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, 1995 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)
101 Montgomery Street, San Francisco, CA 94104
(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.
85,895,520* shares of $.01 par value Common Stock
Outstanding on May 1, 1995
* Reflects the 1995 three-for-two common stock split.
THE CHARLES SCHWAB CORPORATION
Quarterly Report on Form 10-Q
For the Quarter Ended March 31, 1995
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 4-5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 6-12
Part II - Other Information
Item 1. Legal Proceedings 12-13
Item 2. Changes in Securities 13
Item 3. Defaults Upon Senior Securities 13
Item 4. Submission of Matters to a Vote of Security Holders 13
Item 5. Other Information 13
Item 6. Exhibits and Reports on Form 8-K 13
Signature 14
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,
1995 1994
---- ----
Revenues
Commissions $150,947 $160,985
Interest revenue, net of interest expense of
$79,203 in 1995 and $35,230 in 1994 46,048 35,862
Principal transactions 43,296 50,289
Mutual fund service fees 46,239 33,768
Other 10,323 7,001
- ----------------------------------------------------------------------------------
Total 296,853 287,905
- ----------------------------------------------------------------------------------
Expenses Excluding Interest
Compensation and benefits 123,161 121,020
Communications 26,363 28,139
Occupancy and equipment 23,520 20,961
Depreciation and amortization 14,134 12,512
Commissions, clearance and floor brokerage 15,599 12,526
Advertising and market development 10,898 11,796
Professional services 5,647 5,566
Other 14,150 11,841
- ----------------------------------------------------------------------------------
Total 233,472 224,361
- ----------------------------------------------------------------------------------
Income before taxes on income 63,381 63,544
Taxes on income 25,005 25,354
- ----------------------------------------------------------------------------------
Net Income $ 38,376 $ 38,190
==================================================================================
Weighted average number of common and
common equivalent shares outstanding* 88,074 88,204
==================================================================================
Earnings per Common Equivalent Share* $ .44 $ .43
==================================================================================
Dividends Declared per Common Share* $ .060 $ .047
==================================================================================
* Reflects the 1995 three-for-two common stock split.
See Notes to Condensed Consolidated Financial Statements.
- 1 -
THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(In thousands, except share data)
March 31, December 31,
1995 1994
---- ----
(Unaudited)
-----------
Assets
Cash and equivalents (including resale agreements of
$152,110 in 1995 and $242,500 in 1994) $ 417,328 $ 380,616
Cash and investments required to be segregated under
Federal or other regulations (including resale agreements
of $4,321,079 in 1995 and $3,787,984 in 1994) 4,617,642 4,206,466
Receivable from brokers, dealers and clearing organizations 87,655 86,028
Receivable from customers (less allowance for doubtful
accounts of $3,125 in 1995 and $3,204 in 1994) 2,827,269 2,923,867
Equipment, office facilities and property (less accumulated
depreciation and amortization of $172,792 in 1995 and
$162,474 in 1994) 136,238 129,105
Customer lists (less accumulated amortization of $143,686
in 1995 and $140,860 in 1994) 23,988 26,813
Other assets 161,258 164,967
- ------------------------------------------------------------------------------------------------------
Total $8,271,378 $7,917,862
======================================================================================================
Liabilities and Stockholders' Equity
Drafts payable $ 159,000 $ 117,383
Payable to brokers, dealers and clearing organizations 428,406 296,420
Payable to customers 6,813,017 6,670,362
Accrued expenses 190,045 195,320
Long-term borrowings 171,130 171,363
- ------------------------------------------------------------------------------------------------------
Total liabilities 7,761,598 7,450,848
- ------------------------------------------------------------------------------------------------------
Stockholders' equity:
Preferred stock - 10,000,000 shares authorized; $.01 par
value per share; none issued
Common stock - 200,000,000 shares authorized; $.01 par
value per share; 89,229,708 shares issued in
1995 and 1994* 892 595
Additional paid-in capital 170,237 166,103
Retained earnings 406,141 373,161
Treasury stock - 3,435,029 shares in 1995 and 3,781,995
shares in 1994, at cost* (55,004) (57,968)
Unearned ESOP shares (8,146) (10,174)
Unamortized restricted stock compensation (4,340) (4,703)
- ------------------------------------------------------------------------------------------------------
Stockholders' equity 509,780 467,014
- ------------------------------------------------------------------------------------------------------
Total $8,271,378 $7,917,862
======================================================================================================
* Reflects the 1995 three-for-two common stock split.
