UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1998 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.
266,930,923 shares of $.01 par value Common Stock
Outstanding on July 28, 1998
<PAGE>
THE CHARLES SCHWAB CORPORATION
THE CHARLES SCHWAB CORPORATION
Quarterly Report on Form 10-Q
For the Quarter Ended June 30, 1998
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 7-20
Item 3. Quantitative and Qualitative Disclosures About Market
Risk 20-21
Part II - Other Information
Item 1. Legal Proceedings 21
Item 2. Changes in Securities and Use of Proceeds 21
Item 3. Defaults Upon Senior Securities 21
Item 4. Submission of Matters to a Vote of Security Holders 21-22
Item 5. Other Information 22
Item 6. Exhibits and Reports on Form 8-K 22
Signature 23
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, Company
contingencies, strategy, revenues, profit margin, 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 "Description of
Business" 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.
<PAGE>
THE CHARLES SCHWAB CORPORATION
Part 1 - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
<TABLE>
THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(In thousands, except per share amounts)
(Unaudited)
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues
Commissions $ 299,332 $ 261,396 $ 597,177 $ 536,315
Mutual fund service fees 136,360 101,824 261,742 196,522
Interest revenue, net of interest expense(1) 116,277 82,485 220,868 159,208
Principal transactions 59,078 63,598 111,736 132,733
Other 26,913 21,481 50,843 41,660
- ----------------------------------------------------------------------------------------------------------------
Total 637,960 530,784 1,242,366 1,066,438
- ----------------------------------------------------------------------------------------------------------------
Expenses Excluding Interest
Compensation and benefits 278,813 224,119 544,686 444,957
Communications 53,026 45,511 100,070 91,212
Occupancy and equipment 51,536 38,490 96,706 73,904
Advertising and market development 27,567 25,954 67,717 61,789
Depreciation and amortization 35,255 29,686 69,450 57,459
Commissions, clearance and floor brokerage 20,509 22,217 39,858 44,661
Professional services 22,433 16,573 41,480 30,454
Other 22,940 22,491 44,184 45,939
- ----------------------------------------------------------------------------------------------------------------
Total 512,079 425,041 1,004,151 850,375
- ----------------------------------------------------------------------------------------------------------------
Income before taxes on income 125,881 105,743 238,215 216,063
Taxes on income 49,525 41,781 93,895 85,366
- ----------------------------------------------------------------------------------------------------------------
Net Income $ 76,356 $ 63,962 $ 144,320 $ 130,697
================================================================================================================
Weighted-average number of common shares outstanding(2, 3) 273,128 271,637 273,976 271,439
================================================================================================================
Earnings Per Share(2)
Basic $ .29 $ .24 $ .55 $ .50
Diluted $ .28 $ .23 $ .53 $ .48
================================================================================================================
Dividends Declared Per Common Share(2) $ .040 $ .033 $ .080 $ .066
================================================================================================================
(1) Interest revenue is presented net of interest expense. Interest expense for the three months ended
June 30, 1998 and 1997 was $160,643 and $133,126, respectively. Interest expense for the six months
ended June 30, 1998 and 1997 was $316,238 and $256,256, respectively.
(2) Reflects the September 1997 three-for-two common stock split.
(3) Amounts shown are used to calculate diluted earnings per share.
See Notes to Condensed Consolidated Financial Statements.
- 1 -
</TABLE>
<PAGE>
<TABLE>
THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(In thousands, except per share amounts)
(Unaudited)
<CAPTION>
June 30, December 31,
1998 1997
---- ----
<S> <C> <C>
Assets
Cash and cash equivalents $ 915,528 $ 797,447
Cash and investments required to be segregated under federal or other
regulations (including resale agreements of $5,110,264 in 1998
and $4,707,187 in 1997) 7,109,290 6,774,024
Receivable from brokers, dealers and clearing organizations 405,448 267,070
Receivable from customers - net 9,021,642 7,751,513
Securities owned - at market value 232,389 282,569
Equipment, office facilities and property - net 364,518 342,273
Intangible assets - net 50,791 55,854
Other assets 165,536 210,957
- ---------------------------------------------------------------------------------------------------------------
Total $ 18,265,142 $ 16,481,707
===============================================================================================================
Liabilities and Stockholders' Equity
Drafts payable $ 226,035 $ 268,644
Payable to brokers, dealers and clearing organizations 1,339,115 1,122,663
Payable to customers 14,622,864 13,106,202
Accrued expenses and other liabilities 471,442 478,032
Borrowings 391,004 361,049
- ---------------------------------------------------------------------------------------------------------------
Total liabilities 17,050,460 15,336,590
- ---------------------------------------------------------------------------------------------------------------
Stockholders' equity:
Preferred stock - 9,940 shares authorized; $.01 par value
per share; none issued
Common stock - 500,000 shares authorized; $.01 par value per share;
267,688 shares issued in 1998 and 1997 2,677 2,677
Additional paid-in capital 209,519 241,422
Retained earnings 1,078,659 955,496
Treasury stock - 1,093 shares in 1998 and 1,753 shares in 1997,
at cost (37,535) (35,401)
Unearned ESOP shares (1,471) (2,769)
Unamortized restricted stock compensation (38,685) (17,228)
Foreign currency translation adjustment 1,518 920
- ---------------------------------------------------------------------------------------------------------------
Total stockholders' equity 1,214,682 1,145,117
- ---------------------------------------------------------------------------------------------------------------
Total $ 18,265,142 $ 16,481,707
===============================================================================================================
See Notes to Condensed Consolidated Financial Statements.
- 2 -
</TABLE>
<PAGE>
<TABLE>
THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
(Unaudited)
<CAPTION>
Six Months Ended
June 30,
1998 1997
---- ----
<S> <C> <C>
Cash flows from operating activities
Net income $ 144,320 $ 130,697
Noncash items included in net income:
Depreciation and amortization 69,450 57,459
Compensation payable in common stock 15,036 13,300
Deferred income taxes 460 (8,553)
Other 324 1,643
Change in securities owned - at market value 50,180 (62,113)
Change in other assets 44,809 43,710
Change in accrued expenses and other liabilities 28,957 25,785
- ---------------------------------------------------------------------------------------------------------
Net cash provided before change in customer-related balances 353,536 201,928
- ---------------------------------------------------------------------------------------------------------
Change in customer-related balances:
Cash and investments required to be segregated under
federal or other regulations (330,678) 197,937
Receivable from brokers, dealers and clearing organizations (135,818) (66,250)
Receivable from customers (1,268,545) (900,557)
Drafts payable (42,817) (15,871)
Payable to brokers, dealers and clearing organizations 215,009 176,030
Payable to customers 1,510,485 595,674
- ---------------------------------------------------------------------------------------------------------
Net change in customer-related balances (52,364) (13,037)
- ---------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 301,172 188,891
- ---------------------------------------------------------------------------------------------------------
Cash flows from investing activities
Purchase of equipment, office facilities and property - net (85,401) (69,621)
- ---------------------------------------------------------------------------------------------------------
Net cash used by investing activities (85,401) (69,621)
- ---------------------------------------------------------------------------------------------------------
Cash flows from financing activities
Proceeds from borrowings 30,000 10,000
Dividends paid (21,285) (17,571)
Purchase of treasury stock (122,477) (15,702)
Proceeds from stock options exercised and other 15,926 3,590
- ---------------------------------------------------------------------------------------------------------
Net cash used by financing activities (97,836) (19,683)
- ---------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents 146 550
- ---------------------------------------------------------------------------------------------------------
Increase in cash and cash equivalents 118,081 100,137
Cash and cash equivalents at beginning of period 797,447 633,317
- ---------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 915,528 $ 733,454
=========================================================================================================
See Notes to Condensed Consolidated Financial Statements.
