accordingly, the strengthening or weakening of the U.S. dollar versus the euro and Brazilian real impacts the translation of our European and Brazilian subsidiaries' operating results into the U.S. dollar. For the three and six months ended June 30, 2014, as compared to the same periods in 2013, the U.S. dollar strengthened against the Brazilian real but weakened against the euro. The net foreign currency impact of changes in the U.S. dollar average exchange rates against the euro and Brazilian real increased net revenue and operating expenses by approximately 1 percentage point for the three and six months ended June 30, 2014. In addition, changes in foreign currency exchange rates directly impact the calculation of gross dollar volume ("GDV") and gross euro volume ("GEV"), which are used in the calculation of our domestic assessments, cross-border volume fees and volume-related rebates and incentives. In most non-European regions, GDV is calculated based on local currency spending volume converted to U.S. dollars using average exchange rates for the period. In Europe, GEV is calculated based on local currency spending volume converted to euros using average exchange rates for the period. As a result, our domestic assessments, cross-border volume fees and volume-related rebates and incentives are impacted by the strengthening or weakening of the U.S. dollar versus primarily non-European local currencies and the strengthening or weakening of the euro versus primarily European local currencies. The strengthening or weakening of the U.S. dollar is evident when GDV growth on a U.S. dollar-converted basis is compared to GDV growth on a local currency basis. For the three and six months ended June 30, 2014, as compared to the same periods in 2013, GDV on a U.S. dollar converted basis increased 11% while GDV grew on a local currency basis 13%. The Company attempts to limit the impact from these foreign currency exposures through its foreign exchange risk management activities, which are discussed further in Note 14 (Foreign Exchange Risk Management) to the consolidated financial statements included in Part I, Item 1 of this Report. The Company generates revenue and has financial assets in countries at risk for currency devaluation. While these revenues and financial assets are not material to MasterCard on a consolidated basis, they could be negatively impacted if a devaluation of local currencies occurs relative to the U.S. dollar. Revenue Revenue Description MasterCard's business model involves four participants in addition to us: cardholders, merchants, issuers (the cardholders' financial institutions) and acquirers (the merchants' financial institutions). Our gross revenue is generated by assessing our customers based 26-------------------------------------------------------------------------------- Table of Contents primarily on the dollar volume of activity on the cards and other devices that carry our brands and from the fees that we charge our customers for providing transaction processing and other payment-related products and services. Our revenue is based upon transactional information accumulated by our systems or reported by our customers. Our primary revenue billing currencies are the U.S. dollar, euro and Brazilian real. The price structure for our products and services is complex and is dependent on the nature of volumes, types of transactions and type of products and services we offer to our customers. Our net revenue can be significantly impacted by the following: • Domestic or cross-border transactions; • Signature-based or PIN-based transactions; • Geographic region or country the transaction occurs in; • Volumes/transactions subject to tiered rates; • Processed or not processed by MasterCard; • Amount of usage of our other products or services; and • Amount of rebates and incentives provided to customers. The Company classifies its net revenue into the following five categories: 1. Domestic assessments: Domestic assessments are fees charged to issuers and acquirers based primarily on the dollar volume of activity on cards and other devices that carry our brands where the merchant country and the issuer country are the same. Domestic assessments include items such as card assessments, which are fees charged on the number of cards issued or assessments for specific purposes, such as acceptance development or market development programs. 2. Cross-border volume fees: Cross-border volume fees are charged to issuers and acquirers based on the volume of activity on cards and other devices that carry our brands where the merchant country and the issuer country are different. In general, a cross-border transaction generates higher revenue than a domestic transaction since cross-border fees are higher than domestic fees, and in most cases also include fees for currency conversion. 