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Executives

Barbara Gasper – Investor Relations

Robert W. Selander – President & Chief Executive Officer

Martina Hund-Mejean – Chief Financial Officer

Melissa Ballinger – Corporate Controller

Analysts

Andrew Jeffrey – SunTrust Robinson Humphrey

Moshe Katri – Cowen and Co.

Craig Maurer – Calyon Securities

Anurag Rana – Keybank Capital Markets

Tien-Tsin Huang – JP Morgan

James Kissane – Bank of America/Merrill Lynch

Jason Kupferberg - UBS

MasterCard Incorporated (MA) Q1 2009 Earnings Call May 1, 2009 9:00 AM ET

Operator

Welcome to the first quarter 2009 MasterCard earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Ms. Barbara Gasper, Group Executive of Investor Relations. Please proceed.

Barbara Gasper

Good morning and thank you all for joining us today either by phone or web cast for a discussion about our first quarter 2009 financial results. With me on the call this morning are Bob Selander, President and Chief Executive Officer; Martina Hund-Mejean, our Chief Financial Officer and Melissa Ballinger, our Corporate Controller. Following comments from Bob and Martina highlighting some key points about the quarter we will open up the call for your questions.

This morning’s earnings release and the slide deck that will be referenced on this call can be found in the Investor Relations section of our website www.MasterCard.com. The earnings release and slide decks have also been attached to an 8K that we filed with the SEC earlier this morning. A replay of this call will be posted on our website for one week until May 9th.

Finally as set forth in more detail in today’s earnings release, I need to remind everyone that today’s call may include some forward-looking statements about MasterCard's future performance. Actual performance could differ materially from what is suggested by our comments today. Information about the factors that could affect future performance are summarized at the end of our press release as well as contained in our recent SEC filings.

With that I will now to turn the call over to Bob Selander.

Robert Selander

Thanks Barbara. Good morning everyone. Despite the economic realities that we face today this has been a solid quarter for MasterCard. Our volumes have been impacted by significant headwinds such as slower cross-border travel, lower gas prices and an appreciating dollar. But our business model remains resilient and we continue to benefit from the secular shift from cash and checks to electronic payments.

Our focus remains on ensuring that MasterCard is well positioned for long-term growth. Our resources and operations are aligned to support our customers as they look to reprioritize their business strategies and we are prepared to take advantage of any opportunities as they arise.

While our net revenues for the quarter declined 2.2% on an as reported basis, net revenue grew 1.8% on a constant currency basis. In light of the softening top line contribution I am pleased to report that we have taken considerable cost reduction actions to deliver a strong operating margin of 48.6%, an improvement of 5 percentage points over the first quarter of 2008 and the highest quarterly margin to date that we have recorded as a public company.

Now if you could just turn to slide two, let me spend a couple of moments on the economic situation and a little bit on a business update. As I have stated before, we don’t believe there is any reason to assume the economic slowdown across the world will improve for the balance of this year. However, our business model and global diversity continue to provide a good degree of resilience as we navigate through the current environment. As we look at a number of economic indicators important to our business we still face challenges around unemployment, retail sales and the state of the travel industry.

The U.S. official unemployment rate increased in March versus February of this year to 8.5%. It is reasonable to think this trend will likely not plateau until some in 2010. It is going to take awhile for the economic stimulus to make an impact on the wider U.S. economy and restore confidence for both business and consumer spending to return to rates of growth again.

Likewise, the unemployment rate in the Euro area reached 8.5% through the end of February and we expect this number to rise over the remainder of the year before stabilizing.

Turning to the latest MasterCard spending pulse data for the U.S. retail sector, in general the year-over-year comparisons continue to show large declines but the pace of the contraction appears to be stabilizing.

Total retail sales excluding autos and gasoline showed a year-over-year decline of 2.5% in March. This is fairly comparable to the 2.3% decline in February. However, certain industries contracted significantly with furniture and furnishings down almost 24%, electronics and appliances down 27% and apparel down 23%.

In addition, some of the industry figures are negatively impacted by bankruptcies and store closings such as Circuit City in the electronic and appliance category and Linens and Things in the furniture and furnishings sector. U.S. travel is continuing to deteriorate with historically low year-over-year comparisons and lodging. U.S. airlines posted their third consecutive double digit sales decline, decreasing by 17.4%. IATA, the International Air Transport Association, has noted that while global passenger travel has fallen less precipitously compared to freight and shipments, it expects passenger volumes to be down 5.7% for the year.

While the rate of decline in airline sales has slowed, lodging continued to deteriorate and is down 23% in March versus a year ago. Gasoline sales are down significantly due entirely to the 40% year-over-year decline in gas prices. But pumping is recovering to show consistent year-over-year gains for the past two months.

There are some bright spots. The Confidence Board reported earlier this week that U.S. consumer confidence jumped from 26.9% in March to 39.2% in April which is a higher gain than economists were forecasting. Central bankers continue to respond to the crisis by injecting liquidity to ease credit and monetary conditions.