See Notes to Condensed Consolidated Financial Statements.
- 2 -
THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
(Unaudited)
Three Months Ended
March 31,
1995 1994
---- ----
Cash flows from operating activities
Net income $ 38,376 $ 38,190
Noncash items included in net income:
Depreciation and amortization 14,134 12,512
Deferred income taxes 517 7,254
Other 4,067 (137)
Change in accrued expenses (2,719) 25,782
Change in other assets 3,196 10,457
- --------------------------------------------------------------------------------------------------
Net cash provided before change in customer-related balances 57,571 94,058
- --------------------------------------------------------------------------------------------------
Change in customer-related balances:
Payable to customers 142,655 591,736
Receivable from customers 96,677 (80,557)
Drafts payable 41,617 (5,299)
Payable to brokers, dealers and clearing organizations 131,986 24,441
Receivable from brokers, dealers and clearing organizations (1,627) (4,151)
Cash and investments required to be segregated under
Federal or other regulations (411,176) (531,355)
- --------------------------------------------------------------------------------------------------
Net change in customer-related balances 132 (5,185)
- --------------------------------------------------------------------------------------------------
Net cash provided by operating activities 57,703 88,873
- --------------------------------------------------------------------------------------------------
Cash flows from investing activities
Purchase of equipment, office facilities and property - net (18,006) (14,803)
- --------------------------------------------------------------------------------------------------
Net cash used by investing activities (18,006) (14,803)
- --------------------------------------------------------------------------------------------------
Cash flows from financing activities
Purchase of treasury stock (19,031)
Dividends paid (5,142) (4,046)
Other 2,157 931
- --------------------------------------------------------------------------------------------------
Net cash used by financing activities (2,985) (22,146)
- --------------------------------------------------------------------------------------------------
Increase in cash and equivalents 36,712 51,924
Cash and equivalents at beginning of period 380,616 279,828
- --------------------------------------------------------------------------------------------------
Cash and equivalents at end of period $ 417,328 $ 331,752
==================================================================================================
See Notes to Condensed Consolidated Financial Statements.
- 3 -
THE CHARLES SCHWAB CORPORATION
NOTES TO CONDENSED
CONSOLIDATED FINANCIAL
STATEMENTS
(Unaudited)
Basis of Presentation
The accompanying unaudited condensed consolidated financial
statements include The Charles Schwab Corporation (CSC) and its
subsidiaries (collectively the Company), including Charles Schwab &
Co., Inc. (Schwab) and Mayer & Schweitzer, Inc. (M&S). 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 1994 Annual Report to Stockholders, which are
incorporated by reference in the Company's 1994 Annual Report on Form
10-K.
Revenues are presented net of interest expense. Certain 1994
revenues and expenses have been reclassified to conform to the 1995
presentation.
Contingent Liabilities
In the normal course of its margin lending activities, Schwab is
contingently liable to the Options Clearing Corporation for the margin
requirement of customer margin securities transactions. Such margin
requirement is secured by a pledge of customers' margin securities.
This contingent liability was $114 million at March 31, 1995.
In January 1992, the Company filed a petition in U.S. Tax Court
refuting a claim for additional Federal income tax asserted by the
Internal Revenue Service (IRS). A trial is scheduled for August 1995.
The asserted additional tax of $19 million, excluding interest, arises
from the IRS' audit of the tax periods ended March 31, 1988 and
December 31, 1988. The majority of the asserted additional tax
relates to deductions claimed by the Company for amortization of
intangible assets (mainly customer lists) received in the Company's
1987 acquisition of Schwab. The resolution of the contested issues
may also affect the Company's taxable years ended December 31, 1989
through 1994. While a 1993 U.S. Supreme Court decision confirms the
Company's ability to amortize for tax purposes certain of its
intangible assets, issues involving the valuation of these intangible
assets remain unresolved in the Company's case with the IRS. Management
believes that these matters will be resolved without a material adverse
effect on the Company's financial position or results of operations.
M&S has been named as one of thirty-three defendant market-
making firms in a consolidated class action which is pending in
Federal District Court in the Southern District of New York pursuant
to an order of the Judicial Panel on Multidistrict Litigation. On
December 16, 1994, the plaintiffs filed a consolidated amended
complaint purportedly on behalf of certain persons who purchased or sold
Nasdaq securities during the period May 1, 1989 through May 27, 1994.
