UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2005
or
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from ________ to ________
Commission file number 1-7657
AMERICAN EXPRESS COMPANY
(Exact name of registrant as specified in its charter)
NEW YORK 13-4922250
--------------------------------------------------------- ----------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
WORLD FINANCIAL CENTER, 200 VESEY STREET, NEW YORK, NY 10285
--------------------------------------------------------- ----------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (212) 640-2000
--------------------
NONE
------------------------------------------------------------------------------
Former name, former address and former fiscal year, if changed since last
report.
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes /X/ No / /
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Class Outstanding at July 22, 2005
---------------------------------------------- ----------------------------
Common Shares (par value $.20 per share) 1,240,897,854 shares
AMERICAN EXPRESS COMPANY
FORM 10-Q
INDEX
Page No.
--------
Part I. Financial Information:
Item 1. Financial Statements
Consolidated Statements of Income - Three months
ended June 30, 2005 and 2004 1
Consolidated Statements of Income - Six months
ended June 30, 2005 and 2004 2
Consolidated Balance Sheets -June 30, 2005 and
December 31, 2004 3
Consolidated Statements of Cash Flows - Six
months ended June 30, 2005 and 2004 4
Notes to Consolidated Financial Statements 5 - 13
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14 - 45
Item 4. Controls and Procedures 45
Part II. Other Information: 48
Item 1. Legal Proceedings 48
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds 50
Item 4. Submission of Matters to a Vote of Security
Holders 51
Item 6. Exhibits 51
Signatures 52
Exhibit Index E-1
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AMERICAN EXPRESS COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(Millions, except per share amounts)
(Unaudited)
Three Months Ended
June 30,
---------------------
2005 2004
--------- ---------
Revenues:
Discount revenue $ 2,941 $ 2,529
Net investment income 822 785
Management and distribution fees 814 724
Cardmember lending net finance charge revenue 637 561
Net card fees 506 472
Travel commissions and fees 502 468
Other commissions and fees 611 565
Insurance and annuity revenues 403 378
Securitization income, net 296 282
Other 470 468
--------- ---------
Total 8,002 7,232
--------- ---------
Expenses:
Human resources 2,092 1,813
Marketing, promotion, rewards and cardmember services 1,471 1,250
Provisions for losses and benefits:
Annuities and investment certificates 360 314
Life insurance, international banking and other 308 263
Charge card 234 189
Cardmember lending 275 314
Professional services 665 576
Occupancy and equipment 426 402
Interest 251 210
Communications 124 127
Other 477 508
--------- ---------
Total 6,683 5,966
--------- ---------
Pretax income 1,319 1,266
Income tax provision 306 390
--------- ---------
Net income $ 1,013 $ 876
========= =========
Earnings per Common Share:
Basic $ 0.82 $ 0.69
========= =========
Diluted $ 0.81 $ 0.68
========= =========
Average common shares outstanding for
earnings per common share:
Basic 1,231 1,263
========= =========
Diluted 1,254 1,288
========= =========
Cash dividends declared per common share $ 0.12 $ 0.10
========= =========
See Notes to Consolidated Financial Statements.
1
AMERICAN EXPRESS COMPANY
CONSOLIDATED STATEMENTS OF INCOME
(Millions, except per share amounts)
(Unaudited)
Six Months Ended
June 30,
---------------------
2005 2004
--------- ---------
Revenues:
Discount revenue $ 5,613 $ 4,897
Net investment income 1,625 1,526
Management and distribution fees 1,612 1,503
Cardmember lending net finance charge revenue 1,229 1,102
Net card fees 1,004 944
Travel commissions and fees 924 885
Other commissions and fees 1,188 1,094
Insurance and annuity revenues 800 742
Securitization income, net 612 512
Other 968 937
--------- ---------
Total 15,575 14,142
--------- ---------
Expenses:
Human resources 4,085 3,592
Marketing, promotion, rewards and cardmember services 2,829 2,297
Provisions for losses and benefits:
Annuities and investment certificates 679 614
Life insurance, international banking and other 579 500
Charge card 449 387
Cardmember lending 570 601
Professional services 1,245 1,115
Occupancy and equipment 832 792
Interest 470 413
Communications 253 260
Other 890 1,057
--------- ---------
Total 12,881 11,628
--------- ---------
Pretax income before accounting change 2,694 2,514
Income tax provision 735 773
--------- ---------
Income before accounting change 1,959 1,741
Cumulative effect of accounting change, net of tax - (71)
--------- ---------
Net income $ 1,959 $ 1,670
========= =========
Earnings per Common Share -- Basic:
Income before accounting change $ 1.59 $ 1.37
========= =========
Net income $ 1.59 $ 1.31
========= =========
Earnings per Common Share -- Diluted:
Income before accounting change $ 1.56 $ 1.34
========= =========
Net income $ 1.56 $ 1.29
========= =========
Average common shares outstanding for
earnings per common share:
Basic 1,235 1,270
========= =========
Diluted 1,259 1,296
========= =========
Cash dividends declared per common share $ 0.24 $ 0.20
========= =========
See Notes to Consolidated Financial Statements.
2
AMERICAN EXPRESS COMPANY
CONSOLIDATED BALANCE SHEETS
(Millions, except share data)
(Unaudited)
June 30, December 31,
2005 2004
------------ ------------
ASSETS
Cash and cash equivalents $ 9,280 $ 9,907
Accounts receivable and accrued interest:
Cardmember receivables, less reserves: 2005, $848; 2004, $806 30,699 30,270
Other receivables, less reserves: 2005, $84; 2004, $90 4,431 4,380
Investments 61,411 60,809
Loans:
Cardmember lending, less reserves: 2005, $888; 2004, $972 27,213 25,933
International banking, less reserves: 2005, $77; 2004, $95 6,922 6,790
Other, less reserves: 2005, $27; 2004, $17 2,572 2,135
Separate account assets 37,433 35,901
Deferred acquisition costs 4,066 3,989
Land, buildings and equipment - at cost, less accumulated
depreciation: 2005, $3,436; 2004, $3,297 2,965 3,083
Other assets 8,747 9,441
------------ ------------
Total assets $ 195,739 $ 192,638
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Customers' deposits $ 23,510 $ 21,091
Travelers Cheques outstanding 7,417 7,287
Accounts payable 10,106 8,291
Insurance and annuity reserves:
Fixed annuities and variable annuity guarantees 26,729 27,012
Life and health policies 6,094 5,954
Investment certificate reserves 12,174 11,332
Short-term debt 13,369 14,182
Long-term debt 29,901 33,061
Separate account liabilities 37,433 35,901
Other liabilities 11,842 12,507
------------ ------------
Total liabilities 178,575 176,618
------------ ------------
Shareholders' equity:
Common shares, $.20 par value, authorized 3.6 billion shares;
issued and outstanding 1,240 million shares in 2005 and
1,249 million shares in 2004 248 250
Additional paid-in capital 7,915 7,316
Retained earnings 8,697 8,196
Accumulated other comprehensive income (loss), net of tax:
Net unrealized securities gains 711 760
Net unrealized derivatives losses (7) (142)
Foreign currency translation adjustments (384) (344)
Minimum pension liability (16) (16)
------------ ------------
Total accumulated other comprehensive income 304 258
------------ ------------
Total shareholders' equity 17,164 16,020
------------ ------------
Total liabilities and shareholders' equity $ 195,739 $ 192,638
============ ============
See Notes to Consolidated Financial Statements.
3
AMERICAN EXPRESS COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Millions)
(Unaudited)
Six Months Ended
June 30,
----------------------
2005 2004
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 1,959 $ 1,670
Adjustments to reconcile net income
to net cash provided by operating activities:
Provisions for losses and benefits 1,240 1,193
Depreciation and amortization 381 367
Deferred taxes, acquisition costs and other (191) 180
Stock-based compensation 158 109
Changes in operating assets and liabilities, net of
effects of acquisitions and dispositions:
Accounts receivable and accrued interest (293) (810)
Other operating assets 635 (208)
Accounts payable and other liabilities 1,498 608
Increase in Travelers Cheques outstanding 125 283
Increase in insurance reserves 173 113
Cumulative effect of accounting change, net of tax - 71
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 5,685 3,576
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES
Sale of investments 4,248 4,314
Maturity and redemption of investments 2,900 4,057
Purchase of investments (8,231) (9,916)
Net increase in cardmember loans/receivables (2,012) (1,242)
Cardmember receivables redeemed from trust (1,750) -
Cardmember loans sold to trust 2,394 1,794
Cardmember loans redeemed from trust (1,963) (2,500)
Loan operations and principal collections, net (253) (45)
Purchase of land, buildings and equipment (321) (330)
Sale of land, buildings and equipment 136 22
Acquisitions, net of cash acquired (40) (162)
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES (4,892) (4,008)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in customers' deposits 2,761 1,219
Sale of annuities and investment certificates 5,940 4,958
Redemption of annuities and investment certificates (5,261) (4,453)
Net decrease in debt with maturities of three months or less (850) (2,280)
Issuance of debt 4,198 7,626
Principal payments on debt (7,145) (4,683)
Issuance of American Express common shares 484 636
Repurchase of American Express common shares (1,214) (1,978)
Dividends paid (299) (257)
--------- ---------
NET CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (1,386) 788
--------- ---------
Effect of exchange rate changes on cash (34) (11)
--------- ---------
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (627) 345
Cash and cash equivalents at beginning of period 9,907 5,726
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 9,280 $ 6,071
========= =========
See Notes to Consolidated Financial Statements.
4
AMERICAN EXPRESS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying Consolidated Financial Statements should be read in
conjunction with the financial statements which are incorporated by
reference in the Annual Report on Form 10-K of American Express Company
(the Company or American Express) for the year ended December 31, 2004.
Certain reclassifications of prior period amounts have been made to
conform to the current presentation.
The interim financial information in this report has not been audited. In
the opinion of management, all adjustments necessary for a fair statement
of the consolidated financial position and the consolidated results of
operations for the interim periods have been made. All adjustments made
were of a normal, recurring nature. Results of operations reported for
interim periods are not necessarily indicative of results for the entire
year.
On February 1, 2005, the Company announced plans to pursue a spin-off of
American Express Financial Advisors (AEFA) to shareholders. Shareholders
would receive 100 percent of the common shares of American Express
Financial Corporation (referred to herein by its new name, Ameriprise
Financial, Inc. or Ameriprise), through which the financial advisors
business is conducted. The Company has received a ruling from the
Internal Revenue Service (IRS) to the effect that, based on certain
facts, assumptions, representations and undertakings set forth in the
ruling, the distribution will qualify as a transaction that is tax free
under Section 355 and other related provisions of the Internal Revenue
Code of 1986, as amended. In addition, the transaction is conditioned
upon the receipt of a favorable opinion of counsel confirming the
distribution's tax-free status. The transaction is also subject to
certain other conditions, including receipt of necessary regulatory
approvals, as well as final board approval. See Note 23 in the Company's
Annual Report on Form 10-K for the year ended December 31, 2004 and Note
1 in the Company's Quarterly Report on Form 10-Q for the three months
ended March 31, 2005 and the related registration statement on Form 10
filed by Ameriprise on June 7, 2005 as amended on July 25, 2005 for
further discussion of the proposed spin-off. The financial presentation
of the Company's AEFA segment differs in certain significant respects
from the financial presentation of Ameriprise in the Form 10. The
financial statements in the Form 10 were prepared as if Ameriprise were a
stand-alone company, and reflect differences in the businesses comprising
the Company's AEFA segment and Ameriprise. All discussions that follow
describe the Company's business and organization as currently structured.
Net investment income is presented net of interest expense of $82 million
and $50 million for the three months ended June 30, 2005 and 2004,
respectively, and $153 million and $101 million for the six months ended
June 30, 2005 and 2004, respectively, related primarily to the Company's
international banking operations. Cardmember lending net finance charge
revenue is presented net of interest expense of $202 million and $136
million for the three months ended June 30, 2005 and 2004, respectively,
and $380 million and $263 million for the six months ended June 30, 2005
and 2004, respectively.
At both June 30, 2005 and December 31, 2004, cash and cash equivalents
included $1.0 billion segregated in special bank accounts for the benefit
of customers.
The Company had securitized cardmember receivables totaling $1.9 billion
at December 31, 2004 which were included in cardmember receivables on the
Consolidated Balance Sheet as they did not qualify for off-balance sheet
treatment under Statement of Financial Accounting Standards (SFAS) No.
140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities;" likewise, an equal amount of debt was
included in long-term debt. During June 2005, the remaining $1.9 billion
of interests issued by the American Express Master Trust (the Charge
Trust) matured. Management anticipates that the Charge Trust will be
dissolved during the third quarter 2005. During May 2005, a new trust was
established, the American Express Issuance Trust (AEIT), which will be
used to securitize cardmember receivables prospectively. Any cardmember
receivables securitized through AEIT will also not qualify for
off-balance sheet treatment, and, therefore, any interests issued by AEIT
will be included in either short term or long term debt, as appropriate.
5
AMERICAN EXPRESS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
RECENTLY ISSUED ACCOUNTING STANDARDS
In December 2004, the Financial Accounting Standards Board (FASB) issued
SFAS No. 123 (revised 2004), "Share-Based Payment (SFAS No. 123(R))."
Under a rule issued by the Securities and Exchange Commission (SEC) in
April 2005, SFAS No. 123(R) is now effective for public companies for
annual, rather than interim, periods that begin after June 15, 2005. SFAS
No. 123(R) requires entities to measure and recognize the cost of
employee services received in exchange for an award of equity instruments
based on the grant-date fair value of the award. As noted in Note 2
below, the Company adopted, in January 2003, the fair value recognition
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation"
(SFAS No. 123), prospectively for all stock options granted after
December 31, 2002. Substantially all stock options for which intrinsic
value accounting was continued under Accounting Principles Board (APB)
Opinion No. 25 vested by June 30, 2005. SFAS No. 123(R) also requires the
benefits of tax deductions in excess of recognized compensation cost to
be reported as a financing cash flow, rather than as an operating cash
flow as required under current literature. The requirement will reduce
net operating cash flows and increase net financing cash flows in periods
after the effective date. In March 2005, the SEC also issued Staff
Accounting Bulletin No. 107 (SAB No. 107), which summarizes the staff's
views regarding share-based payment arrangements for public companies.
The Company is currently evaluating when it will adopt SFAS No. 123(R)
and believes the adoption will not have a material impact on the
Company's results of operations or its financial position.
In December 2004, the FASB issued FASB Staff Position (FSP) FAS 109-2,
"Accounting and Disclosure Guidance for the Foreign Earnings Repatriation
Provision within the American Jobs Creation Act of 2004 (the Act)" (FSP
FAS 109-2), which would allow additional time beyond the financial
reporting period of enactment to evaluate the effect of the Act on the
Company's plan for reinvestment or repatriation of foreign earnings for
purposes of calculating the income tax provision. The Act contains a
provision that permits an 85% dividends received deduction for qualified
repatriations of earnings that would otherwise be permanently reinvested
outside the United States. The Company does not plan to repatriate any
foreign earnings as a result of the Act.
Effective January 1, 2004, the Company adopted the American Institute of
Certified Public Accountants Statement of Position 03-1, "Accounting and
Reporting by Insurance Enterprises for Certain Nontraditional
Long-Duration Contracts and for Separate Accounts" (SOP 03-1). SOP 03-1
provides guidance on: (i) the classification and valuation of
long-duration contract liabilities; (ii) the accounting for sales
inducements; and (iii) separate account presentation and valuation.
The adoption of SOP 03-1 as of January 1, 2004 resulted in a cumulative
effect of accounting change that reduced first quarter 2004 results by
$71 million ($109 million pretax). The cumulative effect of accounting
change consisted of: (i) $43 million pretax from establishing additional
liabilities for certain variable annuity guaranteed benefits ($33
million) and from considering these liabilities in valuing deferred
acquisition costs (DAC) and deferred sales inducement costs associated
with those contracts ($10 million) and (ii) $66 million pretax from
establishing additional liabilities for certain variable universal life
and single pay universal life insurance contracts under which contractual
cost of insurance charges are expected to be less than future death
benefits ($92 million) and from considering these liabilities in valuing
DAC associated with those contracts ($26 million offset). Prior to the
adoption of SOP 03-1, amounts paid in excess of contract value were
expensed when payable. The Company's accounting for separate accounts was
already consistent with the provisions of SOP 03-1 and, therefore, there
was no impact related to this requirement.
In November 2003, the FASB ratified a consensus on the disclosure
provisions of Emerging Issues Task Force (EITF) Issue 03-1, "The Meaning
of Other-Than-Temporary Impairment and Its Application to Certain
Investments" (EITF 03-1). The Company complied with the disclosure
provisions of this rule in the Consolidated Financial Statements included
in its Annual Report on Form 10-K for the years ended December 31, 2004
and 2003. In March 2004, the FASB reached a consensus regarding the
application of a three-step
6
AMERICAN EXPRESS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
impairment model to determine whether investments accounted for in
accordance with SFAS No. 115, "Accounting for Certain Investments in Debt
and Equity Securities" (SFAS No. 115), and other cost method investments
are other-than-temporarily impaired. However, with the issuance of FSP
EITF 03-1-1, "Effective Date of Paragraphs 10-20 of EITF 03-1," on
September 30, 2004, the provisions of the consensus relating to the
measurement and recognition of other-than-temporary impairments will be
deferred pending further clarification from the FASB. The remaining
provisions of this rule, which primarily relate to disclosure
requirements, are required to be applied prospectively to all current and
future investments accounted for in accordance with SFAS No. 115 and
other cost method investments. The Company will evaluate the potential
impact of EITF 03-1 after the FASB completes its reassessment.
2. STOCK-BASED COMPENSATION
At June 30, 2005, the Company has two stock-based employee compensation
plans, which are described more fully in Note 15 of the Company's Annual
Report on Form 10-K for the year ended December 31, 2004. Effective January
1, 2003, the Company adopted the fair value recognition provisions of SFAS
No. 123 for all stock options granted after December 31, 2002. The Company
expensed $16 million and $14 million after-tax for the three months ended
June 30, 2005 and 2004, respectively, and expensed $39 million and $27
million after-tax for the six months ended June 30, 2005 and 2004,
respectively, related to stock options granted January 1, 2003 or later.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," which amended APB Opinion No.