- 3 -
</TABLE>
<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
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 278 domestic branch offices in 47 states, as well as a branch
in both the Commonwealth of Puerto Rico and the United Kingdom. Another
subsidiary, Mayer & Schweitzer, Inc. (M&S), a market maker in Nasdaq and other
securities, provides trade execution services to broker-dealers, including
Schwab, and institutional customers. Other subsidiaries include Charles Schwab
Investment Management, Inc., the investment advisor for Schwab's proprietary
mutual funds, and Charles Schwab Europe, a retail discount securities brokerage
firm located in the United Kingdom.
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 1997 Annual Report to Stockholders, which are
incorporated by reference in the Company's 1997 Annual Report on Form 10-K and
the Company's Quarterly Report on Form 10-Q for the period ended March 31, 1998.
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 1998 presentation.
New Accounting Standards
Statement of Financial Accounting Standards (SFAS) No. 125 - Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities, was adopted by the Company in 1997, except for certain financial
assets for which the effective date had been delayed by SFAS No. 127 - Deferral
of the Effective Date of Certain Provisions of FASB Statement No. 125, which was
adopted by the Company effective January 1, 1998. SFAS No. 125 provides
accounting and reporting standards for transfers and servicing of financial
assets and extinguishments of liabilities. The adoption of these statements did
not have an effect on the Company's financial position, results of operations,
earnings per share or cash flows.
SFAS No. 130 - Reporting Comprehensive Income, was adopted by the Company
effective January 1, 1998. This statement 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 Six
Months Ended Months Ended
June 30, June 30,
1998 1997 1998 1997
- --------------------------------------------------------------------------------
Net income $ 76,356 $ 63,962 $144,320 $130,697
Foreign currency
translation adjustment (136) 914 598 (1,651)
- --------------------------------------------------------------------------------
Total comprehensive
income $ 76,220 $ 64,876 $144,918 $129,046
================================================================================
SFAS No. 131 - Disclosures about Segments of an Enterprise and Related
Information, was issued in 1997 and the Company is required to adopt this
statement at December 31, 1998. This statement establishes standards for
disclosures related to business operating segments. The adoption of this
statement will not have an effect on the Company's financial position, results
of operations, earnings per share or cash flows, but will impact financial
statement disclosure.
SFAS No. 133 - Accounting for Derivative Instruments and Hedging
Activities, was issued in June 1998 and the Company is required to adopt this
statement by January 1, 2000. 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. While
the Company is currently evaluating the effects of this statement, its adoption
is not expected to have an impact on the Company's financial position, results
of operations, earnings per share or cash flows.
Statement of Position 98-1 - Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use, was issued in March 1998 and is
effective for fiscal years beginning after December 15, 1998. This statement
requires that certain costs incurred for purchasing or developing software for
internal use be capitalized and amortized over the software's useful life.
Currently, the Company capitalizes costs incurred for purchasing software for
internal use, but expenses costs incurred for developing software for internal
use. While the Company is currently evaluating the effects of this statement,
its adoption is expected to have an impact on the Company's financial position,
results of operations, and earnings per share.
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 Six
Months Ended Months Ended
June 30, June 30,
1998 1997 1998 1997
- -------------------------------------------------------------------------------
Net income $ 76,356 $ 63,962 $144,320 $130,697
===============================================================================
Basic Shares (1):
Weighted-average
common shares
outstanding 263,910 261,978 264,298 261,759
===============================================================================
Diluted Shares (1):
Weighted-average
common shares
outstanding 263,910 261,978 264,298 261,759
Common stock
equivalent shares
related to stock
incentive plans 9,218 9,659 9,678 9,680
- -------------------------------------------------------------------------------
Diluted weighted-
average common
shares outstanding 273,128 271,637 273,976 271,439
===============================================================================
Basic EPS (1) $ .29 $ .24 $ .55 $ .50
===============================================================================
Diluted EPS (1) $ .28 $ .23 $ .53 $ .48
===============================================================================
(1) Reflects the September 1997 three-for-two common stock split.
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 June 30, 1998, Schwab's net
capital was $931 million (10% of aggregate debit balances), which was $751
million in excess of its minimum required net capital and $481 million in excess
of 5% of aggregate debit balances. At June 30, 1998, M&S' net capital was $5
million (532% of aggregate debit balances), which was $4 million in excess of
its minimum required net capital.
Schwab and Charles Schwab Europe had portions of their cash and
investments segregated for the exclusive benefit of customers at June 30, 1998,
in accordance with applicable regulations. M&S had no such cash reserve
requirement at June 30, 1998.
Commitments and Contingent Liabilities
The staff of the SEC has indicated that it intends to recommend to the SEC
that it initiate a civil enforcement action against numerous broker-dealers and
individuals, including M&S and certain individuals associated with M&S, in
connection with certain customs and practices in the trading of Nasdaq
securities. The subject matter of the allegations is similar and related to
those in the U.S. Department of Justice antitrust proceeding settled by M&S in
July 1996, the SEC's enforcement action against the National Association of
Securities Dealers, Inc. and Nasdaq settled in August 1996, and the private
antitrust actions settled by M&S in December 1997.
Between August 12, 1993 and November 17, 1995, Schwab was named as a
defendant in eleven class action lawsuits in seven states. The class actions all
purport to be brought on behalf of customers of Schwab who purchased or sold
securities for which Schwab received "order flow" payments from the market
maker, stock dealer or third party who executed the transaction. The complaints
generally allege that Schwab failed to disclose and remit such payments to
members of the class, and generally seek damages equal to the payments received
by Schwab. Through June 1998, one of the actions was voluntarily dismissed and
six were resolved favorably to Schwab on the grounds that the claims asserted
are preempted by federal law. The remaining four cases are pending in state
courts in Texas, California and Louisiana. The action in California has been
dismissed, and plaintiffs have filed an appeal. The actions in Texas and in
Natchitoches Parish, Louisiana, have been stayed. On April 8, 1998, in a case
filed in the Civil District Court for the Parish of Orleans in Louisiana, the
Louisiana Court of Appeals unanimously ruled in favor of Schwab's motion to
dismiss on the grounds of federal preemption. On May 4, 1998, this action was
remanded to the district court for resolution of an issue relating to Schwab's
compliance with SEC Rule 10b-10, which governs disclosure on customer
confirmations.
