EXHIBIT 13.1
The Charles Schwab Corporation
1995 Annual Report to Stockholders
(only those portions specifically incorporated by reference
into The Charles Schwab Corporation 1995 Annual Report on Form 10-K)
The Charles Schwab Corporation
Quarterly Financial Information (Unaudited)
(In Millions, Except Per Share Data and Ratios)
Weighted Fully Dividends
Average Primary Diluted Declared Range Range
Expenses Common Earnings Earnings per of Common of Price/
Excluding Net Equivalent per per Common Stock Price Earnings
Revenues (a) Interest Income Shares (b) Share Share Share per Share (c) Ratio (d)
- -------------------------------------------------------------------------------------------------------------------------------
1995 by Quarter
Fourth $394.8 $332.4 $42.6 179.9 $.24 $.24 $.040 $26.68 - 16.63 28 - 17
Third Dividend Increase/
Stock Split 385.5 307.5 47.2 179.7 .26 .26 .040 29.00 - 20.75 32 - 23
Second 342.7 269.4 44.4 178.1 .25 .25 .030 22.88 - 14.75 27 - 18
First Dividend Increase/
Stock Split 296.9 233.5 38.4 176.1 .22 .22 .030 16.50 - 11.04 21 - 14
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1994 by Quarter
Fourth $270.4 $214.4 $33.8 175.2 $.19 $.19 $.023 $12.33 - 9.21 16 - 12
Third 248.1 196.5 31.2 174.2 .18 .18 .023 10.29 - 8.46 14 - 11
Second 258.2 205.1 32.1 175.1 .18 .18 .023 11.29 - 8.25 16 - 12
First Dividend Increase/ 287.9 224.3 38.2 176.4 .22 .22 .023 11.00 - 8.67 16 - 13
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1993 by Quarter
Fourth $257.5 $212.3 $28.5 179.5 $.16 $.16 $.017 $12.79 - 9.58 19 - 15
Third 238.8 191.1 22.2 (e) 179.0 .12 (e) .12 (e) .017 12.38 - 8.92 18 - 13
Second Dividend Increase/
Stock Split 232.4 180.4 31.6 177.9 .18 .18 .017 9.67 - 6.81 17 - 12
First 236.3 174.9 35.4 177.0 .20 .20 .013 8.28 - 5.53 17 - 11
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1992 by Quarter
Fourth $193.5 $148.2 $25.2 173.5 $.15 $.15 $.013 $ 6.19 - 3.69 13 - 8
Third 159.3 144.3 7.8 174.7 .04 .04 .013 5.78 - 3.72 14 - 9
Second Dividend Increase 176.8 143.8 18.5 177.2 .10 .10 .013 7.69 - 4.53 18 - 10
First 219.9 167.0 29.7 177.5 .17 .17 .009 8.39 - 6.47 22 - 17
- -------------------------------------------------------------------------------------------------------------------------------
1991 by Quarter
Fourth Dividend Increase/
Stock Split $167.3 $138.6 $16.1 176.9 $.09 $.09 $.009 $ 7.47 - 4.41 26 - 16
Third Dividend Increase 147.4 122.9 13.2 176.2 .08 .08 .007 4.63 - 3.69 23 - 19
Second 128.9 112.3 9.5 175.4 .05 .05 .006 3.69 - 2.63 23 - 16
First 126.1 107.7 10.6 175.0 .06 .06 .006 3.04 - 1.69 23 - 13
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All share and per share data reflect the March 1995 three-for-two common stock split and the September 1995 two-for-one common
stock split.
(a) Revenues are presented net of interest expense.
(b) Amounts shown are used to calculate primary earnings per share.
(c) Represents New York Stock Exchange high and low range of common stock price per share.
(d) Price/earnings ratio is computed by dividing the high and low market prices by primary earnings per share for the 12-month
period ended on the last day of the quarter presented. The extraordinary charge in 1993 (described
below) has been excluded.
(e) Net income and primary and fully diluted earnings per share are net of the effect of a $6.7 million ($.04 per share)
extraordinary charge on the early retirement of debt.
1
The Charles Schwab Corporation
Selected Financial and Operating Data
(In Millions, Except Per Share Amounts)
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Growth Rates (1)
Compounded Annual
5-Year 1-Year
1990-1995 1994-1995 1995 1994 1993 1992 1991
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Operating Results (for the year)
Revenues
Commissions 25% 38% $ 751 $ 546 $ 552 $ 441 $ 349
Mutual fund service fees 37% 40% 219 157 99 63 54
Interest revenue, net of interest expense (2) 24% 28% 211 165 120 92 77
Principal transactions (3) 18% 191 163 169 130 63
Other 16% 39% 48 34 25 24 27
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Total 30% 33% 1,420 1,065 965 750 570
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Expenses excluding interest
Compensation and benefits 31% 36% 594 437 393 307 234
Communications 25% 21% 129 107 94 76 57
Occupancy and equipment 21% 27% 111 88 77 65 51
Commissions, clearance and floor brokerage 44% 56% 77 49 43 32 21
Other 17% 46% 231 160 151 124 119
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Total 26% 36% 1,142 841 758 604 482
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Income before taxes on income and
extraordinary charge 57% 24% 278 224 207 146 88
Taxes on income 53% 17% 105 89 82 65 39
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Income before extraordinary charge 59% 28% 173 135 125 81 49
Extraordinary charge-early
retirement of debt 7
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Net income 59% 28% $ 173 $ 135 $ 118 $ 81 $ 49
=========================================================================================================================
Primary earnings per share (4)
Primary earnings before extraordinary charge 61% 26% $ .97 $ .77 $ .70 $ .46 $ .28
Extraordinary charge-early retirement of debt .04
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Primary earnings per share 61% 26% $ .97 $ .77 $ .66 $ .46 $ .28
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Dividends declared per common share (4) 51% 52% $ .140 $ .092 $ .064 $.048 $.028
=========================================================================================================================
Weighted average number of common and
common equivalent shares outstanding (4, 5) 178 175 178 176 176
=========================================================================================================================
Other (for the year)
Return on stockholders' equity (1) 31% 32% 37% 35% 28%
Revenue growth 33% 10% 29% 32% 47%
Pre-tax profit margin 20% 21% 21% 20% 15%
After-tax profit margin 12% 13% 12% 11% 9%
Effective income tax rate 38% 40% 40% 44% 44%
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Other (at year end)
Total assets 20% 33% $10,552 $7,918 $6,897 $5,905 $5,026
Borrowings 14% 44% $ 246 $ 171 $ 185 $ 152 $ 119
Stockholders' equity 33% 36% $ 633 $ 467 $ 379 $ 259 $ 200
Book value per common share (4) 31% 33% $ 3.64 $ 2.73 $ 2.19 $ 1.52 $ 1.15
=========================================================================================================================
(1) In cases where the calculation does not yield a meaningful result, growth rates are not presented.
(2) Interest revenue is presented net of interest expense. Interest expense for 1991 through 1995 was
(in millions): $225, $159, $132, $198 and $357, respectively.
(3) On July 1, 1991, the Company acquired Mayer & Schweitzer, Inc., whose operating results have been
consolidated with those of the Company since the acquisition.
(4) Reflects the March 1995 three-for-two common stock split and the September 1995 two-for-one common stock split.
(5) Amounts shown are used to calculate primary earnings per share.
Certain prior years' revenues and expenses have been reclassified to conform to the 1995 presentation.
2
Management's Discussion and Analysis
of Results of Operations and Financial Condition
DESCRIPTION OF BUSINESS
The Charles Schwab Corporation (CSC) and its subsidiaries (collectively
referred to as the Company) provide brokerage and related investment
services to customers with 3.4 million active(a) accounts and assets that
totaled $181.7 billion at December 31, 1995. CSC's principal subsidiary,
Charles Schwab & Co., Inc. (Schwab), serves an estimated 51% of the
discount brokerage market, up from 50%(b) in 1994. Mayer & Schweitzer, Inc.
(M&S), a market maker in Nasdaq securities, provides trade execution
services to broker-dealers and institutional customers. During 1995, orders
handled by M&S totaled over 7 billion shares, or approximately 7% of the
total shares traded on Nasdaq.
(CHART OMITTED)
With a network of over 225 branch offices, Schwab is physically
represented in 46 states, the Commonwealth of Puerto Rico and the United
Kingdom. In addition, Schwab maintains four regional customer telephone
service centers that handle customer calls and orders. Schwab's touch-tone
telephone trading service, TeleBroker (registered trademark), provides
customers access to Schwab on a 24-hour basis. These complementary customer
service delivery systems - branches, telephone centers and electronic
services - allow Schwab to achieve its customer service quality standards
in a cost-competitive manner. Collectively, these systems handled over
80 million calls and over 15 million trades during 1995.
(CHART OMITTED)
The Company has historically used discount pricing as a tactic in its
efforts to gain market share and enhance the value of its products and
services. In recent years, Schwab has introduced price-competitive product
offerings such as its Mutual Fund OneSource (registered trademark) service,
which offers mutual funds with no transaction fees, and its Schwab 500
Brokerage (trademark) service, which includes commission discounts from
Schwab's standard rates. During 1995, Schwab introduced e.Schwab
(trademark), which provides online trading access and includes significant
commission discounts from Schwab's standard rates. Management expects to
continue aggressive use of discount pricing in the marketing of new
products and services.
Environmental factors influencing the Company's performance include
fundamentally cyclical financial markets, and heavy competition from full
commission and discount brokerage firms, as well as from mutual fund
companies. Increasingly, competition has come from banks, software
development companies, insurance companies and others as they expand their
product lines. Such competition may negatively impact the Company's profit
margin.
