Visa Inc (V)
Q3 2008 Earnings Call
July 30, 2008 5:00 PM, ET

Executives

Jack Carsky – Head of Global Investor Relations
Joseph W. Saunders – Chairman of the Board & Chief Executive Officer
Byron H. Pollitt Jr. – Chief Financial Officer

Analysts

Bob Napoli – Piper Jaffray
Tien-Tsin Huang – J.P. Morgan
Adam Frisch – UBS
Dan Perlin – Wachovia Securities
Elizabeth Grausam – Goldman Sachs
Craig Maurer – Calyon Securities (USA) Inc
Patrick Burton – Citigroup
David Hochstin – Buckingham Research
Christopher Brendler – Stifel Nicolaus
Sanjay Sakhrani – KBW
Andrew Jeffrey – SunTrust
Bruce Harting – Lehman Brothers

Operator

Welcome to Visa Incorporated third quarter earnings conference call. All participants are currently in a listen-only mode. Today’s conference is being recorded. If you have any objection you may disconnect at this time. I would now like to turn the call over to your host, Mr. Jack Carsky, Head of Investor Relations for Visa Inc. Sir you may begin.

Jack Carsky

Thanks Kelly. Good afternoon to everyone and welcome to Visa Inc.’s fiscal third quarter earnings conference call. Speaking today are Joe Saunders, Visa’s Chairman and Chief Executive Officer and Byron Pollitt, our Chief Financial Officer. This call is currently being webcast live over the internet. It can be accessed on the investor relations section of our website at www.investor.visa.com. A replay of the webcast will also be archived on our site for 30 days. A PowerPoint deck containing highlights of today’s commentary was posted to the website prior to this call. Let me please remind you that this presentation may include forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. By their nature forward-looking statements are not guarantees of future performance and as a result of a variety of factors actual results could differ materially from such statements. Additional information in concerning those factors is available in the company’s filings with the SEC, which can be accessed through the SEC website and the investor relations section of the Visa’s website. For historical non-GAAP or pro forma related financial information disclosed in this call, the related GAAP measures and other information required by Regulation G of the SEC are available in the financial and statistical summary accompanying our fiscal third quarter earnings press release. This release can also be accessed through the investor relations section of our website. With that, I’ll turn the call over to Joe.

Joseph W. Saunders

Thanks Jack and thanks to all of you for joining us this afternoon. For some time now we have been saying that Visa, while not immune to economic downturns, does have a high degree of resiliency embedded in its business model. The proof of this resiliency can be seen in our latest earnings results. For fiscal third quarter 2008 Visa’s net income on an adjusted basis was $457 million which is a 40% increase over the prior year’s third quarter on a pro forma basis. This equates to adjusted diluted earnings of $0.59 per share. Net operating revenues in the fiscal third quarter were strong at $1.6 billion or an increase of 18% over the third quarter of 2007 on a pro forma basis as we again saw strong growth across all key categories. As anticipated we are now seeing operating revenues running more in line with our long term guidance and volume growth rates and we expect this dynamics to continue. Last year’s price adjustments which were in full effect by 2/3/2007 had a much more muted impact in the third quarter’s results this year. Byron will discuss the individual revenue line items in a moment.

We’ve also begun to realize the positive impact of our operating scale in our efforts in reorganizing Visa as a publicly traded company. Revenue growth is strong and our expense base is currently growing at a very modest rate. We delivered operating margins ahead of our internal expectations and external guidance over the span of our short public life. Given the opportunities to continue to leverage the scale and effectively manage our expenses, we are increasing our longer term adjusted operating margin guidance to the mid-to-high 40% range. Byron will get into the additional detail in a moment. From a broader economic perspective the financial markets and the economy, particularly here in the U.S., have clearly seen their share of turmoil since we last reported earnings at the end of April. Our expectation going into our fiscal 2008 year was for tougher economic times in the back half of the year and our revenue guidance contemplated this. During the first three fiscal quarters we have exceeded our guidance and although the tougher climate is now here and will likely continue, we expect the fourth fiscal quarter to be at the upper end of our revenue guidance range. For the calendar quarter ending June 2008 on which our fourth fiscal quarter’s USP service revenue will be based. Payment volume in the U.S. though softening has held up pretty well. So what does this mean for Visa? As we have publicly stated our business model remains resilient though not totally immune to the tough economic environment in the U.S. and to some extent globally. We continue to see secular shift to plastic particularly in our debit products in the U.S. and international volumes, including cross border transactions are still posting solid double digit growth. We continue to see increases in consumer-driven non-discretionary spending on cards. Through the end of June U.S. consumer non-discretionary spend as a percentage of total spend is up two percentage points over the end of 2007 and now represents 44% of overall Visa consumer payments volume in the United States. The 2% increase is represented by increased debit and credit usage. So while we are maintaining a cautious posture we are optimistic about the future.

