<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1994 Commission file number 1-9700
THE CHARLES SCHWAB CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 94-3025021
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
101 Montgomery Street, San Francisco, CA 94104
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (415) 627-7000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes x No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
57,114,179 shares of $.01 par value Common Stock
Outstanding on May 9, 1994
<PAGE>
THE CHARLES SCHWAB CORPORATION
Quarterly Report on Form 10-Q
For the Quarter Ended March 31, 1994
Index
<TABLE>
<CAPTION>
Page
----
<S> <C>
Part I - Financial Information
Item 1. Condensed Consolidated Financial Statements:
Statement of Income 1
Balance Sheet 2
Statement of Cash Flows 3
Notes 4-5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 6-12
Part II - Other Information
Item 1. Legal Proceedings 12
Item 2. Changes in Securities 12
Item 3. Defaults Upon Senior Securities 12
Item 4. Submission of Matters to a Vote of Security Holders 13
Item 5. Other Information 13
Item 6. Exhibits and Reports on Form 8-K 13
Signature 14
</TABLE>
<PAGE>
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)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1994 1993
---- ----
<S> <C> <C>
Revenues
Commissions $160,985 $143,450
Principal transactions 50,289 40,481
Interest revenue, net of interest expense of
$35,230 in 1994 and $33,652 in 1993 35,862 26,076
Mutual fund service fees 33,768 20,578
Other 7,001 5,731
- - ---------------------------------------------------------------------------------------------------------------
Total 287,905 236,316
- - ---------------------------------------------------------------------------------------------------------------
Expenses Excluding Interest
Compensation and benefits 121,020 95,394
Communications 28,139 22,058
Occupancy and equipment 20,961 16,955
Depreciation and amortization 12,512 9,473
Commissions, clearance and floor brokerage 12,526 10,722
Advertising and market development 11,796 9,383
Professional services 5,566 2,811
Other 11,841 8,129
- - ---------------------------------------------------------------------------------------------------------------
Total 224,361 174,925
- - ---------------------------------------------------------------------------------------------------------------
Income before taxes on income 63,544 61,391
Taxes on income 25,354 25,999
- - ---------------------------------------------------------------------------------------------------------------
Net Income $ 38,190 $ 35,392
===============================================================================================================
Weighted average number of common and
common equivalent shares outstanding 58,803 58,984
===============================================================================================================
Earnings per Common Equivalent Share $ .65 $ .60
===============================================================================================================
Dividends Declared per Common Share $ .07 $ .04
===============================================================================================================
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
- 1 -
<PAGE>
THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(In thousands, except share data)
<TABLE>
<CAPTION>
March 31, December 31,
1994 1993
---- ----
(Unaudited)
-----------
<S> <C> <C>
Assets
Cash and equivalents (including resale agreements of $301,960 in 1994
and $120,000 in 1993) $ 331,752 $ 279,828
Cash and investments required to be segregated under Federal or other
regulations (including resale agreements of $3,792,126 in 1994
and $3,267,440 in 1993) 4,207,674 3,676,319
Receivable from brokers, dealers and clearing organizations 75,767 71,616
Receivable from customers (less allowance for doubtful accounts
of $2,491 in 1994 and $2,229 in 1993) 2,633,550 2,553,255
Equipment, office facilities and property (less accumulated
depreciation and amortization of $152,132 in 1994 and $143,339 in 1993) 142,872 136,440
Customer lists (less accumulated amortization of $132,394 in 1994
and $130,434 in 1993) 35,154 37,114
Other assets 123,495 141,945
- - --------------------------------------------------------------------------------------------------------------
Total $7,550,264 $6,896,517
==============================================================================================================
Liabilities and Stockholders' Equity
Drafts payable $ 118,085 $ 123,384
Payable to brokers, dealers and clearing organizations 328,422 303,981
Payable to customers 6,337,519 5,745,783
Accrued expenses 187,447 158,866
Long-term and subordinated borrowings 186,931 185,330
- - --------------------------------------------------------------------------------------------------------------
Total liabilities 7,158,404 6,517,344
- - --------------------------------------------------------------------------------------------------------------
Stockholders' equity:
Preferred stock--10,000,000 shares authorized; $.01 par value
per share; none issued
Common stock--200,000,000 shares authorized; $.01 par value per
share; 59,486,680 shares in 1994 and 1993 595 595
Additional paid-in capital 161,339 161,052
Retained earnings 283,726 253,692
Treasury stock--2,257,437 shares in 1994 and
1,649,478 shares in 1993, at cost (40,793) (23,153)
Note receivable from Profit Sharing Plan (1,467) (13,013)
Unearned ESOP Shares (11,540)
- - --------------------------------------------------------------------------------------------------------------
Stockholders' equity 391,860 379,173
- - --------------------------------------------------------------------------------------------------------------
Total $7,550,264 $6,896,517
