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MasterCard Incorporated (NYSE:MA)

Q4 2009 Earnings Call

February 4, 2010 9:00am ET

Executives

Barbara Gasper - Group Executive, Investor Relations

Robert W. Selander - Chief Executive Officer, Director

Martina Hund-Mejean - Chief Financial Officer

Ajaypal Banga - President, Chief Operating Officer

Analysts

Sanjay Sakhrani - Keefe Bruyette & Woods

Julio Quinteros - Goldman Sachs

Bob Napoli - Piper Jaffray

Tien-Tsin Huang - J.P. Morgan

Bruce Harting - Barclays Capital

Rod Bourgeois - Sanford Bernstein

Moshe Katri - Cowen & Co.

Adam Frisch - Morgan Stanley

James Kissane - Bank of America/Merrill Lynch

Operator

Good day, ladies and gentlemen, and welcome to the fourth quarter and full year 2009 MasterCard earnings conference call. My name is Regina, and I will be your operator for today. At this time, all participants are in listen only mode. Later we will conduct a question and answer session. (Operator’s Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Miss Barbara Gasper, Group Executive of Investor Relations. Please proceed.

Barbara Gasper

Thank you, Regina. Good morning, everyone, and thank you for joining us today, either by phone or webcast, for a discussion about our fourth quarter and full year 2009 financial results. With me on the call this morning are Bob Selander, our Chief Executive Officer, Martina Hund-Mejean, our Chief Financial Officer, as well as Ajaypal Banga, our President and Chief Operating Officer. Following comments by Bob and Martina highlighting some of the key points about the business environment and our fourth quarter and full year results, 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, mastercard.com. The earnings release and the slide deck have also been attached to an 8-K that we filed with the SEC earlier this morning. A replay of this call will be posted on our website for one week until February 12.

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 would like to now turn the call over to Bob Selander. Bob?

Robert W. Selander

Thanks, Barbara, and good morning, everyone. I would like to start out by saying that I am very pleased that we have been able to deliver another strong quarter of earnings results. This is indicative of the underlying momentum of our business, including several new and renewed deals that we have signed over the past several months. I will have more to say about some of these deals a little later.

In the fourth quarter, we saw net revenue growth of 6% on an as reported basis, and 2.2% on a constant currency basis. While the weakening U.S. dollar has created a tailwind for us this quarter, we also saw encouraging signs with regard to key aspects of our business. Gross dollar volumes, or GDV, grew 5.3% on a local currency basis. We experienced continued growth in process transactions, and cross border volumes have returned to positive growth. We also began to see the impact of some of our deals in our rebate and incentive line. Total operating expenses increased for the quarter, primarily driven by higher marketing investments and severance charges that we spoke to on our last call. And I am pleased that net income grew 21% for the quarter, excluding any special items.

We delivered strong financial results for the full year with net revenue growth of 2.1% on an as reported basis, or almost 4% on a constant currency basis. Excluding onetime items, we delivered an operating margin improvement of 5.5 percentage points over 2008. Adjusting for special items, as well as a gain from the sale of our remaining interest and ReadyCARD in 2008, net income grew approximately 27% for the year on a constant currency basis.

Throughout 2009 we took important steps to improve our expense management and resource alignment to ensure that the company is well positioned for growth as the global economy continues to improve. With the exception of the United States, gross dollar volume grew double digit during the fourth quarter. We also saw growth of 6.7% in process transactions around the world. Overall, these results continued to underscore the strength that our global business model affords us, even in the current environment.

Turning now to some recent trends in the economy and the state of the business in the U.S. and Europe, as we saw last week, U.S. GDP increased at an annual rate of 5.7% for the fourth quarter, primarily driven by exports and inventory building. While the overall trend is reassuring, personal consumption expenditures grew at only 2% for the same period, and there is no change to our outlook regarding the U.S. consumer. We continue to be cautious about the health of the consumer as reflected in recent spending trends, as well as the slow pace of real improvement for people’s financial security, specifically in housing and unemployment. January’s conference board consumer confidence index improved 2.3 points, signaling that overall general consumer confidence is stable to slightly improving in the U.S.

The short-term outlook was somewhat mixed. The percentage of consumers expecting an improvement in business conditions over the next six months decreased, while those anticipating conditions will worsen increased. While home prices were up for several months through November, they are still much below 2007, and home sales for the year dropped sharply by 23%. Although the rate of unemployment has leveled off and most economists do expect an improvement in the second half of 2010, it remains very high at 10%. Our own research indicates a wavering optimism, where consumers have grown weary of the slowdown and are preparing for it to last longer than they initially thought. A new mindset seems to be emerging which suggests that people are looking for opportunities to spend, while trying to balance the temptation to consume, with a need for restraint due to the realities of the environment.

In Europe, the EU consumer sentiment indicator improved somewhat in December, although it remained slightly negative reflecting a continuing overall pessimistic outlook by Euro’s own consumers on the financial position of their households, the general economic situation, and towards unemployment and the rate of savings.

On a more positive note, European business sentiment improved in December, reflecting an expected improvement in general economic activity. In summary, there are some encouraging signs in the recent economic data and consumer sentiment findings.

We remain cautiously optimistic in our outlook, although our assumptions remain unchanged from those I shared with you last quarter. We don't expect any meaningful global economic improvement until the second half of 2010.

