美國運通 (AXP) 2006 Q2 法說會逐字稿

At this time, I would like to welcome everyone to the second-quarter 2006 earnings conference call.

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer session. (OPERATOR INSTRUCTIONS).

Mr. Stovall, you may begin your conference.

Thank you and welcome to everyone.

We appreciate all of you joining us for today's discussion.

As usual, it's my job today to remind you that the discussion contains certain forward-looking statements about the Company's future financial performance and business prospects, which are subject to risks and uncertainties and speak only as of today.

The words believe, expect, anticipate, optimistic, intend, plan, aim, will, should, could, likely and similar expressions are intended to identify forward-looking statements.

Factors that could cause actual results to differ materially from these forward-looking statements included in the Company's financial and other goals are set forth within today's earnings press release, which was filed in an 8-K report, and in the Company's 2005 10-K report already on file with the Securities and Exchange Commission.

In the second-quarter 2006 earnings release and supplement, which are now posted on our website at ir.americanexpress.com, and on file with the SEC in an 8-K report, we have provided information that compares and reconciles the Company's pro forma return on equity to be discussed today with our consolidated return on equity, as well as the U.S. card services segment's managed basis financial measures with the GAAP financial information.

And we explain why these presentations are useful to management and to investors.

We urge you to review that information in conjunction with today's discussions.

Gary Crittenden, Executive Vice President and Chief Financial Officer of American Express, will provide some introductory remarks highlighting the key points related to today's announcement.

Once he completes his remarks, we will turn to the moderator, who will announce your opportunity to get into the queue for the Q&A period.

Up until then, no one has actually registered to ask questions.

While we will attempt to respond to as many of your questions as possible before we end the call, we do have a limited amount of time.

Based on this, we ask that you limit yourself to one question at a time during the Q&A.

With that, let me turn the discussion over to Gary.

Thank you, Ron, and welcome to all of you.

Thank you for joining with us today.

As you have seen in the earnings documents that we distributed earlier today, our second-quarter results reflect a continuation of the strong business momentum that we reported throughout 2005 and in the first quarter of 2006 and the ongoing benefits of our investments in a broad range of business-building initiatives.

When you compare our financial results from continuing operations for the second quarter to last-year results, our revenues were up 14%, our income increased 13%, and diluted EPS of $0.78 rose by 13%.

In addition, the reported return on equity for the quarter was 30%.

As you know, this calculation reflects net income and average equity over the prior 12-month period, which includes the earnings and capital from our discontinued operations.

Pro forma ROE, which is determined using the trailing 12-month income from continuing operations over average shareholder equity during the period from September 30, 2005, through June 30, 2006, was 33%.

This is the last quarter that we will report this pro forma ROE since next quarter's reported calculation will already reflect a full year of post-spin results.

Second-quarter results from continuing operations included two significant items that impacted the income statement -- first, a $144 million pre-tax or a $131 million after-tax gain related to the completion of the sale of our card business and merchant-related operations in Brazil, and a $62 million pre-tax or $40 million after-tax charge related to a higher redemption rate estimate within the non-U.S. membership rewards reserve model.

The quarter also included $53 million pre-tax or $34 million after tax of reengineering costs.

The impact of the sale of our operations in Brazil had two components -- first, a $131 million after-tax gain that I just referenced, which was reported within our continuing operations, and second, a $22 million after-tax loss, which was reported within our discontinued operations.

The discontinued operations loss reflects the impact of the sale of our Brazilian banking operations, a business from which we have now exited within this market.

The continuing operations gain reflects the sale of our card and merchant-related activities, where we will maintain an active presence in Brazil, but will do so through our GNS partnerships.

Because we sold both our card-issuing and merchant-related activities, the gain was allocated between the international card and global commercial services and global network and merchant services segments accordingly.

Since the sale closed on June 30, the consolidated and segment P&Ls, as well as the quarter-to-date metrics, still include the effects throughout the quarter of the businesses sold.

However, balance sheet results and the period-end metrics such as cards in force have been adjusted to reflect the impact of the transaction.

During the quarter, I am pleased to say that we returned 118% of total capital generated to our shareholders through share repurchases and dividends.

We repurchased a higher level of shares this quarter after our activity was reduced last year in light of the capital implications of the spin-off of Ameriprise.

Since 1994, we have returned 68% of capital generated to shareholders, which is above our 65% long-term target.

In the quarter, the Board also authorized a 25% increase in our quarterly dividend, racing it to $0.15 a share, as well as the repurchase of up to 200 million additional common shares to be repurchased over time as market conditions allow.

The strong revenue growth in the quarter reflects increases in discount revenue, cardmember lending, net finance charge revenue, securitization income and various card-related fees, all of which reflect the excellent spending, lending and cards in force growth that we achieved during the quarter.

Each of our customer segments and major geographic regions contributed to this growth.

Worldwide card-billed business increased 16% versus last year on both a reported basis and on an FX adjusted basis.

In our U.S. proprietary business, consumer spending grew 14%, small-business spending was up 18% and corporate services volume improved by 15%.

In total, U.S. non-T&E-related volumes, which represented approximately 65% of U.S. billings, grew 16%, while T&E-related spending rose 13%.

