MasterCard Q3 2007 Earnings Call Transcript

MasterCard Incorporated (MA)

Q3 2007 Earnings Call

October 31, 2007 9:00 am ET

Executives

Barbara Gasper - Investor Relations

Robert W. Selander - President, Chief Executive Officer, Director

Chris A. McWilton - Chief Financial Officer

Analysts

Patrick M. Burton - Citigroup

Adam Frisch - UBS

Elizabeth W. Grausam - Goldman Sachs

Christopher Mammone - Deutsche Bank

Tien-Tsin Huang - J.P. Morgan

Craig Maurer - Calyon Securities

Moshe Katri - Cowen & Co.

Christopher Brendler - Stifel Nicolaus

Howard Shapiro - Fox-Pitt Kelton

Kenneth A. Posner - Morgan Stanley

Bruce W. Harting - Lehman Brothers

Anurag Rana - Keybanc Capital

Gregory Smith - Merrill Lynch

Robert J. Dodd - Morgan, Keegan

Mark Sproule - Thomas Weisel Partners

Presentation

Operator

Good day, ladies and gentlemen, and welcome to the third quarter 2007 MasterCard Incorporated earnings conference call. My name is Francis and I will be your coordinator for today. (Operator Instructions) I would now like to turn the call over to Barbara Gasper, Head of Investor Relations. Please proceed.

Barbara Gasper

Thank you, Francis. Good morning, everyone, and thank you by joining us today, either by phone or on our webcast for a discussion about our third quarter financial results. With me on the call this morning are Bob Selander, President and Chief Executive Officer; Chris McWilton, our Chief Financial Officer; and Tara Maguire, our Corporate Controller.

Following comments by Bob and Chris highlighting some key points about the third quarter, we will open up the call to your questions. In total, the call will last up to one hour. For your reference, this morning’s earnings release and the slide deck that will be referenced on this call, as well as an updated chart of our classes of stock issued can be found on the investor relations section of our website at MasterCard.com. The earnings release and slide deck have also been attached to an 8-K that we filed with the SEC this morning. A replay of this call will be posted on our website for one week until November the 7th.

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

Robert W. Selander

Thanks, Barbara and good morning, everyone. We are very pleased with our third quarter financial performance. These results show that our strategy is working, as we are able to deliver value to both our customers and shareholders as a unified, global company.

Turning to page two of the slide deck, we delivered net income of $314 million or $2.31 per share on a diluted basis. This includes after-tax gains of $70 million, or $0.51 per share from the sale of 25% of our investment in Redecard.

For the first time in MasterCard's history, we recorded quarterly revenue of over $1 billion. This was driven primarily by strong growth in dollar volume and process transactions, including cross-border volumes, which grew 20.6%.

Additionally, several pricing adjustments in total contributed approximately 2% of the revenue growth in the quarter.

Finally, we saw our operating margin improve 2.1 percentage points to 32.6% from 30.5% in the third quarter of 2006. On a year-to-date basis, our operating margin improved by 7.2 percentage points, excluding the impact of special items, and this demonstrates the continued leveragability of our business model.

In addition to the financial results, there are a few business developments on page three that I would like to highlight.

We are pleased to report that our Board of Directors has approved an incremental $750 million Class A share repurchase program, bringing our total Class A share repurchase program since the IPO to $1.25 billion. We plan to complete the incremental $750 million program through open market repurchases by June 30, 2008.

We are also announcing plans for a second Class B share conversion program in 2007, which allows for the conversion of up to $5.8 million shares of Class B into Class A common stock. This represents the balance of the $13.4 million shares that our board approved for conversion earlier this year. Elections for this second conversion program begin November 17th and will end no later than December 14, 2007.

Last quarter, we promised to provide you with a status update of our Class A share repurchase program and accelerated Class B conversion program. As of September 30th, we had repurchased approximately 2 million shares of Class A common stock in the open market for an aggregate cost of $277 million.

Subsequent to September 30th, we repurchased an additional 1.4 million shares for an aggregate of $223 million, and completed our initial $500 million Class A share repurchase plan with a total of 3.4 million shares repurchased.

With respect to the Class B share conversion program, as of September 30th, certain Class B shareholders elected to convert approximately 5 million shares of Class B common stock to Class A common stock.

Subsequent to September 30th, Class B shareholders converted an additional 2.6 million shares, for a total of 7.6 million shares converted in this first program. Based on the progress from the initial conversion program and the shares that we repurchased, Class A shares now represent 64% of total shares outstanding, 10% of which is held by the MasterCard Foundation.

In the second quarter, we also mentioned that we would disclose the details of any sales of our Redecard shares. In the third quarter, we recognized after-tax gains of $70 million from the sale of 25% of our investment in Redecard. The pretax gain has been recorded as investment income on our income statement. The market value of MasterCard's remaining Redecard shares was $381 million as of September 30, 2007.

Before Chris goes into the specifics about the quarterly results, I would like to spend a few moments commenting about the state of the business around the world. Starting in the U.S., our volume growth has far exceeded retail sales growth to date in 2007. While we cannot control or predict the future of the overall U.S. economy, we expect our results to trend above typical market indicators during difficult economic climates.

Clearly since MasterCard does not have exposure to consumer credit receivables, we may not benefit from the upside when credit trends are favorable but we also do not suffer the downside during tough times.

While consumer credit volume growth is slowing in the U.S., we are making progress in the debit arena. We are very pleased that we are now working with Banc of America on the introduction of a new debit affinity product tied to Major League Baseball and National Football League sports teams.

Meanwhile, we continue to see markets outside of the U.S. driving significant growth for the company. Latin America and South Asia, Middle East, Africa regions were particularly strong. In these markets, the opportunity is about penetrating the emerging middle class and young consumer markets, as well as expanding merchants’ acceptance.

