萬事達 (MA) 2006 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to MasterCard's third quarter 2006 financial results conference call.

My name is Gregory and I will be your coordinator for today. [OPERATOR INSTRUCTIONS]

I would now like the turn the presentation over to your host for today's call, Ms. Barbara Gasper, head of Investor Relations.

Please proceed, ma'am.

Thank you, Gregory.

Good morning to everyone and thank you for joining us today, either by phone or webcast, for a discussion about our third quarter financial results.

With me on the call this morning are Chris McWilton, our Chief Financial Officer, and Tara Maguire, our corporate Controller.

Following comment by Chris, highlighting some key point about the third quarter, we will open up the call for your questions.

In total, the call will last up to one hour.

For your reference, this morning's earnings release and the slide deck that will be referenced on this call can be found in the Investor Relations section of our website at www.mastercard.com.

These documents have also been attached to an 8-K we filed that with the SEC earlier this morning.

A replay of this call will be posted on our website for one week until November the eighth -- excuse me, November the ninth.

Additionally, later today we will be filing our third quarter 10-Q, which will provide additional details about our performance.

I also want to point out that our results are presented on a GAAP basis, and in some cases on a non-GAAP basis.

We believe that the non-GAAP measures facilitate understanding of our operating performance and provide meaningful comparisons of our results between periods.

Any non-GAAP measures are reconciled to their most directly comparable GAAP measures in the reconciliation attached to our earnings release.

Finally, as set forth in more detail in today's earnings release, I need to remind everyone that today's call may include forward-looking statements about MasterCard's future performance.

Actual performance could differ materially from what is suggested by our comments here 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'd now like the turn the call over to Chris McWilton.

Chris?

Thank you, Barbara, and good morning, everyone.

Before I go through the detailed financial results with you, I'd like to discuss the highlights and make a few comments about the third quarter.

Turning to page 2 of the slide deck, I'm happy to report that the strength of our global business model and the momentum of the overall payments industry has resulted in impressive third quarter results.

We delivered net income of $193 million and earnings per share of $1.42.

Revenue growth was 13.9%, driven primarily by strong gross dollar volume, processed transactions growth and a restructuring of cross-border pricing, which was implemented in April 2006.

Currency fluctuations of the Euro against the dollar contributed approximately 1% to this revenue growth.

We achieved [inaudible] operating margin of 30.5%.

And additionally, our already strong capital position remained strong, with $2.3 billion of cash, cash equivalents and available for sale securities at quarter end.

I would now like to address a few topics that aren't covered in the slide deck.

We've had several significant business development in the quarter.

First, as of Monday interchange rates that apply to U.S. merchants are now posted on our website.

Along with this posting we included comprehensive that merchants need to understand the rates and how to apply them.

We thought that just publishing the rates without an explanation could lead to confusion for some merchants who may be seeing this information for the first time.

We generally announce interchange rates during the first quarter of each year, and going forward we will publish this information on our website after each rate announcement.

This posting further our efforts to provide greater transparency to all of our constituents.

Additionally, you may have seen our press release in September about the launch of our World Elite product with HSBC and Saks Fifth Avenue.

The new product targets elite affluent customers, small businesses and executives of large corporations.

Unlike other products geared to these audiences, World Elite MasterCard offers rich rewards, global acceptance and superior travel-related services.

Our decision to launch this product was based on a recognition of the importance of the affluent segment of our customers.

The launch went smoothly, and we are looking forward to continued success.

Finally, with respect to the AMEX, Discover and Merchant lawsuits, we don't have any new updates to provide at this time.

Let's turn to page 3 of the slide deck for more details on the financials.

As I mentioned, our net revenue growth was 13.9% in the quarter versus last year.

Currency fluctuations against the Euro contributed approximately 1% to this growth.

We're very happy with this growth, especially when measured against last year's strong third quarter revenue performance.

Although there were no special items in the third quarter of this year, as we mentioned on the call last year, we had three special items in the third quarter of 2005 that impacted our year-over-year growth rates.

These were, first, a $19 million charge to G&A expenses to reflect an accounting methodology change for cash-based executive incentive plans.

Second, a $48 million increase to our currency conversion accrual, recorded as litigation settlements.

And last, a $17 million gain recorded in other income from the settlement of a contractual dispute.

Adjusting for these three items, our net income growth was 38.8%.

Turning to page 4, in the third quarter we experienced continued growth in both gross dollar volume and processed transactions.

Gross dollar volume grew 15% on a local currency basis and 16.5% on a U.S. dollar converted basis to $502 billion.

Although not shown on slide 4, purchase volume was up 17.2% on a local currency basis and cash volume was up 9.5% on a local currency basis.