The significant growth during 1995 of asset-based revenues such as mutual
fund service fees and net interest revenue has enhanced the consistency of
the Company's revenue streams, enabling the Company to cover a greater
proportion of fixed expenses. However, transaction-based revenues continue
to represent the majority of the Company's revenues. Since these revenues
are heavily influenced by fluctuations in the volume of securities
transactions, it is not unusual for the Company to experience significant
variations in quarterly revenue levels. Most of the Company's expenses do
not vary directly, at least in the short term, with fluctuations in
securities trading volume. The nature of the Company's revenues and
expenses, along with the environmental factors discussed above, may subject
the Company's future earnings and common stock price to significant
volatility.
The Company's long-term performance objectives call for profitable growth
within several markets of the financial services industry - retail
brokerage, mutual funds, equity securities market-making, support services
for independent investment managers and electronic brokerage. The Company's
strategy for achieving its objectives continues to be effective investment
in technology, product development, marketing programs and customer service
delivery systems. It is management's long-term goal to increase the value
of the Company by achieving a 20% annual revenue growth rate while
maintaining a 10% after-tax profit margin and a 20% return on stockholders'
equity.
In addition to the historical information contained throughout this Annual
Report, there are forward-looking statements that reflect management's
expectations for the future. A variety of important factors could cause
actual results to differ materially from such statements. These factors are
noted throughout this Annual Report and in the Company's Annual Report on
Form 10-K and include: the actions of both current and potential new
competitors, rapid changes in technology, financial market volatility,
evolving industry regulation, customer trading patterns, and new products
and services.
(CHART OMITTED)
RESULTS OF OPERATIONS
SUMMARY
Revenues of $1.4 billion in 1995 mark the Company's sixth consecutive year
of record revenues, up 33% from
(a) Accounts with balances or activity within the preceding twelve months.
(b) The Securities Industry Association revised its definition of discount
brokers in 1995. Schwab's share in 1994 was revised to 50% from 42%
under this new definition.
3
1994 and well above management's long-term goal of 20%. Trading activity at
Schwab reached record levels during 1995, with daily average retail trades,
which include Mutual Fund OneSource (registered trademark) trades, increasing
over 29% from 1994 to 56,300. The combined daily average share volume of the
New York Stock Exchange and Nasdaq increased 27% from 1994 to 748 million
shares. The Company's strong performance was also reflected in a $59.1 billion,
or 48%, increase in customer assets. On a dividend reinvested basis, the
Standard & Poor's 500 Index ended the year up 38%.
(CHART OMITTED)
Earnings in 1995 were $173 million, or $.97 per share, marking the
Company's fifth consecutive year of record earnings, up from $135 million,
or $.77 per share, in 1994, and $118 million, or $.66 per share, in 1993.
Share information throughout this report has been restated to reflect the
March 1995 three-for-two common stock split, effected in the form of a 50%
stock dividend, and the September 1995 two-for-one common stock split,
effected in the form of a 100% stock dividend. The after-tax profit margin
for 1995 was 12%, which exceeded the Company's long-term goal of 10%.
Return on stockholders' equity was 31% in 1995, well above the Company's
long-term goal of 20%. Reflecting these strong results, the Company's Board
of Directors declared two cash dividend increases during 1995, raising the
effective annual dividend rate 74% from the end of 1994.
(CHART OMITTED)
During 1995, the Company continued to invest in technology, product and
service enhancements, marketing programs, and new and expanded customer
service capacity. This contributed to a 36% increase in noninterest
expenses, which totaled $1.1 billion. With customer trading activity up 29%
over 1994, the Company increased its servicing capacity by expanding each
of its regional customer telephone service centers and its electronic
delivery services, as well as opening 19 branch offices. Capital
expenditures for 1995 totaled $166 million.
(CHART OMITTED)
REVENUES
Commissions
Commission revenues were $751 million in 1995, compared to $546 million in
1994 and $552 million in 1993. Commission revenues are affected by the
number of customer accounts that traded, the average number of transactions
per account that traded and the average commission per transaction. Schwab
operates in an agency capacity when executing commission transactions.
(CHART OMITTED)
Retail agency commission revenues, which exclude commissions from
institutional customers, constituted approximately 96% of total commissions
in each of the last three years. Commissions earned on retail agency trades
totaled $711 million in 1995, compared to $523 million in 1994 and
$531 million in 1993. The daily average retail agency trade level was
38,000 in 1995, 28,900 in 1994 and 27,700 in 1993. The following table
shows a comparison of certain factors that influence retail agency
commission revenues:
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1995 1994 1993
- --------------------------------------------------------------
Number of customer accounts
that traded during the year
(in thousands) 1,543 1,352 1,227
Average number of retail agency
transactions per account
that traded 6.3 5.4 5.7
Total number of retail agency
transactions (in thousands) 9,753 7,282 7,003
Average commission per retail
agency transaction $72.88 $71.88 $75.89
Total retail agency commission
revenues (in millions) $ 711 $ 523 $ 531
==============================================================
Note: The above table excludes customer transactions in
Schwab's Mutual Fund OneSource (registered trademark) service.
From 1993 to 1995, the total number of retail agency transactions executed
by Schwab has increased as Schwab's customer base has grown. From 1994 to
1995, average commission per retail agency transaction increased $1.00
mainly due to a higher proportion of equity securities transactions, which
carry a higher average commission per trade.
From 1993 to 1994, average commission per retail agency transaction
decreased $4.01 as the proportion of trades in lower commission per transaction
products increased. This was primarily the result of Schwab's success in
attracting customer mutual fund business. Strong price competition,
particularly with respect to customer equity securities transactions, also
contributed to the decrease. The effect of the increase in the total number of
retail agency transactions on retail agency commission revenues for 1994 was
offset entirely by the decrease in average commission per retail agency
transaction.
Attracting new customer accounts is important in generating commission
revenues. Schwab opened 698,000 new customer accounts during 1995, up 1%
and 8%, respectively, over account openings of 688,000 in 1994 and 644,000
in 1993. Prior year amounts are restated to reflect the $1,000 minimum
opening balance requirement for basic brokerage accounts implemented in
July 1994.
4
Mutual Fund Service Fees
The Company earns mutual fund service fees for providing services, such as
reporting of share ownership and dividend activity, administration and
investment management, to its proprietary and certain third-party mutual
funds. These fees are based upon daily balances of customer assets invested
in the funds. Revenues received from customer purchase and sale
transactions of mutual funds are included in commission revenues. The
Company currently does not charge commissions on purchases and sales of its
proprietary funds.
Mutual fund service fees were $219 million in 1995, compared to
$157 million in 1994 and $99 million in 1993. The increases from 1993 to
1995 were 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.
The SchwabFunds include money market funds, bond funds, equity index
funds, and asset allocation funds which contain stocks, bonds and cash
equivalents. Schwab customers may elect to have cash balances in their
brokerage accounts automatically invested in certain SchwabFunds money
market funds. Customer assets invested in the SchwabFunds, substantially
all of which are in SchwabFunds money market funds, were $31.7 billion,
$23.3 billion and $15.8 billion at the end of 1995, 1994 and 1993,
respectively.
At December 31, 1995, Schwab's Mutual Fund OneSource service enabled
customers to trade over 370 mutual funds in 44 well-known fund families
without incurring transaction fees. The service is particularly attractive
to investors who execute mutual fund trades directly with multiple mutual
fund companies to avoid brokerage transaction fees, and to achieve
investment diversity among fund families. In addition, investors' record
keeping and investment monitoring are simplified through one consolidated
statement. Fees received by Schwab via the Mutual Fund OneSource 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 Schwab's proprietary funds,
totaled $23.9 billion, $12.5 billion and $8.3 billion at the end of 1995,
1994 and 1993, respectively.
Interest Revenue, Net of Interest Expense
The Company presents interest revenue, net of interest expense, in its
consolidated financial statements. This presentation eliminates the impact
of market interest rate fluctuations on total revenues, thereby providing a
clearer view of the Company's performance in the areas of attracting and
investing customer cash balances and managing its balance sheet.
In performing its role as clearing broker for its customers' trading
activity, Schwab holds cash balances payable to customers. In most cases,
Schwab pays its customers interest on such cash balances awaiting
investment, and may invest these funds and earn interest revenue. Schwab
also may lend these funds to customers on a secured basis to purchase
qualified securities - a practice commonly known as "margin lending."
Pursuant to Securities and Exchange Commission (SEC) regulations, customer
cash balances that are not used for margin lending are segregated into
investment accounts that are maintained for the exclusive benefit of
customers.
When investing segregated customer cash balances, Schwab and M&S 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. Schwab's and M&S' policies for
credit quality and maximum maturity requirements are more restrictive than
these SEC regulations. In each of the last three years, resale agreements
accounted for over 87% of Schwab's investments in segregated customer cash
balances. The average maturities of Schwab's total investments in
segregated customer cash balances were 48 days, 54 days and 71 days in
1995, 1994 and 1993, respectively.
Interest revenue, net of interest expense, reached a record $211 million
in 1995, compared to $165 million in 1994 and $120 million in 1993 as shown
in the following table (in millions):
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1995 1994 1993
- ----------------------------------------------------------------
Interest Revenue
Investments, customer-related $283 $168 $113
Margin loans to customers 264 185 132
Other 21 10 7
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Total 568 363 252
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Interest Expense
Customer cash balances 321 178 115
Borrowings 12 12 12
Other 24 8 5
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Total 357 198 132
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Interest Revenue, Net of
Interest Expense $211 $165 $120
================================================================
The Company's interest-earning assets (principally investments and margin
loans to customers) are financed primarily by interest-bearing customer
cash balances. Other funding sources include noninterest-bearing customer
cash balances, proceeds from stock-lending activities, borrowings and
stockholders' equity. Average balances and interest rates on customer-
related, interest-earning assets and related funding sources are summarized
as follows (dollars in millions):
5
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1995 1994 1993
- --------------------------------------------------------------------------
Earning Assets (customer-related):
Investments:
Average balance outstanding $4,815 $3,957 $3,469
Average interest rate 5.88% 4.26% 3.25%
Margin loans to customers:
Average balance outstanding $3,221 $2,742 $2,212
Average interest rate 8.20% 6.74% 5.99%
Average yield on earning assets 6.81% 5.28% 4.32%
Funding Sources (customer-related and other):
Interest-bearing customer cash balances:
Average balance outstanding $6,553 $5,472 $4,693
Average interest rate 4.90% 3.25% 2.44%
Other interest-bearing sources:
Average balance outstanding $ 411 $ 353 $ 275
Average interest rate 4.33% 2.94% 3.30%
Average noninterest-bearing portion $1,072 $ 874 $ 713
Average interest rate on funding sources 4.22% 2.81% 2.18%
Summary:
Average yield on earning assets 6.81% 5.28% 4.32%
Average interest rate on funding sources 4.22% 2.81% 2.18%
- --------------------------------------------------------------------------
Average net interest margin 2.59% 2.47% 2.14%
==========================================================================
The increase in interest revenue, net of interest expense, from 1993 to
1995 was primarily due to higher levels of average earning assets, and to
sharper increases in average interest rates on earning assets compared to
funding sources.
