American Express' (AXP) Q3 2016 Results - Earnings Call Transcript

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American Express Company (NYSE:AXP)

Q3 2016 Earnings Conference Call

October 19, 2016 17:00 ET

Executives

Toby Willard - Head, Investor Relations

Jeff Campbell - Executive Vice President and Chief Financial Officer

Analysts

Craig Maurer - Autonomous

David Ho - Deutsche Bank

Bob Napoli - William Blair

Sanjay Sakhrani - KBW

Chris Brendler - Stifel

Chris Donat - Sandler O’Neill

Moshe Orenbuch - Credit Suisse

Ken Bruce - Bank of America/Merrill Lynch

Don Fandetti - Citigroup

James Friedman - Susquehanna Financial Group

Ryan Nash - Goldman Sachs

Eric Wasserstrom - Guggenheim Securities

Rick Shane - JPMorgan

Operator

Ladies and gentlemen, thank you for standing by and welcome to the American Express Third Quarter 2016 Earnings Call. [Operator Instructions] As a reminder, today’s conference is being recorded. I would now like to turn the conference over to Toby Willard, Head of Investor Relations. Please go ahead.

Toby Willard

Thanks, Ryan. Welcome. We appreciate all of you joining us for today’s call. The discussion contains certain forward-looking statements about the company’s future financial performance and business prospects, which are based on management’s current expectations and are subject to risks and uncertainties. Factors that could cause actual results to differ materially from these forward-looking statements are set forth within today’s presentation slides and in the company’s reports on file with the Securities and Exchange Commission. The discussion today also contains certain non-GAAP financial measures. Information relating to comparable GAAP financial measures maybe found in the third quarter 2016 earnings release and presentation slides as well as the earnings materials for prior periods that maybe discussed, all of which are posted on our website at ir.americanexpress.com. We encourage you to review that information in conjunction with today’s discussion.

Today’s discussion will begin with Jeff Campbell, Executive Vice President and Chief Financial Officer, who will review some key points related to the quarter’s results through the series of presentation slides. Once Jeff completes his remarks, we will move to a Q&A session.

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

Jeff Campbell

Well, thanks, Toby, and good afternoon, everyone. As you can see in this afternoon’s earnings release, our earnings per share for the third quarter came in at $1.20, which is 3% below the prior year. These results reflect our continued focus on our priorities of accelerating revenue growth, optimizing investments and substantially reducing our costs. There is clearly still a lot of work to do, but we are pleased with our performance through the third quarter and our results have come in above the expectations that we shared with you earlier this year.

The favorability was driven by faster than anticipated progress on our expense initiatives and steady credit performance. Also as we have discussed previously, we did take a very balanced approach to our second half assumptions given some of the dynamics within the U.S. consumer marketplace, including the portfolio sale last quarter in the overall competitive environment. While the environment continues to evolve, we now have greater clarity after seeing the consistent growth in adjusted billings, loans and revenue that we experienced in the third quarter.

Also as expected, Q3 included a higher level of investment spending than the prior year and certain impacts from our ongoing cost reduction initiatives, including a modest restructuring charge. And finally, we continued to use our capital strength to return a substantial amount of capital to shareholders. Separate from our operating results, this quarter also saw the recent Court of Appeals’ decision in our favor in the Department of Justice antitrust lawsuit. Though I would point out that the DOJ has the right to further appeal the decision.

The progress we have made this year gives us confidence to move ahead more aggressively into Q4 with a number of initiatives that we have been working on for some time. These include a renewed emphasis on our Platinum Card portfolios in the U.S., which provide a combination of service, access and benefits that have been the benchmark of value for more than 30 years. They also include our biggest campaign yet to build on the success of Small Business Saturday and drive additional spending at neighborhood businesses in a way that leverages the ongoing expansion of our merchant network in the U.S. through our OptBlue program. In addition, we are going to continue to build upon the digital marketing capabilities that help to bring on a record number of new card members this year with expanded acquisition campaigns, both in the U.S. and key international markets. Finally, we will be supporting all of these initiatives with an extensive advertising campaign.

With these and other initiatives coming together at the start of the peak shopping season, it will be a very active fourth quarter. In support of this, we are planning a substantial increase in our investment spending to bring together and leverage the combined impact of all these initiatives on our card members and merchants during the remainder of the year and to position us for growth in the years ahead. A highlight that the decision to increase investment levels is consistent with how we have run the company for many years as we seek to leverage earnings capacity to invest for the moderate to long term.

Turning now to the summary of our financial results on Slide 2 the revenues decreased by 5% reflecting the decline in volumes in card member loans following the portfolio sale in Q2. I would note that FX had a relatively small impact on our reported results this quarter, the first such quarter in quite some time. Net income was down 10% versus the prior year due primarily to the lower revenues combined with a higher level of investment spending. These impacts were offset in part by lower rewards and operating expenses.

We again leveraged our strong capital position to provide significant returns to shareholders. Over the past 12 months, we have repurchased 72 million shares which has driven a 7% reduction in our average share count. This decline in shares outstanding, along with our net income, drove EPS of $1.20 for the quarter, which was just 3% below the prior year. These results include a restructuring charge of $44 million this quarter related to our cost reduction efforts. Since we have provided a 2016 EPS outlook, excluding restructuring charges, I would point out that our adjusted EPS, after excluding the $0.04 restructuring charge, was $1.24 in the third quarter and $5.01 on a year-to-date basis. These results brought our reported ROE for the 12 months ended September 30 to 26%.

