American Express Company — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. The interim financial statements are unaudited. American Express is a global payments and travel services company operating through U.S. Card Services, International Card Services, Global Commercial Services, and Global Network & Merchant Services.
Financial performance and position
- Second-quarter revenue: Total revenues net of interest expense were $8.657 billion, up 5% year over year. Net interest income rose 9% to $1.316 billion; non-interest revenue increased 4% to $7.341 billion.
- Profit: Net income was $1.529 billion, up 9%; diluted EPS was $1.43, up 13%. Pretax income was $2.312 billion. The effective tax rate was 33.9%, versus 29.6% a year earlier. The filing does not present a single consolidated operating-margin measure.
- Six-month results: Revenues net of interest expense were $16.856 billion, up 5%; net income was $2.961 billion, up 10%; diluted EPS was $2.77, up 14%.
- Spending and pricing: Worldwide billed business grew 9% in Q2 and 7% in the first half. The average discount rate was 2.48%, down from 2.52% in Q2 2013. Cards-in-force increased 5% to 109.9 million.
- Expenses and credit: Q2 total expenses rose 2% to $5.856 billion; marketing and promotion rose 25%, and rewards expense rose 11%. Provisions for losses were $489 million, down 6% in Q2 but up 4% for the first half. Average Card Member loans grew 4%; Q2 loan net write-off rate was 1.6%, down from 2.0%.
- Cash flow: First-half operating cash flow was $4.9 billion, versus $10.2 billion in 2013; investing cash outflow was $1.6 billion and financing cash outflow was $4.4 billion. Cash and cash equivalents ended June at $18.4 billion, down from $19.5 billion at year-end.
- Debt and liquidity: Short-term borrowings were $3.4 billion and long-term debt $54.8 billion at June 30. Customer deposits were $42.1 billion. Management reported $12.1 billion of excess U.S. cash available for long-term maturities, plus $7.2 billion of committed bank credit facilities; the facilities were undrawn at quarter-end.
- Capital and returns: The reported Basel III Common Equity Tier 1 ratio was 13.4% and total risk-based capital ratio 14.9%. In the first half, the company returned $2.6 billion through dividends and repurchases, including $2.1 billion of repurchases. It said up to $2.3 billion of additional 2014 repurchases were planned, subject to market conditions and its capital plan.
Material changes and unusual items
- On June 30, American Express completed a transaction creating a non-consolidated Global Business Travel joint venture. It retained a 50% interest, valued at approximately $900 million, and recognized a $626 million pretax gain ($409 million after tax).
- The gain was substantially offset by growth investments and other items: a $133 million restructuring charge, $79 million of JV transaction costs, and a $40 million contribution to the American Express Foundation.
- The JV gain reduced reported other expense and materially affected comparisons: GCS Q2 segment income rose to $561 million from $226 million, while the company cautioned that similar year-over-year operating-expense declines were not expected in the second half.
- First-half operating cash flow was lower year over year, partly because the prior-year period benefited from timing-related growth in accounts payable and a corresponding cash inflow.
Outlook, risks, and contingencies
- Management’s long-term, average-over-time targets are revenue growth net of interest expense of at least 8%, EPS growth of 12%–15%, and return on average equity of at least 25%. If EPS and ROE targets are achieved, the company aims to return approximately 50% of generated capital to shareholders over time.
- For 2014, management remained committed to annual operating-expense growth below 3% after adjusting for the JV transaction and related items. It expects lending write-off rates eventually to rise from historically low levels. Management also noted ongoing discount-rate pressure from mix, pricing, competition, and other factors.
- Risks include intense payments competition; regulatory change and higher compliance costs; foreign-exchange, interest-rate, and economic volatility; and possible adverse effects from U.S. tax changes, including failure to renew the active-financing tax provision for 2015 and beyond.
- The DOJ antitrust trial concerning merchant acceptance rules began July 7, 2014. A proposed settlement in related merchant actions was awaiting a final approval hearing scheduled for September 17, 2014. For specified legal and regulatory matters, the estimated reasonably possible loss range was $0–$360 million above accrued liabilities; this is not the maximum exposure.
- European proposals on payment-card fees and network rules remained under debate; the final scope and impact were uncertain. The company also disclosed that possible resolution of tax matters could reduce unrecognized tax benefits by up to $697 million within 12 months, with the effect on the effective tax rate and net income unclear for part of that amount.
Important facts for investors to verify
- How much of Q2 earnings growth reflects recurring business performance versus the $626 million GBT gain and associated investments and charges.
- Whether spending growth can continue while the average discount rate trends lower and rewards and marketing costs rise.
- Credit quality, provisions, and write-off trends as loan balances grow and management anticipates eventual normalization from low loss rates.
- Liquidity, refinancing needs, funding costs, and capital-plan or regulatory constraints on planned share repurchases.
- Developments in the DOJ and merchant litigation, European payments regulation, and tax matters, including the potential range and timing of financial effects.