Edgar Filing: Mastercard Inc

Large accelerated filer

Accelerated filer

Non-accelerated filer

o (do not check if a smaller reporting company)

Smaller reporting company

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q



x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2016



o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 001-32877

Mastercard Incorporated

(Exact name of registrant as specified in its charter)



Delaware	13-4172551
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification Number)

2000 Purchase Street	10577
Purchase, NY	(Zip Code)
(Address of principal executive offices)

(914) 249-2000

(Registrant’s telephone number, including area code)

MasterCard Incorporated

(Former name, changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x

As of October 25, 2016, there were 1,069,495,068 shares outstanding of the registrant’s Class A common stock, par value $0.0001 per share; and 20,119,370 shares outstanding of the registrant’s Class B common stock, par value $0.0001 per share.

MASTERCARD INCORPORATED

FORM 10-Q

TABLE OF CONTENTS



	Page
PART I — FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)	4
Consolidated Balance Sheet — September 30, 2016 and December 31, 2015	4
Consolidated Statement of Operations — Three and Nine Months Ended September 30, 2016 and 2015	5
Consolidated Statement of Comprehensive Income — Three and Nine Months Ended September 30, 2016 and 2015	6
Consolidated Statement of Changes in Equity — Nine Months Ended September 30, 2016	6
Consolidated Statement of Cash Flows — Nine Months Ended September 30, 2016 and 2015	7
Notes to Consolidated Financial Statements	8
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	39
ITEM 4. CONTROLS AND PROCEDURES	39
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM	40

PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS	41
ITEM 1A. RISK FACTORS	41
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	41
ITEM 5. OTHER INFORMATION	41
ITEM 6. EXHIBITS	41
SIGNATURES	42

Table of Contents

In this Report on Form 10-Q (“Report”), references to the “Company,” “Mastercard,” “we,” “us” or “our” refer to the Mastercard brand generally, and to the business conducted by Mastercard Incorporated and its consolidated subsidiaries, including our operating subsidiary, Mastercard International Incorporated.

Forward-Looking Statements

This Report contains forward-looking statements pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical facts may be forward-looking statements. When used in this Report, the words “believe”, “expect”, “could”, “may”, “would”, “will”, “trend” and similar words are intended to identify forward-looking statements. Examples of forward-looking statements include, but are not limited to, statements that relate to the Company’s future prospects, developments and business strategies.

Many factors and uncertainties relating to our operations and business environment, all of which are difficult to predict and many of which are outside of our control, influence whether any forward-looking statements can or will be achieved. Any one of those factors could cause our actual results to differ materially from those expressed or implied in writing in any forward-looking statements made by Mastercard or on its behalf, including, but not limited to, the following factors:


•	payments system-related legal and regulatory challenges (including interchange fees, surcharging and the extension of current regulatory activity to additional jurisdictions or products);


•	the impact of preferential or protective government actions;


•	regulation of privacy, data protection and security;


•	regulation to which we are subject based on our participation in the payments industry;


•	the impact of competition in the global payments industry (including disintermediation and pricing pressure);


•	the challenges relating to rapid technological developments and changes;


•	the impact of information security failures, breaches or service disruptions on our business;


•	issues related to our relationships with our customers (including loss of substantial business from significant customers, competitor relationships with our customers and banking industry consolidation);


•	the impact of our relationships with stakeholders, including issuers and acquirers, merchants and governments;


•	exposure to loss or illiquidity due to settlement guarantees and other significant third-party obligations;


•	the impact of global economic and political events and conditions, including global financial market activity, declines in cross-border activity; negative trends in consumer spending and the effect of adverse currency fluctuation;


•	reputational impact, including impact related to brand perception, account data breaches and fraudulent activity;


•	issues related to acquisition integration, strategic investments and entry into new businesses;


•	potential or incurred liability and limitations on business resulting from litigation; and


•	issues related to our Class A common stock and corporate governance structure.

Please see a complete discussion of these risk factors in Part I, Item 1A - Risk Factors of the Company’s Annual Report on Form 10-K for the year ended December 31, 2015. We caution you that the important factors referenced above may not contain all of the factors that are important to you. Our forward-looking statements speak only as of the date of this Report or as of the date they are made, and we undertake no obligation to update our forward-looking statements.

Table of Contents

PART I — FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

MASTERCARD INCORPORATED

CONSOLIDATED BALANCE SHEET

(UNAUDITED)



	September 30, 2016			December 31, 2015
	(in millions, except per share data)
ASSETS
Cash and cash equivalents	$	5,205		$	5,747
Restricted cash for litigation settlement	543			541
Investments	1,774			991
Accounts receivable	1,298			1,079
Settlement due from customers	1,137			1,068
Restricted security deposits held for customers	997			895
Prepaid expenses and other current assets	822			663
Total Current Assets	11,776			10,984
Property, plant and equipment, net of accumulated depreciation of $585 and $491, respectively	698			675
Deferred income taxes	327			317
Goodwill	1,814			1,891
Other intangible assets, net of accumulated amortization of $952 and $816, respectively	747			803
Other assets	1,961			1,580
Total Assets	$	17,323		$	16,250
LIABILITIES AND EQUITY
Accounts payable	$	437		$	472
Settlement due to customers	1,052			866
Restricted security deposits held for customers	997			895
Accrued litigation	716			709
Accrued expenses	3,214			2,763
Other current liabilities	705			564
Total Current Liabilities	7,121			6,269
Long-term debt	3,326			3,268
Deferred income taxes	82			79
Other liabilities	545			572
Total Liabilities	11,074			10,188
Commitments and Contingencies
Stockholders’ Equity
Class A common stock, $0.0001 par value; authorized 3,000 shares, 1,373 and 1,370 shares issued and 1,072 and 1,095 outstanding, respectively	—			—
Class B common stock, $0.0001 par value; authorized 1,200 shares, 20 and 21 issued and outstanding, respectively	—			—
Additional paid-in-capital	4,135			4,004
Class A treasury stock, at cost, 301 and 275 shares, respectively	(15,921		)	(13,522		)
Retained earnings	18,722			16,222
Accumulated other comprehensive income (loss)	(717		)	(676		)
Total Stockholders’ Equity	6,219			6,028
Non-controlling interests	30			34
Total Equity	6,249			6,062
Total Liabilities and Equity	$	17,323		$	16,250

The accompanying notes are an integral part of these consolidated financial statements.

Table of Contents

MASTERCARD INCORPORATED

CONSOLIDATED STATEMENT OF OPERATIONS

(UNAUDITED)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
	(in millions, except per share data)
Net Revenue	$	2,880		$	2,530		$	8,020		$	7,150
Operating Expenses
General and administrative	933			883			2,731			2,343
Advertising and marketing	184			184			503			502
Depreciation and amortization	93			94			281			273
Provision for litigation settlements	—			—			107			61
Total operating expenses	1,210			1,161			3,622			3,179
Operating income	1,670			1,369			4,398			3,971
Other Income (Expense)
Investment income	12			5			32			20
Interest expense	(23		)	(15		)	(65		)	(49		)
Other income (expense), net	(26		)	(7		)	(30		)	(9		)
Total other income (expense)	(37		)	(17		)	(63		)	(38		)
Income before income taxes	1,633			1,352			4,335			3,933
Income tax expense	449			375			1,209			1,015
Net Income	$	1,184		$	977		$	3,126		$	2,918

Basic Earnings per Share	$	1.08		$	0.86		$	2.84		$	2.57
Basic Weighted-Average Shares Outstanding	1,096			1,130			1,101			1,136
Diluted Earnings per Share	$	1.08		$	0.86		$	2.83		$	2.56
Diluted Weighted-Average Shares Outstanding	1,099			1,133			1,104			1,139

The accompanying notes are an integral part of these consolidated financial statements.

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MASTERCARD INCORPORATED

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(UNAUDITED)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
	(in millions)
Net Income	$	1,184		$	977		$	3,126		$	2,918
Other comprehensive income (loss):
Foreign currency translation adjustments	(2		)	(69		)	3			(319		)
Income tax effect	(5		)	3			(10		)	19
Foreign currency translation adjustments, net of income tax effect	(7		)	(66		)	(7		)	(300		)

Translation adjustments on net investment hedge	(20		)	—			(56		)	—
Income tax effect	7			—			20			—
Translation adjustments on net investment hedge, net of income tax effect	(13		)	—			(36		)	—

Defined benefit pension and other postretirement plans	—			40			(1		)	53
Income tax effect	—			(15		)	—			(19		)
Defined benefit pension and other postretirement plans, net of income tax effect	—			25			(1		)	34

Investment securities available-for-sale	—			(3		)	5			(10		)
Income tax effect	—			—			(2		)	—
Investment securities available-for-sale, net of income tax effect	—			(3		)	3			(10		)

Other comprehensive income (loss), net of tax	(20		)	(44		)	(41		)	(276		)
Comprehensive Income	$	1,164		$	933		$	3,085		$	2,642

The accompanying notes are an integral part of these consolidated financial statements.

