VISA (V) Q2 2011 Earnings Call Transcript

Transcript

Speaker 11

Welcome to Visa Inc.'s Fiscal Q2 2011 Earnings Conference Call. All participants are in a listen-only mode until the question and answer session. Today's conference is being recorded. If you have any objections, you may disconnect at this time. I would now like to turn the conference over to your host, Mr. Jack Carsky, Head of Global Investor Relations. Mr. Carsky, you may begin.

Speaker 9

Good afternoon and welcome to Visa Inc.'s Fiscal 2011 Second Quarter Earnings Conference Call. With us today are Joe Saunders, Visa's Chairman and Chief Executive Officer, and Byron Pollitt, Visa's Chief Financial Officer. This call is currently being webcast 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 our website prior to this call. Let me also 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.

These include setbacks in the global economy and the impact of new financial reform regulations. Additional information concerning these factors is available in our last 10-K on file with the SEC. It can be accessed through the SEC website in the Investor Relations section of our website. For historical non-GAAP or pro forma related financial information disclosed on 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 second quarter earnings press release. This release can also be accessed through the Investor Relations section of our website. I'll turn the call over to Joe.

Speaker 5

Thanks, Jack, and as always, thanks to all of you for joining us today. Visa delivered another quarter of solid financial performance, posting net operating revenue of over $2.2 billion, a 15% increase over the same period last year. As has been the case for over a year now, these revenue gains were driven by double-digit growth in payment volume, cross-border volume, and Visa processed transactions from across the globe. Notably, 62% of our total revenue growth came from outside the United States, getting us progressively closer to our stated objective of having our business outside the United States represent more than half of our revenue by fiscal 2015. Net income for the quarter was $881 million, a 23% increase over the prior year. This equates to diluted earnings per share of $1.23, a 28% increase over the second quarter of 2010.

Speaker 11

Speaker 9

Good afternoon and welcome to Visa Inc.'s Fiscal 2011 Second Quarter Earnings Conference Call. With us today are Joe Saunders, Visa's Chairman and Chief Executive Officer, and Byron Pollitt, Visa's Chief Financial Officer. This call is currently being webcast 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 our website prior to this call. Let me also 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.

Speaker 5

In the second quarter, we effectively repurchased an additional $630 million worth of shares, nearly exhausting our $1 billion authorization first announced at the beginning of this fiscal year. Given that, and recognizing our ongoing commitment to return excess cash to shareholders, today, we're pleased to announce that our board recently authorized a new $1 billion share repurchase program. This brings our total announced effect of repurchases in fiscal 2011 to $2.8 billion. Byron will provide some additional detail on the specifics of the activity. Before covering some of the business highlights from the quarter, I'd like to first address the ongoing legislative dialogue in Washington and the industry's efforts to address the Durbin Bill. Reiterating what I said on last quarter's call, since the introduction of the Durbin Amendment, Visa has worked with the industry to help educate legislators on the unintended consequences of this piece of legislation.

Our efforts are gaining increasing traction. As you know, Senators Tester and Corker have introduced legislation calling for a delay in a study of the Durbin Bill. The Senators' efforts have generated support from a large, growing, and diverse group of individuals and organizations who are concerned about the unintended anti-consumer consequences of debit regulation. We believe strongly that Congress should examine what the real impact of this regulation will be on consumers, the financial institutions that serve them, the payment system, and the economy as a whole. This would be the reasonable and rational course of action. To that end, we are hopeful that the Senate will consider Senators Tester and Corker's bill in the very near future. That said, no matter what happens with Durbin, we will continue to compete in and lead the US electronic payments market and be a growth company for years to come.

I'll now turn to business developments from the past quarter that underscore our focus on driving global revenue growth today, while also setting the stage for future growth through new and innovative ways to pay. As ever, our strong relationships with clients continue to help drive our success. In addition to delivering solid financial gains in the second fiscal quarter, we were successful in advancing our strategy of growing and protecting our core business through key wins and relationship renewals with financial institutions and merchants. First, we grew our core issuance business with several important new deals. For example, in India, we've made significant strides in expanding our business with the State Bank of India. We signed a multi-year deal to issue Visa debit products across the SBI franchise, whereas until now, the bank's business was entirely with our competitor.

Nearly 0.5 million Visa cards have been issued since March, and we expect several million to be issued within the first year of the program, with significant runway beyond that. This new win is in addition to the joint venture we already have in the works with SBI and Elavon to terminalize major metropolitan areas of the country. We also recently signed a multi-year credit and debit agreement with HSBC, covering most of our Latin America and Caribbean region that will considerably broaden our issuance with HSBC in this part of the world. This builds upon the long-term issuing relationship we have had with HSBC globally for many years. In the U.S., we expanded our credit program portfolio with a new seven-year program with U.S. Bank and Kroger, one of the largest grocery retailers in the U.S., which will begin converting to Visa in September.

We also strengthened several relationships with long-time key issuing clients in the U.S. Most recently, we re-signed Regions Bank to a multi-year debit agreement to include signature debit, Interlink, and some processing services. Regions is a top 10 debit issuer in the U.S. and a long-time client of Visa. We also continue to see good traction on the prepaid front in the U.S. with our state government programs. We recently initiated unemployment insurance programs in Connecticut with Chase and in Florida with Wells Fargo. On that subject, our unemployment programs with Bank of America in New Jersey and California are ramping up at a very nice pace. Importantly, though, we are seeing increasing use of these cards at the point of sale versus cash withdrawals at ATM, as consumers get more comfortable with this form of prepaid product.