In Europe, we continue to make progress with securing SAPA related business through our flexible, commercially driven approach for our customers. We have already secured Maestro agreements with many banks in countries such as Germany, Belgium, The Netherlands, and Austria, ensuring the objective of a uniform cardholder experience anywhere in the SAPA region.

Asia-Pacific is a region experiencing strong economic growth. As the number of affluent consumers here continues to grow, we continue to work with our customers to leverage that trend. In response, MasterCard is taking a leadership position in the premium space within this region. Recently, many customers have chosen World MasterCard premium card programs, including customers in Taiwan, Australia, and in India, where the country’s first World MasterCard card was issued this quarter.

Finally, while Chris will be going into more details on expenses later in the call, I would like to quickly comment on our broader thinking about expenses going forward. Similar to our comment on the second quarter earnings call, as we go through our 2008 budget process, we are very focused on ensuring that our expenses support the many global opportunities of our business, while being mindful of our objective to consistently improve our operating results.

We are in the middle of our 2008 budget process and I fully expect that we will find the right balance between investment in the business and continued long-term margin expansion.

With that, I will now turn the call over to Chris McWilton for more details on the financials. Chris.

Chris A. McWilton

Thanks, Bob. Let’s turn to page four of the slide deck; as Bob mentioned, net revenue for the quarter was a record at almost $1.1 billion, a 20.1% increase over 2006. Currency fluctuation on the Euro relative to the U.S. dollar contributed approximately 2.3 percentage points of the net revenue increase.

Net income was $314 million, or $2.31 per share on a diluted basis. Without the impact of gains from the sale of a portion of our investment in Redecard, third quarter EPS would have been $1.80 on a diluted basis.

Turning to page five, in the third quarter, we experienced continued growth in both GDV and process transactions across all regions. GDV grew 12.8% on a local currency basis and 16.6% on a U.S. dollar converted basis to $577 billion. The third quarter was the 14th consecutive quarter of double-digit worldwide GDV growth on a local currency basis.

Although not shown on page five, purchase volume was up 14.1% on a local currency basis, cash volume was up 9.1% on a local currency basis. Additionally, cross-border volume, or the volume that is generated from cardholders who travel outside of the country where their card is issued, was up 20.6%. In the third quarter, cross-border volume came primarily from Europe, Asia-Pacific, and Latin America.

Process transactions, or the transactions processed across MasterCard's networks, increased 13.3% to $4.8 billion in the quarter.

As we’ve discussed in the past, one of the metrics we focus on is revenue yield, or the net revenue per $1,000 of GDV. This metric was 18.8 basis points in the quarter versus 18.2 basis points in the third quarter of last year. While we have said in the past that we expect a slight annual down-draft in this metric, the strength of our business, particularly cross-border volume growth, has put us on a trajectory to experience a slight positive lift in this metric for the full year of 2007.

While the possibility of a broad slowdown in U.S. consumer spending associated with sub-prime mortgage issues is yet to be determined, the global diversification of our business results and MasterCard's ability to generate significant volume and revenue from non-U.S. economies remain very strong.

For example, gross dollar volume in both the Latin America and the South Asia, Middle East, and Africa region continued to grow at very healthy rates. As we’ve discussed in the past, MasterCard's performance-based pricing serves to moderate the impact on revenue driven by swings and volumes. Because of our tiered-based pricing arrangements, not meeting volume hurdles can result in lower rebate incentives.

History demonstrates that we’ve been very resilient in weathering macro-economic events and the cycle shift from paper to electronic forms of payment continues in spite of any local economic downturns.

Note that our U.S. GDV growth rate of 7.7% is now completely normalized after the anniversary of a large debit portfolio conversion that occurred in the second quarter of 2006. Additional details about our operating performance can be found on page 10 of our earnings press release and on the IR section of our website.

On page six, we show that net assessments increased 20.7% versus the third quarter of 2006, or $50 million to $291 million. In the third quarter, gross assessments increased 15.4%, or $70 million to $525 million, due to strong GDV growth. Because our incentives are based on more than just GDV and include payments for things like new cards or program launches, the relationship between gross and net assessments can vary.

Similar to last quarter, net assessments as a percentage of gross assessments improved slightly.

Turning to page seven, you can see that net operations fees increased 19.8% or $131 million to $792 million in the third quarter. Gross operations fees increased 20.6%, or $150 million to $879 million. This growth was driven by several factors. First, growth in process transactions, gross dollar volume, and cross border volumes that I previously mentioned described on page five.

Second, pricing adjustments and new programs, including growth in authorization, settlement, and switch revenue, driven by higher utilization of stand-in authorization services, as well as pricing changes for these services, acceptance development fees, driven by increased volumes and a new fee associated with Rewards programs that was implemented in June, 2007; other operations fees driven by new account enhancement programs that allow our customers to move cardholders to different programs without a change in their account numbers.

Turn to page eight for some detail on expenses. During the third quarter, total operating expenses increased 16.3% to $730 million. This increase was driven mainly by advertising and marketing expenses, which increased 26.4% or $55 million resulting from a change in the timing of 2007 initiatives compared to the same period last year. You’ll recall that in the first half of 2006, we had significant World Cup sponsorship activity versus this year. We plan to shift more of the spending to the second half of the year.

Additionally, general and administrative expenses increased 10.2% for a couple of reasons. First, an increase in personnel costs related to the hiring of additional staff and contractors to support our customer focus strategy. Planned staff hires were made to support our global sales efforts, as well as our product and advisors initiative, primarily in our U.S. and European regions; second, an increase in employee performance incentive accruals.

Partially offsetting the growth in G&A was the impact of higher severance in the third quarter of 2006, due to an adjustment in the assumptions of our severance plan. The increase in total operating expenses was also driven by a $10 million cash contribution for the MasterCard foundation this quarter. We have now made a $30 million contribution of our planned $40 million contribution to the MasterCard Foundation, which we said will be completed within four years of our IPO in May, 2006.

