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, 2002 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.
1,371,319,688 shares of $.01 par value Common Stock
Outstanding on April 30, 2002
THE CHARLES SCHWAB CORPORATION
Quarterly Report on Form 10-Q
For the Quarter Ended March 31, 2002
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 - 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9 - 19
Item 3. Quantitative and Qualitative Disclosures About Market Risk 19 - 20
Part II - Other Information
Item 1. Legal Proceedings 20
Item 2. Changes in Securities and Use of Proceeds 20
Item 3. Defaults Upon Senior Securities 20
Item 4. Submission of Matters to a Vote of Security Holders 20
Item 5. Other Information 20 - 21
Item 6. Exhibits and Reports on Form 8-K 21
Signature 22
Part I - Financial Information
Item 1. Condensed Consolidated Financial Statements
THE CHARLES SCHWAB CORPORATION
Condensed Consolidated Statement of Income
(In millions, except per share amounts)
(Unaudited)
Three Months Ended
March 31,
2002 2001
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Revenues
Asset management and administration fees $ 444 $ 411
Commissions 303 408
Interest revenue, net of interest expense (1) 221 257
Principal transactions 51 95
Other 40 29
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Total 1,059 1,200
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Expenses Excluding Interest
Compensation and benefits 471 493
Other compensation - merger retention programs 14 15
Occupancy and equipment 119 123
Communications 71 96
Depreciation and amortization 83 84
Advertising and market development 53 94
Professional services 49 56
Commissions, clearance and floor brokerage 18 28
Goodwill amortization 16
Restructuring and other charges 27
Other 24 31
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Total 929 1,036
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Income before taxes on income and extraordinary gain 130 164
Tax expense on income 48 67
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Income before extraordinary gain 82 97
Extraordinary gain on sale of corporate trust business, net of tax of $10 12
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Net Income $ 94 $ 97
====================================================================================================================================
Weighted-Average Common Shares Outstanding - Diluted 1,389 1,410
====================================================================================================================================
Earnings Per Share - Basic
Income before extraordinary gain $ .06 $ .07
Extraordinary gain, net of tax $ .01
Net income $ .07 $ .07
Earnings Per Share - Diluted
Income before extraordinary gain $ .06 $ .07
Extraordinary gain, net of tax $ .01
Net income $ .07 $ .07
====================================================================================================================================
Dividends Declared Per Common Share $.0110 $.0110
====================================================================================================================================
(1) Interest revenue is presented net of interest expense. Interest expense for the three months ended
March 31, 2002 and 2001 was $94 million and $332 million, respectively.
See Notes to Condensed Consolidated Financial Statements.
THE CHARLES SCHWAB CORPORATION
Condensed Consolidated Balance Sheet
(In millions, except share and per share amounts)
(Unaudited)
March 31, December 31,
2002 2001
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Assets
Cash and cash equivalents $ 1,850 $ 4,407
Cash and investments segregated and on deposit for federal or other
regulatory purposes(1) (including resale agreements of $16,052 in 2002
and $14,811 in 2001) 18,305 17,741
Securities owned - at market value (including securities pledged of $163
in 2002 and $185 in 2001) 1,996 1,700
Receivables from brokers, dealers and clearing organizations 451 446
Receivables from brokerage clients - net 9,540 9,620
Loans to banking clients - net 4,184 4,046
Equipment, office facilities and property - net 1,002 1,058
Goodwill - net 624 628
Other assets 869 818
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Total $ 38,821 $ 40,464
====================================================================================================================================
Liabilities and Stockholders' Equity
Deposits from banking clients $ 4,117 $ 5,448
Drafts payable 199 396
Payables to brokers, dealers and clearing organizations 1,078 833
Payables to brokerage clients 25,924 26,989
Accrued expenses and other liabilities 1,292 1,327
Short-term borrowings 1,213 578
Long-term debt 730 730
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Total liabilities 34,553 36,301
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Stockholders' equity:
Preferred stock - 9,940,000 shares authorized; $.01 par value per share;
none issued
Common stock - 3 billion shares authorized; $.01 par value per share;
1,391,678,704 and 1,391,673,494 shares issued in 2002 and 2001, respectively 14 14
Additional paid-in capital 1,731 1,726
Retained earnings 2,845 2,794
Treasury stock - 20,937,192 and 23,110,972 shares in 2002 and 2001,
respectively, at cost (252) (295)
Unamortized stock-based compensation (32) (39)
Accumulated other comprehensive loss (38) (37)
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Total stockholders' equity 4,268 4,163
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Total $ 38,821 $ 40,464
====================================================================================================================================
(1) Amounts included represent actual balances on deposit, whereas cash and investments required to be segregated for federal or
other regulatory purposes were $17,414 million and $18,261 million at March 31, 2002 and December 31, 2001, respectively.
On April 2, 2002, the Company withdrew $661 million of excess segregated cash. As of January 3, 2002, the Company had
deposited $710 million to meet its segregated cash requirement.
See Notes to Condensed Consolidated Financial Statements.
THE CHARLES SCHWAB CORPORATION
Condensed Consolidated Statement of Cash Flows
(In millions)
(Unaudited)
Three Months Ended
March 31,
2002 2001
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Cash Flows from Operating Activities
Net income $ 94 $ 97
Adjustments to reconcile net income to net cash used for operating activities:
Depreciation and amortization 83 84
Goodwill amortization 16
Compensation payable in common stock 7 9
Deferred income taxes 27 24
Tax benefits from stock options exercised and other stock-based compensation 3 18
Non-cash restructuring charges 2
Extraordinary gain on sale of corporate trust business, net of tax (12)
Other (5)
Net change in:
Cash and investments segregated and on deposit for federal or other
regulatory purposes (684) (5,309)
Securities owned (excluding securities available for sale) 11 (36)
Receivables from brokers, dealers and clearing organizations (11) 7
Receivables from brokerage clients 52 4,278
Other assets (78) (44)
Drafts payable (197) (192)
Payables to brokers, dealers and clearing organizations 248 (88)
Payables to brokerage clients (924) (265)
Accrued expenses and other liabilities (56) (274)
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Net cash used for operating activities (1,440) (1,675)
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Cash Flows from Investing Activities
Purchases of securities available for sale (612) (245)
Proceeds from sales of securities available for sale 235
Proceeds from maturities, calls and mandatory redemptions of securities
available for sale 108 70
Net change in loans to banking clients (138) 25
Purchase of equipment, office facilities and property - net (32) (129)
Cash payments for business combinations and investments, net of cash received (12)
Proceeds from sale of Canadian operations 20
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Net cash used for investing activities (419) (291)
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Cash Flows from Financing Activities
Net decrease in deposits from banking clients (1,332) (143)
Net change in short-term borrowings 635 (54)
Repayment of long-term debt (2)
Dividends paid (15) (15)
Proceeds from stock options exercised and other 15 8
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Net cash used for financing activities (697) (206)
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Effect of exchange rate changes on cash and cash equivalents (1)
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Decrease in Cash and Cash Equivalents (2,557) (2,172)
Cash and Cash Equivalents at Beginning of Period 4,407 4,876
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Cash and Cash Equivalents at End of Period $ 1,850 $ 2,704
====================================================================================================================================
See Notes to Condensed Consolidated Financial Statements.
THE CHARLES SCHWAB CORPORATION
Notes to Condensed Consolidated Financial Statements
(Tabular Amounts in Millions, Except Per Share Amounts and Ratios)
(Unaudited)
1. Basis of Presentation
The Charles Schwab Corporation (CSC) is a financial holding company
engaged, through its subsidiaries, in securities brokerage and related financial
services. Charles Schwab & Co., Inc. (Schwab) is a securities broker-dealer with
396 domestic branch offices in 48 states, as well as branches in the
Commonwealth of Puerto Rico and the U.S. Virgin Islands. U.S. Trust Corporation
(USTC, and with its subsidiaries collectively referred to as U.S. Trust) is a
wealth management firm that through its subsidiaries also provides fiduciary
services and private banking services with 34 offices in 12 states. Other
subsidiaries include Charles Schwab Europe (CSE), a retail securities brokerage
firm located in the United Kingdom, Charles Schwab Investment Management, Inc.,
the investment advisor for Schwab's proprietary mutual funds, Schwab Capital
Markets L.P. (SCM), a market maker in Nasdaq and other securities providing
trade execution services primarily to broker-dealers and institutional clients,
and CyberTrader, Inc. (CyberTrader), an electronic trading technology and
brokerage firm providing services to highly active, online investors.