Moving now to our billed business performance trends, which you see several views of on Slides 3 through 6. Worldwide FX adjusted billings were down 3% during the quarter as you can see on Slide 3. As we have done the last two quarters, we have also provided a trend of adjusted worldwide billed business growth rates excluding both Costco cobrand volumes at all merchants and non-cobrand volumes at Costco on Slide 4. By this measure, FX adjusted billings growth was 7%, which was down from 8% last quarter.

We saw a number of positive trends within our underlying billings performance during the third quarter. Within the GCS segment, performance amongst both the U.S. and international middle market and small businesses remains healthy. Our international consumer billings growth rates remained strong, which I will come back to in a minute. In the U.S. consumer segment, while the ultimate outcome will play out over time, you are on track with our expectation to capture at least 20% of the out-of-store spending of the former Costco cobrand card members as a result of our acquisition efforts prior to the sale, which does provide some lift to our adjusted billings growth rates, but we are starting to lap it this quitter. We are also on track with the overall performance trends we had expected across the evolving and competitive U.S. consumer space, in particular, seeing strong growth across our U.S. Cashback products.

Our adjusted billings performance this quarter also reflected several challenges, which enacted our year-over-year growth rates. The largest driver of the sequential decline in the growth rate versus the second quarter was the end of our network relationship with Fidelity, which moved to a new network this quarter. As a reminder, the revenue contribution from Fidelity was minimal as we were not the card issuer. U.S. billings growth was also impacted by lower gas and airline ticket prices, which remained headwinds across our U.S. businesses and had a similar impact to the prior quarter. And finally, consistent with prior quarters, spending by large corporations remains weak with billings declining year-over-year, reflecting the slow growth revenue environment and cost reduction efforts being undertaken by many large companies.

Coming back to the drivers of total international billings performance on Slide 6, the increase in FX adjusted billings growth to 11% during the current quarter was driven by improved performance in JAPA, primarily due to an up-tick in growth rates in China. As you know, while China does impact our billings growth rates, it has a very small impact on our revenue and earnings due to the low margin that all networks are in on spending within the industry.

Within the EMEA region, our UK business continues to perform very well with FX adjusted growth of 16% during the third quarter. The weakening of the British pound that has occurred since the Brexit vote at the end of June has been a drag on our reported billings and revenues. But from an earnings perspective, as you recall, we are relatively hedged naturally against the pound as the UK serves as the headquarters for many of our international operations.

Turning now to loan performance on Slide 7, our loans on a GAAP basis were down 12% compared to Q3 ‘15, reflecting the sales of the two co-brand portfolios in the first half of this year. To help understand the underlying trends, on the right side of the slide, we have excluded the sold co-brand portfolios from the prior year and adjusted for FX. On this basis, adjusted worldwide loan growth of 12%, which is down from 13% in the second quarter, but continues to outpace the industry. We continue to see opportunities to increase our share of lending from both existing customers and high quality prospects. Over the last 2 years, as our co-brand loans have declined, we have successfully shifted our mix towards non-co-brand card members. These card members are more likely to revolve their balances, producing good returns for us, but they do have a slightly higher write-off rate. We do not believe that this mix change is driving any significant change to our overall credit profile and it is producing good returns.

Our net interest yield during the quarter was 9.8%, which was up from recent quarters. Several factors influenced this change. The sold co-brand loan had a slightly lower average yield than the rest of our tenured portfolio. In contrast, the non-co-brand card member launch to which our mix has shifted have a higher yield. In addition, some of the new card members from last year have begun to lap their introductory EPR periods. These positives were then partially offset by a small increase in the percentage of loans in introductory promotional periods due to our strong acquisitions over the past year.

Turning to provision on Slide 8, total provision decreased by 5%, as you can see on the left side of the slide, but this result includes provision in Q3 ‘15 related to the two co-brand portfolios that were sold earlier this year. When you exclude those credit costs from the prior year as we do on the right side of the slide, adjusted provision increased 6% versus the prior year. This 6% however, is a combination of two different trends. Charge card provision declined year-over-year due to improved credit performance as both worldwide write-off and delinquency rates were below prior year with the write-off rate in our U.S. consumer business reaching a new historical low. Consistent with prior quarter performance, adjusted lending provision increased by more than the growth rate loans. As expected, we are beginning to see some seasoning of our newer loan vintages.

Turning to our reported lending credit metrics, I would point out that they are impacted by the Costco loans that were not sold as part of the portfolio sale. As a reminder, these loans primarily relate to canceled accounts. They are having an impact on our reported write-off rates this quarter, but no provision impact as they were already reserved for at a higher level. Excluding these loans, adjusted write-off rates are relatively consistent with last quarter and remain best in class among peer issuers. Stepping back from the quarterly credit results, I would emphasize there has been no change in our credit outlook and the credit continues to perform better than our Investor Day expectations. Consistent with our previous comments, we expect the continued growth in adjusted loans and some modest upward pressure on our write-off rates due primarily to the seasoning of loans related to new card members will both contribute to an increase in adjusted provisions going forward.

Turning now to revenue performance on Slide 9, reported revenues were down 5% while adjusted revenue growth accelerated modestly from 4% in Q2 to 5% this quarter. This level of growth is consistent with our year-to-date adjusted revenue growth performance and the expectations we shared at our Investor Day in March. As we look at the detailed components of revenue on Slide 10, we see a decline in discount revenue from lower volumes, while on an adjusted basis, discount revenue increased by 5%. This was driven by the 7% increase in adjusted volumes that I already discussed for the quarter, offset partially by a decline in the ratio of discount revenue to billed business, which I will come back to in a few minutes. Net card fee growth continues to be strong, up 10% this quarter. We are seeing healthy growth in our domestic Platinum, Gold and Delta portfolios as well as in key international markets like Japan and Mexico. Steady growth in card fees is a reminder of the strength of our value propositions and our ability to attract and retain fee paying customers even in the phase of an intense competitive environment.

