Business context and reporting period
Mastercard Incorporated’s unaudited Form 10-Q covers the quarter and nine months ended September 30, 2015, compared with the same 2014 periods. Mastercard operates a global payments network and earns fees from transaction processing, payment-related services, and customer activity volumes; it does not issue cards or extend credit to cardholders.
Financial results and liquidity
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net revenue | $2.530bn | $2.490bn | $7.150bn | $7.030bn |
| Operating income | $1.369bn | $1.420bn | $3.971bn | $4.088bn |
| Operating margin | 54.1% | 57.0% | 55.5% | 58.1% |
| Net income | $977m | $1.015bn | $2.918bn | $2.816bn |
| Diluted EPS | $0.86 | $0.87 | $2.56 | $2.40 |
- Revenue and activity: Net revenue rose 2% in both periods. Processed transactions increased 12% in both periods, and GDV rose 13% in local currency; reported GDV growth was flat in U.S. dollars in Q3 and 1% for the nine months.
- Costs and margins: Operating expenses increased 9% in Q3 and 8% year to date. Excluding disclosed special items, expenses rose 1% and 3%, respectively. Operating margin contracted year over year in both periods.
- Cash flow: Nine-month operating cash flow was $3.004bn, versus $2.682bn. Investing activities used $853m and financing activities used $3.216bn. Cash and cash equivalents ended the period at $3.877bn, down from $5.137bn at December 31, 2014.
- Debt and liquidity: Long-term debt was $1.495bn. Cash, cash equivalents, and investments totaled $5.1bn, excluding restricted litigation cash; the company also reported $3.0bn of unused credit capacity at September 30. A new $3.75bn revolving facility was entered into on October 21, 2015; it had no borrowings as of October 29.
- Capital returns: Mastercard repurchased $2.725bn of shares and paid $548m in dividends during the first nine months. It had $1.3bn remaining under its repurchase authorization at September 30.
Changes, unusual items, and management commentary
- Q3 net income declined 4%; nine-month net income increased 4%. Adjusted net income, excluding special items, increased 1% and 7%, respectively. Adjusted diluted EPS was $0.91 for Q3 and $2.64 year to date; these are non-GAAP measures.
- Reported net revenue growth was held back by foreign currency translation, which reduced growth by 6 percentage points in both periods. Acquisitions contributed 1 percentage point in Q3 and 2 points year to date. Rebates and incentives rose 20% in both periods.
- Special items were a $79m pre-tax ($50m after-tax) charge for termination of the U.S. defined-benefit pension plan, and a $61m provision for a U.K. merchant litigation settlement ($44m after tax), recorded in the nine-month period. The pension charge was recorded in Q3.
- Management stated that existing resources, cash generation, borrowing capacity, and capital-market access should be sufficient for operating needs and potential obligations. The filing provides no specific revenue or earnings guidance.
- Management cited economic uncertainty, currency movements, regulation, competition, and security risks. Foreign currency translation reduced net income growth by 7 percentage points in both periods. A hypothetical 10% adverse currency move could produce an estimated $81m fair-value loss on outstanding currency derivatives.
Legal matters and contingencies
- U.S. merchant litigation: Accrued litigation was $711m at September 30. The settlement’s approval remained subject to appeal and a motion to set aside; merchants representing slightly more than 25% of relevant purchase volume opted out, and more than 30 opt-out complaints had been filed. The company said it could not estimate the ultimate liability if those cases were litigated to a final outcome.
- Europe and U.K.: The European Commission issued a Statement of Objections concerning interregional interchange fees and central acquiring rules; possible fines were not quantified and could be substantial. U.K. retailer claims were reported to exceed $2bn in asserted damages; Mastercard settled one claim for $61m in June 2015, with other claims ongoing.
- Settlement guarantees: Estimated gross settlement exposure was $38.992bn, with $3.531bn collateral and $35.461bn net uncollateralized exposure. The company said exposure is generally short term and historical losses have been low, but economic deterioration or customer failure could increase risk.
- The interim financial statements received a limited review by the independent accountant, not an audit. Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Progress and potential financial impact of U.S. merchant class and opt-out litigation, including the appeal and motion challenging settlement approval.
- Developments in the European Commission proceeding and remaining U.K. merchant claims, including possible fines, settlements, or required business-practice changes.
- Whether volume growth translates into stronger reported revenue and margins as foreign exchange effects and customer incentives evolve.
- Cash availability and capital needs, considering foreign-held funds, repurchases, dividends, acquisitions, and settlement-guarantee exposure.
- Non-GAAP adjustments and the timing or effects of tax examinations; the filing says a reduction in unrecognized tax benefits was reasonably possible but provides no range.