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MasterCard Incorporated (NYSE:MA)

Q2 2008 Earnings Call

July 31, 2008 9:00 am ET

Executives

Barbara Gasper - Investor Relations

Martina Hund-Mejean - Chief Financial Officer

Analysts

Tien-Tsin Huang - J.P. Morgan

Patrick M. Burton - Citigroup

Adam Frisch - UBS

Christopher Mammone - Deutsche Bank - North America

Elizabeth W. Grausam - Goldman Sachs

Christopher Brendler - Stifel Nicolaus

Craig Maurer - Calyon Securities (NYSE:USA) Inc.

Sanjay Sakhrani - Keefe Bruyette & Woods

Tim Willi - Avondale Partners

Charles Murphy - Morgan Stanley

Operator

Welcome to the second quarter 2008 MasterCard Incorporated earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Barbara Gasper, Head of Investor Relations.

Barbara Gasper

Thank you for joining us today, either by phone or webcast, for a discussion about our second quarter 2008 financial results. With me on the call this morning are Martina Hund-Mejean, our Chief Financial Officer; and Tara Maguire, our Corporate Controller.

Following comments by Martina highlighting some key points about the quarter, we will open up the call for your questions. In total, the call will last up to one hour.

This morning’s earnings release and the slide deck that will be referenced on this call can be found in the Investor Relations section of our website, www.mastercard.com. The earnings release and slide 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 August 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 Martina Hund-Mejean.

Martina Hund-Mejean

We are pleased with our overall second quarter results and while we remain mindful of the current economic environment, our business fundamentals continue to provide a solid foundation for us to meet our business objectives for 2008.

Turning to Page 2 of the slide pack, in the second quarter we delivered net income of $276.0 million, or $2.11 per diluted share, excluding a special item related to the settlement of our anti-trust litigation with American Express.

Under the terms of the settlement, we will pay American Express up to a total of $1.8 billion. We recorded in the quarter the pre-tax net present value of this liability of $1.65 billion. On an after-tax basis the charge was just over $1.0 billion. While our results have been impacted by the settlement, we are pleased to have brought this issue to closure. Including the special item, we recorded at net loss of $(747.0) million, or a loss of $(5.74) per diluted share.

Net revenue totaled $1.2 billion, up 25% over the comparable period last year. This was driven primarily by strong growth and worldwide GDV and processed transactions, as well as cross-border volumes, which grew 18.9%. Additionally, pricing changes contributed approximately 5% of the revenue growth in the quarter. Currency fluctuations also represented 5.4% of this growth.

Finally, demonstrating the continued leveraged ability of our business model, we saw our operating margin improve 6.1% to 33.4%, from 27.3% in the second quarter of 2007, excluding special items.

Before getting into the detailed financial results, let me just step back a minute and talk about what we are seeing across our business and the economic environment, both here in the United States and abroad.

Please turn to Page 3. The slow down in the U.S. economy has had an effect on our growth in the United States. Over the last few quarters we have seen a steady decrease in U.S. GDV growth from 10.6% in Q4 of 2007 to 8.9% in Q1 2008 and now the GDV growth for the second quarter was 6.2%. During the second quarter credit volume growth was only 0.7% but debit grew at 15.8%. U.S. purchase volume was slightly higher than GDV growth, while cash volume growth was down. Processed transaction growth is still ahead of volume growth at 7.8%.

As I shared with you on our last earnings call and at our annual investor meeting, in the U.S. we are still seeing consumer spending patterns shifting to more non-discretionary purchases. Our processed transaction data, as well as MasterCard Advisors Spending Cost Analysis, continues to show an increase in sales of necessary goods such as gasoline, food, and health care, largely due to increasing prices.

The impact of higher inflation and lower housing prices are compounded by the fact that consumers are finding it increasingly difficult to obtain credit as financial institutions tighten their criteria for loans and credit extensions.

However, we continue to see double-digit growth in markets outside the U.S., which contributed a little more than half of our revenues in the quarter. While there are economic downturns in the U.K., Spain, and a few other European countries, in general European markets continue to represent strong growth for us.

Furthermore, we still see healthy cross-border volume growth. While down slightly from the 20+% growth levels we have seen over the past two quarters, the second quarter growth rate of 18.9% is higher compared with the same quarter last year. As in recent quarters, this growth continues to be primarily driven by Europeans traveling in Europe and overseas and we have not seen any significant change in travel patterns on a year-over-year basis for any of the regions.

