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Visa Inc. (NYSE:V)

F3Q08 Earnings Call

July 30, 2008 5:00 pm ET

Executives

 

Jack Carsky – Head of Global Investor Relations

Joseph W. Saunders – Chairman of the Board & Chief Executive Officer

Byron H. Pollitt Jr. – Chief Financial Officer

 

Analysts

 

Bob Napoli – Piper Jaffray

Tien-Tsin Huang – J.P. Morgan

Adam Frisch – UBS

Dan Perlin – Wachovia Securities

Elizabeth Grausam – Goldman Sachs & Co.

Craig Maurer – Calyon Securities (NYSE:USA), Inc.

Patrick Burton – Citigroup

[David Haxton – Buckingham Research]

Christopher Brendler – Stifel Nicolaus & Company, Inc.

Sanjay Sakhrani – Keefe, Bruyette & Woods

Andrew Jeffrey – SunTrust Robinson Humphrey

Bruce Harting – Lehman Brothers

 

 

Operator

 

Welcome to Visa Incorporated third quarter earnings conference call. (Operator Instructions)

I would now like to turn the call over to your host, Jack Carsky, Head of Investor Relations for Visa Inc.

Jack Carsky

 

Welcome to Visa Inc.’s fiscal third quarter earnings conference call. Speaking today are Joe Saunders, Visa’s Chairman and Chief Executive Officer and Byron Pollitt, our Chief Financial Officer. This call is currently being webcast live over the internet. It can be accessed on the investor relations section of our website at www.investor.visa.com. A replay of the webcast will also be archived on our site for 30 days. A PowerPoint deck containing highlights of today’s commentary was posted to the website prior to this call.

Let me please remind you that this presentation may include forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. By their nature forward-looking statements are not guarantees of future performance and as a result of a variety of factors actual results could differ materially from such statements. Additional information in concerning of factors is available in the company’s filings with the SEC which can be accessed through the SEC website and the investor relations section of the Visa website. Historical non-GAAP or pro forma related financial information disclosed in this call, the related GAAP measures and other information required by Regulation G of the SEC are available in the financial and statistical summary accompanying our fiscal third quarter earnings press release. This release can also be accessed through the investor relations section of our website.

With that, I’ll turn the call over to Joe.

Joseph W. Saunders

 

For some time now we have been saying that Visa, while not immune to economic downturns, does have a high degree of resiliency embedded in its business model. The proof of this resiliency can be seen in our latest earnings results. For fiscal third quarter 2008 Visa’s net income on an adjusted basis was $457 million which is a 40% increase over the prior year’s third quarter on a pro forma basis. This equates to adjusted diluted earnings of $0.59 per share. Net operating revenues in the fiscal third quarter were strong at $1.6 billion or an increase of 18% over third quarter of 2007 on a pro forma basis as we again saw strong growth across all key categories.

As anticipated we are now seeing operating revenues running more in line with our long term guidance and volume growth rates and we expect this dynamic to continue. Last year’s price adjustments which were in full effect by 2/3/2007 had a much more muted impact in the third quarter’s results this year. Byron will discuss the individual revenue line items in a moment.

We’ve also begun to realize the positive impact of our operating scale in our efforts in reorganizing Visa as a publicly traded company. Revenue growth is strong and our expense base is currently growing at a very modest rate. We delivered operating margins ahead of our internal expectations and external guidance over the span of our short public life. Given the opportunities to continue to leverage the scale and effectively manage our expenses, we are increasing our longer term adjusted operating margin guidance to the mid to high 40% range. Byron will get into the additional detail in a moment.

From a broader economic perspective the financial markets and the economy, particularly here in the U.S., have clearly seen their share of turmoil since we last reported earnings at the end of April. Our expectation going into our fiscal 2008 year was for tougher economic times in the back half of the year and our revenue guidance contemplated this. During the first three fiscal quarters we have exceeded our guidance and although the tougher climate is now here and will likely continue, we expect the fourth fiscal quarter to be at the upper end of our revenue guidance range. For the calendar quarter ending June 2008 on which our fourth fiscal quarter’s USP service revenue will be based. Payment volume in the U.S. though softening has held up pretty well.

So what does this mean for Visa? As we have publicly stated our business model remains resilient though not totally immune to the tough economic environment in the U.S. and to some extent globally. We continue to see secular shift to plastic particularly in our debit products in the U.S. and international volumes, including cross border transactions are still posting solid double digit growth. We continue to see increases in consumer driven non-discretionary spending on cards. Through the end of June U.S. consumer non-discretionary spend as a percentage of total spend is up two percentage points over the end of 2007 and now represents 44% of overall Visa consumer payments volume in the United States. The 2% increase is represented by increased debit and credit usage. So while we are maintaining a cautious posture we are optimistic about the future.

