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 June 30, 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.
174,121,792* shares of $.01 par value Common Stock
Outstanding on August 1, 1995
* Reflects the March 1995 three-for-two common stock split and the two-for-one
common stock split declared July 18, 1995, payable September 1, 1995.
THE CHARLES SCHWAB CORPORATION
Quarterly Report on Form 10-Q
For the Quarter Ended June 30, 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 6-13
Part II - Other Information
Item 1. Legal Proceedings 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 13-14
Item 5. Other Information 14
Item 6. Exhibits and Reports on Form 8-K 14
Signature 15
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 Six Months Ended
June 30, June 30,
1995 1994 1995 1994
---- ---- ---- ----
Revenues
Commissions $179,245 $131,449 $330,192 $292,434
Interest revenue, net of interest expense (1) 49,639 40,125 95,687 75,987
Principal transactions 52,739 40,176 96,035 90,465
Mutual fund service fees 51,601 38,677 97,840 72,445
Other 9,494 7,767 19,817 14,768
- --------------------------------------------------------------------------------------------------------------
Total 342,718 258,194 639,571 546,099
- ---------------------------------------------------------------------------------------------------------------
Expenses Excluding Interest
Compensation and benefits 139,184 106,614 262,345 227,634
Communications 30,097 28,041 56,460 56,180
Occupancy and equipment 27,309 21,749 50,829 42,710
Depreciation and amortization 14,558 13,880 28,692 26,392
Commissions, clearance and floor brokerage 19,252 11,169 34,851 23,695
Advertising and market development 12,295 9,042 23,193 20,838
Professional services 10,202 5,102 15,849 10,668
Other 16,534 9,378 30,684 21,219
- --------------------------------------------------------------------------------------------------------------
Total 269,431 204,975 502,903 429,336
- --------------------------------------------------------------------------------------------------------------
Income before taxes on income 73,287 53,219 136,668 116,763
Taxes on income 28,868 21,060 53,873 46,414
- --------------------------------------------------------------------------------------------------------------
Net Income $ 44,419 $ 32,159 $ 82,795 $ 70,349
==============================================================================================================
Weighted average number of common and
common equivalent shares outstanding* 178,127 175,058 177,144 175,730
==============================================================================================================
Earnings per Common Equivalent Share* $ .25 $ .18 $ .47 $ .40
==============================================================================================================
Dividends Declared per Common Share* $ .030 $ .023 $ .060 $ .047
==============================================================================================================
(1) Interest revenue is presented net of interest expense. Interest expense for the three months ended
June 30, 1995 and 1994 was $87,666 and $43,100, respectively. Interest expense for the six months ended
June 30, 1995 and 1994 was $166,869 and $78,330, respectively.
* Reflects the March 1995 three-for-two common stock split and the two-for-one common stock split declared
July 18, 1995, payable September 1, 1995.
See Notes to Condensed Consolidated Financial Statements.