Principal Transactions
Principal transactions are primarily comprised of net gains from market-
making activities in Nasdaq securities. Factors that influence principal
transactions include the volume of customer trades and market price
volatility. During 1995, a record 101 billion shares traded on Nasdaq, and
the Nasdaq Composite Index increased 40%. As a market maker in Nasdaq
securities, M&S generally executes customer trades as principal. M&S
business practices call for competitively-priced customer trade executions,
generally defined as the highest bid price on a sell order and the lowest
offer price on a buy order available through the National Association of
Securities Dealers (NASD) member firms. Certain customer trades are
executed on a negotiated basis. Substantially all Nasdaq security trades
originated by the customers of Schwab are directed to M&S.
Revenues from principal transactions were $191 million in 1995, compared
to $163 million in 1994 and $169 million in 1993. The 18% increase from
1994 to 1995 was primarily due to an increase in trading volume handled by
M&S.
The volume increase at M&S was partially offset by lower average revenue
per principal transaction mainly due to the impact of the July 1994 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. M&S extended the benefits of the July 1994 NASD Interpretation to
substantially all retail customer limit orders in Nasdaq securities
received from broker-dealers for which it executes such orders. The
introduction of Assurance Trading (trademark) (see discussion below) also
contributed to lower average revenue per principal transaction. The 4%
decrease from 1993 to 1994 was due to a lower average revenue per principal
transaction in 1994 and the impact of the July 1994 NASD Interpretation.
In August 1995, Assurance Trading was introduced. This new service
provides customers an opportunity for price improvement on certain trades
in certain Nasdaq securities through the scanning of multiple computer
systems for a price better than the current quoted Nasdaq inside price.
M&S is a significant participant in the Nasdaq market. 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 1996.
Current and proposed rulemaking, regulatory actions, improvements in
technology, such as those which permit the introduction of Assurance
Trading, changes in market practices and new market systems, if approved,
could significantly impact the manner in which business is currently
conducted in the Nasdaq market. The above factors, individually or in the
aggregate, could continue to have a material adverse impact on M&S' future
revenues from principal transactions.
During 1994, Schwab commenced operation of specialist posts on the Pacific
Stock Exchange to make markets in exchange-listed securities and ended that
year with five posts that collectively made markets in over 240 securities.
At December 31, 1995, Schwab had fourteen specialist posts that
collectively made markets in approximately 700 securities. The majority of
trades originated by the customers of Schwab in exchange-listed securities
for which Schwab makes a market are directed to these posts. Revenues from
these specialist posts also have contributed to the increase in principal
transactions from 1994 to 1995.
Other Revenues
Other revenues include other brokerage fees, IRA maintenance fees, and
software product sales and usage fees. These revenues totaled $48 million
during 1995, compared to $34 million in 1994 and $25 million in 1993. The
39% increase from 1994 to 1995 represented higher other brokerage fees and
increased cash surrender value of company-owned life insurance policies.
The 36% increase from 1993 to 1994 represented higher IRA maintenance fees
and increased sales of StreetSmart (registered trademark) and Equalizer
(registered trademark), Schwab's online trading software products,
partially offset by a decrease in revenues from Schwab's affinity credit
card arrangement.
(CHART OMITTED)
6
EXPENSES
Compensation and Benefits
Compensation and benefits expense includes salaries and wages, variable
compensation, and related employee benefits and taxes. The Company provides
its employees with compensation programs that contain variable pay
components that are tied to the achievement of specified objectives
relating to revenue growth, profit margin and growth in customer assets.
Therefore, a significant portion of compensation and benefits expense will
fluctuate with these measures.
Compensation and benefits expense was $594 million for 1995, compared to
$437 million in 1994 and $393 million in 1993. Variable compensation as a
percentage of total compensation and benefits expense was 24% in 1995, 23%
in 1994 and 27% in 1993. The Company had full-time, part-time and temporary
employees, and persons employed on a contract basis that represented the
equivalent of approximately 9,200 full-time employees at the end of 1995,
compared to approximately 6,500 at the end of both 1994 and 1993. Increases
in compensation and benefits expense between 1993 and 1995 were generally
the result of increases in salaries and wages due to the larger average
number of employees. In 1995, an increase in variable compensation also
contributed to the overall increase in compensation and benefits. In 1994,
the increase in salaries and wages was partially offset by a decline in
variable compensation.
The Company encourages and provides mechanisms for employee ownership of
the Company's common stock through its profit sharing and employee stock
ownership plan, its stock option plans and an automatic investment plan.
The Company's overall compensation structure is intended to attract, retain
and reward highly qualified employees, and to align the interests of
employees with those of stockholders. At December 31, 1995, management,
employees and their families owned directly and through the Company's
profit sharing and employee stock ownership plan approximately 41% of the
Company's outstanding common stock. In addition, management and employees
held options to purchase common stock, which are not considered outstanding
for ownership purposes, that totaled approximately 9% of the Company's
outstanding common stock at December 31, 1995.
(CHART OMITTED)
Communications
Communications expense, including telephone, postage, and news and
quotation charges, was $129 million for 1995, $107 million in 1994 and
$94 million in 1993. The increase in communications expense between 1993
and 1995 primarily resulted from higher customer transaction volumes.
Increases in customer use of toll-free telephone numbers, reflecting a
higher proportion of incoming calls handled by TeleBroker (registered
trademark) and regional customer telephone service centers, and StreetSmart
(registered trademark) usage also contributed to higher telephone expenses
over this period.
Occupancy and Equipment
Occupancy and equipment expense includes the costs of leasing and
maintaining the Company's headquarters, four regional customer telephone
service centers, a primary data center and over 225 branch offices. It also
includes lease and rental expenses on computer and other equipment.
Occupancy and equipment expense was $111 million for 1995, compared to
$88 million in 1994 and $77 million in 1993, reflecting the Company's
continued growth. The Company expanded each of its regional customer
telephone service centers in 1995, opened a regional customer telephone
service center in 1994 and opened its primary data center in Phoenix in
1993. Schwab opened 19 new branch offices in 1995, 10 in 1994 and 23 in
1993.
Commissions, Clearance and Floor Brokerage
Commissions, clearance and floor brokerage expense includes fees paid to
stock and option exchanges for trade executions, fees paid by M&S to broker-
dealers for orders received for execution and fees paid to clearing
entities for trade processing. Commissions, clearance and floor brokerage
expense was $77 million in 1995, $49 million in 1994 and $43 million in
1993. The increases from 1993 to 1995 were primarily attributable to
increases in the number of trades processed by M&S and Schwab.
Depreciation and Amortization
Depreciation and amortization expense includes that relating to equipment
and office facilities, property, leasehold improvements, goodwill and other
intangibles. Such expenses were $69 million for 1995, compared to
$55 million in 1994 and $44 million in 1993. The increases from 1993 to
1995 were primarily due to newly acquired data processing-related assets
and leasehold improvements which increased the Company's customer service
capacity and fixed asset base from the respective preceding year's level. A
portion of the 1995 increase was due to the amortization of goodwill and
other intangibles resulting from businesses acquired during the year.
Advertising and Market Development
Advertising builds the image and awareness of the firm and plays a crucial
role in obtaining new customer accounts, which have represented an
important source of revenue and revenue growth for the Company. Advertising
and market development expense includes television, print and direct mail
advertising expenses and related production, printing and postage costs.
Such expenses totaled $53 million in 1995, $36 million in 1994 and
$41 million in 1993. The 45% increase from 1994 to 1995 was primarily a
result of higher expenses relating to print marketing materials, and cable
television and radio advertising. The 11% decrease from 1993 to 1994 was
primarily a result of the Company's
7
reduced spending on network and cable television advertising, and print
marketing materials.
Professional Services
Professional services expense was $41 million in 1995, $22 million in 1994
and $22 million in 1993. This category includes the cost of consultants
engaged to support product, service and systems development, and legal and
accounting fees. The 88% increase in professional services expense from
1994 to 1995 was primarily due to increases in consulting fees relating to
various development projects - including those involving data processing,
product and customer service enhancement, and company infrastructure.
Other Expenses
Other expenses were $69 million for 1995, $47 million in 1994 and
$44 million in 1993. Other expenses include those relating to travel and
entertainment, errors and bad debts, bank service charges (primarily
relating to costs of processing checks written by customers), registration
fees for employees and other miscellaneous expenses. The increase in these
expenses from 1993 to 1995 was primarily attributable to a combination of
higher staffing levels and to higher transaction volumes. In 1995, higher
charitable contributions also contributed to the overall increase in other
expenses.
Taxes on Income
The Company's effective income tax rate was 37.7% in 1995, and 39.7% in
both 1994 and 1993. The decline in the effective income tax rate during
1995 was primarily due to the accounting for the August 1995 settlement of
substantially all issues raised in the Company's U.S. Tax Court case with
the Internal Revenue Service. See "Commitments and Contingent Liabilities"
note in the Notes to Consolidated Financial Statements. The Company expects
its effective income tax rate in 1996 to be from 40% to 41%.