Finally, many governments continue to provide various forms of stimulus into their economies and their banking systems. We think this is an important foundation upon which consumer confidence will be built in future quarters.

Turning to some of our most recent business trends, when we look at MasterCard processed volumes and transactions through the first four weeks of April we saw the following. Cross border volumes reversed the declining trend we saw in the first three months of this year and stabilized at about flat. Clearly it is too early to estimate what impact the current flu crisis could have on cross-border travel. Going back to early 2003 there was an impact on our Asia Pacific business from SARS for a period of about 6-8 weeks. However, SARS had no material impact on MasterCard’s overall financials.

U.S. processed volume continued to decline at a slightly higher rate than what we saw in the first quarter which we believe is primarily due to current lower gas prices relative to April of last year. We need a few more weeks of data to better assess whether there are persistent, underlying signs of stabilization.

Process volumes for the rest of the world are still growing albeit at a lower rate than in the first quarter. Processed transactions continued to grow in the 7-8% range, a slightly faster pace compared to the first quarter of 2009, driven by more transactions in the United States relative to what we saw in the first quarter.

Moving on to the regulatory front, as many of you are aware we reached an interim arrangement with the European Commission about a month ago regarding our intra-regional, cross-border consumer interchange fees for the European economic area. We are pleased that the Commission has recognized the legitimacy of interchange fees and opened four party payment systems, but we still consider these levels of interchange too low. As you know, cross-border transactions count for less than 5% of our European volumes. We are continuing our appeal in the Court of First Instance against the Commission’s December 2007 decision.

This interim arrangement creates more clarity for the market and for SEPA allowing us to focus on our customers and to provide solutions that benefit the millions of European cardholders and merchants who rely on our cards and services. As they have publicly indicated, we expect the Commission will ensure a level playing field for all four party payment operators across the European payments market.

I will now turn the call over to Martina for a detailed update on our financial results and operational metrics. Martina?

Martina Hund-Mejean

Thanks Bob. Good morning everyone. Let me begin on page three of the deck. As Bob mentioned we delivered another solid quarter despite considerable headwinds. First quarter net revenues of $1.2 billion declined 2.2% over the comparable period last year. This decline was primarily driven by the unfavorable impact of foreign exchange and higher rebates and incentives, partially offset by pricing, increased processed transactions and increases in other payment related services. Adjusting for the exchange fluctuations of the Euro and the Brazilian Real against the Dollar of four percentage points, net revenue grew 1.8% for the quarter on a constant currency basis.

The real bright spot is the work we have been doing on operating expenses which decreased 10.8% for the quarter. Foreign exchange contributed 2.9 percentage points to the decline. Our operating income was $561 million. While the slowdown of both the financial markets and the global economy has impacted our top line growth, we are seeing the results of our cost containment initiatives in the quarter resulting in MasterCard receiving a strong quarterly operating margin of 48.6%. This represents a five percentage point improvement over last year’s first quarter.

During the first quarter of 2009 we delivered net income of $360 million or $2.80 per diluted share. You might recall that during the first quarter of 2008 the company recorded gains from the sale of our remaining investment in RediCard which accounted for $56 million in net income or $0.42 of EPS. Without the impact of RediCard and excluding special items, first quarter EPS was $2.58 per share.

Therefore, on a constant currency basis, excluding the impact of both RediCard and special items we actually delivered net income growth of 13.8% versus last year’s first quarter.

I would also like to point out as we discussed in our last 10K filing, the company has applied the requirement of a new FASB provision related to unvested share based payment awards effective with the beginning of 2009. This has resulted in minor retroactive adjustments of earnings per share from prior periods which you may want to take into account for modeling purposes.

Turning to page four, during the first quarter the global diversification of our business continued to help us weather the cyclic downturn in the U.S. where the year-over-year decline in a number of our business drivers is most evident. Our business continues to generate healthy transactions and volumes on a local currency basis from economies outside of the United States. The secular shift from cash to electronic payment forms continues to provide strong growth opportunities as we see worldwide processed transactions and new card issuances increasing.

Worldwide gross dollar volume (GDV) was essentially flat at 0.3% on a local currency basis in the first quarter and declined 9.7% on a U.S. dollar converted basis to $550 billion. The deceleration in the overall local currency growth rate can be attributed to the U.S. where GDV growth declined 8% due to a double digit decline in credit. Across all other regions, GDV continued to grow at 7.7% on a local currency basis. However, that is a much slower pace than what we have seen either on a year-over-year or sequential basis.

GDV growth rates outside of the U.S. are lower on a U.S. dollar basis due to the strength of the U.S. dollar against most other currencies during the first quarter. Worldwide debit GDV grew 10.7% for the quarter. This compares to about 17.8% growth in worldwide debit in the first quarter of last year but is more in line with the growth on a sequential basis. In the U.S. debit GDV volume grew at 5.6%.

