SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 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 Number)
of incorporation or organization)
120 Kearny Street, San Francisco, CA 94104
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (415) 627-7000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
Common Stock - $.01 par value New York Stock Exchange
Pacific Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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 by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of March 18, 1999, the aggregate market value of the voting stock held by
nonaffiliates of the registrant was $29,311,165,334. For purposes of this
information, the outstanding shares of Common Stock owned by directors and
executive officers of the registrant, and certain investment companies managed
by Charles Schwab Investment Management, Inc. were deemed to be shares of Common
Stock held by affiliates.
The number of shares of Common Stock outstanding as of March 18, 1999 was
406,353,252* shares.
DOCUMENTS INCORPORATED BY REFERENCE
Part I and II of this Form 10-K incorporate certain information contained in the
registrant's 1998 Annual Report to Stockholders by reference to portions of that
document. Part III of this Form 10-K incorporates certain information contained
in the registrant's definitive proxy statement for its annual meeting of
stockholders to be held May 17, 1999 by reference to portions of that document.
* Reflects the December 1998 three-for-two common stock split.
<PAGE>
THE CHARLES SCHWAB CORPORATION
Annual Report On Form 10-K
For Fiscal Year Ended December 31, 1998
TABLE OF CONTENTS
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Part I
<S> <C>
Item 1. Business --------------------------------------------------------------------------------------------- 1
Item 2. Properties ------------------------------------------------------------------------------------------- 9
Item 3. Legal Proceedings ------------------------------------------------------------------------------------ 10
Item 4. Submission of Matters to a Vote of Security Holders -------------------------------------------------- 10
Part II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters -------------------------------- 10
Item 6. Selected Financial Data ------------------------------------------------------------------------------ 10
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations ---------------- 10
Item 7A. Quantitative and Qualitative Disclosures About Market Risk ------------------------------------------- 11
Item 8. Financial Statements and Supplementary Data ---------------------------------------------------------- 11
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ----------------- 11
Part III
Item 10. Directors and Executive Officers of the Registrant --------------------------------------------------- 11
Item 11. Executive Compensation ------------------------------------------------------------------------------- 13
Item 12. Security Ownership of Certain Beneficial Owners and Management --------------------------------------- 13
Item 13. Certain Relationships and Related Transactions ------------------------------------------------------- 13
Part IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K -------------------------------------- 13
Exhibit Index ---------------------------------------------------------------------------------- 15
Signatures ------------------------------------------------------------------------------------- 21
Index to Financial Statement Schedules --------------------------------------------------------- F-1
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FORWARD-LOOKING STATEMENTS - In addition to historical information, this Annual
Report on Form 10-K contains forward-looking statements that reflect
management's beliefs, objectives and expectations as of the date hereof. These
statements relate to, among other things, the Company's strategy, information
systems, the Year 2000 project, competition, average commission per revenue
trade and average revenue per share traded. Achievement of the expressed
beliefs, objectives and expectations is subject to certain risks and
uncertainties that could cause actual results to differ materially from those
beliefs, objectives and expectations.
<PAGE>
THE CHARLES SCHWAB CORPORATION
PART I
Item 1. Business
(a) General Development of Business. The Charles Schwab Corporation (CSC)
was incorporated in 1986 and engages, through its subsidiaries, in securities
brokerage and related financial services. In this report, the "Company" refers
to CSC and its subsidiaries. CSC's principal subsidiary, Charles Schwab & Co.,
Inc. (Schwab), is a securities broker-dealer. Schwab was incorporated in 1971,
and entered the discount brokerage business in 1974. Mayer & Schweitzer, Inc.
(M&S), a subsidiary acquired in 1991, is a market maker in Nasdaq and other
securities that provides trade execution services primarily to broker-dealers
and institutional customers.
Other subsidiaries of CSC include Charles Schwab Investment Management,
Inc. (CSIM), The Charles Schwab Trust Company (CSTC) and Charles Schwab Europe
(CSE). CSIM, incorporated in 1989, acts as the investment advisor for Schwab's
proprietary mutual funds. The Company refers to certain funds for which CSIM is
the investment advisor as the SchwabFunds(R). CSTC, incorporated in 1992, serves
as trustee for employee benefit plans, primarily 401(k) plans. CSE, acquired in
1995 to expand the Company's international operations, is a retail securities
brokerage firm located in the United Kingdom. In December 1998, the Company
entered into agreements to purchase Canadian-based Priority Brokerage Inc. and
Porthmeor Securities Inc. The acquisitions were completed in early 1999 and the
two companies were combined to create Charles Schwab Canada, Co., a subsidiary
of CSC. The cost of these Canadian acquisitions was not material to the
Company's financial position.
New developments in the Company's business during 1998 include the
integration of its online and traditional brokerage services and reduction of
the price of online trades for most of its customers. This resulted in an
increase in the proportion of trades placed through the Company's online
channels and a decline in its average commission per revenue trade. However, an
increase in trading activity more than offset the effect of the lower average
commission per revenue trade. In 1998, the Company continued to expand its
products and services. During 1998, Schwab announced alliances with Intuit, Inc.
and Excite, Inc. to provide investors with investment education, research and
analysis tools. Additionally, Schwab began to offer equity research reports from
Credit Suisse First Boston Corporation (CSFB) and Hambrecht & Quist L.L.C., and
expanded its offerings to certain customers to include debt underwritings
lead-managed by CSFB.
The Company is also enhancing the ways it helps investors develop, evaluate
and access their investment choices. In 1998, Schwab introduced a number of new
Internet-based investment services, including: The Analyst Center(TM), which
connects customers to proprietary and third-party investment research, guidance
and decision-making tools; the Positions Monitor(TM), which tracks customers'
mutual fund and equity holdings' historical performance; the Mutual Fund
Performance Profile(TM), which allows customers to analyze the performance of
their entire mutual fund portfolio; and the Stock Screener(TM), which allows
customers to search over 9,000 equities on the Web. Schwab also introduced two
new services to provide investors with greater access and flexibility in
managing their finances: Schwab MoneyLink(R), which allows customers to transfer
funds electronically between Schwab and other financial institutions via the
Internet, automated telephone system or Schwab representatives; and Schwab
BillPay(TM), which allows customers to use the Internet to initiate payments
electronically. In addition, Schwab introduced a Web site that enables investors
to review their accounts and trade securities in Chinese, and CSE launched a Web
site in the United Kingdom to offer online trading in stocks listed on the
London Stock Exchange.
During 1998, the Company's Board of Directors declared a three-for-two
common stock split, distributed December 1998, effected in the form of a 50%
stock dividend. Share and per share information throughout this report have been
restated. The Board increased the quarterly cash dividend 5% to $.0280 per share
in 1998.
(b) Financial Information About Segments. The Company provides financial
services to individuals, institutional customers and broker-dealers through
three segments -- Individual Investor, Institutional Investor and Capital
Markets. The Individual Investor segment includes the Company's domestic and
international retail operations. The Institutional Investor segment provides
custodial, trading and support services to independent investment managers, and
serves company 401(k) plan sponsors and third-party administrators. The Capital
Markets segment provides trade execution services in exchange-listed, Nasdaq and
other securities primarily to broker-dealers and institutional customers. The
Company's mutual fund services are considered a product and not a segment.
Mutual fund service fees are included in both the Individual Investor and
Institutional Investor segments. For financial information by segment and
geographic area, and for revenues by major customer for the three years ended
December 31, 1998, see note "14. Segment Information" in the Notes to
Consolidated Financial Statements in the Company's 1998 Annual Report to
Stockholders, which are incorporated herein by reference to Exhibit No. 13.1 of
this report.
(c) Narrative Description of Business. The Company's strategy is to attract
and retain customer assets by focusing on a number of areas within the financial
services industry -- retail brokerage, mutual funds, support services for
independent investment managers, 401(k) defined contribution plans and equity
securities market-making. To pursue its strategy and its objective of long-term
profitable growth, the Company plans to continue to leverage its competitive
advantages. These advantages include a nationally recognized brand, a broad
range of products and services, multi-channel delivery systems and an ongoing
investment in technology.
The Company's primary focus is serving retail investors in the U.S., either
directly or through independent investment managers, who want access to a broad
selection of products and services, as well as investment news and information,
tailored to meet their financial needs. The Company, through Schwab, serves 5.6
million active customer accounts(a). Customer assets in these accounts totaled
$491.1 billion at December 31, 1998.
The table below shows the Company's revenues on a comparative basis for the
three years ended December 31, 1998.
Sources of Revenues
(Dollar amounts in thousands)
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Year Ended December 31,
- --------------------------------------------------------------------------------------------------------------------------
1998 1997 1996
-------------------------- -------------------------- ----------------------------
Amount Percent Amount Percent Amount Percent
-------------------------- -------------------------- ----------------------------
<S> <C> <C> <C> <C> <C> <C>
Revenues
Commissions
Exchange-listed securities $ 485,343 18% $ 527,321 23% $ 423,232 23%
Nasdaq 604,712 22% 465,137 20% 393,882 21%
Options 122,409 5% 103,372 5% 66,210 4%
Mutual funds 96,919 3% 78,193 3% 70,805 4%
- --------------------------------------------------------------------------------------------------------------------------
Commissions 1,309,383 48% 1,174,023 51% 954,129 52%
- --------------------------------------------------------------------------------------------------------------------------
Mutual fund service fees 559,241 20% 427,673 19% 311,067 17%
Interest revenue
Margin loans to customers 670,965 24% 489,197 21% 339,433 18%
Investments, customer-related 400,453 15% 376,243 16% 312,841 17%
Other 56,080 2% 34,595 2% 28,586 2%
Interest expense (651,881) (24%) (546,483) (24%) (425,872) (23%)
- --------------------------------------------------------------------------------------------------------------------------
Interest revenue, net of
interest expense 475,617 17% 353,552 15% 254,988 14%
- --------------------------------------------------------------------------------------------------------------------------
Principal transactions 286,754 10% 257,985 11% 256,902 14%
Other 105,226 5% 85,517 4% 73,836 3%
- --------------------------------------------------------------------------------------------------------------------------
Total $2,736,221 100% $2,298,750 100% $1,850,922 100%
==========================================================================================================================
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This table should be read in connection with the Company's consolidated
financial statements and notes in the Company's 1998 Annual Report to
Stockholders, which are incorporated herein by reference to Exhibit No. 13.1 of
this report. Certain prior years' revenues and expenses have been reclassified
to conform to the 1998 presentation.
- --------------------------------------------------------------------------------
(a) Effective in 1998, active accounts are defined as accounts with balances or
activity within the preceding eight months instead of twelve months as
previously defined. This change in definition had the effect of decreasing
the number of active accounts in 1998 by approximately 200,000.
- --------------------------------------------------------------------------------
Advertising and Marketing Programs
The Company's nationwide advertising and marketing programs are designed to
strengthen the Schwab brand, as well as distinguish its products and services.
The Company's advertising and market development expense was $155 million in
1998, compared to $130 million in 1997 and $84 million in 1996. Expenditures for
these programs helped Schwab attract $80.8 billion in net new customer assets in
1998, compared to $68.9 billion in 1997 and $54.2 billion in 1996. New accounts
opened totaled 1,380,000 in 1998, compared to 1,164,000 in 1997 and 985,000 in
1996. Customer assets from new accounts represented approximately 50% of net new
customer assets in each of the three years ended December 31, 1998.
The Company primarily uses a combination of network, cable and local
television, national and local radio, print media, and athletic event
sponsorship in its advertising to investors. Schwab also engages extensively in
targeted direct mail advertising through monthly statement "inserts" and special
mailings.
In its advertising, as well as in promotional events such as press
appearances, Schwab has promoted the name and likeness of its Chairman, Mr.
Schwab. The Company has an agreement with Mr. Schwab by which he, subject to
certain limitations, has assigned to the Company and Schwab all service mark,
trademark, and trade name rights in his name (and variations thereon) and
likeness.
Products and Services
The Company offers a broad range of products and services to meet
customers' varying investment and financial needs, including access to
investment news and information.
Services for Retail Investors. Retail investors, through the Individual
Investor segment or indirectly through the Institutional Investor segment, have
access to the accounts, financing and mutual funds described below.
Accounts and Features. The Company offers the purchase and sale of
securities which include exchange-listed, Nasdaq and other equity securities,
options, mutual funds, unit investment trusts, variable annuities and fixed
income investments, including U.S. Treasuries, zero-coupon bonds,
exchange-listed and over-the-counter corporate bonds, municipal bonds,
Government National Mortgage Association securities and certificates of deposit.
The Company also offers certain of its customers initial and secondary public
stock offerings, debt underwritings, and access to futures and commodities
trading. In addition, customers have access to equity research reports through
the Company's Web site. Customers approved for margin transactions may borrow a
portion of the price of certain securities purchased through Schwab, or may sell
securities short. Customers must have specific approval to trade options; as of
December 31, 1998, 273,000 accounts had such approval. To write uncovered
options, customers must go through an additional approval process and must
maintain a significantly higher level of equity in their brokerage accounts.
Because Schwab does not pay interest on cash balances in basic brokerage
accounts, it provides customers with an option to have cash balances in their
accounts automatically swept, on a weekly basis, into certain taxable or
state-specific municipal tax-exempt SchwabFunds(R) money market funds.
A customer may receive additional services by qualifying for and opening a
Schwab One(R) brokerage account. A customer may access available funds in his or
her Schwab One account either with a personal check or a VISA(R) debit card, in
addition to the Schwab MoneyLink(R) and Schwab BillPay(TM) services offered with
all brokerage accounts. When a Schwab One customer is approved for margin
trading, the checks and debit card also provide access to margin cash available.
For cash balances awaiting investment, Schwab pays interest to Schwab One
customers. Alternatively, qualifying Schwab One customers seeking tax-exempt
income may elect to have cash balances swept daily into state-specific municipal
tax-exempt SchwabFunds money market funds.
Schwab acts as custodian, as well as broker, for Individual Retirement
Accounts (IRAs). In Schwab IRAs, cash balances are swept daily into one of three
SchwabFunds money market funds. During 1998, active IRAs increased over 30% to
2,100,000 accounts and customer assets in all IRAs increased over 30% to $116.4
billion. Schwab also acts as custodian and broker for Keogh accounts.
Customer Financing. Customers' securities transactions are conducted on
either a cash or margin basis. Generally, a customer buying securities in a
cash-only brokerage account is required to make payment by settlement date,
usually three business days after the trade is executed. However, for purchases
of certain types of securities, such as certain mutual fund shares, a customer
must have a cash or money market fund balance in his or her account sufficient
to pay for the trade prior to execution. When selling securities, a customer is
required to deliver the securities, and is entitled to receive the proceeds, on
settlement date. In an account authorized for margin trading, Schwab may lend
its customer a portion of the market value of certain securities up to the limit
imposed by the Federal Reserve Board, which for most equity securities is
initially 50%. Such loans are collateralized by the securities in the customer's
account. Short sales of securities represent sales of borrowed securities and
create an obligation to purchase the securities at a later date. Customers may
sell securities short in a margin account subject to minimum equity and
applicable margin requirements and the availability of such securities to be
borrowed and delivered.
Interest on margin loans to customers provides an important source of
revenue to Schwab. During 1998, Schwab's outstanding margin loans to customers
averaged $8.8 billion.
In permitting a customer to engage in transactions, Schwab faces credit
risk if the customer fails to meet his or her obligations in the event of
adverse changes in the market value of the securities positions in his or her
account. Under applicable rules and regulations for margin transactions, Schwab,
in the event of such an adverse change, requires the customer to deposit
additional securities or cash, so that the amount of the customer's obligation
is not greater than specified percentages of the cash and market values of the
securities in the account. As a matter of policy, Schwab generally requires its
customers to maintain higher percentages of collateral values than the minimum
percentages required under these regulations.
Schwab may use cash balances in customer accounts to extend margin credit
to other customers. Pursuant to the requirements of Rule 15c3-3 under the
Securities Exchange Act of 1934, the portion of such cash balances not used to
extend margin credit (increased or decreased by certain other customer-related
balances) must be held in segregated investment accounts. The balances in these
segregated investment accounts must be invested in qualified interest-bearing
securities. To the extent customer cash balances are available for use by Schwab
at interest costs lower than Schwab's costs of borrowing from alternative
sources, Schwab's cost of funds is reduced and its net income is enhanced. Such
interest savings contribute substantially to Schwab's profitability and, if a
significant reduction of customer cash balances were to occur, Schwab's
borrowings from other sources may have to increase and such profitability would
decline. To the extent Schwab's customers elect to have cash balances in their
brokerage accounts swept into certain SchwabFunds(R) money market funds, the
cash balances available to Schwab for investments or for financing margin loans
are reduced. However, Schwab receives mutual fund service fees from such funds
based upon average daily invested balances.
See also "Management's Discussion and Analysis of Results of Operations and
Financial Condition -- Risk Management" in the Company's 1998 Annual Report to
Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of
this report, and "Regulation" below.
Mutual Funds. Schwab's Mutual Fund Marketplace(R) provides customers with
the ability to invest in over 1,600 third-party mutual funds from 261 fund
families. Within the Mutual Fund Marketplace, Schwab's Mutual Fund OneSource(R)
service enables customers to trade 1,024 mutual funds from 179 fund families
without incurring transaction fees.
Schwab's Mutual Fund OneSource service allows investors to access multiple
mutual fund companies, avoid brokerage transaction fees, and achieve investment
diversity among fund families. In addition, investors' record keeping and
investment monitoring are simplified through one consolidated statement. Fees
received by Schwab for providing services, including record keeping and
shareholder services, from the Mutual Fund OneSource program are based upon the
daily balances of customer assets invested in the participating funds through
Schwab and are paid by the funds and/or fund sponsors. Customer assets held by
Schwab that have been purchased through the Mutual Fund OneSource service
totaled $69.9 billion at the end of 1998.
Customer assets invested in Schwab's Mutual Fund Marketplace, excluding the
Mutual Fund OneSource service, totaled $59.2 billion at the end of 1998. Schwab
charges a transaction fee on trades placed in the funds included in the Mutual
Fund Marketplace (except on trades through the Mutual Fund OneSource service).
These fees are recorded as commission revenues. Commissions from customer
transactions in mutual fund shares comprised approximately 7% of total
commission revenues during the last three years.
In addition to the third-party funds available through the Mutual Fund
Marketplace, Schwab offers a family of proprietary funds, referred to as the
SchwabFunds. SchwabFunds include money market funds, equity index funds, bond
funds, asset allocation funds, and funds that primarily invest in stock, bond
and money market funds. Qualifying Schwab customers may elect to have cash
balances in their brokerage accounts automatically invested in certain
SchwabFunds money market funds. Customer assets invested in the SchwabFunds were
$81.5 billion at the end of 1998. Fees received by the Company from the
SchwabFunds, for providing transfer agent services, shareholder services,
administration and investment management, are based upon the daily balances of
customer assets invested in these funds.
Services for Independent Investment Managers. The Company provides
custodial, trading and support services to independent investment managers
through the Institutional Investor segment. To attract the business of accounts
managed by these managers, Schwab has a dedicated business unit which includes
experienced registered representatives assigned to individual managers.
Independent investment managers participating in this program who custody
customer accounts at Schwab may use SchwabLink(R) and the SchwabLink Web(TM)
site. SchwabLink is a computer-based information network which enables
investment managers to access information about their customers' accounts
directly from Schwab's computer systems and to enter their customers' trades
online. The SchwabLink Web site enables investment managers to use the Internet
to communicate directly with Schwab service teams, as well as receive news and
information. In 1998, Schwab introduced the Managed Account Connection(TM),
which enables investment managers to provide their clients with personalized
equity portfolio management by a variety of institutional asset managers. During
1998, Schwab customer assets held in accounts managed by approximately 5,400
active independent investment managers increased $40.6 billion, or 38%, to a
total of $146.4 billion. Independent investment managers generated approximately
12% of total commission revenues during the last three years.
Retirement Plan Services. The Company provides 401(k) record keeping and
other retirement plan services through the Institutional Investor segment.
Schwab serves company 401(k) plans directly through a dedicated sales force, as
well as indirectly through alliances with national and regional third-party
administrators. In the direct channel, SchwabPlan(R) is the Company's
comprehensive 401(k) retirement plan, which offers plan sponsors a wide array of
investment options, participant education and servicing, trustee services, and
participant-level record keeping. During 1998, Schwab continued to develop its
retirement plan services business, with customer assets in corporate retirement
plans growing $6.4 billion, or 47%, to $20.1 billion.