Moving on, net interest income was down 11% on lower reported loans while up 10% on an adjusted basis. As I mentioned earlier, adjusted loans were up 12% and net interest yield on card member loans increased year-over-year. These impacts were partially offset in net interest income by higher funding costs related to our charge card portfolio due to the increase in interest rates versus last year. Last, I would point out that net interest income represents 17% of our total revenues this quarter, somewhat lower than we have seen in recent quarters, given the sales of the co-brand portfolios.

Coming back now to discount rate performance on Slide 11, we saw the reported discount rate increase 1 basis point year-over-year as lower discount rate volume coming off the network more than offset the rate pressure from merchants’ negotiations, including those tied to new regulations in Europe and the continued growth of OptBlue. We did see the ratio of discount revenue to billed business moved down by 5 basis points year-over-year. The year-over-year decline stems in part from the continued growth from Cashback rewards. The greater sequential change in Q3 versus the reported discount rate is due to our billings mix shifting towards GNS or network business in Q3 as co-brand volumes declined.

Turning now to expense performance on Slide 12, you can see the total expenses were down 3% compared to the prior year. I will speak specifically about marketing shortly, so let me start by focusing on rewards. Reported rewards expense declined 11% versus the prior year, much more than the 3% decline in reported billings I mentioned earlier. We first noted this variance in Q2 as the billings from co-brand products that formerly drove rewards expense come off the network and are partially replaced with new volumes that are more likely to earn Cashback rewards, which are recorded as contra discount revenue. Excluding volumes and rewards in the Costco co-brand in the prior year and including the cost of rewards on Cashback products, the growth in adjusted rewards was relatively in line with the growth in adjusted proprietary billings this quarter. Looking forward, however and consistent with our Investor Day expectations, we would expect this trend to change and for rewards, including Cashback, to grow faster than billings as we continue to enhance our product value propositions over time beginning in the fourth quarter due to the recent enhancements to our U.S. Platinum products.

Turning then to operating expenses, we continue to feel good about the progress we have made to reduce our cost base by $1 billion on a run-rate basis by the end of 2017. We have made faster progress than we had anticipated on identifying and executing the key initiatives behind this effort. In the third quarter, this translated into operating expenses being down 3% year-over-year despite the $44 million restructuring charge that we took in the quarter.

Moving now to marketing and promotion expenses on Slide 13, I would remind you that as we entered 2016, we anticipated that our full year marketing spending will be similar to prior year levels of $3.1 billion. On last quarter’s earnings call, we highlighted that we anticipated full year marketing expenses would be at least $200 million higher than 2015 as we take advantage of attractive investment opportunities. Consistent with these comments from last quarter, marketing and promotion was up 10% versus the prior year in Q3. As we have discussed, new card acquisitions has been one of our investment-focused areas and we did acquire 1.7 million new cards across our U.S. issuing businesses this quarter and 2.5 million on a worldwide basis. This performance remains above our historical average level of acquisitions, though as expected, it is below the levels in recent quarters.

Looking ahead to Q4, the financial performance we have had year-to-date gives us confidence to move ahead more aggressively with the series of initiatives that we have been working on for some time. In particular, we plan to accelerate and leverage the combined progress we have made in several areas. First, providing increased marketing support for the tremendous Platinum card franchise that we have in the U.S., we are excited about the changes announced earlier this month, which will provide expanded travel benefits for our U.S. consumer and small business Platinum products. These new benefits are just one step in a series of further enhancements that we plan to make to the Platinum product over the course of the next year.

Second, leveraging our many years of sponsoring Small Business Saturday to build upon the success that we have had increasing awareness among small business merchants and card members. Small Business Saturday is a great example of how our closed loop enables us to partner and provide value to both our small business merchants and our existing card member base. We have made significant progress growing our small merchant footprint in the U.S. through OptBlue and believe that a fourth quarter promotional campaign represents an excellent opportunity to make our card members aware of the millions of new locations where American Express is now welcomed.

Third, further building on the success of our U.S. card acquisitions across all of our products, including the distinct opportunities present in the consumer cards segment. Fourth, increasing our acquisition efforts in key international markets to build upon the positive momentum seen in our international business. And last, supporting all of these efforts through an increased brand advertising presence around the globe to drive greater penetration and share of mind with both consumers and merchants.

We believe that the fourth quarter provides an opportunity to bring together and leverage the combined impact from all of these initiatives to best position the company for growth in 2017 and many years beyond. As a result, we now anticipate that marketing and promotion expenses during Q4 will be significantly higher sequentially and that for the full year, M&P will be more than 10% above 2015 close.

Moving now to capital, we continue to be pleased with our ability to return excess capital to shareholders through share buybacks and dividends. On a year-to-date basis, we have returned 92% of the capital we have generated to shareholders, which has driven a 7% reduction in our average shares outstanding. While we will, of course, be subject to the annual CCAR process going forward, we remain confident that the strength of our business model provides us with the ability to return significant amounts of capital to shareholders while maintaining our strong capital ratios.

So, let me now conclude by going back to the key themes in our results and providing an update on our outlook for the balance of the year. During the third quarter, we made progress on our key initiatives to accelerate revenue growth, including driving new card acquisitions across our global consumer and commercial portfolios, expanding merchant coverage and driving momentum on our lending growth initiatives. We also remain focused on our cost reduction efforts and continued to leverage our strong capital position to create value for our shareholders.