The ultimate outcome of the legal proceedings described above and the
various other civil actions, arbitration proceedings, and claims pending against
the Company cannot be determined at this time, and the results of these legal
proceedings cannot be predicted with certainty. There can be no assurance that
these legal proceedings 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 and results of operations. However, it is the
opinion of management, after consultation with outside legal counsel, that the
ultimate outcome of these actions will not have a material adverse impact on the
financial condition or operating results of the Company.
Supplemental Cash Flow Information
Certain information affecting the cash flows of the Company follows (in
thousands):
- -------------------------------------------------------
Six Months Ended
June 30,
1998 1997
- -------------------------------------------------------
Income taxes paid $ 62,037 $ 67,961
=======================================================
Interest paid:
Customer cash balances $279,552 $221,877
Stock-lending activities 19,576 16,929
Borrowings 11,543 9,144
Other 5,604 4,102
- -------------------------------------------------------
Total interest paid $316,275 $252,052
=======================================================
<PAGE>
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 5.3 million active customer accounts(a). Customer assets were
$427.6 billion at June 30, 1998. CSC's principal subsidiary, Charles Schwab &
Co., Inc. (Schwab), is a securities broker-dealer with 278 domestic branch
offices in 47 states, as well as a branch in both the Commonwealth of Puerto
Rico and the United Kingdom. Another subsidiary, Mayer & Schweitzer, Inc. (M&S),
a market maker in Nasdaq and other securities, provides trade execution services
to broker-dealers and institutional customers. Other subsidiaries include
Charles Schwab Investment Management, Inc., the investment advisor for Schwab's
proprietary mutual funds, and Charles Schwab Europe, a retail discount
securities brokerage firm located in the United Kingdom.
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,
equity securities market-making and 401(k) defined contribution plans. 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 distinguish the Schwab brand as well as its products and services. These
programs helped the Company open 347,000 new customer accounts and gather $17.5
billion in net new customer assets during the second quarter of 1998.
The Company offers a broad range of value-oriented products and services
to meet customers' varying investment and financial needs. The Company also
offers access to extensive investment news and information. The Company's branch
office network assists investors in developing asset allocation strategies and
evaluating their investment choices. Branch staff also refer investors who
desire additional guidance to independent investment managers through the Schwab
AdvisorSource(TM) service. Schwab provides custodial, trading and support
services to over 5,300 independent investment managers. As of June 30, 1998,
Schwab held $128.3 billion in customer assets in accounts managed by these
investment managers. The Company's Mutual Fund Marketplace(R) provides customers
with the ability to invest in 1,527 mutual funds from 246 fund families,
including 923 Mutual Fund OneSource(R) funds.
- --------
(a) Accounts with balances or activity within the preceding twelve months.
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. 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 and
execute trades on an automated basis through the Company's electronic brokerage
channels that provide both online and telephonic access. Online channels include
PC-based services such as SchwabLink(R) - a service for investment managers, and
the Charles Schwab Web Site(TM) - an information and trading service on the
Internet. Automated telephonic channels include TeleBroker(R) - Schwab's
touch-tone telephone trading service, and VoiceBroker(TM) - Schwab's voice
recognition quote service. Schwab provides every retail customer access to all
delivery channels and flat-fee pricing for Internet-based trades.
The Company's ongoing investment in technology is a key element in
enhancing its delivery systems, providing fast and consistent customer service,
and reducing processing costs. The Company uses technology to empower its
customers to manage their financial affairs and is a forerunner in driving
technological advancements in the financial services industry. During the second
quarter of 1998, Schwab introduced the Mutual Fund Performance Profile(TM), a
new Internet-based investment service which enables investors to evaluate the
historical performance of mutual funds in their portfolios. Also during the
second quarter of 1998, Charles Schwab Europe launched the first Web site in the
United Kingdom to offer online trading in sterling securities listed on the
London Stock Exchange. In addition, Schwab introduced a Web site that enables
investors to review their accounts and trade securities in Chinese.
The Company's operations are highly dependent on the integrity of its
computer and technological systems and the Company's success depends, in part,
on its ability to make timely enhancements and additions to its technology to
anticipate customer demands. To the extent the Company experiences system
interruptions, errors or downtime (which could result from a variety of causes,
including changes in customer use patterns, technological failure, changes to
its systems, linkages with third-party systems, and power failures), the
Company's business and operations could be negatively impacted.
The Company faces significant competition from companies seeking to
attract customer financial assets, including full commission brokerage firms,
discount brokerage firms, mutual fund companies and banks. Certain of these
competitors have significantly greater financial resources than the Company,
particularly given the acceleration of the consolidation trend within the
financial services industry in the first half of 1998. In addition, the recent
expansion and customer acceptance of conducting financial transactions online
has attracted competition from providers of online services and software
development companies. In the first half of 1998, price competition continued in
the area of online investing as competitors sought to gain market share in this
rapidly growing area. Increased competition can be expected due to the low
barriers to entry for the establishment and operation of online investment
services. The Company experienced declines in its average commission per revenue
trade in the first half of 1998 mainly due to the Company's integration of its
online and traditional brokerage services and reduction of the price of online
trades for most of its customers, causing an increase in the proportion of
trades placed through its online brokerage channels. As the Company focuses on
further enhancements to its electronic service offering, average commission per
revenue trade is expected to continue to decline. These competitive factors,
pricing changes and trading trends may negatively impact the Company's revenue
growth and profit margin.
The Company's business, like that of other securities brokerage firms, is
directly affected by the fluctuations in securities trading volumes and price
levels that occur in fundamentally cyclical financial markets. Since
transaction-based revenues continue to represent a majority of the Company's
revenues, the Company may experience significant variations in revenues from
period to period.
The Company adjusts its expenses in anticipation of and in response to
changes in financial market conditions and customer trading patterns. Certain of
the Company's expenses (including variable compensation, portions of
communications, and commissions, clearance and floor brokerage) vary directly
with changes in financial performance or customer trading activity. Expenses
relating to the level of temporary employees, contractors, overtime hours,
professional services, and advertising and market development are adjustable
over the short term to help the Company achieve its financial objectives.
Additionally, developmental spending (including branch openings, product and
service rollouts, and technology enhancements) is discretionary and can be
altered in response to market conditions. However, a significant portion of the
Company's expenses such as salaries and wages, occupancy and equipment, and
depreciation and amortization do not vary directly, at least in the short term,
with fluctuations in revenues or securities trading volumes. Also, the Company
views its developmental spending as essential for future growth and therefore
attempts to avoid major adjustments in such spending unless faced with a
sustained slowdown in customer trading activity. Given the nature of the
Company's revenues and expenses, and the economic and competitive factors
discussed above, 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.