28, "Interim Financial Reporting," to require disclosure about the pro
forma effects of SFAS No. 123 on reported net income of stock-based
compensation accounted for under APB Opinion No. 25, "Accounting for Stock
Issued to Employees." The following table illustrates the effect on net
income and earnings per common share (EPS) assuming the Company had
followed the fair value recognition provisions of SFAS No. 123 for all
outstanding and unvested stock options and other stock-based compensation
for the three and six months ended June 30, 2005 and 2004:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
(Millions, except per share amounts) 2005 2004 2005 2004
--------- --------- --------- ---------
Net income as reported: $ 1,013 $ 876 $ 1,959 $ 1,670
Add: Stock-based employee compensation
included in reported net income, net of
related tax effects 45 35 103 71
Deduct: Total stock-based employee
compensation expense determined under fair
value based method, net of related tax effects (46) (81) (112) (163)
--------- --------- --------- ---------
Pro forma net income $ 1,012 $ 830 $ 1,950 $ 1,578
========= ========= ========= =========
Basic EPS:
As reported $ 0.82 $ 0.69 $ 1.59 $ 1.31
Pro forma $ 0.82 $ 0.66 $ 1.58 $ 1.24
Diluted EPS:
As reported $ 0.81 $ 0.68 $ 1.56 $ 1.29
Pro forma $ 0.81 $ 0.64 $ 1.55 $ 1.22
7
AMERICAN EXPRESS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
3. INVESTMENTS
The following is a summary of investments at June 30, 2005 and December
31, 2004:
June 30, December 31,
(Millions) 2005 2004
---------- ------------
Available-for-Sale securities, at fair value
(cost: 2005, $55,869; 2004, $54,878) $ 57,068 $ 56,188
Investment loans(a)
(fair value: 2005, $3,661; 2004, $3,776) 3,423 3,523
Trading securities, at fair value and equity method investments in hedge
funds(b) 920 1,098
---------- ------------
Total $ 61,411 $ 60,809
========== ============
(a) The carrying value of these assets is at amortized cost, net of
reserves totaling $51 million and $56 million at June 30, 2005 and
December 31, 2004, respectively.
(b) Hedge fund investments in which the Company holds an interest that is
less than 50% are accounted for under the equity method, which
approximates fair value.
Gross realized gains and losses on sales and losses recognized for
other-than-temporary impairments of securities classified as
Available-for-Sale, using the specific identification method, were as
follows for the three and six months ended June 30, 2005 and 2004:
Three Months Ended Six Months Ended
June 30, June 30,
----------------------- -------------------------
(Millions) 2005 2004 2005 2004
-------- -------- -------- --------
Gross realized gains on sales $ 85 $ 22 $ 100 $ 43
Gross realized losses on sales $ (29) $ (6) $ (38) $ (11)
Gross other-than-temporary impairments $ - $ (10) $ (1) $ (10)
4. GUARANTEES
The Company, through its Travel Related Services (TRS) operating segment,
provides cardmember protection plans that cover losses associated with
purchased products, as well as certain other guarantees in the ordinary
course of business that are within the scope of FASB Interpretation No. 45,
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others" (FIN 45). In the
hypothetical scenario that all claims occur within the next 12 months, the
aggregate maximum amount of undiscounted future payments associated with
such guarantees would not exceed $91 billion at June 30, 2005 and December
31, 2004. The total amount of related liability accrued at June 30, 2005
and December 31, 2004 for such programs was $218 million and $257 million,
respectively, which management believes to be adequate based on actual
experience. The Company generally has no collateral or other recourse
provisions related to these guarantees. Expenses relating to actual claims
under these guarantees were approximately $2 million and $5 million for the
three months ended June 30, 2005 and 2004, respectively, and $9 million and
$11 million for the six months ended June 30, 2005 and 2004, respectively.
The Company, through its American Express Bank (AEB) operating segment,
provides various guarantees to its customers in the ordinary course of
business that are also within the scope of FIN 45, including financial
letters of credit, performance guarantees and financial guarantees.
Generally, guarantees range in term from three months to one year. AEB
receives a fee related to these guarantees, many of which help to
facilitate customer cross-border transactions. At June 30, 2005, AEB held
$814 million of collateral supporting these guarantees. The following table
provides information related to such guarantees as of June 30, 2005 and
December 31, 2004:
8
AMERICAN EXPRESS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
June 30, 2005 December 31, 2004
----------------------------------- -----------------------------------
Maximum amount Maximum amount
of undiscounted Amount of of undiscounted Amount of
(Millions) future payments related liability future payments related liability
--------------- ----------------- --------------- -----------------
Type of Guarantee:
Financial letters of credit $ 388 $ 1.7 $ 295 $ 0.4
Performance guarantees 76 0.8 92 1.1
Financial guarantees 545 0.9 554 2.0
--------------- ----------------- --------------- -----------------
Total $ 1,009 $ 3.4 $ 941 $ 3.5
=============== ================= =============== =================
5. COMPREHENSIVE INCOME
Comprehensive income is defined as the aggregate change in shareholders'
equity, excluding changes in ownership interests. It is the sum of net
income and changes in (i) unrealized gains or losses on Available-for-Sale
securities, (ii) unrealized gains or losses on derivatives, (iii) foreign
currency translation adjustments and (iv) minimum pension liability
adjustment. The components of comprehensive income, net of related tax, for
the three and six months ended June 30, 2005 and 2004 were as follows:
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
(Millions) 2005 2004 2005 2004
--------- --------- --------- ---------
Net income $ 1,013 $ 876 $ 1,959 $ 1,670
Change in:
Net unrealized securities gains (losses) 462 (1,081) (49) (702)
Net unrealized derivative (losses) gains (20) 358 135 325
Foreign currency translation adjustments (23) 33 (40) (20)
--------- --------- --------- ---------
Total $ 1,432 $ 186 $ 2,005 $ 1,273
========= ========= ========= =========
6. RETIREMENT PLANS
The components of the net pension cost for all defined benefit plans
accounted for under SFAS No. 87, "Employers' Accounting for Pensions," are
as follows:
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
(Millions) 2005 2004 2005 2004
--------- --------- --------- ---------
Service cost $ 36 $ 33 $ 72 $ 67
Interest cost 35 32 69 63
Expected return on plan assets (40) (41) (81) (81)
Amortization of prior service cost (1) (2) (1) (3)
Recognized net actuarial loss 7 6 14 10
Settlement/curtailment loss 2 3 4 6
--------- --------- --------- ---------
Net periodic pension benefit cost $ 39 $ 31 $ 77 $ 62
========= ========= ========= =========
The net periodic postretirement benefit expense recognized for the three
months ended June 30, 2005 and 2004 was $10 million and $9 million,
respectively, and $20 million for both the six months ended June 30, 2005
and 2004.
9
AMERICAN EXPRESS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
7. TAXES AND INTEREST
Net income taxes paid by the Company during the six months ended June 30,
2005 and 2004 were approximately $1.2 billion and $472 million,
respectively. The Company paid interest of approximately $1.3 billion and
$710 million during the six months ended June 30, 2005 and 2004,
respectively.
8. EARNINGS PER COMMON SHARE
Basic EPS is computed using the average actual shares outstanding during
the period. Diluted EPS is basic EPS adjusted for the dilutive effect of
stock options, restricted stock awards and other financial instruments
that may be converted into common shares. The computations of basic and
diluted EPS for the three and six months ended June 30, 2005 and 2004 are
as follows:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
(Millions, except per share amounts) 2005 2004 2005 2004
------------ ------------ ------------ ------------
NUMERATOR:
Income before accounting change $ 1,013 $ 876 $ 1,959 $ 1,741
Cumulative effect of accounting change, net of tax - - - (71)
------------ ------------ ------------ ------------
Net income $ 1,013 $ 876 $ 1,959 $ 1,670
------------ ------------ ------------ ------------
DENOMINATOR:
Basic: Weighted-average shares outstanding during the
period 1,231 1,263 1,235 1,270
Add: Dilutive effect of stock options, restricted
stock awards and other dilutive securities 23 25 24 26
------------ ------------ ------------ ------------
Diluted 1,254 1,288 1,259 1,296
------------ ------------ ------------ ------------
BASIC EPS:
Income before accounting change $ 0.82 $ 0.69 $ 1.59 $ 1.37
Cumulative effect of accounting change, net of tax - - - (0.06)
------------ ------------ ------------ ------------
Net income $ 0.82 $ 0.69 $ 1.59 $ 1.31
------------ ------------ ------------ ------------
DILUTED EPS:
Income before accounting change $ 0.81 $ 0.68 $ 1.56 $ 1.34
Cumulative effect of accounting change, net of tax - - - (0.05)
------------ ------------ ------------ ------------
Net income $ 0.81 $ 0.68 $ 1.56 $ 1.29
------------ ------------ ------------ ------------
For the three months ended June 30, 2005 and 2004, the dilutive effect of
stock options excludes 20 million and 13 million options, respectively,
from the computation of diluted EPS because to do so would have been
antidilutive. Similarly, the number of these excluded stock options for
the six months ended June 30, 2005 and 2004 was 19 million and 12
million, respectively. As discussed in Note 1 in the Company's Annual
Report on Form 10-K for the year ended December 31, 2004, the convertible
debentures issued in November 2003 will not affect the computation of EPS
unless the Company's common share price exceeds the base conversion price
(currently $69.41 per share). In that scenario, the Company would reflect
the additional common shares in the calculation of diluted earnings per
share using the treasury stock method. The maximum number of shares
issuable under the debentures is 16.7 million.
9. SEGMENT INFORMATION
The Company is principally engaged in providing travel-related, financial
services and international banking services throughout the world. TRS'
products and services include, among others, charge cards, cardmember
lending products, Travelers Cheques and corporate and consumer travel
services. AEFA is comprised primarily of asset management and insurance
businesses whose products are principally offered through its
10
AMERICAN EXPRESS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
network of over 12,000 financial advisors. AEB's products and services
include providing private, financial institution and corporate banking;
personal financial services and global trading. The Company operates on a
global basis, although the principal market for financial advisory
services is the United States.
The following table presents certain information regarding these
operating segments, based on management's evaluation and internal
reporting structure, for the three and six months ended June 30, 2005 and
2004. For certain income statement items that are affected by asset
securitizations at TRS, data are provided on both a GAAP basis, as well
as on a managed basis, which excludes the effect of securitizations.
Pretax income and net income are the same under both a GAAP and managed
basis. See TRS Results of Operations section of MD&A for further
information regarding the effect of securitizations on the financial
statements.
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
(Millions) 2005 2004 2005 2004
------------ ------------ ------------ ------------
REVENUES (GAAP BASIS):
Travel Related Services $ 5,974 $ 5,378 $ 11,556 $ 10,428
American Express Financial Advisors 1,908 1,737 3,769 3,465
American Express Bank 208 203 415 413
Corporate and Other (88) (86) (165) (164)
------------ ------------ ------------ ------------
Total $ 8,002 $ 7,232 $ 15,575 $ 14,142
============ ============ ============ ============
REVENUES (MANAGED BASIS):
Travel Related Services $ 6,183 $ 5,574 $ 11,971 $ 10,903
American Express Financial Advisors 1,908 1,737 3,769 3,465
American Express Bank 208 203 415 413
Corporate and Other (88) (86) (165) (164)
------------ ------------ ------------ ------------
Total $ 8,211 $ 7,428 $ 15,990 $ 14,617
============ ============ ============ ============
PRETAX INCOME (LOSS) BEFORE ACCOUNTING
CHANGE:
Travel Related Services $ 1,168 $ 1,079 $ 2,340 $ 2,052
American Express Financial Advisors 177 264 412 581
American Express Bank 45 42 91 90
Corporate and Other (71) (119) (149) (209)
------------ ------------ ------------ ------------
Total $ 1,319 $ 1,266 $ 2,694 $ 2,514
============ ============ ============ ============
INCOME (LOSS) BEFORE ACCOUNTING CHANGE:
Travel Related Services $ 808 $ 732 $ 1,609 $ 1,397
American Express Financial Advisors 140 174 306 402
American Express Bank 61 28 91 58
Corporate and Other 4 (58) (47) (116)
------------ ------------ ------------ ------------
Total $ 1,013 $ 876 $ 1,959 $ 1,741
============ ============ ============ ============
NET INCOME (LOSS):
Travel Related Services $ 808 $ 732 $ 1,609 $ 1,397
American Express Financial Advisors* 140 174 306 331
American Express Bank 61 28 91 58
Corporate and Other 4 (58) (47) (116)
------------ ------------ ------------ ------------
Total* $ 1,013 $ 876 $ 1,959 $ 1,670
============ ============ ============ ============
* RESULTS FOR THE SIX MONTHS ENDED JUNE 30, 2004 REFLECT A $109 MILLION
NON-CASH PRETAX CHARGE ($71 MILLION AFTER-TAX) RELATED TO THE JANUARY 1, 2004
ADOPTION OF SOP 03-1.
11
AMERICAN EXPRESS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
10. RESTRUCTURING CHARGES
As discussed in Note 22 to the Company's Annual Report on Form 10-K for the
year ended December 31, 2004, the Company recorded aggregate restructuring
charges of $102 million ($66 million after-tax) for initiatives executed
during 2004. During the first quarter of 2005, the Company recorded
additional charges of $10 million relating principally to the restructuring
activities associated with its business travel operations. During the
second quarter of 2005, the Company recorded restructuring charges of $89
million principally related to TRS' international payments business,
business travel operations and the finance and technologies functions, of
which $80 million reflected severance and related costs and is included in
human resources expenses and $9 million reflected other exit costs and is
included in other expenses. The following table summarizes by category the
Company's aggregate restructuring charge activity for the six months ended
June 30, 2005:
AMERICAN
TRAVEL EXPRESS AMERICAN
RELATED FINANCIAL EXPRESS
(Millions) SERVICES ADVISORS BANK TOTAL
------------ ------------ ------------ ------------
SEVERANCE
Liability balance at December 31, 2004 $ 36 $ 2 $ 30 $ 68
Cash paid (26) - (1) (27)
Charges (reversals) 9 (1) - 8
------------ ------------ ------------ ------------
Liability balance at March 31, 2005 19 1 29 49
Cash paid (18) - (17) (35)
Charges 80 - - 80
------------ ------------ ------------ ------------
Liability balance at June 30, 2005 81 1 12 94
------------ ------------ ------------ ------------
OTHER
Liability balance at December 31, 2004 $ 8 $ - $ 5 $ 13
Cash paid (4) - - (4)
Charges 1 - - 1
------------ ------------ ------------ ------------
Liability balance at March 31, 2005 5 - 5 10
Cash paid (4) - (3) (7)
Charges 9 - - 9
------------ ------------ ------------ ------------
Liability balance at June 30, 2005 10 - 2 12
------------ ------------ ------------ ------------
Total liability balance at June 30, 2005 $ 91 $ 1 $ 14 $ 106
============ ============ ============ ============
11. INCOME TAX EXAMINATIONS
The Company is under continuous examination by the IRS and regularly
audited by tax authorities in other countries and states in which the
Company has significant business operations. The tax years under
examination vary by jurisdiction. The Company regularly assesses the
likelihood of additional assessments in each of the taxing jurisdictions
resulting from these examinations. Tax reserves have been established which
the Company believes to be adequate in relation to the potential for
additional assessments. Once established, reserves are adjusted when there
is more information available or when an event occurs necessitating a
change to the reserves.
For the three months ended June 30, 2005, the Company recognized an income
tax benefit of $90 million related to the resolution of certain matters
with the IRS. The IRS is evaluating certain other tax items that may result
in additional tax benefits. The resolution of these tax matters is not
expected to have a material effect on
12
AMERICAN EXPRESS COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
the Company's financial condition, although a resolution could have a
material impact on the Company's results of operations for a particular
future period and on the Company's effective tax rate.
12. INSURANCE SETTLEMENT
On September 11, 2001, the U.S. experienced terrorist attacks. The
Company's headquarters building sustained significant damage which caused
substantial business interruption when the World Trade Center complex,
located across the street from our headquarters, was destroyed in the
attacks and the Company relocated its New York staff to interim facilities.
In the second quarter of 2005, the Company settled its claim with its
insurance carriers related to the events of September 11, 2001. The impact
of the settlement was a net benefit of $115 million ($75 million after-tax)
resulting from the recovery of September 11, 2001 related insurance claims
and was recorded as a reduction of other operating expenses.
13. SUBSEQUENT EVENT
In August 2005, the Company announced an agreement to sell its accounting
and consulting business unit, American Express Tax and Business Services
(TBS) for a purchase price of approximately $220 million. The
transaction is expected to close in the third quarter of 2005, subject to
certain regulatory approvals. The Company does not expect the gain on the
sale of TBS to have a material impact on the third quarter results as the
Company also expects to incur unrelated costs associated with global
reengineering initiatives. The sale is also not expected to have a material
impact on the Company's ongoing earnings.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
American Express Company is engaged in a variety of businesses comprising three
operating segments: Travel Related Services (TRS), American Express Financial
Advisors (AEFA) and American Express Bank (AEB).
TRS includes a broad range of products including charge and credit cards; stored
value products such as Travelers Cheques, Travelers Cheque cards and gift cards;
travel agency services and travel, entertainment and purchasing expense
management services; network services and merchant acquisition and merchant
processing for our network partners and proprietary payments businesses. TRS'
various products are sold globally to diverse customer groups, including
consumers, small businesses, mid-market companies, large corporations and
banking institutions. These products are sold through various channels including
direct mail, on-line applications, targeted sales-forces and direct response
advertising.
TRS generates revenue from a variety of sources including global payments, such
as charge and credit cards, travel services and stored value products, including
Travelers Cheques. Charge and credit cards generate revenue for the Company
primarily in three different ways:
- Discount revenue, the Company's largest single revenue source, which
represents fees charged to merchants when cardmembers use their
cards to purchase goods and services on our network,
- Finance charge revenue, which is earned on outstanding balances
related to the cardmember lending portfolio, and
- Card fees, which are earned for annual membership, and other
commissions and fees such as foreign exchange conversion fees and
card-related fees and assessments.
In addition to operating costs associated with these activities, other major
expense categories are expenses related to marketing and reward programs that
add new cardmembers, promote cardmember loyalty and spending and provisions
for anticipated cardmember credit and fraud losses.
TRS believes that its "spend-centric" business model (in which it focuses
primarily on generating revenues by driving spending on its cards and
secondarily by finance charges and fees) has significant competitive
advantages. For merchants, the higher spending represents greater value to
them in the form of higher sales and loyal customers, which gives TRS the
ability to earn a premium discount rate. As a result of the higher revenues
generated from higher spending, TRS has the flexibility to offer more
attractive rewards and other incentives to cardmembers, which in turn create
an incentive to spend more on their cards.
During the three and six months ended June 30, 2005, the TRS segment accounted
for approximately 75 percent and 74 percent of the Company's total revenues,
respectively, and 80 percent and 82 percent of the Company's net income,
respectively.
AEFA is comprised primarily of asset management and insurance businesses whose
products are principally offered through its network of over 12,000 financial
advisors.
AEFA earns management and distribution fees on mutual funds, wrap products,
assets managed for institutions and separate accounts. AEFA's insurance and
annuity products generate revenue through premiums and other charges collected
from policyholders and contractholders and through investment income earned on
owned assets supporting these products. AEFA incurs various operating costs,
principally provision for losses and benefits for annuities, investment
certificates and insurance products.