Beyond working with our financial institution and merchant clients to expand issuance and acceptance of our core products, we also continue to look ahead and develop new channels and form factors to diversify the utility of these products. For instance, in the mobile space, we just announced our real-time messaging service with our first client, the Gap. This service allows merchants to send real-time location-based discounts and promotions to consumers via text message. In this case, consumers can opt into the Gap Mobile 4U program to receive Gap discounts that are triggered when they conduct a qualified Visa transaction, which they can choose to redeem at a Gap store while they are out shopping. Gap was the first national retailer to test and roll out real-time messaging, and we have a strong pipeline of other retailers to follow.

This is an excellent example of a value-added service that supports merchants' desires to personalize the consumer shopping experience, made possible by the real-time processing capabilities and unparalleled data from our VisaNet processing infrastructure. Equally important, if the legislation is not delayed, RTM, along with other offerings such as CyberSource's and Enhanced Decision Manager, which I'll talk about in a moment, are the types of Visa value-added services that would incent merchants to route transactions over VisaNet. In the area of person-to-person payments, we continue to make important strides in leveraging our network and significant card base to enable people to pay each other using Visa cards. Our recent announcement with CashEdge and Fiserv in the U.S. Billion share repurchase program. This brings our total announced effect of repurchases in fiscal 2011 to $2.8 billion. Byron will provide some additional detail on the specifics of the activity.

Before covering some of the business highlights from the quarter, I'd like to first address the ongoing legislative dialogue in Washington and the industry's efforts to address the Durbin Bill. Reiterating what I said on last quarter's call, since the introduction of the Durbin Amendment, Visa has worked with the industry to help educate legislators on the unintended consequences of this piece of legislation. Our efforts are gaining increasing traction. As you know, Senators Tester and Corker have introduced legislation calling for a delay in a study of the Durbin Bill. The Senators' efforts have generated support from a large, growing, and diverse group of individuals and organizations who are concerned about the unintended anti-consumer consequences of debit regulation.

We believe strongly that Congress should examine what the real impact of this regulation will be on consumers, the financial institutions that serve them, the payment system, and the economy as a whole. This would be the reasonable and rational course of action. To that end, we are hopeful that the Senate will consider Senators Tester and Corker's bill in the very near future. That said, no matter what happens with Durbin, we will continue to compete in and lead the US electronic payments market and be a growth company for years to come. I'll now turn to business developments from the past quarter that underscore our focus on driving global revenue growth today, while also setting the stage for future growth through new and innovative ways to pay. As ever, our strong relationships with clients continue to help drive our success.

In addition to delivering solid financial gains in the second fiscal quarter, we were successful in advancing our strategy of growing and protecting our core business through key wins and relationship renewals with financial institutions and merchants. First, we grew our core issuance business with several important new deals. For example, in India, we've made significant strides in expanding our business with the State Bank of India. We signed a multi-year deal to issue Visa debit products across the SBI franchise, whereas until now, the bank's business was entirely with our competitor. Nearly 0.5 million Visa cards have been issued since March, and we expect several million to be issued within the first year of the program, with significant runway beyond that.

This new win is in addition to the joint venture we already have in the works with SBI and Elavon to terminalize major metropolitan areas of the country. We also recently signed a multi-year credit and debit agreement with HSBC, covering most of our Latin America and Caribbean region that will considerably broaden our issuance with HSBC in this part of the world. This builds upon the long-term issuing relationships we have had with HSBC globally for many years. In the U.S., we expanded our credit program portfolio with a new seven-year program with US Bank and Kroger, one of the largest grocery retailers in the U.S., which will begin converting to Visa in September. We also strengthened several relationships with long-time key issuing clients in the U.S. Most recently, we re-signed Regions Bank to a multi-year debit agreement to include signature debit, Interlink, and some processing services.

Regions is a top 10 debit issuer in the U.S. and a long-time client of Visa. We also continue to see good traction on the prepaid front in the U.S. with our state government programs. We recently initiated unemployment insurance programs in Connecticut with Chase and in Florida with Wells Fargo. On that subject, our unemployment programs with Bank of America in New Jersey and California are ramping up at a very nice pace. Importantly, though, we are seeing increasing use of these cards at the point of sale versus cash withdrawals at ATM, as consumers get more comfortable with this form of prepaid product. Beyond working with our financial institution and merchant clients to expand issuance and acceptance of our core products, we also continue to look ahead and develop new channels and form factors to diversify the utility of these products.

For instance, in the mobile space, we just announced our real-time messaging service with our first client, Gap. This service allows merchants to send real-time location-based discounts and promotions to consumers via text message. In this case, consumers can opt into the Gap Mobile 4U program to receive Gap discounts that are triggered when they conduct a qualified Visa transaction, which they can choose to redeem at a Gap store while they are out shopping. Gap was the first national retailer to test and roll out real-time messaging, and we have a strong pipeline of other retailers to follow. This is an excellent example of a value-added service that supports merchants' desires to personalize the consumer shopping experience, made possible by the real-time processing capabilities and unparalleled data from our VisaNet processing infrastructure.

Equally important, if the legislation is not delayed, RTM, along with other offerings such as CyberSource's and Enhanced Decision Manager, which I'll talk about in a moment, are the types of Visa value-added services that would incent merchants to route transactions over VisaNet. In the area of person-to-person payments, we continue to make important strides in leveraging our network and significant card base to enable people to pay each other using Visa cards. Our recent announcement with CashEdge and Fiserv in the U.S. underscores one of the important ways we are accelerating growth in this area. Increasingly, by working with partners like these who have existing distribution channels, we can broaden the reach and ease of use of P2P payment programs on Visa products. A recent example of one of these P2P programs overseas involves a service we recently launched in Russia and the Ukraine.