==============================================================================================================
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
- 2 -
<PAGE>
THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1994 1993
---- ----
<S> <C> <C>
Cash flows from operating activities
Net income $ 38,190 $ 35,392
Noncash items included in net income:
Depreciation and amortization 12,512 9,473
Deferred income taxes 7,254 (922)
Other (137) 106
Change in accrued expenses 25,782 30,761
Change in other assets 10,457 5,010
- - ----------------------------------------------------------------------------------------------------------------
Net cash provided before change in customer-related balances 94,058 79,820
- - ----------------------------------------------------------------------------------------------------------------
Change in customer-related balances:
Payable to customers 591,736 41,558
Receivable from customers (80,557) (136,460)
Drafts payable (5,299) (10,066)
Payable to brokers, dealers and clearing organizations 24,441 30,057
Receivable from brokers, dealers and clearing organizations (4,151) (5,143)
Cash and investments required to be segregated under
Federal or other regulations (531,355) 64,775
- - ----------------------------------------------------------------------------------------------------------------
Net change in customer-related balances (5,185) (15,279)
- - ----------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 88,873 64,541
- - ----------------------------------------------------------------------------------------------------------------
Cash flows from investing activities
Purchase of equipment, office facilities and property - net (14,803) (12,821)
- - ----------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (14,803) (12,821)
- - ----------------------------------------------------------------------------------------------------------------
Cash flows from financing activities
Purchase of treasury stock (19,031)
Dividends paid (4,046) (2,298)
Repayment of long-term and subordinated borrowings (242) (532)
Other 1,173 369
- - ----------------------------------------------------------------------------------------------------------------
Net cash used by financing activities (22,146) (2,461)
- - ----------------------------------------------------------------------------------------------------------------
Increase in cash and equivalents 51,924 49,259
Cash and equivalents at beginning of period 279,828 204,290
- - ----------------------------------------------------------------------------------------------------------------
Cash and equivalents at end of period $ 331,752 $ 253,549
================================================================================================================
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
- 3 -
<PAGE>
THE CHARLES SCHWAB CORPORATION
NOTES TO CONDENSED
CONSOLIDATED FINANCIAL
STATEMENTS
(Unaudited)
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
include The Charles Schwab Corporation (CSC) and its subsidiaries (collectively
the Company), including Charles Schwab & Co., Inc. (Schwab) and Mayer &
Schweitzer, Inc. (M&S). These financial statements have been prepared pursuant
to the rules and regulations of the Securities and Exchange Commission (SEC)
and, in the opinion of management, reflect all adjustments necessary to present
fairly the financial position, results of operations and cash flows for the
periods presented in conformity with generally accepted accounting principles.
All adjustments were of a normal recurring nature. All material intercompany
balances and transactions have been eliminated. These financial statements
should be read in conjunction with the consolidated financial statements and
notes thereto included in the Company's 1993 Annual Report to Stockholders which
are incorporated by reference in the Company's 1993 Annual Report on Form 10-K.
Revenues are presented net of interest expense. Certain 1993 revenues and
expenses have been reclassified to conform to the 1994 presentation.
Stock Repurchases
During the first three months of 1994, the Company repurchased and recorded
as treasury stock a total of 700,000 shares of its common stock for $19 million.
Employee Benefit Plans
Effective January 1, 1994, the Company adopted Statement of Position 93-6 --
Employers' Accounting for Employee Stock Ownership Plans (the Statement). The
Statement requires income statement recognition of the fair value of common
stock released for allocation to employees through an Employee Stock Ownership
Plan (ESOP). As shares are released for allocation to employees, the shares
become outstanding for earnings per share computations. Previously, the
accounting rules provided for the cost basis of shares released for allocation
through ESOP plans to be recognized as expense and all ESOP shares to be
outstanding for earnings per share computations. Under the "grandfather"
provisions of the new Statement, the Company will not apply the Statement to
shares purchased by the ESOP prior to December 31, 1992. The adoption of this
Statement did not have a material impact on the Company's financial position,
results of operations or earnings per share.
Contingent Liabilities
In January 1992, the Company filed a petition in U.S. Tax Court refuting a
claim for additional Federal income tax asserted by the Internal Revenue Service
(IRS) in December 1991. The asserted additional tax of $28 million, excluding
interest, arises from the IRS' audit of the tax periods ended March 31, 1988 and
December 31, 1988. Substantially all the asserted additional tax relates to
deductions claimed by the Company for depreciation and amortization of tangible
and intangible assets received in the Company's 1987 acquisition of Schwab. The
contested issues extend to the Company's taxable years ended December 31, 1989
through 1993.