On a local currency basis, worldwide purchase volume was also relatively flat at 0.3%. Similar to the GDV trend, U.S. purchase volume declined 7.1% for the quarter driven by a decline in credit volumes. The decline in gas prices on a year-over-year basis accounted for approximately 40% of the decline in U.S. purchase volumes.

Growth of volumes were down 0.7% on a local currency basis or approximately 14% on a U.S. dollar converted basis. This was primarily driven by declines in the mid-teen’s for U.S. cross-border volumes. We saw a deceleration of growth in every other region but only in Latin America did we see volumes decline. Globally, cross-border transactions continued to grow in the mid single digits for the quarter.

Specifically for the U.S. while cross-border volumes declined, transaction growth was flat. From an acquiring perspective, travelers coming to the U.S. did spend less compared to the same period last year.

Looking now to processed transactions, they increased 5.8% compared with the year-ago quarter to $5.1 billion in the first quarter. In the U.S. and Europe, processed transactions grew at a mid single digit rate on both a sequential and year-over-year basis. In Asia Pacific, Middle East, Africa and the Latin American and Caribbean regions, processed transactions grew at double digit rates.

The number of MasterCard branded cards worldwide grew 4% to 967 million in the quarter and excluding the U.S. the rest of the world card issuance grew 12.1%. The majority of this growth was principally driven by the issuance of MasterCard debit and prepaid cards. As of March 31, 2009 there are approximately 1.6 billion MasterCard and Maestro branded cards issued.

Now let’s turn to page five. Early in April we announced that we were modifying our external presentation of our major revenue categories to better align with how management views the drivers of our business. Beginning this quarter we are reporting four major growth revenue categories; domestic assessments, cross-border volume fees, transaction processing fees and other revenue. We are also reporting one combined contra-revenue line for all rebates and incentives.

Historical information regarding the modified presentation of revenues is available on the IR section of MasterCard.com.

As we mentioned before, net revenue declined 2.2% on an as reported basis but grew 1.8% on a constant currency basis. Pricing contributed 4 percentage points to net revenue. Domestic assessment decreased 2.1% from the prior year primarily due to the impact of converting local currency volumes to the strengthening functional currencies which are used to calculate revenues. This was evidenced by GDV growth being flat on a local currency basis but declining 9.7% on a U.S. dollar basis compared to the prior year’s period. New pricing introduced in Europe in October 2008 partially offset the decrease.

Cross-border volume fees decreased by 11.3% versus Q1 2008. While cross-border volumes were essentially flat on a local currency basis, the declined by 14% on a U.S. dollar basis which impacted this revenue line. Increased European pricing partially offset the decrease.

Transaction processing fees increased 7.1% compared to the prior period primarily due to a 5.8% increase in processed transactions and other revenues such as foreign exchange gains on settlement activities. This increase was partially offset foreign exchange [inflation]. Other revenues increased 11.6% due to the increased user-pay fees such as our concierge cardholder services.

While there was some tempering in rebates and incentives due to lower volumes, this line item increased 6.6% primarily as a result of new and renewed deals as well as the favorable impact on rebates and incentives in the first quarter of last year when certain customer incentives were not paid out as a result of performance hurdles not being met.

Now we will turn to page six for some detail on expenses. We continued implementing a number of expense management measures as part of our commitment to a flat expense structure this year. During the first quarter total operating expenses decreased 10.8% despite taking a $19 million severance charge. Currency fluctuations of 2.9 percentage points contributed to the decline. Therefore, total operating expenses decreased 7.9% on a constant currency basis.

The decrease was mainly driven by the following. General and administrative expenses decreased 3% with currency fluctuations representing approximately 2.6 percentage points. On a constant currency basis G&A decreased 0.4%. The decrease was due to the following: Travel expenses decreased approximately 64% or $16 million on a year-over-year basis as a result of continuing cost reduction initiatives and professional fees declined by approximately 39% or $29 million during the quarter due to a significant reduction in legal costs and consulting expenses. Personnel costs for the quarter grew 1% due to a $19 million severance charge. Excluding the severance charges personnel costs declined 5.1%.

Now let’s turn to advertising and marketing spend which decreased by 35.4% versus the year-ago quarter as core marketing activities, priceless advertising and other media investments were scaled back in response to current market conditions and in keeping with our overall cost containment efforts. Additionally, MasterCard was able to take advantage of reduced media rates in certain countries. At the same time, we often obtained more prominent placement and coverage over the quarter. Approximately 3 percentage points of the decline related to the impact of foreign currency fluctuations.

Let’s move to the cash flow statement and balance sheet highlights on page seven. We generated $416 million in cash from operations and ended the quarter with cash and cash equivalents and current investments of $2.3 billion. During the quarter MasterCard acquired a 33% interest in a joint venture with a core in France which will augment our private label capabilities. We also increased our investment in Strategic Payment Services, an Australian processing entity. We now hold a controlling interest in this entity.

