Attached files

file filename
EX-32.1 - EXHIBIT 32.1 CERTIFICATION OF CEO AND CFO - Worldpay, Inc.vntvex-321x2017930.htm
EX-31.2 - EXHIBIT 31.2 CERTIFICATION OF CFO - Worldpay, Inc.vntvex-312x2017930.htm
EX-31.1 - EXHIBIT 31.1 CERTIFICATION OF CEO - Worldpay, Inc.vntvex-311x2017930.htm

 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
FORM 10-Q
 
 
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2017
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
Commission File Number: 001-35462 
 
 
 
Vantiv, Inc.
(Exact name of registrant as specified in its charter)
 
 
 
Delaware
 
26-4532998
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
8500 Governor’s Hill Drive
Symmes Township, OH 45249
(Address of principal executive offices)
(513) 900-5250
(Registrant’s telephone number, including area code)
 
 
 

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 and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted 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 and post such files).  Yes x  No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See 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
 
 
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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o  No x
As of September 30, 2017, there were 162,506,630 shares of the registrant’s Class A common stock outstanding and 15,252,826 shares of the registrant’s Class B common stock outstanding.

 
 
 
 
 
 
 
 
 
 




VANTIV, INC.
FORM 10-Q
 
For the Quarterly Period Ended September 30, 2017
 
TABLE OF CONTENTS
 
 
Page
 
 


2
 
 
 


NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This Quarterly Report on Form 10-Q, including the sections entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors,” contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical fact, including statements regarding our future results of operations and financial position, our business strategy and plans, our objectives for future operations, and any statements of a general economic or industry specific nature, are forward-looking statements. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. Words such as “anticipate,” “estimate,” “expect,” “project,” “plan,” “intend,” “believe,” “may,” “will,” “continue,” “could,” “should,” “can have,” “likely,” or the negative or plural of these words and similar expressions are intended to identify forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and trends that we believe, based on information currently available to our management, may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in the “Risk Factors” section of our most recent Annual Report on Form 10-K. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the future events and trends discussed in this report may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements.
 
You should not rely upon forward-looking statements as predictions of future events. The events and circumstances reflected in the forward-looking statements may not be achieved or occur. Although we believe that the expectations and assumptions reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. We undertake no obligation to publicly update any forward-looking statement after the date of this report, whether as a result of new information, future developments or otherwise, or to conform these statements to actual results or revised expectations, except as may be required by law.


3
 
 
 


PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

Vantiv, Inc.
CONSOLIDATED STATEMENTS OF INCOME
Unaudited
(In thousands, except share data)
 


 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2017
 
2016
 
2017
 
2016
Revenue:
 
 
 
 
 
 

 
 

External customers
 
$
1,017,030

 
$
897,800

 
$
2,910,601

 
$
2,565,529

Related party revenues
 
16,735

 
16,219

 
50,130

 
58,330

Total revenue
 
1,033,765

 
914,019

 
2,960,731

 
2,623,859

Network fees and other costs
 
479,533

 
423,361

 
1,406,358

 
1,221,510

Sales and marketing
 
173,779

 
153,248

 
497,082

 
433,730

Other operating costs
 
79,482

 
72,162

 
234,347

 
219,464

General and administrative
 
49,607

 
40,727

 
189,632

 
133,831

Depreciation and amortization
 
82,500

 
66,086

 
236,964

 
199,550

Income from operations
 
168,864

 
158,435

 
396,348

 
415,774

Interest expense—net
 
(38,521
)
 
(27,474
)
 
(97,441
)
 
(81,321
)
Non-operating income (expenses)
 
21,207

 
(4,633
)
 
13,672

 
(14,949
)
Income before applicable income taxes
 
151,550

 
126,328

 
312,579

 
319,504

Income tax expense
 
44,645

 
39,324

 
83,519

 
101,591

Net income
 
106,905

 
87,004

 
229,060

 
217,913

Less: Net income attributable to non-controlling interests
 
(14,787
)
 
(20,708
)
 
(39,280
)
 
(52,552
)
Net income attributable to Vantiv, Inc.
 
$
92,118

 
$
66,296

 
$
189,780

 
$
165,361

Net income per share attributable to Vantiv, Inc. Class A common stock:
 
 
 
 
 
 
 
 
Basic
 
$
0.57

 
$
0.43

 
$
1.18

 
$
1.06

Diluted
 
$
0.57

 
$
0.41

 
$
1.17

 
$
1.04

Shares used in computing net income per share of Class A common stock:
 
 
 
 
 
 

 
 

Basic
 
161,465,849

 
155,740,660

 
161,205,066

 
155,603,265

Diluted
 
162,882,396

 
197,342,169

 
162,617,782

 
197,126,571

 
See Notes to Unaudited Consolidated Financial Statements.


4
 
 
 


Vantiv, Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Unaudited
(In thousands)
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2017
 
2016
 
2017
 
2016
Net income
 
$
106,905

 
$
87,004

 
$
229,060

 
$
217,913

Other comprehensive gain (loss), net of tax:
 
 
 
 
 
 

 
 

Gain (loss) on cash flow hedges
 
811

 
3,572

 
5,690

 
(9,654
)
Comprehensive income
 
107,716

 
90,576

 
234,750

 
208,259

Less: Comprehensive income attributable to non-controlling interests
 
(14,693
)
 
(21,654
)
 
(40,444
)
 
(49,992
)
Comprehensive income attributable to Vantiv, Inc.
 
$
93,023


$
68,922

 
$
194,306

 
$
158,267

 
See Notes to Unaudited Consolidated Financial Statements.



5
 
 
 


Vantiv, Inc.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
Unaudited
(In thousands, except share data) 
 
September 30,
2017
 
December 31,
2016
Assets
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
92,638

 
$
139,148

Accounts receivable—net
899,389

 
940,052

Related party receivable
1,639

 
1,751

Settlement assets
135,043

 
152,490

Prepaid expenses
48,073

 
39,229

Other
118,664

 
15,188

Total current assets
1,295,446

 
1,287,858

  Customer incentives
64,023

 
67,288

  Property, equipment and software—net
470,308

 
348,553

  Intangible assets—net
732,431

 
787,820

  Goodwill
4,180,307

 
3,738,589

  Deferred taxes
1,322,679

 
771,139

  Other assets
24,740

 
42,760

Total assets
$
8,089,934

 
$
7,044,007

Liabilities and equity
 

 
 

Current liabilities:
 

 
 

Accounts payable and accrued expenses
$
528,473

 
$
471,979

Related party payable
3,037

 
3,623

Settlement obligations
788,261

 
801,381

Current portion of note payable to related party
7,557

 
7,557

Current portion of note payable
133,097

 
123,562

Current portion of tax receivable agreement obligations to related parties
261,844

 
191,014

Current portion of tax receivable agreement obligations
54,798

 
60,400

Deferred income
19,349

 
7,907

Current maturities of capital lease obligations
8,000

 
7,870

Other
6,790

 
13,719

Total current liabilities
1,811,206

 
1,689,012

Long-term liabilities:
 

 
 

Note payable to related party
170,097

 
143,577

Note payable
4,421,522

 
2,946,026

Tax receivable agreement obligations to related parties
876,434

 
451,318

Tax receivable agreement obligations
42,510

 
86,640

Capital lease obligations
6,666

 
13,223

Deferred taxes
98,097

 
62,148

Other
46,297

 
44,774

Total long-term liabilities
5,661,623

 
3,747,706

Total liabilities
7,472,829

 
5,436,718

Commitments and contingencies (See Note 7 - Commitments, Contingencies and Guarantees)


 


Equity:
 

 
 

Class A common stock, $0.00001 par value; 890,000,000 shares authorized; 162,506,630 shares outstanding at September 30, 2017; 161,134,831 shares outstanding at December 31, 2016
1

 
1

Class B common stock, no par value; 100,000,000 shares authorized; 15,252,826 shares issued and outstanding at September 30, 2017; 35,042,826 shares issued and outstanding at December 31, 2016

 

Preferred stock, $0.00001 par value; 10,000,000 shares authorized; no shares issued and outstanding

 

Paid-in capital
25,048

 
706,055

Retained earnings
617,683

 
689,512

Accumulated other comprehensive loss
(1,671
)
 
(6,197
)
Treasury stock, at cost; 2,849,275 shares at September 30, 2017 and 2,710,195 shares at December 31, 2016
(82,893
)
 
(73,706
)
Total Vantiv, Inc. equity
558,168

 
1,315,665

Non-controlling interests
58,937

 
291,624

Total equity
617,105

 
1,607,289

Total liabilities and equity
$
8,089,934

 
$
7,044,007

See Notes to Unaudited Consolidated Financial Statements.