Of the $28 million additional tax asserted by the IRS against the Company,
approximately $11 million relates to deductions derived from the amortization of
customer lists. In April 1993, the U.S. Supreme Court ruled in Newark Morning
Ledger Co. v. U.S. that in appropriate circumstances a taxpayer may amortize the
cost of certain intangible assets (such as customer lists) over the useful life
of such assets. While the Supreme Court's decision in Newark Morning Ledger
confirms the Company's ability to amortize for tax purposes certain of its
intangible assets, issues involving the valuation of these intangible assets
remain unresolved in the Company's case with the IRS.
Management believes that these matters will be resolved without a material
adverse effect on the Company's financial position.
In the normal course of its margin lending activities, Schwab is contingently
liable to the Options Clearing Corporation for the margin requirement of
customer margin securities transactions. Such margin requirement is secured by
a pledge of customers' margin securities. This contingent liability was
$75 million at March 31, 1994.
- 4 -
<PAGE>
Regulatory Requirements
Schwab and M&S are subject to the SEC's Uniform Net Capital Rule and each
computes net capital under the alternative method permitted by this Rule, which
requires the maintenance of minimum net capital, as defined, of the greater of
2% of aggregate debit balances arising from customer transactions or a minimum
dollar amount, which is based on the type of business conducted by the broker-
dealer. The minimum dollar amount for both Schwab and M&S is $1 million. Under
the alternative method, a broker-dealer may not repay subordinated borrowings,
pay cash dividends, or make any unsecured advances or loans to its parent or
employees if such payment would result in net capital of less than 5% of
aggregate debit balances or less than 120% of its minimum dollar amount
requirement. At March 31, 1994, Schwab's net capital was $283 million (10.4% of
aggregate debit balances), which was $229 million in excess of its minimum
required net capital and $147 million in excess of 5% of aggregate debit
balances. At March 31, 1994, M&S' net capital was $14 million (214% of
aggregate debit balances), which was $13 million in excess of its minimum
required net capital.
In accordance with the requirements of SEC Rule 15c3-3, Schwab had a portion
of its cash and investments segregated for the exclusive benefit of customers at
March 31, 1994. Under Rule 15c3-3, M&S had no cash reserve requirement at
March 31, 1994.
Cash Flow Information
Certain investing and financing activities of the Company affect its
financial position but do not affect cash flows. The following table summarizes
those transactions (in thousands):
<TABLE>
<CAPTION>
Three Months
Ended
March 31,
1994 1993
---- ----
<S> <C> <C>
Dividends declared,
not yet paid $4,006 $2,873
====== ======
Equipment, office facilities
and property financed $1,843 $1,490
====== ======
Common stock issued to
Profit Sharing Plan for a
note receivable $15,000
=======
</TABLE>
Certain additional information regarding the cash flows of the Company
follows (in thousands):
<TABLE>
<CAPTION>
Three Months
Ended
March 31,
1994 1993
---- ----
<S> <C> <C>
Income taxes paid $ 462 $ 8,173
======= =======
Interest paid:
Customers $30,857 $29,274
Long-term and
subordinated borrowings 4,740 6,196
Other 71 879
------- -------
Total interest paid $35,668 $36,349
======= =======
</TABLE>
Subsequent Event
From April 1, 1994 through May 9, 1994, the Company repurchased and recorded
as treasury stock a total of 250,000 shares of its common stock for $7 million.
- 5 -
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
General
The Charles Schwab Corporation (CSC) and its subsidiaries (collectively
referred to as the Company) provide brokerage and related investment services to
2.6 million active (a) investors, whose assets entrusted to the Company totaled
$100.4 billion at March 31, 1994. With a network of 200 branch offices, the
Company's principal subsidiary, Charles Schwab & Co., Inc. (Schwab), is
physically represented in 46 states and in the United Kingdom. Mayer &
Schweitzer, Inc. (M&S), a market maker in Nasdaq securities, provides trade
execution services to institutional clients and broker-dealers.
The Company's business, like that of other securities brokerage firms, is
directly affected by fluctuations in volumes and price levels in securities
markets, which are in turn affected by many national and international economic
and political factors that cannot be predicted. Transaction-based revenues,
primarily commission and principal transaction revenues, represent the majority
of the Company's revenues. In the short term, most of the Company's expenses do
not vary directly with fluctuations in securities trading volume and do not
increase or decrease quickly, which could result in the Company experiencing
increased profitability with rapid increases in revenue, or reduced
profitability (or losses) in the event of a material reduction in revenues.
Due to the factors discussed above, the results of any interim period are not
necessarily indicative of results for a full year, and it is not unusual for the
Company to experience significant variations in quarterly revenue growth. In
addition, these factors may subject the Company's future earnings and common
stock price to significant volatility.
Three Months Ended March 31, 1994
Compared To Three Months Ended
March 31, 1993
Summary
- - -------
Net income for the first quarter of 1994 totaled $38 million or $.65 per
share compared with net income of $35 million or $.60 per share for the first
quarter of 1993.