To put the third quarter into the context of our full year plan, as a reminder, the beginning of the year, our outlook was for full year 2016 earnings per share to be between $5.40 and $5.70, excluding restructuring charges and other contingencies. We also pointed out that consistent with our history we expected to use a portion of the portfolio sale gains to fund the increased spending on a range of growth initiatives across the company. We also said that we expected to use the gains to fund spending throughout the year, which would result in some unevenness in our quarterly results. On last quarter’s earnings call, we updated our outlook and said that we expected full year 2016 EPS to be at the high end of the $5.40 to $5.70 range. We also said that the competitive dynamics within the U.S. consumer space created a bit more uncertainty around our second half assumptions.

Today, while competition remains very intense and the environment will continue to evolve, we have greater clarity about the trends we are seeing due to our actual results this quarter. This clarity combined with continued favorable trends in credit and operating expense performance offset partially by the increases in marketing and promotion and rewards that I discussed what would have allowed us to raise our full year 2016 EPS guidance to be between $5.90 and $6. As a reminder, this outlook excludes the impact of restructuring charges or other contingencies.

Turning to 2017, our outlook for full year EPS to be at least $5.60 remains unchanged at this time. Given the faster than expected progress on our cost reduction initiatives, we do now anticipate that operating expenses in 2017 will be lower next year than the $10.9 billion shown in our Investor Day scenario. Depending upon our operating performance and the opportunities that we see in the marketplace, we believe that the accelerated operating expense savings we are achieving could provide us with the flexibility to have higher levels of marketing and promotion next year than in our Investor Day scenario while still tracking towards our $1 billion cost reduction target as well as our earnings target for 2017 of at least $5.60.

We continue to believe we have the right strategy in place to meet our objectives in 2017 and to build a solid base for driving longer term growth. We are pleased that our results so far this year have provided us with the flexibility to bring together marketing efforts in the fourth quarter around the host of initiatives I outlined earlier, while also raising our outlook for full year earnings. We are clearly operating in a challenging environment, but are intensely focused on executing the plans we have in place.

Toby Willard

Great. Thanks, Jeff. Before we open up the lines for Q&A, I will ask those in the queue to please limit yourself to just one question. Thank you for your cooperation. And with that, the operator will now open the line for questions. Ryan?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And we will go to the line of Craig Maurer with Autonomous. Please go ahead.

Craig Maurer

Yes, hi. Thanks for taking my question. Limiting it to one question, if we do see a rise in interest rates, do you expect there to be any change in the competitive environment as it would seem low credit combined – advantageous credit combined with low rates has allowed what you could call some second rate players to simply throw cash at the problem in the form of Cashback rewards?

Jeff Campbell

Well, Craig, I guess a few comments. We run the company and try to make our decisions based on a very long-term view of how we build long-term sustainable value for our shareholders by creating long-term relationships with our card members and merchants. Frankly, when we do that, we take it through the cycle view of the economics as we make decisions about what we can get good investment returns on and what we can’t. And so that leaves us believing that we should be aggressively investing where we see opportunities regardless of where we may be in the cycle. It is a competitive environment right now. But what I would say is that in response to that competitive environment, we try to stay very focused on our longer term goals and on creating the kinds of products, value propositions and offerings to our card members and merchants that bring to us people interested in the same kind of long-term sustainable value and relationships that we are after. Now, what is the rising interest rate environment as mean for that, well, certainly for us, I think everyone would recall that given the significance of our charge card franchise, for us all else being equal, rising interest rates are – cost us a little bit of money. 100 basis points all else being equal is a couple hundred of million dollars. On the other hand, rising interest rates, in theory, should be accompanied by reasonably good economic conditions and that generally provide some kind of offset. So we feel very comfortable that we have in place a range of strategies and tactics that will drive and be economically sustainable through whatever economic environment we face with these rising interest rates. What that might mean for the competitive environment, we will have to see, but we try not to make decisions counting on any particular change in the competitive environment.

Operator

Thank you. We will go to the line now of David Ho with Deutsche Bank.

David Ho

Good afternoon. Just talking about the incremental investment spend, particularly in your Platinum product, was this – how much of it was reactive versus proactive in response to a new entrant late in October and to what extent will this continue and kind of what’s the pace of investment, we kind of felt a taste of that due to a recent value prop increase, but what else next?

Jeff Campbell

I think it’s a good question, David. What I would say is we are continually working to maintain and keep vibrant what we believe is by far the gold standard in high end cards and that’s the Platinum product, both in the consumer market and the small business market. And you see as part of that us steadily and consistently evolving the product. If you think back over the last few years, every year have seen steady enhancements to the product from the introduction of the Centurion lounges to expansion of various travel oriented credits around TSA PreCheck and Global Entry through status that we are able to offer people through things like our partnership with Hilton HHonors. And so you see a very steady stream of these things. And there is a lot of thought, a lot of planning that goes into them. And what we have announced earlier this month is the latest in that steady stream. And as I said in my prepared remarks, you should expect more, so none of those things happen in response to any particular move by our competitors. They are all very long in the planning, but they all do stem from a general view of how we view the competitive environment evolving in general and how we think we can best evolve the product to take advantage of the broad range of brand and service and global reach that we can bring to our customers that are the kinds of things that we think let us stand out and are very difficult for competitors to match.

Operator

Our next question will come from the line of Bob Napoli with William Blair.

Bob Napoli

Thank you. And I guess I don’t want to beat the rewards thing to death, because there are so many other things to focus on. But with the Sapphire card and I would imagine that when you put your planning together, that you were aware that you would expect the Costco, Citi would have very aggressive marketing programs, but are you seeing – have you seen in effect on the cancellation rate or lost cards from these new competitive products and the rewards that you have put in place and the changes that you put in place, do you think that, that’s good enough to slowdown any competitive loss and then possibly lead to American Express starting to gain market share instead of losing market share?