- 1 -
THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(In thousands, except share data)
June 30, December 31,
1995 1994
---- ----
(Unaudited)
-----------
Assets
Cash and equivalents (including resale agreements of
$200,000 in 1995 and $242,500 in 1994) $ 434,701 $ 380,616
Cash and investments required to be segregated under
Federal or other regulations (including resale
agreements of $4,786,404 in 1995 and $3,787,984 in 1994) 5,103,027 4,206,466
Receivable from brokers, dealers and clearing organizations 148,904 86,028
Receivable from customers (less allowance for doubtful
accounts of $3,663 in 1995 and $3,204 in 1994) 2,975,823 2,923,867
Equipment, office facilities and property (less accumulated
depreciation and amortization of $182,819 in 1995 and
$162,474 in 1994) 152,064 129,105
Intangible assets (less accumulated amortization of
$146,243 in 1995 and $140,860 in 1994) 71,104 26,813
Other assets 180,720 164,967
- ------------------------------------------------------------------------------------------------------
Total $9,066,343 $7,917,862
======================================================================================================
Liabilities and Stockholders' Equity
Drafts payable $ 135,230 $ 117,383
Payable to brokers, dealers and clearing organizations 431,971 296,420
Payable to customers 7,510,566 6,670,362
Accrued expenses 218,095 195,320
Long-term borrowings 196,312 171,363
- ------------------------------------------------------------------------------------------------------
Total liabilities 8,492,174 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; 178,459,416 shares issued in 1995 and 1994* 892 595
Additional paid-in capital 180,210 166,103
Retained earnings 445,406 373,161
Treasury stock - 4,451,778 shares in 1995 and 7,563,990
shares in 1994, at cost* (41,707) (57,968)
Unearned ESOP shares (6,038) (10,174)
Unamortized restricted stock compensation (4,102) (4,703)
Foreign currency translation adjustment (492)
- ------------------------------------------------------------------------------------------------------
Stockholders' equity 574,169 467,014
- ------------------------------------------------------------------------------------------------------
Total $9,066,343 $7,917,862
======================================================================================================
* Reflects the March 1995 three-for-two common stock split and the two-for-one common stock split
declared July 18, 1995, payable September 1, 1995.
See Notes to Condensed Consolidated Financial Statements.
- 2 -
THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
(Unaudited)
Six Months Ended
June 30,
1995 1994
---- ----
Cash flows from operating activities
Net income $ 82,795 $ 70,349
Noncash items included in net income:
Depreciation and amortization 28,692 26,392
Deferred income taxes (236) 8,769
Other 10,242 401
Change in accrued expenses 35,994 4,965
Change in other assets (12,686) 6,510
- ----------------------------------------------------------------------------------------------
Net cash provided before change in customer-related balances 144,801 117,386
- ----------------------------------------------------------------------------------------------
Change in customer-related balances (excluding the effects
of business acquired):
Payable to customers 731,510 279,682
Receivable from customers (40,154) (234,544)
Drafts payable 12,026 (4,398)
Payable to brokers, dealers and clearing organizations 135,551 49,531
Receivable from brokers, dealers and clearing organizations (22,004) (1,859)
Cash and investments required to be segregated under
Federal or other regulations (832,058) (98,514)
- ----------------------------------------------------------------------------------------------
Net change in customer-related balances (15,129) (10,102)
- ----------------------------------------------------------------------------------------------
Net cash provided by operating activities 129,672 107,284
- ----------------------------------------------------------------------------------------------
Cash flows from investing activities
Purchase of equipment, office facilities and property - net (42,879) (20,615)
Cash payments for business acquired, net of cash received (48,292)
- ----------------------------------------------------------------------------------------------
Net cash used by investing activities (91,171) (20,615)
- ----------------------------------------------------------------------------------------------
Cash flows from financing activities
Proceeds from long-term borrowings 20,000
Purchase of treasury stock (25,865)
Dividends paid (10,296) (8,042)
Other 6,372 1,104
- ----------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities 16,076 (32,803)
- ----------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and equivalents (492)
- ----------------------------------------------------------------------------------------------
Increase in cash and equivalents 54,085 53,866
Cash and equivalents at beginning of period 380,616 279,828
- ----------------------------------------------------------------------------------------------
Cash and equivalents at end of period $ 434,701 $ 333,694
==============================================================================================
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, and the Company's Quarterly Report on Form 10-Q
for the period ended March 31, 1995.
Intangible assets represent goodwill and customer lists. Prior
periods' financial statements have been reclassified to conform to
the 1995 presentation.
Foreign Currency Translation
Assets and liabilities denominated in foreign currencies are
translated at the exchange rate on the balance sheet date, while
revenues and expenses are translated at average rates of exchange
prevailing during the period. Translation adjustments are
accumulated as a separate component of stockholders' equity.
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 $152 million at June 30,
1995.