Last, as we have discussed before, much of our growth is being driven by the secular shifts of electronic payments, which we believe is somewhat independent of the cyclicality of current market conditions.

We continue to collaborate with our customers to help maximize the value of the payments businesses, recognizing that they are experiencing extraordinarily challenging conditions in the current economic environment. We are partnering with them as they refocus their efforts from account acquisition and marketing towards the maintenance of the existing business and areas such as broad-loss prevention.

We are not insulated from the pain that our customers are feeling and we are actively working our expense structure to deal with the changing demands of our customers. In a few minutes I will reference a couple of examples of actions that we have undertaken.

Switching now to some business highlights: On our last call we discussed our announcement of our debit process platform, Integrated Processing Solutions, OIPS. I am very pleased to report that we are now in light production with our first customer, Security Service Federal Credit Union, having successfully completed the critical first stage of a multi-stage conversion and implementation program.

With respect to our U.S. litigations, I have mentioned that we have entered into a settlement agreement with American Express in June. We will pay Amex up to $150.0 million for 12 quarters beginning this September and the payments will not exceed a total of $1.8 billion.

There are two recent developments related to the Discover case. First, this week we entered into a judgment-sharing agreement with Visa that the portions costs and liabilities both companies may incur in the event of either an adverse judgment or settlement of the case. This agreement provides that Visa would be responsible for the substantial majority of any judgment or settlement, based primarily on relevant volumes. Second, the district court recently indicated that it expects to issue decisions on summary judgment motions no later than August 18, 2008, and has rescheduled the trial to begin on October 14, 2008.

In mid-June we announced that we would comply with the European Commission’s ruling by temporarily repealing our default intra-EEA cross-border consumer card interchange fees effective June 21, 2008. We continue to hold discussions with the Commission to see what interchange fee-setting methodology we might employ in order to be compliant with their decisions. In any event, we will take appropriate action to ensure that we remain competitive in Europe.

With respect to our repurchase program, in the second quarter we repurchased approximately 1.3 million shares of Class A common stock for a total of $355.0 million. We have now completed the approved $1.25 billion repurchase program. We regularly review our capital structure with the Board and will continue to evaluate additional share repurchase programs in the future.

Further, this past February, our Board authorized the conversion of up to 13.1 million shares of Class B stock into Class A stock during 2008. In the second quarter we implemented and completed the conversion program with all of the 2008 authorized shares of Class B common stock converted into an equal number of Class A common stock, which was then subsequently sold for transfer to public investors. Class A shares now represent approximately 76% of total shares outstanding.

Let’s turn to Page 4 of the slide deck. Net revenue for the quarter exceeded $1.2 billion, an increase of 25% versus the year-ago quarter. Current fluctuations of the Euro and the Brazilian real relative to the U.S. dollar constituted 5.4% of the net revenue increase resulting in underlying business growth of 19.6%. Approximately 5% of this was due to pricing changes.

Excluding the several items related to the litigation settlement, our operating income of $416.0 million resulted in an operating margin of 33.4% for the quarter, a 6.1% improvement over the second quarter last year. As we have mentioned in the past, our strong revenue growth enabled us to leverage our operating margins. The contribution from foreign exchange was less than 1% of this increase. Net income we $276.0 million, or $2.11 per diluted share, excluding the special items.

Turning to Page 5, gross dollar volume grew 12.8% on a local-currency basis in the second quarter, and 18.2% on a U.S. dollar-converted basis, to $655.0 billion. This quarter was the 17th consecutive quarter of double-digit worldwide GDV growth on a local-currency basis. Growth in the U.S. was 6.2% and purchase volume growth in the U.S. was higher, at 8% versus the second quarter in 2007. Although not shown on Page 5, on a local currency-basis, worldwide purchase volume was up 14% and cash volume growth of 9.3% was slightly lower than the comparative quarter last year.

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 18.9% over the comparable quarter last year.

I would like to point out that beginning in the second quarter we refined our methodology of calculating our cross-border volume to use the merchant country rather than the acquirer country. The effect of this change only relates to volume growth rates, which is very small and has no impact on our reported revenues.

Prior reporting periods have been re-stated and can be found within the Supplemental Operational Performance data on our Investor Relations website.

Processed transactions, or transactions processed across MasterCard’s network, increased 13.6%, or $5.2 billion in the second quarter. We continue to benefit from the global diversification of our business with our ability to generate significant volumes, transactions, and revenues from economies outside of the U.S.

Net revenue yield was 19 basis points in the quarter, versus 18 basis points in the second quarter of 2007. Pricing changes were the primary driver of this improvement.