6
 
 
 


Vantiv, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited
(In thousands)
 
Nine Months Ended September 30,
 
2017
 
2016
Operating Activities:
 

 
 

Net income
$
229,060

 
$
217,913

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Depreciation and amortization expense
236,964

 
199,550

Amortization of customer incentives
18,648

 
18,508

Amortization of debt issuance costs
3,941

 
4,818

Unrealized gain on deal contingent forward
(24,365
)
 

Share-based compensation expense
35,068

 
25,892

Deferred taxes
60,000

 
49,900

Excess tax benefit from share-based compensation

 
(11,193
)
Tax receivable agreements non-cash items
10,708

 
14,880

Other
2,304

 
433

Change in operating assets and liabilities:
 

 
 

Accounts receivable and related party receivable
46,682

 
(67,938
)
Net settlement assets and obligations
4,327

 
(16,558
)
Customer incentives
(17,703
)
 
(30,808
)
Prepaid and other assets
(82,916
)
 
6,183

Accounts payable and accrued expenses
22,924

 
24,859

Payable to related party
(586
)
 
(1,331
)
Other liabilities
(17,390
)
 
(4,713
)
Net cash provided by operating activities
527,666

 
430,395

Investing Activities:
 

 
 

Purchases of property and equipment
(81,882
)
 
(93,822
)
Acquisition of customer portfolios and related assets and other
(38,165
)
 
(2,179
)
Purchase of derivative instruments

 
(21,523
)
Cash used in acquisitions, net of cash acquired
(531,534
)
 

Net cash used in investing activities
(651,581
)
 
(117,524
)
Financing Activities:
 

 
 

Proceeds from issuance of long-term debt
1,270,000

 

Borrowings on revolving credit facility
5,405,000

 
1,180,000

Repayment of revolving credit facility
(5,046,000
)
 
(1,180,000
)
Repayment of debt and capital lease obligations
(107,969
)
 
(98,019
)
Payment of debt issuance costs
(24,148
)
 

Proceeds from issuance of Class A common stock under employee stock plans
10,847

 
12,340

Purchase and cancellation of Class A common stock
(1,268,057
)
 
(25,008
)
Repurchase of Class A common stock (to satisfy tax withholding obligations)
(9,187
)
 
(6,036
)
Settlement of certain tax receivable agreements
(84,878
)
 
(158,115
)
Payments under tax receivable agreements
(55,695
)
 
(53,474
)
Excess tax benefit from share-based compensation

 
11,193

Distributions to non-controlling interests
(12,508
)
 
(9,018
)
Other

 
(12
)
Net cash provided by (used in) financing activities
77,405

 
(326,149
)
Net decrease in cash and cash equivalents
(46,510
)
 
(13,278
)
Cash and cash equivalents—Beginning of period
139,148

 
197,096

Cash and cash equivalents—End of period
$
92,638

 
$
183,818

Cash Payments:
 

 
 

Interest
$
94,318

 
$
76,404

Taxes
31,585

 
35,709

See Notes to Unaudited Consolidated Financial Statements.

7
 
 
 


Vantiv, Inc.
CONSOLIDATED STATEMENT OF EQUITY
Unaudited
(In thousands)

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated
 
 
 
 
 
Common Stock
 
 
 
 
 
 
 
 
 
Other
 
Non-
 
Total
 
Class A
 
Class B
 
Treasury Stock
 
Paid-in
 
Retained
 
Comprehensive
 
Controlling
 
Equity
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
Capital
 
Earnings
 
Income (Loss)
 
Interests
Beginning Balance, January 1, 2017
$
1,607,289

 
161,135

 
$
1

 
35,043

 
$

 
2,710

 
$
(73,706
)
 
$
706,055

 
$
689,512

 
$
(6,197
)
 
$
291,624

Cumulative effect of accounting change
491

 

 

 

 

 

 

 
1,299

 
(808
)
 

 

Net income
229,060

 

 

 

 

 

 

 

 
189,780

 

 
39,280

Issuance of Class A common stock under employee stock plans, net of forfeitures
10,847

 
1,511

 

 

 

 

 

 
10,847

 

 

 

Repurchase of Class A common stock (to satisfy tax withholding obligation)
(9,187
)
 
(139
)
 

 

 

 
139

 
(9,187
)
 

 

 

 

Purchase and cancellation of Class A common stock
(1,270,589
)
 

 

 
(19,790
)
 

 

 

 
(1,009,788
)
 
(260,801
)
 

 

Settlement of certain tax receivable agreements
45,347

 

 

 

 

 

 

 
45,347

 

 

 

Issuance of tax receivable agreements
(24,403
)
 

 

 

 

 

 

 
(24,403
)


 

 

Unrealized gain on hedging activities, net of tax
5,690

 

 

 

 

 

 

 

 

 
4,526

 
1,164

Distribution to non-controlling interests
(12,508
)
 

 

 

 

 

 

 

 

 

 
(12,508
)
Share-based compensation
35,068

 

 

 

 

 

 

 
29,619

 

 

 
5,449

Reallocation of non-controlling interests of Vantiv Holding due to change in ownership

 

 

 

 

 

 

 
266,072

 

 

 
(266,072
)
Ending Balance, September 30, 2017
$
617,105

 
162,507

 
$
1

 
15,253

 
$

 
2,849

 
$
(82,893
)
 
$
25,048

 
$
617,683

 
$
(1,671
)
 
$
58,937


See Notes to Unaudited Consolidated Financial Statements.



8
 
 
 


Vantiv, Inc.
CONSOLIDATED STATEMENT OF EQUITY
Unaudited
(In thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accumulated
 
 
 
 
 
Common Stock
 
 
 
 
 
 
 
 
 
Other
 
Non-
 
Total
 
Class A
 
Class B
 
Treasury Stock
 
Paid-in
 
Retained
 
Comprehensive
 
Controlling
 
Equity
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
Capital
 
Earnings
 
Income (Loss)
 
Interests
Beginning Balance, January 1, 2016
$
1,225,066

 
155,488

 
$
1

 
35,043

 
$

 
2,593

 
$
(67,458
)
 
$
553,145

 
$
476,304

 
$
(9,204
)
 
$
272,278

Net income
217,913

 

 

 

 

 

 

 

 
165,361

 

 
52,552

Issuance of Class A common stock under employee stock plans, net of forfeitures
12,340

 
1,371

 

 

 

 

 

 
12,340

 

 

 

Excess tax benefit from employee share-based compensation
11,193

 

 

 

 

 

 

 
11,193

 

 

 

Repurchase of Class A common stock
(25,008
)

(457
)











(25,008
)






Repurchase of Class A common stock (to satisfy tax withholding obligation)
(6,036
)
 
(114
)
 

 

 

 
114

 
(6,036
)
 

 

 

 

Termination of certain tax receivable agreements
129,538














129,538







Unrealized loss on hedging activities, net of tax
(9,654
)
 

 

 

 

 

 

 

 

 
(7,094
)
 
(2,560
)
Distribution to non-controlling interests
(9,018
)
 

 

 

 

 

 

 

 

 

 
(9,018
)
Share-based compensation
25,892

 

 

 

 

 

 

 
21,150

 

 

 
4,742

Other
(12
)
 

 

 

 

 

 

 
(12
)
 

 

 

Reallocation of non-controlling interests of Vantiv Holding due to change in ownership














7,501






(7,501
)
Ending Balance, September 30, 2016
$
1,572,214

 
156,288

 
$
1

 
35,043

 
$

 
2,707

 
$
(73,494
)
 
$
709,847

 
$
641,665

 
$
(16,298
)
 
$
310,493

 
See Notes to Unaudited Consolidated Financial Statements.


9
 
 
 


Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
Description of Business
 
Vantiv, Inc., a Delaware corporation, is a holding company that conducts its operations through its majority-owned subsidiary, Vantiv Holding, LLC (“Vantiv Holding”). Vantiv, Inc. and Vantiv Holding are referred to collectively as the “Company,” “Vantiv,” “we,” “us” or “our,” unless the context requires otherwise.
 
The Company provides electronic payment processing services to merchants and financial institutions throughout the United States of America and operates in two reportable segments, Merchant Services and Financial Institution Services. For more information about the Company’s segments, refer to Note 11 - Segment Information. The Company markets its services through diverse distribution channels, including national, regional and mid-market sales teams, third-party reseller clients and a telesales operation. The Company also has relationships with a broad range of referral partners that include merchant banks, independent software vendors (“ISVs”), value-added resellers (“VARs”), payment facilitators, independent sales organizations (“ISOs”) and trade associations, as well as arrangements with core processors.
 
Basis of Presentation and Consolidation
 
The accompanying consolidated financial statements include those of Vantiv, Inc. and all subsidiaries thereof, including its majority-owned subsidiary, Vantiv Holding, LLC. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") and should be read in connection with the Company’s 2016 audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K. The accompanying consolidated financial statements are unaudited; however, in the opinion of management they include all normal and recurring adjustments necessary for a fair presentation of the Company’s financial position, results of operations and cash flows for the periods presented. Results of operations reported for interim periods are not necessarily indicative of results for the entire year due to seasonal fluctuations in the Company’s revenue as a result of consumer spending patterns. All intercompany balances and transactions have been eliminated.
 
As of September 30, 2017, Vantiv, Inc. and Fifth Third Bank (“Fifth Third”) owned interests in Vantiv Holding of 91.42% and 8.58%, respectively (see Note 6 - Controlling and Non-controlling Interests for changes in non-controlling interests).
 
The Company accounts for non-controlling interests in accordance with Accounting Standards Codification (“ASC”) 810, Consolidation. Non-controlling interests primarily represent Fifth Third’s minority share of net income or loss of equity in Vantiv Holding. Net income attributable to non-controlling interests does not include expenses incurred directly by Vantiv, Inc., including income tax expense attributable to Vantiv, Inc. Non-controlling interests are presented as a component of equity in the accompanying consolidated statements of financial position.

Share Repurchase Program

In October 2016, our board of directors authorized a program to repurchase up to $250 million of our Class A common stock. The Company has approximately $243 million of share repurchase authority remaining as of September 30, 2017 under this authorization.

Purchases under the programs may be made from time to time in the open market, in privately negotiated transactions, or otherwise. The manner, timing and amount of any purchases will be determined by management based on an evaluation of market conditions, stock price and other factors. The Company’s share repurchase program does not obligate it to acquire any specific number or amount of shares, there is no guarantee as to the exact number or amount of shares that may be repurchased, if any, and the Company may discontinue purchases at any time that it determines additional purchases are not warranted.