The complaint does not set forth any specific conduct by M&S and does
not request any specific amount of damages, although it requests that
the actual damages be trebled where permitted by statute. The
consolidated amended complaint generally alleges an illegal
combination and conspiracy among the defendant market-making firms to fix
and maintain the spreads between the bid and ask prices of Nasdaq
securities. On February 2, 1995, the defendants filed a motion to
dismiss the consolidated amended complaint for failure to state a
claim. That motion is pending. The ultimate outcome of this
consolidated action cannot currently be determined.
There are other various lawsuits pending against the Company which,
in the opinion of management, will be resolved with no material impact
on the Company's financial position or results of operations.
In December 1994, a $100 million letter of credit facility was
established by CSC with a commercial bank to issue letters of credit
(LOCs) to three of the SchwabFunds (registered trademark) money market
funds in connection with the bankruptcies of Orange County, California
and the Orange County investment pool. CSC has agreed to reimburse
the bank for any payments made under the LOCs, and to leave unutilized
as much as $100 million of its $225 million credit facility. The LOC
facility was voluntarily established by CSC as a precautionary measure
to provide independent support for the valuation of certain securities
held by the funds. These securities were issued by Orange County
and by municipalities that participated in the investment pool
maintained by Orange County.
- 4 -
Although the issuers, other than Orange County, have not filed for
bankruptcy, their ability to repay obligations in a timely manner may be
affected by shortfalls, if any, of amounts scheduled to be received from
investments in the Orange County investment pool.
At March 31, 1995, LOCs totaling $58.5 million were outstanding
under this facility. The funds may make demands for payments under
the LOCs if the issuers of certain municipal securities held by the
funds fail to pay a specified percentage of the principal amount of
the securities when due or if the proceeds received by the funds in
the disposition of any such securities are less than a specified
percentage of the principal amount of the securities. The funds will
absorb losses of principal amounts of the securities, if any, at
disposition or maturity for each security up to a specified
percentage. The LOCs expire and the original maturities of the securities
occur on or before August 1, 1995. Management is currently unable
to determine whether, or to what extent, the funds would make any demands
for payment under the LOCs.
Regulatory Requirements
Schwab and M&S are subject to the SEC's Uniform Net Capital Rule
and each 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 M&S 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, 1995, Schwab's
net capital was $338 million (11% of aggregate debit balances), which
was $279 million in excess of its minimum required net capital and
$191 million in excess of 5% of aggregate debit balances. At
March 31, 1995, M&S' net capital was $6 million (395% of aggregate
debit balances), which was $5 million in excess of its minimum
required net capital.
In accordance with the requirements of SEC Rule 15c3-3, Schwab and
M&S had a portion of their cash and investments segregated for the
exclusive benefit of customers at March 31, 1995.
Cash Flow Information
Certain investing and financing activities of the Company affect
its financial position but do not affect cash flows. The following
table summarizes those transactions (in thousands):
Three Months
Ended
March 31,
1995 1994
---- ----
Transfer of par value on stock
issued in three-for-two
stock split $297
====
Dividends declared,
not yet paid $4,006
======
Equipment, office facilities
and property financed $1,843
======
Certain additional information affecting the cash flows of the
Company follows (in thousands):
Three Months
Ended
March 31,
1995 1994
---- ----
Income taxes paid $ 3,993 $ 462
======= =======
Interest paid:
Customer cash balances $72,468 $30,857
Long-term borrowings 5,204 4,740
Other 3,610 1,232
------- -------
Total interest paid $81,282 $36,829
======= =======
Subsequent Event
In April 1995, CSC announced the terms of an offer to acquire
ShareLink Investment Services plc, a retail discount securities
brokerage firm in the United Kingdom, for approximately $65 million in
cash and/or loan notes. Completion of the transaction is expected by
June 30, 1995 and is subject to regulatory approvals and other
conditions. CSC entered into a contract in April 1995 to purchase British
pound sterling to be used for the ShareLink Investment Services plc
acquisition.
- 5 -
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
General
The Charles Schwab Corporation (CSC) and its subsidiaries
(collectively referred to as the Company) provide brokerage and
related investment services to customers with 3.1 million active (a)
accounts and assets that totaled $136.9 billion at March 31, 1995.
With a network of 208 branch offices, the Company's principal
subsidiary, Charles Schwab & Co., Inc. (Schwab), is physically
represented in 46 states, the Commonwealth of Puerto Rico and the
United Kingdom. Mayer & Schweitzer, Inc. (M&S), a market maker in
Nasdaq securities, provides trade execution services to broker-dealers
and institutional customers.