MASTERCARD INCORPORATED

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

(UNAUDITED)



	Total			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Common Stock				Additional Paid-In Capital		Class A Treasury Stock			Non- Controlling Interests
	Total			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Class A		Class B		Additional Paid-In Capital		Class A Treasury Stock			Non- Controlling Interests
	(in millions, except per share data)
Balance at December 31, 2015	$	6,062		$	16,222		$	(676	)	$	—	$	—	$	4,004	$	(13,522	)	$	34
Net income	3,126			3,126			—			—		—		—		—			—
Activity related to non-controlling interests	(4		)	—			—			—		—		—		—			(4		)
Other comprehensive income (loss), net of tax	(41		)	—			(41		)	—		—		—		—			—
Cash dividends declared on Class A and Class B common stock, $0.57 per share	(626		)	(626		)	—			—		—		—		—			—
Purchases of treasury stock	(2,403		)	—			—			—		—		—		(2,403		)	—
Share-based payments	135			—			—			—		—		131		4			—
Balance at September 30, 2016	$	6,249		$	18,722		$	(717	)	$	—	$	—	$	4,135	$	(15,921	)	$	30

The accompanying notes are an integral part of these consolidated financial statements.

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MASTERCARD INCORPORATED

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)



	Nine Months Ended September 30,
	2016			2015
	(in millions)
Operating Activities
Net income	$	3,126		$	2,918
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of customer and merchant incentives	629			560
Depreciation and amortization	281			273
Share-based payments	15			1
Deferred income taxes	(1		)	18
Other	(24		)	33
Changes in operating assets and liabilities:
Accounts receivable	(190		)	(27		)
Income taxes receivable	4			(83		)
Settlement due from customers	(53		)	78
Prepaid expenses	(818		)	(704		)
Accrued litigation and legal settlements	12			(60		)
Accounts payable	(33		)	(31		)
Settlement due to customers	171			(192		)
Accrued expenses	247			1
Net change in other assets and liabilities	126			219
Net cash provided by operating activities	3,492			3,004
Investing Activities
Purchases of investment securities available-for-sale	(751		)	(862		)
Purchases of investments held-to-maturity	(729		)	(868		)
Proceeds from sales of investment securities available-for-sale	164			666
Proceeds from maturities of investment securities available-for-sale	247			476
Proceeds from maturities of investments held-to-maturity	240			576
Acquisition of businesses, net of cash acquired	—			(584		)
Purchases of property, plant and equipment	(156		)	(125		)
Capitalized software	(124		)	(124		)
Increase in restricted cash for litigation settlement	(2		)	(1		)
Other investing activities	(14		)	(7		)
Net cash used in investing activities	(1,125		)	(853		)
Financing Activities
Purchases of treasury stock	(2,410		)	(2,725		)
Dividends paid	(630		)	(548		)
Tax benefit for share-based payments	44			40
Cash proceeds from exercise of stock options	31			25
Other financing activities	(3		)	(8		)
Net cash used in financing activities	(2,968		)	(3,216		)
Effect of exchange rate changes on cash and cash equivalents	59			(195		)
Net decrease in cash and cash equivalents	(542		)	(1,260		)
Cash and cash equivalents - beginning of period	5,747			5,137
Cash and cash equivalents - end of period	$	5,205		$	3,877

Non-Cash Investing and Financing Activities
Fair value of assets acquired, net of cash acquired	$	—		$	625
Fair value of liabilities assumed related to acquisitions	$	—		$	41

The accompanying notes are an integral part of these consolidated financial statements.

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MASTERCARD INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1. Summary of Significant Accounting Policies

Organization

Mastercard Incorporated and its consolidated subsidiaries, including Mastercard International Incorporated (“Mastercard International” and together with Mastercard Incorporated, “Mastercard” or the “Company”), 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. The Company facilitates the processing of payment transactions including authorization, clearing and settlement, and delivers related products and services. The Company makes payments easier and more efficient by creating a wide range of payment solutions and services through a family of well-known brands, including Mastercard®, Maestro® and Cirrus®. The Company also provides value-added offerings such as loyalty and reward programs, information services and consulting. The Company’s network is designed to ensure safety and security for the global payments system. A typical transaction on the Company’s network involves four participants in addition to the Company: cardholder, merchant, issuer (the cardholder’s financial institution) and acquirer (the merchant’s financial institution). The Company’s customers encompass a vast array of entities, including financial institutions and other entities that act as “issuers” and “acquirers”, as well as merchants, governments, telecommunication companies and other businesses. The Company does not issue cards, extend credit, determine or receive revenue from interest rates or other fees charged to cardholders by issuers, or establish the rates charged by acquirers in connection with merchants’ acceptance of the Company’s branded cards.

Consolidation and basis of presentation

The consolidated financial statements include the accounts of Mastercard and its majority-owned and controlled entities, including any variable interest entities (“VIEs”) for which the Company is the primary beneficiary. As of September 30, 2016 and December 31, 2015, there were no significant VIEs which required consolidation. Intercompany transactions and balances have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform to the 2016 presentation. The Company follows accounting principles generally accepted in the United States of America (“GAAP”).

The balance sheet as of December 31, 2015 was derived from the audited consolidated financial statements as of December 31, 2015. The consolidated financial statements for the three and nine months ended September 30, 2016 and 2015 and as of September 30, 2016 are unaudited, and in the opinion of management, include all normal recurring adjustments that are necessary to present fairly the results for interim periods. The results of operations for the three and nine months ended September 30, 2016 are not necessarily indicative of the results to be expected for the full year.

The accompanying unaudited consolidated financial statements are presented in accordance with the U.S. Securities and Exchange Commission requirements for Quarterly Reports on Form 10-Q. Reference should be made to the Mastercard Incorporated Annual Report on Form 10-K for the year ended December 31, 2015 for additional disclosures, including a summary of the Company’s significant accounting policies.

Non-controlling interest amounts are included in the consolidated statement of operations within other income (expense). For the three and nine months ended September 30, 2016 and 2015, activity from non-controlling interests was insignificant.

Recent accounting pronouncements

Intra-entity asset transfers - In October 2016, the Financial Accounting Standards Board (“FASB”) issued accounting guidance to simplify the accounting for income tax consequences of intra-entity transfers of assets other than inventory. Under this guidance, companies will be required to recognize the income tax consequences of an intra-entity asset transfer when the transfer occurs. The guidance must be applied on a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the period of adoption. The Company is in the process of evaluating the impacts this guidance will have on its consolidated financial statements. However, the Company expects that it will recognize a cumulative-effect adjustment to retained earnings upon adoption of the new guidance related to intra-entity asset transfers occurring before adoption. The guidance is effective for periods beginning after December 15, 2017 and early adoption is permitted.

Share-Based Payments - In March 2016, the FASB issued accounting guidance related to share-based payments to employees. Under this guidance, companies will be required to recognize the tax effects of exercised or vested awards within the income statement, in the period in which they occur, rather than within additional paid-in-capital. In addition, the guidance changes the

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MASTERCARD INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

limit that companies are allowed to withhold for employees without triggering liability accounting and allows companies to make a policy election to either recognize forfeitures as they occur or estimate them. The guidance is effective for periods beginning after December 15, 2016 and early adoption is permitted. The required transition methods for each aspect of the guidance varies between prospective, retrospective and modified retrospective. The Company will adopt the accounting guidance effective January 1, 2017 and the impact on the tax provision during the period will be dependent upon several factors including, the amount and grant value of equity awards that either vest or are exercised, in addition to, Mastercard’s share price on those dates.

Leases - In February 2016, the FASB issued accounting guidance that will change how companies account for and present lease arrangements. The guidance requires companies to recognize leased assets and liabilities for both capital and operating leases. The guidance is effective for periods after December 15, 2018 and early adoption is permitted. Companies are required to adopt the guidance using a modified retrospective method. The Company is in the process of evaluating the potential effects this guidance will have on its consolidated financial statements.

Debt Issuance Costs - In April 2015, the FASB issued accounting guidance that changed the current presentation of debt issuance costs on the balance sheet. This guidance moved debt issuance costs from the assets section of the balance sheet to the liabilities section as a direct deduction from the carrying amount of the debt issued. The Company adopted the accounting guidance effective January 1, 2016. The Company applied the guidance retrospectively and, as such, the December 31, 2015 balance sheet was adjusted to reflect the effects of the standard. This retrospective adjustment resulted in reductions of prepaid expenses and other current assets, other assets and long-term debt by $1 million, $18 million and $19 million, respectively. As of September 30, 2016, $18 million of debt issuance costs were classified as an offset to long-term debt.

Revenue Recognition - In May 2014, the FASB issued accounting guidance that provides a single, comprehensive revenue recognition model for all contracts with customers and supersedes most of the existing revenue recognition requirements. Under this guidance, an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued accounting guidance that delayed the effective date of this standard by one year, making the guidance effective for fiscal years beginning after December 15, 2017. The Company will adopt the accounting guidance effective January 1, 2018. The accounting guidance permits either a full retrospective or modified retrospective transition method. The new revenue guidance will impact the timing of recognition for certain of the Company’s customer incentives. Under the new guidance, the Company will recognize certain customer incentives over the life of the contract as revenue is recognized versus as they are earned by the customer. The Company is in the process of evaluating the potential effects this guidance will have on its consolidated financial statements and which method of adoption it will select.