Sponsorship
 
In order to provide electronic payment processing services, Visa, Mastercard and other payment networks require sponsorship of non-financial institutions by a member clearing bank. The Company has an agreement with Fifth Third (the “Sponsoring Member”) to provide sponsorship services to the Company through December 31, 2024. The Company also has agreements with certain other banks that provide sponsorship into the card networks.

10
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


 
Use of Estimates
 
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

Revenue Recognition
 
The Company has contractual agreements with its clients that set forth the general terms and conditions of the relationship including line item pricing, payment terms and contract duration. Revenues are recognized as earned (i.e., for transaction based fees, when the underlying transaction is processed) in conjunction with ASC 605, Revenue Recognition. ASC 605, Revenue Recognition, establishes guidance as to when revenue is realized or realizable and earned by using the following criteria: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the seller’s price is fixed or determinable; and (4) collectibility is reasonably assured.
 
The Company follows guidance provided in ASC 605-45, Principal Agent Considerations, which states that the determination of whether a company should recognize revenue based on the gross amount billed to a customer or the net amount retained is a matter of judgment that depends on the facts and circumstances of the arrangement and that certain factors should be considered in the evaluation. The Company recognizes processing revenues net of interchange fees, which are assessed to the Company’s merchant customers on all processed transactions. Interchange rates are not controlled by the Company, which effectively acts as a clearing house collecting and remitting interchange fee settlement on behalf of issuing banks, debit networks, credit card associations and its processing customers. All other revenue is reported on a gross basis, as the Company contracts directly with the end customer, assumes the risk of loss and has pricing flexibility.
 
The Company generates revenue primarily by processing electronic payment transactions. Set forth below is a description of the Company’s revenue by segment. 

Merchant Services
 
The Company’s Merchant Services segment revenue is primarily derived from processing credit and debit card transactions. Merchant Services revenue is primarily comprised of fees charged to businesses, net of interchange fees, for payment processing services, including authorization, capture, clearing, settlement and information reporting of electronic transactions. The fees charged consist of either a percentage of the dollar volume of the transaction or a fixed fee, or both, and are recognized at the time of the transaction. Merchant Services revenue also includes a number of revenue items that are incurred by the Company and are reimbursable as the costs are passed through to and paid by the Company’s clients. These items primarily consist of Visa, Mastercard and other payment network fees. In addition, for sales through referral partners in which the Company is the primary party to the contract with the merchant, the Company records the full amount of the fees collected from the merchant as revenue. Merchant Services segment revenue also includes revenue from ancillary services such as fraud management, equipment sales and terminal rent. Merchant Services revenue is recognized as services are performed. 

Financial Institution Services

The Company’s Financial Institution Services segment revenues are primarily derived from debit, credit and automated teller machine (“ATM”) card transaction processing, ATM driving and support, and PIN debit processing services. Financial Institution Services revenue associated with processing transactions includes per transaction and account related fees, card production fees and fees generated from the Company’s Jeanie network. Financial Institution Services revenue related to card transaction processing is recognized when consumers use their client-issued cards to make purchases. Financial Institution Services also generates revenue through other services, including statement production, collections and inbound/outbound call centers for credit transactions and other services such as credit card portfolio analytics, program strategy and support, fraud and security management and chargeback and dispute services. Financial Institution Services revenue is recognized as services are performed.
 
Financial Institution Services provides certain services to Fifth Third. Revenues related to these services are included in the accompanying statements of income as related party revenues.
 

11
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


Expenses
 
Set forth below is a brief description of the components of the Company’s expenses:
 
Network fees and other costs primarily consist of pass through expenses incurred by the Company in connection with providing processing services to its clients, including Visa and Mastercard network association fees, payment network fees, third party processing fees, telecommunication charges, postage and card production costs.
 
Sales and marketing expense primarily consists of salaries and benefits paid to sales personnel, sales management and other sales and marketing personnel, residual payments made to referral partners, and advertising and promotional costs.
 
Other operating costs primarily consist of salaries and benefits paid to operational and IT personnel, costs associated with operating the Company’s technology platform and data centers, information technology costs for processing transactions, product development costs, software fees and maintenance costs.

General and administrative expenses primarily consist of salaries and benefits paid to executive management and administrative employees, including finance, human resources, product development, legal and risk management, share-based compensation costs, equipment, occupancy and consulting costs. The nine months ended September 30, 2017 includes a charge related to a settlement agreement stemming from legacy litigation of an acquired company.

Non-operating income for the three and nine months ended September 30, 2017 consists of an unrealized gain relating to the change in the fair value of a deal contingent forward entered into in connection with the pending Worldpay Group plc (“Worldpay”) acquisition (see Note 12 - Pending Worldpay Transaction), partially offset by the change in fair value of a tax receivable agreement (“TRA”) entered into as part of the acquisition of Mercury Payment Systems, LLC (“Mercury”). Non-operating expenses for the three and nine months ended September 30, 2016 primarily relate to the change in fair value of a TRA entered into as part of the acquisition of Mercury. (see Note 8 - Fair Value Measurements).

Share-Based Compensation
 
The Company expenses employee share-based payments under ASC 718, Compensation—Stock Compensation, which requires compensation cost for the grant-date fair value of share-based payments to be recognized over the requisite service period. The Company estimates the grant date fair value of the share-based awards issued in the form of options using the Black-Scholes option pricing model. The fair value of shares issued under the Employee Stock Purchase Plan (“ESPP”), as restricted stock awards and performance awards is measured based on the market price of the Company’s stock on the grant date. In 2017, the Compensation Committee of the Company’s Board of Directors approved a resolution that stock options, restricted shares and restricted stock units shall vest or become exercisable in three equal annual installments beginning on the first anniversary of the grant date.

In March 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-09, Compensation- Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. The update simplifies several aspects of the accounting for share-based payment award transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The Company adopted this ASU on January 1, 2017. Under previous guidance, excess tax benefits and deficiencies from share-based compensation arrangements were recorded in equity when the awards vested or settled. ASU 2016-09 requires prospective recognition of excess tax benefits and deficiencies in the income statement, resulting in the recognition of excess tax benefits of $1.9 million and $16.0 million in income tax expense, rather than in paid-in capital, for the three and nine months ended September 30, 2017, respectively.

Additionally, under ASU 2016-09, excess income tax benefits from share-based compensation arrangements are classified as cash flow from operations, rather than as cash flow from financing activities. The Company has elected to apply the cash flow classification guidance of ASU 2016-09 prospectively, resulting in an increase to operating cash flow of $16.0 million for the nine months ended September 30, 2017, and the prior year period has not been adjusted. The presentation requirements for cash flows related to employee taxes paid for withheld shares have no impact to the periods presented in our consolidated cash flows statements since such cash flows have historically been presented as a financing activity.

12
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)



Prior to adopting ASU 2016-09 the Company estimated forfeitures as part of share-based compensation expense. Under ASU 2016-09, an entity can make an election to either estimate the number of awards that are expected to vest or account for forfeitures as they occur. The Company has elected to account for forfeitures as they occur. The cumulative-effect of this change in election resulted in an increase to additional paid-in capital of $1.3 million, an increase to deferred tax assets of $0.5 million, and a decrease to retained earnings of $0.8 million at the beginning of 2017.

ASU 2016-09 requires excess tax benefits and deficiencies to be prospectively excluded from assumed future proceeds in the calculation of diluted shares, resulting in an increase in diluted weighted average shares outstanding of approximately 364,000 shares and 412,000 shares for the three and nine months ended September 30, 2017, respectively.

For the nine months ended September 30, 2017 and 2016 total share-based compensation expense was $35.1 million and $25.9 million, respectively.
    
Earnings Per Share
 
Basic earnings per share is computed by dividing net income attributable to Vantiv, Inc. by the weighted average shares outstanding during the period. Diluted earnings per share is computed by dividing net income attributable to Vantiv, Inc., adjusted as necessary for the impact of potentially dilutive securities, by the weighted-average shares outstanding during the period and the impact of securities that would have a dilutive effect on earnings per share. See Note 9 - Net Income Per Share for further discussion.

Dividend Restrictions

The Company does not intend to pay cash dividends on its Class A common stock in the foreseeable future. Vantiv, Inc. is a holding company that does not conduct any business operations of its own. As a result, Vantiv, Inc.’s ability to pay cash dividends on its common stock, if any, is dependent upon cash dividends and distributions and other transfers from Vantiv Holding. The amounts available to Vantiv, Inc. to pay cash dividends are subject to the covenants and distribution restrictions in its subsidiaries’ loan agreements. As a result of the restrictions on distributions from Vantiv Holding and its subsidiaries, essentially all of the Company’s consolidated net assets are held at the subsidiary level and are restricted as of September 30, 2017.

Income Taxes
 
Vantiv, Inc. is taxed as a C corporation for U.S. income tax purposes and is therefore subject to both federal and state taxation at a corporate level.
 
Income taxes are computed in accordance with ASC 740, Income Taxes, and reflect the net tax effects of temporary differences between the financial reporting carrying amounts of assets and liabilities and the corresponding income tax amounts. The Company has deferred tax assets and liabilities and maintains valuation allowances where it is more likely than not that all or a portion of deferred tax assets will not be realized. To the extent the Company determines that it will not realize the benefit of some or all of its deferred tax assets, such deferred tax assets will be adjusted through the Company’s provision for income taxes in the period in which this determination is made. As of September 30, 2017 and December 31, 2016, the Company had recorded no valuation allowances against deferred tax assets.

The Company’s consolidated interim effective tax rate is based upon expected annual income from operations, statutory tax rates and tax laws in the various jurisdictions in which the Company operates. Significant or unusual items, including adjustments to accruals for tax uncertainties, are recognized in the quarter in which the related event occurs.