The Company's business, like that of other securities brokerage
firms, is directly affected by fluctuations in volumes and price
levels in securities markets, which are in turn affected by many
national and international economic and political factors that cannot
be predicted. Transaction-based revenues, primarily commission and
principal transaction revenues, represent the majority of the
Company's revenues. In the short term, most of the Company's expenses
do not vary directly with fluctuations in securities trading volume
and do not increase or decrease quickly, which could result in the
Company experiencing increased profitability with rapid increases in
revenues, or reduced profitability (or losses) in the event of a
material reduction in revenues.
Due to the factors discussed above, the results of any interim
period are not necessarily indicative of results for a full year, and
it is not unusual for the Company to experience significant variations
in quarterly revenue growth. In addition, these factors may subject
the Company's future earnings and common stock price to significant
volatility.
The Company has historically used discount pricing as a tactic in its
efforts to gain market share and enhance the value of its services. In
recent years, Schwab has introduced additional price-competitive product
offerings such as its No-Annual-Fee IRA, its Mutual Fund OneSource
(trademark) service and its Schwab 500 Brokerage (trademark) service, which
includes commission discounts from Schwab's standard rates. Schwab's
on-line brokerage services such as TeleBroker (registered trademark) and
StreetSmart (trademark) also provide customers with discounts on commissions.
Management expects to continue to use aggressively this value-pricing
philosophy in the marketing of new products and services.
Three Months Ended March 31, 1995
Compared To Three Months Ended
March 31, 1994
Summary
Net income for the first quarter of 1995 totaled $38 million or
$.44 per share, relatively unchanged from first quarter 1994 net
income of $38 million or $.43 per share.
First quarter 1995 revenues were $297 million, up 3% from
$288 million for the first quarter of 1994, primarily due to increases
in mutual fund service fees and net interest revenue, largely offset
by decreases in commission and principal transaction revenues.
Mutual fund service fees increased $12 million, or 37% due to growth
in fund balances. Net interest revenue increased $10 million, or 28%
mainly due to increases in customer cash balances and margin loans to
customers. Commission revenues decreased $10 million, or 6% due to a
decrease in average commission per trade. Principal transaction
revenues decreased $7 million, or 14% due to a lower daily average
revenue per principal transaction from market-making activities in
Nasdaq securities.
Assets in customer accounts totaled
(a) Accounts with balances or activity within the preceding twelve months.
- 6 -
$136.9 billion at March 31, 1995, $36.5 billion, or 36%, more than a
year ago primarily resulting from increases in customers' equity securities
of $11.8 billion, or 28%, and increases in customer assets in
Schwab's Mutual Fund Marketplace (registered trademark) of $8.7 billion,
or 33%. Customer assets in cash and money market funds at March 31, 1995
increased 33% over the year-ago level to $30.3 billion. Schwab added
164,900 new customer accounts during the first quarter of 1995, compared to
234,000 new accounts during the first quarter of 1994. The
quarter-over-quarter decrease was due in part to the $1,000 minimum
opening balance requirement implemented in July 1994 for basic brokerage
accounts.
Total operating expenses excluding interest during the first
quarter of 1995 were $233 million, up 4% from $224 million for the first
quarter of 1994. The higher expenses primarily related to the
Company's continued growth and expansion, higher principal
transaction-related expenses such as commissions, clearance and floor
brokerage expenses,
and additional employees.
The profit margin for the first quarter of 1995 was 13%, unchanged
from the first quarter of 1994. The annualized return on
stockholders' equity for the first quarter of 1995 was 28%, down from
36% for the first quarter of 1994, reflecting the Company's higher
equity base in 1995's first quarter.
During the first quarter of 1995, Schwab commenced operation of
four specialists' posts on the Pacific Stock Exchange, bringing the
total number of posts to nine at March 31, 1995. These posts make
markets in over 400 securities, which include common stocks, preferred
stocks and exchange-listed bonds. The Company expects to continue to
expand its capacity to execute principal transactions.
Commissions
Schwab executes commission transactions for customers on an agency
basis. Commission revenues totaled $151 million for the first quarter
of 1995, down $10 million, or 6%, from the first quarter of 1994.
Retail agency commissions constituted approximately 96% of total
commissions, with remaining commissions from institutional customers.