Outside the U.S., proprietary billed business growth was 15% on a foreign exchange-adjusted basis, as we saw 15% growth within our consumer and small-business activities and 17% growth within corporate services volumes.

In addition, we achieve double-digit growth within each major region around the globe.

And finally, within global network services, billed business rose 31%, driven by strong growth outside the U.S. that again exceeded 20%, as well as robust growth within the U.S.

Excluding the impact of the first-quarter transfer of the corporate card activities in certain emerging markets from GNS to the international card and global commercial services segment, our billed business in the GNS segment was even stronger than this reported number.

Worldwide cards in force grew 11%, marking the strongest quarterly growth rate since the second quarter of 2001.

We added 1.9 million net new cards during the quarter and 7.1 million net new cards since last year, reflecting 6% growth versus last year in proprietary cards and 42% growth in network partner cards.

If you adjust for the 1.3 million cards in Brazil transferred from the proprietary international card business to global network services, proprietary growth was 7% and network card growth was 28%.

Spending for proprietary basic card in force grew 7% worldwide despite the suppressing effect of the substantial card additions over the past few years.

During the quarter, our average discount rate was 2.57% versus 2.59% last year and 2.58% last quarter.

The decrease continues to reflect selective repricing initiatives and ongoing changes in the mix of spending between various merchant segments.

Worldwide lending balances on an owned basis rose 29%.

On a managed basis, balances grew 16% on 15% growth in the U.S. portfolio and a 21% increase outside the U.S.

The net finance charge revenue as a percentage of average loans increased versus last quarter and last year.

As you may remember, last quarter's reported rate was suppressed by costs related to the higher-than-anticipated cardmember completion of consumer debt repayment programs.

Over the past few years, we have seen this metric trend upward, despite the rising interest rate environment, reflecting our concentrated effort to shift the lending receivable portfolio from fixed to variable pricing, as we have discussed previously.

Securitization income rose 26% as a higher portfolio yield and substantially lower writeoffs were offset partially by greater interest expense.

Travel commissions and fees decreased by 4%, reflecting lower average transaction fees due in part to the ongoing transition to online booking.

Total travel sales, however, were up 5%, despite a lower level of transactions, as U.S. consumer travel sales continued to grow rapidly, increasing 34%, and global corporate and international consumer sales rose 2%.

Human resource expenses increased 1% versus last year as merit increases and greater benefit costs were partially offset by lower severance-related expenses.

Marketing, promotion, rewards and cardmember services costs increased 16%, reflecting both greater rewards costs and higher marketing and promotion expenses.

Increases in rewards costs continue to reflect strong spending growth, higher redemption rates and increasing cardmember participation.

In addition, the rewards expense growth reflected a decision to modify the ultimate redemption rate assumption within our non-U.S. membership rewards reserve model in order to reflect more recent redemption trends.

In the first quarter, we spoke to you about rewards program changes over the last four to five years that have been geared towards enhancing program utilization levels and have resulted in rising reward redemptions.

As a result, you will recall within the first quarter we modified the redemption rate assumption in our U.S. membership rewards reserve model to reflect redemption trends over the past five years.

After completing the analysis of our non-U.S. programs in the second quarter, we're now making a similar modification in these models.

We believe this modification appropriately captures the impact of reward program enhancements on the redemption rate by focusing the redemption rates assumption around five years' worth of data, which incorporates a rich enough data set that is more reflective of current trends.

The total provision for losses and benefits increased 16% as the lending provision and the investment certificate and other provision rose by 48% and 7%, respectively, while the charge card provision declined by 18%.

The increase in the lending provision was driven by higher loss rates outside the U.S., primarily in Taiwan, and increased loan volumes globally, partially offset by the favorable impact of lower bankruptcy-related charge-offs and strong credit quality in the U.S.

The charge card provision decline reflects improved loss rates versus last year and improved results within our collections activities in the U.S., partially offset by higher volumes worldwide.

The growth in the other provision was due to higher interest rates on larger investment certificate balances.

Interest expense increased 45% versus last year, driven by higher funding costs and a greater average receivable balance.

Growth in the remaining operating expenses reflects the impact of increased volumes and last year's 9/11 insurance benefit, partially offset by this year's gain on the sale of our operations in Brazil and lower reengineering costs.

The consolidated tax rate of 33% for the quarter increased from 23% last year.

This year's rate reflects the relatively low effective tax rate on the Brazil gain, offset by higher tax expense due to uncertainty regarding the Company's ability to obtain tax benefits for certain expenses attributable to foreign subsidiaries.

Last year's lower effective tax rate reflected the $87 million benefit related to an IRS audit of previous years' tax returns.

With that, let me conclude with a few final comments.

We again delivered strong revenue and earnings growth during the quarter while continuing to invest in the business and maintaining substantial balance sheet strength.

This quarter's results continue to illustrate healthy business momentum throughout our proprietary payments business as well as our network business, and our competitive position is strong.

This strength is evidenced by the gap between our spending and lending growth rates and our competitors' rates, which persist despite the tougher comparisons we faced to our strong growth rates in last year's quarter.

To ensure that we are positioned to invest in growth opportunities, we continue to reengineer the business.

While this will likely generate reengineering-related expenses from period to period, it will position us to continue to effectively control underlying operating expense growth.

