UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 001-16111
GLOBAL PAYMENTS INC.
(Exact name of registrant as specified in charter)
Georgia | 58-2567903 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
3550 Lenox Road, Atlanta, Georgia | 30326 | |
(Address of principal executive offices) | (Zip Code) | |
Registrant's telephone number, including area code: 770-829-8000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Name of each exchange on which registered | |
Common Stock, No Par Value | New York Stock Exchange | |
Securities registered pursuant to Section 12(g) of the Act:
NONE
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer x Accelerated filer o
Non-accelerated filer o Smaller reporting company o
Emerging growth company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant's most recently completed second fiscal quarter was $17,478,395,120. The number of shares of the registrant's common stock outstanding at February 19, 2019 was 157,603,304 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Specifically identified portions of the registrant's proxy statement for the 2019 annual meeting of shareholders are incorporated by reference in Part III.
GLOBAL PAYMENTS INC.
2018 ANNUAL REPORT ON FORM 10-K
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PART I | |||
ITEM 1. | |||
ITEM 1A. | |||
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ITEM 3. | |||
PART II | |||
ITEM 5. | |||
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ITEM 7. | |||
ITEM 7A. | |||
ITEM 8. | |||
ITEM 9. | |||
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PART III | |||
ITEM 10. | |||
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ITEM 12. | |||
ITEM 13. | |||
ITEM 14. | |||
PART IV | |||
ITEM 15. | |||
EXPLANATORY NOTE REGARDING TRANSITION PERIOD
In 2016, we changed our fiscal year-end from May 31 to December 31. We refer to the period consisting of the seven-months ended December 31, 2016 as the "2016 fiscal transition period."
When our financial results for the year ended December 31, 2017 and the 2016 fiscal transition period are compared to our financial results for the prior-year periods, the results compare the twelve-month period from January 1, 2017 through December 31, 2017 to the twelve-month period from January 1, 2016 through December 31, 2016 and compare the seven-month period from June 1, 2016 through December 31, 2016 to the seven-month period from June 1, 2015 through December 31, 2015. The results for the twelve months ended December 31, 2016 and the seven months ended December 31, 2015 are unaudited.
CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS
Unless the context requires otherwise, references in this report to "Global Payments," the "Company," "we," "our" or "us," refer to Global Payments Inc. and its subsidiaries.
Some of the statements we use in this report, and in some of the documents we incorporate by reference in this report, contain forward-looking statements concerning our business operations, economic performance and financial condition, including in particular: our business strategy and means to implement the strategy; measures of future results of operations, such as revenues, expenses, operating margins, income tax rates, and earnings per share; other operating metrics such as shares outstanding and capital expenditures; our success and timing in developing and introducing new services and expanding our business; statements about the benefits of our acquisitions, including future financial and operating results, the combined company’s plans, objectives, expectations and intentions, and the successful integration of our future acquisitions. You can sometimes identify forward-looking statements by our use of the words "believes," "anticipates," "expects," "intends," "plan," "forecast," "guidance" and similar expressions. For these statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.
Although we believe that the plans and expectations reflected in or suggested by our forward-looking statements are reasonable, those statements are based on a number of assumptions, estimates, projections or plans that are inherently subject to significant risks, uncertainties and contingencies, many of which are beyond our control, cannot be foreseen and reflect future business decisions that are subject to change. Accordingly, we cannot guarantee you that our plans and expectations will be achieved. Our actual revenues, revenue growth rates and margins, other results of operations and shareholder values could differ materially from those anticipated in our forward-looking statements as a result of many known and unknown factors, many of which are beyond our ability to predict or control. Important factors that may cause actual events or results to differ materially from those anticipated by our forward-looking statements include our ability to safeguard our data; increased competition from larger companies and non-traditional competitors; our ability to update our services in a timely manner; our ability to maintain Visa and Mastercard registration and financial institution sponsorship; our reliance on financial institutions to provide clearing services in connection with our settlement activities; our potential failure to comply with card network requirements; potential systems interruptions or failures; software defects or undetected errors; increased attrition of merchants, referral partners or independent sales organizations; our ability to increase our share of existing markets and expand into new markets; development of market trends and technologies; a decline in the use of cards for payment generally; unanticipated increases in chargeback liability; increases in credit card network fees; changes in laws, regulations or network rules or interpretations thereof; foreign currency exchange and interest rate risks; political, economic and regulatory changes in the foreign countries in which we operate; future performance, integration and conversion of acquired operations, including without limitation difficulties and delays in integrating or fully realizing cost savings and other benefits of our acquisitions at all or within the expected time period; fully realizing anticipated annual interest expense savings from refinancing our Credit Facility (described in "Note 8—Long-Term Debt and Lines of Credit" in the notes to the accompanying consolidated financial statements); loss of key personnel; and other risk factors presented in Item "1A - Risk Factors of this Annual Report on Form 10‑K," which we advise you to review. These cautionary statements qualify all of our forward-looking statements, and you are cautioned not to place undue reliance on these forward-looking statements.
Our forward-looking statements speak only as of the date they are made and should not be relied upon as representing our plans and expectations as of any subsequent date. While we may elect to update or revise forward-looking statements at some time in the future, we specifically disclaim any obligation to publicly release the results of any revisions to our forward-looking statements, except as required by law.
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PART I
ITEM 1- BUSINESS
Global Payments, Inc. and its consolidated subsidiaries are referred to collectively as "Global Payments," the "Company," "we," "our" or "us," unless the context requires otherwise.
Introduction
We are a leading worldwide provider of payment technology and software solutions delivering innovative services to our customers globally. Our technologies, services and employee expertise enable us to provide a broad range of solutions that allow our customers to accept various payment types and operate their businesses more efficiently. We distribute our services across a variety of channels in 32 countries throughout North America, Europe, the Asia-Pacific region and Brazil and operate in three reportable segments: North America, Europe and Asia-Pacific.
We were incorporated in Georgia as Global Payments Inc. in 2000 and spun-off from our former parent company in 2001. Including our time as part of our former parent company, we have been in the payment technology services business since 1967. Since our spin-off, we have expanded in existing markets and into new markets internationally by pursuing further acquisitions and joint ventures. In 2016, we merged with Heartland Payment Systems, Inc. ("Heartland"), which significantly expanded our small and medium-sized enterprise distribution, customer base and vertical reach in the United States. For the year ended December 31, 2018, our revenues were $3.4 billion.
Headquartered in Atlanta, Georgia, we are a member of the Standard & Poor's 500 Index, and our common stock is traded on the New York Stock Exchange under the symbol "GPN."
Recent Acquisitions
On October 17, 2018, we acquired SICOM Systems, Inc. ("SICOM") for total purchase consideration of approximately $409 million. SICOM is a provider of end-to-end enterprise, cloud-based software solutions and other technologies to quick service restaurants and food service management companies. SICOM's technologies are complementary to our existing Xenial solutions, and we believe this acquisition will expand our software-driven payments strategy by enabling us to increase our capabilities and expand on our existing presence in the restaurant vertical market.
On September 4, 2018, we acquired AdvancedMD, Inc. ("AdvancedMD") for total purchase consideration of approximately $707 million. AdvancedMD is a provider of cloud-based enterprise software solutions to small-to-medium sized ambulatory care physician practices in the United States. We believe this acquisition will expand our software-driven payments strategy by enabling us to enter the healthcare vertical market, a large and fragmented market with strong payment fundamentals and attractive growth opportunities.
On September 1, 2017, we acquired the communities and sports divisions of Athlaction Topco, LLC ("ACTIVE Network") for total purchase consideration of $1.2 billion. ACTIVE Network delivers cloud-based enterprise software, including payment technology solutions, to event organizers in the communities and health and fitness vertical markets. This acquisition aligns with our technology-enabled, software driven strategy and adds an enterprise software business operating in two vertical markets that we believe offer attractive growth fundamentals.
See "Note 2—Acquisitions" in the notes to the accompanying consolidated financial statements for further discussion of these and other acquisitions.
Payment Technology and Software Solutions Overview
We provide payment technology and software solutions to customers globally. Our payment technology solutions are similar around the world in that we enable our customers to accept card, electronic, check and digital-based payments. Our comprehensive offerings include, but are not limited to, authorization services, settlement and funding services, customer support and help-desk functions, chargeback resolution, terminal rental, sales and deployment, payment security services, consolidated billing and statements and on-line reporting.
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In addition, we offer a wide array of enterprise software solutions that streamline business operations to customers in numerous vertical markets. We also provide a variety of value-added services, including analytic and engagement tools, payroll services and reporting that assist our customers with driving demand and operating their businesses more efficiently.
Our value proposition is to provide distinctive high-quality, responsive and secure services to all of our customers. We distribute our services through multiple channels and target customers in many vertical markets in 32 countries located throughout North America, Europe, the Asia-Pacific region and in Brazil. The majority of revenues is generated by services priced as a percentage of transaction value or a specified fee per transaction, depending on the card type or the market. We also earn software subscription and licensing fees, as well as other fees based on specific value-added services that may be unrelated to the number or value of transactions.
Direct Distribution
Our primary business model is to actively market and provide our payment services, enterprise software solutions and other value-added services directly to our customers through a variety of distribution channels. We offer high-touch services that provide our customers with reliable and secure solutions coupled with high quality and responsive support services. Through our direct sales force worldwide, as well as bank partnerships, we offer our payment technology services, software and other value-added solutions directly to customers in the markets we serve. See "Business Segments" below for a description of our direct sales forces located around the world.
Many of our payment solutions are technology-enabled in that they incorporate or are incorporated into innovative, technology-driven solutions, including enterprise software solutions, designed to enable merchants to better manage their businesses. Our primary technology-enabled solutions include integrated and vertical markets, ecommerce and omnichannel and gaming solutions, each as described below.
Integrated and Vertical Markets. Our integrated and vertical market solutions provide advanced payments technology that is deeply integrated into business enterprise software solutions either owned by us or by our partners. We grow our business when new merchants implement our enterprise software solutions and when new or existing merchants enable payments services through enterprise software solutions sold by us or by our partners. We distribute our integrated payment solutions primarily through the following businesses:
• | OpenEdge. Through OpenEdge, we offer integrated payment solutions through technology partners across numerous vertical markets, primarily in North America. OpenEdge enables third-party application developers to incorporate payment innovations into their enterprise business solutions. |
• | Ezidebit. Through Ezi Holdings Pty Ltd ("Ezidebit"), we offer integrated payment technology solutions in the Asia-Pacific region. Ezidebit focuses on recurring payments verticals and, similar to OpenEdge, markets its services through a network of integrated software vendors and direct channels to numerous vertical markets. |
• | ACTIVE Network. Through ACTIVE Network, we deliver cloud-based enterprise software, including payment technology solutions, to event organizers in the communities and health and fitness markets. |
• | Education Solutions. We offer integrated payment solutions specifically designed for all levels of educational institutions. At the university level, we offer integrated commerce solutions, payment services, higher education loan services, credentialing services and open- and closed-loop payment solutions. For kindergarten through 12th grade, we provide ecommerce and in-person payments, cafeteria POS solutions and back-office management software, hardware, technical support and training. |
• | AdvancedMD. Through AdvancedMD, we provide cloud-based enterprise solutions to small-to-medium sized ambulatory physician practices in the United States. |
• | Xenial and SICOM. Through Xenial and SICOM, we offer leading-edge enterprise software solutions, integrated with our payment services and other adjacent business service applications, to the restaurant and hospitality and retail vertical markets. |
Ecommerce and Omnichannel. We offer ecommerce and omnichannel solutions to our customers that seamlessly blend payment gateway services, retail payment acceptance infrastructure and payment technology service capabilities though a unified commerce platform to allow merchants to accept various payment methods through any channel across our geographical footprint. We sell ecommerce and omnichannel solutions to customers of all sizes, from small businesses accepting payments in a single
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country, to enterprise and multinational businesses that have complex payment needs and operate retail and online businesses in multiple countries.
Gaming. We offer a comprehensive suite of cash access solutions to the gaming market in North America. These solutions include credit and debit card cash advance, traditional and electronic check processing and other services specific to this market. Our services allow casino patrons in North America fast access to cash with high limits to enable gaming establishments to increase the flow of money to their gaming floors and reduce risk.
Wholesale Distribution
Although our primary business model is to build high quality direct relationships with merchants, we also provide our services through a wholesale distribution channel where we do not maintain the face-to-face relationship with the merchant. Through our wholesale channel, we provide payment services to merchants through independent sales organizations ("ISOs"). The ISOs act as third-party sales groups selling our payment technology services directly to end-user merchant customers. As we continue to grow and control our direct distribution by adding new channels and partners, including expanding our ownership of additional enterprise software solutions in select vertical markets, our wholesale distribution channel has become a smaller portion of our business.
Credit and Debit Card Transaction Processing
Credit and debit card transaction processing includes the processing of the world's major international card brands, including American Express, Discover Card ("Discover"), JCB, Mastercard, UnionPay International ("UPI"), Visa and non-traditional payment methods, as well as certain domestic debit networks, such as Interac in Canada. Credit and debit networks establish uniform regulations that govern much of the payment card industry. During a typical payment transaction, the merchant and the card issuer do not interface directly with each other, but instead rely on payments technology companies, such as Global Payments, to facilitate transaction processing services, including authorization, electronic draft capture, file transfers to facilitate funds settlement and certain exception-based, back office support services such as chargeback and retrieval resolution.
We process funds settlement under two models, a sponsorship model and a direct membership model. Under the sponsorship model, we are designated as an ISO by Mastercard and Visa. To be designated as a certified processor, member clearing financial institutions ("Members") sponsor us and require our adherence to the standards of the networks. In certain markets, we have sponsorship or depository and clearing agreements with financial institution sponsors. These agreements allow us to route transactions under the Members' control and identification numbers to clear card transactions through Mastercard and Visa. In this model, the standards of the card networks restrict us from performing funds settlement or accessing merchant settlement funds, and, instead, require that these funds be in the possession of the Member until the merchant has been funded.
Under the direct membership model, we are direct members in various payment networks, allowing us to process and fund transactions without third-party sponsorship. In this model, we route and clear transactions directly through the card brand’s network and are not restricted from performing funds settlement. Otherwise, we process these transactions similarly to how we process transactions in the sponsorship model. We are required to adhere to the standards of the various networks in which we are direct members. We maintain relationships with financial institutions, which may also serve as our Member sponsors for other card brands or in other markets, to assist with funds settlement.
How a Card Transaction Works
A typical payment transaction begins when a cardholder presents a card for payment at a merchant location where the card information is captured by a POS terminal card reader or mobile device card reader, which may be sold or leased to the merchant and serviced by us. Alternatively, card and transaction information may be captured and transmitted to our network through a POS device or ecommerce portal by one of a number of services that we offer directly or through a value-added reseller. The card reader electronically records sales draft information, such as the card identification number, transaction date and transaction amount.
After the card and transaction information is captured, the POS device automatically connects to our network through the internet or other communication channel in order to receive authorization of the transaction. For a credit card transaction, authorization services generally refer to the process in which the card issuer indicates whether a particular credit card is authentic and whether the impending transaction amount will cause the cardholder to exceed defined credit limits. In a debit card transaction, we obtain authorization for the transaction from the card issuer through the payment network verifying that the cardholder has access to sufficient funds for the transaction amount.
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As an illustration, shown below, on a $100.00 card transaction, the card issuer may fund the Member, our sponsor, (indirectly through the card network) $98.50 after retaining approximately $1.50 referred to as an interchange fee. The card issuer seeks reimbursement of $100.00 from the cardholder in the cardholder's monthly credit card statement. The Member would, in turn, pay the merchant $100.00. The net settlement after this transaction would require us to advance the Member $1.50. After the end of the month, we would bill the merchant a percentage of the transaction amount, or merchant discount, to cover the full amount of the interchange fee and our fee from the transaction. If our discount rate for the merchant in the above example was 2.00%, we would bill the merchant $2.00 after the end of the month for the transaction, reimburse ourselves for $1.50 in interchange fees and retain $0.50 as our fees for the transaction. Under some arrangements, we remit the net amount of $98.00 to the merchant, rather than funding the full $100.00 and subsequently billing the merchant at the end of the month. Discount rates vary based on negotiations with merchants and the economic characteristics of transactions. Interchange rates also vary based on the economic characteristics of individual transactions. Accordingly, our fee per transaction varies across our merchant base and is subject to change based on changes in discount rates and interchange rates. Our profit on the transaction reflects the fee received less payment network fees and operating expenses, including systems cost to process the transaction and commissions paid to our sales force or ISO. Payment network fees are charged by the card brands, in part, based on the value of transactions processed through their networks.
Business Segments
We operate in three reportable segments: North America, Europe and Asia-Pacific. See "Note 16—Segment Information" in the notes to the accompanying consolidated financial statements for additional information about our segments, including revenues, operating income and depreciation and amortization by segment as well as financial information about geographic areas in which we operate. In general, our business has not experienced pronounced seasonality. However, each geographic channel has somewhat higher and lower quarters given the nature of the merchant portfolio. Our foreign operations subject us to various risks, including, without limitation, currency exchange risks and political, economic and regulatory risks. See "Item 1A - Risk Factors" for additional information about these risks.
North America
Approximately 74.9% of our revenues for the year ended December 31, 2018 were derived from our operations in North America, which include the United States and Canada.
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Our primary mode of distribution in North America is our direct distribution channels, including an extensive direct sales force selling our services and solutions across numerous vertical markets, including, but not limited to, education, restaurant, event management, hospitality, retail, healthcare, convenience stores and petroleum, professional services, automotive and lodging.
Our technology-enabled solutions represented a substantial component of our revenues in North America for the year ended December 31, 2018. Our technology-enabled distribution in North America includes integrated and vertical market solutions, ecommerce and omnichannel solutions and gaming solutions.
We also generate a portion of our revenues in North America from our wholesale distribution channel, primarily ISOs acting as third-party selling groups.
Europe
Approximately 18.1% of our revenues for the year ended December 31, 2018 were derived from our operations in Europe, which includes the United Kingdom, the Republic of Ireland, Spain, the Republic of Malta, the Czech Republic, Hungary, Slovakia, Romania and the Russian Federation. We have direct sales forces in these markets through which we sell our services while also leveraging our bank referral relationships. Our ecommerce and omnichannel solutions represent a growing percentage of the services we sell in Europe.
Asia-Pacific
Approximately 6.9% of our revenues for the year ended December 31, 2018 were derived from our operations in the Asia-Pacific region, which includes the following countries and territories: Australia, China, Hong Kong, India, Macau, Malaysia, Maldives, New Zealand, the Philippines, Singapore, Sri Lanka and Taiwan. Our direct sales force in the Asia-Pacific region accounts for substantially all of the services we sell in the region.
Technology-enabled solutions represent a substantial and growing portion of our operations in the Asia-Pacific region, driven by Ezidebit and eWay Limited in Australia.
Industry Overview
The payment technology services industry provides merchants with credit, debit, gift and loyalty card and other payment processing services, along with related information services. The industry continues to grow as a result of wider merchant acceptance, increased consumer use of credit and debit cards and advances in payment processing and telecommunications technology. The proliferation of credit and debit cards has made the acceptance of card-based payments a virtual necessity for many businesses, regardless of size, in order to remain competitive. This increased use of cards and the availability of more sophisticated technology services to all market segments has resulted in a highly competitive and specialized industry.
Competition
We are a leading provider of payments technology and software solutions in North America, where we compete primarily with Bank of America Merchant Services, LLC (a joint venture between First Data Corporation and Bank of America Corporation), Chase Paymentech Solutions, LLC, Elavon, Inc., a subsidiary of U.S. Bancorp, First Data Corporation, Total System Services, Inc., Wells Fargo Bank, N.A and Worldpay, Inc. While these are our primary competitors, some of our vertically focused business in the United States compete with other organizations.
In Europe and the Asia-Pacific region, financial institutions remain the primary providers of payment technology services to merchants, although the outsourcing of these services to third-party service providers is becoming more prevalent. Payment services have become increasingly complex, requiring significant capital commitments to develop, maintain and update the systems necessary to provide these advanced services at competitive prices.
Competitors in Europe include Ayden N.V., Barclays Bank PLC, Spanish banking institutions and Worldpay, Inc. Financial institutions that offer merchant acquiring services are our primary competitors in Asia-Pacific.