Note 2. Acquisitions

On July 21, 2016, Mastercard entered into a definitive agreement to acquire a 92.4% controlling interest in VocaLink Holdings Limited (“VocaLink”) for approximately £700 million (approximately $910 million as of September 30, 2016) after adjusting for cash and certain other estimated liabilities. VocaLink’s existing shareholders have the potential for an earn-out of up to an additional £169 million (approximately $220 million as of September 30, 2016) if certain performance targets are met. Under the agreement, a majority of VocaLink’s shareholders will retain 7.6% ownership for at least three years. VocaLink operates payments clearing systems and ATM switching platforms in the U.K., as well as several other regions. While the Company anticipates completing the transaction by about the middle of 2017, it is subject to regulatory approval and other customary closing conditions.

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MASTERCARD INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

Note 3. Earnings Per Share

The components of basic and diluted earnings per share (“EPS”) for common stock were as follows:



	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
	(in millions, except per share data)
Numerator:
Net income	$	1,184	$	977	$	3,126	$	2,918
Denominator:
Basic weighted-average shares outstanding	1,096		1,130		1,101		1,136
Dilutive stock options and stock units	3		3		3		3
Diluted weighted-average shares outstanding¹	1,099		1,133		1,104		1,139
Earnings per Share:
Basic	$	1.08	$	0.86	$	2.84	$	2.57
Diluted	$	1.08	$	0.86	$	2.83	$	2.56

¹ For the periods presented, the calculation of diluted EPS excluded a minimal amount of anti-dilutive share-based payment awards.

Note 4. Fair Value and Investment Securities

Financial Instruments – Recurring Measurements

The Company classifies its fair value measurements of financial instruments into a three-level hierarchy (the “Valuation Hierarchy”). There were no transfers made among the three levels in the Valuation Hierarchy during the three and nine months ended September 30, 2016.

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MASTERCARD INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

The distribution of the Company’s financial instruments which are measured at fair value on a recurring basis within the Valuation Hierarchy was as follows:



	September 30, 2016
	Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)		Fair Value
	(in millions)
Municipal securities	$	—	$	57		$	—	$	57
Government and agency securities¹	36		125			—		161
Corporate securities	—		905			—		905
Asset-backed securities	—		86			—		86
Other	2		(31		)	—		(29		)
Total	$	38	$	1,142		$	—	$	1,180

	December 31, 2015
	Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)		Fair Value
	(in millions)
Municipal securities	$	—	$	62		$	—	$	62
Government and agency securities ¹	31		64			—		95
Corporate securities	—		645			—		645
Asset-backed securities	—		57			—		57
Other	2		14			—		16
Total	$	33	$	842		$	—	$	875

¹Excludes amounts held in escrow related to the U.S. merchant class litigation settlement of $543 million and $541 million at September 30, 2016 and December 31, 2015, respectively, which would be included in Level 1 of the Valuation Hierarchy. See Note 6 (Accrued Expenses and Accrued Litigation) and Note 11 (Legal and Regulatory Proceedings) for further details.

The fair value of the Company’s available-for-sale municipal securities, government and agency securities, corporate securities and asset-backed securities are based on quoted prices for similar assets in active markets and are therefore included in Level 2 of the Valuation Hierarchy. The Company’s foreign currency derivative asset and liability contracts have also been classified within Level 2 in the Other category of the Valuation Hierarchy, as the fair value is based on broker quotes for the same or similar derivative instruments. See Note 13 (Foreign Exchange Risk Management) for further details. The Company’s U.S. government securities and marketable equity securities are classified within Level 1 of the Valuation Hierarchy as the fair values are based on unadjusted quoted prices for identical assets in active markets.

Financial Instruments - Non-Recurring Measurements

Certain financial instruments are carried on the consolidated balance sheet at cost, which approximates fair value due to their short-term, highly liquid nature. These instruments include cash and cash equivalents, restricted cash, time deposits, accounts receivable, settlement due from customers, restricted security deposits held for customers, accounts payable, settlement due to customers and accrued expenses. In addition, nonmarketable equity investments are measured at fair value on a nonrecurring basis for purposes of initial recognition and impairment testing.

Investments on the consolidated balance sheet include both available-for-sale and short-term held-to-maturity securities. Available-for-sale securities are measured at fair value on a recurring basis and are included in the Valuation Hierarchy table above. Short-term held-to-maturity securities are made up of time deposits with maturities of greater than three months and less than one year and are classified as Level 2 of the Valuation Hierarchy, but are not included in the table above due to their fair values not being measured on a recurring basis. At September 30, 2016 and December 31, 2015, the cost, which approximates fair value, of the Company’s short-term held-to-maturity securities was $563 million and $130 million, respectively. In addition,

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MASTERCARD INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

at September 30, 2016, the Company held $62 million of long-term held-to-maturity securities classified in other assets on the consolidated balance sheet, the cost of which approximates fair value.

Debt

The Company estimates the fair value of its long-term debt using the market pricing approach which applies market assumptions for relevant though not directly comparable undertakings. Long-term debt is classified as Level 2 of the Valuation Hierarchy. At September 30, 2016, the carrying value and fair value of long-term debt was $3.3 billion and $3.6 billion, respectively. At December 31, 2015, the carrying value and fair value of long-term debt was $3.3 billion.

Settlement and Other Guarantee Liabilities

The Company estimates the fair value of its settlement and other guarantees using the market pricing approach which applies market assumptions for relevant though not directly comparable undertakings, as the latter are not observable in the market given the proprietary nature of such guarantees. At September 30, 2016 and December 31, 2015, the carrying value and fair value of settlement and other guarantee liabilities were not material. Settlement and other guarantee liabilities are classified as Level 3 of the Valuation Hierarchy as their valuation requires substantial judgment and estimation of factors that are not currently observable in the market. For additional information regarding the Company’s settlement and other guarantee liabilities, see Note 12 (Settlement and Other Risk Management).

Non-Financial Instruments

Certain assets are measured at fair value on a nonrecurring basis for purposes of initial recognition and impairment testing. The Company’s non-financial assets measured at fair value on a nonrecurring basis include property, plant and equipment, goodwill and other intangible assets. These assets are subject to fair value adjustments in certain circumstances, such as when there is evidence of impairment.

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Amortized Costs and Fair Values – Available-for-Sale Investment Securities

The major classes of the Company’s available-for-sale investment securities, for which unrealized gains and losses are recorded as a separate component of other comprehensive income on the consolidated statement of comprehensive income, and their respective amortized cost basis and fair values as of September 30, 2016 and December 31, 2015 were as follows:



	September 30, 2016
	Amortized Cost		Gross Unrealized Gain		Gross Unrealized Loss			Fair Value
	(in millions)
Municipal securities	$	57	$	—	$	—		$	57
Government and agency securities	160		1		—			161
Corporate securities	901		4		—			905
Asset-backed securities	86		—		—			86
Other	2		—		—			2
Total	$	1,206	$	5	$	—		$	1,211

	December 31, 2015
	Amortized Cost		Gross Unrealized Gain		Gross Unrealized Loss			Fair Value
	(in millions)
Municipal securities	$	62	$	—	$	—		$	62
Government and agency securities	94		1		—			95
Corporate securities	646		—		(1		)	645
Asset-backed securities	57		—		—			57
Other	2		—		—			2
Total	$	861	$	1	$	(1	)	$	861

The Company’s available-for-sale investment securities held at September 30, 2016, primarily carried a credit rating of A-, or better. The municipal securities are primarily comprised of tax-exempt bonds and are diversified across states and sectors. Government and agency securities include U.S. government bonds, U.S. government sponsored agency bonds and foreign government bonds with similar credit quality to that of the U.S. government bonds. Corporate securities are comprised of commercial paper and corporate bonds. The asset-backed securities are investments in bonds which are collateralized primarily by automobile loan receivables.

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Investment Maturities

The maturity distribution based on the contractual terms of the Company’s investment securities at September 30, 2016 was as follows:



	Available-For-Sale
	Amortized Cost		Fair Value
	(in millions)
Due within 1 year	$	475	$	475
Due after 1 year through 5 years	724		728
Due after 5 years through 10 years	1		1
Due after 10 years	5		5
No contractual maturity ¹	1		2
Total	$	1,206	$	1,211

¹Equity securities have been included in the No contractual maturity category, as these securities do not have stated maturity dates.

Investment Income

Investment income primarily consists of interest income generated from cash, cash equivalents and investments. Gross realized gains and losses are recorded within investment income on the Company’s consolidated statement of operations. The gross realized gains and losses from the sales of available-for-sale securities for the three and nine months ended September 30, 2016 and 2015 were not significant.

Note 5. Prepaid Expenses and Other Assets

Prepaid expenses and other current assets consisted of the following:



	September 30, 2016		December 31, 2015
	(in millions)
Customer and merchant incentives	$	442	$	345
Prepaid income taxes	146		72
Other	234		246
Total prepaid expenses and other current assets	$	822	$	663

Other assets consisted of the following:



	September 30, 2016		December 31, 2015
	(in millions)
Customer and merchant incentives	$	1,126	$	810
Nonmarketable equity investments	149		166
Prepaid income taxes	351		352
Income taxes receivable	172		160
Other	163		92
Total other assets	$	1,961	$	1,580

Customer and merchant incentives represent payments made or amounts to be paid to customers and merchants under business agreements. Costs directly related to entering into such an agreement are generally deferred and amortized over the life of the agreement. Amounts to be paid for these incentives and the related liability were included in accrued expenses and other liabilities.