The accompanying unaudited condensed consolidated financial statements
include CSC and its majority-owned subsidiaries (collectively referred to as the
Company). 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 accounting principles generally accepted in the
U.S. All adjustments were of a normal recurring nature, except as discussed in
Note "2 - Accounting Change." Certain items in prior periods' financial
statements have been reclassified to conform to the 2002 presentation. 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 2001 Annual
Report to Stockholders on Form 10-K. The Company's results for any interim
period are not necessarily indicative of results for a full year or any other
interim period.
2. Accounting Change
Statement of Financial Standards (SFAS) No. 142 - Goodwill and Other
Intangible Assets, was issued in June 2001. Under the provisions of SFAS No.
142, companies are no longer permitted to amortize goodwill and certain
intangible assets with an indefinite useful life. Instead, these assets must be
reviewed at least annually for possible impairment under new criteria. The
Company adopted SFAS No. 142, and accordingly discontinued the amortization of
goodwill as of January 1, 2002. During the second quarter of 2002, the Company
plans to complete the initial transitional goodwill impairment test as required.
Except for the cessation of goodwill amortization, the adoption of SFAS No. 142
is not expected to have a material impact on the Company's financial position,
results of operations, earnings per share (EPS), or cash flows.
The decrease in goodwill during the first quarter of 2002 was primarily due
to the sale of the Company's Canadian operations. The carrying amount of
goodwill, net of accumulated amortization, attributable to each of the Company's
reportable segments is as follows:
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March 31, December 31,
2002 2001
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Individual Investor $ 436 $ 440
Institutional Investor 5 5
Capital Markets 25 25
U.S. Trust 158 158
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Total $ 624 $ 628
================================================================================
The table below compares net income and EPS for the three months ended
March 31, 2002, which excludes goodwill amortization, with net income and EPS
for the three months ended March 31, 2001, which has been adjusted to exclude
goodwill amortization.
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Three Months Ended
March 31,
2002 2001
(Reported) (Adjusted)
- --------------------------------------------------------------------------------
Net income:
Reported income before extraordinary gain $ 82 $ 97
Add: Goodwill amortization, net of tax 16
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Reported/adjusted income before
extraordinary gain 82 113
Extraordinary gain, net of tax 12
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Reported/adjusted net income $ 94 $ 113
================================================================================
Basic and diluted EPS:
Reported EPS before extraordinary gain $ .06 $ .07
Add: Goodwill amortization .01
- --------------------------------------------------------------------------------
Reported/adjusted EPS before
extraordinary gain .06 .08
Extraordinary gain, net of tax .01
- --------------------------------------------------------------------------------
Reported/adjusted EPS $ .07 $ .08
================================================================================
3. New Accounting Standard
Long-Lived Assets: SFAS No.144 - Accounting for the Impairment or Disposal
of Long-Lived Assets, was issued in August 2001 and addresses the financial
accounting and reporting for the impairment or disposal of long-lived assets
(e.g., equipment and office facilities). This statement supersedes SFAS No. 121
- - Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of, and certain accounting and reporting provisions of Accounting
Principles Board Opinion No. 30 - Reporting the Results of Operations. The
Company adopted this statement on January 1, 2002. The adoption of SFAS No. 144
did not have a material impact on the Company's financial position, results of
operations, EPS, or cash flows.
4. Restructuring
In the second quarter of 2001, the Company initiated a restructuring plan
to reduce operating expenses. The restructuring plan included a workforce
reduction, a reduction in operating facilities, and the removal of certain
systems hardware, software and equipment from service. Included in these
initiatives are costs associated with the withdrawal from certain international
operations. In the first quarter of 2002, the Company recorded pre-tax
restructuring charges of $27 million.
A summary of the activity in the restructuring liability for the first
quarter of 2002 is as follows:
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Workforce Facilities Systems
Reduction Reduction Removal Total
- --------------------------------------------------------------------------------
Balance at
December 31, 2001 $ 74 $ 97 $ 4 $ 175
Restructuring charges 15 11 1 27
Utilization:
Cash payments (45) (14) (2) (61)
Non-cash charges (1) (2) (2)
- --------------------------------------------------------------------------------
Balance at
March 31, 2002 $ 42 (2) $ 94 (3) $ 3 (4) $ 139
================================================================================
(1) Includes charges for officers' stock-based compensation.
(2) The Company expects to substantially utilize the remaining restructuring
liability through cash payments for severance pay and benefits over the
respective severance periods through 2003.
(3) The Company expects to utilize the remaining restructuring liability
through cash payments for the net lease expense over the respective lease
terms through 2010.
(4) The Company expects to substantially utilize the remaining restructuring
liability in the second quarter of 2002.
5. Sale of Corporate Trust Business
In 2001, U.S. Trust sold its Corporate Trust business to The Bank of New
York Company, Inc. During the first quarter of 2002, the Company recorded an
extraordinary gain of $22 million, or $12 million after tax, which represented
the remaining proceeds from this sale that were realized upon satisfaction of
certain client retention requirements.
6. Allowance for Credit Losses on Banking Loans and Nonperforming Assets
Loans to banking clients of $4.2 billion at March 31, 2002 and $4.0 billion
at December 31, 2001 are presented net of the related allowance for credit
losses. The allowance for credit losses on banking loans was $22 million at
March 31, 2002 and $21 million at December 31, 2001. Recoveries and charge-offs
were not material for each of the three-month periods ended March 31, 2002 and
2001.
Nonperforming assets consist of non-accrual loans of $4 million at March
31, 2002 and $5 million at December 31, 2001.
7. 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:
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
2002 2001
- --------------------------------------------------------------------------------
Net income $ 94 $ 97
Other comprehensive income (loss):
Cumulative effect of accounting
change for adoption of
SFAS No. 133 (12)
Net gain (loss) on cash flow
hedging instruments 6 (11)
Foreign currency translation
adjustment (10)
Change in net unrealized gain (loss)
on securities available for sale (7) 8
- --------------------------------------------------------------------------------
Total comprehensive income,
net of tax $ 93 $ 72
================================================================================
8. 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.
EPS under the basic and diluted computations are as follows:
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Three Months Ended
March 31,
2002 2001
- --------------------------------------------------------------------------------
Net income $ 94 $ 97
================================================================================
Weighted-average common
shares outstanding - basic 1,366 1,379
Common stock equivalent shares
related to stock incentive plans 23 31
- --------------------------------------------------------------------------------
Weighted-average common
shares outstanding - diluted 1,389 1,410
================================================================================
Basic EPS:
Income before extraordinary gain $ .06 $ .07
Extraordinary gain, net of tax $ .01
Net income $ .07 $ .07
================================================================================
Diluted EPS:
Income before extraordinary gain $ .06 $ .07
Extraordinary gain, net of tax $ .01
Net income $ .07 $ .07
================================================================================
The computation of diluted EPS for the three months ended March 31, 2002
and 2001, respectively, excludes outstanding stock options to purchase 86
million and 49 million shares, respectively, 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.
9. Regulatory Requirements
CSC is a financial holding company, which is a type of bank holding company
subject to supervision and regulation by the Board of Governors of the Federal
Reserve System (the Federal Reserve Board) under the Bank Holding Company Act of
1956, as amended (the Act).
Under the Act, the Federal Reserve Board has established consolidated
capital requirements for bank holding companies. CSC is subject to those
guidelines. The regulatory capital and ratios of the Company, U.S. Trust, and
United States Trust Company of New York (U.S. Trust NY) are as follows:
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2002 2001
-------------- --------------
March 31, Amount Ratio(1) Amount Ratio(1)
- --------------------------------------------------------------------------------
Tier 1 Capital:
Company $ 3,717 22.2% $ 3,787 19.4%
U.S. Trust $ 583 17.2% $ 525 19.0%
U.S. Trust NY $ 369 13.7% $ 331 14.8%
Total Capital:
Company $ 3,744 22.3% $ 3,816 19.6%
U.S. Trust $ 605 17.8% $ 545 19.7%
U.S. Trust NY $ 388 14.4% $ 348 15.6%
Leverage:
Company $ 3,717 9.7% $ 3,787 10.3%
U.S. Trust $ 583 9.0% $ 525 9.9%
U.S. Trust NY $ 369 7.2% $ 331 8.0%
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(1) Minimum tier 1 capital, total capital, and tier 1 leverage ratios are 4%,
8%, and 3%-5%, respectively, for bank holding companies and banks.