Turning to the MasterCard spending polls data for the U.S. retail sector. Retail sales, excluding automobiles, increased 2.3% in the fourth quarter, with easier year over year comparisons supported by higher gasoline prices and a generally healthier holiday shopping season. When you exclude both autos and gas, retail sales grew about 1.6%.

The 2009 holiday shopping season returned to a more traditional pattern, with sales beginning on Black Friday and then holding momentum through December. This was different from the 2008 season, where steep discounting ahead of the Thanksgiving holiday pulled a portion of the holiday sales into early November 2008. The net result of differences in the 2008 versus 2009 periods shows a difficult comparison in November and an easier comparison in December of 2009.

E-commerce sales benefited from disruptive weather events in the central region of the U.S. early in the month, with storms on the east coast the weekend before Christmas. This weather prevented consumers from traveling to brick and mortar locations and helped drive online sales to a 17.7% growth rate in December. E-commerce spending was up over 16% for the fourth quarter.

Our analysis shows that retailers did not have to employ broad discounting this holiday season. Inventories appeared to be more aligned with demand which in turn may be resulting in better financials for retailers and a generally healthier retail environment as we head into 2010.

When we look at our MasterCard process volumes and transactions through the first four weeks of January we see the following. Our cross border volumes continued to improve across all regions and were better than the fourth quarter which was low single digits. Once again our Asia Pacific region continues to demonstrate significant growth on a sequential basis and U.S. cross border volumes have improved from low single digit declines and are now trending slightly positive.

While not a perfect proxy for gross dollar volume, U.S. processed volume growth continues in the low single digit range. Process volumes for the rest of the world also continued to improve relative to the fourth quarter.

Finally, process transactions continued to grow in the mid-single digit range, tempered by Maestro losses in the UK versus last year.

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

Martina Hund-Mejean

Thanks, Bob and good morning everyone. Let me begin on page three of the deck where we'll focus on the 2009 actuals versus the 2008 non-GAAP column, which excludes special items.

As Bob said, we are pleased to cap off 2009 with strong fourth quarter financial results. Fourth quarter net revenues grew 6% to $1.3 billion over the comparable period last year. On a constant currency basis, net revenue grew 2.2%. The revenue increase was primarily driven by pricing changes of approximately five percentage points, a 3.9% increase in cross border volume and a 6.7% increase in the number of processed transactions. This was tempered by an increase in rebates and incentives.

While we have continued our focus on expense management, the 9.8% increase we saw in total operating expense for the quarter was driven by our plan for higher advertising and marketing spending and additional severance charges.

Foreign exchange also contributed 3.2 percentage points to the increase. As a result our operating income was $468 million for the quarter and the quarterly operating margin was 36.1%. MasterCard's effective tax rate was 35.8% in the fourth quarter of 2009. The decrease was primarily due to a more favorable mix of earnings, a lower state tax rate and a lower provision for tax reserve in the fourth quarter of 2009. We delivered net income of $294 million or $2.24 per diluted share. Please keep in mind that this includes $0.19 worth of severance related charges.

Turning to page four. The global diversification of our business continues to underscore our ability to generate significant volume, transactions and revenue from regions outside of the United States, and has thus cushioned our business from some of the decline that we experienced in our U.S. business. Worldwide gross dollar volume or GDV was up 5.3% on a local currency basis in the fourth quarter and grew 11% on a U.S. dollar converted basis to $674 billion. We've seen good improvement in U.S. GDV which is down 3.4%. Actually, a great improvement from the high single digit declines in the third quarter. Across the rest of the world, GDV continued to grow a healthy 11% on a local currency basis or an increase of 21.6% on a U.S. dollar basis.

Worldwide credit GDV growth was essentially flat on a local currency basis, improving from the mid-single digit declines in the third quarter. U.S. credit GDV growth continues to improve on a sequential basis but is still down in the low teens range. Credit GDV for the rest of the world continued to grow at 5.4% on a local currency basis, or 16.1% on a U.S. dollar basis.

Worldwide debit GDV grew 19.7% on a local currency basis. This compares to about 11.5% growth in the fourth quarter of last year and is actually the highest quarterly rate of growth this year. In the U.S. debit GDV volume grew at 10.5% and debit growth for the rest of the world was 31.3% primarily driven, once again by growth in our Asia Pacific, Middle East Africa region. On a local currency basis worldwide purchase volume grew 5.7% and U.S. purchase volume declined 1.3% for the quarter driven by a decline in credit volume.

Let's turn to cross border volumes. Cross border volume growth on a local currency basis was up 3.9% . We saw double digit growth in our Asia Pacific, Middle East Africa region, as well as strong cross border growth across our European businesses. In the U.S. cross border volume growth was just slightly negative, a vast improvement from over the last four quarters when we experienced double digit declines in each quarter. We did see a decrease in our Latin American region, due to a sharp drop-off in Venezuelan cross border activity. Our cross border transaction growth in the fourth quarter also returned to double digit growth for the first time since the fourth quarter of 2008.

When we look at processed transactions, they increase 6.7% compared with a year ago quarter to $5.9 billion. In Asia Pacific, Middle East, Africa and select Latin American regions processed transactions grew at double digit rates. With the exception of Europe, all of the regions grew at mid to high single digit rates. Excluding the impact of the loss of two Maestro portfolios in the UK and one U.S. debit portfolio, processed transaction growth would have been in the low double digit range.

