Mastercard Inc. — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2016. The interim financial statements are unaudited; the independent accountant conducted a review, not an audit.
Business context
Mastercard operates a global payments network, processing transactions and providing payment-related products and services. It earns fees primarily from issuers and acquirers based on transaction activity, payment volume and services; it does not issue cards or extend credit to cardholders.
Key financial metrics
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net revenue | $2.88 billion | $2.53 billion | $8.02 billion | $7.15 billion |
| Operating income | $1.67 billion | $1.37 billion | $4.40 billion | $3.97 billion |
| Operating margin | 58.0% | 54.1% | 54.8% | 55.5% |
| Net income | $1.18 billion | $977 million | $3.13 billion | $2.92 billion |
| Diluted EPS | $1.08 | $0.86 | $2.83 | $2.56 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $3.49 billion | $3.00 billion |
- Q3 net revenue rose 14% and net income rose 21% year over year. For the first nine months, revenue rose 12% and net income rose 7%. Adjusted diluted EPS growth, excluding specified special items, was 19% for Q3 and 10% for the nine-month period.
- Processed transactions increased 18% in Q3 and 15% year to date. Local-currency cross-border volume grew 12% in both periods; local-currency worldwide GDV increased 7% and 11%, respectively.
- Revenue growth included transaction processing fees (+19% in both periods) and other revenue (+23% Q3; +22% year to date). Rebates and incentives, recorded as contra-revenue, increased 20% in both periods.
- Operating expenses increased 4% in Q3 and 14% year to date; excluding special items, they increased 12% and 16%, respectively. Management attributed underlying growth principally to personnel and data-processing costs, reflecting investment in digital, services, analytics and geographic expansion.
- At September 30, cash and cash equivalents were $5.21 billion, investments were $1.77 billion, and total assets were $17.32 billion. Cash, cash equivalents and investments available for liquidity purposes were reported as $7.0 billion, versus $6.7 billion at December 31, 2015.
- Long-term debt was $3.33 billion. The company had no borrowings under its credit facility or commercial paper program and reported approximately $3.8 billion of unused credit. Nine-month cash decreased by $542 million to $5.21 billion.
- Nine-month investing cash outflow was $1.13 billion and financing cash outflow was $2.97 billion. Mastercard repurchased 26.3 million shares for approximately $2.41 billion and paid $630 million in dividends.
Material changes and unusual items
- Q3 2015 included a $79 million pre-tax charge for settlement of the U.S. defined-benefit pension plan. The first nine months of 2016 included a $107 million pre-tax provision for a U.K. merchant litigation judgment; the comparable 2015 period included a $61 million U.K. merchant settlement provision.
- The U.S. appeals court vacated approval of the merchant class settlement in June 2016 and remanded the case. Mastercard reported a $705 million reserve for the U.S. merchant class litigation and filed and anticipated opt-out cases; the balance-sheet accrued-litigation line was $716 million.
- In July 2016, Mastercard agreed to acquire a 92.4% controlling interest in U.K.-based VocaLink for approximately £700 million (about $910 million at the reported exchange rate), subject to regulatory approval and other conditions. Closing was anticipated around mid-2017; potential earn-out consideration is up to £169 million.
- The company extended its $3.75 billion revolving credit facility by one year, to October 2021, after quarter-end.
Outlook, risks and contingencies
The filing provides no quantified earnings or revenue guidance. Management said cash, investments, available credit and operating cash flow were sufficient for liquidity needs. It intends to continue quarterly dividends, subject to board discretion, and had $2.10 billion remaining under its share-repurchase authorization at September 30.
- Legal and regulatory exposure is significant. The European Commission’s interchange-fee investigation could result in substantial fines. For unresolved U.K. merchant claims, Mastercard estimated the lower end of a negotiated settlement could be approximately $300 million, but did not accrue that amount and could not estimate exposure if litigated to final judgment.
- A proposed U.K. consumer collective action sought damages exceeding £14 billion. The filing also describes Canadian merchant claims, U.S. ATM-rule litigation, and a U.S. EMV liability-shift case.
- Mastercard guarantees settlement between issuers and acquirers. Estimated gross settlement exposure was $43.27 billion, collateral held was $4.00 billion and net uncollateralized exposure was $39.28 billion at September 30. The company noted that adverse economic or political conditions could increase the risk of customer failures.
- Other stated risks include interchange regulation, competition and pricing pressure, customer concentration, foreign-exchange movements, cybersecurity and service disruptions, litigation, and economic conditions. A hypothetical 10% adverse move in foreign-currency forward rates could produce an estimated $82 million fair-value loss on hedging-program derivatives.
Important facts for investors to verify
- Progress and potential financial impact of the vacated U.S. merchant class settlement, opt-out cases, U.K. merchant claims and U.K. consumer action.
- Whether VocaLink receives regulatory approval, closes on expected terms and meets any earn-out targets.
- Whether transaction-volume and revenue growth persist while rebates, incentives and operating expenses rise.
- Availability and location of liquidity: $4.3 billion of cash, cash equivalents and investments was held by foreign subsidiaries, with historic earnings intended to remain reinvested abroad.
- Changes in settlement exposure, collateral coverage and customer credit conditions, as well as the company’s continued capacity for repurchases and dividends.