Commissions earned on retail agency trades totaled $145 million on a
daily average retail agency trade level of 32,800 in the first quarter
of 1995, compared with commission revenues of $155 million on a daily
average retail agency trade level of 33,300 for the comparable period
in 1994. The following table shows a comparison of certain factors
that influence retail agency commission revenues:
- ----------------------------------------------------------------------------------
Three Months
Ended
March 31, Percent
1995 1994 Change
- ----------------------------------------------------------------------------------
Number of customer
accounts that traded during
the quarter (in thousands) 666 643 4%
Average number of retail agency
transactions per account
that traded 3.11 3.27 (5)
Total number of retail agency
transactions (in thousands) 2,069 2,098 (1)
Average commission per
retail agency transaction $70.10 $73.85 (5)
Total retail agency commission
revenues (in millions) $ 145 $ 155 (6)
==================================================================================
Note: The above table excludes customer transactions in Schwab's
Mutual Fund OneSource (trademark) service.
The 4% increase in the number of customer accounts that traded during
the quarter was fully offset by a 5% decline in the number of retail
agency trades per such accounts. Average commission per retail agency
transaction declined 5% from the year-ago level as the proportion
of trades handled by TeleBroker (registered trademark) and StreetSmart
(trademark), which provide users a 10% commission discount, and
Schwab 500 Brokerage (trademark) service, which also provides commission
discounts, increased. The combination of 1% fewer retail agency trades
handled during the quarter and the 5% decline in average commission per
retail agency transaction resulted in a 6% decline in total retail agency
- 7 -
commission revenues.
Schwab continues to experience significant commission price competition
and expects to continue to develop price-competitive products and services
that address the needs of customers for which pricing is a primary factor
in their selection of financial services.
Interest Revenue, Net of Interest Expense
Interest revenue, net of interest expense increased $10 million, or
28%, to $46 million from the prior year's first quarter as shown in
the following table (in millions):
- ---------------------------------------------------------------------
Three Months
Ended
March 31,
1995 1994
- ---------------------------------------------------------------------
Interest Revenue
Investments, customer-related $ 63 $31
Margin loans to customers 58 38
Other 4 2
- ---------------------------------------------------------------------
Total 125 71
- ---------------------------------------------------------------------
Interest Expense
Customer cash balances 72 31
Long-term borrowings 3 3
Other 4 1
- ---------------------------------------------------------------------
Total 79 35
- ---------------------------------------------------------------------
Interest Revenue, Net of Interest Expense $ 46 $36
=====================================================================
When investing segregated customer cash balances, the Company must
adhere to SEC regulations that restrict investments to U.S. government
securities, participation certificates and mortgage-backed securities
guaranteed by the Government National Mortgage Association,
certificates of deposit issued by U.S. banks and thrifts and resale
agreements collateralized by qualified securities. The Company's
policies for credit quality and maximum maturity requirements are
more restrictive than these SEC regulations. Investment information
for the first three months of 1995 and 1994 is as follows:
- ---------------------------------------------------------
Three Months
Ended
March 31,
1995 1994
- ---------------------------------------------------------
Investment composition
(in billions at quarter end):
Resale agreements $4.3 $3.8
Certificates of deposit .2 .2
Average maturity of investments
(in days):
During the quarter 40 67
At quarter end 46 64
=========================================================
Customer-related daily average balances, interest rates
and average net interest margin for the first quarters of 1995 and
1994 are summarized in the following table (dollars in millions):
- ------------------------------------------------------------------------------
Three Months Ended
March 31,
1995 1994
- ------------------------------------------------------------------------------
Earning Assets (customer-related):
Investments:
Average balance outstanding $4,276 $3,861
Average interest rate 5.94% 3.30%
Margin loans to customers:
Average balance outstanding $2,869 $2,601
Average interest rate 8.25% 5.96%
Average yield on earning assets 6.87% 4.37%
Funding Sources (customer-related
and other):
Interest-bearing customer cash balances:
Average balance outstanding $5,880 $5,229
Average interest rate 4.96% 2.40%
Other interest-bearing sources:
Average balance outstanding $ 342 $ 353
Average interest rate 4.18% 3.03%
Average noninterest-bearing portion $ 923 $ 880
Average interest rate on funding sources 4.28% 2.11%
Summary:
Average yield on earning assets 6.87% 4.37%
Average interest rate on funding sources 4.28% 2.11%
- ------------------------------------------------------------------------------
Average net interest margin 2.59% 2.26%
==============================================================================
Interest revenue from customer-related investments increased
$32 million due to an 11% increase in average balances outstanding,
and a 264 basis point increase in the average interest rate
- 8 -
earned on such investments. Interest earned on margin loans to
customers increased $20 million as average margin balances increased
10%, and the average interest rate earned on such balances increased
229 basis points. Interest expense on customer cash balances increased
$41 million due to a 12% increase in average balances outstanding, and
a 256 basis point increase in average interest rates paid on such
balances.