In addition to historical information, this interim report contains
forward-looking statements that reflect management's expectations. These
statements relate to, among other things, Company contingencies (see
"Commitments and Contingent Liabilities" note in the Notes to Condensed
Consolidated Financial Statements), the Company's strategy (see Description of
Business), revenues (see Principal Transactions), profit margin (see Principal
Transactions), 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. Important
factors that may cause such differences are noted throughout this interim report
and include, but are not limited to: the effect of customer trading patterns on
Company revenues and earnings; changes in technology; computer system failures;
risks associated with the Year 2000 computer system conversions; the effects of
competitors' pricing, product and service decisions and intensified competition;
evolving regulation and changing industry customs and practices adversely
affecting the Company; adverse results of litigation; changes in revenues and
profit margin due to cyclical securities markets and interest rates; 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 June 30, 1998
Compared To Three Months Ended
June 30, 1997
Financial Overview
Net income for the second quarter of 1998 was $76 million, up 19% from
second quarter 1997 net income of $64 million. Diluted earnings per share for
the second quarters of 1998 and 1997 were $.28 and $.23 per share, respectively.
Share and per share data have been restated to reflect the effects of the
September 1997 three-for-two common stock split.
Second quarter 1998 revenues were $638 million, up 20% from $531 million
for the second quarter of 1997, primarily due to a 15% increase in commission
revenues, a 34% increase in mutual fund service fees, and a 41% increase in
interest revenue, net of interest expense (referred to as net interest revenue).
These increases mainly resulted from higher trading volume and increases in
customer assets and margin loans to customers. During the second quarter of
1998, total trading activity reached record levels as shown in the following
table (in thousands):
- -------------------------------------------------------------
Three Months
Ended
June 30, Percent
Daily Average Trades 1998 1997 Change
- -------------------------------------------------------------
Revenue Trades
Online 48.9 22.6 116%
TeleBroker(R) 7.9 10.9 (28)
Regional customer telephone
service centers, branch offices
and other 31.2 30.5 2
- -------------------------------------------------------------
Total 88.0 64.0 38%
=============================================================
Mutual Fund OneSource(R) Trades
Online 17.0 12.5 36%
TeleBroker 1.0 1.2 (17)
Regional customer telephone
service centers, branch offices
and other 21.4 18.8 14
- -------------------------------------------------------------
Total 39.4 32.5 21%
=============================================================
Total Daily Average Trades
Online 65.9 35.1 88%
TeleBroker 8.9 12.1 (26)
Regional customer telephone
service centers, branch offices
and other 52.6 49.3 7
- -------------------------------------------------------------
Total 127.4 96.5 32%
=============================================================
Assets in Schwab customer accounts were $427.6 billion at June 30, 1998,
an increase of $121.3 billion, or 40%, from a year ago as shown in the table
below. This increase resulted from net new customer assets of $77.8 billion and
net market gains of $43.5 billion.
- ----------------------------------------------------------
Growth in Schwab Customer
Assets and Accounts
(In billions, at quarter end, June 30, Percent
except as noted) 1998 1997 Change
- ----------------------------------------------------------
Assets in Schwab customer accounts
Schwab One(R) and other
cash equivalents (1) $ 13.8 $ 11.1 24%
SchwabFunds(R):
Money market funds (1) 55.5 43.8 27
Equity and bond funds 11.2 5.4 107
- -----------------------------------------------------------
Total SchwabFunds 66.7 49.2 36
- -----------------------------------------------------------
Mutual Fund Marketplace(R)(2):
Mutual Fund OneSource 69.3 49.5 40
All other 58.0 42.9 35
- -----------------------------------------------------------
Total Mutual Fund
Marketplace 127.3 92.4 38
Equity and other securities(2) 196.4 130.4 51
Fixed income securities 32.3 29.3 10
Margin loans outstanding (8.9) (6.1) 46
- -----------------------------------------------------------
Total $ 427.6 $ 306.3 40%
===========================================================
Net growth in assets in Schwab
customer accounts
(for the quarter ended)
Net new customer assets $ 17.5 $ 12.0 46%
Net market gains 3.4 26.7 (87)
- -----------------------------------------------------------
Net growth $ 20.9 $ 38.7 (46%)
============================================================
New Schwab customer accounts
(in thousands, for the
quarter ended) 347.3 290.1 20%
Active Schwab customer accounts
(in millions) 5.3 4.4 20
============================================================
(1) Represents a component of customer cash and equivalents.
(2) Excludes money market funds and all of Schwab's proprietary
money market, equity and bond funds.
Total operating expenses excluding interest during the second quarter of
1998 were $512 million, up 20% from $425 million for the second quarter of 1997,
primarily resulting from additional staff and related costs.
The after-tax profit margin for the second quarter of 1998 was 12.0%, down
slightly from 12.1% for the second quarter of 1997. The annualized return on
stockholders' equity for the second quarter of 1998 was 26%, down from 27% for
the second quarter of 1997, reflecting the Company's higher equity base in the
second quarter of 1998.
REVENUES
- -------------------------------------------------------------
Three Months
Ended
June 30,
Composition of Revenues 1998 1997
- -------------------------------------------------------------
Commissions 47% 49%
Mutual fund service fees 21 19
Net interest revenue 18 16
Principal transactions 9 12
Other 5 4
- ------------------------------------------------------------
Total 100% 100%
=============================================================
Commissions
Commission revenues for the Company were $299 million for the second
quarter of 1998, up $38 million, or 15%, from the second quarter of 1997. As
shown in the table below, the total number of revenue trades executed by the
Company has increased 35% as the Company's customer base has grown. Average
commission per revenue trade decreased 15%. This decrease was mainly due to the
Company's reduction of the price of online trades for most of its customers in
the first quarter of 1998, causing relatively more trades to be placed through
online brokerage channels.
- ---------------------------------------------------------
Three Months
Commissions Earned Ended
on Customer Revenue June 30, Percent
Trades 1998 1997 Change
- ---------------------------------------------------------
Customer accounts that
traded during the quarter
(in thousands) 1,263 1,000 26%
Average customer
revenue trades
per account 4.38 4.09 7
Total revenue
trades (in thousands) 5,534 4,091 35
Average commission
per revenue trade $ 54.12 $ 63.59 (15)
Commissions earned
on customer revenue
trades (in millions) (1) $ 299 $ 260 15
=========================================================
(1) Excludes commissions on trades with specialists
totaling $1 million in the second quarter of 1997.
Attracting new customer accounts is important in generating commission
revenues. Schwab added 347,000 new customer accounts during the second quarter
of 1998, an increase of 20% from the 290,000 new accounts added during the
second quarter of 1997.
Mutual Fund Service Fees
Mutual fund service fees were $136 million for the second quarter of 1998,
up $35 million, or 34%, from the second quarter of 1997. This increase was
primarily due to significant increases in customer assets in funds purchased
through Schwab's Mutual Fund OneSource(R) service, and in customer assets in
Schwab's proprietary funds, collectively referred to as the SchwabFunds(R) (see
Growth in Schwab Customer Assets and Accounts table in Financial Overview). The
Company earns mutual fund service fees for transfer agent services, shareholder
services, administration and investment management provided to the SchwabFunds,
as well as record keeping and shareholder services provided to funds in the
Mutual Fund OneSource service.