The Company’s effective tax rates were 26.7% and 31.8% respectively, for the nine months ended September 30, 2017 and 2016. The effective tax rate for each period reflects the impact of the Company’s non-controlling interests not being taxed at the statutory corporate tax rates. The effective tax rate for the nine months ended September 30, 2017 includes a $16.0 million credit to income tax expense relating to excess tax benefits as a result of the Company’s adoption of ASU 2016-09, Compensation - Stock Compensation (Topic 718) - Improvements to Employee Share-Based Payment Accounting.


13
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


Cash and Cash Equivalents
 
Cash on hand and investments with original maturities of three months or less (that are readily convertible to cash) are considered to be cash equivalents.
 
Accounts Receivable—net
 
Accounts receivable primarily represent processing revenues earned but not collected. For a majority of its customers, the Company has the authority to debit the client’s bank accounts through the Federal Reserve’s Automated Clearing House; as such, collectibility is reasonably assured. The Company records a reserve for doubtful accounts when it is probable that the accounts receivable will not be collected. The Company reviews historical loss experience and the financial position of its customers when estimating the allowance. As of September 30, 2017 and December 31, 2016, the allowance for doubtful accounts was not material to the Company’s statements of financial position.
 
Customer Incentives
 
Customer incentives represent signing bonuses paid to customers. Customer incentives are paid in connection with the acquisition or renewal of customer contracts, and are therefore deferred and amortized using the straight-line method based on the contractual agreement. Related amortization is recorded as contra-revenue.
 
Property, Equipment and Software—net
 
Property, equipment and software consists of the Company’s facilities, furniture and equipment, software, land and leasehold improvements. These facilities, furniture and equipment and software are depreciated on a straight-line basis over their respective useful lives, which are 15 to 40 years for the Company’s facilities and related improvements, 2 to 10 years for furniture and equipment, 3 to 8 years for software and 3 to 10 years for leasehold improvements or the lesser of the estimated useful life of the improvement or the term of the lease. Also included in property, equipment and software is work in progress consisting of costs associated with software developed for internal use which has not yet been placed in service. Accumulated depreciation as of September 30, 2017 and December 31, 2016 was $379.0 million and $309.7 million, respectively.
 
The Company capitalizes certain costs related to computer software developed for internal use and amortizes such costs on a straight-line basis over an estimated useful life of 5 to 8 years. Research and development costs incurred prior to establishing technological feasibility are charged to operations as such costs are incurred. Once technological feasibility has been established, costs are capitalized until the software is placed in service, at which time the Company begins to amortize such costs over their estimated useful life.
 
Goodwill and Intangible Assets
 
In accordance with ASC 350, Intangibles—Goodwill and Other, the Company tests goodwill for impairment for each reporting unit on an annual basis, or when events occur or circumstances indicate the fair value of a reporting unit is below its carrying value. If the fair value of a reporting unit is less than its carrying value, an impairment loss is recorded to the extent that fair value of the goodwill within the reporting unit is less than its carrying value. The Company performed its most recent annual goodwill impairment test for all reporting units as of July 31, 2017 using market data and discounted cash flow analyses. Based on this analysis, it was determined that the fair value of all reporting units were substantially in excess of the carrying value. There have been no other events or changes in circumstances subsequent to the testing date that would indicate impairment of these reporting units as of September 30, 2017.

Intangible assets consist of acquired customer relationships, trade names, customer portfolios and related assets that are amortized over their estimated useful lives. The Company reviews finite lived intangible assets for possible impairment whenever events or changes in circumstances indicate that carrying amounts may not be recoverable. As of September 30, 2017, there have been no such events or circumstances that would indicate potential impairment of finite lived intangible assets.
 

14
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


Settlement Assets and Obligations
 
Settlement assets and obligations result from Financial Institution Services when funds are transferred from or received by the Company prior to receiving or paying funds to a different entity. This timing difference results in a settlement asset or obligation. The amounts are generally collected or paid the following business day.
 
The settlement assets and obligations recorded by Merchant Services represent intermediary balances due to differences between the amount the Sponsoring Member receives from the card associations and the amount funded to the merchants. Such differences arise from timing differences, interchange expenses, merchant reserves and exception items. In addition, certain card associations limit the Company from accessing or controlling merchant settlement funds and, instead, require that these funds be controlled by the Sponsoring Member. The Company follows a net settlement process whereby, if the settlement received from the card associations precedes the funding obligation to the merchant, the Company temporarily records a corresponding liability. Conversely, if the funding obligation to the merchant precedes the settlement from the card associations, the amount of the net receivable position is recorded by the Company, or in some cases, the Sponsoring Member may cover the position with its own funds in which case a receivable position is not recorded by the Company.
 
Derivatives
 
The Company accounts for derivatives in accordance with ASC 815, Derivatives and Hedging. This guidance establishes accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. All derivatives, whether designated in hedging relationships or not, are required to be recorded on the statement of financial position at fair value. If the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and the hedged item will be recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portion of the change in the fair value of the derivative will be recorded in accumulated other comprehensive income (loss) (“AOCI”) and will be recognized in the statement of income when the hedged item affects earnings. The Company does not enter into derivative financial instruments for speculative purposes.

Tax Receivable Agreements
 
As of September 30, 2017, the Company is party to several TRAs in which the Company agrees to make payments to various parties of 85% of the federal, state, local and foreign income tax benefits realized by the Company as a result of certain tax deductions. Payments under the TRAs will be based on the tax reporting positions of the Company and, generally, are only required to the extent the Company realizes cash savings as a result of the underlying tax attributes. Under the agreement between the Company and Fifth Third dated August 7, 2017, in certain specified circumstances, the Company may be required to make payments in excess of such cash savings. The cash savings realized by the Company are computed by comparing the actual income tax liability of the Company to the amount of such taxes the Company would have been required to pay had there been no deductions related to the tax attributes discussed below. The Company will retain the benefit of the remaining 15% of the cash savings associated with the TRAs. The Company has entered into the following three TRAs:

TRAs with investors prior to the Company’s initial public offering (“IPO”) for its use of NPC Group, Inc. net operating losses (“NOLs”) and other tax attributes existing at the IPO date (the “NPC TRA”), all of which is currently held by Fifth Third.

A TRA with Fifth Third (the “Fifth Third TRA”) in which the Company realizes tax deductions as a result of the increases in tax basis from the purchase of Vantiv Holding units or from the exchange of Vantiv Holding units for cash or shares of Class A common stock, as well as the tax benefits attributable to payments made under such TRAs.

A TRA with Mercury shareholders (the “Mercury TRA”) as part of the acquisition of Mercury as a result of the increase in tax basis of the assets of Mercury resulting from the acquisition and the use of the net operating losses and other tax attributes of Mercury that were acquired as part of the acquisition.

Obligations recorded pursuant to the TRAs are based on estimates of future taxable income and future tax rates. On an annual basis, the Company evaluates the assumptions underlying the TRA obligations.

In connection with the Fifth Third Exchange and share purchase as discussed in Note 6 - Controlling and Non-controlling Interests, the Company recorded a liability of approximately $647.5 million during the quarter ending September 30, 2017 under the tax receivable agreements the Company entered into with Fifth Third Bank at the time of its

15
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


initial public offering. This liability is based on the closing share price of the Company’s Class A common stock on August 4, 2017.     

In 2016, the Company entered into a purchase addendum in connection with the Company’s TRA with Fifth Third (the “Fifth Third TRA Addendum”) to terminate and settle a portion of the Company’s obligations owed to Fifth Third under the Fifth Third TRA and the NPC TRA. Under the terms of the Fifth Third TRA Addendum, the Company paid approximately $116.3 million to Fifth Third to settle approximately $330.7 million of obligations under the Fifth Third TRA, the difference of which was recorded as an addition to paid-in capital, net of deferred taxes.

In addition to the 2016 Fifth Third TRA settlement discussed above, as of September 30, 2017, the Fifth Third TRA Addendum provides that the Company may be obligated to pay up to a total of approximately $123.9 million to Fifth Third to terminate and settle certain remaining obligations under the Fifth Third TRA and the NPC TRA, totaling an estimated $275.8 million, the difference of which will be recorded as an addition to paid-in capital upon the exercise of the Call Options or Put Options discussed below.

In March, June and September 2017, the Company made payments of $15.1 million, $15.6 million, and $16.1 million, respectively, pursuant to the Fifth Third TRA Holders under the terms of the Fifth Third TRA Addendum. These payments resulted in a net gain recorded in equity of approximately $45.3 million after taxes.
    
As of September 30, 2017, the following are the remaining terms of the Fifth Third TRA Addendum. Beginning December 1, 2017, March 1, 2018, June 1, 2018, September 1, 2018 and December 1, 2018, and ending December 10, 2017, March 10, 2018, June 10, 2018, September 10, 2018 and December 10, 2018, respectively, the Company is granted call options (collectively, the “Call Options”) pursuant to which certain additional obligations of the Company under the Fifth Third TRA and the NPC TRA would be terminated and settled in consideration for cash payments of $16.6 million, $25.6 million, $26.4 million, $27.2 million and $28.1 million, respectively.

Under the remaining terms of the Fifth Third TRA Addendum, in the unlikely event the Company does not exercise the relevant Call Option, Fifth Third is granted put options beginning December 20, 2017, March 20, 2018, June 20, 2018, September 20, 2018 and December 20, 2018, and ending December 31, 2017, March 31, 2018, June 30, 2018, September 30, 2018 and December 31, 2018, respectively (collectively, the “Put Options”), pursuant to which certain additional obligations of the Company would be terminated and settled in consideration for cash payments with similar amounts to the Call Options.

The full carrying amount of the Fifth Third callable/puttable TRA obligations for the options exercisable within 12 months of the balance sheet date have been classified as current obligations in the accompanying balance sheet ($216.8 million.)