3. Transaction processing fees: Transaction processing fees are charged for both domestic and cross-border transactions and are primarily based on the number of transactions. Transaction processing fees include charges to issuers for the following: • Transaction Switching fees for the following services: • Authorization is the process by which a transaction is routed to the issuer for approval. In certain circumstances such as when the issuer's systems are unavailable or cannot be contacted, MasterCard or others on behalf of the issuer approve in accordance with either the issuer'sinstructions or applicable rules (also known as "stand-in"). • Clearing is the exchange of financial transaction information between issuers and acquirers after a transaction has been successfully conducted at the point of interaction. MasterCard clears transactions among customers through our central and regional processing systems. • Settlement is facilitating the exchange of funds between parties. • Connectivity fees are charged to issuers and acquirers for network access, equipment and the transmission of authorization and settlement messages. These fees are based on the size of the data being transmitted through and the number of connections to the Company's network. 4. Other revenues: Other revenues consist of other payment-related products and services and are primarily associated with the following: • Consulting and research fees are primarily generated by MasterCard Advisors, the Company's professional advisory services group. • Fraud products and services used to prevent or detect fraudulent transactions. This includes fees for warning bulletins provided to issuers and acquirers either electronically or in paper form. 27-------------------------------------------------------------------------------- Table of Contents • Loyalty and rewards solution fees are charged to issuers for benefits provided directly to consumers with MasterCard-branded cards, such as insurance, assistance for lost cards, locating ATMs and rewards programs. • Program management services provided to prepaid card issuers consist of foreign exchange margin, commissions, load fees and ATM withdrawal fees paid by cardholders on the sale andencashment of prepaid cards. • The Company also charges for a variety of other payment-related products and services, including account and transaction enhancement services, rules compliance and publications. 5. Rebates and incentives (contra-revenue): Rebates and incentives are provided to certain MasterCard customers and are recorded as contra-revenue. Revenue Analysis In the three and six months ended June 30, 2014, gross revenue increased $395 million and $742 million, or 14%, respectively, versus the comparable periods in 2013. Gross revenue growth in the three and six months ended June 30, 2014 was primarily driven by increased growth in dollar volume of activity on cards carrying our brands, increased transactions and increased other payment-related products and services. Rebates and incentives, in the three and six months ended June 30, 2014, increased $114 million and $190 million, or 17% and 14%, respectively, versus the comparable periods in 2013 primarily due to the impact from new and renewed agreements and increased volumes. Our net revenue increased 13% and 14% for the three and six months ended June 30, 2014, respectively, versus the comparable periods in 2013. Our revenue is primarily based on volumes and transactions, which are driven by the dollar volume of activity on cards and other devices carrying our brands and the number of transactions. During the three and six months ended June 30, 2014, our GDV increased 13% on a local currency basis while our processed transactions increased 12% and 13%, respectively. The following table provides a summary of the trend in volume and transaction growth: Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 Growth (USD) Growth (Local) Growth (USD) Growth (Local) Growth (USD) Growth (Local) Growth (USD) Growth (Local) MasterCard-Branded GDV 1 11 % 13 % 13 % 13 % 11 % 13 % 12 % 13 % Asia Pacific/Middle East/Africa 15 % 18 % 19 % 21 % 13 % 18 % 20 % 22 % Canada (1 )% 5 % 6 % 8 % (1 )% 6 % 5 % 6 % Europe 14 % 13 % 15 % 14 % 14 % 14 % 14 % 14 % Latin America 5 % 13 % 17 % 17 % 4 % 14 % 14 % 16 % United States 9 % 9 % 6 % 6 % 9 % 9 % 5 % 5 % Cross-border Volume Growth 1 16 % 17 % 16 % 17 % Processed Transactions Growth 12 % 11 % 13 % 12 % 1 Excludes volume generated by Maestro and Cirrus cards. A significant portion of our revenue is concentrated among our five largest customers. The loss of any of these customers or their significant card programs could adversely impact our revenue. In addition, as part of our business strategy, MasterCard, among other efforts, enters into business agreements with customers. These agreements can be terminated in a variety of circumstances. 28-------------------------------------------------------------------------------- Table of Contents The significant components of our net revenue for the three and six months ended June 30, 2014 and 2013 were as follows: Three Months Ended Percent Six Months Ended Percent June 30, Increase June 30, Increase 2014 2013 1 (Decrease) 2014 2013 1 (Decrease) (in millions, except percentages) Domestic assessments $ 1,008 $ 912 11% $ 1,946 $ 1,785 9% Cross-border volume fees 750 658 14% 1,445 1,247 16% Transaction processing fees 995 865 15% 1,931 1,686 15% Other revenues 392 315 24% 733 595 23% Gross revenue 3,145 2,750 14% 6,055 5,313 14% Rebates and incentives (contra-revenue) (768 ) (654 ) 17% (1,501 ) (1,311 ) 14% Net revenue $ 2,377 $ 2,096 13% $ 4,554 $ 4,002 14% 1 Certain prior period amounts have been