Non-current prepaid income taxes, included in the other asset table above, primarily consists of taxes paid in 2014 relating to the deferred charge on intercompany profits resulting from the reorganization of the Company’s legal entity and tax structure to better align with the business footprint of its non-U.S. operations. This deferred charge is amortized over 25 years.

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Note 6. Accrued Expenses and Accrued Litigation

Accrued expenses consisted of the following:



	September 30, 2016		December 31, 2015
	(in millions)
Customer and merchant incentives	$	2,326	$	1,748
Personnel costs	389		473
Advertising	56		114
Income and other taxes	162		143
Other	281		285
Total accrued expenses	$	3,214	$	2,763

As of September 30, 2016 and December 31, 2015, the Company’s provision for litigation was $716 million and $709 million, respectively. These amounts are not included in the accrued expenses table above and are separately reported as accrued litigation on the consolidated balance sheet. See Note 11 (Legal and Regulatory Proceedings) for further discussion of the U.S. merchant class litigation and the U.K. merchant litigation which relate to these accruals.

Note 7. Stockholders’ Equity

The Company’s Board of Directors has approved share repurchase programs authorizing the Company to repurchase its Class A common stock. The Company typically completes a share repurchase program before a new program becomes effective. The following table summarizes the Company’s share repurchase authorizations of its Class A common stock through September 30, 2016, as well as historical purchases:



	Authorization Dates
	December 2015		December 2014		December 2013		Total
	(in millions, except average price data)
Board authorization	$	4,000	$	3,750	$	3,500	$	11,250
Dollar value of shares repurchased during the nine months ended September 30, 2015	$	—	$	2,450	$	275	$	2,725
Remaining authorization at December 31, 2015	$	4,000	$	507	$	—	$	4,507
Dollar value of shares repurchased during the nine months ended September 30, 2016	$	1,903	$	507	$	—	$	2,410
Remaining authorization at September 30, 2016	$	2,097	$	—	$	—	$	2,097
Shares repurchased during the nine months ended September 30, 2015	—		27.0		3.2		30.2
Average price paid per share during the nine months ended September 30, 2015	$	—	$	90.87	$	84.31	$	90.16
Shares repurchased during the nine months ended September 30, 2016	20.6		5.7		—		26.3
Average price paid per share during the nine months ended September 30, 2016	$	92.35	$	89.76	$	—	$	91.80
Cumulative shares repurchased through September 30, 2016	20.6		40.8		45.8		107.2
Cumulative average price paid per share	$	92.35	$	92.03	$	76.42	$	85.42

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Note 8. Accumulated Other Comprehensive Income (Loss)

The changes in the balances of each component of accumulated other comprehensive income (loss), net of tax, for the nine months ended September 30, 2016 and 2015 were as follows:



	Foreign Currency Translation Adjustments			Translation Adjustments on Net Investment Hedge			Defined Benefit Pension and Other Postretirement Plans			Investment Securities Available-for-Sale			Accumulated Other Comprehensive Income (Loss)
	(in millions)
Balance at December 31, 2014	$	(230	)	$	—		$	(26	)	$	(4	)	$	(260	)
Current period other comprehensive income (loss) ^1,2,3	(300		)	—			34			(10		)	(276		)
Balance at September 30, 2015	$	(530	)	$	—		$	8		$	(14	)	$	(536	)

Balance at December 31, 2015	$	(663	)	$	(26	)	$	13		$	—		$	(676	)
Current period other comprehensive income (loss) ^1,3	(7		)	(36		)	(1		)	3			(41		)
Balance at September 30, 2016	$	(670	)	$	(62	)	$	12		$	3		$	(717	)

¹For the nine months ended September 30, 2016 and 2015, gains and losses on available-for-sale investment securities, reclassified from accumulated other comprehensive income (loss) to investment income, were not significant.

²During the nine months ended September 30, 2015, the increase in other comprehensive loss related to foreign currency translation adjustments was driven primarily by the euro.

³ During the nine months ended September 30, 2015, $41 million of deferred costs ($26 million after-tax) related to the Company’s defined benefit pension plan and other post retirement plans were reclassified to general and administrative expenses. These deferred costs were primarily due to the termination of the Company's U.S. defined benefit plan. For the nine months ended September 30, 2016, deferred costs related to the Company’s postretirement plans, reclassified from accumulated other comprehensive income (loss) to earnings, were not significant.

Note 9. Share-Based Payments

During the nine months ended September 30, 2016, the Company granted the following awards under the MasterCard Incorporated 2006 Long Term Incentive Plan, as amended and restated (“LTIP”). The LTIP is a shareholder-approved plan that permits the grant of various types of equity awards to employees.



	Granted in 2016	Weighted-Average Grant-Date Fair Value
	(in millions)
Non-qualified stock options	1.7	$19
Restricted stock units	1.4	$88
Performance stock units	0.2	$92

Stock options generally vest in four equal annual installments beginning one year after the date of grant and have a term of ten years. The Company used the Black-Scholes option pricing model to estimate the grant date fair value of stock options and calculated the expected term and the expected volatility based on historical Mastercard information. As a result, the expected term of stock options granted in 2016 was five years, while the expected volatility was determined to be 23.3%.

Vesting of the shares underlying the restricted stock units and performance stock units will generally occur three years after the date of grant. The fair value of restricted stock units is determined and fixed on the grant date based on the Company’s Class A common stock price, adjusted for the exclusion of dividend equivalents. The Monte Carlo simulation valuation model was used to determine the grant date fair value of performance stock units granted.

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Compensation expense is recorded net of estimated forfeitures over the shorter of the vesting period or the date the individual becomes eligible to retire under the LTIP. The Company uses the straight-line method of attribution over the requisite service period for expensing equity awards.

Note 10. Income Taxes

The effective income tax rates were 27.5% and 27.7% for the three months ended September 30, 2016 and 2015, respectively. The effective income tax rates were 27.9% and 25.8% for the nine months ended September 30, 2016 and 2015, respectively. For the three months ended September 30, 2016, the reduction in the effective tax rate versus the comparable period in 2015 was due to various discrete benefits recognized in the period, which were partially offset by a lower repatriation benefit. For the nine months ended September 30, 2016, the increase in the effective tax rate versus the comparable period in 2015 was due to the lapping of discrete benefits recognized in 2015 relating to certain foreign taxes becoming eligible to be claimed as credits in the United States and a lower repatriation benefit in the current year, which were partially offset by a more favorable geographic mix of taxable earnings in 2016.

The Company conducts operations in multiple countries and, as a result, is subjected to tax examinations in various jurisdictions, including the United States. Uncertain tax positions are reviewed on an ongoing basis and are adjusted after considering facts and circumstances, including progress of tax audits, developments in case law and closing of statutes of limitations. Within the next twelve months, the Company believes that the resolution of certain federal, foreign and state and local tax examinations are reasonably possible and that a change in estimate may occur. While such a change may be significant, it is not possible to provide a range of the potential change until the examinations progress further or the related statutes of limitation expire. The Company has effectively settled its U.S. federal income tax obligations through 2008, with the exception of transfer pricing issues which are settled through 2011. With limited exception, the Company is no longer subject to state and local or foreign examinations by tax authorities for years before 2009.

Note 11. Legal and Regulatory Proceedings

Mastercard is a party to legal and regulatory proceedings with respect to a variety of matters in the ordinary course of business. Some of these proceedings are based on complex claims involving substantial uncertainties and unascertainable damages. Accordingly, except as discussed below, it is not possible to determine the probability of loss or estimate damages, and therefore, Mastercard has not established reserves for any of these proceedings. When the Company determines that a loss is both probable and reasonably estimable, Mastercard records a liability and discloses the amount of the liability if it is material. When a material loss contingency is only reasonably possible, Mastercard does not record a liability, but instead discloses the nature and the amount of the claim, and an estimate of the loss or range of loss, if such an estimate can be made. Unless otherwise stated below with respect to these matters, Mastercard cannot provide an estimate of the possible loss or range of loss based on one or more of the following reasons: (1) actual or potential plaintiffs have not claimed an amount of monetary damages or the amounts are unsupportable or exaggerated, (2) the matters are in early stages, (3) there is uncertainty as to the outcome of pending appeals or motions, (4) there are significant factual issues to be resolved, (5) the existence in many such proceedings of multiple defendants or potential defendants whose share of any potential financial responsibility has yet to be determined, and/or (6) there are novel legal issues presented. Furthermore, except as identified with respect to the matters below, Mastercard does not believe that the outcome of any individual existing legal or regulatory proceeding to which it is a party will have a material adverse effect on its results of operations, financial condition or overall business. However, an adverse judgment or other outcome or settlement with respect to any proceedings discussed below could result in fines or payments by Mastercard and/or could require Mastercard to change its business practices. In addition, an adverse outcome in a regulatory proceeding could lead to the filing of civil damage claims and possibly result in significant damage awards. Any of these events could have a material adverse effect on Mastercard’s results of operations, financial condition and overall business.