Since Fifth Third is a significant stockholder, a special committee of the Company’s board of directors comprised of independent, disinterested directors authorized the TRA Addendum. 

During 2015, the Company entered into a Repurchase Addendum to the Mercury Tax Receivable Agreement (the “Mercury TRA Addendum”) with each of the pre-acquisition owners of Mercury ("Mercury TRA Holders"). The Mercury TRA Addendum contains the following provisions to acquire the remaining Mercury TRA:

As of September 30, 2017, the following are the remaining terms under the Mercury TRA Addendum. Beginning December 1st of each of 2017 and 2018, and ending June 30th of 2018 and 2019, respectively, the Company is granted call options (collectively, the "Call Options") pursuant to which certain additional obligations of the Company under the Mercury TRA would be terminated in consideration for cash payments of $38.0 million and $43.0 million, respectively.

In June 2017 and 2016, the Company exercised the December 2016 and December 2015 Call Options under the Mercury TRA Addendum and made the related $38.1 million and $41.4 million payments to the Mercury TRA Holders.

In the unlikely event the Company does not exercise the relevant Call Option, the Mercury TRA Holders are granted put options beginning July 10th and ending July 25th of each of 2018 and 2019, respectively (collectively, the "Put Options"), pursuant to which certain additional obligations of the Company would be terminated in consideration for cash payments with similar amounts to the Call Options.

16
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)



Except to the extent our obligations under the Mercury TRA, the Fifth Third TRA and the NPC TRA have been terminated and settled in full in accordance with the terms of the Mercury TRA and Fifth Third TRA Addendums, the Mercury TRA, Fifth Third TRA and the NPC TRA will each remain in effect, and the parties thereto will continue to have all rights and obligations thereunder.

All TRA obligations are recorded based on the full and undiscounted amount of the expected future payments, except for the Mercury TRA which represents contingent consideration relating to an acquired business, and is recorded at fair value for financial reporting purposes (see Note 8 - Fair Value Measurements).
    
The timing and/or amount of aggregate payments due under the TRAs outside of the call/put structures may vary based on a number of factors, including the amount and timing of the taxable income the Company generates in the future and the tax rate then applicable, the use of loss carryovers and amortizable basis. Payments under the TRAs, if necessary, are required to be made no later than January 5th of the second year immediately following the taxable year in which the obligation occurred. The Company made payments under the TRA obligations of approximately $55.7 million and $53.5 million in January 2017 and January 2016, respectively. Unless settled under the terms of the repurchase addenda, the term of the TRAs will continue until all the underlying tax benefits have been utilized or expired.

New Accounting Pronouncements

In August 2017, the FASB issued Accounting Standards Update (“ASU”) 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, which amends and simplifies existing guidance to better align an entity’s risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. This ASU is effective for the Company in the first quarter of fiscal 2019, with early adoption permitted. The Company is currently evaluating the impact of the adoption of this principle on the Company’s consolidated financial statements.
    
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The update clarifies how cash receipts and cash payments in certain transactions are presented and classified in the statement of cash flows. The effective date of this update is for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017, with early adoption permitted. The update requires retrospective application to all periods presented but may be applied prospectively if retrospective application is impracticable. The Company is currently evaluating the impact of the adoption of this principle on the Company’s consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This ASU amends the existing guidance by recognizing all leases, including operating leases, with a term longer than 12 months on the balance sheet and disclosing key information about the lease arrangements. The effective date of this update is for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted. The update requires modified retrospective transition, which requires application of the ASU at the beginning of the earliest comparative period presented in the year of adoption. The Company is forming a project team to evaluate the impact of the adoption of this principle on the Company’s consolidated financial statements. The Company anticipates adopting this ASU on January 1, 2019.

In May 2014, the FASB issued ASU 2014-09, Revenue From Contracts With Customers. The ASU supersedes the revenue recognition requirements in ASC 605, Revenue Recognition. The new standard provides a five-step analysis of transactions to determine when and how revenue is recognized, based upon the core principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new standard also requires additional disclosures regarding the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The new standard, as amended, is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017, with early adoption permitted. The amendment allows companies to use either a full retrospective or a modified retrospective approach to adopt this ASU. The Company has formed a project team and is currently assessing the impact of the adoption of this principle on the Company’s consolidated financial statements. Based on the Company’s analysis to date, the Company does not anticipate material changes to the amount and timing of its revenue recognition. The Company expects the primary impact to result from the requirement to capitalize and amortize costs to obtain and fulfill a contract, which are currently expensed as incurred. This analysis is subject to change as the Company continues to refine its assessment of the standard. The Company anticipates adopting this ASU on January 1, 2018 using the modified retrospective approach.

17
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


2. BUSINESS COMBINATIONS

Acquisition of Paymetric Holdings, Inc.

On May 25, 2017, the Company completed the acquisition of Paymetric Holdings, Inc. (“Paymetric”) by acquiring 100% of the issued and outstanding shares. Paymetric automates business-to-business payment workflows within enterprise systems and tokenizes payments data within these systems in order to enable secure storage of customer information and history. This acquisition helps to further accelerate the Company’s growth.

The acquisition was accounted for as a business combination under ASC 805, Business Combinations (“ASC 805”). The purchase price was allocated to the assets acquired and the liabilities assumed based on the estimated fair value at the date of acquisition. The excess of the purchase price over the fair value of the net assets acquired was allocated to goodwill, of which approximately $7.8 million is deductible for tax purposes. Goodwill, assigned to Merchant Services, consists primarily of the acquired workforce and growth opportunities, none of which qualify as an intangible asset. The preliminary purchase price allocation is as follows (in thousands):
Cash acquired
$
11,864

Current assets
7,243

Property, equipment and software, net
92,121

Intangible assets
47,800

Goodwill
435,032

Other assets
67

Current liabilities
(17,702
)
Deferred tax liability
(24,492
)
Non-current liabilities
(8,535
)
Total purchase price
$
543,398


The above estimated fair values of assets acquired and liabilities assumed are preliminary and are based on the information that was available as of the reporting date to estimate the fair value of assets acquired and liabilities assumed. The Company believes that the information provides a reasonable basis for estimating the fair values of the acquired assets and assumed liabilities, but the potential for measurement period adjustments exists based on the Company’s continuing review of
matters related to the acquisition. The Company expects to complete the purchase price allocation as soon as practicable, but no later than one year from the acquisition date.

Intangible assets primarily consist of customer relationship assets with a weighted average estimated useful life of 10 years.

The Company incurred transaction expenses of approximately $7.1 million during the nine months ended September 30, 2017 in conjunction with the acquisition of Paymetric, which are included in general and administrative expenses on the accompanying consolidated statement of income. From the acquisition date of May 25, 2017 through September 30, 2017, revenue and net income included in the accompanying statement of income for the three months and nine months ended September 30, 2017 attributable to Paymetric is not material.

Under the terms of the Paymetric transaction agreement, the Company replaced employee stock options held by certain employees of Paymetric. The number of replacement awards was based on options outstanding at the acquisition date. The weighted average fair value of the replacement awards was $8.0 million and was calculated on the acquisition date using the Black-Scholes option pricing model. The portion of the fair value of the replacement awards related to the services provided prior to the acquisition of $5.9 million was part of the consideration transferred to acquire Paymetric. The remaining portion of the fair value is associated with future service and will be recognized as expense over the future service period.

The pro forma results of the Company reflecting the acquisition of Paymetric were not material to our financial results and therefore have not been presented.


18
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


Acquisition of Moneris Solutions, Inc.

On December 21, 2016, the Company completed the acquisition of Moneris Solutions, Inc. (“Moneris USA”) by acquiring 100% of the issued and outstanding shares. Moneris USA is a provider of payment processing solutions offering credit, debit, wireless and online payment services for merchants in virtually every industry segment. This acquisition helps to further accelerate the Company’s growth.

The acquisition was accounted for as a business combination under ASC 805. The purchase price was allocated to the assets acquired and the liabilities assumed based on the estimated fair value at the date of acquisition. The excess of the purchase price over the fair value of the net assets acquired was allocated to goodwill, of which approximately $14.0 million is deductible for tax purposes. Goodwill, assigned to Merchant Services, consists primarily of the acquired workforce and growth opportunities, none of which qualify as an intangible asset. The preliminary purchase price allocation is as follows (in thousands):
Cash acquired
$
22,851

Current assets
44,047

Property and equipment
22

Intangible assets
72,000

Goodwill
378,747

Current liabilities
(65,966
)
Deferred tax liability
(19,192
)
Non-current liabilities
(2,881
)
Total purchase price
$
429,628


The above estimated fair values of assets acquired and liabilities assumed are preliminary and are based on the information that was available as of the reporting date to estimate the fair value of assets acquired and liabilities assumed. The Company believes that the information provides a reasonable basis for estimating the fair values of the acquired assets and assumed liabilities, but the potential for measurement period adjustments exists based on the Company’s continuing review of
matters related to the acquisition. The Company expects to complete the purchase price allocation as soon as practicable, but no later than one year from the acquisition date.

Intangible assets consist of customer relationship assets of $72.0 million with a weighted average estimated useful life of 5 years.

The pro forma results of the Company reflecting the acquisition of Moneris USA were not material to our financial results and therefore have not been presented.

3. GOODWILL AND INTANGIBLE ASSETS

Changes in the carrying amount of goodwill, by business segment, are as follows (in thousands):

 
 
Merchant Services
 
Financial Institution Services
 
Total
Balance as of December 31, 2016
 
$
3,163,739

 
$
574,850

 
$
3,738,589

Goodwill attributable to acquisition of Moneris USA (1)
 
6,686

 

 
6,686

Goodwill attributable to acquisition of Paymetric
 
435,032

 

 
435,032

Balance as of September 30, 2017
 
$
3,605,457

 
$
574,850

 
$
4,180,307

(1) Amount represents adjustments to goodwill associated with the acquisition of Moneris USA as a result of an update to the purchase price allocation, primarily related to revisions of certain estimates from the preliminary amounts reported as of December 31, 2016.