The secondized (ph) shift from cash electronic payment forms continues to provide significant growth opportunities. The number of MasterCard branded cards worldwide declined 1.3% to $966 million for the quarter primarily as a result of U.S. issuers purchasing accounts. Excluding the U.S. the rest of the WorldCard issuance grew 7.3%. As of December 31, 2009 there were approximately 1.6 billion MasterCard and Maestro branded cards issued globally.

Now let's turn to page five. As I mentioned earlier net revenue for the fourth quarter grew 6% on an as recorded basis or 2.2% on a constant currency basis. Domestic assessments increased 4.9% from the fourth quarter of 2008, primarily due to increased volumes partially offset by the repeal of some European pricing. As you know, we agreed to pro-repeal some of our October 2008 pricing actions as part of an interim arrangement with the European commission effective July 2009.

Cross border volume fees increased by 21.4% versus the fourth quarter of 2008 primarily due to new pricing implemented during the quarter, most of which was rebated to customers. Cross border volume growth of 12.1% on a U.S. dollar basis also contributed to the growth in this revenue line item.

Transaction processing fees increased 20.3% compared to the prior period. Pricing changes introduced in the U.S. in April 2009 accounted for approximately half of the increase. Growth in processed transactions accounted for most of the remaining increase.

Other revenues increased 8.8% versus the fourth quarter of 2008, primarily driven by a number of items such as compliance and penalty fees. All of these factors that I just mentioned resulted in a 13.5% increase in gross revenue.

As Bob mentioned earlier we began to see the impact of some deals that closed in the quarter on the rebates and incentives lines. Of the 35.1% increase, approximately two-thirds was due to new and renewed customer agreements and the other third was due to rebates associated with the new cross border pricing. For the quarter, rebates and incentives represented 30.7% of gross revenues versus the 25.7% in the fourth quarter a year ago.

Now we'll turn to page six for some detail on expenses. During the fourth quarter total operating expenses increased 9.8% excluding special items. This includes severance related charges of $38 million for the quarter. Without the impact of severance in both this quarter and the year ago quarter, total operating expenses increased 7.4%. Including special items total operating expenses increased 6.6% on constant currency basis.

The increase was mainly driven by the following. General and administrative expenses increased 1.6%, with currency fluctuations accounting for 2.3 percentage points of the increase. G&A included the severance related charges. Excluding those charges for both periods, general and administrative expenses decreased, actually 2.3% versus the same period in 2008. Advertising and marketing expense increased by 25.1% versus a year ago period. This increase represents incremental investment in priority countries, including funds originally anticipated to be deployed in the third quarter and increased investments in media, customer marketing and promotions. Foreign currency fluctuations accounted for 5.4 percentage points of the increase.

Now let's turn to page seven and let's take a quick look at our strong 2009 full year performance which we're very proud of, when you consider the environment that we were facing at this time last year. We delivered net income of $1.5 billion excluding special items or $11.19 per diluted share. Also excluding the gains from the sale of our Redecard investments in 2008, net income grew approximately 27% for 2009. And excluding seven charges in both years, net income grew approximately 32%.

We achieved full year net revenue of $5.1 billion, representing growth of 2.1% and on a constant currency basis net revenue 3.9%. Pricing adjustments contributed approximately 6 percentage points of the growth and net revenue growth for 2009 was also driven by process transaction growth of 6.9%. Its positive factors were partially offset by the impact of lower cross-border volumes on a $US basis, and higher rebates and incentives. Total operating expenses for the year declined 6.9%, excluding special items and declined 10.5% when you also exclude severance related charges in both periods. Finally, we saw over 2009 full year operating margins improved 5.5 percentage points to 44.5% from 39% in 2008, excluding special items in both years.

Moving to the cash flow statement and the balance sheet highlights of page eight. We generated $284 million in cash from operations in the fourth quarter, and end of the year with cash, cash equivalent and current investments of $2.9 billion.

Before moving on to our 2010 outlook, I'd just like to spend a minute one other CAPM structure item, many of you have asked about what happens to our Class B stock upon the fourth anniversary of our IPO in May. As you will recall following the conversion programs that we have run the last three years, shares of Class B common stock now represents just over 15% or approximately $20 million of our outstanding shares. When Class B ownership drops below 15% as a result of holder's voluntary election to convert the Class M shares and associated voting right will be automatically redeemed. Earlier this week, our board of directors approved plans for further Class D conversion programs that will begin after May 31st. We included a summary of these programs in our Form 8-K files earlier this morning.

Turning to 2010, we believe the road ahead is a positive one, though there will undoubtedly be some challenges as we navigate through the first half of the year. We're carefully balancing our risks and opportunities looking at the realities of what's happening across the world. While most economic and consumer indicators are slowly improving, we expect challenges during the first half will be concentrated in the U.S. and in Europe.

In the U.S. there is still uncertainty in the industry around the implication of the credit card act, while this plays out we will of course determine our customers' actions with respect to their (inaudible) businesses. And in Europe we are making nice progress across the SEPA and Eastern European regions, although as I mentioned earlier this is being tempered by Maestro losses in the U.K. and the repeal of some 2008 pricing.