Turning to page eight, the economic slowdown around the world continues to prove challenging for both us and our customers and we see no reason to change our short-term view of no improvement until 2010. From a revenue standpoint in 2009 we expect to fall below our minimum average annual growth rate performance objective of 12% on a constant currency basis due to lower volume growth. As you know, as part of our interim arrangement with the European Commission, some of the European pricing actions that took place in October 2008 representing about half of this quarter’s pricing contribution to revenues will be repealed on July 1 and will impact both the growth assessment and cross-border volume revenue lines.

With this repeal and other pricing actions implemented in April we currently expect to see at least 400 basis points in top line growth coming from pricing this year. Given the relative weakness on top line we have increased our scrutiny around managing expenses even more tightly. When looking at full-year 2009 we now expect to deliver flat to slightly down total operating expenses even when factoring in all potential severance charges for 2009.

We have not yet completed all of our work around right sizing following our reorganization back in January so while we are not able to give you a total anticipated amount of severance for the full year we do expect to record additional severance charges well in excess of the $19 million we took in the first quarter. We also expect the quarterly rate of depreciation to pick up slightly from the $31 million level we saw in Q1.

With respect to A&M spend, advertising and marketing expense, we expect full year 2009 to fall below full-year 2008 on both an as reported and constant currency basis. In terms of this year’s quarterly cadence of the spend, I would expect all three remaining quarters to be significantly higher than the $116 million we recorded in Q1 for advertising and marketing expenses.

We will continue to evaluate whether to make further adjustments to our expense structure keeping in mind our intention to invest wisely to protect future growth opportunities. We remain committed to our longer term performance objectives and do not intend to jeopardize them in order to deliver short-term results.

I will now hand it back to Bob to share some recent business highlights.

Bob?

Robert Selander

Before moving to the Q&A session let me share a couple of recent business highlights from around the world. Under difficult economic conditions we continue to readjust our plans and make sure we are aligned to meet the changing needs of our customers. As evidenced through the new agreements and partnerships we entered, our customers recognize us as an important partner and we are committed to delivering real value that will help them optimize their payments business.

As we mentioned last quarter MasterCard Integrated Processing Solutions (IPS), the debit and prepaid processing platform we introduced last year, continues to build momentum. Just this morning we announced a deal strengthening our partnership with Travelex, the world’s largest distributor of foreign currency prepaid cards. This new global processing and brand agreement is significant as it underscores the value of our IPS platform and the strength of our prepaid expertise and global brand.

In the U.S. we signed a multi-year signature debit contract extension with Fifth Third Bank to continue our brand relationship. Fifth Third, a MasterCard issuer for more than 25 years will continue to issue consumer and small business debit MasterCard cards as well as consumer, small business and commercial MasterCard credit cards.

Solidifying our long standing relationship with Bank of the West, we signed two new multi-year contracts that extend our commercial credit and consumer and small business credit relationships with the bank. In early March, Orange and Barclaycard announced the launch of new co-branded products and services including a range of mobile offerings where their customers will be able to use their mobile phones to pay for goods and services using contactless technology. We are very pleased that MasterCard will provide the payment capabilities for the transactions.

In addition to supporting Orange and Barclaycard with mobile payment capabilities there are a couple of other innovative products and solutions worth noting including the launch of the MasterCard ATM Hunter, the first in a series of applications that we are developing specifically for Apple for their iPhone and iPod Touch. Together with Blaze Mobile we introduced the Blaze Mobile MasterCard Paypass Mobile Payment sticker, enabling any mobile device to be used for tap and go purchases. This innovation has been noted by the Contactless Intelligence Industry Group as the type of development that may be the way to encourage movement towards large scale, near field communications implementations.

In partnership with Citi Cards Canada and Bell Mobility, in April we announced the completion of the first near field communications trial of mobile Paypass in Canada. This was the first trial in Canada to use Bell Mobility’s cell phone infrastructure allowing participants to make purchases using their mobile device at MasterCard Paypass acceptance locations across Canada.

Finally, earlier in the quarter we announced we had issued more than 50 million Paypass devices globally. As of March 31 there are nearly 55 million Paypass cards and devices usable at more than 146,000 merchant locations worldwide.

In summary, whether it is through the innovative products and solutions we offer or our unmatched advisory and information services, we are making payments easier and more efficient for everyone involved. I will now turn the call back to Barbara so we can begin taking your questions.

Barbara Gasper

We are now ready to begin the question-and-answer period. In order to get to as many people as possible in our allotted time frame, we ask that you limit yourself to a single question with one follow-up and then queue back in for additional questions. Can we please start the Q&A session?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Andrew Jeffrey – SunTrust Robinson Humphrey.

Andrew Jeffrey – SunTrust Robinson Humphrey

Can you talk a little bit about the trends you are seeing in assessments? I know you mentioned they were a little bit higher this quarter; the rebates were a little bit higher than you would have anticipated. Is there new business that you won that contributes to volume as the year goes on or are we going to see a little bit of a lag by which those rebates start to moderate with the decline in volume that you have seen?