reclassified to conform to the 2014 presentation. Net revenue is not impacted. The following table summarizes the primary drivers of net revenue growth in the three and six months ended June 30, 2014 versus the three and six months ended June 30, 2013: For the Three Months Ended June 30, Volume Foreign Currency 1 Other Total 2014 2013 2 2014 2013 2 2014 2013 2 2014 2013 2 Domestic assessments 11 % 12 % - % - % - % 3 (4 )% 3 11 % 8 % Cross-border volume fees 14 % 14 % 1 % 1 % (1 )% 5 % 14 % 20 % Transaction processing fees 10 % 9 % 1 % - % 4 % (1 )% 15 % 8 % Other revenues ** ** 1 % - % 23 % 4 17 % 4 24 % 17 % Rebates and incentives 7 % 4 % 1 % - % 9 % 5 (2 )% 5 17 % 2 % Net revenue 11 % 12 % 1 % - % 1 % 3 % 13 % 15 % For the Six Months Ended June 30, Volume Foreign Currency 1 Other Total 2014 2013 2 2014 2013 2 2014 2013 2 2014 2013 2 Domestic assessments 12 % 12 % - % (1 )% (3 )% 3 (2 )% 3 9 % 9 % Cross-border volume fees 15 % 14 % 1 % - % - % 3 % 16 % 17 % Transaction processing fees 11 % 9 % - % - % 4 % (1 )% 15 % 8 % Other revenues ** ** 1 % - % 22 % 4 12 % 4 23 % 12 % Rebates and incentives 7 % 8 % - % - % 7 % 5 - % 5 14 % 8 % Net revenue 12 % 11 % 1 % - % 1 % 1 % 14 % 12 % ** Not applicable 1 Reflects translation from the euro and Brazilian real to the U.S. dollar. 2 Certain prior period amounts have been reclassified to conform to the 2014 presentation. Net revenue is not impacted. 3 Includes impact of the allocation of revenue to service deliverables, which are recorded in other revenue when services are performed. 4 Positively impacted by consulting fees, fraud service fees and other payment-related products and services. 5 Includes the impact from timing of new, renewed and expired agreements. 29-------------------------------------------------------------------------------- Table of Contents Operating Expenses Our operating expenses are comprised of general and administrative, advertising and marketing and depreciation and amortization expenses. Operating expenses increased $126 million and $219 million, or 15% and 13%, for the three and six months ended June 30, 2014, respectively, versus the comparable periods in 2013, primarily due to higher general and administrative expenses. The components of operating expenses for the three and six months ended June 30, 2014 and 2013 were as follows: Three Months Ended Percent Six Months Ended Percent June 30, Increase June 30, Increase 2014 2013 (Decrease) 2014 2013 (Decrease) (in millions, except percentages) General and administrative $ 740 $ 621 20% $ 1,410 $ 1,229 15% Advertising and marketing 173 186 (7)% 322 315 2% Depreciation and amortization 81 61 30% 154 123 24% Total operating expenses $ 994 $ 868 15% $ 1,886 $ 1,667 13% Total operating expenses as a percentage of net revenue 41.8 % 41.4 % 41.4 % 41.6 % General and Administrative General and administrative expenses increased $119 million and $181 million, or 20% and 15%, for the three and six months ended June 30, 2014, respectively, versus the comparable periods in 2013, primarily due to an increase in personnel expenses. The significant components of our general and administrative expenses for the three and six months ended June 30, 2014 and 2013 were as follows: Three Months Ended Percent Six Months Ended Percent June 30, Increase June 30, Increase 2014 2013 (Decrease) 2014 2013 (Decrease) (in millions, except percentages) Personnel $ 485 $ 423 15% $ 935 $ 835 12% Professional fees 61 52 18% 121 98 23% Data processing and telecommunications 65 53 21% 126 106 18% Foreign exchange activity 17 (12 ) * (2 ) (13 ) * Other 112 105 8% 230 203 13% General and administrative expenses $ 740 $ 621 20% $ 1,410 $ 1,229 15% * Not Meaningful • Personnel expense increased for the three and six months ended June 30, 2014 versus the comparable periods in 2013, due to an increase in the number of employees to support the Company's strategic initiatives. • Professional fees consist primarily of third-party services, legal costs to defend our outstanding litigation and the evaluation of regulatory developments that impact our industry and company. Professional fees for the three and six months ended June 30, 2014 versus the comparable periods in 2013, increased primarily due to support required for strategic development efforts. • Data processing and telecommunication expense consists of expenses to support our global payments network infrastructure, expenses to operate and maintain our computer systems and other telecommunication systems. These expenses vary with business volume growth, system upgrades and usage. • Foreign exchange activity includes gains and losses on foreign exchange derivative contracts and the impact of remeasurement of assets and liabilities denominated in foreign currencies. See Note 14 (Foreign Exchange Risk Management) to the consolidated financial statements included in Part I, Item 1 of this Report. Since the Company does not designate foreign currency derivatives as hedging instruments pursuant to the accounting standards for derivative instruments and hedging activities, it records gains and losses on foreign exchange derivatives on a current basis, with the associated offset being recognized as the exposures materialize. • Other expenses include costs to provide loyalty and