UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1999 Commission file number 1-9700
THE CHARLES SCHWAB CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 94-3025021
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
120 Kearny Street, San Francisco, CA 94108
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (415) 627-7000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes x No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
819,968,787* shares of $.01 par value Common Stock
Outstanding on October 29, 1999
* Reflects the July 1999 two-for-one common stock split.
THE CHARLES SCHWAB CORPORATION
Quarterly Report on Form 10-Q
For the Quarter Ended September 30, 1999
Index
Page
Part I - Financial Information
Item 1. Condensed Consolidated Financial Statements:
Statement of Income 1
Balance Sheet 2
Statement of Cash Flows 3
Notes 4-6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 7-22
Item 3. Quantitative and Qualitative Disclosures About Market
Risk 22-23
Part II - Other Information
Item 1. Legal Proceedings 24
Item 2. Changes in Securities and Use of Proceeds 24
Item 3. Defaults Upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8-K 24
Signature 25
FORWARD-LOOKING STATEMENTS In addition to historical information, this interim
report contains forward-looking statements that reflect management's
expectations. These statements relate to, among other things, contingent
liabilities, strategy, Internet trade pricing for independent investment
managers, sources of liquidity, capital expenditures, and the Year 2000 project.
Achievement of the expressed expectations is subject to certain risks and
uncertainties that could cause actual results to differ materially from those
expectations. See "Forward-Looking Statements" in Management's Discussion and
Analysis of Financial Condition and Results of Operations in this interim report
for a discussion of important factors that may cause such differences.
THE CHARLES SCHWAB CORPORATION
Part 1 - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
1999 1998 1999 1998
---- ---- ---- ----
Revenues
Commissions $ 383,826 $ 337,031 $1,320,695 $ 934,208
Mutual fund service fees 192,903 143,977 541,770 405,719
Interest revenue, net of interest expense (1) 182,325 124,346 499,983 345,214
Principal transactions 92,905 74,823 361,053 186,559
Other 31,728 25,094 93,873 75,937
- -----------------------------------------------------------------------------------------------------------------
Total 883,687 705,271 2,817,374 1,947,637
- -----------------------------------------------------------------------------------------------------------------
Expenses Excluding Interest
Compensation and benefits 368,610 290,684 1,162,461 835,370
Communications 60,609 53,449 196,684 153,519
Occupancy and equipment 69,082 50,796 190,877 147,502
Advertising and market development 57,716 34,009 164,790 101,726
Depreciation and amortization 40,014 35,175 111,301 104,625
Professional services 40,259 22,240 108,963 63,720
Commissions, clearance and floor brokerage 21,336 20,379 70,225 60,237
Other 22,212 36,040 122,553 80,224
- -----------------------------------------------------------------------------------------------------------------
Total 679,838 542,772 2,127,854 1,546,923
- -----------------------------------------------------------------------------------------------------------------
Income before taxes on income 203,849 162,499 689,520 400,714
Taxes on income 79,270 64,727 271,083 158,622
- -----------------------------------------------------------------------------------------------------------------
Net Income $ 124,579 $ 97,772 $ 418,437 $ 242,092
=================================================================================================================
Weighted-average common shares outstanding - diluted (2) 844,466 820,379 842,875 821,418
=================================================================================================================
Earnings Per Share (2)
Basic $ .16 $ .13 $ .52 $ .31
Diluted $ .15 $ .12 $ .50 $ .30
=================================================================================================================
Dividends Declared Per Common Share (2) $ .0140 $ .0134 $ .0420 $ .0400
=================================================================================================================
(1) Interest expense for the three months ended September 30, 1999 and 1998 was $193,961 and $166,780, respectively.
Interest expense for the nine months ended September 30, 1999 and 1998 was $543,602 and $483,018, respectively.
(2) Reflects the July 1999 two-for-one common stock split.
See Notes to Condensed Consolidated Financial Statements.
THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(In thousands, except per share amounts)
(Unaudited)
September 30, December 31,
1999 1998
---- ----
Assets
Cash and cash equivalents $ 1,632,556 $ 1,155,928
Cash and investments required to be segregated under federal or other
regulations (including resale agreements of $7,305,800 in 1999
and $7,608,067 in 1998) 8,406,914 10,242,943
Receivable from brokers, dealers and clearing organizations 409,817 334,334
Receivable from customers - net 13,570,948 9,646,140
Securities owned - at market value 303,980 242,115
Equipment, office facilities and property - net 532,145 396,163
Intangible assets - net 46,097 46,274
Other assets 185,565 200,493
- ---------------------------------------------------------------------------------------------------------------
Total $25,088,022 $22,264,390
===============================================================================================================
Liabilities and Stockholders' Equity
Drafts payable $ 215,793 $ 324,597
Payable to brokers, dealers and clearing organizations 1,262,107 1,422,300
Payable to customers 20,363,468 18,119,622
Accrued expenses and other liabilities 725,848 618,249
Borrowings 465,012 351,000
- ---------------------------------------------------------------------------------------------------------------
Total liabilities 23,032,228 20,835,768
- ---------------------------------------------------------------------------------------------------------------
Stockholders' equity:
Preferred stock - 9,940 shares authorized; $.01 par value
per share; none issued
Common stock - 2,000,000 and 500,000 shares authorized in 1999
and 1998, respectively; $.01 par value per share; 819,616 and 803,765
shares issued and outstanding in 1999 and 1998, respectively* 8,196 4,019
Additional paid-in capital 488,258 213,312
Retained earnings 1,635,272 1,254,953
Unearned ESOP shares (981) (1,088)
Unamortized restricted stock compensation (76,026) (43,882)
Foreign currency translation adjustment 1,075 1,308
- ---------------------------------------------------------------------------------------------------------------
Total stockholders' equity 2,055,794 1,428,622
- ---------------------------------------------------------------------------------------------------------------
Total $25,088,022 $22,264,390
===============================================================================================================
* Shares issued and outstanding reflect the July 1999 two-for-one common stock split.
See Notes to Condensed Consolidated Financial Statements.
THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended
September 30,
1999 1998
---- ----
Cash flows from operating activities
Net income $ 418,437 $ 242,092
Noncash items included in net income:
Depreciation and amortization 111,301 104,625
Compensation payable in common stock 21,419 27,797
Deferred income taxes 10,407 16,362
Other 5,742 2,757
Change in securities owned (61,865) 70,031
Change in other assets 4,513 58,488
Change in accrued expenses and other liabilities 283,389 58,463
- ------------------------------------------------------------------------------------------------------
Net cash provided before change in customer-related balances 793,343 580,615
- ------------------------------------------------------------------------------------------------------
Change in customer-related balances:
Cash and investments required to be segregated under
federal or other regulations 1,834,530 (979,845)
Receivable from brokers, dealers and clearing organizations (76,671) (60,529)
Receivable from customers (3,930,185) (1,187,221)
Drafts payable (108,183) (83,084)
Payable to brokers, dealers and clearing organizations (161,000) 38,012
Payable to customers 2,247,163 2,227,345
- ------------------------------------------------------------------------------------------------------
Net change in customer-related balances (194,346) (45,322)
- ------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 598,997 535,293
- ------------------------------------------------------------------------------------------------------
Cash flows from investing activities
Purchase of equipment, office facilities and property - net (194,409) (144,842)
Costs of internal-use software (46,440)
Cash payments for business acquired, net of cash received (5,657)
Cash value received on life insurance policies 65,324
- ------------------------------------------------------------------------------------------------------
Net cash used by investing activities (181,182) (144,842)
- ------------------------------------------------------------------------------------------------------
Cash flows from financing activities
Repayments of loans on life insurance policies (65,321)
Proceeds from borrowings 144,000 30,000
Repayment from borrowings (30,068) (40,047)
Dividends paid (34,063) (31,925)
Purchase of treasury stock (147,884)
Proceeds from stock options exercised and other 45,175 22,268
- ------------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities 59,723 (167,588)
- ------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents (910) 662
- ------------------------------------------------------------------------------------------------------
Increase in cash and cash equivalents 476,628 223,525
Cash and cash equivalents at beginning of period 1,155,928 797,447
- ------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $1,632,556 $1,020,972
======================================================================================================
See Notes to Condensed Consolidated Financial Statements.