Net Interest Revenue
Net interest revenue was $116 million for the second quarter of 1998, up
$34 million, or 41%, from the second quarter of 1997 as shown in the following
table (in millions):
- ------------------------------------------------------------
Three Months
Ended
June 30,
1998 1997
- ------------------------------------------------------------
Interest Revenue
Margin loans to customers $ 169 $ 111
Investments, customer-related 96 96
Other 12 8
- ------------------------------------------------------------
Total 277 215
- ------------------------------------------------------------
Interest Expense
Customer cash balances 142 116
Stock-lending activities 10 10
Borrowings 6 5
Other 3 2
- ------------------------------------------------------------
Total 161 133
- ------------------------------------------------------------
Net interest revenue $ 116 $ 82
============================================================
Customer-related daily average balances, interest rates and average net
interest margin for the second quarters of 1998 and 1997 are summarized in the
following table (dollars in millions):
- -----------------------------------------------------------
Three Months Ended
June 30,
1998 1997
- -----------------------------------------------------------
Interest-Earning Assets (customer-related):
Investments:
Average balance outstanding $ 7,290 $ 7,193
Average interest rate 5.29% 5.36%
Margin loans to customers:
Average balance outstanding $ 8,825 $ 5,774
Average interest rate 7.67% 7.73%
Average yield on interest-earning assets 6.59% 6.42%
Funding Sources (customer-related
and other):
Interest-bearing customer cash balances:
Average balance outstanding $12,841 $10,406
Average interest rate 4.44% 4.47%
Other interest-bearing sources:
Average balance outstanding $ 1,345 $ 1,108
Average interest rate 4.32% 4.56%
Average noninterest-bearing portion $ 1,929 $ 1,453
Average interest rate on funding sources 3.90% 3.98%
Summary:
Average yield on interest-earning assets 6.59% 6.42%
Average interest rate on funding sources 3.90% 3.98%
- -----------------------------------------------------------
Average net interest margin 2.69% 2.44%
===========================================================
The increase in net interest revenue from the second quarter of 1997 was
primarily due to higher levels of margin loans to customers.
Principal Transactions
Principal transaction revenues were $59 million for the second quarter of
1998, down $5 million, or 7%, from the second quarter of 1997. This decrease was
primarily due to lower average revenue per principal transaction (see discussion
below), partially offset by greater share volume handled by M&S.
Certain new Securities and Exchange Commission (SEC) rules and rule
amendments, known as the Order Handling Rules, have significantly altered the
manner in which orders for both Nasdaq and exchange-listed securities are
handled. These rules were implemented in phases between January 20, 1997 and
October 13, 1997. Additionally, in June 1997, most major U.S. securities
markets, including Nasdaq and the New York Stock Exchange, Inc., began quoting
and trading securities in increments of one-sixteenth dollar per share instead
of one-eighth dollar per share for most securities, and these markets are
currently considering further reductions in the increments by which securities
are priced. Mainly as a result of these regulatory changes and changes in
industry customs and practices, average revenue per principal transaction
declined in the second quarter of 1998 as compared to the same period in 1997.
Average revenue per principal transaction increased, however, in the second
quarter of 1998 compared to the first quarter of 1998. Since the change to
trading securities in increments of one-sixteenth dollar per share was
implemented in June 1997 and the Order Handling Rules were not fully implemented
until October 1997, the Company expects M&S' average revenue per principal
transaction for 1998 to be materially less than during comparable periods of
1997. Two proposed regulatory changes, the National Association of Securities
Dealers, Inc.'s (NASD) Next Nasdaq trading system, and the Primary Market Maker
Rules, have the potential to further reduce M&S' principal transaction revenues,
although the Company is working with the NASD to modify these proposals to
minimize their impact.
See "Commitments and Contingent Liabilities" note in Item 1. Notes to
Condensed Consolidated Financial Statements regarding certain civil litigation
relating to various principal transaction activities.
Expenses Excluding Interest
Compensation and benefits expense was $279 million for the second quarter
of 1998, up $55 million, or 24%, from the second quarter of 1997 primarily due
to a greater number of employees. The following table shows a comparison of
certain compensation and benefits components and employee data (in thousands):
- -------------------------------------------------------------
Three Months
Ended
June 30,
1998 1997
- -------------------------------------------------------------
Compensation and benefits expense as a
% of revenues 44% 42%
Variable compensation as a
% of compensation and benefits expense 21% 20%
Compensation for temporary employees,
contractors and overtime hours as a
% of compensation and benefits expense 15% 15%
Full-time equivalent employees(1) 13.2 11.2
Revenues per average full-time equivalent
employee $48.1 $47.1
=============================================================
(1) Includes full-time, part-time and temporary employees,
and persons employed on a contract basis.
Occupancy and equipment expense was $52 million in the second quarter of
1998, up $13 million, or 34%, from the second quarter of 1997. This increase was
primarily due to additional lease expenses on the Company's expanded office
space, as well as increased lease and maintenance expenses on data processing
equipment.
Advertising and market development expense was $28 million in the second
quarter of 1998, up $2 million, or 6%, from the second quarter of 1997. This
increase was primarily due to online advertising, as well as increased media
spending, partially offset by reduced direct mail spending. Advertising and
market development expense was 4% and 5% of revenues for the second quarters of
1998 and 1997, respectively.
Depreciation and amortization expense was $35 million in the second
quarter of 1998, up $6 million, or 19%, from the second quarter of 1997. This
increase was primarily due to newly acquired data processing equipment which
expanded the Company's customer service capacity.
Professional services expense was $22 million in the second quarter of
1998, up $6 million, or 35%, from the second quarter of 1997. This increase was
primarily due to consulting fees related to customer service enhancements.
The Company's effective income tax rate for the second quarters of 1998
and 1997 was 39.3% and 39.5%, respectively.
Six Months Ended June 30, 1998
Compared To Six Months Ended
June 30, 1997
Financial Overview
Net income for the first half of 1998 was $144 million, up 10% from first
half 1997 net income of $131 million. Diluted earnings per share for the first
halves of 1998 and 1997 were $.53 and $.48 per share, respectively.
Revenues for the first half of 1998 were $1,242 million, up 17% from
$1,066 million for the first half of 1997, primarily due to a 33% increase in
mutual fund service fees, a 39% increase in net interest revenue, and an 11%
increase in commission revenues. These increases mainly resulted from increases
in customer assets and margin loans to customers, as well as higher trading
volume. During the first half of 1998, trading activity reached record levels as
shown in the following table (in thousands):
- -------------------------------------------------------------
Six Months
Ended
June 30, Percent
Daily Average Trades 1998 1997 Change
- -------------------------------------------------------------
Revenue Trades
Online 45.8 21.9 109%
TeleBroker(R) 8.5 11.8 (28)
Regional customer telephone
service centers, branch offices
and other 32.4 32.3 -
- -------------------------------------------------------------
Total 86.7 66.0 31%
=============================================================
Mutual Fund OneSource(R) Trades
Online 17.3 12.7 36%
TeleBroker 1.2 1.4 (14)
Regional customer telephone
service centers, branch offices
and other 21.6 20.3 6
- -------------------------------------------------------------
Total 40.1 34.4 17%
=============================================================
Total Daily Average Trades
Online 63.1 34.6 82%
TeleBroker 9.7 13.2 (27)
Regional customer telephone
service centers, branch offices
and other 54.0 52.6 3
- -------------------------------------------------------------
Total 126.8 100.4 26%
=============================================================
Total operating expenses excluding interest during the first half of 1998
were $1,004 million, up 18% from $850 million for the first half of 1997,
primarily resulting from additional staff and related costs.