We are working with QIWI, Russia's largest payment kiosk operator, First Processing Bank in Russia, and PrivatBank, the Ukraine's largest bank. Together, we are enabling domestic transfers within Russia and with the cross-border functionality between Visa account holders in the Ukraine and Russia. Over time, we will partner with additional entities to expand these programs globally. On the e-commerce front, we closed the PlaySpan acquisition on March 1st. In the meantime, we have seen CyberSource's business continue to grow rapidly and gain increasing traction in the marketplace. During the quarter, CyberSource delivered 38% billable transaction growth and secured a number of new business wins with major merchants, including ADS, America and Olympus America. I also want to point out one or more of the recent examples of the synergies we are finding with CyberSource that deliver tangible value to our global merchant base.

This quarter, we combined the strength of Visa and CyberSource's individual fraud detection capabilities to launch our first iteration of Enhanced Decision Manager, which I mentioned earlier. By combining the risk scores that CyberSource has historically provided to its merchant clients with data from the Visa Inc. Advanced Authorization Service, we are delivering a unique and unparalleled view of transaction data that merchant clients recognize will serve them as a powerful new fraud detection mechanism for their business. All of these advancements are important steps towards capturing the enormous opportunity we see ahead, with payments innovation fueling our business growth over the moderate to long term. All of us know the way people connect and transact across the globe is changing dramatically, driven by two global forces.

First, the continued secular shift from paper-based to electronic payments that still largely occurs at the physical point of sale, and second, the widespread adoption of mobile and internet technology. These forces are converging, and consumers and merchants are looking for payment solutions that harness these technologies. To that end, we have been working hard to develop a Visa-quality payment solution that brings reliability, security, and convenience to mobile and e-commerce environments. In our view, a globally viable payment solution must have five fundamental characteristics: convenience and simplicity, standardization, interoperability, and global accessibility, underscores one of the important ways we are accelerating growth in this area. Increasingly, by working with partners like these who have existing distribution channels, we can broaden the reach and ease of use of person-to-person payment programs on Visa products.

A recent example of one of these P2P programs overseas involves a service we recently launched in Russia and the Ukraine. We are working with QIWI, Russia's largest payment kiosk operator, First Processing Bank in Russia, and Privat Bank, the Ukraine's largest bank. Together, we are enabling domestic transfers within Russia and with the cross-border functionality between Visa account holders in the Ukraine and Russia. Over time, we will partner with additional entities to expand these programs globally. On the e-commerce front, we closed the PlaySpan acquisition on March 1. In the meantime, we have seen CyberSource's business continue to grow rapidly and gain increasing traction in the marketplace. During the quarter, CyberSource delivered 38% billable transaction growth and secured a number of new business wins with major merchants, including ADS, America, and Olympus America.

I also want to point out one or more of the recent examples of the synergies we are finding with CyberSource that deliver tangible value to our global merchant base. This quarter, we combined the strength of Visa and CyberSource's individual fraud detection capabilities to launch our first iteration of Enhanced Decision Manager, which I mentioned earlier. By combining the risk scores that CyberSource has historically provided to its merchant clients with data from the Visa Inc. Advanced Authorization Service, we are delivering a unique and unparalleled view of transaction data that merchant clients recognize will serve them as a powerful new fraud detection mechanism for their business. All of these advancements are important steps towards capturing the enormous opportunity we see ahead, with payments innovation fueling our business growth over the moderate to long term.

All of us know the way people connect and transact across the globe is changing dramatically, driven by two global forces. First, the continued secular shift from paper-based to electronic payments that still largely occurs at the physical point of sale, and second, the widespread adoption of mobile and internet technology. These forces are converging, and consumers and merchants are looking for payment solutions that harness these technologies. To that end, we have been working hard to develop a Visa-quality payment solution that brings reliability, security, and convenience to mobile and e-commerce environments. In our view, a globally viable payment solution must have five fundamental characteristics: convenience and simplicity, standardization, interoperability, global accessibility, and security. None of the solutions we have seen from competitors is comprehensive enough because they don't address all of these criteria at once.

Visa has long delivered solutions at the physical point of sale that passed this test, and we are applying the same standard in the online and mobile arenas. Look for us to make an announcement of our global e-commerce and mobile strategy later this month. Now, over to Byron.

Speaker 19

Thank you, Joe. I'll begin with some overall observations. First, Visa's 15% net revenue growth was broad-based, with solid 10% growth in the U.S. and a very strong 21% growth rate in the rest of the world. As Joe mentioned earlier, over 60% of the quarter's revenue growth came from outside the United States. This means non-U.S. revenue is now 45% of Visa's total. Second, U.S. revenue growth has been supported by five consecutive quarters of year-over-year positive credit payment volume growth. Most recently, the months of February and March both comped at 11%, which is the first time we have seen double-digit growth since the recession. We are clearly encouraged by this trend. Third callout relates to client incentives. Incentives for the quarter as a percent of gross revenue were 16.7%, up from 15.3% in the First Quarter.