THE CHARLES SCHWAB CORPORATION
NOTES TO CONDENSED
CONSOLIDATED FINANCIAL
STATEMENTS
(Unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
include The Charles Schwab Corporation (CSC) and its subsidiaries (collectively
referred to as the Company). CSC is a holding company engaged, through its
subsidiaries, in securities brokerage and related financial services. CSC's
principal subsidiary, Charles Schwab & Co., Inc. (Schwab), is a securities
broker-dealer with 319 domestic branch offices in 47 states, as well as branches
in the Commonwealth of Puerto Rico and the U.S. Virgin Islands. Another
subsidiary, Charles Schwab Europe (CSE) is a retail securities brokerage firm
located in the United Kingdom. Other subsidiaries include Charles Schwab
Investment Management, Inc., the investment advisor for Schwab's proprietary
mutual funds, and Mayer & Schweitzer, Inc. (M&S), a market maker in Nasdaq and
other securities providing trade execution services to broker-dealers and
institutional customers.
These financial statements have been prepared pursuant to the rules and
regulations of the Securities and Exchange Commission (SEC) and, in the opinion
of management, reflect all adjustments necessary to present fairly the financial
position, results of operations and cash flows for the periods presented in
conformity with generally accepted accounting principles. All adjustments were
of a normal recurring nature. All material intercompany balances and
transactions have been eliminated. These financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's 1998 Annual Report to Stockholders, which are
incorporated by reference in the Company's 1998 Annual Report on Form 10-K and
the Company's Quarterly Reports on Form 10-Q for the periods ended March 31,
1999 and June 30, 1999. The Company's results for any interim period are not
necessarily indicative of results for a full year.
Certain items in prior periods' financial statements have been
reclassified to conform to the 1999 presentation.
2. New Accounting Standard
Statement of Financial Accounting Standards (SFAS) No. 137 - Accounting for
Derivative Instruments and Hedging Activities - Deferral of the Effective Date
of FASB Statement No. 133 - An Amendment of FASB Statement No. 133, was issued
in June 1999 and amends the effective date of SFAS No. 133. The Company is
required to adopt SFAS No. 133 by January 1, 2001. This statement establishes
accounting and reporting standards requiring that every derivative instrument be
recorded on the balance sheet as either an asset or liability, measured at its
fair value. The statement requires that changes in the derivative's fair value
be recognized currently in earnings unless specific hedge accounting criteria
are met and such hedge accounting treatment is elected. While the Company is
currently evaluating the effects of this statement, its adoption is not expected
to have a material impact on the Company's financial position, results of
operations, earnings per share or cash flows.
3. Costs of Internal-Use Software
Statement of Position 98-1 - Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use, was adopted by the Company effective
January 1, 1999. This statement requires that certain costs incurred for
purchasing or developing software for internal use be capitalized and amortized
over the software's estimated useful life of three years. In prior periods, the
Company capitalized costs incurred for purchasing internal-use software, but
expensed costs incurred for developing internal-use software. In accordance with
this statement, prior periods' financial statements were not adjusted to reflect
this accounting change. Adoption of this statement resulted in the
capitalization of $19 million of internal-use software development costs during
the third quarter of 1999, which increased net income by $12 million (net of
income taxes of $7 million), or $.01 diluted earnings per share. Adoption of
this statement resulted in the capitalization of $46 million of internal-use
software development costs during the first nine months of 1999, which increased
net income by $28 million (net of income taxes of $18 million), or $.03 diluted
earnings per share.
4. Comprehensive Income
SFAS No. 130 - Reporting Comprehensive Income, establishes standards for
the reporting and display of comprehensive income, which includes net income and
changes in equity except those resulting from investments by, or distributions
to, stockholders. Comprehensive income is as follows (in thousands):
- --------------------------------------------------------------------------------
Three Nine
Months Ended Months Ended
September 30, September 30,
1999 1998 1999 1998
- --------------------------------------------------------------------------------
Net income $124,579 $ 97,772 $418,437 $242,092
Foreign currency translation adjustment 2,119 898 (233) 1,496
- --------------------------------------------------------------------------------
Total comprehensive income $126,698 $ 98,670 $418,204 $243,588
================================================================================
5. Earnings Per Share
SFAS No. 128 - Earnings Per Share, requires a dual presentation of basic
and diluted earnings per share (EPS). Basic EPS excludes dilution and is
computed by dividing net income by the weighted-average number of common shares
outstanding for the period. Diluted EPS reflects the potential reduction in EPS
that could occur if securities or other contracts to issue common stock were
exercised or converted into common stock. Earnings per share under the basic and
diluted computations are as follows (in thousands, except per share amounts):
- --------------------------------------------------------------------------------
Three Nine
Months Ended Months Ended
September 30, September 30,
1999 1998 1999 1998
- --------------------------------------------------------------------------------
Net income $124,579 $ 97,772 $418,437 $242,092
================================================================================
Weighted-average common shares
outstanding - basic (1) 812,016 793,687 808,504 793,162
Common stock equivalent shares
related to stock incentive plans (1) 32,450 26,692 34,371 28,256
- --------------------------------------------------------------------------------
Weighted-average common shares
outstanding - diluted (1) 844,466 820,379 842,875 821,418
================================================================================
Basic EPS (1) $ .16 $ .13 $ .52 $ .31
================================================================================
Diluted EPS (1) $ .15 $ .12 $ .50 $ .30
================================================================================
(1) Reflects the July 1999 two-for-one common stock split.
The computation of diluted EPS for the nine months ended September 30,
1999 and 1998, respectively, excludes stock options to purchase 5,040,000 and
20,495,000 shares, respectively, because the exercise prices for those options
were greater than the average market price of the common shares, and therefore
the effect would be antidilutive.
6. Regulatory Requirements
Schwab and M&S are subject to the Uniform Net Capital Rule under the
Securities Exchange Act of 1934 (the 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 September 30, 1999, Schwab's
net capital was $1,400 million (10% of aggregate debit balances), which was
$1,130 million in excess of its minimum required net capital and $725 million in
excess of 5% of aggregate debit balances. At September 30, 1999, M&S' net
capital was $12 million, which was $11 million in excess of its minimum required
net capital.
Schwab and CSE had portions of their cash and investments segregated for
the exclusive benefit of customers at September 30, 1999, in accordance with
applicable regulations. M&S had no such cash reserve requirement at September
30, 1999.
7. Commitments and Contingent Liabilities
The nature of the Company's business subjects it to numerous regulatory
investigations, claims, lawsuits and other proceedings in the ordinary course of
its business. The results of these legal proceedings cannot be predicted with
certainty. There can be no assurance that these matters will not have a material
adverse effect on the Company's results of operations in any future period,
depending partly on the results for that period, and a substantial judgment
could have a material adverse impact on the Company's financial condition.
However, it is the opinion of management, after consultation with outside legal
counsel, that the ultimate outcome of the current matters will not have a
material adverse impact on the financial condition or operating results of the
Company.
8. Segment Information
Under SFAS No. 131 - Disclosures about Segments of an Enterprise and
Related Information, the Company structures its segments according to its
various types of customers and the services provided to those customers. These
segments have been aggregated, based on similarities in economic
characteristics, types of customers, services provided, distribution channels
and regulatory environment, into three reportable segments - Individual
Investor, Institutional Investor and Capital Markets.
Financial information for the Company's reportable segments is presented
in the table below (in thousands). Intersegment revenues are immaterial and are
therefore not disclosed. Total revenues and income before taxes on income are
equal to the Company's consolidated amounts as reported in the condensed
consolidated statement of income.
- --------------------------------------------------------------------------------
Three Nine
Months Ended Months Ended
September 30, September 30,
1999 1998 1999 1998
- --------------------------------------------------------------------------------
Revenues
Individual Investor $629,130 $499,133 $1,979,397 $1,401,660
Institutional Investor 148,988 117,324 436,259 322,353
Capital Markets 105,569 88,814 401,718 223,624
- --------------------------------------------------------------------------------
Total $883,687 $705,271 $2,817,374 $1,947,637
================================================================================
Income Before Taxes on Income
Individual Investor $146,166 $124,478 $ 488,185 $ 315,245
Institutional Investor 42,409 32,797 116,376 83,995
Capital Markets 15,274 5,224 84,959 1,474
- --------------------------------------------------------------------------------
Total $203,849 $162,499 $ 689,520 $ 400,714
================================================================================
9. Supplemental Cash Flow Information
Certain information affecting the cash flows of the Company follows (in
thousands):
- --------------------------------------------------------------------------------
Nine Months Ended
September 30,
1999 1998
- --------------------------------------------------------------------------------
Income taxes paid $101,860 $ 98,382
================================================================================
Interest paid:
Customer cash balances $486,048 $427,595
Stock-lending activities 23,646 30,039
Borrowings 24,858 24,024
Other 13,049 7,899
- --------------------------------------------------------------------------------
Total interest paid $547,601 $489,557
================================================================================
THE CHARLES SCHWAB CORPORATION
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Description of Business
The Charles Schwab Corporation (CSC) and its subsidiaries (collectively
referred to as the Company) provide securities brokerage and related financial
services for 6.3 million active customer accounts(a). Customer assets in these
accounts totaled $595.0 billion at September 30, 1999. CSC's principal
subsidiary, Charles Schwab & Co., Inc. (Schwab), is a securities broker-dealer
with 319 domestic branch offices in 47 states, as well as branches in the
Commonwealth of Puerto Rico and the U.S. Virgin Islands. Another subsidiary,
Charles Schwab Europe (CSE), is a retail securities brokerage firm located in
the United Kingdom. Other subsidiaries include Charles Schwab Investment
Management, Inc., the investment advisor for Schwab's proprietary mutual funds,
and Mayer & Schweitzer, Inc. (M&S), a market maker in Nasdaq and other
securities providing trade execution services to broker-dealers and
institutional customers.