On February 1, 2005, the Company announced plans to pursue a spin-off of AEFA
to shareholders. Shareholders would receive 100 percent of the common shares
of American Express Financial Corporation (referred to herein by its new name,
Ameriprise Financial, Inc. or Ameriprise), through which the financial
advisors business is conducted. The Company has received a ruling from the
Internal Revenue Service (IRS) to the effect that, based on
14
certain facts, assumptions, representations and undertakings set forth in the
ruling the distribution will qualify as a transaction that is tax free under
Section 355 and other related provisions of the Internal Revenue Code of
1986, as amended. In addition, the transaction is conditioned upon the
receipt of a favorable opinion of counsel confirming the distribution's
tax-free status. The transaction is also subject to certain other conditions,
including receipt of necessary regulatory approvals, as well as final board
approval. Expenses related to this spin-off will be reflected in each quarter
as incurred. See Note 23 in the Company's Annual Report on Form 10-K for the
year ended December 31, 2004 and Note 1 in the Company's Quarterly Report on
Form 10-Q for the three months ended March 31, 2005 and the related
registration statement on Form 10 filed by Ameriprise on June 7, 2005 as
amended on July 25, 2005 for further discussion of the proposed spin-off. The
financial presentation of the Company's AEFA segment differs in certain
significant respects from the financial presentation of Ameriprise in the
Form 10. The financial statements in the Form 10 were prepared as if
Ameriprise were a stand-alone company, and reflect differences in the
businesses comprising the Company's AEFA segment and Ameriprise. All
discussions that follow describe the Company's business and organization as
currently structured.
AEB offers financial products and services to retail customers, wealthy
individuals and financial institutions outside the United States that generate
interest income, commissions and fees, foreign exchange income and other
revenue. In addition to various operating costs, AEB recognizes provisions for
credit losses, mainly on its outstanding loans.
The Company follows accounting principles generally accepted in the United
States (GAAP). In addition to information provided on a GAAP basis, the
Company discloses certain data on a "managed basis." This information, which
should be read only as a supplement to GAAP information, assumes there have
been no securitization transactions at TRS, i.e., as if all securitized
cardmember loans and related income effects are reflected in the Company's
balance sheets and income statements. See the TRS Results of Operations
section for further discussion of this approach.
Certain of the statements below are forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. See the
"Forward-Looking Statements" section below.
CONSOLIDATED RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2005
AND 2004
The Company's consolidated net income rose 16 percent to $1.0 billion and
diluted earnings per share (EPS) rose 19 percent to $0.81 in the three-month
period ended June 30, 2005 as compared to the same period a year ago. On a
trailing 12-month basis, return on average shareholders' equity was 23.1
percent.
Both the Company's revenues and expenses are affected by changes in the
relative values of non-U.S. currencies to the U.S. dollar. The currency rate
changes increased revenue and expense growth by approximately 1 and 2
percentage points, respectively, for the three months ended June 30, 2005.
Results for the three months ended June 30, 2005 included the following items:
- A tax benefit of approximately $90 million resulting from a Federal
tax audit,
- A $115 million benefit ($75 million after-tax) related to the
settlement of an insurance claim associated with September 11, 2001,
- $102 million ($66 million after-tax) of reengineering costs
principally related to restructuring costs within the International
Payments business, the Corporate Travel business and the Finance and
Technologies functions,
- $59 million of costs ($38 million after-tax) related to the spin-off
of American Express Financial Advisors, and
- Costs associated with various securities industry legal and
regulatory matters of $35 million ($23 million after-tax).
15
The following discussion is presented on a basis consistent with GAAP unless
otherwise noted.
REVENUES
Consolidated revenues for the three months ended June 30, 2005 were $8.0
billion, up 11 percent from $7.2 billion in the same period a year ago
reflecting 11 percent growth at TRS, 10 percent growth at AEFA and a 2 percent
increase at AEB. As discussed in further detail below, the increase in the
second quarter was due primarily to higher discount revenue, increased
management and distribution fees, greater cardmember lending net finance
charge revenue and higher net investment income.
Discount revenue at TRS rose 16 percent to $2.9 billion as compared to a year
ago as a result of an 18 percent increase in worldwide billed business,
reflecting a 13 percent increase in average cardmember spending per
proprietary basic card and 8 percent growth in cards-in-force, offset in part
by a lower average discount rate.
Net investment income of $822 million increased 5 percent over the year ago
period primarily as a result of a 6 percent increase at AEFA that was
partially offset by lower net interest income at AEB. The increase at AEFA
reflects higher levels of invested assets and the impact of higher net
investment gains versus the prior year principally as a result of a $36
million gain from the sale of all of AEFA's interest in a collateralized debt
obligation (CDO) securitization trust.
Management and distribution fees at AEFA increased 12 percent to $814 million
reflecting higher levels of assets under management and higher fees from sales
of non-proprietary products, primarily wrap accounts.
Cardmember lending net finance charge revenue at TRS of $637 million rose 14
percent, reflecting 6 percent growth in the average balance of the owned
cardmember lending portfolio and a higher portfolio yield.
EXPENSES
Consolidated expenses for the three months ended June 30, 2005 were $6.7
billion, up 12 percent from $6.0 billion for the same period in 2004
reflecting increases of 12 percent at TRS and 17 percent at AEFA while AEB was
essentially flat. As discussed in further detail below, the increase in the
second quarter of 2005 was primarily driven by higher expenses for human
resources, increased marketing, promotion, rewards and cardmember services
expenses, larger total provisions for losses and benefits and greater
professional services expenses, partially offset by lower other expenses.
Consolidated expenses for the three months ended June 30, 2005 include $102
million of reengineering costs principally related to $89 million of
restructuring costs within TRS' international payments business, business
travel operations and the finance and technologies functions, of which $80
million represents severance and related costs and is included in human
resources expenses and $9 million related to other exit costs and is included
in other expenses; $59 million of spin-off related expenses principally at
AEFA; and $35 million of costs associated with various securities industry
legal and regulatory matters at AEFA. These expenses were offset by a $115
million benefit from the recovery of insurance claims associated with
September 11, 2001, of which $90 million was recognized at TRS, $21 million at
Corporate and Other and $2 million each at AEFA and AEB.
Human resources expenses increased 15 percent to $2.1 billion due to severance
related costs resulting from the restructuring initiatives noted above,
increased costs related to management incentives, including the impact of an
additional year of higher stock-based compensation expenses, merit increases,
and employee benefit expenses. The higher stock-based compensation expense from
stock options reflects the Company's decision to expense stock options beginning
in 2003, partially offset by the decision to issue fewer stock options. Higher
expense related to restricted stock awards reflects the Company's decision to
modify compensation practices and use restricted stock awards in place of stock
options for middle management.
Marketing, promotion, rewards and cardmember services expenses increased 18
percent to $1.5 billion versus a year ago primarily due to an 18 percent
increase at TRS, reflecting higher marketing and promotion expenses and
greater reward costs. The increase in marketing and promotion expenses was
primarily driven by the Company's recent global brand advertising campaign and
continued focus on business-building initiatives. Rewards costs reflect
significant volume growth, higher redemption rates and strong cardmember
loyalty program participation. Management believes, based on historical
experience, that cardmembers enrolled in rewards and co-brand programs yield
higher spend, better retention, stronger credit performance and greater profit
for the Company.
16
Total provisions for losses and benefits increased 9 percent to $1.2 billion
over last year, primarily resulting from increases in the charge card and
other provisions at TRS and increased interest credited on investment
certificates at AEFA. These increases were partially offset by decreased
cardmember lending provisions at TRS.
Professional services expenses increased 16 percent to $665 million primarily
due to increased technology costs related to higher business and
service-related volumes at TRS and spin-off related costs, primarily at AEFA.
Other expenses decreased 7 percent to $477 million primarily reflecting the
$115 million insurance recovery discussed previously and lower expenses as a
result of the third quarter 2004 sale of the ATM business in TRS, partially
offset by increased costs related to restructuring and reengineering
activities and higher business volumes, primarily at TRS, and $35 million of
costs associated with various securities industry legal and regulatory matters
at AEFA (see Mutual Fund Industry Developments below for further discussion).
The effective tax rate was 23 and 31 percent for the three-month periods ended
June 30, 2005 and 2004, respectively. The decrease in the effective tax rate
for the three month period ended June 30, 2005 primarily reflects the impact
of the $90 million benefit resulting from an IRS audit of previous years' tax
returns. Of this amount, $49 million was recognized in the Corporate and Other
segment, $33 million in AEB, $5 million in TRS and $3 million in AEFA.
As previously disclosed, the Company expects to continue to incur expenses
related to the proposed tax-free spin-off of AEFA, which cumulatively will be
significant. The Company plans to provide a $1 billion capital infusion to
Ameriprise prior to the spin-off. A portion of the capital contribution from
the Company will pre-fund an estimated $875 million in pretax separation
costs to be borne by Ameriprise, of which approximately $340 million is
expected to be incured in 2005. In addition, the American Express Parent
expects to incur approximately $70 million of pretax separation costs, $50
million of which will be incurred in 2005. To date, the Company on a
consolidated basis has incurred total spin-off related costs of $59 million
($38 million after-tax) in second quarter of 2005 and $22 million ($14
million after-tax) in first quarter of 2005. The transaction is expected to
occur late in the third quarter of this year.
In August 2005, the Company announced an agreement to sell its accounting and
consulting business unit, American Express Tax and Business Services (TBS)
for a purchase price of approximately $220 million. The transaction is
expected to close in the third quarter of 2005, subject to certain regulatory
approvals. The sale is not expected to have a material impact on the
Company's ongoing earnings.
In addition, the Company does not expect the gain on the sale of TBS to have
a material impact on the third quarter results as the Company continues to
engage in various reengineering activities, which are expected to result in
significant expenses during the next several quarters. The Company is also
working with tax authorities to complete tax audits for certain prior years,
the completion of which may result in the Company's recognizing significant
benefits.
CONSOLIDATED RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2005 AND
2004
The Company's consolidated net income rose 17 percent to $2.0 billion and
diluted earnings per share (EPS) rose 21 percent to $1.56 in the six-month
period ended June 30, 2005 as compared to a year ago. The Company's
consolidated income before the prior year's accounting change rose 13 percent
and diluted EPS before accounting change rose 16 percent. On a trailing
12-month basis, return on average shareholders' equity was 23.1 percent.
Net income and EPS for the six months ended June 30, 2004 reflect the $71
million ($109 million pretax) or $0.05 per diluted share impact of the
Company's adoption of the American Institute of Certified Public Accountants
(AICPA) Statement of Position 03-1, "Accounting and Reporting by Insurance
Enterprises for Certain Nontraditional Long-Duration Contracts and for
Separate Accounts" (SOP 03-1). SOP 03-1 requires insurance enterprises to
establish liabilities for benefits that may become payable under variable
annuity death benefit guarantees or other insurance or annuity contract
provisions. Previous to the adoption of SOP 03-1, these costs were expensed
when payable.
Both the Company's revenues and expenses are affected by changes in the
relative values of non-U.S. currencies to the U.S. dollar. The currency rate
changes increased both revenue and expense growth by approximately 1
percentage point for the six months ended June 30, 2005.
The following discussion is presented on a basis consistent with GAAP unless
otherwise noted.
17
REVENUES
Consolidated revenues for the six months ended June 30, 2005 were $15.6
billion, up 10 percent from $14.1 billion in the same period a year ago
reflecting 11 percent growth at TRS, 9 percent growth at AEFA and a slight
increase at AEB. As discussed in further detail below, the increase in the
first half of 2005 was due primarily to higher discount revenue, increased
management and distribution fees, greater cardmember lending net finance
charge revenue and increased net investment income.
Discount revenue at TRS rose 15 percent to $5.6 billion as compared to a year
ago as a result of an 18 percent increase in worldwide billed business,
reflecting an 11 percent increase in average cardmember spending per
proprietary basic card and 8 percent growth in cards-in-force, offset in part
by a lower average discount rate.
Net investment income of $1.6 billion increased 7 percent over the year ago
period primarily as a result of a 9 percent increase at AEFA that was
partially offset by lower net interest income at AEB. The increase at AEFA
reflects higher levels of invested assets and the effect of net investment
gains in 2005 compared to net investment losses in 2004.
Management and distribution fees at AEFA increased 7 percent to $1.6 billion
primarily reflecting higher levels of assets under management and higher fees
earned on wrap accounts and brokered mutual funds.
Cardmember lending net finance charge revenue at TRS of $1.2 billion rose 12
percent, reflecting 6 percent growth in the average balance of the owned
cardmember lending portfolio and a higher portfolio yield.
EXPENSES
Consolidated expenses for the six months ended June 30, 2005 were $12.9
billion, up 11 percent from $11.6 billion for the same period in 2004
reflecting increases of 10 percent at TRS and 16 percent at AEFA. As discussed
in further detail below, the increase in the first half of 2005 was primarily
driven by higher marketing, promotion, rewards and cardmember services
expenses, greater human resources costs, greater provisions for losses and
benefits and increased professional services expenses, which were partially
offset by lower other expenses. Consolidated expenses for the six months ended
June 30, 2005 include $123 million of reengineering costs principally related
to restructuring costs within TRS' international payments business, business
travel operations and the finance and technologies functions, of which $89
million represents severance and related costs and is included in human
resources expenses; $81 million of spin-off related expenses principally at
AEFA; and $70 million of costs associated with various securities industry
legal and regulatory matters at AEFA. These expenses were offset by a $115
million benefit from the recovery of insurance claims associated with
September 11, 2001, of which $90 million was recognized at TRS, $21 million at
Corporate and Other and $2 million each at AEFA and AEB.
Human resources expenses increased 14 percent to $4.1 billion due to severance
related costs resulting from the restructuring initiatives noted above,
increased costs related to management incentives, including the impact of an
additional incremental year of higher stock-based compensation expenses, merit
increases and employee benefit expenses as previously discussed. The increase
in human resources expenses also includes the first quarter 2004 impact of the
$44 million deferred acquisition cost (DAC) valuation benefit at AEFA
reflecting a portion of the benefit of the lengthening of amortization periods
for certain insurance and annuity products in conjunction with the adoption of
SOP 03-1. The total DAC valuation benefit of $66 million (including the $22
million benefit noted below) and the impact of the adoption of SOP 03-1 are
discussed in the AEFA Results of Operations section below.
Marketing, promotion, rewards and cardmember services expenses increased 23
percent to $2.8 billion versus a year ago primarily due to a 23 percent
increase at TRS, reflecting higher marketing and promotion expenses and
greater reward costs. The increase in marketing and promotion expenses was
primarily driven by the Company's recent global brand advertising campaign and
continued focus on business-building initiatives. Rewards costs reflect
significant volume growth, higher redemption rates and strong cardmember
loyalty program participation.
Total provisions for losses and benefits increased 8 percent to $2.3 billion
over last year, primarily resulting from increases in the charge card and
other provisions at TRS and increased interest credited on investment
certificates
18
and higher losses and expenses on property-casualty insurance at AEFA. These
increases were partially offset by decreased cardmember lending provisions at
TRS.
Professional services expenses increased 12 percent to $1.2 billion primarily
due to increased technology costs related to higher business and
service-related volumes at TRS and spin-off related costs, primarily at AEFA.
Other expenses decreased 16 percent to $890 million primarily reflecting the
$115 million insurance recovery discussed previously and lower expenses as a
result of the third quarter 2004 sale of the ATM business in TRS partially
offset by increased costs related to restructuring and reengineering
activities and higher business volumes, primarily at TRS. These decreases were
partially offset by increased expenses related to securities industry legal
and regulatory matters at AEFA (see Mutual Fund Industry Developments below
for further discussion) offset by the impact of $22 million DAC valuation
benefit in the first quarter 2004 at AEFA.
The effective tax rate was 27 and 31 percent for the six-month periods ended
June 30, 2005 and 2004, respectively. The decrease in the effective tax rate
for the six-month period ended June 30, 2005 reflects the impact of a $90
million benefit resulting from an IRS audit of previous years' tax returns
discussed earlier.
CONSOLIDATED LIQUIDITY AND CAPITAL RESOURCES
CAPITAL STRATEGY
The Company believes allocating capital to its growing businesses with a
return on risk-adjusted equity in excess of their cost of capital will
continue to build shareholder value. The Company's philosophy is to retain
earnings sufficient to enable it to meet its growth objectives, and, to the
extent capital exceeds investment opportunities, return excess capital to
shareholders. Assuming the Company achieves its financial objectives of 12 to
15 percent EPS growth, 18 to 20 percent return on equity and 8 percent revenue
growth, on average and over time, it will seek to return to shareholders an
average of 65 percent of capital generated, subject to business mix,
acquisitions and rating agency requirements. Assuming the completion of the
AEFA spin-off discussed above, the Company plans to raise its return on equity
target to 28 to 30 percent while maintaining a 65 percent payout of capital
generated. During the six months ended June 30, 2005, the Company paid $299
million in dividends and continued share repurchases as discussed below.
SHARE REPURCHASES
The Company has in place a share repurchase program to return equity capital
in excess of its business needs to shareholders. These share repurchases are
made to both offset the issuance of new shares as part of employee
compensation plans and to reduce shares outstanding. The Company repurchases
its common shares primarily by open market purchases using several brokers at
competitive commission and fee rates. In addition, common shares may also be
purchased from the Company-sponsored Incentive Savings Program (ISP) to
facilitate the ISP's required disposal of shares when employee-directed
activity results in an excess common share position. Such purchases are made
at market price without commissions or other fees. During the six months ended
June 30, 2005, the Company repurchased 22.8 million common shares at an
average price of $53.33. Since the inception of the share repurchase program
in September 1994, 518.3 million shares have been acquired under total
authorizations to repurchase up to 570 million shares, including purchases
made under past agreements with third parties. The lower repurchase activity
during the first six months of 2005 compared to the same period last year
reflects a more measured approach to repurchases as the Company evaluates the
capital implications of the anticipated AEFA spin-off.
CASH FLOWS
CASH FLOWS FROM OPERATING ACTIVITIES
The Company generated net cash provided by operating activities in amounts
greater than net income for both the six months ended June 30, 2005 and 2004
primarily due to provisions for losses and benefits, which represent expenses
in the Consolidated Statements of Income but do not require cash at the time
of provision. Similarly, depreciation and amortization represent non-cash
expenses. In addition, net cash was provided by fluctuations in other
operating assets and liabilities. These accounts vary significantly in the
normal course of business due to the amount and timing of various payments.
19
Management believes cash flows from operations, available cash balances and
short-term borrowings will be sufficient to fund the Company's operating
liquidity needs.