In January 1992, the Company filed a petition in U.S. Tax Court
refuting a claim for additional Federal income tax arising from the
Internal Revenue Service's (IRS) audit of the tax periods ended
March 31, 1988 and December 31, 1988. The majority of the asserted
additional tax related to deductions claimed by the Company for
amortization of intangible assets (mainly customer lists) received in
the Company's 1987 acquisition of Schwab. In August 1995, a settlement
with the IRS was reached regarding these deductions for the tax periods
under audit and any subsequent period. This settlement had no material
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. On August 3, 1995, the motion was granted in part with
permission to file an amended complaint. The ultimate outcome of
this consolidated action cannot currently be determined.
On June 30, 1995, a class was certified in Civil District Court
for the Parish of Orleans in Louisiana for Louisiana residents who
purchased or sold securities through Schwab between February 1, 1985
and February 1, 1995. Schwab has been named as a defendant, and in
one case as a representative of an alleged defendant class, in seven
additional class action lawsuits filed in state courts in Minnesota,
Illinois, New York, Louisiana and Texas. The class actions were
filed between August 12, 1993 and July 17, 1995, and purport to be
brought on behalf of customers of Schwab who purchased or sold
securities in the over-the-counter market for which Schwab received
monetary payments from the market maker who executed the transaction.
The complaints allege that Schwab failed to disclose and remit such
payments to
- 4 -
members of the class, and generally seek damages equal to
the payments received by Schwab. The ultimate outcome of these
actions 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.
At June 30, 1995, letters of credit (LOCs) totaling $58.5 million
were outstanding under a $100 million letter of credit facility
established by CSC with a commercial bank in December 1994 for three
of the SchwabFunds (registered trademark) money market funds (the Funds)
in connection with the bankruptcies of Orange County, California and the
Orange County investment pool. In August 1995, the $100 million
facility and one LOC were each reduced to $10.4 million and the maturity of
each was extended from August 1, 1995 to August 1, 1996. The remaining LOCs
expired unutilized in August 1995. Although management is currently
unable to determine whether, or to what extent, the Funds would make
any demands for payments under the LOC, any such payments would not
have a material impact on the Company's financial position or results
of operations.
Acquisition
In June 1995, the Company purchased a majority interest (93% of
the outstanding common stock) of ShareLink Investment Services plc
(ShareLink), a retail discount securities brokerage firm in the
United Kingdom, for approximately $60 million including acquisition-
related expenses. The Company expects to purchase the remaining
common stock of ShareLink during the third quarter of 1995. The
transaction was accounted for as a purchase. The operating results
of ShareLink since the date of the acquisition are included in the
consolidated results of the Company.
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 June 30, 1995, Schwab's
net capital was $342 million (11% of aggregate debit balances), which
was $280 million in excess of its minimum required net capital and
$186 million in excess of 5% of aggregate debit balances. At
June 30, 1995, M&S' net capital was $5 million (314% of aggregate
debit balances), which was $4 million in excess of its minimum
required net capital.
Schwab, M&S and ShareLink had portions of their cash and
investments segregated for the exclusive benefit of customers at
June 30, 1995, in accordance with applicable regulations.
Cash Flow Information
Certain additional information affecting the cash flows of the
Company follows (in thousands):
Six Months
Ended
June 30,
1995 1994
---- ----
Income taxes paid $ 43,111 $ 43,126
======== ========
Interest paid:
Customer cash balances $151,147 $ 69,060
Long-term borrowings 5,406 5,638
Other 8,429 2,837
-------- --------
Total interest paid $164,982 $ 77,535
======== ========
Subsequent Event
On July 18, 1995, the Board of Directors approved a two-for-one
stock split of the Company's common stock, which will be effected in
the form of a 100% stock dividend. The stock dividend is payable
September 1, 1995 to stockholders of record August 1, 1995. Share
and per share data have been restated to reflect the March 1995 three-
for-two common stock split and this transaction. The Board also
increased the quarterly cash dividend from $.06 per share to $.08 per
share payable August 15, 1995 to stockholders of record August 1,
1995. The indicated quarterly cash dividend on shares outstanding
after the September 1, 1995 two-for-one common stock split is $.04
per share.
