Mastercard Incorporated — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; financial statements are unaudited. Mastercard operates a global payments network and provides transaction processing and related services; it does not issue cards or extend credit. Unless noted, comparisons are with Q1 2016.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net revenue | $2.734 billion | $2.446 billion | +12% |
| Operating expenses | $1.228 billion | $1.098 billion | +12% |
| Operating income | $1.506 billion | $1.348 billion | +12% |
| Operating margin | 55.1% | 55.1% | Unchanged |
| Net income | $1.081 billion | $959 million | +13% |
| Diluted EPS | $1.00 | $0.86 | +16% |
| Operating cash flow | $745 million | $1.058 billion | Down $313 million |
- Gross revenue rose 15% to $4.013 billion, while rebates and incentives increased 23% to $1.279 billion, limiting net revenue growth.
- Transaction processing revenue rose 16% to $1.347 billion; domestic assessments rose 16% to $1.189 billion; cross-border volume fees rose 15% to $916 million; other revenue rose 13% to $561 million.
- Switched transactions increased 17%; cross-border volume grew 13% in local currency. GDV rose 8% worldwide in local currency when adjusted for the EU regulation change (5% as reported).
- Adjusted, non-GAAP results exclude a $15 million Canadian merchant litigation provision: adjusted operating margin was 55.6%, adjusted net income was $1.091 billion, and adjusted diluted EPS was $1.01. Adjusted diluted EPS growth was 17%.
- The effective tax rate declined to 26.9% from 28.3%, attributed to geographic earnings mix and share-based payment accounting, partly offset by a lower U.S. foreign tax credit benefit.
Liquidity, debt and capital allocation
- At March 31, cash, cash equivalents and investments totaled $7.7 billion, excluding restricted cash and customer deposits; unused credit capacity was $3.8 billion. These balances compared with $8.3 billion and $3.8 billion, respectively, at year-end.
- Long-term debt was $5.216 billion, with earliest principal maturity in 2019. No commercial paper or credit-facility borrowings were outstanding. The company reported compliance with credit-facility covenants.
- Operating cash flow fell to $745 million, primarily due to higher customer incentive payments and settlement timing, partly offset by higher net income adjusted for noncash items. Investing activities used $246 million; financing activities used $1.237 billion.
- Mastercard repurchased 8.8 million shares for $962 million at an average $109.06 per share and paid $238 million in dividends. The declared quarterly dividend was $0.22 per share.
- $4.0 billion of cash, cash equivalents and investments were held by foreign subsidiaries and intended to be indefinitely reinvested outside the U.S., according to management.
Material changes, outlook and risks
- Operating expenses increased 12%; excluding the Canadian litigation provision, they rose 11%, primarily reflecting higher personnel costs and the timing of marketing spend. Advertising and marketing expense increased 25%.
- Adoption of share-based payment guidance contributed $20 million of excess tax benefits within income tax expense and increased Q1 diluted EPS by $0.02. The filing notes a related change in diluted-share calculation.
- On April 28, 2017, after quarter-end, Mastercard acquired a 92.4% controlling interest in VocaLink for £719 million, or $929 million, in cash, subject to possible earn-out payments of up to £169 million. VocaLink operates payment systems and ATM switching platforms.
- No numerical earnings or revenue guidance is provided. Management said existing cash, investment balances, operating cash generation, borrowing capacity and capital-market access should be sufficient for anticipated operating and other liquidity needs. It also noted continuing uncertainty in the global economic recovery and payments-industry environment.
- Key risks include interchange-fee regulation and litigation, competition and pricing pressure, technology change, cybersecurity and service disruption, customer concentration, foreign-exchange and macroeconomic conditions, and settlement guarantees. U.S. net revenue represented 37% of total revenue, versus 39% a year earlier.
- Legal contingencies remain significant. The U.S. merchant class settlement was vacated on appeal in 2016, with further proceedings and opt-out merchant cases ongoing; the company accrued $705 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 settlement agreement in principle prompted a $15 million Q1 provision. In Europe, a possible European Commission fine could exceed $1 billion if the Commission reaches a negative decision, but Mastercard could not estimate a loss range. A U.K. consumer collective action seeks more than £14 billion; no loss was accrued.
- Settlement guarantees had estimated gross exposure of $37.189 billion, collateral of $4.010 billion and net uncollateralized exposure of $33.179 billion at March 31. Exposure is generally short-term, but adverse customer or economic conditions could increase risk.
Investor verification priorities
- Track net revenue against the faster growth in rebates and incentives, and monitor transaction, cross-border and GDV trends, including the effect of EU regulation and currency.
- Assess the sustainability of cash generation given the year-over-year decline in operating cash flow and the timing and level of customer incentives.
- Review developments, reserves and potential financial exposure in U.S., Canadian and European interchange matters, including whether settlements or adverse decisions change the recorded litigation liability.
- Verify VocaLink’s final purchase accounting, integration costs, earn-out exposure and contribution after the April 28 closing.
- Monitor settlement-guarantee exposure, customer collateral, foreign-held liquidity and the company’s significant share repurchases and dividend payments.
The independent accountant performed a review of the interim financial statements, not a full audit.