The after-tax profit margin for the first half of 1998 was 11.6%, down
from 12.3% for the first half of 1997. The annualized return on stockholders'
equity for the first half of 1998 was 24%, down from 28% for the first half of
1997, reflecting the Company's higher equity base in the first half of 1998.
REVENUES
- -------------------------------------------------------------
Six Months
Ended
June 30,
Composition of Revenues 1998 1997
- -------------------------------------------------------------
Commissions 48% 50%
Mutual fund service fees 21 18
Net interest revenue 18 15
Principal transactions 9 12
Other 4 5
- -------------------------------------------------------------
Total 100% 100%
=============================================================
Commissions
Commission revenues for the Company were $597 million for the first half
of 1998, up $61 million, or 11%, from the first half of 1997. As shown in the
table below, the total number of revenue trades executed by the Company has
increased 30% as the Company's customer base has grown. Average commission per
revenue trade decreased 14%. This decrease was mainly due to the Company's
reduction of the price of online trades described in the comparison between the
three-month periods.
- -------------------------------------------------------------
Six Months
Commissions Earned Ended
on Customer Revenue June 30, Percent
Trades 1998 1997 Change
- -------------------------------------------------------------
Customer accounts that
traded during the period
(in thousands) 1,923 1,541 25%
Average customer
revenue trades
per account 5.59 5.35 4
Total revenue
trades (in thousands) 10,756 8,251 30
Average commission
per revenue trade $ 55.46 $ 64.57 (14)
Commissions earned
on customer revenue
trades (in millions) (1) $ 596 $ 533 12
=============================================================
(1) Excludes commissions on trades with specialists totaling
$1 million in the first half of 1998 and $3 million in the
first half of 1997.
Schwab added 705,000 new customer accounts during the first half of 1998,
an increase of 20% from the 587,000 new accounts added during the first half of
1997.
Mutual Fund Service Fees
Mutual fund service fees were $262 million for the first half of 1998, up
$65 million, or 33%, from the first half of 1997. This increase was generally
attributable to the factors described in the comparison between the three-month
periods.
Net Interest Revenue
Net interest revenue was $221 million for the first half of 1998, up $62
million, or 39%, from the first half of 1997 as shown in the following table (in
millions):
- ------------------------------------------------------------
Six Months
Ended
June 30,
1998 1997
- ------------------------------------------------------------
Interest Revenue
Margin loans to customers $ 318 $ 210
Investments, customer-related 194 190
Other 25 15
- ------------------------------------------------------------
Total 537 415
- ------------------------------------------------------------
Interest Expense
Customer cash balances 280 225
Stock-lending activities 20 18
Borrowings 12 9
Other 4 4
- ------------------------------------------------------------
Total 316 256
- ------------------------------------------------------------
Net interest revenue $ 221 $ 159
============================================================
Customer-related daily average balances, interest rates and average net
interest margin for the first halves of 1998 and 1997 are summarized in the
following table (dollars in millions):
- -----------------------------------------------------------
Six Months Ended
June 30,
1998 1997
- -----------------------------------------------------------
Interest-Earning Assets (customer-related):
Investments:
Average balance outstanding $ 7,323 $ 7,211
Average interest rate 5.36% 5.32%
Margin loans to customers:
Average balance outstanding $ 8,333 $ 5,563
Average interest rate 7.68% 7.62%
Average yield on interest-earning assets 6.60% 6.32%
Funding Sources (customer-related
and other):
Interest-bearing customer cash balances:
Average balance outstanding $12,570 $10,253
Average interest rate 4.49% 4.42%
Other interest-bearing sources:
Average balance outstanding $ 1,274 $ 1,043
Average interest rate 4.43% 4.47%
Average noninterest-bearing portion $ 1,812 $ 1,478
Average interest rate on funding sources 3.96% 3.91%
Summary:
Average yield on interest-earning assets 6.60% 6.32%
Average interest rate on funding sources 3.96% 3.91%
- -----------------------------------------------------------
Average net interest margin 2.64% 2.41%
===========================================================
The increase in net interest revenue from the first half of 1997 was
primarily due to higher levels of margin loans to customers.
Principal Transactions
Principal transaction revenues were $112 million for the first half of
1998, down $21 million, or 16%, from the first half of 1997. This decrease was
primarily due to lower average revenue per principal transaction (see discussion
in the comparison between the three-month periods), partially offset by greater
share volume handled by M&S.
See "Commitments and Contingent Liabilities" note in Item 1. Notes to
Condensed Consolidated Financial Statements regarding certain civil litigation
relating to various principal transaction activities.
Expenses Excluding Interest
Compensation and benefits expense was $545 million for the first half of
1998, up $100 million, or 22%, from the first half of 1997 primarily due to a
greater number of employees. The following table shows a comparison of certain
compensation and benefits components and employee data (in thousands):
- -------------------------------------------------------------
Six Months
Ended
June 30,
1998 1997
- -------------------------------------------------------------
Compensation and benefits expense as a
% of revenues 44% 42%
Variable compensation as a
% of compensation and benefits expense 19% 21%
Compensation for temporary employees,
contractors and overtime hours as a
% of compensation and benefits expense 15% 14%
Full-time equivalent employees(1) 13.2 11.2
Revenues per average full-time equivalent
employee $93.9 $96.5
=============================================================
(1) Includes full-time, part-time and temporary employees,
and persons employed on a contract basis.
Advertising and market development expense was $68 million in the first
half of 1998, up $6 million, or 10%, from the first half of 1997. This increase
was primarily attributable to online advertising, as well as increased media
spending, partially offset by reduced production and direct mail spending.
Advertising and market development expense was 5% and 6% of revenues for the
first halves of 1998 and 1997, respectively.
Explanations of fluctuations in occupancy and equipment, depreciation and
amortization, and professional services presented in the three-month results
generally explain fluctuations in those expenses between the six-month periods.
The Company's effective income tax rate for the first halves of 1998 and
1997 was 39.4% and 39.5%, 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 $14.0 billion and $12.7 billion at June 30, 1998 and December 31, 1997,
respectively. 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.
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 June 30, 1998, Schwab had $931 million of net capital (10% of
aggregate debit balances), which was $751 million in excess of its minimum
required net capital and $481 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, a larger portion of
cash flows have been retained to support aggregate debit balances.