While the United States remains our largest region in terms of both volume and revenue, regions outside of the United States, such as south Asia, Middle East, Africa and Latin America, are growing at a laster rate, demonstrating the global strength of our business.

Processed transactions -- or the transactions processed across MasterCard's network increased 18.9% to $4.2 billion.

Turning to page 5, overall net revenue for the quarter was $902 million, a 13.9% increase versus 2005.

As I just mentioned, currency fluctuations contributed to approximately 1% of that growth.

Revenue growth for approximately 3.3% was attributable to pricing changes implemented last quarter, which I will discuss in a moment.

Looking at the revenue growth by category, slide 5 shows that net assessments, which are primarily volume-based, decreased by $37 million or 13.3% to $241 million.

This decline versus overall GDV growth of 15% on a local currency basis was due to increased pricing pressure, evidenced by a 36.3% increase in rebates and intentives.

Gross assessments increased $20 million or 4.6% over 2005, due to increased GDV offset by pricing changes, which we discussed on last quarter's call, and were implemented in Europe during April 2006 to address SEPA requirements.

As a result of these pricing changes, certain assessment fees totaling $42 million were reclassified to the currency conversion and cross-border components within operations fees.

Net assessments, as a percentage of gross assessments declined due to increased incentives, primarily from new and renewed customer and merchant agreements.

As I mentioned last quarter, based on this reclassification and the expected increase in rebates and incentives, we expect continued negative net assessment growth for 2006, and the spread between gross assessments and net assessments to continue to increase.

Turning to slide 6.

Slide 6 shows that net operations fees -- excuse me -- which are primarily transaction based increased $147 million or 28.6%.

Gross operations fees increased $169 million or 30.2%.

This growth was driven mainly by two factors.

First, growth in processed transactions and gross dollar volume that I previously described on slide 4.

The second, a restructuring of currency conversion and cross-border revenues, which took place in April 2006, which we discussed last quarter and resulted in a $106 million increase in the third quarter over the comparable period last year.

Included in the $106 million increase is the reclassification of $42 million from assessments for operations fees, which I just mentioned on slide 5.

Net operations fees. as a percentage of gross operations fees declined on a year-over-year basis, as expected, due to an increase in rebates resulting from customer consolidation and the restructured pricing I just discussed.

Turning now to slide 7, total operating expenses decreased 2.6% to $627 million during the third quarter, formally detailed in appendix A of the slide deck, excluding the impact -- year-ago impact of litigation settlements.

A charge to reflect an accounting methodology change for cash-based executive incentive plans, operating expenses increased 8.8%.

This increase was primarily driven by an 18.7% increase in general and administrative expenses, primarily due to two factors.

First, an increase in personnel costs, as we continue to develop our customer-focused strategy.

In addition, approximately 3% of the total G&A growth was due to additional severance expense, as we updated the actuarial assumptions of our severance plan.

And second, an increase in professional fees primarily related to legal costs to defend outstanding litigation.

I want to pause here and briefly explain the components of our personnel costs, since I know there has been some confusion about what is included in this line item.

The personnel line, which is broken out in our 10-Q to be filed later today, consists of more than just full-time salaries.

It includes costs for benefits, training, recruiting, severance, and also the costs of contract and temporary staff.

While we don't break these components out separately, I would caution that any full time employee productivity or cost analysis performed using this expense line could be misleading.

There's a varied mix of expenses included many this category.

I would also like to reiterate a point we have made in the past that we expect to continue on grow our employee base to support our strategic customer-focused initiatives.

Pushing back to expense growth, as we expected, advertising and market development expenses decreased 4.6% to $209 million, due to higher spending for the 2006 FIFA World Cup earlier in the year.

As you may remember we shifted our patten of advertising and market development expense in 2006 to support our sponsorship of the 2006 FIFA World Cup.

There were no litigation settlements accrued in the third quarter of 2006, although the final settlement documents were signed in several of our foreign exchange cases.

Currency fluctuations contributed approximately 1% of the increase in expenses in the quarter.

Moving to slide 8, and beginning with the balance sheet, we ended the third quarter of 2006 with $2.3 billion [excuse me] in cash, cash equivalents and available for sale securities, a $1 billion increase from the end of 2005. $650 million of this increase was received as part of our IPO proceeds.

We also had stock holders equity of $2.3 billion.

Accounts receivable increased $97 million primarily due to three factors.

First, a pricing recalibration in Europe back in April, resulting in a change in the frequency of revenue collections.

Second, volume increases when compared to the fourth quarter of 2005.

And, last, an increase in VAT receivables due to the timing of payments.

Obligations under the U.S.