Let’s turn to Page 6. Here you can see the net operations fee increased 28.7%, or $209.0 million, to $938.0 million in the second quarter. Gross operation fees increased 27.5%, or $225.0 million to a little more than $1.0 billion. This growth was driven by several factors. First, growth in processed transactions, cross-border volumes, and gross dollar volumes that were previously described on Page 5. Second, new pricing changes implemented in January of this year on cross-border acquiring volumes and on retail purchases in the U.S. by non-U.S. cardholders. And third, revenue for other payment-related services such as new accounts enhancement program launched late in the second quarter of 2007 in global cardholder services.

In the second quarter net operation fees, as a percentage of gross operation fees, improved slightly due to a continuation of lower rebates to customers who did not achieve contractual performance criteria.

On Page 7 we show that net assessments increased 14.9%, or $40.0 million, versus the second quarter of 2007. Gross assessments increased 15.9% versus U.S. dollar GDV growth of 18.2%, or $80.0 million, to $583.0 million due to strong GDV growth slightly offset by mix. Net assessments as a percentage of gross assessments declined somewhat compared to the second quarter of 2007.

Please turn to Page 8 for some detail on expenses. In the second quarter, excluding the special items, total operating expenses increased 14.6%, of which 4.5% were related to currency fluctuations. The increase was mainly driven by two factors.

First, a 15.7% increase in general administration expenses, of which 3.3% were related to currency fluctuation. The growth in G&A was driven by higher personnel costs, excluding the impact of FX, personnel costs increased 18.1%, primarily driven by the hiring of new personnel as well as higher severance costs as we continue to align our business needs against our existing talent pool.

Second, we recorded a 13% increase in advertising and marketing expense. Currency fluctuations represented 6.6% of this increase. A&M growth was primarily due to the timing of expenses, mostly for sponsorship activities related to the UEFA and European Championship soccer events, as well as ongoing investments in high-growth markets.

Moving to the cash flow statement and balance sheet highlights on Page 9, we generated $319.0 million in cash flow from operations during the quarter. We ended the quarter with $2.7 billion in cash, cash equivalents, and available-for-sale securities. This includes the repayment of $80.0 million of subordinated debt. Available-for-sale securities decreased $84.0 million in the quarter, mostly due to the sale of short-term bond funds.

The American Express litigation had an impact on primarily two areas of our balance sheet. First, litigation liability increased by $1.65 billion. Second, our deferred income tax assets increased by $530.0 million. Both of these totals were broken down into their short- and long-term components that booked to the balance sheet.

In April this year we formally integrated the operating structures of our operations in France with Europay France forming a new entity, MasterCard France. This resulted in a 70% equity interest for MasterCard accounting for this transaction as 100% acquisition and we recorded a liability for the present value of the fixed purchase price of EU $15.0 million which will be paid by MasterCard in three years. At that point we will own 100% of the entity.

As of quarter end we have finalized the repurchase of approximately 1.3 million Class A shares in the open market for $355.0 million.

Before moving to the Q&A, I would like to spend a few minutes on Slide 10, highlighting a couple of items for your consideration as you refine and update your models for the remainder of 2008.

In light of what we currently see for our business, the longer-term performance objectives, what we talked about on May 29, remain unchanged. However, we have refined our outlook for full-year 2008.

We continue to expect slower net revenue growth than the 22.3% growth we experienced in 2007 but still at double-digit rates and assuming constant FX. Mid-year our revenue growth has been [inaudible] excluding FX. Lower U.S. growth [inaudible] net revenue growth for the rest of the year [inaudible] effect of performance criteria and customer agreements in our continued strong [inaudible].

Our outlook for G&A expenses, excluding special items, remains unchanged. It should grow at a rate that is both slower than 2008 net revenue growth and below the 2008 G&A growth rate of 16.8%. Similar to revenue growth, our 2008 outlook assumes constant FX. On a year-to-date basis G&A growth has been 10.3%, excluding FX.

With respect to A&M we now anticipate to spend roughly the same amount as in 2007 based on current FX rates as we adjust our efforts in line with our custom activities. We don’t anticipate as much marketing expense in the second half of this year, particularly in Q4. Previously we had been expecting to see a modest increase in total A&M spend for full year 2008 assuming constant FX.

These thoughts continue to assume no global recession and no event which significantly disrupts cross-border travel.