To manage Schwab's regulatory capital position, CSC provides Schwab with a
$450 million subordinated revolving credit facility maturing in September 1999,
of which $390 million was outstanding at June 30, 1998. At quarter end, Schwab
also had outstanding $25 million in fixed-rate subordinated term loans from CSC
maturing in 2000. Borrowings under these subordinated lending arrangements
qualify as regulatory capital for Schwab.
For use in its brokerage operations, Schwab maintained uncommitted,
unsecured bank credit lines totaling $620 million at June 30, 1998. Schwab used
such borrowings for six days during the first half of 1998, with the daily
amounts borrowed averaging $87 million. These lines were unused at June 30,
1998.
To satisfy the margin requirement of customer option transactions with the
Options Clearing Corporation, Schwab had unsecured letter of credit agreements
with six banks totaling $500 million at June 30, 1998. Schwab pays a fee to
maintain these letter of credit agreements. No funds were drawn under these
agreements during the first half of 1998.
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
cash equivalents, receivable from brokers, dealers and clearing organizations,
and marketable securities.
M&S' liquidity is affected by the same net capital regulatory requirements
as Schwab (see discussion above). At June 30, 1998, M&S had $5 million of net
capital (532% of aggregate debit balances), which was $4 million in excess of
its minimum required net capital.
M&S may borrow up to $35 million under a subordinated lending arrangement
with CSC. Borrowings under this arrangement qualify as regulatory capital for
M&S. This facility was unused during the first half of 1998.
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 $391
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 1998 to 2008 and fixed interest
rates ranging from 5.67% to 7.72% with interest payable semiannually. The
Medium-Term Notes are rated A3 by Moody's Investors Service and A- by Standard &
Poor's Ratings Group.
At June 30, 1998, $55 million in Senior or Senior Subordinated Medium-Term
Notes, Series A, remained unissued under CSC's registration statement with
respect to such securities. On July 8, 1998, SEC declared effective CSC's
registration statement covering the issuance of up to an additional $150 million
in Senior or Senior Subordinated Medium-Term Notes, Series A, bringing the
aggregate principal amount of such notes available to be issued to $205 million.
CSC may borrow under committed, unsecured credit facilities aggregating
$350 million with a group of 10 banks. One-half of the commitments under these
facilities expires in June 1999, and the other half expires in June 2001. The
funds are available for general corporate purposes for which CSC pays a
commitment fee on the unused balance. The terms of 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 future
dividend or funding requirements. These facilities were unused during the first
half of 1998.
Cash Flows and Capital Resources
Net income plus depreciation and amortization was $214 million for the
first half of 1998, up 14% from $188 million for the first half of 1997,
allowing the Company to finance its operations primarily with internally
generated funds. Depreciation and amortization expense related to equipment,
office facilities and property was $64 million for the first half of 1998, as
compared to $52 million for the first half of 1997, or 5% of revenues for each
period. Amortization expense related to intangible assets was $5 million for
both of the first halves of 1998 and 1997.
The Company's capital expenditures were $85 million in the first half of
1998 and $70 million in the first half of 1997, or 7% of revenues for each
period. Capital expenditures in the first half of 1998 were for leasehold
improvements, equipment relating to continued enhancements of the Company's
data processing systems, as well as additional office furniture and equipment.
In addition, the Company opened six new branch offices during the first half of
1998, compared to 19 branch offices opened during the first half of 1997.
Capital expenditures may vary from period to period as business conditions
change.
The Company issued $30 million in Medium-Term Notes during the first half
of 1998.
During the first half of 1998, the Company repurchased 3,333,500 shares of
its common stock for $123 million. During the full year of 1997, the Company
repurchased 820,000 shares of its common stock for $18 million. From the
inception of the repurchase plan in 1988 through June 30, 1998, the Company has
repurchased 43,440,800 shares of its common stock for $287 million.
During the first half of 1998, the Company paid common stock cash dividends
totaling $21 million, up from $18 million paid during the first half of 1997.
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 June 30, 1998 was $1,606 million, up $100 million, or
7% from December 31, 1997. At June 30, 1998, the Company had borrowings of $391
million, or 24% of total financial capital, that bear interest at a
weighted-average rate of 6.64%. At June 30, 1998, the Company's stockholders'
equity was $1,215 million, or 76% 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 could be material. The Company is
currently modifying its computer systems in order to enable its systems to
process data and transactions incorporating year 2000 dates without material
errors or interruptions.
As of June 30, 1998, the Company completed modifying the critical
mainframe trading systems of Schwab to enable those systems to process Year 2000
data and transactions without material errors or interruptions. As of June 30,
1998, the Company also completed installation of those modifications into
Schwab's production systems, and had commenced additional post-installation
testing to confirm the readiness of those systems to process Year 2000 dates and
transactions. The Company plans to have its significant systems modified by the
end of 1998.
The success of the Company's plan depends in part on parallel efforts
being undertaken by other entities with which the Company's systems interact and
therefore, the Company is taking steps to determine the status of these other
entities' Year 2000 compliance. There can be no assurance that all such other
entities will provide accurate and complete information, or that all their
systems in fact will achieve full Year 2000 compliance. Other entities' Year
2000 processing failures might have a material adverse impact on the Company's
systems and operations. The Company's plan may be affected by regulatory
changes, changes in industry customs and practices, and significant systems
modifications unrelated to the Year 2000 project including upgrades and
additions to capacity, and the cost and continued availability of qualified
personnel and other resources.
The Company currently estimates that it will cost approximately $42
million to $50 million to modify its core brokerage computer systems, which
include Schwab's critical trading systems and certain additional systems, to be
Year 2000 compliant. The Company currently estimates that the cost of completing
the Company's entire Year 2000 project, including core brokerage computer
systems, distributed applications, facilities, and systems in subsidiaries other
than Schwab, but excluding potential costs related to the implementation of
contingency plans which address possible Year 2000 failures of third-party
systems or the Company's systems, is approximately $60 million to $75 million.
This estimate excludes the time that may be spent by management and
administrative staff in guiding and assisting the information technology effort
described above. As of June 30, 1998, the Company had incurred approximately $21
million of the estimated cost of the entire project.
The cost of the project is 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 could differ materially
from these estimates. The Company expects to fund all Year 2000 related costs
through operating cash flows and a reallocation of the Company's overall
developmental spending. In accordance with generally accepted accounting
principles, Year 2000 expenditures will be expensed as incurred.
Euro Conversion
Accommodating transactions in the new euro currency, scheduled to take
effect January 1, 1999, is not expected to have a material financial impact on
the Company.
