UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2000 Commission file number 1-9700
THE CHARLES SCHWAB CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 94-3025021
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
120 Kearny Street, San Francisco, CA 94108
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (415) 627-7000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes x No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
841,697,688* shares of $.01 par value Common Stock
Outstanding on April 28, 2000
* Excludes the effects of the three-for-two common stock split declared May 3,
2000 and payable May 30, 2000.
THE CHARLES SCHWAB CORPORATION
Quarterly Report on Form 10-Q
For the Quarter Ended March 31, 2000
Index
Page
Part I - Financial Information
Item 1. Condensed Consolidated Financial Statements:
Statement of Income 1
Balance Sheet 2
Statement of Cash Flows 3
Notes 4-7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8-16
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 16-17
Part II - Other Information
Item 1. Legal Proceedings 18
Item 2. Changes in Securities and Use of Proceeds 18
Item 3. Defaults Upon Senior Securities 18
Item 4. Submission of Matters to a Vote of Security Holders 18
Item 5. Other Information 18
Item 6. Exhibits and Reports on Form 8-K 18
Signature 19
FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains
"forward-looking statements" within the meaning of Section 27A of the Securities
Act, and Section 21E of the Securities Exchange Act of 1934. Forward-looking
statements are identified by words such as "believe," "anticipate," "expect,"
"intend," "plan," "will," "may" and other similar expressions. In addition, any
statements that refer to expectations, projections or other characterizations of
future events or circumstances are forward-looking statements. These
forward-looking statements, which reflect management's beliefs, objectives and
expectations as of the date hereof, are necessarily estimates based on the best
judgment of the Company's senior management. These statements relate to, among
other things, the Company's potential status under the Bank Holding Company Act,
contingent liabilities, the ability to successfully pursue the Company's
strategy to attract and retain customer assets, the ability of the Company to
realize the expected benefits of a merger, the decline in average revenue per
share traded, sources of liquidity and capital expenditures. Achievement of the
expressed beliefs, objectives and expectations is subject to certain risks and
uncertainties that could cause actual results to differ materially from those
beliefs, objectives and expectations. Readers are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of the date of
this Quarterly Report on Form 10-Q. Important factors that may cause such
differences are noted in this interim report, the Company's 1999 Annual Report
to Stockholders and the Company's Form 10-K for the year ended December 31,
1999. See "Forward-Looking Statements" in Management's Discussion and Analysis
of Financial Condition and Results of Operations in this interim report for a
discussion of important factors that may cause such differences.
THE CHARLES SCHWAB CORPORATION
Part 1 - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended
March 31,
2000 1999
---- ----
Revenues
Commissions $ 783,250 $ 472,652
Mutual fund service fees 236,973 169,295
Interest revenue, net of interest expense of
$266,009 in 2000 and $173,545 in 1999 263,980 149,851
Principal transactions 245,280 131,311
Other 42,393 28,476
- ----------------------------------------------------------------------------------------------------
Total 1,571,876 951,585
- ----------------------------------------------------------------------------------------------------
Expenses Excluding Interest
Compensation and benefits 591,338 390,214
Occupancy and equipment 79,134 59,975
Communications 86,510 66,763
Advertising and market development 100,934 52,591
Depreciation and amortization 49,693 33,593
Professional services 62,124 32,277
Commissions, clearance and floor brokerage 41,648 24,387
Goodwill amortization 4,756 1,276
Other 76,078 54,417
- ----------------------------------------------------------------------------------------------------
Total 1,092,215 715,493
- ----------------------------------------------------------------------------------------------------
Income before taxes on income 479,661 236,092
Taxes on income 195,414 93,225
- ----------------------------------------------------------------------------------------------------
Net Income $ 284,247 $ 142,867
====================================================================================================
Weighted-average common shares outstanding - diluted (1) 852,465 838,502
====================================================================================================
Earnings Per Share (1)
Basic $ .35 $ .18
Diluted $ .33 $ .17
====================================================================================================
Dividends Declared Per Common Share (1) $ .0140 $ .0140
====================================================================================================
Pro forma weighted-average common shares outstanding - diluted (2) 1,278,698 1,257,753
====================================================================================================
Pro Forma Earnings Per Share (2)
Basic $ .23 $ .12
Diluted $ .22 $ .11
====================================================================================================
Pro Forma Dividends Declared Per Common Share (2) $ .0093 $ .0093
====================================================================================================
(1) Excludes the effects of the three-for-two common stock split declared May 3, 2000 and payable May 30, 2000.
(2) Pro forma amounts include the effects of the three-for-two common stock split declared May 3, 2000 and payable
May 30, 2000.
See Notes to Condensed Consolidated Financial Statements.
THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(In thousands, except per share amounts)
(Unaudited)
March 31, December 31,
2000 1999
---- ----
Assets
Cash and cash equivalents $ 2,227,177 $ 2,079,128
Cash and investments required to be segregated under federal or other
regulations (including resale agreements of $4,267,081 in 2000
and $6,165,043 in 1999) 6,917,622 8,465,528
Receivable from brokers, dealers and clearing organizations 673,928 482,657
Receivable from customers - net 22,021,513 17,060,222
Securities owned - at market value 413,070 339,634
Equipment, office facilities and property - net 667,431 597,761
Goodwill - net 520,565 43,786
Other assets 299,148 230,345
- ----------------------------------------------------------------------------------------------------------
Total $33,740,454 $29,299,061
==========================================================================================================
Liabilities and Stockholders' Equity
Drafts payable $ 476,270 $ 467,758
Payable to brokers, dealers and clearing organizations 2,148,125 1,748,765
Payable to customers 26,203,756 23,422,592
Accrued expenses and other liabilities 1,114,525 931,011
Borrowings 655,129 455,000
- ----------------------------------------------------------------------------------------------------------
Total liabilities 30,597,805 27,025,126
- ----------------------------------------------------------------------------------------------------------
Stockholders' equity:
Preferred stock - 9,940 shares authorized; $.01 par value
per share; none issued
Common stock - 2,000,000 shares authorized; $.01 par value per share;
839,215 and 822,249 shares issued and outstanding in 2000 and 1999,
respectively* 8,394 8,224
Additional paid-in capital 1,150,861 539,408
Retained earnings 2,067,070 1,794,282
Unearned ESOP shares (453) (967)
Unamortized restricted stock compensation (83,282) (70,926)
Foreign currency translation adjustment 59 3,914
- ----------------------------------------------------------------------------------------------------------
Total stockholders' equity 3,142,649 2,273,935
- ----------------------------------------------------------------------------------------------------------
Total $33,740,454 $29,299,061
==========================================================================================================
* Excludes the effects of the three-for-two common stock split declared May 3, 2000 and payable May 30, 2000.
See Notes to Condensed Consolidated Financial Statements.
THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
(Unaudited)
Three Months Ended
March 31,
2000 1999
---- ----
Cash flows from operating activities
Net income $ 284,247 $ 142,867
Noncash items included in net income:
Depreciation and amortization 49,693 33,648
Goodwill amortization 4,756 1,221
Compensation payable in common stock 21,766 16,759
Deferred income taxes (3,465) (2,402)
Other 3,947 3,717
Change in securities owned (73,431) (74,541)
Change in other assets (32,768) (25,951)
Change in accrued expenses and other liabilities 207,452 101,466
- ----------------------------------------------------------------------------------------------------------
Net cash provided before change in customer-related balances 462,197 196,784
- ----------------------------------------------------------------------------------------------------------
Change in customer-related balances:
Cash and investments required to be segregated under
federal or other regulations 1,541,546 1,156,233
Receivable from brokers, dealers and clearing organizations (187,649) (164,219)
Receivable from customers (4,958,103) (2,175,730)
Drafts payable 8,695 (61,896)
Payable to brokers, dealers and clearing organizations 403,619 80,501
Payable to customers 2,779,572 897,245
- ----------------------------------------------------------------------------------------------------------
Net change in customer-related balances (412,320) (267,866)
- ----------------------------------------------------------------------------------------------------------
Net cash provided (used) by operating activities 49,877 (71,082)
- ----------------------------------------------------------------------------------------------------------
Cash flows from investing activities
Purchase of equipment, office facilities and property - net (116,363) (55,962)
Cash payments for business combinations and investments,
net of cash received 10,011 (5,657)
- ----------------------------------------------------------------------------------------------------------
Net cash used by investing activities (106,352) (61,619)
- ----------------------------------------------------------------------------------------------------------
Cash flows from financing activities
Proceeds from borrowings 200,000
Dividends paid (11,468) (11,287)
Proceeds from stock options exercised and other 16,564 28,972
- ----------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 205,096 17,685
- ----------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents (572) (949)
- ----------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents 148,049 (115,965)
Cash and cash equivalents at beginning of period 2,079,128 1,155,928
- ----------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 2,227,177 $ 1,039,963
==========================================================================================================
See Notes to Condensed Consolidated Financial Statements.
THE CHARLES SCHWAB CORPORATION
NOTES TO CONDENSED
CONSOLIDATED FINANCIAL
STATEMENTS
(Unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
include The Charles Schwab Corporation (CSC) and its subsidiaries (collectively
referred to as the Company). CSC is a holding company engaged, through its
subsidiaries, in securities brokerage and related financial services. CSC's
principal subsidiary, Charles Schwab & Co., Inc. (Schwab), is a securities
broker-dealer with 356 domestic branch offices in 48 states, as well as branches
in the Commonwealth of Puerto Rico and the U.S. Virgin Islands. Another
subsidiary, Charles Schwab Europe (CSE) is a retail securities brokerage firm
located in the United Kingdom. Other subsidiaries include Charles Schwab
Investment Management, Inc., the investment advisor for Schwab's proprietary
mutual funds, and Schwab Capital Markets L.P. (SCM) (prior to March 1, 2000,
this business was known as Mayer & Schweitzer, Inc.), a market maker in Nasdaq
and other securities providing trade execution services to broker-dealers and
institutional customers. On March 1, 2000, the Company completed the acquisition
of CyBerCorp, Inc. (CyBerCorp), an electronic trading technology and brokerage
firm providing Internet-based services to highly active, online investors.
These financial statements have been prepared pursuant to the rules and
regulations of the Securities and Exchange Commission (SEC) and, in the opinion
of management, reflect all adjustments necessary to present fairly the financial
position, results of operations and cash flows for the periods presented in
conformity with generally accepted accounting principles. All adjustments were
of a normal recurring nature. All material intercompany balances and
transactions have been eliminated. These financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's 1999 Annual Report to Stockholders, which are
incorporated by reference in the Company's 1999 Annual Report on Form 10-K. The
Company's results for any interim period are not necessarily indicative of
results for a full year.
Certain items in prior periods' financial statements have been reclassified
to conform to the 2000 presentation.
2. New Accounting Standard
Statement of Financial Accounting Standards (SFAS) No. 137, which amended
the effective date of SFAS No. 133 - Accounting for Derivative Instruments and
Hedging Activities, was issued in June 1999. The Company is required to adopt
SFAS No. 133 by January 1, 2001. This statement establishes accounting and
reporting standards requiring that all derivative instruments are recorded on
the balance sheet as either an asset or a liability, measured at its fair value.
The statement requires that changes in the derivative's fair value are
recognized currently in earnings unless specific hedge accounting criteria are
met and such hedge accounting treatment is elected. While the Company is
currently evaluating the effects of this statement, its adoption is not expected
to have a material impact on the Company's financial position, results of
operations, earnings per share or cash flows.
3. Business Combinations
Share data throughout this Note has not been restated to reflect the
effects of the three-for-two common stock split declared May 3, 2000 and payable
May 30, 2000.
On March 1, 2000, the Company acquired CyBerCorp for $517 million in a
non-taxable stock-for-stock exchange. Pursuant to the acquisition, CyBerCorp
became a wholly owned subsidiary of CSC which resulted in 11,713,000 shares of
CSC's common stock and 2,051,000 options to purchase CSC common stock being
exchanged for all of the outstanding shares, options and equity rights of
CyBerCorp. Because the acquisition is accounted for using the purchase method,
the operating results of CyBerCorp are included in the consolidated results of
the Company since the acquisition date. The historical results of CyBerCorp are
not included in periods prior to the acquisition. The net assets acquired are
recorded at fair value and the excess of the purchase price over the fair value
of net assets acquired is recorded as goodwill. The Company recorded intangible
assets acquired of approximately $512 million, including approximately $482
million of goodwill. The goodwill is amortized on a straight-line basis over a
period of ten years. Other intangible assets acquired, which consist primarily
of purchased technology and total $30 million, are amortized on a straight-line
basis over a period of three years.
On January 13, 2000, the Company announced the execution of a merger
agreement with U.S. Trust Corporation (U.S. Trust). Under the terms of the
agreement, U.S. Trust will become a wholly owned subsidiary of CSC and U.S.
Trust shareholders will receive 3.427 shares of CSC's common stock for each
common share of U.S. Trust. Based on the number of common shares of U.S. Trust
and options and other equity rights to acquire common shares of U.S. Trust
outstanding on January 12, 2000, the Company anticipates that U.S. Trust's
shareholders will receive approximately 73,000,000 shares (net of shares for
employees' payroll tax withholding) of CSC's common stock in the merger. Upon
completion of the merger, the Company expects to incur merger-related costs of
$53 million pre-tax, or $44 million after-tax, for professional fees and change
in control related compensation payable to U.S. Trust employees. In addition,
under the terms of the merger agreement, the Company plans to establish a
retention program for all U.S. Trust employees, whereby the employees will
receive cash compensation and stock options, contingent upon continued
employment, at the end of the two-year period following the completion of the
merger. The Company plans to recognize the $125 million cost of the cash
component of the U.S. Trust retention program over this two-year period.
Accordingly, the Company plans to recognize $16 million pre-tax, or $10 million
after-tax, per quarter for this merger-related compensation expense. Following
the merger, the Company expects to become a financial holding company under the
Bank Holding Company Act of 1956, as amended. The transaction is subject to the
approval of the Board of Governors of the Federal Reserve System (Federal
Reserve Board), other regulatory approvals and to U.S. Trust shareholder
approval. The transaction, which is expected to be completed by June 2000, is
intended to be a non-taxable stock-for-stock exchange and to qualify for pooling
of interests accounting treatment. See note "11 - Subsequent Events."
4. Comprehensive Income
Comprehensive income includes net income and changes in equity except those
resulting from investments by, or distributions to, stockholders. Comprehensive
income is as follows (in thousands):
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
2000 1999
- --------------------------------------------------------------------------------
Net income $284,247 $142,867
Foreign currency translation adjustment (3,855) (1,247)
- --------------------------------------------------------------------------------
Total comprehensive income $280,392 $141,620
================================================================================
5. Earnings Per Share
Basic EPS excludes dilution and is computed by dividing net income by the
weighted-average number of common shares outstanding for the period. Diluted EPS
reflects the potential reduction in EPS that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock.
Earnings per share under the basic and diluted computations are as follows (in
thousands, except per share amounts):
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
2000 1999
- --------------------------------------------------------------------------------
Net income $284,247 $142,867
================================================================================
Weighted-average common
shares outstanding - basic (1) 821,907 803,379
Common stock equivalent shares
related to stock incentive plans (1) 30,598 35,123
- --------------------------------------------------------------------------------
Weighted-average common
shares outstanding - diluted (1) 852,505 838,502
================================================================================
Basic earnings per share (1) $ .35 $ .18
================================================================================
Diluted earnings per share (1) $ .33 $ .17
================================================================================
(1) Excludes the effects of the three-for-two common stock split declared May 3,
2000 and payable May 30, 2000.