rewards programs, travel and entertainment, rental expense for our facilities, litigation settlements not related to the U.S. merchant class litigation, investment related expenses and other 30-------------------------------------------------------------------------------- Table of Contents miscellaneous operating expenses. Other expenses increased for the three and six months ended June 30, 2014 versus the comparable periods in 2013, primarily due to expenses incurred to support strategic development efforts. Advertising and Marketing Our brands are valuable strategic assets that drive acceptance and usage of our products and facilitate our ability to successfully introduce new service offerings and access new markets globally. Our advertising and marketing strategy is to increase global MasterCard brand awareness, preference and usage through integrated advertising, sponsorship, promotions, interactive media and public relations programs on a global scale. We will continue to invest in marketing programs at the regional and local levels and sponsor diverse events aimed at multiple target audiences. Advertising and marketing expenses decreased $13 million, or 7% and increased $7 million, or 2%, for the three and six months ended June 30, 2014, respectively, versus the comparable periods in 2013 mainly due to the timing of media spend and sponsorship promotions to support our strategic initiatives. Depreciation and Amortization Depreciation and amortization expenses increased $20 million and $31 million, or 30% and 24% for the three and six months ended June 30, 2014, respectively, versus the comparable periods in 2013. The increase in depreciation and amortization expense was primarily due to increased amortization of capitalized software costs and acquisition-related intangible assets. Other Income (Expense) Other income (expense) is comprised primarily of investment income, interest expense, our share of income (losses) from equity method investments and other gains and losses. Other expense for the three and six months ended June 30, 2014 increased primarily due to higher interest expense related to our debt issuance in March 2014 versus the comparable periods in 2013. Income Taxes The effective income tax rates were 32.2% and 31.2% for the three months ended June 30, 2014 and 2013, respectively. The effective income tax rates were 32.1% and 30.9% for the six months ended June 30, 2014 and 2013, respectively. For the three and six months ended June 30, 2014, the effective tax rate was higher versus the comparable periods in 2013, due primarily to a less favorable geographic mix of taxable earnings. Liquidity and Capital Resources We need liquidity and access to capital to fund our global operations, credit and settlement exposure, capital expenditures, investments in our business and current and potential obligations. The Company generates the cash required to meet these needs through operations. The following table summarizes the cash, cash equivalents and investment securities balances and credit available to the Company at June 30, 2014 and December 31, 2013: June 30, December 31, 2014 2013 (in billions) Cash, cash equivalents and available-for-sale investment securities 1 $ 5.7 $ 6.3 Unused line of credit 2 3.0 3.0 1 Excludes restricted cash related to the U.S. merchant class litigation settlement of $540 million and $723 million at June 30, 2014 and December 31, 2013, respectively. 2 The Company did not use any funds from the line of credit during the periods presented. Cash, cash equivalents and available-for-sale investment securities held by our foreign subsidiaries (i.e., any entities where earnings would be subject to U.S. tax upon repatriation) was $3.8 billion and $3.6 billion at June 30, 2014 and December 31, 2013, respectively, or 67% and 57% of our total cash, cash equivalents and available-for-sale investment securities as of such dates. It is our present intention to permanently reinvest the undistributed earnings associated with our foreign subsidiaries as of December 31, 2013 outside of the United States (as disclosed in Note 17 (Income Tax) to the consolidated financial statements included in Part II, Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2013), and our current plans do not require repatriation of these earnings. If these earnings are needed for U.S. operations or can no longer be permanently reinvested outside of the United States, the Company would be subject to U.S. tax upon repatriation. Our liquidity and access to capital could be negatively impacted by global credit market conditions. The Company guarantees the settlement of many of the MasterCard, Cirrus and Maestro branded transactions between our issuers and acquirers. See Note 13 (Settlement and Other Risk Management) to the consolidated financial statements in Part I, Item 1 of this Report for a description of these guarantees. Historically, payments under these guarantees have not been significant; however, historical trends may not 31-------------------------------------------------------------------------------- Table of Contents be an indication of the future. The risk of loss on these guarantees is specific to individual customers, but may also be driven significantly by regional or global economic