AXP

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended June 30, 2002, for American Express Company. The company operates primarily through three segments: Travel Related Services (TRS), American Express Financial Advisors (AEFA), and American Express Bank (AEB). The filing reflects the adoption of SFAS No. 142 regarding goodwill and other intangible assets, eliminating goodwill amortization for 2002. Results are significantly influenced by the aftermath of the September 11, 2001 terrorist attacks, weak equity markets, and specific investment losses related to WorldCom debt.

Key Financial Metrics

Income Statement (Three Months Ended June 30, 2002)

• Total Revenues: $5,945 million (GAAP basis), up 13% from $5,268 million in 2001.
• Pretax Income: $961 million, compared to $153 million in 2001.
• Net Income: $683 million, compared to $178 million in 2001.
• Diluted Earnings Per Share (EPS): $0.51, compared to $0.13 in 2001.
• Expenses: $4,984 million, a 3% decrease from the prior year.

Income Statement (Six Months Ended June 30, 2002)

• Total Revenues: $11,704 million (GAAP basis), up 7% from $10,987 million in 2001.
• Pretax Income: $1,819 million, compared to $894 million in 2001.
• Net Income: $1,301 million, compared to $716 million in 2001.
• Diluted EPS: $0.97, compared to $0.53 in 2001.

Balance Sheet and Liquidity (As of June 30, 2002)

• Total Assets: $145,897 million, down from $151,100 million at year-end 2001.
• Cash and Cash Equivalents: $8,903 million.
• Short-term Debt: $18,741 million (down from $31,569 million at year-end 2001).
• Long-term Debt: $15,469 million (up from $7,788 million at year-end 2001).
• Shareholders' Equity: $13,290 million.

Cash Flow (Six Months Ended June 30, 2002)

• Net Cash Provided by Operating Activities: $4,854 million.
• Net Cash Provided by Investing Activities: $2,091 million.
• Net Cash Used in Financing Activities: $(5,388) million.
• Net Increase in Cash: $1,681 million.

Material Changes vs. Prior Period

• Profitability Surge: Net income increased 284% for the quarter and 82% for the six-month period. This is largely attributable to a favorable comparison against 2001, which included $1,008 million in pretax losses from the write-down of high-yield securities at AEFA.
• Revenue Composition: While GAAP revenues rose, "managed basis" revenues (excluding securitization effects) were relatively flat or slightly down, indicating that organic growth was offset by weaker travel demand and lower management fees due to market depreciation.
• Debt Structure: The company shifted its funding strategy, issuing approximately $6.0 billion in medium-term notes to reduce reliance on commercial paper. Commercial paper outstanding dropped from $18 billion to $10 billion.
• Restructuring Benefits: The company recognized a net benefit of $19 million (pretax) in the first half of 2002 from adjustments to restructuring reserves established in late 2001, primarily due to voluntary attrition and facility renegotiations.
• Investment Losses: 2002 results included a $78 million pretax loss related to WorldCom debt holdings, contrasting with the massive high-yield losses in 2001.

Guidance, Outlook, and Risks

Outlook and Guidance

• EPS Expectation: Management stated that full-year 2002 EPS is unlikely to exceed the analyst consensus of $2.01. This caution is due to equity market uncertainty, diminishing benefits from lower interest rates, and planned increased investment in growth initiatives in the second half of the year.
• Reengineering Savings: The company expects to realize over $1 billion in reengineering-related benefits for the full year 2002.
• Stock Options: The company announced it will expense all stock options granted beginning in 2003, adopting the fair-value-based method (SFAS No. 123). Had this been applied to 2002 grants, EPS would have been reduced by $0.07.

Risks and Contingencies

• September 11 Impact: The company has incurred approximately $140 million in costs related to the attacks, which it expects to be covered by insurance. However, ongoing evaluation of business interruption and repair costs continues.
• Legal Proceedings: Three putative class-action lawsuits were filed in July 2002 alleging securities law violations regarding high-yield bond investments. Additionally, a dispute with British Airways regarding corporate net fares is ongoing.
• Market Volatility: AEFA's results remain sensitive to equity market levels, affecting Deferred Acquisition Costs (DAC) amortization and the value of structured investments.
• Credit Ratings: While ratings were affirmed as A+, outlooks were revised to negative by some agencies in early 2002 due to weak travel and capital markets, though Fitch revised its outlook to stable in April 2002.

Investor Verification Checklist

• Quality of Earnings: Verify the extent to which the reported profit increase is driven by the absence of 2001's $1 billion+ high-yield write-downs versus organic operational improvement.
• Travel Segment Health: Assess the sustainability of TRS revenue given the 14% decline in travel commissions and fees and the 7% drop in U.S. T&E volumes.
• Debt Maturity Profile: Review the shift from commercial paper to medium-term notes and the associated interest rate risks.
• WorldCom Exposure: Confirm the remaining exposure to WorldCom debt and the adequacy of reserves for other high-yield investments.
• Insurance Recovery: Monitor the status of insurance claims related to September 11 costs to ensure the $140 million incurred is fully recoverable.
• Stock Option Expense: Evaluate the potential impact of the new stock option expensing policy on future earnings starting in 2003.