On the legislative front we had a busy quarter as well. As we were no longer subject to the IPO restrictions of speaking about our company we were able to make some good headway in Washington on the issue of interchange and Visa’s part in the process. This involved a significant amount of outreach to committees and their members as well as testimony from our management team. While there’s no way of knowing for certain what the final outcome will be we feel better knowing that the issues are now being appropriately debated. We would also note that there has been opposition to the Conyer’s bill on both sides of the aisle as well as from consumer groups, credit union coalitions and the Department of Justice. We will continue to actively participate in legislative and regulatory activities which affect our industry.

On the litigation front there are a few developments to report in the Discover action which is a covered case under Visa’s retrospective responsibility plan. We recently entered into a judgment sharing agreement which allocates payment responsibilities between Visa and MasterCard for judgments or settlements in the Discover case, with Visa’s share being larger primarily based on relevant bias. At the same time we entered into a mutual release agreement in which Visa and MasterCard release any claims each may have against the other in connection with prior business practices. This includes MasterCard’s claims regarding Visa’s settlement service fee which is referenced in our SEC filings as not a covered claim under our retrospective responsibility plan. As a result of these agreements we increased our litigation reserve for the quarter by $31 million on an after tax basis. Because the Discover litigation and related claims are non-recurring legacy items we have not included these reserves in our adjusted income figures.

With that, let me turn the call over to Byron who will take you through the financial results and I’ll be back to provide more detail around some of the newer initiatives we have recently started.

Byron H. Pollitt Jr.

 

Before discussing the P&L let me highlight some of the business and revenue drivers from the quarter. Payment volume, which is a key driver of revenue, grew 19% to $652 billion over the same quarter of 2007 as we continued to see strong results across all of our regions. Credit growth, which was just under 19% worldwide while growing here in the U.S. at a little over 8%, compared to debit in aggregate which grew closer to 20% made up of a solid 16% growth domestically and a strong 44% internationally. We continue to view the secular migration to debit and the opening up of additional payment categories as very attractive near term opportunities.

For the calendar quarter through the end of June we have experienced continued solid payment volume growth in the U.S. of 10%. Though moderating a bit from the 12% we reported for the March quarter, we have seen a fairly consistent monthly rate through the end of June and continuing into July. Cross border volume growth, which is currently growing at a robust mid to high teens rate, has trended lower as well from the mid 20% range we experienced through March. The exception to this has been our CEMEA region which continues to grow in the mid 30s range. From an overall payment volume perspective we believe the combination of U.S. debit and international growth will continue to provide growth momentum to our business in spite of the increasingly challenging economic backdrop. Total transactions, including payment and cash transactions, were up 15% to $13.2 billion in the quarter ending March 2008 versus the prior year. While the U.S. grew approximately 12% during the period we say very strong gains across the globe, highlighted by our CEMEA region at 24% and Asia Pacific and Latin America at 20% and 18% respectively.

process transactions were those that we define as being processed over Visa’s network totaled $9.5 billion in the fiscal third quarter, an increase of 13% over the similar period a year ago. This transaction growth drove strong gains in data processing fees which rose 20% over the prior year to $539 million. Card growth for the period ending March was up 14% excluding Europe with over 1.6 billion cards now carrying the Visa brand. Credit grew 14% to 814 million cards while debit rose 15% to 850 million cards. On an international basis credit card growth was very strong, growing 19% year-over-year while international debit cards grew 16%.

Moving on to the income statement, gross revenues of $1.9 billion were up 23% from the year ago period’s $1.5 billion. Volume and support incentives increased by $99 billion to $274 million representing 15% of gross revenue. For the fourth fiscal quarter we see volume and support incentives running at around 16% of gross revenue. Total net operating revenues were just over $1.6 billion, an 18% over the pro forma operating revenues of $1.4 billion reported for the third quarter of 2007. As we stated on last quarter’s earnings call price adjustments made in non-U.S. regions that were fully implemented in the fiscal third quarter of 2007 are no longer influencing year-over-year comparables to as large a degree as they have in previous quarters, so the impact is still positive.

During the quarter we observed certain dynamics across all of our key fee categories that continue to reinforce our belief that our business model can sustain attractive growth despite a weakened U.S. economy. Globally, service fees were $749 million up 13% over the pro forma result of the prior year period reflective of higher year-over-year payment volumes in all regions. Data processing fees posted strong gains rising 20% over the prior year to $539 million. We continue to benefit from the greater transaction volumes domestically while continuing our focus on increasing the number of transactions we process internationally.

International transaction fees were up 44% to $449 million and continue to benefit from higher multicurrency payment volume across all regions as well as from pricing adjustments we made in April of this year to cross border transactions involving U.S. issued cards. As mentioned earlier cross border transactions remain strong although we are starting to observe a moderation in the growth rate. Our adjusted operating margin was approximately 45% this quarter, an increase of approximately seven percentage points over the similar period last year. The combination of 18% net revenue growth with 4% expense growth drove this margin expansion and resulted in a 42% increase in operating income.

