Mastercard Incorporated — Q2 2018 Form 10-Q
Business context and reporting period. Mastercard operates a global payments technology network, processing transactions and providing related services. This unaudited quarterly report covers the three and six months ended June 30, 2018; the balance sheet is compared with December 31, 2017.
Financial performance
- Revenue: Q2 net revenue was $3.665 billion, up 20% year over year (18% currency-neutral). First-half revenue was $7.245 billion, up 25% (22% currency-neutral). Growth reflected higher transaction and payment volume, cross-border activity and other services. Adoption of the new revenue standard and prior-year acquisitions together contributed 4 percentage points of Q2 growth and 5 points for the first half.
- Profit and margins: Q2 operating income was $1.936 billion, up 17%, and net income was $1.569 billion, up 33%; diluted EPS was $1.50, up 36%. First-half operating income was $3.761 billion, up 19%, net income $3.061 billion, up 36%, and diluted EPS $2.91, up 39%. GAAP operating margin was 52.8% in Q2 and 51.9% for the first half, down 1.3 and 2.7 percentage points, respectively. Excluding litigation provisions, adjusted operating margin was 59.0% for Q2 and 56.6% for the first half.
- Cash flow and capital returns: First-half operating cash flow was $2.524 billion, versus $2.052 billion a year earlier. Investing activities used $6 million, compared with $1.245 billion, largely reflecting the prior-year acquisition outlay. Financing activities used $2.416 billion. Mastercard repurchased 16.2 million shares for $2.881 billion and paid $525 million in dividends during the first half.
- Liquidity and debt: Cash, cash equivalents and investments totaled approximately $7.7 billion at June 30, excluding restricted balances; $3.8 billion of revolving credit capacity was unused. Total debt, including current maturities, was $6.4 billion, up from $5.4 billion at year-end, following a $1 billion note issuance. The earliest stated maturity was $500 million in April 2019. Management said existing liquidity, cash generation and borrowing capacity were sufficient for operating and other needs.
- Balance sheet: Total assets were $22.471 billion and total equity $5.279 billion at June 30. Accrued litigation was $949 million. Cash and cash equivalents alone were $6.210 billion.
Material changes versus prior periods
- Revenue grew strongly, with local-currency gross dollar volume up 14% and cross-border volume up 19% in Q2; switched transactions grew 17% after adjustment for Venezuela deconsolidation.
- GAAP operating expenses increased 23% in Q2 and 33% in the first half, primarily reflecting litigation provisions. Excluding special litigation items, adjusted expenses increased 7% and 20%, respectively.
- The effective tax rate fell to 18.3% for Q2 and 17.8% for the first half, from 27.7% and 27.3%. The filing attributes the decrease primarily to the lower U.S. statutory tax rate, geographic earnings mix and share-based payment benefits.
- New revenue accounting increased reported Q2 revenue by $105 million and net income by $32 million; for the first half it increased revenue by $212 million and net income by $90 million. It also changed the timing of certain incentives and caused some market-development contributions and expenditures to be reported gross. Prior periods were not restated.
Outlook, risks and unusual items
- The filing provides no specific quantitative earnings or revenue guidance. Management noted that economic recovery and business conditions remained uncertain and described continued investment in digital infrastructure, safety and security, data analytics and geographic expansion.
- Q2 included $225 million of litigation provisions: $210 million related to U.S. merchant class and opt-out litigation and $15 million related to U.K. merchant settlements. First-half provisions totaled $342 million. The U.S. Damages Class reached an agreement in principle in June, subject to formal terms and court approval; Rules Relief claims remain unresolved.
- The company reported $947 million accrued for U.S. merchant class and opt-out litigation. Separately, it said a potential European Commission fine related to interchange practices could be substantial and potentially exceed $1 billion, but it could not estimate a loss range. A July 2018 U.K. appellate ruling, after quarter-end, found against Mastercard and Visa on two legal issues and returned cases for further proceedings.
- Settlement guarantees are a material contingent exposure: estimated gross exposure was $47.872 billion, collateral was $4.494 billion, and net uncollateralized exposure was $43.378 billion at June 30. Mastercard said settlement losses historically had been low, but adverse customer, regional or global economic conditions could increase risk.
- Foreign exchange remains a risk. A hypothetical 10% adverse change in U.S. dollar forward rates could produce an estimated $102 million fair-value loss on outstanding derivatives. A $100 million contribution to the Mastercard Center for Inclusive Growth was made in the first quarter.
Most important facts for investors to verify
- Whether the U.S. merchant Damages Class agreement was finalized and approved, and how much further litigation-related expense or cash payment may arise.
- Developments in European Commission and U.K. interchange proceedings, including potential fines, damages and required business-practice changes.
- Whether strong transaction and cross-border growth continues, and how customer incentives, currency movements and the new revenue accounting affect reported growth.
- How the company manages settlement guarantees and customer credit risk against its available liquidity and debt maturities.
- The sustainability of margins and earnings growth after excluding litigation provisions and considering the lower tax rate and share repurchases.