We have seen continued positive momentum in our global network services business, where we delivered 31% billings and 42% cards in force growth this quarter, with strong contributions from both our U.S. and international network partners.

This quarter in the U.S., we successfully launched our first cards as part of our partnership with Bank of America and USAA.

Internationally, we continue to realize strong growth from our network relationships, which now span more than 100 companies.

These businesses not only provide strong results in their own right, but also serve as an important complement to our proprietary business by expanding our breadth and depth of merchant coverage.

We remain optimistic about the opportunities available within the payments industry.

We believe that the relatively low current levels of plastic penetration within the geographies and customers segments in which we operate provide significant opportunity for American Express to drive additional spending to our network, further penetrating cash and check payments.

As you know, even the more mature U.S. consumer segment still has only around 40% of total spending penetrated by plastic.

Outside the U.S. within the U.S. small business segment, and within the global middle market sector, penetration rates are even lower.

The strong growth achieved over recent quarters, which has trended upwards from 7% in the first quarter of 2004 to 11% this quarter, demonstrates the benefits of our recent acquisition-related investments.

This growth in cards provides volume growth potential over multiple years as these customer relationships mature and the expanded customer base further enhances American Express' market relevance.

The card growth is particularly important in light of our ability to drive customer spending.

Our vertically integrated revenue model, which encompasses the issuer, acquirer and network revenue streams, and is enabled by our closed loop network, provides fundamental advantages versus other industry players, who operate in only one or a few aspects of the payment industry value chain.

By focusing on leveraging the robust customer, transaction and merchant data our network provides, we believe that we can continue to create compelling products and services that operates like a discrete marketplace by linking our cardmembers to merchant offers and helping to drive incremental spend.

In summary, our recent business success, coupled with our strong track record of innovation, product development and customer-focused marketing, makes us confident that we are positioned to continue to drive attractive growth and returns into the future.

Thank you very much for listing.

We are now ready to take your questions.

(OPERATOR INSTRUCTIONS).

Bob Napoli, Piper Jaffray.

A question -- very strong revenue growth and very nice revenue growth trends.

Some of the expense items were higher than what we were looking for on the professional fees, and the marketing was a little bit higher.

Are we at the point where expense -- where the leverage, the operating leverage of the Company is maybe working against us -- obviously, higher interest rates and provisions -- credit probably can't get much better.

And then on the expense side, it seems like we lost maybe some momentum.

It's only one quarter -- maybe not -- but I was wondering if you could maybe elaborate on some of those expense trends [multiple speakers]?

I would be happy to, Bob.

First of all, if you look at overall margin trends, and if you look at pretax margin as a percentage of revenue, the improvement actually year over year is pretty attractive.

And as you correctly mentioned, virtually none of that came from provision in this quarter and none came from interest expense leverage.

It was all operating expense leverage.

And there were a couple of special items, obviously.

One was the membership rewards number that you see in the marketing and rewards line item on the income statement.

There's $62 million there that relates to the change that we made in our reserving model internationally that is consistent with what we did in the U.S. in the first quarter.

But I think if you, obviously, adjust for that $62 million and focus on the other line items, actually the management was pretty impressive.

The HR growth rate in the quarter was up, I believe, 1%.

Even if you adjust for the year-over-year difference in the severance cost -- we had a little higher severance cost last year -- it was up by a relatively immaterial amount -- I think generally it was managed pretty well.

The professional fees line items reflects the fact that we continue to outsource certain of our operations, and as we do that, obviously, we receive benefit on other line items within the income statement.

And so we think that swap actually makes a lot of sense for us.

So, frankly, I feel pretty good about the overall expense control against the backdrop of a couple of items that are difficult for us to control specifically, like provision and interest costs.

What tax rate would be the proper tax rate to expect?

Well, we don't give a forecast for that, Bob.

I think the best thing to do is to go back a couple of years.

We had so much noise in the system last year that it's a little difficult to judge from last year's numbers.

So I would go back a couple of years and look at those kinds of numbers.

Chris Brendler, Stifel Nicolaus.

One thing I had I guess on the credit side, if you could just give us a little more detail -- the international loss rate flagged Taiwan.

Can you tell us at all, quantify maybe the size of that portfolio, what kind of loss experience you saw in the second quarter, and then also maybe address the size of your UK exposure and any trends you're seeing on the credit front there?

We took a charged a charge, obviously, in the first quarter related to Taiwan.

And now we have an additional expense in this quarter.

As we size the amount of the loss that we have experienced relative to other players who have had similar losses, it appears to us that we are pretty consistent with the kind of losses that they have experienced.

That is not a very large business for us.

But even against a not particularly large business, if you have a market turn the way that market has, given the change in regulations there, it can have a pretty significant impact on the business.

And we have obviously seen that in the first and second quarters of this year.

In the other international markets, particularly the UK, we have actually seen rising credit losses in the UK over the last year or so.

And we think we have appropriately reserved for that, and we don't think that there is anything that is so out of pattern with historic trends that it would be worthwhile calling out.

But clearly, there are a couple of international markets that have been somewhat problematic, and Taiwan and the UK would be on that list.

Just a quick follow-up, if I could.