We're seeing encouraging signs in other parts of the world, for instance in Asia Pacific in some countries in Latin America we continue to expect double digit volume growth. Additionally, cross-border activity levels are picking up around the world, which as you know is an attractive revenue driver for us.

As outlined on slide nine, the following represents our current view of 2010 on a constant currency basis. We expect that net revenue growth will be better than the 3.9% growth we saw in 2009. Based on what we expect for the first few months of the year it is unlikely that in 2010 we can get back to our old 12%-15% average annual net revenue objective. We expect some contribution from pricing though at a lower level than what we saw last year. Rebates and incentives as a percentage of growth revenue will continue to grow in a trajectory, a bit deeper than what we've experienced over the past two years, the sum variation between the quarters depending on our ideal activity.

As Bob mentioned earlier we are very pleased with the number of new and renewed deals that we have signed in 2009 and we look for this momentum to continue into 2010. As a result the rebate in intensive line will include the impact of both 2009 deals, as well as new agreements that we sign in 2010. Also included will be the impact of the new cross-border pricing that has a rebate component to it. So if you just think about it, rebates and incentives are just another form of reinvestment in our business, so it should not be surprising to see this line increase as we work to drive volume and new business opportunities.

Over the last year or so we have made significant progress in realigning the expense base of our company in response to the realities of the market, we anticipate our total operating expenses will be flat to slightly down. At this point in time, we believe our expense realignment efforts are essentially behind us. We will continue to invest for future growth therefore you should be careful about factoring the entire benefit of the 2009 severance action into your model.

Turning to advertising and marketing we currently expect to be up mid-single digits from (inaudible) full-year 2009 spent. If the market environment recovers faster than we currently expect we will then need to reassess and potentially increase our marketing support.

In terms of quarterly (inaudible) past years spending in the first quarter will be the lowest of the year. We are currently planning for the spend in the remaining three quarters to be relatively equal, although this is something that we will be evaluating on a quarter-by-quarter basis as the year progresses.

Finally, we remain committed to our longer term objectives of annual merging expansion of three to five percentage points and average annual net income growth of 20%-30%. Remember, while all of our objectives are on a constant currency basis, our as-reported numbers will include any impact of foreign exchange; you are also assuming an effective tax rate of 34.5% for 2010. Overall, as we look at our performance expectations for 2010 we believe that we will be able to see her through the challenges in order to deliver another solid year.

Let me now turn the call back to Bob to cover some recent business highlights.

Robert W. Selander

Before moving in to the Question and Answer Session, I'd like to share with you some of our recent business successes and developments from around the world, beginning with some recent deal ends starting with some debit and prepaid examples.

A few weeks ago we announced that SunTrust has chosen MasterCard to be its payments partner in debit. SunTrust will convert all of its debit card programs to MasterCard. After the conversion, which is expected to begin later this year, SunTrust will issue approximately 5 million MasterCard debit cards. This is a significant win for our U.S. debit business and we are very pleased to start off the year with this new partnership. Additionally, SunTrust will be expanding its current commercial offering in the future to include MasterCard commercial credit cards. We look forward to working with SunTrust to enhance the value of their payments business.

In January we renewed and extended our agreement with Woodforest Bank, one of our largest debit insurers based in Texas. This includes both our consumer and small business debit portfolios. We also renewed and extended our agreement with Primerica Bank in December, both our commercial cards and our public sector prepaid business with Primerica is included within the scope of this agreement. We're pleased to continue to work with both Primerica and Woodforest to grow our mutual businesses and to reinforce our already strong partnerships.

In a deal that represents both our prepaid expertise and our best-in-class processing capabilities, ABN AMRO in the Netherlands, has selected our IPS processing platform for their prepaid business. IPS was implemented in 2009 and has enabled ABN AMRO to achieve back office efficiencies which has led to increased productivity and competitiveness in winning new business.

In Germany, West LB started issuance of the first payback Maestro debit cards with the initial conversion of their private-label portfolio. The new issuance has enabled cardholders to immediately benefit from value-adding Maestro functions including worldwide acceptance, secure online shopping through SecureCode, and contactless payments with PayPass. PayBack is one of Europe's leading loyalty programs. We're happy to be working with West LB and PayBack.

Turning to some recent developments within our innovative platforms group, we're pleased with recent announcements about our MasterCard in Control offering. As many of you know this is our innovative product that offers financial institutions an array of advanced authorization, routing, and alert controls that they can use to create products for their cardholders.

In the UK, Barclaycard will now offer the option of MasterCard in Control functionality. This is the first consumer use of our service that enables cardholders to set spending controls and receive realtime information about their accounts. Features include automated SMS alerts to keep tabs on spending, alerts and blocks for online card spending or high-value transactions, and weekly or monthly budgets with alerts when that budget is reached.

In mobile there are two developments I'd like to highlight. In Canada we announced a mobile trial with Bank of Montreal and Research in Motion to bring mobile payments to Blackberry smart phones through our MasterCard PayPass Tap & Go technology.