Martina Hund-Mejean

I think I have talked a number of times about it. That is probably one of the line items that is more difficult to really forecast. Obviously with where the volume trend is you typically would see some moderating on a one-for-one basis on the rebates and incentives line. But we happen to have actually a very good trajectory from a business point of view and we are, as you heard this morning, signing new deals and we are also obviously renewing some business and that will be a counter effect because you obviously have to take what we are doing there on rebates and on incentives into account in our financials.

So, net/net I think it is probably one of the more difficult lines to call.

Andrew Jeffrey – SunTrust Robinson Humphrey

But it sounds like you feel pretty good about your share position as a consequence to some new business signings?

Martina Hund-Mejean

That is really not how we are looking at it. Share is just one input but really what is important to us is to sign profitable business and that is what we are more interested in.

Andrew Jeffrey – SunTrust Robinson Humphrey

Just to clarify on pricing it sounds like the 4% gain from pricing this year is a little bit better than what you had been contemplating around your 2% long-term goals. Is that a little bit of a step up in your expectations?

Martina Hund-Mejean

That is true. As we got our hands around some of the pricing actions that we are putting into the market we feel more comfortable that this will be a good zip code for the rest of the year, the at least 400 basis points. Albeit, I just want to remind everybody I would not be expecting that kind of number going forward. I think in general we would be pulling back to on a normal steady state basis we should be seeing about 200 basis point contribution to our net revenues.

Operator

The next question comes from Moshe Katri – Cowen and Co.

Moshe Katri – Cowen and Co.

Can you comment on EPS growth for 2009? I think you made some commentary on that in previous quarters. Looking at credit card usage given the trends impacting this area can you touch base on the recent changes in consumer behavior in terms of using credit cards? Are consumers still using credit cards for large purchases, etc.?

Martina Hund-Mejean

First of all, we don’t really talk in EPS for growth. We are talking in terms of net income growth. As you have seen for our first quarter if you excluded special items that we had in the first quarter of 2008, if you exclude for the RediCard proceeds or gains we had in the first quarter of 2008 and if you adjust on a constant currency basis our net income growth was 13.8% and that is obviously below our 20-30% long-term performance objectives we had laid out some time ago. Our advice for 2009 we said we would likely be coming in lower than that.

If you tell me where the economy is going to go we can tell you a little bit more in terms of what our expectations would be. I would think that the first quarter and how we were able to navigate through what is happening on the top line versus what we were able to do from an operating expense and margin point of view that is probably a pretty good analysis in order to extrapolate how we might go through the rest of the year. It very much depends on how the economy not only in the U.S. but also the rest of the world will be performing.

Moshe Katri – Cowen and Co.

On the second question about credit card usage?

Robert Selander

Let me make a couple of comments there. If you take a look at the quarter in terms of the credit and charge programs purchase volume in the U.S. was down nearly 14%. In the rest of the world purchase volume grew a little over 7%. Clearly the impact we are seeing in the U.S. is much more dramatic thus far than we are seeing in the rest of the world. I think if you take a look at sort of the staging of the cycle and take a look at some of the issuing reports that have come out in the first quarter we have seen a slow down in acquisition programs. We have seen increases in delinquencies and of course in charge offs. Virtually all of our issuers were reporting similar levels of reduction year-over-year in terms of the purchase volumes on their U.S. card base. I think what we are seeing is the reality in what is going on in the economy play through our numbers.

Having said that if you look at the various categories that I mentioned in terms of the first few weeks of April, we haven’t seen a turn around in the U.S. volumes during the month of April. What we have seen is transactions continue to grow year-over-year and I’m not talking about total MasterCard. I don’t have it at my fingertips the mix of debit and credit but total transactions do continue to grow. We are looking forward to obviously seeing the stimulus begin to have some impact later in the year and I think that is probably the earliest we will be able to tell you more about what is going to happen in terms of the performance on credit as compared with credit and debit combined.

Operator

The next question comes from Craig Maurer – Calyon Securities.

Craig Maurer – Calyon Securities

I had a question on your comment regarding April being worse than the just reported quarter. That seems to be in contradiction to what your largest competitor said the other day where they said that April was an improvement over the March quarter with credit remaining stable in terms of the downturn year-over-year. I was wondering if you could give us a little more detail on your April comments.

Robert Selander

I don’t have a lot more detail other than what I have already shared. From the standpoint of cross-border that was flat pretty much with what we had seen in the first quarter. Again, we don’t know what impact if any we will see in the rest of this quarter as a result of what is happening with the flu. The U.S. volumes I mentioned in April continued to decline year-over-year. In fact the decline was slightly higher than what we had seen in the first quarter. I did, as you know, caveat that with the dramatic change in the price of gasoline in the U.S. where it is down about 40% year-over-year from the comparable period last April. If I recall correctly, gas is about 6% of our volumes. I think it is about 15% of our transactions.