Your reserve coverage ratios, I believe, as a percentage of past dues fell, both charge card and lending, and I imagine what is going on in the lending side, or even in the charge card as well, is that you in these reserves you've built up for maybe UK or Taiwan, now that you're seeing the higher losses, you're seeing those come down.

Can you give us any color on maybe your U.S. reserve ratios relative to past dues?

Yes.

There's a couple of things going on that are a little different in each category.

On the charge side, we had particularly good collections experience.

In fact, some of the reasons for the professional service fee number being up a little bit is we turned some additional focus onto some earlier delinquency buckets than we have in the past.

And so our collections experience in the U.S. was particularly good in this quarter.

And that contributed to a reduction in the required reserve that we have on the charge card side.

On the lending side, the key driver there, obviously, is the continued benefit that we see from the bankruptcy legislation in the U.S. last year.

So we had some positive associated with the bankruptcy legislation in the U.S. last year, obviously some negative associated with the international losses, primarily in Taiwan, as we have just been talking about.

And that contributed to the overall result that you see in the number.

Fair to say you feel pretty good about U.S. consumer credit quality?

We do.

David Hochstim, Bear, Stearns.

I wonder if you could clarify a couple of things.

What did you say the number of cards in Brazil that were transferred to GNS?

1.3 million.

And then when you ran through that comparison of margin for Bob, what were you excluding, if anything, from last year's results?

There are a number of sort of unusual items last year as well.

Can you remind us what, I guess, with Ken's guidance last October, what we should be thinking about in terms of operating earnings or normal earnings?

Let me just kind of take you through the scorecard here.

We try to include everything that we show in the supplement.

So I'll just kind of take you through the pieces as I would see them.

So in last year's number, we obviously had reported net income from continuing operations of about $860 million.

We had included in that number reengineering expense of about $74 million.

And then we had a couple of unusual items.

We had a tax benefit that happened in that quarter of about $87 million, and we had a recovery of certain insurance benefits of about $73 million.

So if you subtract those away from the 860, you come up with a number of something like 774.

This year, if I kind of put the same math together, I start out with a reported net income of 972 million.

I subtract from that Brazil gain of 131 million.

I have the incremental MR charge of about 40 million.

And then I had reengineering expense in this quarter of $34 million.

So that takes me to 915 million.

And so if you go through all of that math, it would say that you have about an 18% increase in net income from 774 million to 915 million.

Now, obviously, we don't do and can't do that kind of math in our reported financial statements.

Those are all non-GAAP measures.

But if you kind of ask us to make some general judgments about what is in and what's out, that's probably the way we would think about it.

So should we think of the reengineering charge as kind of a discretionary expense?

Well, I think what we have done is when we see that we have an opportunity, obviously, because we have something like a Brazil gain or a tax gain, we do everything we can to identify reengineering opportunities to utilize that gain, because that benefits us, then, in future quarters.

So we've tried to be wise about that.

Frankly, if we had had more opportunities that we could have triggered quickly, we probably would have increased that $34 million.

We closed on Brazil on June 30.

And so there was not an awful lot of time -- we didn't know exactly what day the deal would close -- we didn't have an awful lot of time to put all of the proper documentation steps in place to actually incur the reengineering charge in the quarter.

So we did all that we could, frankly, in the quarter to qualify.

So in that sense, it is discretionary.

But, obviously, it is driven by our desire to have good operating expense management going forward.

And then finally, could you just explain what the investment certificates you referenced are?

Yes, the bank sells investment certificates to its customers.

It is a spread business, basically.

And so when interest rates go up, we get squeezed in the spread.

Laura Kaster, Sandler O'Neill.

Your revenue growth was very strong.

One area that outpaced my estimates were other revenues.

That was up 15% year over year.

Can you give me a little color on how much of that was attributable to AMP as it was last quarter?

Yes, most of it is attributable to AMP.

Okay, great.

So you would not think on a year-over-year basis that that run rate would continue?

I don't think so.

Kind of majority of the growth rate was associated with AMP.

Okay, great.

And then also, your lending finance charge revenue was very strong.

That rate was about 9.9%.

How much of that portfolio is variable versus fixed, and how sustainable do you think that rate could be?

Well, we've talked in previous quarters about kind of doing a flip-flop, so a couple of years ago, I think about 60% of the portfolio was fixed and 40% variable.

And that now roughly goes the other way -- about 60% variable and 40% fixed.

And so we think that is sustainable.

There is no reason to think that that change is not a permanent change, and that will continue to benefit us, obviously, in future quarters.

Steven Wharton, JPMorgan.

I just wanted to follow up on the Taiwan situation.

So it looks like you had about a $63 million, I believe, increase in your provision expense from 4Q to 1Q in the international card segment.

And then there was a further, I think, about 11 million or so increase this quarter.

And I'm just trying to get a sense on -- is this, like, the sustainable sort of provision level as a result of the problems in Taiwan?

Or did you build reserves or incur a level of chargeoffs over these last two quarters that is sufficient, that maybe we can return to a run rate of provision expense that is maybe what we saw closer to last year?

Because these year-over-year increases in the provision line on that line of business are running, like, 50% year on year.

The second way that you framed it is closer to the way I would think about it.

We obviously don't think that the issues in Taiwan will continue on forever.