Merchant lawsuit and other litigation settlements decreased $40 million due to payments of litigation settlements.

It was offset by $55 million in accruals and interest accretion.

Turning to the cash flow statement, we generated $447 million in cash flow during the first nine months of the year.

Turning to slide 9, for those of you trying to model our fourth quarter performance, I would like to remind you about one special item that affected fourth quarter performance last year, but will not recur this year.

That is a $27 million increase to our currency conversion accrual recorded as litigation settlements expense.

Additionally, please remember that we are not a linear business, and we don't follow typical retail spending patterns.

Our fourth quarter revenues are typically offset by an increase in rebates and incentives to merchants and issuers.

Fourth quarter is also a period of heavy advertising and marketing spend.

We expect a high level of spend, even with World Cup expenses in the first and second quarters.

As a result of all this, our fourth quarter is usually our period of lowest profitability.

Turning to page 10, as you know, he don't provide earnings guidance.

However, I would like to remind of you our three to five-year performance objectives that we previously communicated; 8% to 10% revenue growth, one to two percentage point improvement in operating margin per year, 15% to 20% net income growth, and at least 20% return on equity, excluding the IPO proceeds of $650 million.

On an ongoing basis we will evaluate whether changes to any of these long-term performance objectives is required.

I'd like to pause here and remind everyone that, unlike other newly-public companies, we have been operating with a high level of commercial rigor for several years before our IPO.

After our merger with Europay, now MasterCard Europe, we spent several years affecting synergies and operating the business in a more productive way.

I want to emphasize that we continue to -- we expect to continue to achieve our operating margin improvement through scale, while continue to go invest in our brand, our people and our customer-focused strategy.

In summary, we're very pleased with the overall performance in our first full quarter as a publicly listed Company.

Additionally, we believe that given our momentum and trajectory, we are comfortable with our ability to meet our performance objectives in 2006 and are confident about the state of the business.

We're now ready to begin the question and answer period.

And in order to get 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 requeue if you have additional questions.

Operator, can we have the first question, please.

Yes, mam. [OPERATOR INSTRUCTIONS] Your first question comes from the line of Pat Burton from Citigroup.

Please proceed.

Hi.

Congratulations on the great numbers.

Chris, my question relates to, one, the strength of the overall top line in terms of transaction and GDV.

Are there any particular areas of the world economy that you think maybe are running above trend line and we should watch for that to come back over time, or is it just strength across the board?

Sure, Pat.

Thanks for the congratulatory remarks.

I think what we're seeing strength in Latin America, in particular.

We're also seeing strength in Europe, but pretty much around the world we're seeing global strength of the economies.

We haven't had any sort of major geopolitical event, which is going to impact international travel, which our business is quite sensitive to.

I think we're hitting on all cylinders, but I would pay attention, particularly to Latin America and Europe as areas of future growth.

As a follow-up, the large conversion that did you in the second quarter, are all those cards now out in the market producing transactions?

Yes, they are.

The Washington Mutual conversion, and we're very pleased with the performance of that program.

That conversion was completed in 2Q and moving along very nicely.

Thank you.

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

Please proceed.

Hi, guys.

Just wanted to get a little bit more insight into the added marketing budget and how it's been developing over the course of the year.

I think it came in well below, at least, my expectations for the quarter, suggesting the December quarter might be up from where we expected it.

Could you help us understand on how a total year-over-year basis you might be looking at your '06 budget relative to '05?

I think what we said in the past, Liz, is that we put the budget together.

We look at what our customers needs are and what makes sense from overall growth of the business.

This year was an unusual year because of the World Cup, which is every four-year event, as you know.

We don't take our advertising and marketing budget and then incremental it for the World Cup spend.

We look at it in total and figure out a way to tie a lot of our programs around that World Cup event.

We're looking sort of at a normal growth rate for the full year for advertising and marketing.

Now we did front load some of that into the second quarter, and first quarter, as a result of the timing of that event.

But we continue to expect to spend -- the fourth quarter will be our period of highest advertising and marketing spend.

It will be less than it was last year, but certainly on a sequential quarterly basis, it will continue to be a period of the highest ad and marketing spend.

Meaning on an absolute dollar basis, it will be less than the fourth quarter than it was last year?

On an absolute dollar basis it will be less than it was fourth quarter last year, but still our highest A&M spend in the four quarters of this year.

Okay, great.

And then just a quick question on the investment income.

It was substantially ahead of where we had it, as well.

Can you help us understand how you're investing the cash and what yield you're generating on it?

Sure.

We have a -- I would call a brutally conservative investment portfolio.

We take those securities and -- take the cash and invest it in high-grade municipal securities.