The rest of the world also was showing slower growth in the first quarter in terms of volume. First quarter was about a little over 8% purchase volume growth so we have seen a slight slow down from that. On the other hand, in total the processed transactions we have seen are up. So what we see is people continuing to use it but the average ticket size continues to come down so transaction growth was up 7-8%. To the degree those are the shoots of spring starting to poke through because that is up from the 5.8% in the first quarter. We think it is too early to call the spring. We are waiting for how things play out over the next several weeks.

Craig Maurer – Calyon Securities

One follow-up, regarding Europe, SEPA and everything that is going on there, it seemed to me that if one assumes the U.S. is cyclical the real focus for MasterCard and big opportunities should be focusing to Europe as the year moves on. With the economic conditions what they are in Europe and the likelihood that Europe has a more prolonged downturn than the U.S. and with the EC mandating specific items in their recent release that would require the banks in Europe to implement new IP systems, it would seem there is a lot of motivation to not invest in something like Monet right now and new IP systems. My question is, would you believe the current conditions provide additional incentive with SEPA deadlines looming for European banks who own local processing schemes to view MasterCard more favorably as the SEPA compliance solution considering the Maestro penetration in the countries within the EU?

Robert Selander

Would you like to come help sell with us? That was a good pitch. Thank you! Just a couple of thoughts. Europe is struggling as well. I mentioned the unemployment data there, the most recent data I recall was the February data where it was 8.5% similar to what we see in the U.S. for March. I guess Spain is up in the 17% range and they are talking about it hitting 20% over the course of this year. So Europe is struggling economically and many of their financial institutions have significant challenges with regard to capital and they are going through the same things that are happening with our customers here in the U.S.

So I don’t really bifurcate the U.S. and Europe. I sort of look at the same things playing out perhaps on a slightly different time table. So I’m not optimistic that Europe is going to be a lot better in the next quarter whereas I think perhaps by early 2010 the U.S. will be. It is not clear on Europe. Specifically on SEPA and the European Commission, I mentioned in my comments we reached an interim agreement or a cease fire with the European Commission which recognizes the principle of interchange and we hope that provides a little more comfort to the financial institutions how the regulators are going to approach this so we don’t sit there with a thought well interchange, which is a fundamental balancing mechanism that is essential for development and the continued strength and growth of the payment system, they don’t have to worry as much about that principle being challenged any more. So that was one of the reasons we thought that was an important agreement to reach.

If you put those two things together and I think the second one gives you a little more comfort on incentive. On the other hand the economic environment continues to challenge customers and they are pacing their investments in everything whether it is their IP systems, or their marketing programs. They are doing the same kinds of things we see institutions doing here in the U.S. So I think that is going to continue to drag things out a little bit and it also does, I think to your point, make it a lot easier for them to take what they already have on 300+ million cards in Europe, the Maestro brand, and treat that as the solution to ensure that they are SEPA compliant and competitively positioned favorably with their other financial institutions with whom they compete for consumer and merchant business.

Operator

The next question comes from Anurag Rana – Keybank Capital Markets.

Anurag Rana – Keybank Capital Markets

Bob, any update in Europe as it relates to the release to the domestic countries looking at interchange because of what the decision that was taken was on cross-border?

Robert Selander

As you know many of the best of regulators are looking at interchange. What we have tried to do and I think most financial instutions have tried to do with their domestic regulators is to say hey why don’t you wait until this European Commission appeal plays through in the Court of First Instance. If you do look at what has happened over the last several years, the two regulatory decisions that were challenged in the courts both were reversed and both were reversed in favor of financial institutions and the principle of interchange. I am referring both to the Office of Fair Trading in the U.K. where the competition tribunal reversed their decision and also more recently late last year in Poland where a Polish court threw out the competition authority ruling against interchange in Poland.

So we can’t confirm this will happen but what we are encouraging domestic regulators and our financial institution colleagues are encouraging the regulators is hold on a second. The decisions that have been taken along very similar lines of principle by two domestic regulators have been overturned in the courts and it is not clear how this interim agreement will fare once it does get to the court as MasterCard gets its appeal in the Court of First Instance.

Anurag Rana – Keybank Capital Markets

As a follow-up, you mentioned that operating expenses would be flat to slightly down. They were down about 11% in the first quarter. Just it seems a bit conservative given the amount of reduction we have seen in ad and marketing in the first quarter we shouldn’t expect a little higher reduction in operating expenses for the full year.

Martina Hund-Mejean

In particular for advertising and marketing for the first quarter we printed a number of $116 million and you can just take basically what we spent on A&M last year. Obviously those numbers will be down but nevertheless for the next three quarters you can expect advertising and marketing expenses will be significantly higher than the first quarter. That is one of the things you have to take into account. When you look at the general and administrative line that is down but what we are saying, and that is a change from before, we will be basically as part of the whole operating expense reduction we will be able to basically cover any of the potential future severance expenses we are still expecting we are going to have come through the P&L. So I think you have one covering the severance expenses. Two, we might be slightly down. I think when you put all that together and in terms of seeing how we try to really work between the top line and the bottom line in the first quarter I think that probably gives you a pretty good roadmap for the rest of the year.