Interchange Litigation and Regulatory Proceedings

Mastercard’s interchange fees and other practices are subject to regulatory and/or legal review and/or challenges in a number of jurisdictions, including the proceedings described below. When taken as a whole, the resulting decisions, regulations and legislation with respect to interchange fees and acceptance practices may have a material adverse effect on the Company’s prospects for future growth and its overall results of operations, financial position and cash flows.

United States. In June 2005, the first of a series of complaints were filed on behalf of merchants (the majority of the complaints were styled as class actions, although a few complaints were filed on behalf of individual merchant plaintiffs) against Mastercard

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International, Visa U.S.A., Inc., Visa International Service Association and a number of financial institutions. Taken together, the claims in the complaints were generally brought under both Sections 1 and 2 of the Sherman Act, which prohibit monopolization and attempts or conspiracies to monopolize a particular industry, and some of these complaints contain unfair competition law claims under state law. The complaints allege, among other things, that Mastercard, Visa, and certain financial institutions conspired to set the price of interchange fees, enacted point of sale acceptance rules (including the no surcharge rule) in violation of antitrust laws and engaged in unlawful tying and bundling of certain products and services. The cases were consolidated for pre-trial proceedings in the U.S. District Court for the Eastern District of New York in MDL No. 1720. The plaintiffs filed a consolidated class action complaint that seeks treble damages.

In July 2006, the group of purported merchant class plaintiffs filed a supplemental complaint alleging that Mastercard’s initial public offering of its Class A Common Stock in May 2006 (the “IPO”) and certain purported agreements entered into between Mastercard and financial institutions in connection with the IPO: (1) violate U.S. antitrust laws and (2) constituted a fraudulent conveyance because the financial institutions allegedly attempted to release, without adequate consideration, Mastercard’s right to assess them for Mastercard’s litigation liabilities. The class plaintiffs sought treble damages and injunctive relief including, but not limited to, an order reversing and unwinding the IPO.

In February 2011, Mastercard and Mastercard International entered into each of: (1) an omnibus judgment sharing and settlement sharing agreement with Visa Inc., Visa U.S.A. Inc. and Visa International Service Association and a number of financial institutions; and (2) a Mastercard settlement and judgment sharing agreement with a number of financial institutions. The agreements provide for the apportionment of certain costs and liabilities which Mastercard, the Visa parties and the financial institutions may incur, jointly and/or severally, in the event of an adverse judgment or settlement of one or all of the cases in the merchant litigations. Among a number of scenarios addressed by the agreements, in the event of a global settlement involving the Visa parties, the financial institutions and Mastercard, Mastercard would pay 12% of the monetary portion of the settlement. In the event of a settlement involving only Mastercard and the financial institutions with respect to their issuance of Mastercard cards, Mastercard would pay 36% of the monetary portion of such settlement.

In October 2012, the parties entered into a definitive settlement agreement with respect to the merchant class litigation (including with respect to the claims related to the IPO) and the defendants separately entered into a settlement agreement with the individual merchant plaintiffs. The settlements included cash payments that were apportioned among the defendants pursuant to the omnibus judgment sharing and settlement sharing agreement described above. Mastercard also agreed to provide class members with a short-term reduction in default credit interchange rates and to modify certain of its business practices, including its No Surcharge Rule. Objections to the settlement were filed by both merchants and certain competitors, including Discover. Discover’s objections included a challenge to the settlement on the grounds that certain of the rule changes agreed to in the settlement constitute a restraint of trade in violation of Section 1 of the Sherman Act. The court granted final approval of the settlement in December 2013, and objectors to the settlement appealed that decision to the U.S. Court of Appeals for the Second Circuit. In June 2016, the court of appeals vacated the class action certification, reversed the settlement approval and sent the case back to the district court for further proceedings. The court of appeals’ ruling was based primarily on whether the merchants were adequately represented by counsel in the settlement.

Prior to the reversal of the settlement approval, merchants representing slightly more than 25% of the Mastercard and Visa purchase volume over the relevant period chose to opt out of the class settlement. Mastercard had anticipated that most of the larger merchants who opted out of the settlement would initiate separate actions seeking to recover damages, and over 30 opt-out complaints have been filed on behalf of numerous merchants in various jurisdictions. Mastercard has executed settlement agreements with a number of opt-out merchants. Mastercard believes these settlement agreements are not impacted by the ruling of the court of appeals. The defendants have consolidated all of these matters (except for one state court action in New Mexico) in front of the same federal district court that approved the merchant class settlement. In July 2014, the district court denied the defendants’ motion to dismiss the opt-out merchant complaints for failure to state a claim. Deposition discovery in these actions and the class action is scheduled to commence in December 2016.

As of September 30, 2016, Mastercard had accrued a liability of $705 million as a reserve for both the merchant class litigation and the filed and anticipated opt-out merchant cases. As of September 30, 2016 and December 31, 2015, Mastercard had $543 million and $541 million, respectively, in a qualified cash settlement fund related to the merchant class litigation and classified as restricted cash on its balance sheet. Mastercard believes the reserve for both the merchant class litigation and the filed and anticipated opt-out merchants represents its best estimate of its probable liabilities in these matters at September 30, 2016. The portion of the accrued liability relating to both the opt-out merchants and the merchant class litigation settlement does not

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represent an estimate of a loss, if any, if the matters were litigated to a final outcome. Mastercard cannot estimate the potential liability if that were to occur.

Canada. In December 2010, a proposed class action complaint was commenced against Mastercard in Quebec on behalf of Canadian merchants. That suit essentially repeated the allegations and arguments of a previously filed application by the Canadian Competition Bureau to the Canadian Competition Tribunal (dismissed in Mastercard’s favor) concerning certain Mastercard rules related to point-of-sale acceptance, including the “honor all cards” and “no surcharge” rules. The Quebec suit sought compensatory and punitive damages in unspecified amounts, as well as injunctive relief. In the first half of 2011, additional purported class action lawsuits were commenced in British Columbia and Ontario against Mastercard, Visa and a number of large Canadian financial institutions. The British Columbia suit seeks compensatory damages in unspecified amounts, and the Ontario suit seeks compensatory damages of $5 billion on the basis of alleged conspiracy and various alleged breaches of the Canadian Competition Act. The British Columbia and Ontario suits also seek punitive damages in unspecified amounts, as well as injunctive relief, interest and legal costs. The Quebec suit was later amended to include the same defendants and similar claims as in the British Columbia and Ontario suits. Additional purported class action complaints have been commenced in Saskatchewan and Alberta with claims that largely mirror those in the British Columbia, Ontario and Quebec suits. With respect to the status of the proceedings: (1) several of the merchants’ claims in the British Columbia case have been allowed to proceed on a class basis, and a trial date has been set for September 2018, (2) the class certification hearing in the Quebec suit is scheduled for November 2017 and (3) the Ontario, Saskatchewan and Alberta suits are temporarily suspended while the British Columbia suit proceeds.

Europe. In July 2015, the European Commission issued a Statement of Objections related to Mastercard’s interregional interchange fees and central acquiring rules within the European Economic Area. The Statement of Objections, which follows an investigation opened in 2013, includes preliminary conclusions concerning the anticompetitive effects of these practices. The European Commission has indicated it intends to seek fines if these conclusions are subsequently confirmed. Although the Statement of Objections does not quantify the level of fines, it is possible that they could be substantial. In April 2016, Mastercard submitted a response to the Statement of Objections disputing the Commission’s preliminary conclusions and participated in a related oral hearing in May 2016.

In the United Kingdom, beginning in May 2012, a number of retailers filed claims or threatened litigation against Mastercard seeking damages for alleged anti-competitive conduct with respect to Mastercard’s cross-border interchange fees and its U.K. and Ireland domestic interchange fees (the “U.K. Merchant claimants”), with claimed purported damages exceeding $1 billion. The U.K. Merchant Claimants (including all resolved matters) represent approximately 40% of Mastercard’s U.K. interchange volume over the relevant damages period. Additional merchants have filed or threatened litigation with respect to interchange rates in Europe (the “Pan-European claimants”) for purported damages exceeding $1 billion. In June 2015, Mastercard entered into a settlement with one of the U.K. Merchant claimants for $61 million, recorded as a provision for litigation settlement. Mastercard has submitted statements of defense to the remaining retailers’ claims disputing liability and damages. Following the conclusion of a trial for liability and damages for one of the U.K. merchant cases, in July 2016, the tribunal issued a judgment against Mastercard for damages. Mastercard has sought permission from the court to appeal this judgment. Mastercard recorded a litigation provision of $107 million in the second quarter of 2016, that includes the amount of the judgment and related legal fees and costs. In October 2016, a liability hearing concluded in a separate action brought on behalf of 11 merchants. If liability is found in this action, the hearing related to damages is not scheduled to start until early 2018.

With respect to the remaining U.K. Merchant claimants’ litigations, Mastercard believes that it is reasonably possible that it could incur a loss and estimates the lower end of a negotiated settlement could result in a loss of approximately $300 million. This revised estimate involves significant judgment and may change from time to time due to the varying stages of the U.K. Merchant claimants’ litigations, the filing of claims by additional U.K. merchants, progress in settlement negotiations and the potential uncertainty of numerous unresolved legal issues. As such, subsequent progress in negotiations and/or decisions by courts could increase or decrease this estimate. The above estimate relates only to potential settlements, and Mastercard cannot estimate the potential liability, if any, if the remaining U.K. Merchant claimant litigations are litigated to a final decision. At this time, Mastercard is unable to estimate a probable loss for the matters, if any, and accordingly has not accrued for any loss.