Our treasury policy has very high standards -- credit standards against which we can apply those proceeds.

Many cases are tax exempt municipal securities, double A, triple A rated.

That's where the cash is headed.

Great.

Thank you.

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

Please proceed.

Hi, Chris.

I'm wondering if you can talk a little bit about volatility in transactions processed and GDV from quarter-to-quarter.

From a 30,000 foot perspective one wouldn't expect big changes from quarter-to-quarter.

You're kind enough to point out the currency effect in the revenue growth rates.

I'm curious, what rear drivers in the business could cause those two numbers to swing around a little bit from one period to the next?

Ken, I think one of the key factors that drive quarter-to-quarter volatility is travel, international travel.

As you know, there are many parts of the world where we don't actually process the transaction.

It appears on a MasterCard branded card.

It is done by domestic schemes.

However, when somebody crosses the border, that's where the value of our network and franchise really comes into play.

That transaction has to be processed on our network.

We generally get not only the processing fee, but we'll also get a currency conversion fee -- or currency conversion assessment.

So, international travel does swing the GDV numbers and the processed transaction numbers around quite a bit.

And you'll see that in the third quarter, that's a period of heavy travel, particularly in Europe.

People are moving, crossing borders, et cetera.

They're getting on planes, traveling with family to perhaps foreign countries, et cetera, and we do tend to see more processed transactions and more higher yield on those transactions in the third quarter.

Can I ask in terms of the advertising spend, do you see an immediate lift from spending advertising dollars or does that tend to filter in over a multi -- or multi--year period or a multi-quarter period?

Actually, Larry Flanagan, our Chief Marketing Officer, is going to be speaking at -- I think your conference actually, Ken, next week, is that correct?

Should I save that question --?

So you're challenging the subject matter expertise of the CFO when it comes to --

Okay.

As a follow-up then, let me just ask a different question.

I will withdraw that question, and ask if you can give more detail on the severance expense, which I think you pointed contributed three percentage points of the growth in the G&A.

Can you just talk a little bit about what the severance plan entails?

Is this ongoing turnover or is this wide-scale firings or what is all this -- what's this about?

That's a great question, because I think there is tendancy to think of it as wide-scale firings.

It really is not.

We're growing the work force.

What we have in MasterCard is a severance plan, which it's a written plan, which based upon however many years of service you have at MasterCard, you earn credits in the event you are severed from the Company.

For many quarters we've been looking at the assumptions with respect to how many people we would sever, the band level or the pay grade of the people we would sever, and we're continuing to update those.

Now, we have an accounting policy, which doesn't defer actuarial gains and losses on this plan, similar to our defined benefit pension or post-retirement medical plan.

If there's ever a change in actuarial assumptions on this plan, we take the charge right away.

Okay.

And so, can you comment on changes in severance-related turnover rates this quarter versus -- this year versus last year?

Yes, it's -- the number of people we're severing is up over what we've had in the past.

I can't go into specifics of what those are.

We are seeing a higher number of people being severed, simply because we have a bigger population base to work from.

And also some of the levels that we're severing at are higher than they have been in the past.

We're going out and hiring people to face off against sophisticated customers.

Those people do not come inexpensively.

If for some reason is doesn't work out, either the position or the person, we've got to sever them and that costs more, and those all have to be baked into the severance calculation.

Thank you very much.

Your next question is from the line of Tien-Tsin Huang of JPMorgan.

Please proceed.

Good morning and congrats on the results.

It was nice to see net revenue as a percentage of GDV hold firm this quarter.

Any reason why we should expect that metric to be materially different than what we saw in the prior year's fourth quarter?

I think you're going to see continued fourth quarter compression of our yield in the fourth quarter.

I don't think you'll see it as high as it was, perhaps, last year's fourth quarter because really that was the year we had sort of the -- a real run-up in merchant incentives and the real, I guess, increase in those programs.

So we're going to continue those programs this year, but obviously the quarter-over-quarter impact that you saw in the fourth quarter of '05 will not be there.

We are planning on spending heavily around merchant incentive programs in the fourth quarter.

We find those to be very effective.

You also find in the fourth quarter the tiering effect of many of our arrangements with our customers.

The more volume they put on MasterCard branded cards, the lower pricing they receive.

And therefore, the fourth quarter tends to be our lowest period of revenue on a yield basis.

Right.

So what we'll see is slight decay there in the yield?

That's right.

As a follow-up, I guess, in terms of the head count, is there any way you can share with us head count at the quarter?

And then, maybe if we can get some kind of update on head count growth for the rest of '06 and '07 and if there's anything you're seeing in terms of wage inflation overall?

Thanks.

I think we've not disclosed -- Eric can help me, not disclosed head count in the quarter, as we do it on an annual basis.