The average net interest margin pertaining to customer-related
earning assets and related funding sources increased 33 basis points
over that of 1994's first quarter to 2.59%. This was primarily
due to larger increases in average interest rates with respect to earning
assets compared to average interest rates on funding sources.
Principal Transactions
During the first quarter of 1995, principal transaction revenues
decreased $7 million, or 14%, from the comparable period in 1994 to
$43 million. This decrease was due to a lower daily average revenue
per principal transaction from market-making activities in Nasdaq
securities in the first quarter of 1995, partially offset by an
increase in trading volume handled by M&S. A portion of this decrease
was attributable to the impact of the July 1994 National Association
of Securities Dealers, Inc. (NASD) Interpretation to its Rules of Fair
Practice governing the way in which market makers in Nasdaq securities
handle the execution of limit orders accepted from certain types of
customers. M&S has extended the benefits of the Interpretation to
substantially all retail customer limit orders in Nasdaq securities
received from broker-dealers for which it executes such orders. As a
market maker in Nasdaq securities, M&S generally executes customer
trades as principal. Substantially all Nasdaq security trades
originated by the customers of Schwab are directed to M&S.
During 1994, the Department of Justice, the SEC and the NASD
commenced a series of investigations and regulatory actions involving
the activities of many market makers in Nasdaq securities. These
investigations and regulatory actions have continued into 1995. M&S is
a significant participant in the Nasdaq market. As a result of such
investigations and actions, and possible future regulatory actions,
changes are occurring in the manner in which this market conducts its
business. Current practices may change as a consequence of rulemaking
and improvements in technology and may be subject to increased
disclosure requirements. New market systems, if approved, could
significantly impact the manner in which business is currently
conducted. Schwab and M&S are cooperating with the various
investigations and have and will continue to work with the regulators
to respond to questions related to their businesses. These
investigations and regulatory actions may have a material adverse
impact on M&S' future business. The Company anticipates that it will
adapt to any new market environment and intends to promote practices
which are designed to benefit its customers.
Mutual Fund Service Fees
Mutual fund service fees increased $12 million, or 37%, to
$46 million in the first quarter of 1995 from the comparable period in
1994. The increase was primarily attributable to significant
increases in customer assets in Schwab's proprietary funds,
collectively referred to as the SchwabFunds (registered trademark),
and customer assets in funds purchased through Schwab's Mutual Fund
OneSource (trademark) service. Most of these fees are earned for
transfer agent and investment management services provided to
proprietary money market funds and for record keeping and shareholder
services provided to funds in the Mutual Fund OneSource service.
The SchwabFunds include money market funds, bond funds and equity
index funds. Schwab customers may elect to have cash balances in their
brokerage accounts automatically invested in certain SchwabFunds money
market funds. This feature provides a significant competitive
advantage to SchwabFunds money market funds as uninvested customer
cash is swept into these funds on a regular basis. Customer assets
invested in the
- 9 -
SchwabFunds (registered trademark), substantially all of which are in money
market funds, were $24.9 billion at March 31, 1995, compared to $17.8
billion at March 31, 1994, a 40% increase. Fees received by Schwab
via the Mutual Fund OneSource (trademark) program are based on daily
balances of customer assets invested in the participating funds through
Schwab and are paid by the funds and/or fund sponsors. Customer assets
held by Schwab that have been purchased through the Mutual Fund OneSource
service, excluding SchwabFunds, totaled $15.1 billion at March 31, 1995,
compared to $9.5 billion at March 31, 1994, a 59% increase.
Expenses Excluding Interest
Total operating expenses excluding interest for the first quarter
of 1995 were $233 million, up 4% from $224 million for the first
quarter of 1994. Compensation and benefits expense for the first
quarter of 1995 increased $2 million, or 2%, to $123 million primarily
due to an increase in salaries and wages, partially offset by a
decrease in variable compensation. The Company had approximately
6,900 employees and contractors at March 31, 1995 compared to 6,700 at
March 31, 1994. These amounts include full-time, part-time, and
temporary employees, and persons employed on a contract basis.
Occupancy and equipment expense increased $3 million, or 12%, to
$24 million from the prior year's first quarter primarily due to
increased data processing equipment expense and to branch and customer
telephone service center expansions.