And there is nothing in our portfolio outside of Taiwan today that would give us the same kind of concern that Taiwan has given us over the last couple of quarters.

So barring something that we don't foresee right now, I think that there's no reason to think that history wouldn't be a relatively good indication of what the future would be.

We clearly have had some unusual effects from Taiwan this year.

We had the same thing basically happen in Hong Kong back in 2001 and 2002.

And I think that is a good period to go back and scrutinize.

You see that we had, I think, at that time three quarters of impact from the Hong Kong writeoff, essentially.

And then we saw some improvement happen in the Hong Kong provision as the dust finally settled there.

And I don't know exactly, obviously, what the pattern will be here in Taiwan, but when we have these blips internationally, they tend to be temporary in nature, and then the Company gets back to a more normalized level.

Obviously, we wish they didn't happen.

But they do.

So that implies that we have seen the worst of it, then, these last few quarters?

I can never say that we've gotten everything behind us.

From an accounting perspective, we have done everything that we think is appropriate to reflect the losses that we expect to see in this portfolio in this year -- in this quarter's income statement.

One final thing -- is there any way you could provide us with, like, the balances in Taiwan or the reserves or chargeoff rate that you are incurring right now?

We just don't split it out.

Meredith Whitney, CIBC World Markets.

I have a couple of questions.

First is related to -- I appreciate your confident focus on investing in the business.

But it seems as if the market never truly understands the noise that is associated with these reengineering costs.

How mindful are you guys of what investors want in terms of clean quarters?

And then just to follow up on that, if you could break out what -- there's some confusion between -- on the market spend, what is fixed and what is variable in terms of redeemable rewards?

I am going to have to have you clarify that second piece in just a minute.

But obviously, what we report and what we break out in each quarter is what we actually see in our underlying results.

What we try to do, obviously, is manage the business for the medium to long term.

And a key portion or a key part of that has been our ability to reengineer over the last few years.

And we have been fortunate in some quarters to have these one-time gains, which we generally view as a positive.

When you have a tax reduction or when you have an insurance recovery, or when you have the sale of a business that is a net present value-positive decision to sell a business, we view those as positive things.

But obviously, we want to limit the tax implications of taking kind of an uncovered gain, and at the same time use those opportunities to sprint ahead a little bit in terms of our restructuring so that we lower our costs for future quarters so that we can maintain the strong momentum that we have had historically and have those dollars available to invest in the business rather than spend them on expenses.

And that is just kind of the underlying philosophy that we have followed now for a very long period of time.

And it does result in noise like this, obviously, from quarter to quarter.

And I think we have talked quite a bit about the fact that this quarter in particular would be one where we would have some noise versus the prior year because we did have those gains that took place in last year's quarter as well as the restructuring costs.

So we are sensitive to it, obviously, and want to make it as clear as possible.

That is why I stepped through the numbers here with David.

But I think a reasonable person looking at it would, I think, conclude that both the metrics and the underlying financial performance were very strong in the quarter.

I look at the revenue number and I get excited for those results to drop to the bottom line.

But maybe I am getting too excited here.

The follow-up on that is in the confusion of trying to parse together what is recurring, what is nonrecurring, some confusion was around the international high issue that you went through domestically last quarter.

If you wanted to have a longer-term look at what was not discretionary but what is, going forward, the higher cost of a higher redeem, higher reward-focused customer, can you clarify the difference between spending on Ellen DeGeneres ads and spending on rewards, to break that out.

And I know you guys do that in the annual, but is there any more color you guys can provide with respect to that?

Well, let me just give a couple -- I have a couple of thought on it that maybe will be helpful.

We had disclosed previously that if you took the split -- this goes back now to 2005 -- if you took the split between rewards and marketing in 2005 at the end of the year, we were spending roughly 59% on rewards and about 41% of that line item on marketing overall.

Within this year's rewards number, we have done two special things.

We have updated the model for the U.S. and we updated the model for international.

And when you update the model and establish a new ultimate redemption rate, what that does is it reprices all of the points that you currently have in the bank.

Now, once those bank points are repriced, you don't have to reincur that expense, right?

Those prices -- those points have already been repriced.

So you don't have that same kind of blip associated with that in future quarters, or expense associated with that in future quarters.

And that is as it relates to the 59% of the total as it stood at the end of 2005.

And I think in aggregate, we had something like $112 million in charge that we took in the first quarter and $62 million in charge that we took in this quarter.

So there is roughly 180 million or so in aggregate between those two that is related to updating the model to what we now believe is the appropriate or new ultimate redemption rate, both internationally and domestically that includes the repricing of the bank.

On the marketing side, 41% of the total at the end of the year was marketing related.

In that, you know, there's a broad range of spending that includes our brand campaigns, as well as our direct acquisition programs.

You can get a little bit of a sense for the size of those programs based on the year-to-year segment changes.

If you go back and look in the segment that includes our network services business, you can see how the brand advertising campaign was increased, and then the brand campaign has been decreased a little bit this year.

You can kind of follow the pattern there a little and get a sense for the variability in the marketing expense associated with that.

So all of this, though, really goes to one major fact, which is that we really do think about rewards and marketing as a fungible line item.

I think a reasonable question on your part would be, why don't you just split this out and give us more detail?