Finally, while we do not plan to break out the interest accretion impact associated with the American Express settlement as a special item, we do expect it will increase interest expense by $44.0 million for the second half of 2008. We have included in our schedule in the appendix to this presentation which models the increased quarterly interest expense amount over the settlement pay-out period over the next 12 quarters.

We are very pleased with our second quarter results but are mindful of the economic conditions that we are operating in. We are managing our business plans in light of a tougher market and are taking the necessary expense management actions as we see our customers realigning their plans. We remain committed to growing our business by managing costs and investments in order to drive shareholder value.

Barbara Gasper - Investor Relations

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Tien-Tsin Huang with J.P. Morgan.

Tien-Tsin Huang - J.P. Morgan

First, on U.S. credit growth, last quarter you mentioned a contract termination. Did that occur in the quarter, and if so, what was the impact?

Martina Hund-Mejean

I think we talked about that in the last quarter already. That was where a customer of ours sold their business to somebody else, and the impact in the quarter was actually relatively small, very small.

Tien-Tsin Huang - J.P. Morgan

I think you commented 0.7% growth in credit. Is that where it would have hit? I’m just curious what the growth would have been excluding that change.

Martina Hund-Mejean

It would not have significantly been different.

Tien-Tsin Huang - J.P. Morgan

Can you comment on monthly trends in general on U.S. purchase volume growth in the second quarter?

Martina Hund-Mejean

We saw during the quarter it came down a little bit in June. It wasn’t a cabalistic decline. But I can tell you that what we are seeing here, on average, for the second quarter, we are seeing as a trend, also, for July.

Tien-Tsin Huang - J.P. Morgan

And on G&A, did you quantify the higher severance costs and what kind of savings you expect to get out it?

Martina Hund-Mejean

We can certainly do that. If you just looked at the G&A expenses overall, you saw a 15.7% increase of which 3.3% were related to currency fluctuations, and then in terms of the severance, I can guide you that that was about 3% of that.

Tien-Tsin Huang - J.P. Morgan

And the savings you expect out of that, going forward?

Martina Hund-Mejean

I think you know pretty much our run rate in terms of what we spend on average per employee, so we do obviously expect some savings, otherwise we wouldn’t have done that. But it’s really realigning our work forces with the kind of business needs we’re seeing forward. Again, as you know, we are still investing in the business but we are also seeking to expand our operating margin.

Operator

Your next question comes from Pat Burton with Citi.

Patrick M. Burton - Citigroup

My question is about cross border travel. As you approach the year-ago numbers where you had some pretty hefty growth, how much do you think that 18% number will decelerate? Are we talking like 5% sequentially, something like that?

Martina Hund-Mejean

That is a very difficult question. What we have seen is that cross product growth has actually accelerated over the last year. In particular when you looked at the fourth quarter of last year and it had kind of continued into the first quarter of this year. We are talking relatively still extremely healthy growth rates of almost 19%.

What I can tell you is we really have not seen any change in travel patterns. The travel patterns are really still pretty much the same from what we saw before. We saw the Latin Americans maybe traveling a little bit more in Latin America versus coming to the United States. We really saw no discernable difference between what the Europeans do and what people in Asia/Pacific do.

So we still believe that cross border volume going forward will be healthy. But I think it will be really hard for us to guide you to any particular number for the future.

Operator

Your next question comes from Adam Frisch with UBS.

Adam Frisch - UBS

Martina, as you see the top line potentially enduring some more headwinds, whether it be from year-over-year comps being tougher in the second half, or a slower consumer, obviously your growth has held up really well so far. But I think expenses are going to become a bigger part of the margin equation going forward. Good to see that A&M is staying steady year-over-year but what can we expect from G&A going forward? Because that’s really the expectation, I think, of a lot of your investors with where there is operating leverage in the model, to achieve higher operating margins going forward.

Martina Hund-Mejean

We are very mindful between the top line growth and what we have to do on the G&A perspective. I mean, we pretty much reiterated our thoughts for 2008, we are very mindful of what happened to the United States and how it could possibly impact our growth rates.

Despite that, as you know, we have some pretty good leverage to moderate any kind of impact, be it what happens in terms of a tiering perspective from our customer agreements, be it that more than half of our revenue growth is actually generated out of the United States and from a G&A perspective, again, we are pretty much reiterating what we had said before.

And when you put the numbers together, you should see some pretty healthy margin expansion. But you already saw for the first six months as well as the remaining six months of the year.

Adam Frisch - UBS

On the credit portfolio, Tien-Tsin brought up a customer loss, you said it was small. Is there anything else going on in your credit portfolio that would explain the growth there?

