Mastercard Incorporated — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; comparative figures are for Q1 2015 unless stated otherwise. Mastercard operates a global payments network and earns fees from transaction processing, payment activity and related services; it does not issue cards or extend credit. Financial statements are unaudited and interim results are not necessarily indicative of full-year performance.
Financial results
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Net revenue | $2.446 billion | $2.230 billion | +10% reported; +14% currency-neutral |
| Operating expenses | $1.098 billion | $879 million | +25% reported; +29% currency-neutral |
| Operating income | $1.348 billion | $1.351 billion | Approximately flat |
| Operating margin | 55.1% | 60.6% | Down 5.5 percentage points |
| Net income | $959 million | $1.020 billion | Down 6%; down 2% currency-neutral |
| Diluted EPS | $0.86 | $0.89 | Down 3%; up 1% currency-neutral |
| Effective tax rate | 28.3% | 23.9% | Up 4.4 percentage points |
| Operating cash flow | $1.008 billion | $911 million | Up $97 million |
Revenue mix: Domestic assessments rose 7% to $1.027 billion; cross-border volume fees rose 10% to $796 million; transaction processing fees rose 16% to $1.165 billion; and other revenue rose 19% to $497 million. Gross revenue increased 12% to $3.485 billion, while rebates and incentives increased 18% to $1.039 billion, limiting net revenue growth.
Activity: Processed transactions grew 14%; Mastercard-branded gross dollar volume increased 13% in local currency (7% in U.S. dollars); and cross-border volume grew 12% in local currency (6% in U.S. dollars). The Brazilian real’s depreciation and other currency effects weighed on reported results.
Cash, liquidity and debt: Cash and cash equivalents were $4.894 billion at March 31, versus $5.747 billion at year-end; cash, cash equivalents and investments totaled $6.2 billion, excluding restricted litigation cash. Operating cash flow was $1.008 billion; investing outflow was $385 million and financing outflow was $1.545 billion. Long-term debt was $3.333 billion, with no borrowings under the commercial paper program or revolving credit facility. The company reported $3.8 billion of unused credit capacity and stated that available liquidity, cash generation and borrowing capacity were sufficient for expected needs. Current assets were $10.606 billion and current liabilities $6.440 billion.
Capital returns: Mastercard repurchased 15.4 million shares for approximately $1.36 billion at an average $88.26 per share and paid $212 million in dividends. Remaining authorization under the repurchase programs was approximately $3.15 billion.
Material changes and management commentary
- Revenue growth reflected higher payment volumes and transactions, growth in related services and acquisition contributions, partly offset by higher customer rebates and incentives.
- Operating expenses rose substantially, particularly general and administrative costs. Foreign-exchange activity shifted from a gain in Q1 2015 to a loss in Q1 2016 and adversely affected expense growth by 16 percentage points. Personnel spending also increased as Mastercard invested in digital, services and data analytics and absorbed wage increases.
- Net income and reported EPS declined despite revenue growth, primarily as expense growth and a higher effective tax rate offset revenue gains. The tax-rate comparison was affected by a discrete foreign-tax-credit benefit recorded in Q1 2015.
- Management described growth opportunities in electronic payments, digital and mobile payments, services, data analytics, transit, person-to-person transfers and financial inclusion. The filing provides no specific full-year revenue or earnings guidance.
Risks, contingencies and unusual items
- Merchant litigation: The U.S. merchant class settlement remained subject to appeals and challenges; more than 30 opt-out complaints had been filed, with additional actions anticipated. Mastercard carried a $710 million reserve for the class and filed or anticipated opt-out matters. The filing says the opt-out reserve is not an estimate of ultimate litigation exposure; an adverse outcome or reversal of settlement approval could materially affect results, financial position and cash flows.
- European interchange matters: The European Commission’s 2015 Statement of Objections concerned interregional interchange fees and central acquiring rules; possible fines were not quantified and could be substantial. UK merchant claims included a stated estimate that the lower end of a negotiated settlement could be $270 million; no loss was accrued, and ultimate litigated exposure could not be estimated. A UK trial concluded in March 2016, with a decision expected later in the year.
- Other proceedings: Canadian merchant class actions, ATM surcharge litigation and a new U.S. EMV liability-shift complaint remained pending. The filing generally could not estimate losses for these matters.
- Settlement guarantees: Gross settlement exposure was $38.208 billion, offset by $3.439 billion of collateral, leaving $34.769 billion net uncollateralized exposure. Exposure is generally short-term, but customer failures or deteriorating economic conditions could increase losses.
- Foreign exchange risk: A hypothetical 10% adverse currency move could produce an estimated $126 million fair-value loss on outstanding foreign-currency derivatives. Q1 included $40 million of foreign-exchange losses, compared with $88 million of foreign-exchange gains in general and administrative expenses in Q1 2015 (including $55 million of balance-sheet remeasurement gains).
- Other key risks identified include regulatory and interchange-fee actions, competition and pricing pressure, economic weakness, dependence on major customers, cybersecurity or service disruptions, and litigation. The filing reports no material change in internal control over financial reporting and says disclosure controls were effective.
Important facts for investors to verify
- Progress and potential financial impact of U.S. merchant opt-out cases, settlement appeals and the $710 million recorded litigation reserve.
- Developments in the European Commission matter and UK merchant claims, including the outcome of the completed trial and the unaccrued settlement estimate.
- Whether revenue growth and transaction-volume trends continue to outpace growth in rebates, incentives and operating expenses.
- Currency effects, foreign-exchange hedging results and the sensitivity of reported growth to exchange rates.
- Use of cash for repurchases and dividends relative to operating cash flow, and the level of settlement exposure and collateral coverage.