Well-capitalized tier 1 capital, total capital, and tier 1 leverage ratios
are 6%, 10%, and 5%, respectively. Each of CSC's other depository
institution subsidiaries exceed the well-capitalized standards set forth by
the banking regulatory authorities.
Based on their respective regulatory capital ratios at March 31, 2002 and
2001, the Company, U.S. Trust and U.S. Trust NY are considered well capitalized
(the highest category). There are no conditions or events that management
believes have changed the Company's, U.S. Trust's, and U.S. Trust NY's
well-capitalized status.
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. This method requires the
maintenance of minimum net capital, as defined, of the greater of 2% of
aggregate debit balances arising from client 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, 2002, Schwab's net capital was $1.2 billion (12% of
aggregate debit balances), which was $990 million in excess of its minimum
required net capital and $697 million in excess of 5% of aggregate debit
balances. At March 31, 2002, SCM's net capital was $21 million, which was $20
million in excess of its minimum required net capital.
10. Commitments and Contingent Liabilities
The nature of the Company's business subjects it to claims, lawsuits,
regulatory examinations and other proceedings in the ordinary course of
business. The results of these matters 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 and results of operations.
However, it is the opinion of management, after consultation with legal counsel,
that the ultimate outcome of these matters will not have a material adverse
impact on the financial condition or operating results of the Company.
11. Segment Information
The Company structures its segments according to its various types of
clients and the services provided to those clients. These segments have been
aggregated, based on similarities in economic characteristics, types of clients,
services provided, distribution channels, and regulatory environment, into four
reportable segments - Individual Investor, Institutional Investor, Capital
Markets, and U.S. Trust.
Financial information for the Company's reportable segments is presented in
the following table. The Company evaluates the performance of its segments based
on adjusted operating income before taxes, which excludes restructuring and
other charges, merger- and acquisition-related charges, and extraordinary gains.
Intersegment revenues are not material and are therefore not disclosed. Total
revenues, income before taxes on income and extraordinary gain, and net income
are equal to the Company's consolidated amounts as reported in the condensed
consolidated statement of income.
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
2002 2001
- --------------------------------------------------------------------------------
Revenues
Individual Investor $ 616 $ 692
Institutional Investor 213 213
Capital Markets 63 126
U.S. Trust 167 169
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Total $ 1,059 $ 1,200
================================================================================
Operating income before taxes
Individual Investor $ 66 $ 66
Institutional Investor 64 71
Capital Markets 8 20
U.S. Trust (1) 35 37
- --------------------------------------------------------------------------------
Operating income before taxes 173 194
Restructuring charges (2) (27)
Merger- and acquisition-related
charges (3) (16) (30)
- --------------------------------------------------------------------------------
Income before taxes on income
and extraordinary gain 130 164
Tax expense on income 48 67
Extraordinary gain on sale of
corporate trust business,
net of tax of $10 12
- --------------------------------------------------------------------------------
Net Income $ 94 $ 97
================================================================================
(1) Excludes an extraordinary pre-tax gain of $22 million for the three months
ended March 31, 2002 (see note "5 - Sale of Corporate Trust Business").
(2) Includes costs relating to workforce, facilities, systems hardware,
software, and equipment reductions.
(3) Includes retention program compensation related to the merger with USTC,
and intangible asset amortization and retention program compensation
related to the acquisition of CyberTrader. For the three months ended March
31, 2001, amount also includes goodwill amortization, which ceased on
January 1, 2002 upon the adoption of SFAS No. 142 (see note "2 - Accounting
Change").
12. Supplemental Cash Flow Information
Certain information affecting the cash flows of the Company follows:
- --------------------------------------------------------------------------------
Three
Months Ended
March 31,
2002 2001
- --------------------------------------------------------------------------------
Income taxes paid $ 11 $ 24
================================================================================
Interest paid:
Brokerage client cash balances $ 53 $ 270
Deposits from banking clients 22 41
Long-term debt 26 28
Stock-lending activities 9
Short-term borrowings 7 5
- --------------------------------------------------------------------------------
Total interest paid $ 108 $ 353
================================================================================
Non-cash investing and financing activities:
Common stock and options issued
for purchases of businesses $ 6
================================================================================
THE CHARLES SCHWAB CORPORATION
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Description of Business
The Company: The Charles Schwab Corporation (CSC) and its subsidiaries
(collectively referred to as the Company) provide securities brokerage and
related financial services for 7.9 million active client accounts(a). Client
assets in these accounts totaled $857.7 billion at March 31, 2002. Charles
Schwab & Co., Inc. (Schwab) is a securities broker-dealer with 396 domestic
branch offices in 48 states, as well as branches in the Commonwealth of Puerto
Rico and the U.S. Virgin Islands. U.S. Trust Corporation (USTC, and with its
subsidiaries collectively referred to as U.S. Trust) is a wealth management firm
that through its subsidiaries also provides fiduciary services and private
banking services with 34 offices in 12 states. Other subsidiaries include
Charles Schwab Europe, a retail securities brokerage firm located in the United
Kingdom, Charles Schwab Investment Management, Inc., the investment advisor for
Schwab's proprietary mutual funds, Schwab Capital Markets L.P. (SCM), a market
maker in Nasdaq and other securities providing trade execution services
primarily to broker-dealers and institutional clients, and CyberTrader, Inc.
(CyberTrader), an electronic trading technology and brokerage firm providing
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
clients and broker-dealers through four segments - Individual Investor,
Institutional Investor, Capital Markets, and U.S. Trust. 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 financial advisors, serves company 401(k) plan sponsors and
third-party administrators, and supports company stock option plans and stock
purchase programs. The Capital Markets segment provides trade execution services
in Nasdaq, exchange-listed, and other securities primarily to broker-dealers,
including Schwab, and institutional clients. The U.S. Trust segment provides
investment and wealth management, fiduciary services, and private banking
services to individual and institutional clients.
Business Strategy: In 2001, the Company focused on aligning its
infrastructure and resources with its current strategic priorities, which
include:
- - providing the spectrum of affluent investors with the advice,
relationships, and choices that support their desired investment outcomes;
- - delivering the information, technology, service, and pricing needed to
remain a leader in serving active traders;
- - providing individual investing services through employers, including
retirement and option plans as well as personal brokerage accounts;
- - offering selected banking services and developing investment products that
give clients greater control and understanding of their finances;
- - retaining a strong capital markets business to address investors' financial
product and trade execution needs; and
- - continuing to provide high quality service to clients with smaller
investment portfolios.
For further discussion of the Company's business strategy, see
"Management's Discussion and Analysis of Results of Operations and Financial
Condition - Description of Business - Business Strategy" in the Company's 2001
Annual Report to Stockholders, which is filed as Exhibit 13.1 to the Company's
Form 10-K for the year ended December 31, 2001. See also "Products, Services,
and Advice Offerings" in the Company's Form 10-K for the year ended December 31,
2001. Significant recent developments relating to these strategic priorities, as
well as other significant developments, follows:
Services for Affluent Investors: In the first quarter of 2002, the Company
-------------------------------
established the Schwab Advisor Network, the successor to the Schwab
AdvisorSource referral program. This program strengthens the
Schwab/advisor/client relationship through a pricing model that allows for
sharing fee income on referred accounts, and features independent financial
advisors more prominently in advertising that targets affluent investors. Schwab
also improved its Managed Account Select offering, which enables independent
financial advisors to provide their clients with access to pre-screened money
managers under a single-fee structure, by adding fixed income managers to the
group for the first time. The Company launched a new print advertising campaign,
during the first quarter of 2002, to increase awareness of the U.S. Trust brand
and educate investors about wealth management. The Company also made several
enhancements to U.S. Trust's online services - clients can now download their
account information into selected financial software programs, view their
portfolio asset allocations in real-time, and make bill payments directly from
the Web site.