Currency fluctuation of the Euro relative to the U.S. dollar increased total operating expenses by approximately 1.6 percentage points in the quarter.

Moving to the cash flow statement and balance sheet highlights on page nine, we’ve generated $718 million in cash flow from operations during the first nine months of 2007; $272 million of which was generated in the third quarter. We ended the quarter with $3.3 billion in cash, cash equivalents, and available for sale securities. We also had $3.2 billion in stockholders equity.

During the third quarter, we repurchased approximately 2 million Class A shares for an aggregate of $277 million. All of the Class A shares repurchased in our now completed $500 million share repurchase program are classified as treasury stock on our balance sheet.

Finally, investment securities available for sale increased $299 million, mainly due to a mark-to-market adjustment of our remaining Redecard investment.

Turning to page 10, there are a few items that I would like to highlight for your consideration as you refine and update your models for the fourth quarter of 2007.

First, there was one special item in the fourth quarter of 2006 -- litigation settlements of $2 million.

Second, with respect to G&A, due to delays in hiring and shifts in the timing of technology projects, we now expect second half growth to be slightly lower than the first half growth of 16.4%. However, the fourth quarter will have the highest sequential and year-over-year growth rate for any quarter in 2007.

Third, we continue to anticipate low single-digit full year growth in A&M in 2007. Also, consistent with our comments from the second quarter call, we expect that the highest quarter of spend will occur in the fourth quarter, the spend will be more evenly distributed between the third and fourth quarters than in prior years.

Finally, we expect to provide an update on the second phase of our Class B share conversion program and the incremental $750 million Class A share repurchase program on our fourth quarter and full year 2007 earnings conference call.

To wrap up, we’ll pleased -- very pleased with our third quarter results and are encouraged by the global momentum we continue to see in the business. While the broader U.S. economy is undergoing some challenges, we are on an excellent trajectory. We continue to demonstrate global strength and the ability to deliver value to our customers, merchants and shareholders.

Barbara Gasper

Thank you, Chris and Bob. We are now ready to begin the question-and-answer period. In order to get to as many people as possible during our allotted timeframe, we ask that you limit yourself to a single question with one follow-up and the re-queue if you have additional questions. Operator, I’ll turn the call over to you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Pat Burton with Citigroup. Please proceed.

Patrick M. Burton - Citigroup

Congratulations on your first $1 billion quarter -- tremendous numbers. My question is for Chris, and that is Chris, the factors between the 12.8% local currency GDV growth and the 20% net revenue growth, could you again just outline basically what the difference is there -- price increase, foreign currency, et cetera -- and how sustainable those factors are? Thanks.

Chris A. McWilton

You will see a disconnect as you have over time, Pat, on the growth rates between revenue and GDV on a local basis. We do assess, outside of Europe, on a U.S. dollar basis so we do get revenue growth because we take a transaction that occurs volume wise in a foreign currency, we convert that to U.S. dollars and then we [set] based on that, so you are going to see uplift from that process. You are going to see the normal currency conversion of the European operations back to U.S. dollars. You are going to see the impact of pricing, which was about 2% in the quarter. So all of those things have resulted in us being able to get that spread between revenue growth and GDV up to a pretty healthy level this quarter.

Now, the strengthening of different currencies around the world to the U.S. dollar, we don’t control. However, I think we’ve done a very good job of maintaining our pricing. I talked about the revenue yield a little bit in my comments and I think 18.7 basis points on volume is something we are pretty proud of.

Patrick M. Burton - Citigroup

And the cross-border number of 20.6, is that on the higher end of where we normally see it?

Chris A. McWilton

That’s a very healthy number and that is another reason we are seeing the revenue growth outpace the GDV because on those transactions, we are profiting the transaction across our network and we are also getting cross-border fees on that, which have been very healthy for us. So those are very healthy cross-border numbers.

Patrick M. Burton - Citigroup

Thanks.

Operator

Your next question comes from the line of Adam Frisch with UBS. Please proceed.

Adam Frisch - UBS

Thanks, guys, Pretty impressive quarter you guys just put up again. Two questions here; setting up some pretty tough revenue and margin comps for ’08. Obviously if there is a slowdown in the U.S. that perpetuates or gets more intense, it’s going to create some headwinds for you.

Bob, you mentioned in your opening comments that you are going to find a balance in operating expenses between growth and margin expansion, so with the realization that maybe next year, to Pat’s question, some of the things that are really driving top line this year, like cross-border, et cetera, may or may not continue in ’08. Should we expect a bigger focus on expenses going forward?

Robert W. Selander

Adam, I think we’ve always had a good focus on expenses and from my perspective, we are going to continue that going forward. And as I mentioned in my remarks, as we go through the budget process, I’m being presented -- we’re reviewing opportunities from all over the world for the various business units and I’m in the fortunate position of having more interesting things to invest in in order to build this franchise over time as opposed to people coming in and going jeez, we don’t know what to do next.

I recognize that there’s a pacing challenge there and I also know that we’ve made commitments, both inside and outside this company, to see margin improvements, and so that’s the balancing act we are going through now, and I feel quite confident that we are going to get ourselves to a position in terms of our budget, which lets us fund those things that are important to the future of the company but still show those operating margin improvements.

If the world gives us a more challenging environment than we may anticipate, then I think we also have an approach which builds flexibility into that budget because people know those things, if we get wind at our back, those things that we’ll probably move to next and if we have wind in our face, those things that we’ll probably have to slow down the pacing of.

Adam Frisch - UBS

Okay. Well said. A quick question on interchange, the text in the 10-Q seemed a little bit more guarded on Europe. A ruling from the governing body over there is widely expected in the next few months on cross-border interchange. Two aspects of this; one, obviously reduced interchange doesn’t impact you directly in your revenues or margins, but can you speak to some of the indirect impact? And then two, do you think this could trigger other activities in Europe, whether it be litigation or bank movement or whatever?