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Emerging Trends
The payments technology industry continues to grow worldwide and as a result, certain large payment technology companies, including us, have expanded operations globally by pursuing acquisitions and creating alliances and joint ventures. We expect to continue to expand into new markets internationally and increase our scale and improve our competitiveness in existing markets by pursuing further acquisitions and joint ventures.
We believe that the number of electronic payment transactions will continue to grow and that an increasing percentage of these will be facilitated through emerging technologies. As a result, we expect an increasing portion of our future capital investment will be allocated to support the development of new and emerging technologies; however, we do not expect our aggregate capital spending to increase materially from our current level of spending as a result of this.
We also believe new markets will continue to develop in areas that have been previously dominated by paper-based transactions. We expect industries such as education, government and healthcare, as well as recurring payments and business-to-business payments, to continue to see transactions migrate to electronic-based solutions. We anticipate that the continued development of new services and the emergence of new vertical markets will be a factor in the growth of our business and our revenue in the future.
Strategy
We seek to leverage the adoption of, and transition to, card, electronic and digital-based payments by expanding share in our existing markets through our distribution channels and service innovation, as well as through acquisitions to improve our offerings and scale. We also seek to enter new markets through acquisitions, alliances and joint ventures around the world. We intend to continue to invest in and leverage our technology infrastructure and our people to increase our penetration in existing markets.
The key tenets of our strategy include the following:
• | Grow and control our direct distribution by adding new channels and partners, including expanding our ownership of additional enterprise software solutions in select vertical markets; |
• | Deliver innovative services by developing value-added applications, enhancing existing services and developing new systems and services to blend technology with customer needs; |
• | Leverage technology and operational advantages throughout our global footprint; |
• | Continue to develop seamless multinational solutions for leading global customers; |
• | Provide customer service at levels that exceed our competition, while investing in technology, training and enhancements to our service offerings; and |
• | Pursue potential domestic and international acquisitions of, investments in and alliances with companies that have high growth potential, significant market presence, sustainable distribution platforms and/or key technological capabilities. |
Competitive Strengths
We believe that our competitive strengths include the following:
• | Global Footprint and Distribution - Our worldwide presence allows us to focus our investments on markets with promising gross domestic product fundamentals and favorable secular trends, makes us more attractive to merchants with international operations and exposes us to emerging innovations that we can adopt globally, while diversifying our economic risk. |
• | Technology Solutions - We provide innovative technology-based solutions, including enterprise software solutions, that enable our customers to operate their business more efficiently and simplify the payments process, regardless of the channel through which the transaction occurs. We believe our robust technology solutions will continue to differentiate us in the marketplace and will position us for continued growth. |
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• | Scalable Operating Environment and Technology Infrastructure - We operate as a single, unified international organization, with a multi-channel, global technology infrastructure, which provides scalable and innovative service offerings and a consistent service experience to our merchants and partners worldwide, while also driving sustainable operating efficiencies. |
• | Strong, Long-lasting Partner Relationships - We have established strong, long-lasting relationships with many financial institutions, enterprise software providers, value-added resellers and other technology-based payment service providers, which facilitate lead generation and enable us to deliver a diverse solutions set to our merchant customers. |
• | Disciplined Acquisition Approach - Our proven track record for selectively and successfully sourcing, completing and integrating acquired businesses in existing and new markets positions us well for future growth and as an attractive partner for potential acquisition targets. |
Safeguarding Our Business
In order to provide our services, we obtain and store sensitive business information and personal information about our merchants, merchants’ customers, merchants’ employees, vendors, partners and other parties, which may include credit and debit card numbers, bank account numbers, social security numbers, drivers' license numbers, names and addresses, and other types of personal information or sensitive business information. Some of this information is also processed and stored by our third-party service providers and other agents (which we refer to collectively as our "associated third parties") as well as merchants and ISOs. We have responsibility to the card networks, their member financial institutions, and in some instances, our merchants, ISOs and/or individuals, for our failure or the failure of our associated third parties or merchants (as applicable) to protect this information.
We are subject to cyber security and information theft risks in our operations, which we seek to manage through a cyber and information security programs, training and insurance coverage. To strengthen our security and cyber defenses, we continue to deploy multiple methods at different layers to defend our systems against misuse, intrusions and cyberattacks and to protect the data we collect. Further, we work with information security and forensics firms and employ advanced technologies to help prevent, investigate and address issues relating to processing system security and availability. We also collaborate with industry third parties, regulators and law enforcement, when appropriate, to resolve security incidents and assist in efforts to prevent unauthorized access to our processing systems.
Intellectual Property
Our intellectual property is an important part of our strategy to be a leading provider of payment technology and software solutions. We use a combination of internal policies, intellectual property laws, and contractual provisions to protect our proprietary technologies and brands. In addition, to protect our various brands, we seek and maintain registration of U.S. and international trademarks, service marks and domain names that align with our brand strategy. We also enforce our trademarks against potential sources of confusion that could harm our brand and ability to compete.
Employees and Labor
As of December 31, 2018, we had approximately 11,000 employees, many of whom are highly skilled in technical areas specific to payment technology and software solutions.
Regulation
Various aspects of our business are subject to regulation and supervision under federal, state and local laws in the United States, such as the California Consumer Privacy Act (the "CCPA), and foreign laws, regulations and rules, including Directive 2007/64/EC in the European Union (the "Payment Services Directive"), as well as local escheat laws and privacy and information security regulations. In addition, we are subject to rules promulgated by the various payment networks, including American Express, Discover, Interac, Mastercard, UPI and Visa. In addition, because we provide data processing services to banks and other financial institutions, we are subject to examination by the Federal Financial Institutions Examination Council (the "FFIEC"). Set forth below is a brief summary of some of the significant laws and regulations that apply to us. These descriptions are not exhaustive, and these laws, regulations and rules frequently change and are increasing in number.
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Dodd-Frank Act
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Dodd-Frank Act"), which was signed into law in the United States in 2010, resulted in significant structural and other changes to the regulation of the financial services industry. The Dodd-Frank Act directed the Board of Governors of the Federal Reserve (the "Federal Reserve Board") to regulate the debit interchange transaction fees that a card issuer or payment card network receives or charges for an electronic debit transaction. Pursuant to the so-called "Durbin Amendment" to the Dodd-Frank Act, these fees must be "reasonable and proportional" to the cost incurred by the card issuer in authorizing, clearing and settling the transaction. Pursuant to regulations promulgated by the Federal Reserve Board, debit interchange rates for card issuers with assets of $10 billion or more are capped at $0.21 per transaction and an ad valorem component of 5 basis points to reflect a portion of the issuer's fraud losses plus, for qualifying issuers, an additional $0.01 per transaction in debit interchange for fraud prevention costs. The cap on interchange fees has not had a material direct effect on our results of operations.
In addition, the Dodd-Frank Act limits the ability of payment card networks to impose certain restrictions because it allows merchants to: (i) set minimum dollar amounts (not to exceed $10) for the acceptance of a credit card (and allows federal governmental entities and institutions of higher education to set maximum amounts for the acceptance of credit cards) and (ii) provide discounts or incentives to encourage consumers to pay with cash, checks, debit cards or credit cards.
The rules also contain prohibitions on network exclusivity and merchant routing restrictions that require a card issuer to enable at least two unaffiliated networks on each debit card, prohibit card networks from entering into exclusivity arrangements and restrict the ability of issuers or networks to mandate transaction routing requirements. The prohibition on network exclusivity has not significantly affected our ability to pass on network fees and other costs to our customers, nor do we expect it to in the future.
The Dodd-Frank Act also created the Financial Stability Oversight Council (the "FSOC"), which was established to, among other things, identify risks to the stability of the U.S. financial system. The FSOC has the authority to require supervision and regulation of nonbank financial companies that the FSOC determines pose a systemic risk to the U.S. financial system. Accordingly, we may be subject to additional systemic risk-related oversight.
Payment Network Rules
We are subject to the rules of American Express, Discover, Interac, Mastercard, UPI and Visa and other payment networks. In order to provide our services, several of our subsidiaries are either registered as service providers for member institutions with Mastercard, Visa and other networks or are direct members of Mastercard, Visa and other networks. Accordingly, we are subject to card association and network rules that could subject us to a variety of fines or penalties that may be levied by the card networks for certain acts or omissions.
Banking Laws and Regulations
The FFIEC is an interagency body comprised of federal bank and credit union regulators such as the Federal Reserve Board, the Federal Deposit Insurance Corporation, the National Credit Union Administration, the Office of the Comptroller of the Currency and the Consumer Financial Protection Bureau (the "CFPB"). The FFIEC examines large data processors in order to identify and mitigate risks associated with systemically significant service providers, including specifically the risks they may pose to the banking industry. In addition, we are subject to the Payment Services Directive, which was implemented in most European Union member states through national legislation. As a result of this legislation, we are subject to regulation and oversight in certain European Union member nations, including the requirement that we maintain specified regulatory capital; however, these regulatory capital requirements are generally insignificant to our total assets and total equity and have no material effect on our liquidity.
Privacy, Information Security and Healthcare Technology Laws
We provide services that may be subject to various state, federal and foreign privacy laws and regulations, and, as a result of our recent acquisition of AdvancedMD, certain healthcare technology laws, including the Health Insurance Portability and Accountability Act of 1996, as amended (“HIPAA”) and the Health Information Technology for Economic and Clinical Health Act. These laws and regulations also include the federal Gramm-Leach-Bliley Act of 1999, which applies to a broad range of financial institutions and to companies that provide services to financial institutions in the United States, including our gaming business. and the CCPA, which requires companies that process personal information of California residents to make new disclosures to consumers about their data collection and use, and will grant consumers specific access rights to their data. Outside the United States, these laws include, without limitation, the EU General Data Protection Regulation, Canada’s Personal
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Information Protection and Electronic Documents Act, Hong Kong’s Personal Data Privacy Ordinance (Cap. 486), the Taiwan Personal Data Protection Law, the Philippines’ Data Privacy Act of 2012, and Australia’s Federal Privacy Act of 1988. See Item 1A. Risk Factors - "Any new implementation of or changes made to laws, regulations, card network rules or other industry standards affecting our business in any of the geographic regions in which we operate may require significant development efforts or have an unfavorable effect on our financial results and our cash flows."
Anti-Money Laundering and Counter Terrorist Requirements
In many countries, we are legally or contractually required to comply with anti-money laundering laws and regulations, such as, in the United States, the Bank Secrecy Act, as amended by the USA PATRIOT Act of 2001 (collectively, the "BSA"), and the BSA implementing regulations of the Financial Crimes Enforcement Network ("FinCEN"), a bureau of the U.S. Department of the Treasury. A variety of similar anti-money laundering requirements apply in other countries. In some countries, we are directly subject to these requirements; in other countries, we have contractually agreed to assist our sponsor banks with their obligation to comply with anti-money laundering requirements that apply to them. These laws typically require organizations to:
• | establish and audit anti-money laundering programs; |
• | establish procedures for obtaining and verifying customer information; |
• | file reports on large cash transactions; and |
• | file suspicious activity reports if the financial institution believes a customer may be violating U.S. laws and regulations. |
Regulations issued by the Office of Foreign Assets Control ("OFAC") of the U.S. Department of Treasury place prohibitions and restrictions on all U.S. citizens and entities, including the Company, with respect to transactions by U.S. persons with specified countries and individuals and entities identified on OFAC's Specially Designated Nationals list (for example, individuals and companies owned or controlled by, or acting for or on behalf of, countries subject to certain economic and trade sanctions, as well as terrorists, terrorist organizations and narcotics traffickers identified by OFAC under programs that are not country specific). Similar requirements apply to transactions and dealings with persons and entities specified in lists maintained in other countries. We have developed procedures and controls that are designed to monitor and address legal and regulatory requirements and developments and that allow our customers to protect against having direct business dealings with such prohibited countries, individuals or entities.
Escheat Laws
We are subject to unclaimed or abandoned property state laws in the United States and in certain foreign countries that require us to transfer to certain government authorities the unclaimed property of others that we hold when that property has been unclaimed for a certain period of time. Moreover, we are subject to audit by state and foreign regulatory authorities with regard to our escheatment practices.
Foreign Laws and Regulations
We are subject to foreign laws and regulations that affect the payment technology services industry in each of the foreign countries in which we operate. Some of these countries, such as the Russian Federation, India and the United Kingdom, have undergone significant political, economic and social change in recent years. In these countries, there is a greater risk of new, unforeseen changes that could result from, among other things, instability or changes in a country’s or region’s economic conditions; changes in laws or regulations or in the interpretation of existing laws or regulations, whether caused by a change in government or otherwise; increased difficulty of conducting business in a country or region due to actual or potential political or military conflict; or action by the European Union or the United States, Canada or other governments that may restrict our ability to transact business in a foreign country or with certain foreign individuals or entities, such as sanctions by or against the Russian Federation.
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Debt Collection and Credit Reporting Laws
Portions of our business may be subject to the Fair Debt Collection Practices Act, the Fair Credit Reporting Act and similar state laws. These debt collection laws are designed to eliminate abusive, deceptive and unfair debt collection practices and may require licensing at the state level. The Fair Credit Reporting Act regulates the use and reporting of consumer credit information and also imposes disclosure requirements on entities that take adverse action based on information obtained from credit reporting agencies.
Where to Find More Information
We file annual and quarterly reports, proxy statements and other information with the U.S. Securities and Exchange Commission ("SEC"). You may read and print materials that we have filed with the SEC from its website at www.sec.gov. In addition, certain of our SEC filings, including our annual reports on Form 10-K, our transition report on Form 10-K for the 2016 fiscal transition period, our quarterly reports on Form 10-Q, our current reports on Form 8-K and amendments to them can be viewed and printed, free of charge, from the investor relations section of our website at www.globalpaymentsinc.com. Certain materials relating to our corporate governance, including our codes of ethics applicable to our directors, senior financial officers and other employees, are also available in the investor relations section of our website. Copies of our filings, specified exhibits and corporate governance materials are also available, free of charge, by writing us using the address on the cover of this Annual Report on Form 10-K. You may also telephone our investor relations office directly at (770) 829-8478. We are not including the information on our website as a part of, or incorporating it by reference into, this Annual Report on Form 10-K.
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ITEM 1A - RISK FACTORS
An investment in our common stock involves a high degree of risk. You should consider carefully the following risks and other information contained in this Annual Report on Form 10-K and other SEC filings before you decide whether to buy our common stock. The risks identified below are not all encompassing but should be considered in establishing an opinion of our future operations. If any of the events contemplated by the following discussion of risks should occur, our business, results of operations, financial condition and cash flows could suffer significantly. As a result, the market price of our common stock could decline and you may lose all or part of your investment in our common stock.
Risks Related to Our Business and Operations
Our ability to protect our systems and data from continually evolving cybersecurity risks or other technological risks could affect our reputation among our customers and cardholders, adversely affect our continued card network registration or membership and financial institution sponsorship, and may expose us to penalties, fines, liabilities and legal claims.
In order to provide our services, we process and store sensitive business information and personal information about our merchants, merchants’ customers, merchants’ employees, ISOs, vendors, partners and other parties. This information may include credit and debit card numbers, bank account numbers, social security numbers, driver’s license numbers, names and addresses, and other types of personal information or sensitive business information. Some of this information is also processed and stored by our third-party service providers and other agents (which we refer to collectively as our "associated third parties") as well as merchants and ISOs. We have responsibility to the card networks, their member financial institutions, and in some instances, our merchants, ISOs and/or individuals, for our failure or the failure of our associated third parties or merchants (as applicable) to protect this information.
We are a regular target of malicious third-party attempts to identify and exploit system vulnerabilities, and/or penetrate or bypass our security measures, in order to gain unauthorized access to our networks and systems or those of our associated third parties. Such access could lead to the compromise of sensitive, business, personal or confidential information. As a result, we follow a defense-in-depth model for cybersecurity, meaning we proactively seek to employ multiple methods at different layers to defend our systems against intrusion and attack and to protect the data we collect. However, we cannot be certain that these measures will be successful and will be sufficient to counter all current and emerging technology threats.
Our computer systems and/or our associated third parties’ computer systems could be subject to penetration, and our data protection measures may not prevent unauthorized access. The techniques used to obtain unauthorized access, disable or degrade service or sabotage systems change frequently and are often difficult to detect and continually evolve and become more sophisticated. Threats to our systems and our associated third parties’ systems can derive from human error, fraud or malice on the part of employees or third parties, including state-sponsored organizations with significant financial and technological resources. Computer viruses and other malware can be distributed and could infiltrate our systems or those of our associated third parties. In addition, denial of service or other attacks could be launched against us for a variety of purposes, including to interfere with our services or create a diversion for other malicious activities. Our defensive measures may not prevent downtime, unauthorized access or use of sensitive data. While we maintain first- and third-party insurance coverage that may cover certain aspects of cyber risks, such insurance coverage may be insufficient to cover all losses. Companies we acquire may require post-closing implementation of additional cyber defense methods to align with our standards and, as a result, there may be a period of increased risk between the closing of an acquisition and the completion of such implementation. Further, our third-party relationships are subject to our vendor management program and governed by written contracts; however, we do not control the actions of our associated third parties, and any problems experienced by these third parties, including those resulting from breakdowns or other disruptions in the services provided by such parties or cyberattacks and security breaches, could adversely affect our ability to service our merchant customers or otherwise conduct our business.
We also could be subject to liability for claims relating to misuse of personal information in violation of contractual obligations or data privacy laws. Regulatory authorities around the world are considering or have enacted a number of legislative and regulatory proposals concerning data protection and use, and the interpretation and application of consumer and data protection laws in the United States, Europe, the Asia-Pacific region and elsewhere is increasingly uncertain. It is possible that these laws may be interpreted and applied in a manner that is inconsistent with our data practices or operations model, which could result in potential liability for fines, damages or a need to incur substantial costs to modify our operations. In addition, we cannot provide assurance that the contractual requirements related to use, security and privacy that we impose on our associated third parties who have access to this data will be followed or will be adequate to prevent the misuse of this data. Any misuse or compromise of personal information or failure to adequately enforce these contractual requirements could result in liability, protracted and costly litigation and, with respect to misuse of personal information of our merchants and consumers, lost revenue and reputational harm. In addition, as the regulatory environment related to information security, data collection and use and privacy becomes increasingly
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rigorous, with new and constantly changing requirements applicable to our business, compliance with those requirements could also result in additional costs.
Any type of security breach, attack or misuse of data described above or otherwise, whether experienced by us or an associated third party, could harm our reputation and deter existing and prospective customers from using our services or from making electronic payments generally, increase our operating expenses in order to contain and remediate the incident, expose us to unanticipated or uninsured liability, disrupt our operations (including potential service interruptions), distract our management, increase our risk of litigation or regulatory scrutiny, result in the imposition of penalties and fines under state, federal and foreign laws or by the card networks, and adversely affect our continued card network registration or membership and financial institution sponsorship. Our removal from networks' lists of Payment Card Industry Data Security Standard compliant service providers could mean that existing merchant customers, sales partners or other third parties may cease using or referring our services. Also, prospective merchant customers, sales partners or other third parties may choose to terminate negotiations with us, or delay or choose not to consider us for their processing needs. In addition, the card networks could refuse to allow us to process through their networks.
The payment technology services industry is highly competitive, and some of our competitors are larger and have greater financial and operational resources than we do, which may give them an advantage with respect to the pricing of services offered to customers and the ability to develop new technologies.
We operate in the payment technology services industry, which is highly competitive. In this industry, our primary competitors include other independent payment processors, as well as financial institutions, ISOs and, potentially, card networks. Many of our competitors are companies that are larger than we are, with greater financial and operational resources than we have. Our competitors that are financial institutions or subsidiaries of financial institutions do not incur the costs associated with being sponsored by a direct member for participation in the card networks, as we do in certain jurisdictions, and may be able to settle transactions more quickly for merchants than we can. These financial institutions may also provide payment processing services to merchants at a loss in order to generate banking fees from the merchants. It is also possible that larger financial institutions could decide to perform in-house some or all of the services that we currently provide or could provide. These attributes may provide them with a competitive advantage in the market.