Services for Active Traders: During the first quarter of 2002, the Company
---------------------------
initiated a pilot program that allows clients to experience the active trader
offering firsthand by meeting with a specially trained field consultant in a
branch office. These field consultants have received training on market
structures as well as active trading strategies and technologies.
Corporate Services: The Company made several improvements to its
--------------------
retirement, stock option, and stock purchase plan offerings in the first quarter
of 2002. The Company created a Corporate Services division, integrating the
Company's investment and brokerage services for corporations under a single
division. The Company introduced SchwabPlan Select, a comprehensive bundled
401(k) plan for retirement plans with assets between $2 million and $20 million.
Under SchwabPlan Select, plan sponsors can build investment menus from hundreds
of different mutual funds and participants have full access to Schwab's online
planning and education tools, regional client telephone service centers, and Web
support. The Company also initiated the 401(k) Checkup, a complimentary initial
consultation in which a Schwab investment consultant works with current and
prospective clients to evaluate their current retirement plan holdings, compare
them to alternative choices, and make asset allocation recommendations based on
the individual's personal goals. Additionally, the Company introduced a live
interactive seminar called `Stock Option Strategies and Issues' for clients
looking for information on what to consider when developing a personalized stock
option strategy. This is the second in a series of three seminars that are being
presented across the country; the other two cover the fundamentals of stock
options and stock purchase plans.
Banking and Other Financial Products: The Company anticipates filing an
-------------------------------------
application to charter a new bank in the second quarter of 2002 and, subject to
regulatory approval, expects to commence banking operations in late 2002 or
early 2003.
Capital Markets: To meet growing client demand for fixed income
-----------------
information, Schwab began offering new issue bond alerts on its Web site. Client
assets in fixed income securities were a record $108.4 billion at March 31,
2002, an increase of $14.8 billion, or 16%, from a year ago. The Company also
commenced, through selective hirings, the expansion of its institutional equity
capabilities to focus on improving execution capabilities for all clients.
Other Significant Developments: The Company demonstrated continued
---------------------------------
leadership in combining people and technology through several important
technology-based initiatives during the first quarter of 2002. Schwab enhanced
its Web site to include a new section called `My Home' that allows clients to
view and manage all of their account balances, watch lists, quotes, research,
and market information on one customizable page. Similarly, for prospective
clients, Schwab simplified the Web site navigation process to facilitate client
contact with Schwab representatives. Also, quotes on money market yields and
bill pay enrollment are now available online.
Mutual fund-based investing remains an important element of the Company's
Core & ExploreTM investing philosophy. In the first quarter of 2002, Schwab
redesigned its Mutual Fund Select List to include qualitative analyses for each
asset class as well as an integrated view that includes asset class summaries,
category descriptions, and average expenses for each fund, presented together on
a single page. In addition, to support service representatives' fund-related
advice interactions, Schwab's internal Mutual Fund Web site now provides
representatives with Morningstar analysis on over 1,400 funds.
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 2001 Annual Report to
Stockholders, which is filed as Exhibit 13.1 to the Company's Form 10-K for the
year ended December 31, 2001. 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 or any other interim
period. 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," "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
ability to achieve its strategic priorities (see Description of Business -
Business Strategy), goodwill impairment (see Expenses Excluding Interest),
sources of liquidity and capital (see Liquidity and Capital Resources -
Liquidity and - Commitments), the Company's cash position and cash flows (see
Liquidity and Capital Resources - Cash Flows and Capital Resources) and
contingent liabilities (see Part II - Other Information, Item 1 - Legal
Proceedings). 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 and include,
but are not limited to: the effect of client trading patterns on Company
revenues and earnings; changes in revenues and profit margin due to cyclical
securities markets and fluctuations in 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;
the Company's inability to attract and retain key personnel; the timing and
impact of changes in the Company's level of investments in personnel,
technology, or advertising; changes in technology; computer system failures and
security breaches; evolving legislation, regulation, and changing industry
practices adversely affecting the Company; adverse results of litigation; the
inability to obtain external financing at acceptable rates; a significant
decline in the real estate market, including the Company's ability to sublease
certain properties; and the effects of competitors' pricing, product and service
decisions, and intensified industry competition and consolidation.
Critical Accounting Policies
Certain of the Company's accounting policies that involve a higher degree
of judgment and complexity are discussed in "Management's Discussion and
Analysis of Results of Operations and Financial Condition - Critical Accounting
Policies" in the Company's 2001 Annual Report to Stockholders, which is filed as
Exhibit 13.1 to the Company's Form 10-K for the year ended December 31, 2001.
There have been no material changes to these critical accounting policies in the
first quarter of 2002.
Three Months Ended March 31, 2002 Compared To
Three Months Ended March 31, 2001
All references to earnings per share information in this report reflect
diluted earnings per share unless otherwise noted.
FINANCIAL OVERVIEW
- ------------------
The Company's financial performance in the first quarter of 2002 was
adversely affected by declines in client trading activity as investor confidence
continued to be weighed down by mixed economic news, concerns about corporate
accounting, and recent world events. In the difficult market environment that
prevailed during the first quarter of 2002, daily average revenue trades
decreased 25% and average revenue per share traded in the Capital Markets
segment decreased 57% from year-earlier levels. As a result of these two
factors, the Company's trading revenues in the first quarter of 2002 decreased
30% from the first quarter of 2001 and total revenues decreased 12% for the same
period.
Non-trading revenues, which include asset management and administration
fees, interest revenue, net of interest expense (referred to as net interest
revenue), and other revenues, were flat overall in the first quarter of 2002
compared to the year-ago level. Average margin loans to clients in the first
quarter of 2002 decreased 35% from year-ago levels, which greatly contributed to
the 14% decrease in net interest revenue. This decrease was offset by an
increase in asset management and administration fees, primarily resulting from
an increase in assets in Schwab's proprietary funds (collectively referred to as
the SchwabFunds) at March 31, 2002 from the year-ago level.
Total expenses excluding interest during the first quarter of 2002 were
$929 million, down 10% from $1.0 billion during the first quarter of 2001. This
decrease resulted primarily from the Company's continued expense reduction
measures, including the restructuring plan implemented during 2001. Excluding
the non-operating charges as detailed in the following table, expenses during
the first quarter of 2002 were $886 million, down 12% from $1.0 billion during
the first quarter of 2001.
In 2001, U.S. Trust sold its Corporate Trust business to The Bank of New
York Company, Inc. During the first quarter of 2002, the Company recorded an
extraordinary gain of $22 million, or $12 million after tax, which represented
the remaining proceeds from this sale that were realized upon satisfaction of
certain client retention requirements.
In evaluating the Company's financial performance, management uses adjusted
operating income, which excludes non-operating items as detailed in the
following table. The Company's after-tax operating income for the first quarter
of 2002 was $108 million, down 10% from the first quarter of 2001, and its
after-tax operating profit margin for the first quarter of 2002 was 10.2%, up
from 10.0% for the first quarter of 2001. A reconciliation of the Company's
operating income to net income is shown in the following table (in millions):
- --------------------------------------------------------------------------------
Three Months
Ended
March 31, Percent
2002 2001 Change
- --------------------------------------------------------------------------------
Operating income, after tax $ 108 $ 120 (10%)
Non-operating items:
Extraordinary gain (1) 22
Restructuring charges (2) (27)
Merger- and acquisition-related charges (3) (16) (30) (47)
- --------------------------------------------------------------------------------
Total non-operating items (21) (30) (30)
Tax effect 7 7
- --------------------------------------------------------------------------------
Total non-operating items, after tax (14) (23) (39)
- --------------------------------------------------------------------------------
Net income $ 94 $ 97 (3%)
================================================================================
(1) Represents the remaining proceeds from the sale of USTC's Corporate Trust
business.
(2) Includes costs relating to workforce, facilities, systems hardware,
software, and equipment reductions.
(3) Includes retention program compensation related to the merger with USTC,
and intangible asset amortization and retention program compensation
related to the acquisition of CyberTrader. For the three months ended March
31, 2001, amount also includes goodwill amortization, which ceased on
January 1, 2002 upon the adoption of Statement of Financial Accounting
Standards No. 142.