Jeff Campbell

Well, there is a couple of good questions there Bob and let me start by talking about a couple of different product value propositions. When you look at the Platinum franchise, I would point out to you, as I said in my prepared remarks, that we have seen very nice growth both in numbers of Platinum members in the U.S. as well as the fee income from Platinum members over the course of the past year and that was a contributing factor in our card fees being up 10%. So I would start there and say we feel pretty good about that franchise and its part of why we are continually thinking about how we enhance the proposition in response to the evolving environment. When you look at the Cashback climate, we have been very successful. And again in my prepared remarks, I talked about a particularly good growth we have seen in the U.S. consumer space with our Cashback products. So we feel pretty good about those value propositions. So we will have to – it’s far too early to see any impact from things that have only been launched in very recent weeks and months. And there is – I said a few minutes ago, we are in the game for the very long-term to build long-term relationships with our customers. We believe we have product value propositions that are about creating the kind of relationship with our card members that goes on for many, many years. I would point out that when you look at our Platinum franchise, in many ways is built upon a group of people who stay with us for decades, not for short periods of times. So we feel pretty good about all those value propositions. In terms of market share, we have many, many different products across the consumer small business and commercial segments.

When you look at the U.S. market in total across all of those segments to remind everyone we found ourselves gaining quite a bit of share in the couple of years right after the financial crisis and ignoring the portfolio sales for just a second. We have had some modest share declines in the last couple of years. First and foremost, we run the company to create value, financial value for our shareholders. We create product value propositions that we think are attractive to our card members and will create long-term value for our shareholders. Certainly as we make decisions, one factor we consider is what’s happening with overall market share. But I would say our number one goal is how we create long-term sustainable financial value, and market share is just one factor that goes into that. So we are not ever happy or content to see ourselves losing a little bit of market share we have lost in the U.S. over the last couple of years. I would point out that outside the U.S., we have been gaining share in almost every market in which we operate. But I would close by saying our number one objective though is making the right decisions to build sustainable financial value.

Operator

Thank you. We will now go to the line of Sanjay Sakhrani with KBW.

Sanjay Sakhrani

Thank you. Jeff, I was wondering if you could help us with the run-rate of expenses as we move into 2017. I know 2016 has a lot of numbers, not a lot of stuff in there, but maybe you could just help us with how to think about the beginning point for 2017 off of which you will have those expense saves? And then secondly, just as far as the rewards costs are concerned, can you just help us think about how to think of the impacts to the rewards rate on the expense line and the discount rate as far as the cash rewards are concerned? Thanks.

Jeff Campbell

Well, there is quite a bit there. Sanjay let me take a cut at a few of those. On 2017 expenses broadly, I guess, I maybe break them into three categories: operating expenses and M&P and rewards. So to remind everyone, in March at our Investor Day, we showed one scenario for how you might get to our EPS target for 2017 of earning at least $5.60. In that scenario and we did point out there were other ways to get there as well, but in that scenario, we had operating expense in 2017 of $10.9 billion. And what I am telling you this evening is when we look at the progress we have made in identifying and executing on a range of initiatives, we will do better than that. Just how much better, we will have to see, but we will clearly do better and we feel good about that and we are continuing to work everyday to find more money and get the number as low as we can. The next thing I said in that Investor Day scenario is that versus a 2015 base of M&P of about $3.1 billion, we thought we could trim as much as $200 million to $400 million. We will have to see on that one. I would tell you that certainly to the extent we can do better on OpEx, to the extent we have revenue trends that allow us to achieve our financial bottom line targets, I suspect we will probably not pull down M&P as much as we suggested in that Investor Day scenario both because we may have the financial flexibility enough to do it. And look, I am certainly not going to sit on this call, Sanjay, try to argue with people that the environment doesn’t continue everyday to be a very, very competitive environment. So, our M&P probably comes somewhat off that 2015 level, but perhaps not as much.

Rewards is certainly a moving target, because it’s a function both of the new value propositions we put in the marketplace with Platinum as well as the evolving mix across our Cashback cobrand and proprietary portfolios. So on that one, I will tell you, other than the directional comment that beginning with the fourth quarter, you will see a reversal of the trend we have seen the last few quarters where neutral rewards have been growing a little bit more slowly than billings that will clearly reverse in Q4. It should be clear to you we have been planning that for some time. That’s why going back as far as Investor Day, I said built into the 2017 numbers and the scenarios we showed for what might happen beyond, we had assumed that rewards cost will grow faster than billings. But I think, Sanjay, I am probably going to wait one more quarter until we provide a little bit more insight into 2017 to be much more specific than that and the Q4 results I think will help everyone begin to calibrate as well.

Sanjay Sakhrani

Thanks.

Operator

Our next question comes from the line of Chris Brendler with Stifel. Please go ahead.

Chris Brendler

Hi, thanks. Good afternoon. First question on the UK, you see an acceleration there. I think it’s reflecting the same question I asked last quarter, it was 10% I think last quarter FX adjusted, now it’s 16%, lot of competitors sort of reacting to the interchange reductions there. What’s your strategy there? Are you gaining share because you are sort of holding the line of rewards in the face of the interchange reductions? And is there any color you can provide on your outlook for the UK business given that sort of competitive advantage at this point? Thanks.