- 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 3.2 million active (a)
accounts and assets that totaled $153.1 billion at June 30, 1995.
With a network of 210 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 (registered 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
(registered trademark) also provide customers with discounts on commissions.
Management expects to continue aggressive use of this value-pricing
philosophy in the marketing of new products and services.
Three Months Ended June 30, 1995
Compared To Three Months Ended
June 30, 1994
Summary
Net income for the second quarter of 1995 totaled $44 million or
$.25 per share, up 38% from second quarter 1994 net income of
$32 million or $.18 per share. All share and per share amounts
reflect the March 1995 three-for-two common stock split and the two-
for-one common stock split declared July 18, 1995, payable
September 1, 1995.
Second quarter 1995 revenues were $343 million, up 33% from
$258 million for the second quarter of 1994, primarily resulting from
higher trading volume and an increase in customer assets.
Assets in customer accounts totaled $153.1 billion at June 30,
1995, $47.2 billion, or 45%, more than a year ago primarily resulting
from increases in customers' equity securities of $18.3 billion, or
42%, and increases in customer assets in Schwab's Mutual Fund
Marketplace (registered trademark) of $12.5 billion, or 45%. Customer
assets in cash
(a) Accounts with balances or activity within the preceding twelve months.
- 6 -
and money market funds at June 30, 1995 increased 34% over the year-ago
level to $33.2 billion. Schwab added 178,800 new customer accounts during
the second quarter of 1995, compared to 210,000 new accounts during the
second 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 second
quarter of 1995 were $269 million, up 31% from $205 million for the
second quarter of 1994, primarily resulting from higher variable
compensation, additional staff to support the Company's continued
growth and expansion, and higher transaction-related expenses. In the second
quarter of 1995, the Company opened two new branch offices.
The profit margin for the second quarter of 1995 was 13%, up from
12% for the second quarter of 1994. The return on stockholders'
equity for the second quarter of 1995 was 33%, up from 32% for the
second quarter of 1994.
Commissions
Schwab executes commission transactions for customers on an agency
basis. Commission revenues totaled $179 million for the second
quarter of 1995, up $48 million, or 36%, from the second quarter of
1994. Commissions earned on retail agency trades, which exclude
commissions from institutional customers, totaled $172 million on a
daily average retail agency trade level of 36,200 in the second
quarter of 1995, compared with commission revenues of $126 million on
a daily average retail agency trade level of 28,300 for the
comparable period in 1994. The following table shows a comparison of
certain factors that influence retail agency commission revenues:
- -----------------------------------------------------------------
Three Months
Ended
June 30, Percent
1995 1994 Change
- -----------------------------------------------------------------
Number of customer
accounts that traded during
the quarter (in thousands) 709 590 20%
Average number of retail agency
transactions per account
that traded 3.32 2.98 11
Total number of retail agency
transactions (in thousands) 2,352 1,757 34
Average commission per
retail agency transaction $73.08 $71.44 2
Total retail agency commission
revenues (in millions) $ 172 $ 126 36
==================================================================
Note: The above table excludes customer transactions in Schwab's
Mutual Fund OneSource (registered trademark) service.
Total retail agency commission revenues increased 36% from the
second quarter of 1994 as Schwab's customer base continued to grow
and customer accounts in general were more active.