The Company's operating income before taxes for the first quarter of 2002
was $173 million, down $21 million, or 11%, from the first quarter of 2001
primarily due to decreases of $7 million, or 10%, in the Institutional Investor
segment and $12 million, or 60%, in the Capital Markets segment. The decrease in
the Capital Markets segment was primarily due to lower average revenue per share
traded and lower levels of trading activity.
The Company's net income for the first quarter of 2002 was $94 million, or
$.07 per share, compared to $97 million, or $.07 per share, for the first
quarter of 2001. The Company's after-tax profit margin for the first quarter of
2002 was 8.9%, up from 8.1% for the first quarter of 2001.
The annualized return on stockholders' equity for the first quarter of 2002
was 9%, unchanged from the same period last year.
REVENUES
- --------
Revenues declined $141 million, or 12%, to $1.1 billion in the first
quarter of 2002 compared to the first quarter of 2001, due to a $105 million, or
26%, decrease in commission revenues, a $44 million, or 46%, decrease in
principal transaction revenues, and a $36 million, or 14%, decrease in net
interest revenue. These declines were partially offset by a $33 million, or 8%,
increase in asset management and administration fees and an $11 million, or 38%,
increase in other revenues. As trading volumes decreased substantially during
the first quarter of 2002, the Company's non-trading revenues represented 67% of
total revenues as compared to 58% for the first quarter of 2001 as shown in the
following table:
- --------------------------------------------------------------------------------
Three Months
Ended
March 31,
Composition of Revenues 2002 2001
- --------------------------------------------------------------------------------
Commissions 29% 34%
Principal transactions 4 8
- --------------------------------------------------------------------------------
Total trading revenues 33 42
- --------------------------------------------------------------------------------
Asset management and administration fees 42 34
Net interest revenue 21 21
Other 4 3
- --------------------------------------------------------------------------------
Total non-trading revenues 67 58
- --------------------------------------------------------------------------------
Total 100% 100%
================================================================================
While the Individual Investor and Institutional Investor segments generate
both trading and non-trading revenues, the Capital Markets segment generates
primarily trading revenues and the U.S. Trust segment generates primarily
non-trading revenues. The $141 million decline in revenues from the first
quarter of 2001 was primarily due to decreases in revenues of $76 million, or
11%, in the Individual Investor segment and $63 million, or 50%, in the Capital
Markets segment. See note "11 - Segment Information" in the Notes to Condensed
Consolidated Financial Statements for financial information by segment.
Asset Management and Administration Fees
- ----------------------------------------
Asset management and administration fees include mutual fund service fees,
as well as fees for other asset-based financial services provided to individual
and institutional clients. 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 client assets invested in third-party funds and upon the
average daily net assets of the Company's proprietary funds. Mutual fund service
fees are earned primarily through the Individual Investor and Institutional
Investor segments. The Company also earns asset management and administration
fees for financial services, including investment management and consulting,
trust and fiduciary services, financial and estate planning, and private banking
services, provided to individual and institutional clients. These fees are
primarily based on the value and composition of assets under management and are
earned primarily through the U.S. Trust, Individual Investor, and Institutional
Investor segments.
Asset management and administration fees were $444 million for the first
quarter of 2002, up $33 million, or 8%, from the first quarter of 2001, as shown
in the following table (in millions):
- --------------------------------------------------------------------------------
Three Months
Ended
Asset Management March 31, Percent
and Administration Fees 2002 2001 Change
- --------------------------------------------------------------------------------
Mutual fund service fees:
Proprietary funds
(SchwabFunds(R)and Excelsior(R)) $220 $190 16%
Mutual Fund OneSource(R) 71 72 (1)
Other 10 10
Asset management and related services 143 139 3
- --------------------------------------------------------------------------------
Total $444 $411 8%
================================================================================
The increase in asset management and administration fees was primarily due
to increases in SchwabFunds assets, which led to an increase in service fees.
Assets in client accounts were $857.7 billion at March 31, 2002, an
increase of $51.9 billion, or 6%, from a year ago as shown in the following
table. This increase from a year ago included net new client assets of $58.1
billion, partially offset by net market losses of $6.2 billion related to client
accounts.
- --------------------------------------------------------------------------------
Growth in Client Assets and Accounts
(In billions, at quarter end, March 31, Percent
except as noted) 2002 2001 Change
- --------------------------------------------------------------------------------
Assets in client accounts
Schwab One(R), other cash
equivalents and deposits
from banking clients $ 29.2 $ 28.8 1%
Proprietary funds (SchwabFunds(R)
and Excelsior(R)):
Money market funds 130.0 125.5 4
Equity and bond funds 33.2 27.7 20
- --------------------------------------------------------------------------------
Total proprietary funds 163.2 153.2 7
- --------------------------------------------------------------------------------
Mutual Fund Marketplace(R)(1):
Mutual Fund OneSource(R) 90.3 84.2 7
Mutual Fund clearing services 22.3 19.1 17
All other 78.8 68.7 15
- --------------------------------------------------------------------------------
Total Mutual Fund Marketplace 191.4 172.0 11
- --------------------------------------------------------------------------------
Total mutual fund assets 354.6 325.2 9
- --------------------------------------------------------------------------------
Equity and other securities (1) 374.7 370.0 1
Fixed income securities 108.4 93.6 16
Margin loans outstanding (9.2) (11.8) (22)
- --------------------------------------------------------------------------------
Total client assets $857.7 $ 805.8 6%
================================================================================
Net growth in assets
in client accounts
(for the quarter ended)
Net new client assets $ 15.4 $ 30.9
Net market losses (3.6) (96.8)
- ---------------------------------------------------------------------
Net growth (decline) $ 11.8 $ (65.9)
=====================================================================
New client accounts
(in thousands, for the
quarter ended) 232.3 280.4 (17%)
Active client accounts
(in millions) (2) 7.9 7.6 4%
- --------------------------------------------------------------------------------
Active online Schwab client
accounts (in millions) (3) 4.3 4.3
Online Schwab client assets $341.9 $ 327.9 4%
- --------------------------------------------------------------------------------
(1) Excludes money market funds and all proprietary money market, equity, and
bond funds.
(2) Active accounts are defined as accounts with balances or activity within
the preceding eight months.
(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.
Commissions
- -----------
The Company earns commission revenues by executing client trades primarily
through the Individual Investor and Institutional Investor segments. These
revenues are affected by the number of client accounts that trade, the average
number of commission-generating trades per account, and the average commission
per trade. Commission revenues for the Company were $303 million for the first
quarter of 2002, down $105 million, or 26%, from the first quarter of 2001.
The Company's client trading activity is shown in the following table (in
thousands):
- --------------------------------------------------------------------------------
Three Months
Ended
March 31, Percent
Daily Average Trades 2002 2001 Change
- --------------------------------------------------------------------------------
Revenue Trades
Online 123.9 165.5 (25%)
TeleBroker(R)and Schwab by PhoneTM 6.7 9.0 (26)
Regional client telephone service
centers, branch offices and other 16.8 21.3 (21)
- --------------------------------------------------------------------------------
Total 147.4 195.8 (25%)
================================================================================
Mutual Fund OneSource(R) Trades
Online 46.4 38.8 20%
TeleBroker and Schwab by Phone .5 .5
Regional client telephone service
centers, branch offices and other 11.6 18.4 (37)
- --------------------------------------------------------------------------------
Total 58.5 57.7 1%
================================================================================
Total Daily Average Trades
Online 170.3 204.3 (17%)
TeleBroker and Schwab by Phone 7.2 9.5 (24)
Regional client telephone service
centers, branch offices and other 28.4 39.7 (28)
- --------------------------------------------------------------------------------
Total 205.9 253.5 (19%)
================================================================================
As shown in the following table, the total number of revenue trades
executed by the Company has decreased 27% as the number of client accounts that
traded and client trading activity per account have declined.
- --------------------------------------------------------------------------------
Three Months
Ended
Commissions Earned on March 31, Percent
Client Revenue Trades 2002 2001 Change
- --------------------------------------------------------------------------------
Client accounts that traded during
the quarter (in thousands) 1,374 1,613 (15%)
Average client revenue trades
per account that traded 6.44 7.53 (14)
Total revenue trades
(in thousands) 8,851 12,149 (27)
Number of trading days 60 62 (3)
Average commission per
revenue trade $36.03 $33.81 7
Commissions earned on client
revenue trades (in millions) (1) $ 319 $ 411 (22)
- --------------------------------------------------------------------------------
(1) Includes certain non-commission revenues relating to the execution of
client trades. Excludes commissions on trades relating to specialist
operations and U.S. Trust commissions on trades.