Robert W. Selander

Well, the European Commission has said that it’s going to issue a decision regarding MasterCard’s European cross-border interchange fees. I believe they have publicly stated they think that would happen by the end of the year. That’s I think how we [put] it in our 2Q 10. I’m not sure exactly what the wording was in this quarter’s.

As we said in that filing, we think they could come out with a negative ruling and if that’s the case, at least based on the material that we’ve reviewed and the comments we’ve reviewed from them, we’re likely to appeal that, very similar to the way we handled the OFT decision in the U.K. a couple of years ago, because we think we have extremely strong legal arguments for doing so.

Having said that, we are examining various scenarios around the possible decisions that might be rendered. And while we can’t conclude exactly how they will rule, until we know the final income, it’s really difficult to answer the question, other than to say our primary focus will be to ensure our products remain competitive in the European market.

Adam Frisch - UBS

Thank you.

Operator

Your next question comes from the line of Liz Grausam with Goldman Sachs. Please proceed.

Elizabeth W. Grausam - Goldman Sachs

Thank you very much. You commented on 2% revenue lift this quarter from pricing changes that you’ve been able to effect. Could you go into a little bit more detail of where those pricing changes were put in place geographically? And then also where they are in terms of the services that you are offering?

Chris A. McWilton

We talked on the second quarter call about some additional pricing we put in place around stand-in services, which is basically, those of you who aren’t familiar with that, when a customer’s authorization systems go down, they obviously don’t want their cardholders to be sitting at the cash register or someplace that they can’t get their purchase authorized. So we stand in for them in those cases. They give us parameters with which we can act as a surrogate for them.

So we put some pricing in place around those in pretty much all regions around the world, and we’ve got the full quarter impact of that in Q2 -- Q3, I’m sorry, Q3. And we also put an additional acceptance fee in place in the U.S. around some enhanced reward platforms.

So it was on the stand-ins, pretty much global, and in the acceptance arena, it was in the U.S.

Elizabeth W. Grausam - Goldman Sachs

Okay, great. And then, on the cross-border transactions, could you give us a sense of what percentage of your total transactions are actually cross-border and how that’s trended over time?

Robert W. Selander

Off the top of my head, I don’t have an answer for you, Liz. We process all of the cross-border, so we have a very good handle on that. We don’t necessarily process all the other transactions, so -- the rule of thumb I’ve used is it tends to be less than 5%. Certain markets have the propensity to travel, so it may be higher for a given country but the rule of thumb I’ve always used is somewhere in the 3% to 5% range.

Elizabeth W. Grausam - Goldman Sachs

Great. Thank you very much.

Operator

Your next question comes from the line of Christopher Mammone with Deutsche Bank. Please proceed.

Christopher Mammone - Deutsche Bank

Thanks. It looks like you’ve shifted some advertising assumptions from the fourth quarter. I think we expected the third quarter to be slightly higher than the second, and it was down --

Barbara Gasper

Chris, could you speak up closer to the phone?

Christopher Mammone - Deutsche Bank

Sure. Is that better?

Barbara Gasper

Yes.

Christopher Mammone - Deutsche Bank

Okay, sorry. Just on your ad spending assumptions, I think that we had expected that the third quarter would be slightly than the second quarter and it was slightly down, so it looks like you are shifting some ad spending in the fourth quarter. Could you talk about maybe what’s changed there?

Robert W. Selander

Well, I think the seasonality factor this year is what we would call a more normal year than last year. As you’ll recall in 2006, we had a very big second quarter as a result of the World Cup spending taking place in that year. And I think Chris mentioned in his comments that we will have a more normalized pattern this year where traditionally, as you’ll know from prior years, the fourth quarter tends to be the heaviest ad and marketing spend in our business.

Chris A. McWilton

I’d just add that we still expect very modest full year A&M growth.

Christopher Mammone - Deutsche Bank

And then I guess just on a higher level topic, with the dollar continuing to fall, I’m just looking at your U.S. card base being more than double what it is in Europe. At what point does that start to affect international travel trends, U.S. consumers traveling over to Europe and maybe overcompensating for the benefit you are getting from --

Barbara Gasper

Chris, are you speaking on speaker phone? You’re breaking up and we really cannot hear your question.

Christopher Mammone - Deutsche Bank

Sorry, no, I’m on a handset. Is that better?

Barbara Gasper

A little bit, but not --

Christopher Mammone - Deutsche Bank

Sorry. Just on your cross-border, with the weakening dollar, is there a time when it starts to bleed into the numbers as far as your U.S. account, your U.S. card base being more than double what it is in Europe. At what point does that start to affect international travel trends by U.S. consumers traveling over to Europe and more than offsetting the benefits you are getting from currency and the like?

Robert W. Selander

That’s a tough one for I think anybody to answer. From our perspective, we continue to enjoy very robust cross-border volumes of business. Now clearly, Europeans who are traveling to the U.S. have one of the strongest currencies they’ve ever had and so for them, this side of the Atlantic looks like a bargain basement, whereas of course the U.S., whether it’s a business or tourist trap, are going across to Europe obviously is not spending as much for the very simple reason that to get that cup of coffee is now $2 as opposed to maybe $1 a year ago.

We have very strong cross-border volumes, however, coming out of Latin America, coming out of Asia. Cross-border in the Middle East region as well, so I guess from my perspective, I’m more focused on the domestic activity in the U.S. market and what happens with the economy here. We have seen that slow down. We have seen some slowdown in consumer spending and that is the thing that we are more focused on, if you will, from the standpoint of an impact on our business.

Chris A. McWilton

I think the other thing I would add is we process all the transactions in the U.S., essentially all of them. Outside of the U.S., there are large [slots] of geography where we don’t process -- we only assess based on volume. So when the dollar is weak and people travel across the border, we would get transactions processed that we might not otherwise process. So the weak dollar is helping and as I mentioned earlier, we also assess on the U.S. dollar converted basis, so that tends to improve the revenue growth.