    



19
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


As of September 30, 2017 and December 31, 2016, the Company’s finite lived intangible assets consisted of the following (in thousands):
 
 
September 30, 2017
 
December 31, 2016
Customer relationship intangible assets
 
$
1,712,681

 
$
1,671,581

Customer portfolios and related assets
 
247,935

 
178,480

Patents
 
1,217

 
955

 
 
1,961,833

 
1,851,016

Less accumulated amortization on:
 
 
 
 
  Customer relationship intangible assets
 
1,112,851

 
980,595

  Customer portfolios and related assets
 
116,551

 
82,601

 
 
1,229,402

 
1,063,196

Intangible assets, net
 
$
732,431

 
$
787,820

  
Customer portfolios and related assets acquired during the nine months ended September 30, 2017 have weighted-average amortization periods of 4.8 years. Amortization expense on intangible assets for the three months ended September 30, 2017 and 2016 was $55.2 million and $49.7 million, respectively. Amortization expense on intangible assets for the nine months ended September 30, 2017 and 2016 was $166.5 million and $149.0 million, respectively.

The estimated amortization expense of intangible assets for the remainder of 2017 and the next five years is as follows (in thousands):
Three months ending December 31, 2017
 
$
55,393

2018
 
208,917

2019
 
192,553

2020
 
112,134

2021
 
62,906

2022
 
41,392


4. LONG-TERM DEBT

As of September 30, 2017 and December 31, 2016, the Company’s long-term debt consisted of the following (in thousands): 
 
September 30,
2017
 
December 31,
2016
Term A loan, maturing in October 2021(1)
$
2,376,773

 
$
2,469,375

Term B loan, maturing in October 2023(2)
759,263

 
765,000

Incremental Term B loan, maturing in August 2024(3)
1,270,000

 

Leasehold mortgage, expiring on August 10, 2021(4)
10,131

 
10,131

Revolving credit facility, expiring in October 2021(5)
359,000

 

Less: Current portion of note payable and current portion of note payable to related party
(140,654
)
 
(131,119
)
Less: Original issue discount
(3,197
)
 
(3,631
)
Less: Debt issuance costs
(39,697
)
 
(20,153
)
Note payable and note payable to related party
$
4,591,619

 
$
3,089,603

(1) 
Interest at a variable base rate (LIBOR) plus a spread rate (175 basis points) (total rate of 2.99% at September 30, 2017) and amortizing on a basis of 1.25% per quarter during each of the first twelve quarters (March 2017 through December 2019), 1.875% per quarter during the next four quarters (March 2020 through December 2020) and 2.50% during the next three quarters (March 2021 through September 2021) with a balloon payment due at maturity.
(2) 
Interest at a variable base rate (LIBOR) with a floor of 75 basis points plus a spread rate (250 basis points) (total rate of 3.74% at September 30, 2017) and amortizing on a basis of 0.25% per quarter, with a balloon payment due at maturity.

20
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


(3) 
Interest at a variable base rate (LIBOR) plus a spread rate (225 base points) (total rate of 3.48% at September 30, 2017) and amortizing on a basis of 0.25% per quarter, with a balloon payment due at maturity.
(4) 
Interest payable monthly at a fixed rate of 6.22%.
(5) 
$100 million revolving credit facility borrowing interest at a variable base rate (LIBOR) plus a spread rate (175 basis points) (total rate of 2.95% at September 30, 2017); $259 million revolving credit facility borrowing interest at a variable base rate (Prime) with a spread rate (75 basis points) (total rate of 5.0% at September 30, 2017).

In October, 2016, Vantiv, LLC completed a debt refinancing by entering into a second amended and restated loan agreement (“Second Amended Loan Agreement”). The Second Amended Loan Agreement provided for senior secured credit facilities comprised of an approximately $2.5 billion term A loan, a $765.0 million term B loan and a $650 million revolving credit facility. The maturity date and debt service requirements relating to the term A and term B loans are listed in the table above. The revolving credit facility matures in October 2021 and includes a $100 million swing line facility and a $40 million letter of credit facility. The commitment fee rate for the unused portion of the revolving credit facility is 0.250% (or 0.375% if the total leverage ratio is greater than 3.75 to 1.00) per year.

On August 7, 2017, the Company funded the Fifth Third share purchase discussed in Note 6 - Controlling and Non-controlling Interests, by amending the Second Amended Loan Agreement to permit Vantiv LLC to obtain approximately $1.27 billion of additional seven-year term B loans (the Second Amended Loan Agreement, as so amended, the “Existing Loan Agreement”). As a result of this borrowing, the Company capitalized approximately $23.1 million of deferred financing fees during the three months ended September 30, 2017.
    
There were outstanding borrowings of $359.0 million on the revolving credit facility at September 30, 2017. There were no outstanding borrowings on the revolving credit facility at December 31, 2016.
    
As of September 30, 2017 and December 31, 2016, Fifth Third held $177.7 million and $151.1 million, respectively, of the term A loans and the revolving credit facility, which are presented as note payable to related party on the consolidated statements of financial position.    

Guarantees and Security
 
The Company’s debt obligations at September 30, 2017 are unconditional and are guaranteed by Vantiv Holding and certain of Vantiv Holding’s existing and subsequently acquired or organized domestic subsidiaries. The refinanced debt and related guarantees are secured on a first-priority basis (subject to liens permitted under the Second Amended Loan Agreement) by substantially all the capital stock (subject to a 65% limitation on pledges of capital stock of foreign subsidiaries and domestic holding companies of foreign subsidiaries) and personal property of Vantiv Holding and any obligors as well as any real property in excess of $25 million in the aggregate held by Vantiv Holding or any obligors (other than Vantiv Holding), subject to certain exceptions. 

Covenants
 
There are certain financial and non-financial covenants contained in the Existing Loan Agreement for the refinanced debt, which are tested on a quarterly basis. The financial covenants require maintenance of certain leverage and interest coverage ratios. At September 30, 2017, the Company was in compliance with these financial covenants.


21
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


5. DERIVATIVES AND HEDGING ACTIVITIES
 
Risk Management Objective of Using Derivatives
 
The Company enters into derivative financial instruments to manage differences in the amount, timing and duration of its known or expected cash payments related to its variable-rate debt and the pending Worldpay transaction (see Note 12 - Pending Worldpay Transaction). As of September 30, 2017 and December 31, 2016, the Company’s derivative instruments consisted of interest rate swaps and interest rate cap agreements. Additionally, during the three months ended September 30, 2017, the Company entered into a deal contingent forward, which is a foreign currency forward contract. The interest rate swaps hedge the variable rate debt by converting floating-rate payments to fixed-rate payments. The interest rate cap agreements cap a portion of the Company’s variable rate debt if interest rates rise above the strike rate on the contract. The foreign currency forward serves as an economic hedge of the pound sterling denominated portion of the purchase price relating to the Worldpay acquisition. As of September 30, 2017, the interest rate cap agreements had a fair value of $20.8 million, classified within other current and non-current assets on the Company’s consolidated statements of financial position. The interest rate swaps and caps (collectively “interest rate contracts”) are designated as cash flow hedges for accounting purposes. As of September 30, 2017, the foreign currency forward had a fair value of approximately $24.4 million, classified within other current assets on the Company’s consolidated statements of financial position. The foreign currency forward has not been designated as a hedge for accounting purposes.
 
Accounting for Derivative Instruments
 
The Company recognizes derivatives in other current and non-current assets or liabilities in the accompanying consolidated statements of financial position at their fair values. Refer to Note 8 - Fair Value Measurements for a detailed discussion of the fair value of its derivatives. The Company designates its interest rate contracts as cash flow hedges of forecasted interest rate payments related to its variable-rate debt.
 
The Company formally documents all relationships between hedging instruments and underlying hedged transactions, as well as its risk management objective and strategy for undertaking hedge transactions. This process includes linking all derivatives that are designated as cash flow hedges to forecasted transactions. A formal assessment of hedge effectiveness is performed both at inception of the hedge and on an ongoing basis to determine whether the hedge is highly effective in offsetting changes in cash flows of the underlying hedged item. Hedge effectiveness is assessed using a regression analysis. If it is determined that a derivative ceases to be highly effective during the term of the hedge, the Company will discontinue hedge accounting for such derivative.
 
The Company’s interest rate contracts qualify for hedge accounting under ASC 815, Derivatives and Hedging. Therefore, the effective portion of changes in fair value were recorded in AOCI and will be reclassified into earnings in the same period during which the hedged transactions affect earnings.

Cash Flow Hedges of Interest Rate Risk
 
The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish these objectives, the Company uses a combination of interest rate swaps and caps as part of its interest rate risk management strategy. As of September 30, 2017, the Company had a total of 4 outstanding interest rate swaps covering an exposure period from January 2017 through January 2019 with a combined notional balance of $500.0 million. Fifth Third is counterparty to 2 of the 4 outstanding interest rate swaps with a $250 million notional balance for January 2017 to January 2018 and another $250 million notional balance for January 2018 to January 2019. Additionally, as of September 30, 2017, the Company had a total of 6 interest rate cap agreements with a combined notional balance of $1.0 billion, cap strike rate of 0.75%, covering an exposure period from January 2017 to January 2020.
 