Commissions, clearance and floor brokerage expense increased
$3 million, or 25%, to $16 million from the prior year's first quarter
primarily due to increases in the average price per share for orders
received by M&S and increases in the number of trades processed by M&S.
The Company's effective income tax rate for the first three months
of 1995 was 39.5% compared to 39.9% for the comparable period in 1994.
Liquidity and Capital Resources
Liquidity
Schwab
Most of Schwab's assets are liquid, consisting primarily of short-
term (i.e., less than 90 days) investment-grade, interest-earning
investments (substantially all of which are segregated for the
exclusive benefit of customers pursuant to regulatory requirements)
and receivables from customers and brokers. Customer margin loans are
demand loan obligations secured by readily marketable securities.
Receivables from and payables to other brokers, dealers and clearing
organizations primarily represent current open transactions, which
usually settle or can be closed out within a few business days.
Liquidity needs relating to customer trading and margin borrowing
activities are met primarily through cash balances in customer
accounts, which totaled $6.8 billion at March 31, 1995, up 2% from the
December 31, 1994 level of $6.7 billion. Earnings from Schwab's
operations are the primary source of liquidity for capital
expenditures and investments in new services, marketing and
technology. Management believes that customer cash balances and
operating earnings will continue to be the primary sources of
liquidity for Schwab in the future.
To manage Schwab's regulatory capital position, CSC provides Schwab
with a $180 million subordinated revolving credit facility maturing in
September 1996, of which $99 million was outstanding at March 31,
1995. At quarter end, Schwab also had outstanding $25 million in
fixed-rate subordinated term loans from CSC maturing in 1996 and 1997.
In April 1995, the maturity date for $10 million of the $25 million
debt scheduled to mature in 1996 was extended to 1997. Borrowings
under these subordinated lending arrangements qualify as regulatory
capital for Schwab.
For use in its brokerage operations, Schwab maintains uncommitted
bank credit lines totaling
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$480 million, of which $400 million is available on an unsecured basis.
Schwab used such borrowings for four days during the first three months
of 1995, with the daily amounts borrowed averaging $35 million. These
lines were unused at March 31, 1995.
M&S
M&S' liquidity needs are generally met through earnings generated
by its operations. Most of M&S' assets are liquid, consisting
primarily of receivables from brokers, dealers and clearing
organizations, marketable securities, and cash and equivalents. M&S
may borrow up to
$10 million under a subordinated lending arrangement with CSC. Borrowings
under this arrangement qualify as regulatory capital for M&S. This facility
has never been used.
The Charles Schwab Corporation
CSC's liquidity needs are generally met through cash generated by
its subsidiaries. Schwab and M&S are the principal sources of this
liquidity and are subject to regulatory requirements that are intended
to ensure the general financial soundness and liquidity of broker-
dealers. These regulations would prohibit Schwab and M&S from
repaying subordinated borrowings to CSC, paying cash dividends, or
making any unsecured advances or loans to their parent or employees if
such payment would result in net capital of less than 5% of their
aggregate debit balances or less than 120% of their minimum dollar
amount requirement of $1 million. At March 31, 1995, Schwab had
$338 million of net capital (11% of aggregate debit balances), which
was $279 million in excess of its minimum required net capital. At
March 31, 1995, M&S had $6 million of net capital (395% of aggregate
debit balances), which was $5 million in excess of its minimum
required net capital. Management believes that funds generated by
Schwab's and M&S' operations will continue to be the primary funding
source in meeting CSC's liquidity needs and maintaining Schwab's and
M&S' net capital.
CSC has individual liquidity needs that arise from its $170 million
Senior Medium-Term Notes, Series A (Medium-Term Notes), as well as
from the funding of cash dividends, common stock repurchases and
acquisitions. The Medium-Term Notes have maturities ranging from two
to nine years and fixed interest rates ranging from 4.95% to 7.72%
with interest payable semiannually. CSC's liquidity is adequate
to effect the completion of the proposed acquisition of ShareLink
Investment Services plc (see "Subsequent Event" note in the
Notes to Condensed Consolidated Financial Statements).
CSC has a prospectus supplement covering the issuance of up to $100
million in Senior or Senior Subordinated Medium-Term Notes, Series A,
pursuant to a registration statement filed with the SEC. Currently,
$80 million in securities remain unissued under the registration
statement.
CSC may borrow under its $225 million committed unsecured credit
facility with a group of eleven banks through June 1995. The funds
are available for general corporate purposes and CSC pays a commitment
fee on the unused balance. The terms of this facility require CSC to
maintain minimum levels of stockholders' equity and Schwab and M&S to
maintain minimum levels of net capital, as defined. This facility has
never been used. CSC has agreed to maintain availability under this
facility to repay any obligations arising under the $100 million
letter of credit facility (see below).