Market-Making Activities. Market-making activities in exchange-listed,
Nasdaq and other securities are conducted through the Capital Markets segment.
M&S provides trade execution services in Nasdaq and other securities primarily
to broker-dealers, including Schwab, and institutional customers. As a market
maker in Nasdaq and other securities, M&S generally executes customer trades as
principal. While substantially all Nasdaq security trades originated by the
customers of Schwab are directed to M&S, the majority of M&S' trading volume
comes from parties other than Schwab.
Schwab has specialist operations on the Pacific Exchange and the Boston
Stock Exchange to make markets in exchange-listed securities. The majority of
trades originated by the customers of Schwab in exchange-listed securities for
which Schwab makes a market are directed to these operations. At December 31,
1998, Schwab had eleven specialists on the Pacific Exchange and three
specialists on the Boston Stock Exchange that collectively made markets in 800
and 100 securities, respectively.
In the normal course of their market making in exchange-listed, Nasdaq and
other securities, Schwab and M&S maintain inventories in such securities on both
a long and short basis. While long inventory positions represent Schwab's and
M&S' ownership of securities, short inventory positions represent obligations of
Schwab and M&S to deliver specified securities at a contracted price, which may
differ from market prices prevailing at the time of completion of the
transaction. Accordingly, long or short inventory positions may result in gains
or losses as market values of such securities fluctuate.
See also "Management's Discussion and Analysis of Results of Operations and
Financial Condition -- Risk Management" in the Company's 1998 Annual Report to
Stockholders, which is incorporated herein by reference to Exhibit No. 13.1 of
this report, and "Regulation" below.
Multi-Channel Delivery Systems
The Company's multi-channel delivery systems allow customers to choose how
they prefer to do business with the Company. In addition to its branch office
network, the Company maintains four regional customer telephone service centers,
two online customer support centers as well as automated telephonic and online
channels, primarily serving retail investors through the Individual Investor and
Institutional Investor segments.
Branch Office Network. At December 31, 1998, Schwab operated 291 domestic
branch offices in 47 states, as well as branches in the Commonwealth of Puerto
Rico, the United Kingdom and the U.S. Virgin Islands. In addition, the Company
has offices in Hong Kong and the Cayman Islands. The Company's branch office
network plays a key role in building its business. With the customer service
support of regional customer telephone service centers and automated telephonic
and online channels, branch personnel are focusing a significant portion of
their time on business development. Customers can use branch offices to open
accounts, deliver and receive checks and securities, obtain market information,
place orders, and obtain related customer services in person, yet most of these
activities are conducted by telephone and mail. Branch offices also provide
investors with access to the Internet.
The Company is enhancing the ways in which it may help investors by using
the branch office network to assist investors in developing asset allocation
strategies and evaluating their investment choices. Branch representatives also
refer investors who desire additional guidance to independent investment
managers through the Schwab AdvisorSource(TM) service.
Regional Customer Telephone Service Centers. Schwab's four regional
customer telephone service centers, located in Indianapolis, Denver, Phoenix and
Orlando, handle customer trading and service calls twenty-four hours-a-day,
seven days-a-week. Customer orders placed during nonmarket hours are routed to
appropriate markets the following business day. The capacity of the service
centers allows the branch office network to be maintained at lower staffing
levels and to focus on business development.
The Company's customer service approach is to use teams led by registered
representatives in the service centers, who work closely with branch office
network personnel. Additionally, certain teams at these centers provide
specialized services to active and affluent investors. Each registered
representative has immediate access to the customer account and market-related
information necessary to respond to customer inquiries. For most customer
orders, registered representatives can enter the order and confirm the
transaction immediately. As a result of this approach, the departure of a
registered representative generally does not result in a loss of customers for
the Company.
Automated Telephonic and Online Channels. Customers are able to obtain
financial information and execute trades on an automated basis through the
Company's automated telephonic and online channels. These channels are designed
to provide added convenience for customers and minimize Schwab's costs of
responding to and processing routine customer transactions. To assist customers
in using online channels, the Company maintains two online customer support
centers that operate both during and after normal market hours.
Automated telephonic channels include TeleBroker(R) -- Schwab's touch-tone
telephone quote and trading service, and VoiceBroker(TM) -- Schwab's voice
recognition quote and trading service. Schwab's automated telephonic channels
handled over 70% of total customer calls received in 1998. Online channels
include the Charles Schwab Web Site(TM) -- an information and trading service on
the Internet for individual investors, and PC-based services such as
SchwabLink(R) for independent investment managers. The Company's online channels
handled 54% of total trades in 1998.
Information Systems
Schwab's operations rely heavily on its information processing and
communications systems. Schwab's system for processing a securities transaction
is highly automated. Registered representatives equipped with online computer
terminals can access customer account information, obtain securities prices and
related information, and enter orders online.
To support its multi-channel delivery systems, as well as other
applications such as clearing functions, account administration, record keeping
and direct customer access to investment information, Schwab maintains a
sophisticated computer network connecting all of the branch offices and regional
customer telephone service centers. Schwab's computers are also linked to the
major registered U.S. securities exchanges, M&S, the National Securities
Clearing Corporation and The Depository Trust Company.
Failure of Schwab's information processing or communications systems for a
significant period of time could limit Schwab's ability to process its large
volume of transactions accurately and rapidly. This could cause Schwab to be
unable to satisfy its obligations to customers and other securities firms, and
could result in regulatory violations.
External events, such as an earthquake or power failure, loss of external
information feeds such as security price information, as well as internal
malfunctions such as those that could occur during the implementation of system
modifications, could render part or all of such systems inoperative.
To enhance the reliability of the system and integrity of data, Schwab
maintains backup and recovery functions. These include logging of all critical
files intraday, duplication and storage of all critical data outside of its
central computer site every twenty-four hours, and maintenance of facilities for
backup and communications. They also include the maintenance and periodic
testing of a disaster recovery plan that management believes would permit Schwab
to recommence essential computer operations if its central computer site were to
become inaccessible. To reduce the exposure to system failures caused by
external factors, including earthquakes, the Company's two primary data centers
are located in Phoenix. In 1998, the Company built the second data center in
Phoenix intended, in part, to further improve the recovery of business
processing in the event of an emergency.
Year 2000. Many existing computer programs use only two digits to identify
a specific year and therefore may not accurately recognize the upcoming change
in the century. If not corrected, many computer applications could fail or
create erroneous results by or at the year 2000. Due to the Company's dependence
on computer technology to operate its business, and the dependence of the
financial services industry on computer technology, the nature and impact of
Year 2000 processing failures on the Company's business, financial position,
results of operations or cash flows could be material. The Company 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. Because systems critical to the Company's functioning other than
its computer systems may be affected by the century change, the Company's Year
2000 compliance efforts also encompass facilities and equipment which rely on
date-dependent technology, such as building equipment that contains embedded
technology. For a discussion on the Company's state of readiness, project costs
and risks, and contingency plans regarding the Year 2000 issue, see
"Management's Discussion and Analysis of Results of Operations and Financial
Condition -- Year 2000" in the Company's 1998 Annual Report to Stockholders,
which is incorporated herein by reference to Exhibit No. 13.1 of this report.
Clearing and Account Maintenance
Schwab performs clearing services for all securities transactions in
customer accounts. Schwab clears the vast majority of customer transactions
through the facilities of the National Securities Clearing Corporation or the
Options Clearing Corporation. Certain other transactions, such as mutual fund
transactions and transactions in securities not eligible for settlement through
a clearing corporation, are settled directly with the mutual funds or other
financial institutions. Schwab is obligated to settle transactions with clearing
corporations, mutual funds and other financial institutions even if Schwab's
customer fails to meet his or her obligations to Schwab. In addition, for
transactions that do not settle through a clearing corporation, Schwab takes the
risk of the other party's failure to settle the trade. See note "13. Financial
Instruments with Off-Balance-Sheet and Credit Risk" in the Notes to Consolidated
Financial Statements in the Company's 1998 Annual Report to Stockholders, which
are incorporated herein by reference to Exhibit No. 13.1 of this report.
Employees
As of December 31, 1998, the Company had full-time, part-time and temporary
employees, and persons employed on a contract basis that represented the
equivalent of 13,300 full-time employees.
Risk Management
The Company's business and activities expose it to different types of
risks. Proper identification, assessment and management of these risks are
essential to the success and financial soundness of the Company. For a
discussion on the Company's principal risks and some of the policies and
procedures for risk identification, assessment and mitigation, see "Management's
Discussion and Analysis of Results of Operations and Financial Condition -- Risk
Management" in the Company's 1998 Annual Report to Stockholders, which is
incorporated herein by reference to Exhibit No. 13.1 of this report, and
"Information Systems," "Competition" and "Regulation" in this report.
Competition
The Company faces significant competition from companies seeking to attract
customer financial assets, including full-commission brokerage firms, discount
brokerage firms, online brokerage firms, mutual fund companies and banks.
Certain of these competitors have significantly greater financial resources than
the Company, particularly given the consolidation trend within the financial
services industry. 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. The Company
experienced declines in its average commission per revenue trade in 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,
resulting in an increase in the proportion of trades placed through its online
channels. As the Company focuses on further enhancements to its electronic
service offering and online trades increase, average commission per revenue
trade is expected to continue to decline.
Many brokerage firms employ substantial funds in advertising and direct
solicitation of customers to increase their market share of commission dollars
and other securities-related income. Most discount brokerage firms and online
brokerage firms charge commissions lower than Schwab. Full-commission brokerage
firms also offer discounted commissions to selected retail brokerage customers.
In addition, some full-commission brokerage firms have begun to offer discounted
or free online trades, usually as part of a fee-based account. Such competition
may negatively impact the Company's customer asset growth, revenue growth and
profit margin.
While certain competitors, especially brokerage firms focused on trading
via online channels, are expected to continue price-based competition,
management believes that providing superior service and value are crucial to
appealing to a broad set of investors. Management believes that the Company
primarily competes on the basis of its ability to combine people and technology
in ways that provide investors with the access, information, guidance and advice
they expect, as well as superior service, all at a significantly lower cost than
traditional providers of financial services. As a result, the Company expects to
increasingly compete with full-commission brokerage firms, banks and other
traditional providers of financial products and services.
Regulation
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. The Securities and Exchange
Commission (SEC) is the federal agency charged with administration of the
federal securities laws. Schwab and M&S are registered as broker-dealers with
the SEC. Schwab and CSIM are registered as investment advisors with the SEC.
Additionally, Schwab is regulated by the Commodities Futures Trading Commission
(CFTC) with respect to its introduced futures and commodities trading
activities.
Much of the regulation of broker-dealers has been delegated to
self-regulatory organizations, principally the National Association of
Securities Dealers, Inc. (NASD) and the national securities exchanges such as
the New York Stock Exchange (NYSE), which has been designated by the SEC as
Schwab's primary regulator with respect to its securities activities. The NASD
has been designated by the SEC as M&S' primary regulator with respect to its
securities activities. The NYSE has been designated as Schwab's primary
regulator with respect to its options trading activities for 1998 and 1999. The
National Futures Association (NFA) has been designated by the CFTC as Schwab's
primary regulator with respect to its introduced futures and commodities trading
activities. These self-regulatory organizations adopt rules (subject to approval
by the SEC or CFTC) governing the industry and conduct periodic examinations of
broker-dealers. Securities firms are also subject to regulation by state
securities authorities in the states in which they do business. In addition to
its membership in the NYSE, Schwab is also a member of most other major U.S.
securities exchanges and is consequently subject to their rules and regulations.
Schwab was registered as a broker-dealer in fifty states, the District of
Columbia and Puerto Rico as of December 31, 1998. M&S was registered as a
broker-dealer in thirty-two states and the District of Columbia as of December
31, 1998.
The principal purpose of regulations and discipline of broker-dealers and
investment advisors is the protection of customers and the securities markets,
rather than protection of creditors and stockholders of broker-dealers and
investment advisors. The regulations to which broker-dealers and investment
advisors are subject cover all aspects of the securities business, including
sales methods, trading practices among broker-dealers, uses and safekeeping of
customers' funds and securities, capital structure of securities firms, record
keeping and reporting, fee arrangements, disclosure to clients, and the conduct
of directors, officers and employees. As registered investment advisors, Schwab
and CSIM are subject to the requirements of the Investment Advisers Act of 1940
and the regulations thereunder, which impose, among other things, various record
keeping, reporting, and disclosure requirements and impose limitations on fees
and principal transactions between an advisor and its clients. The state
securities law requirements applicable to registered investment advisors are in
certain cases more comprehensive than those imposed under the federal securities
laws.
Additional legislation, changes in rules promulgated by the SEC, other
federal and state regulatory authorities and self-regulatory organizations, or
changes in the interpretation or enforcement of existing laws and rules may
directly affect the method of operation and profitability of broker-dealers and
investment advisors. The profitability of broker-dealers and investment advisors
could also be affected by rules and regulations which impact the business and
financial communities in general, including changes to the laws governing
taxation, antitrust regulation and electronic commerce. The SEC, CFTC,
self-regulatory organizations and state securities authorities may conduct civil
or administrative proceedings which can result in censure, fine, cease and
desist orders, or suspension or expulsion of a broker-dealer or an investment
advisor, its officers, or employees. Schwab and M&S have been the subject of
such administrative proceedings.
Certain 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 NYSE, began quoting and
trading most securities in increments of one-sixteenth dollar per share instead
of one-eighth dollar per share. Mainly as a result of these regulatory changes
and changes in industry practices, M&S' average revenue per share traded
declined during 1998 as compared to 1997. The major U.S. securities markets have
announced that at an unspecified date after the beginning of 2000, they intend
to begin quoting and trading securities in decimal increments. This change is
likely to cause further decreases in average revenue per share traded. See also
"Management's Discussion and Analysis of Results of Operations and Financial
Condition -- Revenues -- Principal Transactions" in the Company's 1998 Annual
Report to Stockholders, which is incorporated herein by reference to Exhibit No.
13.1 of this report.
As registered broker-dealers and NASD member organizations, Schwab and M&S
are required by federal law to belong to the Securities Investor Protection
Corporation (SIPC), which provides, in the event of the liquidation of a
broker-dealer, protection for securities held in customer accounts held by the
firm of up to $500,000 per customer, subject to a limitation of $100,000 for
claims of cash balances. SIPC is funded through assessments on registered
broker-dealers. In addition, Schwab purchased from a private surety company
additional account protection of up to $99.5 million per customer, as defined,
for customer securities in each account, of which $500,000 is available for
claims of cash balances. Stocks, bonds, mutual funds and money market funds are
considered securities for the purposes of SIPC protection and the additional
protection (i.e., protected securities may either be replaced or converted into
an equivalent market value as of the date a SIPC trustee is appointed). Neither
SIPC protection nor the additional protection applies to fluctuations in the
market value of securities.
Schwab is authorized by the Municipal Securities Rulemaking Board to
conduct transactions in municipal securities on behalf of its customers and has
obtained certain additional registrations with the SEC and state regulatory
agencies necessary to permit it to engage in certain other activities incidental
to its brokerage business.
Margin lending by Schwab and M&S is subject to the margin rules of the
Board of Governors of the Federal Reserve System and the NYSE. Under such rules,
broker-dealers are limited in the amount they may lend in connection with
certain purchases and short sales of securities and are also required to impose
certain maintenance requirements on the amount of securities and cash held in
margin accounts. In addition, those rules and rules of the Chicago Board Options
Exchange govern the amount of margin customers must provide and maintain in
writing uncovered options.
As a California state-chartered trust company, CSTC is primarily regulated
by the State of California Department of Financial Institutions. Since it
provides employee benefit plan trust services, CSTC is also required to comply
with the Employee Retirement Income Security Act of 1974 (ERISA) and,
consequently, is subject to oversight by both the Internal Revenue Service and
Department of Labor. CSTC is required under ERISA to maintain a fidelity bond
for the protection of employee benefit trusts for which it serves as trustee.
The Company's business is also subject to regulation by various non-U.S.
governments, securities exchanges and regulatory bodies, particularly in those
countries where it has acquired subsidiaries. Such regulation may directly
affect the method of operation and profitability of the Company's foreign
operations.
Charles Schwab Limited, a subsidiary of Schwab, is registered as an
arranger with the Securities and Futures Authority (SFA) in the United Kingdom,
and engages in business development activities on behalf of Schwab.
Charles Schwab Europe is registered as a broker-dealer with the SFA in the
United Kingdom.
Charles Schwab, Hong Kong, Ltd., a subsidiary of CSC, is registered as a
securities dealer and commodity trading advisor under the Securities and Futures
Commission in Hong Kong.
Net Capital Requirements
As registered broker-dealers, Schwab and M&S are subject to the Uniform Net
Capital Rule (Rule 15c3-1) under the Securities Exchange Act of 1934 (the Net
Capital Rule), which has also been adopted through incorporation by reference in
NYSE Rule 325. The CFTC and NFA also impose net capital requirements. Schwab is
a member firm of the NYSE, the NASD and the NFA, and M&S is a member firm of the
NASD. The Net Capital Rule specifies minimum net capital requirements that are
intended to ensure the general financial soundness and liquidity of
broker-dealers. Failure to maintain the required net capital may subject a firm
to suspension or expulsion by the NYSE and the NASD, certain punitive actions by
the SEC and other regulatory bodies, and ultimately may require a firm's
liquidation. Because CSC itself is not a registered broker-dealer, it is not
subject to the Net Capital Rule. However, if Schwab failed to maintain specified
levels of net capital, such failure would constitute a default by CSC under
certain debt covenants.
"Net capital" is essentially defined as net worth (assets minus
liabilities), plus qualifying subordinated borrowings, less certain deductions
that result from excluding assets that are not readily convertible into cash and
from conservatively valuing certain other assets. These deductions include
charges that discount the value of firm security positions to reflect the
possibility of adverse changes in market value prior to disposition.
The Net Capital Rule requires notice of equity capital withdrawals to be
provided to the SEC prior to and subsequent to withdrawals exceeding certain
sizes. Such rule prohibits withdrawals that would reduce a broker-dealer's net
capital to an amount less than 25% of its deductions required by the Net Capital
Rule as to its security positions. The Net Capital Rule also allows the SEC,
under limited circumstances, to restrict a broker-dealer from withdrawing equity
capital for up to twenty business days.
Schwab and M&S have elected the alternative method of calculation under
paragraph (a)(1)(ii) of the Net Capital Rule, which requires a broker-dealer to
maintain minimum net capital equal to 2% of its "aggregate debit items,"
computed in accordance with the Formula for Determination of Reserve
Requirements for Brokers and Dealers (Rule 15c3-3 under the Securities Exchange
Act of 1934). "Aggregate debit items" are assets that have as their source
transactions with customers, primarily margin loans. Under the alternative
method of the Net Capital Rule, a broker-dealer may not (a) pay, or permit the
payment or withdrawal of, any subordinated borrowings or (b) pay cash dividends
or permit equity capital to be removed if, after giving effect to such payment,
withdrawal, or removal, its net capital would be less than 5% of its aggregate
debit items.
Under NYSE Rule 326, Schwab is required to reduce its business if its net
capital is less than 4% of aggregate debit items for more than fifteen
consecutive business days; NYSE Rule 326 also prohibits the expansion of
business if net capital is less than 5% of aggregate debit items for more than
fifteen consecutive business days. The provisions of NYSE Rule 326 also become
operative if capital withdrawals (including scheduled maturities of subordinated
borrowings during the following six months) would result in a reduction of a
firm's net capital to the levels indicated.
If compliance with applicable net capital rules were to limit Schwab's or
M&S' operations and their ability to repay subordinated debt to CSC, this in
turn could limit CSC's ability to repay debt, pay cash dividends and purchase
shares of its outstanding stock. See also "Management's Discussion and Analysis
of Results of Operations and Financial Condition -- Liquidity and Capital
Resources -- Liquidity" in the Company's 1998 Annual Report to Stockholders,
which is incorporated herein by reference to Exhibit No. 13.1 of this report.
At December 31, 1998, Schwab was required to maintain minimum net capital
under the Net Capital Rule of $194 million and had total net capital of $987
million. At December 31, 1998, the amounts in excess of 2%, 4% and 5% of
aggregate debit items were $793 million, $600 million and $503 million,
respectively.