Jeff Campbell

Well, I do – we are pleased by the growth we have seen in the UK, which has been in the double-digits, above 10% for quite some time now. And then I would also point out, as I said earlier, that, that is typical of the majority of countries outside the U.S. where we, in most countries, not all, but in most do find ourselves are gaining share albeit starting from much smaller basis in share than what we have in the U.S. We have a very flexible business model. You hear us talk a lot about the many different advantages of having a closed loop model gives us and we talked a lot about the value that we get from that fact everyday we have to go out and negotiate with merchants to demonstrate our value. And everyday, we have got to demonstrate our value to card members. That is giving us some flexibility in the UK and across Europe to try to craft propositions for both the merchants and card members that people find very attractive as that environment evolves. So, we are pleased with the growth in the UK. I would say that growth has been strong for some time, but it does seem to have picked up even a little bit more steam as you look at this year. So, we are pleased with that and we are working hard all across the EU to further build on that momentum. I would remind everyone however that in the nearer term an offset, which we talk about when we talk about the discount rate is that we are in a multiyear process probably of slowly renegotiating many of our merchant agreements in Europe. And as we renegotiate them because of the caps on interchange, there is more pressure on us in many ways to keep the differential similar, but bring the absolute breakdown and that’s part of what we have been talking about for some time now. That’s part of what’s putting some unusual downward pressure on our discount rate. So, that is an offset that we should remember to some of the nice volume performance we are seeing in Europe.

Chris Brendler

Thanks so much, Jeff.

Jeff Campbell

Thanks, Chris.

Operator

Our next question comes from the line of Chris Donat with Sandler O’Neill. Please go ahead.

Chris Donat

Good afternoon and thanks for taking my question. I wanted to ask about the success you have talked about in digital marketing with the 1.7 million accounts you added in the U.S. this quarter and 5.9 million year-to-date. Are you seeing improvements in your cost of acquisition relative to what you have seen in the past and is that a function of being digital or you are just getting better at acquiring customers than maybe were a couple of years ago?

Jeff Campbell

Yes. There is probably a couple of different phenomenon, Chris, worth commenting on. So yes, every quarter, we get better, more sophisticated more thoughtful about how we leverage our closed loop data in terms of making our digital marketing more effective. And that’s why across the globe in our consumer businesses, the majority of our new card member acquisitions for sometime now have come through digital channels. So, one of the reasons why we believe we can moderate marketing and promotional spend over time without losing traction on accelerating revenue growth is every quarter, we get a little better in digital marketing. It is far more economically efficient than some of the other direct mail or depending on what country you are in and the world we used direct sales channels sometimes in a few countries. The one thing I would acknowledge that goes the other way a little bit is certainly our relationship with Costco provided a really good source of acquiring new customers and that was a very low cost acquisition channel and they were good customers attracted to two good brands. So, we have lost that. One of the things internally that we do look at that and are pleased by is as we have lost that channel, we have effectively had to completely replace that acquisition effort with efforts in other channels. Digital has played a big part of that and we feel we have crossed the threshold, if you will, where our acquisitions now even though we have lost that one big former channel, we are above what they were in the prior year and we feel good about that mix. I would say though that certainly not all of our card member acquisitions are digital yet, and one of the positives to me about that is it means I see many years still ahead of us of getting better every year and that’s going to give us a little bit better economics every year. So thanks for the question.

Operator

And our next question comes from the line of Moshe Orenbuch with Credit Suisse. Please go ahead.

Moshe Orenbuch

Great. Thanks. Jeff, most of my questions were actually asked, but I was just hoping you could kind of discuss the performance of the global merchant services, the growth rate in revenue, you talked about – you mentioned Fidelity in your comments, but talk a little bit about the revenue growth and margin trends there, if you could?

Jeff Campbell

Yes. I would remind Moshe, you and for everyone, as we re-segmented the company after ‘10, reorganized the company late last year, we created the four new segments. In the new segments, what we call GMS, which is led by Anré Williams represents our merchant and loyalty businesses. That business does not have in it the – what we call the GMS or network business, which is the business that goes out and negotiates with third-party issues such as the third-party issuer of the Fidelity co-brands. That business is reported in our international consumer segment for the most card part because most of those are relationships are outside the U.S. Fidelity was one of the small number that were in the U.S. So with that as background, when you look at the GMS segment, quite frankly, it’s really going to track the overall company because what you are really seeing in that segment are the acquirer and network economics that go with the issuing done by the consumer in commercial segments. What you see when you look at what we are calling ICNS or the International Consumer and Network Services segment, is the combination of our proprietary issuing businesses outside the U.S. along with the network business. And we do provide in the tables some information about the growth in the network side of the business, which continues as it has for many years now to be of the highest growth in terms of billing segment of the company. So with all that as background, what I would say is the GMS segment really just reflects the overall company economics. And I am not sure I would add a lot there. When you look at the performance of the GMS or network business, we continued to be very pleased by growth in that business outside the U.S. I would say the business in the U.S. is not a growth business. It was down this quarter driven by Fidelity and that would be one thing that I would say is not a particular growth opportunity for the company at least in the near-term. But outside the U.S., we see very nice growth in Europe, Asia as well as Latin America. So thank you for the question.

Operator

Our next question comes from the line of Ken Bruce with Bank of America/Merrill Lynch. Please go ahead.

Ken Bruce

Thank you. Good evening and a surprising quarter in a very good way, so congratulations. My question relates to credit, you talked about competition being intense and most of that’s around rewards. One of the other areas that we have noticed is there has been a lot more focus on growing loans across the board and we are seeing some expansion of the credit box, all things being equal, you guys have been growing fast yourself and you talk about higher loss rates, I guess I would like you to try to dimensionalize kind of where you are expanding the credit box versus what you think is just seasoning within the portfolio without really changing the composition, the overall composition of that loan book. If you could help us with that, that would be great. Thank you.