The computation of diluted EPS for the three months ended March 31, 2000
excludes stock options to purchase 3,262,000 shares because the exercise prices
for those options were greater than the average market price of the common
shares, and therefore the effect would be antidilutive. There were no such
antidilutive stock options outstanding at March 31, 1999.
6. Potential Bank Holding Company Act Requirements
Upon consummation of the transaction with U.S. Trust, the Company expects
to become a financial holding company, subject to Federal Reserve Board
supervision, under the Bank Holding Company Act of 1956, as amended. The
transaction is subject to Federal Reserve Board and other regulatory approvals
and to U.S. Trust's shareholder approval. If such regulatory and shareholder
approvals are obtained, the Company will be required to limit its business to
financial services. It may be required to maintain capital at certain levels
which could affect its ability to pay dividends. Under certain circumstances,
the Company may be required to provide additional capital to its subsidiaries,
and such subsidiaries may be prohibited from paying dividends. Additionally,
Federal Reserve Board approval will be required for certain changes in control
of CSC. See note "11 - Subsequent Events."
7. Regulatory Requirements
Schwab and SCM are subject to the Uniform Net Capital Rule under the
Securities Exchange Act of 1934 (the Rule). Schwab and SCM compute net capital
under the alternative method permitted by this Rule, which requires the
maintenance of minimum net capital, as defined, of the greater of 2% of
aggregate debit balances arising from customer transactions or a minimum dollar
amount, which is based on the type of business conducted by the broker-dealer.
The minimum dollar amount for both Schwab and SCM is $1 million. Under the
alternative method, a broker-dealer may not repay subordinated borrowings, pay
cash dividends, or make any unsecured advances or loans to its parent or
employees if such payment would result in net capital of less than 5% of
aggregate debit balances or less than 120% of its minimum dollar amount
requirement. At March 31, 2000, Schwab's net capital was $2,228 million (10% of
aggregate debit balances), which was $1,781 million in excess of its minimum
required net capital and $1,111 million in excess of 5% of aggregate debit
balances. At March 31, 2000, SCM's net capital was $68 million, which was $67
million in excess of its minimum required net capital. Certain other
subsidiaries of CSC are subject to regulatory and other requirements of the
jurisdictions in which they operate. At March 31, 2000, these subsidiaries were
in compliance with their applicable requirements.
Schwab, SCM and CSE had portions of their cash and investments segregated
for the exclusive benefit of customers at March 31, 2000, in accordance with
applicable regulations.
8. Commitments and Contingent Liabilities
The nature of the Company's business subjects it to numerous regulatory
investigations, claims, lawsuits and other proceedings in the ordinary course of
its business. The results of these legal proceedings cannot be predicted with
certainty. There can be no assurance that these matters will not have a material
adverse effect on the Company's results of operations in any future period,
depending partly on the results for that period, and a substantial judgment
could have a material adverse impact on the Company's financial condition.
However, it is the opinion of management, after consultation with outside legal
counsel, that the ultimate outcome of the current matters will not have a
material adverse impact on the financial condition or operating results of the
Company.
9. Segment Information
The Company structures its segments according to its various types of
customers and the services provided to those customers. These segments have been
aggregated, based on similarities in economic characteristics, types of
customers, services provided, distribution channels and regulatory environment,
into three reportable segments - Individual Investor, Institutional Investor and
Capital Markets.
Financial information for the Company's reportable segments is presented in
the table below (in thousands). Intersegment revenues are immaterial and are
therefore not disclosed. Total revenues and income before taxes on income are
equal to the Company's consolidated amounts as reported in the condensed
consolidated statement of income.
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
2000 1999
- --------------------------------------------------------------------------------
Revenues
Individual Investor $1,094,593 $664,723
Institutional Investor 218,602 141,996
Capital Markets 258,681 144,866
- --------------------------------------------------------------------------------
Total $1,571,876 $951,585
================================================================================
Income Before Taxes on Income
Individual Investor $ 334,348 $167,072
Institutional Investor 78,878 33,985
Capital Markets 66,435 35,035
- --------------------------------------------------------------------------------
Total $ 479,661 $236,092
================================================================================
10. Supplemental Cash Flow Information
Certain information affecting the cash flows of the Company follows (in
thousands):
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
2000 1999
- --------------------------------------------------------------------------------
Income taxes paid $ 67,050 $ 31,695
================================================================================
Interest paid:
Customer cash balances $240,857 $154,958
Stock-lending activities 15,540 11,934
Borrowings 12,011 8,146
Other 873 1,850
- --------------------------------------------------------------------------------
Total interest paid $269,281 $176,888
================================================================================
Non-cash investing and financing activities:
Common stock and options issued for
purchase of CyBerCorp $504,332
================================================================================
11. Subsequent Events
Subsequent to March 31, 2000 and prior to the date of this report, the
Company issued the remaining $111 million in Senior Medium-Term Notes, Series A
available under its current prospectus supplement on file with the SEC. On May
5, 2000, the Company filed a Registration Statement under the Securities Act of
1933 on Form S-3 relating to the issuance of up to $750 million aggregate
principal amount of debt securities. As of the filing date of this quarterly
report on Form 10-Q, the Registration Statement has not yet been declared
effective by the SEC, and therefore these securities are not yet issuable. The
proceeds from the sale of these securities will be used for general corporate
purposes.
On May 3, 2000, the Board of Directors approved a three-for-two split of
CSC's common stock, which will be effected in the form of a 50% stock dividend.
The stock dividend is payable May 30, 2000 to stockholders of record May 12,
2000.
As a consequence of the stock split, the exchange ratio in the U.S. Trust
merger transaction will be adjusted such that holders of the common shares of
U.S. Trust will receive 5.1405 shares of CSC's common stock for each common
share that they own. The 5.1405 rate replaces the exchange ratio of 3.427
described in note "3 - Business Combinations."
On May 1, 2000, the Federal Reserve Board announced its approval of the
Company's application to become a bank holding company by acquiring U.S. Trust.
The Federal Reserve Board also announced that the Company's election to be a
financial holding company would become effective upon the consummation of CSC's
acquisition of U.S. Trust. The transaction has also been approved by the bank
regulatory authorities in Connecticut, Delaware, New York and North Carolina,
and the process of obtaining other requisite regulatory approvals is continuing.
THE CHARLES SCHWAB CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Description of Business
The Charles Schwab Corporation (CSC) and its subsidiaries (collectively
referred to as the Company) provide securities brokerage and related financial
services for 6.9 million active customer accounts(a). Customer assets in these
accounts totaled $823.2 billion at March 31, 2000. CSC's principal subsidiary,
Charles Schwab & Co., Inc. (Schwab), is a securities broker-dealer with 356
domestic branch offices in 48 states, as well as branches in the Commonwealth of
Puerto Rico and the U.S. Virgin Islands. Another subsidiary, Charles Schwab
Europe (CSE), is a retail securities brokerage firm located in the United
Kingdom. Other subsidiaries include Charles Schwab Investment Management, Inc.,
the investment advisor for Schwab's proprietary mutual funds, and Schwab Capital
Markets L.P. (SCM) (prior to March 1, 2000, this business was known as Mayer &
Schweitzer, Inc.), a market maker in Nasdaq and other securities providing trade
execution services to broker-dealers and institutional customers. On March 1,
2000, the Company completed the acquisition of CyBerCorp, Inc. (CyBerCorp), an
electronic trading technology and brokerage firm providing Internet-based
services to highly active, online investors.
- ---------------
(a) Accounts with balances or activity within the preceding eight months.