Furthermore, we are facing increasing competition from nontraditional competitors, including new entrant technology companies who offer certain innovations in payment methods. Some of these competitors utilize proprietary software and service solutions. Some of these nontraditional competitors have significant financial resources and robust networks and are highly regarded by consumers. In addition, some nontraditional competitors, such as private companies or startup companies, may be less risk averse than we are and, therefore, may be able to respond more quickly to market demands. If these nontraditional competitors gain a greater share of total electronic payments transactions, it could have a material adverse effect on our business, financial condition, results of operations and cash flows. These competitors may compete in ways that minimize or remove the role of traditional card networks, processors and/or point-of-sale software in the electronic payments process.
In order to remain competitive and to continue to increase our revenues and earnings, we must continually and quickly update our services, a process that could result in higher costs and the loss of revenues, earnings and customers if the new services do not perform as intended or are not accepted in the marketplace.
The payment technology services industry in which we compete are characterized by rapid technological change, new product introductions, evolving industry standards and changing customer needs. In order to remain competitive, we are continually involved in a number of projects, including the development of a new authorization platform, mobile payment applications, ecommerce services and other new offerings emerging in the payment technology services industry. These projects carry the risks associated with any development effort, including cost overruns, delays in delivery and performance problems. In the payment technology services markets, these risks are even more acute. Any delay in the delivery of new services or the failure to differentiate our services could render our services less desirable to customers, or possibly even obsolete. Furthermore, as the market for alternative payment processing services evolves, it may develop too rapidly or not rapidly enough for us to recover the costs we have incurred in developing new services targeted at this market.
In addition, the services we deliver to the payment technology services markets are designed to process very complex transactions and deliver reports and other information on those transactions, all at very high volumes and processing speeds. Any failure to deliver an effective and secure product or any performance issue that arises with a new product or service could result in significant processing or reporting errors or other losses. As a result of these factors, our development efforts could result in higher costs that could reduce our earnings in addition to a loss of revenues and earnings if promised new services are not delivered
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timely to our customers or do not perform as anticipated. We rely in part on third parties, including some of our competitors and potential competitors, for the development of and access to new technologies.
Our revenues from the sale of services to merchants that accept Visa cards and Mastercard cards are dependent upon our continued Visa and Mastercard registrations, financial institution sponsorship and, in some cases, continued membership in certain card networks.
In order to provide our Visa and Mastercard transaction processing services, we must be either a direct member or be registered as a merchant processor or service provider of Visa and Mastercard, respectively. Registration as a merchant processor or service provider is dependent upon our being sponsored by Members of each organization in certain jurisdictions. If our sponsor financial institution in any market should stop providing sponsorship for us, we would need to find another financial institution to provide those services or we would need to attain direct membership with the card networks, either of which could prove to be difficult and expensive. If we are unable to find a replacement financial institution to provide sponsorship or attain direct membership, we may no longer be able to provide processing services to affected customers and potential customers in that market, which would negatively affect our revenues, earnings and cash flows. Furthermore, some agreements with our financial institution sponsors give them substantial discretion in approving certain aspects of our business practices, including our solicitation, application and qualification procedures for merchants and the terms of our agreements with merchants. Our sponsors' discretionary actions under these agreements could have a material adverse effect on our business, financial condition, results of operations and cash flows. In connection with direct membership, the rules and regulations of various card associations and networks prescribe certain capital requirements. Any increase in the capital level required would limit our use of capital for other purposes.
We rely on various financial institutions to provide clearing services in connection with our settlement activities. If we are unable to maintain clearing services with these financial institutions and are unable to find a replacement, our business may be adversely affected.
We rely on various financial institutions to provide clearing services in connection with our settlement activities. If such financial institutions should stop providing clearing services, we must find other financial institutions to provide those services. If we are unable to find a replacement financial institution we may no longer be able to provide processing services to certain customers, which could negatively affect our revenues, earnings and cash flows.
If we fail to comply with the applicable requirements of the card networks, they could seek to fine us, suspend us or terminate our registrations or membership. If we incur fines or penalties for which our merchants or ISOs are responsible that we cannot collect or pursue collection from them, we may have to bear the cost of such fines or penalties.
We are subject to card association and network rules that could subject us to a variety of fines or penalties that may be levied by the card networks for certain acts or omissions. The rules of the card networks are set by their boards, which may be influenced by card issuers, and some of those issuers are our competitors with respect to these processing services. Many banks directly or indirectly sell processing services to merchants in direct competition with us. These banks could attempt, by virtue of their influence on the networks, to alter the networks' rules or policies to the detriment of non-members, including us in certain jurisdictions. The termination of our registrations or our membership or our status as a service provider or a merchant processor, or any changes in card association or other network rules or standards, including interpretation and implementation of the rules or standards, that increase the cost of doing business or limit our ability to provide transaction processing services to our customers, could have a material adverse effect on our business, financial condition, results of operations and cash flows. If a merchant or an ISO fails to comply with the applicable requirements of the card associations and networks, we or the merchant or ISO could be subject to a variety of fines or penalties that may be levied by the card associations or networks. If we cannot collect or pursue collection of such amounts from the applicable merchant or ISO, we may have to bear the cost of such fines or penalties, resulting in lower earnings for us. The termination of our registration, or any changes in the Visa or Mastercard rules that would impair our registration, could require us to stop providing Visa and Mastercard payment processing services, which would make it impossible for us to conduct our business on its current scale.
Our systems or our third-party providers' systems may fail, which could interrupt our service, cause us to lose business, increase our costs and expose us to liability.
We depend on the efficient and uninterrupted operation of our computer systems, software, data centers and telecommunications networks, as well as the systems and services of third parties. A system outage or data loss could have a material adverse effect on our business, financial condition, results of operations and cash flows. Not only would we suffer damage to our reputation in the event of a system outage or data loss, but we may also be liable to third parties. Our systems and operations or those of our third-party providers could be exposed to damage or interruption from, among other things, fire, natural disaster, power loss, telecommunications failure, terrorist acts, war, unauthorized entry, human error, and computer viruses or other defects.
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Defects in our systems or those of third parties, errors or delays in the processing of payment transactions, telecommunications failures, or other difficulties (including those related to system relocation) could result in loss of revenue, loss of customers, loss of merchant and cardholder data, harm to our business or reputation, exposure to fraud losses or other liabilities, negative publicity, additional operating and development costs, fines and other sanctions imposed by card networks, and/or diversion of technical and other resources.
We may experience software defects, undetected errors, and development delays, which could damage customer relations, decrease our potential profitability and expose us to liability.
Our services are based on software and computing systems that often encounter development delays, and the underlying software may contain undetected errors, viruses or defects. Defects in our software services and errors or delays in our processing of electronic transactions could result in additional development costs, diversion of technical and other resources from our other development efforts, loss of credibility with current or potential customers, harm to our reputation and exposure to liability claims.
In addition, we rely on technologies and software supplied by third parties that may also contain undetected errors, viruses or defects that could have a material adverse effect on our business, financial condition, results of operations and cash flows.
Increased merchant, referral partner or ISO attrition could cause our financial results to decline.
We experience attrition in merchant credit and debit card processing volume resulting from several factors, including business closures, transfers of merchants' accounts to our competitors, unsuccessful contract renewal negotiations and account closures that we initiate for various reasons, such as heightened credit risks or contract breaches by merchants. If an ISO partner switches to another transaction processor, terminates our services, internalizes payment processing functions that we perform, merges with or is acquired by one of our competitors, or shuts down or becomes insolvent, we may no longer receive new merchant referrals from the ISO, and we risk losing existing merchants that were originally enrolled by the ISO. We cannot predict the level of attrition in the future and it could increase. Our referral partners are a significant source of new business. Higher than expected attrition could negatively affect our results, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.
Our future growth depends in part on the continued expansion within markets in which we already operate, the emergence of new markets, and the continued availability of alliance relationships and strategic acquisition opportunities.
Our future growth and profitability depend upon our continued expansion within the markets in which we currently operate, the further expansion of these markets, the emergence of other markets for payment technology and software solutions and our ability to penetrate these markets. As part of our strategy to achieve this expansion, we look for acquisition opportunities, investments and alliance relationships with other businesses that will allow us to increase our market penetration, technological capabilities, product offerings and distribution capabilities. We may not be able to successfully identify suitable acquisition, investment and alliance candidates in the future, and if we do, they may not provide us with the value and benefits we anticipate.
Our expansion into new markets is also dependent upon our ability to apply our existing technology or to develop new applications to meet the particular service needs of each new market. We may not have adequate financial or technological resources to develop effective and secure services and distribution channels that will satisfy the demands of these new markets. If we fail to expand into new and existing markets for payment technology and software solutions, we may not be able to continue to grow our revenues and earnings.
There may be a decline in the use of cards and other electronic payments as a payment mechanism for consumers or adverse developments with respect to the card industry in general.
If consumers do not continue to use credit or debit cards or other electronic payment methods as a payment mechanism for their transactions or if there is a change in the mix of payments between cash, checks, credit cards, and debit cards, which is adverse to us, it could have a material adverse effect on our business, financial condition, results of operations and cash flows. Consumer credit risk may make it more difficult or expensive for consumers to gain access to credit facilities such as credit cards. Regulatory changes may result in financial institutions seeking to charge their customers additional fees for use of credit or debit cards. Such fees may result in decreased use of credit or debit cards by cardholders. In each case, our business, financial condition, results of operations and cash flows may be adversely affected. We believe future growth in the use of credit and debit cards and other electronic payments will be driven by the cost, ease-of-use, and quality of services offered to consumers and businesses. In order to consistently increase and maintain our profitability, consumers and businesses must continue to use electronic payment methods that we process, including credit and debit cards.
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We incur chargeback losses when our merchants refuse or cannot reimburse us for chargebacks resolved in favor of their customers. Any increase in chargebacks not paid by our merchants may adversely affect our business, financial condition, results of operations and cash flows.
In the event a dispute between a cardholder and a merchant is not resolved in favor of the merchant, the transaction is normally charged back to the merchant and the purchase price is credited or otherwise refunded to the cardholder. If we are unable to collect such amounts from the merchant's account or reserve account (if applicable), or if the merchant refuses or is unable, due to closure, bankruptcy or other reasons, to reimburse us for a chargeback, we bear the loss for the amount of the refund paid to the cardholder. The risk of chargebacks is typically greater with those merchants that promise future delivery of goods and services rather than delivering goods or rendering services at the time of payment. We may experience significant losses from chargebacks in the future. Any increase in chargebacks not paid by our merchants could have a material adverse effect on our business, financial condition, results of operations and cash flows. We have policies to manage merchant-related credit risk and often mitigate such risk by requiring collateral and monitoring transaction activity. Notwithstanding our programs and policies for managing credit risk, it is possible that a default on such obligations by one or more of our merchants could have a material adverse effect on our business.
Fraud by merchants or others could have an adverse effect on our financial condition, results of operations and cash flows.
We have potential liability for fraudulent electronic payment transactions or credits initiated by merchants or others. Examples of merchant fraud include when a merchant or other party knowingly uses a stolen or counterfeit credit or debit card, card number, or other credentials to record a false sales or credit transaction, processes an invalid card, or intentionally fails to deliver the merchandise or services sold in an otherwise valid transaction. Criminals are using increasingly sophisticated methods to engage in illegal activities such as counterfeiting and fraud. Failure to effectively manage risk and prevent fraud could increase our chargeback losses or cause us to incur other liabilities. It is possible that incidents of fraud could increase in the future. Increases in chargebacks or other liabilities could have a material adverse effect on our financial condition, results of operations and cash flows.
We are subject to economic and political risk, the business cycles and credit risk of our customers and the overall level of consumer, business and government spending, which could negatively affect our business, financial condition, results of operations and cash flows.
The global payment technology services industry depends heavily on the overall level of consumer, business and government spending. We are exposed to general economic conditions that affect consumer confidence, consumer spending, consumer discretionary income and changes in consumer purchasing habits. A sustained deterioration in general economic conditions in the markets in which we operate or increases in interest rates may adversely affect our financial performance by reducing the number or average purchase amount of transactions made using electronic payments. A reduction in the amount of consumer spending could result in a decrease in our revenues and profits. If our merchants make fewer sales to consumers using electronic payments or consumers using electronic payments spend less per transaction, we will have fewer transactions to process or lower transaction amounts, each of which would contribute to lower revenues.
A downturn in the economy could force retailers to close, resulting in exposure to potential credit losses and future transaction declines. Furthermore, credit card issuers may reduce credit limits and be more selective with respect to whom they issue credit cards. We also have a certain amount of fixed and other costs, including rent, debt service, and salaries, which could limit our ability to quickly adjust costs and respond to changes in our business and the economy. Changes in economic conditions could also adversely affect our future revenues and profits and cause a materially adverse effect on our business, financial condition, results of operations and cash flows.
In addition, a recessionary economic environment could affect our merchants through a higher rate of bankruptcy filings, resulting in lower revenues and earnings for us. Our associated third parties are also liable for any fines or penalties that may be assessed by any card networks. In the event that we are not able to collect such amounts from our merchants or the associated third parties, due to fraud, breach of contract, insolvency, bankruptcy or any other reason, we may be liable for any such charges.
Reject losses arise from the fact that, in most markets, we collect our fees from our merchants on the first day after the monthly billing period. This results in the build-up of a substantial receivable from our customers. If a merchant has gone out of business during the billing period, we may be unable to collect such fees, which could negatively affect our business, financial condition, results of operations and cash flows.
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Increases in card network fees may result in the loss of customers and/or a reduction in our earnings.
From time-to-time, the card networks, including Visa and Mastercard, increase the fees that they charge processors. We could attempt to pass these increases along to our merchant customers, but this strategy might result in the loss of customers to our competitors who may not pass along the increases, thereby reducing our revenues and earnings. If competitive practices prevent us from passing along the higher fees to our merchant customers in the future, we may have to absorb all or a portion of such increases, thereby increase our operating costs and reducing our earnings.
Any new implementation of or changes made to laws, regulations, card network rules or other industry standards affecting our business in any of the geographic regions in which we operate may require significant development efforts or have an unfavorable effect on our financial results and our cash flows.
Our business is affected by laws and regulations and examinations that affect us and our industry in the countries in which we operate. Regulation and proposed regulation of the payments industry has increased significantly in recent years. Failure to comply with regulations or guidelines may result in the suspension or revocation of a license or registration, the limitation, suspension or termination of service, and the imposition of civil and criminal penalties, including fines, or may cause customers or potential customers to be reluctant to do business with us, any of which could have an adverse effect on our financial condition. For example, we are subject to the card network rules of Visa, Mastercard and other card networks, Interac, and various debit networks; applicable privacy and information security regulations in the regions where we operate and of the card networks; the Payment Services Directive in Europe; The Code of Conduct for the Credit and Debit Card Industry in Canada (issued by Canada's Department of Finance); the Housing Assistance Tax Act of 2008 in the United States, which requires information returns to be made for each calendar year by merchant acquiring entities; and a myriad of U.S. federal and state consumer protection laws and state escheat regulations. We are also subject to examination by the FFIEC as a result of our provision of data processing services to financial institutions. Additionally, we manage a membership discount program that is billed to customers annually on a recurring basis. Change in regulation of this type of billing could negatively affect our revenue.
Interchange fees (which are retained by the card issuer in connection with transactions) are subject to intense legal, regulatory and legislative scrutiny worldwide. For instance, the Dodd-Frank Act, which was signed into law in July 2010, significantly changed the U.S. financial regulatory system. Changes affecting the payment processing industry include restricting amounts of debit card fees that certain issuing institutions can charge merchants and allowing merchants to set minimum amounts for the acceptance of credit cards and to offer discounts for different payment methods. These types of restrictions could negatively affect the number of debit transactions, which would adversely affect our business. The Dodd-Frank Act also created the CFPB, which has assumed responsibility for enforcing federal consumer protection laws, and the Financial Stability Oversight Council, which has the authority to determine whether any nonbank financial company, such as us, should be supervised by the Board of Governors of the Federal Reserve System (the "Federal Reserve") on the ground that it is "systemically important "to the U.S. financial system. Any such designation would result in increased regulatory burdens on our business, which increases our risk profile and may have an adverse effect on our business, financial condition, results of operations and cash flows.
All persons offering or providing financial services or products to consumers, directly or indirectly, can be subject to prohibitions against unfair, deceptive, or abusive acts or practices ("UDAAP") under the Dodd-Frank Act. The CFPB has enforcement authority to prevent an entity that offers or provides consumer financial services or products or a service provider from committing or engaging in UDAAP, including the ability to engage in joint investigations with other agencies, issue subpoenas and civil investigative demands, conduct hearings and adjudication proceedings, commence a civil action, grant relief (e.g., limit activities or functions; rescission of contracts), and refer matters for criminal proceedings. More generally, all persons engaged in commerce, including, but not limited to, us and our merchant and financial institution customers, are also subject to Section 5 of the Federal Trade Commission ("FTC") Act prohibiting unfair or deceptive acts or practices ("UDAP"). In addition, there are other laws, rules and or regulations, including the Telemarketing Sales Act, that may directly impact the activities of our merchant customers and in some cases may subject us, as the merchant's payment processor, to investigations, fees, fines and disgorgement of funds in the event we are deemed to have aided and abetted or otherwise provided the means and instrumentalities to facilitate the illegal activities of the merchant through our payment processing services. Various federal and state regulatory enforcement agencies, including the FTC, the CFPB and the states’ attorneys general have the authority to take action against nonbanks that engage in UDAP or violate other laws, rules or regulations and, to the extent we are processing payments for a merchant that may be in violation of these laws, rules or regulations, we may be subject to enforcement actions and as a result may incur losses and liabilities.
In many countries, we are legally or contractually required to comply with the anti-money laundering laws and regulations, such as, in the United States, the BSA, as amended by the USA PATRIOT Act, and similar laws of other countries, which require that customer identifying information be obtained and verified. In some countries, we are directly subject to these requirements; in other countries, we have contractually agreed to assist our sponsor financial institutions with their obligation to comply with
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anti-money laundering requirements that apply to them. In addition, we and our sponsor financial institutions are subject to the laws and regulations enforced by OFAC, which prohibit U.S. persons from engaging in transactions with certain prohibited persons or entities. Similar requirements apply in other countries. Our failure to comply with any of these contractual requirements or laws could adversely affect our business, financial credit results of operations and cash flows.
We are also subject to a variety of foreign and domestic laws, and their implementing regulations, which establish requirements for the collection, processing, storage, use and disclosure of personal information, require notice to individuals of privacy practices, and provide individuals with certain rights to prevent use and disclosure of protected information. Outside the United States, these laws include, without limitation, the EU General Data Protection Regulation. As a result of our acquisition of AdvancedMD, we are also subject to laws and regulations affecting the healthcare industry, including but not limited to false or fraudulent claim laws; HIPAA and other health privacy regulations; prescribing laws; electronic health record laws; claims and transmission laws; and prompt pay laws. Under HIPAA, covered entities and business associates must establish administrative, physical and technical safeguards to protect the confidentiality, integrity and availability of electronic protected health information maintained or transmitted by them or by others on their behalf. Compliance with these laws and regulations can be costly and time consuming, adding a layer of complexity to business practices and innovation. As with other regulatory schemes, our failure to comply could result in public or private enforcement action and accompanying litigation costs, losses, fines and penalties.
Portions of our business may be subject to the Fair Debt Collection Practices Act, the Fair Credit Reporting Act and similar state laws. These debt collection laws are designed to eliminate abusive, deceptive and unfair debt collection practices and may require licensing at the state level. The Fair Credit Reporting Act regulates the use and reporting of consumer credit information and also imposes disclosure requirements on entities that take adverse action based on information obtained from credit reporting agencies. If we fail to comply with any of these laws, to the extent they are applicable to us, we may be subject to fines, penalties and litigation.
Changes to legal rules and regulations, or interpretation or enforcement thereof, even if not directed at us, may require significant efforts to change our systems and services and may require changes to how we price our services to customers, adversely affecting our business. Even an inadvertent failure to comply with laws and regulations, as well as rapidly evolving social expectations of corporate fairness, could damage our business or our reputation. Furthermore, we are subject to tax laws in each jurisdiction where we conduct business. Changes in such laws or their interpretations could decrease the value of revenues we receive, the value of tax losses and tax credit carry forwards recorded on our balance sheet and have a material adverse effect on our financial condition, results of operations and cash flows.
We are subject to risks associated with changes in interest rates or currency exchange rates, which could adversely affect our business, financial position, results of operations and cash flows, and we may not effectively hedge against these risks.