Taken together, incentives as a percent of gross revenue were 16% for the first half of the fiscal year, at the low end of our guidance. While we still expect client incentives to be in the range of 16%-16.5% for fiscal 2011, if implementation of the Durbin Amendment is not delayed beyond July, it is probable that we would see some upward pressure on this number as a result of potential actions we would take to mitigate volume loss with certain issuers and merchants. Fourth callout relates to Durbin. Whether the legislation gets delayed or not, we still expect to deliver revenue growth in the 11%-15% range and earnings per share growth of greater than 20%.

Finally, it's worth noting that beginning with the second fiscal quarter, our three key revenue drivers are now growing at double-digit rates while comping double-digit growth in the same quarter of the prior year. This is true both globally and for the U.S., indicating that the strength of the recovery is now more broad-based. Now let's turn to the numbers. First, I will cover our global payment volume and transaction trends for the December and March quarters, as well as more recent payment and transaction results for the entire month of April. I'll then cover the financial highlights of our fiscal second quarter, followed by our guidance outlook for fiscal year 2011. Global payment volume growth for the March quarter in constant dollars was 13%, a modest decline from the fiscal.

Speaker 5

None of the solutions we have seen from competitors is comprehensive enough because they don't address all of these criteria at once. Visa has long delivered solutions at the physical point of sale that passed this test, and we are applying the same standard in the online and mobile arenas. Look for us to make an announcement of our global e-commerce and mobile strategy later this month. Now, over to Byron.

Speaker 19

In the U.S., payment volume growth was 12%, relatively flat from the December quarter. The rest of the world payment volume on a constant dollar basis grew at 15%, down two points from the 17% rate in the December quarter. More recently, in the month of April, US payment volume growth came in at 11%. Although not yet available, based on the trends we saw during the second quarter, we expect the rest of the world payment volume growth to be higher than the U.S.'s 11%. Global, cross-border volume delivered a solid 13% growth rate on a constant dollar basis in the March quarter, down slightly from a 15% rate in the December quarter. There was notable drop-off in inbound travel to Japan, the Middle East, and North Africa. In aggregate, these situations may have negatively impacted growth by about 50 basis points.

In April, cross-border volumes on a constant dollar basis grew 13%. Transactions processed over Visa's network totaled $12 billion in the fiscal second quarter, a 13% increase over the year-ago period, and modestly behind the 15% growth rate we saw in the December quarter. In April, processed transactions posted growth of 12%. CyberSource billable transactions totaled just over $1 billion for the quarter, a very strong 38% growth rate over the same period a year ago. We continue to expect strong results in this part of our business as e-commerce growth remains strong in the U.S. and internationally. Now, turning to the income statement. In our fiscal second quarter, gross revenue of $2.7 billion was up 16% from the similar period in 2010. Net operating revenue in the quarter was $2.2 billion, a 15% increase year-over-year, driven by a sustained economic recovery, previously enacted pricing changes, and cross-border transaction growth.

Moving to the individual revenue line items, service revenue was $1.1 billion, up 24% over the prior year period. This is reflective of strong payment volume growth in the December quarter and the impact of pricing adjustments. Data processing revenue was $823 million, up 13% over the prior year's quarter, based on strong transaction growth rates for both Visa processed and CyberSource transactions. As expected and discussed previously, data processing revenue growth has moderated due to the impact of key contract renewals two quarters ago and by the prospective removal of certain offsetting gateway pass-through revenue and expense. International transaction revenue was up 14% to $624 million due to the sustained improvement in cross-border volumes during the period. Percent growth we saw in the December quarter. We saw the following breakdowns in the March quarter figures. In the U.S., payment volume growth was 12%, relatively flat from the December quarter.

The rest of the world payment volume on a constant dollar basis grew at 15%, down two points from the 17% rate in the December quarter. More recently, in the month of April, US payment volume growth came in at 11%. Although not yet available, based on the trends we saw during the second quarter, we expect the rest of the world payment volume growth to be higher than the U.S.'s 11%. Global cross-border volume delivered a solid 13% growth rate on a constant dollar basis in the March quarter, down slightly from a 15% rate in the December quarter. There was notable drop-off in inbound travel to Japan, the Middle East, and North Africa. In aggregate, these situations may have negatively impacted growth by about 50 basis points. In April, cross-border volumes on a constant dollar basis grew 13%.

Transactions processed over Visa's network totaled $12 billion in the fiscal second quarter, a 13% increase over the year-ago period, and modestly behind the 15% growth rate we saw in the December quarter. In April, processed transactions posted growth of 12%. CyberSource billable transactions totaled just over $1 billion for the quarter, a very strong 38% growth rate over the same period a year ago. We continue to expect strong results in this part of our business as e-commerce growth remains strong in the U.S. and internationally. Now, turning to the income statement. In our fiscal second quarter, gross revenue of $2.7 billion was up 16% from the similar period in 2010. Net operating revenue in the quarter was $2.2 billion, a 15% increase year-over-year, driven by a sustained economic recovery, previously enacted pricing changes, and cross-border transaction growth.

Moving to the individual revenue line items, service revenue was $1.1 billion, up 24% over the prior year period. This is reflective of strong payment volume growth in the December quarter and the impact of pricing adjustments. Data processing revenue was $823 million, up 13% over the prior year's quarter, based on strong transaction growth rates for both Visa processed and CyberSource transactions. As expected and discussed previously, data processing revenue growth has moderated due to the impact of key contract renewals two quarters ago and by the prospective removal of certain offsetting gateway pass-through revenue and expense. International transaction revenue was up 14% to $624 million due to the sustained improvement in cross-border volumes during the period. As I mentioned, client incentives as a percentage of gross revenue came in at 16.7% and are running at 16% fiscal year to date, on track with expectations.