First quarter 1994 revenues were $288 million, up 22% from $236 million for
the first quarter of 1993, primarily due to increases in all major revenue
categories. Commission revenues increased 12% and principal transaction
revenues increased 24% due to higher trading volume. Mutual fund service fees
increased 64% due to growth in fund balances.
Assets in customer accounts totaled $100.4 billion at March 31, 1994, $27.4
billion, or 38%, more than a year ago primarily resulting from increases in
customer assets in Schwab's Mutual Fund Marketplace (registered trademark)
of $12.0 billion and increases in customers' equity securities of $8.5
billion. Total customer assets at March 31, 1994 included $22.8 billion in
cash and money market mutual funds compared to $16.6 billion a year earlier.
This growth in customer cash and money market balances contributed to
increased net interest revenue and mutual fund service fees.
Total operating expenses excluding interest during the first quarter of 1994
were $224 million, up 28% from the first quarter of 1993. The higher expenses
primarily related to additional staff and office facilities to support the
Company's expansion and to higher volume-related expenses such as communications
expense and commissions, clearance and floor brokerage expense. During the
first quarter of 1994, the Company opened a new customer telephone service
center, two new branch offices and added 150 employees. A decline in the
Company's effective income tax expense rate
- - ------------
(a) Accounts with balances or activity within the preceding twelve months.
- 6 -
<PAGE>
from the first quarter of 1993 had a positive impact on net income for the first
quarter of 1994.
The after-tax profit margin for the first quarter of 1994 was 13%, down from
15% for the first quarter of 1993. The higher profit margin in the first
quarter of 1993 was primarily due to low levels of staff relative to trading
volume experienced. During periods where actual customer trading
activity exceeds Company expectations, such as that experienced during the
first quarter of 1993, short-term profit margins are temporarily raised.
Such higher short-term profit margins are not sustained over the long term
because staffing is adjusted to levels consistent with customer trading
activity and the Company's service quality standards. Similarly, if
customer trading activity is below Company expectations, short-term profit
margins will decline temporarily until staffing is adjusted to appropriate
levels.
The annualized return on stockholders' equity for the first quarter of 1994
was 36%, down from 44% in the first quarter of 1993, reflecting the
Company's higher equity base in 1994's first quarter.
Commissions
- - -----------
Schwab executes commission transactions for customers on an agency basis.
Commission revenues totaled $161 million for the first quarter of 1994, up 12%
from the first quarter of 1993. Retail agency commissions, which include
commissions relating to retail customer accounts handled by financial advisors,
constitute approximately 95% of total commissions. Remaining commissions
represent business done with institutional customers. Commissions earned on
retail agency trades totaled $155 million on an average daily agency trade level
of 33,300 trades in the first quarter of 1994, compared with commission revenue
of $139 million on an average daily agency trade level of 29,300 for the
comparable period in 1993. The following table shows a comparison of certain
factors that influence retail commission revenue:
<TABLE>
<CAPTION>
- - -------------------------------------------------------------------
Three Months
Ended
March 31, Percent
1994 1993 Change
- - -------------------------------------------------------------------
<S> <C> <C> <C>
Number of retail customer
accounts that traded during the
quarter (in thousands) 643 555 16
Average number of retail agency
transactions per account
that traded 3.27 3.27 ---
Total number of retail agency
transactions (in thousands) 2,098 1,815 16
Average commission per
retail agency transaction $73.85 $76.56 (4)
Total retail commission
revenues (in millions) $ 155 $ 139 12
===================================================================
</TABLE>
Note: The above table excludes customer transactions in Schwab's Mutual Fund
OneSource (trademark) service.
The total number of retail agency transactions executed by Schwab increased
16% from the first quarter of 1993 as Schwab's customer base continued to grow.
Schwab added 234,000 new customer accounts during the first quarter of 1994,
compared to 183,000 new accounts during the first quarter of 1993. The number
of total active customer accounts increased 24% from the year-ago level to 2.6
million at March 31, 1994.
Average commission per retail agency trade has declined from the year-ago
level as the proportion of trades in lower commission per trade products, such
as mutual funds, has increased. This is primarily the result of Schwab's
success in attracting customer mutual fund business, as well as strong price
competition, particularly with respect to customer equity securities
transactions, which yield a higher average commission per trade. Management
believes that such price competition will, in the short term, preclude general
price increases across its product lines. In addition, Schwab recently expanded
its special services program offered to customers that meet certain annual
thresholds of trading activity. The expansion of this program, which includes
discounts from Schwab's standard retail
- 7 -
<PAGE>
commission rates, is intended to attract customers that trade frequently.