At December 31, 1998, M&S was required to maintain minimum net capital
under the Net Capital Rule of $1 million and had total net capital of $14
million. At December 31, 1998, the amount in excess of its minimum required net
capital was $13 million.
Item 2. Properties
The Company's corporate headquarters are located in a 28-story building at
101 Montgomery Street in San Francisco, California. The building contains
296,000 square feet and is leased by Schwab under a term expiring in the year
2010. Schwab has three successive five-year options to renew the lease at then
current market rates. Schwab also has a lease for 398,000 square feet of office
space located at 211 Main Street in San Francisco, California. The lease expires
in 2018 and includes two ten-year extension options at then current market
rates. In addition to these locations, Schwab leases space in other buildings
for its San Francisco operations, including its principal executive offices at
120 Kearny Street, aggregating 960,000 additional square feet. M&S' headquarters
are located in leased office space in Jersey City, New Jersey.
All of the Company's branch offices are located in leased premises,
generally with lease expiration dates five to ten years from inception. In
addition, the Company has four regional customer telephone service centers. The
Company owns the service centers located in Phoenix and Indianapolis, with
288,000 and 164,000 square feet, respectively. The Company also leases an
additional 148,000 square feet as part of its Phoenix service center. The
Company leases the service centers located in Orlando and Denver, with 213,000
and 163,000 square feet, respectively.
The Company owns its two primary data center facilities located in Phoenix
totaling 147,000 square feet.
While the corporate headquarters and data centers support all of the
Company's segments, the branch offices and service centers primarily support the
Individual Investor and Institutional Investor segments and M&S' headquarters
supports the Capital Markets segment.
Item 3. Legal Proceedings
The information required to be furnished pursuant to this item is included
in note "12. Commitments and Contingent Liabilities" in the Notes to
Consolidated Financial Statements in the Company's 1998 Annual Report to
Stockholders, which are incorporated herein by reference to Exhibit No. 13.1 of
this report.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of the Company's security holders
during the fourth quarter of 1998.
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters
The Company's common stock is listed on the NYSE and the Pacific Exchange
under the ticker symbol SCH. The number of common stockholders of record as of
March 18, 1999 was 7,350.
The other information required to be furnished pursuant to this item is
included in "Quarterly Financial Information (Unaudited)" in the Company's 1998
Annual Report to Stockholders, which is incorporated herein by reference to
Exhibit No. 13.1 of this report.
Item 6. Selected Financial Data
The information required to be furnished pursuant to this item is included
in "Selected Financial and Operating Data" in the Company's 1998 Annual Report
to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1
of this report.
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The information required to be furnished pursuant to this item is included
in "Management's Discussion and Analysis of Results of Operations and Financial
Condition" in the Company's 1998 Annual Report to Stockholders, which is
incorporated herein by reference to Exhibit No. 13.1 of this report.
Average balances and interest rates for the fourth quarters of 1998 and
1997 are summarized as follows (dollars in millions):
<TABLE>
<CAPTION>
Three Months Ended
December 31,
1998 1997
- ---------------------------------------------------------------------
<S> <C> <C>
Interest-Earning Assets (customer-related):
Margin loans to customers:
Average balance outstanding $ 9,048 $ 7,702
Average interest rate 7.54% 7.74%
Investments:
Average balance outstanding $ 8,895 $ 6,353
Average interest rate 4.95% 5.42%
Average yield on interest-earning assets 6.25% 6.69%
Funding Sources (customer-related and other):
Interest-bearing customer cash balances:
Average balance outstanding $14,586 $11,180
Average interest rate 4.13% 4.63%
Other interest-bearing sources:
Average balance outstanding $ 1,305 $ 1,217
Average interest rate 3.75% 4.43%
Average noninterest-bearing portion $ 2,052 $ 1,658
Average interest rate on funding sources 3.63% 4.07%
Summary:
Average yield on interest-earning assets 6.25% 6.69%
Average interest rate on funding sources 3.63% 4.07%
- ---------------------------------------------------------------------
Average net interest margin 2.62% 2.62%
=====================================================================
</TABLE>
The increase in interest revenue, net of interest expense, from the fourth
quarter of 1997 to the fourth quarter of 1998 was primarily due to higher levels
of average earning assets, partially offset by higher levels of average customer
cash balances.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The information required to be furnished pursuant to this item is included
in "Management's Discussion and Analysis of Results of Operations and Financial
Condition -- Risk Management -- Market Risk" in the Company's 1998 Annual Report
to Stockholders, which is incorporated herein by reference to Exhibit No. 13.1
of this report.
Item 8. Financial Statements and Supplementary Data
The information required to be furnished pursuant to this item is included
in the Consolidated Financial Statements and "Quarterly Financial Information
(Unaudited)" in the Company's 1998 Annual Report to Stockholders, which are
incorporated herein by reference to Exhibit No. 13.1 of this report.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information relating to directors of the Company required to be
furnished pursuant to this item is incorporated by reference from portions of
the Company's definitive proxy statement for its annual meeting of stockholders
to be filed with the SEC pursuant to Regulation 14A within 120 days after
December 31, 1998 (the Proxy Statement) under "The Board of Directors" and
"Principal Stockholders."
Executive Officers of the Registrant
The following table provides certain information about each of the
Company's current executive officers. Executive officers are elected by and
serve at the discretion of the Company's Board of Directors. However, Mr. Schwab
has an employment agreement with the Company through March 2003, which includes
an automatic renewal feature that, as of each March 31, extends the agreement
for an additional year unless either party elects to not extend the agreement.
<PAGE>
<TABLE>
<CAPTION>
==============================================================================================================================
Executive Officers of the Registrant
Name Age Title
<S> <C> <C>
Charles R. Schwab 61 Chairman, Co-Chief Executive Officer, and Director
David S. Pottruck 50 President, Co-Chief Executive Officer, and Director
Karen W. Chang 50 Enterprise President - General Investor Services
John Philip Coghlan 47 Enterprise President - Services for Investment Managers and
Retirement Plan Services
Linnet F. Deily 53 President - Retail Group
Lon Gorman 50 Enterprise President - Capital Markets and Trading
Daniel O. Leemon 45 Executive Vice President and Chief Strategy Officer
Dawn Gould Lepore 44 Executive Vice President and Chief Information Officer
Susanne D. Lyons 41 Enterprise President - Retail Client Services
Gideon Sasson 43 Enterprise President - Electronic Brokerage
Steven L. Scheid 45 Executive Vice President, Chief Financial Officer, and
Enterprise President - Financial Products and Services
Luis E. Valencia 54 Enterprise President - International
==============================================================================================================================
</TABLE>
<PAGE>
Mr. Schwab has been Co-Chief Executive Officer of the Company since January
1998, and Chairman and a director of the Company since its incorporation in
1986. Mr. Schwab was Chief Executive Officer of the Company from 1986 to 1997.
Mr. Schwab was a founder of Schwab in 1971 and has been its Chairman since 1978.
Mr. Schwab is currently a director of The Gap, Inc., Transamerica Corporation,
Siebel Systems, Inc., AirTouch Communications, Inc. and a trustee of The Charles
Schwab Family of Funds, Schwab Investments, Schwab Capital Trust and Schwab
Annuity Portfolios, all registered investment companies.
Mr. Pottruck has been Co-Chief Executive Officer of the Company since
January 1998, director of the Company since 1994, and President of the Company
since 1992. Mr. Pottruck was Chief Operating Officer of the Company from 1994 to
September 1998. Mr. Pottruck has been Chief Executive Officer of Schwab since
1992 and President of Schwab since 1988 (except for the period September 1997 to
April 1998). Mr. Pottruck joined Schwab in 1984. Mr. Pottruck is currently a
director of Intel Corporation, McKesson HBOC, Inc. and Preview Travel, Inc. In
1998, Mr. Pottruck was named to the Federal Advisory Commission on Electronic
Commerce.
Ms. Chang has been Enterprise President - General Investor Services of
Schwab and Executive Vice President of the Company since 1997. Ms. Chang was
Executive Vice President - Retail Branch Network of the Company and Schwab from
1996 to 1997 and Senior Vice President - Retail Branch Network of the Company
and Schwab from 1994 to 1996. Prior to joining Schwab in 1994, Ms. Chang was
Senior Marketing Vice President of American Express Company from 1989 to 1994.
Mr. Coghlan has been Enterprise President - Services for Investment
Managers of Schwab since May 1998, Enterprise President - Retirement Plan
Services of Schwab since 1997 and Executive Vice President of the Company since
1992. Mr. Coghlan was Executive Vice President of Schwab and General Manager of
Schwab Institutional from 1992 to 1997. Mr. Coghlan joined Schwab in 1986,
became Vice President in 1988 and became Senior Vice President in 1990.
Ms. Deily has been President - Retail Group of Schwab since May 1998 and
Executive Vice President of the Company since 1997. Ms. Deily was Enterprise
President - Services for Investment Managers of Schwab from 1997 to 1998 and
Executive Vice President and General Manager - Services for Investment Managers
of the Company and Schwab from 1996 to 1997. Before joining Schwab in 1996, Ms.
Deily was Chairman, President and Chief Executive Officer of First Interstate
Bank of Texas from 1991 to 1996.
Mr. Gorman has been Enterprise President - Capital Markets and Trading of
Schwab and Executive Vice President of the Company since 1997. Mr. Gorman was
Executive Vice President - Capital Markets and Trading of the Company and Schwab
from 1996 to 1997. Before joining Schwab in 1996, Mr. Gorman was a Managing
Director of Credit Suisse First Boston Corporation from 1988 to 1996. Mr. Gorman
was named a director of the Securities Industry Association in 1998.
Mr. Leemon has been Executive Vice President and Chief Strategy Officer of
the Company and Schwab since 1995. Before joining Schwab in 1995, Mr. Leemon
held various positions with The Boston Consulting Group, Inc., a management
consulting firm, from 1989 to 1995, including Vice President from 1990.
Ms. Lepore has been Executive Vice President and Chief Information Officer
of the Company and Schwab since 1993. Ms. Lepore joined Schwab in 1983. In 1998,
Ms. Lepore was named a director of the Times Mirror Company.
Ms. Lyons has been Enterprise President - Retail Client Services of Schwab
and Executive Vice President of the Company since 1997. Ms. Lyons was Executive
Vice President - Retail Marketing of the Company and Schwab from 1996 to 1997
and Senior Vice President - Active Trader of the Company and Schwab from 1994 to
1996. Ms. Lyons was Senior Vice President - Retail Service Delivery of the
Company and Schwab from 1993 to 1994. Ms. Lyons joined Schwab in 1992.
Mr. Sasson has been Enterprise President - Electronic Brokerage of Schwab
and Executive Vice President of the Company since 1997. Mr. Sasson was Senior
Vice President - Electronic Brokerage of the Company and Schwab from 1995 to
1997. Before joining Schwab in 1995, Mr. Sasson was Vice President - Information
Services of International Business Machines Corporation in 1995. Mr. Sasson was
Vice President, Systems Engineering of FYI Online, a joint venture of MCI
Communications Corporation and Equifax, Inc., from 1992 to 1995.
Mr. Scheid has been Executive Vice President and Chief Financial Officer of
the Company and Schwab since 1996 and Enterprise President - Financial Products
and Services of Schwab since May 1998. Before joining Schwab in 1996, Mr. Scheid
was Executive Vice President of Finance of First Interstate Bancorp from 1994 to
1996 and was Principal Financial Officer from 1995 to 1996. From 1990 to 1994,
Mr. Scheid was Chief Financial Officer of First Interstate Bank of Texas.
Mr. Valencia has been Enterprise President - International of Schwab since
May 1998 and Executive Vice President of the Company and Schwab since 1996. Mr.
Valencia served as Chief Administrative Officer of the Company and Schwab from
1996 to December 1998. From 1994 to 1996, Mr. Valencia was Executive Vice
President - Human Resources of the Company and Schwab. Before joining Schwab in
1994, Mr. Valencia served as a Managing Director of Commercial Credit Company, a
subsidiary of Travelers Group Inc. engaged in consumer finance for Travelers
Group Inc., from 1993 to 1994.
Item 11. Executive Compensation
The information required to be furnished pursuant to this item is
incorporated by reference from portions of the Proxy Statement under "Director
Compensation," "Summary Compensation Table," "Option Grants," "Options
Exercised," "Compensation Committee Report," "Certain Transactions," and
"Appendix A -- Employment and Severance Agreements."
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required to be furnished pursuant to this item is
incorporated by reference from portions of the Proxy Statement under "Principal
Stockholders."
Item 13. Certain Relationships and Related Transactions
The information required to be furnished pursuant to this item is
incorporated by reference from a portion of the Proxy Statement under "Certain
Transactions."
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Documents filed as part of this Report
1. Financial Statements
The financial statements and independent auditors' report are included in
the Company's 1998 Annual Report to Stockholders, which are incorporated herein
by reference to Exhibit No. 13.1 of this report and are listed below:
Consolidated Statement of Income
Consolidated Balance Sheet
Consolidated Statement of Cash Flows
Consolidated Statement of Stockholders' Equity
Notes to Consolidated Financial Statements
Independent Auditors' Report
2. Financial Statement Schedules
The financial statement schedules required to be furnished pursuant to this
item are listed in the accompanying index appearing on page F-1.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of 1998.
<PAGE>
(c) Exhibits
The exhibits listed below are filed as part of this annual report on Form
10-K.
Exhibit
Number Exhibit
- --------------------------------------------------------------------------------
3.7 Third Restated Certificate of Incorporation, as amended on May 6,
1996, of the Registrant, filed as Exhibit 3.7 to the
Registrant's Form 10-Q for the quarter ended September 30, 1996 and
incorporated herein by reference.
3.8 Second Restated Bylaws, as amended on July 17, 1996, of the
Registrant, filed as Exhibit 3.8 to the Registrant's Form 10-Q for the
quarter ended September 30, 1996 and incorporated herein by reference.
3.9 Second Restated Bylaws, as amended on September 22, 1998, of the
Registrant (supersedes Exhibit 3.8) filed as Exhibit 3.9 to the
Registrant's Form 10-Q for the quarter ended September 30, 1998 and
incorporated herein by reference.
4.2 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.
10.4 Form of Release Agreement dated as of March 31, 1987 among BAC,
Registrant, Schwab Holdings, Inc., Charles Schwab & Co., Inc. and
former shareholders of Schwab Holdings, Inc. *
10.20 License Agreements dated April 18, 1979 and April 11, 1983 between
International Business Machines Corporation and Charles Schwab & Co.,
Inc. *
10.22 License Agreement dated as of February 28, 1979 between Applied Data
Research, Inc. and Beta Systems, Inc. and Assignment, dated
February 21, 1979. *
10.23 License Agreement dated as of February 21, 1979 between Beta Systems,
Inc. and Charles Schwab & Co., Inc. *
10.25 333 Bush Street Office Lease dated July 29, 1987 between 333 Bush
Street Associates and Charles Schwab & Co., Inc. *
10.34 Form of Indemnification Agreement entered into between Registrant and
certain members of the Board of Directors of Registrant, filed
as Exhibit 10.34 to the Registrant's Form 10-K for the year ended
December 31, 1993.
10.57 Registration Rights and Stock Restriction Agreement, dated as of
March 31, 1987, between the Registrant and the holders of the
Common Stock, filed as Exhibit 4.23 to Registrant's Registration
Statement No. 33-16192 on Form S-1 and incorporated herein by
reference.
10.72 Restatement of Assignment and License, as amended January 25, 1988,
among Charles Schwab & Co., Inc., Charles R. Schwab and the
Registrant, filed as Exhibit 10.72 to the Registrant's Form 10-K
for the year ended December 31, 1994 and incorporated herein
by reference.
10.87 Trust Agreement under the Charles Schwab Profit Sharing and Employee
Stock Ownership Plan, effective November 1, 1990, dated October 25,
1990, filed as Exhibit 10.87 to the Registrant's Form 10-Q for
the quarter ended September 30, 1995 and incorporated herein by
reference. +
10.101 First Amendment to the Trust Agreement under the Charles Schwab Profit
Sharing and Employee Stock Ownership Plan, effective January 1, 1992,
dated December 20, 1991, filed as Exhibit 10.101 to the Registrant's
Form 10-K for the year ended December 31, 1996 and incorporated herein
by reference. +
10.116 Second Amendment to the Trust Agreement for the Charles Schwab Profit
Sharing and Employee Stock Ownership Plan effective July 1, 1992,
dated June 30, 1992, filed as Exhibit 10.116 to the Registrant's Form
10-Q for the quarter ended June 30, 1997 and incorporated herein by
reference. +
10.120 ESOP Loan Agreement, effective as of January 19, 1993, between
Registrant and The Charles Schwab Profit Sharing and Employee Stock
Ownership Plan and Trust, filed as Exhibit 10.120 to the Registrant's
Form 10-K for the year ended December 31, 1997 and incorporated herein
by reference. +
10.138 Form of Nonstatutory Stock Option Agreement for Non-Employee
Directors, filed as Exhibit 4.4 to the Registrant's Registration
Statement No. 33-47842 on Form S-8 and incorporated herein by
reference. +
10.140 Form of Restricted Shares Agreement, filed as Exhibit 4.6 to the
Registrant's Registration Statement No. 33-54701 on Form S-8 and
incorporated herein by reference. +
10.146 Annual Executive Individual Performance Plan dated as of January 1,
1995, filed as Exhibit 10.146 to the Registrant's Form 10-K for the
year ended December 31, 1994 and incorporated herein by reference. +
10.149 Employment Agreement dated as of March 31, 1995 between the Registrant
and Charles R. Schwab, filed as Exhibit 10.149 to the Registrant's
Form 10-K for the year ended December 31, 1994 and incorporated herein
by reference. +
10.156 Agreement of Sale, dated as of September 18, 1995, as amended by
letter agreement dated September 21, 1995 and by Second Amendment to
Agreement of Sale dated September 22, 1995, between American Express
Company and Charles Schwab & Co., Inc., regarding American Express
Western Regional Operations Center located at 2423 Lincoln Drive,
Phoenix, Arizona, filed as Exhibit 10.156 in the Registrant's Form
10-Q for the quarter ended September 30, 1995 and incorporated herein
by reference.
10.157 The Charles Schwab Corporation Directors' Deferred Compensation Plan,
effective January 1, 1996, filed as Exhibit 10.157 to the Registrant's
Form 10-K for the year ended December 31, 1995 and incorporated herein
by reference. +
10.158 Credit Agreement dated June 28, 1996 between the Registrant and the
banks listed therein, filed as Exhibit 10.158 to the Registrant's Form
10-Q for the quarter ended June 30, 1996 and incorporated herein by
reference.
10.162 The Charles Schwab Corporation Deferred Compensation Plan, as amended
September 17, 1996, filed as Exhibit 10.162 to the Registrant's Form
10-Q for the quarter ended September 30, 1996 and incorporated herein
by reference. +
10.163 Lease of 101 Montgomery Street between 101 Montgomery Street Co. and
Charles Schwab & Co., Inc. dated October 8, 1996, filed as Exhibit
10.163 to the Registrant's Form 10-K for the year ended December 31,
1996 and incorporated herein by reference.
10.164 Office Lease of Pacific Telesis Center Telesis Tower between
Post-Montgomery Associates and Charles Schwab & Co., Inc. dated
October 4, 1996, filed as Exhibit 10.164 to the Registrant's Form 10-K
for the year ended December 31, 1996 and incorporated herein by
reference.