Operator

The next question comes from Tien-Tsin Huang – JP Morgan.

Tien-Tsin Huang – JP Morgan

First I just want to ask about cross-border. The flat local volume growth was basically in line with our view but we significantly underestimated the FX impact. Martina can you give us some help on the currency mix here? Or rule of thumb on major currencies we need to translate for this revenue line item?

Martina Hund-Mejean

That is really hard to give a rule of thumb for that one. If you can appreciate we are pretty much exposed to almost all currencies in the world. Our major fraction of currencies are the U.S. Dollar, the Euro as well as the Brazilian Real of course. Most of our revenues that we charge locally are charged on a local currency basis and then converted versus the functional currency. As you see the movement of those currencies versus the U.S. dollar as well as versus the Euro that is a major impact. The impact was not as large in prior quarters but for this quarter was significantly large and that is why you are seeing I think for the first time ever to quote a first quarter number on a U.S. dollar basis and not only on a local currency basis. Otherwise, you would probably not be able to really explain what is going on in the prior quarter fee line item that is running through our revenues.

Tien-Tsin Huang – JP Morgan

I guess we should assume the same kind of path assuming no change obviously unless we have seen another mix within the quarter. Is that fair to assume?

Martina Hund-Mejean

Yes. Mix plays a little bit sometimes. Let me just, in terms of overall revenue if I can just pull you back to the P&L so neg revenue impact if we were to stay at current rates, like at leveraged rates we had for the first quarter you saw we had a 4 percentage point on net revenues and that is pretty much what you would expect for the rest of the year as a headwind assuming we have those rates stabilizing at those levels.

Tien-Tsin Huang – JP Morgan

Just as a follow-up, on the expense side what kind of savings do you expect from the severance actions taken in the quarter? Also just as a follow-up with Amex being down over 40%, Visa down 9% and you down 35% can we expect ad and marketing spending to be down comfortably double digits for the rest of the year assuming no change in the environment?

Robert Selander

I’m going to comment on the ad and marketing and let Martina pick up on the other points. In terms of the ad and marketing obviously we are looking forward to seeing the economy and some things begin to improve. As I have mentioned, I don’t think that is happening. As we sit here we can’t say that is happening in the second quarter but we certainly would expect that the stimulus and the amount of money particularly in the U.S. but in other markets in the world that is going to start to work its way in the second half. As that happens, we have I think adequate advertising marketing capacity in our thinking to be able to respond to that and as Martina mentioned we would expect this would be a low point for the year this first quarter and that we would see a significant growth in marketing spending going through the rest of the year.

Now if we don’t see that happening then that would clearly temper and cause us to rethink whether or not we want to make those investments or not. Many of those are being done with customers. If some customers say no I don’t want to do a promotion then obviously we are not going to do that. Right now, there is a level of expectation on our part that as things get better we will be increasing our marketing spend. We have benefited as have all other advertisers and marketers from reductions in the cost. So we are getting more bang for our buck. As things snap back, we expect as other advertisers return that may not be the case as it is in many of the markets around the world although in a couple of markets ad and marketing costs are actually up year-over-year.

I hope that helps on the ad marketing.

Tien-Tsin Huang – JP Morgan

When you say up you mean relative to Q1 right?

Robert Selander

Yes.

Tien-Tsin Huang – JP Morgan

Martina you were saying about severance actions and the savings expected?

Martina Hund-Mejean

Just on the severance actions and I am not even going to comment for the first quarter related to the $19 million but when you calculate the pay back year-over-year on that it is just shy of two years because given it is the actions for the first quarter and then you have a [inaudible] pay back gives you pretty much a good view of what you can model. I am not going to comment on what you might be doing in the future simply because we are still working on how exactly that will look like and as soon as we can comment on it we will of course.

Operator

The next question comes from James Kissane – Bank of America/Merrill Lynch.

James Kissane – Bank of America/Merrill Lynch

Bob just following up on the question regarding advertising and marketing. In a normal environment what do you think the right level is maybe as a percentage of revenue based on your sense of returns on advertising and marketing?

Robert Selander

We don’t know. We don’t use a mindless ratio of 30% or whatever of revenue is what your advertising and marketing should be. It will vary from market to market. It depends on the state of our brand in a given market. If we have been there for years and have high awareness and have good advertising recall and positive consumer and merchant sentiment towards the brand then you wouldn’t need to invest as much in a similar market that didn’t have those things in order to establish yourself. So when we are looking at our marketing spend we are looking across all of the markets that we operate in the world. We are also looking at more than just media. We are looking at promotional and sponsorships. Most of our sponsorship deals are deals that have been signed for multiple years. Those are formed better description fixed in the short run from a spending standpoint. Variability is principally in the media area and to the degree there are utilization of sponsorships through promotions that also provides another dimension of variability.

As we see things improve we want to take advantage of those opportunities and it will vary market by market and customer by customer as to when and how that happens. But we anticipate with the recovery in the economy and consumer spending that we are going to want to go in there and promote our brand and product and it will vary as a percentage of revenues depending on the stage of the development, the nature of the opportunity in each individual market.