Principal Transactions
- - ----------------------
During the first quarter of 1994, principal transaction revenues increased
$10 million, or 24%, from the comparable period in 1993 to $50 million,
primarily due to an increase in trading volume handled by M&S. As a market
maker in Nasdaq securities, M&S generally executes customer orders as principal.
Factors that influence revenues from principal transactions include the volume
of orders and shares executed, and market price volatility. M&S processes
substantially all Nasdaq security trades originated by the customers of Schwab.
Interest Revenue, Net of Interest Expense
- - -----------------------------------------
Interest revenue net of interest expense increased 38% to $36 million from
the prior year's first quarter as shown in the following table (in millions):
<TABLE>
<CAPTION>
- - -------------------------------------------------------
Three Months
Ended
March 31,
1994 1993
- - -------------------------------------------------------
<S> <C> <C>
Interest Revenue
Investments, customer-related $31 $29
Margin loans to customers 38 29
Other 2 2
- - -------------------------------------------------------
Total 71 60
- - -------------------------------------------------------
Interest Expense
Customer cash balances 31 29
Long-term and subordinated
borrowings 3 3
Other 1 2
- - -------------------------------------------------------
Total 35 34
- - -------------------------------------------------------
Interest Revenue, Net of
Interest Expense $36 $26
=======================================================
</TABLE>
Customer-related average daily balances, interest rates, and average net
interest margin for the first quarters of 1994 and 1993 are summarized in the
following table (dollars in millions):
<TABLE>
<CAPTION>
- - ------------------------------------------------------------------
Three Months Ended
March 31,
1994 1993
- - ------------------------------------------------------------------
<S> <C> <C>
Earning Assets (customer-related):
Investments:
Average balance outstanding $3,861 $3,487
Average interest rate 3.30% 3.38%
Margin loans to customers:
Average balance outstanding $2,601 $1,975
Average interest rate 5.96% 6.00%
Average yield on earning assets 4.37% 4.33%
Funding Sources (customer-related
and other):
Interest-bearing customer cash balances:
Average balance outstanding $5,229 $4,574
Average interest rate 2.40% 2.59%
Other interest-bearing sources:
Average balance outstanding $ 353 $ 242
Average interest rate 3.03% 4.64%
Average noninterest-bearing portion $ 880 $ 646
Average interest rate on funding sources 2.11% 2.38%
Summary:
Average yield on earning assets 4.37% 4.33%
Average interest rate on funding sources 2.11% 2.38%
- - ------------------------------------------------------------------
Average net interest margin 2.26% 1.95%
==================================================================
</TABLE>
Interest revenue from customer-related investments increased $2 million due
to an 11% increase in the average balance outstanding, partially offset by an
eight basis point decline in the average rate earned on such investments.
Despite a four basis point decline in the average rate earned on margin loans to
customers, interest earned on such balances increased $9 million as average
margin balances increased 32%. Interest expense on customer cash balances
increased by $2 million due to a 14% increase in average balances outstanding,
partially offset by a 19 basis point decline in interest rates paid on these
balances.
The average net interest margin pertaining to customer-related earning assets
and related funding sources increased 31 basis points over that of 1993's first
quarter. This is primarily due to sharper declines in interest rates with
respect to funding sources compared to interest rate declines
- 8 -
<PAGE>
on margin loans to customers and investments. Margin loans to customers,
which carry a higher average interest rate than investments, represented a
higher proportion of total earning assets during the first quarter of 1994
(40%), compared to the first quarter of 1993 (36%). This relationship
also increased the average net interest margin.
Mutual Fund Service Fees
- - ------------------------
Mutual fund service fees increased $13 million, or 64%, to $34 million in the
first quarter of 1994 from the comparable period in 1993 primarily due to growth
in customer assets. Most of these fees are earned for services provided by
subsidiaries of the Company to proprietary money market mutual funds. Fees
earned for providing record keeping and shareholder services relating to
customer assets purchased through Schwab's no-transaction-fee Mutual Fund
OneSource (trademark) service also contributed to the increase.
Schwab's proprietary funds, collectively referred to as the SchwabFunds
(registered trademark), include money market funds, bond funds and equity index
funds. Customer assets invested in the SchwabFunds averaged $16.8 billion during
the first quarter of 1994 compared to $12.0 billion during the first quarter of
1993.
During the first quarter of 1994, mutual fund trades placed through the
Mutual Fund OneSource service averaged 15,300 per day, including 1,000 trades
per day in SchwabFunds. Since trades handled through the Mutual Fund OneSource
service do not generate commission revenue, they are not included in agency
trade totals. Customer mutual fund assets purchased through the Mutual Fund
OneSource service, excluding SchwabFunds, totaled $9.5 billion at March 31,
1994, up 217% from a year ago.