And the fact is that we actually move dollars between marketing and rewards quite frequently, as we change different kinds of campaigns and the focus of what we are doing.

And so the numbers really are somewhat fungible.

We tend to draw a hard and fast line here.

But the numbers do tend to be fungible between the two categories.

Joel Houck, Wachovia Securities.

I am wondering, people generally think the world growth slowed down in the second quarter.

Yet you guys are showing good acceleration from Q1 in revenue growth, which implies market share gains.

I am wondering if you can expand on that theme and maybe particularly by geography for both U.S. and outside the U.S., where you guys are getting the most traction?

Well, the good news is, frankly, that we saw good growth in every region outside the U.S.

So we had double-digit growth in every region outside the U.S.

We have now said that, I think, for a couple of quarters running, which is really good news.

So I think the strategy which Ed and his team have led outside the U.S. of really having a spend-centric approach to the business with kind of a premium lending focus is clearly gaining traction and delivering great results.

So we saw good growth in lending balances and good growth in billed business outside the U.S.

And as I said, that was consistent really in every region, and we are pretty enthused about what we have seen there.

Within the U.S., we had the split that we have seen historically, where the consumer business has been slightly weaker than the small business.

I think the consumer business was up 14%.

The small business portion was up 18%.

If you kind of blend the two of those -- I'm sorry, the consumer was up 14 -- did I say that correctly?

Up 14.

And small business was up 18.

If you blend those together, we are up about 15 or so in the U.S.

And it really does reflect, I think, again, the consistent spending that we have done over a longer period of time.

The interesting thing about this is that it is not just a one-quarter phenomenon.

But it has been the fact that we have been sustaining this level of spending for a long period of time that gives you momentum that is particularly attractive.

And I have to say that we are now really starting to see nice contribution from the GNS business.

So when you see year-over-year increases of 31% in that business, and I mentioned that that 31% excludes a transfer of some business out of GNS into our corporate card business that we haven't adjusted for, the GNS business is really showing strong traction.

And that's not just in the U.S.; it also includes outside the U.S., where our growth rate outside the U.S. was in excess of 20%.

So I think we are really feeling the traction that is happening in the GNS business.

We are seeing good card growth there.

We are seeing real strong billed business, and I think an increasing understanding of how that can be a competitively very successful business for us down the road.

Good color.

And then just to drill into the margin a little more, Gary, the big jump in the quarter -- I can appreciate the dynamics of the variable-rate portfolio working in your favor, but were there other things in there?

Is a close to 10% margin the right way to look at this going forward, or even higher, perhaps?

If you look at it versus last quarter -- last quarter, obviously, we had this adjustment that we had to take for cardmembers who were on this guarantee program.

You remember that from last quarter.

They repaid their debt.

We did a charge-off associated with them.

That artificially depressed our number last quarter.

So last quarter's number actually would have been roughly at the same order of magnitude, had that persisted, or had that fact not been in place.

So it is a 60/40 split.

If interest rates continue to go up, you are going to get impacted, obviously.

There is going to be some drag associated with that 40% that you can't get around.

But there's nothing about the current number that we think is unsustainable or unusual.

It also reflects the fact that we've made a concerted effort to drive down the percentage of the total portfolio that is kind of balance transfer-related.

That number tends to move within a band, and we are kind of at the lower end of that band right now.

But we have worked to kind of bring that balance transfer number down because it tends to depress that net yield in ways that are not very attractive for us.

Ed Groshans, Fox-Pitt, Kelton.

I guess I really just have two questions.

One is pretty brief.

Can you give us just a little bit of geography of where the gain on Brazil falls out in the expense lines?

It is in the other expense line item.

It is in the other expense.

Okay.

And then on interest expense, that grew fairly healthy, and it seems like rates have been going up for quite some time.

We haven't seen that kind of jump in the interest expense lines.

Is there something else that has occurred there?

Is there a little more color?

No.

You know, I have said for awhile that we were about 50% hedged this year.

And we are about 50% hedged.

As interest rates continue to go up, that impacts us.

And as I have said before, we are substantially less hedged as we go into 2007 and 2008 as the hedges begin to roll off.

This is something that we monitor very closely and we try to manage our way through.

And part of our reengineering programs, obviously, look forward with an eye on what could happen to interest costs.

We try to take that into account.

That said, because we are continuing to spend strongly on marketing initiatives, one of the reasons why the interest costs are high is that the underlying economy is doing pretty well, at least from our perspective.

Our underlying business is doing well.

So you get some natural offset to those interest increases.

But obviously, we would be happy with a positive net rate as long as it didn't imply economic weakness.

And then just on the return of capital, it seems likely we're over 100% through the first half of this year.

Can you kind of address that?

Do you expect it to keep at the accelerated pace going forward for a while?

Or is there some time you expect to pull back and go back more towards that 65% target?

Well, the target that we have, obviously, is 65.

And it remains at 65.

I am pleased to say that there's a lot of very good things happening in the Company from a capital reengineering standpoint that range from the way we think about our business and the capital that is required in order to support the business to the mix of businesses that we actually operate, that have put us in a very favorable position for the first couple of quarters this year.

You know, hopefully, we can continue to be good at that.