22
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


The Company does not offset derivative positions in the accompanying consolidated financial statements. The table below presents the fair value of the Company’s derivative financial instruments designated as cash flow hedges included within the accompanying consolidated statements of financial position (in thousands):
 
Consolidated Statement of
Financial Position Location
 
September 30, 2017
 
December 31, 2016
Interest rate contracts
Other current assets
 
$
6,829

 
$
2,144

Interest rate contracts
Other long-term assets
 
13,934

 
21,085

Interest rate contracts
Other current liabilities
 
5,006

 
9,551

Interest rate contracts
Other long-term liabilities
 
1,479

 
5,507

 
Any ineffectiveness associated with such derivative instruments will be recorded immediately as interest expense in the accompanying consolidated statements of income. As of September 30, 2017, the Company estimates that $4.5 million will be reclassified from accumulated other comprehensive income as an increase to interest expense during the next 12 months.

The table below presents the pre-tax effect of the Company’s interest rate contracts on the accompanying consolidated statements of comprehensive income for the three and nine months ended September 30, 2017 and 2016 (in thousands): 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
2017
 
2016
Derivatives in cash flow hedging relationships:
 
 
 
 
 
 
 
 
Amount of gain (loss) recognized in OCI (effective portion) (1)
 
$
306

 
$
1,247

 
$
55

 
$
(22,964
)
Amount of (loss) reclassified from accumulated OCI into earnings (effective portion)
 
(1,057
)
 
(3,923
)
 
(8,377
)
 
(9,010
)
(1) 
“OCI” represents other comprehensive income.

Credit Risk Related Contingent Features

As of September 30, 2017, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $6.8 million.

The Company has agreements with each of its derivative counterparties that contain a provision where if the Company defaults on any of its indebtedness, then the Company could also be declared in default on its derivative obligations. As of September 30, 2017, the Company had not posted any collateral related to these agreements. If the Company had breached any of these provisions at September 30, 2017, it could have been required to settle its obligations under the agreements at their termination value of $6.8 million.

Deal Contingent Forward

On August 9, 2017, the Company entered into a 1.150 billion Pounds Sterling notional deal contingent forward to hedge a portion of the purchase price relating to the pending Worldpay acquisition (see Note 12 - Pending Worldpay Transaction). The deal contingent forward runs through March 31, 2018 and the change in fair value is reported in non-operating income (expense) in the Company’s Unaudited Consolidated Statements of Income, which is an unrealized gain of approximately $24.4 million for the three months and nine months ended September 30, 2017.

6. CONTROLLING AND NON-CONTROLLING INTERESTS
 
The Company has various non-controlling interests that are accounted for in accordance with ASC 810, Consolidation (“ASC 810”). As discussed in Note 1 - Basis of Presentation and Summary of Significant Accounting Policies, Vantiv, Inc. owns a controlling interest in Vantiv Holding, and therefore consolidates the financial results of Vantiv Holding and its subsidiaries and records non-controlling interest for the economic interests in Vantiv Holding held by Fifth Third. The Exchange Agreement entered into prior to the IPO provides for a 1 to 1 ratio between the units of Vantiv Holding and the common stock of Vantiv, Inc.
 

23
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


In May 2014, the Company entered into a joint venture with a bank partner which provides customers a comprehensive suite of payment solutions. Vantiv Holding owns 51% and the bank partner owns 49% of the joint venture. The joint venture is consolidated by the Company in accordance with ASC 810, with the associated non-controlling interest included in “Net income attributable to non-controlling interests” in the consolidated statements of income.

As of September 30, 2017, Vantiv, Inc.’s interest in Vantiv Holding was 91.42%. Changes in units and related ownership interest in Vantiv Holding are summarized as follows:
 
Vantiv, Inc.
 
Fifth Third
 
Total
As of December 31, 2016
161,134,831

 
35,042,826

 
196,177,657

% of ownership
82.14
%
 
17.86
%
 
 

Fifth Third exchange of Vantiv Holding units for shares of Class A common stock
19,790,000

 
(19,790,000
)
 

Purchase and cancellation of Class A common stock
(19,790,000
)
 

 
(19,790,000
)
Equity plan activity (1)
1,371,799

 

 
1,371,799

As of September 30, 2017
162,506,630

 
15,252,826

 
177,759,456

% of ownership
91.42
%
 
8.58
%
 


(1) 
Includes stock issued under the equity plans net of Class A common stock withheld to satisfy employee tax withholding obligations upon vesting or exercise of employee equity awards and forfeitures of restricted Class A common stock awards.

On August 7, 2017, the Company entered into a transaction agreement with Fifth Third Bank pursuant to which Fifth Third Bank agreed to exercise its right to exchange 19,790,000 Class B Units in Vantiv Holding, LLC for 19,790,000 shares of the Company’s Class A common stock and immediately thereafter, the Company purchased those newly issued shares of Class A common stock directly from Fifth Third Bank at a price of $64.04 per share, the closing share price of the Company’s Class A common stock on the New York Stock Exchange on August 4, 2017. The purchased shares were cancelled and are no longer outstanding.

As a result of changes in ownership interests in Vantiv Holding, periodic adjustments are made in order to reflect the portion of net assets of Vantiv Holding attributable to non-controlling unit holders based on changes in the proportionate ownership interests in Vantiv Holding during a period.
 
The table below provides a reconciliation of net income attributable to non-controlling interests based on relative ownership interests as discussed above (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net income
$
106,905

 
$
87,004

 
$
229,060

 
$
217,913

Items not allocable to non-controlling interests:
 
 
 
 
 

 
 

Vantiv, Inc. expenses (1)
14,219

 
23,628

 
25,095

 
58,019

Vantiv Holding net income
$
121,124

 
$
110,632

 
$
254,155

 
$
275,932

 
 
 
 
 
 
 
 
Net income attributable to non-controlling interests of Fifth Third (2)
$
14,092

 
$
20,155

 
$
37,549

 
$
50,082

Net income attributable to joint venture non-controlling interest (3)
695

 
553

 
1,731

 
2,470

Total net income attributable to non-controlling interests
$
14,787

 
$
20,708

 
$
39,280

 
$
52,552

 
(1)       Primarily represents income tax expense related to Vantiv, Inc.
(2)       Net income attributable to non-controlling interests of Fifth Third reflects the allocation of Vantiv Holding’s net income based on the proportionate ownership interests in Vantiv Holding held by the non-controlling unit holders. The net income attributable to non-controlling unit holders reflects the changes in ownership interests summarized in the table above.
(3)  
Reflects net income attributable to the non-controlling interest of the joint venture.


24
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


7. COMMITMENTS, CONTINGENCIES AND GUARANTEES

Legal Reserve
 
From time to time, the Company is involved in various litigation matters arising in the ordinary course of its business. While it is impossible to ascertain the ultimate resolution or range of financial liability with respect to these contingent matters, management believes none of these matters, either individually or in the aggregate, would have a material effect upon the Company’s consolidated financial statements, except as described below.

On April 17, 2017, the Company entered into a preliminary settlement agreement (the “Agreement”) to settle class action litigation filed by plaintiffs in the United States District Court for the Northern District of Georgia (the “Court”) under the caption Champs Sports Bar & Grill Co.et al. v. Mercury Payment Systems, LLC et al. regarding certain legacy business practices of the defendants, Mercury Payment Systems, LLC (“Mercury”) and Global Payments Direct, Inc., dating back to 2009. The Company acquired Mercury on June 13, 2014.

The Company has agreed to settle the lawsuit after engaging in a successful mediation session occurring on February 16, 2017, at which the parties first identified the potential for resolution, and subsequent negotiations between the parties. The parties agreed to such mediation session after a previous mediation session held in December 2016 ended without a potential path toward resolution.

Under the terms of the Agreement, in exchange for a release from all claims relating to such legacy business practices from the beginning of the applicable settlement class period through the date of preliminary approval of the settlement, the Company anticipates paying $38 million based on the estimated number of participants who opt-in to the settlement.
    
While the agreement contains no admission of wrongdoing and the Company believes it has meritorious defenses to the claims, the Company agreed to the structure of the settlement, in order to save costs and avoid the risks of on-going litigation.

In connection with the settlement, the Company recorded a charge of $38 million in the first quarter of 2017. The Company will pay the settlement amount from available resources.

On May 16, 2017, the Court determined the proposed Agreement satisfied the criteria for preliminary approval and issued a preliminary approval order. Pursuant to the terms of the Agreement, the preliminary approval order required that the Company fund an escrow account to pay all future class action claims, legal fees and administrative fees. The Company funded such account on July 5, 2017.

On August 29, 2017, a final approval hearing took place and the Agreement was approved.

8. FAIR VALUE MEASUREMENTS

     Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The Company uses the hierarchy prescribed in ASC 820, Fair Value Measurement (“ASC 820”), based upon the available inputs to the valuation and the degree to which they are observable or not observable in the market. The three levels in the hierarchy are as follows:
 
Level 1 Inputs—Quoted prices (unadjusted) for identical assets or liabilities in active markets that are accessible as of the measurement date.
 
Level 2 Inputs—Inputs other than quoted prices within Level 1 that are observable either directly or indirectly, including but not limited to quoted prices in markets that are not active, quoted prices in active markets for similar assets or liabilities and observable inputs other than quoted prices such as interest rates or yield curves.
 
Level 3 Inputs—Unobservable inputs reflecting the Company’s own assumptions about the assumptions that market participants would use in pricing the asset or liability, including assumptions about risk.