The Company provides financial services to individuals, institutional
customers and broker-dealers through three segments - Individual Investor,
Institutional Investor and Capital Markets. The Individual Investor segment
includes the Company's domestic and international retail operations. The
Institutional Investor segment provides custodial, trading and support services
to independent investment managers, and serves company 401(k) plan sponsors and
third-party administrators. The Capital Markets segment provides trade execution
services in Nasdaq, exchange-listed and other securities primarily to
broker-dealers and institutional customers. The Company's mutual fund services
are considered a product and not a segment. Mutual fund service fees are
included in both the Individual Investor and Institutional Investor segments.
The Company's strategy is to attract and retain customer assets by focusing
on a number of areas within the financial services industry - retail brokerage,
mutual funds, support services for independent investment managers, 401(k)
defined contribution plans and equity securities market-making.
To pursue its strategy and its objective of long-term profitable growth,
the Company plans to continue to leverage its competitive advantages. These
advantages include a nationally recognized brand, a broad range of products and
services, multi-channel delivery systems and an ongoing investment in
technology. While the Company's business continues to be predominantly conducted
in the U.S., the Company continues to selectively expand its international
presence.
Brand: The Company's nationwide advertising and marketing programs support
its strategy by continually reinforcing the strengths and key attributes of
Schwab's full-service offering. By maintaining a consistent level of visibility
in the market place, the Company seeks to establish a leading and lasting
financial service brand in a focused and cost-effective manner. The Company
primarily uses a combination of network, cable and local television, print
media, and athletic event sponsorship in its advertising to investors. These
programs helped the Company attract $44.0 billion in net new customer assets and
open 494,000 new accounts during the first quarter of 2000.
Products and Services: The Company offers a broad range of value-oriented
products and services to meet customers' varying investment and financial needs,
including help and advice and access to extensive investment research, news and
information. The Company's approach to advice is based on long-term investment
strategies and guidance on portfolio diversification and asset allocation. The
Company strives to demystify investing by educating and assisting customers in
the development of investment plans. This approach is designed to be offered
consistently across all of the Company's delivery channels and provides
customers with a wide selection of choices for their investment needs. Schwab's
registered representatives can assist investors in developing asset allocation
strategies and evaluating their investment choices, and refer investors who
desire additional guidance to independent investment managers through the Schwab
AdvisorSource(TM) service. Schwab's Mutual Fund Marketplace(R) provides
customers with the ability to invest in 1,987 mutual funds from 323 fund
families, including 1,165 Mutual Fund OneSource(R) funds. Schwab also provides
custodial, trading and support services to approximately 6,000 independent
investment managers. As of March 31, 2000, these managers were guiding the
investments of 902,000 Schwab customer accounts containing $235.9 billion in
assets.
The Company responds to changing customer needs with continued product,
technology and service innovations. During the first quarter of 2000, the
Company launched the Schwab Portfolio Consultation(TM), a package of analytical
services and individual consultations with Schwab investment specialists
designed to assist customers in evaluating their asset allocations and
determining whether, when and how to re-balance their investments. Schwab
introduced a number of Web-based service offerings during the first quarter of
2000, including the Schwab Learning Center, which provides access to interactive
courseware designed to help customers learn more about investing principles and
using the online channel. Additionally, Schwab introduced the Charles Schwab
Stock Analyzer(TM), a tool that guides customers through the basics of equity
research, and launched a comprehensive retirement planning Web site that
contains a variety of planning tools and educational materials. Further, Schwab
added Market Analysis and Trade Notification alerts to the SchwabAlerts(TM)
customer e-mail service, and also enhanced the Schwab Portfolio Check-Up(TM)
online asset allocation tool so that customers can include non-Schwab holdings
in their analyses. Schwab also introduced PocketBroker(TM), a wireless product
that enables U.S. investors to access account information and place orders
through cellular phones or other handheld devices.
Delivery Systems: The Company's multi-channel delivery systems allow
customers to choose how they prefer to do business with the Company. To enable
customers to obtain services in person with a Company representative, the
Company maintains a network of branch offices which also provides investors with
access to the Internet. Telephonic access to the Company is provided primarily
through four regional customer telephone service centers and two online customer
support centers that operate both during and after normal market hours.
Additionally, customers are able to obtain financial information on an automated
basis through the Company's automated telephonic and online channels. Automated
telephonic channels include TeleBroker(R), Schwab's touch-tone telephone quote
and trading service, and VoiceBroker(TM), Schwab's voice recognition quote and
trading service. Online channels include the Charles Schwab Web Site(TM), an
information and trading service on the Internet at www.schwab.com, and PC-based
services such as SchwabLink(R), a service for investment managers. While the
online channel is the Company's fastest-growing channel, the Company continues
to stress the importance of Clicks and Mortar(TM) access - blending the power of
the Internet with personal service to create a full-service customer experience.
Schwab provides every retail customer access to all delivery channels and
flat-fee pricing for Internet trades. During the first quarter of 2000, Schwab
announced reduced online pricing for more actively trading investors and a plan
to increase fees related to minimum account balances.
Technology: The Company's ongoing investment in technology is a key element
in expanding its product and service offerings, enhancing its delivery systems,
providing fast and consistent customer service, reducing processing costs, and
facilitating the Company's ability to handle significant increases in customer
activity without a corresponding rise in staffing levels. The Company uses
technology to empower its customers to manage their financial affairs and is a
leader in driving technological advancements in the financial services industry.
International Expansion: In February 2000, the Company formed a joint
venture with ecorp Limited to provide financial services to investors in
Australia and New Zealand. Additionally during the first quarter of 2000, Schwab
expanded its international offering by announcing plans to work with Barclays
PLC to develop and operate an automated foreign exchange facility that will
enable non-U.S. investors to buy and sell securities in different foreign
markets through their Schwab account. Schwab also launched a new online service
that features research and information about U.S. financial markets in Chinese.
Pending Merger: During the first quarter of 2000, the Company announced the
execution of a merger agreement with U.S. Trust Corporation (U.S. Trust), a
leading wealth management firm serving affluent individuals and families. This
transaction is intended to combine certain of the Company's strengths -
technology, operations, advertising and distribution - with U.S. Trust's highly
personalized service model, research capabilities, trust and estate services,
investment track record and reputation in wealth management services. Management
believes that the combined organization can create a comprehensive, integrated,
value-priced, wealth management offering for affluent households, including both
individual investors and customers of independent investment managers. The
transaction, which is expected to be completed by June 2000, is intended to
qualify for pooling of interests accounting treatment.
Risk Management
For discussion on the Company's principal risks and some of the policies
and procedures for risk identification, assessment and mitigation, see
"Management's Discussion and Analysis of Results of Operations and Financial
Condition - Risk Management" in the Company's 1999 Annual Report to
Stockholders, which is filed as Exhibit 13.1 to the Company's Form 10-K for the
year ended December 31, 1999. See Liquidity and Capital Resources of this report
for a discussion on liquidity risk; and see Item 3- Quantitative and Qualitative
Disclosures About Market Risk for additional information relating to market
risk.
Given the nature of the Company's revenues, expenses and risk profile, the
Company's earnings and CSC's common stock price may be subject to significant
volatility from period to period. The Company's results for any interim period
are not necessarily indicative of results for a full year. Risk is inherent in
the Company's business. Consequently, despite the Company's attempts to identify
areas of risk, oversee operational areas involving risk and implement policies
and procedures designed to mitigate risk, there can be no assurance that the
Company will not suffer unexpected losses due to operating or other risks.