Given our performance through the third fiscal quarter and despite our expectation for modest margin compression in the fourth quarter we now expect to deliver an adjusted mid 40s margin for all of fiscal 2008, ahead of our initial long term guidance of the low 40s. As we look out to 2009 and beyond, the resilience of our business model combined with opportunities for additional operating leverage make us comfortable raising our adjusted operating margin guidance to the mid to high 40% range as part of our outlook through fiscal 2010.

On an adjusted basis, operating expenses for the quarter increased $31 million or 3.6% year-over-year to $883 million as modest increases in personnel, network and marketing costs were offset by lower professional and consulting fee expenses. On a sequential quarter basis, adjusted expenses increased by $100 million primarily as a result of stepped up marketing and advertising costs commensurate with the mid May kickoff of our Olympic programs and modestly higher professional fees tied to our new product initiatives. In the fourth quarter we anticipate further increases in marketing and advertising spend tied both to the Olympics and marketing programs ahead of the fourth calendar quarter holiday season. All told, marketing and advertising spend should total about $1 billion in fiscal 2008.

We also expect a step up in professional fees tied to supporting the new product and channel initiatives which Joe will speak about in a moment. Capital expenditures were $86 million in the quarter, over half of which are dedicated to the build out of our new data center. Full year capital spending is expected to be in the range of $425 million to $450 million. As we have previously stated we expect capital expenditures to remain at an elevated level through the end of fiscal 2009 as we complete our new data processing center. After this we expect cap ex to run at around 3% to 4% of gross revenue on an annualized basis.

Moving on to the balance sheet, we ended the third quarter with cash, cash equivalent, available for sale investment and restricted cash of $8.4 billion, an increase of approximately $400 million over the prior quarter. Of this total there is restricted cash of approximately $2 billion which represents the balance of the $3 billion litigation escrow established at the IPO less the initial payment to American Express of $945 million last quarter and their first quarterly payment of $70 million. In addition we ended to use $2.7 billion cash to redeem all of the Series 2 and a portion of the Series 3 Class C shares this October that are held by Visa Europe. As mentioned previously, given our sizable and growing cash balances we are very focused on not allowing excess cash to build up on our balance sheet and to that end we will be considering a share repurchase program as early as the first fiscal quarter of 2009.

Now I would like to comment on what we see over the balance of 2008. As I mentioned a moment ago we entered 2008 with the expectation that a softer U.S. economy would have an effect on our payment volume and revenue growth over the next several quarters and we are now starting to see that impact. We also have a pretty clear view into our U.S. payment volumes for April through June which will be reflected in service fee revenue in our fourth fiscal quarter.

Based on this early view we are still running at the higher end of our stated revenue guidance range of 11% to 15%. As noted earlier we are increasing adjusted operating margin guidance from the low 40% range to the mid 40% range for fiscal 2008 and over the longer term, 2009 through 2010 to the mid to high 40% range. We also remain on track to deliver adjusted diluted earnings per share growth upgraded in 20% and annual free cash flow exceeding $1 billion.

That concludes my comments so I’ll turn the call back over to Joe.

Joseph W. Saunders

 

Before we begin the question and answer period let me touch on some of the longer term initiatives and progress we have seen over the past several months. As many of you know, on our IPO road show we outlined a series of near term and longer term strategic priorities that we would be investing in support our growth. Near term we talked about the opportunity to export many of the successful programs we established here in the U.S., like our affluent credit programs, Visa Signature and Visa Infinite, and our debit card product. Executing on these initiatives continues to represent a significant opportunity to have an influence on our 2009 plan.

Longer term opportunities we’ve identified include money transfer, prepaid mobile payments and e-commerce. Many of these innovations are already operational in Visa regions worldwide and under Visa’s new structure can be scaled more easily on a global basis. While these initiatives are relatively small today in relation to our total value we see opportunity to invest in these programs, use our brand and business scale and drive incremental transactions on the Visa network over the longer term. Of note is Visa’s money transfer service where we continue to build momentum.

Today we are announcing the extension of Visa’s card based money transfer service to millions of additional card holders with the launch of new services in Indonesia and the expansion of the program in Singapore. Specifically, Bank Mandiri, Indonesia’s largest bank is making Visa money transfer available to approximately 8 million debit card holders. The service will allow Bank Mandiri’s card holders to send money through any of the bank’s 3,000 ATMs to any other Visa card holder in Indonesia. Recipients are able to use the money to make purchases, pay bills or withdraw cash from any Visa or Plus ATM anywhere Visa is accepted in the world.

Additionally Singapore Post Limited plans to expand its recently launched money transfer service to automated machines that will be available to card holders 24 hours a day. The service facilitates money transfer from customers in Singapore to Visa card holders in nine countries, including China, Indonesia and the United Kingdom. Today’s announcement builds on our existing stable of 46 Visa money transfer programs that have been rolled out in 13 countries. We believe the scale and reach of Visa’s global network ideally positions us to capitalize on the money transfer opportunity over the long term.