CASH FLOWS FROM INVESTING ACTIVITIES
The Company's investing activities primarily include funding TRS' cardmember
loans and receivables and AEFA's Available-for-Sale investment portfolio.
For the six months ended June 30, 2005 and 2004, net cash was used in
investing activities primarily due to net increases in cardmember receivables
and loans at TRS and increases in investments due to the cumulative benefit of
sales of annuities, insurance and certificate products at AEFA.
CASH FLOWS FROM FINANCING ACTIVITIES
The Company's financing activities primarily include the issuance of debt and
AEFA's sale of annuities and investment certificates, in addition to taking
customer deposits. The Company also regularly repurchases its common shares.
For the six months ended June 30, 2005, net cash was used in financing
activities versus net cash provided by financing activities for the same
period a year ago primarily due to a net decrease in total debt versus a net
increase in 2004, partially offset by increases in customers' deposits, a
reduced amount of share repurchase activity and net increases in sales of
annuities and investment certificates.
PARENT COMPANY FUNDING
At June 30, 2005, the Parent Company had $4.3 billion of debt or equity
securities available for issuance under shelf registrations filed with the
Securities and Exchange Commission (SEC). In addition, TRS; American Express
Centurion Bank (Centurion Bank), a wholly-owned subsidiary of TRS; American
Express Credit Corporation (Credco), a wholly-owned subsidiary of TRS;
American Express Overseas Credit Corporation Limited, a wholly-owned
subsidiary of Credco; and AEB have established programs for the issuance,
outside the United States, of debt instruments to be listed on the Luxembourg
Stock Exchange. The maximum aggregate principal amount of debt instruments
outstanding at any one time under the program will not exceed $6.0 billion. At
June 30, 2005, $3.2 billion was outstanding under this program.
The Board of Directors authorized a Parent Company commercial paper program
supported by the multi-purpose bank credit facility discussed below. There
was no Parent Company commercial paper outstanding as of June 30, 2005 and no
borrowings have been made under its bank credit facility. As of June 30,
2005, the Company maintained total bank lines of credit totaling $13.9
billion, which included $0.6 billion allocated to the Parent Company. During
April 2005, the Company renewed and extended a total of $7 billion of these
credit line facilities. In connection with the renewal and extension, the
Company renegotiated the consolidated tangible net worth covenant contained
therein (as well as in the remaining credit facility containing such
covenant) to provide for an adjustment upon completion of the proposed
spin-off of the shares of Ameriprise. This covenant is applicable only to the
Parent Company's credit lines. Under the terms of this covenant, the Parent
Company's right to borrow under the credit facilities is subject to the
Company's maintaining consolidated tangible net worth (as defined under the
credit facilities) of not less than $9 billion until the completion of the
proposed spin-off. After completion of the proposed spin-off, the amount
required under the consolidated tangible net worth covenant would be reduced
by approximately 70% of Ameriprise's pre-spin-off contribution to the
Company's consolidated tangible net worth.
20
TRAVEL RELATED SERVICES
RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004
STATEMENTS OF INCOME
(Dollars in millions) Three Months Ended Six Months Ended
June 30, June 30,
----------------------- Percentage ----------------------- Percentage
2005 2004 Inc/(Dec) 2005 2004 Inc/(Dec)
---------- ---------- ---------- ---------- ---------- ----------
Net revenues:
Discount revenue $ 2,941 $ 2,529 16.3% $ 5,613 $ 4,897 14.6%
Lending:
Finance charge revenue 839 697 20.5 1,609 1,365 17.9
Interest expense 202 136 48.7 380 263 44.6
---------- ---------- ---------- ----------
Net finance charge revenue 637 561 13.7 1,229 1,102 11.5
Net card fees 506 472 7.0 1,004 944 6.3
Travel commissions and fees 502 468 7.1 924 885 4.3
Other commissions and fees 602 551 9.3 1,165 1,061 9.8
Travelers Cheque investment
income 94 95 (1.1) 188 188 0.1
Securitization income, net 296 282 4.8 612 512 19.4
Other revenues 396 420 (5.3) 821 839 (1.9)
---------- ---------- ---------- ----------
Total net revenues 5,974 5,378 11.1 11,556 10,428 10.8
---------- ---------- ---------- ----------
Expenses:
Marketing, promotion, rewards
and cardmember services 1,440 1,225 17.6 2,756 2,248 22.6
Provision for losses and claims:
Charge card 234 189 23.4 449 387 15.9
Lending 275 314 (12.4) 570 601 (5.1)
Other 72 33 # 107 62 71.8
---------- ---------- ---------- ----------
Total 581 536 8.4 1,126 1,050 7.2
Charge card interest expense 211 175 19.9 387 343 12.7
Human resources 1,224 1,081 13.1 2,367 2,146 10.3
Other operating expenses:
Professional services 538 488 10.3 1,020 957 6.6
Occupancy and equipment 342 313 9.3 665 621 7.1
Communications 110 114 (3.5) 225 235 (4.3)
Other 360 367 (1.7) 670 776 (13.4)
---------- ---------- ---------- ----------
Total other operating
expenses 1,350 1,282 5.4 2,580 2,589 (0.3)
---------- ---------- ---------- ----------
Total expenses 4,806 4,299 11.8 9,216 8,376 10.0
---------- ---------- ---------- ----------
Pretax income 1,168 1,079 8.2 2,340 2,052 14.0
Income tax provision 360 347 3.8 731 655 11.5
---------- ---------- ---------- ----------
Net income $ 808 $ 732 10.4 $ 1,609 $ 1,397 15.2
========== ========== ========== ==========
# - Denotes a variance of more than 100%.
TRS reported net income of $808 million for the three month period ended June
30, 2005, a 10 percent increase from $732 million for the same period a year
ago. For the six month period ended June 30, 2005, TRS reported net income of
$1.6 billion, a 15 percent increase from $1.4 billion for the same period a
year ago.
The following management discussion includes information on both a GAAP basis
and managed basis. The Company presents TRS information on a managed basis
because that is the way the Company's management views and manages the
business. It differs from the accompanying financial statements, which are
prepared in accordance with GAAP, as managed basis presentation assumes there
have been no securitization transactions, i.e., as if all securitized
cardmember loans and related income effects are reflected in the Company's
balance sheet and income
21
statement, respectively. Management believes that the trends in the Company's
cardmember lending business are more accurately portrayed by evaluating the
performance of both securitized and non-securitized cardmember loans. Asset
securitization is just one of several ways the Company funds cardmember loans.
Use of a managed basis presentation, including non-securitized and securitized
cardmember loans, presents a more accurate picture of the key dynamics of the
cardmember lending business, avoiding distortions due to the mix of funding
sources at any particular point in time. For example, irrespective of the mix,
it is important for management and investors to see metrics, such as changes
in delinquencies and write-off rates, for the entire cardmember lending
portfolio because it is more representative of the economics of the aggregate
cardmember relationships and ongoing business performance and trends over
time. It is also important for investors to see the overall growth of
cardmember loans and related revenue and changes in market share, which are
significant metrics in evaluating the Company's performance and which can only
be properly assessed when all non-securitized and securitized cardmember loans
are viewed together on a managed basis.
On a GAAP basis, results reflect finance charge revenue on the owned loan
portfolio as well as finance charge revenue on the retained seller's interest
from securitization activity. GAAP basis results also include investment
income on the Company's investments in other subordinated retained interests
from loan securitization issuances.
TRS' owned portfolio is primarily comprised of cardmember receivables
generated by the Company's charge card products and unsecuritized cardmember
loans. The Company securitizes cardmember loans as part of its financing
strategy; consequently, the level of unsecuritized cardmember loans is
primarily a function of the Company's financing requirements. As a portfolio,
unsecuritized cardmember loans tend to be less seasoned than securitized
loans, primarily because of the lead time required to designate and securitize
each loan. The Company does not currently securitize international loans.
Delinquency, reserve coverage and net write-off rates have historically been
broadly comparable between the Company's owned and managed portfolios.
On a GAAP basis, results reflect net securitization income, which is comprised
of the non-credit provision components of the net gains and charges from
securitization activities, the amortization and related impairment charges, if
any, of the interest-only strip, excess spread related to securitized loans,
net finance charge revenue on retained interests in securitized loans, and
servicing income, net of related discounts or fees. Excess spread, which is
the net positive cash flow from interest and fee collections allocated to the
investor's interests after deducting the interest paid on investor
certificates, credit losses, contractual servicing fees and other expenses is
recognized in securitization income as it is earned. Net securitization income
of $296 million and $612 million for the three and six months ended June 30,
2005, respectively, increased 5 percent and 19 percent versus the same periods
a year ago primarily due to a greater average balance of securitized loans, a
higher portfolio yield and a decrease in the portfolio write-offs, partially
offset by greater interest expense due to a higher coupon rate paid to
certificate holders and an increase in the payment speed of the trust assets.
See Selected Statistical Information below for data relating to TRS' owned
loan portfolio.
During the three months ended June 30, 2005 and 2004, TRS recognized net
gains, including the credit components, of $1 million ($1 million after-tax)
and $9 million ($6 million after-tax), respectively, from net securitization
activities. For the three months ended June 30, 2005, the net gains consisted
of $38 million of income from the securitization of $1.2 billion of cardmember
loans, including the impact of the related credit reserves on the sold loans.
This amount was partially offset by $37 million of charges related to the
maturity of $1.0 billion of previously outstanding issuances. For the three
months ended June 30, 2004, the net gains consisted of $119 million of income
from the securitization of $1.0 billion of cardmember loans, including the
impact of the related credit reserves on the sold loans, and the sale of $1.4
billion of certain retained interests of previous securitization activities.
This amount was partially offset by $110 million of charges related to the
maturity of $2.5 billion of securitizations.
During the six months ended June 30, 2005 and 2004, TRS recognized net gains,
including the credit components, of $7 million ($5 million after-tax) and $17
million ($11 million after-tax), respectively, from net securitization
activities. For the six months ended June 30, 2005, the net gains consisted of
$79 million of income from the securitization of $2.4 billion of cardmember
loans, including the impact of the related credit reserves on the sold loans.
This amount was partially offset by $72 million of charges related to the
maturity of $2.0 billion of previously outstanding issuances. For the six
months ended June 30, 2004, the net gains consisted of $158 million
22
of income from the securitization of $1.8 billion of cardmember loans,
including the impact of the related credit reserves on the sold loans, and the
sale of $1.4 billion of certain retained interests from previous
securitization activities. This amount was partially offset by $141 million of
charges related to the maturity of $2.5 billion of securitizations and changes
in interest-only strip assumptions.
Management views any net gains from securitizations as discretionary benefits
to be used for card acquisition expenses, which are reflected in both
marketing, promotion, rewards and cardmember services and other operating
expenses. Consequently, the managed basis presentation for the three months
ended June 30, 2005 and 2004 assumes that the impact of this net activity was
offset by higher marketing, promotion, rewards and cardmember services
expenses of $1 million and $6 million, respectively, and other operating
expenses of nil and $3 million, respectively. Similarly, the managed basis
presentation for the six months ended June 30, 2005 and 2004 assumes that the
impact of this net activity was offset by higher marketing, promotion, rewards
and cardmember services expenses of $5 million and $10 million, respectively,
and other operating expenses of $2 million and $7 million, respectively.
Accordingly, the incremental expenses, as well as the impact of this net
activity, have been eliminated in the managed basis presentations. The
following tables reconcile the GAAP basis for certain TRS income statement
line items to the managed basis information, where different.
23
GAAP BASIS TO MANAGED BASIS RECONCILIATION -- EFFECT OF SECURITIZATIONS
THREE MONTHS ENDED JUNE 30, (Dollars in millions)
GAAP Basis Securitization Effect Managed Basis
------------------------------------ ----------------------------------------------------------------
Percentage Percentage
2005 2004 Inc/(Dec) 2005 2004 2005 2004 Inc/(Dec)
------------------------------------ ----------------------------------------------------------------
Net revenues:
Discount revenue $ 2,941 $ 2,529 16.3%
Lending:
Finance charge
revenue 839 697 20.5 $ 618 $ 489 $ 1,457 $ 1,186 23.0%
Interest expense 202 136 48.7 164 61 366 197 86.7
----------------------- ---------------------------------------------------
Net finance
charge revenue 637 561 13.7 454 428 1,091 989 10.4
Net card fees 506 472 7.0
Travel commissions
and fees 502 468 7.1
Other commissions
and fees 602 551 9.3 51 50 653 601 8.7
Travelers Cheque
investment income 94 95 (1.1)
Securitization
income, net 296 282 4.8 (296) (282) - - -
Other revenues 396 420 (5.3)
----------------------- ---------------------------------------------------
Total net revenues 5,974 5,378 11.1 209 196 6,183 5,574 10.9
----------------------- ---------------------------------------------------
Expenses:
Marketing, promotion,
rewards and
cardmember services 1,440 1,225 17.6 (1) (6) 1,439 1,219 18.0
Provision for losses
and claims:
Charge card 234 189 23.4
Lending 275 314 (12.4) 210 205 485 519 (6.3)
Other 72 33 #
----------------------- ---------------------------------------------------
Total 581 536 8.4 210 205 791 741 7.0
----------------------- ---------------------------------------------------
Charge card
interest expense 211 175 19.9
Human resources 1,224 1,081 13.1
Other operating
expenses:
Professional services 538 488 10.3
Occupancy and
equipment 342 313 9.3
Communications 110 114 (3.5)
Other 360 367 (1.7) - (3) 360 364 (0.9)
----------------------- ---------------------------------------------------
Total 1,350 1,282 5.4 - (3) 1,350 1,279 5.7
----------------------- ---------------------------------------------------
Total expenses 4,806 4,299 11.8 $ 209 $ 196 $ 5,015 $ 4,495 11.6
----------------------- ---------------------------------------------------
Pretax income 1,168 1,079 8.2
Income tax provision 360 347 3.8
-----------------------
Net income $ 808 $ 732 10.4
=======================
24
SIX MONTHS ENDED JUNE 30, (Dollars in millions)
GAAP Basis Securitization Effect Managed Basis
------------------------------------ ----------------------------------------------------------------
Percentage Percentage
2005 2004 Inc/(Dec) 2005 2004 2005 2004 Inc/(Dec)
------------------------------------ ----------------------------------------------------------------
Net revenues:
Discount revenue $ 5,613 $ 4,897 14.6%
Lending:
Finance charge
revenue 1,609 1,365 17.9 $ 1,227 $ 1,028 $ 2,836 $ 2,393 18.6%
Interest expense 380 263 44.6 304 144 684 407 68.4
----------------------- ---------------------------------------------------
Net finance
charge revenue 1,229 1,102 11.5 923 884 2,152 1,986 8.4
Net card fees 1,004 944 6.3
Travel commissions
and fees 924 885 4.3
Other commissions
and fees 1,165 1,061 9.8 104 103 1,269 1,164 8.9
Travelers Cheque
investment income 188 188 0.1
Securitization
income, net 612 512 19.4 (612) (512) - - -
Other revenues 821 839 (1.9)
----------------------- ---------------------------------------------------
Total net revenues 11,556 10,428 10.8 415 475 11,971 10,903 9.8
----------------------- ---------------------------------------------------
Expenses:
Marketing, promotion,
rewards and
cardmember services 2,756 2,248 22.6 (5) (10) 2,751 2,238 22.9
Provision for losses
and claims:
Charge card 449 387 15.9
Lending 570 601 (5.1) 422 492 992 1,093 (9.2)
Other 107 62 71.8
----------------------- ---------------------------------------------------
Total 1,126 1,050 7.2 422 492 1,548 1,542 0.4
----------------------- ---------------------------------------------------
Charge card
interest expense 387 343 12.7
Human resources 2,367 2,146 10.3
Other operating
expenses:
Professional services 1,020 957 6.6
Occupancy and
equipment 665 621 7.1
Communications 225 235 (4.3)
Other 670 776 (13.4) (2) (7) 668 769 (13.1)
----------------------- ---------------------------------------------------
Total 2,580 2,589 (0.3) (2) (7) 2,578 2,582 (0.1)
----------------------- ---------------------------------------------------
Total expenses 9,216 8,376 10.0 $ 415 $ 475 $ 9,631 $ 8,851 8.8
----------------------- ---------------------------------------------------
Pretax income 2,340 2,052 14.0
Income tax provision 731 655 11.5
-----------------------
Net income $ 1,609 $ 1,397 15.2
=======================
25
SELECTED STATISTICAL INFORMATION
(Amounts in billions, except percentages and where indicated)
Three Months Ended Six Months Ended
June 30, June 30,
------------------- Percentage ------------------- Percentage
2005 2004 Inc/(Dec) 2005 2004 Inc/(Dec)
-------- -------- ---------- -------- -------- ----------
Total cards-in-force (millions):*
United States 41.0 37.5 9.3% 41.0 37.5 9.3%
Outside the United States 26.3 25.0 5.1 26.3 25.0 5.1
-------- -------- -------- --------
Total 67.3 62.5 7.6 67.3 62.5 7.6
======== ======== ======== ========
Basic cards-in-force (millions):*
United States 31.1 28.5 9.3 31.1 28.5 9.3
Outside the United States 21.8 20.8 4.6 21.8 20.8 4.6
-------- -------- -------- --------
Total 52.9 49.3 7.3 52.9 49.3 7.3
======== ======== ======== ========
Card billed business:*
United States $ 88.5 $ 75.7 16.9 $ 168.1 $ 145.8 15.3
Outside the United States 32.3 26.7 20.9 62.0 52.0 19.3
-------- -------- -------- --------
Total $ 120.8 $ 102.4 17.9 $ 230.1 $ 197.8 16.3
======== ======== ======== ========
Average discount rate 2.54% 2.56% 2.55% 2.57%
Average basic cardmember spending
(dollars)* $ 2,640 $ 2,339 12.9 $ 5,052 $ 4,541 11.3
Average fee per card -managed
(dollars)* $ 35 $ 34 2.9 $ 35 $ 34 2.9
Travel sales $ 5.6 $ 5.2 7.8 $ 10.7 $ 10.0 6.7
Travel commissions and fees/sales 8.9% 9.0% 8.7% 8.9%
Travelers Cheque and prepaid
products:
Sales $ 4.9 $ 4.8 2.5 $ 9.1 $ 9.2 (0.4)
Average outstanding $ 7.1 $ 6.9 3.7 $ 7.1 $ 6.9 3.9
Average investments $ 7.7 $ 7.3 5.6 $ 7.8 $ 7.3 6.2
Investment yield 5.2% 5.5% 5.2% 5.5%
Tax equivalent yield 8.0% 8.5% 8.0% 8.4%
* Card billed business and cards-in-force include activities related to
proprietary cards and cards issued under network partnership agreements.
Average basic cardmember spending and average fee per card are computed
from proprietary card activities only.