A substantial portion of our indebtedness bears interest at a variable rate, and we may incur additional variable-rate indebtedness in the future. Increases in interest rates will reduce our operating cash flows and could hinder our ability to fund our operations, capital expenditures, acquisitions, share repurchases or dividends.
We are also subject to risks related to the changes in currency exchange rates as a result of our investments in foreign operations and from revenues generated in currencies other than the U.S. dollar. Revenues and profit generated by international operations will increase or decrease compared to prior periods as a result of changes in currency exchange rates. Volatility in currency exchange rates has affected and may continue to affect our financial results.
In certain of the jurisdictions in which we operate, we may become subject to exchange control regulations that might restrict or prohibit the conversion of our foreign currencies into U.S. dollars or limit our ability to freely move currency in or out of particular jurisdictions. The occurrence of any of these factors could decrease the value of revenues we receive from our international operations and have a material adverse effect on our business.
We may seek to reduce our exposure to fluctuations in interest rates or currency exchange rates through the use of hedging arrangements. To the extent that we hedge our interest rate or currency exchange rate exposures, we forgo the benefits we would otherwise experience if interest rates or currency exchange rates were to change in our favor. Developing an effective strategy for dealing with movements in interest rates and currency exchange rates is complex, and no strategy can completely insulate us from risks associated with such fluctuations. In addition, a counterparty to the arrangement could default on its obligation, thereby exposing us to credit risk. We may have to repay certain costs, such as transaction fees or breakage costs, if we terminate these arrangements.
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Changes in the method for determining LIBOR and the potential replacement of the LIBOR benchmark interest rate could adversely affect our business, financial condition, results of operations and cash flows.
A substantial portion of our indebtedness bears interest at a variable rate based on LIBOR. Furthermore, we have entered into hedging instruments to manage our exposure to fluctuations in the LIBOR benchmark interest rate. In July 2017, the United Kingdom’s Financial Conduct Authority ("FCA"), a regulator of financial services firms and financial markets in the United Kingdom, stated that they will plan for a phase out of regulatory oversight of LIBOR interest rates indices. The FCA has indicated they will support the LIBOR indices through 2021, to allow for an orderly transition to an alternative reference rate. The Alternative Reference Rates Committee has proposed the Secured Overnight Financing Rate ("SOFR") as its recommended alternative to LIBOR, and the Federal Reserve Bank of New York began publishing SOFR rates in April 2018. SOFR is intended to be a broad measure of the cost of borrowing cash overnight collateralized by U.S. Treasury securities.
We are evaluating the potential impact of the eventual replacement of the LIBOR benchmark interest rate, including the possibility of SOFR as the dominant replacement. The market transition away from LIBOR and towards SOFR is expected to be gradual and complicated, including the development of term and credit adjustments to accommodate differences between LIBOR and SOFR. Introduction of an alternative rate also may introduce additional basis risk for market participants as an alternative index is utilized along with LIBOR. There can be no guarantee that SOFR will become widely used and that alternatives may or may not be developed with additional complications. We are not able to predict whether LIBOR will cease to be available after 2021, whether SOFR will become a widely accepted benchmark in place of LIBOR, or what the impact of such a possible transition to SOFR may be on our business, financial condition, and results of operations.
We conduct a portion of our business in various foreign countries where the risk of continued political, economic and regulatory change that could affect our operating results is greater than in the United States.
We expect to continue to expand our operations in North America, Europe and the Asia-Pacific region. Some of the countries in which we operate, such as the Russian Federation, India and the United Kingdom, have undergone significant political, economic and social change in recent years, and the risk of new, unforeseen changes in these countries remains greater than in the United States. Our business, growth, financial condition or results of operations could be materially adversely affected by instability or changes in a country’s or region’s economic conditions; inflation; changes in laws or regulations or in the interpretation of existing laws or regulations, whether caused by a change in government or otherwise; increased difficulty of conducting business in a country or region due to actual or potential political or military conflict; or action by the European Union or the United States, Canada or other governments that may restrict our ability to transact business in a foreign country or with certain foreign individuals or entities, such as sanctions by or against the Russian Federation. A possible slowdown in global trade caused by increasing tariffs or other restrictions could decrease consumer or corporate confidence and reduce consumer, government and corporate spending in countries outside the United States, which could adversely affect our foreign operations.
In addition, maintenance of certain types of data by electronic means and telecommunications is subject to specific regulation in many countries. Changes in these regulations, such as taxation or limitations on transfers of data between countries or the type of permission that must be obtained in conjunction with the use of such data, could have a material adverse effect on our business, growth, financial condition, results of operations or cash flows.
On June 23, 2016, the United Kingdom held a referendum in which voters approved an exit from the European Union, commonly referred to as "Brexit," and on March 29, 2017, notified the European Union that it intended to exit as provided in Article 50 of the Treaty on European Union. In March 2018, the parties agreed to a transition period of 21 months - from March 29, 2019 until the end of 2020 - before the United Kingdom leaves the European Union completely, assuming approval of the negotiated withdrawal agreement. The terms of the withdrawal are subject to ongoing negotiation that has created uncertainty about the future relationship between the United Kingdom and the European Union.
Brexit has caused, and may continue to cause, economic uncertainty, including volatility in global stock markets and currency exchange rate fluctuations, which may adversely affect the profitability of our U.K. operations. In addition, Brexit could lead to increased regulatory complexities, including, without limitation, regulation relating to data security, privacy and taxation. With a range of outcomes still possible, the full effect of Brexit is uncertain and depends on any agreements the United Kingdom may make to retain access to European Union markets. Consequently, no assurance can be given about the effect of the outcome on our U.K. business and its financial conditions, results of operations and cash flows may be adversely affected.
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The integration and conversion of our acquired operations or other future acquisitions, if any, could result in increased operating costs if the anticipated synergies of operating these businesses as one are not achieved, a loss of strategic opportunities if management is distracted by the integration process, and a loss of customers if our service levels drop during or following the integration process.
The acquisition, integration, and conversion of businesses (such as, but not limited to, the recent acquisitions of AdvancedMD and SICOM) and the formation or operation of alliances, such as joint ventures and other partnering arrangements involve a number of risks. Core risks are in the area of valuation (negotiating a fair price for the business based on inherently limited diligence) and integration and conversion (managing the complex process of integrating the acquired company's people, services, information security and technology and other assets to realize the projected value of the acquired company and the synergies projected to be realized in connection with the acquisition). In addition, international acquisitions and alliances often involve additional or increased risks including, for example: managing geographically separated organizations, systems, and facilities; integrating personnel with diverse business backgrounds and organizational cultures; complying with foreign regulatory requirements; fluctuations in currency exchange rates; enforcement of intellectual property rights in some foreign countries; difficulty entering new foreign markets due to, among other things, customer acceptance and business knowledge of those new markets; and general economic and political conditions.
If the integration and conversion process does not proceed smoothly, the following factors, among others, could reduce our revenues and earnings, increase our operating costs, and result in us not achieving projected synergies:
• | If we are unable to successfully integrate the benefits plans, duties and responsibilities, and other factors of interest to the management and employees of the acquired business, we could lose employees to our competitors in the region, which could significantly affect our ability to operate the business and complete the integration; |
• | If the integration process causes any delays with the delivery of our services, or the quality of those services, we could lose customers to our competitors, which would reduce our revenues and earnings; |
• | The acquisition may otherwise cause disruption to the acquired company’s business and operations and relationships with financial institution sponsors, customers, merchants, employees and other partners; |
• | The acquisition and the related integration could divert the attention of our management from other strategic matters including possible acquisitions and alliances and planning for new product development or expansion into new markets for payments technology and software solutions; and |
• | The costs related to the integration of the acquired company’s business and operations into ours may be greater than anticipated. |
The costs and effects of pending and future litigation, investigations or similar matters, or adverse facts and developments related thereto, could materially affect our business, financial position, results of operations and cash flows.
We are from time-to-time involved in various litigation matters and governmental or regulatory investigations or similar matters arising out of our current or future business. Our insurance or indemnities may not cover all claims that may be asserted against us, and any claims asserted against us, regardless of merit or eventual outcome, may harm our reputation. Furthermore, there is no guarantee that we will be successful in defending ourselves in pending or future litigation or similar matters under various laws. Should the ultimate judgments or settlements in any pending litigation or future litigation or investigation significantly exceed our insurance coverage, they could have a material adverse effect on our business, financial condition, results of operations and cash flows.
We may not be able to successfully manage our intellectual property and may be subject to infringement claims.
In our rapidly developing legal framework, we rely on a combination of contractual rights and copyright, trademark, patent and trade secret laws to establish and protect our proprietary technology. Despite our efforts to protect our intellectual property, third parties may infringe or misappropriate our intellectual property or may develop software or technology that competes with ours. Our competitors may independently develop similar technology, duplicate our services or design around our intellectual property rights. We may have to litigate to enforce and protect our intellectual property rights, trade secrets and know-how or to determine their scope, validity or enforceability, which is expensive and could cause a diversion of resources and may not prove to be successful. The loss of intellectual property protection or the inability to secure or enforce intellectual property protection could harm our business and ability to compete.
We may also be subject to costly litigation in the event our services and technology infringe upon another party’s proprietary rights. Third parties may have, or may eventually be issued, patents that would be infringed by our services or technology. Any of these third parties could make a claim of infringement against us with respect to our services or technology. We may also be subject to claims by third parties for breach of copyright, trademark or license usage rights. Any such claims and any resulting
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litigation could subject us to significant liability for damages. An adverse determination in any litigation of this type could limit our ability to use the intellectual property subject to these claims and require us to design around a third party’s patent, which may not be possible, or to license alternative technology from another party, which may be costly. In addition, litigation is often time consuming and expensive to defend and could result in the diversion of the time and attention of our management and employees.
New or revised tax regulations, unfavorable resolution of tax contingencies or changes to enacted tax rates could adversely affect our tax expense.
Changes in tax laws or their interpretations could result in changes to enacted tax rates and may require complex computations to be performed that were not previously required, significant judgments to be made in interpretation of the new or revised tax regulations and significant estimates in calculations, as well as the preparation and analysis of information not previously relevant or regularly produced. Future changes in enacted tax rates could negatively affect our results of operations.
The U.S. Tax Cuts and Jobs Act of 2017 (the "2017 U.S. Tax Act") significantly changed the taxation of U.S.-based multinational corporations. The U.S. Treasury Department, the U.S. Internal Revenue Service and state tax authorities have issued and are expected to continue to issue guidance on how the provisions of the 2017 U.S. Tax Act will be applied or otherwise administered. The legislation could be subject to potential amendments and technical corrections, any of which could materially change certain effects of the legislation. As regulations and guidance evolve with respect to the 2017 U.S. Tax Act, and as we gather information and perform more analysis, our results may differ from previous estimates and may materially affect our financial position.
Our tax returns and positions are subject to review and audit by federal, state, local and international taxing authorities. An unfavorable outcome to a tax audit could result in higher tax expense, thereby negatively affecting our results of operations and cash flows. We have recognized estimated liabilities on the balance sheet for material known tax exposures relating to deductions, transactions and other matters involving some uncertainty as to the proper tax treatment of the item. These liabilities reflect what we believe to be reasonable assumptions as to the likely final resolution of each issue if raised by a taxing authority. While we believe that the liabilities are adequate to cover reasonably expected tax risks, there can be no assurance that, in all instances, an issue raised by a tax authority will be finally resolved at a financial amount no more than any related liability. An unfavorable resolution, therefore, could negatively affect our financial position, results of operations and cash flows in the current and/or future periods.
We may become subject to additional U.S., state or foreign taxes that cannot be passed through to our customers, in which case our earnings could be adversely affected.
We are or may be subject in various jurisdictions to certain taxes that are not derived based on earnings (e.g. sales, gross receipts, property, value-added and other business taxes). Application of these taxes is an emerging issue in our industry and the taxing authorities have not yet all adopted uniform regulations on certain of these topics. If we are required to pay such taxes and are not able to pass the tax cost through to our customers, our earnings and cash flows would be negatively affected.
We have structured our business in accordance with existing tax laws and interpretations of such laws which have been confirmed through either tax rulings or opinions obtained in various jurisdictions, including those related to value-added taxes in Europe. Changes in tax laws or their interpretations could decrease the value of revenues we receive and the amount of our cash flows and have a material adverse effect on our business.
Risks Related to Our Organizational and Capital Structure
If we lose key personnel or are unable to attract additional qualified personnel as we grow, our business could be adversely affected.
All of our businesses function at the intersection of rapidly changing technological, social, economic and regulatory developments that requires a wide ranging set of expertise and intellectual capital. To successfully compete and grow, we must recruit, develop and retain the necessary personnel who can provide the needed expertise across the entire spectrum of intellectual capital needs. In addition, we must develop our personnel to fulfill succession plans capable of maintaining continuity in the midst of the inevitable unpredictability of human capital. However, the market for qualified personnel is competitive, and we may not succeed in recruiting additional personnel or may fail to effectively replace current personnel who depart with qualified or effective successors. We cannot assure that key personnel, including executive officers, will continue to be employed or that we will be able to attract and retain qualified personnel in the future. Failure to retain or attract key personnel could have a material adverse effect on our business, financial condition, results of operations and cash flows.
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Our substantial indebtedness could adversely affect us and decrease our business flexibility.
We have a significant amount of indebtedness. Our level of debt and the covenants to which we have agreed in connection with this and other financing transactions could, among other things, (i) require us to dedicate a larger portion of our cash flow from operations to servicing and repayment of the debt, (ii) reduce funds available for strategic initiatives and opportunities, working capital, capital investment and other general corporate needs and (iii) limit our ability to incur certain kinds or amounts of additional indebtedness, which could restrict our flexibility to react to changes in our business, our industry and economic conditions.
The Company's debt agreements contain restrictions that may limit our flexibility in operating our business and our ability to return capital to our shareholders.
Our Credit Facility contains various covenants that limit our ability and the ability of our subsidiaries to engage in specified types of transactions. These covenants limit our ability in certain circumstances to, among other things:
• | incur additional indebtedness; |
• | create liens; |
• | consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; |
• | enter into certain lines of business; |
• | enter into certain transactions with affiliates; and, |
• | pay dividends and repurchase shares of our common stock. |
Our Credit Facility also contains customary financial covenants based on our leverage ratio and our interest coverage ratio.
A breach of any of these covenants could result in a default under one or more of these agreements, including as a result of cross default provisions and, in the case of the Revolving Credit Facility (described in "Note 8—Long-Term Debt and Lines of Credit" in the notes to the accompanying consolidated financial statements), permit the lenders to cease making loans to us. Upon the occurrence of an event of default under our Credit Facility, the lenders could elect to declare all amounts outstanding under our Credit Facility to be immediately due and payable and terminate all commitments to extend further credit. If we are unable to repay those amounts, the lenders under our Credit Facility could accelerate the repayment of borrowings, and we may not have sufficient assets to repay our indebtedness.
We may need to raise additional funds to finance our future capital needs, which may prevent us from growing our business.
We may need to raise additional funds to finance our future capital needs, including developing new products and technologies or to fund future acquisitions or operating needs. If we raise additional funds through the sale of equity securities, these transactions may dilute the value of our outstanding common stock. We may also decide to issue securities, including debt securities that have rights, preferences and privileges senior to our common stock. We may be unable to raise additional funds on terms favorable to us or at all. If financing is not available or is not available on acceptable terms, we may be unable to fund our future needs. This may prevent us from increasing our market share, capitalizing on new business opportunities or remaining competitive in our industry.
Our balance sheet includes significant amounts of goodwill and intangible assets. The impairment of a portion of these assets could negatively affect our business, financial condition and results of operations.
As a result of our acquisitions, a significant portion of our total assets are intangible assets (including goodwill). Goodwill and intangible assets, net of amortization, together accounted for approximately 67% of our total assets as of December 31, 2018. We expect to engage in additional acquisitions, which may result in our recognition of additional intangible assets and goodwill. We evaluate on a regular basis whether all or a portion of our goodwill and other intangible assets may be impaired. Under current accounting rules, any determination that impairment has occurred would require us to record an impairment charge, which would negatively affect our earnings. An impairment of a portion of our goodwill or intangible assets could have a material adverse effect on our business, financial condition and results of operations.
We may not be able or permitted to, or we may decide not to, pay dividends or repurchase shares at a level anticipated by our shareholders, which could reduce shareholder returns.
The extent to which we pay dividends on our common stock and repurchase our common stock in the future is at the discretion of our board of directors and will depend on, among other factors, our results of operations, financial condition, capital requirements, compliance with debt covenants and such other factors as our board of directors deems relevant. Our Credit Facility may prohibit
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us from (i) repurchasing an amount more than the greater of $350 million or 3% of our total assets of our common stock in any year and (ii) paying quarterly dividends in excess of $0.01 per share. No assurance can be given that we will be able to or will choose to pay any dividends or repurchase any shares in the foreseeable future.
Our risk management policies and procedures may not be fully effective in mitigating our risk exposure in all market environments or against all types of risk.
We operate in a rapidly changing industry. Accordingly, our risk management policies and procedures may not be fully effective to identify, monitor and manage our risks. If our policies and procedures are not fully effective or if we are not always successful in identifying and mitigating all risks to which we are or may be exposed, we may suffer uninsured liability, harm to our reputation or be subject to litigation or regulatory actions that could have a material adverse effect on our business, financial condition, results of operations and cash flows.
Failure to maintain effective internal controls in accordance with Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on our business and stock price.
Section 404 of the Sarbanes-Oxley Act requires us to evaluate annually the effectiveness of our internal control over financial reporting as of the end of each year and to include a management report assessing the effectiveness of our internal control over financial reporting in our annual report. If we fail to maintain the adequacy of our internal controls, including, but not limited to, preventing unauthorized access to our systems, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. Furthermore, this assessment may be complicated by any acquisitions we may complete.
In certain markets, including, without limitation, China, the Republic of Malta and Spain, our member sponsors perform payment processing operations and related support services pursuant to services agreements. We expect that the member sponsors will continue to provide these services until such time as we may integrate these functions into our operations. Accordingly, we rely on our member sponsors to provide financial data, such as amounts billed to merchants, to assist us with compiling our accounting records. As such, our internal control over financial reporting could be materially affected, or is reasonably likely to be materially affected, by the internal control and procedures of our member sponsors in these markets.
While we continue to dedicate resources and management time to ensuring that we have effective internal control over financial reporting, failure to achieve and maintain an effective internal control environment could have a material adverse effect on the market's perception of our business and on our stock price.
Anti-takeover provisions of our articles of incorporation and by-laws and provisions of Georgia law could delay or prevent a change in control that individual shareholders favor.
Provisions of our articles of incorporation and by-laws and provisions of applicable Georgia law may discourage, delay or prevent a merger or other change in control that individual shareholders may consider favorable. The provisions of our articles and by-laws, among other things:
• | divide our board of directors into three classes, with members of each class to be elected in staggered three-year terms; |
• | limit the right of shareholders to remove directors; |
• | regulate how shareholders may present proposals or nominate directors for election at annual meetings of shareholders; and |
• | authorize our board of directors to issue preferred shares in one or more series, without shareholder approval. |
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ITEM 2 - PROPERTIES
We have properties for operational, sales and administrative purposes. At December 31, 2018, we leased approximately 70 properties in the United States and approximately 120 properties in countries outside the United States. In addition, we owned four properties located outside the United States.
Our principal facilities in North America are located in Atlanta, Georgia; Dallas, Texas; Jeffersonville, Indiana; Lansdale, Pennsylvania, Las Vegas, Nevada; Oklahoma City, Oklahoma; Salt Lake City, Utah; and Toronto, Canada. Our principal facilities in Europe are located in Barcelona, Spain; Dublin, Ireland; Leicester, England; London, England; Moscow, Russia; and Prague, Czech Republic. Our principal facilities in the Asia-Pacific region are located in Brisbane, Australia; Hong Kong Special Administrative Region, China; and Manila, Philippines.
We believe that all of our properties will be suitable and adequate for our business as presently conducted.
ITEM 3 - LEGAL PROCEEDINGS
We are party to a number of claims and lawsuits incidental to our business. In our opinion, the liabilities, if any, which may ultimately result from the outcome of such matters, individually or in the aggregate, are not expected to have a material adverse effect on our financial position, liquidity, results of operations or cash flows.
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Part II
ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock trades on the New York Stock Exchange under the ticker symbol "GPN." As of February 19, 2019, there were 2,116 shareholders of record.