Net Interest Revenue
- --------------------
Net interest revenue is the difference between interest earned on assets
(mainly margin loans to clients, investments required to be segregated for
clients, securities available for sale, and private banking loans) and interest
paid on liabilities (mainly brokerage client cash balances and banking
deposits). 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 and
hedging strategies.
Most of the Company's net interest revenue is earned through the Individual
Investor, Institutional Investor, and U.S. Trust segments.
Net interest revenue was $221 million for the first quarter of 2002, down
$36 million, or 14%, from the first quarter of 2001 as shown in the following
table (in millions):
- --------------------------------------------------------------------------------
Three Months
Ended
March 31, Percent
2002 2001 Change
- --------------------------------------------------------------------------------
Interest Revenue
Margin loans to clients $ 133 $ 302 (56%)
Investments, client-related 86 158 (46)
Private banking loans 60 58 3
Securities available for sale 17 21 (19)
Other 19 50 (62)
- --------------------------------------------------------------------------------
Total 315 589 (47)
- --------------------------------------------------------------------------------
Interest Expense
Brokerage clients cash balances 52 264 (80)
Deposits from banking clients 22 40 (45)
Long-term debt 13 14 (7)
Short-term borrowings 6 4 50
Stock-lending activities 1 9 (89)
Other 1 n/m
- --------------------------------------------------------------------------------
Total 94 332 (72)
- --------------------------------------------------------------------------------
Net interest revenue $ 221 $ 257 (14%)
================================================================================
n/m Not meaningful.
Client-related and other daily average balances, interest rates, and
average net interest spread for the first quarters of 2002 and 2001 are
summarized in the following table (dollars in millions):
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
2002 2001
- --------------------------------------------------------------------------------
Interest-Earning Assets (client-related and other):
Investments (client-related):
Average balance outstanding $ 17,907 $ 11,952
Average interest rate 1.94% 5.37%
Margin loans to clients:
Average balance outstanding $ 9,283 $ 14,272
Average interest rate 5.79% 8.57%
Private banking loans:
Average balance outstanding $ 4,063 $ 3,064
Average interest rate 5.99% 7.68%
Securities available for sale:
Average balance outstanding $ 1,445 $ 1,343
Average interest rate 4.86% 6.23%
Average yield on interest-earning assets 3.67% 7.13%
Funding Sources (client-related and other):
Interest-bearing brokerage client cash balances:
Average balance outstanding $ 23,580 $ 22,504
Average interest rate 0.91% 4.76%
Interest-bearing banking deposits:
Average balance outstanding $ 3,866 $ 3,333
Average interest rate 2.30% 4.90%
Other interest-bearing sources:
Average balance outstanding $ 1,009 $ 1,449
Average interest rate 2.24% 4.73%
Average noninterest-bearing portion $ 4,242 $ 3,345
Average interest rate on funding sources 1.01% 4.25%
Summary:
Average yield on interest-earning assets 3.67% 7.13%
Average interest rate on funding sources 1.01% 4.25%
- --------------------------------------------------------------------------------
Average net interest spread 2.66% 2.88%
================================================================================
The decrease in net interest revenue from the first quarter of 2001 was
primarily due to lower levels of, and lower rates received on, margin loans to
clients, as well as lower rates received on client-related investments,
partially offset by higher average balances of client-related investments and
lower rates paid on brokerage client cash balances.
Principal Transactions
- ----------------------
Principal transaction revenues are primarily comprised of net gains from
market-making activities in Nasdaq and other securities effected through the
Capital Markets segment, as well as revenues from client fixed income securities
trading activity. Factors that influence principal transaction revenues include
the volume of client trades, market price volatility, average revenue per share
traded, and changes in regulations and industry practices.
Principal transaction revenues were $51 million for the first quarter of
2002, down $44 million, or 46%, from the first quarter of 2001. This decrease
was primarily due to lower average revenue per share traded, which in turn was
primarily caused by the change to decimal pricing, and lower share volume
handled by SCM. This decrease was partially offset by higher revenues from
client fixed income securities trading activity.
Other Revenues
- --------------
Other revenues were $40 million for the first quarter of 2002, up $11
million, or 38%, from the first quarter of 2001. This increase was primarily due
to net gains on investments in 2002, compared to net losses on investments in
2001, and a gain recorded on the sale of the Company's Canadian operations,
partially offset by a decrease in payments for order flow.
EXPENSES EXCLUDING INTEREST
- ---------------------------
Total expenses excluding interest for the first quarter of 2002 declined
$107 million, or 10%, from the first quarter of 2001. Total expenses excluding
non-operating charges for the first quarter of 2002 declined $120 million, or
12%, from the first quarter of 2001. The Company's initiatives under its
restructuring plan and other expense reduction measures have resulted in
decreases in most expense categories during the first quarter of 2002 when
compared to the first quarter of 2001. The Company recorded total pre-tax
charges of $27 million in the first quarter of 2002 for restructuring charges
under its restructuring plan initiated in the second quarter of 2001.
Compensation and benefits expense was $471 million for the first quarter of
2002, down $22 million, or 4%, from the first quarter of 2001 primarily due to a
reduction in full-time equivalent employees, partially offset by a discretionary
bonus to employees in the first quarter of 2002. The following table shows a
comparison of certain compensation and benefits components and employee data (in
thousands):
- --------------------------------------------------------------------------------
Three Months
Ended
March 31,
2002 2001
- --------------------------------------------------------------------------------
Compensation and benefits expense as a
% of total revenues 44% 41%
Variable compensation as a
% of compensation and benefits expense 14% 11%
Compensation for temporary employees,
contractors and overtime hours as a
% of compensation and benefits expense 5% 7%
Full-time equivalent employees
(at end of quarter) (1) 19.4 25.2
Revenues per average full-time equivalent
employee $54.2 $47.1
- --------------------------------------------------------------------------------
(1) Includes full time, part-time, and temporary employees, and persons
employed on a contract basis.
Occupancy and equipment expense was $119 million for the first quarter of
2002, down $4 million, or 3%, from the first quarter of 2001. While the
Company's expense reduction measures including the restructuring plan
contributed to this decline, these measures were partially offset by higher
occupancy costs related to new facilities.
Communications expense was $71 million for the first quarter of 2002, down
$25 million, or 26%, from the first quarter of 2001. This decrease was primarily
due to lower client trading volumes and the Company's expense reduction
measures.
Advertising and market development expense was $53 million for the first
quarter of 2002, down $41 million, or 44%, from the first quarter of 2001. This
decrease was primarily a result of reductions in television and print media
spending as part of the Company's expense reduction measures.
Goodwill amortization expense for the first quarter of 2001 was $16
million. On January 1, 2002, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 142 - Goodwill and Other Intangible Assets. Upon
adoption of SFAS No. 142, amortization of the existing goodwill ceased and
therefore there was no such expense in the first quarter of 2002. The Company
did not record any goodwill impairment charges in the first quarter of 2002, and
upon completion of the initial transitional impairment test in the second
quarter of 2002, management does not expect to record any such charges.
The Company's effective income tax rate was 38.2% for the first quarter of
2002, down from 40.9% for the first quarter of 2001. The decrease was primarily
due to the cessation of goodwill amortization upon the adoption of SFAS No. 142
in 2002.
Liquidity and Capital Resources
CSC is a financial holding company, which is a type of bank holding company
subject to supervision and regulation by the Board of Governors of the Federal
Reserve System (Federal Reserve Board) under the Bank Holding Company Act of
1956, as amended. CSC conducts virtually all business through its wholly owned
subsidiaries. The capital structure among CSC and its subsidiaries is designed
to provide each entity with capital and liquidity consistent with its
operations. See note "9 - Regulatory Requirements" in the Notes to Condensed
Consolidated Financial Statements.