To help attract and retain customer assets in a highly competitive
environment, the Company previously agreed to absorb all or part of the
operating expenses of many of the SchwabFunds during their first months of
operations and waive certain fees. In certain cases, the Company continues to
waive fees and absorb expenses beyond the original agreement. Although these
actions do not ensure that fund balances will continue to grow at historic
rates, management believes the long-term benefits derived from the growth in
fund balances will outweigh the unfavorable impact on current earnings caused by
these actions.
Expenses Excluding Interest
- - ---------------------------
Total operating expenses excluding interest for the first quarter of 1994
were $224 million, 28% over the first quarter of 1993. Compensation and
benefits expense for the first quarter of 1994 increased $26 million, or 27%, to
$121 million as additional employees were hired in response to the growth in
Schwab's active customer base. Employees, including full-time, part-time, and
temporary employees and persons employed on a contract basis, totaled
approximately 6,700 at March 31, 1994 compared to 4,900 at March 31, 1993.
Communications expense increased $6 million, or 28%, to $28 million from the
prior year's first quarter primarily due to higher postage and printing
costs reflecting increased customer account openings, servicing activity and
promotional mailings. Higher trading and customer call volumes contributed to
higher telephone, financial news and securities quotation services expenses.
Occupancy and equipment expense increased $4 million, or 24%, to $21 million
from the prior year's first quarter primarily due to increased rental and
maintenance costs resulting from branch and customer telephone service
center expansion and to additional equipment rental and software costs.
Depreciation and amortization expense increased $3 million, or 32%, to $13
million from the prior year's first quarter as newly acquired data
processing related assets and leasehold improvements increased the Company's
depreciable fixed asset base from the year-ago period.
Commissions, clearance and floor brokerage expense increased $2 million, or
17%, to
- 9 -
<PAGE>
$13 million from the prior year's first quarter due primarily to an increase
in trading volume handled by M&S.
Advertising and market development expense increased $2 million, or 26%, to
$12 million from the prior year's first quarter as the Company increased
spending on network and cable television and radio advertising.
Professional services expense increased $3 million, or 98%, to $6 million
from the prior year's first quarter due primarily to increases in consulting
fees relating to various company development projects and to an increase in
legal expenses.
The Company currently expects it will need less customer-service capacity
than that utilized during the first quarter of 1994. Accordingly, the Company
has recently initiated steps to reduce staffing-related and other expenses to
levels consistent with lower expected trading volumes.
Income Taxes
- - ------------
The Company's effective income tax rate for the first three months of 1994
was 39.9% compared to 42.4% for the comparable period in 1993. This decline in
the effective rate is primarily due to changes in the Company's estimate of the
anticipated tax effects of the amortization of certain intangible assets (see
discussion of the Supreme Court's April 1993 ruling in Newark Morning Ledger
below).
In January 1992, the Company filed a petition in U.S. Tax Court refuting a
claim for additional Federal income tax asserted by the Internal Revenue Service
(IRS) in December 1991. The asserted additional tax of $28 million, excluding
interest, arises from the IRS' audit of the tax periods ended March 31, 1988 and
December 31, 1988. Substantially all the asserted additional tax relates to the
deductions claimed by the Company for depreciation and amortization of tangible
and intangible assets received in the Company's 1987 acquisition of Schwab. The
issues being contested in the Tax Court by the Company with respect to the
periods audited by the IRS extend to the Company's tax years ended December 31,
1989 through 1993.
Of the $28 million additional tax asserted by the IRS against the Company,
approximately $11 million relates to deductions derived from the amortization of
customer lists. In April 1993, the U. S. Supreme Court ruled in Newark Morning
Ledger Co. v. U.S. that in appropriate circumstances a taxpayer may amortize the
cost of certain intangible assets (such as customer lists) over the useful life
of such assets. While the Supreme Court's decision in Newark Morning Ledger
confirms the Company's ability to amortize for tax purposes certain of
its intangible assets, issues involving the valuation of these intangible
assets remain unresolved in the Company's case with the IRS.
Management believes that these matters will be resolved without a material
adverse effect on the Company's financial position.
Liquidity and Capital Resources
Liquidity
Schwab
Most of Schwab's assets are liquid, consisting primarily of short-term (i.e.,
less than 90 days) investment-grade, interest-earning investments (a substantial
portion of which are segregated for the exclusive benefit of customers pursuant
to regulatory requirements) and receivables from customers and broker-dealers.
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 days.
Liquidity needs relating to customer trading and margin borrowing activities
are met primarily through cash balances in customer accounts, which totaled $6.3
billion at March 31, 1994, up 10% from the December 31, 1993 level of $5.7
billion.
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<PAGE>
Earnings from Schwab's operations are the primary source of liquidity for
capital expenditures and investments in new services, marketing and
technology. Management believes that customer cash balances and operating
earnings will continue to be the primary sources of liquidity for Schwab in the
future.