In September 2016, a proposed collective action was filed in the United Kingdom on behalf of U.K. consumers seeking damages for intra-EEA and domestic U.K. interchange fees that were allegedly passed on to consumers by merchants between 1992 and 2008. The complaint, which seeks to leverage the European Commission’s 2007 decision on intra-EEA interchange fees, claims damages in an amount that exceeds £14 billion (approximately $18 billion). The court has scheduled a case management conference for November 2016.

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ATM Non-Discrimination Rule Surcharge Complaints

In October 2011, a trade association of independent Automated Teller Machine (“ATM”) operators and 13 independent ATM operators filed a complaint styled as a class action lawsuit in the U.S. District Court for the District of Columbia against both Mastercard and Visa (the “ATM Operators Complaint”). Plaintiffs seek to represent a class of non-bank operators of ATM terminals that operate in the United States with the discretion to determine the price of the ATM access fee for the terminals they operate. Plaintiffs allege that Mastercard and Visa have violated Section 1 of the Sherman Act by imposing rules that require ATM operators to charge non-discriminatory ATM surcharges for transactions processed over Mastercard’s and Visa’s respective networks that are not greater than the surcharge for transactions over other networks accepted at the same ATM. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys’ fees. Plaintiffs have not quantified their damages although they allege that they expect damages to be in the tens of millions of dollars.

Subsequently, multiple related complaints were filed in the U.S. District Court for the District of Columbia alleging both federal antitrust and multiple state unfair competition, consumer protection and common law claims against Mastercard and Visa on behalf of putative classes of users of ATM services (the “ATM Consumer Complaints”). The claims in these actions largely mirror the allegations made in the ATM Operators Complaint, although these complaints seek damages on behalf of consumers of ATM services who pay allegedly inflated ATM fees at both bank and non-bank ATM operators as a result of the defendants’ ATM rules. Plaintiffs seek both injunctive and monetary relief equal to treble the damages they claim to have sustained as a result of the alleged violations and their costs of suit, including attorneys’ fees. Plaintiffs have not quantified their damages although they allege that they expect damages to be in the tens of millions of dollars.

In January 2012, the plaintiffs in the ATM Operators Complaint and the ATM Consumer Complaints filed amended class action complaints that largely mirror their prior complaints. In February 2013, the district court granted Mastercard’s motion to dismiss the complaints for failure to state a claim. On appeal, the Court of Appeals reversed the district court’s order in August 2015 and sent the case back for further proceedings. In March 2016, certain of the plaintiffs in the ATM Operators Complaint filed a motion seeking a preliminary injunction enjoining the enforcement of the nondiscrimination rules pending the outcome of the litigation. In June 2016, the U.S. Supreme Court agreed to hear oral arguments from Mastercard and its co-defendants in both cases, which is scheduled for December 2016.

U.S. Liability Shift Litigation

In March 2016, a proposed U.S. merchant class action complaint was filed in federal court in California alleging that Mastercard, Visa, American Express and Discover (the “Network Defendants”), EMVCo, and a number of issuing banks (the “Bank Defendants”) engaged in a conspiracy to shift fraud liability for card present transactions from issuing banks to merchants not yet in compliance with the standards for EMV chip cards in the United States (the “EMV Liability Shift”), in violation of the Sherman Act and California law. Plaintiffs allege the damages would be the value of all chargebacks for which class members became liable as a result of the EMV Liability Shift on October 1, 2015. The plaintiffs seek treble damages, attorney’s fees and costs and an injunction against future violations of governing law, and the defendants have filed a motion to dismiss. In September 2016, the court denied the Network Defendants’ motion to dismiss the complaint, but granted such a motion for EMVCo and the Bank Defendants. The case against the Network Defendants is now proceeding with a trial currently scheduled for late 2017.

Note 12. Settlement and Other Risk Management

Mastercard’s rules guarantee the settlement of many of the Mastercard, Cirrus and Maestro branded transactions between its issuers and acquirers (“settlement risk”). Settlement exposure is the outstanding settlement risk to customers under Mastercard’s rules due to the difference in timing between the payment transaction date and subsequent settlement. While the term and amount of the guarantee are unlimited, the duration of settlement exposure is short term and typically limited to a few days. Gross settlement exposure is estimated using the average daily card volume during the quarter multiplied by the estimated number of days to settle. The Company has global risk management policies and procedures, which include risk standards, to provide a framework for managing the Company’s settlement risk. Customer-reported transaction data and the transaction clearing data underlying the settlement exposure calculation may be revised in subsequent reporting periods.

In the event that Mastercard effects a payment on behalf of a failed customer, Mastercard may seek an assignment of the underlying receivables of the failed customer. Customers may be charged for the amount of any settlement loss incurred during these ordinary course activities of the Company.

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The Company’s global risk management policies and procedures are aimed at managing the settlement exposure. These risk management procedures include interaction with the bank regulators of countries in which it operates, requiring customers to make adjustments to settlement processes, and requiring collateral from customers. Mastercard requires certain customers that are not in compliance with the Company’s risk standards in effect at the time of review to post collateral, typically in the form of cash, letters of credit, or guarantees. This requirement is based on management’s review of the individual risk circumstances for each customer that is out of compliance. In addition to these amounts, Mastercard holds collateral to cover variability and future growth in customer programs. The Company may also hold collateral to pay merchants in the event of an acquirer failure. Although the Company is not contractually obligated under its rules to effect such payments to merchants, the Company may elect to do so to protect brand integrity. Mastercard monitors its credit risk portfolio on a regular basis and the adequacy of collateral on hand. Additionally, from time to time, the Company reviews its risk management methodology and standards. As such, the amounts of estimated settlement exposure are revised as necessary.

The Company’s estimated settlement exposure from Mastercard, Cirrus and Maestro branded transactions was as follows:



	September 30, 2016			December 31, 2015
	(in millions)
Gross settlement exposure	$	43,272		$	39,674
Collateral held for settlement exposure	(3,996		)	(3,601		)
Net uncollateralized settlement exposure	$	39,276		$	36,073

General economic and political conditions in countries in which Mastercard operates affect the Company’s settlement risk. Many of the Company’s financial institution customers have been directly and adversely impacted by political instability and uncertain economic conditions. These conditions present increased risk that the Company may have to perform under its settlement guarantee. This risk could increase if political, economic and financial market conditions deteriorate further. The Company’s global risk management policies and procedures are revised and enhanced from time to time. Historically, the Company has experienced a low level of losses from financial institution failures.

Mastercard also provides guarantees to customers and certain other counterparties indemnifying them from losses stemming from failures of third parties to perform duties. This includes guarantees of Mastercard-branded travelers cheques issued, but not yet cashed of $407 million and $420 million at September 30, 2016 and December 31, 2015, respectively, of which $321 million and $332 million at September 30, 2016 and December 31, 2015, respectively, is mitigated by collateral arrangements. In addition, the Company enters into business agreements in the ordinary course of business under which the Company agrees to indemnify third parties against damages, losses and expenses incurred in connection with legal and other proceedings arising from relationships or transactions with the Company. Certain indemnifications do not provide a stated maximum exposure. As the extent of the Company’s obligations under these agreements depends entirely upon the occurrence of future events, the Company’s potential future liability under these agreements is not determinable. Historically, payments made by the Company under these types of contractual arrangements have not been material.

Note 13. Foreign Exchange Risk Management

The Company monitors and manages its exposures as part of its overall risk management program which focuses on the unpredictability of financial markets and seeks to reduce the potentially adverse effects that the volatility of these markets may have on its operating results. A principal objective of the Company’s risk management strategies is to reduce significant, unanticipated earnings fluctuations that may arise from volatility in foreign currency exchange rates principally through the use of derivative instruments.

Derivatives

The Company enters into foreign currency derivative contracts to manage risk associated with anticipated receipts and disbursements which are valued based on currencies other than its functional currencies. The Company may also enter into foreign currency derivative contracts to offset possible changes in value due to foreign exchange fluctuations of earnings, assets and liabilities. The objective of these activities is to reduce the Company’s exposure to gains and losses resulting from fluctuations of foreign currencies against its functional currencies.

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MASTERCARD INCORPORATED

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) – (Continued)

As of September 30, 2016, the majority of derivative contracts to hedge foreign currency fluctuations had been entered into with customers of Mastercard. Mastercard’s derivative contracts are summarized below:



	September 30, 2016					December 31, 2015
	Notional		Estimated Fair Value			Notional		Estimated Fair Value
	(in millions)
Commitments to purchase foreign currency	$	485	$	1		$	232	$	1
Commitments to sell foreign currency	1,195		(32		)	1,430		12
Options to sell foreign currency	—		—			44		1
Balance sheet location:
Accounts receivable ¹			$	13				$	23
Other current liabilities ¹			(44		)			(9		)

¹ The fair values of derivative contracts are presented on a gross basis on the balance sheet and are subject to enforceable master netting arrangements, which contain various netting and setoff provisions.