Christopher Mammone - Deutsche Bank

Okay, thanks. Sorry for the bad connection.

Operator

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

Tien-Tsin Huang - J.P. Morgan

Thanks. Just a few questions on the revenue yield -- is the level sustainable going forward here, adjusting for a seasonal effect? Meaning is this a safety base that we should model from, Chris?

Chris A. McWilton

I would just be cautious about the fourth quarter revenue yield. That tends to be our lowest revenue yield seasonally, because in that period, we are doing a lot of incentive arrangements and promotions with merchants, so if you pattern out or model revenue yield by quarter, you will see that the fourth quarter has historically been our lowest quarter. So I would not straight-line that across a full year.

As I said in my comments, I think we are pleasantly surprised by the fact we’ve been able to maintain that revenue yield. Last year in Q3 we were 18.2 basis points, 18.7 basis points this quarter. And I think full year, as I mentioned on the call, we’re going to see a slight improvement in that trajectory year over year. Last year we were at 17.3% and I think we’ll be able to do a little bit better than that for the full year 2007.

Next year we are cautiously optimistic that we can continue to see good cross-border growth helping to sustain that momentum, and again, we don’t see any cliff or precipice when it comes to that revenue yield on a short-term basis.

Tien-Tsin Huang - J.P. Morgan

Okay, just two quick follow-ups to that then; if we strip out the effects of cross-border fees, how would the revenue yield look on a year-over-year basis? Is it safe to assume that the revenue yield would still be up? And then I have a follow-up, if you want to address that first.

Chris A. McWilton

I don’t have that number off the top of my head. I assume there’s enough disclosure in the Q or around that that you might be able to --

Tien-Tsin Huang - J.P. Morgan

Okay, fair enough. And then longer term, can the revenue yield move higher longer term here, assuming you capture more operation fees internationally?

Chris A. McWilton

Yes, that’s something we definitely have the highest yield and we’re processing the transaction, generating cross-border or currency conversion fees on that. Ticket sizes tend to be higher for cross-border activities and doing volume assessments based on that, so if those numbers, those international travel numbers and cross-border numbers continue to be healthy, we will do quite well.

Tien-Tsin Huang - J.P. Morgan

Great. Great results.

Operator

Your next question comes from the line of Craig Maurer with Calyon. Please proceed.

Craig Maurer - Calyon Securities

Good morning. This question is for Bob. You had mentioned during your prepared comments, your SAPA achievements. I was hoping you could just frame that a little bit for us in terms of what inning you feel we’re in regarding SAPA and that conversion that will continue throughout Europe. And in terms of how the market itself is playing out, in terms of processors, merging, selling, what’s going on there and how you plan to pick up additional business. Thanks.

Robert W. Selander

Craig, I can’t pick an inning here, although I am a baseball fan. I can’t assign one to this process. There are clear timetables that were established but I think there is a level of uncertainty for issuers and acquirers, particularly surrounding the commission’s lack of support and thus far, lack of a decision with regard to interchange.

And as you know, the business models of every player in Europe that issues cards are premised on some form of balancing mechanism, namely interchange. So at this point, I think the timetable is pretty clear but whether or not that will actually happen I think remains to be seen.

Having said that, we are making good progress, I believe. As you know, we have half roughly of our 600-million plus Maestro cards around the world are in Europe, and we’ve already had very positive developments in Switzerland and Austria in terms of movement to Maestro. We’ve had commitments from banks in other countries, including Germany, Italy, recently the Allied Irish Banks in Ireland made a commitment to move their domestically branded and ATM only cards to Maestro.

So I’m feeling good things about the progress, but I think the real evolution of the market is one that is very hard to predict whether this is the third inning from a timetable standpoint or really the bottom of a first inning.

Having said that, I feel really good about how we are positioned and from a processing standpoint, as you’ve observed, there have been various of these previously bank-owned processors that have been acquired. I think I’ve mentioned on past calls or Chris has that we’ve looked at virtually every one of those and for one reason or another, we’ve decided that they weren’t going to be value-adding for our business. But we have seen processing competitors move into those marketplaces and we continue to have scale in our processing and I think a very good offering with our Maestro product in that marketplace, at least on the debit side.

So all in all, I feel that we are in pretty good shape. I think it’s going to be a very competitive marketplace over the next few years. I believe the regulatory positions are ones that are going to have to be solidified in order to give all the businesses there a platform on which they can then evaluate and judge the investment decisions they have to make.

Craig Maurer - Calyon Securities

Thank you.

Operator

Your next question comes from the line of Moshe Katri with Cowen. Please proceed.

Moshe Katri - Cowen & Co.

Thanks. Good morning. As a follow-up to the question about pricing, can we expect further pricing adjustments as we go along, maybe they’re in the fourth quarter? That’s number one.

And then, can you talk a bit about the opportunities for MasterCard in the prepaid card business and how well is actually the company positioned in that area? Thanks.

Chris A. McWilton

We are always looking at ways to provide value to our customers and do it in a way where they think they are growing their business and becoming more profitable as a result of the services and products we are providing. So we are always thinking about -- it doesn’t necessarily have to be a strict pricing increase but new service proposition, new value-added proposition. So we are always thinking about that.

We have a global committee that’s sitting around, trying to figure out on a regular basis whether we’ve optimized pricing. We have a very extensive product development group which is trying to come up with new ways to help customers and work with customers on their opportunities.

So we can’t rule out pricing in the fourth quarter but it’s something we’re always thinking about and I think we demonstrated that by maintaining that revenue yield at pretty healthy rates.

Robert W. Selander

On prepaid, just a couple of observations. Obviously this is something that several of our customers view as very important and we bring the same strengths from the standpoint of the global acceptance of the brand, et cetera, that we bring to other products that our customers are interested in.

We do through MasterCard advisors do quite a bit of advisory work in support of customers’ prepaid initiatives. We do have a platform that obviously supports those products for those institutions that may not be running their own platform.

