Business Context and Reporting Period
Company: American Express Company
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2006
Business Overview: A leading global payments, network, and travel company offering charge/credit cards, stored value products, travel services, and international banking. The company operates under a "spend-centric" model, generating revenue primarily through merchant discount fees, finance charges, and card fees.
Key Financial Metrics
Three Months Ended June 30, 2006 (vs. 2005):
- Total Revenues: $6.85 billion (up 14%)
- Net Income: $945 million (down 7% due to discontinued operations)
- Income from Continuing Operations: $972 million (up 13%)
- Diluted EPS (Continuing Ops): $0.78 (up 13%)
- Diluted EPS (Net Income): $0.76 (down 6%)
- Provisions for Losses: $730 million (up 16%)
Six Months Ended June 30, 2006 (vs. 2005):
- Total Revenues: $13.17 billion (up 13%)
- Net Income: $1.82 billion (down 7%)
- Income from Continuing Operations: $1.85 billion (up 15%)
- Diluted EPS (Continuing Ops): $1.48 (up 17%)
- Diluted EPS (Net Income): $1.45 (down 7%)
Liquidity and Balance Sheet (as of June 30, 2006):
- Cash and Cash Equivalents: $6.80 billion
- Total Assets: $117.28 billion
- Total Liabilities: $106.81 billion
- Shareholders' Equity: $10.48 billion
- Short-term Debt: $15.04 billion
- Long-term Debt: $36.17 billion
- Net Cash Provided by Operating Activities (6 months): $4.46 billion
Material Changes vs. Prior Period
- Revenue Growth: Driven by a 16% increase in worldwide billed business ($140.5 billion for the quarter) and a 32% increase in cardmember lending net finance charge revenue. Discount revenue rose 15% despite a slight decline in the average discount rate (2.57% vs. 2.59%).
- Expense Increases: Marketing, promotion, and rewards expenses rose 16% due to volume growth and higher redemption rates. Provisions for losses increased 16%, driven by higher charge-offs outside the U.S. (specifically Taiwan) and increased loan volumes.
- Discontinued Operations: Net income was negatively impacted by a $27 million loss from discontinued operations in Q2 2006, compared to $153 million of income in Q2 2005. This reflects the spin-off of Ameriprise Financial in 2005 and the sale of Brazilian banking operations in 2006.
- Membership Rewards Charges: The company recorded a $62 million charge in Q2 2006 and a $112 million charge in Q1 2006 related to adjustments in the Membership Rewards reserve model to reflect higher ultimate redemption rates.
Guidance, Outlook, and Risks
Management Commentary & Strategy:
- Capital Allocation: The company targets 12-15% EPS growth and 28-30% return on shareholders' equity. It aims to return approximately 65% of generated capital to shareholders via dividends and share repurchases.
- Dividends: The Board approved a 25% increase in the quarterly dividend from $0.12 to $0.15 per share.
- Share Repurchases: In the first six months of 2006, the company repurchased 41 million shares. In May 2006, the Board authorized an additional 200 million shares for repurchase.
Significant Transactions:
- Brazil Sale: Completed the sale of card/merchant activities and international banking in Brazil to Banco Bradesco for ~$470 million. This generated a $109 million after-tax gain (reported in continuing operations) and a $22 million after-tax loss (reported in discontinued operations).
- Egyptian American Bank (EAB): Completed the sale of its investment in EAB, generating an $88 million gain.
Risks and Contingencies:
- Credit Risk: Elevated charge-offs in Taiwan due to industry-wide credit issues. Approximately $300 million of cardmember receivables/loans in Taiwan are net of reserves.
- Airline Industry: Exposure to Delta Air Lines bankruptcy. American Express lent $350 million as part of Delta's debtor-in-possession financing; $300 million remained outstanding at period end.
- Legal Proceedings: Multiple class actions regarding antitrust tying arrangements and "anti-steering" rules. The company believes it has meritorious defenses.
- Tax Uncertainty: Higher effective tax rates in 2006 due to uncertainty regarding tax benefits for foreign subsidiaries and foreign exchange translation impacts.
Investor Verification Checklist
- Discontinued Operations Impact: Verify the distinction between the $109 million gain (continuing ops) and $22 million loss (discontinued ops) from the Brazil sale to understand true operational performance.
- Credit Quality in Taiwan: Review the specific exposure and reserve adequacy regarding the $300 million net receivables in Taiwan, which drove a significant portion of the increased provision for losses.
- Membership Rewards Reserve: Assess the long-term impact of the $174 million total charge ($62M + $112M) related to the revised redemption rate assumptions on future profitability.
- Delta Air Lines Exposure: Monitor the status of the $300 million loan to Delta and the potential impact of Delta's reorganization on the SkyMiles co-brand portfolio (less than 10% of billed business).
- Securitization Activity: Note the difference between "GAAP" and "Managed Basis" reporting for U.S. Card Services, as management uses the latter to evaluate the full lending portfolio including securitized loans.