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 24%, to $50 million from the prior year's second quarter as shown
in the following table (in millions):
- 7 -
- -----------------------------------------------------------
Three Months
Ended
June 30,
1995 1994
- ------------------------------------------------------------
Interest Revenue
Investments, customer-related $ 71 $38
Margin loans to customers 61 43
Other 5 2
- ------------------------------------------------------------
Total 137 83
- ------------------------------------------------------------
Interest Expense
Customer cash balances 79 38
Long-term borrowings 2 3
Other 6 2
- ------------------------------------------------------------
Total 87 43
- ------------------------------------------------------------
Interest Revenue, Net of Interest Expense $ 50 $40
============================================================
Customer-related daily average balances, interest rates and
average net interest margin for the second quarters of 1995 and 1994
are summarized in the following table (dollars in millions):
- -----------------------------------------------------------------
Three Months Ended
June 30,
1995 1994
- -----------------------------------------------------------------
Earning Assets (customer-related):
Investments:
Average balance outstanding $4,640 $4,005
Average interest rate 6.11% 3.79%
Margin loans to customers:
Average balance outstanding $2,939 $2,732
Average interest rate 8.38% 6.38%
Average yield on earning assets 6.99% 4.84%
Funding Sources (customer-related
and other):
Interest-bearing customer cash balances:
Average balance outstanding $6,167 $5,525
Average interest rate 5.13% 2.79%
Other interest-bearing sources:
Average balance outstanding $ 411 $ 339
Average interest rate 4.27% 2.79%
Average noninterest-bearing portion $1,001 $ 873
Average interest rate on funding sources 4.40% 2.43%
Summary:
Average yield on earning assets 6.99% 4.84%
Average interest rate on funding sources 4.40% 2.43%
- ----------------------------------------------------------------
Average net interest margin 2.59% 2.41%
================================================================
The increase in interest revenue, net of interest expense from the
prior year's second quarter was primarily due to sharper increases
in average interest rates with respect to earning assets compared to
funding sources, and to higher levels of average earning assets.
Principal Transactions
During the second quarter of 1995, principal transaction revenues
increased $13 million, or 31%, from the comparable period in 1994 to
$53 million. This increase was due to higher trading volume handled
by M&S and the addition of such revenues relating to specialist
posts. During the third quarter of 1994, Schwab commenced operation
of specialist posts on the Pacific Stock Exchange. At June 30,
1995, Schwab had nine posts that collectively make markets in over
400 securities. The Company expects to continue to expand its
capacity to execute principal transactions. The increase in
principal transaction revenues discussed above was partially offset
due to the impact beginning in July 1994 of the 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 customer limit 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 Securities and Exchange
Commission (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
- 8 -
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 $13 million, or 33%, to
$52 million in the second 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 (registered trademark) service. Most of these fees are
earned for transfer agent, shareholder 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.
Customer assets invested in the SchwabFunds, substantially all of
which are in money market funds, were $27.5 billion at June 30, 1995,
compared to $20.0 billion at June 30, 1994, a 38% increase. Customer
assets held by Schwab that have been purchased through the Mutual
Fund OneSource service, excluding SchwabFunds, totaled $18.1 billion
at June 30, 1995, compared to $10.4 billion at June 30, 1994, a 74%
increase.
Expenses Excluding Interest
Total operating expenses excluding interest for the second quarter
of 1995 were $269 million, up 31% from $205 million for the second
quarter of 1994. Compensation and benefits expense for the second
quarter of 1995 increased $33 million, or 31%, to $139 million
primarily due to increases in variable compensation, and salaries and
wages. At June 30, 1995, the Company had full-time, part-time and temporary
employees, and persons employed on a contract basis that represented the
equivalent of 7,300 full-time employees, compared to approximately 6,100
at June 30, 1994.
Occupancy and equipment expense increased $6 million, or 26%, to
$27 million from the prior year's second quarter primarily due to a
one-time charge made to operating lease expense, increased data
processing equipment expense, and to branch network and customer
telephone service center expansions.
Commissions, clearance and floor brokerage expense increased
$8 million, or 72%, to $19 million from the prior year's second
quarter primarily due to increases in the number of trades processed
by M&S and Schwab, and in the average price per share paid for orders
by M&S.
Professional services expense increased $5 million, or 100%, to
$10 million from the prior year's second quarter primarily due to
increases in consulting fees relating to various company development
projects and legal expenses.
Other expenses increased $7 million, or 76%, to $17 million from
the prior year's second quarter primarily due to increases in
charitable contributions, and travel and entertainment expense.
The Company's effective income tax rate for the second quarter of
1995 was 39.4% compared to 39.6% for the comparable period in 1994.