10.166 The Charles Schwab Corporation 1987 Executive Officer Stock Option
Plan, restated to include amendments through February 26, 1997, with
form of Non-Qualified Stock Option Agreement (Executive Officer Stock
Option Plan (1987)) attached, (supersedes Exhibit 10.159) filed as
Exhibit 10.166 to the Registrant's Form 10-Q for the quarter ended
March 31, 1997 and incorporated herein by reference. +
10.167 The Charles Schwab Corporation 1987 Stock Option Plan, restated to
include amendments through February 26, 1997, with form of
Non-Qualified Stock Option Agreement attached, (supersedes Exhibit
10.160) filed as Exhibit 10.167 to the Registrant's Form 10-Q for the
quarter ended March 31, 1997 and incorporated herein by reference. +
10.169 Third Amendment to the Trust Agreement for the Charles Schwab Profit
Sharing and Employee Stock Ownership Plan effective January 1, 1996,
dated May 8, 1996 filed as Exhibit 10.169 to the Registrant's Form
10-Q for the quarter ended June 30, 1997 and incorporated herein by
reference. +
10.175 Form of Restricted Shares Award Agreement with performance vesting
conditions of The Charles Schwab Corporation 1992 Stock Incentive Plan
(supersedes Exhibit 10.155) filed as Exhibit 10.175 to the
Registrant's Form 10-Q for the quarter ended June 30, 1997 and
incorporated herein by reference. +
10.176 Form of Nonstatutory Stock Option Agreement of The Charles Schwab
Corporation 1987 Stock Option Plan (supersedes Form of Non-Qualified
Stock Option Agreement in Exhibit 10.167) filed as Exhibit 10.176 to
the Registrant's Form 10-Q for the quarter ended June 30, 1997 and
incorporated herein by reference. +
10.177 Form of Incentive Stock Option Agreement of The Charles Schwab
Corporation 1987 Stock Option Plan filed as Exhibit 10.177 to the
Registrant's Form 10-Q for the quarter ended June 30, 1997 and
incorporated herein by reference. +
10.178 Form of Restricted Shares Award Agreement of The Charles Schwab
Corporation 1987 Stock Option Plan filed as Exhibit 10.178 to the
Registrant's Form 10-Q for the quarter ended June 30, 1997 and
incorporated herein by reference. +
10.179 Form of Nonstatutory Stock Option Agreement of The Charles Schwab
Corporation 1987 Executive Officer Stock Option Plan (supersedes Form
of Non-Qualified Stock Option Agreement in Exhibit 10.166) filed as
Exhibit 10.179 to the Registrant's Form 10-Q for the quarter ended
June 30, 1997 and incorporated herein by reference. +
10.180 Form of Restricted Shares Award Agreement of The Charles Schwab
Corporation 1987 Executive Officer Stock Option Plan filed as Exhibit
10.180 to the Registrant's Form 10-Q for the quarter ended June 30,
1997 and incorporated herein by reference. +
10.181 Commercial office lease of 211 Main Street between Main Plaza, LLC and
Charles Schwab & Co., Inc. dated August 8, 1997 filed as Exhibit
10.181 to the Registrant's Form 10-Q for the quarter ended September
30, 1997 and incorporated herein by reference.
10.182 The Charles Schwab Corporation Corporate Executive Bonus Plan, amended
and restated, effective January 1, 1996 (supersedes Exhibit 10.147)
filed as Exhibit 10.182 to the Registrant's Form 10-Q for the quarter
ended September 30, 1997 and incorporated herein by reference. +
10.185 The Charles Schwab Corporation Senior Executive Severance Policy,
effective December 7, 1995 filed as Exhibit 10.185 to the Registrant's
Form 10-Q for the quarter ended September 30, 1997 and incorporated
herein by reference. +
10.186 The Charles Schwab Corporation 1987 Stock Option Plan, as amended
October 22, 1997, with form of Non-Qualified Stock Option Agreement
(General Management Plan) attached (supersedes Exhibit 10.160) filed
as Exhibit 10.186 to the Registrant's Form 10-K for the year ended
December 31, 1997 and incorporated herein by reference. +
10.187 The Charles Schwab Corporation 1992 Stock Incentive Plan (Restated to
include Amendments through October 22, 1997) (supersedes Exhibit
10.170) filed as Exhibit 10.187 to the Registrant's Form 10-K for the
year ended December 31, 1997 and incorporated herein by reference. +
10.188 The Charles Schwab Corporation Executive Officer Stock Option Plan
(1987), as amended October 22, 1997, with form of Non-Qualified Stock
Option Agreement (Executive Officer Stock Option Plan (1987))
attached, (supersedes Exhibit 10.159) filed as Exhibit 10.188 to the
Registrant's Form 10-K for the year ended December 31, 1997 and
incorporated herein by reference. +
10.189 Annual Executive Individual Performance Plan as amended January 1,
1998 filed as Exhibit 10.189 to the Registrant's Form 10-K for the
year ended December 31, 1997 and incorporated herein by reference. +
10.190 The Charles Schwab Corporation Employee Stock Incentive Plan dated
October 22, 1997 filed as Exhibit 10.190 to the Registrant's Form 10-K
for the year ended December 31, 1997 and incorporated herein by
reference. +
10.191 Form of Restricted Shares Award Agreement of The Charles Schwab
Corporation 1992 Stock Incentive Plan (supersedes Exhibit 10.171)
filed as Exhibit 10.191 to the Registrant's Form 10-K for the year
ended December 31, 1997 and incorporated herein by reference. +
10.192 Form of Nonstatutory Stock Option Agreement of The Charles Schwab
Corporation 1992 Stock Incentive Plan (supersedes Exhibit 10.172)
filed as Exhibit 10.192 to the Registrant's Form 10-K for the year
ended December 31, 1997 and incorporated herein by reference. +
10.193 Form of Nonstatutory Stock Option and Performance Unit Agreement of
The Charles Schwab Corporation 1992 Stock Incentive Plan (supersedes
Exhibit 10.173) filed as Exhibit 10.193 to the Registrant's Form 10-K
for the year ended December 31, 1997 and incorporated herein by
reference. +
10.194 Form of Incentive Stock Option Agreement of The Charles Schwab
Corporation 1992 Stock Incentive Plan (supersedes Exhibit 10.174)
filed as Exhibit 10.194 to the Registrant's Form 10-K for the year
ended December 31, 1997 and incorporated herein by reference. +
10.195 Charles Schwab Profit Sharing and Employee Stock Ownership Plan, as
amended through December 1, 1997 (supersedes Exhibit 10.168) filed as
Exhibit 10.195 to the Registrant's Form 10-K for the year ended
December 31, 1997 and incorporated herein by reference. +
10.196 Credit Agreement dated June 27, 1997 between the Registrant and the
banks listed therein (supersedes Exhibit 10.158) filed as Exhibit
10.196 to the Registrant's Form 10-Q for the quarter ended March 31,
1998 and incorporated herein by reference.
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.
10.199 The Charles Schwab Corporation Deferred Compensation Plan, as amended
through July 24, 1998 (supersedes Exhibit 10.162), filed as Exhibit
10.199 to the Registrant's Form 10-Q for the quarter ended September
30, 1998 and incorporated herein by reference. +
10.200 Form of Indemnification Agreement entered into between Registrant and
members of the Board of Directors of Registrant (supersedes exhibit
10.34).
10.201 Seventh Amendment to the Charles Schwab Profit Sharing and Employee
Stock Ownership Plan (Amendments 1 through 6 of the Charles Schwab
Profit Sharing and Employee Stock Ownership Plan are incorporated
under Exhibit 10.195, filed with the Registrant's Form 10-K for the
fiscal year ended December 31, 1997). +
10.202 Fourth Amendment to the Trust Agreement for the Charles Schwab Profit
Sharing and Employee Stock Ownership Plan effective January 1, 1998. +
10.203 The Charles Schwab Corporation 1992 Stock Incentive Plan, restated
to include Amendments through March 20, 1998 (supersedes Exhibit
10.187). +
12.1 Computation of Ratio of Earnings to Fixed Charges.
13.1 Portions of The Charles Schwab Corporation 1998 Annual Report to
Stockholders, which have been incorporated herein by reference. Except
for such portions, such annual report is not deemed to be "filed"
herewith.
21.1 Subsidiaries of the Registrant.
23.1 Independent Auditors' Consent.
27.1 Financial Data Schedule (electronic only).
* Incorporated by reference to the identically-numbered exhibit to
Registrant's Registration Statement No. 33-16192 on Form S-1, as
amended and declared effective on September 22, 1987.
+ Management contract or compensatory plan.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on March 25, 1999.
THE CHARLES SCHWAB CORPORATION
(Registrant)
BY: /s/ Charles R. Schwab
----------------------------
Charles R. Schwab
Chairman, Co-Chief Executive
Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated, on March 25, 1999.
Signature / Title Signature / Title
----------------- -----------------
/s/ Charles R. Schwab /s/ David S. Pottruck
- -------------------------------- --------------------------------
Charles R. Schwab, David S. Pottruck,
Chairman, Co-Chief Executive Officer President, Co-Chief Executive
and Director Officer and Director
(principal executive officer) (principal executive officer)
/s/ Steven L. Scheid
- --------------------------------
Steven L. Scheid,
Executive Vice President
and Chief Financial Officer
(principal financial and accounting officer)
/s/ Nancy H. Bechtle /s/ C. Preston Butcher
- -------------------------------- --------------------------------
Nancy H. Bechtle, Director C. Preston Butcher, Director
/s/ Donald G. Fisher
- -------------------------------- --------------------------------
Donald G. Fisher, Director Anthony M. Frank, Director
/s/ Frank C. Herringer /s/ Stephen T. McLin
- -------------------------------- --------------------------------
Frank C. Herringer, Director Stephen T. McLin, Director
/s/ Mark A. Pulido /s/ Arun Sarin
- -------------------------------- --------------------------------
Mark A. Pulido, Director Arun Sarin, Director
/s/ George P. Shultz /s/ Roger O. Walther
- -------------------------------- --------------------------------
George P. Shultz, Director Roger O. Walther, Director
<PAGE>
THE CHARLES SCHWAB CORPORATION
Index to Financial Statement Schedules
Page
Independent Auditors' Report F-2
Schedule I - Condensed Financial Information of Registrant:
Condensed Balance Sheet F-3
Condensed Statement of Income F-4
Condensed Statement of Cash Flows F-5
Notes to Condensed Financial Information F-6
Schedule II - Valuation and Qualifying Accounts F-7
Schedules not listed are omitted because of the absence of the conditions under
which they are required or because the information is included in the Company's
consolidated financial statements and notes in the Company's 1998 Annual Report
to Stockholders, which are incorporated herein by reference to Exhibit No. 13.1
of this report.
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
- ------------------------------
To the Stockholders and Board of Directors of
The Charles Schwab Corporation:
We have audited the consolidated financial statements of The Charles Schwab
Corporation and subsidiaries (the Company) as of December 31, 1998 and 1997, and
for each of the three years in the period ended December 31, 1998, and have
issued our report thereon dated February 22, 1999; such consolidated financial
statements and report are included in your 1998 Annual Report to Stockholders
and are incorporated herein by reference. Our audits also included the financial
statement schedules of the Company listed in Item 14. These financial statement
schedules are the responsibility of the Company's management. Our responsibility
is to express an opinion based on our audits. In our opinion, such financial
statement schedules, when considered in relation to the basic consolidated
financial statements taken as a whole, present fairly in all material respects
the information set forth therein.
/s/DELOITTE & TOUCHE LLP
San Francisco, California
February 22, 1999
F-2
<PAGE>
SCHEDULE I
THE CHARLES SCHWAB CORPORATION
(PARENT COMPANY ONLY)
<TABLE>
<CAPTION>
Condensed Financial Information of Registrant
Condensed Balance Sheet
(In thousands)
December 31,
1998 1997
---- ----
<S> <C> <C>
Assets
Cash and cash equivalents $ 180,025 $ 79,802
Advances to subsidiaries 460,848 350,606
Investments in subsidiaries, at equity 1,223,417 1,083,122
Other assets 8,683 4,618
- ------------------------------------------------------------------------------------------------------------------------
Total $ 1,872,973 $ 1,518,148
========================================================================================================================
Liabilities and Stockholders' Equity
Accrued expenses and other liabilities $ 93,351 $ 12,031
Borrowings 351,000 361,000
- ------------------------------------------------------------------------------------------------------------------------
Total liabilities 444,351 373,031
Stockholders' equity 1,428,622 1,145,117
- ------------------------------------------------------------------------------------------------------------------------
Total $ 1,872,973 $ 1,518,148
========================================================================================================================
</TABLE>
See Notes to Condensed Financial Information.
F-3
<PAGE>
SCHEDULE I
THE CHARLES SCHWAB CORPORATION
(PARENT COMPANY ONLY)
<TABLE>
<CAPTION>
Condensed Financial Information of Registrant
Condensed Statement of Income
(In thousands)
Year Ended December 31,
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Interest revenue $ 42,780 $ 30,699 $ 26,287
Interest expense (25,429) (20,546) (19,091)
- -------------------------------------------------------------------------------------------------------------------------
Net interest revenue 17,351 10,153 7,196
Other revenues 409 544 268
Other income (expenses) (12,104) 4,423 (3,400)
- -------------------------------------------------------------------------------------------------------------------------
Income before income tax expense and equity
in earnings of subsidiaries 5,656 15,120 4,064
Income tax expense 2,092 5,692 1,568
- -------------------------------------------------------------------------------------------------------------------------
Income before equity in earnings of subsidiaries 3,564 9,428 2,496
Equity in earnings of subsidiaries
Equity in undistributed earnings of subsidiaries 56,913 199,869 154,922
Dividends paid by subsidiaries 287,985 60,980 76,385
- -------------------------------------------------------------------------------------------------------------------------
Total 344,898 260,849 231,307
Net income $ 348,462 $ 270,277 $ 233,803
=========================================================================================================================
</TABLE>
See Notes to Condensed Financial Information.
F-4
<PAGE>
SCHEDULE I
THE CHARLES SCHWAB CORPORATION
(PARENT COMPANY ONLY)
<TABLE>
<CAPTION>
Condensed Financial Information of Registrant
Condensed Statement of Cash Flows
(In thousands)
Year Ended December 31,
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities
Net income $ 348,462 $ 270,277 $ 233,803
Noncash items included in net income:
Equity in undistributed earnings of subsidiaries (56,913) (199,869) (154,922)
Change in other assets (3,932) 279 (157)
Change in accrued expenses and other liabilities 13,753 (4,122) (7,805)
- ------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 301,370 66,565 70,919
- ------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities
Increase in net advances to subsidiaries (26,465) (51,939) (8,554)
Increase in investments in subsidiaries (800) (50,614) (10,132)
Cash payments for businesses acquired (1,400) (1,200) (4,709)
- ------------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (28,665) (103,753) (23,395)
- ------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities
Proceeds from borrowings 30,000 111,000 64,000
Repayment of borrowings (40,000) (28,000) (26,000)
Dividends paid (43,068) (37,091) (31,495)
Purchase of treasury stock (150,180) (18,234) (28,171)
Proceeds from stock options exercised and other 30,766 14,530 7,729
- ------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities (172,482) 42,205 (13,937)
- ------------------------------------------------------------------------------------------------------------------
Increase in cash and cash equivalents 100,223 5,017 33,587
Cash and cash equivalents at beginning of year 79,802 74,785 41,198
- ------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 180,025 $ 79,802 $ 74,785
==================================================================================================================
</TABLE>
See Notes to Condensed Financial Information.
F-5
<PAGE>
SCHEDULE I
THE CHARLES SCHWAB CORPORATION
(PARENT COMPANY ONLY)
Condensed Financial Information of Registrant
Notes to Condensed Financial Information
1. Introduction and basis of presentation
The condensed financial information of The Charles Schwab Corporation (the
Parent Company) should be read in conjunction with the consolidated
financial statements of The Charles Schwab Corporation and subsidiaries
(the Company) and notes thereto found in the Company's 1998 Annual Report
to Stockholders, which are incorporated herein by reference to Exhibit No.
13.1 of this report.
2. Supplemental cash flow information
During 1998, the Parent Company recorded a non-cash capital contribution of
$69 million to its subsidiary, Charles Schwab & Co., Inc. (Schwab), through
the assumption of indebtedness.
Certain information affecting the cash flows of the Parent Company follows
(in thousands):
<TABLE>
<CAPTION>
Year ended December 31,
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Income taxes paid (received) $ 5,539 $ 2,608 $ (48)
========= ========= =========
Interest paid:
Borrowings $ 24,113 $ 18,773 $ 16,887
Other 306 364 339
--------- --------- ---------
Total interest paid $ 24,419 $ 19,137 $ 17,226
========= ========= =========
</TABLE>
3. Common stock split
The Parent Company's Board of Directors declared a three-for-two common
stock split, distributed December 1998, effected in the form of a 50% stock
dividend.
4. Related party transactions
The Parent Company provides subordinated revolving credit facilities to
its subsidiaries, Schwab and Mayer & Schweitzer, Inc. (M&S). Schwab had a
$450 million subordinated revolving credit facility maturing in September
2000, of which $405 million was outstanding at December 31, 1998. This
credit facility was $400 million at the end of 1997, of which $315
million was outstanding at December 31, 1997. At year end 1998, Schwab
also had outstanding $25 million in fixed-rate subordinated term loans
from the Parent Company maturing in 2000. The outstanding balance of these
term loans was also $25 million at year end 1997. M&S had a $35
million subordinated lending arrangement maturing in 2000, which was not
used in 1998 or 1997. Interest earned by the Parent Company from these
subordinated lending arrangements totaled $37 million in 1998, $26 million
in 1997 and $22 million in 1996.
F-6
<PAGE>
SCHEDULE II
THE CHARLES SCHWAB CORPORATION
<TABLE>
<CAPTION>
Valuation and Qualifying Accounts
(In thousands)
Additions
Balance at ------------------------ Balance at
Beginning Charged End
Description of Year to Expense Other Written off of Year
----------- --------- ---------- ----- ----------- -------
<S> <C> <C> <C> <C> <C>
For the year ended
December 31, 1998:
Allowance for doubtful accounts $ 7,717 $ 4,752 $ 231 $(5,125) $ 7,575
=======================================================================
For the year ended
December 31, 1997:
Allowance for doubtful accounts $ 5,518 $ 3,896 $ 195 $(1,892) $ 7,717
=======================================================================
For the year ended
December 31, 1996:
Allowance for doubtful accounts $ 3,700 $ 2,651 $ 99 $ (932) $ 5,518
=======================================================================
</TABLE>
F-7
Exhibit 10.200
INDEMNIFICATION AGREEMENT
AGREEMENT, effective as of ______________________, between The
Charles Schwab Corporation, a Delaware corporation (the "Company"), and
____________________ (the "Indemnitee"). Capitalized terms in this Agreement
shall have the meanings set forth in Section 19 hereof.
WHEREAS, it is essential to the Company to attract, engage and
retain as directors and officers the most capable persons available;
WHEREAS, Indemnitee is a director/officer of the Company;
WHEREAS, both the Company and Indemnitee recognize the increased
risk of litigation and other claims being asserted against directors of public
companies in today's environment;
WHEREAS, basic protection against undue risk of personal
liability of directors and officers has been provided through insurance coverage
providing reasonable protection at reasonable cost, and Indemnitee is relying on
the availability of such coverage; however, there can be no assurance as to the
future availability of such insurance on terms providing reasonable protection
at reasonable cost;
WHEREAS, the Restated Certificate of Incorporation and the
By-laws of the Company require the Company to indemnify and advance expenses to
its directors to the fullest extent authorized by law and the Indemnitee has
been serving and continues to serve as a director or officer of the Company in
part in reliance on such Restated Certificate of Incorporation and By-laws;
WHEREAS, in recognition of Indemnitee's need for substantial
protection against personal liability in order to enhance Indemnitee's continued
service to the Company in an effective manner and Indemnitee's reliance on the
aforesaid Restated Certificate of Incorporation and By-laws, and in part to
provide Indemnitee with specific and additional contractual assurance that the
protection provided by such Restated Certificate of Incorporation and By-laws
will be available to Indemnitee (regardless of, among other things, any
amendment to or revocation of such Restated Certificate of Incorporation and
By-laws or any change in the composition of the Company's Board of Directors or
acquisition transaction relating to the Company), and in order to induce
Indemnitee to continue to provide services to the Company as a director or
officer thereof, the Company wishes to provide in this Agreement for the
indemnification of and the advancing of expenses to Indemnitee to the fullest
extent (whether partial or complete) permitted by law and as set forth in this
Agreement, and, to the extent insurance is maintained, for the continued
coverage of Indemnitee under the Company's directors' and officers' liability
insurance policies.