Martina Hund-Mejean

No. From everything that we can really see, this is what is happening in the market in the United States. In my opening remarks I told you the economic environment is pretty tough. We obviously still the moves of non-discretionary purchases to discretionary purchases, but we also do believe that the housing crisis and the restrictions in credit for consumers have an impact on the consumers utilizing their cards.

Adam Frisch - UBS

On debit, obviously you’re making a bigger push into that market. IPS, you have your first customer close to up and running. What are your other plans for debit growth going forward? Do you plan on doing it organically or potentially via M&A?

Martina Hund-Mejean

I think we really have all options open. IPS is obviously a significant investment that we did over last year and the first part of this year. So that is our primary focus, to make sure that we get Security Service Federal Credit Union up and running and then focus the next customers in the pipeline.

But depending on what kind of things will come in the market, we have an open mind.

Operator

Your next question comes from Chris Mammone with Deutsche Bank.

Christopher Mammone - Deutsche Bank - North America

Last quarter you guys talked about one customer falling short of volume thresholds that caused you guys [inaudible]. I’m just wondering what kind of multiplier effect might have happened in the second quarter, how many customers might have been affected by falling short of volume goals?

Martina Hund-Mejean

As you said, in the first quarter we had actually a significant impact from one particular customer. That’s really why we pointed that out. In this quarter there is no really particular customer, any particular customer who impacted this. But you see how the volume growth in the United States, in particular on the credit side, was lower than in prior quarters and in a year ago, and that is where our customer agreements are actually working from a rebate and inventive point of view. And the kind of performance our customers have to achieve in order to get into the next tier. So we have a little bit of an offsetting lever.

But there is no particular customer in this quarter that we would be pointing to. I think it’s a general part of the environment.

Christopher Mammone - Deutsche Bank - North America

And then, any metrical lift from the government stimulus checks? I know about $100.0 billion had reached consumers’ hands by the end of June.

Martina Hund-Mejean

We really looked at our data to see whether we could see any discernable difference, especially where we’re hearing that people are spending those kind of checks. And we really cannot find from our network data any appreciable difference.

Operator

Your next question comes from Liz Grausam with Goldman Sachs.

Elizabeth W. Grausam - Goldman Sachs

I wanted to ask a question on SEPA and looking into the next two years as you reach some of the critical hurdles in that regulatory framework. How should we think about that as possibly some offset in your processed transaction growth, where we could see some decoupling between your GDV and your processed transaction growth trends as you’re gaining share in the processing landscape out there?

Martina Hund-Mejean

That is a good question. As we have talked about it before, SEPA is really a guideline, it’s not a law. The banks in Europe are supposed to comply with the guideline, I believe by the end of 2010. However, this is a relatively slow process. I think at our investor meeting Javier did a really nice job in terms of pointing out where we’re actually going with SEPA and the kind of wins that we already had.

And just to remind you, we’re not just working with banks in the market, but we’re also working with merchants in the market because at this point in time, merchants can actually re-point wherever they would like to have the acquiring activity to go through. And obviously given our network and the cost-effectiveness of our network, we found ourselves to be the first choice in a number of those engagements.

These kinds of things are going on. There’s nothing in particular that we want to disclose at this point in time, but these efforts that have the analysts talking about have continued in Q2 and we are believing that it definitely will continue for the rest of the year and the next couple of years.

But given that it is so early still in this evolution, and given that a lot of the European banks really have to grabble with what are they going to do with their own processing facility, it’s really hard for us to give you a particular guidance in terms of how this might impact our GDV, or processed transactions.

Elizabeth W. Grausam - Goldman Sachs

Another question on the cross-border trends that you’re seeing. Visa reported last night that they saw a little bit of softening, as well, in cross-border trends, but mostly pegged it on the U.S. consumer not going overseas and that’s where the softness is coming with really no major change in trend in the foreign consumer traveling. Is that somewhat of what you’re seeing and have fuel prices affected the ability for Europeans yet to pursue cross-border travel and how are you thinking about that going forward?

Martina Hund-Mejean

At this point in time, as I pretty said, we are not seeing significant changes for region-over-region. I mean, we see a little bit of a variation in the growth rate in this region versus that region, but it’s nothing significantly different than what we saw over the last, I would say, three quarters or so.

Even in Europe, where people are often traveling by car and obviously with these high gas prices have to spend a lot more money in order to get from, whatever, Germany to France, we are really not seeing any appreciable difference than what we’ve seen before. So from a trend perspective, again, as I said, it’s really hard to say where this is going to go. But at this point in time, 18.9% is still a pretty significant growth rate.