Approximately 65% of the year-over-year dollar increase in incentives is due to payment volume growth in client portfolios. About another 25% of the increase is due to non-U.S. client renewals. Total operating expense for the quarter was $862 million, up 3% from the prior year. Increases in personnel, professional fees, and general and administrative expense were offset by lower marketing in the period. Additionally, I'll continue to remind you of this for the next two quarters, recall that we announced an earnings-neutral change in income statement presentation related to revenue and operating expense associated with certain pass-through activities. As a result, $50.5 million of revenue and expense, which was booked in Q2 fiscal year 2010, did not reoccur in Q2 fiscal year 2011. In Q2, this represented three percentage points of revenue growth.

For the remainder of the year, these changes in presentation will continue to be earnings-neutral and will affect revenue growth. The foreign exchange impact on net revenue in the second fiscal quarter was moderated by our hedging activities and contributed a positive 2% increase compared to the same prior year period. While our operating margin for the quarter was 62%, please note that we expect to aggressively fund important long-term investments across our entire business. Capital expenditures were $72 million in the quarter, representing ongoing investment in technology, infrastructure, and growth initiatives. Lastly, the PlaySpan acquisition had a diluted impact to earnings per share of $0.01 for the second quarter of fiscal 2011, and we anticipate a diluted impact to earnings per share of $0.04 for the full 2011 fiscal year.

Moving on to the balance sheet, we ended the second quarter in great shape with negligible debt and cash, cash equivalents, restricted cash, and available for sale investments of $6.6 billion. Of this total, $3 billion is restricted cash, which represents amounts sufficient to fully pay out the balance of the American Express settlement over the remaining three quarters, with $2.7 billion uncommitted as of the end of the second quarter. In terms of our ongoing buyback, at the end of the quarter, we announced the pre-funding of the litigation escrow by $400 million to be funded with cash previously designated for our $1 billion share repurchase. This was executed at an average price of $73.81 per share. Additionally, we repurchased $230 million of our shares in the open market during the quarter at an average price of $70.53 per share.

All told, we effectively repurchased 8.7 million shares at an average price of $72.58. This leaves us with $64 million of open to buy under the original program. At the end of the quarter, we had 704 million shares outstanding on an as-converted basis. Importantly, the A-class now accounts for almost 75% of our outstanding shares. Management remains committed to returning excess cash to shareholders. To this end, as Joe mentioned at the outset, our Board of Directors authorized a new $1 billion repurchase plan, which we will execute at prices we feel are attractive relative to the long-term value of Visa. As to guidance for the balance of 2011, given results to date, we are not making any adjustments at this time. With or without a Durbin delay, we expect to deliver revenue growth in the 11%-15% range and EPS growth of better than 20%.

Once the timing and content of the Reform Act regulations are clarified, we will determine whether any 2011 guidance requires adjustment, such as client incentives, and we will consider providing an early earnings outlook for fiscal 2012. In summary, we expect Visa to remain a solid growth company for years to come. Our core businesses continue to grow at healthy rates while we are aggressively investing in technologies and platforms that will extend our core payment and processing capabilities, thereby creating new sources of growth. Finally, we expect to deliver this growth while driving significant free cash flow, which we will use to enhance shareholder returns through continued dividend increases and share repurchases. We are ready to take questions.

Speaker 11

Thank you. If you would like to ask a question, please press star one and clearly record your name. You will be announced prior to asking your question. To ensure all questioners are heard, we ask that you please limit yourself to one question. If you would like to ask a follow-up question, please place yourself back in the queue. Once again, to ask a question, please press star one. To withdraw your question, press star two. One moment for our first question, please. The first question comes from Bruce Harting with Barclays Capital. Your line is open.

Speaker 13

Thanks. With 60% of growth coming from the rest of the world, Byron, just trying to circle the next time you have an earnings announcement, hopefully we'll know one way.

Speaker 19

As I mentioned, client incentives as a percentage of gross revenue came in at 16.7% and are running at 16% fiscal year to date, on track with expectations. Approximately 65% of the year-over-year dollar increase in incentives is due to payment volume growth in client portfolios. About another 25% of the increase is due to non-U.S. client renewals. Total operating expense for the quarter was $862 million, up 3% from the prior year. Increases in personnel, professional fees, and general and administrative expense were offset by lower marketing in the period. Additionally, I'll continue to remind you of this for the next two quarters, recall that we announced an earnings-neutral change in income statement presentation related to revenue and operating expense associated with certain pass-through activities.

As a result, $50.5 million of revenue and expense, which was booked in Q2 fiscal year 2010, did not reoccur in Q2 fiscal year 2011. In Q2, this represented 3 percentage points of revenue growth. For the remainder of the year, these changes in presentation will continue to be earnings-neutral and will affect revenue growth. The foreign exchange impact on net revenue in the second fiscal quarter was moderated by our hedging activities and contributed a +2% increase compared to the same prior year period. While our operating margin for the quarter was 62%, please note that we expect to aggressively fund important long-term investments across our entire business. Capital expenditures were $72 million in the quarter, representing ongoing investment in technology, infrastructure, and growth initiatives.