- 9 -
Six Months Ended June 30, 1995
Compared To Six Months Ended
June 30, 1994
Summary
Net income for the first half of 1995 totaled $83 million or $.47
per share, compared with net income of $70 million or $.40 per share
for the first half of 1994.
First half 1995 revenues were $640 million, up 17% from
$546 million for the first half of 1994, due to increases in all
major revenue categories primarily resulting from higher trading
volume and an increase in customer assets.
Total operating expenses excluding interest during the first half
of 1995 were $503 million, up 17% from $429 million for the first
half of 1994, primarily resulting from additional staff to support
the Company's continued growth and expansion, and higher-transaction
related expenses. In the first half of 1995, total Company trading
volume was 7.1 million trades, up 15% from the first half of 1994.
Also during this period, the Company opened two new branch offices
and started the expansion of one of its customer telephone service centers.
The profit margin of 13% for the first half of 1995 remained
unchanged from the first half of 1994. The return on stockholders'
equity for the first half of 1995 was 32%, down from 35% for the
first half of 1994, reflecting the Company's higher equity base in
the first half of 1995.
Commissions
Commission revenues totaled $330 million for the first half of
1995, up $38 million, or 13%, from the first half of 1994.
Commissions earned on retail agency trades, which exclude commissions
from institutional customers, totaled $317 million on a daily
average retail agency trade level of 35,400 in the first half of
1995, compared with commission revenues of $280 million on a daily
average retail agency trade level of 30,800 for the comparable period
in 1994. The following table shows a comparison of certain factors
that influence retail agency commission revenues:
- ---------------------------------------------------------------------
Six Months
Ended
June 30, Percent
1995 1994 Change
- ---------------------------------------------------------------------
Number of customer
accounts that traded during
the period (in thousands) 1,044 945 10%
Average number of retail agency
transactions per account
that traded 4.23 4.08 4
Total number of retail agency
transactions (in thousands) 4,420 3,855 14
Average commission per
retail agency transaction $71.68 $72.75 (1)
Total retail agency commission
revenues (in millions) $ 317 $ 280 13
====================================================================
Note: The above table excludes customer transactions in Schwab's
Mutual Fund OneSource (registered trademark) service.
Total retail agency commission revenues increased 13% from the
first half of 1994 as Schwab's customer base continued to grow and
customer accounts in general were more active. Schwab added 344,000
new customer accounts during the first half of 1995, compared to
444,000 new accounts during the first half of 1994.
Interest Revenue, Net of Interest Expense
Interest revenue, net of interest expense increased $20 million, or
26%, to $96 million from the prior year's first six months as shown
in the following table (in millions):
- 10 -
- -------------------------------------------------------------
Six Months
Ended
June 30,
1995 1994
- -------------------------------------------------------------
Interest Revenue
Investments, customer-related $133 $ 69
Margin loans to customers 120 82
Other 10 3
- -------------------------------------------------------------
Total 263 154
- -------------------------------------------------------------
Interest Expense
Customer cash balances 151 69
Long-term borrowings 5 6
Other 11 3
- -------------------------------------------------------------
Total 167 78
- -------------------------------------------------------------
Interest Revenue, Net of Interest Expense $ 96 $ 76
=============================================================
Customer-related daily average balances, interest rates, and
average net interest margin for the first six months of 1995 and 1994
are summarized in the following table (dollars in millions):
- ---------------------------------------------------------------
Six Months Ended
June 30,
1995 1994
- ---------------------------------------------------------------
Earning Assets (customer-related):
Investments:
Average balance outstanding $4,459 $3,934
Average interest rate 6.03% 3.55%
Margin loans to customers:
Average balance outstanding $2,904 $2,667
Average interest rate 8.32% 6.18%
Average yield on earning assets 6.93% 4.61%
Funding Sources (customer-related
and other):
Interest-bearing customer cash balances:
Average balance outstanding $6,025 $5,378
Average interest rate 5.04% 2.60%
Other interest-bearing sources:
Average balance outstanding $ 377 $ 334
Average interest rate 4.23% 2.58%
Average noninterest-bearing portion $ 961 $ 889
Average interest rate on funding sources 4.34% 2.25%
Summary:
Average yield on earning assets 6.93% 4.61%
Average interest rate on funding sources 4.34% 2.25%
- ----------------------------------------------------------------
Average net interest margin 2.59% 2.36%
================================================================
The increase in interest revenue, net of interest expense from the
first six months of 1994 was primarily due to sharper increases in average
interest rates with respect to earning assets compared to funding sources,
and to higher levels of average earning assets.