- --------
(a) Accounts with balances or activity within the preceding eight months.
The Company provides financial services to individuals, institutional
customers and broker-dealers through three segments - Individual Investor,
Institutional Investor and Capital Markets. The Individual Investor segment
includes the Company's domestic and international retail operations. The
Institutional Investor segment provides custodial, trading and support services
to independent investment managers, and serves company 401(k) plan sponsors and
third-party administrators. The Capital Markets segment provides trade execution
services in Nasdaq, exchange-listed and other securities primarily to
broker-dealers and institutional customers. The Company's mutual fund services
are considered a product and not a segment. Mutual fund service fees are
included in both the Individual Investor and Institutional Investor segments.
The Company's strategy is to attract and retain customer assets by
focusing on a number of areas within the financial services industry - retail
brokerage, mutual funds, support services for independent investment managers,
401(k) defined contribution plans and equity securities market-making.
To pursue its strategy and its objective of long-term profitable growth,
the Company plans to continue to leverage its competitive advantages. These
advantages include a nationally recognized brand, a broad range of products and
services, multi-channel delivery systems and an ongoing investment in
technology.
The Company's nationwide advertising and marketing programs are designed
to strengthen the Schwab brand, as well as distinguish its products and
services. The Company primarily uses a combination of network, cable and local
television, print media, national and local radio, and athletic event
sponsorship in its advertising to investors. These programs helped the Company
attract $24.6 billion in net new customer assets and open 282,000 new accounts
during the third quarter of 1999.
The Company offers a broad range of value-oriented products and services
to meet customers' varying investment and financial needs, including access to
extensive investment research, news and information. The Company's registered
representatives can assist investors in developing asset allocation strategies
and evaluating their investment choices, and refer investors who desire
additional guidance to independent investment managers through the Schwab
AdvisorSource(TM) service. The Company's Mutual Fund Marketplace(R) provides
customers with the ability to invest in 1,851 mutual funds from 303 fund
families, including 1,127 Mutual Fund OneSource(R) funds. Schwab also provides
custodial, trading and support services to approximately 5,700 independent
investment managers. As of September 30, 1999, these managers were guiding the
investments of 808,000 Schwab customer accounts containing $180.3 billion in
assets.
The Company responds to changing customer needs with continued product,
technology and service innovations. During the third quarter of 1999, Schwab
launched an online trading system, Velocity(TM), to provide enhanced trade
information and order execution for more active customers. Also during the third
quarter of 1999, in an effort to provide all customers with more convenient and
efficient service, Schwab enabled customers to open a new account, update
contact information, sign up for the Schwab MoneyLink(R) service and request a
check entirely through Web-based automated processes. Additionally, customers
can now access multiple Schwab accounts using a single sign-on. Further, during
the third quarter of 1999 the Company signed an agreement with Donaldson, Lufkin
& Jenrette, Inc., Fidelity Global Brokerage Group, Inc., and Spear, Leeds &
Kellogg LP to form a new company which will utilize the existing technology of
REDIBook ECN LLC's electronic communications network (ECN). This new company
intends to rely on the ECN's limit order matching capabilities and the partners'
order flow to provide customers with a separate after-hours trading session for
most Nasdaq and certain exchange-listed stocks.
The Company's multi-channel delivery systems allow customers to choose how
they prefer to do business with the Company. To enable customers to obtain
services in person with a Company representative, the Company maintains a
network of branch offices. The Company's branch office network also provides
investors with access to the Internet. Telephonic access to the Company is
provided primarily through four regional customer telephone service centers and
two online customer support centers that operate both during and after normal
market hours. Additionally, customers are able to obtain financial information
on an automated basis through the Company's automated telephonic and online
channels. Automated telephonic channels include TeleBroker(R), Schwab's
touch-tone telephone quote and trading service, and VoiceBroker(TM), Schwab's
voice recognition quote and trading service. Online channels include the Charles
Schwab Web Site(TM), an information and trading service on the Internet at
www.schwab.com, and PC-based services such as SchwabLink(R), a service for
investment managers. Schwab provides every retail customer access to all
delivery channels and flat-fee pricing for Internet-based trades. During the
third quarter of 1999, Schwab announced a plan to provide independent investment
managers with enhanced services, including a new Schwab Institutional website
and flat-fee pricing for online trades.
The Company's ongoing investment in technology is a key element in
expanding its product and service offerings, enhancing its delivery systems,
providing fast and consistent customer service, reducing processing costs, and
facilitating the Company's ability to handle significant increases in customer
activity without a corresponding rise in staffing levels. The Company uses
technology to empower its customers to manage their financial affairs and is a
leader in driving technological advancements in the financial services industry.
In July 1999, the Company entered into a joint venture agreement with The
Tokio Marine and Fire Insurance Co., Limited (TMI) and certain of its affiliates
(collectively, the TMI Group). The Company and each member of the TMI Group are
shareholders in a Japanese corporation, Schwab Tokio Marine Securities Co., Ltd.
(STMS), in which the Company has a 50% equity interest. STMS, whose business is
expected to commence in the first quarter of 2000, will provide retail brokerage
and investment services in U.S. dollar-denominated securities to residents of
Japan. STMS is currently expected to offer Japanese Yen-denominated securities
later in 2000. In the fourth quarter of 1999, pursuant to the joint venture
agreement, the Company will make an initial capital contribution of 3.0 billion
Yen, or approximately $27 million. The Company may, under certain circumstances,
be required to make additional capital contributions pursuant to the joint
venture agreements, including contributions to assure that STMS is in compliance
with regulatory requirements regarding capital adequacy.
Risk Management
For discussion on the Company's principal risks and some of the policies
and procedures for risk identification, assessment and mitigation, see
"Management's Discussion and Analysis of Results of Operations and Financial
Condition - Risk Management" in the Company's 1998 Annual Report to
Stockholders, which is filed as Exhibit 13.1 to the Company's Form 10-K for the
year ended December 31, 1998. See Liquidity and Capital Resources of this report
for a discussion on liquidity risk; and see Item 3 - Quantitative and
Qualitative Disclosures About Market Risk for additional information relating to
market risk.
Given the nature of the Company's revenues, expenses and risk profile, the
Company's earnings and common stock price may be subject to significant
volatility from period to period. The Company's results for any interim period
are not necessarily indicative of results for a full year. Risk is inherent in
the Company's business. Consequently, despite the Company's attempts to identify
areas of risk, oversee operational areas involving risk and implement policies
and procedures designed to mitigate risk, there can be no assurance that the
Company will not suffer unexpected losses due to operating or other risks.
Forward-Looking Statements
In addition to historical information, this interim report contains
forward-looking statements that reflect management's expectations as of the date
hereof. These statements relate to, among other things, contingent liabilities
(see note "7 - Commitments and Contingent Liabilities" in the Notes to Condensed
Consolidated Financial Statements), the Company's strategy (see Description of
Business), Internet trade pricing for independent investment managers (see
Revenues-Commissions), sources of liquidity (see Liquidity and Capital
Resources-Liquidity), capital expenditures (see Liquidity and Capital
Resources-Cash Flows and Capital Resources), and the Year 2000 project (see
Liquidity and Capital Resources-Year 2000). Achievement of the expressed
expectations is subject to certain risks and uncertainties that could cause
actual results to differ materially from the expressed expectations described in
these statements. Important factors that may cause such differences are noted in
this interim report, the Company's 1998 Annual Report to Stockholders and the
Company's Form 10-K for the year ended December 31, 1998 and include, but are
not limited to: the effect of customer trading patterns on Company revenues and
earnings; changes in the Company's level of personnel hiring, investment in new
or existing technology, or utilization of public media for advertising; changes
in technology; computer system failures; risks and uncertainties associated with
the Company's, its vendors', and other third parties' Year 2000 computer systems
compliance; the effects of competitors' pricing, product and service decisions
and intensified competition; evolving regulation and changing industry practices
adversely affecting the Company; adverse results of litigation; the availability
of external financing; changes in revenues and profit margin due to cyclical
securities markets and interest rates; the level and volatility of equity
prices; and a significant downturn in the securities markets over a short period
of time or a sustained decline in securities prices and trading volumes.