LIQUIDITY AND CAPITAL RESOURCES
CSC operates as a holding company, conducting virtually all business
through its wholly owned subsidiaries. The capital structure among CSC and
its subsidiaries is designed to provide each entity with capital and
liquidity consistent with its operations. A description of significant
aspects of this structure for CSC and its two principal subsidiaries,
Schwab and M&S, follows.
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
(the majority of which are segregated for the exclusive benefit of
customers pursuant to regulatory requirements), receivables from customers,
and receivables from brokers, dealers and clearing organizations. 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 $8.4 billion in 1995, $6.7 billion in 1994 and $5.7 billion
in 1993. 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
$250 million subordinated revolving credit facility maturing in September
1997, of which $174 million was outstanding at December 31, 1995. This
facility was increased in December 1995 from $180 million. At year end,
Schwab also had outstanding $25 million in fixed-rate subordinated term
loans from CSC maturing in 1997. In January 1996, the maturity date for
$15 million of the $25 million debt scheduled to mature in 1997 was
extended to 1998. Borrowings under these subordinated lending arrangements
qualify as regulatory capital for Schwab.
For use in its brokerage operations, Schwab maintains uncommitted
unsecured bank credit lines totaling $470 million. The need for short-term
borrowings arises primarily from timing differences between cash flow
requirements and the scheduled liquidation of interest-bearing investments,
or, if applicable, the release of funds from required regulatory reserves.
Schwab used such borrowings for 9 days in 1995, 29 days in 1994 and 25 days
in 1993, with the daily amounts borrowed averaging $24 million, $43 million
and $19 million, respectively. These lines were unused at December 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, cash and
equivalents, and marketable securities. M&S may borrow up to $35 million
under a subordinated lending arrangement with CSC. This facility was
increased in December 1995 from $10 million. At year end, M&S had
outstanding $4 million maturing in December 1997 under this facility.
Borrowings under this arrangement qualify as regulatory capital for M&S.
CSC
CSC's liquidity needs are generally met through cash generated by its
subsidiaries, as well as cash provided by external financing. Schwab and
M&S 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
8
dividends, or making unsecured advances or loans to their parent or employees
if such payment would result in net capital of less than 5% of aggregate debit
balances or less than 120% of their minimum dollar amount requirement of
$1 million. At December 31, 1995, Schwab had $392 million of net capital
(10% of aggregate debit balances), which was $310 million in excess of its
minimum required net capital. At December 31, 1995, M&S had $6 million of net
capital (110% of aggregate debit balances), which was $5 million in excess of
its minimum required net capital. Management believes that funds generated
by the operations of CSC's subsidiaries will continue to be the primary funding
source in meeting CSC's liquidity needs and maintaining Schwab's and M&S'
net capital.
CSC has individual liquidity needs that arise from its issued and
outstanding $240 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 2005 and fixed interest rates ranging from 4.95% to 7.72% with
interest payable semiannually.
In August 1995, a prospectus supplement covering the issuance of up to
$140 million in Senior or Senior Subordinated Medium-Term Notes, Series A,
was filed with the SEC of which $110 million in securities remained
unissued at December 31, 1995.
In October 1994, CSC prepaid its $35 million Senior Term Loan due in March
1995 using working capital funds. When the loan was prepaid, a related
interest rate exchange arrangement was terminated.
CSC may borrow under its $250 million committed unsecured credit facility
with a group of ten banks through June 1996. The funds are available for
general corporate purposes for which 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.
See "Commitments and Contingent Liabilities" note in the Notes to
Consolidated Financial Statements.
(CHART OMITTED)
Cash Flows and Capital Resources
Net income plus depreciation and amortization was $241 million during
1995, up 27% from $190 million in 1994, allowing the Company to finance the
majority of its growth with internally-generated funds. During 1995, the
Company invested $166 million in various capital expenditures including the
expansion of each of its regional customer telephone service centers, and
enhancements to its data processing and telecommunications systems. The
Company also opened 19 branch offices and made improvements to certain
existing office facilities.
As has been the case in recent years, capital expenditures will vary from
period to period as business conditions change. While management retains
substantial flexibility to adjust capital expenditures as necessary, in
general the level of future expenditures will be influenced by the rate of
growth in customer assets and trading activities, staffing and facilities
requirements, and availability of relevant technology to support innovation
in products and services. Management currently anticipates that 1996
capital expenditures will be comparable to, and may exceed, the 1995 level.
In addition, during 1995, the Company:
- - Paid approximately $68 million, net of cash received, for businesses
acquired. The largest acquisition was ShareLink Investment Services plc,
a retail discount securities brokerage firm located in the United
Kingdom.
- - Issued $70 million in Medium-Term Notes.
- - Repurchased 873,800 shares of its common stock for $17 million. As of
December 31, 1995, authorization granted by the Company's Board of
Directors allowed for the repurchase of up to 952,000 additional shares.
The Company will continue to monitor opportunities to repurchase common
stock in cases where stockholder value would be enhanced.
- - Paid common stock dividends of $24 million.
(CHART OMITTED)
The Company monitors both the relative composition and absolute level of
its financial capital. The Company's stockholders' equity at December 31,
1995 totaled $633 million. In addition, the Company had borrowings of
$246 million that bear interest at a weighted average rate of 6.28%. These
borrowings, together with the Company's equity, provided total financial
capital of $879 million at December 31, 1995, up $241 million, or 38% from
a year ago. Management currently anticipates that the proportions of
borrowings and stockholders' equity in the Company's financial capital will
remain comparable to current levels.
EFFECTS OF STATEMENT OF FINANCIAL ACCOUNTING STANDARDS
The Company is required to adopt Statement of Financial Accounting
Standards (SFAS) No. 121 - Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of - in 1996. The statement
requires that long-lived assets and certain identifiable intangibles to be
held and used by an entity be reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may
not be recoverable.
The Company is also required to adopt SFAS No. 123 - Accounting for Stock-
Based Compensation - in 1996. The statement establishes accounting and
disclosure requirements using a fair value-based method of accounting for
stock-based employee compensation plans. The
9
Company plans to implement only the disclosure requirements of the statement.
Management believes the adoption of these statements in 1996 will have no
effect on the Company's results of operations, earnings per share or cash
flows.
LOOKING AHEAD
The continued general financial success within the securities industry
over the past several years has strengthened existing competitors and
attracted new competitors. Management expects intense competition to
continue in 1996. The Company intends to respond to such competition by
continuing to invest heavily in technology, customer service facilities and
product development. To help ensure effective use of resources, the Company
will continue to focus on improving its internal business processes with
the goal of enhancing customer service quality and the Company's cost
structure.
The Company will continue to leverage cross-marketing opportunities within
its existing customer base and develop new products and services consistent
with evolving customer needs and its competitive-pricing philosophy. The
Company intends to continue to support its products and services with
aggressive marketing and promotional efforts, and to focus its business
development activities on attracting customer assets.
While these activities require significant operating expense outlays and,
during certain years, significant capital expenditures, they are important
investments for the Company's long-term profitable growth. Management's
financial goals are to achieve over the long term a 20% annual revenue
growth rate while maintaining a 10% after-tax profit margin and a return on
stockholders' equity of 20%.
10
The Charles Schwab Corporation
Consolidated Statement of Income
(In Thousands, Except Per Share Amounts)
<caption
Year Ended December 31, 1995 1994 1993
- -----------------------------------------------------------------------------------------------------
Revenues
Commissions $ 750,896 $ 546,112 $552,206
Mutual fund service fees 218,784 156,812 98,554
Interest revenue, net of interest expense of
$357,223 in 1995, $198,236 in 1994 and
$132,382 in 1993 210,897 164,708 119,849
Principal transactions 191,392 162,595 169,081
Other 47,934 34,370 25,323
- -----------------------------------------------------------------------------------------------------
Total 1,419,903 1,064,597 965,013
- -----------------------------------------------------------------------------------------------------
Expenses Excluding Interest
Compensation and benefits 594,105 437,064 392,768
Communications 128,554 106,682 94,348
Occupancy and equipment 110,977 87,641 76,668
Commissions, clearance and floor brokerage 77,061 49,344 43,039
Depreciation and amortization 68,793 54,556 44,433
Advertising and market development 52,772 36,401 40,726
Professional services 41,304 21,928 22,385
Other 69,233 46,638 44,374
- -----------------------------------------------------------------------------------------------------
Total 1,142,799 840,254 758,741
- -----------------------------------------------------------------------------------------------------
Income before taxes on income and
extraordinary charge 277,104 224,343 206,272
Taxes on income 104,500 89,000 81,904
- -----------------------------------------------------------------------------------------------------
Income before extraordinary charge 172,604 135,343 124,368
Extraordinary charge - early retirement of debt,
net of tax 6,700
- -----------------------------------------------------------------------------------------------------
Net Income $ 172,604 $ 135,343 $117,668
=====================================================================================================
Weighted average number of common and
common equivalent shares outstanding (1, 2) 178,476 175,206 178,350
=====================================================================================================
Per Common Share (1)
Net earnings before extraordinary charge $ .97 $ .77 $ .70
Extraordinary charge - early retirement of
debt .04
- -----------------------------------------------------------------------------------------------------
Primary Earnings per Share $ .97 $ .77 $ .66
=====================================================================================================
Fully Diluted Earnings per Share $ .97 $ .77 $ .66
=====================================================================================================
Dividends Declared per Common Share (1) $ .140 $ .092 $ .064
=====================================================================================================
(1) Reflects the March 1995 three-for-two common stock split and the September 1995 two-for-one common stock split.
(2) Amounts shown are used to calculate primary earnings per share.
See Notes to Consolidated Financial Statements.