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, CSC's depository institution subsidiaries and SCM 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, meeting CSC's depository institution subsidiaries' capital
guidelines, and maintaining Schwab's and SCM's net capital. Based on their
respective regulatory capital ratios at March 31, 2002, the Company and its
depository institution subsidiaries are considered well capitalized.
CSC has liquidity needs that arise from its issued and outstanding $679
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 2002 to 2010 and fixed interest
rates ranging from 6.04% to 8.05% with interest payable semiannually. The
Medium-Term Notes are rated A2 by Moody's Investors Service, A by Standard &
Poor's Ratings Group, and A+ by Fitch IBCA, Inc.
CSC has a prospectus supplement on file with the Securities and Exchange
Commission enabling CSC to issue up to $750 million in Senior or Senior
Subordinated Medium-Term Notes, Series A. At March 31, 2002, all of these notes
remained unissued.
CSC has authorization from its Board of Directors to issue up to $1.2
billion in commercial paper. At March 31, 2002, no commercial paper has been
issued. CSC's ratings for these short-term borrowings are P-1 by Moody's
Investors Service and A-1 by Standard & Poor's Ratings Group.
CSC maintains a $1.2 billion committed, unsecured credit facility with a
group of twenty-three banks which is scheduled to expire in June 2002. CSC plans
to establish a similar facility to replace this one when it expires. Any
issuances under CSC's commercial paper program (see above) will reduce the
amount available under this facility. The funds under this facility are
available for general corporate purposes and CSC pays a commitment fee on the
unused balance of this facility. The financial covenants in this facility
require CSC to maintain a minimum level of tangible net worth, and Schwab and
SCM to maintain specified levels of net capital, as defined. Management believes
that these restrictions will not have a material effect on its ability to meet
foreseeable dividend or funding requirements. This facility was unused during
the first three months of 2002.
CSC also has direct access to $665 million of the $845 million uncommitted,
unsecured bank credit lines, provided by seven 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 three months
of 2002.
Schwab
Liquidity needs relating to client trading and margin borrowing activities
are met primarily through cash balances in brokerage client accounts, which were
$24.0 billion and $25.0 billion at March 31, 2002 and December 31, 2001,
respectively. Management believes that brokerage client 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, 2002, Schwab's net capital was $1.2 billion (12% of
aggregate debit balances), which was $990 million in excess of its minimum
required net capital and $697 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 client margin loans.
To manage Schwab's regulatory capital position, CSC provides Schwab with a
$1.4 billion subordinated revolving credit facility maturing in September 2003,
of which $220 million was outstanding at March 31, 2002. At quarter end, Schwab
also had outstanding $10 million and $15 million in fixed-rate subordinated term
loans from CSC maturing in 2003 and 2004, respectively. Borrowings under these
subordinated lending arrangements qualify as regulatory capital for Schwab.
To manage short-term liquidity, Schwab maintains uncommitted, unsecured
bank credit lines with a group of seven banks totaling $845 million at March 31,
2002 (as noted previously, $665 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 1 day during the
first three months of 2002, with the amount borrowed totaling $15 million. There
were no borrowings outstanding under these lines at March 31, 2002.
To satisfy the margin requirement of client option transactions with the
Options Clearing Corporation (OCC), Schwab had unsecured letter of credit
agreements with eleven banks in favor of the OCC aggregating $805 million at
March 31, 2002. Schwab pays a fee to maintain these letters of credit. No funds
were drawn under these letters of credit at March 31, 2002.
U.S. Trust
U.S. Trust's liquidity needs are generally met through earnings generated
by its operations.
U.S. Trust is subject to the Federal Reserve Board's risk-based and
leverage capital guidelines. These regulations require banks and bank holding
companies to maintain minimum levels of capital. In addition, CSC's depository
institution subsidiaries are subject to limitations on the amount of dividends
they can pay to USTC.
In addition to traditional funding sources such as deposits, federal funds
purchased, and repurchase agreements, CSC's depository institution subsidiaries
have established their own external funding sources. At March 31, 2002, U.S.
Trust had $50 million in Trust Preferred Capital Securities outstanding with a
fixed interest rate of 8.41%. Certain of CSC's depository institution
subsidiaries have established credit facilities with the Federal Home Loan Bank
System (FHLB) totaling $711 million. At March 31, 2002, $375 million in
short-term borrowings and $1 million in long-term debt were outstanding under
these facilities. Additionally, at March 31, 2002, U.S. Trust had $673 million
of federal funds purchased outstanding.
CSC provides U.S. Trust with a $300 million short-term credit facility
maturing in 2003. Borrowings under this facility do not qualify as regulatory
capital for U.S. Trust. The amount outstanding under this facility was $40
million at March 31, 2002.
SCM
SCM's liquidity needs are generally met through earnings generated by its
operations. Most of SCM's assets are liquid, consisting primarily of cash and
cash equivalents, marketable securities, and receivables 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, 2002, SCM's net capital was $21
million, which was $20 million in excess of its minimum required net capital.
SCM may borrow up to $70 million under a subordinated lending arrangement
with CSC maturing in 2003. Borrowings under this arrangement qualify as
regulatory capital for SCM. In addition, CSC provides SCM with a $50 million
short-term credit facility. Borrowings under this arrangement do not qualify as
regulatory capital for SCM. No funds were drawn under these facilities at March
31, 2002.
Liquidity Risk Factors
Specific risk factors which may affect the Company's liquidity position are
discussed in "Management's Discussion and Analysis of Results of Operations and
Financial Condition - Liquidity and Capital Resources - Liquidity Risk Factors"
in the Company's 2001 Annual Report to Stockholders, which is filed as Exhibit
13.1 to the Company's Form 10-K for the year ended December 31, 2001. There have
been no material changes to these liquidity risk factors in the first quarter of
2002.
Cash Flows and Capital Resources
Net income plus depreciation and amortization including goodwill
amortization was $177 million for the first quarter of 2002, down 10% from $197
million for the first quarter of 2001. Depreciation and amortization expense
related to equipment, office facilities and property was $80 million for the
first quarter of 2002, as compared to $81 million for the first quarter of 2001,
or 8% and 7% of revenues for each period, respectively. Amortization expense
related to intangible assets was $3 million for each of the first quarters of
2002 and 2001. Goodwill amortization expense was $16 million for the first
quarter of 2001.
The Company's cash position (reported as cash and cash equivalents on the
condensed consolidated balance sheet) and cash flows are affected by changes in
brokerage client cash balances and the associated amounts required to be
segregated under federal or other regulatory guidelines. Timing differences
between cash and investments actually segregated on a given date and the amount
required to be segregated for that date may arise in the ordinary course of
business and are addressed by the Company in accordance with applicable
regulations. Other factors which affect the Company's cash position and cash
flows include investment activity in securities owned, levels of capital
expenditures, banking client deposit and loan activity, financing activity in
short-term borrowings and long-term debt, and repurchases of CSC's common stock.
In the first quarter of 2002, cash and cash equivalents decreased $2.6 billion,
or 58%, to $1.9 billion primarily due to movements of brokerage client-related
funds to meet segregation requirements, as well as decreases in banking client
deposits. Management does not believe that this decline in cash and cash
equivalents is an indication of a trend.
The Company's capital expenditures were $32 million in the first quarter of
2002 and $129 million in the first quarter of 2001, or 3% and 11% of revenues
for each period, respectively. Capital expenditures in the first quarter of 2002
were for software and equipment relating to the Company's information technology
systems and certain facilities. Capital expenditures as described above include
the capitalized costs for developing internal-use software of $16 million in the
first quarter of 2002 and $25 million in the first quarter of 2001. Schwab
opened 1 new domestic branch office during the first quarter of 2002, as
compared to 14 for the first quarter of 2001. Capital expenditures may vary from
period to period as business conditions change.
During the first quarter of 2002, 2,066,100 of the Company's stock options,
with a weighted-average exercise price of $7.08, were exercised with cash
proceeds received by the Company of $15 million and a related tax benefit of $3
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 quarter of 2002, CSC did not repurchase any of its common
stock. During the first quarter of 2001, CSC repurchased 1,175,000 shares of its
common stock for $18 million. At March 31, 2002, the authorization granted by
the Board of Directors allows for future repurchases of CSC's common stock
totaling up to $399 million.
During each of the first quarters of 2002 and 2001, the Company paid common
stock cash dividends of $15 million.