Equity Compensation Plan Information
The information regarding our compensation plans under which equity securities are authorized for issuance is set forth in "Item 12—Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters" of this Annual Report.
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Stock Performance Graph
The following graph compares our cumulative shareholder returns with the Standard & Poor's Information Technology Index and the Standard & Poor's 500 Index for the years ended December 31, 2018 and 2017, the 2016 fiscal transition period and the years ended May 31, 2016, 2015 and 2014. The line graph assumes the investment of $100 in our common stock, the Standard & Poor's 500 Index and the Standard & Poor's Information Technology Index on May 31, 2013 and assumes reinvestment of all dividends.
COMPARISON OF 5-YEAR CUMULATIVE TOTAL RETURN*
Among Global Payments Inc., the S&P 500 Index
and the S&P Information Technology Index
*$100 invested on May 31, 2013 in stock or index, including reinvestment of dividends.
Copyright© 2019 Standard & Poor's, a division of S&P Global. All rights reserved.
Global Payments | S&P 500 Index | S&P Information Technology Index | ||||||||||
May 31, 2013 | $ | 100.00 | $ | 100.00 | $ | 100.00 | ||||||
May 31, 2014 | 143.14 | 120.45 | 123.89 | |||||||||
May 31, 2015 | 218.13 | 134.67 | 147.20 | |||||||||
May 31, 2016 | 324.92 | 136.98 | 151.80 | |||||||||
December 31, 2016 | 290.37 | 148.08 | 168.59 | |||||||||
December 31, 2017 | 419.54 | 180.41 | 234.05 | |||||||||
December 31, 2018 | 431.79 | 172.50 | 233.38 | |||||||||
Recent Sales of Unregistered Securities
There were no unregistered sales of equity securities during the year ended December 31, 2018.
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Issuer Purchases of Equity Securities
Information about the shares of our common stock that we repurchased during the quarter ended December 31, 2018 is set forth below:
Period | Total Number of Shares Purchased (1) | Approximate Average Price Paid per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs (2) | |||||||||
(in millions) | |||||||||||||
October 2018 | 784 | $ | 114.94 | — | |||||||||
November 2018 | 967 | 103.87 | — | ||||||||||
December 2018 | 315,260 | 99.37 | — | ||||||||||
Total | 317,011 | $ | 99.43 | — | $ | 387.8 | |||||||
(1) | Our board of directors has authorized us to repurchase shares of our common stock through any combination of Rule 10b5-1 open-market repurchase plans, accelerated share repurchase plans, discretionary open-market purchases or privately negotiated transactions. |
During the quarter ended December 31, 2018, pursuant to our employee incentive plans, we withheld 2,028 shares at an average price per share of $107.99 in order to satisfy employees' tax withholding and payment obligations in connection with the vesting of awards of restricted stock, which we withheld at fair market value on the vesting date.
(2) | On February 6, 2018, our board of directors approved an increase to our existing share repurchase program authorization, which raised the total available authorization to $600 million. As of December 31, 2018, the approximate dollar value of shares that may yet be purchased under our share repurchase program was $387.8 million. On February 5, 2019, the board of directors increased its authorization to repurchase shares of our common stock to $750 million, inclusive of prior share repurchase programs authorized by the board and repurchases made thereunder. The authorizations by the board of directors do not expire, but could be revoked at any time. In addition, we are not required by any of the board's authorizations or otherwise to complete any repurchases by any specific time or at all. |
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ITEM 6 - SELECTED FINANCIAL DATA
You should read the selected financial data set forth below in conjunction with (i) "Item 7 ‑ Management's Discussion and Analysis of Financial Condition and Results of Operations," (ii) "Item 8 ‑ Financial Statements and Supplementary Data" and (iii) the historical consolidated financial statements of Global Payments and the related notes presented in this Annual Report on Form 10-K.
Year Ended December 31, | Seven Months Ended December 31, | Year Ended May 31, | |||||||||||||||||||||
2018 | 2017 | 2016 | 2016 | 2015 | 2014 | ||||||||||||||||||
(in thousands, except per share data) | |||||||||||||||||||||||
Income statement data: | |||||||||||||||||||||||
Revenues | $ | 3,366,366 | $ | 3,975,163 | $ | 2,202,896 | $ | 2,898,150 | $ | 2,773,718 | $ | 2,554,236 | |||||||||||
Operating income | 737,055 | 558,868 | 237,951 | 424,944 | 456,597 | 405,499 | |||||||||||||||||
Net income | 484,667 | 494,070 | 137,683 | 290,217 | 309,115 | 269,952 | |||||||||||||||||
Net income attributable to Global Payments | 452,053 | 468,425 | 124,931 | 271,666 | 278,040 | 245,286 | |||||||||||||||||
Per share data: | |||||||||||||||||||||||
Basic earnings per share | $ | 2.85 | $ | 3.03 | $ | 0.81 | $ | 2.05 | $ | 2.07 | $ | 1.70 | |||||||||||
Diluted earnings per share | 2.84 | 3.01 | 0.81 | 2.04 | 2.06 | 1.69 | |||||||||||||||||
Dividends per share | 0.04 | 0.04 | 0.02 | 0.04 | 0.04 | 0.04 | |||||||||||||||||
Balance sheet data (at period end): | |||||||||||||||||||||||
Total assets | $ | 13,230,774 | $ | 12,998,069 | $ | 10,664,350 | $ | 10,509,952 | $ | 5,779,301 | $ | 4,002,527 | |||||||||||
Settlement lines of credit | 700,486 | 635,166 | 392,072 | 378,436 | 592,629 | 440,128 | |||||||||||||||||
Long-term debt | 5,130,243 | 4,659,716 | 4,438,612 | 4,515,286 | 1,740,067 | 1,390,507 | |||||||||||||||||
Total equity | 4,186,343 | 3,965,231 | 2,779,342 | 2,877,404 | 863,553 | 1,132,799 | |||||||||||||||||
As more fully described in "Note 1—Basis of Presentation and Summary of Significant Accounting Policies" and "Note 3—Revenues" in the notes to the accompanying consolidated financial statements, we adopted a new revenue accounting standard on January 1, 2018 that results in revenue being presented net of certain fees that we pay to third parties, including payment networks. This change in presentation affected our reported revenues and operating expenses during the year ended December 31, 2018 by the same amount and had no effect on operating income.
The selected financial data in the table above reflect the effects of acquisitions and borrowings to fund certain of those acquisitions. See "Note 2—Acquisitions" in the notes to the accompanying consolidated financial statements for further discussion of our acquisitions.
Operating income, net income, net income attributable to Global Payments and basic and diluted earnings per share in the table above reflect acquisition and integration expenses of $56.1 million for the year ended December 31, 2018, $94.6 million for the year ended December 31, 2017, $91.6 million for the 2016 fiscal transition period and $51.3 million for the year ended May 31, 2016.
Net income, net income attributable to Global Payments and basic and diluted earnings per share in the table above also reflect:
(a) the effects of a net income tax benefit of $23.3 million in connection with adjustments made to accounting estimates associated with the 2017 U.S. Tax Act for the year ended December 31, 2018 and a provisional net income tax benefit of $158.7 million recorded in connection with the 2017 U.S. Tax Act for the year ended December 31, 2017. See "Note 10—Income Tax" in the notes to the accompanying consolidated financial statements for further discussion; and,
(b) a gain of $41.2 million recorded in connection with the sale of our membership interests in Visa Europe Limited ("Visa Europe") for the seven months ended December 31, 2016. See "Note 7—Other Assets" in the notes to the accompanying consolidated financial statements for further discussion.
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ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with "Item 6 - Selected Financial Data" and "Item 8 - Financial Statements and Supplementary Data." This discussion and analysis contains forward-looking statements about our plans and expectations of what may happen in the future. Forward-looking statements are based on a number of assumptions and estimates that are inherently subject to significant risks and uncertainties, and our actual results could differ materially from the results anticipated by our forward-looking statements as a result of many known and unknown factors, including but not limited to those discussed in "Item 1A - Risk Factors." See "Cautionary Notice Regarding Forward-Looking Statements" located above "Item 1 - Business."
General
We are a leading worldwide provider of payment technology and software solutions delivering innovative services to our customers globally. Our technologies, services and employee expertise enable us to provide a broad range of solutions that allow our customers to accept various payment types and operate their businesses more efficiently. We distribute our services across a variety of channels in 32 countries throughout North America, Europe, the Asia-Pacific region and Brazil and operate in three reportable segments: North America, Europe and Asia-Pacific.
We were incorporated in Georgia as Global Payments Inc. in 2000 and spun-off from our former parent company in 2001. Including our time as part of our former parent company, we have been in the payment technology services business since 1967. Since our spin-off, we have expanded in existing markets and into new markets internationally by pursuing further acquisitions and joint ventures, including recent acquisitions of technology-enabled and software-driven businesses. In April 2016, we merged with Heartland Payment Systems, Inc. ("Heartland"), which significantly expanded our small and medium-sized enterprise distribution, merchant base and vertical reach in the United States.
We provide payment technology and software solutions to customers globally. Our payment technology solutions are similar around the world in that we enable our customers to accept card, electronic, check and digital-based payments. Our comprehensive offerings include, but are not limited to, authorization services, settlement and funding services, customer support and help-desk functions, chargeback resolution, terminal rental, sales and deployment, payment security services, consolidated billing and statements and on-line reporting.
In addition, we offer a wide array of enterprise software solutions that streamline business operations to customers in numerous vertical markets. We also provide a variety of value-added services, including analytic and engagement tools, payroll services and reporting that assist our customers with driving demand and operating their businesses more efficiently.
The majority of our revenues is generated by services priced as a percentage of transaction value or a specified fee per transaction, depending on the card type or the vertical. We also earn software subscription and licensing fees, as well as other fees based on specific value-added services that may be unrelated to the number or value of transactions.
Our primary business model is to actively market and provide our payment services, enterprise software solutions and other value-added services directly to our customers through a variety of distribution channels. We offer high-touch services that provide our customers with reliable and secure solutions coupled with high quality and responsive support services. Through our direct sales force worldwide, as well as bank partnerships, which we generally refer to as "direct distribution," we offer our payment technology services, software and other value-added solutions directly to customers in the markets we serve. In addition, we also provide certain of our services through a wholesale distribution channel where we do not maintain the face-to-face relationship with the customer. As we continue to grow and control our direct distribution by adding new channels and partners, including expanding our ownership of additional enterprise software solutions in select vertical markets, our wholesale distribution channel has become a smaller portion of our business.
We seek to leverage the continued shift to electronic payments by expanding market share in our existing markets through our distribution channels or through acquisitions in North America, Europe and the Asia-Pacific region and investing in and leveraging technology and people, thereby maximizing shareholder value. We also seek to enter new markets through acquisitions in Europe, the Asia-Pacific region and the Latin America region.
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In general, our business has not experienced pronounced seasonality. However, each geographic channel has somewhat higher and lower quarters given the nature of the merchant portfolio.
In 2016, we changed our fiscal year end from May 31 to December 31. As a result, the period consisting of the seven months ended December 31, 2016 is considered the "2016 fiscal transition period." When our financial results for the year ended December 31, 2017 and the 2016 fiscal transition period are compared to our financial results for the prior-year periods, the results compare the twelve-month period from January 1, 2017 through December 31, 2017 to the twelve-month period from January 1, 2016 through December 31, 2016 and compare the seven-month period from June 1, 2016 through December 31, 2016 to the seven-month period from June 1, 2015 through December 31, 2015. The results for the twelve months ended December 31, 2016 and the seven months ended December 31, 2015 are unaudited.
Segment Information
For a description of our reportable segments see "Note 16—Segment Information" in the notes to the accompanying consolidated financial statements, which is incorporated herein by reference.
Executive Overview
As more fully described in "Note 1—Basis of Presentation and Summary of Significant Accounting Policies" and "Note 3—Revenues" in the notes to the accompanying consolidated financial statements, we adopted a new revenue accounting standard on January 1, 2018 that results in revenue being presented net of certain fees that we pay to third parties, including payment networks. This change in presentation affected our reported revenues and operating expenses during the year ended December 31, 2018 by the same amount and had no effect on operating income.
We experienced strong business and financial performance around the world during the year ended December 31, 2018. Highlights related to our financial condition and results of operations as of December 31, 2018 and for the year then ended include the following:
• | Consolidated revenues were $3,366.4 million and $3,975.2 million for the years ended December 31, 2018 and 2017, respectively. Consolidated revenues without the effect of the new revenue accounting standard increased by 12.6% to $4,475.6 million for the year ended December 31, 2018 compared to $3,975.2 million for 2017. The increase in revenues without the effect of the new revenue accounting standard was primarily due to organic growth. |
• | Consolidated operating income was $737.1 million and $558.9 million for the years ended December 31, 2018 and 2017, respectively. Our operating margin for the year ended December 31, 2018 was 21.9%. Without the effect of the new revenue accounting standard, our operating margin for the year ended December 31, 2018 was 15.6% compared to 14.1% for 2017. The increase in operating income and operating margin without the effect of the new revenue accounting standard was primarily due to the contribution of revenue growth and a decrease in costs associated with acquisition and integration expenses of $38.5 million. |
• | Net income attributable to Global Payments was $452.1 million for the year ended December 31, 2018 compared to $468.4 million for 2017, and diluted earnings per share was $2.84 for the year ended December 31, 2018 compared to $3.01 for 2017. |
• | On December 22, 2017, the United States enacted the U.S. Tax Cuts and Jobs Act of 2017 (the "2017 U.S. Tax Act"). As a result, we recorded a provisional net income tax benefit of $158.7 million, which increased diluted earnings per share by $1.02 for the year ended December 31, 2017. During 2018, we continued to analyze other provisions of the 2017 U.S. Tax Act and completed our accounting for the transition effects of the 2017 U.S. Tax Act, which resulted in an income tax benefit of $23.3 million. |
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Emerging Trends
For a further discussion of trends, uncertainties and other factors that could affect our continuing operating results, see the section entitled "Risk Factors" in Item 1A in this Annual Report on Form 10-K.
The payments technology industry continues to grow worldwide and as a result, certain large payment technology companies, including us, have expanded operations globally by pursuing acquisitions and creating alliances and joint ventures. We expect to continue to expand into new markets internationally and increase our scale and improve our competitiveness in existing markets by pursuing further acquisitions and joint ventures.
We believe that the number of electronic payment transactions will continue to grow and that an increasing percentage of these will be facilitated through emerging technologies. As a result, we expect an increasing portion of our future capital investment will be allocated to support the development of new and emerging technologies; however, we do not expect our aggregate capital spending to increase materially from our current level of spending as a result of this.
We also believe new markets will continue to develop in areas that have been previously dominated by paper-based transactions. We expect industries such as education, government and healthcare, as well as recurring payments and business-to-business payments, to continue to see transactions migrate to electronic-based solutions. We anticipate that the continued development of new services and the emergence of new vertical markets will be a factor in the growth of our business and our revenue in the future.
Recent Acquisitions
On October 17, 2018, we acquired SICOM Systems, Inc. ("SICOM") for total purchase consideration of approximately $409 million, which we funded with cash on hand and by drawing on our Revolving Credit Facility (described in "Note 8—Long-Term Debt and Lines of Credit" in the notes to the accompanying consolidated financial statements). SICOM is a provider of end-to-end enterprise, cloud-based software solutions and other technologies to quick service restaurants and food service management companies.
On September 4, 2018, we acquired AdvancedMD, Inc. ("AdvancedMD") for total purchase consideration of approximately $707 million, which we funded with cash on hand and by drawing on our Revolving Credit Facility. AdvancedMD is a provider of cloud-based enterprise software solutions to small-to-medium sized ambulatory care physician practices in the United States.
On September 1, 2017, we acquired the communities and sports divisions of Athlaction Topco, LLC ("ACTIVE Network") for total purchase consideration of $1.2 billion, consisting of approximately $600 million in cash and 6.4 million shares of our common stock. We funded the cash consideration primarily by drawing on our Revolving Credit Facility. ACTIVE Network delivers cloud-based enterprise software, including payment technology solutions, to event organizers in the communities and health and fitness vertical markets.
These acquisitions align with our technology-enabled, software driven strategy and add enterprise software businesses operating in existing vertical markets that we serve and additional vertical markets that we believe offer attractive growth fundamentals. See "Note 2—Acquisitions" in the notes to the accompanying consolidated financial statements for further discussion of these and other acquisitions.
Results of Operations
Revenues
As more fully described in "Note 1—Basis of Presentation and Summary of Significant Accounting Policies" and "Note 3—Revenues" in the notes to the accompanying consolidated financial statements, we adopted a new revenue accounting standard on January 1, 2018 that results in revenue being presented net of certain fees that we pay to third parties, including payment networks. This change in presentation affected our reported revenues and operating expenses during the year ended December 31, 2018 by the same amount and had no effect on operating income.
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The majority of our revenues is generated by services priced as a percentage of transaction value or a specified fee per transaction, depending on card type or the vertical. We also earn software subscription and licensing fees, as well as other fees based on specific value-added services that may be unrelated to the number or value of transactions. These revenues depend upon a number of factors, such as demand for and price of our services, the technological competitiveness of our offerings, our reputation for providing timely and reliable service, competition within our industry and general economic conditions.
We provide payment technology and software solutions to customers and fund settlement either directly, in markets where we have direct membership with the payment networks, or through our relationship with a member financial institution in markets where we are sponsored. Revenues are recognized in the amount of customer billing net of interchange fees and, beginning in 2018, payment network fees. We market our services through a variety of sales channels, including a direct sales force, trade associations, agent and enterprise software providers and referral arrangements with value-added resellers ("VARs"), which we generally refer to as "direct distribution." We also sell services through our ISO channel, where the ISO receives a share of the customer profitability in the form of a monthly residual payment, which is reflected as a component of selling, general and administrative expenses in the consolidated statements of income.
Operating Expenses
Cost of Service
Cost of service consists primarily of salaries, wages and related expenses paid to operations and technology-related personnel, including those who monitor our transaction processing systems and settlement functions; the cost of transaction processing systems, including third-party services; the cost of network telecommunications capability; depreciation and occupancy costs associated with the facilities performing these functions; amortization of intangible assets and provisions for operating losses. For periods prior to 2018, payment network fees were included in cost of service.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist primarily of salaries, wages, commissions and related expenses paid to sales personnel, customer support functions other than those supporting revenue, administrative employees and management; acquisition and integration expenses; amortization of capitalized customer acquisition costs; residuals paid to ISOs; fees paid to VARs, independent contractors and other third parties; other selling expenses; occupancy costs of leased space directly related to these functions; share-based compensation expense and advertising costs.
Operating Income and Operating Margin
For the purpose of discussing segment operations, we refer to "operating income," which is calculated by subtracting segment direct expenses from segment revenues. Overhead and shared expenses, including share-based compensation, are not allocated to segment operations; they are reported in the caption "Corporate." Similarly, we refer to "operating margin" regarding segment operations, which is calculated by dividing segment operating income by segment revenues.
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Year Ended December 31, 2018 Compared to Year Ended December 31, 2017
The following table sets forth key selected financial data for the year ended December 31, 2018 and 2017, this data as a percentage of total revenues, and the changes between periods in dollars and as a percentage of the prior-period amount. The income statement data for the year ended December 31, 2018 and 2017 are derived from the audited consolidated financial statements included in Item 8 - Financial Statements and Supplementary Data.