Operator

Your next question comes from Chris Brendler with Stifel Nicolaus.

Christopher Brendler - Stifel Nicolaus

One of the issues you talked about last quarter and result in a slow down was you may see transaction growth slow less than volume growth, with lower average ticket. And looking at the numbers for this quarter, in my calculations, in the U.S. credit program particularly, the average ticket actually went up a little bit, so that did not happen. Any insights on what exactly is happening in U.S. credit? People have been pulling back so I would think you would see a ticket slow down. Do you think it’s more issuer related and do see any evidence of consumers just moving away from credit cards, given their more limited budgets and trying to stick more to a budget on a debit card product?

Martina Hund-Mejean

I think it’s a mixture of things. Obviously what’s happening with the issuer environment and they way that they have to manage their portfolio in order to make sure that their existing accounts continue to be very profitable for them and the work around it that they have to do on the credit side, that does have some impact and we already said that.

We do see some step up of the average tickets but mostly related to, I would say, to what people pump at the gas stations, as well as little bit related to food. The one noticeable difference that we are seeing is related to fuel in this country. So this is a U.S. comment. Actually from a transaction point of view, now I think it’s the second quarter in a row, that we actually have debit transactions being equal to credit transactions. Before you had the number of credit transactions bigger than debit transactions.

So that’s the only real discernable difference, but I do believe that inflation do drive some of the things that you’re seeing on the average ticket.

Christopher Brendler - Stifel Nicolaus

There’s this big drop-off in cash transactions, particularly in the U.S. credit program. Does that have an impact on your revenue slide or is that cash transactions are a lower margin?

Martina Hund-Mejean

That really comes at a lower margin. That really does not have a significant impact whatsoever on our revenues. And I think when you see the growth in the U.S. credit and the follow-up on the cash volume, that does explain, that fits together.

Christopher Brendler - Stifel Nicolaus

Have you had any color from your issuing customers, do you think that we’ve seen the worst of them pulling back or do you think that there’s more to come in the second half as we get into this tougher economic environment?

Martina Hund-Mejean

I think this is really hard to tell. Obviously quite a number of our customers have made sure that they are really surrounding their debit card and credit card portfolios with the right kind of discipline that they need to have in order to keep those portfolios profitable. These portfolios are still very profitable for each of the banks. So I really think it depends on which customer you’re talking about.

Some of our customers are feeling actually that they could take advantage of this environment at this point in time and are more aggressive in terms of the account credit acquisition side and marketing. And some customers just don’t feel that way. So I think it’s a mixed bag but in general I would say that people are probably more cautious, still at this point in time, because we don’t know what more is going to come or how long this kind of slow down is really going to last.

Operator

Your next question comes from Craig Maurer with Calyon.

Craig Maurer - Calyon Securities (USA) Inc.

First, regarding pricing, just an update on your thoughts regarding where you are in the competitive market place with Visa, both on the acquirer and issuing side.

Martina Hund-Mejean

First of all, on pricing, I think we had, in the first quarter, right about 6% and in this quarter about 5% and I think for the rest of the year we see pretty much a similar impact. We did disclose some of what kind of pricing we did, which is a significant part is related, obviously, to cross-border volume as well as a number of other services and products that we felt like we really needed to adjust the prices in line with the value proposition that we have for our customers. It’s obviously good that we were able to move forward with these kinds of things.

In terms of comments of us versus our competition, we are really not seeing, on the pricing unto itself, two different things than what we already said at the investor day. We believe that we are doing, obviously, the right thing from a pricing point of view, given how we work with our customers and our competition has to think about what they have to do.

Craig Maurer - Calyon Securities (USA) Inc.

In comparison, do you feel you’re at relative parity on a global level or has one moved ahead of the other?

Martina Hund-Mejean

First of all, it’s really region-by-region specific, and then you really are going to have to think about what is the pricing environment on the issuing side versus the acquiring side. And on the issuing side, as you know, it’s not just list prices in terms of what you actually charge to issuers, but it really is dependent on what kind of customer business agreement we strike, which have often rebates and incentives attached to performance, total incentives. So you have to take all of this into account.

And we do believe that when you take all of this into account, that we are very competitive in the market.

Craig Maurer - Calyon Securities (USA) Inc.

Regarding the Visa agreement that you just entered into regarding sharing of liability, why now on this agreement? What changed all of a sudden that prompted this agreement?