Principal Transactions, Mutual Fund Service Fees, and Expenses
Excluding Interest
Explanations and fluctuations in principal transactions, mutual
fund service fees, and expenses excluding interest presented in the
three-month results generally explain fluctuations in those revenues
and expenses between the six-month periods.
The Company's effective income tax rate for the first six months
of 1995 was 39.4% compared to 39.8% for the comparable period in
1994.
Liquidity and Capital Resources
Liquidity
Schwab
Liquidity needs relating to customer trading and margin borrowing
activities are met primarily through cash balances in customer
accounts, which totaled $7.4 billion at June 30, 1995, up 11% 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
June 30, 1995. At quarter end, Schwab also had outstanding
$25 million in fixed-
- 11 -
rate subordinated term loans from CSC maturing in 1996 and 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 $495 million, of which $415 million is
available on an unsecured basis. Schwab used such borrowings for
five days during the first six months of 1995, with the daily amounts
borrowed averaging $33 million. These lines were unused at June 30,
1995.
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 June 30, 1995, Schwab had
$342 million of net capital (11% of aggregate debit balances), which
was $280 million in excess of its minimum required net capital. At
June 30, 1995, M&S had $5 million of net capital (314% of aggregate
debit balances), which was $4 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
$190 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 1996 to 2003 and fixed interest rates ranging from 4.95%
to 7.72% with interest payable semiannually.
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.
At June 30, 1995, $60 million in securities remain unissued under the
registration statement.
In June 1995, CSC's committed unsecured credit facility with a
group of ten banks was increased to $250 million from $225 million.
This facility expires in June 1996. 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. In December 1994, CSC agreed to maintain availability
under this facility to repay any obligations arising under the then-
existing $100 million letter of credit facility. As part of the
reduction and extension of such letter of credit facility (described
below), this availability requirement was eliminated.
At June 30, 1995, letters of credit (LOCs) totaling $58.5 million
were outstanding under a $100 million letter of credit facility
established by CSC with a commercial bank in December 1994 for three
of the SchwabFunds (registered trademark) money market funds (the Funds)
in connection with the bankruptcies of Orange County, California and the Orange
County investment pool. In August 1995, the $100 million facility and one
LOC were each reduced to $10.4 million and the maturity of each was
extended from August 1, 1995 to August 1, 1996. The remaining LOCs expired
unutilized in August 1995. Although management is currently unable to
determine whether, or to what extent, the Funds would make any demands
for payments under the LOC, any such payments would not have a material
impact on the Company's financial position or results of operations.
- 12 -
See "Contingent Liabilities" note in the Notes to Condensed
Consolidated Financial Statements.
Cash Flows
Net cash provided by operating activities was $130 million for the
first six months of 1995, up 21% from $107 million for the first six
months of 1994. This increase was primarily due to increases in
accrued expenses and net income. During the first six months of
1995, the Company invested $43 million in equipment and office
facilities as it continued to enhance its data processing and
telecommunications systems. The Company also opened two new branch
offices and started the expansion of one of its customer telephone
service centers. In addition, the Company purchased ShareLink
Investment Services plc in June 1995 for approximately $48 million,
net of cash received, and issued $20 million in Medium-Term Notes
during the first half of 1995.