To manage Schwab's regulatory capital position, CSC provides Schwab with a
$180 million subordinated revolving credit facility maturing in September 1995,
of which $108 million was outstanding at March 31, 1994. At quarter end, Schwab
also had outstanding $25 million in fixed-rate subordinated term loans from CSC
maturing in 1995 and 1996. For use in its brokerage operations, Schwab also
maintains uncommitted bank credit lines totaling $415 million, of which
$335 million is available on an unsecured basis. Schwab used such borrowings
for 11 days during the first three months of 1994, with the daily amounts
borrowed averaging $35 million. These lines were unused at March 31, 1994.
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 cash and
equivalents, receivables from brokers, dealers and clearing organizations and
marketable securities. M&S may borrow up to $10 million under a subordinated
lending arrangement with CSC. Borrowings under this arrangement qualify as
regulatory capital for M&S. This credit facility has never been used.
The Charles Schwab Corporation
CSC's liquidity needs are generally met through cash generated by its
subsidiaries. Schwab and M&S are the principal sources of this liquidity and
are subject to regulatory requirements that are intended to ensure the general
financial soundness and liquidity of broker-dealers. These regulations would
prohibit Schwab and M&S from repaying subordinated borrowings to CSC, paying
cash dividends, or making any unsecured advances or loans to CSC or employees if
such payment would result in net capital for such subsidiary of less than 5% of
its aggregate debit balances or less than 120% of its minimum dollar amount
requirement of $1 million. At March 31, 1994, Schwab had $283 million of net
capital (10.4% of aggregate debit balances), which was $229 million in excess of
its minimum required net capital. At March 31, 1994, M&S had $14 million of net
capital (214% of aggregate debit balances), which was $13 million in excess of
its minimum required net capital. Management believes that funds generated by
Schwab's and M&S' operations will continue to be the primary funding source in
meeting CSC's liquidity needs and maintaining Schwab's and M&S' net capital.
In addition to liquidity needed by the broker-dealer subsidiaries, CSC has
individual liquidity needs that arise from its long-term debt, which includes
$150 million of its Senior Medium-Term Notes, Series A (Medium-Term Notes). The
Medium-Term Notes have maturities ranging from three to ten years and fixed
interest rates ranging from 4.9% to 6.3% with interest payable semiannually.
CSC has a $35 million Senior Term Loan due in March 1995. An interest rate
exchange arrangement has been used to convert the loan's variable interest rate
to a fixed rate of 6.9%. The loan contains covenants, among others, that
require CSC to maintain minimum levels of stockholders' equity, and require
Schwab and M&S to maintain minimum levels of net capital as defined.
In June 1993, CSC renewed its $225 million committed unsecured credit
facility with a group of twelve banks. The funds are available for general
corporate purposes and CSC pays a commitment fee on the unused balance. The
terms of this credit facility require CSC to maintain minimum levels of
stockholders' equity and Schwab to maintain minimum levels of net capital as
defined. This credit facility has never been used.
On April 12, 1994, the SEC declared effective
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<PAGE>
a Registration Statement filed by CSC covering the issuance of up to $100
million aggregate principal amount of debt securities, which may be issued by
CSC from time to time as senior or senior subordinated debt securities, and
may carry fixed or variable interest rates. The net proceeds of the sale of
the debt securities will be used for general corporate purposes.
On April 14, 1994, a Prospectus Supplement covering the issuance of up to
$100 million in Senior or Senior Subordinated Medium-Term Notes, Series A,
pursuant to the Registration Statement was filed with the SEC. Currently, there
are no securities issued under this Prospectus Supplement.
Cash Flows
Cash provided by operating activities was $89 million for the first
three months of 1994, up 38% from $65 million for the first three months of
1993. During 1994's first quarter period, the Company invested $15 million in
equipment, office facilities and property as it continued to expand its branch
office network and customer telephone service center facilities and improve its
data processing and telecommunications systems. The Company opened its fourth
customer telephone service center in January 1994.
During the first three months of 1994, the Company repurchased and recorded
as treasury stock a total of 700,000 shares of its common stock for $19 million.
From April 1, 1994, through May 9, 1994, the Company repurchased an additional
250,000 shares of its common stock for $7 million. Currently, the Company has
authorization from its Board of Directors to repurchase a total of 1,325,000
additional shares of its common stock.
In January 1994, the Board of Directors announced an increase in the
quarterly cash dividend from $.05 per share to $.07 per share. During the first
three months of 1994, the Company paid common stock cash dividends totaling
$4 million, up from $2 million paid during the first three months of 1993.
Capital Adequacy
The Company's stockholders' equity at March 31, 1994 totaled $392 million.
In addition to its equity, the Company had long-term borrowings of $185 million
that bear interest at a weighted average rate of 6.0%. These borrowings,
together with the Company's equity, provided total financial capital of
$577 million at March 31, 1994.