Martina Hund-Mejean

I don’t think I really can talk about the timing and why now, but obviously you’ve heard what Discover said publicly in the market in terms of damages and Visa and ourselves feel very similar in terms of we feel very strongly about our proposition. We are very aligned in terms of how we look at that case and it happened to be at the right time for us to be entering into this kind of agreement.

You might recall that there was actually court-mandated mediation prior to June 30, which was Visa and us together with Discover, and that court-mandated mediation, which we did enter into, did not really lead to any results.

Craig Maurer - Calyon Securities (USA) Inc.

You had commented on a shifting of resources. Where are you focusing your new hiring these days as opposed to where it might have been a year ago? Or two years ago?

Martina Hund-Mejean

The one big area that is of difference is our Integrated Processing Solutions platform. Obviously a year ago, a little bit more than a year ago, so really I’m taking you back to the beginning of 2007, we did not have a lot of people related to development of that platform, as well as implementation for customers.

That has ramped up significantly over the last 18 months and that is going to continue to ramp up as we’re having more customer implementation. So I would say in terms of one area, that’s a big area.

Another area that is important for us, from a numbers point of view, not quite as what I just talked about for the IPS platform, but it’s high-growth markets. High-growth markets are important for us, we are making significant investments in there. And we will continue to do so because we do believe that’s where we see the future.

Craig Maurer - Calyon Securities (USA) Inc.

And where is it shrinking?

Martina Hund-Mejean

The areas I would say we are really massaging our head count and putting it into the right kind of business propositions we want to see, is one, in the U.S., of course, given that not only the majority of all revenues come from overseas. We have to make sure that our work force is very much aligned between what we want to see in the United States versus overseas. And then a number of other areas related to our products. We just do some alignments in order to be appropriately focused on the kind of things we want to put out in the market here in the future.

Operator

Your next question comes from Sanjay Sakhrani with KBW.

Sanjay Sakhrani - Keefe Bruyette & Woods

I just had a question on the assessment rebates and incentives line. I mean, with the deceleration on the U.S. volume side I would have thought we would have seen a little bit lower accrual, or that come down a little bit more than it actually has. Is there any color you could provide on that line?

Martina Hund-Mejean

That’s pretty hard to do because I think we said in the past, you have to be very careful not to torture rebates and incentives on a quarterly basis because it all depends not only on what’s happening in the volume in the quarter, but it also depends on what kind of new agreements we actually signed in the quarter, and we happened to have signed new agreements in the quarter, and some of that actually can drive the timing in terms of when we book the rebates and the incentives.

So I don’t think there’s really anything particular that you should read out of that, but I would encourage you to really look at it over time rather than on a quarter-by-quarter basis.

Sanjay Sakhrani - Keefe Bruyette & Woods

Is there a quick rule of thumb on how much of that line is U.S. versus international?

Martina Hund-Mejean

We don’t really give that out.

Sanjay Sakhrani - Keefe Bruyette & Woods

I want to drill down on the volume growth in Europe. As you mentioned, it’s become kind of a hot topic recently. How much of that growth in Europe is organic growth versus new customer additions? Because the growth still remains relatively strong.

Martina Hund-Mejean

I would say it’s a mixture. But I just want to give you a couple of examples. This is really coinciding with the secular trends we see from paper payments to electronic payments. But when you compare the U.S. to, let’s say, France, a Frenchman uses their credit card maybe five times a month, a German uses their credit card maybe one time a month, so the things that have yet on their team to, in terms of really encouraging higher use of credit and debit cards, in terms of the categories that they are actually opening up from a merchant acceptance point of view, and I think we speak to the number of those positive examples, you know, the Lufthansa deal, the co-op deal in Switzerland, etc.. I think that really does influence how we work with our banks.

It really does influence the end customer in terms of where they find the utilization of a card much easier than utilizing cash or a check. But that is an evolutionary trend. So there is a big impact from that.

Customer agreement, as we have said before, we are very encouraged by all the different activities that we see there on the agreements that we actually sign across Europe. So, that does have an impact.

It’s really hard for me to tell you, how much is driven organically versus acquisition, but those factors are important in driving that growth.

Sanjay Sakhrani - Keefe Bruyette & Woods

On the cash balance, post Amex settlement, should we expect the carrying amount to come down a bit and that factor into capital management strategy?

Martina Hund-Mejean

For sure it needs to factor into the capital management. As I said, we are reviewing with the Board constantly, how our capital structure should be taken though. We do have the Discover case out there with a trial date. We are probably taking that into account in some fashion.