Three Months Ended September 30, 1999
Compared To Three Months Ended September 30, 1998
Financial Overview
Net income for the third quarter of 1999 was $125 million, up 27% from
third quarter 1998 net income of $98 million. Diluted earnings per share for the
third quarters of 1999 and 1998 were $.15 and $.12 per share, respectively.
Share and per share data throughout this report have been restated to reflect
the effects of the July 1999 two-for-one common stock split.
Revenues increased mainly due to higher customer trading volume and an
increase in customer assets. Revenues of $884 million in the third quarter of
1999 grew $178 million, or 25%, from the third quarter of 1998 due to increases
in revenues of $130 million, or 26%, in the Individual Investor segment, $32
million, or 27%, in the Institutional Investor segment, and $16 million, or 19%,
in the Capital Markets segment. See note "8 - Segment Information" in the Notes
to Condensed Consolidated Financial Statements for financial information by
segment.
The Company's trading activity is shown in the following table (in
thousands):
- --------------------------------------------------------------------------------
Three Months
Ended
September 30, Percent
Daily Average Trades 1999 1998 Change
- --------------------------------------------------------------------------------
Revenue Trades
Online 97.7 58.1 68%
TeleBroker(R)and VoiceBroker(TM) 6.5 8.1 (20)
Regional customer telephone
service centers, branch offices
and other 30.9 33.4 (7)
- --------------------------------------------------------------------------------
Total 135.1 99.6 36%
================================================================================
Mutual Fund OneSource(R) Trades
Online 20.1 18.8 7%
TeleBroker and VoiceBroker .9 1.1 (18)
Regional customer telephone
service centers, branch offices
and other 19.3 22.4 (14)
- --------------------------------------------------------------------------------
Total 40.3 42.3 (5%)
================================================================================
Total Daily Average Trades
Online 117.8 76.9 53%
TeleBroker and VoiceBroker 7.4 9.2 (20)
Regional customer telephone
service centers, branch offices
and other 50.2 55.8 (10)
- --------------------------------------------------------------------------------
Total 175.4 141.9 24%
================================================================================
Assets in Schwab customer accounts were $595.0 billion at September 30,
1999, an increase of $186.8 billion, or 46%, from a year ago as shown in the
table below. This increase from September 30, 1998 resulted from net new
customer assets of $96.1 billion and net market gains of $90.7 billion.
- --------------------------------------------------------------------------------
Growth in Schwab Customer
Assets and Accounts
(In billions, at quarter end, September 30, Percent
except as noted) 1999 1998 Change
- --------------------------------------------------------------------------------
Assets in Schwab customer accounts
Schwab One(R) and other cash equivalents $ 20.1 $ 14.7 37%
SchwabFunds(R):
Money market funds 82.3 63.0 31
Equity and bond funds 18.9 11.0 72
- --------------------------------------------------------------------------------
Total SchwabFunds 101.2 74.0 37
- --------------------------------------------------------------------------------
Mutual Fund Marketplace(R)(1):
Mutual Fund OneSource(R)
Retail 41.7 31.5 32
Schwab Institutional(TM)(2) 36.6 27.5 33
- --------------------------------------------------------------------------------
Total Mutual Fund OneSource 78.3 59.0 33
All other 66.1 51.7 28
- --------------------------------------------------------------------------------
Total Mutual Fund Marketplace 144.4 110.7 30
- --------------------------------------------------------------------------------
Total mutual fund assets 245.6 184.7 33
- --------------------------------------------------------------------------------
Equity and other securities (1) 298.8 183.3 63
Fixed income securities 44.0 34.4 28
Margin loans outstanding (13.5) (8.9) 52
- --------------------------------------------------------------------------------
Total $595.0 $408.2 46%
================================================================================
Net growth in assets
in Schwab customer accounts
(for the quarter ended)
Net new customer assets $ 24.6 $ 18.8
Net market losses (21.3) (38.1)
- --------------------------------------------------------------------------------
Net growth (decline) $ 3.3 $(19.3)
================================================================================
New Schwab customer accounts
(in thousands, for the
quarter ended) 282.0 278.4 1%
Active Schwab customer
accounts (in millions) (3) 6.3 5.5 15%
================================================================================
Active online Schwab customer
accounts (in millions) (4) 3.0 2.0 50%
Online Schwab customer
assets $263.6 $130.5 102%
================================================================================
(1) Excludes money market funds and all of Schwab's proprietary money market,
equity and bond funds.
(2) Represents assets invested in Mutual Fund OneSource by independent
investment managers and retirement plans.
(3) Effective with the fourth quarter of 1998, active accounts are defined as
accounts with balances or activity within the preceding eight months
instead of twelve months as previously defined. This change in definition
had the effect of decreasing the number of active accounts by approximately
200,000. Prior quarters have not been restated.
(4) Active online accounts are defined as all active accounts within a
household that has had at least one online session within the past twelve
months.
Total operating expenses excluding interest during the third quarter of
1999 were $680 million, up 25% from $543 million for the third quarter of 1998,
primarily resulting from additional staff and related costs.
The after-tax profit margin for the third quarter of 1999 was 14.1%, up
from 13.9% for the third quarter of 1998. The annualized return on stockholders'
equity for the third quarter of 1999 was 25%, down from 31% for the third
quarter of 1998.
REVENUES
Revenues grew $178 million, or 25%, in the third quarter of 1999, due to a
$58 million, or 47%, increase in interest revenue, net of interest expense
(referred to as net interest revenue), a $49 million, or 34%, increase in mutual
fund service fees, and a $47 million, or 14%, increase in commission revenues,
as well as an $18 million, or 24%, increase in principal transaction revenues.
- --------------------------------------------------------------------------------
Three Months
Ended
September 30,
Composition of Revenues 1999 1998
- --------------------------------------------------------------------------------
Commissions 43% 48%
Principal transactions 11 11
- --------------------------------------------------------------------------------
Total trading revenues 54 59
- --------------------------------------------------------------------------------
Mutual fund service fees 22 20
Net interest revenue 21 18
Other 3 3
- --------------------------------------------------------------------------------
Total non-trading revenues 46 41
- --------------------------------------------------------------------------------
Total 100% 100%
================================================================================
Commissions
The Company earns commission revenues by executing customer trades
primarily through the Individual Investor and Institutional Investor segments.
These revenues are affected by the number of customer accounts that traded, the
average number of commission-generating trades per account, and the average
commission per trade.
Commission revenues for the Company were $384 million for the third
quarter of 1999, up $47 million, or 14%, from the third quarter of 1998. As
shown in the table below, the total number of revenue trades executed by the
Company has increased 36% as the Company's customer base, as well as customer
trading activity per account, has grown. Average commission per revenue trade
decreased 15%. This decline was mainly due to an increase in the proportion of
trades placed through the Company's online channels, which have lower commission
rates than the Company's other channels.
In the third quarter of 1999, the Company announced a plan to provide
independent investment managers with flat-fee pricing for Internet trades
(effective November 1, 1999). This price reduction is designed to enhance the
Company's competitive position and to align the pricing of Internet trades for
independent investment managers with that offered to most of the Company's
individual customers. While the effect of this price reduction cannot be
predicted with certainty, management expects that the impact of this reduction
on the Company's results of operations will be offset by the lower cost of
processing Internet trades and by expected growth in customer assets and trading
volumes associated with independent investment managers. This price reduction
will only affect the Institutional Investor segment and, based on management's
expectations, it will not have a material impact on that segment's revenues.
- --------------------------------------------------------------------------------
Three Months
Commissions Earned Ended
on Customer Revenue September 30, Percent
Trades 1999 1998 Change
- --------------------------------------------------------------------------------
Customer accounts that
traded during the quarter
(in thousands) 1,510 1,333 13%
Average customer
revenue trades
per account 5.73 4.78 20
Total revenue
trades (in thousands) 8,648 6,376 36
Average commission
per revenue trade $44.72 $52.83 (15)
Commissions earned
on customer revenue
trades (in millions) (1) $ 387 $ 337 15
================================================================================
(1) Includes certain non-commission revenues relating to the execution of
customer trades totaling $9 million in the third quarter of 1999 and $7
million in the third quarter of 1998. Excludes commissions on trades
relating to specialist operations totaling $6 million in the third quarter
of 1999 and $7 million in the third quarter of 1998.
Mutual Fund Service Fees
The Company earns mutual fund service fees for recordkeeping and
shareholder services provided to third-party funds, and for transfer agent
services, shareholder services, administration and investment management
provided to its proprietary funds. These fees are based upon the daily balances
of customer assets invested in third-party funds and upon the average daily net
assets of Schwab's proprietary funds. Mutual fund service fees are earned
primarily through the Individual Investor and Institutional Investor segments.