That is part of our job.

Eric Wasserstrom, UBS.

If I could just get a point of clarification on Ed's question about interest expense, the reason why the increase in the interest expense this period was somewhat greater than a year ago, despite similar rates and similar movements in rates, was a lesser degree of hedging.

Is that correct?

Last year, we were at about 65% hedged.

And obviously, the mix of interest costs for us would have been different than the rates in the market overall.

So keep that in mind.

So our hedging would have taken place over a long time period and resulted in a particular mix that led to a particular interest expense.

Some of those hedges have rolled off, as we had said, four or five quarters ago.

So this year, we are about a position of being roughly 50% hedged.

And as I said, as we go into next year, we have substantially less than that hedged today because it simply doesn't make sense for us to hedge in an environment where rates are relatively higher -- rising rate environment.

We typically just don't do that.

And so we have seen in this quarter, as a consequence of the hedges coming down and the fact that interest costs have been climbing, an increase in interest that is pretty substantial.

And that is what is reflected in that 45%.

Offsetting that as we go forward is hopefully strong underlying performance in the business, and then secondly, everything we can do to continue to reengineer to ensure that our operating expenses are well-controlled.

And on the membership rewards charge for the international in this period, was this something that you were contemplating when you made the change to the domestic -- you made the same change on the domestic side last year?

I'm just curious, given how you have highlighted it in this quarter -- was this why there maybe wasn't some indication that maybe another charge of this nature was forthcoming?

I did everything in my power -- when we talked about the domestic charge that we experienced last quarter, I did everything that I could on the call last quarter to indicate that this was a domestic change and that we continually evaluated our positions, particularly internationally, so that you all would have a clear sense that we go through this all the time and scrutinize to make sure that our portfolios are correct.

So we did, obviously, do this domestically in the first quarter.

For this second quarter, it took us longer to complete that work, because we have to attack each one of the markets separately and we had to ensure that five years' worth of historical data was a rich enough data set that we could do appropriate projections off of that information.

We had to get the appropriate confirmation of our approach with PWC, and that just takes longer than it took to do the single domestic business.

That being said, we knew we were working on this, obviously, in the first quarter.

We tried to signal that, obviously, on our call.

And now we have basically aligned the methodology of these two models and feel very comfortable with this approach.

But we will continue to work on this.

This is a large expense for us.

We spend a lot of time evaluating our reserving methodology.

We compare our approach with the approach of others to the extent that we can get information about them.

And we will continue to refine it going forward.

But, yes, this is something that we have been working on and that we anticipated in the first quarter.

Okay, and just very quickly on that last point that you made -- is there any part of this existing analysis that remains in process, or is it substantially completed?

It is substantially completed.

Bruce Harting, Lehman Brothers.

Gary, is that comment you made about the tax rate a slight increase from previous guidance?

And I have one other comment.

Actually, I wasn't trying to give guidance on it.

Because of the natural management of our tax exposure, it will bounce around a little bit.

And so I feel really uncomfortable giving any real guidance on this.

One thing I am certain about is that last year's numbers, obviously, did not reflect what our long-term rates would be.

There's no reason for me to think the year before that wasn't pretty indicative of what normal tax rates will be.

But as we resolve certain tax positions that we have with the IRS, within the range that we are talking about here, the numbers can bounce around a little bit.

So I don't want to put too fine a point on it.

And I know you guys are good and everything, but these numbers are really terrific.

I mean, you're not -- can you comment on any exposure you might be seeing in terms of thinking about competitors that we have seen report already?

It doesn't seem like you've have had any UK exposure.

It doesn't seem like you had any -- as good as the credit is, the offset might have been lower late fees or finance charges.

It doesn't seem like that has impacted this quarter.

And then, you are the company with the spend model, yet you are outdoing all the companies with the lend model.

And not only is the margin up while others might be a little bit down, but you're also continuing to grow at this great rate while imposing floating rate across your card base.

Can you just offer any comment on how that continues to work for you?

I would characterize it exactly as you did, Bruce.

I don't think there's anything magic about this.

This is something that we have worked on for a very long period of time.

And each component that you described is something that we have had real focus on.

So as I mentioned, we have had exposure in the UK for some time now.

Interest -- credit losses in the UK just didn't spike in the first quarter.

That's been underway for the last probably four quarters or so.

And anybody who travels there frequently reads about that in the paper, and it is pretty clear that that's happening.

The late fee issue for us -- no, finance charge has not been a particular issue because of the strength of the FICO scores that underlie our portfolio.

So as credit improves, that doesn't hurt us as bad as it hurt others.

At the same time, we haven't gotten as much benefit from the bankruptcy reserves that others have gotten.

We have continued to focus on the spend model as much as we possibly can.

We knew interest rates were going to go up and that our hedges would eventually roll off.

And so we worked hard to change the mix of the pricing on our lending portfolio.

And that has helped us as we have gone into this period of rising interest rates.

And we've tried to just sustain this effort.

And all of this, of course, is underlined by real good reengineering that has provided the fuel that we have needed at the right times to continue to drive the business.

So we feel really good about where the business is.

And there is nothing unusual or undisclosed that I didn't cover in my comments up front.

Joseph Dickerson, Atlantic Equities.

My question has been answered.