We were able to participate most recently with the fires here in the United States out in California. We managed to get -- I guess it was about $25,000 worth of prepaid cards through one of our customers out to the Red Cross so that they could fuel their vehicles and so forth as they responded to those California wildfires. So it’s nice to see some of the functionality being utilized in real practical day-to-day basis like that.

Moshe Katri - Cowen & Co.

Do think that on an ongoing basis, maybe starting in 2008, we are going to see a more significant contribution from that area to MasterCard financially, or this is still too early? Thanks.

Robert W. Selander

The way we think about that is it’s embedded in the other elements of our business, so we get to do the authorization, clearing and settlement, obviously the processing fees, depending on where these products are being utilized. They are on our platform or, as a result of our advisory work, there are other fees to be realized. So it’s similar to the balance of our business model. There will be some dollar volume related franchise fees, processing fees, and potentially obviously the third category, advisory fees.

Moshe Katri - Cowen & Co.

Thanks. Great quarter.

Operator

Your next question is from the line of Christopher Brendler with Stifel Nicolaus. Please proceed.

Christopher Brendler - Stifel Nicolaus

Good morning. Can you just give us a little more color on your domestic volumes? I know you lapped a big conversion, but you came in a little bit below our estimates. Do you see any slowdown in spending patterns?

And then also, are you -- any progress to report on additional debit conversions?

Robert W. Selander

Let me just take a crack at that one. When you say domestic, I’m going to assume you mean U.S. domestic?

Christopher Brendler - Stifel Nicolaus

Correct.

Robert W. Selander

If you take a look at -- I guess it’s in the press release -- we do have specifics with regard to U.S. dollar volume. I happen to look particularly at purchase volume, and you’ll see that purchase volume growth for the third quarter was 9.4%. When you consider that in the context of what rate of retail spending is taking place here, that’s obviously several percentage points. I would say probably about six percentage points or so above the rate that you would see for consumer spending or retail sales broadly in the economy. That in part is I think the success of electronic and card-based payments and in part, it’s our success in terms of the way we work with our customers.

As the U.S. economy has slowed and we have a service that we call spending pulse, which is data that comes out just ahead of the Department of Commerce data monthly, we’ve seen that spending pulse report showing slowing consumer and retail level spending from first to second quarter, second to third quarter. And not surprisingly, we’ve seen our spending volumes tracking down, although obviously not as low as those growth rates, for the reasons I’ve already mentioned.

As we look forward, we have I guess cautious optimism in terms of the control of inflation and the way the fed is going to behave in ensuring that the economy weathers some of the challenges coming out of the sub-prime market.

The best news I guess is that we don’t have the credit exposures that some companies have, either through the fact that they are lending money to cardholders or in other ways involved.

So I’m pretty comfortable that with our very strong growth internationally, we’ll be able to show a good, positive, overall corporate growth, even if we have a market like the U.S. that may get a little slower domestically.

Christopher Brendler - Stifel Nicolaus

Any debit conversion updates?

Robert W. Selander

I’m sorry, any --

Christopher Brendler - Stifel Nicolaus

Any new debit relationships?

Robert W. Selander

I mentioned a couple of the ones that had popped in Europe. Allied Irish Banks recently made a commitment with regard to moving their domestically branded and ATM only cards to Maestro. I can’t recall if we shared with you the Swiss Bank’s movement. I think in my commentary during my remarks at the opening of the call, I mentioned that we are obviously delighted to be working with Banc of America on the affinity debit programs with Major League Baseball and National League Football teams here in the U.S.

Christopher Brendler - Stifel Nicolaus

Would you say that your U.S. volumes were in line with your expectations at the 9% level, the purchase volumes?

Robert W. Selander

I’m sorry, I missed the question.

Christopher Brendler - Stifel Nicolaus

Were they in line with your expectations in the quarter? Do you see any signs of a slowdown?

Robert W. Selander

I would say they are broadly in line. When we see our spending pulse data coming out and we see what’s going on overall in the economy, if it’s a lower quarter coming up than the one we’ve just experienced, we adjust our expectations accordingly and if it’s an improving quarter, we’ll push them up.

So I was not at all surprised with where we came out in the third quarter. I guess I’m just delighted with some of the results we are getting in some other markets which show very robust growth.

Christopher Brendler - Stifel Nicolaus

Without a doubt. One quick one for Chris; you had mentioned in the past not to focus too much on the quarterly movements in rebates and incentives, but throughout most of the year, they have tracked below year-ago levels, which is contrary to the trend in prior years. Any of the price increases that you mentioned related to rebates and incentives? Thanks.

Chris A. McWilton

I think from a rebate and incentive perspective, you are going to see, particularly in the assessment area, you are going to see the growth moderating a bit. What’s happening there is that as the base moves up, you are going to have to have a bigger rebate and incentive against a program to move that dial on a percentage basis, so we are seeing slowdown in the assessment rebates and incentives. And the operation fees, you are coming off a very small base, so even a small change in that number is going to have a fairly dramatic impact on the growth rate.

There are cases where, based upon a specific customer situation, if we put a pricing increase in place, we might need to accommodate that for some contractual issue we might have, or a customer relationship issue. It depends upon the facts or circumstances. So sometimes you do see rebates and incentives move up or down with a pricing change.

Christopher Brendler - Stifel Nicolaus

Thank you.

Operator

Your next question comes from the line of Howard Shapiro with Fox-Pitt Kelton. Please proceed.

Howard Shapiro - Fox-Pitt Kelton

Thanks very much. I’m just wondering if you can help us understand -- when you allocate spending by region or by product, how does your assessment of changing economic growth or spending patterns, i.e. a slowdown in the U.S., influence how you are going to be allocating marketing spend going forward?

Robert W. Selander

Specifically in the area of advertising and marketing, we go through a modeling process which enables us to allocate funds basically on a country level during our budget process. And one of the indicators that we use is an underlying assumption in terms of what is going to go on with the economy and growth in that market.