Item 3. Quantitative and Qualitative
Disclosures About Market Risk
Financial Instruments Held For Trading Purposes
The Company held government and other securities with a fair value of
approximately $13 million at June 30, 1998. 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, Nasdaq and other securities on both a long and short basis. The
fair value of these securities at June 30, 1998 was $36 million in long
positions and $34 million in short positions. The potential loss or gain in fair
value, using a hypothetical 10% increase or decrease in prices, respectively, is
estimated to be approximately $200,000 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 inventory
positions. This hypothetical 10% change in fair value of these securities at
June 30, 1998 would not be material to the Company's financial position, results
of operations or cash flows. The notional amount of option contracts was not
material to the Company's consolidated balance sheet at June 30, 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 maturities for which fair value approximates carrying
value and which do not present a material interest rate risk (dollars in
millions):
- --------------------------------------------------------------
Principal amount Fair
by maturity date value
June 30, June 30,
1999 Thereafter 1998
- --------------------------------------------------------------
Resale agreements (1) $5,210 --- $5,210
Weighted-average
interest rate 5.54%
Certificates of deposit $1,387 --- $1,387
Weighted-average
interest rate 5.55%
Commercial paper $ 328 --- $ 328
Weighted-average
interest rate 6.15%
==============================================================
(1) Includes resale agreements of $5,110 million included in cash and
investments required to be segregated under federal or other regulations and
$100 million included in cash and cash equivalents.
At June 30, 1998, CSC had $391 million aggregate principal amount of
Medium-Term Notes, with fixed interest rates ranging from 5.67% 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 June
30, 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
- ------------------------------------------------------------
1998 6.1% $ 40
1999 6.8% 40
2000 6.3% 48
2001 7.0% 39
2002 7.0% 40
Thereafter 6.7% 184
============================================================
The Company maintains investments in mutual funds, approximately $46
million at June 30, 1998, to fund obligations under its deferred compensation
plan, which is available to certain employees. Any decrease in the fair value of
these investments would be offset by a reduction 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
The discussion of legal proceedings in Notes to Condensed Consolidated
Financial Statements, under "Commitments and Contingent Liabilities" in Part I -
Financial Information, Item 1., is incorporated herein by reference.
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
At the Company's Annual Meeting of Stockholders held on May 11, 1998, its
stockholders voted upon the following proposals:
Proposal No. 1 - Election of Two Directors:
Shares Shares
For Against
--- -------
Donald G. Fisher 244,919,527 4,810,584
Anthony M. Frank 244,910,852 4,819,259
There were no abstentions or broker non-votes with respect to the election
of directors.
Proposal No. 2 - Amendment to the 1992 Stock Incentive Plan -- Amendment to the
1992 Stock Incentive Plan to increase the maximum number of shares that may be
granted to any one employee in any one year.
Shares Shares
For Against Abstentions
--- ------- -----------
215,927,172 33,002,938 800,001
There were no broker non-votes with respect to the amendment to the 1992
Stock Incentive Plan.
A total of 249,730,111 shares were present in person or by proxy at the
Annual Meeting.
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are filed as part of this quarterly report on
Form 10-Q.
- --------------------------------------------------------------
Exhibit
Number Exhibit
- --------------------------------------------------------------
10.197 Credit Agreement (364-Day Commitment), between
the Registrant and each of the banks listed
therein, dated as of June 26, 1998 (supersedes
Exhibit 10.196), filed as Exhibit 10.1 to the
Registrant's Current Report on Form 8-K dated
July 17, 1998, and incorporated herein by
reference.
10.198 Credit Agreement (3-Year Commitment), between
the Registrant and each of the banks listed
therein, dated as of June 26, 1998 (supersedes
Exhibit 10.196), filed as Exhibit 10.2 to the
Registrant's Current Report on Form 8-K dated
July 17, 1998, and incorporated herein by
reference.
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 17, 1998, the Registrant filed a Current Report on Form 8-K
relating to up to $205 million aggregate principal amount of debt
securities issuable by the Registrant pursuant to Registration Statement
Numbers 333-54001 and 333-12727 declared effective by the SEC on July 8,
1998 and November 1, 1996, respectively. Certain exhibits relating to the
Medium-Term Notes, Series A, which are issuable pursuant to the
Registration Statements, are contained in the Current Report.
<PAGE>
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: August 11, 1998 /s/ Steven L. Scheid
--------------- -----------------------------
Steven L. Scheid
Executive Vice President and
Chief Financial Officer
<TABLE>
EXHIBIT 12.1
THE CHARLES SCHWAB CORPORATION
Computation of Ratio of Earnings to Fixed Charges
(Dollar amounts in thousands)
(Unaudited)
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
Earnings before taxes on income $ 125,881 $ 105,743 $ 238,215 $ 216,063
- ----------------------------------------------------------------------------------------------------------------------
Fixed charges
Interest expense - customer 142,017 116,019 279,689 224,809
Interest expense - other 18,626 17,107 36,549 31,447
Interest portion of rental expense 7,970 6,521 15,369 12,747
- ----------------------------------------------------------------------------------------------------------------------
Total fixed charges (A) 168,613 139,647 331,607 269,003
- ----------------------------------------------------------------------------------------------------------------------
Earnings before taxes on income and fixed charges (B) $ 294,494 $ 245,390 $ 569,822 $ 485,066
======================================================================================================================
Ratio of earnings to fixed charges (B) divided by (A)* 1.7 1.8 1.7 1.8
======================================================================================================================
Ratio of earnings to fixed charges excluding
customer interest expense** 5.7 5.5 5.6 5.9
======================================================================================================================
* The ratio of earnings to fixed charges is calculated in a manner consistent with SEC requirements.
For such purposes, "earnings" consist of earnings before taxes on income and fixed charges.
"Fixed charges" consist of interest expense incurred on payables to customers, borrowings
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 excluding customer interest
expense reflects the elimination of such interest expense as a fixed charge.
</TABLE>
<TABLE> <S> <C>
<ARTICLE> BD
<LEGEND>
This schedule contains summary financial information extracted from the
Condensed Consolidated Statement of Income and Condensed Consolidated Balance
Sheet of the Company's Quarterly Report on Form 10-Q for the quarterly period
ended June 30, 1998, and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 6-mos
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 2,914,554
<RECEIVABLES> 9,427,090
<SECURITIES-RESALE> 5,110,264
<SECURITIES-BORROWED> 0
<INSTRUMENTS-OWNED> 232,389
<PP&E> 364,518
<TOTAL-ASSETS> 18,265,142
<SHORT-TERM> 226,035
<PAYABLES> 15,961,979
<REPOS-SOLD> 0
<SECURITIES-LOANED> 0
<INSTRUMENTS-SOLD> 0
<LONG-TERM> 391,004
0
0
<COMMON> 2,677
<OTHER-SE> 1,212,005
<TOTAL-LIABILITY-AND-EQUITY> 18,265,142
<TRADING-REVENUE> 111,736
<INTEREST-DIVIDENDS> 537,106
<COMMISSIONS> 597,177
<INVESTMENT-BANKING-REVENUES> 0
<FEE-REVENUE> 261,742
<INTEREST-EXPENSE> 316,238
<COMPENSATION> 544,686
<INCOME-PRETAX> 238,215
<INCOME-PRE-EXTRAORDINARY> 238,215
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 144,320
<EPS-PRIMARY> .55<F1>
<EPS-DILUTED> .53<F1>
<FN>
<F1> The information has been prepared in accordance with SFAS No. 128. Basic
and diluted EPS have been entered in place of primary and fully diluted,
respectively.
</FN>
</TABLE>