Forward-Looking Statements
This Quarterly Report on Form 10-Q, contains "forward-looking statements"
within the meaning of Section 27A of the Securities Act, and Section 21E of the
Securities Exchange Act of 1934. Forward-looking statements are identified by
words such as "believe," "anticipate," "expect," "intend," "plan," "will," "may"
and other similar expressions. In addition, any statements that refer to
expectations, projections or other characterizations of future events or
circumstances are forward-looking statements. These forward-looking statements,
which reflect management's beliefs, objectives and expectations as of the date
hereof, are necessarily estimates based on the best judgment of the Company's
senior management. These statements relate to, among other things, the Company's
potential status under the Bank Holding Company Act (see note "6 - Potential
Bank Holding Company Act Requirements" in Item 1 - Notes to Condensed
Consolidated Financial Statements), contingent liabilities (see note "8 -
Commitments and Contingent Liabilities" in Item 1 - Notes to Condensed
Consolidated Financial Statements), the ability to successfully pursue the
Company's strategy to attract and retain customer assets (see Description of
Business), the ability of the Company to realize the expected benefits of a
merger (see Description of Business - Pending Merger), the decline in average
revenue per share traded (see Revenues - Principal Transactions), sources of
liquidity (see Liquidity and Capital Resources - Liquidity), and capital
expenditures (see Liquidity and Capital Resources - Cash Flows and Capital
Resources). Achievement of the expressed expectations is subject to certain
risks and uncertainties that could cause actual results to differ materially
from the expressed expectations described in these statements. Important factors
that may cause such differences are noted in this interim report, the Company's
1999 Annual Report to Stockholders and the Company's Form 10-K for the year
ended December 31, 1999 and include, but are not limited to: the effect of
customer trading patterns on Company revenues and earnings; the risk of not
completing the above described merger; the ability to assimilate acquired
companies and to achieve the anticipated benefits; the Company's ability to
attract and retain key personnel; changes in the Company's level of personnel
hiring, investment in new or existing technology, or utilization of public media
for advertising; changes in technology; computer system failures and security
breaches; the effects of competitors' pricing, product and service decisions and
intensified competition; evolving regulation and changing industry practices
adversely affecting the Company; adverse results of litigation; the ability to
obtain external financing; changes in revenues and profit margin due to cyclical
securities markets and interest rates; the level and volatility of equity
prices; a significant downturn in the securities markets over a short period of
time or a sustained decline in securities prices and trading volumes; and risks
associated with international expansion and operations.
Three Months Ended March 31, 2000
Compared To Three Months Ended March 31, 1999
Financial Overview
The Company's revenues increased in the first quarter of 2000 mainly due to
higher customer trading volume and an increase in customer assets. Revenues of
$1,572 million in the first quarter of 2000 grew $620 million, or 65%, from the
first quarter of 1999 due to increases in revenues of $430 million, or 65%, in
the Individual Investor segment, $76 million, or 54%, in the Institutional
Investor segment, and $114 million, or 79%, in the Capital Markets segment. See
note "9 - Segment Information" in Item 1 - Notes to Condensed Consolidated
Financial Statements for financial information by segment.
Total operating expenses excluding interest during the first quarter of
2000 were $1,092 million, up 53% from $715 million for the first quarter of
1999, primarily resulting from additional staff and related costs.
Net income for the first quarter of 2000 was a record $284 million, up 99%
from first quarter 1999 net income of $143 million. Diluted earnings per share
for the first quarters of 2000 and 1999 were $.33 and $.17 per share,
respectively. All references to earnings per share information in this report
reflect diluted earnings per share unless otherwise noted. Share and per share
data throughout this report have not been restated to reflect the effects of the
three-for-two common stock split declared May 3, 2000 and payable May 30, 2000.
The after-tax profit margin for the first quarter of 2000 was 18.1%, up
from 15.0% for the first quarter of 1999. The annualized return on stockholders'
equity for the first quarter of 2000 was 42%, up from 36% for the first quarter
of 1999.
The Company's first quarter 2000 results include charges for goodwill and
intangible asset amortization, professional fees and other expenses relating to
the acquisition of CyBerCorp and the pending merger with U.S. Trust. These
charges totaled $13 million after-tax, or $.02 per share. Excluding these
charges, the Company's first quarter 2000 after-tax profit margin would have
been 18.9% and earnings would have been $297 million, up 108% from the first
quarter of 1999.
Trading activity reached record levels in the first quarter of 2000, as
shown in the following table (in thousands):
- -------------------------------------------------------------------------------
Three Months
Ended
March 31, Percent
Daily Average Trades 2000 1999 Change
- --------------------------------------------------------------------------------
Revenue Trades
Online 256.5 112.2 129%
TeleBroker(R)and VoiceBroker(TM) 11.6 10.1 15
Regional customer telephone
service centers, branch offices
and other 42.0 40.5 4
- --------------------------------------------------------------------------------
Total 310.1 162.8 90%
================================================================================
Mutual Fund OneSource(R) Trades
Online 47.5 25.2 88%
TeleBroker and VoiceBroker 1.9 1.3 46
Regional customer telephone
service centers, branch offices
and other 27.1 23.4 16
- --------------------------------------------------------------------------------
Total 76.5 49.9 53%
================================================================================
Total Daily Average Trades
Online 304.0 137.4 121%
TeleBroker and VoiceBroker 13.5 11.4 18
Regional customer telephone
service centers, branch offices
and other 69.1 63.9 8
- --------------------------------------------------------------------------------
Total 386.6 212.7 82%
================================================================================
Assets in Schwab customer accounts were $823.2 billion at March 31, 2000,
an increase of $281.2 billion, or 52%, from a year ago as shown in the table
below. This increase from a year ago resulted from net new customer assets of
$123.5 billion and net market gains of $157.7 billion.
- --------------------------------------------------------------------------------
Growth in Schwab Customer
Assets and Accounts
(In billions, at quarter end, March 31, Percent
except as noted) 2000 1999 Change
- --------------------------------------------------------------------------------
Assets in Schwab customer accounts
Schwab One(R) and other
cash equivalents $ 26.0 $ 18.5 41%
SchwabFunds(R):
Money market funds 92.6 74.4 24
Equity and bond funds 23.8 16.4 45
- --------------------------------------------------------------------------------
Total SchwabFunds 116.4 90.8 28
- --------------------------------------------------------------------------------
Mutual Fund Marketplace(R)(1):
Mutual Fund OneSource
Retail 69.7 39.0 79
Schwab Institutional(TM)(2) 52.4 34.2 53
-----------------------------------------------------------------------------
Total Mutual Fund
OneSource 122.1 73.2 67
All other 78.1 61.8 26
- --------------------------------------------------------------------------------
Total Mutual Fund Marketplace 200.2 135.0 48
- --------------------------------------------------------------------------------
Total mutual fund assets 316.6 225.8 40
- --------------------------------------------------------------------------------
Equity and other securities (1) 450.2 272.2 65
Fixed income securities 52.2 37.2 40
Margin loans outstanding (21.8) (11.7) 86
- --------------------------------------------------------------------------------
Total $823.2 $542.0 52%
================================================================================
Net growth in assets
in Schwab customer accounts
(for the quarter ended)
Net new customer assets $ 44.0 $ 27.4
Net market gains 54.0 23.5
- --------------------------------------------------------------------------------
Net growth $ 98.0 $ 50.9
================================================================================
New Schwab customer accounts
(in thousands, for the
quarter ended) 494.1 388.2 27%
Active Schwab customer
accounts (in millions) 6.9 5.9 17%
================================================================================
Active online Schwab customer
accounts (in millions) (3) 3.7 2.5 48%
Online Schwab customer
assets $417.7 $219.0 91%
================================================================================
(1) Excludes money market funds and all of Schwab's proprietary money market,
equity and bond funds.
(2) Represents assets invested in Mutual Fund OneSource by independent
investment managers and retirement plans.
(3) Active online accounts are defined as all accounts within a household that
has had at least one online session within the past twelve months.