We tend to make sure we put enough money into a market so we can get the job done in the market, from the standpoint of trying to meet the customers’ expectations where we have agreements with customers to do certain things, but also to the extent that there’s a threshold of spending that may be required in order to have adequate impact to achieve a brand awareness objective or whatever it may be.

To the extent there is a dramatic change from what we look at at the time we are doing our budget, that would be something that we would make adjustment for in the course of the year. Obviously if you get into a situation where there’s a catastrophic shutdown, then we would shutdown our marketing.

The most recent example I can think of is when we had the SARs scare, I guess it was, back in 2003 and several markets, international travel was basically shut down and so that component of our advertising and marketing budget, we put into hibernation until that resumed.

So there is a level of flexibility around it but it is something that we just have to stay on top of day to day.

Howard Shapiro - Fox-Pitt Kelton

Thank you.

Operator

Your next question comes from the line of Ken Posner with Morgan Stanley. Please proceed.

Kenneth A. Posner - Morgan Stanley

Good morning. I wondered if you could just compare and contrast the net assessment yields in the U.S. versus overseas? Or net revenue yields?

Chris A. McWilton

I don’t think we’ve broken that down in our filings before, Ken. I will tell you that in the U.S., we are going to process the transaction whether it’s cross-border or not. And, as I’ve indicated before, whenever we process a transaction, obviously we’re getting fees that we wouldn’t if were just simply assessing based upon the volume on the card, which might take place intra-country within Europe or one of the Asia-Pacific countries.

So yields is much higher generally in the U.S. than we see in other parts of the world if you take out the cross-border activity, just based on processing. We also process in the U.K., Canada, and Australia and Brazil. So you see yields higher in those geographies as well.

Kenneth A. Posner - Morgan Stanley

Chris, without disclosing anything you haven’t disclosed, can we say anything about rough ballparks? Would it be safe to assume that in emerging markets and fast-growing markets, that you get a healthier assessment than you do in a mature market like the U.S.?

Robert W. Selander

Let me make an observation on that. I think we have disclosed the dollar volume that’s in the U.S. versus international. We’ve also disclosed the revenue that’s U.S. versus international, and we are looking at I think in the second quarter, and I don’t have the third quarter at my fingertips, about 50% of our revenue was U.S. and 50% was international, and something around I think 43% or 44% of our volume was U.S., so you can see that there is more revenue per dollar of volume coming out of the U.S.

Chris has already hit on the points that drive that. We process everything that we do in the U.S. -- all the transactions, essentially, which is not necessarily the case in other markets outside of the U.S. that you would expect to get both brand and processing fees.

And then there’s obviously the mix of other revenues in terms of advisory services and other things that aren’t necessarily driven off of the actual volume or processing of a transaction, and so that would also affect that yield calculation. But you can do a gross estimate based on those two data points that I mentioned.

Kenneth A. Posner - Morgan Stanley

Thank you. That’s helpful.

Operator

Your next question comes from the line of Bruce Harting with Lehman Brothers. Please proceed.

Bruce W. Harting - Lehman Brothers

Thanks for the good news in an otherwise tough year here. In the context of your commentary on the fourth quarter, should we just expect net assessment and operation fees to be impacted in ratio terms by incentives or rebates by roughly similar amounts to last year?

And then, very favorably strong growth in GDV outside U.S. -- could you just help us understand that in terms of the proportion of contribution from price increase versus your share increase in those markets versus say consumer organic spending within the local economies? Thanks.

Chris A. McWilton

I think I’ll simplify your question and I would again encourage you to look at revenue yield. I think if you go and you model the revenue yield over the past three years and look at what happens to that yield in the fourth quarter, I think you can make some observations with respect to the decline, the gradual decline that takes place in Q4.

As I mentioned in my remarks, there’s a lot of activity going on with merchants and acceptance activity in the fourth quarter and that is reported as contra revenue. Volume does increase but again, we are getting into the tail-end of our tier-based pricing arrangements with our major customers, so the pricing on those deals tend to be the lowest in the fourth quarter. So put the two of those together and you do see basis point degradation historically in Q4, not something unexpected.

That’s how we look at it. We don’t necessarily dissect the rebates and incentives as operations fees or assessments. We are managing the business in terms of the total picture to our shareholders and customers.

Bruce W. Harting - Lehman Brothers

Thanks.

Operator

Your next question comes from the line of Anurag Rana with Keybanc. Please proceed.

Anurag Rana - Keybanc Capital

Good morning, gentlemen. Great quarter. Chris, just a quick housekeeping item; what would be the normalized investment income if we were to take out all the investments or the gains from Redecard? And the D&A went down a little bit compared to the last quarter. Could you please help us understand that?

Chris A. McWilton

As I mentioned in the call, the gains on the Redecard sales, the 25% of our holdings was $107 million pretax in the quarter, so you can back that out. And the D&A went down, we had some adjustments around some of our estimated useful lives and residual values on some of our fixed assets in the quarter, but nothing that I would see as something you would have to consider going forward in your modeling.

Anurag Rana - Keybanc Capital

Thank you.

Operator

Your next question comes from the line of Greg Smith with Merrill Lynch. Please proceed.

Gregory Smith - Merrill Lynch

On the modeling issue, regarding sales and marketing, I think you guys had said on the last call o 2Q that it would be up sequentially, when in fact it was down. So I guess the question is, is it possible that we can see sales and marketing down for the full year, even though you are saying it might be up?

Chris A. McWilton

Sometimes we have shifts in timing of our end marketing programs that are driven by our customers that we don’t have unilateral control over, so we might be planning a program to advertise around a paypass launch or a world card launch with a specific customer, and they call us up two weeks before the program is supposed to kick off and say we’re not ready for that, we’re going to do it in Q4 versus Q3, so we did have some slippage from Q4 to Q3 as we forecast our A&M --- Q3 to Q4, I’m sorry, in our A&M spend, but we are still looking at that very modest full-year growth. So it’s simply a shift in timing from Q3 to Q4.