In July 1995, the Board of Directors approved a two-for-one stock
split of the Company's common stock, which will be effected in the
form of a 100% stock dividend. The stock dividend is payable
September 1, 1995 to stockholders of record August 1, 1995. Share
and per share data have been restated to reflect the March 1995 three-
for-two common stock split and this transaction. The Board also
increased the quarterly cash dividend from $.06 per share to $.08 per
share. The indicated quarterly cash dividend on shares outstanding
after the September 1, 1995 two-for-one common stock split is
$.04 per share. During the first six months of 1995, the Company
paid common stock cash dividends totaling $10 million, up from
$8 million paid during the first six months of 1994.
Capital Adequacy
The Company's stockholders' equity at June 30, 1995 totaled
$574 million. In addition to its equity, the Company had long-term
borrowings of $196 million that bear interest at a weighted average
rate of 6.16%. These borrowings, together with the Company's equity,
provided total financial capital of $770 million at June 30, 1995, up
$163 million, or 27% from a year ago.
At June 30, 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 93% of the Company's total assets relate to customer
activity (primarily margin loans and segregated investments).
Management believes that the Company's present level of equity could
support up to $7.6 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 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
At the Company's Annual Meeting of Stockholders held on May 8,
1995, its stockholders voted upon election of directors for the
ensuing year (all share amounts reflect the March 1995 three-for-two
common stock split and the two-for-one common stock split declared
July 18, 1995, payable September 1, 1995):
- 13 -
Shares Shares
For Against
--- -------
Election of director:
Charles R. Schwab 148,689,462 453,889
Lawrence J. Stupski 148,676,425 466,926
David S. Pottruck 148,439,536 703,815
Nancy H. Bechtle 148,659,756 483,595
C. Preston Butcher 148,660,067 483,284
Donald G. Fisher 148,661,400 481,951
Anthony M. Frank 148,648,072 495,279
James R. Harvey 148,653,329 490,022
Stephen T. McLin 148,633,754 509,597
Roger O. Walther 148,640,216 503,135
There were no abstentions or broker non-votes with respect to the
election of directors. Voting results on the following additional items
were as follows:
Proposal II - Employment Agreement with Charles R. Schwab - Approval
of the Employment Agreement between The Charles Schwab Corporation
and Charles R. Schwab, effective March 31, 1995.
Shares Shares Broker
For Against Abstentions Non-Votes
--- ------- ----------- ---------
124,643,341 3,401,579 714,297 20,384,134
Proposal III - Amendments to the Corporate Executive Bonus Plan -
Approval of Amendments to the Corporate Executive Bonus Plan that
change the methods used to determine the amount of annual cash
bonuses payable to the Corporation's executive officers other than
the Chairman.
Shares Shares Broker
For Against Abstentions Non-Votes
--- ------- ----------- ---------
123,580,573 4,585,394 1,056,346 19,921,038
A total of 149,143,351 shares were present in person or by proxy at
the Annual Meeting.
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.
<caption
Exhibit
Number Exhibit
10.152 The Charles Schwab Profit Sharing and Employee Stock
Ownership Plan, amended July 6, 1995, effective January 1,
1995 and April 1, 1995 (supersedes Exhibit 10.145 to the
Registrant's Form 10-K for the year ended December 31,
1994).
10.153 First Amendment dated June 29, 1995 to the Credit
Agreement dated June 30, 1994, between the Registrant and
the banks listed therein.
10.154 First Amendment dated July 31, 1995, as further amended
August 7, 1995, to the Reimbursement Agreement, dated
December 19, 1994, between the Registrant and Bank of
America National Trust and Savings Association.
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
On July 21, 1995, the Registrant filed a Current Report on Form 8-K
relating to the certification of a class on June 30, 1995 and denial
of a motion to dismiss a complaint against Schwab relating to
disclosure of order flow payments and the filing of certain other
similar actions.
- 14 -
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: August 11, 1995 A. John Gambs /s/
--------------- ------------------------------------
A. John Gambs
Executive Vice President - Finance,
and Chief Financial Officer
- 15 -