conditions, including, but not limited to the health of the financial institutions in a country or region. Our liquidity and access to capital could also be negatively impacted by the outcome of any of the legal or regulatory proceedings to which we are a party. For additional discussion of these and other risks facing our business, see Part I, Item 1A - Risk Factors of the Company's Annual Report on Form 10-K for the year ended December 31, 2013; and in Part II, Item 1A (Risk Factors) of this Report; Note 12 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part I, Item 1 of this Report; and "-Business Environment". Cash Flow The table below shows a summary of the cash flows from operating, investing and financing activities for the six months ended June 30, 2014 and 2013: Six Months Ended June 30, 2014 2013 (in millions) Cash Flow Data: Net cash provided by operating activities $ 1,297 $ 1,614 Net cash provided by (used in) investing activities (432 ) 118 Net cash used in financing activities (1,585 ) (1,421 ) Net cash provided by operating activities was $1.3 billion and $1.6 billion for the six months ended June 30, 2014 and 2013, respectively. Net cash provided by operating activities for the six months ended June 30, 2014 was primarily due to net income, partially offset by payments for prepaid and accrued expenses. Net cash provided by operating activities for the six months ended June 30, 2013 was primarily due to net income. Net cash used in investing activities for the six months ended June 30, 2014 primarily related to purchases of investment securities and acquisitions, partially offset by the proceeds from sales and maturities of investment securities. Net cash provided by investing activities for the six months ended June 30, 2013 primarily related to the proceeds from sales and maturities of investment securities, partially offset by purchases of investment securities. Net cash used in financing activities for the six months ended June 30, 2014 primarily related to the repurchase of the Company's Class A common stock, partially offset by proceeds from the debt offering completed in March 2014. Net cash used in financing activities for the six months ended June 30, 2013 primarily related to the repurchase of the Company's Class A common stock. The table below shows a summary of the balance sheet data at June 30, 2014 and December 31, 2013: June 30, December 31, 2014 2013 (in millions) Balance Sheet Data: Current assets $ 10,577 $ 10,950 Current liabilities 5,790 6,032 Long-term liabilities 2,271 715 Equity 6,314 7,495 The Company believes that its existing cash, cash equivalents and investment securities balances, its cash flow generating capabilities, its borrowing capacity and its access to capital resources are sufficient to satisfy its future operating cash needs, capital asset purchases, outstanding commitments and other liquidity requirements associated with its existing operations and potential obligations. Debt and Credit Availability In March 2014, MasterCard Incorporated issued $500 million aggregate principal amount of 2.000% Notes due April 1, 2019 (the "2019 Notes") and $1 billion aggregate principal amount of 3.375% Notes due April 1, 2024 (the "2024 Notes") (collectively the "Notes"). The effective interest rates were 2.081% and 3.426% on the 2019 Notes and 2024 Notes, respectively. The net proceeds from the issuance of the Notes, after deducting the underwriting discount and offering expenses, were $1,484 million. The Company 32-------------------------------------------------------------------------------- Table of Contents is not subject to any financial covenants under the Notes. Interest on the Notes is payable semi-annually on April 1 and October 1, commencing on October 1, 2014. The Notes may be redeemed in whole, or in part, at our option at any time for a specified make-whole amount. The Notes are senior unsecured obligations and would rank equally with any future unsecured and unsubordinated indebtedness. The proceeds of the Notes are to be used for general corporate purposes. The Company has a $3 billion committed unsecured revolving credit facility (the "Credit Facility") which expires on November 15, 2018. The Credit Facility decreases to $2.95 billion during the final year of the Credit Facility agreement. Borrowings under the Credit Facility are available to provide liquidity for general corporate purposes, including providing liquidity in the event of one or more settlement failures by the Company's customers. The Credit Facility contains customary representations, warranties, events of default and affirmative and negative covenants, including a financial covenant limiting the maximum level of consolidated debt to earnings before interest, taxes, depreciation and amortization. MasterCard was in compliance in all material respects with the covenants of the Credit Facility at June 30, 2014 and December 31, 2013. The majority of Credit Facility lenders are customers or affiliates of customers of MasterCard. Dividends and Share Repurchases MasterCard has historically paid quarterly dividends on its outstanding Class A common stock and Class B common stock. Subject to legally available funds, we intend to continue to pay a quarterly cash dividend. However, the