NOW, THEREFORE, in consideration of the premises and of
Indemnitee continuing to serve the Company directly or, at its request, with
another enterprise, and intending to be legally bound hereby, the parties hereto
agree as follows:
1. Agreement to Indemnify.
a. Indemnity of Indemnitee. In the event Indemnitee
was, is or becomes a party to or witness or other participant in, or is
threatened to be made a party to or witness or other participant in, a
Proceeding by reason of (or arising in part out of) an Indemnifiable Event, the
Company shall indemnify Indemnitee to the fullest extent authorized by law. The
Company shall indemnify Indemnitee as soon as practicable but in any event no
later than thirty days after written demand is presented to the Company, against
any and all Expenses, judgments, fines, losses, penalties and amounts paid in
settlement (including all interest, assessments and other charges paid or
payable in connection with or in respect of such Expenses, judgments, fines,
losses, penalties or amounts paid in settlement) of such Proceeding and any
federal, state, local or foreign taxes imposed on the Indemnitee as a result of
the actual or deemed receipt of any payments under this Agreement (including the
creation of the trust under Section 3 hereof). Notwithstanding anything in this
Agreement to the contrary and except as provided in Section 4, prior to a Change
in Control Indemnitee shall not be entitled to indemnification pursuant to this
Agreement in connection with any Proceeding initiated by Indemnitee against the
Company or any director or officer of the Company unless the Company has joined
in or consented to the initiation of such Proceeding. If so requested by
Indemnitee, the Company shall advance (within thirty business days of such
request) any and all Expenses to Indemnitee (an "Expense Advance").
b. Indemnification Procedures.
(1) Reviewing Party determination.Notwithstanding
the foregoing, the obligations of the Company under Section 1(a) to Indemnitee
shall be subject to the condition that the Reviewing Party shall not have
determined (in a written opinion, in any case in which the Reviewing Party is
Independent Legal Counsel in the event of a Change in Control, as provided in
Section 2 hereof) that Indemnitee would not be permitted to be indemnified under
applicable law.
(2) Expense Advances. Notwithstanding Section
1(a), the obligation of the Company to make an Expense Advance pursuant to
Section 1(a) shall be subject to the condition that, if, when and to the extent
that the Reviewing Party determines that Indemnitee would not be permitted to be
so indemnified under applicable law, the Company shall be entitled to be
reimbursed by Indemnitee (who hereby agrees to reimburse the Company) for all
such amounts theretofore paid; provided, however, that if Indemnitee has
commenced legal proceedings in a court of competent jurisdiction to secure a
determination that Indemnitee should be indemnified under applicable law, any
determination made by the Reviewing Party that Indemnitee would not be permitted
to be indemnified under applicable law shall not be binding and Indemnitee shall
not be required to reimburse the Company for any Expense Advance until a final
judicial determination is made with respect thereto (as to which all rights of
appeal therefrom have been exhausted or lapsed). Indemnitee's obligation to
reimburse the Company for Expense Advances shall be unsecured and no interest
shall be charged thereon.
(3) Selection of Reviewing Party.
(a) Change in Control. If there has been a
Change in Control (other than a Change in Control which has been approved by a
majority of the Company's Board of Directors who were members of the Incumbent
Board (as defined in Section 19(a)(2) hereof) immediately prior to such Change
in Control), the Reviewing Party shall be the Independent Legal Counsel referred
to in Section 2 hereof and selected by Indemnitee.
(b) No Change in Control. If (i)there has
not been a Change in Control, or (ii) there has been a Change in Control which
has been approved by a majority of the Company's Board of Directors who were
members of the Incumbent Board (as defined in Section 19(a)(2) hereof)
immediately prior to such Change in Control, the Reviewing Party shall be
designated and selected by the Board of Directors and may be Independent Legal
Counsel should the Board so decide; provided, however, that if requested by
Indemnitee, the Reviewing Party shall be Independent Legal Counsel selected by
the Board of Directors.
(4) Remedies of Indemnitee. If there has been no
determination by the Reviewing Party or if the Reviewing Party determines that
Indemnitee substantively would not be permitted to be indemnified in whole or in
part under applicable law, Indemnitee shall have the right to commence
litigation in any court in the States of California or Delaware having subject
matter jurisdiction thereof and in which venue is proper, seeking an initial
determination by the court or challenging any such determination by the
Reviewing Party or any aspect thereof, including the legal or factual bases
therefor. The Company hereby consents to service of process and to appear in any
such proceeding. Any determination by the Reviewing Party otherwise shall be
conclusive and binding on the Company and Indemnitee.
2. Change in Control. The Company agrees that if there is a
Change in Control of the Company (other than a Change in Control which has been
approved by a majority of the Company's Board of Directors who were members of
the Incumbent Board (as defined in Section 19(a)(2) hereof) immediately prior to
such Change in Control) then Independent Legal Counsel shall be selected by
Indemnitee and such Independent Legal Counsel shall determine whether the
officer or director is entitled to indemnity payments and Expense Advances under
this Agreement or any other agreement or Restated Certificate of Incorporation
or Bylaws of the Company now or hereafter in effect relating to Proceedings
involving Indemnifiable Events. The Company agrees to pay the reasonable fees of
the Independent Legal Counsel and to indemnify fully such Independent Legal
Counsel against any and all expenses (including attorneys' fees), claims,
liabilities and damages arising out of or relating to this Agreement or the
engagement of Independent Legal Counsel pursuant hereto.
3. Potential Change in Control. In the event of a Potential
Change in Control, the Company shall, upon written request by Indemnitee, create
a trust for the benefit of the Indemnitee and from time to time upon written
request of Indemnitee shall fund such trust in an amount sufficient to satisfy
any and all Expenses reasonably anticipated at the time of each such request to
be incurred in connection with investigating, preparing for and defending any
Proceeding relating to an Indemnifiable Event, and any and all judgments, fines,
losses, penalties and settlement amounts arising from any and all Proceedings
relating to an Indemnifiable Event from time to time actually paid or claimed,
reasonably anticipated or proposed to be paid. The amount or amounts to be
deposited in the trust pursuant to the foregoing funding obligation shall be
determined by the Reviewing Party. The terms of the trust shall provide that
upon a Change in Control (i) the trust shall not be revoked or the principal
thereof invaded, without the written consent of the Indemnitee, (ii) the trustee
shall advance, within thirty business days of a request by the Indemnitee, any
and all Expenses to the Indemnitee (and the Indemnitee hereby agrees to
reimburse the trust under the circumstances under which the Indemnitee would be
required to reimburse the Company under Section 1(b) of this Agreement), (iii)
the trust shall continue to be funded by the Company in accordance with the
funding obligation set forth above, (iv) the trustee shall promptly pay to the
Indemnitee all amounts for which the Indemnitee shall be entitled to
indemnification pursuant to this Agreement or otherwise, and (v) all unexpended
funds in such trust shall revert to the Company upon a final determination by
the Reviewing Party or a final judicial determination by a court of competent
jurisdiction (as to which all rights of appeal therefrom have been exhausted or
lapsed), as the case may be, that the Indemnitee has been fully indemnified
under the terms of this Agreement. The trustee shall be chosen by the
Indemnitee. Nothing in this Section 3 shall relieve the Company of any of its
obligations under this Agreement. All income earned on the assets held in the
trust shall be reported as income by the Company for federal, state, local and
foreign tax purposes.
4. Indemnification for Expenses Incurred in Enforcing this
Agreement. The Company shall indemnify Indemnitee against any and all expenses
(of the types described in the definition of Expenses in Section 19 of this
Agreement including attorneys' fees) which are incurred by Indemnitee in
connection with any claim asserted against or action brought by Indemnitee for
(i) indemnification or advance payment of Expenses by the Company under this
Agreement or any other agreement or under applicable law or the Company's
Restated Certificate of Incorporation or By-laws now or hereafter in effect
relating to Proceedings for Indemnifiable Events and/or (ii) recovery under any
directors' and officers' liability insurance policies maintained by the Company
and/or (iii) recovery of Expenses advanced by the Company to Indemnitee, but
only if Indemnitee has been successful on the merits or otherwise therein in
whole or in part. If so requested by Indemnitee, the Company shall advance
(within thirty business days of such request) any and all Expenses to Indemnitee
which are incurred in connection with any such claim or action brought or
defended by Indemnitee; provided, however, that if it has been finally
judicially determined (as to which all rights of appeal have been exhausted or
lapsed) that Indemnitee was not entitled to be indemnified with respect to such
claim, action or defense, the Company shall be entitled to be reimbursed by
Indemnitee (who hereby agrees to reimburse the Company) for such amounts
theretofore advanced.
5. Partial Indemnity. If Indemnitee is entitled under any
provision of this Agreement to indemnification by the Company for some or a
portion of the Expenses, judgments, fines, penalties and amounts paid in
settlement of a Proceeding but not, however, for all of the total amount
thereof, the Company shall nevertheless indemnify Indemnitee for the portion
thereof to which Indemnitee is entitled. Moreover, notwithstanding any other
provision of this Agreement, to the extent that Indemnitee has been successful
on the merits or otherwise in defense of any or all Proceedings relating in
whole or in part to an Indemnifiable Event or in defense of any issue or matter
therein, Indemnitee shall be indemnified against all Expenses incurred.
6. Defense to Indemnification, Burden of Proof and Presumptions.
a. Defense to Indemnification. It shall be a defense
to any action brought by the Indemnitee against the Company to enforce this
Agreement (other than an action brought to enforce a claim for Expenses incurred
in defending a Proceeding in advance of its final disposition) that the
Indemnitee has not met the standards of conduct that make it permissible under
the Delaware General Corporation Law for the Company to indemnify the Indemnitee
for the amount claimed.
b. Burden of Proof. In connection with any determination
by the Reviewing Party or otherwise as to whether the Indemnitee is entitled to
be indemnified hereunder, the burden of proof shall be on the Company to
establish that Indemnitee is not so entitled.
c. No Presumptions. In any action brought by Indemnitee
against the Company to enforce this Agreement:
(1) Neither (i) the failure of the Company
(including its Board of Directors or its stockholders) or the Reviewing Party to
have made a determination prior to the commencement of such action by the
Indemnitee that indemnification of the claimant is proper under the
circumstances because he or she has met the applicable standard of conduct set
forth in the Delaware General Corporation Law or had a particular belief, nor
(ii) an actual determination by the Company (including its Board of Directors or
its stockholders) or the Reviewing Party that the Indemnitee had not met such
applicable standard of conduct or did not have such belief, shall, of itself, be
a defense to the action or create a presumption that the Indemnitee has not met
the applicable standard of conduct or did not have any particular belief.
(2) For purposes of this Agreement, the termination
of any Proceeding, by judgment, order, settlement (whether with or without court
approval) or conviction, or upon a plea of nolo contendere, or its equivalent,
shall not, of itself, create a presumption that Indemnitee did not meet any
particular standard of conduct or have any particular belief or that a court has
determined that indemnification is not permitted by applicable law.
7. Non-Exclusivity. The rights of the Indemnitee hereunder shall
be in addition to any other rights Indemnitee may have under the Company's
Restated Certificate of Incorporation or By-laws or the Delaware General
Corporation Law or any statute or vote of stockholders or disinterested
directors or otherwise. To the extent that a change in the Delaware General
Corporation Law (whether by statute or judicial decision) permits broader
indemnification by agreement than would be afforded currently under the
Company's Restated Certificate of Incorporation and By-laws and this Agreement,
it is the intent of the parties hereto that the Company will provide Indemnitee
such broader indemnification to the maximum extent permitted by the Delaware
General Corporation Law. Any repeal or modification of relevant provisions of
Delaware General Corporation Law or any other applicable laws shall not in any
way diminish Indemnitee's rights to indemnification or the obligations of the
Company under this Agreement.
8. No Construction as Employment Agreement. Nothing contained
herein shall be construed as giving Indemnitee any right to be retained in the
employ of the Company or any of its subsidiaries.
9. Liability Insurance. To the extent the Company maintains an
insurance policy or policies providing directors' and officers' liability
insurance, Indemnitee shall be covered by such policy or policies, in accordance
with its or their terms, to the maximum extent of the coverage available for any
Company director or officer.
10. Period of Limitations. No legal action under this Agreement
shall be brought and no cause of action shall be asserted by or in the right of
the Company against Indemnitee or Indemnitee's spouse, heirs, executors or
personal or legal representatives after the expiration of two years from the
date of accrual of such cause of action, and any such cause of action or claim
of the Company shall be extinguished and deemed released unless asserted by the
timely filing of a legal action within such two-year period; provided, however,
that if any shorter period of limitations is otherwise applicable to any such
cause of action such shorter period shall govern.
11. Amendment of This Agreement. No supplement, modification or
amendment of this Agreement shall be binding unless executed in writing by both
of the parties hereto. No waiver of any of the provisions of this Agreement
shall be deemed or shall constitute a waiver of any other provisions hereof
(whether or not similar) nor shall such waiver constitute a continuing waiver.
12. Subrogation. In the event of payment under this Agreement,
the Company shall be subrogated to the extent of such payment to all of the
rights of recovery of Indemnitee, who shall execute all papers required and
shall do everything that may be necessary to secure such rights, including the
execution of such documents necessary to enable the Company effectively to bring
suit to enforce such rights.
13. No Duplication of Payments. The Company shall not be liable
under this Agreement to make any payment in connection with any claim made
against Indemnitee to the extent Indemnitee has otherwise actually received
payment (under any insurance policy, Restated Certificate of Incorporation or
By-laws of the Company or otherwise) of the amounts otherwise indemnifiable
hereunder.
14. Settlement of Proceedings. The Company shall not settle any
Proceeding in any manner which would impose any penalty or limitation on
Indemnitee without Indemnitee's written consent; provided, however, that under
no circumstances shall (i) the full or partial settlement of any Proceeding
which releases the Company or any party other than Indemnitee but does not
release Indemnitee, be deemed, in itself, a penalty or limitation on Indemnitee;
or (ii) the Company be required to obtain the consent of Indemnitee to the full
or partial settlement of any Proceeding that grants Indemnitee a complete and
unqualified release in respect of the potential liability. Neither the Company
nor the Indemnitee will unreasonably withhold their consent to any proposed
settlement. The Company shall not be liable to indemnify the Indemnitee under
this Agreement with regard to any award in any proceeding if the Company was not
given a reasonable and timely opportunity, at its expense, to meaningfully
participate in the defense of such Proceeding.
15. Binding Effect. This Agreement shall be binding upon and
inure to the benefit of and be enforceable by the parties hereto and their
respective successors, assigns, including any direct or indirect successor by
purchase, merger, consolidation or otherwise to all or substantially all of the
business and/or assets of the Company, spouses, heirs, and personal and legal
representatives. The Company shall require and cause any successor (whether
direct or indirect by purchase, merger, consolidation or otherwise) to all,
substantially all, or a substantial part, of the business and/or assets of the
Company, by written agreement in form and substance satisfactory to the
Indemnitee, expressly to assume and agree to perform this Agreement in the same
manner and to the same extent that the Company would be required to perform if
no such succession had taken place. This Agreement shall continue in effect
regardless of whether Indemnitee continues to serve as a director or officer of
the Company or a director, officer, employee, trustee, agent or fiduciary of any
other enterprise at the Company's request.
16. Severability. The provisions of this Agreement shall be
severable in the event that any of the provisions hereof (including any
provision within a single section, paragraph or sentence) is held by a court of
competent jurisdiction to be invalid, void or otherwise unenforceable in any
respect, and the validity and enforceability of any such provision in every
other respect and of the remaining provisions hereof shall not be in any way
impaired and shall remain enforceable to the fullest extent permitted by law.
Furthermore, to the fullest extent possible, the provisions of this Agreement
(including, without limitation, each portion of this Agreement containing any
provision held to be invalid, void or otherwise unenforceable, that is not
itself invalid, void or unenforceable) shall be construed so as to give effect
to the intent manifested by the provision held invalid, illegal or
unenforceable.
17. Governing Law. This Agreement shall be governed by and
construed and enforced in accordance with the laws of the State of Delaware
applicable to contracts made and to be performed in such State without giving
effect to the principles of conflicts of laws.
18. Preclusion. The Company shall be precluded from asserting in
any judicial proceeding commenced pursuant to Section 1(b)(4) that the
procedures and presumptions in this Agreement are not valid, binding and
enforceable and shall stipulate in any such court that the Company is bound by
all the provisions of this Agreement.
19. Certain Definitions.
a. Change in Control: Any of the following events:
(1) The acquisition by any individual, entity or group (within the
meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act
of 1934, as amended (the "Exchange Act")) (a "Person") of beneficial
ownership (within the meaning of Rule 13d-3 promulgated under the
Exchange Act) of 20% or more of either (i) the then outstanding shares
of common stock of the Company (the "Outstanding Corporation Common
Stock") or (ii) the combined voting power of the then outstanding voting
securities of the Company entitled to vote generally in the election of
directors (the "Outstanding Corporation Voting Securities"); provided,
however, that for purposes of this paragraph (1), the following
acquisitions shall not constitute a Change of Control: (i) any
acquisition directly from the Company, (ii) any acquisition by the
Company, (iii) any acquisition by any employee benefit plan (or related
trust) sponsored or maintained by the Company or any corporation
controlled by the Company or (iv) any acquisition by any corporation
pursuant to a transaction which complies with clauses (i), (ii) and
(iii) of paragraph 3 hereof; or
(2) Individuals who, as of May 12, 1998 constitute the Board (the
"Incumbent Board") cease for any reason to constitute at least a
majority of the Board; provided, however, that any individual becoming a
director subsequent to May 12, 1998 whose election, or nomination for
election by the Company's shareholders, was approved by a vote of at
least a majority of the directors then comprising the Incumbent Board
shall be considered as though such individual were a member of the
Incumbent Board, but excluding, for this purpose, any such individual
whose initial assumption of office occurs as a result of an actual or
threatened election contest with respect to the election or removal of
directors or other actual or threatened solicitation of proxies or
consents by or on behalf of a Person other than the Board;
(3) Consummation of a reorganization, merger or consolidation or sale or
other disposition of all or substantially all of the assets of the
Company (a "Business Combination"), in each case, unless following such
Business Combination, (i) all or substantially all of the individuals
and entities who were beneficial owners, respectively, of the
Outstanding Corporation Common Stock and Outstanding Corporation Voting
Securities immediately prior to such Business Combination beneficially
own, directly or indirectly, more than 50% of, respectively, the then
outstanding shares of common stock and the combined voting power of the
then outstanding voting securities entitled to vote generally in the
election of the directors, as the case may be, of the corporation
resulting from such Business Combination (including, without limitation,
a corporation which as a result of such transaction owns the Company or
all or substantially all of the Company's assets either directly or
through one or more subsidiaries) in substantially the same proportions
as their ownership, immediately prior to such Business Combination, of
the Outstanding Corporation Common Stock and Outstanding Corporation
Voting Securities, as the case may be, (ii) no Person (excluding any
corporation resulting from such Business Combination or any employee
benefit plan (or related trust) of the Company or such corporation
resulting from such Business Combination) beneficially owns, directly or
indirectly, 20% or more of, respectively, the then outstanding shares of
common stock of the corporation resulting from such Business Combination
or the combined voting power of the then outstanding voting securities
of such corporation except to the extent that such ownership existed
prior to the Business Combination and (iii) at least a majority of the
members of the board of directors of the corporation resulting from such
Business Combination were members of the Incumbent Board at the time of
the execution of the initial agreement, or of the action of the Board,
providing for such Business Combination; or
(4) Approval by the shareholders of the Company of a complete
liquidation or dissolution of the Company.