Mutual fund service fees were $193 million for the third quarter of 1999,
up $49 million, or 34%, from the third quarter of 1998. This increase was
primarily due to a significant increase in customer assets in Schwab's
proprietary funds, collectively referred to as the SchwabFunds(R), as well as an
increase in customer assets in funds purchased through Schwab's Mutual Fund
OneSource(R) service.
Net Interest Revenue
Net interest revenue is the difference between interest earned on assets
(mainly margin loans to customers and investments) and interest paid on
liabilities (mainly customer cash balances). Net interest revenue is affected by
changes in the volume and mix of these assets and liabilities, as well as by
fluctuations in interest rates. Substantially all of the Company's net interest
revenue is earned by Schwab through the Individual Investor and Institutional
Investor segments.
Net interest revenue was $182 million for the third quarter of 1999, up $58
million, or 47%, from the third quarter of 1998 as shown in the following table
(in millions):
- --------------------------------------------------------------------------------
Three Months
Ended
September 30, Percent
1999 1998 Change
- --------------------------------------------------------------------------------
Interest Revenue
Margin loans to customers $254 $181 40%
Investments, customer-related 99 96 3
Other 24 14 71
- --------------------------------------------------------------------------------
Total 377 291 30
- --------------------------------------------------------------------------------
Interest Expense
Customer cash balances 174 148 18
Stock-lending activities 7 10 (30)
Borrowings 7 7
Other 7 2 250
- --------------------------------------------------------------------------------
Total 195 167 17
- --------------------------------------------------------------------------------
Net interest revenue $182 $124 47%
================================================================================
Customer-related daily average balances, interest rates and average net
interest margin for the third quarters of 1999 and 1998 are summarized in the
following table (dollars in millions):
- --------------------------------------------------------------------------------
Three Months Ended
September 30,
1999 1998
- --------------------------------------------------------------------------------
Interest-Earning Assets (customer-related):
Margin loans to customers:
Average balance outstanding $13,405 $ 9,359
Average interest rate 7.50% 7.69%
Investments:
Average balance outstanding $ 8,262 $ 7,195
Average interest rate 4.72% 5.24%
Average yield on interest-earning assets 6.44% 6.63%
Funding Sources (customer-related
and other):
Interest-bearing customer cash balances:
Average balance outstanding $17,596 $13,364
Average interest rate 3.93% 4.40%
Other interest-bearing sources:
Average balance outstanding $ 1,339 $ 1,341
Average interest rate 4.23% 4.32%
Average noninterest-bearing portion $ 2,732 $ 1,849
Average interest rate on funding sources 3.45% 3.90%
Summary:
Average yield on interest-earning assets 6.44% 6.63%
Average interest rate on funding sources 3.45% 3.90%
- --------------------------------------------------------------------------------
Average net interest margin 2.99% 2.73%
================================================================================
The increase in net interest revenue from the third quarter of 1998 was
primarily due to higher levels of margin loans to customers, partially offset by
higher average customer cash balances.
Principal Transactions
Principal transaction revenues are primarily comprised of net gains from
market-making activities in Nasdaq and other securities transactions effected
through the Capital Markets segment. Factors that influence principal
transaction revenues include the volume of customer trades, market price
volatility, average revenue per share traded, level of underwriting
participation and changes in regulations and industry practices.
Principal transaction revenues were $93 million for the third quarter of
1999, up $18 million, or 24%, from the third quarter of 1998. This increase was
primarily due to greater share volume handled by M&S, partially offset by lower
average revenue per share traded. The remainder of the increase was primarily
due to higher revenues related to Schwab's underwriting activities.
Expenses Excluding Interest
Compensation and benefits expense was $369 million for the third quarter of
1999, up $78 million, or 27%, from the third quarter of 1998 primarily due to a
greater number of employees and higher variable compensation expense resulting
from the Company's financial performance. This change was partially offset by
lower accrued liabilities for deferred compensation and estimated payroll taxes
on stock options resulting from the decline in CSC's stock price during the
quarter, and a decrease in the Company's expected contribution rate to its
employee stock ownership plan. The following table shows a comparison of certain
compensation and benefits components and employee data (in thousands):
- --------------------------------------------------------------------------------
Three Months
Ended
September 30,
1999 1998
- --------------------------------------------------------------------------------
Compensation and benefits expense as a
% of revenues 42% 41%
Variable compensation as a
% of compensation and benefits expense 22% 25%
Compensation for temporary employees,
contractors and overtime hours as a
% of compensation and benefits expense 15% 14%
Full-time equivalent employees(1) 17.4 13.0
Revenues per average full-time equivalent
employee $51.9 $54.1
================================================================================
(1) Includes full-time, part-time and temporary employees, and persons employed
on a contract basis.
Occupancy and equipment expense was $69 million for the third quarter of
1999, up $18 million, or 36%, from the third quarter of 1998. This increase was
primarily due to higher data processing equipment lease and maintenance expenses
resulting from the Company's continued investment in technology. Additionally,
office lease expenses increased reflecting the Company's continued expansion.
Advertising and market development expense was $58 million for the third
quarter of 1999, up $24 million, or 70%, from the third quarter of 1998. This
increase was primarily a result of the Company's increased television and print
media spending.
Professional services expense was $40 million for the third quarter of
1999, up $18 million, or 81%, from the third quarter of 1998. This increase was
primarily due to consulting fees related to various information technology
projects.
Other expenses were $22 million for the third quarter of 1999, down $14
million, or 38%, from the third quarter of 1998. This change was primarily due
to lower accrued liabilities resulting from the decline in CSC's stock price
during the quarter, including estimated local business taxes on stock options
and deferred fees for CSC's Board of Directors. This change in other expenses
was also due to lower trade errors, partially offset by an increase in higher
travel and related costs, and higher volume-related regulatory assessments and
dues.
The Company's effective income tax rate for the third quarters of 1999 and
1998 was 38.9% and 39.8%, respectively.
Nine Months Ended September 30, 1999
Compared To Nine Months Ended September 30, 1998
Financial Overview
Net income for the first nine months of 1999 was a record $418 million, up
73% from the first nine months of 1998 net income of $242 million. Diluted
earnings per share for the first nine months of 1999 and 1998 were $.50 and $.30
per share, respectively.
Revenues increased mainly due to higher customer trading volume. Revenues
of $2,817 million in the first nine months of 1999 grew $870 million, or 45%,
from the first nine months of 1998 due to increases in revenues of $578 million,
or 41%, in the Individual Investor segment, $178 million, or 80%, in the Capital
Markets segment, and $114 million, or 35%, in the Institutional Investor
segment. See note "8 - Segment Information" in the Notes to Condensed
Consolidated Financial Statements for financial information by segment.
The Company's trading activity is shown in the following table (in
thousands):
- --------------------------------------------------------------------------------
Nine Months
Ended
September 30, Percent
Daily Average Trades 1999 1998 Change
- --------------------------------------------------------------------------------
Revenue Trades
Online 108.1 50.0 116%
TeleBroker(R)and VoiceBroker(TM) 8.5 8.4 1
Regional customer telephone
service centers, branch offices
and other 35.9 32.7 10
- --------------------------------------------------------------------------------
Total 152.5 91.1 67%
================================================================================
Mutual Fund OneSource(R) Trades
Online 22.4 17.8 26%
TeleBroker and VoiceBroker 1.0 1.1 (9)
Regional customer telephone
service centers, branch offices
and other 21.1 21.9 (4)
- --------------------------------------------------------------------------------
Total 44.5 40.8 9%
================================================================================
Total Daily Average Trades
Online 130.5 67.8 92%
TeleBroker and VoiceBroker 9.5 9.5
Regional customer telephone
service centers, branch offices
and other 57.0 54.6 4
- --------------------------------------------------------------------------------
Total 197.0 131.9 49%
================================================================================
Assets in Schwab customer accounts were $595.0 billion at September 30,
1999, an increase of $103.9 billion, or 21%, from December 31, 1998. During the
first nine months of 1999, net new customer assets and new accounts increased
from the first nine months of 1998 as shown in the table below.
- --------------------------------------------------------------------------------
Nine Months
Growth in Schwab Customer Ended
Assets and Accounts September 30, Percent
(In billions, except as noted) 1999 1998 Change
- --------------------------------------------------------------------------------
Net growth in assets
in Schwab customer accounts
Net new customer assets $ 73.6 $ 56.6
Net market gains (losses) 30.3 (2.0)
- --------------------------------------------------------------------------------
Net growth $ 103.9 $ 54.6
================================================================================
New Schwab customer accounts
(in thousands) 1,092.1 983.8 11%
================================================================================
Total operating expenses excluding interest during the first nine months
of 1999 were $2,128 million, up 38% from $1,547 million for the first nine
months of 1998, primarily resulting from additional staff and related costs.