In Brazil, Itaú Unibanco and ReadyCARD with the mobile operator Vivo will be the first to use the MasterCard Mobile Payments Gateway to deliver mobile payment solutions to the bank's customers in Brazil. This will allow customers to use their phone as a mobile wallet and link existing credit, debit, or prepaid MasterCard or Maestro accounts to their phone to fund mobile initiated payments. In the transit space when you couple our leading contactless PayPass technology with the unparalleled speed of our network it results in great values and efficiencies for both transit systems and cardholders and we've had several new developments including in Turkey we expanded the number of cities that accept PayPass for transit payments. In the UK contactless payments went live in Liverpool with Stagecoach's 200 strong bus network and Transport for London is also planning to accept PayPass.

In France, the second phase of the public transportation trial with PayPass went live with RATP and La Banque Postale, and in Brazil's Rio de Janeiro we launched the first contactless payment application for public transportation in Latin America.

Overall we're very pleased with the business momentum we have as we head into the new year. We look forward to working with our customers and merchant partners on these and future opportunities that will make everyday commerce easier and more efficient for everyone involved.

I'll now turn the call back over to Barbara so we can begin taking your questions.

Question-and-Answer Session

Barbara Gasper

We're now ready to begin the question-and-answer period. And in order to get to as many people as possible in our allotted timeframe we ask that you limit yourself to a single question with one followup and then queue back in for additional questions. Operator?

Operator

(Operator's Instructions) And your first question today comes from the line of Sanjay Sakhrani with Keefe Bruyette & Woods.

Sanjay Sakhrani - Keefe Bruyette & Woods

Okay thank you. I was wondering if I could get a little bit more color on the rebates line. My math shows about 24% rebates to growth revenues. I was wondering what we should expect specifically for 2010? Will it be higher than this? And could you just help with the seasonality in that line throughout the quarters?

Martina Hund-Mejean

Yeah, Sanjay. What I referenced when I talked a little bit about 2010 was what you saw in 2008 from a rebate point of view and what you saw from 2009 a rebate point of view as a percentage of growth. So when you look at 2008 percentage of growth rebates and incentives were almost 23%, like 22.7%. And in 2009 as you know it goes up to 24% and what we are at this point in time expecting for 2010 is that the rates will be a little bit of a steeper increase than the differential between those two years. Now please keep in mind we have a number of things going on. We already told you the pricing changes that we made in October of 2009 has a rebate component to it and we pretty much gave you the numbers which allow you to calculate how much in that particular quarter our rebates related to pricing impacted the rebates and incentive line and that will be pretty much going on for all of 2010. And then the other part will be due to the agreement we already signed and some new agreements that we are expecting to sign in 2010.

Sanjay Sakhrani - Keefe Bruyette & Woods

Okay. And then just to followup on the pricing changes you mentioned, Martina. I mean, could you provide a little bit more color as far as scope and timing?

Martina Hund-Mejean

Pricing changes, what do you mean?

Sanjay Sakhrani - Keefe Bruyette & Woods

Oh, in this year.

Martina Hund-Mejean

This year? Well, as you know the only real pricing changes that we have announced is an April pricing change, but other than that I don't think we have anything else to say at this point.

Sanjay Sakhrani - Keefe Bruyette & Woods

Okay great, thank you.

Operator

Your next question comes from the line of Julio Quinteros with Goldman Sachs.

Julio Quinteros - Goldman Sachs

Great, thanks. Martina, just to sort of bracket your comments around the revenue growth. So obviously your average target for revenue growth, it sounded like you're saying you were going to be below that, but better than the 3.9, so do we walk away from this with a range of 3.9-11 or can you just help us think a little bit better about the revenue growth there?

Martina Hund-Mejean

Yeah, Julio, that's a tough one because we do not give annual revenue guidance as you know, and so we just are trying to be helpful to focus it for you between what we saw last year. Certainly we are going to see a better trajectory this year based on our assumptions, economic assumptions. And you can try to do some calculations given the 12%-15% that we had on the table sometime ago, but we're not really giving an annual revenue guidance.

Julio Quinteros - Goldman Sachs

Okay. And just one quick followup, your target is a constant currency number. In 2010 you are expecting currency to be — is it a benefit or a drag in your —

Martina Hund-Mejean

Julio, it depends. You're seeing what the euro is doing at this point in time.

Julio Quinteros - Goldman Sachs

I know, I know (laughs).

Martina Hund-Mejean

Apparently yesterday it broke the 1.39 barrier so Q1 and Q2 of last year we had like a 1.30-1.33 euro on average I think in the quarter so it definitely would be — I mean, unless they have the euro cratering we have still some benefit ahead of us, but that could turn in the latter part of the year.

Julio Quinteros - Goldman Sachs

Okay great. Thank you, guys. Good luck.

Operator

Your next question comes from the line of Bob Napoli with Piper Jaffray.

Bob Napoli - Piper Jaffray

Thank you. A little bit of color, I'd like to get a little more color on the Maestro losses, the two Maestro losses in Europe and also the processing loss in the US?

Robert W. Selander

I think probably that is one that I referred to in my comments and you'll probably recall, and I think this was about two years ago, we lost some Maestro business in the UK and those conversions are working their way through our card numbers in terms of Maestro cards as well as processed transactions in the UK. That will continue, I believe, throughout 2010, and we should be at what I would call I guess the new steady state starting 2011.