26
SELECTED STATISTICAL INFORMATION (CONTINUED)
(Amounts in billions, except percentages and where indicated)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- Percentage -------------------- Percentage
2005 2004 Inc/(Dec) 2005 2004 Inc/(Dec)
-------- -------- ---------- -------- -------- ----------
Worldwide cardmember receivables:
Total receivables $ 31.5 $ 28.4 11.0% $ 31.5 $ 28.4 11.0%
90 days past due as a % of total 1.7% 1.9% 1.7% 1.9%
Loss reserves (millions): $ 848 $ 864 (1.8) $ 848 $ 864 (1.8)
% of receivables 2.7% 3.0% 2.7% 3.0%
% of 90 days past due 160% 163% 160% 163%
Net loss ratio as a % of charge volume 0.25% 0.25% 0.24% 0.26%
Worldwide cardmember lending - owned basis:
Total loans $ 28.1 $ 26.4 6.4 $ 28.1 $ 26.4 6.4
Past due loans as a % of total:
30-89 days 1.4% 1.5% 1.4% 1.5%
90+ days 1.0% 1.0% 1.0% 1.0%
Loss reserves (millions):
Beginning balance $ 918 $ 994 (7.6) $ 972 $ 998 (2.6)
Provision 262 282 (7.3) 528 539 (2.2)
Net write-offs (285) (267) (6.7) (552) (531) (3.9)
Other (7) 21 # (60) 24 #
-------- -------- -------- --------
Ending balance $ 888 $ 1,030 (13.9) $ 888 $ 1,030 (13.9)
======== ======== ======== ========
% of loans 3.2% 3.9% 3.2% 3.9%
% of past due 133% 154% 133% 154%
Average loans $ 27.5 $ 25.9 6.0 $ 27.0 $ 25.6 5.5
Net write-off rate 4.1% 4.1% 4.1% 4.1%
Net interest yield 8.8% 8.4% 8.6% 8.3%
Worldwide cardmember lending - managed basis:
Total loans $ 48.8 $ 45.1 8.0 $ 48.8 $ 45.1 8.0
Past due loans as a % of total:
30-89 days 1.4% 1.5% 1.4% 1.5%
90+ days 0.9% 1.0% 0.9% 1.0%
Loss reserves (millions):
Beginning balance $ 1,419 $ 1,570 (9.6) $ 1,475 $ 1,541 (4.3)
Provision 445 486 (8.4) 916 1,031 (11.2)
Net write-offs (490) (504) 2.7 (964) (1,023) 5.8
Other (7) (17) (56.5) (60) (14) #
-------- -------- -------- --------
Ending balance $ 1,367 $ 1,535 (11.0) $ 1,367 $ 1,535 (11.0)
======== ======== ======== ========
% of loans 2.8% 3.4% 2.8% 3.4%
% of past due 121% 136% 121% 136%
Average loans $ 47.5 $ 44.9 5.7 $ 47.0 $ 44.9 4.9
Net write-off rate 4.1% 4.5% 4.1% 4.6%
Net interest yield 8.7% 8.6% 8.7% 8.7%
# - Denotes a variance of more than 100%.
27
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2005 AND 2004
The following discussion of TRS' results of operations for the three months
ended June 30, 2005 and 2004 is presented on a managed basis.
Revenues and expenses are affected by changes in the relative values of
non-U.S. currencies to the U.S. dollar. The currency rate changes increased
both revenue and expense growth by approximately 2 percentage points for the
three months ended June 30, 2005.
REVENUES
TRS' net revenues increased 11 percent to $6.2 billion primarily due to higher
discount revenue and increased cardmember lending net finance charge revenue.
Discount revenue of $2.9 billion rose 16 percent compared to a year ago as a
result of an 18 percent increase in billed business partially offset by a
lower average discount rate. The decrease in the discount rate reflects in
part changes in the mix of spending between various merchant segments due to
the cumulative impact of stronger than average growth in the lower rate retail
and other "everyday spend" merchant categories (e.g., supermarkets,
discounters, etc.). As previously indicated, based on the Company's business
strategy, it expects to see continued changes in the mix of business. This,
combined with volume-related pricing discounts and selective repricing
initiatives, will probably continue to result in some discount rate erosion
over time.
The 18 percent increase in billed business to $120.8 billion resulted from a
13 percent increase in spending per proprietary basic card worldwide and 8
percent growth in cards-in-force. U.S. billed business rose 17 percent to
$88.5 billion reflecting 16 percent growth within the consumer card business,
19 percent growth in small business services volume and an 11 percent increase
within corporate services. U.S. non-T&E related volume categories, which
represented approximately 67 percent of U.S. billed business during the second
quarter of 2005, increased 19 percent over the same period a year ago while
U.S. T&E volumes rose 11 percent reflecting continued improvement in all T&E
industries during the quarter. Total billed business outside the United
States, excluding the impact of foreign exchange translation, was up 15
percent reflecting double-digit proprietary growth in all regions, with the
largest increases in Canada and Latin America. Worldwide airline related
volumes, which represented 13 percent of total billed business volumes during
the quarter, rose 16 percent as a result of 17 percent growth in transaction
volumes, partially offset by a 1 percent decrease in the average airline
charge. Additionally, global network billed business grew over 35 percent as
compared to the year ago period.
U.S. cards-in-force rose 9 percent to 41.0 million reflecting the benefit of
continued strong card acquisition spending and an improved average customer
retention level within the proprietary issuing business, as well as growth in
U.S. network cards. Non-U.S. cards-in-force increased 5 percent to 26.3
million due to growth in both proprietary and network partnership cards.
Cardmember lending net finance charge revenue of $1.1 billion rose 10 percent
on 6 percent growth in the average balance of the managed lending portfolio
and a higher portfolio yield. The net interest yield on the managed worldwide
lending portfolio increased to 8.7% from 8.6% in 2004 reflecting a lower
proportion of the U.S. portfolio on introductory or promotional rates,
increased finance charge rates, partially offset by rising funding costs.
EXPENSES
TRS' total expenses increased 12 percent to $5.0 billion primarily due to
higher marketing, promotion, rewards, greater human resources expenses,
increased provisions for losses and higher professional services expenses
partially offset by lower other operating expenses. As noted earlier, total
expenses for the three months ended June 30, 2005 include $100 million of the
consolidated $102 million reengineering costs which principally relate to
restructuring costs within the international payments business, business
travel operations and the finance and technologies functions (of which $80
million reflected severance and related costs and is included in human
resources expenses). Also included in total expenses was $90 million of the
insurance recovery discussed previously.
28
Marketing, promotion, rewards and cardmember services expenses of $1.4 billion
increased 18 percent compared to the prior year, reflecting substantially
higher marketing and promotion expenses and greater reward costs. The increase
in marketing and promotion expenses is primarily due to the Company's ongoing
global brand advertising campaign and continued focus on business building
initiatives. The growth in rewards costs is attributable to significant volume
growth, a higher redemption rate and strong cardmember loyalty program
participation.
Total provisions for losses and claims increased 7 percent due to increased
provisions for losses on charge card products reflecting higher cardmember
receivables balances and higher other provisions reflecting higher insurance
and travel reserves. These increases were partially offset by decreased
provisions on the worldwide lending portfolio despite growth in loans
outstanding due to well-controlled credit practices and, in part, due to the
alignment of initial reserves with demonstrated credit performance for certain
new products. The net write-off rate for the worldwide lending portfolio was
4.1% for the three months ended June 30, 2005 as compared to 4.5% for the same
period a year ago.
Human resources expenses of $1.2 billion increased 13 percent versus last year
due to severance costs noted earlier, higher management incentive expenses,
including an additional year of incremental stock-based compensation expenses,
merit increases and increased employee benefit costs.
Professional services expenses rose 10 percent due to increased technology
costs related to higher business and service-related volumes. Other operating
expenses decreased 1 percent to $360 million reflecting the $90 million
insurance recovery discussed previously and lower expenses as a result of the
third quarter 2004 sale of the ATM business partially offset by increased
costs related to restructuring and reengineering activities and higher
business volumes.
The effective tax rate was 31 and 32 percent for the three-month periods ended
June 30, 2005 and 2004, respectively.
RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2005 AND 2004
The following discussion of TRS' results of operations for the six months
ended June 30, 2005 and 2004 is presented on a managed basis.
Revenues and expenses are affected by changes in the relative values of
non-U.S. currencies to the U.S. dollar. The currency rate changes increased
both revenue and expense growth by approximately 1 percentage point for the
six months ended June 30, 2005.
REVENUES
TRS' net revenues increased 10 percent to $12.0 billion primarily due to
higher discount revenue, increased cardmember lending net finance charge
revenue and greater commissions and fees.
Discount revenue of $5.6 billion rose 15 percent compared to a year ago as a
result of a 16 percent increase in billed business partially offset by a lower
average discount rate. The decrease in the discount rate reflects in part
changes in the mix of spending between various merchant segments due to the
cumulative impact of stronger than average growth in the lower rate retail and
other "everyday spend" merchant categories (e.g., supermarkets, discounters,
etc.).
The 16 percent increase in billed business to $230.1 billion resulted from an
11 percent increase in spending per proprietary basic card worldwide and 8
percent growth in cards-in-force. U.S. billed business rose 15 percent to
$168.1 billion reflecting 14 percent growth within the consumer card business,
18 percent growth in small business services volume and a 9 percent increase
within corporate services. U.S. non-T&E related volume categories, which
represented approximately 67 percent of U.S. billed business during the first
half of 2005, increased 18 percent over the same period a year ago while U.S.
T&E volumes rose 10 percent reflecting continued improvement in all T&E
industries during the quarter. Total billed business outside the United
States, excluding the impact of foreign exchange translation, was up 14
percent reflecting a growth rate in the mid-teens in Latin America and Canada
and low double-digit growth in Europe and Asia. Worldwide airline related
volumes, which
29
represented 13 percent of total billed business volumes during the first half
of 2005, rose 12 percent as a result of 15 percent growth in transaction
volumes, partially offset by a 3 percent decrease in the average airline
charge. Additionally, global network billed business grew more than 35 percent
as compared to the year ago period.
Cardmember lending net finance charge revenue of $2.2 billion rose 8 percent
on 5 percent growth in average balance of the managed lending portfolio. The
net interest yield on the managed worldwide lending portfolio was 8.7% in 2005
and 2004.
Other commissions and fees increased 9 percent to $1.3 billion on greater
volume-related foreign exchange conversion fees and higher card-related fees
and assessments and network partner-related fees.
EXPENSES
TRS' total expenses increased 9 percent to $9.6 billion primarily due to
higher marketing, promotion, rewards and cardmember services expenses and
greater human resources expenses, partially offset by reduced provision for
losses on the worldwide lending portfolio and lower other operating expenses.
As noted earlier, total expenses for the six months ended June 30, 2005
include $118 million of the consolidated $123 million reengineering costs
principally related to restructuring costs within the international payments
business, business travel operations and the finance and technologies
functions of which $89 million reflected severance and related costs and is
included in human resources expenses. Also included in total expenses was $90
million of the insurance recovery discussed previously.
Marketing, promotion, rewards and cardmember services expenses of $2.8 billion
increased 23 percent compared to the prior year, reflecting substantially
higher marketing and promotion expenses and greater reward costs. The increase
in marketing and promotion expenses is primarily due to the Company's ongoing
global brand advertising campaign and continued focus on business building
initiatives. The growth in rewards costs is attributable to significant volume
growth, a higher redemption rate and strong cardmember loyalty program
participation.
The provision for losses on the worldwide lending portfolio decreased 9
percent to $992 million despite growth in loans outstanding due to
well-controlled credit practices and, in part, due to the alignment of initial
reserves with demonstrated credit performance for certain new products. The
net write-off rate for the worldwide lending portfolio was 4.1% for the six
months ended June 30, 2005 as compared to 4.6% for the same period a year ago.
Human resources expenses of $2.4 billion increased 10 percent versus last year
due to severance costs, higher management incentive expenses, including an
additional year of incremental stock-based compensation expenses, merit
increases and increased employee benefit costs.
Other operating expenses decreased 13 percent to $668 million reflecting the
$90 million insurance recovery discussed previously and lower expenses as a
result of the third quarter 2004 sale of the ATM business partially offset by
increased costs related to restructuring and reengineering activities.
The effective tax rate was 31 and 32 percent for the six-month periods ended
June 30, 2005 and 2004, respectively.
AIRLINE INDUSTRY MATTERS
Historically, the Company has not experienced significant revenue declines
resulting from a particular airline's scaling-back or closure of operations
due to bankruptcy or other financial challenges because the volumes generated
from the airline are typically shifted to other participants in the industry
that accept the Company's card products. Nonetheless, the Company is exposed
to business and credit risk in the airline industry primarily through business
arrangements where the Company has remitted payment to the airline for a
cardmember purchase of tickets that have not yet been used or "flown." This
creates a potential exposure for the Company in the event that the cardmember
is not able to use the ticket and the Company, based on the facts and
circumstances, credits the cardmember for the unused ticket. Historically,
this type of exposure has not generated any significant losses for the Company
because of the need for an airline that is operating under bankruptcy
protection to continue accepting credit and charge cards and honoring requests
for credits and refunds in the ordinary course in furtherance of its
reorganization and its formal assumption, with bankruptcy court approval, of
its card acceptance agreement, including approval of the Company's right to
hold cash to cover these potential exposures to provide credits to
30
cardmembers. Typically, as an airline's financial situation deteriorates the
Company increases cash held to protect itself in the event of an ultimate
liquidation of the airline. The Company's goal in these distressed situations
is to hold sufficient cash over time to ensure that upon liquidation the cash
held is equivalent to the credit exposure related to any unused tickets.
As previously disclosed, during the fourth quarter of 2004, the Company
announced that it signed agreements with Delta Air Lines to extend its
co-brand, Membership Rewards and merchant partnerships. The agreements will
extend these partnerships into the next decade. The prepayment has a
three-year term, is fully collateralized by a pool of assets and is subject to
certain conditions. The Company prepaid $250 million of Delta SkyMiles rewards
points in the fourth quarter of 2004 and prepaid the remaining $250 million of
Delta SkyMiles rewards points in the first quarter of 2005. In addition to the
prepayment, the Company has commitments to loan Delta up to an aggregate $75
million under a senior secured facility arranged by General Electric Company,
a portion of which is in the form of a term loan and a portion of which is in
the form of a revolving line of credit. In May 2005, the Company entered into
amendments with Delta to modify certain financial covenants set forth in the
agreements with respect to the prepayment and the senior secured facility. As
of June 30, 2005, approximately $70 million was outstanding under the senior
secured facility. Both the prepayment and the senior secured facility have a
three-year term, are fully collateralized by a pool of assets and are subject
to certain conditions.
LIQUIDITY AND CAPITAL RESOURCES
SELECTED BALANCE SHEET INFORMATION
(GAAP Basis)
(Dollars in billions, except percentages)
June 30, December 31, Percentage June 30, Percentage
2005 2004 Inc/(Dec) 2004 Inc/(Dec)
-------- ------------ ---------- -------- ----------
Accounts receivable, net $ 32.6 $ 31.8 2.6% $ 29.4 11.2%
Travelers Cheque investments $ 8.3 $ 8.4 (1.0) $ 7.8 6.6
Cardmember loans $ 28.1 $ 26.9 4.4 $ 26.4 6.4
Total assets $ 87.9 $ 87.8 0.1 $ 79.6 10.4
Travelers Cheques outstanding $ 7.4 $ 7.3 1.8 $ 7.1 4.5
Short-term debt $ 16.8 $ 17.2 (2.2) $ 19.9 (15.5)
Long-term debt $ 25.1 $ 28.3 (11.1) $ 18.9 32.9
Total liabilities $ 78.2 $ 79.0 (1.0) $ 71.0 10.2
Total shareholder's equity $ 9.7 $ 8.8 10.5 $ 8.6 12.4
Return on average total shareholder's equity* 33.7% 33.4% - 32.1% -
Return on average total assets** 3.7% 3.5% - 3.4% -
* Computed on a trailing 12-month basis using total shareholder's equity as
included in the Consolidated Financial Statements prepared in accordance
with GAAP.
** Computed on a trailing 12-month basis using total assets as included in
the Consolidated Financial Statements prepared in accordance with GAAP.
Net accounts receivable and cardmember loans increased as compared to December
31, 2004 and June 30, 2004 primarily as a result of higher average cardmember
spending and an increase in the number of cards-in-force.
Long-term debt increased as compared to June 30, 2004 primarily as a result of
increased funding requirements due to increases in cardmember receivable and
loan balances as noted above. Short-term and long-term debt decreased from
December 31, 2004 primarily as a result of scheduled maturities or payments
using funds generated from operations.
TRS funds its cardmember receivables and loans using various funding sources,
such as short- and long-term debt, medium-term notes, and sales of cardmember
receivables and loans in securitizations. As of June 30, 2005, Credco had the
ability to issue approximately $7.2 billion of debt securities under shelf
registration statements filed with the SEC.
31
As noted earlier, as of June 30, 2005, the Company maintained bank credit
facilities of $13.9 billion, of which $13.4 billion related to TRS. As of June
30, 2005, outstanding borrowings of $3.8 billion under these bank credit
facilities consisted of $2.2 billion related to the Australian credit facility
and $1.6 billion related to the Canadian credit facility. Of the $13.9 billion
available for borrowing, Credco may borrow a maximum amount of $12.6 billion
(including amounts outstanding), with a commensurate reduction in the amount
available to the Parent Company. The following table shows the credit line
facilities available for borrowing and the borrowings outstanding under these
facilities as of June 30, 2005.
Available
(Billions) Credit Facilities (a) Borrowings
------------------------------------
American Express Company (Parent Company only) $ 0.6 $ -
American Express Credit Corporation 12.0 3.8
American Express Centurion Bank 0.4 -
American Express Bank, FSB (FSB) 0.4 -
------------------------------------
Total $ 13.4 $ 3.8
====================================
(a) Excludes $500 million at AEB.
The availability of the credit lines to Credco, Centurion Bank and the FSB is
subject to their compliance with certain financial covenants, which do not
include the previously referenced tangible net worth covenant that is
applicable only to the Parent Company's borrowings on its credit lines. These
facilities expire as follows:
(Billions)
2006 $ 2.0
2009 6.4
2010 5.0
---------
Total $ 13.4
=========
Credco's ability to borrow under its credit facilities is subject to its
maintenance of a 1.25 ratio of combined earnings and fixed charges to fixed
charges. These credit facilities do not condition borrowing on the absence of a
material adverse change. The facilities may not be terminated should there be a
change in the Company's credit rating.
In the fourth quarter of 2003, the Company began a program to develop a
liquidity portfolio to provide back-up liquidity, primarily for the commercial
paper program at Credco, and also flexibility for other short-term funding
programs at Centurion Bank. These funds are invested in two to three year U.S.