On the legislative front we had a busy quarter as well. As we were no longer subject to the IPO restrictions of speaking about our company, we were able to make some good headway in Washington on the issue of interchange and Visa’s part in the process. This involved a significant amount of outreach to committees and their members as well as testimony from our management team. While there’s no way of knowing for certain what the final outcome will be we feel better knowing that the issues are now being appropriately debated. We would also note that there has been opposition to the Congress bill on both sides of the aisle as well as from consumer groups, credit union coalitions and the Department of Justice. We will continue to actively participate in legislative and regulatory activities which affect our industry. On the litigation front there are a few developments to report in the Discover action which is a covered case under Visa’s retrospective responsibility plan. We recently entered into a judgment sharing agreement which allocates payment responsibilities between Visa and MasterCard for judgments or settlements in the Discover case, with Visa’s share being larger primarily based on relevant volumes. At the same time we entered into a mutual release agreement in which Visa and MasterCard release any claims each may have against the other in connection with prior business practices. This includes MasterCard’s claims regarding Visa’s settlement service fee which is referenced in our SEC filings as not a covered claim under our retrospective responsibility plan. As a result of these agreements we increased our litigation reserve for the quarter by $31 million on an after tax basis. Because the Discover litigation and related claims are non-recurring legacy items, we have not included these reserves in our adjusted income figures. With that, let me turn the call over to Byron who will take you through the financial results and I’ll be back to provide more detail around some of the newer initiatives we have recently started.

Byron. H Pollitt Jr – Chief Financial Officer

Thank you, Joe. Before discussing the P&L let me highlight some of the business and revenue drivers from the quarter. Payment volume, which is a key driver of revenue, grew 19% to $652 billion over the same quarter of 2007, as we continued to see strong results across all of our regions. Credit growth, which was just under 19% worldwide while growing here in the U.S. at a little over 8%, compared to debit in aggregate which grew closer to 20%, made up of a solid 16% growth domestically and a strong 44% internationally. We continue to view the secular migration to debit and the opening up of additional payment categories as very attractive near-term opportunities. For the calendar quarter through the end of June, we have experienced continued solid payment volume growth in the U.S. of 10%. Though moderating a bit from the 12% we reported for the March quarter, we have seen a fairly consistent monthly rate through the end of June and continuing into July. Cross border volume growth, which is currently growing at a robust mid to high teens rate, has trended lower as well from the mid 20% range we experienced through March. The exception to this has been our CEMEA region which continues to grow in the mid 30s range. From an overall payment volume perspective we believe the combination of U.S. debit and international growth will continue to provide growth momentum to our business in spite of the increasingly challenging economic backdrop. Total transactions, including payment and cash transactions, were up 15% to $13.2 billion in the quarter ending March 2008 versus the prior year. While the U.S. grew approximately 12% during the period we saw very strong gains across the globe, highlighted by our CEMEA region at 24% and Asia Pacific and Latin America at 20% and 18% respectively.

Process transactions were those that we define as being processed over Visa’s network totaled $9.5 billion in the fiscal third quarter, an increase of 13% over the similar period a year ago. This transaction growth drove strong gains in data processing fees which rose 20% over the prior year to $539 million. Card growth for the period ending March was up 14% excluding Europe with over 1.6 billion cards now carrying the Visa brand. Credit grew 14% to 814 million cards while debit rose 15% to 850 million cards. On an international basis credit card growth was very strong, growing 19% year-over-year while international debit cards grew 16%. Moving on to the income statement, gross revenues of $1.9 billion were up 23% from the year ago period’s $1.5 billion. Volume and support incentives increased by $99 million to $274 million representing 15% of gross revenue. For the fourth fiscal quarter we see volume and support incentives running at around 16% of gross revenue. Total net operating revenues were just over $1.6 billion, an 18% increase over the pro forma operating revenues of $1.4 billion reported for the third quarter of 2007. As we stated on last quarter’s earnings call, price adjustments made in non-U.S. regions that were fully implemented in the fiscal third quarter of 2007 are no longer influencing year-over-year comparables to as large a degree as they have in previous quarters, though the impact is still positive.