REVENUES
Revenues grew $620 million, or 65%, in the first quarter of 2000 compared
to the first quarter of 1999, due to a $311 million, or 66%, increase in
commission revenues, a $114 million, or 76%, increase in interest revenue, net
of interest expense (referred to as net interest revenue), and a $114 million,
or 87%, increase in principal transaction revenues, as well as a $68 million, or
40%, increase in mutual fund service fees. Non-trading revenues represented 35%
of total revenues for the first quarter of 2000, down from 36% for the first
quarter of 1999 as shown in the table below.
- --------------------------------------------------------------------------------
Three Months
Ended
March 31,
Composition of Revenues 2000 1999
- --------------------------------------------------------------------------------
Commissions 50% 50%
Principal transactions 15 14
- --------------------------------------------------------------------------------
Total trading revenues 65 64
- --------------------------------------------------------------------------------
Mutual fund service fees 15 18
Net interest revenue 17 16
Other 3 2
- --------------------------------------------------------------------------------
Total non-trading revenues 35 36
- --------------------------------------------------------------------------------
Total 100% 100%
================================================================================
Commissions
The Company earns commission revenues by executing customer trades
primarily through the Individual Investor and Institutional Investor segments.
These revenues are affected by the number of customer accounts that trade, the
average number of commission-generating trades per account, and the average
commission per trade.
Commission revenues for the Company were $783 million for the first quarter
of 2000, up $311 million, or 66%, from the first quarter of 1999. As shown in
the table below, the total number of revenue trades executed by the Company has
increased 97% as the Company's customer base, as well as customer trading
activity per account, has grown. Average commission per revenue trade decreased
16%. This decline was mainly due to an increase in the proportion of trades
placed through the Company's online channels, which have lower commission rates
than the Company's other channels.
- --------------------------------------------------------------------------------
Three Months
Commissions Earned Ended
on Customer Revenue March 31, Percent
Trades 2000 1999 Change
- --------------------------------------------------------------------------------
Customer accounts that
traded during the quarter
(in thousands) 2,360 1,662 42%
Average customer
revenue trades
per account 8.28 5.98 38
Total revenue
trades (in thousands) 19,543 9,940 97
Average commission
per revenue trade $40.12 $47.72 (16)
Commissions earned
on customer revenue
trades (in millions) (1) $ 784 $ 474 65
================================================================================
(1) Includes certain non-commission revenues relating to the execution of
customer trades totaling $14 million in the first quarter of 2000 and $8
million in the first quarter of 1999. Excludes commissions on trades
relating to specialist operations totaling $13 million in the first quarter
of 2000 and $7 million in the first quarter of 1999.
Mutual Fund Service Fees
The Company earns mutual fund service fees for recordkeeping and
shareholder services provided to third-party funds, and for transfer agent
services, shareholder services, administration and investment management
provided to its proprietary funds. These fees are based upon the daily balances
of customer assets invested in third-party funds and upon the average daily net
assets of Schwab's proprietary funds. Mutual fund service fees are earned
primarily through the Individual Investor and Institutional Investor segments.
Mutual fund service fees were $237 million for the first quarter of 2000,
up $68 million, or 40%, from the first quarter of 1999. This increase was
primarily due to an increase in customer assets in Schwab's proprietary funds,
collectively referred to as the SchwabFunds(R), as well as an increase in
customer assets in funds purchased through Schwab's Mutual Fund OneSource(R)
service.
Net Interest Revenue
Net interest revenue is the difference between interest earned on assets
(mainly margin loans to customers and investments) and interest paid on
liabilities (mainly customer cash balances). Net interest revenue is affected by
changes in the volume and mix of these assets and liabilities, as well as by
fluctuations in interest rates. Substantially all of the Company's net interest
revenue is earned by Schwab through the Individual Investor and Institutional
Investor segments.
Net interest revenue was $264 million for the first quarter of 2000, up
$114 million, or 76%, from the first quarter of 1999 as shown in the following
table (in millions):
- --------------------------------------------------------------------------------
Three Months
Ended
March 31, Percent
2000 1999 Change
- --------------------------------------------------------------------------------
Interest Revenue
Margin loans to customers $401 $198 103%
Investments, customer-related 100 111 (10)
Other 29 14 107
- --------------------------------------------------------------------------------
Total 530 323 64
- --------------------------------------------------------------------------------
Interest Expense
Customer cash balances 237 155 53
Stock-lending activities 14 9 56
Borrowings 9 6 50
Other 6 3 100
- --------------------------------------------------------------------------------
Total 266 173 54
- --------------------------------------------------------------------------------
Net interest revenue $264 $150 76%
================================================================================
Customer-related daily average balances, interest rates and average net
interest margin for the first quarters of 2000 and 1999 are summarized in the
following table (dollars in millions):
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
2000 1999
- --------------------------------------------------------------------------------
Interest-Earning Assets (customer-related):
Margin loans to customers:
Average balance outstanding $19,666 $11,083
Average interest rate 8.21% 7.25%
Investments:
Average balance outstanding $ 7,955 $ 9,694
Average interest rate 5.06% 4.65%
Average yield on interest-earning assets 7.30% 6.04%
Funding Sources (customer-related
and other):
Interest-bearing customer cash balances:
Average balance outstanding $20,724 $16,292
Average interest rate 4.61% 3.86%
Other interest-bearing sources:
Average balance outstanding $ 2,367 $ 1,709
Average interest rate 4.10% 3.36%
Average noninterest-bearing portion $ 4,530 $ 2,776
Average interest rate on funding sources 3.81% 3.30%
Summary:
Average yield on interest-earning assets 7.30% 6.04%
Average interest rate on funding sources 3.81% 3.30%
- --------------------------------------------------------------------------------
Average net interest margin 3.49% 2.74%
- --------------------------------------------------------------------------------
The increase in net interest revenue from the first quarter of 1999 was
primarily due to higher levels of margin loans to customers, partially offset by
higher average customer cash balances.
Principal Transactions
Principal transaction revenues are primarily comprised of net gains from
market-making activities in Nasdaq and other securities transactions effected
through the Capital Markets segment. Factors that influence principal
transaction revenues include the volume of customer trades, market price
volatility, average revenue per share traded and changes in regulations and
industry practices.
Principal transaction revenues were $245 million for the first quarter of
2000, up $114 million, or 87%, from the first quarter of 1999. This increase was
primarily due to greater share volume handled by SCM, partially offset by lower
average revenue per share traded.
During the first quarter of 2000, SCM implemented midpoint pricing, a
practice whereby most customer orders at market opening are matched or crossed
at the price that represents the midpoint between the prevailing bid and offer
prices. This change, which eliminates any potential spread that could be earned
by a market maker on trades executed at the market opening, is likely to cause
decreases in average revenue per share traded, will only affect the Capital
Markets segment and, based on management's expectations, will not have a
material impact on that segment's revenues.
Expenses Excluding Interest
Compensation and benefits expense was $591 million for the first quarter of
2000, up $201 million, or 52%, from the first quarter of 1999 primarily due to a
greater number of employees and higher incentive and variable compensation
expense resulting from the Company's financial performance. The following table
shows a comparison of certain compensation and benefits components and employee
data (in thousands):
- --------------------------------------------------------------------------------
Three Months
Ended
March 31,
2000 1999
- --------------------------------------------------------------------------------
Compensation and benefits expense as a
% of total revenues 38% 41%
Incentive and variable compensation as a
% of compensation and benefits expense 38% 33%
Compensation for temporary employees,
contractors and overtime hours as a
% of compensation and benefits expense 9% 12%
Full-time equivalent employees(1) 20.3 14.8
(at end of quarter)
Revenues per average full-time equivalent
employee $81.4 $67.7
================================================================================
(1) Includes full-time, part-time and temporary employees, and persons employed
on a contract basis.
Advertising and market development expense was $101 million for the first
quarter of 2000, up $48 million, or 92%, from the first quarter of 1999. This
increase was primarily a result of the Company's increased brand-focused
television and print media spending.