11
The Charles Schwab Corporation
Consolidated Balance Sheet
(In Thousands, Except Share Data)
December 31, 1995 1994
- ------------------------------------------------------------------------------------------------------------------------------
Assets
Cash and equivalents (including resale agreements of $250,000 in 1995 and
$242,500 in 1994) $ 429,298 $ 380,616
Cash and investments required to be segregated under Federal or other
regulations (including resale agreements of $4,384,298 in 1995
and $3,787,984 in 1994) 5,426,619 4,206,466
Receivable from brokers, dealers and clearing organizations 141,916 86,028
Receivable from customers (less allowance for doubtful accounts
of $3,700 in 1995 and $3,204 in 1994) 3,946,295 2,923,867
Securities owned - at market value 113,522 60,226
Equipment, office facilities and property (less accumulated depreciation
and amortization of $212,035 in 1995 and $162,474 in 1994) 243,472 129,105
Intangible assets (less accumulated amortization of $162,358 in 1995
and $148,722 in 1994) 80,863 29,968
Other assets 170,023 101,586
- ------------------------------------------------------------------------------------------------------------------------------
Total $10,552,008 $7,917,862
==============================================================================================================================
Liabilities and Stockholders' Equity
Drafts payable $ 212,961 $ 117,383
Payable to brokers, dealers and clearing organizations 581,226 296,420
Payable to customers 8,551,996 6,670,362
Accrued expenses and other 326,785 195,320
Borrowings 246,146 171,363
- ------------------------------------------------------------------------------------------------------------------------------
Total liabilities 9,919,114 7,450,848
- ------------------------------------------------------------------------------------------------------------------------------
Stockholders' equity:
Preferred stock - 9,940,000 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* 1,785 595
Additional paid-in capital 180,302 166,103
Retained earnings 520,532 373,161
Treasury stock - 4,427,255 shares in 1995 and 7,563,990 shares in 1994, at cost* (50,968) (57,968)
Unearned ESOP shares (9,397) (10,174)
Unamortized restricted stock compensation (7,074) (4,703)
Foreign currency translation adjustment (2,286)
- ------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 632,894 467,014
- ------------------------------------------------------------------------------------------------------------------------------
Total $10,552,008 $7,917,862
==============================================================================================================================
* Reflects the March 1995 three-for-two common stock split and the September 1995 two-for-one common stock split.
See Notes to Consolidated Financial Statements.
12
The Charles Schwab Corporation
Consolidated Statement of Cash Flows
(In Thousands)
December 31, 1995 1994 1993
- ----------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities
Net income $ 172,604 $ 135,343 $ 117,668
Noncash items included in net income:
Depreciation and amortization 68,793 54,556 44,433
Deferred income taxes (6,975) 3,781 (5,352)
Other 3,609 3,699 (1,074)
Extraordinary charge - early retirement of debt 11,205
Change in securities owned - at market value (53,296) (25,189) (10,639)
Change in accrued expenses and other 141,431 40,908 43,653
Change in other assets (44,894) (2,026) (26,986)
- -----------------------------------------------------------------------------------------------------------------------
Net cash provided before change in customer-related balances 281,272 211,072 172,908
- -----------------------------------------------------------------------------------------------------------------------
Change in customer-related balances (excluding the effects
of businesses acquired):
Payable to customers 1,775,434 924,579 670,276
Receivable from customers (1,011,008) (371,587) (648,548)
Drafts payable 89,909 (6,001) 21,052
Payable to brokers, dealers and clearing organizations 285,363 (7,561) 105,483
Receivable from brokers, dealers and clearing organizations (15,908) (14,412) (23,250)
Cash and investments required to be segregated under
Federal or other regulations (1,157,717) (530,147) (166,170)
- -----------------------------------------------------------------------------------------------------------------------
Net change in customer-related balances (33,927) (5,129) (41,157)
- -----------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 247,345 205,943 131,751
- -----------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities
Purchase of equipment, office facilities and property - net (165,630) (31,534) (77,127)
Cash payments for businesses acquired, net of cash received (68,244)
Purchase of life insurance policies (39,628) (41,684)
Other (606) 6,241
- -----------------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (273,502) (73,824) (70,886)
- -----------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities
Proceeds from loans on life insurance policies 38,297 41,299
Proceeds from borrowings 70,000 20,000 150,000
Repayment of borrowings (2,781) (35,916) (128,032)
Purchase of treasury stock (17,345) (46,781)
Dividends paid (24,249) (16,038) (10,946)
Other 11,623 6,105 3,651
- -----------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities 75,545 (31,331) 14,673
- -----------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and equivalents (706)
- -----------------------------------------------------------------------------------------------------------------------
Increase in cash and equivalents 48,682 100,788 75,538
Cash and equivalents at beginning of year 380,616 279,828 204,290
- -----------------------------------------------------------------------------------------------------------------------
Cash and equivalents at end of year $ 429,298 $ 380,616 $ 279,828
=======================================================================================================================
See Notes to Consolidated Financial Statements.
13
The Charles Schwab Corporation
Consolidated Statement of Stockholders' Equity
(In Thousands)
Note
Receivable Unamortized Foreign
Common Stock Additional From Profit Unearned Restricted Currency
---------------- Paid-In Retained Treasury Sharing ESOP Stock Translation
Shares* Amount Capital Earnings Stock Plan Shares Compensation Adjustment Total
- ----------------------------------------------------------------------------------------------------------------------------------
Balance at
December 31, 1992 170,024 $ 392 $141,946 $147,168 $(26,444) $ (4,254) $258,808
Net income 117,668 117,668
Dividends declared
on common stock (10,946) (10,946)
Stock options exercised
and restricted stock
compensation awards 1,311 4,005 3,291 7,296
Three-for-two stock
split effected in
the form of a 50%
stock dividend 198 (198)
Common stock issued
to Profit Sharing
Plan for a note
receivable 2,177 5 14,995 (15,000)
Collection on note
receivable from
Profit Sharing Plan 6,241 6,241
Other 106 106
- ----------------------------------------------------------------------------------------------------------------------------------
Balance at
December 31, 1993 173,512 595 161,052 253,692 (23,153) (13,013) 379,173
- ----------------------------------------------------------------------------------------------------------------------------------
Net income 135,343 135,343
Dividends declared
on common stock (16,038) (16,038)
Purchase of treasury
stock (5,000) (46,781) (46,781)
Stock options exercised
and restricted stock
compensation awards 2,384 4,293 11,966 $(4,892) 11,367
Amortization of
restricted stock
compensation awards 189 189
Collection on note
receivable from
Profit Sharing Plan 1,467 1,467
Reclassification of note
receivable from Profit
Sharing Plan 11,546 $(11,546)
ESOP shares released
for allocation 758 164 1,372 2,294
- ----------------------------------------------------------------------------------------------------------------------------------
Balance at
December 31, 1994 170,896 595 166,103 373,161 (57,968) (10,174) (4,703) 467,014
- ----------------------------------------------------------------------------------------------------------------------------------
Net income 172,604 172,604
Dividends declared
on common stock (24,249) (24,249)
Purchase of treasury
stock (874) (17,345) (17,345)
Stock options exercised
and restricted stock
compensation awards 4,010 12,809 24,345 (3,511) 33,643
Three-for-two stock
split effected in
the form of a 50%
stock dividend 297 (297)
Two-for-one stock
split effected in
the form of a 100%
stock dividend 893 (893)
Amortization of
restricted stock
compensation awards 1,140 1,140
ESOP shares released
for allocation 1,390 206 777 2,373
Foreign currency
translation
adjustment $(2,286) (2,286)
- ----------------------------------------------------------------------------------------------------------------------------------
Balance at
December 31, 1995 174,032 $1,785 $180,302 $520,532 $(50,968) $ (9,397) $(7,074) $(2,286) $632,894
==================================================================================================================================
*Share amounts are presented net of treasury shares and reflect the March 1995 three-for-two common stock split and the
September 1995 two-for-one common stock split.
See Notes to Consolidated Financial Statements.
14
The Charles Schwab Corporation
Notes to Consolidated Financial Statements
Basis of Presentation
The consolidated financial statements include The Charles Schwab
Corporation (CSC) and its subsidiaries (collectively, the Company). CSC is
a holding company engaged, through its subsidiaries, in securities
brokerage and related investment services. CSC's principal operating
subsidiary, Charles Schwab & Co., Inc. (Schwab), is a securities broker-
dealer with a network of over 225 branch offices in 46 states. Another
subsidiary, Mayer & Schweitzer, Inc. (M&S), a market maker in Nasdaq
securities, provides trade execution services to broker-dealers, including
Schwab, and institutional customers. Fees received from the Company's
proprietary mutual funds represented approximately 12% of the Company's
consolidated revenues in 1995. As of December 31, 1995, approximately 28%
of Schwab's total customer accounts were located in California.
Certain items in prior years' financial statements have been reclassified
to conform to the 1995 presentation. All material intercompany balances and
transactions have been eliminated.
Significant Accounting Policies
Securities transactions recorded by Schwab and the related revenues and
expenses are recorded on a trade date basis for 1995 and a settlement date
basis for years prior to 1995. Revenues and expenses on a settlement date
basis for Schwab were not materially different from trade date and the
effect of the change is not material to the financial statements. M&S
records principal transactions and the related revenues and expenses on a
trade date basis.
Cash and investments required to be segregated under Federal or other
regulations consist primarily of securities purchased under agreements to
resell (Resale Agreements), certificates of deposit and, in the case of
ShareLink Investment Services plc (ShareLink), money market funds. Resale
Agreements are accounted for as collateralized financing transactions and
are recorded at their contractual amounts. Certificates of deposit and
money market funds are stated at cost, which approximates market.
Use of estimates in the preparation of the financial statements - The
preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities at
the date of the financial statements, and the reported amounts of revenues
and expenses during the period. Such estimates relate to useful lives of
equipment, office facilities, property and intangible assets, fair value of
financial instruments, allowance for doubtful accounts, and legal reserves.
Actual results could differ from such estimates.