Martina Hund-Mejean

Yeah. Just to add to that, Bob, we have one customer that (inaudible) in the UK which will pretty much roll off in the middle of this year, one other which is going to go through the whole year, and then one US customer when we're not really sure when it will start, but we do think that our, at least process transaction numbers will be tempered for the whole year for that customer too.

Bob Napoli - Piper Jaffray

Okay. My followup question I guess to try to dig a little bit more into rebates because I mean your big competitor doesn't seem to be having the same issue on rebates so I'm a little bit confused why you're having that issue. And I guess when you talk about revenue growth you're talking about net revenue growth after rebates and you're still forecasting very big margin increases, but if you could — why are the rebates raising so much for you guys versus Visa?

Martina Hund-Mejean

I'm not sure you can really make the statement in terms of our rebates increasing a lot more than our competitors, but what you do have to realize is that when you look at the growth revenues versus the net revenues, a number of us have different list prices and different tiers that we're giving to our customers to the numbers are not actually comparable in a very easy manner.

The second thing that you have to factor in, which is a little different I have to say than what we had in the past, is what we did on the cross border pricing increasing which you had in October of 2009 which really has two components to it. There is one component where it goes through the gross revenue line, the other component which goes now for the rebates and incentive line and you typically don't have that, Bob, so that's a new factor. But we designed that price increase in a particular way in order to encourage our customers for a certain behavior and the financial perspective came out to be that way. So that is a big component of the increase that you will see in 2010.

Bob Napoli - Piper Jaffray

Thank you.

Operator

Your next question comes from the line of Tien-Tsin Huang with J.P. Morgan.

Tien-Tsin Huang - J.P. Morgan

Thanks, good morning. I had a couple of questions first I guess on the rebates and incentives. I was kind of curious about — let me ask you this way. Is this level a new normal for the company, meaning should we expect this kind of growth trajectory beyond 2010 given your ambition to grow the business? And similarly should we change our thinking for longer-term revenue yield given what we're seeing in new bids?

Martina Hund-Mejean

Tien-Tsin it's Martina again. I guess I'm not doing such a great job on rebates and incentives, but let me — I mean when you look back, and look back all the way back to the 2006 financials, you actually had ups and downs in the rebates and incentives as a percentage of growth quite a bit. The real difference between 2009 and prior years in 2010 again is what we did on the cross border pricing. In addition to that, as we are now growing and expecting to grow again you would expect rebates and incentives to also grow in sync with gross revenue growth. And as we are going after a number of new agreements as well as some renewed agreements, that has a factor in it too.

Tien-Tsin Huang - J.P. Morgan

Got it. I guess that makes sense. I was thinking about it beyond 2010, but it sounds like you're going to see a similar effect on net revenue.

Martina Hund-Mejean

Yeah. What I would urge you is to really look overall at the net revenue line and one thing that I just want to remind everybody on, rebates and incentives are very lumpy. Quarter over quarter over quarter it's probably the hardest line for us to forecast as well as for you to forecast because it completely depends on when we sign a particular customer agreement.

Tien-Tsin Huang - J.P. Morgan

Okay. So maybe I'll ask then, in general when you sign a new deal, what drives the accounting for the up-front rebates versus ongoing rebates? I believe it's different from Visa. I just thought it might make sense to understand that a little bit better here.

Martina Hund-Mejean

Yeah. I mean every deal is a little bit different, but if we do, for instance, sign-on bonuses, what we do is we amortize the sign-on bonuses equally over the years of the agreement.

Tien-Tsin Huang - J.P. Morgan

Over the years of the agreement, got it. I'll move off rebates and end with a quick one, just process transaction growth. That came in a touch below our estimate, but the revenues there were actually in line so it looks like the revenue per transaction picked up a bit sequentially. So my question is, is this level sustainable and is it indicative of the lower revenue yield of some of the lost business?

Martina Hund-Mejean

No, Tien-Tsin. There are a number of other things that are going around. When we actually look at the average ticket price per transaction it has not picked up in this point in time, but we had a number of other things in the transaction line that drive that growth and it's just the other normal items that we have like settlements, et cetera.

Tien-Tsin Huang - J.P. Morgan

Okay, thank you.

Operator

Your next question comes from the line of Bruce Harting with Barclays Capital.

Bruce Harting - Barclays Capital

You said to be careful about how we treat severance in terms of thinking about the growth in your guidance on flat expenses. Can you just expand on that a little? Should we be basing our 20% EPS growth off the number as reported or add back the severance cost? And then also how do we think about the progression in terms of the flat expense with regard to severance? Thanks.

Martina Hund-Mejean

Good question, Bruce. The 20%-30% average annual net income growth should be calculated on the as reported numbers. In terms of severance, for the whole year of 2009 we had almost $140 million of severance, $139 million of severance in the numbers. Every year we had usually some small, very small amount of severance. We think the small amount of severance will continue, but at this point in time we believe that we are by and large done with any employee-related actions so we are not going to foresee a large severance charge at this point in time.

Just in terms of to be helpful in terms of what could drop to the bottom line, it's about a 2-2.2 year payback of the program so of that $140 million or so that we spent you can assume that in 2010 about $70-$80 million will drop to the bottom line on the G&A side. Although as you heard in my comments we are reinvesting some of that money in specifically advertising and marketing as we said that would go up in the mid-single digit rate. So hopefully that gives you a little bit of help on your model.