The Company monitors both the relative composition and absolute level of
its capital structure. The Company's total financial capital (long-term debt
plus stockholders' equity) at March 31, 2002 was $5.0 billion, up $105 million,
or 2%, from December 31, 2001. At March 31, 2002, the Company had long-term debt
of $730 million, or 15% of total financial capital, that bear interest at a
weighted-average rate of 7.35%. At March 31, 2002, the Company's stockholders'
equity was $4.3 billion, or 85% of total financial capital.
Commitments
A summary of the Company's principal contractual obligations and other
commitments as of March 31, 2002 is shown in the following table. Management
believes that funds generated by its operations will continue to be the primary
funding source in meeting these obligations and commitments.
Less than 1 - 3 4 - 5 After 5
1 Year Years Years Years Total
- --------------------------------------------------------------------------------
Operating leases (1) $ 202 $ 845 $252 $ 757 $2,056
Long-term debt 114 237 106 273 730
Short-term borrowings 1,213 1,213
Merger-retention programs (2) 104 104
Credit-related financial
instruments (3) 553 119 672
Other commitments (4) 6 6
- --------------------------------------------------------------------------------
Total $2,192 $1,201 $358 $1,030 $4,781
================================================================================
(1) Includes minimum rental commitments and maximum guaranteed residual values
under noncancelable leases for office space and equipment.
(2) Includes commitments under merger-retention programs for employees of U.S.
Trust.
(3) Includes U.S. Trust firm commitments to extend credit primarily for
mortgage loans to private banking clients and standby letters of credit.
(4) Includes committed capital contributions to venture capital funds.
In addition to the commitments summarized above, in the ordinary course of
its business the Company has entered into various agreements with third-party
vendors, including agreements for advertising, sponsorships of sporting events,
data processing equipment purchases, licensing, and software installation. These
agreements typically can be canceled by the Company if notice is given within
the terms specified in the agreements.
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 $43 million and
$59 million at March 31, 2002 and 2001, respectively. These securities, and the
associated interest rate risk, are not material to the Company's financial
position, results of operations or cash flows.
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, 2002 was $160 million in long positions and $35 million
in short positions. The fair value of these securities at March 31, 2001 was $40
million in long positions and $35 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 $13 million and $500,000 at March
31, 2002 and 2001, respectively, due to the offset of change in fair value in
long and short positions. In addition, the Company generally enters into
exchange-traded futures and options to hedge against potential losses in equity
inventory positions, thus offsetting this potential loss exposure. A
hypothetical 10% change in fair value of the futures and options at March 31,
2002 and 2001 would substantially offset the potential loss or gain on the
equity securities discussed above. The notional amount and fair value of futures
and options were not material to the Company's consolidated balance sheets at
March 31, 2002 and 2001.
Financial Instruments Held For Purposes Other Than Trading
- ----------------------------------------------------------
The Company maintains investments in mutual funds related to its deferred
compensation plan, which is available to certain employees. These investments
were approximately $62 million at March 31, 2002 and 2001. These securities, and
the associated market risk, are not material to the Company's financial
position, results of operations or cash flows.
Debt Issuances
- --------------
At March 31, 2002, CSC had $679 million aggregate principal amount of
Medium-Term Notes, with fixed interest rates ranging from 6.04% to 8.05%. At
March 31, 2001, CSC had $716 million aggregate principal amount of Medium-Term
Notes, with fixed interest rates ranging from 6.04% to 8.05%. At March 31, 2002
and 2001, U.S. Trust had $50 million Trust Preferred Capital Securities
outstanding, with a fixed interest rate of 8.41%. In addition at March 31, 2002
and 2001, U.S. Trust had $1 million and $2 million FHLB long-term debt
outstanding, respectively. The FHLB long-term debt had a fixed interest rate of
6.69% at March 31, 2002 and fixed interest rates ranging from 6.69% to 6.76% at
March 31, 2001.
The Company has fixed cash flow requirements regarding these long-term debt
obligations due to the fixed rate of interest. The fair value of these
obligations at March 31, 2002 and 2001, based on estimates of market rates for
debt with similar terms and remaining maturities, approximated their carrying
amount.
Net Interest Revenue Simulation
- -------------------------------
The Company uses net interest revenue simulation modeling techniques to
evaluate and manage the effect of changing interest rates. The simulation model
(the model) includes all interest-sensitive assets and liabilities, as well as
Swaps utilized by U.S. Trust to hedge its interest rate risk. Key variables in
the model include assumed margin loan and brokerage client cash balance growth
or decline, changes to the level and term structure of interest rates, the
repricing of financial instruments, prepayment and reinvestment assumptions,
loan, banking deposit, and brokerage client cash balance pricing and volume
assumptions. The simulations involve assumptions that are inherently uncertain
and as a result, the simulations cannot precisely estimate net interest revenue
or precisely predict the impact of changes in interest rates on net interest
revenue. Actual results may differ from simulated results due to the timing,
magnitude, and frequency of interest rate changes as well as changes in market
conditions and management strategies, including changes in asset and liability
mix.
As demonstrated by the simulations presented below, the Company is
positioned so that the consolidated balance sheet produces an increase in net
interest revenue when interest rates rise and, conversely, a decrease in net
interest revenue when rates fall (i.e., interest-earning assets are repricing
more quickly than interest-bearing liabilities). U.S. Trust's interest-bearing
liabilities are positioned to reprice more quickly than interest-earning assets,
which naturally offsets a portion of Schwab's asset-sensitive interest-rate risk
exposure.
The simulations in the following table assume that the asset and liability
structure of the consolidated balance sheet would not be changed as a result of
the simulated changes in interest rates. As the Company actively manages its
consolidated balance sheet and interest rate exposure, in all likelihood the
Company would take steps to manage any additional interest rate exposure that
could result from changes in the interest rate environment. The following table
shows the effect of a gradual 100 basis point increase or decrease in interest
rates relative to the Company's current base rate forecast on simulated net
interest revenue over the next twelve months at March 31, 2002 and 2001.
- --------------------------------------------------------------------------------
Impact on Net Interest Revenue
Percentage Increase (Decrease)
March 31, 2002 2001
- --------------------------------------------------------------------------------
Increase of 100 basis points 1.5% 3.3%
Decrease of 100 basis points (1.8%) (3.1%)
- --------------------------------------------------------------------------------
The impact of the Company's hedging activities upon net interest revenue
for the quarters ended March 31, 2002 and 2001 was immaterial to the Company's
results of operations.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The nature of the Company's business subjects it to claims, lawsuits,
regulatory examinations, and other proceedings in the ordinary course of
business. The results of these matters 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 and results of operations.
However, it is the opinion of management, after consultation with legal counsel,
that the ultimate outcome of these matters will not have a material adverse
impact on the financial condition or operating results of the Company.
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
Effective February 19, 2002, Steven L. Scheid, Vice Chairman of the Company
and Schwab and President - Retail of Schwab, resigned. David S. Pottruck,
Co-Chief Executive Officer and President of the Company, has assumed Mr.
Scheid's responsibilities while retaining his previous responsibilities.
Effective February 28, 2002, Elizabeth Gibson Sawi, Executive Vice
President and Chief Administration Officer of the Company and Schwab, retired.
Dawn Gould Lepore, Vice Chairman - Technology and Administration of the Company
and Schwab, has assumed Ms. Sawi's responsibilities while retaining
responsibility for the oversight of technology.
Effective February 28, 2002, H. Marshall Schwarz retired as Executive Vice
President of the Company and Chairman of USTC and U.S. Trust NY. Because of Mr.
Schwarz's retirement, he is not seeking re-election to the Company's Board of
Directors at the annual meeting of stockholders on May 13, 2002. Mr. Schwarz's
term on the Board of Directors will expire on that date.
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibit is filed as part of this quarterly report on Form
10-Q.
- --------------------------------------------------------------------------------
Exhibit
Number Exhibit
- --------------------------------------------------------------------------------
12.1 Computation of Ratio of Earnings to Fixed
Charges.
- --------------------------------------------------------------------------------
(b) Reports on Form 8-K
None.
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, 2002 /s/ Christopher V. Dodds
-------------- ------------------------------
Christopher V. Dodds
Executive Vice President and
Chief Financial Officer