Obviously pension.

The head count is going up.

When you see it at the end of the year ,it will be higher than it was last year.

I can't give you more specifics on that.

From an inflationary standpoint, like I said, we are hiring sophisticated people to deal with sophisticated customers, trying to grow their payments business.

Like I said, they don't come inexpensively.

Your next question comes from the line of Craig Maurer from Soleil.

Please proceed.

Good morning.

My question focuses on the repricing due to the step initiative.

I don't know if you mentioned it, but what was -- can you disclose the dollar level of that contribution to revenue, as I am trying to come to what a true grow-over number would be for next year, as you are showing somewhat elevated numbers due to the fact that this was established in April.

Thanks.

Really it's a reclass entry.

It's a transfer of the revenue -- of recharacterization of the revenue from assessments to operations fees.

So I think it was slide 5 and 6, perhaps, on the deck where we talked about that in more detail.

But it simply was an adjusted pricing as we adjusted pricing in Europe.

We believe the fees, as adjusted, are more appropriately characterized as a cross currency assessment, essentially revenue neutral across that region.

Okay, so the actual growth rates not affected --

Correct.

-- in terms of net revenues?

That's correct.

Just a follow-up on the marketing.

Was there any -- you know, we saw a marketing decline out of AMEX of roughly 5% quarter-to-quarter.

Obviously yours was more significant.

But was there any -- in terms of what you saw in the quarter, was part of that decline in marketing driven by perhaps either your partner banks not needing the additional support of your marketing or a lack of opportunity seen in the marketplace that could have caused the decline in that number?

No, Craig, it was all timing, a pacing of our advertising and marketing spend this year with the World Cup versus last year.

We got lots of demands from our customers for advertising and marketing.

Our Chief Marketing Officer has a healthy appetite for advertising and marketing opportunities.

We're never at a loss for those.

So it's more a World Cup driven than customer demand or internal marketing demand.

Okay.

Thanks.

Your next question comes from the line of Chris Brendler from Stifel Nicolaus.

Please proceed.

Thanks.

Good morning.

I wonder if you could give us just a little bit of a higher level view of just first, the change in the currency conversion, pricing, and how it relates to SEPA?

And then, I guess more importantly, how you're thinking about SEPA today?

I think last time I talked to you on the topic you felt like there was tremendous opportunity in Europe to play a larger part, but it likely would have to be through acquisition, and just sort of [inaudible] the IPO.

So has that changed at all, especially given the strength of your stock and the ability, probably, to operate more from a position of strength?

Is there any updated thoughts you'd give us on strategic plan for Europe?

Okay.

Let my take those, Chris, and I think the order they came in there.

The change in our currency conversion pricing, I think we discussed in a little bit of detail last quarter.

Basically we went from a fee for when we converted currency to charging both issuers and acquirers a fee for a cross-border transaction, regardless of whether we actually converted the currency at the point -- or the currency was converted at the point-of-sale.

With that, we protected a key revenue stream for us, and you saw the significant growth in that during the quarter.

Now, SEPA is unrelated to that change in the way we handle currency conversion or cross-border transactions.

We did, as I just mentioned, reclass about $42 million in the quarter from assessments to operations fees, because we believe that in Europe some of these fees are more appropriately characterized now as a cross-border type fee than a true assessment.

So we moved them from ops fees over to -- or from assessment over to ops fees -- excuse me -- just for consistency of classification.

Again, it's charging issuers and acquirers, regardless of whether we convert the currency and we actually lowered the price when we actually do convert the currency.

From a SEPA strength standpoint, I think we continued to feel very good about our positioning and SEPA.

The EU is looking for a common experience for cardholders.

Wherever they travel within the EU, we have approximately 300 million Maestro-branded cards in Europe.

We have acceptance across Europe.

We have a strong brand, a strong network and we can provide the scale that the domestic processing schemes simply can't provide at this point in time.

We continue to believe there is a lot of opportunities in Europe.

I did mention the growth in Europe earlier on in the question and answer period.

We continue to think we're well positioned to capture those opportunities.

Okay.

Great.

One quick follow-up, if I could.

Did you see any [inaudible] income, at least some evidence that there was a little bit of a consumer spending slowdown in the U.S. in the third quarter?

Did you see any evidence of that in your results?

I think the question -- I had trouble hearing it.

Did we see evidence of consumer -- U.S. consumer spending slowdown in the third quarter?

That's correct.

No, we didn't.

I think in the second quarter we got some boost from gas prices, but I think as gas prices have come down, people have decided to do other things with their money.

I don't think they're putting it in the bank accounts.