The after-tax profit margin for the first nine months of 1999 was 14.9%,
up from 12.4% for the first nine months of 1998. The annualized return on
stockholders' equity for the first nine months of 1999 was 32%, up from 26% for
the first nine months of 1998.
REVENUES
Revenues grew $870 million, or 45%, in the first nine months of 1999, due
to a $386 million, or 41%, increase in commission revenues, a $174 million, or
94%, increase in principal transaction revenues, a $155 million, or 45%,
increase in net interest revenue and a $136 million, or 34%, increase in mutual
fund service fees.
- --------------------------------------------------------------------------------
Nine Months
Ended
September 30,
Composition of Revenues 1999 1998
- --------------------------------------------------------------------------------
Commissions 47% 48%
Principal transactions 13 10
- --------------------------------------------------------------------------------
Total trading revenues 60 58
- --------------------------------------------------------------------------------
Mutual fund service fees 19 21
Net interest revenue 18 18
Other 3 3
- --------------------------------------------------------------------------------
Total non-trading revenues 40 42
- --------------------------------------------------------------------------------
Total 100% 100%
================================================================================
Commissions
Commission revenues for the Company were $1,321 million for the first nine
months of 1999, up $386 million, or 41%, from the first nine months of 1998. As
shown in the table below, the total number of revenue trades executed by the
Company has increased 67% as the Company's customer base, as well as customer
trading activity per account, has grown. Average commission per revenue trade
decreased 15%. This decline was mainly due to an increase in the proportion of
trades placed through the Company's online channels as described in the
comparison between the three-month periods.
- --------------------------------------------------------------------------------
Nine Months
Commissions Earned Ended
on Customer Revenue September 30, Percent
Trades 1999 1998 Change
- --------------------------------------------------------------------------------
Customer accounts that
traded during the period
(in thousands) 2,822 2,405 17%
Average customer
revenue trades
per account 10.16 7.12 43
Total revenue
trades (in thousands) 28,668 17,131 67
Average commission
per revenue trade $ 46.36 $ 54.48 (15)
Commissions earned
on customer revenue
trades (in millions) (1) $ 1,329 $ 933 42
================================================================================
(1) Includes certain non-commission revenues relating to the execution of
customer trades totaling $28 million in the first nine months of 1999 and
$17 million in the first nine months of 1998. Excludes commissions on
trades relating to specialist operations totaling $20 million in the first
nine months of 1999 and $18 million in the first nine months of 1998.
Mutual Fund Service Fees
Mutual fund service fees were $542 million for the first nine months of
1999, up $136 million, or 34%, from the first nine months of 1998. This increase
was attributable to the factors described in the comparison between the
three-month periods.
Net Interest Revenue
Net interest revenue was $500 million for the first nine months of 1999, up
$155 million, or 45%, from the first nine months of 1998 as shown in the
following table (in millions):
- --------------------------------------------------------------------------------
Nine Months
Ended
September 30, Percent
1999 1998 Change
- --------------------------------------------------------------------------------
Interest Revenue
Margin loans to customers $ 687 $ 499 38%
Investments, customer-related 298 290 3
Other 59 39 51
- --------------------------------------------------------------------------------
Total 1,044 828 26
- --------------------------------------------------------------------------------
Interest Expense
Customer cash balances 486 428 14
Stock-lending activities 23 30 (23)
Borrowings 20 19 5
Other 15 6 150
- --------------------------------------------------------------------------------
Total 544 483 13
- --------------------------------------------------------------------------------
Net interest revenue $ 500 $ 345 45%
================================================================================
Customer-related daily average balances, interest rates and average net
interest margin for the first nine months of 1999 and 1998 are summarized in the
following table (dollars in millions):
- --------------------------------------------------------------------------------
Nine Months Ended
September 30,
1999 1998
- --------------------------------------------------------------------------------
Interest-Earning Assets (customer-related):
Margin loans to customers:
Average balance outstanding $12,563 $ 8,678
Average interest rate 7.31% 7.69%
Investments:
Average balance outstanding $ 8,602 $ 7,280
Average interest rate 4.63% 5.32%
Average yield on interest-earning assets 6.22% 6.61%
Funding Sources (customer-related
and other):
Interest-bearing customer cash balances:
Average balance outstanding $16,886 $12,838
Average interest rate 3.85% 4.46%
Other interest-bearing sources:
Average balance outstanding $ 1,516 $ 1,295
Average interest rate 3.70% 4.39%
Average noninterest-bearing portion $ 2,763 $ 1,825
Average interest rate on funding sources 3.34% 3.94%
Summary:
Average yield on interest-earning assets 6.22% 6.61%
Average interest rate on funding sources 3.34% 3.94%
- --------------------------------------------------------------------------------
Average net interest margin 2.88% 2.67%
================================================================================
The increase in net interest revenue from the first nine months of 1998
was primarily due to higher levels of margin loans to customers, partially
offset by higher average customer cash balances.
Principal Transactions
Principal transaction revenues were $361 million for the first nine months
of 1999, up $174 million, or 94%, from the first nine months of 1998. This
increase was primarily due to greater share volume handled by M&S, as well as
higher average revenue per share traded.
Expenses Excluding Interest
Compensation and benefits expense was $1,162 million for the first nine
months of 1999, up $327 million, or 39%, from the first nine months of 1998
primarily due to a greater number of employees and higher variable compensation
expense resulting from the Company's financial performance. The following table
shows a comparison of certain compensation and benefits components and employee
data (in thousands):
- --------------------------------------------------------------------------------
Nine Months
Ended
September 30,
1999 1998
- --------------------------------------------------------------------------------
Compensation and benefits expense as a
% of revenues 41% 43%
Variable compensation as a
% of compensation and benefits expense 29% 22%
Compensation for temporary employees,
contractors and overtime hours as a
% of compensation and benefits expense 14% 14%
Full-time equivalent employees(1) 17.4 13.0
Revenues per average full-time equivalent
employee $181.4 $148.0
================================================================================
(1) Includes full-time, part-time and temporary employees, and persons employed
on a contract basis.
Communications expense was $197 million for the first nine months of 1999,
up $43 million, or 28%, from the first nine months of 1998. This increase was
primarily due to higher customer trading volumes and the introduction of certain
online research tools in 1999.
Occupancy and equipment expense was $191 million for the first nine months
of 1999, up $43 million, or 29%, from the first nine months of 1998. This
increase was attributable to the factors described in the comparison between the
three-month periods.
Advertising and market development expense was $165 million for the first
nine months of 1999, up $63 million, or 62%, from the first nine months of 1998.
This increase was attributable to the factors described in the comparison
between the three-month periods.
Professional services expense was $109 million for the first nine months of
1999, up $45 million, or 71%, from the first nine months of 1998. This increase
was attributable to the factors described in the comparison between the
three-month periods.
The Company's effective income tax rate for the first nine months of 1999
and 1998 was 39.3% and 39.6%, respectively.
Liquidity and Capital Resources
Liquidity
Schwab
Liquidity needs relating to customer trading and margin borrowing
activities are met primarily through cash balances in customer accounts, which
were $20.1 billion and $17.5 billion at September 30, 1999 and December 31,
1998, respectively. Management believes that customer cash balances and
operating earnings will continue to be the primary sources of liquidity for
Schwab in the future.
Schwab is subject to regulatory requirements that are intended to ensure
the general financial soundness and liquidity of broker-dealers. These
regulations prohibit Schwab from repaying subordinated borrowings to CSC, paying
cash dividends, or making unsecured advances or loans to its parent or employees
if such payment would result in net capital of less than 5% of aggregate debit
balances or less than 120% of its minimum dollar amount requirement of $1
million. At September 30, 1999, Schwab's net capital was $1,400 million (10% of
aggregate debit balances), which was $1,130 million in excess of its minimum
required net capital and $725 million in excess of 5% of aggregate debit
balances. Schwab has historically targeted net capital to be 10% of its
aggregate debit balances, which primarily consist of customer margin loans. To
achieve this target, as customer margin loans have grown, an increasing amount
of cash flows have been retained to support aggregate debit balances.
To manage Schwab's regulatory capital position, CSC provides Schwab with a
$1,400 million subordinated revolving credit facility maturing in September
2001, of which $615 million was outstanding at September 30, 1999. At quarter
end, Schwab also had outstanding $25 million in fixed-rate subordinated term
loans from CSC maturing in 2001. Borrowings under these subordinated lending
arrangements qualify as regulatory capital for Schwab.