Professional services expense was $62 million for the first quarter of
2000, up $30 million, or 92%, from the first quarter of 1999. This increase was
primarily due to consulting fees related to various information technology
projects and professional fees relating to the pending merger with U.S. Trust.
The Company's effective income tax rate was 40.7% for the first quarter of
2000, up from 39.5% for the first quarter of 1999. This change was primarily due
to charges, which are non-deductible for tax purposes, for certain professional
fees relating to the pending merger with U.S. Trust and goodwill amortization
relating to the acquisition of CyBerCorp.
Liquidity and Capital Resources
Liquidity
CSC
CSC's liquidity needs are generally met through cash generated by its
subsidiaries, as well as cash provided by external financing. As discussed
below, Schwab, SCM and CSE are subject to regulatory requirements that may
restrict them from certain transactions with CSC. Management believes that funds
generated by the operations of CSC's subsidiaries will continue to be the
primary funding source in meeting CSC's liquidity needs and maintaining Schwab's
and SCM's net capital.
CSC has liquidity needs that arise from its issued and outstanding $655
million Senior Medium-Term Notes, Series A (Medium-Term Notes), as well as from
the funding of cash dividends, acquisitions and other investments. The
Medium-Term Notes have maturities ranging from 2000 to 2010 and fixed interest
rates ranging from 5.96% to 8.05% with interest payable semiannually. The
Medium-Term Notes are rated A3 by Moody's Investors Service and A by Standard &
Poor's Ratings Group. The rating by Standard & Poor's was raised to A from A- on
April 14, 2000.
CSC has a prospectus supplement on file with the Securities and Exchange
Commission pursuant to which as of March 31, 2000, up to $111 million in Senior
or Senior Subordinated Medium-Term Notes, Series A remained available for
issuance. See note "11 Subsequent Events" in Item 1 - Notes to Condensed
Consolidated Financial Statements.
CSC may borrow under its committed, unsecured credit facilities. CSC
maintains a $600 million facility with a group of fourteen banks which expires
in June 2000 and a $175 million facility with a group of nine banks which
expires in June 2001. CSC plans to renegotiate the terms for the facility that
is due to expire in June 2000. The funds under both of these facilities are
available for general corporate purposes and CSC pays a commitment fee on the
unused balance of these facilities. The financial covenants in these facilities
require CSC to maintain minimum levels of stockholders' equity, and Schwab and
SCM to maintain specified levels of net capital, as defined. The Company
believes that these restrictions will not have a material effect on its ability
to meet foreseeable dividend or funding requirements. These facilities were
unused during the first quarter of 2000.
CSC also has direct access to $635 million of the $795 million uncommitted,
unsecured bank credit lines, provided by nine banks, that are primarily utilized
by Schwab to manage short-term liquidity. The amount available to CSC under
these lines is lower than the amount available to Schwab because the credit line
provided by one of these banks is only available to Schwab, while the credit
line provided by another one of these banks includes a sub-limit on credit
available to CSC. These lines were not used by CSC during the first quarter of
2000.
Schwab
Liquidity needs relating to customer trading and margin borrowing
activities are met primarily through cash balances in customer accounts, which
were $26.0 billion and $23.0 billion at March 31, 2000 and December 31, 1999,
respectively. Management believes that customer cash balances and operating
earnings will continue to be the primary sources of liquidity for Schwab in the
future.
Schwab is subject to regulatory requirements that are intended to ensure
the general financial soundness and liquidity of broker-dealers. These
regulations prohibit Schwab from repaying subordinated borrowings to CSC, paying
cash dividends, or making unsecured advances or loans to its parent or employees
if such payment would result in net capital of less than 5% of aggregate debit
balances or less than 120% of its minimum dollar amount requirement of $1
million. At March 31, 2000, Schwab's net capital was $2,228 million (10% of
aggregate debit balances), which was $1,781 million in excess of its minimum
required net capital and $1,111 million in excess of 5% of aggregate debit
balances. Schwab has historically targeted net capital to be 10% of its
aggregate debit balances, which primarily consist of customer margin loans. To
achieve this target, as customer margin loans have grown, an increasing amount
of cash flows have been retained to support aggregate debit balances.
To manage Schwab's regulatory capital position, CSC provides Schwab with a
$1,400 million subordinated revolving credit facility maturing in September
2001, of which $905 million was outstanding at March 31, 2000. At quarter end,
Schwab also had outstanding $25 million in fixed-rate subordinated term loans
from CSC - $10 million maturing in 2001 and $15 million maturing in 2002.
Borrowings under these subordinated lending arrangements qualify as regulatory
capital for Schwab.
To manage short-term liquidity, Schwab maintains uncommitted, unsecured
bank credit lines totaling $795 million at March 31, 2000 ($635 million of these
lines are also available for CSC to use). The need for short-term borrowings
arises primarily from timing differences between cash flow requirements and the
scheduled liquidation of interest-bearing investments. Schwab used such
borrowings for 16 days during the first quarter of 2000, with the daily amounts
borrowed averaging $80 million. These lines were unused at March 31, 2000.
To satisfy the margin requirement of customer option transactions with the
Options Clearing Corporation (OCC), Schwab had unsecured letter of credit
agreements with twelve banks in favor of the OCC aggregating $1,005 million at
March 31, 2000. Schwab pays a fee to maintain these letters of credit. No funds
were drawn under these letters of credit at March 31, 2000.
SCM
SCM's liquidity needs are generally met through earnings generated by its
operations. Most of SCM's assets are liquid, consisting primarily of marketable
securities, cash and cash equivalents, and receivable from brokers, dealers and
clearing organizations.
SCM's liquidity is affected by the same net capital regulatory requirements
as Schwab (see discussion above). At March 31, 2000, SCM's net capital was $68
million, which was $67 million in excess of its minimum required net capital.
SCM may borrow up to $35 million under a subordinated lending arrangement
with CSC maturing in 2001. Borrowings under this arrangement qualify as
regulatory capital for SCM. In addition, CSC provides SCM with a $25 million
short-term credit facility. Borrowings under this arrangement do not qualify as
regulatory capital for SCM. These facilities were unused during the first
quarter of 2000.
CSE
CSE's liquidity needs are generally met through earnings generated by its
operations. Most of CSE's assets are liquid, consisting primarily of cash and
investments required to be segregated, receivable from brokers, dealers and
clearing organizations, and receivable from customers and others.
CSE may borrow up to (pound)70 million, equivalent to $111 million at March
31, 2000, under subordinated lending arrangements with CSC. At March 31, 2000,
CSE had outstanding (pound)18 million under these arrangements, equivalent to
$29 million, with (pound)5 million maturing in 2001 and (pound)13 million
maturing in 2003.
Cash Flows and Capital Resources
Net income plus depreciation and amortization was $339 million for the
first quarter of 2000, up 90% from $178 million for the first quarter of 1999,
allowing the Company to finance its operations primarily with internally
generated funds. Depreciation and amortization expense related to equipment,
office facilities and property was $48 million for the first quarter of 2000, as
compared to $33 million for the first quarter of 1999, or 3% of revenues for
each period, respectively. Amortization expense related to goodwill and other
intangible assets was $6 million for the first quarter of 2000, as compared to
$2 million for the first quarter of 1999. This increase was primarily due to
goodwill amortization related to the acquisition of CyBerCorp.
The Company's capital expenditures net of proceeds from the sale of fixed
assets were $116 million in the first quarter of 2000 and $56 million in the
first quarter of 1999, or 7% and 6% of revenues for each period, respectively.