They're out either taking their families to dinner or taking that extra vacation or whatever the case might be.

But they're still spending, they're still traveling, and we didn't see any softness in the U.S. in our business.

Great.

Thanks so much.

Your next question is from the line of Moshe Katri with Cowen & Co. Please proceed.

Moshe, are you there?

Operator, let's move to the next question, please.

Yes, ma'am.

Your next question will come from the line of Howard Mason with Alliance Capital.

Please proceed.

Thanks for taking my question.

I wonder if you can help me understand the variance between constant currency GDV growth, which I think was about 15%. and transaction growth for about 9%, what drives that variance and whether you think it's sustainable?

And then, secondarily, it looks as if there was a little bit of an improvement sequentially in the pricing for the [inaudible] transactions, and I wondered if you could confirm that and perhaps explain what was driving, if indeed that sequential pricing improvement pricing occurred?

Well, you're going to see transaction growth generally outpace the GDV growth because of generally smaller ticket sizes, as we roll out products like PayPass and they use them at the McDonald's drive-ups, et cetera.

Ticket sizes are coming down.

People are using plastic for more every day transactions, so you'll see that.

And also, we have a traction that we're able to process that we haven't processed in past.

In other words, we pick up a domestic processing scheme or whatever the case might be.

That is already occurred in the GDV totals, because it occurred on a MasterCard-branded card.

Now we're doing the transaction processing.

You will get growth in transactions, but you won't get growth in GDV, so you're going to see that disconnect between the two.

Do we think it is sustainable?

I don't know if it's a question of sustainability.

I think it is a fact of life that people are using plastic for smaller ticket transactions, and we like to see that.

Howard, can I ask you to --

-- sequential pricing.

Can I ask you to repeat, yes, the second question?

I didn't quite --

It just looks as if there was a little bit of an improvement in pricing sequentially on the operations fees.

My number suggests that you're getting about $0.173 per processed transaction Q3 '06 versus $0.169 Q2 '06.

I wondered if that conforms with your understanding and if so, what drove it?

Yes, it absolutely does, and it's consistent with what expected.

That is driven by a lot of international travel during the third quarter.

We're getting cross-border currency fees.

Again, when people cross the border we process the transaction, and I think if you go back and plot out, Howard, our effective basis-point pricing per quarter over the past four years, you're going to see the third quarter being pretty strong because of the international activity.

Okay.

Thank you.

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

Please proceed.

Hi, guys.

Just on the merchant side.

Can you tell us when you paid the $95 million in the litigation liability?

Was it the beginning and middle of the quarter?

And then the follow-up, now that you posted the interchange rates to your website, are you actually going to provide a help desk service or anything like that for the merchants to -- if they don't understand it and don't understand the information that you've included along with the rates, so they can call you up and actually ask questions?

First off, we paid the Merchant settlement at the beginning of the quarter.

With respect to the publishing of the interchange rates, I don't know if anybody's had a chance to go through those.

They are fairly detailed, they're very comprehensive, very robust.

That being said, I'm sure there are merchants out there that will have difficult sort of ferreting through that information, figuring out what merchant category they're in or what the transaction looked like.

But really, the relationship between the merchant and the acquirer is where the merchant is going to be able to request more information and more clarification.

We view merchants as part of the payment system, a constituent of our four-party payment system, but we don't define them as a customer, and that relationship is between the acquiring bank and the merchant.

We just think this will provide them with information so they can have educated conversations with their acquiring bank, be able to second guess and push back and perhaps work out ways they can lower their discount rates, simply by the way they either classify or process transactions.

Okay, thanks.

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

Thanks, and congratulations for a very, very strong and impressive quarter.

Thank you.

If one looks at your operating expenses, one can actually make an argument that on a relative basis the expense ratios are pretty high.

Looking at from a -- looking forward maybe from three to five years from now, is there anything that you can actually -- is there anything that you can -- can you make a comment on where these operating expenses can go to?

We're -- right now we're at about a level 70% to 80% of revenues.

Do you think if we bring it down to 40%, 50%, that will be more of a normalized rate?

And again, your business is extremely profitable.

I don't think it really needs a lot of investments.

Obviously you're expanding in Europe, and you have other things that you're focusing on, but is there any -- can you comment on that and I think that's a very important point that everybody focuses on these days?

Well I think, as we laid out our objectives for the next three to five years, we've talked about steady one to two point improvements in operating margins over a three to five-year horizon.

I will emphasize and I emphasized in my remarks that we've been operating this business as a for-profit entity for some period of time before our public offering.

We -- obviously as a CFO, I always believe there's room for cost improvement.

I wouldn't be doing my job if I didn't.

I have some people in my business who disagree with me.

