VISA INC. annual report, FY2012

Business context and reporting period

Visa Inc. filed this Form 10-K for the fiscal year ended September 30, 2012. Although the request metadata refers to 2012 Q4, the filing reports full-year results; quarterly figures are noted where relevant. Visa operates a global, open-loop electronic payments network and earns most revenue from client fees tied to payment volume, processed transactions, and related services. It does not issue cards or extend credit.

Financial performance and liquidity

Metric	FY 2012	FY 2011
Operating revenues, net of client incentives	$10.421 billion	$9.188 billion
Operating income	$2.139 billion	$5.456 billion
Operating margin, reported	21%	59%
Net income attributable to Visa	$2.144 billion	$3.650 billion
Diluted Class A EPS	$3.16	$5.16
Cash provided by operating activities	$5.009 billion	$3.872 billion

• Revenue grew 13%. Service revenue rose 14% to $4.872 billion, data processing revenue rose 14% to $3.975 billion, and international transaction revenue rose 13% to $3.025 billion. Client incentives, recorded primarily as a revenue reduction, increased 15% to $2.155 billion.
• Reported profit and margin were heavily affected by a $4.1 billion litigation provision. Excluding the filing’s identified unusual items, adjusted operating expenses were $4.184 billion, adjusted operating margin was 60%, adjusted net income was $4.203 billion, and adjusted diluted EPS was $6.20. FY 2011 adjusted net income and diluted EPS were $3.528 billion and $4.99, respectively. These are non-GAAP adjustments presented by management.
• Key operating indicators: nominal payments volume increased 10% (for the 12 months ended June 30, the basis used for service revenue); cross-border volume increased 11%; Visa-processed transactions increased 5%. U.S. debit growth slowed amid regulation; Interlink transactions fell 51% in the second half versus the prior-year period.
• At September 30, cash and cash equivalents were $2.074 billion, restricted litigation escrow was $4.432 billion, and total assets were $40.013 billion. Total equity was $27.630 billion. There were no borrowings under the $3 billion revolving facility or $500 million commercial-paper program; the revolving facility was due to expire in February 2013, and Visa said it was being replaced.
• Visa reported $5.009 billion of operating cash flow, $2.414 billion of cash used in investing, and $2.655 billion of cash used in financing. The company stated that projected liquidity would cover needs for more than 12 months. Debt balances were zero at year-end.

Material changes and unusual items

• The $4.1 billion covered-litigation provision drove reported operating income down sharply. The provision related to the U.S. merchant interchange litigation and was associated with Visa’s retrospective responsibility plan and escrow arrangements.
• FY 2012 net income included a $627 million fourth-quarter increase from reversing tax reserves and accrued interest related to the deductibility of covered litigation payments; a separate $208 million non-cash deferred-tax benefit also benefited results. Management’s adjusted presentation excludes these items and the litigation provision.
• The effective tax rate was 3% reported, versus 36% in FY 2011; management expected a more normalized FY 2013 rate of 30%–32%.
• Visa returned capital through $595 million of dividends and $710 million of open-market share repurchases in FY 2012. It also deposited $1.715 billion into the litigation escrow; these deposits reduced the as-converted share count under the responsibility plan.

Outlook, risks and contingencies

• Management expected low double-digit operating-revenue growth in FY 2013. It projected client incentives at 18%–18.5% of gross revenue, marketing expense below $1 billion, capital expenditures of $425–$475 million, and approximately $52 million of pension and postretirement contributions.
• Dodd-Frank debit rules capped certain U.S. debit interchange fees and expanded network choice and merchant routing options. Visa estimated the rules’ net FY 2012 impact, including mitigation efforts, at a $0.15 reduction in diluted Class A EPS. The company described continuing pricing, incentive, routing, and transaction-volume pressure.
• On October 19, 2012, Visa and other defendants signed an agreement to settle the class claims in the interchange litigation for approximately $4 billion, with payments from escrow, plus temporary credit interchange reductions and rule changes including conditional credit-card surcharging. The court granted preliminary approval on November 9, 2012; final approval and appeals remained unresolved as of the filing.
• Visa settled individual merchant claims for approximately $350 million, paid from escrow on October 29, 2012. The filing also describes other pending competition, regulatory, consumer, and intellectual-property matters for which losses were not generally estimable.
• Visa Europe can exercise a perpetual put requiring Visa to buy its outstanding shares. The recorded fair-value liability was $145 million, but the potential purchase obligation could be several billion dollars or more and was not reliably estimable.
• Other material risks include client pricing pressure and concentration, competition and disintermediation, economic weakness and reduced cross-border activity, cyberattacks or processing outages, settlement guarantees, and additional regulation. Estimated maximum settlement exposure was $49.3 billion, partly supported by collateral and guarantees.
• Charles W. Scharf was appointed CEO effective November 1, 2012. KPMG reported that the financial statements were fairly presented under U.S. GAAP and that internal control over financial reporting was effective as of September 30, 2012.

Investor verification priorities

1. Confirm the final court approval and appeal status, actual cash payments, and any remaining exposure under the approximately $4 billion interchange class settlement and the $350 million individual-merchant settlement.
2. Reconcile reported FY 2012 EPS of $3.16 with management’s adjusted EPS of $6.20, including the litigation provision, tax-reserve reversal, and deferred-tax benefit.
3. Track FY 2013 revenue growth, incentive rates, debit routing and pricing effects, and whether the stated outlook was achieved.
4. Verify replacement financing for the $3 billion revolving facility due to expire in February 2013, and monitor unrestricted liquidity separately from the restricted litigation escrow.
5. Assess the likelihood, valuation assumptions, financing needs, and potential dilution associated with Visa Europe’s put option.
6. Monitor outcomes of pending regulatory inquiries and litigation, and any changes in settlement exposure, client concentration, or payment-network security and reliability.