Gregory Smith - Merrill Lynch

And then, it sounds like you guys are suggesting that G&A is going to be up sequentially a fair amount in the fourth quarter. As we think about the first quarter, is it possible that we can see a sequential decline, just given all the activity in the fourth quarter that you may not have in the first quarter?

Chris A. McWilton

I think we would give some commentary and context around that when we get to the year-end. We are still in the midst of -- we’re right in the middle of our budget process, arm-wresting with all the business units and they are working on timing, et cetera, and which programs they will calendarize which way, so it’s really premature to think about Q1.

Gregory Smith - Merrill Lynch

Okay, we’ll take a guess. Thank you.

Operator

Your next question comes from the line of Robert Dodd with Morgan, Keegan. Please proceed.

Robert J. Dodd - Morgan, Keegan

To extend that question, on the G&A side, I was expecting somewhat more substantial growth in Q4 and I think you’ve given indications that really you are not changing your second half, so along those lines, what changed during the third quarter to push out some of those technology investments? [It must] take a little bit longer planning than two weeks ahead on the advertising spend, calling up and pushing it out. So can you give us an idea why some of those expenses have slipped into Q4?

Chris A. McWilton

A lot of it has to do around hiring and if you look at our G&A components, the biggest piece is the personnel cost. You know, our business units do have plans to bring the folks on board to work on projects, initiatives with customers, et cetera. And I think we saw a delay in hiring, as I mentioned in my remarks, that people did not come on as quickly as we thought they would. They will come on in the fourth quarter and that’s why we’ve continued to project both a sequential growth and the fourth quarter being the absolute highest spend of any quarter.

So it is sort of a push-out and timing issue from 3Q to 4Q, just around delays in hiring, and when hiring gets delayed, projects get delayed. So if there is any outside support and vendor support to do a project and we don’t have the people internally to do it, it compounds that. So we are seeing that shift out from 3Q to 4Q.

Robert J. Dodd - Morgan, Keegan

Just expanding that, I mean, on why are you having the delays in hiring? Is it problems finding the right IT people or the right sales people? Are they just not available in the market at this point or is there another issue?

Chris A. McWilton

No, I think you hit the nail on the head there. I think there’s a relative scarcity of resources in the technology area, as well as customer-facing people that have the skill sets we are looking at to deal with customers at the level we are expecting to. We are not looking for clerks and back-office support. We’re looking for people that can go in and deal with sophisticated customers in a sophisticated business and it’s a longer hiring cycle than I think we’ve anticipated.

Robert J. Dodd - Morgan, Keegan

Thank you.

Barbara Gasper

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

Operator

Your last question comes from the line of Mark Sproule with Thomas Weisel Partners. Please proceed.

Mark Sproule - Thomas Weisel Partners

Thank you. Maybe if I could touch on -- I guess a little bit of a rehash of some of the other questions, but looking at your spending but also looking at it in the context of what some of your customers are doing with their portfolios and a number of the credit card issuers domestically especially are having --

Robert W. Selander

Mark, could you speak up a bit?

Mark Sproule - Thomas Weisel Partners

Sorry, can you hear me better now?

Robert W. Selander

Yes.

Mark Sproule - Thomas Weisel Partners

Just looking at the credit card issuers that are your customers, many of them are looking to re-center their portfolio to protect themselves against increased credit losses, maybe putting incremental fees on their customers and constricting some of the lending that they are doing out in the marketplace.

Is there any concern that one, that could have an impact on your domestic volumes as we go into Q4? But also, how does that play into what you’ve talked about briefly a few minutes ago about the timing of your advertising if some of these guys maybe pull back on their own spending?

Robert W. Selander

Well, let’s use your hypothesis. Let’s assume that turns out to be the case. There is a slowdown in the marketing around card-related products here in the U.S. There are less incentives being placed out there for cardholders to use their products, than I would say yes, that we would react to that. One, we would probably see some slowdowns, but we would also see delays in our marketing spend and support programs that would be used for those customers.

To the extent there is a lessening of domestic volumes versus what we currently anticipated, the vast majority of our customers here in the United States have agreements which involve tiered pricing, and to the extent they don’t get to certain volume levels, they may not qualify for that lower pricing. I think Chris has made it pretty clear, earlier comments today and on other calls that the fourth quarter is our quarter generally of lowest effective yield, and that in part is because we are getting to those higher tiers from various lines of business our customers do, and therefore lower pricing tiers.

To the extent they don’t get there, there is a little bit of a balancing mechanism, if you will, in terms of the structure of our pricing.

Mark Sproule - Thomas Weisel Partners

That’s helpful. And then, on a different side of the equation, when you look at the debit market, obviously nice growth in the signature side, is there any inclination of trying to maybe make a bigger splash in the PIN debit market to counteract some of the other players that are out there? Thanks.

Robert W. Selander

Well, the debit market I think of globally and I think we are making pretty big splashes in it. If I look at growth in the U.S., debt continues to be stronger than credit, and we had nearly 15% growth in purchase volume during the quarter in our domestic signature-based debit. I’ve mentioned here the relationship with Banc of America, which we are delighted to be working with them.

Outside of the U.S., Maestro is a very strong performer. We have over 600 million Maestro cards, and I’ve highlighted some of the things that we’ve been doing with players, particularly in Europe, but we are doing similar types of things in other regions of the world as well.

So I feel good about our position in debit. It’s a rapidly growing market. It continues to receive focus and we look forward to having more successes there.

Operator

I would like to turn the call back over to Mr. Bob Selander for closing remarks.

Robert W. Selander

I would like to thank everybody for joining us today. Again, we are just delighted with our results for the quarter and we are glad we were able to share them with all of you. Have a great day. Thanks.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect and have a great day.

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