Treasury securities. At June 30, 2005, the Company held $5.0 billion in U.S.
Treasury notes under this program.
Securitization of cardmember receivables generated under designated consumer
charge card accounts are accomplished through the transfer of cardmember
receivables to the American Express Master Trust (the Charge Trust).
Securitizations of these receivables are accounted for as secured borrowings
because the Charge Trust is not a qualifying special purpose entity (QSPE).
Accordingly, the related assets being securitized are not treated as sold and
the securities issued to third-party investors are reported as long-term debt
on the Company's Consolidated Balance Sheets. During June 2005, the remaining
interests issued by the Charge Trust matured. Management anticipates that the
Charge Trust will be dissolved during the third quarter 2005. During May 2005,
a new trust was established, the American Express Issuance Trust (AEIT), which
will be used to securitize cardmember receivables prospectively. Any
cardmember receivables securitized through AEIT will also not qualify for
off-balance sheet treatment, and, therefore, any interests issued by AEIT will
be included in either short-term or long-term debt, as appropriate.
Securitization of cardmember loans arising from various portfolios of consumer
accounts are accomplished through the transfer of cardmembers loans to a QSPE,
the American Express Credit Account Master Trust (the Lending Trust). As of
June 30, 2005, the Lending Trust held total assets of $27.8 billion, of which
$20.7 billion had been sold. When securities and notes issued by the Lending
Trust mature, principal collections received from the Lending Trust assets are
used to redeem the securities and notes.
32
The following table summarizes activity related to the Charge and Lending
Trusts for the first half of 2005:
(Billions) Charge Trust Lending Trust
-------------------------------------------------------------------------------- -------------- -------------
Proceeds received from external parties from new securitizations $ - $ 2.4
Cash paid to external parties for maturities of previously issued securities $ 1.8 $ 2.0
Scheduled maturities during the next 12 months of previously issued securities $ - $ 6.4
33
AMERICAN EXPRESS FINANCIAL ADVISORS
RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005 AND 2004
STATEMENTS OF INCOME
Three Months Ended Six Months Ended
(Dollars in millions) June 30, June 30,
-------------------- Percentage -------------------- Percentage
2005 2004 Inc/(Dec) 2005 2004 Inc/(Dec)
-------- -------- ---------- -------- -------- ----------
Revenues:
Net investment income $ 638 $ 603 5.9% $ 1,260 $ 1,159 8.7%
Investment management and service fees 454 411 10.3 904 840 7.5
Distribution fees 362 315 15.3 713 667 7.0
Variable life insurance and variable
annuity charges* 113 111 2.5 227 220 3.6
Life and health insurance premiums 92 88 4.2 181 174 3.8
Property-casualty insurance premiums 121 103 17.5 236 199 18.6
Other 128 106 18.0 248 206 19.9
-------- -------- -------- --------
Total revenues 1,908 1,737 9.8 3,769 3,465 8.8
-------- -------- -------- --------
Expenses:
Provision for losses and benefits:
Interest credited on annuities and
universal life-type contracts 281 280 0.1 554 563 (1.7)
Benefits on insurance and annuities 125 124 1.0 237 223 6.1
Interest credited on investment
certificates 96 48 97.3 172 93 85.0
Losses and expenses on property-casualty
insurance 92 80 16.5 180 154 17.6
-------- -------- -------- --------
Total 594 532 11.6 1,143 1,033 10.7
Human resources - Field 393 333 17.8 769 681 12.8
Human resources - Non-field 279 210 33.4 551 431 27.7
Amortization of deferred acquisition costs 125 125 0.3 253 189 34.1
Other 340 273 23.8 641 550 16.5
-------- -------- -------- --------
Total expenses 1,731 1,473 17.4 3,357 2,884 16.4
-------- -------- -------- --------
Pretax income before accounting change 177 264 (32.8) 412 581 (29.0)
Income tax provision 37 90 (58.5) 106 179 (40.6)
-------- -------- -------- --------
Income before accounting change 140 174 (19.4) 306 402 (23.8)
Cumulative effect of accounting change, net
of tax - - - - (71)** #
-------- -------- -------- --------
Net income $ 140 $ 174 (19.4) $ 306 $ 331 (7.6)
======== ======== ======== ========
# - Denotes a variance of more than 100%.
* Includes variable universal life and universal life insurance charges.
**Reflects a $109 million non-cash pretax charge ($71 million after-tax)
related to the January 1, 2004 adoption of SOP 03-1.
34
SELECTED STATISTICAL INFORMATION
(Amounts in millions, except percentages and where indicated)
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- Percentage -------------------- Percentage
2005 2004 Inc/(Dec) 2005 2004 Inc/(Dec)
-------- -------- ---------- -------- -------- ----------
Life insurance inforce (billions) $ 153.2 $ 139.1 10.1% $ 153.2 $ 139.1 10.1%
Deferred annuities inforce (billions) $ 53.2 $ 49.3 7.9 $ 53.2 $ 49.3 7.9
Assets owned, managed or administered
(billions):
Assets managed for institutions $ 136.8 $ 125.5 9.0 $ 136.8 $ 125.5 9.0
Assets owned, managed or administered
for individuals:
Owned assets:
Separate account assets 37.4 32.9 13.8 37.4 32.9 13.8
Other owned assets 63.3 57.9 9.4 63.3 57.9 9.4
-------- -------- -------- --------
Total owned assets 100.7 90.8 11.0 100.7 90.8 11.0
Managed assets 118.4 108.8 8.8 118.4 108.8 8.8
Administered assets 59.6 55.3 7.8 59.6 55.3 7.8
-------- -------- -------- --------
$ 415.5 $ 380.4 9.2 $ 415.5 $ 380.4 9.2
Total ======== ======== ======== ========
Market appreciation (depreciation) and foreign
currency translation during the period:
Owned assets:
Separate account assets $ 614 $ (101) # $ 41 $ 655 (93.7)
Other owned assets $ 614 $ (1,476) # $ (164) $ (763) 78.5
Managed assets $ 4,093 $ 232 # $ 249 $ 5,685 (95.6)
Cash sales:
Mutual funds $ 9,830 $ 8,480 15.9 $ 19,660 $ 18,279 7.6
Annuities 2,440 1,912 27.7 4,456 4,098 8.7
Investment certificates 1,896 1,445 31.2 4,122 2,769 48.9
Life and other insurance products 242 221 9.5 478 439 8.9
Institutional 2,519 2,841 (11.3) 4,277 4,256 0.5
Other 1,081 1,116 (3.2) 2,006 2,408 (16.7)
-------- -------- -------- --------
Total cash sales $ 18,008 $ 16,015 12.4 $ 34,999 $ 32,249 8.5
======== ======== ======== ========
Number of financial advisors 12,162 11,943 1.8 12,162 11,943 1.8
Fees from financial plans and advice services $ 51.3 $ 39.3 30.6 $ 90.4 $ 72.5 24.6
Percentage of total sales from financial plans
and advice services 75.4% 74.6% - 76.0% 75.0% -
# - Denotes a variance of more than 100%.
RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2005 AND 2004
AEFA reported net income of $140 million for the three months ended June 30,
2005, down 19 percent from $174 million in the same period a year ago.
REVENUES
Total revenues increased 10 percent to $1.9 billion primarily due to increased
distribution fees, greater investment management and service fees, increased
net investment income, higher property-casualty insurance premiums and greater
other revenues.
Net investment income increased 6 percent to $638 million reflecting higher
levels of invested assets and the impact of higher net investment gains in
2005 versus 2004. For the three months ended June 30, 2005, $87 million
35
of gross investment gains were partially offset by $30 million of gross
investment losses and impairments, of which $82 million and $29 million,
respectively, arose from sales of investments classified as
Available-for-Sale. Included in the gross gains was $36 million related to the
sale of all of AEFA's interest in a CDO securitization trust, reflecting
management's decision to continue to improve the investment portfolio's risk
profile through the further liquidation of certain structured investments. For
the three months ended June 30, 2004, $36 million of total investment gains
were partially offset by $6 million of impairments and losses. The gross
investment gains included an $18 million pretax benefit reflecting lower than
expected losses resulting from management's first quarter 2004 decision to
liquidate a secured loan trust (SLT) managed and consolidated by AEFA. Also
included in these gross investment gains and losses were $17 million of gross
realized gains and $5 million of gross realized losses from sales of
securities, as well as $1 million of other-than-temporary impairment losses on
investments, classified as Available-for-Sale.
Investment management and service fees of $454 million increased 10 percent
due to higher average assets under management, reflecting improved equity
market valuations and net asset inflows. Distribution fees increased 15
percent to $362 million due to greater fees earned on wrap accounts and
brokered mutual funds. Total mutual fund cash sales increased 16 percent as
higher sales of non-proprietary products more than offset lower proprietary
product sales. A significant portion of non-proprietary sales continued to
occur in wrap accounts (which are included in managed assets).
Property-casualty insurance premiums increased 18 percent to $121 million,
reflecting a 16 percent increase in the average number of policies inforce
generated, most notably, from the Costco relationship. Other revenues
increased 18 percent to $128 million principally as a result of higher fees
from financial planning and advice services and non-proprietary funds.
EXPENSES
Total expenses increased 17 percent to $1.7 billion primarily due to increased
human resources expenses, greater provisions for losses and benefits as well
as higher other operating expenses. As noted previously, the Company incurred
a total of $59 million of expenses related to AEFA spin-off activities during
the second quarter of 2005, of which $54 million ($35 million after-tax) was
recorded at AEFA.
Total provision for losses and benefits increased 12 percent to $594 million
principally as a result of significantly higher interest credited on
investment certificates and higher losses and expenses on property-casualty
insurance. Interest credited on investment certificates rose 97 percent to $96
million due to higher interest crediting rates and higher average reserve
balances, partially as a result of a marketing promotion that ran during the
first quarter of this year for certificates.
During the three months ended June 30, 2005, field force human resources
expense increased 18 percent to $393 million reflecting $23 million of the $54
million in spin-off related costs noted above, improved advisor productivity
and growth in the advisor force. The total advisor force grew 2 percent from
year ago levels to 12,162. Non-field human resources costs rose 33 percent to
$279 million reflecting higher management incentives primarily at Threadneedle
Asset Management Holdings LTD (Threadneedle), $11 million of the spin-off
related costs noted earlier, merit increases, severance costs and greater
benefit costs. The average number of non-field employees was relatively
unchanged from year ago levels.
Other operating expenses increased 24 percent to $340 million reflecting $20
million of the spin-off related costs noted earlier, increased expenses
related to securities industry legal and regulatory matters and higher
insurance charges as well as higher advertising and promotion expenses. See
Mutual Fund Industry Developments below for further discussion.
As noted earlier, AEFA recognized a tax benefit of $3 million resulting from
an IRS audit of previous years' tax returns. The effective tax rate was 21
percent and 34 percent for the three-month periods ended June 30, 2005 and
2004, respectively. The decrease in the effective tax rate reflects lower
levels of pretax income compared to tax advantaged items, as well as, the
impact of the $3 million tax audit benefit this year versus a $16 million tax
expense recorded in the prior year as a result of required amendments to
prior-year returns.
36
RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2005 AND 2004
AEFA reported net income of $306 million for the six months ended June 30,
2005, down 8 percent from $331 million in the same period a year ago. Income
before accounting change was down 24 percent from $402 million a year ago.
During the first quarter of 2004 and in conjunction with the adoption of SOP
03-1, AEFA (1) established additional liabilities for insurance benefits that
may become payable under variable annuity death benefit guarantees or on
single pay universal life contracts, which prior to January 1, 2004, were
expensed when payable; and (2) extended the time periods over which DAC
associated with certain insurance and annuity products are amortized to
coincide with the liability funding periods in order to establish the proper
relationships between these liabilities and DAC associated with the same
contracts. As a result, AEFA recognized a $109 million charge ($71 million
after-tax) due to the accounting change on establishing the future liability
under death benefit guarantees and recognized a $66 million ($43 million
after-tax) reduction in DAC amortization expense to reflect the lengthening of
the amortization periods for certain products impacted by SOP 03-1.
REVENUES
Total revenues increased 9 percent to $3.8 billion primarily due to increased
net investment income, greater investment management and service fees,
increased distribution fees, higher property-casualty insurance premiums and
increased other revenues.
Net investment income increased 9 percent to $1.3 billion reflecting higher
levels of invested assets and the effect of net investment gains in 2005
compared to net investment losses in 2004. For the six months ended June 30,
2005, $107 million of gross investment gains were partially offset by $40
million of gross investment losses and impairments. Included in these gross
investment gains and losses are $95 million of gross realized gains and $38
million of gross realized losses from sales, as well as $1 million of
other-than-temporary impairment losses, on investments classified as
Available-for-Sale. Included in the gross gains was $36 million related to the
sale of all of AEFA's interest in a CDO securitization trust, reflecting
management's decision to continue to improve the investment portfolio's risk
profile through the further liquidation of certain structured investments.
Gross investment gains also included a $13 million benefit arising from lower
than expected losses on a secured loan trust which management decided to
liquidate in the fourth quarter of 2004. For the six months ended June 30,
2004, $56 million of gross investment gains were more than offset by $64
million of impairments and losses. The gross investment gains included an $18
million benefit reflecting lower than expected losses resulting from
management's first quarter 2004 decision to liquidate a secured loan trust
managed by AEFA. Gross investment losses include the original first quarter
$49 million charge related to the same early liquidation. Also included in
these gross investment gains and losses are $35 million of gross realized
gains and $10 million of gross realized losses from sales of securities, as
well as $1 million of other-than-temporary impairment losses on investments,
classified as Available-for-Sale.
Investment management and service fees of $904 million increased 8 percent due
to higher average assets under management, reflecting improved equity market
valuations and net asset inflows. Distribution fees rose 7 percent to $713
million primarily as a result of greater fees earned on wrap accounts and
brokered mutual funds partially offset by lower fees earned on limited
partnership and proprietary mutual fund sales. Total mutual fund cash sales
rose 8 percent as higher sales of non-proprietary products more than offset
lower proprietary product sales. A significant portion of non-proprietary
sales continued to occur in wrap accounts (which are included in managed
assets).
Property-casualty insurance premiums increased 19 percent to $236 million,
reflecting a 17 percent increase in the average number of policies inforce
generated, most notably, from the Costco relationship. Other revenues
increased 20 percent to $248 million principally as a result of growth in
financial planning and advice services fees and higher fees earned on
non-proprietary funds.
EXPENSES
Total expenses increased 16 percent to $3.4 billion primarily due to increased
human resources expenses, greater provisions for losses and benefits, higher
amortization of deferred acquisition costs as well as higher other operating
expenses. As noted previously, the Company incurred a total of $81 million of
expenses related to AEFA spin-off activities during the first half of 2005, of
which $74 million ($48 million after-tax) was recorded at AEFA.
37
Total provision for losses and benefits increased 11 percent to $1.1 billion
principally as a result of significantly higher interest credited on
investment certificates and higher losses and expenses on property-casualty
insurance. Interest credited on investment certificates rose 85 percent to
$172 million due to higher interest crediting rates and higher average reserve
balances.
During the six months ended June 30, 2005, field force human resources expense
increased 13 percent to $769 million reflecting $36 million of the $74 million
in spin-off related costs noted above, improved advisor productivity and
growth in the advisor force. Non-field human resources costs rose 28 percent
to $551 million reflecting higher management incentives primarily at
Threadneedle, $11 million of the $74 million in spin-off related costs, merit
increases and higher benefit costs.
DAC amortization expense of $253 million increased 34 percent primarily due to
the impact of the first quarter 2004 $66 million reduction in DAC amortization
expense noted earlier. See Deferred Acquisition Costs below for further
discussion of DAC and related adjustments. Other operating expenses increased
17 percent to $641 million reflecting $27 million of the $74 million in
spin-off related costs noted above, higher advertising and promotion expenses
and increased expenses related to securities industry legal and regulatory
matters. See Mutual Fund Industry Developments below for further discussion.
The effective tax rate was 26 percent and 31 percent for the six-month periods
ended June 30, 2005 and 2004, respectively. The decrease in the effective tax
rate primarily reflects the impact of the $16 million expense recorded in the
prior year as a result of required amendments to prior-year returns, as well
as the impact of lower pretax income compared to tax advantaged items.
DEFERRED ACQUISITION COSTS
Deferred acquisition costs represent the costs of acquiring new business,
principally direct sales commissions and other distribution and underwriting
costs that have been deferred on the sale of annuity, life and health
insurance and, to a lesser extent, property/casualty and certain mutual fund
products. These costs are deferred to the extent they are recoverable from
future profits. For annuity and insurance products, DAC are amortized over
periods approximating the lives of the business, generally as a percentage of
premiums or estimated gross profits or as a portion of the interest margins
depending on the products' characteristics. For certain mutual fund products,
DAC are generally amortized over fixed periods on a straight-line basis.
For annuity and insurance products, the projections underlying the
amortization of DAC require the use of certain assumptions, including interest
margins, mortality rates, persistency rates, maintenance expense levels and
customer asset value growth rates for variable products. Management routinely
monitors a wide variety of trends in the business, including comparisons of
actual and assumed experience. The customer asset value growth rate is the
rate at which contract values are assumed to appreciate in the future. The
rate is net of asset fees and anticipates a blend of equity and fixed income
investments. Management reviews and, where appropriate, adjusts its
assumptions with respect to customer asset value growth rates on a quarterly
basis.
Management monitors other principal DAC assumptions, such as persistency,
mortality rates, interest margin and maintenance expense level assumptions,
each quarter. Unless management identifies a material deviation over the
course of the quarterly monitoring, management reviews and updates these DAC
assumptions annually in the third quarter of each year. When assumptions are
changed, the percentage of estimated gross profits or portion of interest
margins used to amortize DAC might also change. A change in the required
amortization percentage is applied retrospectively; an increase in
amortization percentage will result in an increase in DAC amortization expense
while a decrease in amortization percentage will result in a decrease in DAC
amortization expense. The impact on results of operations of changing
assumptions with respect to the amortization of DAC can be either positive or
negative in any particular period and is reflected in the period in which such
changes are made.
During the first quarter of 2004 and in conjunction with the adoption of SOP
03-1, AEFA (1) established additional liabilities for insurance benefits that
may become payable under variable annuity death benefit guarantees or on
single pay universal life contracts, which prior to January 1, 2004, were
expensed when payable; and (2) extended the time periods over which DAC
associated with certain insurance and annuity products are amortized to
coincide
38
with the liability funding periods in order to establish the proper
relationships between these liabilities and DAC associated with the same
contracts. As a result, AEFA recognized a $109 million charge ($71 million
after-tax) due to the accounting change on establishing the future liability
under death benefit guarantees and recognized a $66 million ($43 million
after-tax) reduction in DAC amortization expense to reflect the lengthening of
the amortization periods for certain products impacted by SOP 03-1.