But you’re absolutely right. We have moved through one major issue with the Amex litigation issue and you will be hearing from us in the future.

Operator

Your next question comes from Tim Willi with Avondale Partners.

Tim Willi - Avondale Partners

The question around international, one was were there any trends in what you would describe as maybe your more established international markets as you went through the quarter. It may not have looked like the U.S., maybe it looked light a lighter version of the U.S., in terms of slowing growth as the quarter progressed.

And a follow-up is can you just give us some qualitative thoughts around margin profiles of the various regions of the world? Does their operating contribution approximate what the revenue contribution, or some of the larger more mature established markets, much higher, much lower margins, versus the corporate average?

Martina Hund-Mejean

Let me take your first question. On the international front, let me just take region by region. On Europe we do have a mixture. And I already quoted the U.K. as well as Spain. There are a couple of other countries that seem to be feeling the heat from an economic point of view, like Italy, Portugal, France, and Ireland. That does not really show up that significantly in our volume growth.

Again, I truly believe, in terms of what Sanjay and I just talked about, the secular trend, opening up the merchant categories, making end consumers more comfortable using their cards, does definitely have an impact on this, so despite the economic environment, we feel very comfortable on the growth over there.

In Asia/Pacific, again, you can see that the growth is still very healthy. But when you look at China and India and a couple of the other markets, they are impacted by the higher commodity prices that we see across the world. We’re watching that very carefully, but given the significant potential for moving people from cash to an electronic-based payment, I think you will see a really good balance there. So I think we feel good about it.

Latin America, I think that’s like a two-headed story. Mexico does feel the credit crunch more and we do see that a bit more in our data, versus Brazil. Brazil is just going gang-busters and we are feeling very healthy there. So I think you have a bit of a mix.

There’s not a one-size-fits-all. You really have to take it market by market. But what’s really happening in the U.S. and how deep the U.S. went down from an economic down turn point of view, the U.K. is maybe closest to that but we’re not quite yet seeing the other countries being there. And there are other things in the market that would offset that.

In terms of your second question, the margin profile question, as you know, we really don’t disclose this kind of data from a regional point of view. The only pointers that I can kind of give you is where we not only see the volume where we charge the assessment fee, where we also process different factions, where we also get a transaction fee.

Those are obviously very good markets for us and I think as you know from our filings, there are really five markets in the world where we do process most of the volume. And that particular focus is really important. That’s where we want to expand, too.

Tim Willi - Avondale Partners

Is it inappropriate to think that in some of the more emerging economies, while they might be smaller now and are experiencing extremely strong growth, that just the investments you’re making in brand and resources, would have those obviously being a lower margin region for you with a lot of margin up side over time?

Martina Hund-Mejean

It depends. It depends totally on what the infrastructure in the market is, it depends on how the acquiring actually gets done in the market. So for some markets you’re absolutely right, we’re making investments, we’re encouraging the right kind of behavior in order to get to electronic payments and that way you might see some lower margin.

But there are actually some other emerging markets where the infrastructure is in such a way where we don’t have to do that.

Barbara Gasper - Investor Relations

We have time for one more question, please.

Operator

Your last question comes from Charles Murphy with Morgan Stanley.

Charles Murphy - Morgan Stanley

Martina, I was wondering if you could update us on what you’ve seen in July for cross-border GDV and for processed transaction growth.

Martina Hund-Mejean

I really cannot. The only thing that we see on a weekly basis is process volume. At this point in time we also see processed transactions. And I think from what I said before in response to one of the other questions, is that we really see in July the same kinds of things continuing as we saw it in the second quarter.

Charles Murphy - Morgan Stanley

As a quick follow-up, could you clarify the outlook for A&M spend. Should third quarter be lower than second and then fourth be lower than third?

Martina Hund-Mejean

I think you’ve got it.

Operator

I would now like to turn the call back over to Barbara Gasper for closing remarks.

Martina Hund-Mejean

I would like to say thank you for joining us this morning. Obviously we talked about the difficult economic environment in the U.S. but I just want to say how pleased we are with our results for the second quarter. We really believe that our business fundamentals continue to provide a solid foundation for us to meet our business objectives, not only in 2008, but also for the longer term. We definitely remain committed to grow our business and we will manage our costs in order to drive shareholder value.

So thank you for your time today.

Barbara Gasper - Investor Relations

If anyone has any further questions, please feel free to contact Investor Relations. Thank you for your time.

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Source: MasterCard Incorporated Q2 2008 Earnings Call Transcript

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