The amount of gain (loss) recognized in income for the contracts to purchase and sell foreign currency is summarized below:



	Three Months Ended September 30,					Nine Months Ended September 30,
	2016			2015		2016			2015
	(in millions)
Foreign currency derivative contracts
General and administrative	$	(6	)	$	35	$	(42	)	$	57

The fair value of the foreign currency derivative contracts generally reflects the estimated amounts that the Company would receive (or pay), on a pre-tax basis, to terminate the contracts. The terms of the foreign currency derivative contracts are generally less than 18 months. The Company had no deferred gains or losses related to foreign exchange contracts in accumulated other comprehensive income as of September 30, 2016 and December 31, 2015, as these contracts were not accounted for under hedge accounting.

The Company’s derivative financial instruments are subject to both market and counterparty credit risk. Market risk is the risk of loss due to the potential change in an instrument’s value caused by fluctuations in interest rates and other variables related to currency exchange rates. The effect of a hypothetical 10% adverse change in foreign currency forward rates could result in a fair value loss of approximately $82 million on the Company’s foreign currency derivative contracts outstanding at September 30, 2016 related to the hedging program. Counterparty credit risk is the risk of loss due to failure of the counterparty to perform its obligations in accordance with contractual terms. To mitigate counterparty credit risk, the Company enters into derivative contracts with selected financial institutions based upon their credit ratings and other factors. Generally, the Company does not obtain collateral related to derivatives because of the high credit ratings of the counterparties.

Net investment hedge

The Company uses foreign currency denominated debt to hedge a portion of its net investment in foreign operations against adverse movements in exchange rates, with changes in the value of the debt recorded within currency translation adjustment in accumulated other comprehensive income (loss). During the fourth quarter of 2015, the Company designated its €1.65 billion euro-denominated debt as a net investment hedge for a portion of its net investment in European foreign operations. As of September 30, 2016, the Company had a net foreign currency transaction pre-tax loss of $96 million in accumulated other comprehensive income (loss) associated with hedging activity. There was no ineffectiveness in the current period.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following supplements management's discussion and analysis of Mastercard Incorporated for the year ended December 31, 2015 as contained in the Company's Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission on February 12, 2016. 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 (together, “Mastercard” or the “Company”), included elsewhere in this Report. 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. Currency-neutral growth rates exclude the impacts from both translational and transactional foreign currency. Columns labeled “Foreign Currency” within the tables included within represent the impacts from both translational and transactional foreign currency.

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 what we believe is 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 (an individual who holds a card or uses another device enabled for payment), 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 rates charged by acquirers in connection with merchants’ acceptance of our branded cards. In most cases, cardholder relationships belong to, and are managed by, our financial institution customers.

We generate revenue by charging fees primarily 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.

Our Strategy

Our ability to grow our business is influenced by personal consumption expenditure growth, driving cash and check transactions toward electronic forms of payment, increasing our share in electronic payments and providing value-added products and services. We drive growth by growing, diversifying and building our business.

Grow. We focus on growing our core businesses globally, including growing our credit, debit, prepaid and commercial products and solutions and increasing the number of payment transactions we process.

Diversify. We look to diversify our business by focusing on:


•	diversifying our customer base in new and existing markets by working with partners such as governments, merchants, large digital companies and other technology companies, mobile providers and other businesses;


•	encouraging use of our products and solutions in areas that provide new opportunities for electronic payments, such as transit and person-to-person transfers;


•	driving acceptance at small merchants and merchants who have not historically accepted Mastercard products; and


•	broadening financial inclusion for the unbanked and underbanked.

Build. We build our business by:


•	taking advantage of the opportunities presented by evolving ways consumers interact and transact as physical and digital payments converge; and

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•	using our safety and security products and solutions, data analytics and loyalty solutions to add value.

We grow, diversify and build our business through a combination of organic growth and strategic investments, including acquisitions.

Strategic Partners. We work with a variety of stakeholders. We provide financial institutions with solutions to help them increase revenue and increase preference for their Mastercard-branded products. We help merchants by delivering data-driven insights and other services to help them grow and create better and secure purchase experiences for consumers across physical and digital channels. We partner with large digital companies and other technology companies, mobile providers and telecommunication companies to support their digital payment solutions with our technology, expertise and security protocols. We help national 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.

Special Items and Non-GAAP Financial Information

Non-GAAP financial information is defined as a numerical measure of a company’s performance that excludes or includes amounts so as to be different than the most comparable measure calculated and presented in accordance with accounting principles generally accepted in the United States (“GAAP”). See “Financial Results Overview” for the table that provides a reconciliation of the non-GAAP operating results and growth to the most directly comparable GAAP measures. These non-GAAP financial measures exclude the impact of the following special items (“Special Items”):


•	In the second quarter of 2016, the Company recorded a provision for litigation of $107 million ($78 million after tax, or $0.07 per diluted share) related to a judgment issued against the Company in a litigation with a merchant in the U.K.


•	In the second quarter of 2015, the Company recorded a provision for litigation of $61 million ($44 million after tax, or $0.04 per diluted share) related to a settlement with a merchant in the U.K.


•	In the third quarter of 2015, the Company recorded a settlement charge of $79 million ($50 million after tax or $0.04 per diluted share) relating to the termination of its qualified U.S. defined benefit pension plan in general and administrative expenses (the “U.S. Employee Pension Plan Settlement Charge”).

The provisions for litigation for both years discussed above, relate to separate merchant litigations in the U.K. (collectively the “U.K. Merchant Litigation Provision”). See Note 11 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part I, Item I of this Report for further discussion. Mastercard excluded the U.K. Merchant Litigation Provision because its management monitors material litigation judgments and settlements separately from ongoing operations and evaluates ongoing performance without these amounts. The Company also excluded the U.S. Employee Pension Plan Settlement Charge because its management monitors significant one-time items separately from ongoing operations and evaluates ongoing performance without these amounts. For additional discussion regarding the U.S. Employee Pension Plan Settlement Charge, see Note 11 (Pension, Postretirement and Savings Plans) in Part II, Item 8 of the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

In addition, Mastercard presents growth rates on a currency-neutral basis, which is a non-GAAP financial measure. Currency-neutral growth rates are calculated by remeasuring the prior period’s results using the current period’s exchange rates for both the translational and transactional impacts on operating results. The impact of foreign currency translation represents the effect of translating operating results where the functional currency is different than our U.S. dollar reporting currency. The impact of the transactional foreign currency represents the effect of converting revenue and expenses occurring in a currency other than the functional currency. Mastercard’s management believes the presentation of certain currency-neutral growth rates provides relevant information.

Mastercard’s management believes that the non-GAAP financial measures presented facilitate an understanding of Mastercard’s operating performance and provide a meaningful comparison of its results between periods. Mastercard’s management uses non-GAAP financial measures to, among other things, evaluate its ongoing operations in relation to historical results, for internal planning and forecasting purposes and in the calculation of performance-based compensation. The presentation of non-GAAP financial measures should not be considered in isolation or as a substitute for the Company’s related financial results prepared in accordance with GAAP.

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Financial Results Overview

The following table provides a summary of our operating results for the three and nine months ended September 30, 2016 and 2015:



	Three Months Ended September 30,												Percent Increase/(Decrease)
	2016			2015									Percent Increase/(Decrease)
	Actual			Actual			Special Item			Non-GAAP ¹			Actual	Special Item	Non-GAAP ¹
	(in millions, except per share data and percentages)
Net revenue	$	2,880		$	2,530		$	—		$	2,530		14%	—%	14%

Operating expenses	$	1,210		$	1,161		$	(79	)	$	1,082		4%	(8)%	12%
Operating income	$	1,670		$	1,369		$	79		$	1,448		22%	7%	15%
Operating margin	58.0		%	54.1		%				57.2		%

Income tax expense	$	449		$	375		$	29		$	404		20%	9%	11%
Effective income tax rate	27.5		%	27.7		%				28.2		%

Net income	$	1,184		$	977		$	50		$	1,027		21%	6%	15%

Diluted earnings per share	$	1.08		$	0.86		$	0.04		$	0.91		26%	7%	19%
Diluted weighted-average shares outstanding	1,099			1,133						1,133			(3)%		(3)%



	Nine Months Ended September 30,																		Percent Increase/(Decrease)
	2016									2015									Percent Increase/(Decrease)
	Actual			Special Item			Non-GAAP ²			Actual			Special Items			Non-GAAP ^1,2			Actual	Special Items	Non-GAAP ^1,2
	(in millions, except per share data and percentages)
Net revenue	$	8,020		$	—		$	8,020		$	7,150		$	—		$	7,150		12%	—%	12%

Operating expenses	$	3,622		$	(107	)	$	3,515		$	3,179		$	(140	)	$	3,039		14%	(2)%	16%
Operating income	$	4,398		$	107		$	4,505		$	3,971		$	140		$	4,111		11%	1%	10%
Operating margin	54.8		%				56.2		%	55.5		%				57.5		%

Income tax expense	$	1,209		$	29		$	1,238		$	1,015		$	45		$	1,060		19%	2%	17%
Effective income tax rate	27.9		%				27.9		%	25.8		%				26.0		%

Net income	$	3,126		$	78		$	3,204		$	2,918		$	95		$	3,013		7%	1%	6%

Diluted earnings per share	$	2.83		$	0.07		$	2.90		$	2.56		$	0.08		$	2.64		11%	1%	10%
Diluted weighted-average shares outstanding	1,104						1,104			1,139						1,139			(3)%		(3)%

* Tables may not sum due to rounding.