Lastly, the PlaySpan acquisition had a diluted impact to earnings per share of $0.01 for the second quarter of fiscal 2011, and we anticipate a diluted impact to earnings per share of $0.04 for the full 2011 fiscal year. Moving on to the balance sheet, we ended the second quarter in great shape with negligible debt and cash, cash equivalents, restricted cash, and available for sale investments of $6.6 billion. Of this total, $3 billion is restricted cash, which represents amounts sufficient to fully pay out the balance of the American Express settlement over the remaining three quarters, with $2.7 billion uncommitted as of the end of the second quarter. In terms of our ongoing buyback, at the end of the quarter, we announced the pre-funding of the litigation escrow by $400 million to be funded with cash previously designated for our $1 billion share repurchase.

This was executed at an average price of $73.81 per share. Additionally, we repurchased $230 million of our shares in the open market during the quarter at an average price of $70.53 per share. All told, we effectively repurchased 8.7 million shares at an average price of $72.58. This leaves us with $64 million of open to buy under the original program. At the end of the quarter, we had 704 million shares outstanding on an as-converted basis. Importantly, the A-class now accounts for almost 75% of our outstanding shares. Management remains committed to returning excess cash to shareholders. To this end, as Joe mentioned at the outset, our Board of Directors authorized a new $1 billion repurchase plan, which we will execute at prices we feel are attractive relative to the long-term value of Visa.

As to guidance for the balance of 2011, given results to date, we are not making any adjustments at this time. With or without a Durbin delay, we expect to deliver revenue growth in the 11%-15% range and EPS growth of better than 20%. Once the timing and content of the Reform Act regulations are clarified, we will determine whether any 2011 guidance requires adjustment, such as client incentives, and we will consider providing an early earnings outlook for fiscal 2012. In summary, we expect Visa to remain a solid growth company for years to come. Our core businesses continue to grow at healthy rates while we are aggressively investing in technologies and platforms that will extend our core payment and processing capabilities, thereby creating new sources of growth.

Finally, we expect to deliver this growth while driving significant free cash flow, which we will use to enhance shareholder returns through continued dividend increases and share repurchases. With that, we are ready to take questions.

Speaker 11

Speaker 13

Speaker 5

Speaker 11

The next question comes from Adam Frisch with Morgan Stanley. Your line is open.

Speaker 15

Thanks. Good afternoon, guys. I want to address the A&M line in the quarter because all the calls I'm getting post the release is on this. I know, Byron, you went through the details. It was based on the accounting changes around extras and no Olympics this year and so forth. Just to set an apples-to-apples basis, what would the year-over-year EPS compare have been? As a follow-on, you said that you'll continually invest in growth initiatives. With the margins at 62%, does that mean they're not sustainable at current levels? Thank you.

Speaker 19

I think what you're asking, Adam, on marketing is because we took the Visa extras out of the expense space going forward, does that have a P&L impact? Is that the question? Because

The revenue came out equal to the expenses. While marketing is down, and it is down in part because of the removal of extras and also because of timing, the full-year impact of the change that we made with Visa extras is income statement neutral. No impact on EPS and no impact on the full-year guidance for marketing because when we guided, while marketing is down versus the same quarter of last year, given the campaign that we had last year relative to the Olympics, you would naturally expect it to be down somewhat. We are still fully consistent with the guidance that we gave earlier on marketing and the adjustments we made for extras, no income statement impact.

With regards to the margin at 62% for the quarter, what you should take away is that we are increasingly investing in our products and platforms to drive future growth, and the margin will simply be an outcome of the level of investment that we make. We continue to invest aggressively in that arena.

Speaker 11

The next question comes from Dan Perlin with RBC Capital Markets. Your line is open.

Speaker 0

Thanks. I had a question as it pertains to watching inflation, gas prices, and food. I wanted to know what really has been your experience where certain, I guess, friction points or price levels really start to impact your transaction growth relative to benefits you guys get from higher average ticket prices. Are you really concerned at current levels, or would you be concerned if these levels were kind of held up for a prolonged period of time? Thanks.

Speaker 19

This is Byron. Let me give you a little bit of factual perspective first. With regards, and let's talk about this in the context of the U.S. For gas, historically, you go back a year and gas prices were roughly 30% less on average than they are today. We were running about 8% of total US payment volume in the gas category. We refer to it as oil, in the oil category. In the month of April, that was just a little over 10% of US payment volume, suggesting that the share had moved up about, that's about a 25% increase in the share of US payment volume.

When you compare that to roughly, based on our measures, a 32% increase in the average price of gasoline April versus about where we were a year ago, and you factor in that there has probably been some degree of consumption cutback given prices that are now posted in the $4+ range, that is the immediate impact. We have not yet seen, and it may be a bit early, we have not yet seen any specific callouts relative to tradeouts on other spending categories, which may be in part due to the additional disposable income created by reductions in withholding tax and Social Security. We're still trying to sort that out. Inevitably, there's probably going to be some friction, but at the moment, it's hard for us to identify it.

Speaker 11

The next question comes from Andrew Jeffrey with SunTrust. Your line is open.

Speaker 21

Hi, guys. Thanks for taking the question. Byron, if we operate under the assumption that indeed Durbin is not delayed and, as you said, you would adjust incentives to, you know, to maintain volume, could we think about that? First of all, I'm assuming what you're saying is you'd be above the high end of the 16.5% range you set. Second, would that effectively be a one-time event concentrated in the second half of 2011, and then you'd go back to more normalized levels in the future, or is that a structurally higher level of volume since it's pure incentives in your view?