Depreciation and amortization - Equipment and office facilities are
depreciated on a straight-line basis over the estimated useful life of the
asset, generally three to seven years. Property is depreciated on a
straight-line basis over twenty years. Leasehold improvements are amortized
on a straight-line basis over the lesser of the estimated useful life of
the asset or the life of the lease. Other intangibles, including goodwill
and customer lists, are amortized on a straight-line basis over periods
from three to fifteen years.
Earnings per share are calculated by dividing net income by the sum of the
weighted average number of common shares outstanding during the period plus
common share equivalents. The weighted average number of common shares
outstanding during 1995, 1994 and 1993 was 172,284,974, 169,953,118 and
172,674,255, respectively. Common share equivalents from the dilutive
effect of stock options utilized in computing earnings per share in 1995,
1994 and 1993 were 6,191,145, 5,253,000 and 5,675,844 for primary, and
6,577,351, 5,387,553 and 6,044,554 for fully diluted, respectively.
Information presented in the Consolidated Financial Statements and notes
thereto regarding share and per share amounts, stock option data and market
prices give effect to the March 1995 three-for-two common stock split and
the September 1995 two-for-one common stock split.
Cash equivalents - For purposes of reporting cash flows, the Company
considers all highly liquid investments (including Resale Agreements) with
original maturities of three months or less that are not required to be
segregated under Federal or other regulations to be cash equivalents.
Income taxes - The Company accounts for income taxes under Statement of
Financial Accounting Standards (SFAS) No. 109 - Accounting for Income Taxes
- - which requires the recognition of deferred tax assets and liabilities at
tax rates expected to be in effect when these balances reverse. Future tax
benefits attributable to temporary differences are recognized currently to
the extent that realization of such benefits is more likely than not.
Estimated fair value of financial instruments - The Company considers the
amounts presented for financial instruments on the consolidated balance
sheet to be reasonable estimates of fair value except for certain
borrowings and certain off-balance sheet financial instruments. Disclosure
of the fair value of these instruments, determined by the Company using
available market information and appropriate valuation methodologies, is
presented under the "Borrowings" note. Considerable judgment is necessarily
required in interpreting market data to develop the estimates of fair value
and, accordingly, the estimates are not necessarily indicative of the
amounts that the Company could realize in a current market transaction.
15
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.
Derivatives - During 1995 and 1994, the Company's derivatives activities
were limited to exchange-traded option contracts to reduce market risk on
inventories in Nasdaq and exchange-listed securities, a forward foreign
currency contract to reduce foreign exchange risk and an interest rate
exchange arrangement to reduce interest risk. The notional amount of such
derivatives was not material to the Company's consolidated balance sheet at
December 31, 1995.
Acquisitions
During 1995, the Company completed several acquisitions. The largest
acquisition was ShareLink, a retail discount securities brokerage firm in
the United Kingdom, for $60 million, net of cash received. Because the
acquisitions were accounted for using the purchase method of accounting,
the operating results of the acquired companies are included in the
consolidated results of the Company since the respective dates of
acquisitions. The historic results of the acquired companies are not
included in periods prior to such acquisitions.
Securities Owned
The market value of securities owned at December 31, 1995 and 1994
consist of the following (in thousands):
- ------------------------------------------------------
1995 1994
- ------------------------------------------------------
Equity and bond funds $ 40,657 $ 10,928
Equity and other securities 38,821 22,436
Money market funds 34,044 26,862
- ------------------------------------------------------
Total $113,522 $ 60,226
======================================================
Securities sold, but not yet purchased of $24 million and $16 million at
December 31, 1995 and 1994, respectively, consist primarily of equity and
other securities, and are included at market value in accrued expenses and
other.
Payable to Customers
The principal source of funding for Schwab's margin lending is cash
balances in customer Schwab One (registered trademark) brokerage accounts.
At December 31, 1995, Schwab was paying interest at 4.7% on $7.3 billion of
cash balances in Schwab One brokerage accounts, which were included in
payable to customers. At December 31, 1994, Schwab was paying interest at
4.7% on $5.8 billion of such cash balances.
Borrowings
Borrowings at December 31, 1995 and 1994 consist of the following (in
thousands):
- ------------------------------------------------------
1995 1994
- ------------------------------------------------------
Senior Medium-Term Notes $240,000 $170,000
Other 6,146 1,363
- ------------------------------------------------------
Total $246,146 $171,363
======================================================
CSC has $240 million aggregate principal amount of Senior Medium-Term
Notes, Series A (Medium-Term Notes), with fixed interest rates ranging from
4.95% to 7.72% and maturities as follows: 1996 - $26 million; 1997 -
$28 million; 1998 - $40 million; 1999 - $40 million; 2000 - $38 million;
and thereafter - $68 million. The Medium-Term Notes carry a weighted
average interest rate of 6.29%. The fair value of the Medium-Term Notes was
estimated to be $243 million and $156 million at December 31, 1995 and
1994, respectively, based on estimates of market rates for debt with
similar terms and remaining maturities.
In August 1995, a prospectus supplement covering the issuance of up to
$140 million in Senior or Senior Subordinated Medium-Term Notes, Series A,
was filed with the Securities and Exchange Commission (SEC) of which
$110 million in securities remained unissued at December 31, 1995.
In October 1994, CSC prepaid its $35 million Senior Term Loan due in March
1995 using working capital funds. When the loan was prepaid, a related
interest rate exchange arrangement was terminated.
For use in its brokerage operations, at December 31, 1995, Schwab
maintained uncommitted unsecured bank credit lines totaling $470 million.
At December 31, 1994, Schwab's uncommitted bank credit lines totaled
$480 million, of which $400 million was available on an unsecured basis.
There were no borrowings outstanding under these lines at December 31,
1995 and 1994.
CSC may borrow under its $250 million committed unsecured credit facility
with a group of ten banks through June 1996. The funds are available for
general corporate purposes for which 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.
During 1994, CSC had agreed to maintain availability under this facility to
repay any obligations arising under the then-
16
existing $100 million letter of credit facility that had been established by
CSC for three of the SchwabFunds (registered trademark) money market funds
(the Funds). As part of the 1995 reduction and extension of such letter of
credit facility (described in the "Commitments and Contingent Liabilities"
note), this availability requirement was eliminated. At December 31, 1995 and
1994, had the Funds disposed of all the specified securities at values provided
by the Funds' pricing service, the Funds would have had the right to make
demands for payments on the bank totaling approximately zero and
$9 million, respectively. These values may not be representative of market
values in effect at December 31, 1995 and 1994.
Taxes on Income
Income tax expense, including the current tax benefit related to the
extraordinary charge, is as follows (in thousands):
- --------------------------------------------------------------------
Year Ended December 31,
1995 1994 1993
- --------------------------------------------------------------------
Current:
Federal $ 96,742 $72,157 $72,362
State 14,733 13,062 14,894
- --------------------------------------------------------------------
Total current 111,475 85,219 87,256
- --------------------------------------------------------------------
Deferred:
Federal (6,818) 3,221 (4,477)
State (157) 560 (875)
- --------------------------------------------------------------------
Total deferred (6,975) 3,781 (5,352)
- --------------------------------------------------------------------
Taxes on income before
extraordinary charge 104,500 89,000 81,904
Current tax benefit -
extraordinary charge (4,504)
- --------------------------------------------------------------------
Total taxes on income $104,500 $89,000 $77,400
====================================================================
The above amounts do not include the tax benefit from the exercise of
stock options, which for accounting purposes is credited directly to
additional paid-in capital. Such tax benefits reduced income taxes paid by
$22 million for 1995, $5 million for 1994 and $4 million for 1993.
The temporary differences which created deferred tax assets and
liabilities, included in other assets, and accrued expenses and other, are
detailed below (in thousands):
- -----------------------------------------------------------
At
December 31,
1995 1994
- -----------------------------------------------------------
Deferred Tax Assets:
Deferred compensation $12,078 $ 8,086
Depreciation and amortization 16,564 3,386
Reserves and allowances 10,495 8,321
State and local taxes 2,624 1,325
- -----------------------------------------------------------
Total deferred assets 41,761 21,118
- -----------------------------------------------------------
Deferred Tax Liabilities:
Asset valuation difference (15,912) (7,870)
Other (6,003) (1,534)
- -----------------------------------------------------------
Total deferred liabilities (21,915) (9,404)
- -----------------------------------------------------------
Net deferred tax asset $19,846 $11,714
===========================================================
The Company determined that no valuation allowance against deferred tax
assets at December 31, 1995 and 1994 was necessary.
The effective income tax rate differs from the amount computed by applying
the Federal statutory income tax rate as follows:
- ----------------------------------------------------------------
Year Ended December 31,
1995 1994 1993
- ----------------------------------------------------------------
Federal statutory income tax rate 35.0% 35.0% 35.0%
State income taxes, net of
Federal tax benefit 3.4 4.0 4.5
Other (.7) .7 .2
- ----------------------------------------------------------------
Effective income tax rate 37.7% 39.7% 39.7%
================================================================
Stock Options, Restricted Stock Awards and Performance Units
The Company's stock option plans provide for granting to officers,
directors and other key employees options for the purchase of shares of
common stock at not less than market value on the date of grant, restricted
stock and performance units. Certain options are immediately exercisable
and all options expire within either eight or ten years from the date of
grant. The options and shares acquired upon exercise of each option
generally vest over a four or five-year period from the date of grant of
the option. The Company may repurchase unvested shares related to certain
options at the exercise price from any participant who ceases to be an
employee or director of CSC or any of its subsidiaries. A summary of option
activity follows:
17
- ------------------------------------------------------------------------
Number Option Price
of Shares Per Share
- ------------------------------------------------------------------------
Outstanding at December 31, 1992 15,662,737 $ .19 - 8.11
- ------------------------------------------------------------------------
Granted 1,842,642 6.92 - 11.54
Exercised (1,232,884) .19 - 4.36
Canceled (430,823) 1.44 - 4.36
- ------------------------------------------------------------------------
Outstanding at December 31, 1993 15,841,672 .19 - 11.54
- ------------------------------------------------------------------------
Granted 3,695,108 8.50 - 10.79
Exercised (1,927,718) .19 - 9.21
Canceled (176,190) 1.94 - 11.17
- ------------------------------------------------------------------------
Outstanding at December 31, 1994 17,432,872 .19 - 11.54
- ------------------------------------------------------------------------
Granted 2,628,550 14.46 - 25.63
Exercised (3,858,343) .19 - 11.54
Canceled (755,331) 1.94 - 22.63
- ------------------------------------------------------------------------
Outstanding at December 31, 1995 15,447,748 $ .93 - 25.63
========================================================================
At December 31, 1995, options to purchase 7,039,345 shares were vested,
8,408,403 shares were unvested and 3,929,289 shares were available for
future grants.