25
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)



The following table summarizes assets and liabilities measured at fair value on a recurring basis as of September 30, 2017 and December 31, 2016 (in thousands):
 
September 30, 2017
 
December 31, 2016
 
Fair Value Measurements Using
 
Level 1
 
Level 2
 
Level 3
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
 
 
 
 
Interest rate contracts
$

 
$
20,763

 
$

 
$

 
$
23,229

 
$

  Deal contingent forward

 
24,365

 

 

 



Liabilities:
 

 
 

 
 

 
 

 
 

 
 

Interest rate contracts
$

 
$
6,485

 
$

 
$

 
$
15,058

 
$

  Mercury TRA

 

 
97,308

 

 

 
147,040

 
Interest Rate Contracts
 
The Company uses interest rate contracts to manage interest rate risk. The fair value of interest rate swaps is determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on the expectation of future interest rates (forward curves) derived from observed market interest rate curves. The fair value of the interest rate caps is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected future cash flows of each interest rate cap. This analysis reflects the contractual terms of the interest rate caps, including the period to maturity, and uses observable market inputs including interest rate curves and implied volatilities. In addition, to comply with the provisions of ASC 820, credit valuation adjustments, which consider the impact of any credit enhancements to the contracts, are incorporated in the fair values to account for potential nonperformance risk. In adjusting the fair value of its interest rate contracts for the effect of nonperformance risk, the Company has considered any applicable credit enhancements such as collateral postings, thresholds, mutual puts, and guarantees.
 
Although the Company determined that the majority of the inputs used to value its interest rate contracts fell within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its interest rate contracts utilized Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of September 30, 2017 and December 31, 2016, the Company assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its interest rate contracts and determined that the credit valuation adjustment was not significant to the overall valuation of its interest rate contracts. As a result, the Company classified its interest rate contract valuations in Level 2 of the fair value hierarchy. See Note 5 - Derivatives and Hedging Activities for further discussion of the Company’s interest rate contracts.

Deal Contingent Forward

The Company uses a foreign currency contract to manage its foreign currency exposure relating to the pending Worldpay transaction (see Note 12 - Pending Worldpay Transaction). The fair value of the foreign currency forward is determined using the market standard methodology of discounting the projected settlement value of the instrument. The projected settlement value is based on the expectation of future foreign currency rates derived from observed market interest rate curves. In addition, to comply with the provisions of ASC 820, credit valuation adjustments are incorporated in the fair values to account for potential nonperformance risk. In adjusting the fair value of its foreign currency forward contract for the effect of nonperformance risk, the Company has considered any applicable credit enhancements such as collateral postings, thresholds, mutual puts, and guarantees.
 
Although the Company determined that the majority of the inputs used to value its foreign currency contract fell within Level 2 of the fair value hierarchy, certain Level 3 inputs were utilized, including the probability of successfully closing the Worldpay merger and certain other estimates required to compute the credit valuation analysis, such as the estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of September 30, 2017, the Company assessed the significance of the impact of the Level 3 inputs on the overall valuation of its foreign currency contract and determined that those inputs were in the aggregate not significant to the overall valuation of its foreign currency contract. As a result, the Company classified its foreign currency contract valuation in Level 2 of the fair value hierarchy. See Note 5 - Derivatives and Hedging Activities for further discussion of the Company’s foreign currency contract.


26
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


Mercury TRA

The Mercury TRA is considered contingent consideration as it is part of the consideration payable to the former owners of Mercury. Such contingent consideration is measured at fair value and is based on significant inputs not observable in the market, which is classified in Level 3 of the fair value hierarchy. The Mercury TRA is recorded at fair value based on estimates of discounted future cash flows associated with the estimated payments to the Mercury TRA Holders. The significant unobservable input used in the fair value measurement of the Mercury TRA is the discount rate, which was approximately 14% as of September 30, 2017 and December 31, 2016. Any significant increase (decrease) in this input would result in a significantly lower (higher) fair value measurement. The liability recorded is re-measured at fair value at each reporting period with the change in fair value recognized in earnings as a non-operating expense. The change in value of the Mercury TRA from December 31, 2016 to September 30, 2017 consists of the increase in fair value of $10.7 million and the decrease from payments of $60.5 million related to the Mercury TRA obligations and the exercised 2016 Call Option. The Company recorded non-operating expenses of $3.1 million and $4.6 million related to the change in fair value during the three months ended September 30, 2017 and 2016, respectively. The Company recorded non-operating expenses of $10.7 million and $14.9 million related to the change in fair value during the nine months ended September 30, 2017 and 2016, respectively.

The following table summarizes carrying amounts and estimated fair values for the Company’s financial instrument liabilities that are not reported at fair value in our consolidated statements of financial position as of September 30, 2017 and December 31, 2016 (in thousands):
 
September 30, 2017
 
December 31, 2016
 
Carrying Amount
 
Fair Value
 
Carrying Amount
 
Fair Value
Liabilities:
 

 
 

 
 

 
 

Note payable
$
4,732,273

 
$
4,785,387

 
$
3,220,722

 
$
3,250,025

 
We consider that the carrying value of cash and cash equivalents, receivables, accounts payable and accrued expenses approximates fair value (level 1) given the short-term nature of these items. The fair value of the Company’s note payable was estimated based on rates currently available to the Company for bank loans with similar terms and maturities and is classified in Level 2 of the fair value hierarchy.

9.  NET INCOME PER SHARE
 
Basic net income per share is calculated by dividing net income attributable to Vantiv, Inc. by the weighted-average shares of Class A common stock outstanding during the period.

Diluted net income per share is calculated assuming that Vantiv Holding is a wholly-owned subsidiary of Vantiv, Inc., therefore eliminating the impact of Fifth Third’s non-controlling interest. Pursuant to the Exchange Agreement, the Class B units of Vantiv Holding (“Class B units”), which are held by Fifth Third and represent the non-controlling interest in Vantiv Holding, are convertible into shares of Class A common stock on a one-for-one basis. Based on this conversion feature, diluted net income per share is calculated assuming the conversion of the Class B units on an “if-converted” basis. Due to the Company’s structure as a C corporation and Vantiv Holding’s structure as a pass-through entity for tax purposes, the numerator in the calculation of diluted net income per share is adjusted accordingly to reflect the Company’s income tax expense assuming the conversion of the Fifth Third non-controlling interest into Class A common stock.

During the three months and nine months ended September 30, 2017, approximately 23.6 million and 31.2 million weighted-average Class B units of Vantiv Holding were excluded in computing diluted net income per share because including them would have an antidilutive effect. As the Class B units of Vantiv Holding were not included, the numerator used in the calculation of diluted net income per share was equal to the numerator used in the calculation of basic net income per share for the three months and nine months ended September 30, 2017. As of September 30, 2017 and 2016, there were approximately 15.3 million and 35.0 million Class B units outstanding, respectively.
 
In addition to the Class B units discussed above, potentially dilutive securities during the three and nine months ended September 30, 2017 included restricted stock awards, restricted stock units, stock options, performance share awards and ESPP purchase rights. Potentially dilutive securities during the three and nine months ended September 30, 2016 included restricted stock awards, restricted stock units, the warrant held by Fifth Third which allows for the purchase of Class C units of Vantiv Holding, stock options and ESPP purchase rights.


27
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


The shares of Class B common stock do not share in the earnings or losses of the Company and are therefore not participating securities. Accordingly, basic and diluted net income per share of Class B common stock have not been presented.
 
The following table sets forth the computation of basic and diluted net income per share (in thousands, except share data): 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Basic:
 
 
 
 
 
 
 

Net income attributable to Vantiv, Inc.
$
92,118

 
$
66,296

 
$
189,780

 
$
165,361

Shares used in computing basic net income per share:


 


 
0

 
 
Weighted-average Class A common shares
161,465,849

 
155,740,660

 
161,205,066

 
155,603,265

Basic net income per share
$
0.57

 
$
0.43

 
$
1.18

 
$
1.06

Diluted:
 
 
 
 


 
 
Consolidated income before applicable income taxes
$

 
$
126,328

 
$

 
$
319,504

Income tax expense excluding impact of non-controlling interest

 
45,478

 

 
115,021

Net income attributable to Vantiv, Inc.
$
92,118

 
$
80,850

 
$
189,780

 
$
204,483

Shares used in computing diluted net income per share:


 
 
 


 
 
Weighted-average Class A common shares
161,465,849

 
155,740,660

 
161,205,066

 
155,603,265

Weighted-average Class B units of Vantiv Holding

 
35,042,826

 

 
35,042,826

Warrant

 
5,550,050

 

 
5,428,637

Stock options
739,835

 
506,635

 
706,632

 
547,640

Restricted stock awards, restricted stock units and employee stock purchase plan
645,508

 
501,998

 
664,275

 
504,203

Performance awards
31,204

 

 
41,809

 

Diluted weighted-average shares outstanding
162,882,396

 
197,342,169

 
162,617,782

 
197,126,571

Diluted net income per share
$
0.57

 
$
0.41

 
$
1.17

 
$
1.04


28
 
 
 

Vantiv, Inc.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (continued)


10. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
 
The activity of the components of accumulated other comprehensive income (loss) related to cash flow hedging and other activities for the three and nine months ended September 30, 2017 and 2016 is presented below (in thousands):
 
 
 
 
Total Other Comprehensive Income (Loss)
 
 
 
 
 AOCI Beginning Balance
 
Pretax Activity
 
Tax Effect
 
 Net Activity
 
Attributable to non-controlling interests
 
Attributable to Vantiv, Inc.
 
AOCI Ending Balance
Three Months Ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Net change in fair value recorded in accumulated OCI
 
$
(17,942
)
 
$
306

 
$
(186
)
 
$
120

 
$
184

 
$
304

 
$
(17,638
)
 Net realized loss reclassified into earnings (a)
 
15,366

 
1,057

 
(366
)
 
691

 
(90
)
 
601

 
15,967

 Net change
 
$
(2,576
)
 
$
1,363

 
$
(552
)
 
$
811

 
$
94

 
$
905

 
$
(1,671
)