Notwithstanding the foregoing, no acquisition by (i) Charles R. Schwab and/or
his spouse or any of his lineal descendants or (ii) any trust created by or for
the benefit of Charles R. Schwab and/or his spouse or any of his lineal
descendants or (iii) the Schwab Family Foundation shall constitute a Change in
Control.
b. Expense: includes attorneys' fees and all other
costs, travel expenses, fees of experts, transcript costs, filing fees, witness
fees, telephone charges, postage, delivery service fees, expenses and
obligations of any nature whatsoever paid or incurred in connection with
investigating, defending, being a witness in or participating in (including on
appeal), or preparing to defend, be a witness in or participate in any
Proceeding relating to any Indemnifiable Event.
c. Indemnifiable Event: any event or occurrence that
takes place either prior to or after the execution of this Agreement, related to
the fact that Indemnitee is or was a director or an officer of the Company, or
while a director or officer is or was serving at the request of the Company as a
director, officer, employee, trustee, agent or fiduciary of another corporation,
partnership, joint venture, employee benefit plan, trust or other enterprise, or
by reason of anything done or not done by Indemnitee in any such capacity.
d. Independent Legal Counsel: a law firm, a member of
a law firm, or an independent practitioner, that is experienced in matters of
corporation law. Independent Legal Counsel shall not be any person who, under
the applicable standards of professional conduct then prevailing would have a
conflict of interest in representing either the Company or Indemnitee in an
action to determine Indemnitee's rights under this Agreement, nor shall
Independent Legal Counsel be any person who has been sanctioned or censured for
ethical violations of applicable standards of professional conduct.
e. Potential Change in Control: shall be deemed to have
occurred if (i) the Company enters into an agreement or arrangement, the
consummation of which would result in the occurrence of Change in Control; (ii)
any person (including the Company) publicly announces an intention to take or to
consider taking actions which if consummated would constitute Change in Control;
or (iii) the Board adopts a resolution to the effect that, for purposes of this
Agreement, a Potential Change in Control has occurred.
f. Proceeding: any threatened, pending or completed
action, suit or proceeding, or any inquiry, hearing or investigation, whether
conducted by the Company or any other party, that Indemnitee in good faith
believes might lead to the institution of any such action, suit or proceeding,
whether civil, criminal, administrative, investigative or other.
g. Reviewing Party: any appropriate person or body
consisting of a member or members of the Company's Board of Directors, or
Independent Legal Counsel.
IN WITNESS WHEREOF, the parties hereto have duly executed and
delivered this Agreement as of the __________ day of ___________, 19______.
THE CHARLES SCHWAB CORPORATION
By:
Name:
Title:
Name:
Indemnitee
Exhibit 10.201
SEVENTH AMENDMENT
TO THE
CHARLES SCHWAB
PROFIT SHARING AND EMPLOYEE STOCK OWNERSHIP PLAN
1. The name of the Plan shall be changed to The SchwabPlan Retirement Savings
and Investment Plan.
2. The term defined in Section 2.23 shall be the "ESOP Entry Date," and the term
"ESOP Entry Date" shall replace the term "ESOP/Profit Sharing Entry Date"
wherever it appears in the Plan.
3. Effective as of January 1, 1999, the first paragraph of Section 2.26 is
amended to read as follows:
2.26 "Hours of Service" means hours during the applicable Computation
Period in which an individual performs Service or is treated as performing
Service and, except in the case of military service or as otherwise determined
by the Committee, for which the Participant is directly or indirectly entitled
to payment. Hours of Service shall be credited for the applicable period in
which such Hours of Service accrue in accordance with Labor Department
Regulation 29 CFR ss. 2530.200b-2(c), which regulation is incorporated herein by
reference; provided that Hours of Service for reasons other than the performance
of duties shall be credited in accordance with Labor Department Regulation 29
CFR ss. 2530.200b-2(b), which regulation is incorporated herein by reference.
4. Effective as of January 1, 1999, Section 2.47 is deleted.
5. Effective as of January 1, 1999, Subsection 3.1(b)(i) is amended to read as
follows:
(i) Elective Contributions, Matching Contributions and Qualified
Nonelective Contributions on the first day of the fourth month following his or
her commencement of Service (or, in the case of an Employee whose service
commences on the first day of a month, the first day of the third month
following his or her commencement of Service), provided that the Employee
completes at least one Hour of Service in each such month; and
6. Effective as of January 1, 1999, Subsection 3.1(c) is amended to read as
follows:
An Employee who is eligible to become a Participant, but declines to
participate in the Plan, may become a Participant at any time, as soon as
administratively feasible following a request to participate.
7. Effective as of January 1, 1999, Section 3.3 is amended to read as follows:
A Participant who has incurred a Total Break in Service and
subsequently returns to Service shall be treated as a new Employee for all
purposes of the Plan. In all other cases, a former Participant who returns to
Service following a Break in Service shall again become a Participant as of the
first date of such former Participant's return to Service, except that if such
former Participant is not then an Employee, such former Participant shall again
become a Participant as of the first day on which such former Participant again
becomes an Employee.
8. The following Section 4.9 is added to Article IV:
4.9 Profit Sharing Contributions. Notwithstanding anything to the
contrary contained in the Plan, no Profit Sharing contributions shall be made to
the Plan for Plan Years beginning after December 31, 1994. Effective as of
October 1, 1998, all Profit Sharing balances of Participants shall be fully
vested and shall be merged with Participants' Matching Contribution Accounts.
Thereafter, no forfeitures of Profit Sharing Contributions shall occur, and all
references in the Plan to Profit Sharing Subaccounts shall be deemed to refer to
Matching Contribution Subaccounts.
9. Section 5.1(a) is amended to read as follows:
5.1 (a) A Participant may elect to make Elective Contributions in any
Plan Year by entering into a Salary Reduction Agreement with the Employer. Each
Salary Reduction Agreement shall provide that a portion of the Participant's
Compensation shall be paid through payroll deduction to the Trust Fund as an
Elective Contribution pursuant to Section 4.1 rather than paid currently to the
Participant. The Salary Reduction Agreement shall provide for Elective
Contributions equal to any whole percentage between one percent (1%) and fifteen
percent (15%) of a Participant's Compensation in any payroll period, not to
exceed the limitation set forth in Section 402(g) of the Code (adjusted
automatically for increases in accordance with the Regulations). Notwithstanding
the foregoing provisions of this Section 5.1, the Committee may, but need not,
adopt a procedure to enable Participants to make lump sum Elective Contributions
under the Plan through payroll deductions. No Salary Reduction Agreement shall
be effective unless the Participant has made an investment direction pursuant to
Section 8.3.
10. The first paragraph of Section 5.2 is amended to read as follows:
5.2 Change or Suspension of Salary Reduction Agreements. Subject to
Section 5.1, a Participant may enter into or change his or her Salary Reduction
Agreement at any time, effective as soon as practicable, in accordance with
rules determined by the Committee. A Participant may also suspend his or her
Salary Reduction Agreement at any time, in accordance with rules determined by
the Committee. A Participant who suspends his or her Salary Reduction Agreement
in accordance with this Section 5.2 may enter into a new Salary Reduction
Agreement at any time, effective as soon as administratively feasible.
11. Effective as of January 1, 1998, Section 7.2(a) is amended to read as
follows:
(a) Subject to the provisions of Section 4, the ESOP Account maintained
for each Participant will be credited as of the last day of each Plan Year with
the Participant's allocable share of:
(i) Shares purchased using cash contributed by or on behalf of
the Participating Employer employing such Participant (and any earnings on any
cash contributions made prior to the last day of the Plan Year),
(ii) Shares contributed directly to the Trust Fund;
(iii) Dividends paid to the Trust Fund during the Plan Year on
any Shares that were purchased by the Purchasing Agent or contributed directly
to the Trust Fund prior to the last day of the Plan Year; and
(iv) Shares released from the Suspense Subfund pursuant to
Section 7.3 and allocable to the contribution made by or on behalf of such
Participating Employer pursuant to Section 7.4.
12. The first paragraph of Section 11.2 is amended to read as follows:
Notwithstanding any other provision of the Plan to the contrary, (i) if
a Participant has a Vested Interest in his or her Account with a value of $5,000
or less, it shall be distributed in one lump sum as soon as is administratively
feasible following the last day of the calendar month in which such
Participant's termination of employment occurs, and (ii) if a Participant has a
Vested Interest in his or her Account with a value of more than $5,000, it shall
not commence to be distributed without the consent of the Participant before the
Participant's Normal Retirement Date.
13. Effective as of January 1, 1998, Section 13 is amended in its entirety
to read as follows:
SECTION 13. VOTING AND TENDER OR EXCHANGE RIGHTS
13.1 Voting and Tender or Exchange of Shares in General. Except as
otherwise required by the Act, the Code and the Regulations, all voting and
tender or exchange rights of Shares held in Participants' Accounts shall be
exercised by the Purchasing Agent only as directed by the Participants or their
Beneficiaries or as otherwise provided in accordance with the provisions of this
Section 13.
13.2 Voting of Allocated Shares.
(a) If any Participating Employer has a registration-type
class of securities (as defined in Section 409(e)(4) of the Code or any
successor statute thereto), then, with respect to all corporate matters
submitted to shareholders, all Shares (including fractional interests in Shares)
allocated and credited to the Accounts of Participants shall be voted in
accordance with the directions of such Participants as given to the Purchasing
Agent; provided that (i) with regard to Shares allocated to ESOP Accounts,
allocated Shares for which no directions are received by the Purchasing Agent
shall be voted in the same proportion as allocated Shares for which directions
are received are voted pursuant to this Section 13.2, and (ii) Shares allocated
to Accounts other than ESOP Accounts for which no directions are received by the
Purchasing Agent shall not be voted.
(b) If no Participating Employer has a registration-type class of
securities (as defined in Section 409(e)(4) of the Code or any successor statute
thereto), then, only with respect to corporate matters relating to a corporate
merger or consolidation, recapitalization, reclassification, liquidation,
dissolution, sale of substantially all assets of a trade or business, or such
other similar transaction that Regulations require, all Shares allocated and
credited to the Accounts of Participants shall be voted in accordance with the
directions of such Participants as given to the Purchasing Agent; provided that
(i) with respect to Shares allocated to ESOP Accounts, allocated Shares for
which no directions are received by the Purchasing Agent shall be voted in the
same proportion as allocated Shares for which directions are received are voted
pursuant to this Section 13.2, and (ii) Shares allocated to Accounts other than
ESOP Accounts for which no directions are received by the Purchasing Agent shall
not be voted.
13.3 Mechanics of Voting Allocated Shares. If Participants are entitled
under Section 13.2 to direct the vote with respect to allocated Shares, then, at
least 30 days before each annual or special shareholders' meeting of the
Employer (or, if such schedule cannot be met, as early as practicable before
such meeting), the Committee shall cause each Participant to be furnished with a
copy of the proxy solicitation material sent generally to shareholders, together
with a form requesting confidential instructions concerning the manner in which
the Shares allocated to such Participant's Account are to be voted. Upon timely
receipt of such instructions, the Purchasing Agent (after combining votes of
fractional Shares to give effect to the greatest extent possible to
Participants' instructions) shall vote the Shares as instructed. The
instructions received by the Purchasing Agent from each Participant shall be
held by the Purchasing Agent in strict confidence and shall not be divulged or
released to any person, including, without limitation, any officers or Employees
of any Participating Employer, or of any other Employer. The Trustee, the
Employer, the Purchasing Agent and the Committee shall not make recommendations
to Participants concerning whether to vote or how to vote.
13.4 Voting of Unallocated Shares. With respect to unallocated Shares
held in the Trust Fund, absent specific instructions from the Trustee or other
fiduciary pursuant to the Trust Agreement, the Purchasing Agent shall vote such
Shares in the same proportion as Shares are voted pursuant to Section 13.2;
provided that the Purchasing Agent shall follow any directions of the Trustee or
any other fiduciary authorized to instruct the Trustee with respect to the
voting of such unallocated Shares under the Trust Agreement.
13.5 Tender or Exchange of Allocated Shares. The Committee shall notify
each Participant of each tender or exchange offer for the Shares and utilize its
best efforts to distribute or cause to be distributed to each Participant in a
timely manner all information distributed to shareholders of the Employer in
connection with any such tender or exchange offer. Each Participant shall have
the right from time to time with respect to the Shares allocated to the
Participant's Account to instruct the Purchasing Agent in writing as to the
manner in which to respond to any tender or exchange offer which shall be
pending or which may be made in the future for all Shares or any portion
thereof. A Participant's instructions shall remain in force until superseded by
the Participant. The Purchasing Agent shall tender or exchange whole Shares only
as and to the extent so instructed. If the Purchasing Agent does not receive
instructions from a Participant regarding any tender or exchange offer for
Shares, the Purchasing Agent shall have no discretion in such matter and shall
not tender or exchange any such Shares in response thereto. For purposes of
responding to such tender or exchange offers, each Participant shall be the
"named fiduciary" with respect to such Shares allocated to his or her Account.
Unless and until Shares are tendered or exchanged, the individual instructions
received by the Purchasing Agent from Participants shall be held by the
Purchasing Agent in strict confidence and shall not be divulged or released to
any person, including, without limitation, any officers or Employees of any
Participating Employer, or of any other Employer; provided, however, that the
Purchasing Agent shall advise the Employer, at any time upon request, of the
total number of Shares not subject to instructions to tender or exchange.
13.6 Tender or Exchange of Unallocated Shares. Absent specific
instructions from the Trustee or other fiduciary pursuant to the Trust
Agreement, the Purchasing Agent shall tender unallocated Shares held in the
Trust Fund in proportion to the ratio that (A) the number of Shares with respect
to which Participant instructions in favor of the tender or exchange have been
received bears to (b) the number of Shares with respect to which Participant
instructions for or against the tender or exchange have been received; provided
that the Purchasing Agent shall follow any directions of the Trustee or any
other fiduciary authorized to instruct the Trustee with respect to the tender or
exchange of unallocated Shares under the Trust Agreement.
13.7 Voting of Deceased Participant's Shares. If this Section 13 applies
to Shares allocated to the Account of a deceased Participant, such Participant's
Beneficiary shall be entitled to direct the manner in which to respond to any
tender or exchange offer as if such Beneficiary were the Participant.
14. Except as otherwise set forth specifically herein, this Amendment shall be
effective as of October 1, 1998.
Exhibit 10.202
FOURTH AMENDMENT TO THE TRUST AGREEMENT
FOR THE CHARLES SCHWAB
PROFIT SHARING AND EMPLOYEE STOCK OWNERSHIP PLAN
The Trust Agreement for the Charles Schwab Profit Sharing and Employee
Stock Ownership Plan ("Plan"), as amended, is hereby amended as follows,
effective as of January 1, 1998:
1. The name of the Trust is changed to: The Trust Agreement for
the SchwabPlan Retirement Savings and Investment Plan.
2. Section 5.05(f) is amended to read as follows:
Voting or proxy or other rights with respect to Employer
Securities shall be disposed of as provided in this Section.
With respect to Employer Securities that are allocated to
Participants' Accounts, each Participant shall be entitled to
direct the Purchasing Agent as to the manner in which such
Employer Securities then allocated to his Account shall be
voted. Such directions may be achieved through the use of
proxy or similar statements delivered by the Purchasing Agent
to the Participants with respect to the Employer Securities
allocated to their Accounts. The Plan Administrator shall
provide any information requested by the Purchasing Agent that
is necessary or convenient in connection with obtaining and
preserving the confidentiality of the Participants'
directions. Any allocated Employer Securities allocated to
Participants' ESOP Accounts (as defined in the Plan) with
respect to which Participants are entitled to issue directions
pursuant to the foregoing and for which such directions are
not received by the Purchasing Agent shall be voted in the
same proportion as allocated Employer Securities for which
such directions are received. Allocated Employer Securities
for which such directions are not received by the Purchasing
Agent (other than those allocated to Participants' ESOP
Accounts) shall not be voted by the Purchasing Agent. All
unallocated Employer Securities shall be voted by the
Purchasing Agent in the same proportion as allocated Employer
Securities are voted; provided that the Purchasing Agent shall
follow any directions received from the Trustee (or from any
fiduciary authorized to instruct the Trustee with respect to
the voting of unallocated Employer Securities under the Trust
Agreement) to vote such shares in a different manner.
With respect to Employer Securities allocated to Participant
Accounts, each Participant may instruct the Purchasing Agent
as to the manner in which to respond to any tender or exchange
offer for all or any portion of such allocated Employer
Securities. The Purchasing Agent shall tender or exchange
Employer Securities only as and to the extent so instructed.
If the Purchasing Agent does not receive instructions from a
Participant regarding any tender or exchange offer for
allocated Employer Securities, the Purchasing Agent shall have
no discretion in such matter and shall not tender or exchange
any such Employee Securities in response thereto. With respect
to unallocated Employer Securities, the Purchasing Agent shall
tender or exchange such allocated Employer Securities in
proportion to the ratio that (A) the number of Employer
Securities with respect to which Participant instructions in
favor of the tender or exchange have been received bears to
(B) the number of Shares with respect to which Participant
instructions for or against the tender or exchange have been
received; provided that the Purchasing Agent shall follow any
directions received from the Trustee (or from any fiduciary
authorized to instruct the Trustee with respect to the tender
or exchange of unallocated Employer Securities under the Trust
Agreement) to tender or exchange such shares in a different
manner.
Exhibit 10.203
THE CHARLES SCHWAB CORPORATION
1992 STOCK INCENTIVE PLAN
(Restated to include Amendments through March 20, 1998)
Article 1. Introduction.
The Plan was adopted by the Board of Directors on March 26, 1992. The
purpose of the Plan is to promote the long-term success of the Company and the
creation of incremental stockholder value by (a) encouraging Non-Employee
Directors and Key Employees to focus on long-range objectives, (b) encouraging
the attraction and retention of Non-Employee Directors and Key Employees with
exceptional qualifications and (c) linking Non-Employee Directors and Key
Employees directly to stockholder interests. The Plan seeks to achieve this
purpose by providing for Awards in the form of Restricted Shares, Performance
Share Awards or Options, which may constitute incentive stock options or
nonstatutory stock options. The Plan shall be governed by, and construed in
accordance with, the laws of the State of Delaware.
Article 2. Administration.
2.1 The Committee. The Plan shall be administered by the Committee. The
Committee shall consist of two or more Non-Employee Directors, who shall be
appointed by the Board.
2.2 Committee Responsibilities. The Committee shall select the Key
Employees who are to receive Awards under the Plan, determine the amount,
vesting requirements and other conditions of such Awards, may interpret the
Plan, and make all other decisions relating to the operation of the Plan. The
Committee may adopt such rules or guidelines as it deems appropriate to
implement the Plan. The Committee's determinations under the Plan shall be final
and binding on all persons.
Article 3. Limitations on Awards.
The aggregate number of Restricted Shares, Performance Share Awards and
Options awarded under the Plan shall not exceed 29,150,000 (including those
shares awarded prior to the amendment of the Plan). If any Restricted Shares,
Performance Share Awards or Options are forfeited, or if any Performance Share
Awards terminate for any other reason without the associated Common Shares being
issued, or if any Options terminate for any other reason before being exercised,
then such Restricted Shares, Performance Share Awards or Options shall again
become available for Awards under the Plan.
Subject to the overall limit on the aggregate shares set forth above,
the following limitations shall apply: (a) The maximum number of Common Shares
which may be granted subject to an Option to any one Participant in any one
fiscal year shall be 2,250,000; and (b) The maximum number of Restricted Shares
or Performance Share Awards which may be granted to any one Participant in any
one fiscal year shall be 900,000. The limitations set forth in the preceding
sentence shall be subject to adjustment pursuant to Article 10; and
The limitations of this Article 3 shall each be subject to adjustment
pursuant to Article 10. Any Common Shares issued pursuant to the Plan may be
authorized but unissued shares or treasury shares.
Article 4. Eligibility.
4.1 General Rule. Key Employees and Non-Employee Directors shall
be eligible for designation as Participants by the Committee.
4.2 Non-Employee Directors. In addition to any awards pursuant to
Section 4.1, Non-Employee Directors shall be entitled to receive the automatic
NSOs described in this Section 4.2.
(a) Each Non-Employee Director shall receive a Non-Officer Stock
Option covering 2,500 Common Shares for each Award Year with respect
to which he or she serves as a Non-Employee Director on the grant
date described in subsection (b) below; provided that the Non-Officer
Stock Option shall cover 1,500 shares if the Exercise Price
determined as of the grant date, is $35 or more;
(b) The NSO for a particular Award Year shall be granted to each
Non-Employee Director as of May 15 of each Award Year, and if May 15
is not a business day, then the grant shall be made on and as of the
next succeeding business day;
(c) Each NSO shall be exercisable in full at all times during its
term;
(d) The term of each NSO shall be 10 years; provided, however, that
any unexercised NSO shall expire on the date that the Optionee ceases
to be a Non-Employee Director or a Key Employee for any reason other
than death or disability. If an Optionee ceases to be a Non-Employee
Director or Key Employee on account of death or disability, any
unexercised NSO shall expire on the earlier of the date 10 years
after the date of grant or one year after the date of death or
disability of such Director; and
(e) The Exercise Price under each NSO shall be equal to the Fair
Market Value on the date of grant and shall be payable in any of the
forms described in Article 6.