Capital expenditures in the first quarter of 2000 were for equipment relating to
the Company's information technology systems, software, and leasehold
improvements. Capital expenditures as described above include the capitalized
costs for developing internal-use software of $21 million in the first quarter
of 2000 and $11 million in the first quarter of 1999. The Company opened sixteen
new domestic branch offices during the first quarter of 2000, compared to seven
domestic branch offices opened during the first quarter of 1999. Capital
expenditures may vary from period to period as business conditions change.
The Company issued $200 million in Medium-Term Notes during the first
quarter of 2000.
During the first quarter of 2000, 4,228,700 of the Company's stock options,
with a weighted-average exercise price of $3.82, were exercised with cash
proceeds received by the Company of $17 million and a related tax benefit of $33
million. The cash proceeds are recorded as an increase in cash and a
corresponding increase in stockholders' equity. The tax benefit is recorded as a
reduction in income taxes payable and a corresponding increase in stockholders'
equity.
During the first quarters of 2000 and 1999, the Company did not repurchase
any common stock. Since the inception of the repurchase plan in 1988 through
March 31, 2000, the Company has repurchased 132,830,700 shares of its common
stock for $314 million. There is no current authorization for share repurchases.
On May 3, 2000, the Board of Directors approved a three-for-two split of
CSC's common stock, which will be effected in the form of a 50% stock dividend.
The stock dividend is payable May 30, 2000 to stockholders of record May 12,
2000.
During each of the first quarters of 2000 and 1999, the Company paid common
stock cash dividends of $11 million.
The Company monitors both the relative composition and absolute level of
its capital structure. The Company's total financial capital (borrowings plus
stockholders' equity) at March 31, 2000 was $3,798 million, up $1,069 million,
or 39% from December 31, 1999. At March 31, 2000, the Company had borrowings of
$655 million, or 17% of total financial capital, that bear interest at a
weighted-average rate of 7.13%. At March 31, 2000, the Company's stockholders'
equity was $3,143 million, or 83% of total financial capital.
Year 2000 Century Change
The Company's mission critical systems operated throughout the Year 2000
century change, including the February 2000 leap year, without material errors
or interruptions when processing data and transactions incorporating year 2000
dates, including leap year dates, and the Company did not encounter any material
problems with any of its mission critical vendor-supplied systems, services or
products. Mission critical systems, services and products means those systems,
services and products critical to the ongoing operation of the business.
Compliance Costs
As of March 31, 2000, the Company spent approximately $94 million for its
Year 2000 project.
The Company funded all Year 2000 related costs through operating cash flows
and a reallocation of the Company's overall developmental spending. This
reallocation did not result in the delay of any critical information technology
projects. In accordance with generally accepted accounting principles, Year 2000
expenditures were expensed as incurred.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Financial Instruments Held For Trading Purposes
The Company held municipal, other fixed income and government securities
and certificates of deposit with a fair value of approximately $35 million and
$23 million at March 31, 2000 and 1999, respectively. These securities, and the
associated interest rate risk, are not material to the Company's financial
position, results of operations or cash flows.
Through Schwab and SCM, the Company maintains inventories in
exchange-listed, Nasdaq and other equity securities on both a long and short
basis. The fair value of these securities at March 31, 2000 was $95 million in
long positions and $68 million in short positions. The fair value of these
securities at March 31, 1999 was $50 million in long positions and $32 million
in short positions. Using a hypothetical 10% increase or decrease in prices, the
potential loss or gain in fair value is estimated to be approximately $2,700,000
and $1,800,000 at March 31, 2000 and 1999, respectively, due to the offset of
change in fair value in long and short positions. In addition, the Company
generally enters into exchange-traded option contracts to hedge against
potential losses in equity inventory positions, thus reducing this potential
loss exposure. This hypothetical 10% change in fair value of these securities at
March 31, 2000 and 1999 would not be material to the Company's financial
position, results of operations or cash flows. The notional amount and fair
value of option contracts were not material to the Company's consolidated
balance sheets at March 31, 2000 and 1999.
Financial Instruments Held For Purposes Other Than Trading
For its working capital and reserves required to be segregated under
federal or other regulations, the Company invests in money market funds, resale
agreements, certificates of deposit, and commercial paper. Money market funds do
not have maturity dates and do not present a material market risk. The other
financial instruments, as shown in the following table, are fixed rate
investments with short-term maturities and are not subject to material changes
in value due to interest rate movements (dollars in millions):
- --------------------------------------------------------------------------------
Principal Amount
by Maturity Date Fair Value
March 31, 2001 Thereafter 2000 1999
- --------------------------------------------------------------------------------
Resale agreements (1) $5,117 $5,117 $6,923
Weighted-average interest rate 5.92%
Certificates of deposit $1,115 $1,115 $1,753
Weighted-average interest rate 5.97%
Commercial paper $ 923 $ 923 $ 375
Weighted-average interest rate 6.21%
================================================================================
(1) Fair value at March 31, 2000 includes resale agreements of $4,267 million
included in cash and investments required to be segregated under federal or
other regulations and $850 million included in cash and cash equivalents.
At March 31, 2000, CSC had $655 million aggregate principal amount of
Medium-Term Notes, with fixed interest rates ranging from 5.96% to 8.05%. At
March 31, 1999, CSC had $351 million aggregate principal amount of Medium-Term
Notes, with fixed interest rates ranging from 5.78% to 7.72%. The Company has
fixed cash flow requirements regarding these Medium-Term Notes due to the fixed
rate of interest. The fair value of these Medium-Term Notes at March 31, 2000
and 1999, based on estimates of market rates for debt with similar terms and
remaining maturities, approximated their carrying amount. The table below
presents the principal amount of these Medium-Term Notes by year of maturity
(dollars in millions):
- --------------------------------------------------------------------------------
Year Ending Weighted-Average Principal
December 31, Interest Rate Amount
- --------------------------------------------------------------------------------
2000 6.3% $ 48
2001 7.0% 39
2002 7.0% 53
2003 6.5% 49
2004 6.6% 81
Thereafter 7.4% 385
================================================================================
The Company maintains investments primarily in mutual funds, approximately
$65 million and $50 million at March 31, 2000 and 1999, respectively, to fund
obligations under its deferred compensation plan, which is available to certain
employees. Any decrease in the fair value of these investments would result in a
comparable decrease in the deferred compensation plan obligation and would not
affect the Company's financial position, results of operations or cash flows.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are filed as part of this quarterly report on Form
10-Q.
- --------------------------------------------------------------------------------
Exhibit
Number Exhibit
- --------------------------------------------------------------------------------
10.211 The Charles Schwab Corporation Annual Executive Individual
Performance Plan, amended and restated as of January 1, 2000
(supersedes Exhibit 10.189).
10.212 The Charles Schwab Corporation Corporate Executive Bonus Plan,
amended and restated as of January 1, 2000 (supersedes Exhibit
10.182).
12.1 Computation of Ratio of Earnings to Fixed Charges.
27.1 Financial Data Schedule (electronic only).
- --------------------------------------------------------------------------------
(b) Reports on Form 8-K
On January 14, 2000, the Registrant filed a Current Report on Form 8-K
dated January 12, 2000, which relates to the merger agreement between The
Charles Schwab Corporation and subsidiaries (the Company), U.S. Trust
Corporation and Patriot Merger Corporation.
On February 22, 2000, the Registrant filed a Current Report on Form 8-K
which includes the audited consolidated balance sheets of the Company as of
December 31, 1999 and 1998, and the related consolidated statements of
income, stockholders' equity and cash flows for each of the years ended
December 31, 1999, 1998 and 1997, together with the Independent Auditors'
Report thereon, as well as the Company's management's discussion and
analysis of results of operations and financial condition, and
supplementary financial information.
THE CHARLES SCHWAB CORPORATION
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE CHARLES SCHWAB CORPORATION
(Registrant)
Date: May 10, 2000 /s/ Christopher V. Dodds
----------------- --------------------------------
Christopher V. Dodds
Executive Vice President and
Chief Financial Officer