In 1995 and 1994, the Company granted 164,200 and 456,000 shares of common
stock, respectively, to certain officers of the Company. The 1995 and 1994
common stock grants had aggregate fair market values of $4 million and
$5 million, respectively, at their grant dates. Shares granted in the 1995
and 1994 stock grants are restricted from sale, and have a five-year
amortization and vesting period. A portion of the 1995 grants vests based
upon the Company achieving certain financial measures.
In 1995 and 1994, the Company granted 302,025 and 896,554 performance
units in tandem with stock options on a one-to-one basis, respectively, to
certain officers and other key employees of the Company. In lieu of
exercising the related stock option, each unit gives the participant the
right to receive cash, based upon the Company achieving a certain level of
annual after-tax net income. For financial statement purposes, the Company
assumes a portion of these units will be redeemed for cash. The units and
options vest over a five-year period.
The Company is required to adopt SFAS No. 123 - Accounting for Stock-Based
Compensation - in 1996. The new standard establishes accounting and
disclosure requirements using a fair value-based method of accounting for
stock-based employee compensation plans. Under the new standard, the
Company may either adopt the new fair value-based accounting method or
continue using the intrinsic value-based method under Accounting Principles
Board Opinion No. 25 and provide pro forma disclosures of net income and
earnings per share as if the accounting provision of the new standard had
been adopted. The Company plans to implement only the disclosure
requirements of the new standard; therefore, such adoption in 1996 will
have no effect on the Company's results of operations, earnings per share
or cash flows.
Employee Benefit Plans
The Company has a profit sharing and employee stock ownership plan (the
Profit Sharing Plan), including a 401(k) salary deferral component, for
eligible employees who have met certain service requirements. The Company
matches certain employee contributions; additional contributions to this
plan are at the discretion of the Company. Total Company contribution
expense was $32 million for 1995, $14 million for 1994 and $16 million for
1993. The increase from 1994 to 1995 was primarily due to changes in the
way in which the Company accounts for the employee stock ownership plan
(ESOP) component of the Profit Sharing Plan (described below).
Commencing January 1, 1994, in connection with the adoption of Statement
of Position No. 93-6 - Employers' Accounting for Employee Stock Ownership
Plans (the Statement), the Company recognizes as expense the fair value of
shares released for allocation to employees through an ESOP. For shares
purchased by the ESOP prior to 1993, the Company recognized as expense the
cost basis of shares released for allocation through the ESOP.
In January 1993, the Profit Sharing Plan borrowed $15 million from the
Company to purchase 2,177,416 newly issued shares of the Company's common
stock. The note receivable from the plan bears interest at 7.9% and is due
in annual installments through 2007. Upon implementation of the Statement,
the note from the plan was reclassified from note receivable to unearned
ESOP shares on the consolidated balance sheet. As the note is repaid,
shares are released for allocation to eligible employees based on the
proportion of debt service paid during the year. In accordance with the
Statement, at December 31, 1995 and 1994, only released ESOP shares were
considered outstanding for earnings per share computations. At December 31,
1993, unreleased ESOP shares were considered outstanding for earnings per
share computations. Dividends on allocated shares and unallocated shares
are charged to retained earnings and compensation and benefits expense,
respectively. Compensation and benefits expense related to shares released
for allocation through the ESOP loan repayments was $2 million in 1995 and
$3 million in 1994, for shares purchased in 1993, and $2 million in 1994,
for shares purchased prior to 1993. ESOP information is as follows:
18
- ----------------------------------------------------------------------------------
Shares Purchased Shares Purchased
in 1993 Prior to 1993
- ----------------------------------------------------------------------------------
Number of shares purchased 2,177,416 4,462,810
Shares released for allocation
prior to 1994 (417,582) (3,505,956)
Shares released for allocation in 1994 (283,167) (956,854)
- ----------------------------------------------------------------------------------
Unreleased shares at December 31, 1994
(fair value: $17,166,242) 1,476,667
- ----------------------------------------------------------------------------------
Shares released for allocation in 1995 (112,474)
- ----------------------------------------------------------------------------------
Unreleased shares at December 31, 1995
(fair value: $27,454,384) 1,364,193
==================================================================================
In January 1991, the Company implemented a four-year cash incentive plan
for certain officers and key employees. Payments under this plan were based
upon achieving a certain level of pre-tax income, as defined, over the four-
year period ended December 31, 1994. Related compensation expense, accrued
as pre-tax income reached certain targeted levels, was $18 million for 1994
and $16 million for 1993.
During 1994, the Company, as the beneficiary, implemented a life insurance
program covering the majority of its employees. Under the program, the cash
surrender value of the insurance policies is recorded net of policy loans
in other assets. At December 31, 1995, policy loans with an interest rate
of 8.96% totaled $80 million. At December 31, 1994, policy loans with an
interest rate of 10.32% totaled $41 million.
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 December 31,
1995, Schwab's net capital was $392 million (10% of aggregate debit
balances), which was $310 million in excess of its minimum required net
capital and $188 million in excess of 5% of aggregate debit balances. At
December 31, 1995, M&S' net capital was $6 million (110% of aggregate debit
balances), which was $5 million in excess of its minimum required net
capital.
Schwab and ShareLink had portions of their cash and investments segregated
for the exclusive benefit of customers at December 31, 1995, in accordance
with applicable regulations. M&S had no such cash reserve requirement at
December 31, 1995.
Commitments and Contingent Liabilities
The Company has noncancelable operating leases for office space and
equipment. Future minimum rental commitments under these leases at
December 31, 1995 are as follows (in thousands):
- ------------------------------------------
1996 $54,996
1997 47,640
1998 35,172
1999 32,798
2000 19,381
Thereafter 49,665
==========================================
Certain leases contain provisions for renewal options and rent escalations
based on increases in certain costs incurred by the lessor. Rent expense
was $79 million for 1995, $64 million for 1994 and $56 million for 1993.
The Company has entered into certain agreements with its Chairman that
provide compensation for employment through March 2000 and for the use of
his name and likeness subsequent to his employment. The employment
agreement includes an automatic renewal feature that, as of each March 31
(beginning in 1996), extends the agreement for an additional year unless
either party elects to not extend the agreement. The agreements can be
terminated only under limited circumstances. Aggregate amounts paid
pursuant to the name and likeness agreement cannot exceed $2 million per
year (subject to adjustment for changes in the cost of living since 1987)
for a maximum of 15 years after compensation under the employment agreement
ceases.
In September 1995, the Company entered into an agreement to purchase for
$32 million an office building located in Phoenix, Arizona to be used for
the expansion of its operations. The Company expects to close this
transaction in April 1996 using general corporate resources or external
financing.
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 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 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
19
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. A second consolidated amended complaint was
filed on August 22, 1995. The consolidated 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 complaint generally alleges an
illegal combination and conspiracy among the defendant market makers to fix
and maintain the spreads between the bid and ask prices of Nasdaq
securities. 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 for which Schwab received monetary payments from the market maker or
stock dealer who executed the transaction. On August 16, 1995, another
class was certified in Civil District Court for the Parish of Natchitoches
in Louisiana for residents of all states who purchased or sold securities
through Schwab since 1985 for which Schwab received monetary payments from
the market maker or other third party who executed the transaction. Schwab
has appealed both class certifications to the Louisiana Court of Appeals.
Schwab has been named as a defendant in nine additional class action
lawsuits filed in state courts in Minnesota, Illinois, New York, Texas,
Florida and California. The class actions were filed between August 12,
1993 and November 17, 1995, and purport to be brought on behalf of
customers of Schwab who purchased or sold securities for which Schwab
received payments from market makers, stock dealers or others who executed
the transaction. The complaints allege that Schwab failed to disclose and
remit such payments to 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 December 31, 1994, 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 for 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, relating to
one Fund, 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 Fund 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.
Financial Instruments with Off-Balance-Sheet and Credit Risk
Through Schwab and M&S, the Company loans securities temporarily to other
brokers in connection with its security lending activities. The Company
receives cash as collateral for the securities loaned. Increases in
security prices may cause the market value of the securities loaned to
exceed the amount of cash received as collateral. In the event the
counterparty to these transactions does not return the loaned securities,
the Company may be exposed to the risk of acquiring the securities at
prevailing market prices in order to satisfy its customer obligations. The
Company mitigates this risk by requiring credit approvals for
counterparties, by monitoring the market value of securities loaned on a
daily basis and by requiring additional cash as collateral when necessary.
The Company is obligated to settle transactions with brokers and other
financial institutions even if its customers fail to meet their obligations
to the Company. Customers are required to complete their transactions on
settlement date, generally three business days after trade date. If
customers do not fulfill their contractual obligations, the Company may
incur losses. The Company has established procedures to reduce this risk by
requiring deposits from customers for certain types of trades.
In the normal course of its margin lending activities, Schwab may be
liable for the margin requirement of customer margin securities
transactions. As customers write option contracts or sell securities short,
the Company may incur losses if the customers do not fulfill their
obligations and the collateral in customer accounts is not sufficient to
fully cover losses which customers may incur from these strategies. To
mitigate this risk, the Company monitors required margin levels daily and
customers are required to deposit additional collateral, or reduce
positions, when necessary.