Speaker 19

Let me deal with the first part of your question. We've delivered the first six months at 16% incentives as a percent of gross, and our guidance was 16%-16.5%. That 16%-16.5% guidance did assume that Durbin would not be delayed, that we would have some impact of Durbin before the end of the year. We provided for some degree of incentives in the event that that were to happen. Without knowing the exact timing, without knowing exactly how the rules will be promulgated, without knowing the implementation timing associated with those rules, those are some pretty big wildcards with regards to the incentives that we may or may not be.

Speaker 5

Of our primary customers, financial institutions.

Speaker 11

The next question comes from Adam Frisch with Morgan Stanley. Your line is open.

Speaker 15

Speaker 19

On the first one, I think what you're asking, Adam, on marketing is because we took the Visa extras out of the expense base, going forward, does that have a P&L impact? Is that the question? The revenue came out equal to the expenses. While marketing is down, and it is down in part because of the removal of extras and also because of timing, the full-year impact of the change that we made with Visa extras is income statement neutral. No impact on EPS and no impact on the full-year guidance for marketing because when we guided, while marketing is down versus the same quarter of last year, there's always, given the campaign that we had last year relative to the Olympics, you would naturally expect it to be down somewhat.

We are still fully consistent with the guidance that we gave earlier on marketing and the adjustments we made for extras, no income statement impact. With regards to the margin at 62% for the quarter, what you should take away is that we are increasingly investing in our products and platforms to drive future growth, and the margin will simply be an outcome of the level of investment that we make, and we continue to invest aggressively in that arena.

Speaker 11

The next question comes from Dan Perlin with RBC Capital Markets. Your line is open.

Hi, good evening. Joe, as you look at markets such as Asia, I mean, there's clearly a very strong growth trajectory. I was curious on the headwind side. I mean, how do you feel about the competitive sort of landscape from a regional network perspective? We've talked to some folks over there, and it seems like they're continuing to be pretty active.

Speaker 5

There is a lot of competitive activity that is different in Asia than in the United States. I mean, there is China UnionPay, there is JCB, there are national payment system considerations, and so there is a lot going on. We have been doing business around the area for a lengthy period of time. We have had people on the ground for decades in most of these countries. The fact that these economies are emerging and that electronic payment mechanisms are becoming more and more prevalent, we continue to have a huge opportunity almost everywhere in the world. I am not being dismissive about the competition that we face. I mean, obviously, there are areas of the world like China where we cannot do business domestically.

I do not think that our numbers would suggest to you that we are doing quite well in increasing our volume in Asia and other parts of Latin America and other regions outside the United States. I am pretty bullish on where we will be in the next few years in the area.

Speaker 11

The next question comes from Julio Quinteros with Goldman Sachs. Your line is open.

Speaker 8

Great. Thanks. Byron, maybe just to sort of hone in a little bit on the confidence to grow through Durbin, as we think about that longer term, is it the volume growth outside of the U.S., some of the mitigation strategies that you're talking about? What gives you guys the confidence, or is it a combination of all of the above? You guys have a visibility on, obviously, where the growth of the business is, but maybe any way to sort of hone in on how you're thinking about the mitigation efforts themselves in terms of post-Durbin world, etc.?

Speaker 5

This is Joe. It would be kind of silly for me to sit here and tell you exactly what we were going to do because it clearly has something to do with competition in the event that the rules change. We certainly haven't been passive as it relates to understanding what the various implications and scenarios could be coming out of the Durbin, whether it is delayed or it's not delayed, what the final wins from the Fed would be. In each of those cases, we have a different set of mitigation tactics that we would intend to use. Obviously, there are some things that we would intend to do across the board, regardless of how things developed. Our, our.

Speaker 19

Putting on the table this fiscal year. Therefore, we were drawing attention to the fact that we've got a year in the bag at 16, but there's some significant uncertainty still to go. Some of those uncertainties were contemplated. Do not automatically assume that, were it to be, were it not to be delayed, we would necessarily be above that range. Where we end up is going to be a function of the timing and the exact wording of the rules. I would say on the second, it's just hard to know, with regards to how we would be deploying incentives today versus how we would do it under Durbin. The notion that incentives would be in play, I think, is a fair assumption.

To what degree, whether it would be one-time or sustained, I think it'll be once we understand better the environment ahead, we'll be much better able to opine on that.

Speaker 11

The next question comes from Dave Koning with Baird. Your line is open.

Speaker 20

Speaker 19

Speaker 11

Next question comes from David Hochstim, Buckingham Research. Your line is open.

Speaker 5

Speaker 11

The next question comes from Craig Maurer with CLSA. Your line is open.

Yes, you're misinterpreting. The incentive contracts that we have in place are based on most of them are based on volume growth. If the routing provisions go into place where the financial institution potentially has less influence over the actual routing, we just have to look at the incentive provisions to make sure that they are reflective of the way the operating environment will conduct itself under legislation.

The next question comes from Chris Mammone with Deutsche Bank. Your line is open.

Speaker 18

Good afternoon. Just wondering, I know it's so small, but just wondering if you could elaborate on the PlaySpan acquisition. We know that the digital gaming category is displaying pretty explosive growth. Just any color on early thought to strategy there as you layer in that platform. Maybe as a quick follow-up, was there anything to call out in volumes, Byron, regarding the Easter shift? Thanks.

Speaker 19

On the Easter shift, I would say there might be, that one's hard for us. There might be a little noise in April, but we've got a pretty diversified portfolio. I don't think there's really a call out April and May. Early days on PlaySpan. Joe, do you want to add anything? We just completed the acquisition. We're fast integrating it, and that may be part of it.