Bruce Harting - Barclays Capital

Thanks. And then just a quick follow, my memory is that you said something about 200 basis points in 2010 prior guidance for pricing increase, is that still? I didn't hear that mentioned today.

Martina Hund-Mejean

Yeah. What I actually said here as part of our 2010 assumptions is that we still expect some benefit from pricing, albeit at a lower rate than what we had in 2009.

Bruce Harting - Barclays Capital

Okay, thank you.

Operator

Your next question comes from the line of Rod Bourgeois with Sanford Bernstein.

Rod Bourgeois - Sanford Bernstein

Great. I was wondering if you could give us some updated trends maybe for the month of January. We know at Visa, US credit volume growth turned positive in the month of December and in January and I was wondering if you could comment on whether MasterCard is experiencing similar trends on the US credit front and possibly even on the cross-border front as things seem to be improving into the month of January.

Robert W. Selander

Well, I think I made a couple of observations on that in my overview, Rod, in terms of our cross border volumes continuing to improve across all regions during the month of January. They were better than what we saw in the fourth quarter which was low single-digit growth. Once again I think regionally there are going to be some variations on that. Asia-Pacific is very strong. They continue to grow on a sequential basis. From the standpoint of the US, cross-border volumes have improved from what were low single-digit declines and they are now trending slightly positive.

If you look at processed volumes which are a pretty good indicator, but they're not a perfect indicator of what the eventual gross dollar volume numbers will be that we report, process volume growth has continued in the US in the low-single digit rates and that's a blend of both credit and debit. I don't have the credit breakout. I don't know, Martina, do you have a sense of what credit debit is?

Martina Hund-Mejean

Yeah. The credit is still in the low-single digit decline at this point in time and credit is still as healthy as it was before.

Rod Bourgeois - Sanford Bernstein

Okay. And guys, just as followup, when you look at your major priorities for investment in 2010, should we be expecting your disproportion investment priorities in the areas of new customers wins maybe following on the SunTrust deal or possibly some priority investments in the area of sort of new product categories?

Robert W. Selander

I think you're going to find a little bit of all of the above. If you think about it we've got a great global presence that we're operating with and there are clearly some of our customers and consumers in various markets in the world who are more healthy and more aggressive in terms of investing in their payments business and so we're trying to be there with them as that happens. What we did this past year in realigning resources, and that manifested itself in terms of some of the severance and other charges we took that realignment process was to position ourselves to take advantage of what our customers were going to start doing or had begun doing in the course of last year and that varies by geography and product.

We have a regional amount of energy going into Asia-Pacific and Latin America. From a product sense, the affluent, the prepaid, and the debt, I've already shared some of the highlights and things we're seeing happening in the prepaid and debit marketplace in the first month of 2010. So we think there's plenty of opportunities out there. At the end of the day, globally with the size and importance of both the US and Western Europe we need those economies and those consumers to start getting better. And while we see early positive signs we think we still have a ways to go.

Rod Bourgeois - Sanford Bernstein

That's helpful. Thanks, guys.

Operator

Your next question comes from the line of Moshe Katri with Cowen & Co.

Moshe Katri - Cowen & Co.

Yeah, thanks. You've had a decent acceleration in year-over-year growth rates in all of your metrics whether it's GDV, purchase volume, cross border, et cetera. Do you see anything out there that will slow down this trend or these trends as we go along throughout the year? And then as a followup, can you comment on some of the trends you're seeing in credit, specifically in North America? Thanks.

Robert W. Selander

Boy, let your imagination run wild in terms of the things that could adversely impact us. I think it's been, for most businesses, a very challenging 18 months. And while I think we've come through this one in a stronger position to capitalize on opportunities as they present themselves with our customers and in markets around the world, it also has made us acutely aware of how flexible and adaptable we have to be as the environmental conditions throw potential challenges our way. As I said we're viewing the first half of the year as challenging and that makes us a little conservative I hope, or a little cautious, versus what the reality will be. Then as I expect the world and at least the consensus of economists I follow, expect the world and the US and Europe to get healthier in the second half, and that would for me mean improving employment statistics, improving consumer confident statistics, and those are necessary for us to start to see the consumer reengage actively in the economy and that's really what we're all looking forward to.

Moshe Katri - Cowen & Co.

Any color on credit trends in North America?

Robert W. Selander

The color commentary you just heard from Martina when we look at January's performance and compare it with the fourth quarter. We continue to see year-over-year declines in credit and charge volume in the low single digit range. Now that's significantly improved, but as you go back to the second quarter say of last year, we were seeing 15% order of magnitude year-over-year declines in our credit volumes. Now, through this whole time debit has performed well and we see that continuing in January as well.

Moshe Katri - Cowen & Co.

Thanks.

Operator

Your next question comes from the line of Adam Frisch with Morgan Stanley.

Adam Frisch - Morgan Stanley

Thanks, good morning. Real fast on the rebates and incentive, I think we've kind of gone through that a lot, but just to clarify what's going on here, are you prepared to offset the increase in rebates incentives with cost management to preserve the 3%+ margin increase objective in the year?

Martina Hund-Mejean

Adam, obviously there are a lot of things that go in a P&L of a company, but net-net, what we said in the end we will be, or will be expecting at least to 2010 the 3-5 percentage point improvement in operating margin.