Another important area of investment for Visa is prepaid which we believe is critical to unlocking new opportunities worldwide. By offering consumers the option to pay ahead, Visa is able to reach new demographics such as the unbanked or under banked and expand relationships with clients including governments, businesses, health care providers and merchants. One of our best success stories to date is government benefits. In the U.S., 35 states participate in 58 Visa prepaid programs to disburse funds including child support, unemployment insurance, workers’ comp and other assistance instead of checks. Last month the State of Michigan launched a Visa prepaid program to deliver unemployment insurance funds which will provide consumers a safe and convenient option to checks and bring cost savings to the state.

Around the globe Visa prepaid products are bringing significant value to consumers who rely heavily on cash and checks. Last week Visa and Absa Bank, a subsidiary of Barclays, introduced the first reloadable prepaid cards in South Africa and in June, Visa and Taiwan Cooperative Bank launched Taiwan’s first general purpose reloadable prepaid card, further extending the reach of Visa prepaid programs to underserved consumers.

Mobile payments are a great opportunity but also a great complexity as multiple wireless standards and operating systems exist around the globe. To address these challenges we launched the Visa mobile platform last year, a suite of technologies that enables Visa, its clients and mobile operators to engage in trial activities in more rapidly developed commercially scalable mobile services. While more work must be done, Visa has successfully launched a range of mobile services that are in market or being tested today with cardholders in 14 countries around the world, including the U.S., Australia, Canada, Taiwan and Brazil.

With more than 3.5 billion mobile devices in the market around the world and 80% of the world’s population living within range of a cellular network we believe Visa has a significant opportunity to build on our leadership, extend our products and services to new geographies and drive more electronic transactions to Visa net. As we have stated in the past our focus on the e-commerce phase is designed to increase our industry leading 47% payment penetration here in the United States. We are developing enhanced checkout, gateway and online authentication services to improve merchant and cardholder experiences. In fact, we expect to bring to market the next upgrade of online authentication later this year.

We are also in the process of further advancing cross border functionality especially between the U.S. and Latin America and the U.S. and Asia. More recently, in India, we launched eMarketplace in association with ICICI Bank, one of the largest financial institutions in that country, enabling end-to-end execution of procurement and payment over the internet using a Visa purchasing card. This is the first Visa eMarketplace service to be launched in Asia Pacific.

As always we will continue to update you on these initiatives as they progress. With that, we’re ready to take your questions.

Question-and-Answer Session

Operator

 

(Operator Instructions) The first question is from Bob Napoli of Piper Jaffray.

Bob Napoli – Piper Jaffray

 

Question, I think it would have been a bigger surprise if you had not raised your operating income margin guidance but I just wondered if you could break it down a little bit on what drove the income guidance, the increase. Is it lower volume and support agreements or general, better efficiency than what you expected? What drove that increase?

Byron H. Pollitt Jr.

 

The math of it is, as we continue to drive strong double digit gains in revenue above our initial expectations for this year; so we delivered 18% this quarter and on that only a 4% increase in expenses and we were able to sustain higher levels of revenue growth for this year compared to our original expectations. We became much more confident that we could sustain a margin higher than what we had originally anticipated and therefore felt confident in adjusting the margin guidance.

Bob Napoli – Piper Jaffray

Just a follow-up, do you think that there is a natural cap on your margin driven by volume support agreement, demands from customers or …? I just wonder if you could comment on that.

Byron H. Pollitt Jr.

The way we’ve chosen to respond to margin expectations is with our guidance, and so over the next two years we believe that we can sustain operating margins in the mid to high 40s and that is as far out as we’re looking at margins today.

Operator

 

The next question is from Tien-Tsin Huang of J.P. Morgan.

Tien-Tsin Huang – J.P. Morgan

In a couple quarters, a couple questions from the quarter. First, Byron, I guess the cross border volume trends. What is the geographic exposure that you have there and what regions are you seeing growth moderate the most?

Byron H. Pollitt Jr.

 

That would be the, what we would say on the cross border volume is that we’re maintaining very, very strong, robust growth outside the United States even though it has moderated a bit. As we said on the call it is still mid to high teens in terms of growth and that growth is very healthy across the globe outside the United States. The growth rates are still positive in the U.S. but we’re seeing more of the impact in the U.S. than anywhere else in particular and CEMEA of course was a call out of maintaining 30 plus percent growth rates on cross border.

Tien-Tsin Huang – J.P. Morgan

Is your exposure to the U.S. in cross border similar to your overall exposure to the U.S. in terms of purchase volume?

Byron H. Pollitt Jr.

 

What we’d say is it’s a well diversified portfolio of cross border

Tien-Tsin Huang – J.P. Morgan

I just wanted to confirm that you expect fourth quarter revenues to be at the high end of your 11% to 15% range.

Byron H. Pollitt Jr.

 

That’s correct. The annualized guidance is 11% to 15%. When you apply that to the fourth fiscal quarter what we’re suggesting is that our performance is consistent with coming in at the higher end of that range, net revenue for the fourth quarter.

Tien-Tsin Huang – J.P. Morgan

So if that’s the case I’m just trying to understand what would drive the shift from the 18% growth in the third quarter to roughly 15% in the fourth quarter.

