Mastercard Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. The interim financial statements are unaudited; PwC performed a review, not an audit. Mastercard operates a global payments network and provides transaction processing and related services; it does not issue cards or extend credit.
Financial results
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net revenue | $3.398B (+18%) | $2.880B | $9.185B (+15%) | $8.020B |
| Operating income | $1.941B (+16%) | $1.670B | $5.100B (+16%) | $4.398B |
| Operating margin | 57.1% | 58.0% | 55.5% | 54.8% |
| Net income | $1.430B (+21%) | $1.184B | $3.688B (+18%) | $3.126B |
| Diluted EPS | $1.34 (+24%) | $1.08 | $3.43 (+21%) | $2.83 |
| Operating cash flow | Not separately provided | Not separately provided | $3.794B | $3.543B |
Q3 revenue growth was 17% currency-neutral; nine-month growth was 14%. Switched transactions rose 17% in both periods. Local-currency cross-border volume grew 15% in Q3 and 14% year to date. Gross dollar volume rose 10% and 7%, respectively, on a local-currency basis, adjusted for the EU regulation change.
For the nine months, net cash used in investing was $1.656B, including $1.175B for acquisitions; net cash used in financing was $3.494B. Cash and cash equivalents were $5.559B at quarter-end, down from $6.721B at December 31, 2016. Cash, cash equivalents and investments totaled $7.4B, excluding restricted amounts; $4.5B was held by foreign subsidiaries. Long-term debt was $5.393B, versus $5.180B at year-end. The company reported $3.8B of unused credit availability and no borrowings under its commercial paper program or revolving facility. Current assets were $13.231B and current liabilities $7.984B.
Changes and management commentary
- Revenue growth reflected higher transaction activity, dollar volume and other payment-related services, partly offset by rebates and incentives. Rebates and incentives increased 20% in Q3 and 21% year to date.
- Operating expenses increased 20% in Q3 and 13% year to date. Management attributed the increase mainly to personnel and strategic investment; acquisitions contributed 8 percentage points of Q3 expense growth and 5 points year to date. Q3 operating margin fell 0.9 percentage points, while the nine-month margin increased 0.7 points. Excluding litigation items, the nine-month adjusted margin declined 0.5 points.
- The effective tax rate declined to 26.0% in Q3 and 26.8% year to date, from 27.5% and 27.9%. Mastercard cited a more favorable geographic mix of taxable earnings, partly offset by a lower U.S. foreign tax credit benefit.
- Mastercard acquired a 92.4% controlling interest in VocaLink, a U.K. payments and ATM switching platform, in April 2017. Total fair value of 2017 acquisitions was preliminarily estimated at $1.566B. VocaLink’s sellers retained a 7.6% interest with future put/call options; contingent consideration may depend on 2018 revenue targets.
- The company repurchased 23.1 million shares for $2.731B and paid $709M in dividends during the first nine months. It had $2.265B remaining under its then-current repurchase authorization.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management said existing liquidity, operating cash generation, borrowing capacity and capital access were expected to meet operating and other liquidity needs.
- Merchant interchange litigation remains a material uncertainty. The U.S. merchant class settlement was overturned on appeal in 2016; class proceedings and more than 30 opt-out complaints are progressing. Mastercard had accrued $707M for the U.S. merchant class and opt-out matters, and held $545M of restricted cash for the class settlement. The company said it could not estimate potential liability if the matters proceed to final litigation.
- A European Commission investigation concerns interregional interchange fees and central acquiring rules. Mastercard said a negative decision could result in fines potentially exceeding $1B, but it could not estimate a loss range; it expected greater clarity in Q4 2017 or early 2018.
- Mastercard reached a Canadian merchant class settlement subject to court approval and recorded a $15M provision in Q1. Other U.K. merchant and ATM surcharge disputes remain, among other proceedings.
- Settlement guarantees are large relative to reported balance-sheet liabilities: estimated gross settlement exposure was $44.595B, collateral held was $4.135B, and net uncollateralized exposure was $40.460B at September 30. Exposure is generally short-term, but failures of financial-institution customers or adverse economic conditions could increase losses.
- Foreign-exchange risk included approximately $140M of exposure in Venezuela. A hypothetical 10% adverse move in foreign-currency forward rates could produce an estimated $97M fair-value loss on outstanding derivatives. The company also noted restricted-currency and economic risks.
- Adoption of the new revenue-recognition standard was planned for January 1, 2018 using the modified retrospective method. It will change the timing of recognition for certain customer incentives; the impact had not yet been quantified. The revolving credit facility was extended in October 2017 to October 2022.
Key facts for investors to verify
- Progress and potential financial exposure in U.S., European, Canadian and U.K. interchange litigation, including the basis and adequacy of recorded reserves.
- VocaLink’s contribution to growth and expenses, final acquisition accounting, and any contingent consideration or retained-interest payments.
- Whether revenue growth and transaction trends persist after accounting for currency, EU regulation effects, rebates and incentives, and acquisition contributions.
- Settlement-guarantee exposure, collateral coverage, and liquidity available if customer failures or legal payments rise.
- The eventual effect of the 2018 revenue-recognition adoption on reported revenue, customer incentives and retained earnings.