In fact, we're going through the budget process now.

I have battle scars from that.

But we're thoughtful about how we spend.

The investments we make in our brand are extremely important to our customers.

They obviously get very upset when we cut back on advertising of our brand of their geographies where they're trying to grow those businesses.

We're investing in people and we're going to continue to invest in people.

We're becoming much more customer focused.

We're working with customers on brand initiatives, helping to make their payments businesses more profitable.

And we're -- as a management team and I think as a board, we're not in the game of sort of cost cutting our way to prosperity here.

We're going to make investments in the business and continue to grow in a thoughtful way.

And that's understood.

As a follow-up question, you mentioned that you're expecting to get scale from the operation.

Where do you think you will get the most scale, maybe looking at your G&A line?

Well, obviously we have a network that we spend a fair amount of time maintaining and making sure that it's safe, secure, reliable and meets the needs of our customers, and it doesn't cost a lot, if anything, to put in another transaction over that network.

Scale, certainly on the network basis, makes a lot of sense.

I think scale from our brand, it doesn't cost much money, if any again, to put another dollar value of volume on the back of the strength of the brand.

So the brand itself and the network, I think, provide the most scale in this business.

Thanks.

Your next question comes from the line of Bruce Harding from Lehman Brothers.

Please proceed.

Yes, thank you.

In terms of the various geographies, and the non-linear earnings on a quarterly basis, maybe you can discuss a little bit about is there a limit to where you see rebates as a percentage of gross and -- in any given quarter?

And across the geographies, given that the U.S. is probably a little more mature market in terms of the use of cards rather than cash and others, you know, maybe you can compare to other geographies where you are growing faster and where you're using rebates versus more, as you said, sophisticated hiring to help people with their payments, and if you could just talk about that a little bit?

Thanks.

Sure.

Where can rebates and incentives go I think was the question.

I think sometimes there's a view that rebates and incentives are all evil.

And as I've stressed before on conference calls and on the road, they're not necessarily evil.

What we're doing is we're sharing scale in the business with customers that is are willing to commit volumes to us on a go-forward basis.

I believe we're going to continue to see downward pressure on our effective basis-point pricing, going forward.

I don't think it will be anything calamitous or cliff-like.

I think if you plot out sort of the natural decline in pricing that's taken place over the last three years, it hasn't been that significant.

We don't expect it to, again, drop off significantly going forward.

So where can they go?

I think three to five years you're going to see sort of a very moderate down draft on that basis-point pricing.

In the U.S., we have very sophisticated customers that are working in a very consolidated environment, a banking environment.

Our rebates and incentives in that part of the globe have been higher than they've been in other parts of the globe.

It is a mature market. it's a very competitive market.

These customers have payments businesses that generate significant amounts of their profitability.

And they are under the spotlight from analysts to say make sure their payments businesses are profitable, and they're trying to squeeze every penny they can out of their payments businesses.

We are responsive to that [inaudible] we can.

We also try to make sure that we're partnering with them, making sure that they're not just viewing us as a necessary cost of doing business, but working with them on more advisory-type projects to help them expand the profitability of the payments businesses.

Thanks.

Good quarter.

And also, just in terms of WAMU, any comment on how much that -- can you isolate that in terms of the impact on the quarter?

Thanks.

Unfortunately I can't comment on that specific customer program, but we are very pleased with where that program has gone, and I think that's been a real successful story.

Thank you very much.

Your next question comes from the line of Chris Mammone from Deutsche Bank.

Please proceed.

Hi, guys.

Update on PayPass.

Are you seeing higher incidents with fraud with that product and are you pleased with customer adoption to date?

I am sorry, Chris, I missed the -- PayPass is what I heard.

Any incidents of fraud?

Yes.

Are you experiencing higher incidences of fraud and also are you pleased with customer adoption to date?

No and yes.

No, we're not seeing higher incidences of fraud, and yes we're very pleased with the roll out of the product.

It's one of those cases where it's like a snowball going downhill.

You have to get acceptance to get issuance, and you have to get issuance to get acceptance, and as soon as the two start reaching critical mass, it just snowballs downhill.

We're very pleased with where that's going.

I think you will see more PayPass and PayPass terminals in your travels.

Okay.

And as a follow-up, more philosophically on advertising, $1 billion spent last year, $1 billion plus this year.

Would the growth prospect of the business really fundamentally change if, say, the budget was cut by even 25%?

We think so or else we wouldn't spend the money.

We're thoughtful about this.

If you can get an invitation to the Morgan Stanley conference or listen on the webcast, Larry Flanagan our Chief Marketing Officer, is going to be doing a whole session at that conference on how we think about marketing spend, how it grows business, how it generates GDV, how it's important to our customers, et cetera.