Byron H. Pollitt Jr.

 

We have annualized a number of price adjustments that are having, really we’re coming to the end of their full effect and we already are informed by our U.S. volume which is consistent with the, on a month-to-month basis, has been consistently delivering around a 10% payment volume growth from March forward and with the moderating impact that we alluded to in our cross border volume. We would see a somewhat marginal decline in our revenue growth from 18%, which we delivered in this quarter, to the upper end of our guidance range, 11% to 15%.

Operator

 

The next question is from Adam Frisch of UBS.

Adam Frisch – UBS

 

In my conversations with investors I get the feeling that most people are focused on a slower consumer but forgetting about the secular trends that are a cornerstone to our thesis, so can you address from what you are seeing in your payment trends? Will there be a shift from credit to debit or other factors that could make us feel good that the model is still holding up and there are secular trends still in play here? Also, describe the hedging that your volume support line offers. I’m assuming it works very well in a slowdown but a meltdown might be a different kind of story, if the consumer feel off the cliff. If you could just address those two perspectives?

Byron H. Pollitt Jr.

Let me start with the hedging. With regards to our FX exposure on revenue, which is one way of looking at this, our revenue lift is roughly 2% and with regards to the overall exposure to the cross boarder volume, I think we have a very well diversified set of strong growth rates cross region so in that regard we feel that if the economy falls in any one particular country or region, we are well diversified. Then, an increasing number of our contracts are multiyear in nature and therefore have incentive clauses that will vary by volume and so if the growth rate in any of these contracts slows down, we have a natural adjustment as it relates to the way the incentive formulas work. So, while not immune to a slowdown in any part of the world or in any particular economy or client, we do have, I think, a well diversified set of factors that will help make our business less vulnerable and more resilient.

Adam Frisch – UBS

Pricing impact on the quarter you said was more muted, should we anticipate any change in the near term there that could get the growth rate up a little bit more than we’re expecting?

Byron H. Pollitt Jr.

I would suggest that you go back to our guidance. We have fully factored in all the factors including pricing adjustments that would impact our net revenue growth and we feel very good about high end of that 11% to 15% range for the fourth fiscal quarter and we feel very good about delivering in that range over the two years 2009 and 2010 at this point.

Adam Frisch – UBS

Last question here, I was going to ask about cost but the card based remittance initiative I have to ask because it’s been a long time coming from what we’ve been writing about. How has this been tracking in the market it’s been around in for a while? And, are you gaining new customers or taking share from traditional players?

Joseph W. Saunders

I’m not sure I understand the question.

Adam Frisch – UBS

On the card based remittance programs that you already have out there, how have they been tracking in terms of growth? And, are you gaining new customers or taking share from traditional players? In other words the new customers being people that never spent money before?

Joseph W. Saunders

In general, we’re gaining new customers. We’re offering a new service to our own customers and its being done on a global basis and it’s being done between many different varying countries, it isn’t a US to Latin America, or US to Asia center program. I don’t think it’s big enough yet to say we’ve stolen share from anyone.

Operator

 

Our next question comes from Dan Perlin – Wachovia Securities.

Dan Perlin - Wachovia Securities

Just a couple of quick questions, one is if you could maybe decouple – you know, your international fee growth was up over 40%, I think Byron you mentioned your transactions were in the mid to high teens, maybe even low 20s and obviously FX had an impact there. Can you just talk about reconciling the transaction growth that drove that along with FX so we can kind of figure out what the pricing component of that was?

Byron H. Pollitt Jr.

Dan, the primary component of the difference between the two, remember this is an area where we have probably done the most in terms of price adjustments over the past year or so and what you’re seeing is the impact of those. Initially with cards issued outside the United States and as recently as April we took some steps that would increase the revenue impact based on cards issued in the United States and that’s the primary explanation for the difference between what we recorded in aggregate and the percentage increase in transactions.

Dan Perlin - Wachovia Securities

Is there another one that we should be thinking about as we go in to 2009?

Byron H. Pollitt Jr.

On the international side we have not announced anything and with regards to pricing in general, all of that – let me just assure you, we take appropriate steps that make good business sense for our customers, our clients and all of that is reflected in the guidance we have given you for the fourth quarter and for the next two years.

Dan Perlin - Wachovia Securities

Then on the other revenue line, that was up quite a bit as well. Were there some pricing adjustments that you took advantage of there?

Byron H. Pollitt Jr.

No.

Dan Perlin - Wachovia Securities

Can you just remind us, consumer inflation, the impact that you have on your non-discretionary spending line, is that playing a meaningful role in the quarters or not so much?

Byron H. Pollitt Jr.

We haven’t looked at that and evaluated it. Our sense would be short of certain commodities that have increased significantly in price that that is generally not so much a factor.

Dan Perlin - Wachovia Securities

Then a question on the marketing and advertising spending, you gave us a number of $1 billion for the full year so that implies somewhere around $300 million. What was in last year’s number because that number would be down pretty significantly year-over-year? Were there some onetime items? I just forget, on a year-over-year basis it will be year-over-year down pretty significantly?

