Mastercard Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. The unaudited financial statements are prepared under U.S. GAAP; 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 and key metrics
- Q2 revenue: Net revenue was $3.053 billion, up 13% year over year; currency-neutral growth was 14%. Gross revenue increased 16%, while rebates and incentives rose 21%.
- Q2 earnings: Operating income was $1.653 billion, up 20%, and GAAP operating margin was 54.1%, versus 51.2%. Net income was $1.177 billion, up 20%; diluted EPS was $1.10, up 24%.
- First-half results: Net revenue was $5.787 billion, up 13%; operating income was $3.159 billion, up 16%; net income was $2.258 billion, up 16%; diluted EPS was $2.09, up 19%. GAAP operating margin was 54.6%, compared with 53.1%.
- Adjusted comparison: Excluding specified litigation provisions, Q2 adjusted operating margin was 54.1%, down 1.1 percentage points, and adjusted diluted EPS rose 15% (16% currency-neutral). First-half adjusted operating margin was 54.8%, down 0.4 points, while adjusted diluted EPS rose 15%. These are non-GAAP measures.
- Business activity: Switched transactions grew 17% in both Q2 and the first half. Cross-border volume rose 14% in Q2 and 13% in the first half. Mastercard-branded GDV grew 6% and 5%, respectively, in local currency; growth was 9% and 8% after adjustment for the EU regulation change.
- Cash flow: First-half operating cash flow was $2.039 billion, versus $2.119 billion. Investing cash outflow was $1.254 billion, including $951 million for acquisitions; financing cash outflow was $2.452 billion. Cash and cash equivalents declined to $5.177 billion from $6.721 billion at year-end.
- Liquidity and debt: Cash, cash equivalents and investments totaled $7.0 billion, excluding restricted cash and customer deposits; unused credit capacity was $3.8 billion. Long-term debt was $5.326 billion, versus $5.180 billion at year-end; earliest principal maturity was 2019. No commercial paper or revolving-facility borrowings were outstanding.
- Capital returns: Mastercard repurchased 16.6 million shares for about $1.893 billion and paid $474 million in dividends in the first half. Remaining repurchase authorization was $3.103 billion at June 30.
- Balance sheet: Total assets were $19.839 billion, current liabilities $7.583 billion, and total equity $5.878 billion. Accrued litigation was $736 million.
Material changes and notable items
- Revenue growth reflected higher transaction counts and volumes, other payment-related services, and acquisitions, partly offset by higher customer rebates and incentives. Acquisitions contributed 2 percentage points to Q2 net revenue growth and 1 point to first-half growth.
- Operating costs increased with strategic investment, acquisitions, and foreign-exchange losses. Adjusted operating expenses rose 16% in Q2 and 13% in the first half. GAAP comparisons also reflect litigation charges: $15 million in Q1 2017 for Canadian merchant litigation versus $107 million in Q2 2016 for a U.K. merchant judgment.
- On April 28, Mastercard acquired a 92.4% controlling interest in U.K. payments platform Vocalink. Preliminary total fair value was $1.306 billion, including contingent consideration; up to approximately $220 million of additional consideration may be payable if 2018 revenue targets are met. Mastercard also agreed in July 2017 to acquire Brighterion, subject to closing conditions.
- Adoption of share-based payment accounting guidance increased first-half diluted EPS by $0.03, according to the filing. The Company plans to adopt new revenue-recognition guidance in 2018; it expects certain customer incentives to be recognized over contract lives and was still assessing the financial impact.
Outlook, risks and contingencies
- The filing provides no specific numerical earnings or revenue guidance. Management said global economic recovery remained uncertain and the business environment could challenge growth; it continues to monitor economic and political conditions.
- Interchange litigation remains a significant uncertainty. The U.S. merchant class settlement was vacated on appeal in 2016, and opt-out merchant cases are proceeding. Mastercard had accrued $706 million for the class and filed or anticipated opt-out matters and said it could not estimate potential liability if litigated to a final outcome. A Canadian class settlement was reached in June 2017, subject to provincial court approval.
- The European Commission’s interchange-fee proceeding could result in substantial fines, potentially exceeding $1 billion if the Commission issues a negative decision; Mastercard could not estimate a loss range. Separately, the U.K. court denied a proposed consumer collective action in July 2017, though plaintiffs could seek judicial review.
- Mastercard guarantees settlement between issuers and acquirers. Estimated gross settlement exposure was $42.565 billion and collateral was $4.138 billion, leaving net uncollateralized exposure of $38.427 billion at June 30. Historically, losses have been low, but adverse customer or economic conditions could increase risk.
- Other disclosed risks include competition, regulation, customer concentration, cybersecurity and service disruption, foreign exchange, and legal proceedings. A hypothetical 10% adverse change in foreign-currency forward rates could produce an estimated $94 million fair-value loss on outstanding derivatives. The filing reported approximately $130 million of Venezuela exposure.
- Management stated existing liquidity, operating cash generation, borrowing capacity, and capital access were sufficient for expected operating needs and potential obligations. Cash held by foreign subsidiaries was $3.8 billion; Mastercard intended to indefinitely reinvest historic undistributed foreign earnings.
Important facts for investors to verify
- Progress and potential financial exposure in U.S., Canadian, and European interchange litigation, including settlement approvals, appeals, and any changes to the $706 million merchant-litigation reserve.
- Vocalink integration, achievement of its 2018 revenue targets, contingent consideration, and the status and cost of the Brighterion acquisition.
- Whether transaction and cross-border volume growth continues to support revenue growth as rebates and incentives and strategic investment costs rise.
- Cash conversion and liquidity after acquisitions, share repurchases, dividends, and customer-incentive payments; also monitor settlement exposure and collateral coverage.
- The eventual effects of new revenue-recognition guidance on customer incentives and reported revenue.