To manage short-term liquidity, Schwab maintains uncommitted, unsecured
bank credit lines totaling $715 million at September 30, 1999 (these lines are
also available for CSC to use). Schwab used such borrowings for 22 days during
the first nine months of 1999, with the daily amounts borrowed averaging $138
million. These lines were unused at September 30, 1999.
To satisfy the margin requirement of customer option transactions with the
Options Clearing Corporation (OCC), Schwab had unsecured letter of credit
agreements with 11 banks in favor of the OCC aggregating $855 million at
September 30, 1999. Schwab pays a fee to maintain these letters of credit. No
funds were drawn under these letters of credit at September 30, 1999.
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 marketable
securities, receivable from brokers, dealers and clearing organizations, and
cash and cash equivalents.
M&S' liquidity is affected by the same net capital regulatory requirements
as Schwab (see discussion above). At September 30, 1999, M&S' net capital was
$12 million, which was $11 million in excess of its minimum required net
capital.
M&S may borrow up to $35 million under a subordinated lending arrangement
with CSC maturing in 2000. Borrowings under this arrangement qualify as
regulatory capital for M&S. This facility was unused during the first nine
months of 1999.
CSC
CSC's liquidity needs are generally met through cash generated by its
subsidiaries, as well as cash provided by external financing. As discussed
above, Schwab and M&S are subject to regulatory requirements that may restrict
them from certain transactions with CSC. Management believes that funds
generated by the operations of CSC's subsidiaries will continue to be the
primary funding source in meeting CSC's liquidity needs and maintaining Schwab's
and M&S' net capital.
CSC has liquidity needs that arise from its issued and outstanding $465
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 1999 to 2009 and fixed interest
rates ranging from 5.90% to 7.50% with interest payable semiannually. The
Medium-Term Notes are rated A3 by Moody's Investors Service and A- by Standard &
Poor's Ratings Group.
CSC has a prospectus supplement on file with the Securities and Exchange
Commission enabling CSC to issue up to $395 million in Senior or Senior
Subordinated Medium-Term Notes, Series A. At September 30, 1999, $311 million of
these notes remained unissued.
CSC may borrow under its committed, unsecured credit facilities. CSC
maintains a $600 million facility with a group of fourteen banks which expires
in June 2000 and a $175 million facility with a group of nine banks which
expires in June 2001. The funds under both of these facilities are available for
general corporate purposes and CSC pays a commitment fee on the unused balance
of these facilities. The financial covenants in these facilities require CSC to
maintain minimum levels of stockholders' equity, and Schwab and M&S to maintain
specified levels of net capital, as defined. The Company believes that these
restrictions will not have a material effect on its ability to meet foreseeable
dividend or funding requirements. These facilities were unused during the first
nine months of 1999.
CSC also has access to the $715 million uncommitted, unsecured bank credit
lines that are primarily utilized by Schwab to manage short-term liquidity.
These lines were not used by CSC during the first nine months of 1999.
CSE
CSE's liquidity needs are generally met through earnings generated by its
operations. Most of CSE's assets are liquid, consisting primarily of cash and
investments required to be segregated, receivable from brokers, dealers and
clearing organizations, and receivable from customers and others.
CSE may borrow up to 20 million British pound, equivalent to $33 million at
September 30, 1999, under subordinated lending arrangements with CSC. At
September 30, 1999, CSE had outstanding 15 million British pound under these
arrangements, equivalent to $24 million, with 5 million British pound maturing
in 2001 and 10 million British pound maturing in 2003.
Cash Flows and Capital Resources
Net income plus depreciation and amortization was $530 million for the
first nine months of 1999, up 53% from $347 million for the first nine months of
1998, allowing the Company to finance its operations primarily with internally
generated funds. Depreciation and amortization expense related to equipment,
office facilities and property was $105 million for the first nine months of
1999, as compared to $97 million for the first nine months of 1998, or 4% and 5%
of revenues for each period, respectively. Amortization expense related to
intangible assets was $6 million for the first nine months of 1999, as compared
to $8 million for the first nine months of 1998.
The Company's capital expenditures net of proceeds from the sale of fixed
assets were $194 million in the first nine months of 1999 and $145 million in
the first nine months of 1998, or 7% of revenues for each period. Capital
expenditures in the first nine months of 1999 were for equipment relating to the
Company's information technology systems, telecommunications equipment, and
leasehold improvements. The Company opened twenty-eight new domestic branch
offices during the first nine months of 1999, compared to seven domestic branch
offices opened during the first nine months of 1998. Capital expenditures may
vary from period to period as business conditions change.
As reported in the Company's 1998 Annual Report to Stockholders,
management expected 1999 capital expenditures to increase 40% over the $190
million level in 1998, and estimated that approximately 75% of the 1999 planned
expenditures related to capacity and approximately 25% related to facilities
expansion and improvements. Management currently anticipates that full year 1999
capital expenditures will increase approximately 50% to 55% over the 1998 level
primarily due to the Company's enhancements to capacity and information
technology (approximately 65% of the total 1999 capital expenditures), and
facilities expansion and improvements (approximately 35% of the total).
The Company issued $144 million and repaid $30 million in Medium-Term Notes
during the first nine months of 1999.
During the first nine months of 1999, 14,427,100 of the Company's stock
options, with a range of exercise prices from $.97 to $27.50, were exercised
with cash proceeds received by the Company of $45 million and a related tax
benefit of $176 million. The cash proceeds are recorded as an increase in cash
and a corresponding increase in stockholders' equity. The tax benefit is
recorded as a reduction in income taxes payable and a corresponding increase in
stockholders' equity.
During the first nine months of 1999, the Company did not repurchase any
common stock. During the first nine months of 1998, the Company repurchased
12,309,500 shares of its common stock for $148 million. Since the inception of
the repurchase plan in 1988 through September 30, 1999, the Company has
repurchased 132,830,700 shares of its common stock for $314 million. At
September 30, 1999, authorization granted by the Company's Board of Directors
allows for future repurchases of 2,450,600 shares.
In April 1999, the Board of Directors approved a two-for-one split of the
Company's common stock, effected in the form of a 100% stock dividend. The stock
dividend was distributed on July 1, 1999 to stockholders of record June 1, 1999.
Share and per share data throughout this report have been restated to reflect
this transaction.
During the first nine months of 1999, the Company paid common stock cash
dividends totaling $34 million, up from $32 million paid during the first nine
months of 1998.
The Company monitors both the relative composition and absolute level of
its capital structure. The Company's total financial capital (borrowings plus
stockholders' equity) at September 30, 1999 was $2,521 million, up $741 million,
or 42% from December 31, 1998. At September 30, 1999, the Company had borrowings
of $465 million, or 18% of total financial capital, that bear interest at a
weighted-average rate of 6.71%. At September 30, 1999, the Company's
stockholders' equity was $2,056 million, or 82% of total financial capital.
Year 2000
Many existing computer programs use only two digits to identify a specific
year and therefore may not accurately recognize the upcoming change in the
century. If not corrected, many computer applications could fail or create
erroneous results by or at the year 2000. Due to the Company's dependence on
computer technology to operate its business, and the dependence of the financial
services industry on computer technology, the nature and impact of Year 2000
processing failures on the Company's business, financial position, results of
operations or cash flows could be material. The Company has modified and tested
its computer systems in order to enable its systems to process data and
transactions incorporating year 2000 dates without material errors or
interruptions. Because systems critical to the Company's functioning other than
its computer systems may be affected by the century change, the Company's Year
2000 compliance efforts also encompass facilities and equipment which rely on
date-dependent technology, such as building equipment that contains embedded
technology.
Status of Compliance Efforts
The Company's Year 2000 compliance efforts have been directed towards
defined categories of actions, which include awareness, inventory, assessment,
remediation, testing, installation, contingency planning and vendor management.
Attempting to assure that the Company's mission critical systems achieve Year
2000 compliance, that is, that they will operate without material errors or
interruptions when processing data and transactions incorporating year 2000
dates, has received the highest priority in the Company's Year 2000 compliance
efforts. "Mission critical" systems means systems critical to the ongoing
operation of the business. The remediation and associated required testing of
the Company's mission critical internal systems are complete, including the
systems of the Company's material subsidiaries.
Currently, the primary focus of the Company's efforts is contingency
planning, year-end planning and maintaining Year 2000 compliance as system
changes (including non-Year 2000 related products and enhancements) are
introduced. The Company anticipates that work on these phases of the project
will continue through the century change.
The Company's vendor management initiatives have included creating
inventories of vendors, analyzing the results of the inventories to assess the
criticality of specific vendor relationships in order to formulate plans for
dealing with possible Year 2000 issues, inquiring directly as to the status of
vendors' Year 2000 compliance efforts, and continuing contacts with vendors to
monitor the progress of vendors who may not yet have achieved Year 2000
compliance. All material vendor compliance efforts for mission critical
third-party products and services were completed as of the end of the third
quarter of 1999, except for efforts where completion is dependent on third
parties whose actions are beyond the Company's control, and except for
contingency planning efforts which by their nature will be continuing until the
century change is completed.