Byron H. Pollitt Jr.

A damn good question. I know that it will be of interest to many to figure out how to seasonally model our marketing and it’s simply too early or it’s just premature to try and do that at this point. You have the math right in terms of the $300 million or so given that we have three quarters of actual but, as we had indicated I think, on a prior call, we still have a relatively new in place chief marketing officer who is rationalizing our marketing spend globally, reprioritizing it based on return on investment and as a result, past is not something you should count on as prolog and as we develop a more normalized cadence in our marketing then we’ll be able to highlight for you and you’ll be able to model it better.

Operator

 

Our next question is from Elizabeth Grausam – Goldman Sachs & Co.

Elizabeth Grausam – Goldman Sachs & Co.

I just wanted to ask another question around your US volume. In the comments you made earlier, you had about 12% total payments volume in March quarter in the US and I think you said that went to 10% from the month of March to the month of June. Is that the correct progression to think about? And also, was that dominantly driven by further deceleration in credit from March to June or did you also see your debit portfolio decelerate in growth?

Joseph W. Saunders

What we said was that the growth in the US volume was about 10% from March through this month. And, so the 12% to 10% was on a quarter-by-quarter basis and what that would suggest was that the growth was more robust in January/February. But, since March it has been very consistent. So, the answer is we don’t see a lot of movement in the volume, or we haven’t seen much movement in the volume in the US since February. And, February’s growth rate was influenced to some extent by the fact that there were 29 days in February.

Elizabeth Grausam – Goldman Sachs & Co.

 

And the deceleration you saw in January and February through to March to June was that predominately in credit or both credit and debt, was it blended?

Joseph W. Saunders

Predominately it would be more pronounced in credit.

Elizabeth Grausam – Goldman Sachs & Co.

Another question on your service fees, a similar question as Dan asked around your international fees, the service fee growth in the quarter was about 13% revenue growth but it was on 19% volume. It’s the first time we’ve seen revenue growth actually below the volume growth but yet the incentives line was also lighter. Can you help us understand the balance between thinking about pricing and the gross service fees and how that mechanism works with your incentive fees?

Byron H. Pollitt Jr.

More to come on this later Liz, I think from our perspective it’s just a bit premature to look for quarter-to-quarter patters until we can normalize our operations now that we’re in for profit mode. We have everything from seasonality, price adjustments, FX movements and until we can get in to a more normalized cadence, it’s hard for us to provide a thoughtful explanation as to particularly the sequential growth. Year-over-year is easier but the sequential is harder until we can accelerate through the normalization of a for profit company. More to come on this one.

Joseph W. Saunders

But, on a sequential basis, the previous quarter included December.

Operator

Our next question comes from Craig Maurer – Calyon Securities (USA), Inc.

Craig Maurer – Calyon Securities (USA), Inc.

I was hoping you could comment on the spending from your signature customers as we saw a big fall off in American Express’ numbers and their card holders are generally viewed to be at the upper tier. So, I was wondering if you could comment on if there was any unusual drop off in your signature cards versus your standard Visa cards.

Joseph W. Saunders

Actually, our signature volume has held up very, very well and as a matter of fact, it’s significantly up on a year-over-year basis. It’s our traditional card volume that is down and I talked about that last quarter. You’re asking me a question about signature cards versus AMEX in general and while they have a huge component of that and I can’t speak for them, they’ve also gotten in to lending a lot of money.

Operator

 

Our next question come from Patrick Burton – Citigroup.

Patrick Burton – Citigroup

I guess I’ll ask about the tax rate. Byron, it looks like you’re looking for a little higher tax rate this year and then progressing lower from the 41 level?

Byron H. Pollitt Jr.

That’s correct. So, just to repeat expectations, as we completed our restructuring in October and for the first time assembled our five businesses, we had no corporate tax planning and as a result we find ourselves unenviable at a 41% rate and we are engaging in what we would describe as classic global tax planning and over the next five years expect to get down in to the 36% range and would expect in the year to come, fiscal year 2009, to generate at least one to two percentage points reduction in that tax rate.

Patrick Burton – Citigroup

And would you expect 41% in the fourth quarter?

Byron H. Pollitt Jr.

Note that when we do our adjusted earnings, we apply a 41% tax rate. From a book standpoint, we actually have some adjustments that we have described in our financial statements that are largely due to purchase accounting and therefore do not have a cash impact on our tax rate. So, to assume something in the vicinity of 41% as a cash tax rate for the fourth quarter would be fair.

Operator

 

Our next question comes from [David Haxton – Buckingham Research].

[David Haxton – Buckingham Research]

Could you maybe provide a little bit more color on what you’re seeing so far in terms of marketing spending and where there are some opportunities to shift dollars? And, also provide us color on US credit card spending? You mentioned that signature volume was up a lot but are there any other kind of noteworthy trends geographically or by other products?