Brad Ball, Citigroup.

I wonder, would you take a minute to talk about, I guess, how you would score the U.S.

GNS business to date.

It has been about two years since the Supreme Court ruled in the DOJ's favor, and you've made a lot of headway.

Would you say that having the experience of MBNA and Citi and now B of A, you are quicker to market with product?

Would you say that you are overcoming the challenges of cannibalization?

Is that working out to be an issue for you?

What kind of responses have you gotten from the merchants now that some other card issuers are issuing AMEX cards?

Just give us an update on where you are.

And I think you mentioned also that USAA brought new cards this past quarter.

Who's next?

I think Juniper is probably in the pipeline.

And then who would be after that?

What would be the timeline going forward?

Actually, we feel terrific about where the U.S. is.

I wish, frankly, I could give you the exact percentage growth numbers.

But the percentage growth numbers in the U.S. have been outstanding.

If you think that the average is 31 and that the domestic business is 20, and so that must mean the U.S. business is doing very well overall in order to get to that 31% growth rate, particularly if you exclude the corporate number that was taken out of that.

So the U.S. business, I think, is doing just fine.

And if you look at the pieces, it has been an interesting process for us because there have been learnings that we have had as we have gone through this process.

Where we initially, I think, had the view that we would sign up one of our partners and immediately they would start issuing cards, and we would see those volumes materialize instantaneously, and surprisingly, it has actually been work.

We have had to get in and work together with them to help them understand the spend-centric model, how to kind of effectively target that business.

And as we have done that with our partners, our relationships have gotten stronger and stronger.

I think as they see that we have some ability to add value and we gain great respect for the capabilities that they have, that kind of working together on this has really been very beneficial for us, and we have seen some very nice increases overall.

So I think we have learned a lot from the first year and a half.

And that has enabled us to move a little more quickly with follow-on partners, and I have really good confidence in the business going forward.

One of the things that I receive is I get a daily report of our billed business of all of our partners around the world so I can actually watch the daily volumes of our partners grow over time.

And as you actually watch these daily volumes build, it gives you real confidence in what the penetration curve of each business is going to look like.

And obviously, each partner is on a slightly different curve.

The earlier partners are now moving into their expansion cycle.

And we have some brand-new partners like USAA that are just right at the start of that curve.

But we feel good about where that business is and the prospect that it has for us going forward.

We haven't really seen the full power that that business can bring to our return on equity.

As that business becomes larger and larger as a percentage of our total and requires relatively little capital, the impact that that can have on our return on equity is a side benefit that obviously has yet to materialize in our financial statements.

You know, we really don't disclose exactly when our partners are going to be launching things.

We like to do those as kind of big fanfare events.

And so I'm going to choose not to do that now.

But we have not only new partners, but within existing partners I think a good and compelling schedule of new product launches that you will see coming over the next few months that will continue to support our ability to grow the business in the U.S.

Just as a follow-up, Gary, your comment about the ROE -- so you are showing returns on segment capital of over 50%.

Are those numbers actually sustainable, or does that just reflect the growth of the GNS business?

No, I think -- I mean, there is nothing about that number that I don't think is sustainable.

As I say, I think GNS is an early stage of its development.

And so you get fee income that comes into that segment without a similar amount of capital associated with it.

And if the business were to play out according to what we think it has the potential to do, that should be the dynamic that we see within that segment.

And just finally, are you seeing the cannibalization that had been widely predicted?

Or has that not really amounted to much of a challenge for you?

There is cannibalization, and we have been able to quantify that.

We have actually gone out and studied that in some detail, particularly with our earliest partners.

But we then also look at what the incremental spend had been among those customers.

And what we have seen is that the incremental spend that we get, when they come over to the American Express network, more than offsets the loss that we get from the cannibalization.

That has been our experience so far.

Scott Valentin, Friedman, Billings, Ramsey.

A quick follow-up.

In the GNS business, you mentioned that a big portion of the Brazilian gain was offset by amortization adjustment.

I was wondering if that is a true-up or a recurring item -- a permanent increase in amortization?

And maybe some color on what that relates to a joint venture?

Yes, it was a true-up.

We had inappropriately amortized the goodwill on our Swiss card joint venture going back to 2001.

And so when we discovered that during the course of the quarter, we expensed it appropriately.

So it is a one-time item.

And just a follow-up -- on the GNS business, do you track spending for cards [multiple speakers]?

We do.

And actually, you can actually do the math, if you'd like.

We disclosed the billed business in the quarter and the number of cards that we have, so you can actually go through and do the math.

Now, if you look in this month's or this quarter's statement, realize that we brought over the full number of Brazil cards, but not the amount of Brazil spending, so you have to subtract 1.3 million cards out of that number in order to get to the true apples-and-apples comparison.

But I think what you would see is that billed business was up 31% and the cards adjusted for the 1.3 was up 27.

So average spend continues to grow on the GNS side, as it does on the proprietary side of the business.

We probably have time for just one more question.

Ken Posner, Morgan Stanley.

Gary, I think you already answered my question.

So maybe you guys --

Great.

You closed out easily for me, Ken, thank you.

Well, thank you all for joining.

We appreciate it.

Thank you for participating in today's conference.

You may now disconnect.