During the quarter we observed certain dynamics across all of our key fee categories that continue to reinforce our belief that our business model can sustain attractive growth despite a weakened U.S. economy. Globally, service fees were $749 million, up 13% over the pro forma result of the prior year period reflective of higher year-over-year payment volumes in all regions. Data processing fees posted strong gains rising 20% over the prior year to $539 million. We continue to benefit from the greater transaction volumes domestically while continuing our focus on increasing the number of transactions we process internationally. International transaction fees were up 44% to $449 million and continued to benefit from higher multicurrency payment volume across all regions as well as from pricing adjustments we made in April of this year to cross border transactions involving U.S. issued cards. As mentioned earlier cross border transactions remain strong, although we are starting to observe a moderation in the growth rate. Our adjusted operating margin was approximately 45% this quarter, an increase of approximately seven percentage points over the similar period last year. The combination of 18% net revenue growth with 4% expense growth drove this margin expansion and resulted in a 42% increase in operating income.

Given our performance through the third fiscal quarter and despite our expectation for modest margin compression in the fourth quarter we now expect to deliver an adjusted mid 40s margin for all of fiscal 2008, ahead of our initial long-term guidance of below 40. As we look out to 2009 and beyond, the resilience of our business model combined with opportunities for additional operating leverage make us comfortable raising our adjusted operating margin guidance through the mid-to-high 40% range as part of our outlook through fiscal 2010. On an adjusted basis, operating expenses for the quarter increased $31 million or 3.6% year-over-year to $883 million as modest increases in personnel, network and marketing costs were offset by lower professional and consulting fee expenses. On a sequential quarter basis, adjusted expenses increased by $100 million primarily as a result of stepped up marketing and advertising costs to measure with the mid May kickoff of our Olympic programs and modestly higher professional fees tied to our new product initiatives. In the fourth quarter we anticipate further increases in marketing and advertising spend tied both to the Olympics and marketing programs ahead of the fourth calendar quarter holiday season. All told, marketing and advertising spend should total about $1 billion in fiscal 2008.We also expect a step up in professional fees tied to supporting the new product and channel initiatives which Joe will speak about in a moment. Capital expenditures were $86 million in the quarter, over half of which are dedicated to the build out of our new data center. Full year capital spending is expected to be in the range of $425 million to $450 million. As we have previously stated we expect capital expenditures to remain at an elevated level through the end of fiscal 2009 as we complete our new data processing center. After this we expect CapEx to run at around 3% to 4% of gross revenue on an annualized basis.

Moving on to the balance sheet, we ended the third quarter with cash, cash equivalent, available for sale investment and restricted cash of $8.4 billion, an increase of approximately $400 million over the prior quarter. Of this total, there is restricted cash of approximately $2 billion which represents the balance of the $3 billion litigation escrow established at the IPO less the initial payment to American Express of $945 million last quarter and their first quarterly payment of $70 million. In addition we ended to use $2.7 billion cash to redeem all of the Series 2 and a portion of the Series 3 Class C shares this October that are held by Visa Europe. As mentioned previously, given our sizable and growing cash balances we are very focused on not allowing excess cash to build up on our balance sheet and to that end we will be considering a share repurchase program as early as the first fiscal quarter of 2009. Now I would like to comment on what we see over the balance of 2008. As I mentioned a moment ago, we entered 2008 with the expectation that a softer U.S. economy would have an effect on our payment volume and revenue growth over the next several quarters and we are now starting to see that impact. We also have a pretty clear view into our U.S. payment volumes for April through June which will be reflected in service fee revenue in our fourth fiscal quarter. Based on this early view we are still running at the higher end of our stated revenue guidance range of 11% to 15%. As noted earlier we are increasing adjusted operating margin guidance from the low 40% range to the mid 40% range for fiscal 2008 and over the longer term, 2009 through 2010 to the mid to high 40% range. We also remain on track to deliver adjusted diluted earnings per share growth of greater than 20% and annual free cash flow exceeding $1 billion. That concludes my comments. So, I’ll turn the call back over to Joe.

Joseph W. Saunders