Mastercard Incorporated — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; balance-sheet comparisons are with December 31, 2017. The interim financial statements are unaudited and were reviewed, not audited, by the independent accountant.
Business context and results
Mastercard operates a global payments technology network, earning revenue from payment volumes, transaction processing and related services. The company reported strong revenue and earnings growth, but higher operating costs and litigation provisions reduced its reported operating margin.
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net revenue | $3.580 billion | $2.734 billion | +31%; +27% currency-neutral |
| Operating income | $1.825 billion | $1.506 billion | +21% |
| Operating margin | 51.0% | 55.1% | Down 4.1 percentage points |
| Net income | $1.492 billion | $1.081 billion | +38% |
| Diluted EPS | $1.41 | $1.00 | +41% |
| Operating cash flow | $1.035 billion | $727 million | +$308 million |
Adjusted, non-GAAP operating margin was 54.2%, down 1.4 percentage points; adjusted diluted EPS was $1.50, up 49% (43% currency-neutral). These measures exclude litigation provisions and should be considered alongside GAAP results.
Revenue drivers and material changes
- All reported revenue categories increased: domestic assessments 23%, cross-border volume fees 26%, transaction processing 27%, and other revenues 33%. Gross dollar volume grew 14% in local currency; cross-border volume grew 21% and switched transactions grew 17% when adjusted for Venezuela deconsolidation.
- Management attributed currency-neutral net revenue growth to core activity, acquisitions (2.5 percentage points) and the new revenue standard (4 percentage points). Rebates and incentives increased 16% reported, or 13% currency-neutral.
- The new revenue standard changed the timing of certain customer incentives and the gross-versus-net presentation of market-development arrangements. It added $107 million to Q1 reported net revenue and $58 million to net income. Mastercard estimated a full-year 2018 increase of approximately $300 million in net revenue and $200 million in operating expenses from the standard; estimates may change.
- Operating expenses rose 43% reported, or 35% excluding special items. Drivers included acquisitions, continued investment and a $100 million contribution to the Mastercard Center for Inclusive Growth, as well as accounting-standard effects.
- The effective tax rate fell to 17.3% from 26.9%, mainly reflecting the lower U.S. statutory corporate tax rate following U.S. tax reform and discrete share-based payment benefits. Accounting for certain tax-reform items remained provisional.
Cash, debt and capital allocation
- Cash and cash equivalents were $6.890 billion; reported cash, cash equivalents and investments totaled $8.3 billion, excluding restricted cash. The company also had $3.8 billion of unused revolving credit capacity and no commercial-paper or revolver borrowings at quarter-end.
- Long-term debt was $6.469 billion, up from $5.424 billion at year-end. Mastercard issued $1 billion of notes in February 2018, due in 2028 and 2048. The earliest principal maturity is 2019.
- Operating cash flow was $1.035 billion; investing activities provided $367 million and financing activities used $665 million. Financing included $1.352 billion of share repurchases and $263 million of dividends, partly offset by debt proceeds.
- Quarter-end current assets were $14.707 billion and current liabilities were $8.948 billion. Management stated existing liquidity, cash generation, borrowing capacity and capital-market access were sufficient for anticipated operating and other requirements.
- Mastercard repurchased 7.9 million shares at an average $171.52 per share and had $3.882 billion remaining under its active repurchase authorization. The quarterly dividend was $0.25 per share.
Outlook, risks and contingencies
- The filing provides no specific company-wide revenue, earnings or margin guidance. Management cited continued growth opportunities in electronic payments, digital services and other payment flows, while cautioning that economic recovery and the business environment remain uncertain.
- Interchange regulation and litigation remain significant exposures. At March 31, the company had accrued $737 million for U.S. merchant class and opt-out cases and $828 million in total accrued litigation. It held $548 million in restricted cash for the U.S. merchant class matter. Mastercard said the reserve is its best estimate of probable liabilities, not an estimate of possible loss if the cases proceed to final judgment.
- A European Commission proceeding concerning interregional interchange fees and central acquiring rules could result in fines potentially exceeding $1 billion if there is an adverse decision; the company could not estimate a loss range. It expected greater clarity in Q2 or Q3 2018. U.K. and Pan-European merchant claims also involve substantial claimed damages; Q1 included $19 million of U.K. and $70 million of Pan-European settlement provisions.
- Mastercard guarantees settlement of many network transactions. Estimated gross settlement exposure was $47.157 billion, with $4.816 billion of collateral and $42.341 billion net uncollateralized exposure. Historical losses have been low, but adverse customer, regional or global conditions could increase risk.
- Other key risks include competition and pricing pressure, customer concentration, cybersecurity and service disruptions, foreign-exchange volatility, regulation, tax uncertainty and economic or political developments. A hypothetical 10% adverse move in U.S. dollar forward rates could produce an estimated $115 million fair-value loss on outstanding foreign-currency derivatives.
- Management reported effective disclosure controls and no material quarterly change in internal control over financial reporting.
Important facts for investors to verify
- Whether underlying payment volumes and transactions sustain momentum, separating organic growth from currency, acquisitions and the revenue-standard effect.
- How the new revenue standard and customer incentives affect reported revenue, expenses, margins and cash conversion over the rest of 2018.
- Developments in the European Commission proceeding and U.S., U.K. and Pan-European merchant litigation, including reserve adequacy and settlement payments.
- Debt, repurchase and dividend decisions alongside liquidity needs, settlement guarantees and the company’s substantial net uncollateralized settlement exposure.
- Whether tax-reform provisional estimates or foreign-cash reinvestment assumptions change materially as tax guidance and examinations progress.