Year Ended December 31, | Year Ended December 31, | |||||||||||||||||||
(dollar amounts in thousands) | 2018 | % of Revenue(1) | 2017 | % of Revenue(1) | Change | % Change | ||||||||||||||
Revenues(2)(3): | ||||||||||||||||||||
North America | $ | 2,522,284 | 74.9 | % | $ | 2,929,522 | 73.7 | % | $ | (407,238 | ) | (13.9 | )% | |||||||
Europe | 610,930 | 18.1 | % | 767,524 | 19.3 | % | (156,594 | ) | (20.4 | )% | ||||||||||
Asia-Pacific | 233,152 | 6.9 | % | 278,117 | 7.0 | % | (44,965 | ) | (16.2 | )% | ||||||||||
Total revenues | $ | 3,366,366 | 100.0 | % | $ | 3,975,163 | 100.0 | % | $ | (608,797 | ) | (15.3 | )% | |||||||
Consolidated operating expenses(2)(3): | ||||||||||||||||||||
Cost of service | $ | 1,095,014 | 32.5 | % | $ | 1,928,037 | 48.5 | % | $ | (833,023 | ) | (43.2 | )% | |||||||
Selling, general and administrative | 1,534,297 | 45.6 | % | 1,488,258 | 37.4 | % | 46,039 | 3.1 | % | |||||||||||
Operating expenses | $ | 2,629,311 | 78.1 | % | $ | 3,416,295 | 85.9 | % | $ | (786,984 | ) | (23.0 | )% | |||||||
Operating income (loss)(3): | ||||||||||||||||||||
North America | $ | 570,630 | 17.0 | % | $ | 457,009 | 11.5 | % | $ | 113,621 | 24.9 | % | ||||||||
Europe | 318,392 | 9.5 | % | 272,769 | 6.9 | % | 45,623 | 16.7 | % | |||||||||||
Asia-Pacific | 93,402 | 2.8 | % | 81,273 | 2.0 | % | 12,129 | 14.9 | % | |||||||||||
Corporate(4) | (245,369 | ) | (7.3 | )% | (252,183 | ) | (6.3 | )% | 6,814 | (2.7 | )% | |||||||||
Operating income | $ | 737,055 | 21.9 | % | $ | 558,868 | 14.1 | % | $ | 178,187 | 31.9 | % | ||||||||
Operating margin(2)(3): | ||||||||||||||||||||
North America | 22.6 | % | 15.6 | % | 7.0 | % | ||||||||||||||
Europe | 52.1 | % | 35.5 | % | 16.6 | % | ||||||||||||||
Asia-Pacific | 40.1 | % | 29.2 | % | 10.9 | % | ||||||||||||||
(1) Percentage amounts may not sum to the total due to rounding.
(2) As more fully described in "Note 1—Basis of Presentation and Summary of Significant Accounting Policies" and "Note 3—Revenues" in the notes to the accompanying consolidated financial statements, we adopted a new revenue accounting standard on January 1, 2018 that results in revenue being presented net of certain fees that we pay to third parties, including payment networks. This change in presentation affected our reported revenues and operating expenses during the year ended December 31, 2018 by the same amount and had no effect on operating income; however, the change in presentation did have the effect of increasing our operating margin, which is calculated by dividing operating income by revenue.
(3) Revenues, operating expenses, operating income and operating margin reflect the effect of acquired businesses from the respective dates of acquisition. For further discussion, see "Note 2—Acquisitions" in the notes to the accompanying consolidated financial statements.
(4) During the years ended December 31, 2018 and 2017, operating loss for Corporate included acquisition and integration expenses of $56.1 million and $94.6 million, respectively, which are included primarily in selling, general and administrative expenses in the consolidated statements of income.
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Revenues
Effective January 1, 2018, our revenues are presented net of certain fees that we pay to third parties, including payment networks. This change in presentation affected our reported revenues and operating expenses for 2018 by the same amount and had no effect on operating income. Consolidated revenues without the effect of the new revenue accounting standard increased by 12.6% to $4,475.6 million for the year ended December 31, 2018.
North America Segment. The change in presentation decreased our reported North America segment revenues for the year ended December 31, 2018 by $726.3 million. Revenues from our North America segment without the effect of the new revenue accounting standard increased by 10.8% to $3,247.0 million for the year ended December 31, 2018 primarily due to the acquisition of ACTIVE Network.
Europe Segment. The change in presentation decreased our reported Europe segment revenues for the year ended December 31, 2018 by $307.3 million. Revenues from our Europe segment without the effect of the new revenue accounting standard increased by 19.6% to $918.2 million for the year ended December 31, 2018 primarily due to organic growth.
Asia-Pacific Segment. The change in presentation decreased our reported Asia-Pacific segment revenues for the year ended December 31, 2018 by $77.2 million. Revenues from our Asia-Pacific segment without the effect of the new revenue accounting standard increased by 11.6% to $310.4 million for the year ended December 31, 2018 primarily due to organic growth.
Operating Expenses
Cost of Service. Effective January 1, 2018, the new revenue accounting standard changed our presentation of certain fees that we pay to third parties, including payment networks, which decreased cost of service by $1,042.9 million for the year ended December 31, 2018. Cost of service without the effect of the new revenue accounting standard increased by 11.2% to $2,143.9 million for the year ended December 31, 2018, primarily due to additional costs associated with revenue growth and an increase in amortization of acquired intangibles of $39.8 million. Cost of service without the effect of the new revenue accounting standard as a percentage of revenues without the effect of the new revenue accounting standard were 47.9% for the year ended December 31, 2018, compared to 48.5% for the prior year.
Selling, General and Administrative Expenses. Effective January 1, 2018, the new revenue accounting standard changed our presentation of certain fees that we pay to third parties, which decreased selling, general and administrative expenses by $67.9 million for the year ended December 31, 2018. Selling, general and administrative expense without the effect of the new revenue accounting standard increased by 9.6% to $1,631.4 million for the year ended December 31, 2018, primarily due to additional costs to support the growth of our business, partially offset by a reduction in acquisition and integration expenses of $38.5 million. Selling, general and administrative expenses without the effect of the new revenue accounting standard as a percentage of revenues without the effect of the new revenue accounting standard decreased to 36.5% for the year ended December 31, 2018, compared to 37.4% for the prior year, primarily due to the reduction in acquisition and integration expenses.
Operating Income and Operating Margin
North America Segment. Operating income in our North America segment increased by 24.9% to $570.6 million for the year ended December 31, 2018, compared to the prior year, primarily due to the acquisition of ACTIVE Network. Operating margin without the effect of the new revenue accounting standard increased to 16.5% for the year ended December 31, 2018, compared to 15.6% for the prior year.
Europe Segment. Operating income in our Europe segment increased by 16.7% to $318.4 million for the year ended December 31, 2018, compared to the prior year, primarily due to organic growth. Operating margin without the effect of the new revenue accounting standard decreased to 34.7% for the year ended December 31, 2018, compared to 35.5% for the prior year, due to the unfavorable effect of currency fluctuations.
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Asia-Pacific Segment. Operating income in our Asia-Pacific segment increased by 14.9% to $93.4 million for the year ended December 31, 2018, compared to the prior year, primarily due to organic growth. Operating margin without the effect of the new revenue accounting standard increased to 29.8% for the year ended December 31, 2018, compared to 29.2% for the prior year.
Corporate. Corporate expenses decreased by 2.7% to $245.4 million for the year ended December 31, 2018, compared to the prior year, primarily due to a decrease in acquisition and integration expenses of $38.5 million, partially offset by an increase in share-based compensation expense of $18.7 million and additional costs to support the growth of our business.
Other Income/Expense, Net
Interest and other income increased by $12.1 million to $20.7 million for the year ended December 31, 2018 compared to the prior year primarily due to a gain of $9.6 million recognized on the reorganization of a debit network association of which we were a member through one of our Canadian subsidiaries.
Interest and other expense increased by $20.8 million to $195.6 million for the year ended December 31, 2018 compared to the prior year. Interest expense for the year ended December 31, 2018 reflects an increase in our outstanding long-term debt to fund acquisitions as well as an increase in the London Interbank Offered Rate ("LIBOR").
Income Tax Benefit (Provision)
We reported an income tax provision of $77.5 million for the year ended December 31, 2018. During the year ended December 31, 2018, we continued to analyze our foreign tax pools and resulting foreign tax credits and reduced our estimated transition tax liability, which resulted in an income tax benefit of $23.3 million. Our effective tax rate for the year ended December 31, 2018 was 13.8%, which reflects the benefit of the adjustment to the one-time transition tax liability.
For the year ended December 31, 2017, we reported an income tax benefit of $101.4 million, reflecting the effect of a provisional net income tax benefit of $158.7 million recorded in connection with the 2017 U.S. Tax Act. Our effective tax rate for the year ended December 31, 2017 was a benefit of 25.8%, which differs from the federal U.S. statutory rate and the effective income tax rate for the year ended December 31, 2018 primarily due to the net tax benefit we recorded in connection with the 2017 U.S. Tax Act. See "Note 10—Income Tax" in the notes to the accompanying consolidated financial statements for more discussion about the effects of the 2017 U.S. Tax Act on our accounting for income taxes for the years ended December 31, 2018 and 2017.
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Year Ended December 31, 2017 Compared to Year Ended December 31, 2016
The following table sets forth key selected financial data for the years ended December 31, 2017 and 2016, this data as a percentage of total revenues, and the changes between periods in dollars and as a percentage of the prior-period amount. The income statement data for the year ended December 31, 2017 are derived from the audited consolidated financial statements included in Item 8 - Financial Statements and Supplementary Data. The income statement data for the year ended December 31, 2016 are derived from our unaudited consolidated financial statements for that period.
Year Ended December 31, | Year Ended December 31, | |||||||||||||||||||
(dollar amounts in thousands) | 2017 | % of Revenue(1) | 2016 | % of Revenue(1) | Change | % Change | ||||||||||||||
Revenues(2): | ||||||||||||||||||||
North America | $ | 2,929,522 | 73.7 | % | $ | 2,475,323 | 73.4 | % | $ | 454,199 | 18.3 | % | ||||||||
Europe | 767,524 | 19.3 | % | 655,477 | 19.4 | % | 112,047 | 17.1 | % | |||||||||||
Asia-Pacific | 278,117 | 7.0 | % | 240,176 | 7.1 | % | 37,941 | 15.8 | % | |||||||||||
Total revenues | $ | 3,975,163 | 100.0 | % | $ | 3,370,976 | 100.0 | % | $ | 604,187 | 17.9 | % | ||||||||
Consolidated operating expenses(2): | ||||||||||||||||||||
Cost of service | $ | 1,928,037 | 48.5 | % | $ | 1,603,532 | 47.6 | % | $ | 324,505 | 20.2 | % | ||||||||
Selling, general and administrative | 1,488,258 | 37.4 | % | 1,411,096 | 41.9 | % | 77,162 | 5.5 | % | |||||||||||
Operating expenses | $ | 3,416,295 | 85.9 | % | $ | 3,014,628 | 89.4 | % | $ | 401,667 | 13.3 | % | ||||||||
Operating income (loss)(2): | ||||||||||||||||||||
North America | $ | 457,009 | 11.5 | % | $ | 350,291 | 10.4 | % | $ | 106,718 | 30.5 | % | ||||||||
Europe | 272,769 | 6.9 | % | 232,882 | 6.9 | % | 39,887 | 17.1 | % | |||||||||||
Asia-Pacific | 81,273 | 2.0 | % | 58,709 | 1.7 | % | 22,564 | 38.4 | % | |||||||||||
Corporate(3) | (252,183 | ) | (6.3 | )% | (285,534 | ) | (8.5 | )% | 33,351 | (11.7 | )% | |||||||||
Operating income | $ | 558,868 | 14.1 | % | $ | 356,348 | 10.6 | % | $ | 202,520 | 56.8 | % | ||||||||
Operating margin(2): | ||||||||||||||||||||
North America | 15.6 | % | 14.2 | % | 1.4 | % | ||||||||||||||
Europe | 35.5 | % | 35.5 | % | — | % | ||||||||||||||
Asia-Pacific | 29.2 | % | 24.4 | % | 4.8 | % | ||||||||||||||
(1) Percentage amounts may not sum to the total due to rounding.
(2) Revenues, operating expenses, operating income and operating margin reflect the effect of acquired businesses from the respective dates of acquisition. For further discussion, see "Note 2—Acquisitions" in the notes to the accompanying consolidated financial statements.
(3) During the years ended December 31, 2017 and 2016, operating loss for Corporate included acquisition and integration expenses of $94.6 million and $142.1 million, respectively, which are included primarily in selling, general and administrative expenses in the consolidated statements of income.
Revenues
For the year ended December 31, 2017, revenues increased by $604.2 million, or 17.9%, compared to the prior year, to $3,975.2 million, reflecting growth in each of our operating segments.
North America Segment. For the year ended December 31, 2017, revenues from our North America segment increased by $454.2 million, or 18.3%, compared to the prior year, to $2,929.5 million primarily due to our merger with Heartland, the results of
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which were included in our consolidated statement of income for a full year during the year ended December 31, 2017, compared to approximately eight months during the year ended December 31, 2016.
Europe Segment. For the year ended December 31, 2017, revenues from our Europe segment increased by $112.0 million, or 17.1%, compared to the prior year, to $767.5 million, primarily due to organic growth.
Asia-Pacific Segment. For the year ended December 31, 2017, revenues from our Asia-Pacific segment increased by $37.9 million, or 15.8%, compared to the prior year, to $278.1 million, primarily due to organic growth.
Operating Expenses
Cost of Service. For the year ended December 31, 2017, cost of service increased by $324.5 million, or 20.2%, compared to the prior year, to $1,928.0 million. As a percentage of revenues, cost of service increased to 48.5% for the year ended December 31, 2017 compared to 47.6% for the prior year. These increases were driven primarily by an increase in the variable costs associated with our revenue growth, including incremental expenses associated with acquired businesses, as well as additional intangible asset amortization associated with recently acquired businesses of $78.6 million.
Selling, General and Administrative Expenses. For the year ended December 31, 2017, selling, general and administrative expenses increased by $77.2 million, or 5.5%, compared to the prior year, to $1,488.3 million. The increase in selling, general and administrative expenses was primarily due to additional costs to support the growth of our business, including incremental expenses associated with acquired businesses. As a percentage of revenues, selling, general and administrative expenses decreased to 37.4% for the year ended December 31, 2017 compared to 41.9% for the prior year. The decrease in selling, general and administrative expenses as a percentage of revenues was primarily due to synergies achieved in general and administrative expenses from the merger with Heartland, as well as the decrease in acquisition and integration expenses during the year ended December 31, 2017 of $47.5 million.
Operating Income and Operating Margin
North America Segment. Operating income in our North America segment increased by 30.5% to $457.0 million for the year ended December 31, 2017 compared to the prior year and operating margin increased by 1.4 percentage points. The increase in operating income was primarily due to revenue growth in our U.S. business, which during the year ended December 31, 2017 was partially offset by additional intangible asset amortization associated with acquired businesses. The increase in operating margin during the year ended December 31, 2017 was primarily due to revenue growth and a decrease in Heartland customer-related intangible asset amortization, which is calculated using an accelerated method.
Europe Segment. Operating income in our Europe segment increased by 17.1% to $272.8 million for the year ended December 31, 2017 compared to the prior year, while operating margin remained equal to the prior year. The increase in operating income was primarily due to revenue growth.
Asia-Pacific Segment. Operating income in our Asia-Pacific segment increased by 38.4% to $81.3 million for the year ended December 31, 2017 compared to the prior year and operating margin increased by 4.8 percentage points. The increases in operating income and operating margin were primarily due to organic revenue growth.
Corporate. Corporate expenses decreased by 11.7% to $252.2 million for the year ended December 31, 2017 compared to the prior year primarily due to a decrease in acquisition and integration expenses.
Other Income/Expense, Net
Interest and other income decreased by $38.1 million for the year ended December 31, 2017 compared to the prior year, which included a gain of $41.2 million in connection with the sale of our membership interests in Visa Europe.
Interest and other expense increased by $28.7 million for the year ended December 31, 2017 compared to the prior year. The outstanding borrowings on our long-term debt facilities increased significantly in April 2016 as a result of incremental borrowings we made to fund a portion of the total consideration for our merger with Heartland. Since then, we have made principal repayments
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that have lowered our average outstanding borrowings, and we have lowered the leverage-based margins we pay on interest rates through refinancing activities that we completed in October 2016 and May 2017. The savings in interest expense that we realized during the second half of 2017 due to these refinancing activities were partially offset by increases in LIBOR during the intervening time frame and additional borrowings under our Revolving Credit Facility to complete the acquisition of ACTIVE Network.
Income Tax (Benefit) Provision
We reported an income tax benefit of $101.4 million for the year ended December 31, 2017, reflecting the effect of a provisional net income tax benefit of $158.7 million recorded in connection with the 2017 U.S. Tax Act. Our effective tax rate for the year ended December 31, 2017 was a benefit of 25.8%, which differs from the federal U.S. statutory rate and the effective income tax rate for the year ended December 31, 2016 primarily due to the net tax benefit we recorded in connection with the 2017 U.S. Tax Act. See "Note 10—Income Tax" in the notes to the accompanying consolidated financial statements for more discussion about the effects of the 2017 U.S. Tax Act on our accounting for income taxes for the year ended December 31, 2017.
For the year ended December 31, 2016, we recorded an income tax provision of $36.3 million, which equated to an effective tax rate of 14.1%. The effective income tax rate for the year ended December 31, 2016 included a benefit from eliminating certain net deferred tax liabilities associated with undistributed earnings from Canada, as a result of management's plans at that time to reinvest these earnings outside the United States indefinitely.
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Seven Months Ended December 31, 2016 Compared to Seven Months Ended December 31, 2015
The following table sets forth key selected financial data for the seven months ended December 31, 2016 and 2015, this data as a percentage of total revenues, and the changes between periods in dollars and as a percentage of the prior-period amount. The income statement data for the seven months ended December 31, 2016 are derived from the audited consolidated financial statements included in Item 8 - Financial Statements and Supplementary Data. The income statement data for the seven months ended December 31, 2015 are derived from our unaudited consolidated financial statements for that period.
Seven Months Ended December 31, | Seven Months Ended December 31, | |||||||||||||||||||
(dollar amounts in thousands) | 2016 | % of Revenue(1) | 2015 | % of Revenue(1) | Change | % Change | ||||||||||||||
Revenues(2): | ||||||||||||||||||||
North America | $ | 1,650,616 | 74.9 | % | $ | 1,227,916 | 71.0 | % | $ | 422,700 | 34.4 | % | ||||||||
Europe | 403,823 | 18.3 | % | 380,246 | 22.0 | % | 23,577 | 6.2 | % | |||||||||||
Asia-Pacific | 148,457 | 6.7 | % | 121,908 | 7.0 | % | 26,549 | 21.8 | % | |||||||||||
Total revenues | $ | 2,202,896 | 100.0 | % | $ | 1,730,070 | 100.0 | % | $ | 472,826 | 27.3 | % | ||||||||
Consolidated operating expenses(2): | ||||||||||||||||||||
Cost of service | $ | 1,094,593 | 49.7 | % | $ | 638,700 | 36.9 | % | $ | 455,893 | 71.4 | % | ||||||||
Selling, general and administrative | 870,352 | 39.5 | % | 784,823 | 45.4 | % | 85,529 | 10.9 | % | |||||||||||
Operating expenses | $ | 1,964,945 | 89.2 | % | $ | 1,423,523 | 82.3 | % | $ | 541,422 | 38.0 | % | ||||||||
Operating income (loss)(2): | ||||||||||||||||||||
North America | $ | 233,850 | $ | 191,185 | $ | 42,665 | 22.3 | % | ||||||||||||
Europe | 145,767 | 157,722 | (11,955 | ) | (7.6 | )% | ||||||||||||||
Asia-Pacific | 37,530 | 29,564 | 7,966 | 26.9 | % | |||||||||||||||
Corporate(3) | (179,196 | ) | (71,924 | ) | (107,272 | ) | 149.1 | % | ||||||||||||
Operating income | $ | 237,951 | 10.8 | % | $ | 306,547 | 17.7 | % | $ | (68,596 | ) | (22.4 | )% | |||||||
Operating margin: | ||||||||||||||||||||
North America | 14.2 | % | 15.6 | % | (1.4 | )% | ||||||||||||||
Europe | 36.1 | % | 41.5 | % | (5.4 | )% | ||||||||||||||
Asia-Pacific | 25.3 | % | 24.3 | % | 1.0 | % | ||||||||||||||
(1) Percentage amounts may not sum to the total due to rounding.
(2) Revenues, operating expenses, operating income and operating margin reflect the effect of acquired businesses from the respective dates of acquisition. Notably, on April 22, 2016, we merged with Heartland as further discussed in "Note 2—Acquisitions" in the notes to the accompanying consolidated financial statements.
(3) During the seven months ended December 31, 2016, operating loss for Corporate included acquisition and integration costs of $91.6 million, which are included in selling, general and administrative expenses in the consolidated statements of income.
Revenues
For the seven months ended December 31, 2016, revenues increased 27.3% to $2,202.9 million compared to the prior-year period, reflecting growth in each of our operating segments, in spite of the unfavorable effect of fluctuations in foreign currency exchange rates. For the seven months ended December 31, 2016, currency exchange rate fluctuations reduced our revenues by $35.3 million compared to the prior-year period, calculated by converting revenues for the seven months ended December 31, 2016 in local currencies using exchange rates for the seven months ended December 31, 2015.