4.3 Ten-Percent Stockholders. A Key Employee who owns more than 10
percent of the total combined voting power of all classes of outstanding stock
of the Company or any of its Subsidiaries shall not be eligible for the grant of
an ISO unless (a) the Exercise price under such ISO is at least 110 percent of
the Fair Market Value of a Common Share on the date of grant and (b) such ISO by
its terms is not exercisable after the expiration of five years from the date of
grant.
4.4 Attribution Rules. For purposes of Section 4.3, in determining
stock ownership, a Key Employee shall be deemed to own the stock owned, directly
or indirectly, by or for his or her brothers, sisters, spouse, ancestors or
lineal descendants. Stock owned, directly or indirectly, by or for a
corporation, partnership, estate or trust shall be deemed to be owned
proportionately by or for its stockholders, partners or beneficiaries. Stock
with respect to which the Key Employee holds an option shall not be counted.
4.5 Outstanding Stock. For purposes of Section 4.3, "outstanding stock"
shall include all stock actually issued and outstanding immediately after the
grant of the ISO to the Key Employee. "Outstanding stock" shall not include
treasury shares or shares authorized for issuance under outstanding options held
by the Key Employee or by any other person.
Article 5. Options.
5.1 Stock Option Agreement. Each grant of an Option under the Plan
shall be evidenced by a Stock Option Agreement between the Optionee and the
Company. Such Option shall be subject to all applicable terms and conditions of
the Plan, and may be subject to any other terms and conditions which are not
inconsistent with the Plan and which the Committee deems appropriate for
inclusion in a Stock Option Agreement. The provisions of the various Stock
Option Agreements entered into under the Plan need not be identical. The
Committee may designate all or any part of an Option as an ISO, except for
Options granted to Non-Employee Directors under Section 4.2. The Committee may
designate all or any part of an Option as an ISO (or, in the case of a Key
Employee who is subject to the tax laws of a foreign jurisdiction, as an option
qualifying for favorable tax treatment under the laws of such foreign
jurisdiction), except for Options granted to Non-Employee Directors under
section 4.2.
5.2 Options Nontransferability. No Option granted under the Plan shall
be transferable by the Optionee other than by will or the laws of descent and
distribution. An Option may be exercised during the lifetime of the Optionee
only by him or her. No Option or interest therein may be transferred, assigned,
pledged or hypothecated by the Optionee during his or her lifetime, whether by
operation of law or otherwise, or be made subject to execution, attachment or
similar process.
5.3 Number of Shares. Each Stock Option Agreement shall specify the
number of Common Shares subject to the Option and shall provide for the
adjustment of such number in accordance with Article 10. Each Stock Option
Agreement shall also specify whether the Option is an ISO or an NSO.
5.4 Exercise Price. Each Stock Option Agreement shall specify the
Exercise Price. The Exercise Price under an Option shall not be less than 100
percent of the Fair Market Value of a Common Share on the date of grant, except
as otherwise provided in Section 4.3. Subject to the preceding sentence, the
Exercise Price under any Option shall be determined by the Committee. The
Exercise Price shall be payable in accordance with Article 6.
5.5 Exercisability and Term. Each Stock Option Agreement shall specify
the date when all or any installment of the Option is to become exercisable. The
Stock Option Agreement shall also specify the term of the Option. The term of an
ISO shall in no event exceed 10 years from the date of grant, and Section 4.3
may require a shorter term. Subject to the preceding sentence, the Committee
shall determine when all or any part of an Option is to become exercisable and
when such Option is to expire; provided that, in appropriate cases, the Company
shall have the discretion to extend the term of an Option or the time within
which, following termination of employment, an Option may be exercised, or to
accelerate the exercisability of an Option. A Stock Option Agreement may provide
for expiration prior to the end of its term in the event of the termination of
the Optionee's employment and shall provide for the suspension of vesting when
an employee is on a leave of absence for a period in excess of six months in
appropriate cases, as determined by the Company; provided that the
exercisability of Options shall be accelerated in the event of the Participant's
death or Disability and, in the case of Retirement, the exercisability of all
outstanding Options shall be accelerated, other than any Options that had been
granted within two years of the date of the Optionee's Retirement. Except as
provided in Section 4.2, NSOs may also be awarded in combination with Restricted
Shares, and such an Award may provide that the NSOs will not be exercisable
unless the related Restricted Shares are forfeited. In addition, NSOs granted
under this Section 5 may be granted subject to forfeiture provisions which
provide for forfeiture of the Option upon the exercise of tandem awards, the
terms of which are established in other programs of the Company.
5.6 Limitation on Amount of ISOs. The aggregate fair market value
(determined at the time the ISO is granted) of the Common Shares with respect to
which ISOs are exercisable for the first time by the Optionee during any
calendar year (under all incentive stock option plans of the Company) shall not
exceed $100,000; provided, however, that all or any portion of an Option which
cannot be exercised as an ISO because of such limitation shall be treated as an
NSO.
5.7 Effect of Change in Control. The Committee (in its sole discretion)
may determine, at the time of granting an Option, that such Option shall become
fully exercisable as to all Common Shares subject to such Option immediately
preceding any Change in Control with respect to the Company.
5.8 Restrictions on Transfer of Common Shares. Any Common Shares issued
upon exercise of an Option shall be subject to such special forfeiture
conditions, rights of repurchase, rights of first refusal and other transfer
restrictions as the Committee may determine. Such restrictions shall be set
forth in the applicable Stock Option Agreement and shall apply in addition to
any general restrictions that may apply to all holders of Common Shares.
5.9 Authorization of Replacement Options. Concurrently with the grant
of any Option to a Participant (other than NSOs granted pursuant to Section
4.2), the Committee may authorize the grant of Replacement Options. If
Replacement Options have been authorized by the Committee with respect to a
particular award of Options (the "Underlying Options"), the Option Agreement
with respect to the Underlying Options shall so state, and the terms and
conditions of the Replacement Options shall be provided therein. The grant of
any Replacement Options shall be effective only upon the exercise of the
Underlying Options through the use of Common Shares pursuant to Section 6.2 or
Section 6.3. The number of Replacement Options shall equal the number of Common
Shares used to exercise the Underlying Options, and, if the Option Agreement so
provides, the number of Common Shares used to satisfy any tax withholding
requirements incident to the exercise of the Underlying Options in accordance
with Section 13.2. Upon the exercise of the Underlying Options, the Replacement
Options shall be evidenced by an amendment to the Underlying Option Agreement.
Notwithstanding the fact that the Underlying Option may be an ISO, a Replacement
Option is not intended to qualify as an ISO. The Exercise Price of a Replacement
Option shall be no less than the Fair Market Value of a Common Share on the date
the grant of the Replacement Option becomes effective. The term of each
Replacement Option shall be equal to the remaining term of the Underlying
Option. No Replacement Options shall be granted to Optionees when Underlying
Options are exercised pursuant to the terms of the Plan and the Underlying
Option Agreement following termination of the Optionee's employment. The
Committee, in its sole discretion, may establish such other terms and conditions
for Replacement Options as it deems appropriate.
5.10 Options Granted to Non-United States Key Employees. In the case of
Key Employees who are subject to the tax laws of a foreign jurisdiction, the
Company may issue Options to such Key Employees that contain terms required to
conform with any requirements for favorable tax treatment imposed by the laws of
such foreign jurisdiction, or as otherwise may be required by the laws of such
foreign jurisdiction. The terms of any such Options shall be governed by the
Plan, subject to the terms of any Addendum to the Plan specifically applicable
to such Options.
Article 6. Payment for Option Shares.
6.1 General Rule. The entire Exercise Price of Common Shares issued
upon exercise of Options shall be payable in cash at the time when such Common
Shares are purchased, except as follows:
(a) In the case of an ISO granted under the Plan, payment shall be
made only pursuant to the express provisions of the applicable Stock
Option Agreement. However, the Committee may specify in the Stock
Option Agreement that payment may be made pursuant to Section 6.2 or
6.3.
(b) In the case of an NSO, the Committee may at any time accept
payment pursuant to Section 6.2 or 6.3.
6.2 Surrender of Stock. To the extent that this Section 6.2 is
applicable, payment for all or any part of the Exercise Price may be made with
Common Shares which are surrendered to the Company. Such Common Shares shall be
valued at their Fair Market Value on the date when the new Common Shares are
purchased under the Plan. In the event that the Common Shares being surrendered
are Restricted Shares that have not yet become vested, the same restrictions
shall be imposed upon the new Common Shares being purchased.
6.3 Exercise/Sale. To the extent this Section 6.3 is applicable,
payment may be made by the delivery (on a form prescribed by the Company) of an
irrevocable direction to Charles Schwab & Co., Inc. to sell Common Shares
(including the Common Shares to be issued upon exercise of the Options) and to
deliver all or part of the sales proceeds to the Company in payment of all or
part of the Exercise Price and any withholding taxes.
Article 7. Restricted Shares and Performance Share Awards.
7.1 Time, Amount and Form of Awards. The Committee may grant Restricted
Shares or Performance Share Awards with respect to an Award Year during such
Award Year or at any time thereafter. Each such Award shall be evidenced by a
Stock Award Agreement between the Award recipient and the Company. The amount of
each Award of Restricted Shares or Performance Share Awards shall be determined
by the Committee. Awards under the Plan may be granted in the form of Restricted
Shares or Performance Share Awards or in any combination thereof, as the
Committee shall determine at its sole discretion at the time of the grant.
Restricted Shares or Performance Share Awards may also be awarded in combination
with NSOs, and such an Award may provide that the Restricted Shares or
Performance Share Awards will be forfeited in the event that the related NSOs
are exercised.
7.2 Payment for Restricted Share Awards. To the extent that an Award is
granted in the form of Restricted Shares, the Award recipient, as a condition to
the grant of such Award, shall be required to pay the Company in cash an amount
equal to the par value of such Restricted Shares.
7.3 Vesting or Issuance Conditions. Each Award of Restricted Shares
shall become vested, in full or in installments, upon satisfaction of the
conditions specified in the Stock Award Agreement. Common Shares shall be issued
pursuant to Performance Share Awards in full or in installments upon
satisfaction of the issuance conditions specified in the Stock Award Agreement.
The Committee shall select the vesting conditions in the case of Restricted
Shares, or issuance conditions in the case of Performance Share Awards, which
may be based upon the Participant's service, the Participant's performance, the
Company's performance or such other criteria as the Committee may adopt;
provided that, in the case of an Award of Restricted Shares where vesting is
based entirely on the Participant's service, (i) vesting shall be accelerated in
the event of the Participant's death or Disability; (ii) in the case of
Retirement, vesting shall be accelerated for all Restricted Shares that had been
granted more than two years prior to the date of the Participant's Retirement;
and (iii) vesting shall be suspended when an employee is on a leave of absence
for a period in excess of six months in appropriate cases, as determined by the
Company. The Committee, in its sole discretion, may determine, at the time of
making an Award of Restricted Shares, that such Award shall become fully vested
in the event that a Change in Control occurs with respect to the Company. The
Committee, in its sole discretion, may determine, at the time of making a
Performance Share Award, that the issuance conditions set forth in such Award
shall be waived in the event that a Change in Control occurs with respect to the
Company.
7.4 Form of Settlement of Performance Share Awards. Settlement of
Performance Share Awards shall only be made in the form of Common Shares. Until
a Performance Share Award is settled, the number of Performance Share Awards
shall be subject to adjustment pursuant to Article 10.
7.5 Death of Recipient. Any Common Shares that are to be issued
pursuant to a Performance Share Award after the recipient's death shall be
delivered or distributed to the recipient's beneficiary or beneficiaries. Each
recipient of a Performance Share Award under the Plan shall designate one or
more beneficiaries for this purpose by filing the prescribed form with the
Company. A beneficiary designation may be changed by filing the prescribed form
with the Company at any time before the Award recipient's death. If no
beneficiary was designated or if no designated beneficiary survives the Award
recipient, then any Common Shares that are to be issued pursuant to a
Performance Share Award after the recipient's death shall be delivered or
distributed to the recipient's estate. The Committee, in its sole discretion,
shall determine the form and time of any distribution(s) to a recipient's
beneficiary or estate.
Article 8. Claims Procedures.
Claims for benefits under the Plan shall be filed in writing with the
Committee on forms supplied by the Committee. Written notice of the disposition
of a claim shall be furnished to the claimant within 90 days after the claim is
filed. If the claim is denied, the notice of disposition shall set forth the
specific reasons for the denial, citations to the pertinent provisions of the
Plan, and, where appropriate, an explanation as to how the claimant can perfect
the claim. If the claimant wishes further consideration of his or her claim, the
claimant may appeal a denied claim to the Committee (or to a person designated
by the Committee) for further review. Such appeal shall be filed in writing with
the Committee on a form supplied by the Committee, together with a written
statement of the claimant's position, no later than 90 days following receipt by
the claimant of written notice of the denial of his or her claim. If the
claimant so requests, the Committee shall schedule a hearing. A decision on
review shall be made after a full and fair review of the claim and shall be
delivered in writing to the claimant no later than 60 days after the Committee's
receipt of the notice of appeal, unless special circumstances (including the
need to hold a hearing) require an extension of time for processing the appeal,
in which case a written decision on review shall be delivered to the claimant as
soon as possible but not later than 120 days after the Committee's receipt of
the appeal notice. The claimant shall be notified in writing of any such
extension of time. The written decision on review shall include specific reasons
for the decision, written in a manner calculated to be understood by the
claimant, and shall specifically refer to the pertinent Plan provisions on which
it is based. All determinations of the Committee shall be final and binding on
Participants and their beneficiaries.
Article 9. Voting Rights and Dividends.
9.1 Restricted Shares.
(a) All holders of Restricted Shares who are not Named Executive
Officers shall have the same voting, dividend, and other rights as
the Company's other stockholders.
(b) During the period of restriction, Named Executive Officers
holding Restricted Shares granted hereunder shall be credited with
all regular cash dividends paid with respect to all Restricted Shares
while they are so held. If a dividend is paid in the form of cash,
such cash dividend shall be credited to Named Executive Officers
subject to the same restrictions on transferability and
forfeitability as the Restricted Shares with respect to which they
were paid. If any dividends or distributions are paid in shares of
Common Stock, the shares of Common Stock shall be subject to the same
restrictions on transferability and forfeitability as the Restricted
Shares with respect to which they were paid. Subject to the
succeeding paragraph, and to the restrictions on vesting and the
forfeiture provisions, all dividends credited to a Named Executive
Officer shall be paid to the Named Executive Officer within
forty-five (45) days following the full vesting of the Restricted
Shares with respect to which such dividends were earned.
In the event that any dividend constitutes a "derivative
security" or an "equity security" pursuant to Rule 16(a) under the
Exchange Act, such dividend shall be subject to a vesting period
equal to the longer of: (i) the remaining vesting period of the
Restricted Shares with respect to which the dividend is paid; or (ii)
six (6) months. The Committee shall establish procedures for the
application of this provision.
Named Executive Officers holding Restricted Shares shall have
the same voting rights as the Company's other stockholders.
9.2 Performance Share Awards. The holders of Performance Share Awards
shall have no voting or dividend rights until such time as any Common Shares are
issued pursuant thereto, at which time they shall have the same voting, dividend
and other rights as the Company's other stockholders.
Article 10. Protection Against Dilution; Adjustment of Awards.
10.1 General. In the event of a subdivision of the outstanding Common
Shares, a declaration of a dividend payable in Common Shares, a declaration of a
dividend payable in a form other than Common Shares, a combination or
consolidation of the outstanding Common Shares (by reclassification or
otherwise) into a lesser number of Common Shares, a recapitalization, a spinoff
or a similar occurrence, the Committee shall make appropriate adjustments in one
or more of (a) the number of Options, Restricted Shares and Performance Share
Awards available for future Awards under Article 3, (b) the maximum number of
Common Shares which may be granted under Article 3 to any one Participant in any
one fiscal year either subject to an Option or as Restricted Shares or
Performance Share Awards, (c) the number of Performance Share Awards included in
any prior Award which has not yet been settled, (d) the number of Common Shares
covered by each outstanding Option or (e) the Exercise Price under each
outstanding Option.
10.2 Reorganizations. In the event that the Company is a party to a
merger or other reorganization, outstanding Options, Restricted Shares and
Performance Share Awards shall be subject to the agreement of merger or
reorganization. Such agreement may provide, without limitation, for the
assumption of outstanding Awards by the surviving corporation or its parent, for
their continuation by the Company (if the Company is a surviving corporation),
for accelerated vesting or for settlement in cash.
10.3 Reservation of Rights. Except as provided in this Article 10, a
Participant shall have no rights by reason of any subdivision or consolidation
of shares of stock of any class, the payment of any stock dividend or any other
increase or decrease in the number of shares of stock of any class. Any issue by
the Company of shares of stock of any class, or securities convertible into
shares of stock of any class, shall not affect, and no adjustment by reason
thereof shall be made with respect to, the number or Exercise Price of Common
Shares subject to an Option. The grant of an Award pursuant to the Plan shall
not affect in any way the right or power of the Company to make adjustments,
reclassifications, reorganizations or changes of its capital or business
structure, to merge or consolidate or to dissolve, liquidate, sell or transfer
all or any part of its business or assets.
Article 11. Limitation of Rights.
11.1 Employment Rights. Neither the Plan nor any Award granted under
the Plan shall be deemed to give any individual a right to remain employed by
the Company or any Subsidiary. The Company and its Subsidiaries reserve the
right to terminate the employment of any employee at any time, with or without
cause, subject only to a written employment agreement (if any).
11.2 Stockholders' Rights. A Participant shall have no dividend rights,
voting or other rights as a stockholder with respect to any Common Shares
covered by his or her Award prior to the issuance of such Common Shares, whether
by issuance of a certificate, book entry or other procedure. No adjustment shall
be made for cash dividends or other rights for which the record date is prior to
the date when such certificate is issued, except as expressly provided in
Articles 7, 9 and 10.
11.3 Creditors' Rights. A holder of Performance Share Awards shall have
no rights other than those of a general creditor of the Company. Performance
Share Awards represent unfunded and unsecured obligations of the Company,
subject to the terms and conditions of the applicable Stock Award Agreement.
11.4 Government Regulations. Any other provision of the Plan
notwithstanding, the obligations of the Company with respect to Common Shares to
be issued pursuant to the Plan shall be subject to all applicable laws, rules
and regulations, and such approvals by any governmental agencies as may be
required. The Company reserves the right to restrict, in whole or in part, the
delivery of Common Shares pursuant to any Award until such time as:
(a) Any legal requirements or regulations have been met relating to
the issuance of such Common Shares or to their registration,
qualification or exemption from registration or qualification under
the Securities Act of 1933, as amended, or any applicable state
securities laws; and
(b) Satisfactory assurances have been received that such Common
Shares, when issued, will be duly listed on the New York Stock
Exchange or any other securities exchange on which Common Shares are
then listed.
Article 12. Limitation of Payments.
12.1 Basic Rule. Any provision of the Plan to the contrary
notwithstanding, in the event that the independent auditors most recently
selected by the Board (the "Auditors") determine that any payment or transfer in
the nature of compensation to or for the benefit of a Participant, whether paid
or payable (or transferred or transferable) pursuant to the terms of this Plan
or otherwise (a "Payment"), would be nondeductible for federal income tax
purposes because of the provisions concerning "excess parachute payments" in
section 280G of the Code, then the aggregate present value of all Payments shall
be reduced (but not below zero) to the Reduced Amount; provided, however, that
the Committee, at the time of making an Award under this Plan or at any time
thereafter, may specify in writing that such Award shall not be so reduced and
shall not be subject to this Article 12. For purposes of this Article 12, the
"Reduced Amount" shall be the amount, expressed as a present value, which
maximizes the aggregate present value of the Payments without causing any
Payment to be nondeductible by the Company because of section 280G of the Code.
12.2 Reduction of Payments. If the Auditors determine that any Payment
would be nondeductible because of section 280G of the Code, then the Company
shall promptly give the Participant notice to that effect and a copy of the
detailed calculation thereof and of the Reduced Amount, and the Participant may
then elect, in his or her sole discretion, which and how much of the Payments
shall be eliminated or reduced (as long as after such election, the aggregate
present value of the Payments equals the Reduced Amount) and shall advise the
Company in writing of his or her election within 10 days of receipt of notice.