We don't go at advertising and marketing lightly, and there's a lot of thought that goes into it.

There's a lot more science than art than you would expect in this area, and I think you will be impressed when Larry lays out how he thinks about his budget.

Thanks.

Your next question comes from the line of Nicolas De Smet from HSBC.

Please proceed.

Good morning.

Most of my questions have been asked, but maybe to go back on the top line growth, which was strong, and I don't know whether you can actually provide a proper answer here.

But clearly, the underlying spending is strong, but could you break up your growth in terms of volumes, in terms of volume growth, pricing, impact and maybe market share gain?

And maybe a follow-up on advertising [still].

Do you think there's a chance in absolute money spending '07 could be below '06 because of lack of the World Cup, for instance, or was this just a seasonal readjustment in '06 and normally that should continue growing in '07?

Well, you're going to have to repeat the second question and I'll answer the first one.

I think if you look broadly across the year, you are not going to see any significant uptick in our pricing on a basis point to dollar volume measure.

So the growth you're seeing is coming out of volume.

Now that might bounce around a little bit on a quarter-over-quarter basis, but I think big picture, broadly, we are seeing revenue growth from volume and broader acceptance of our products, not from pricing increases.

Why don't you ask me the second question again, because that was a long one.

So, just -- well maybe I'll follow up on this one.

Just on the volume.

Do you think that this is really just -- and allowing spending growing that fast across the board in Europe to U.S. and EMA, or wherever, or do you think you are growing much faster than the actual spending that, i.e., you're gaining market share against your rivals?

Well, I think as we've tried to make clear in the Roadshow and Last Call, we're not measuring this business based on market share.

We are measuring it on profitable market share.

We can certainly go out and buy all the share we want, but I don't think investors would be terribly happy without getting the returns they need.

So we're focused on growing the business in a thoughtful way, hitting those objectives I talked about financially with the revenue growth and that income growth.

And you know, share's going to bounce around over a quarter, it's going to bounce around over a five-year period, but these kind of financial results, it's hard to argue with how we're approaching the business.

Okay.

Thank you.

Operator, I believe we have time for one more question, please.

Yes, mam.

And your last question is from the line of Matthew Park from Prudential.

Please proceed.

Good morning.

Could you remind us how you're working to differentiate your brand and the network from competitors and especially since we keep hearing from some issuers that they don't really see a huge amount of difference between the Visa and MasterCard.

But I know you're working on it, so if you can elaborate on what kind of programs or spending effort that you are making, that will be helpful?

Thank you.

Well, in addition to a very strong recognized brand and a great network, we are working with customers more intimately now on growing their payments businesses.

So we have the platform.

We have the brand and now we're spending time with them, sitting down, understanding their objectives, making sure our objectives are aligned with theirs, bringing to bear resources in technology, in brand, payments businesses, et cetera.

They view us as not just somebody that has a common brand and a common technology platform, but somebody that can really work on them on a consultative basis to grow their payments businesses.

We think our brand is different that Visa.

We think we have a very strong brand.

We think with brand recognition metrics, which Larry will be sharing at that conference next week, our Millward Brown recognition scores are higher than our competition.

I think we continue to make smart investments.

I think we are becoming more -- much more of a business partner with our customers.

They view us much more as a business partner.

If we can help them make money, we make money as well.

Okay.

And as a follow-up, can you give us color on your more recent dialog with your issuer-clients now that you have concluded some renewals?

Whether -- I am sorry -- to whether it has -- whether the topic has changed from your prior dialogs or whether some of the points that they are working on is different from that they were working on prior?

Thanks.

Prior to what, the IPO or --?

Prior to their -- well, prior to the previous contract negotiations, I guess.

I'm just trying to get a sense about whether the issuers are looking at different issues now.

They're interested in growing their business.

They're interested in select segments of the market, whether it be affluent or commercial or prepaid.

They're tough negotiators.

I don't think that's changed.

It is probably -- if anything, it's gotten more intense in sitting down and negotiating deals, which make sense for them and make sense for us economically.

And you feel that you are adding appropriate value to those discussions?

I believe so.

Thank you.

Ladies and gentlemen, that does conclude today's question and answer session.

I would now like it turn it back over to Chris McWilton for any closing remarks.

Thank you, everyone, for joining this morning.

Obviously we're delighted in these results, our first fum quarter as a publicly listed Company.

We're very confident in the business right now, and think these results show that our strategy and our thoughts and our investments are on the right path for the future.

Again, thank you for joining us.

Ladies and gentlemen, thank you for your participation in today's event.

This does conclude the presentation, and you may now disconnect.

Have a great day.