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North America Segment. For the seven months ended December 31, 2016, revenues from our North America segment increased by $422.7 million, or 34.4%, compared to the prior-year period to $1,650.6 million primarily due to our merger with Heartland.
Europe Segment. For the seven months ended December 31, 2016, revenues from our Europe segment increased by $23.6 million, or 6.2%, compared to the prior-year period to $403.8 million due to a joint venture with Erste Group Bank AG ("Erste Group") in Central and Eastern Europe that commenced in June 2016, despite the unfavorable effect of currency fluctuations in Europe of $34.3 million.
Asia-Pacific Segment. For the seven months ended December 31, 2016, revenues from our Asia-Pacific segment increased by $26.5 million, or 21.8%, compared to the prior-year period to $148.5 million, primarily due to organic growth.
Operating Expenses
Cost of Service. Cost of service increased by 71.4% to $1,094.6 million for the seven months ended December 31, 2016 compared to the prior-year period. As a percentage of revenues, cost of service increased to 49.7% for the seven months ended December 31, 2016 compared to 36.9% in the prior year. The increase in cost of service was driven primarily by an increase in the variable costs associated with our revenue growth, including those related to our merger with Heartland, and by additional intangible asset amortization associated with recently acquired businesses of $145.6 million for the seven months ended December 31, 2016.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased by 10.9% to $870.4 million for the seven months ended December 31, 2016 compared to the prior-year period. As a percentage of revenues, selling, general and administrative expenses decreased to 39.5% for the seven months ended December 31, 2016 compared to 45.4% in the prior year. The increase in selling, general and administrative expenses was primarily due to additional costs to support the growth of our business, including incremental expenses associated with the integration of Heartland. The decrease in selling, general and administrative expenses as a percentage of revenues was primarily due to synergies achieved in general and administrative expenses from the merger with Heartland.
Operating Income and Operating Margin
North America Segment. Operating income in our North America segment increased by 22.3% to $233.9 million for the seven months ended December 31, 2016 compared to the prior-year period. The increase in operating income was primarily due to revenue growth in our U.S. business, partially offset by expenses associated with the integration of Heartland and additional intangible asset amortization associated with the merger. Operating margin decreased by 1.4 percentage points for the seven months ended December 31, 2016 compared to the prior-year period primarily as a result of the incremental merger-related expenses.
Europe Segment. Operating income in our Europe segment decreased by 7.6% to $145.8 million for the seven months ended December 31, 2016 compared to the prior-year period, including the effect of unfavorable currency fluctuations of $19.6 million. Operating margin decreased 5.4 percentage points for the seven months ended December 31, 2016 compared to the prior-year period. The decreases in operating income and operating margin were primarily driven by the effect of unfavorable currency fluctuations.
Asia-Pacific Segment. Operating income in our Asia segment increased by 26.9% to $37.5 million for the seven months ended December 31, 2016 compared to the prior-year period. Operating margin increased 1.0 percentage point for the seven months ended December 31, 2016 compared to the prior-year period. The increases in operating income and operating margin were primarily due to organic revenue growth.
Corporate. Corporate expenses increased by $107.3 million for the seven months ended December 31, 2016 compared to the prior-year period, primarily due to the merger with Heartland and incremental expenses of $91.6 million associated with its integration.
Other Income/Expense, Net
Interest and other income for the seven months ended December 31, 2016 increased primarily due to a gain of $41.2 million recorded in connection with the sale of our membership interests in Visa Europe.
Interest and other expense increased by $76.8 million for the seven months ended December 31, 2016 compared to the prior-
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year period primarily due to an increase in interest expense incurred resulting from an increase in the outstanding borrowings to fund the merger with Heartland.
Income Tax Provision
Our effective income tax rates were 20.6% and 25.3%, respectively, for the seven months ended December 31, 2016 and 2015. The decrease in our effective income tax rate was primarily due to a higher percentage of income generated in international jurisdictions with lower tax rates (primarily as a result of the acquisition and integration-related expenses incurred in the United States).
Liquidity and Capital Resources
In the ordinary course of our business, a significant portion of our liquidity comes from operating cash flows. Cash flow from operating activities is used to make planned capital investments in our business, to pursue acquisitions that meet our corporate objectives, to pay dividends, to pay principal and interest on our outstanding debt and to repurchase shares of our common stock. Accumulated cash balances are invested in high-quality, marketable short-term instruments.
Our capital plan objectives are to support our operational needs and strategic plan for long-term growth while maintaining a low cost of capital. We use our financing, such as term loans and our Revolving Credit Facility, for general corporate purposes and to fund acquisitions. In addition, specialized lines of credit are also used in certain of our markets to fund merchant settlement prior to receipt of funds from the card network. We regularly evaluate our liquidity and capital position relative to cash requirements, and we may elect to raise additional funds in the future, through the issuance of debt, equity or otherwise.
At December 31, 2018, we had cash and cash equivalents totaling $1,210.9 million. Of this amount, we consider $434.5 million to be available for general purposes, of which approximately $18 million is undistributed foreign earnings considered to be indefinitely reinvested outside the United States. Under the 2017 U.S. Tax Act, a company's foreign earnings accumulated under legacy tax laws are deemed repatriated, and the 2017 U.S. Tax Act generally eliminates U.S. federal income taxes on dividends from foreign subsidiaries. The available cash of $434.5 million does not include the following: (i) settlement-related cash balances, (ii) funds held as collateral for merchant losses ("Merchant Reserves") and (iii) funds held for customers. Settlement-related cash balances represent funds that we hold when the incoming amount from the card networks precedes the funding obligation to the merchant. Settlement-related cash balances are not restricted; however, these funds are generally paid out in satisfaction of settlement processing obligations the following day. Merchant Reserves serve as collateral to minimize contingent liabilities associated with any losses that may occur under the merchant agreement. While this cash is not restricted in its use, we believe that designating this cash to collateralize Merchant Reserves strengthens our fiduciary standing with our member sponsors and is in accordance with the guidelines set by the card networks. Funds held for customers and the corresponding liability that we record in "customer deposits" include amounts collected prior to remittance on our customers' behalf.
Operating activities provided net cash of $1,106.1 million during the year ended December 31, 2018, which was primarily attributable to net income of $484.7 million adjusted for non-cash items, including depreciation and amortization expense of $522.8 million, partially offset by a decrease in operating assets and liabilities of $44.5 million.
Fluctuations in operating assets and liabilities are affected primarily by timing of month-end and transaction volume, especially changes in settlement processing assets and liabilities, and by the effects of businesses we acquire that have different working capital requirements. Changes in settlement processing assets and liabilities increased operating cash flows by $83.5 million during the year ended December 31, 2018 and decreased operating cash flows by $361.7 million during the year ended December 31, 2017. Changes in settlement processing assets and liabilities increased operating cash flows by $35.6 million during the 2016 fiscal transition period and $218.1 million during the year ended May 31, 2016.
Operating activities provided net cash of $512.4 million, $515.8 million and $592.9 million, respectively, during the year ended December 31, 2017, the transition period ended December 31, 2016 and the year ended May 31, 2016, respectively. The increase in cash flows provided by operating activities since 2016, during which time we completed the acquisitions of Heartland, ACTIVE Network, AdvancedMD and SICOM, among others, was primarily due to our revenue growth and corresponding increase in operating income. The increase in operating cash flows from our growing business during this period was partially offset by investments made to integrate the acquired businesses. During the years ended December 31, 2018 and 2017, the 2016 fiscal transition period and the year ended May 31, 2016 we incurred $56.1 million, $94.6 million, $91.6 million and $51.3 million, respectively, of acquisition and
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integration expenses primarily related to the acquired businesses. In addition, during that same period of time, our interest expense has increased as a result of long-term debt we have issued, primarily to help fund these acquisitions, as well as increases in interest rates. During the years ended December 31, 2018 and 2017, the 2016 fiscal transition period and the year ended May 31, 2016, cash paid for interest expense was $177.5 million, $154.2 million, $93.6 million and $58.7 million, respectively. Based on the recent increase in our level of indebtedness to fund acquisitions, together with recent increases in interest rates, we expect our interest expense for the year ending December 31, 2019 to increase compared to interest expense for the year ended December 31, 2018, which could affect our cash flows and earnings.
We used net cash in investing activities of $1,476.3 million, $736.0 million, $86.7 million and $2,127.2 million during the years ended December 31, 2018 and 2017, the 2016 fiscal transition period and the year ended May 31, 2016, respectively. Cash used for investing activities represents primarily cash used to fund business acquisitions and capital expenditures.
During the years ended December 31, 2018 and 2017, the 2016 fiscal transition period and the year ended May 31, 2016, respectively, we used cash of $1,259.7 million, $562.7 million, $33.9 million and $2,034.4 million to complete acquisitions. In addition to cash, we used our common stock to fund a portion of the consideration for both the Heartland and ACTIVE Network acquisitions. See "Note 2—Acquisitions" in the notes to the accompanying consolidated financial statements for further discussion of our business acquisitions and how we funded acquired businesses.
We made capital expenditures of $213.3 million, $181.9 million, $88.9 million and $91.6 million to purchase property and equipment (including internal-use capitalized software development projects) during the years ended December 31, 2018 and 2017, the 2016 fiscal transition period and the year ended May 31, 2016, respectively. These investments include software and hardware to support the development of new technologies, continued consolidation and enhancement of our operating platforms and infrastructure to support our growing business.
During the year ended December 31, 2017, we sold our operating facility in Jeffersonville, Indiana for $37.5 million. In addition, during the 2016 fiscal transition period we exchanged all of our membership interest in Visa Europe to Visa for up-front consideration, including cash of approximately $37.7 million.
Financing activities include borrowings and repayments made under our Credit Facility (described in "Note 8—Long-Term Debt and Lines of Credit" in the notes to the accompanying consolidated financial statements) as well as borrowings and repayments made under specialized lines of credit to fund daily settlement activities. Our borrowing arrangements are further described below under "Long-Term Debt and Lines of Credit." Financing activities also include cash flows associated with common stock repurchase programs and share-based compensation programs as well as cash distributions made to noncontrolling interests and our shareholders. Cash flows from financing activities provided net cash of $286.9 million and $352.3 million during the years ended December 31, 2018 and December 31, 2017, respectively. During the 2016 fiscal transition period, we used net cash in financing activities of $278.8 million. During the year ended May 31, 2016, cash flows from financing activities provided net cash of $1,957.6 million.
Proceeds from long-term debt were $2.8 billion, $2.0 billion, $1.3 billion and $6.1 billion for the years ended December 31, 2018 and 2017, the 2016 fiscal transition period and the year ended May 31, 2016, respectively. Repayments of long-term debt were $2.3 billion, $1.8 billion, $1.4 billion and $3.7 billion for the years ended December 31, 2018 and 2017, the 2016 fiscal transition period and the year ended May 31, 2016, respectively. Proceeds from long-term debt include borrowings that we make from time-to-time under our Revolving Credit Facility, including those we have made to fund a portion of the cash consideration paid for acquired businesses. Repayments of long-term debt include repayments that we make from time-to-time under our Revolving Credit Facility as well as scheduled principal repayments made under our term loans. Debt issuance costs reflect the amount of fees we paid to complete these borrowing activities. During the year ended December 31, 2018, we repatriated $457.7 million from certain of our foreign subsidiaries and used the cash to reduce outstanding borrowings under our Revolving Credit Facility.
Because we often receive funding from the payment networks after we fund our merchants, we have specialized lines of credit in various markets where we do business to fund settlement. Activity under our settlement lines of credit is affected primarily by timing of month-end and transaction volume. During the years ended December 31, 2018 and 2017 and the 2016 fiscal transition period, we had net proceeds from settlement lines of credit of $70.8 million, $221.5 million and $20.6 million, respectively. During the year ended May 31, 2016, we had net repayments of settlement lines of credit of $206.0 million.
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We make repurchases of our common stock mainly through open market repurchase plans and, at times, through accelerated share repurchase programs. During the years ended December 31, 2018 and 2017, the 2016 fiscal transition period and the year ended May 31, 2016, we invested cash of $208.2 million, $34.8 million, $178.2 million and $136.0 million, respectively, to repurchase shares of our common stock. As of December 31, 2018, we had $387.8 million of share repurchase authority remaining under a program authorized by the board of directors, announced on February 6, 2018. On February 5, 2019, the board of directors increased its authorization to repurchase shares of our common stock to $750 million, inclusive of prior share repurchase programs authorized by the board and repurchases made thereunder.
We believe that our current level of cash and borrowing capacity under our long-term debt and lines of credit described below, together with future cash flows from operations will be sufficient to meet the needs of our existing operations and planned requirements for the foreseeable future.
Long-Term Debt and Lines of Credit
We are party to a credit facility agreement with Bank of America, N.A., as administrative agent, and a syndicate of financial institutions as lenders and other agents (as amended from time to time, the "Credit Facility"). As of December 31, 2018, the Credit Facility provided for secured financing comprised of (i) a $1.5 billion revolving credit facility (the "Revolving Credit Facility"); (ii) a $1.5 billion term loan (the "Term A Loan"), (iii) a $1.37 billion term loan (the "Term A-2 Loan"), (iv) a $1.14 billion term loan facility (the "Term B-2 Loan") and (v) a $500 million term loan (the "Term B-4 Loan"). Substantially all of the assets of our domestic subsidiaries are pledged as collateral under the Credit Facility. As of December 31, 2018, the aggregate outstanding balance on the term loans was $4.5 billion, and the outstanding balance on the Revolving Credit Facility was $704.0 million.
The borrowings outstanding under our Credit Facility as of December 31, 2018 reflect amounts borrowed for acquisitions and other activities we completed in 2018, including a reduction to the interest rate margins applicable to our Term A Loan, Term A-2 Loan, Term B-2 Loan and the Revolving Credit Facility, an extension of the maturity dates of the Term A Loan, Term A-2 Loan and the Revolving Credit Facility, and an increase in the total financing capacity under the Credit Facility to approximately $5.5 billion in June 2018.
In October 2018, we entered into an additional term loan in the amount of $500 million (the "Term B-4 Loan"). We used the proceeds from the Term B-4 Loan to pay down a portion of the balance outstanding under our Revolving Credit Facility.
The Credit Facility provides for an interest rate, at our election, of either LIBOR or a base rate, in each case plus a margin. As of December 31, 2018, the interest rates on the Term A Loan, the Term A-2 Loan, the Term B-2 Loan and the Term B-4 Loan were 4.02%, 4.01%, 4.27% and 4.27%, respectively, and the interest rate on the Revolving Credit Facility was 3.92%. In addition, we are required to pay a quarterly commitment fee with respect to the unused portion of the Revolving Credit Facility at an applicable rate per annum ranging from 0.20% to 0.30% depending on our leverage ratio.
The Term A Loan and the Term A-2 Loan mature, and the Revolving Credit Facility expires, on January 20, 2023. The Term B-2 Loan matures on April 22, 2023. The Term B-4 Loan matures on October 18, 2025. The Term A Loan and Term A-2 Loan principal amounts must each be repaid in quarterly installments in the amount of 0.625% of principal through June 2019, increasing to 1.25% of principal through June 2021, increasing to 1.875% of principal through June 2022 and increasing to 2.50% of principal through December 2022, with the remaining principal balance due upon maturity in January 2023. The Term B-2 Loan principal must be repaid in quarterly installments in the amount of 0.25% of principal through March 2023, with the remaining principal balance due upon maturity in April 2023. The Term B-4 Loan principal must be repaid in quarterly installments in the amount of 0.25% of principal through September 2025, with the remaining principal balance due upon maturity in October 2025.
We may issue standby letters of credit of up to $100 million in the aggregate under the Revolving Credit Facility. Outstanding letters of credit under the Revolving Credit Facility reduce the amount of borrowings available to us. Borrowings available to us under the Revolving Credit Facility are further limited by the covenants described below under "Compliance with Covenants." The total available commitments under the Revolving Credit Facility at December 31, 2018 were $783.6 million.
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Settlement Lines of Credit
In various markets where we do business, we have specialized lines of credit, which are restricted for use in funding settlement. The settlement lines of credit generally have variable interest rates, are subject to annual review and are denominated in local currency but may, in some cases, facilitate borrowings in multiple currencies. For certain of our lines of credit, the available credit is increased by the amount of cash we have on deposit in specific accounts with the lender. Accordingly, the amount of the outstanding line of credit may exceed the stated credit limit. As of December 31, 2018 and 2017, a total of $70.6 million and $59.3 million, respectively, of cash on deposit was used to determine the available credit.
As of December 31, 2018 and 2017, respectively, we had $700.5 million and $635.2 million outstanding under these lines of credit with additional capacity of $710.3 million as of December 31, 2018 to fund settlement. The weighted-average interest rate on these borrowings was 2.97% and 1.97% at December 31, 2018 and 2017, respectively.
Compliance with Covenants
The Credit Facility Agreement contains customary affirmative and restrictive covenants, including, among others, financial covenants based on our leverage and interest coverage ratios, as defined in the agreement. As of December 31, 2018, financial covenants under the Credit Facility Agreement required a leverage ratio no greater than: (i) 5.00 to 1.00 as of the end of any fiscal quarter ending during the period from April 1, 2018 through June 30, 2019; (ii) 4.75 to 1.00 as of the end of any fiscal quarter ending during the period from July 1, 2019 through June 30, 2020; and (iii) 4.50 to 1.00 as of the end of any fiscal quarter ending thereafter. The interest coverage ratio is required to be no less than 3.25 to 1.00.
The Credit Facility Agreement and settlement lines of credit also include various other covenants that are customary in such borrowings. The Credit Facility Agreement includes covenants, subject in each case to exceptions and qualifications that may restrict certain payments, including, in certain circumstances, the repurchasing of our common stock and paying cash dividends in excess of our current rate of $0.01 per share per quarter. We were in compliance with all applicable covenants as of December 31, 2018.
See "Note 8—Long-Term Debt and Lines of Credit" in the notes to the accompanying consolidated financial statements for further discussion of our borrowing arrangements.
Off-Balance Sheet Arrangements
We have not entered into any off-balance sheet arrangements that have, or are reasonably likely to have, a material effect on our financial condition, revenues, results of operations, liquidity, capital expenditures or capital resources, other than the guarantee services described in "Note 1—Basis of Presentation and Summary of Significant Accounting Policies" in the notes to the accompanying consolidated financial statements.
BIN/ICA Agreements
We have entered into sponsorship or depository and processing agreements with certain banks. These agreements allow us to use the banks' identification numbers, referred to as Bank Identification Number ("BIN") for Visa transactions and Interbank Card Association ("ICA") number for Mastercard transactions, to clear credit card transactions through Visa and Mastercard. Certain of such agreements contain financial covenants, and we were in compliance with all such covenants as of December 31, 2018.
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Commitments and Contractual Obligations
The following table summarizes our contractual obligations and commitments as of December 31, 2018:
Payments Due by Future Period | |||||||||||||||||||
Total | Less than 1 Year | 1-3 Years | 3-5 Years | 5+ Years | |||||||||||||||
(in thousands) | |||||||||||||||||||
Long-term debt | $ | 5,167,643 | $ | 124,176 | $ | 355,827 | $ | 4,212,640 | $ | 475,000 | |||||||||
Interest on long-term debt(1) | 888,317 | 206,112 | 410,538 | 235,158 | 36,509 | ||||||||||||||
Settlement lines of credit | 700,486 | 700,486 | — | — | — | ||||||||||||||
Operating lease obligations(2) | 433,408 | 50,095 | 124,790 | 33,298 | 225,225 | ||||||||||||||
Purchase obligations(3) | 302,001 | 88,022 | 157,532 | 22,909 | 33,538 | ||||||||||||||
(1) Interest on long-term debt is based on rates effective and amounts borrowed as of December 31, 2018. The estimated effect of interest rate swaps is included in interest on long-term debt. Since the contractual rates for our long-term debt and settlements on our interest rate swaps are variable, actual cash payments may differ from the estimates provided.
(2) Operating lease obligations include approximately $70 million for operating lease agreements not commenced at December 31, 2018.
(3) Includes estimate of future payments for noncancelable contractual obligations related to service arrangements with suppliers for fixed or minimum amounts.