Speaker 5

It will play a role beyond the gaming space in our strategic direction, which we will, so this is kind of an ad for next week, which will become much more apparent next week when we make an announcement.

Speaker 11

The next question comes from Moshe Katri with Cowen. Your line is open.

Speaker 3

Hey, thanks for taking my call. Byron, can you comment on the expected timeframes for contract renewals with some of the maybe top 5 or maybe top 10 banks? How much flexibility do you have in trying to modify some of those contract terms long before some of those contracts expire? Obviously, specifically, we've been focusing on what you're saying regarding rebates, etc. Thanks.

Speaker 19

Yeah, there are no top 5 contracts scheduled for renewal, I want to say, for a good 18 months or more. We do from time to time, when the opportunity is attractive, we will look at early renewals. In terms of major contract renewals, at the end of last year, we pretty much cleared the decks and don't expect when we have no scheduled major renewals for at least another 18 months.

Great. Thank you very much, Jack. Joe, do you think the economics with mobile will be better, worse, or the same compared with, you know, plastic today? Given that there's going to be carriers involved, handset manufacturers involved, potentially technology companies? Thank you.

Speaker 5

I think we have a terrific opportunity in mobile technology. I did mention, answering one of the other questions, I believe that we believe that not only, as it relates to the technology and just payments in general, we do believe that there are other sources of revenue that would be made available to us that are not now. That takes our CyberSource acquisition, PlaySpan acquisition, and other things that we've done. When we put it all together, we're pretty excited about the revenue that can come out of this in the future. Now, let me caution you. I'm not talking about a spike in revenue in 2012. This isn't something that happens overnight. It's something that evolves.

The next question comes from Moshe Orenbuch with Cowen. Your line is open.

Speaker 10

Speaker 19

Yeah, there are no top 5 contracts scheduled for renewal, I want to say, for a good 18 months or more. We do, from time to time, when the opportunity is attractive, look at early renewals. In terms of major contract renewals, at the end of last year, we pretty much cleared the decks and don't expect, we have no scheduled major renewals for at least another 18 months.

Speaker 5

We just announced Regions today.

Speaker 11

The next question comes from Bob Napoli with Piper Jaffray. Your line is open.

Speaker 16

Thank you. Joe, I know you're not going to give—there's a lot more data coming next week, but I was hoping you might be able to give a little more color on, like, with the Visa announcement that you're leading us to tonight for next week, is it going to be something that is comprehensive with other joint ventures combined that is live business? Is this something that's incremental? Maybe a little bit more color to help prepare us for next week.

Speaker 5

I think that what I said earlier was that we recognize that as time moves on, mobile and e-commerce technology are going to consume a greater and greater role in the electronic payments arena. If we are going to remain as a viable player as we are today, then we are going to have to be out in front as it relates to interoperability, simplicity, security, and factors of that nature. We have been paying attention to that, the acquisitions that we have made with that in the back of our mind. We have a strategy both for the United States and other mature economies and a different strategy in different parts of the world where there are emerging economies that depend more on mobile technology.

It is kind of bringing that together, the way that we think about that, what we've done, what we have ready to introduce, and what we will be contemplating doing as time moves on. Our point of view, it's significant. From our point of view, we are at a better place than any of the competition that we think we have to deal with has been at because our solution is a more complete solution than what we've seen in the market here before. We have been reluctant to talk about it until we have it put together and put together in an appropriate way where we can tell you something positive and significant, and we can talk about how it all comes together. That's where we are.

Speaker 11

The next question comes from Bill Carcache with Macquarie. Your line is open.

Speaker 4

Speaker 5

Yeah. Chips, it is gaining traction, and we've supported it. We made an announcement several months ago, as it related to our support globally. We didn't encourage it in the U.S. There have been a lot of things going on, as you are probably aware, like the CARD Act and the Durbin Act, and distracting to issuers in the United States. For cards to be global, chips are going to play a role. We encourage moving to chip technology. We don't necessarily encourage moving to PINs and chips. We encourage moving to chips and other forms of identification or authentication than what exists, have existed here before. We don't believe that contactless chips will become something that is ubiquitous within the point-of-sale marketplace in the United States in the future. We believe that there will be specific things to which it is applicable and for which it will be used.

It won't necessarily be widespread tomorrow or the next day or in 2012 or 2013.

Speaker 9

Jose, at this point, we have time for one more question.

Speaker 11

The last question does come from Jim Kissane with Bank of America Merrill Lynch. Your line is open.

Speaker 1

Great. Thank you very much, Jack.

Joe, do you think the economics with mobile will be better, worse, or the same compared with, you know, plastic today? Given that there's going to be carriers involved, handset manufacturers involved, potentially technology companies? Thank you.

Speaker 5

I think we have a terrific opportunity in mobile technology. I did mention, answering one of the other questions, I believe that we believe that not only, as it relates to the technology and just payments in general, we do believe that there are other sources of revenue that would be made available to us that are not now. That takes our CyberSource acquisition, PlaySpan acquisition, and other things that we've done. We've done well. We put it all together. We're pretty excited about the revenue that can come out of this in the future. Now, let me caution you. I'm not talking about a spike in revenue in 2012. This isn't something that happens overnight. It's something that evolves.

Speaker 9

Thank you all very much for joining us today. If anybody has any follow-up questions, feel free to give myself or Victoria a call.

Speaker 11

Thank you for your participation in today's conference call. The call has concluded. You may go ahead and disconnect.

Visa - Earnings Call - Q2 2011

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