DAC balances for various insurance, annuity and other products sold by AEFA
are set forth below:
June 30, December 31,
(Millions) 2005 2004
----------------------------------
Annuities $ 1,942 $ 1,872
Life and health insurance 1,807 1,766
Other 166 200
----------------------------------
Total $ 3,915 $ 3,838
==================================
IMPACT OF MARKET VOLATILITY ON RESULTS OF OPERATIONS
Various aspects of AEFA's business are impacted by equity and fixed income
market levels and other market-based events. Several areas in particular can
be positively or negatively affected by market movements including
amortization of DAC and deferred sales inducements, recognition of guaranteed
minimum death benefits (GMDB) and certain other variable annuity benefits,
asset management fees and structured investments. The direction and magnitude
of the changes in equity markets can increase or decrease amortization of DAC
and deferred sales inducement benefits, incurred amounts under GMDB and other
variable annuity benefit provisions and asset management fees and
correspondingly affect results of operations in any particular period.
Similarly, the value of AEFA's structured investment portfolio is impacted by
various market factors. Persistency of, or increases in, bond and loan default
rates, among other factors, could result in negative adjustments to the market
values of these investments in the future, which would adversely impact
results of operations. See AEFA's Liquidity and Capital Resources section for
a further discussion of structured investments and consolidated derivatives.
MUTUAL FUND INDUSTRY DEVELOPMENTS
As has been widely reported, the SEC, the National Association of Securities
Dealers, Inc. (NASD) and several state attorneys general have brought
proceedings challenging several mutual fund industry practices, including late
trading, market timing, disclosure of revenue sharing arrangements and
inappropriate sales of B shares. AEFA has received requests for information
concerning its practices and is providing information and cooperating fully
with these inquiries.
On March 21, 2005, AEFA's broker-dealer subsidiary entered into an agreement
with the NASD to settle alleged violations of NASD rules arising from the sale
to AEFA customers of Class B (i.e., no front end load) mutual fund shares
between January 1, 2002 and July 31, 2003. AEFA's agreement with the NASD is
one of several that the NASD entered into with certain brokerage firms
regarding allegedly inappropriate sales of Class B shares. Under the terms of
the settlement, AEFA consented to the payment of a fine to the NASD in the
amount of $13 million. The Company established reserves in prior quarters to
cover the payment of the fine. AEFA also agreed to offer certain customers who
purchased Class B shares in any fund family from January 1, 2002 through the
date of the settlement and continue to hold such shares the option of
converting their Class B shares into a number of Class A shares equal to (x)
the number of Class A shares that the customer could have purchased on the
date(s) that they purchased their Class B shares plus (y) any shares
reflecting reinvestment of dividends. AEFA agreed to pay cash to certain
customers who have sold a portion or all of their Class B shares in order to
put them into substantially the same financial position (based on actual fund
performance and redemption value) in which such customers would have been had
the customers purchased Class A shares instead of Class B shares.
In May 2004, the Company reported that the broker-dealer subsidiary of AEFA
had received notification from the staff of the NASD indicating that it had
made a preliminary determination to recommend that the NASD bring an action
against AEFA for potential violations of federal securities laws and the rules
and regulations of the SEC and the NASD. The notice received by AEFA comes in
the context of a broader industry-wide review of the mutual
39
fund and brokerage industries that is being conducted by various regulators.
The NASD staff's allegations relate to AEFA's practices with respect to
various revenue sharing arrangements pursuant to which AEFA receives payments
from certain non-proprietary mutual funds for agreeing to make their products
available through AEFA's national distribution network. In particular, the
NASD has alleged that AEFA: (i) failed to properly disclose such revenue
sharing arrangements from January 2001 until May 2003; (ii) failed to properly
disclose such revenue sharing arrangements in its brokerage confirmations; and
(iii) received directed brokerage from January 2001 until December 2003. The
notice from the NASD staff is intended to give AEFA an opportunity to discuss
the issues it has raised. AEFA has been availing itself of this opportunity
and continues to cooperate fully with the NASD's inquiry regarding this
matter, as well as all other regulatory inquiries.
Congress has also proposed legislation and the SEC has proposed and, in some
instances, adopted rules relating to the mutual fund industry, including
expenses and fees, mutual fund corporate governance and disclosures to
customers. For example, during the past year, mutual fund and investment
advisors were required by the SEC to adopt and implement written policies and
procedures designed to prevent violation of the federal securities laws and to
designate a chief compliance officer responsible for administering these
policies and procedures. While there remains a significant amount of
uncertainty as to what legislative and regulatory initiatives may ultimately
be adopted, these initiatives could negatively impact mutual fund industry
participants' results, including AEFA's, in future periods.
LIQUIDITY AND CAPITAL RESOURCES
SELECTED BALANCE SHEET INFORMATION
(Dollars in billions, except percentages)
June 30, December 31, Percentage June 30, Percentage
2005 2004 Inc/(Dec) 2004 Inc/(Dec)
-------- ------------ ---------- -------- ----------
Accounts receivable, net $ 6.9 $ 5.9 17.3% $ 5.3 30.9%
Investments $ 44.8 $ 44.9 (0.2) $ 41.8 7.1
Separate account assets $ 37.4 $ 35.9 4.3 $ 32.9 13.8
Deferred acquisition costs $ 3.9 $ 3.8 2.0 $ 3.9 0.2
Total assets $ 100.7 $ 97.1 3.7 $ 90.8 11.0
Customers' deposits $ 5.9 $ 5.6 5.4 $ 4.9 20.5
Client contract reserves $ 45.0 $ 44.3 1.6 $ 41.9 7.4
Separate account liabilities $ 37.4 $ 35.9 4.3 $ 32.9 13.8
Total liabilities $ 94.0 $ 90.7 3.6 $ 84.5 11.3
Total shareholder's equity $ 6.7 $ 6.4 4.2 $ 6.3 6.4
Return on average total shareholder's equity
before accounting change* 10.8% 11.8% 11.7%
Return on average total shareholder's equity* 10.8% 10.8% 10.5%
* Computed on a trailing 12-month basis using total shareholder's equity as
included in the Consolidated Financial Statements prepared in accordance
with GAAP.
AEFA's total assets and liabilities increased from a year ago levels primarily
due to higher investments, client contract reserves and separate account
assets and liabilities, which increased as a result of market appreciation and
net client inflows. The increase in managed assets, including separate
accounts, to $292.6 billion (as compiled from the Selected Statistical
Information table) since June 30, 2004 resulted from market appreciation and
foreign currency translation of $20.6 billion and net inflows of $4.9 billion.
When compared to December 31, 2004, managed assets, including separate
accounts, were relatively flat as net outflows of $0.4 billion were partially
offset by market appreciation and foreign currency translation of $0.3
billion. In addition, accounts receivable and customers' deposits increased
due to increased Membership Banking activity, which was transferred into the
AEFA operating segment (from TRS) during 2004.
40
The following table provides information on below investment grade securities
(excluding net unrealized appreciation and depreciation) and non-performing
assets included within AEFA's investment portfolio.
June 30, December 31, June 30,
(Billions, except percentages) 2005 2004 2004
-------- ------------ ----------
Below investment grade securities (excluding net
unrealized appreciation and depreciation) $ 2.9 $ 3.1 $ 3.2
Percentage of AEFA's investment portfolio 7% 7% 8%
Non-performing assets relative to invested assets
(excluding short-term cash positions) 0.02% 0.02% 0.04%
The table below provides investment information excluding below investment
grade securities (excluding net unrealized appreciation and depreciation),
which were recorded as a result of the adoption of the Financial Accounting
Standards Board (FASB) Interpretation No. 46 (revised December 2003),
"Consolidation of Variable Interest Entities," (FIN 46) as management believes
this is a more relevant measure of exposure of AEFA's below investment grade
securities and non-performing assets. As these assets are for the benefit of
the CDO debt holders, and reductions in value of such investments will be
fully absorbed by the third party investors, management analyzes its
investments excluding these assets that are not available for AEFA's general
use.
June 30, December 31, June 30,
(Billions, except percentages) 2005 2004 2004
-------- ------------ ----------
Below investment grade securities (excluding net
unrealized appreciation and depreciation)
excluding the impacts of FIN 46 $ 2.7 $ 2.9 $ 3.0
Percentage of AEFA's investment portfolio 6% 7% 7%
During the second quarter of this year, AEFA sold all of its retained interest
in a CDO-related securitization trust and realized a pretax gain of $36
million. The carrying value of this retained interest was $705 million at
December 31, 2004, of which $523 million was considered investment grade.
As of June 30, 2005, AEFA continued to hold investments in CDOs managed by
AEFA that were not consolidated pursuant to the adoption of FIN 46 as the
Company was not considered the primary beneficiary. As a condition to its
managing certain CDOs, AEFA is generally required to invest in the residual or
"equity" tranche of the CDO, which is typically the most subordinated tranche
of securities issued by the CDO entity. AEFA's exposure as an investor is
limited solely to its aggregate investment in the CDOs, and it has no
obligations or commitments, contingent or otherwise, that could require any
further funding of such investments. As of June 30, 2005, the carrying values
of the CDO residual tranches managed by AEFA were $37 million, a net increase
of $10 million from December 31, 2004 primarily as a result of the placement
of new CDO products with clients. CDOs are illiquid investments. As an
investor in the residual tranche of CDOs, AEFA's return correlates to the
performance of portfolios of high-yield bonds and/or bank loans comprising the
CDOs.
The carrying value of the CDOs, as well as derivatives recorded on the balance
sheet as a result of consolidating certain SLTs which are in the process of
being liquidated, and AEFA's projected return are based on discounted cash
flow projections that require a significant degree of management judgment as
to assumptions primarily related to default and recovery rates of the
high-yield bonds and/or bank loans either held directly by the CDOs or in the
reference portfolio of the SLTs and, as such, are subject to change. Although
the exposure associated with AEFA's investment in CDOs is limited to the
carrying value of such investments, they have significant volatility
associated with them because the amount of the initial value of the loans
and/or other debt obligations in the related portfolios is significantly
greater than AEFA's exposure. In the event of significant deterioration of a
portfolio, the relevant CDO may be subject to early liquidation, which could
result in further deterioration of the investment return or, in severe cases,
loss of the CDO carrying amount. The derivatives recorded as a result of
consolidating certain SLTs
41
under FIN 46 are primarily valued based on the expected gains and losses from
liquidating a reference portfolio of high-yield loans. The overall exposure to
loss related to these derivatives is represented by the pretax net assets of
the SLTs, which was $164.6 million at June 30, 2005. However, because the
portfolio has been substantially liquidated, a significant portion of the net
assets within the structure is cash and cash equivalents and, as a result, the
overall market exposure is considered negligible.
AMERICAN EXPRESS BANK
RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2005 AND
2004
STATEMENTS OF INCOME
Three Months Ended Six Months Ended
(Dollars in millions) June 30, June 30,
--------------------- Percentage ---------------------- Percentage
2005 2004 Inc/(Dec) 2005 2004 Inc/(Dec)
------- ------- ---------- -------- -------- ----------
Net revenues:
Interest income $ 157 $ 131 20.9% $ 305 $ 265 15.5%
Interest expense 84 51 66.5 158 104 53.1
------- ------- -------- --------
Net interest income 73 80 (8.2) 147 161 (8.7)
Commissions and fees 78 70 10.3 151 140 7.6
Foreign exchange income and other
revenues 57 53 6.6 117 112 4.4
------- ------- -------- --------
Total net revenues 208 203 2.1 415 413 0.4
------- ------- -------- --------
Expenses:
Human resources 81 71 14.4 162 146 10.9
Other operating expenses 80 78 1.0 155 150 2.7
Provision for losses 2 12 (82.8) 7 18 (61.0)
Restructuring charges - - - - 9 #
------- ------- -------- --------
Total expenses 163 161 0.8 324 323 0.1
------- ------- -------- --------
Pretax income 45 42 6.9 91 90 1.3
Income tax (benefit) provision (16) 14 # - 32 (99.6)
------- ------- -------- --------
Net income $ 61 $ 28 # $ 91 $ 58 57.9
======= ======= ======== ========
# - Denotes a variance of more than 100%.
AEB reported net income of $61 million and $91 million for the three and six
months ended June 30, 2005, respectively, up significantly from $28 million
and $58 million, respectively, for the same periods a year ago. The
three-month period ended June 30, 2005 included a $33 million benefit from the
previously mentioned IRS audit, a $5 million gain on the sale of AEB's Egypt
branch and a $2 million benefit from the recovery of insurance claims associated
with September 11, 2001. The six-months ended June 30, 2005 include $5 million
($4 million after-tax) of costs related to ongoing reengineering activities.
For the six-month period ended June 30, 2004, results included $11 million ($8
million after-tax) of reengineering costs, $9 million of which reflected a
restructuring charge related to the exit of businesses in Pakistan and
Bangladesh and $2 million of which was related to ongoing reengineering
activities.
Net interest income of $73 million and $147 million for the three and
six-month periods ended June 30, 2005, respectively, decreased 8 percent and 9
percent, respectively, as lower spreads in the investment portfolio and
decreased loan volume in Hong Kong during the second quarter were partially
offset by higher Private Banking volumes. Commissions and fees increased 10
percent and 8 percent in the three and six-month periods ended June 30, 2005,
respectively, primarily due to higher volumes in the Financial Institutions
Group (FIG) and Private Banking. For the three months ended June 30, 2005,
foreign exchange income and other revenues rose 7 percent reflecting a gain on
the sale of AEB's Egypt branch, offset by higher funding costs associated with
the AEIDC joint venture. For the six months ended June 30, 2005, foreign
exchange income and other revenues also include a small gain on the sale of
the Luxembourg Private Banking business recognized in the first quarter.
Human resources expenses rose 14 percent and 11 percent for the three and
six-month periods ended June 30, 2005, respectively, reflecting severance
costs related to reengineering activities, higher management incentive costs,
merit
42
increases and a negative impact from foreign exchange. Other operating
expenses rose 1 percent and 3 percent, respectively, for the same periods
reflecting increased business volume-related expenses, partially offset by the
$2 million insurance recovery, as discussed earlier, in the second quarter and
the ongoing benefits of reengineering initiatives.
Provision for losses decreased 83 percent and 61 percent for the three and six
months, respectively, primarily due to Corporate Banking recoveries of
accounts previously written-off.
For the three-month periods ended June 30, 2005 and 2004, the effective tax
rate was a benefit rate of 36 percent and provisional rate of 33 percent,
respectively. For the six-month periods ended June 30, 2005 and 2004, the
effective tax rate was nil and 36 percent. The decrease in the effective tax
rate for the three and six-month periods ended June 30, 2005 reflects the
impact of a $33 million benefit resulting from an IRS audit of previous
years' tax returns discussed earlier.
43
LIQUIDITY AND CAPITAL RESOURCES
SELECTED BALANCE SHEET INFORMATION (GAAP BASIS)
(Dollars in billions, except where indicated) June 30, December 31, Percentage June 30, Percentage
2005 2004 Inc/(Dec) 2004 Inc/(Dec)
--------- ------------ ---------- ---------- ----------
Total loans $ 7.0 $ 6.9 1.7% $ 6.5 8.4%
Total Non-CFS loans $ 5.6 $ 5.5 2.2 $ 5.2 10.0
Non-CFS loan loss reserves (millions):
Beginning balance $ 48 $ 57 (15.0) $ 61 (20.0)
Provision - 1 # 2 #
Net charge-offs 3 - # (5) #
Other (5) - # 4 #
--------- ------------ ----------
Ending balance $ 46 $ 58 (20.6) $ 62 (25.6)
--------- ------------ ----------
% of Non-CFS loans 0.8% 1.0% 1.2%
Total non-performing loans (millions) $ 21 $ 37 (42.8) $ 50 (57.7)
Total CFS loans $ 1.4 $ 1.4 (0.4) $ 1.3 2.4
Past due as a % of total CFS loans:
30-89 days past due 3.5% 3.8% 4.6%
90+ days past due 0.7% 0.7% 0.9%
CFS loan reserves (millions):
Beginning balance $ 35 $ 39 (9.4) $ 45 (21.9)
Provision 7 7 2.6 10 (26.6)
Net charge-offs (11) (10) 7.4 (13) (17.4)
Other - 1 # (1) (64.9)
--------- ------------ ----------
Ending balance $ 31 $ 37 (15.7) $ 41 (23.8)
--------- ------------ ----------
% of CFS loans 2.3% 2.7% 3.1%
% of 30 days past due CFS loans 54% 61% 57%
Net write-off rate 3.2% 3.0% 4.0%
Assets owned, managed*/administered
Owned $ 14.0 $ 13.4 4.5 $ 14.1 (1.2)
Managed/administered 19.7 19.2 2.4 16.9 16.4
--------- ------------ ----------
Total $ 33.7 $ 32.6 3.3 $ 31.0 8.4
--------- ------------ ----------
Assets of non-consolidated joint ventures** $ 1.9 $ 1.8 7.9 $ 1.7 14.3
Deposits $ 11.3 $ 10.4 7.9 $ 11.2 0.5
Total liabilities $ 13.0 $ 12.4 4.3 $ 13.2 (1.6)
Total shareholder's equity (millions) $ 987 $ 924 6.8 $ 953 3.5
Return on average total assets 0.96% 0.70% 0.81%
Return on average total shareholder's 13.7% 10.0% 11.9%
equity
Risk-based capital ratios:
Tier 1 11.7% 11.0% 12.0%
Total 11.1% 10.1% 11.8%
Leverage ratio 6.0% 5.8% 5.9%
* Includes assets managed by AEFA.
** Excludes American Express International Deposit Company's total assets
(which are 100% consolidated at AEFA).
# - Denotes a variance of more than 100%.
AEB had worldwide loans outstanding at June 30, 2005 of approximately $7.0
billion, up from $6.9 billion at December 31, 2004 and $6.5 billion at June
30, 2004. The following table summarizes the composition of AEB's loan
portfolio by business line as of June 30, 2005, December 31, 2004 and June
30, 2004:
Percentage of total loans
----------------------------------------------------------
June 30, 2005 December 31, 2004 June 30, 2004
------------- ----------------- -------------
Private Banking 49% 48% 46%
Consumer 21 22 22
Financial Institution 30 29 30
Corporate Banking - 1 2
In addition to the loan portfolio, other banking activities, such as
securities, unrealized gains on foreign exchange and derivatives contracts,
various contingencies and market placements added approximately $7.6 billion
to AEB's
44
credit exposures at June 30, 2005 and $7.2 billion and $7.7 billion at
December 31, 2004 and June 30, 2004, respectively. Included in the $7.6
billion of additional exposures at June 30, 2005 were cash and
securities-related balances totaling $5.3 billion.
As of June 30, 2005, AEB had a $500 million secured borrowing facility.