Jeff Campbell

It’s a good question. Okay. I guess I would say a couple of things. As I said in my prepared remarks, what you have seen is that as our co-brand loan portfolio has shrunk due to the portfolio of sales, we have worked very hard to replace the growth that was formerly coming from those co-brand card members with non-co-brand card members. And as a general statement, we find that the non-co-brand card members are more likely to revolve on their balances. They do have higher write-off rates, so the average credit quality is marginally below where it was for the co-brand card members. We price for that. That’s part of why as I went to the net interest yield, our net interest yield sequentially has gone up a little bit because you are losing the lower yielding co-brand card members and you are gaining more non-co-brand card members where the yield tends to be a little bit better. So that’s the one area where I would say there is some evolution in the nature of the card members. You add to that seasoning because you go through a process over the first year or 2 years that you require a revolving card member where they evolve through the credit process. And those are the two things going on that have led us for some time now to say we feel good about our loan growth. We think we can grow loans at the kind of rates we have been growing them for a very long time and we think we can do without materially changing the overall credit profile of the company. Because I would also just remind you the other reason that we have been able to do that for some years now, because remember it’s not – we didn’t just accelerate our loan growth, it’s been well above the industry for several years now. And you haven’t seen a change in the relative credit profiles. We are able to grow loans probably because we are just focused on it now and we are creating the products that are attractive to consumers in that area. We are creating marketing that actually drives people to the product and could we just have more focus on it here as a management team. And as you heard us say over and over again over the last year, we really were leaving a target rich opportunity for ourselves with our very low penetration into our own card members borrowing behaviors. And so that’s a key difference I think Ken, between us and where others maybe because as we thought a few years ago to begin to accelerate our growth in loans, we really didn’t have to figure out we are already capturing our share of our own card members behaviors. How are you going to attract new card members, we had a very different proposition ahead of us. We could just say well, what do we do to start tuning our marketing and products so that we capture more of our appropriate share of wallet that we already captured on spend. So I think that gives us a very different opportunity set than others may have. And I think it’s an important component of why we had several years of growth above the industry while maintaining our relative credit positioning. So hope that helped.

Ken Bruce

Thank you. Yes, it does. Thank you.

Operator

Our next question comes from the line of Don Fandetti with Citigroup. Please go ahead.

Don Fandetti

Jeff, I was wondering if we can talk a little bit about where your thinking is on the international strategy, it sounds like it’s going to be one of the areas of investment that you highlighted, it’s been a pretty strong area where some of the U.S. consumer businesses are feeling intense competition, can you talk a bit about what you are thinking, are you getting more aggressive there, or is this just sort of continuing the pace?

Jeff Campbell

No, I – it’s a good question Don. And I do think we are trying to drive even more growth out of our international businesses. I will point out for some time now with the one challenge we had and Canada aside, we have seen really nice growth across our international consumer businesses. Our international small business segment, which is reported in GCS is – has consistently for some time now been our highest growth segment in the company. So we feel really good about the growth we have been getting and we will be doing a number of things to try to accelerate it further. When you say though talk about your international strategy, that’s always a challenging question, because we don’t have an international strategy. We have a strategy in the UK. We have different strategy in Germany where we are greatly able to leverage the tremendous strength of our business, which has really nice synergies. The card business, we have a totally different opportunity in Mexico where we have one of the largest market shares we have outside of the U.S. and a tremendous market position that’s growing rapidly. We have a very different strategy in Japan where due to a relationship we struck with JCB many, many years ago, it is one of the few international markets where we have tremendous coverage. And that has been fueling growth rates in the double-digits for a number of years right now. Sorry, I could go on, but I guess my point is we feel good about the trends that we have seen for a couple of years now. We are trying to provide even more resource and focus to invest in the markets where frankly we see the greatest traction and I just named a couple of them. It might be go on, but I won’t – don’t want to take too much of everyone’s time. And it’s really more about just putting more time, effort, resource and focus behind the things we are already doing.

Don Fandetti

And just as to quickly clarify I know it’s not material, but the China activity pick up, is that outbound coming out of China, is that sort of just organic growth or are there new signings of deals?

Jeff Campbell

No, it’s really organic growth. And so you do see the growth across all types, including outbound, but the biggest chunk is still intra China, where like all networks our share, we are allotted under the Chinese government’s rules is quite modest, to put it mildly. So we like to thank we have continued to you very successfully build the brand and build presence of China. We have been able to do that without putting any capital into China. And as the Chinese government inevitably moves towards a more open and competitive market, we hope that that brand presence that we have been able to create is an asset that we will be able to leverage more over time in the future.

Don Fandetti

Thank you.

Operator

Our next question comes from the line of James Friedman with American Express [ph]. Please go ahead.

James Friedman

Hi. I want to ask Jeff, if you had any observations or comments about your incubation strategy, I remember a couple of years ago you sold your Concur out of your portfolio, I think you probably disclosed Foursquare and [indiscernible] in China, I was wondering are there any assets that you are particularly excited about, I think that you might monetize over time? Thank you.

Jeff Campbell

That’s a good question, James. Certainly, we were pleased in the last couple of years, I would say, you saw two in particular really significant investments that turned out quite well for us, the ICBC investment as well as the Concur investment. We do run, as you would find it, many if not most companies of our size and scale, a venture capital group. And we do have very modest investments in a range of companies across the payments and technology spectrum. I would say our goal there is really about making sure we stay very close to where innovation is happening across all of the spaces that are interesting to us. Our goal is to invest with companies where we can also create working relationships and operating relationships where we can help them succeed and we can also stay with the pulse. And our goal is not to necessarily as the first priority find ourselves making lots of money by buying and selling these stakes. That’s not really the goal. And our goal is not to lose money. So from time to time, we have one of those companies that has some – take some kind of exit and there are modest gains that I don’t usually even bother to talk about are modest losses. For now that’s too quite a nice modest positive. But as I said, that’s not the goal. There is nothing else in the portfolio that I would say is material at this point that an investor should be aware of. There are always investments are quite small.