Adam Frisch - Morgan Stanley

Okay great, just wanted to clarify that. And then you an Bob spoke to a bunch of different initiatives whether it be in emerging markets around the globe or prepaid and debit and all that kind of stuff. There are a lot of things that were thrown out here. If you could just clarify for us in terms of what are your top priorities right now in terms of spend? Maybe rank the top three or four or five or something just to give us an idea in terms of how you're allocating resources, that would be helpful.

Robert W. Selander

Yeah. As we went through our budget process we really went down to a local market level to an extent that we hadn't in several years and that's because of the fairly significant divergence among various markets around the world both from the standpoint of the health of the financial institution and the health of the consumer and the economy, but also from the perspective of differing challenges in those markets with regard to the evolution of the structure of their payment system.

Let me be specific you still have a lot of ATM transactions in a market like Japan relative to the POS number of transactions that you would expect to see in a more developed market. And so as we went through our planning process, we became very market focused and those initiatives that we felt would produce the best value for the company, and you will have to go market by market to answer that question. That is not something I am in a position to do today.

The three or four themes that emerged are the ones that I have already mentioned. We have got a lot of focus on the debit prepaid space around the world. The more affluent consumer has performed better, has gotten through this difficult time better, and has an increasing focus of the financial institutions we do business with, and as I already mentioned, our focus on making investments in some of the emerging markets, Asia-Pacific, Latin America, and so forth, continues to have a high priority for the company as those are the places where we see greater growth opportunity for the near to midterm future.

Adam Frisch - Morgan Stanley

Any clarity in terms of the emerging markets, and obviously the Asia-Pac and Latin have a lot of different submarkets, but are there specific countries or regions that you are focused on in those areas?

Robert W. Selander

Well, I gave you a couple of examples of some programs we have announced. Brazil is a very exciting market for us. We have a great presence there, and we think we have great growth opportunities. That is one of the ones in Latin America. We believe that several in Asia are significant opportunities for us. India would be an example. Clearly Japan is a great growth opportunity. Australia — we are doing very well there. The economies tend to be better in that part of the world so there is a greater mix of opportunity right now probably in Asia than any other place in the world.

Adam Frisch - Morgan Stanley

Okay, thank you.

Barbara Gasper

Operator, I think we have time for one more question.

Operator

Excellent. Your last question comes from the line of James Kissane with Bank of America.

James Kissane - Bank of America/Merrill Lynch

Great. Thanks, Barbara. Martina, could you clarify when you say that pricing added 5%. Is that a gross number or is that on a net basis, and has the definition changed as a result of —

Martina Hund-Mejean

Just to remind everybody, what we do when we announce a pricing change is, is the change that we have in this price is less any particular related waivers or rebates, so it is the net number from that point of view, and what we have done for that 5% in this particular quarter, in particular on the cross border pricing is that we took the gross revenues and we deducted from it what we gave back in rebates, which I said is pretty much most of it. Okay? So you can count on that this is still the same kind of sensitivity as, you know, the same kind of calculation as we have done before.

James Kissane - Bank of America/Merrill Lynch

Okay, so if you look at the pricing on a gross basis where do you think it would be?

Martina Hund-Mejean

You know, Jim, we don’t give that kind of number. I don’t think it is even relevant, you know, at this point in time.

James Kissane - Bank of America/Merrill Lynch

Well then, I guess, just philosophically how you think about rebates and incentives? I think Bob called it investment. Should we not think of it more as pricing actions?

Martina Hund-Mejean

Other than, let me just tell you, the crux (ph) as I said before on the cross border pricing that was a very particularly designed pricing to encourage customers for certain behaviors. If the customers do the certain behaviors that we encouraged them to do, they will get a rebate. We have not designed price increases like this before. So this is an extraordinary way of how we designed it and that is what you are seeing in addition to the normal development on the rebates and incentive line. We have not changed our thinking on the rest of the rebates and incentives. It truly goes with where the business goes, i.e. when you have increased gross revenues, you typically see an in line increase with rebates and incentives, and then in addition to that, when we sign new or renew agreements, you might see some variations in the line.

James Kissane - Bank of America/Merrill Lynch

Got you. Thank you very much.

Operator

This concludes the Q and A portion of the call. I will turn the call back over to Bob Selander for closing remarks.

Robert W. Selander

Well, thanks again for joining us today. We are very pleased with our strong fourth quarter and full year results, particularly since we deliver those results in what has been the most challenging business and economic environment we have faced, certainly since I have been at MasterCard and perhaps in the company’s 44 year history.

Fortunately, when we headed into the economic crisis at the end of 2008, we did so as a strong company. Our business model, good capital structure, and sound management practices allowed us to remain flexible and adaptable as we weathered the storm. Now, some 18 months later, I believe we have emerged even stronger.

We have made investments that laid the groundwork for future growth, we have sharpened our focus on local market opportunities, and we have achieved efficiencies that allow us to benefit from a higher operating margin. As the global economy rebounds, we remain optimistic that our efforts of the last year and a half will pay dividends and prove their value in the future. So thanks again for your time today. Have a good one.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes our presentation and you may now disconnect. Have a wonderful day.

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Source: MasterCard Q4 2009 Earnings Call Transcript
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