In December 1994, a $100 million letter of credit facility was
established by CSC with a commercial bank to issue letters of credit
(LOCs) to three of the SchwabFunds (registered trademark) money market
funds in connection with the bankruptcies of Orange County, California
and the Orange County investment pool. CSC has agreed to reimburse the
bank for any payments made under the LOCs, and to leave unutilized as
much as $100 million of its $225 million credit facility. The LOC
facility was voluntarily established by CSC as a precautionary measure
to provide independent support for the valuation of certain securities
held by the funds. These securities were issued by Orange County
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and by
municipalities that participated in the investment pool maintained by
Orange County. Although the issuers, other than Orange County, have
not filed for bankruptcy, their ability to repay obligations in a timely
manner may be affected by shortfalls, if any, of amounts scheduled to
be received from investments in the Orange County investment pool.
At March 31, 1995, LOCs totaling $58.5 million were outstanding
under this facility. The funds may make demands for payments under the
LOCs if the issuers of certain municipal securities held by the funds
fail to pay a specified percentage of the principal amount of the
securities when due or if the proceeds received by the funds
in the disposition of any such securities are less than a specified
percentage of the principal amount of the securities. The funds will
absorb losses of principal amounts of the securities, if any, at
disposition or maturity for each security up to a specified
percentage. The LOCs expire and the original maturities of the securities
occur on or before August 1, 1995. Management is currently unable to
determine whether, or to what extent, the funds would make any demands
for payment under the LOCs.
See "Contingent Liabilities" note in the Notes to Condensed Consolidated
Financial Statements.
Cash Flows
Net cash provided by operating activities was $58 million for the
first three months of 1995, down 35% from $89 million for the first
three months of 1994. This decrease was primarily due to a decrease
in accruals relating to employee compensation. During the first three
months of 1995, the Company invested $18 million in equipment and office
facilities as it continued to enhance its data processing and
telecommunications systems and expand its customer telephone service center
facilities.
In January 1995, the Board of Directors approved a three-for-two
stock split of the Company's common stock, which was effected in the
form of a 50% stock dividend. The stock dividend was paid in March
1995. Share and per share data have been restated to reflect this
transaction. The Board also increased the quarterly cash dividend 29%
to $.06 per share. During the first three months of 1995, the Company
paid common stock cash dividends totaling $5 million, up from
$4 million paid during the first three months of 1994.
Capital Adequacy
The Company's stockholders' equity at March 31, 1995 totaled
$510 million. In addition to its equity, the Company had long-term
borrowings of $171 million that bear interest at a weighted average
rate of 6.04%. These borrowings, together with the Company's equity,
provided total financial capital of $681 million at March 31, 1995, up
$102 million, or 18% from a year ago.
The Company monitors its financial leverage and the adequacy of its
capital base relative to the level and composition of its assets using
various financial measures. One of these measures is the ratio of
total assets to total stockholders' equity. At March 31, 1995, the
ratio of total assets to total stockholders' equity was 16 to 1
compared to a ratio of 17 to 1 at December 31, 1994. Over 95% of the
Company's total assets relate to customer activity (primarily margin
loans and segregated investments). Given the Company's intention of
continuing to maintain an appropriate capital base as customer
balances grow, management believes that the Company's present level of
equity could support up to $7.0 billion of additional assets relating
to customer activity.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Discussed in Notes to Condensed Consolidated Financial Statements,
under "Contingent Liabilities" in Part I, Item 1, and in Management's
Discussion and Analysis of Financial
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Condition and Results of Operations, under "Principal Transactions" in
Part I, Item 2, and incorporated herein by reference.
Item 2. Changes in Securities
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
10.83 First Amendment to Revolving Subordinated Loan Agreement, as of
April 18, 1990, between the Registrant and Charles Schwab &
Co., Inc.
10.151 Foreign Exchange Transaction dated as of April 13, 1995 between
the Registrant and Morgan Stanley & Co. Incorporated.
11.1 Computation of Earnings per Common Equivalent Share.
12.1 Computation of Ratio of Earnings to Fixed Charges.
27.1 Financial Data Schedule (electronic only).
(b) Reports on Form 8-K
None.
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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 12, 1995 A. John Gambs /s/
------------ -----------------------------------
A. John Gambs
Executive Vice President - Finance,
and Chief Financial Officer
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