The Company monitors its financial leverage and the adequacy of its capital
base relative to the level and composition of its assets using various financial
measures. One of these measures is the ratio of total assets to total
stockholders' equity. At March 31, 1994, the ratio of total assets to total
stockholders' equity was 19 to 1 compared to a ratio of 18 to 1 at December 31,
1993. Over 90% of the Company's total assets relate to customer activity
(primarily margin loans and segregated investments). Given the Company's
intention of continuing to maintain an appropriate capital base as customer
balances grow, management believes that the Company's present level of equity
could support up to $3 billion of additional assets relating to customer
activity.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
Discussed in Notes to Condensed Consolidated Financial Statements under
Contingent Liabilities in Part I, Item 1, and under Part I, Item 2 -
Management's Discussion and Analysis of Financial Condition and Results of
Operations, under Income Taxes, and incorporated herein by reference.
Item 2. Changes in Securities
None.
Item 3. Defaults Upon Senior Securities
None.
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<PAGE>
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
In March 1994, David S. Pottruck, President of the Company, was named to the
additional positions of Chief Operating Officer of the Company and member of
the Company's Board of Directors.
Item 6. Exhibits and Reports on Form 8-K
(a) Reports on Form 8-K:
On April 14, 1994, the Registrant filed a Current Report on Form 8-K
relating to up to $100 million aggregate principal amount of debt
securities issuable by the Registrant pursuant to Registration
Statement Number 33-50923 declared effective by the SEC on April 12,
1994. Certain exhibits relating to Medium Term Notes, Series A,
issuable pursuant to the Registration Statement are contained in the
Current Report.
(b) The following exhibits are filed as part of this quarterly report on Form
10-Q.
<TABLE>
<CAPTION>
Exhibit
Number Exhibit
- - -----------------------------------------
<S> <C>
4.2*
11.1 Computation of Earnings per
Common Equivalent Share.
12.1 Computation of Ratio of Earnings
to Fixed Charges.
</TABLE>
* Neither the Registrant nor its subsidiaries are parties to any instrument
with respect to long-term debt for which securities authorized thereunder
exceed 10% of the total assets of the Registrant and its subsidiaries on a
consolidated basis. Copies of instruments with respect to long-term debt of
lesser amounts will be provided to the SEC upon request.
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<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE CHARLES SCHWAB CORPORATION
(Registrant)
Date: May 13, 1994 A. John Gambs /s/
----------------------------------
A. John Gambs
Executive Vice President - Finance,
and Chief Financial Officer
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<PAGE>
EXHIBIT 11.1
THE CHARLES SCHWAB CORPORATION
Computation of Earnings per Common Equivalent Share
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1994 1993
---- ----
<S> <C> <C>
Net Income $38,190 $35,392
===============================================================================
Shares
Weighted average number of common
shares outstanding 56,977 57,289
Common stock equivalent shares
related to option plans 1,826 1,695
- - -------------------------------------------------------------------------------
Weighted average number of common and
common equivalent shares outstanding 58,803 58,984
===============================================================================
Earnings per Common Equivalent Share $ .65 $ .60
===============================================================================
</TABLE>
<PAGE>
EXHIBIT 12.1
THE CHARLES SCHWAB CORPORATION
Computation of Ratio of Earnings to Fixed Charges
(Dollar amounts in thousands, unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1994 1993
---- ----
<S> <C> <C>
Earnings before income taxes $ 63,544 $61,391
- - -------------------------------------------------------------------------------------
Fixed charges:
Interest expense - customer 30,949 29,245
Interest expense - other 4,281 4,407
Interest portion of rental expense 4,031 3,664
- - -------------------------------------------------------------------------------------
Total fixed charges (a) 39,261 37,316
- - -------------------------------------------------------------------------------------
Earnings before income taxes and fixed charges (b) $102,805 $98,707
=====================================================================================
Ratio of earnings to fixed charges (b) (divided by) (a)* 2.6 2.6
=====================================================================================
Ratio of earnings to fixed charges as adjusted** 8.6 8.6
=====================================================================================
* The ratio of earnings to fixed charges is calculated in a manner consistent
with SEC requirements. For such purposes, "earnings" consist of earnings
before income taxes and fixed charges. "Fixed charges" consist of interest
expense incurred on payables to customers, subordinated borrowings, term debt,
capitalized interest, and one-third of rental expense, which is estimated
to be representative of the interest factor.
** Because interest expense incurred in connection with payables to customers is
completely offset by interest revenue on related investments and margin
loans, the Company considers such interest to be an operating expense.
Accordingly, the ratio of earnings to fixed charges as adjusted reflects the
elimination of such interest expense as a fixed charge.
</TABLE>
<PAGE>