In its capacity as market maker, M&S maintains inventories in Nasdaq
securities on both a long and short basis. While long inventory positions
represent M&S ownership of securities, short inventory positions represent
obligations of M&S to deliver specified securities at a contracted price,
which may differ from market prices
20
prevailing at the time of completion of the transaction. Accordingly, both long
and short inventory positions may result in losses or gains to M&S as market
values of securities fluctuate. Also, Schwab maintains inventories in
exchange-listed securities on both a long and short basis relating to its
specialist operations and could incur losses or gains as a result of changes
in the market value of these securities. To mitigate the risk of losses, long
and short positions are marked to market daily and are continuously monitored
to assure compliance with limits established by the Company. Additionally,
the Company may purchase exchange-traded option contracts to reduce market
risk on these inventories.
Schwab enters into collateralized Resale Agreements principally with other
broker-dealers which could result in losses in the event the counterparty
to the transaction does not purchase the securities held as collateral for
the cash advanced and the market value of these securities declines. To
mitigate this risk, Schwab requires that the counterparty deliver to a
custodian securities to be held as collateral with a market value in excess
of the resale price. Schwab also sets standards for the credit quality of
the counterparty. Schwab also monitors the market value of the underlying
securities as compared to the related receivable, including accrued
interest, and requires additional collateral where deemed appropriate.
Supplemental Cash Flow Information
- ------------------------------------------------------------------------------
Year Ended December 31,
(in thousands) 1995 1994 1993
- ------------------------------------------------------------------------------
Cash paid during the year for:
Income taxes $ 98,444 $ 75,530 $ 86,453
==============================================================================
Interest:
Customers $319,645 $176,487 $114,606
Borrowings 11,131 11,632 13,584
Other 18,939 7,422 4,400
- ------------------------------------------------------------------------------
Total interest $349,715 $195,541 $132,590
==============================================================================
Noncash investing and financing activity:
Common stock issued to Profit
Sharing Plan for a note receivable $15,000
==============================================================================
Businesses acquired:
Assets acquired $219,457
Liabilities assumed (138,204)
Loan notes issued (5,484)
- ------------------------------------------------------------------------------
Cash payments 75,769
Cash received (7,525)
- ------------------------------------------------------------------------------
Cash payments, net of cash received $ 68,244
==============================================================================
21
Management's Report
To Our Stockholders:
Management of the Company is responsible for the preparation, integrity
and objectivity of the consolidated financial statements and the other
financial information presented in this report. To meet these
responsibilities we maintain a system of internal control that is designed
to provide reasonable assurance as to the integrity and reliability of the
financial statements, the protection of Company and customer assets from
unauthorized use, and the execution and recording of transactions in
accordance with management's authorization. The system is augmented by
careful selection of our managers, by organizational arrangements that
provide an appropriate division of responsibility and by communications
programs aimed at assuring that employees adhere to the highest standards
of personal and professional integrity. The Company's internal audit
function monitors and reports on the adequacy of and compliance with our
internal controls, policies and procedures. Although no cost-effective
internal control system will preclude all errors and irregularities, we
believe the Company's system of internal control is adequate to accomplish
the objectives set forth above.
The consolidated financial statements have been prepared in conformity
with generally accepted accounting principles and necessarily include some
amounts that are based on estimates and our best judgments. The financial
statements have been audited by the independent accounting firm of Deloitte
& Touche LLP, whose audit included consideration of the internal control
structure to the extent necessary to render their opinion on the financial
statements. We made available to Deloitte & Touche LLP all the Company's
financial records and related data. We believe that all representations
made to Deloitte & Touche LLP during their audit were valid and
appropriate.
The Board of Directors through its Audit Committee, which is comprised
entirely of nonmanagement directors, has an oversight role in the area of
financial reporting and internal control. The Audit Committee periodically
meets with Deloitte & Touche LLP, our internal auditors and Company
management to review accounting, auditing, internal control and financial
reporting matters.
Charles R. Schwab
Chairman of the Board and Chief Executive Officer
A. John Gambs
Executive Vice President and Chief Financial Officer
Independent Auditors' Report
To the Stockholders and Board of Directors
of The Charles Schwab Corporation:
We have audited the accompanying consolidated balance sheets of The
Charles Schwab Corporation and subsidiaries (the Company) as of
December 31, 1995 and 1994, and the related consolidated statements of
income, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of The Charles Schwab
Corporation and subsidiaries at December 31, 1995 and 1994, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1995 in conformity with generally accepted
accounting principles.
DELOITTE & TOUCHE LLP
San Francisco, California
February 21, 1996
22
THE CHARLES SCHWAB CORPORATION
Chart Appendix List
In this appendix, the following descriptions of certain charts in portions
of the Company's 1995 Annual Report to Stockholders that are omitted from the
EDGAR Version are more specific with respect to the actual numbers, amounts
and percentages than is determinable from the charts themselves. The Company
submits more specific descriptions only for the purpose of complying with the
requirements for transmitting portions of this Annual Report on Form 10-K
electronically via EDGAR; such more specific descriptions are not intended in
any way to provide information that is additional to the information otherwise
provided in portions of the Company's 1995 Annual Report to Stockholders.
EDGAR
Version
Page
Number CHART DESCRIPTION
- ------ -----------------
3 Bar chart titled "Active Schwab Customer Accounts" depicting the number
of active Schwab customer accounts at year end 1991, 1992, 1993, 1994 and
1995 (shown on the bottom axis) as follows (millions of accounts) (bar
labeled): 1.6, 2.0, 2.5, 3.0 and 3.4, respectively.
3 Stacked bar chart titled "Assets in Schwab Customer Accounts" depicting
the composition of assets in Schwab customer accounts at year end 1991,
1992, 1993, 1994 and 1995 (shown on the bottom axis) as follows
(billions of dollars): Cash and Equivalents $12.6, $15.6, $20.1, $28.6
and $37.9, respectively; Stocks (net of margin loans) $22.1, $29.6,
$39.5, $46.1 and $71.6, respectively; Mutual Fund Marketplace
(registered trademark) $6.4, $12.2, $26.2, $32.2 and $52.0,
respectively; Fixed Income Securities $6.4, $8.2, $10.0, $15.7 and
$20.2, respectively; Assets in Schwab Customer Accounts (bar labeled)
$47.5, $65.6, $95.8 and $122.6 and $181.7, respectively.
3 Bar chart titled "Revenues" depicting the revenues for the fiscal years
1991, 1992, 1993, 1994 and 1995 (shown on the bottom axis) as follows
(millions of dollars) (bar labeled): $570, $750, $965, $1,065 and
$1,420, respectively.
4 Stacked bar chart titled "Schwab Customers' Daily Average Trading
Volume" depicting the composition of Schwab customers' daily average
trading volume for the fiscal years 1991, 1992, 1993, 1994 and 1995
(shown on the bottom axis) as follows (thousands of trades):
Commission and Other Trades 17.6, 22.2, 27.9, 29.2 and 38.3,
respectively; Mutual Fund OneSource (registered trademark) Trades .3,
1.4, 7.4, 14.3 and 18.0, respectively; Schwab Customers' Daily Average
Trading Volume (bar labeled) 17.9, 23.6, 35.3, 43.5 and 56.3,
respectively.
4 Bar chart titled "Net Income" depicting the net income for the fiscal
years 1993, 1994 and 1995 (shown on the bottom axis) as follows
(millions of dollars) (bar labeled): $118, $135 and $173,
respectively.
4 Pie chart titled "Composition of Revenues" depicting the composition of
revenues (percent of total) for the fiscal years 1993, 1994 and 1995
as follows: Commissions 57%, 51% and 53%, respectively; Mutual Fund
Service Fees 10%, 15% and 15%, respectively; Net Interest Revenue 12%,
15% and 15%, respectively; Principal Transactions 18%, 15% and 13%,
respectively; Other 3%, 4% and 4%, respectively.
4 Stacked bar chart titled "Commissions" depicting the composition of
commissions for the fiscal years 1993, 1994 and 1995 (shown on the
bottom axis) as follows (millions of dollars): Listed $299, $278 and
$356, respectively; Nasdaq $169, $169 and $283, respectively; Options
$37, $39 and $53, respectively; Other $47, $60 and $58, respectively;
Commissions (bar labeled) $552, $546 and $751, respectively.
6 Pie chart titled "Expenses Excluding Interest" depicting the
composition of expenses excluding interest (percent of total) for the
fiscal years 1993, 1994 and 1995 as follows: Compensation and Benefits
52%, 52% and 52%, respectively; Communications 12%, 13% and 11%,
respectively; Occupancy and Equipment 10%, 10% and 10%, respectively;
Commissions, Clearance and Floor Brokerage 6%, 6% and 7%, respectively;
Other 20%, 19% and 20%, respectively.
7 Stacked bar chart titled "Compensation and Benefits" depicting the
composition of compensation and benefits for the fiscal years 1993,
1994 and 1995 (shown on the bottom axis) as follows (millions of
dollars): Salaries and Wages $225, $273 and $355, respectively;
Variable Compensation $108, $101 and $144, respectively; Other Benefits
$60, $63 and $95, respectively; Compensation and Benefits (bar labeled)
$393, $437 and $594, respectively.
9 Bar chart titled "Net Income Plus Depreciation and Amortization"
depicting the net income plus depreciation and amortization for the
fiscal years 1993, 1994 and 1995 (shown on the bottom axis) as follows
(millions of dollars) (bar labeled): $162, $190 and $241,
respectively.
9 Bar chart titled "Dividends Declared Per Common Share" depicting the
dividends declared per common share for the fiscal years 1993, 1994
and 1995 (shown on the bottom axis) as follows (bar labeled): $.064,
$.092 and $.140, respectively.