Joseph W. Saunders

Well, I think that what we’ve said is that credit card spending in general is much softer, it’s not down but it’s marginally up in the low single digits. So, our debit card spending on the other hand has continued to grow and is very robust. Signature cards are not a predominate part of our overall volume.

[David Haxton – Buckingham Research]

Could you give us an update in terms of what percentage of volume is on signature now?

Joseph W. Saunders

We don’t break that out right now.

[David Haxton – Buckingham Research]

And in terms of marketing, I guess looking at expenses overall as you’ve become a for profit company and you’ve started your review of expenditures around the world, what kinds of things are you seeing that are opportunities?

Joseph W. Saunders

Well, first of all we have an opportunity to consolidate the way we spend money by consolidating agencies and running the marketing environment out of a single place. We obviously have marketing people in all of our regions that support our marketing efforts but it is more singularly and more effectively driven and it certainly will be in 2009 and its improved over the year 2008. As it relates to where we spend money or how we spend money, we spend money predicated on a pretty rigid ROI model and we are looking at opportunities in different regions in the world where we think we can make a difference.

[David Haxton – Buckingham Research]

Then can you just tell us, I think there was an uptick in investment income this quarter, was there anything there?

Byron H. Pollitt Jr.

We’re carrying higher cash balances and that’s the principal reason. We’re getting a little more yield but, it’s principally higher cash balances.

Operator

 

Our next question is from Christopher Brendler – Stifel Nicolaus & Company, Inc.

Christopher Brendler – Stifel Nicolaus & Company, Inc.

Just to beat down on the pricing a little bit more, the international fee increase on cross boarder that you implemented in April, that was the only significant price increase in the second quarter?

Byron H. Pollitt Jr.

That is the principle price increase for the second quarter.

Christopher Brendler – Stifel Nicolaus & Company, Inc.

And that’s actually effective in the fiscal third quarter revenues you just reported?

Byron H. Pollitt Jr.

Yes. Think of that as beginning in the fiscal third quarter.

Christopher Brendler – Stifel Nicolaus & Company, Inc.

So, I guess I’m trying to understand is a couple of things, we talked about the pressure I guess on services fees, if you look at volume on service fees relative to revenues the margins there got squeezed a little bit and your guidance for fourth quarter revenues at the high end of you guidance what kind of volume are you assuming for the fourth quarter. Does the margin continue to compress a little bit? Or, is there anything else that we’re not really discussing yet in terms of pricing that would cause the service fees to bounce back a little bit in the September quarter?

Byron H. Pollitt Jr.

Obviously there are a lot of factors that go in to a projection. The way that we’ve tried to be helpful with this is to give you a combination of revenue guidance, 11% to 15% upper end of that range for the fourth quarter and to do that – which reflects all the initiatives we have underway including anything that we may have done on the pricing front and then to combine that with a margin expectation which, as you noticed, we have moved our margin guidance up for the full year to mid 40s although we do expect some margin compression in the fourth quarter. But, that is less about revenue and much more about an increase in marketing spend which we called out as well as professional fees associated with new product initiatives so that’s much more expensive driven, that margin compression. Then, with regards to the impact that any other action we might take within the pricing front, all of that is reflected in the revenue guidance we’ve given for 2009 and 2010 which again, we have given all of you with an expectation of operating margins associated with that which gives you the type of operating leverage we expect to deliver and of course, on this call we have raised that to mid to high 40s with an 11% to 15% annual revenue guidance. So, that’s how we’ve tried to be helpful on this point.

Christopher Brendler – Stifel Nicolaus & Company, Inc.

Let me ask you just one more way. I didn’t quite understand that your answer to Liz’s question on the service fees as well. What are the quarter-to-quarter variances? How does FX impact that line? One thing that I was thinking about was your seeing a little slower growth in credit and debit may be a little bit lower margin on a revenue basis so that’s impacting a little bit. Anything else you could sort of call out quarter-to-quarter that would impact? I wasn’t quite sure what you were referring to in your earlier answer on the service fees.

Byron H. Pollitt Jr.

Again, I would say nothing to call out at this time. They’re just a number of factors that vary from quarter-to-quarter and as I mentioned before, it’s seasonality, incentives, FX is definitely a part, the timing and impact of price adjustments, all these things in order to be helpful ultimately with an answer that can inform models so that you can get better projections, we’ve got to sort that out and we’re doing it in our first year as a public company and we’re simply not at a normalized rate where we’re prepared to give a thoughtful point of view on that kind of breakdown. So, if you’ll just bare with us a bit longer we’d be happy to be more informative as we get in to our more normalized operating mode.

Christopher Brendler – Stifel Nicolaus & Company, Inc.

One final just clarification, the deceleration in cross boarder activity, you said that was more pronounced in the US. How much more pronounced in the US and is it relatively stable outside the US or is it also slowing outside the US?

Byron H. Pollitt Jr.

We didn’t guide to that, what we said was that back in March it was in the mid to high 20s. What we’re now seeing today is mid to high teens so it has moderated but it is still very robust at mid to high teens and as you would expect, the US given its economic backdrop would be feeling that a bit more than the other regions outside the US.