The success of the Company's Year 2000 compliance efforts depends in part
on parallel efforts being undertaken by vendors and other third parties with
which the Company's systems interact and therefore, the Company has taken steps
to determine the status of critical third parties' Year 2000 compliance. There
can be no assurance that all such third parties will provide accurate and
complete information or that all their systems in fact will achieve full Year
2000 compliance. Third parties' Year 2000 processing failures might have a
material adverse impact on the Company's systems and operations. The Company's
Year 2000 compliance efforts may also be adversely affected by regulatory
changes, changes in industry practices, the cost and continued availability of
qualified personnel and other resources, and significant systems modifications
unrelated to the Year 2000 project including upgrades and additions to capacity.
The progress of the Company's Year 2000 compliance efforts is managed and
reviewed by senior management and the Company's Year 2000 Corporate Steering
Committee, which is responsible for maintaining awareness of Year 2000 issues
throughout the Company, monitoring overall progress of the project, resolving
issues, and providing strategic direction. The Company's Board of Directors
receives regular status reports on the project.
Contingency Planning and Risks
The Company commenced its contingency planning efforts in 1997. Its
contingency planning process is intended to create, update, and implement, as
necessary, plans in the event of Year 2000 errors or failures of third parties
with whom the Company interacts or who supply critical services or goods to the
Company, or of the Company itself.
In management's opinion, there is not sufficient reliable information
available to enable the Company to determine whether any specific Year 2000
failures are reasonably likely to occur. However, the Company has developed
firm-wide contingency scenarios which take into account multiple simultaneous
failures, and corresponding contingency plans. These scenario-based contingency
plans are in addition to both contingency plans developed on a business-unit
level and the Company's overall business resumption plans. Corresponding
staffing and training plans have been completed. A Corporate Command Center is
being established for contingency plan activation and centralized
communications.
The Company continues to take steps to reduce this uncertainty by
participating in industry conferences, communicating with business alliance
partners, monitoring critical vendors, monitoring national and international
governmental and industry initiatives, and working with professional consultants
and advisors. Given the uncertainty of predicting which, if any, Year 2000
errors or failures are reasonably likely to occur, the Company's contingency
planning process targets systems, transactions, processes, and third parties
that are deemed to be critical to the Company's business, results of operations,
or financial condition.
Compliance Cost Estimates
The Company currently estimates that the cost of completing its Year 2000
project, including mission critical and other core brokerage computer systems,
distributed applications, facilities, and systems in subsidiaries other than
Schwab, is approximately $86 million to $91 million. Additionally, the Company
currently anticipates spending prior to the end of 1999 approximately $8 million
to complete its contingency plans. This amount does not include the costs of
executing such plans if certain contingencies occur.
The Company's cost estimates exclude the time that may be spent by staff
not specifically dedicated to the Year 2000 project. As of September 30, 1999,
the Company had incurred approximately $81 million of the estimated cost of the
project and an additional $2 million on its contingency plans.
The estimated cost and timing of the project are based on the Company's
estimates, which make numerous assumptions about future events. However, there
can be no assurance that these estimates will be correct and actual costs and
timing could differ materially from these estimates. The Company has funded and
expects to fund all Year 2000 related costs through operating cash flows and a
reallocation of the Company's overall developmental spending. This reallocation
did not result in the delay of any critical information technology projects. In
accordance with generally accepted accounting principles, Year 2000 expenditures
are expensed as incurred.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Financial Instruments Held For Trading Purposes
The Company held government securities and certificates of deposit with a
fair value of approximately $26 million and $11 million at September 30, 1999
and 1998, respectively. These securities, and the associated interest rate risk,
are not material to the Company's financial position, results of operations or
cash flows.
Through Schwab and M&S, the Company maintains inventories in
exchange-listed and Nasdaq equity securities on both a long and short basis. The
fair value of these securities at September 30, 1999 was $61 million in long
positions and $39 million in short positions. The fair value of these securities
at September 30, 1998 was $37 million in long positions and $46 million in short
positions. Using a hypothetical 10% increase or decrease in prices, the
potential loss or gain in fair value is estimated to be approximately $2,200,000
and $900,000 at September 30, 1999 and 1998, respectively, due to the offset of
change in fair value in long and short positions. In addition, the Company
generally enters into exchange-traded option contracts to hedge against
potential losses in equity inventory positions, thus reducing this potential
loss exposure. This hypothetical 10% change in fair value of these securities at
September 30, 1999 and 1998 would not be material to the Company's financial
position, results of operations or cash flows. The notional amount and fair
value of option contracts were not material to the Company's consolidated
balance sheets at September 30, 1999 and 1998.
Financial Instruments Held For Purposes Other Than Trading
For its working capital and reserves required to be segregated under
federal or other regulations, the Company invests in money market funds, resale
agreements, certificates of deposit, and commercial paper. Money market funds do
not have maturity dates and do not present a material market risk. The other
financial instruments, as shown in the following table, are fixed rate
investments with short-term maturities and are not subject to material changes
in value due to interest rate movements (dollars in millions):
- --------------------------------------------------------------------------------
Principal Amount
by Maturity Date Fair Value
September 30, 2000 Thereafter 1999 1998
- --------------------------------------------------------------------------------
Resale agreements (1) $7,621 $7,621 $5,680
Weighted-average interest rate 5.14%
Certificates of deposit $ 940 $ 940 $1,559
Weighted-average interest rate 5.31%
Commercial paper $ 240 $ 240 $ 553
Weighted-average interest rate 5.60%
================================================================================
(1) Fair value at September 30, 1999 includes resale agreements of $7,306
million included in cash and investments required to be segregated under
federal or other regulations and $315 million included in cash and cash
equivalents.
At September 30, 1999, CSC had $465 million aggregate principal amount of
Medium-Term Notes, with fixed interest rates ranging from 5.90% to 7.50%. At
September 30, 1998, CSC had $351 million aggregate principal amount of
Medium-Term Notes, with fixed interest rates ranging from 5.78% to 7.72%. The
Company has fixed cash flow requirements regarding these Medium-Term Notes due
to the fixed rate of interest. The fair value of these Medium-Term Notes at
September 30, 1999 and 1998, based on estimates of market rates for debt with
similar terms and remaining maturities, approximated their carrying amount. The
table below presents the principal amount of these Medium-Term Notes by year of
maturity (dollars in millions):
- --------------------------------------------------------------------------------
Year Ending Weighted-Average Principal
December 31, Interest Rate Amount
- --------------------------------------------------------------------------------
1999 5.9% $ 10
2000 6.3% 48
2001 7.0% 39
2002 7.0% 53
2003 6.5% 49
Thereafter 6.8% 266
================================================================================
The Company maintains investments in mutual funds, approximately $55
million and $42 million at September 30, 1999 and 1998, respectively, to fund
obligations under its deferred compensation plan, which is available to certain
employees. Any decrease in the fair value of these investments would result in a
comparable decrease in the deferred compensation plan obligation and would not
affect the Company's financial position, results of operations or cash flows.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are filed as part of this quarterly report on Form
10-Q.
- --------------------------------------------------------------------------------
Exhibit
Number Exhibit
- --------------------------------------------------------------------------------
3.10 Fourth Restated Certificate of Incorporation, effective July 30,
1999, of the Registrant, which includes amendments through May 20,
1999 (supersedes Exhibit 3.7).
10.207 The Charles Schwab Corporation 1992 Stock Incentive Plan, restated
to include Amendments through May 17, 1999 (supersedes Exhibit
10.203).
12.1 Computation of Ratio of Earnings to Fixed Charges.
27.1 Financial Data Schedule (electronic only).
- --------------------------------------------------------------------------------
(b) Reports on Form 8-K
On July 6, 1999, the Registrant filed a Current Report on Form 8-K relating
to up to $395 million aggregate principal amount of debt securities
issuable by the Registrant pursuant to Registration Statement Numbers
333-77381 and 333-54001 declared effective by the Securities and Exchange
Commission on June 25, 1999 and July 8, 1998, respectively. Certain
exhibits relating to the Medium-Term Notes, Series A, which are issuable
pursuant to the Registration Statements, are contained in the Form 8-K.
THE CHARLES SCHWAB CORPORATION
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE CHARLES SCHWAB CORPORATION
(Registrant)
Date: November 10, 1999 /s/ Christopher V. Dodds
----------------- ------------------------------------
Christopher V. Dodds
Executive Vice President and
Chief Financial Officer