declaration and payment of future dividends is at the sole discretion of our Board of Directors after taking into account various factors, including our financial condition, operating results, available cash and current and anticipated cash needs. On December 10, 2013, our Board of Directors declared a quarterly cash dividend of $0.11 per share paid on February 10, 2014 to holders of record on January 9, 2014 of our Class A common stock and Class B common stock. The aggregate amount of this dividend was $131 million. On February 4, 2014, our Board of Directors declared a quarterly cash dividend of $0.11 per share payable on May 9, 2014 to holders of record on April 9, 2014 of our Class A common stock and Class B common stock. The aggregate amount of this dividend was $129 million. On June 3, 2014, our Board of Directors declared a quarterly cash dividend of $0.11 per share payable on August 8, 2014 to holders of record on July 9, 2014 of our Class A common stock and Class B common stock. The aggregate amount of this dividend will be $127 million. Aggregate payments for quarterly dividends totaled $260 million and $110 million for the six months ended June 30, 2014 and 2013, respectively. 33-------------------------------------------------------------------------------- Table of Contents Shares in the Company's common stock that are repurchased are considered treasury stock. The timing and actual number of additional shares repurchased will depend on a variety of factors, including the operating needs of the business, legal requirements, price and economic and market conditions. In December 2013, our Board of Directors approved a new share repurchase program authorizing the Company to repurchase up to $3.5 billion of our Class A common stock. During January 2014, the Company exhausted its purchases under its February 2013 share repurchase program. As of July 24, 2014, the cumulative repurchases by the Company under its December 2013 share repurchase program totaled approximately 36.5 million shares of its Class A common stock for an aggregate cost of approximately $2.8 billion at an average price of $75.98 per share of Class A common stock. As of July 24, 2014, the Company had approximately $728 million remaining under its December 2013 share repurchase program. The following table summarizes the Company's share repurchase authorizations of its Class A common stock through June 30, 2014, as well as historical purchases: Authorization Dates December February June 2013 2013 2012 Total (in millions, except average price data) Board authorization $ 3,500 $ 2,000 $ 1,500 $ 7,000 Remaining authorization at December 31, 2013 $ 3,500 $ 161 $ - $ 3,661 Dollar value of shares repurchased during the six months ended June 30, 2014 $ 2,666 $ 161 $ - $ 2,827 Remaining authorization at June 30, 2014 $ 834 $ - $ - $ 834 Shares repurchased during the six months ended June 30, 2014 35.1 1.9 - 37.0 Average price paid per share during the six months ended June 30, 2014 $ 75.99 $ 83.22 $ - $ 76.37 Cumulative shares repurchased through June 30, 2014 35.1 31.1 31.1 97.3 Cumulative average price paid per share $ 75.99 $ 64.26 $ 48.16 $ 63.34 See Note 8 (Stockholders' Equity) to the consolidated financial statements included in Part I, Item 1 of this Report for further discussion. Off-Balance Sheet Arrangements MasterCard has no off-balance sheet debt other than lease arrangements and other commitments as presented in the future obligations table in Item 7 (Liquidity and Capital Resources) in Part II of the Company's Annual Report on Form 10-K for the year ended December 31, 2013. Recent Accounting Pronouncements Refer to Note 1 (Summary of Significant Accounting Policies) to the consolidated financial statements included in Part I, Item 1. Item 3. Quantitative and Qualitative Disclosures About Market Risk Market risk is the potential for economic losses to be incurred on market risk sensitive instruments arising from adverse changes in market factors such as interest rates, foreign currency exchange rates and equity price risk. Our exposure to market risk from changes in interest rates, foreign exchange rates and equity price risk is limited. Management establishes and oversees the implementation of policies governing our funding, investments and use of derivative financial instruments. We monitor risk exposures on an ongoing basis. The effect of a hypothetical 10% adverse change in foreign currency rates could result in a fair value loss of approximately $206 million on our foreign currency derivative contracts outstanding at June 30, 2014 related to the hedging program. A 100 basis point adverse change in interest rates would not have a material impact on the Company's financial assets or liabilities at June 30, 2014 or December 31, 2013. In addition, there was no material equity price risk at June 30, 2014 or December 31, 2013. The Dodd-Frank Wall Street Reform and Consumer Protection Act in the United States includes provisions related to derivative financial instruments. The Company believes the adoption of such provisions will not have a material adverse effect on the Company's financial position or results of operations. 34-------------------------------------------------------------------------------- Table of Contents |