Operator

 

Our next question comes from Sanjay Sakhrani – Keefe, Bruyette & Woods.

Sanjay Sakhrani – Keefe, Bruyette & Woods

Most of my questions have been asked already but just a quick question maybe on the supply side. Have you guys seen any noticeable trends from your financial institution partners in pulling back lines or decelerating account growth?

Joseph W. Saunders

Well, I think it’s clear that there is some of that going on, it’s a fairly difficult environment. But, remember our income is driven by activity and that means that we are primarily influenced by cardholders that are not at the pushing the top of their credit limit, they’re not delinquent. These are not the types of bank customers that drive much volume through our system. So, it’s harder for me to discern those trends and the data that we would have on it would be at least a quarter old.

Sanjay Sakhrani – Keefe, Bruyette & Woods

Just clarification on the litigation commentary, that $31 million, that’s all for the Discover litigation?

Byron H. Pollitt Jr.

No, what we said was that as a result of a review of our litigation portfolio and agreements that we have entered in to that it was appropriate for us to take a FAS 5 litigation reserve against legacy cases that we do not expect to repeat going forward. So, as you can appreciate, it is not our practice to discuss ongoing litigation but the reserve is a FAS 5 reserve associated with a case that would not be covered by our retrospective responsibility plan.

Joseph W. Saunders

But, is related to the Discover litigation.

Operator

 

Our next question comes from Andrew Jeffrey – SunTrust Robinson Humphrey.

Andrew Jeffrey – SunTrust Robinson Humphrey

Byron, just maybe on a more qualitative basis, I look at the volume and support incentives, can you just comment on how you are issuing customers who are performing versus the contractual obligations that were set up when you entered in to each of those just sort of directionally better, worse, kind of in line?

Byron H. Pollitt Jr.

Most of the incentives that we commit to contractually today are in the United States so as a backdrop, if the economy is more challenging and if payment volume growth rates are less than what they have been over the past several years when the US economy was stronger, then it would be natural for the incentive earn outs to be less than what they would have been a year or two ago. These things are difficult to model absent knowing exactly what growth rate each individual client is delivering. But, I would say on average as a US portfolio, it is paying out less primarily driven by the economic environment that all our clients find themselves in today in the US.

Andrew Jeffrey – SunTrust Robinson Humphrey

Any view toward ongoing or maybe accelerated deceleration if you will, a slowdown in volume growth would have probably a commensurate positive affect if you will on the contra revenue line?

Byron H. Pollitt Jr.

What we tried to give you to be helpful is first very near term, what we’ve indicated that for the fourth quarter of this year, we think the incentives, we think of it as incentives as a percent of gross revenue. We’re suggesting or guiding that we think it will be around 16% incentives to gross revenue in the fourth quarter which is in a much more normalized range of incentives to gross revenues. So, something in that range of 16% to 17% is something we think would be fair to think about in the near term.

Andrew Jeffrey – SunTrust Robinson Humphrey

Then, just a question on the competitive environment, anything changing first of all on pricing? And secondly, obviously MasterCard has announced a fairly aggressive push in to debit, one of the features of which is the option to use any MasterCard, signature card as a pin debit card. Any view on how that might sway issuers decisions as to who’s brand they’d rather have predominate on their cards?

Joseph W. Saunders

We’re mindful of what MasterCard has done and we’re respectful of them and what they have done but there’s no way in the world I would guide you to the fact that we’re going to lose any significant debit volume in the near future or in the future that I can see.

Operator

 

Our next question is from Bruce Harting – Lehman Brothers.

Bruce Harting – Lehman Brothers

It looks like this is your strongest debit volume growth quarter in the last seven or eight. How high can that go and how low do you think the credit growth can go specific to the US? And Joe, you mentioned you have the ability to visit Washington, if you could, could you frame the debate as you see it and what the Visa platform is?

Joseph W. Saunders

I think we’re looking at reasonably steady state growth parameters in the credit and the debit right now. I don’t see it changing a lot in the near future. But, I don’t know. I mean, it’s not predictable. As it relates to Washington, I think what we said earlier was that we have an ability to go there and we have an ability to talk to them and we have an ability to lay out the facts and we’re considerably more positive about the end result than we might have been even a couple of months ago and we’ll continue to do that. Of course, I’m talking about Interchange, I’m not talking about Fair Credit Billing Practices. That is not an issue that we are directly involved in. It is not an issue that we would talk to anybody in Washington about, that is an issue between financial institutions and the Fed and Congress.

Bruce Harting – Lehman Brothers

Is there anything between now and the election that would come forth out of Washington on Interchange?

Joseph W. Saunders

I don’t believe so.

Jack Carsky

 

Thank you all very much for joining us today. If anybody has follow up questions, please feel free to call investor relations.

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Source: Visa Inc. F3Q08 (Qtr End 06/30/08) Earnings Call Transcript
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