CORPORATE AND OTHER
Corporate and Other reported net income of $4 million and net expenses of $47
million for the three and six months ended June 30, 2005, respectively,
compared with net expenses of $58 million and $116 million in the same periods
a year ago. As discussed earlier, 2005 results included a $49 million tax
benefit from an IRS audit of previous years' tax returns, $21 million ($14
million after-tax) benefit from the recovery of insurance claims associated
with September 11, 2001 and $8 million ($5 million after-tax) of AEFA spin-off
related expenses, $5 million ($3 million after-tax) of which was recorded in
the second quarter. 2004 results included a similar $18 million tax benefit
also from the final settlement of previous years' Federal tax audits.
OTHER REPORTING MATTERS
ACCOUNTING DEVELOPMENTS
See "Recently Issued Accounting Standards" section of Note 1 to the
Consolidated Financial Statements.
ITEM 4. CONTROLS AND PROCEDURES
The Company's management, with the participation of the Company's Chief
Executive Officer and Chief Financial Officer, has evaluated the effectiveness
of the Company's disclosure controls and procedures (as such term is defined
in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act")) as of the end of the period covered by this
report. Based on such evaluation, the Company's Chief Executive Officer and
Chief Financial Officer have concluded that, as of the end of such period, the
Company's disclosure controls and procedures are effective. There have not
been any changes in the Company's internal control over financial reporting
(as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange
Act) during the fiscal quarter to which this report relates that have
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
FORWARD-LOOKING STATEMENTS
This report includes forward-looking statements, which are subject to risks
and uncertainties. The words "believe," "expect," "anticipate," "optimistic,"
"intend," "plan," "aim," "will," "may," "should," "could," "would," "likely,"
and similar expressions are intended to identify forward-looking statements.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date on which they are made. The
Company undertakes no obligation to update or revise any forward-looking
statements. Factors that could cause actual results to differ materially from
these forward-looking statements include, but are not limited to, the
following: the Company's ability to complete the planned spin-off of its AEFA
business unit, which is subject to final approval by the Company's Board of
Directors, the receipt of necessary regulatory approvals and a favorable tax
opinion from counsel, and in connection with the proposed spin-off, the
Company's ability to capitalize AEFA consistent with rating agency
requirements and to manage transition costs and implement effective transition
arrangements with AEFA on a post-completion basis; the Company's ability to
grow its business and meet or exceed its return on shareholders' equity target
by reinvesting approximately 35% of annually-generated capital, and returning
approximately 65% of such capital to shareholders, over time, which will
depend on the Company's ability to manage its capital needs and the effect of
business mix, acquisitions and rating agency requirements; consumer and
business spending on the Company's travel related services products,
particularly credit and charge cards and Travelers Cheques and other prepaid
products and growth in card lending balances, which depend in part on the
ability to issue new and enhanced card and prepaid products, services and
rewards programs, and increase revenues from such products, attract new
cardmembers, reduce cardmember attrition, capture a greater share of existing
cardmembers' spending, sustain premium discount rates on its card products in
light of regulatory and market pressures, increase merchant coverage, retain
cardmembers after low introductory lending rates have
45
expired, and expand the global network services (GNS) business; the Company's
ability to introduce new products, reward program enhancements and service
enhancements on a timely basis during the latter half of 2005 and the first
half of 2006; the success of the GNS business in partnering with banks in the
United States, which will depend in part on the extent to which such business
further enhances the Company's brand, allows the Company to leverage its
significant processing scale, expands merchant coverage of the network,
provides U.S. GNS bank partners the benefits of greater cardmember loyalty and
higher spend per customer, and merchant benefits such as greater transaction
volume and additional higher spending customers; the continuation of favorable
trends, including increased travel and entertainment spending and the overall
level of consumer confidence; successfully cross-selling, travel, card and
other products and services to the Company's customer base, both in the United
States and abroad; the Company's ability to generate sufficient revenues for
expanded investment spending, and the ability to capitalize on such
investments to improve business metrics; the costs and integration of
acquisitions; the success, timeliness and financial impact (including costs,
cost savings and other benefits including increased revenues), and beneficial
effect on the Company's operating expense to revenue ratio, both in the
short-term and over time, of reengineering initiatives being implemented or
considered by the Company, including cost management, structural and strategic
measures such as vendor, process, facilities and operations consolidation,
outsourcing (including, among others, technologies operations), relocating
certain functions to lower-cost overseas locations, moving internal and
external functions to the Internet to save costs, and planned staff reductions
relating to certain of such reengineering actions; the ability to control and
manage operating, infrastructure, advertising and promotion expenses as
business expands or changes, including the ability to accurately estimate the
provision for the cost of the Membership Rewards program; the Company's
ability to manage credit risk related to consumer debt, business loans,
merchant bankruptcies and other credit trends and the rate of bankruptcies,
which can affect spending on card products, debt payments by individual and
corporate customers and businesses that accept the Company's card products and
returns on the Company's investment portfolios; bankruptcies, restructurings
or similar events affecting the airline or any other industry representing a
significant portion of TRS' billed business, including any potential negative
effect on particular card products and services and billed business generally
that could result from the actual or perceived weakness of key business
partners in such industries; the triggering of obligations to make payments to
certain co-brand partners, merchants, vendors and customers under contractual
arrangements with such parties under certain circumstances; a downturn in the
Company's businesses and/or negative changes in the Company's and its
subsidiaries' credit ratings, which could result in contingent payments under
contracts, decreased liquidity and higher borrowing costs; risks associated
with the Company's prepayment to Delta Air Lines of $500 million for the
future purchases of Delta SkyMiles rewards points and its loan of up to $75
million to Delta; AEFA's ability to improve investment performance, including
attracting and retaining high-quality personnel, and reduce outflows of
invested funds; AEFA's ability to develop and introduce new and attractive
products to clients in a timely manner and effectively manage the economics in
selling a growing volume of non-proprietary mutual funds and other retail
financial products to clients; fluctuation in the equity and fixed income
markets, which can affect the amount and types of investment products sold by
AEFA, the market value of its managed assets, and management, distribution and
other fees received based on the value of those assets; AEFA's ability to
recover deferred acquisition costs (DAC), as well as the timing of such DAC
amortization, in connection with the sale of annuity, insurance and certain
mutual fund products, and the level of guaranteed minimum death benefits paid
to clients; changes in assumptions relating to DAC, which could impact the
amount of DAC amortization; changes in federal securities laws affecting the
mutual fund industry, including possible enforcement proceedings and the
adoption of rules and regulations designed to prevent trading abuses, restrict
or eliminate certain types of fees, change mutual fund governance and mandate
additional disclosures, and the ability to make the required investment to
upgrade compliance systems and procedures in response to these changes; AEFA's
ability to avoid deterioration in its high-yield portfolio in order to
mitigate losses in its investment portfolio; fluctuations in foreign currency
exchange rates; fluctuations in interest rates, which impact the Company's
borrowing costs, return on lending products and spreads in the insurance,
annuity and investment certificate products; accuracy of estimates for the
fair value of the assets in the Company's investment portfolio and, in
particular, those investments that are not readily marketable, including the
valuation of the interest-only strip relating to TRS' lending securitizations;
the potential negative effect on the Company's businesses and infrastructure,
including information technology, of terrorist attacks, disasters or other
catastrophic events in the future; political or economic instability in
certain regions or countries, which could affect lending and other commercial
activities, among other businesses, or restrictions on convertibility of
certain currencies; changes in laws or government regulations, including
changes in tax laws or regulations that could result in the elimination of
certain tax benefits; outcomes and costs associated with litigation and
compliance and regulatory matters;
46
deficiencies and inadequacies in the Company's internal control over financial
reporting, which could result in inaccurate or incomplete financial reporting;
and competitive pressures in all of the Company's major businesses. A further
description of these and other risks and uncertainties can be found in the
Company's Annual Report on Form 10-K for the year ended December 31, 2004, and
its other reports filed with the SEC.
47
PART II. OTHER INFORMATION
AMERICAN EXPRESS COMPANY
Item 1. Legal Proceedings
The Company and its subsidiaries are involved in a number of legal and
arbitration proceedings, including class actions, concerning matters
arising in connection with the conduct of their respective business
activities. The Company believes it has meritorious defenses to each of
these actions and intends to defend them vigorously. The Company believes
that it is not a party to, nor are any of its properties the subject of,
any pending legal or arbitration proceedings that would have a material
adverse effect on the Company's consolidated financial condition, results
of operation or liquidity. However, it is possible that the outcome of
any such proceedings could have a material impact on results of
operations in any particular reporting period as the proceedings are
resolved. Certain legal proceedings involving the Company are set forth
below. For a discussion of certain other legal proceedings involving the
Company and its subsidiaries, please refer to the Company's Annual Report
on Form 10-K for the year ended December 31, 2004.
TRS PROCEEDINGS
The Company has been named in a number of purported class actions in
which the plaintiffs allege an unlawful antitrust tying arrangement
between the Company's charge cards, credit cards and debit cards in
violation of various state and federal laws, including the following: (i)
COHEN RESE GALLERY ET AL. V. AMERICAN EXPRESS COMPANY ET AL., U.S.
District Court for the Northern District of California (filed July 2003);
(ii) ITALIAN COLORS RESTAURANT V. AMERICAN EXPRESS COMPANY ET AL., U.S.
District Court for the Northern District of California (filed August
2003); (iii) DRF JEWELER CORP. V. AMERICAN EXPRESS COMPANY ET AL., U.S.
District Court for the Southern District of New York (filed December
2003); (iv) HAYAMA INC. V. AMERICAN EXPRESS COMPANY ET AL., Superior
Court of California, Los Angeles County (filed December 2003); (v) CHEZ
NOELLE RESTAURANT V. AMERICAN EXPRESS COMPANY ET AL., U.S. District Court
for the Southern District of New York (filed January 2004); (vi) MASCARI
ENTERPRISES D/B/A SOUND STATIONS V. AMERICAN EXPRESS COMPANY ET AL., U.S.
District Court for the Southern District of New York (filed January
2004); (vii) MIMS RESTAURANT V. AMERICAN EXPRESS COMPANY ET AL., U.S.
District Court for the Southern District of New York (filed February
2004); and (viii) THE MARCUS CORPORATION V. AMERICAN EXPRESS COMPANY ET
AL., U.S. District Court for the Southern District of New York (filed
July 2004). The plaintiffs in these actions seek injunctive relief and an
unspecified amount of damages. Upon motion to the Court by the Company,
the venue of the Cohen Rese and Italian Colors actions was moved to the
U.S. District Court for the Southern District of New York in December
2003. Each of the above-listed actions (except for Hayama) is now pending
in the U.S. District Court for the Southern District of New York. On
April 30, 2004, the Company filed a motion to dismiss all the actions
filed prior to such date that were pending in the U.S. District Court for
the Southern District of New York. A decision on that motion is pending.
In addition, the Company has asked the Court in the Hayama action to stay
that action pending resolution of the motion in the Southern District of
New York. The Company filed a motion to dismiss the action filed by The
Marcus Corporation, which was denied in July 2005. Nonetheless, the
Company continues to believe that it has meritorious defenses and will
continue to vigorously defend against this action.
In May 2005, Amex Bank of Canada was added as a defendant to a motion to
authorize a class action captioned OPTION CONSOMMATEURS AND
JOEL-CHRISTIAN ST-PIERRE V. BANK OF MONTREAL ET AL. filed in the Superior
Court of Quebec, District of Quebec. The motion, which also names as
defendants Royal Bank of Canada, Toronto-Dominion Bank, HSBC Bank of
Canada, among others, alleges that the defendants violated the Quebec
Consumer Protection Act by imposing finance charges on credit card
transactions prior to 21 days following the receipt of the statement
48
containing the charge. It is alleged that the Quebec Consumer Protection
Act ("QCPA") provisions, which require a 21-day grace period prior to
imposing finance charges, applies to credit cards issued by Amex Bank of
Canada in Quebec and that finance charges imposed prior to this grace
period violate the QCPA. The proposed class seeks reimbursement of all
finance charges imposed in violation of the QCPA, $100 in punitive
damages per class member, interest and fees and costs.
AEFA PROCEEDINGS
The SEC, NASD and several state attorneys general have brought numerous
enforcement proceedings against individuals and firms challenging several
mutual fund industry practices, including late trading (allowing mutual
fund customers to receive 4:00 p.m. ET prices for orders placed or
confirmed after 4:00 p.m. ET), market timing (abusive rapid trading in
mutual fund shares) and disclosure of revenue sharing arrangements, which
are paid by fund advisers or companies to brokerage firms who agree to
sell those funds. We have received requests for information and have been
contacted by regulatory authorities concerning our practices and are
cooperating fully with these inquiries.
On February 17, 2005, the New Hampshire Bureau of Securities Regulation
(the "NHBSR") filed a petition against AEFA. The petition alleged that
AEFA violated New Hampshire and federal securities laws by failing to
disclose revenue sharing and directed brokerage payments received from
non-proprietary mutual funds for agreeing to make their products
available through AEFA's national distribution network. The petition also
alleged that AEFA failed to disclose incentives for advisors to sell
proprietary products and other alleged conflicts of interest. The
petition sought, among other things, an order to show cause why AEFA's
broker-dealer license should not have been denied, suspended or revoked,
proposed a fine and restitution of financial planning fees during the
relevant period (principally 1999 to 2003) in the amount of $17.5
million, and disgorgement of revenue sharing and directed brokerage
payments and other relief. In July 2005, AEFA entered into a settlement
agreement with the NHBSR in settlement of the allegations contained in
the petition. Under the terms of the settlement, AEFA has consented to
the payment of a fine to the NHBSR in the amount of $5 million and agreed
to make restitution of up to $2 million. AEFA has also agreed to pay
$375,000 for all costs associated with the NHBSR's investigation. The
Company established reserves in prior quarters to cover this matter. In
addition, under the terms of the settlement, AEFA has agreed to retain a
consultant to review its practices and procedures in all its offices
located in New Hampshire and to determine the ultimate amount of the
restitution to be paid to New Hampshire clients up to the maximum of $2
million.
In June 2004, an action captioned JOHN E. GALLUS ET AL. V. AMERICAN
EXPRESS FINANCIAL CORP. AND AMERICAN EXPRESS FINANCIAL ADVISORS, INC. was
filed in the United States District Court for the District of Arizona.
The plaintiffs allege that they are investors in several "AXP" mutual
funds and they purport to bring the action derivatively on behalf of
those funds under the Investment Company Act of 1940. The plaintiffs
allege that fees allegedly paid to the defendants by the funds for
investment advisory and administrative services are excessive. The
plaintiffs seek remedies including restitution and rescission of
investment advisory and distribution agreements. The plaintiffs
voluntarily agreed to transfer this case to the United States District
Court for the District of Minnesota. In March 2005, the Court dismissed
one count of the complaint that fund directors breached their fiduciary
duties. The Court denied the motion to dismiss the remaining counts, but
granted plaintiffs only limited discovery after which time the Company
will be permitted to renew its motion to dismiss.
49
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
(c) Issuer Purchases of Securities
The table below sets forth the information with respect to purchases of
the Company's common stock made by or on behalf of the Company during the
quarter ended June 30, 2005.
Total Number Maximum
of Shares Number of
Purchased as Shares that
Part of May Yet Be
Publicly Purchased
Total Number Announced Under
of Shares Average Price Plans or the Plans or
Period Purchased Paid Per Share Programs (3) Programs
------------------------------ -------------- --------------- ------------ ------------
April 1-30, 2005
Repurchase program (1) 1,255,000 $ 51.77 1,255,000 60,944,723
Employee transactions (2) 58,075 $ 52.03 N/A N/A
May 1-31, 2005
Repurchase program (1) 8,503,000 $ 52.66 8,503,000 52,441,723
Employee transactions (2) 14,216 $ 53.36 N/A N/A
June 1-30, 2005
Repurchase program (1) 700,000 $ 54.94 700,000 51,741,723
Employee transactions (2) 41,116 $ 53.38 N/A N/A
-------------- ------------
Total
Repurchase program (1) 10,458,000 $ 52.71 10,458,000
Employee transactions (2) 113,407 $ 52.69 N/A
(1) The Board of Directors of the Company authorized the repurchase
of 120 million shares of common stock in November 2002. At
present, there are approximately 51.7 million shares remaining
under such authorization. Such authorization does not have an
expiration date, and at present, there is no intention to
modify or otherwise rescind such authorization. Since September
1994, the Company has acquired 518.3 million shares of common
stock under various Board authorizations to repurchase up to an
aggregate of 570 million shares, including purchases made under
agreements with third parties.
(2) Includes: (1) shares delivered by or deducted from holders of
employee stock options who exercised options (granted under the
Company's incentive compensation plans) in satisfaction of the
exercise price and/or tax withholding obligation of such
holders and (2) restricted shares withheld (under the terms of
grants under the Company's incentive compensation plans) to
offset tax withholding obligations that occur upon vesting and
release of restricted shares. The Company's incentive
compensation plans provide that the value of the shares
delivered or attested to, or withheld, shall be the average of
the high and low price of the Company's common stock on the
date the relevant transaction occurs.
(3) Share purchases under publicly announced programs are made
pursuant to open market purchases or privately negotiated
transactions (including with employee benefit plans) as market
conditions warrant and at prices the Company deems appropriate.
50
Item 4. Submission of Matters to a Vote of Security Holders
For information relating to the matters voted upon at the Company's
annual meeting of shareholders held on April 27, 2005, see the
information set forth under the caption "Item 4, Submission of Matters to
a Vote of Security Holders" in the Company's Quarterly Report on Form
10-Q for the quarterly period ended March 31, 2005, which is incorporated
herein by reference.
Item 6. Exhibits
The list of exhibits required to be filed as exhibits to this report are
listed on page E-1 hereof, under "Exhibit Index," which is incorporated
herein by reference.
51
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
AMERICAN EXPRESS COMPANY
------------------------
(Registrant)
Date: August 2, 2005 By /s/ Gary L. Crittenden
--------------------------------------
Gary L. Crittenden
Executive Vice President and
Chief Financial Officer
Date: August 2, 2005 By /s/ Joan C. Amble
--------------------------------------
Joan C. Amble
Executive Vice President and
Comptroller
(Principal Accounting Officer)
52
EXHIBIT INDEX
The following exhibits are filed as part of this Quarterly Report:
Exhibit Description
------- -----------
12 Computation in Support of Ratio of Earnings to Fixed Charges.
31.1 Certification of Kenneth I. Chenault pursuant to Rule 13a-14(a)
promulgated under the Securities Exchange Act of 1934, as amended.
31.2 Certification of Gary L. Crittenden pursuant to Rule 13a-14(a)
promulgated under the Securities Exchange Act of 1934, as amended.
32.1 Certification of Kenneth I. Chenault and Gary L. Crittenden pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
E-1