James Friedman

Thank you.

Operator

Our next question comes from the line of Ryan Nash with Goldman Sachs. Please go ahead.

Ryan Nash

Hi, good evening guys. I will try to make this one quick. Jeff, you gave us a lot of detail in terms of the puts and takes on the expense base, whether it’s the below 10.9 and/or the marketing and promotion dollars, can you just – given all the customer acquisition that you have done this year, can you just help us understand the outlook for revenues, clearly you talked about a lot of different areas, small business, calling back market share, increase lending what you have talked about on this call, but can you give us a sense of how you are progressing relative to expectations on revenues and given this increased marketing spend that you are doing, could – is there a potential we could see higher than expected revenue growth?

Jeff Campbell

Well, I think Ryan, as you would probably expect me to say, we will have to see. We are pleased that when you look at Q3, you saw a little bit of sequential acceleration from the 4% you saw in Q2. We are pleased that year-to-date 35% [ph], I would remind everyone that our scenario that we showed back in March at Investor Day through 2017 had a 5% revenue CAGR, so we are already there. We as a management team, we are laser focused on thinking through the best strategies for accelerating revenue growth further into the kind of higher range scenario that we talked about beyond 2017 at Investor Day. But we will have to see. There is – we feel very comfortable and confident in the choices we have made, but there is a lot of factors, whether it’s the economy or interest rates that someone brought up earlier or the evolving competitive environment. What I would say is we feel good about the earnings guidance we have given people for 2016 and 2017. We feel good about the revenue trends we have seen year-to-date. We feel good about the decisions we have made and we will see how that all plays out in 2017.

Ryan Nash

Thanks.

Operator

Next question comes from the line of Eric Wasserstrom with Guggenheim Securities. Please go ahead.

Eric Wasserstrom

Thanks very much. Jeff, I was hoping that you might just clarify how we should think about net income for next year? I mean, obviously, you have given the guidance on the EPS and we know that there is going to be significant share repurchases and you have talked to a number of the expense line items. But how do we think about the net income and core profitability relative to, let’s say, an annualized run-rate for the quarter that you just produced?

Jeff Campbell

Well, I would make a few comments. I think you should presume that we will execute upon the CCAR approvals that we have from a share repurchase perspective. And so that math will get you to some continued significant uplift in EPS versus net income. When you think about the quarter we were just in, I would say a couple of things. You would expect to see based on all the comments we have made a little growth in rewards costs relative to the quarter we just saw. On the other hand, we have a lot of operating expense that we are now confident we will get out as we get into 2017. We also believe we can moderate the marketing and promotional line somewhat. I talked a little bit earlier about the tubing and throwing that we will debate internally over the next couple of months about just how much. And then clearly, we are very focused on continuing to get good revenue growth and our goal is to accelerate it. So, you can sort of back into what that will mean depending on what you want to believe about where we end up on an EPS perspective. In some ways, I suppose the probably least variable of all the – variables I just talked you through would be share repurchase, because you can publicly see what we are going to do. Thanks to the CCAR process. So, that’s probably the way I would think about it, Eric.

Eric Wasserstrom

Thanks very much.

Toby Willard

Hey, Ryan, I think we have time for one more question.

Operator

Okay. That comes from the line of Rick Shane with JPMorgan. Please go ahead.

Rick Shane

Hey, guys. Thanks for taking my question. I will try to be quick here. Jeff, you had talked a little bit about the distortion that’s occurring is as you increase the mix towards Cashback between member rewards and the impact on net discount revenue. I am curious as we think about the fourth quarter and your emphasis on marketing – or excuse me, on growing the Platinum book, how we should think about that relationship, because I am assuming that’s not a Cashback offer?

Jeff Campbell

Correct. Yes, so it’s a good question, Rick. So to remind everyone, what I have been trying to do the last few quarters just due to the way the accounting rules work, we put our Cashback rewards up as a contra revenue and our membership rewards and cobrand rewards generally go down is what you see in the rewards line. So, we try to add all those up as they have been growing so much similarly in recent quarters. Rewards have actually been growing a little bit slower than billings. That will clearly change next quarter because of the Platinum changes. There were also in last year’s fourth quarter a couple of true-ups that kind of one-time things you have from time-to-time that helped lower last year’s Q4 rewards line. So the year-over-year change will look a little bit more exaggerated in this Q4 than in others. In some ways, it might be better to look at the sequential run-rates of rewards, Rick, to try to figure out what happens to the rewards line. But that Cashback counter rewards sequentially aren’t going to do anything unusual other than just grow as the products grow. And the two things that will change on the rewards line are the implementation of these Platinum changes, which will clearly drive significant cost. How much? We will have to see what the take up is, etcetera, along with this accounting item that I talked about from last year. So hopefully, that’s a little helpful in how you think about it.

Rick Shane

And the good news is that the clock is now ticking on anniversarying all of these adjustments. So 12 months from now, we won’t be thinking about this quite as much.

Jeff Campbell

I think everyone will enjoy the October 2017 earnings call, Rick, when I don’t have to do adjust at anything. Thank you very much for that reminder.

Rick Shane

You could be happiest guy out there.

Toby Willard

Alright. Thanks, everybody for joining tonight’s call and thank you for your continued interest in American Express. Ryan, I think we are all set.

Operator

Okay. Ladies and gentlemen that does conclude today’s conference. Thank you for your participation. You may now disconnect.

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