James Kissane – Bank of America/Merrill Lynch

Just given some of the consolidation in the issuer market when do you expect a resolution on some of that portfolio with contracts in play? For example, Wamu? Would you think that is a 2009 event?

Robert Selander

I expect that will be a 2009 event. There are various agreements that come up both here in the U.S. and other parts of the world over the course of the next year and our customers as we do like to get those things lined up in anticipation of, let’s say the current agreement ends at the end of this year, we will be working with our customer to try and get those things aligned during the course of the summer in the third quarter so we are not all sitting around on New Year’s Eve wondering what is going to happen. That is normal business as usual practice. When we know something about a particular deal and a customer has agreed we will share it with you much the same way as we have shared this morning reminding you about the Fifth Third deal and I guess we released the information about Travelex which was signed this morning as well.

Operator

The next question comes from Jason Kupferberg – UBS.

Jason Kupferberg - UBS

Last quarter I believe you said you needed high single digit constant currency revenue growth to get to the 20-30% net income target specifically for 2009 unless you were to take some additional cost actions. Can you just update us on that construct? I know you aren’t point guides for 2009 per se but just your thought processes around those relationships between top line growth and net income growth. Also as part of that if you could clarify whether that 20-30% includes or excludes severance?

Martina Hund-Mejean

Our long-term performance objectives of 20-30% net income growth has always excluded severance. We never have that in there. When we actually made the comments for 2009 in terms of that we would have to be in the high single digits net revenue growth in order to produce the bottom line objective that was assuming that our operating expenses were flat. Again, that does not include any potential severance charges.

Now, to the extent we can obviously cover the severance charges within that flat operating expenses and if to the extent we actually come in below or lower than flat on operating expenses of course you would have probably reduced your high single digit metrics for net revenues. It can throttle back and forth. Do the numbers given that we gave you quite a bit to model it but that would be the natural conclusion.

Jason Kupferberg - UBS

So the number you gave for the quarter in terms of constant currency and net income growth, the 13-ish% I think you mentioned, did that include severance?

Martina Hund-Mejean

Yes that did.

Jason Kupferberg - UBS

So what would that be if you excluded the severance since that is kind of apples-to-apples versus the 20-30%. Correct?

Martina Hund-Mejean

It was $19 million pre-tax so you are going to have to take the taxes. $15 million of tax. So that was about a 3-4%.

Jason Kupferberg - UBS

So you really wouldn’t have been that far below the 20-30% on an apples-to-apples basis?

Martina Hund-Mejean

Correct.

Jason Kupferberg - UBS

Lastly, a bigger picture question. Recognizing that unemployment is obviously one of the more important metrics impacting your business and if we are still 3-4 quarters away from seeing unemployment ceasing does that mean from your perspective credit and volume trends probably haven’t topped yet? Or should we not necessarily draw that conclusion since the year-over-year comps I believe should start to get easier in the second quarter going forward?

Robert Selander

First, on the last comment I’m not sure the comparisons get easier in the second quarter. I think the comparisons will only really get easier in the fourth quarter because if you go back and you look, things were going along pretty well at least from a consumer standpoint and then that weakened September and the Lehman, AIG, etc. which was roughly mid-month around the 15th of September that is when we started to see like a wake up call to consumers. Hey there is something going on here. We started to see the year-over-year deterioration in growth occur in the fourth quarter. So I think the comparables will be easier in the fourth quarter rather than the second and third.

From a standpoint of unemployment there are two dimensions here. There is unemployment and there is spending. Clearly as people lose jobs they are less able to spend. I have no reason to believe that the economists who have suggested unemployment will continue to rise through the first quarter and get up to circa 10% I have no reason not to believe that is likely to happen based on any of the indicators I am seeing. So that is a downward impact.

On the other hand, the stimulus and some beginning improvement in consumer confidence and the stability we have seen in prices particularly down in the commodities areas, gasoline is a great example of that one, that will encourage some spending we expect as we proceed into the year. We would look to see that spending offset if you will in the unemployment impact over the course of the next couple of quarters or at least we hope it would. Then we get a better comparable for the fourth quarter.

Jason Kupferberg – UBS

So I guess bottom line, a little too soon to say if buying metrics have [inaudible].

Robert Selander

I think that is exactly how I would summarize it.

I think that is it. I think we are done. Barbara let me make a couple of comments in summary here. Despite the current economic realities we delivered a solid first quarter. The current market environment has led to softening in our revenue line but we have taken considerable cost reduction actions to deliver a strong operating margin. We will continue to position ourselves to ride out these challenging times and remain focused on ensuring that we are well positioned for longer term growth.

I look forward to sharing more of our thinking at our upcoming investment community event on May 13th. Thanks for your time today everybody.

Operator

Thank you for your participation in today’s conference. This concludes your presentation. You may now disconnect.

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Source: MasterCard Incorporated Q1 2009 Earnings Call Transcript
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