¹ Represents effect of excluding the U.S. Employee Pension Plan Settlement Charge, see “Special Items and Non-GAAP Financial Information” above.

² Represents effect of excluding the U.K. Merchant Litigation Provision, see “Special Items and Non-GAAP Financial Information” above.

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For the three and nine months ended September 30, 2016, we recorded net income of $1.2 billion and $3.1 billion, an increase of 21% and 7%, respectively, versus the comparable periods in the prior year. For the three and nine months ended September 30, 2016, earnings per diluted share was $1.08 and $2.83, up 26% and 11%, respectively, versus the comparable periods in the prior year.

Excluding the impact of Special Items, adjusted net income increased 15% and 6%, or 15% and 8% on a currency-neutral basis, for the three and nine months ended September 30, 2016, respectively, versus the comparable periods in 2015. In addition, for the three and nine months ended September 30, 2016, adjusted earnings per diluted share increased 19% and 10%, or 19% and 12% on a currency-neutral basis, respectively, versus the comparable periods in 2015.

Key highlights for the three and nine months ended September 30, 2016 are as follows:

•

For the three and nine months ended September 30, 2016, our net revenue increased 14% and 12%, respectively, or 14% for both periods on a currency-neutral basis, versus the comparable periods in 2015, primarily driven by increases across our revenue categories, partially offset by higher rebates and incentives. Our processed transactions increased 18% and 15% for the three and nine months ended September 30, 2016, respectively, versus the comparable periods in 2015. On a local currency basis, our worldwide GDV increased 7% and 11%, respectively, and cross border volumes increased 12% for both periods, versus the comparable periods in 2015.

•

For the three and nine months ended September 30, 2016, operating expenses increased 4% and 14%, respectively, versus the comparable periods in 2015. For those same periods, adjusted operating expenses, which excludes the impact of Special Items, increased 12% and 16%, or 12% and 17% on a currency-neutral basis, respectively, versus the comparable periods in 2015. These increases are primarily due to higher personnel costs due to continued investment in our strategic initiatives, as well as higher data processing expenses. In addition, for the three and nine months ended September 30, 2016, the impact from foreign exchange derivative contracts and balance sheet remeasurement increased operating expense growth by 2 and 4 percentage points, respectively, versus the comparable periods in 2015.

•

For the three and nine months ended September 30, 2016, the effective tax rate was 27.5% and 27.9%, respectively. The effective tax rate decreased 0.2 percentage points for the three months ended September 30, 2016 versus the comparable period in 2015, due to various discrete benefits recognized in the period, which were partially offset by a lower repatriation benefit. The effective tax rate increased 2.1 percentage points for the nine months ended September 30, 2016 versus the comparable period in 2015, due to the lapping of foreign tax credits recorded in 2015 and a lower repatriation benefit in the current year, which were partially offset by a more favorable geographic mix of taxable earnings in 2016.

Other financial highlights for the nine months ended September 30, 2016 were as follows:


•	We generated net cash flows from operations of $3.5 billion compared to $3.0 billion for the comparable period in 2015.


•	We repurchased 26.3 million shares and paid dividends of $630 million.

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 38% of total net revenue for the three and nine months ended September 30, 2016 and 39% for the three and nine months ended September 30, 2015. No individual country, other than the United States, generated more than 10% of total net revenue in each 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 trends (including distress in financial markets, turmoil in specific economies around the world and additional government intervention) have impacted the environment in which we operate. Certain of our customers, merchants that accept our brands and cardholders who use our brands, have been directly impacted by these adverse economic conditions.

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

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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 a full 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, 2015.

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 11 (Legal and Regulatory Proceedings) to the consolidated financial statements included in Part I, Item 1 of this Report 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, 2015. 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, 2015 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 foreign currency translation, which represents the effect of translating operating results where the functional currency is different than our U.S. dollar reporting currency.

Our operating results can also be impacted by transactional foreign currency. The impact of transactional foreign currency represents the effect of converting revenue and expenses occurring in a currency other than the functional currency. 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 non-European local currencies and the strengthening or weakening of the euro versus other European local currencies. For example, our billing in Australia is in the U.S. dollar, however, consumer spend in Australia is in the Australian dollar. The foreign currency transactional impact of converting Australian dollars to our U.S. dollar billing currency will have an impact on the revenue generated. 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 nine months ended September 30, 2016, as compared to the same periods in 2015, GDV on a U.S. dollar-converted basis increased 5% and 7%, respectively, while GDV on a local currency basis grew 7% and 11%, respectively. Further, the impact from transactional foreign currency occurs in transaction processing revenue, other revenue and operating expenses when the local currency of these items are different than the functional currency.

The following table provides a summary of the foreign currency translational and transactional impact on growth for the following items in operating results for the three and nine months ended September 30, 2016, versus the comparable periods in 2015:



	Positive (Negative) Impact from Foreign Currency ¹
	Three Months Ended September 30, 2016	Nine Months Ended September 30, 2016
Net Revenue	Less than (1%)	(2)%
Operating Expenses	1%	2%
Net Income	Less than 1%	(2)%

¹ Excludes the impact from Special Items.

In addition, the Company incurs foreign currency gains and losses from remeasuring monetary assets and liabilities that are in a currency other than the functional currency and from remeasuring foreign exchange derivative contracts (collectively “Foreign exchange activity”). The impact of Foreign exchange activity has not been eliminated in our currency-neutral results (see “Non-GAAP Financial Information”) and is recorded in general and administrative expenses. The Company attempts to manage the impact of transactional foreign currency exposures through its foreign exchange risk management activities, which are discussed further in Note 13 (Foreign Exchange Risk Management) to the consolidated financial statements included in Part I, Item 1 of this

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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.

Financial Results

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 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 in which the transaction occurs;


•	volumes/transactions subject to tiered rates;


•	processed or not processed across the Mastercard network;


•	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:

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.

Cross-border volume fees: Cross-border volume fees are charged to issuers and acquirers based on the dollar 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 for the following:


•	Switching fees for the following products and services:


Ø	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’s instructions or applicable rules (also known as “stand-in”).


Ø	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.

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Ø	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.


•	Other Processing fees: We extend our processing capabilities in the payment value chain for issuer and acquirer solutions; payment gateways for e-commerce merchants; and mobile gateways for mobile initiated transactions.


4.	Other revenues: Other revenues consist of other payment-related products and services and are primarily associated with the following:


•	Consulting, data analytic and research fees are primarily generated by Mastercard Advisors, the Company’s professional advisory services group.


•	Safety and security services fees are for products and services we offer to prevent, detect and respond to fraud and to ensure the safety of transactions made on Mastercard products. We work with issuers, merchants and governments to help deploy standards for safe and secure transactions for the global payments system.

•

Loyalty and rewards solution fees are charged to issuers for benefits provided directly to consumers with Mastercard-branded cards, such as access to a global airline lounge network, global and local concierge services, individual insurance coverages, emergency card replacement, emergency cash advance services and a 24-hour cardholder service center. For merchants, we provide targeted offers and rewards campaigns and management services for publishing offers, as well as opportunities for holders of co-brand or loyalty cards and rewards program members to obtain rewards points faster.


•	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 and encashment 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 nine months ended September 30, 2016, gross revenue increased 16% and 14%, respectively, or 16% for both periods on a currency-neutral basis, versus the comparable periods in 2015. Gross revenue growth in the three and nine months ended September 30, 2016 was driven by an increase in transactions, dollar volume of activity on cards carrying our brands, and other payment-related products and services. Rebates and incentives, in the three and nine months ended September 30, 2016, increased 20% for both periods, or 21% and 22%, on a currency-neutral basis, respectively, versus the comparable periods in 2015, primarily due to the impact from new and renewed agreements and increased volumes. Our net revenue for the three and nine months ended September 30, 2016, increased 14% and 12%, respectively, or 14% for both periods on a currency-neutral basis, versus the comparable periods in 2015.

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The following table provides a summary of the trend in volume and transaction growth.



	Three Months Ended September 30,								Nine Months Ended September 30,
	2016				2015				2016				2015
	Growth (USD)		Growth (Local)		Growth (USD)		Growth (Local)		Growth (USD)		Growth (Local)		Growth (USD)		Growth (Local)
Worldwide GDV ¹	5	%	7	%	—	%	13	%	7	%	11	%	1	%	13	%
Asia Pacific/Middle East/Africa	9	%	10	%	3	%	14	%	8	%	12	%	6	%	15	%
Canada	10	%	9	%	(2	)%	18	%	5	%	10	%	1	%	17	%
Europe	2	%	5	%	(6	)%	17	%	7	%	12	%	(7	)%	16	%
Latin America	7	%	14	%	(15	)%	17	%	(1	)%	15	%	(9	)%	16	%
United States	5	%	5	%	8	%	8	%	7	%	7	%	7	%	7	%
Cross-border Volume ¹	9	%	12	%	—	%	16	%	8	%	12	%	1	%	17	%
Processed Transactions			18	%