The table above excludes other obligations that we may have, such as employee benefit obligations and other noncurrent liabilities reflected in our consolidated balance sheet, because the timing of the related payments is not determinable or because there is no contractual obligation associated with the underlying obligations.
Critical Accounting Policies
Our consolidated financial statements have been prepared in accordance with GAAP, which often require the judgment of management in the selection and application of certain accounting principles and methods. We consider the following accounting policies to be critical to understanding our consolidated financial statements because the application of these policies requires significant judgment on the part of management, and as a result, actual future developments may be different from those expected at the time that we make these critical judgments. We have discussed these critical accounting policies with the audit committee of the board of directors.
Accounting estimates necessarily require subjective determinations about future events and conditions. Therefore, the following descriptions of our critical accounting policies are forward-looking statements, and actual results could differ materially from the results anticipated by these forward-looking statements. You should read the following in conjunction with "Note 1—Basis of Presentation and Summary of Significant Accounting Policies" of the notes to the accompanying consolidated financial statements and the risk factors contained in "Item 1A - Risk Factors" of this Annual Report on Form 10-K.
Goodwill
We perform our annual goodwill impairment test as of October 1. We test goodwill for impairment at the reporting unit level annually and more often if an event occurs or circumstances change that indicate the fair value of a reporting unit is below its carrying amount. We have the option of performing a qualitative assessment of impairment to determine whether any further quantitative assessment for impairment is necessary. The option of whether or not to perform a qualitative assessment is made annually and may vary by reporting unit.
Factors we consider in the qualitative assessment include general macroeconomic conditions, industry and market conditions, cost factors, overall financial performance of our reporting units, events or changes affecting the composition or carrying amount of the net assets of our reporting units, sustained decrease in our share price, and other relevant entity-specific events. If we elect to
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bypass the qualitative assessment or if we determine, on the basis of qualitative factors, that the fair value of the reporting unit is more likely than not less than the carrying amount, a quantitative test would be required.
We have seven reporting units: North America Payments, Integrated Solutions and Vertical Markets, United Kingdom, Asia-Pacific, Central and Eastern Europe, Russia and Spain. As of October 1, 2018, we elected to perform a qualitative assessment of impairment for each of our reporting units. We determined on the basis of qualitative factors that the fair value of each reporting unit was not more likely than not less than the respective carrying amounts. We believe that the fair value of each of our reporting units is substantially in excess of its carrying amount.
Intangible and Long-lived Assets
Other intangible assets include customer-related intangible assets (such as customer lists and merchant contracts), contract-based intangible assets (such as non-compete agreements, referral agreements and processing rights), acquired technologies and trademarks and trade names associated with business combinations. These assets are amortized over their estimated useful lives. The useful lives for customer-related intangible assets are determined based primarily on forecasted cash flows, which include estimates for the revenues, expenses, and customer attrition associated with the assets. The useful lives of contract-based intangible assets are equal to the terms of the agreements. The useful lives of amortizable trademarks and trade names are based on our plans to phase out the trademarks and trade names in the applicable markets. We use the straight-line method of amortization for our amortizable acquired technologies, trademarks and trade names and contract-based intangibles.
Amortization for most of our customer-related intangible assets is calculated using an accelerated method. In determining amortization expense under our accelerated method for any given period, we calculate the expected cash flows for that period that were used in determining the acquired value of the asset and divide that amount by the expected total cash flows over the estimated life of the asset. We multiply that percentage by the initial carrying amount of the asset to arrive at the amortization expense for that period. If the cash flow patterns that we experience differ significantly from our initial estimates, we adjust the amortization schedule prospectively. These cash flow patterns are derived using certain assumptions and cost allocations due to a significant amount of asset interdependencies that exist in our business. We believe that our accelerated method better approximates the expected distribution of cash flows generated by our acquired customer relationships. We did not make any significant adjustments to the amortization schedules of our intangible assets during the year ended December 31, 2018.
We regularly evaluate whether events and circumstances have occurred that indicate the carrying amount of property and equipment and finite-life intangible assets may not be recoverable. When factors indicate that these long-lived assets should be evaluated for possible impairment, we assess the potential impairment by determining whether the carrying amount of such long-lived assets will be recovered through the future undiscounted cash flows expected from use of the asset and its eventual disposition. If the carrying amount of the asset is determined not to be recoverable and exceeds its fair value, an impairment loss is recorded, measured as the difference between the fair value and the carrying amount. Fair values are determined based on quoted market prices or discounted cash flow analysis as applicable. We regularly evaluate whether events and circumstances have occurred that indicate the useful lives of property and equipment and finite-life intangible assets may warrant revision.
Capitalization of Internal-Use Software
We develop software that is used in providing services to customers. Capitalization of internal-use software, primarily associated with operating platforms, occurs when we have completed the preliminary project stage, management authorizes the project, management commits to funding the project, it is probable the project will be completed and the project will be used to perform the function intended. The preliminary project stage consists of the conceptual formulation of alternatives, the evaluation of alternatives, the determination of existence of needed technology and the final selection of alternatives. Costs incurred during the preliminary project stage are expensed as incurred. Currently unforeseen circumstances in software development, such as a significant change in the manner in which the software is intended to be used, obsolescence or a significant reduction in revenues due to merchant attrition, could require us to implement alternative plans with respect to a particular effort, which could result in the impairment of previously capitalized software development costs. The carrying amount of internal-use software, including work-in-progress, at December 31, 2018 was $404.6 million. Costs capitalized during the year ended December 31, 2018, the year ended December 31, 2017, the 2016 fiscal transition period and the year ended May 31, 2016 totaled $97.9 million, $79.3 million, $37.7 million and $36.5 million, respectively. Internal-use software is amortized over its estimated useful life, which is typically 2 to 10 years, in a manner that best reflects the pattern of economic use of the assets.
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Income Taxes
We determine our provision for income taxes using management's judgments, estimates and the interpretation and application of complex tax laws in each of the jurisdictions in which we operate. Judgment is also required in assessing the timing and amounts of deductible and taxable items. These differences result in deferred tax assets and liabilities in our consolidated balance sheet.
Accounting Standards Codification ("ASC") Topic 740, "Income Taxes" ("ASC 740") requires companies to recognize the effect of tax law changes in the period of enactment. To address the application of GAAP in situations when a registrant does not have the necessary information available, prepared or analyzed in reasonable detail to complete the accounting for certain income tax effects of the 2017 U.S. Tax Act, which was enacted on December 22, 2017, the SEC issued Staff Accounting Bulletin No. 118 ("SAB 118"), which in March 2018 was codified by the FASB in ASC 740. SAB 118 provides guidance for registrants regarding the application of ASC Topic 740 in the reporting period that includes December 22, 2017, including reporting provisional amounts for those specific income tax effects of the 2017 U.S. Tax Act for which the accounting is incomplete but a reasonable estimate can be determined. In addition, SAB 118 requires provisional amounts or adjustments to provisional amounts identified in the measurement period, as defined, to be included as an adjustment to tax expense or benefit from continuing operations in the period the amounts are determined.
As a result of the enactment of the 2017 U.S. Tax Act, our income tax benefit for the year ended December 31, 2017 included a net benefit of $158.7 million, reflecting provisional amounts for specific income tax effects as a result of the enactment of the 2017 U.S. Tax Act for which our accounting was incomplete but could be reasonably estimated as of December 31, 2017. During the year ended December 31, 2018, we continued to analyze our foreign tax pools and resulting foreign tax credits and reduced the estimated transition tax liability, which resulted in an income tax benefit of $23.3 million. As of December 31, 2018, we have completed our accounting for the transition effects of the 2017 U.S. Tax Act.
We believe our tax return positions are fully supportable; however, we recognize the benefit for tax positions only when it is more likely than not that the position will be sustained based on its technical merits. Issues raised by a tax authority may be resolved at an amount different than the related benefit recognized. When facts and circumstances change (including an effective settlement of an issue or statute of limitations expiration), the effect is recognized in the period of change. The unrecognized tax benefits that exist at December 31, 2018 would affect our provision for income taxes in the future, if recognized. Judgment is required to determine whether or not some portion or all of our deferred tax assets will not be realized. To the extent we determine that we will not realize the benefit of some or all of our deferred tax assets, then these deferred tax assets are adjusted through our provision for income taxes in the period in which this determination is made.
Effect of New Accounting Pronouncements - Recently Issued Pronouncements Not Yet Adopted
As more fully described in "Note 1—Basis of Presentation and Summary of Significant Accounting Policies" in the notes to the accompanying consolidated financial statements, effective January 1, 2019, we will adopt a new lease accounting standard that requires lessees to recognize, on the balance sheet, assets and liabilities for the rights and obligations created by leases. The application of the new lease accounting standard will also require several new disclosures. We have made substantial progress in the execution of our implementation plan, and we are substantially complete with our evaluation of the effect of ASU 2016-02 on our consolidated financial statements. We currently estimate that we will recognize lease liabilities on the balance sheet of approximately $275 million at adoption for our operating leases. We expect right of use assets will be approximately $235 million, reflecting adjustments for the net amount of lease-related items previously recognized on the balance sheet. We do not expect adoption to have a material effect on any line items in our consolidated statement of income or on our cash flows from operating activities, investing activities or financing activities included in our consolidated statement of cash flows.
Refer to "Note 1—Basis of Presentation and Summary of Significant Accounting Policies" in the notes to the accompanying consolidated financial statements for additional information on the new lease accounting standard and other recently issued accounting pronouncements not yet adopted.
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ITEM 7A - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Currency Exchange Rate Risk
Certain of our operations are conducted in foreign currencies. Consequently, a portion of our revenues and expenses may be affected by fluctuations in foreign currency exchange rates. We have not historically hedged our translation risk on foreign currency exposure, but we may do so in the future. For the years ended December 31, 2018 and 2017 and the 2016 fiscal transition period, currency rate fluctuations calculated by converting revenues and expenses for the current year in local currency using the prior-year period rates had an immaterial effect on our revenues and operating income. For the year ended May 31, 2016, currency rate fluctuations reduced our revenues by $117.0 million and our operating income by $43.6 million as compared to the prior-year period, calculated by converting revenues and expenses for the year ended May 31, 2016 in local currency using prior-year period rates.
Generally, the functional currency of our various subsidiaries is their local currency. We are exposed to currency fluctuations on transactions that are not denominated in the functional currency. Gains and losses on such transactions are included in determining net income for the period. We seek to mitigate our foreign currency risk through timely settlement of transactions and cash flow matching, when possible. For the years ended December 31, 2018 and 2017, the 2016 fiscal transition period and the year ended May 31, 2016, our transaction gains and losses were insignificant.
Additionally, we are affected by currency fluctuations in our funds settlement process on merchant payment, chargeback and card network settlement transactions that are not denominated in the currency of the underlying credit or debit card transaction. Gains and losses on these transactions are included in revenues for the period.
We are also affected by fluctuations in exchange rates on our investments in foreign operations. Relative to our net investment in foreign operations, the assets and liabilities of subsidiaries whose functional currency is a foreign currency are translated at the period-end rate of exchange. The resulting translation adjustment is recorded as a component of other comprehensive income and is included in shareholders' equity. Transaction gains and losses on intercompany balances of a long-term investment nature are also recorded as a component of other comprehensive income.
Interest Rate Risk
We are exposed to market risk related to changes in interest rates on our long-term debt and cash investments. We invest our excess cash in securities that we believe are highly liquid and marketable in the short term. These investments earn a floating rate of interest and are not held for trading or other speculative purposes.
We have a Credit Facility for general corporate purposes, as well as various lines of credit that we use to fund settlement in certain of our markets. Interest rates on these debt instruments and settlement lines of credit are based on market rates and fluctuate accordingly. As of December 31, 2018, the amount outstanding under these variable-rate debt arrangements and settlement lines of credit was $5.9 billion.
The interest earned on our invested cash and the interest paid on our debt are based on variable interest rates; therefore, the exposure of our net income to a change in interest rates is partially mitigated as an increase in rates would increase both interest income and interest expense, and a reduction in rates would decrease both interest income and interest expense. Under our current policies, we may selectively use derivative instruments, such as interest rate swaps or forward rate agreements, to manage all or a portion of our exposure to interest rate changes. We have interest rate swaps that reduce a portion of our exposure to market interest rate risk on our LIBOR-based debt as discussed in "Note 8—Long-Term Debt and Lines of Credit" in the notes to our accompanying consolidated financial statements.
Based on balances outstanding under variable-rate debt agreements and invested cash balances at December 31, 2018, a hypothetical increase of 50 basis points in applicable interest rates as of December 31, 2018 would increase our annual interest expense by approximately $17.5 million and increase our annual interest income by approximately $3.3 million.
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ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders and the Board of Directors of Global Payments Inc.
Opinion on Internal Control over Financial Reporting
We have audited the internal control over financial reporting of Global Payments Inc. and subsidiaries (the "Company") as of December 31, 2018, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements and financial statement schedule as of and for the year ended December 31, 2018, of the Company and our report dated February 21, 2019, expressed an unqualified opinion on those financial statements and included an emphasis of a matter paragraph regarding the Company's change of its fiscal year end from May 31 to December 31, in 2016, and an explanatory paragraph regarding the Company's change in its method of accounting for revenue from contracts with customers in fiscal year 2018, due to the adoption of ASU 2014-09, Revenue from Contracts with Customers (Topic 606). As described in Management’s Report on Internal Control over Financial Reporting, management excluded from its assessment a portion of the internal control over financial reporting at AdvancedMD, Inc. ("AdvancedMD"), which was acquired on September 4, 2018, and SICOM Systems, Inc. ("SICOM"), which was acquired on October 17, 2018. AdvancedMD and SICOM's combined financial statements constitute less than 2% of consolidated revenues and approximately 5% of consolidated assets (excluding goodwill related to the transactions which were integrated into the Company's systems and control environment), as of and for the year ended December 31, 2018. AdvancedMD and SICOM did not contribute to net income for the year ended December 31, 2018. Accordingly, our audit did not include the internal control over financial reporting at AdvancedMD and SICOM that is excluded from management’s assessment.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
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Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ DELOITTE & TOUCHE LLP
Atlanta, Georgia
February 21, 2019
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholders and the Board of Directors of Global Payments Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Global Payments Inc. and subsidiaries (the "Company") as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, changes in equity, and cash flows for the years ended December 31, 2018 and 2017, the seven months ended December 31, 2016, and the year ended May 31, 2016, and the related notes and the schedule listed in the Index at Item 15 (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for the years ended December 31, 2018 and 2017, the seven months ended December 31, 2016, and the year ended May 31, 2016, in conformity with the applicable accounting principles generally accepted in the United States of America. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 21, 2019 expressed an unqualified opinion on the Company's internal control over financial reporting.
Emphasis of Matter
As discussed in Note 1 to the consolidated financial statements, the Company changed its fiscal year end from May 31 to December 31 in 2016.
Change in Accounting Principle
As discussed in Note 1 to the consolidated financial statements, the Company has changed its method of accounting for revenue from contracts with customers in fiscal year 2018 due to the adoption of Accounting Standards Codification Topic 606, Revenue from Contracts with Customers.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ DELOITTE & TOUCHE LLP
Atlanta, Georgia
February 21, 2019
We have served as the Company’s auditors since 2002.
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GLOBAL PAYMENTS INC.
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except per share data)
Years Ended December 31, | Seven Months Ended December 31, | Year Ended May 31, | |||||||||||||
2018 | 2017 | 2016 | 2016 | ||||||||||||
Revenues | $ | 3,366,366 | $ | 3,975,163 | $ | 2,202,896 | $ | 2,898,150 | |||||||
Operating expenses: | |||||||||||||||
Cost of service | 1,095,014 | 1,928,037 | 1,094,593 | 1,147,639 | |||||||||||
Selling, general and administrative | 1,534,297 | 1,488,258 | 870,352 | 1,325,567 | |||||||||||
2,629,311 | 3,416,295 | 1,964,945 | 2,473,206 | ||||||||||||
Operating income | 737,055 | 558,868 | 237,951 | 424,944 | |||||||||||
Interest and other income | 20,719 | 8,662 | 44,382 | 5,284 | |||||||||||
Interest and other expense | (195,619 | ) | (174,847 | ) | (108,989 | ) | (69,316 | ) | |||||||
(174,900 | ) | (166,185 | ) | (64,607 | ) | (64,032 | ) | ||||||||
Income before income taxes | 562,155 | 392,683 | 173,344 | 360,912 | |||||||||||
Income tax (provision) benefit | (77,488 | ) | 101,387 | (35,661 | ) | (70,695 | ) | ||||||||
Net income | 484,667 | 494,070 | 137,683 | 290,217 | |||||||||||
Less: Net income attributable to noncontrolling interests | (32,614 | ) | (25,645 | ) | (12,752 | ) | (18,551 | ) | |||||||
Net income attributable to Global Payments | $ | 452,053 | $ | 468,425 | $ | 124,931 | $ | 271,666 | |||||||
Earnings per share attributable to Global Payments: | |||||||||||||||
Basic earnings per share | $ | 2.85 | $ | 3.03 | $ | 0.81 | $ | 2.05 | |||||||
Diluted earnings per share | $ | 2.84 | $ | 3.01 | $ | 0.81 | $ | 2.04 | |||||||
See Notes to Consolidated Financial Statements.
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GLOBAL PAYMENTS INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
Years Ended December 31, | Seven Months Ended December 31, | Year Ended May 31, | |||||||||||||
2018 | 2017 | 2016 | 2016 | ||||||||||||
Net income | $ | 484,667 | $ | 494,070 | $ | 137,683 | $ | 290,217 | |||||||
Other comprehensive income (loss): | |||||||||||||||
Foreign currency translation adjustments | (118,439 | ) | 146,401 | (92,229 | ) | (55,858 | ) | ||||||||
Income tax provision related to foreign currency translation adjustments | (832 | ) | — | — | — | ||||||||||
Net unrealized gains (losses) on hedging activities | (7,553 | ) | 4,549 | 5,532 | (12,859 | ) | |||||||||
Reclassification of net unrealized (gains) losses on hedging activities to interest expense | (4,792 | ) | 5,673 | 4,222 | 8,240 | ||||||||||
Income tax benefit (provision) related to hedging activities | 2,972 | (2,583 | ) | (3,639 | ) | 1,738 | |||||||||
Other, net of tax | 760 | (660 | ) | 1,030 | (848 | ) | |||||||||
Other comprehensive income (loss) | (127,884 | ) | 153,380 | (85,084 | ) | (59,587 | ) | ||||||||
Comprehensive income | 356,783 | 647,450 | 52,599 | 230,630 | |||||||||||
Less: comprehensive income attributable to noncontrolling interests | (29,918 | ) | (39,452 | ) | (4,335 | ) | (19,022 | ) | |||||||
Comprehensive income attributable to Global Payments | $ | 326,865 | $ | 607,998 | $ | 48,264 | $ | 211,608 | |||||||
See Notes to Consolidated Financial Statements.
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GLOBAL PAYMENTS INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
December 31, 2018 | December 31, 2017 | ||||||
ASSETS | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | 1,210,878 | $ | 1,335,855 | |||
Accounts receivable, net of allowances for doubtful accounts of $3,164 and $1,827, respectively | 348,400 | 301,887 | |||||
Settlement processing assets | 1,600,222 | 2,459,292 | |||||
Prepaid expenses and other current assets | 216,708 | 206,545 | |||||
Total current assets | 3,376,208 | 4,303,579 | |||||
Goodwill | 6,341,355 | 5,703,992 | |||||
Other intangible assets, net | 2,488,618 | 2,181,707 | |||||
Property and equipment, net | 653,542 | 588,348 | |||||
Deferred income taxes | 8,128 | 13,146 | |||||
Other noncurrent assets | 362,923 | 207,297 | |||||
Total assets | $ | 13,230,774 | $ | 12,998,069 | |||
LIABILITIES AND EQUITY | |||||||
Current liabilities: | |||||||
Settlement lines of credit | $ | 700,486 | $ | 635,166 | |||
Current portion of long-term debt | 115,075 | 100,308 | |||||
Accounts payable and accrued liabilities | 1,176,703 | 1,039,607 | |||||
Settlement processing obligations | 1,276,356 | 2,040,509 | |||||
Total current liabilities | 3,268,620 | 3,815,590 | |||||
Long-term debt | 5,015,168 | ||||||