If no such election is made by the Participant within such 10-day period, then
the Company may elect which and how much of the Payments shall be eliminated or
reduced (as long as after such election the aggregate present value of the
Payments equals the Reduced Amount) and shall notify the Participant promptly of
such election. For purposes of this Article 12, present value shall be
determined in accordance with section 280G(d)(4) of the Code. All determinations
made by the Auditors under this Article 12 shall be binding upon the Company and
the Participant and shall be made within 60 days of the date when a Payment
becomes payable or transferable. As promptly as practicable following such
determination and the elections hereunder, the Company shall pay or transfer to
or for the benefit of the Participant such amounts as are then due to him or her
under the Plan, and shall promptly pay or transfer to or for the benefit of the
Participant in the future such amounts as become due to him or her under the
Plan.
12.3 Overpayments and Underpayments. As a result of uncertainty in the
application of section 280G of the Code at the time of an initial determination
by the Auditors hereunder, it is possible that Payments will have been made by
the Company which should not have been made (an "Overpayment") or that
additional Payments which will not have been made by the Company could have been
made (an "Underpayment"), consistent in each case with the calculation of the
Reduced Amount hereunder. In the event that the Auditors, based upon the
assertion of a deficiency by the Internal Revenue Service against the Company or
the Participant which the Auditors believe has a high probability of success,
determine that an Overpayment has been made, such Overpayment shall be treated
for all purposes as a loan to the Participant which he or she shall repay to the
Company on demand, together with interest at the applicable federal rate
provided in section 7872(f)(2) of the Code; provided, however, that no amount
shall be payable by the Participant to the Company if and to the extent that
such payment would not reduce the amount which is subject to taxation under
section 4999 of the Code. In the event that the Auditors determine that an
Underpayment has occurred, such Underpayment shall promptly be paid or
transferred by the Company to or for the benefit of the Participant, together
with interest at the applicable federal rate provided in section 7872(f)(2) of
the Code.
12.4 Related Corporations. For purposes of this Article 12, the term
"Company" shall include affiliated corporations to the extent determined by the
Auditors in accordance with section 280G(d)(5) of the Code.
Article 13. Withholding Taxes.
13.1 General. To the extent required by applicable federal, state,
local or foreign law, the recipient of any payment or distribution under the
Plan shall make arrangements satisfactory to the Company for the satisfaction of
any withholding tax obligations that arise by reason of such payment or
distribution. The Company shall not be required to make such payment or
distribution until such obligations are satisfied.
13.2 Nonstatutory Options, Restricted Shares or Performance Share
Awards. The Committee may permit an Optionee who exercises NSOs, or who receives
Awards of Restricted Shares, or who receives Common Shares pursuant to the terms
of a Performance Share Award, to satisfy all or part of his or her withholding
tax obligations by having the Company withhold a portion of the Common Shares
that otherwise would be issued to him or her under such Awards. Such Common
Shares shall be valued at their Fair Market Value on the date when taxes
otherwise would be withheld in cash. The payment of withholding taxes by
surrendering Common Shares to the Company, if permitted by the Committee, shall
be subject to such restrictions as the Committee may impose, including any
restrictions required by rules of the Securities and Exchange Commission.
Article 14. Assignment or Transfer of Award.
14.1 General Rule. Any Award granted under the Plan shall not be
anticipated, assigned, attached, garnished, optioned, transferred or made
subject to any creditor's process, whether voluntarily, involuntarily or by
operation of law, except to the extent specifically permitted by Section 14.2.
14.2 Exceptions to General Rule. Notwithstanding Section 14.1, this
Plan shall not preclude (i) a Participant from designating a beneficiary to
succeed, after the Participant's death, to those of the Participant's Awards
(including without limitation, the right to exercise any unexercised Options) as
may be determined by the Company from time to time in its sole discretion, (ii)
a transfer of any Award hereunder by will or the laws of descent or
distribution, or (iii) a voluntary transfer of an Award (other than an ISO) to a
trust or partnership for the exclusive benefit of one or more members of the
Participant's family, but only if the Participant has sole investment control
over such trust or partnership.
Article 15. Future of Plans.
15.1 Term of the Plan. The Plan, as set forth herein, shall become
effective on May 8, 1992. The Plan shall remain in effect until it is terminated
under Section 15.2, except that no ISOs shall be granted after May 7, 2002.
15.2 Amendment or Termination. The Committee may, at any time and for
any reason, amend or terminate the Plan; provided, however, that any amendment
of the Plan shall be subject to the approval of the Company's stockholders to
the extent required by applicable laws, regulations or rules.
15.3 Effect of Amendment or Termination. No Award shall be made under
the Plan after the termination thereof. The termination of the Plan, or any
amendment thereof, shall not affect any Option, Restricted Share or Performance
Share Award previously granted under the Plan.
Article 16. Definitions.
16.1 "Award" means any award of an Option, a Restricted Share or a
Performance Share Award under the Plan.
16.2 "Award Year" means a fiscal year beginning January 1 and
ending December 31 with respect to which an Award may be granted.
16.3 "Board" means the Company's Board of Directors, as constituted
from time to time.
16.4 "Change in Control" means the occurrence of any of the following
events after the effective date of the Plan as set out in Section 15.1:
(a) A change in control required to be reported pursuant to Item 6(e)
of Schedule 14A of Regulation 14A under the Exchange Act;
(b) A change in the composition of the Board, as a result of which
fewer than two-thirds of the incumbent directors are directors who
either (i) had been directors of the Company 24 months prior to such
change or (ii) were elected, or nominated for election, to the Board
with the affirmative votes of at least a majority of the directors
who had been directors of the Company 24 months prior to such change
and who were still in office at the time of the election or
nomination;
(c) Any "person" (as such term is used in sections 13(d) and 14(d) of
the Exchange Act) becomes the beneficial owner, directly or
indirectly, of securities of the Company representing 20 percent or
more of the combined voting power of the Company's then outstanding
securities ordinarily (and apart from rights accruing under special
circumstances) having the right to vote at elections of directors
(the "Base Capital Stock"); provided, however, that any change in the
relative beneficial ownership of securities of any person resulting
solely from a reduction in the aggregate number of outstanding shares
of Base Capital Stock, and any decrease thereafter in such person's
ownership of securities, shall be disregarded until such person
increases in any manner, directly or indirectly, such person's
beneficial ownership of any securities of the Company.
16.5 "Code" means the Internal Revenue Code of 1986, as amended.
16.6 "Committee" means the Compensation Committee of the Board, as
constituted from time to time.
16.7 "Common Share" means one share of the common stock of the Company.
16.8 "Company" means The Charles Schwab Corporation, a Delaware
corporation.
16.9 "ERISA" means the Employee Retirement Income Security Act of 1974,
as amended.
16.10 "Exchange Act" means the Securities Exchange Act of 1934, as
amended.
16.11 "Exercise Price" means the amount for which one Common Share may
be purchased upon exercise of an Option, as specified by the Committee in the
applicable Stock Option Agreement.
16.12 "Fair Market Value" means the market price of a Common Share,
determined by the committee as follows:
(a) If the Common Share was traded on a stock exchange on the date in
question, then the Fair Market Value shall be equal to the closing
price reported by the applicable composite-transactions report for
such date;
(b) If the Common Share was traded over-the-counter on the date in
question and was classified as a national market issue, then the Fair
Market Value shall be equal to the last transaction price quoted by
the NASDAQ system for such date;
(c) If the Common Share was traded over-the-counter on the date in
question but was not classified as a national market issue, then the
Fair Market Value shall be equal to the mean between the last
reported representative bid and asked prices quoted by the NASDAQ
system for such date; and
(d) If none of the foregoing provisions is applicable, then the Fair
Market Value shall be determined by the Committee in good faith on
such basis as it deems appropriate.
16.13 "ISO" means an incentive stock option described in section
422(b) of the Code.
16.14 "Key Employee" means a key common-law employee of the Company or
any Subsidiary, as determined by the Committee.
16.15 "Named Executive Officer" means a Participant who, as of the date
of vesting of an Award is one of a group of "covered employees," as defined in
the Regulations promulgated under Code Section 162(m), or any successor statute.
16.16 "Non-Employee Director" means a member of the Board who is not a
common-law employee.
16.17 "NSO" means an employee stock option not described in sections
422 through 424 of the Code.
16.18 "Option" means an ISO or NSO or, in the case of a Key Employee
who is subject to the tax laws of a foreign jurisdiction, an option qualifying
for favorable tax treatment under the laws of such jurisdiction, including a
Replacement Option, granted under the Plan and entitling the holder to purchase
one Common Share.
16.19 "Optionee" means an individual, or his or her estate, legatee
or heirs at law that holds an Option.
16.20 "Participant" means a Non-Employee Director or Key Employee who
has received an Award.
16.21 "Performance Share Award" means the conditional right to receive
in the future one Common Share, awarded to a Participant under the Plan.
16.22 "Plan" means this 1992 Stock Incentive Plan of The Charles Schwab
Corporation, as it may be amended from time to time.
16.23 "Replacement Option" means an Option that is granted when a
Participant uses a Common Share held or to be acquired by the Participant to
exercise an Option and/or to satisfy tax withholding requirements incident to
the exercise of an Option.
16.24 "Restricted Share" means a Common Share awarded to a Participant
under the Plan.
16.25 "Stock Award Agreement" means the agreement between the Company
and the recipient of a Restricted Share or Performance Share Award which
contains the terms, conditions and restrictions pertaining to such Restricted
Share or Performance Share Award.
16.26 "Stock Option Agreement" means the agreement between the Company
and an Optionee which contains the terms, conditions and restrictions pertaining
to his or her option.
16.27 "Subsidiary" means any corporation, if the Company and/or one or
more other Subsidiaries own not less than 50 percent of the total combined
voting power of all classes of outstanding stock of such corporation. A
corporation that attains the status of a Subsidiary on a date after the adoption
of the Plan shall be considered a Subsidiary commencing as of such date.
16.28. "Retirement" shall mean any termination of employment of an
Optionee for any reason other than death at any time after the Optionee has
attained fifty (50), but only if, at the time of such termination, the
Participant has been credited with at least seven (7) Years of Service under the
Charles Schwab Profit Sharing and Employee Stock Ownership Plan. The foregoing
definition shall apply to all Stock Option Agreements entered into pursuant to
the Plan, irrespective of any definition to the contrary contained in any such
Stock Option Agreement.
16.29 "Disability" means the inability to engage in any substantial
gainful activity considering the Participant's age, education and work
experience by reason of any medically determined physical or mental impairment
that has continued without interruption for a period of at least six months and
that can be expected to be of long, continued and indefinite duration. All
determinations as to whether a Participant has incurred a Disability shall be
made by the Employee Benefits Administration Committee of the Company, the
findings of which shall be final, binding and conclusive.
ADDENDUM A
The provisions of the Plan, as amended by the terms of this
Addendum A, shall apply to the grant of Approved Options to Key U.K. Employees.
1. For purposes of this Addendum A, the following definitions
shall apply in addition to those set out in section 16 of the Plan:
Approved Option Means a stock option designed to qualify as an
approved executive share option under the Taxes Act;
Inland Revenue means the Board of the Inland Revenue in the
United Kingdom.
Key U.K. Employee means a designated employee of Sharelink
Investment Services plc or any subsidiary (as that term is
defined in the Companies Act 1985 of the United Kingdom, as
amended) of which Sharelink Investment Services plc has
control for the purposes of section 840 of the Taxes Act;
Taxes Act means the Income and Corporation Taxes Act 1988 of
the United Kingdom.
2. An Approved Option may only be granted to a Key U.K.
Employee who:
(i) is employed on a full-time basis; and
(ii) does not fall within the provisions of
paragraph 8 of Schedule 9 to the Taxes Act.
For purposes of this section 2(i) of Addendum A, "full-time"
shall mean an employee who is required to work 20 hours per week, excluding meal
breaks.
3. No Approved Option may be granted to a Key U.K. Employee if
it would cause the aggregate of the exercise price of all subsisting Approved
Options granted to such employee under the Plan, or any other subsisting options
granted to such employee under any other share option scheme approved under
Schedule 9 of the Taxes Act and established by the Company or an associated
company, to exceed the higher of (a) one hundred thousand pounds sterling and
(b) four times such employee's relevant emoluments for the current or preceding
year of assessment (whichever is greater); but where there were no relevant
emoluments for the previous year of assessment, the limit shall be the higher of
one hundred thousand pounds sterling or four times such employee's relevant
emoluments for the period of twelve months beginning with the first day during
the current year of assessment in respect of which there are relevant
emoluments. For the purpose of this section 3 of Addendum A, "associated
company" means an associated company within the meaning of section 416 of the
Taxes Act; "relevant emoluments" has the meaning given by paragraph 28(4) of
Schedule 9 to the Taxes Act and "year of assessment" means a year beginning on
any April 6 and ending on the following April 5.
4. Common Shares issued pursuant to the exercise of Approved
Options must satisfy the conditions specified in paragraphs 10 to 14 of Schedule
9 to the Taxes Act.
5. Notwithstanding the provisions of Section 5.4 of the Plan,
the exercise price of an Approved Option shall not be less than 100 percent of
the closing price of a Common Share as reported in the New York Stock Exchange
Composite Index on the date of grant.
6. No Approved Option may be exercised at any time by a Key
U.K. Employee when that Key U.K. Employee falls within the provisions of
paragraph 8 of Schedule 9 to the Taxes Act. If at any time the shares under an
Approved Option cease to comply with the conditions in paragraphs 10 to 14 of
Schedule 9 to the Taxes Act, then all Approved Options then outstanding shall
lapse and cease to be exercisable from the date of the shares ceasing so to
comply, and no optionee shall have any cause of action against the Company,
Sharelink Investment Services plc or any subsidiary of the Company or any other
person in respect thereof.
7. An Approved Option may contain such other terms, provisions
and conditions as may be determined by the Committee consistent with the Plan,
provided that the approved option otherwise complies with the requirements for
approved executive option schemes specified in Schedule 9 of the Taxes Act.
8. In relation to an Approved Option, notwithstanding the
terms of section 10.1 of the Plan, no adjustment shall be made pursuant to
section 10.1 of the Plan to any outstanding Approved Options without the prior
approval of the Inland Revenue.
9. In relation to an Approved Option any Key U.K. Employee
shall make arrangements satisfactory to the Company for the satisfaction of any
tax withholding or deduction -- at -- source obligations that arise by reason of
the grant to him or her of such option, or its subsequent exercise.
10. In relation to an Approved Option, in addition to the
provisions set out in section 15.2 of the Plan, no amendment which affects any
of the provisions of the Plan relating to Approved Options shall be effective
until approved by the Inland Revenue, except for such amendment as are required
to obtain and maintain the approval of Inland Revenue pursuant to Schedule 9 to
the Taxes Act.
EXHIBIT 12.1
THE CHARLES SCHWAB CORPORATION
Computation of Ratio of Earnings to Fixed Charges
(Dollar amounts in thousands, unaudited)
<TABLE>
<CAPTION>
Year Ended December 31,
1998 1997 1996 1995 1994
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Earnings before taxes on income $ 576,544 $ 447,247 $ 394,063 $ 277,104 $ 224,343
- ----------------------------------------------------------------------------------------------------------------------
Fixed charges
Interest expense - customer 579,930 480,988 368,462 321,225 178,067
Interest expense - other 71,951 65,495 57,410 35,998 20,169
Interest portion of rental expense 32,326 26,045 23,051 20,810 17,102
- ----------------------------------------------------------------------------------------------------------------------
Total fixed charges (A) 684,207 572,528 448,923 378,033 215,338
- ----------------------------------------------------------------------------------------------------------------------
Earnings before taxes on income and fixed charges (B) $ 1,260,751 $ 1,019,775 $ 842,986 $ 655,137 $ 439,681
======================================================================================================================
Ratio of earnings to fixed charges (B) divided by (A)* 1.8 1.8 1.9 1.7 2.0
======================================================================================================================
Ratio of earnings to fixed charges excluding
customer interest expense** 6.5 5.9 5.9 5.9 7.0
======================================================================================================================
</TABLE>
* 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 payable 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 payable 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.
EXHIBIT 13.1
The Charles Schwab Corporation
1998 Annual Report to Stockholders
(Only those portions specifically incorporated by reference
into The Charles Schwab Corporation 1998 Annual Report on Form 10-K)
The Charles Schwab Corporation
Selected Financial and Operating Data
(In Millions, Except Per Share Amounts and Ratios)
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
Growth Rates
---------------------
Compounded Annual
5-Year 1-Year
1993-1998 1997-1998 1998 1997(1) 1996 1995 1994
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Operating Results
Revenues 23% 19% $ 2,736 $ 2,299 $ 1,851 $ 1,420 $ 1,065
Expenses excluding interest 23% 17% $ 2,160 $ 1,852 $ 1,457 $ 1,143 $ 840
Net income 24% 29% $ 348 $ 270 $ 234 $ 173 $ 135
Basic earnings per share (2) 24% 28% $ .88 $ .69 $ .60 $ .45 $ .35
Diluted earnings per share (2) 24% 29% $ .85 $ .66 $ .58 $ .43 $ .34
Dividends declared per common share (2) 31% 16% $ .1080 $ .0933 $ .0800 $ .0622 $ .0416
Weighted-average common shares outstanding - diluted (2) 412 409 404 402 394
Trading revenues as a percentage of revenues (3) 58% 62% 66% 66% 67%
Non-trading revenues as a percentage of revenues (3) 42% 38% 34% 34% 33%
Effective income tax rate 39.6% 39.6% 40.7% 37.7% 39.7%
====================================================================================================================================
Performance Measures
Revenue growth 19% 24% 30% 33% 10%
Pre-tax profit margin 21.1% 19.5% 21.3% 19.5% 21.1%
After-tax profit margin 12.7% 11.8% 12.6% 12.2% 12.7%
Return on stockholders' equity 27% 27% 31% 31% 32%
====================================================================================================================================
Financial Condition (at year end)
Total assets 26% 35% $22,264 $16,482 $13,779 $10,552 $ 7,918
Borrowings 14% (3%) $ 351 $ 361 $ 284 $ 246 $ 171
Stockholders' equity 30% 25% $ 1,429 $ 1,145 $ 855 $ 633 $ 467
====================================================================================================================================
</TABLE>
Certain prior years' revenues and expenses have been reclassified to conform to
the 1998 presentation.
(1) 1997 includes charges for a litigation settlement of $24 million after-tax
($.06 per share for both basic and diluted earnings per share).
(2) Reflects the December 1998 three-for-two common stock split.
(3) Trading revenues include commission and principal transaction revenues.
Non-trading revenues include mutual fund service fees, net interest revenue
and other revenues.
1
<PAGE>
The Charles Schwab Corporation
Management's Discussion and Analysis
of Results of Operations and Financial Condition
DESCRIPTION OF BUSINESS
The Charles Schwab Corporation (CSC) and its subsidiaries (collectively
referred to as the Company) provide securities brokerage and related financial
services for 5.6 million active customer accounts(a). Customer assets in these
accounts totaled $491.1 billion at December 31, 1998. CSC's principal
subsidiary, Charles Schwab & Co., Inc. (Schwab), is a securities broker-dealer
with 291 domestic branch offices in 47 states, as well as branches in the
Commonwealth of Puerto Rico, the United Kingdom and the U.S. Virgin Islands.
Another subsidiary, Charles Schwab Europe (CSE), is a retail securities
brokerage firm located in the United Kingdom. Other subsidiaries include Charles
Schwab Investment Management, Inc. (CSIM), the investment advisor for Schwab's
proprietary mutual funds, and Mayer & Schweitzer, Inc. (M&S), a market maker in
Nasdaq and other securities providing trade execution services to broker-dealers
and institutional customers.
- --------------------------------------------------------------------------------
(a) Effective in 1998, active accounts are defined as accounts with balances or
activity within the preceding eight months instead of twelve months as
previously defined. This change in definition had the effect of decreasing
the number of active accounts in 1998 by approximately 200,000.
- --------------------------------------------------------------------------------
The Company provides financial services to individuals, institutional
customers and broker-dealers through three segments -- Individual Investor,
Institutional Investor and Capital Markets. The Individual Investor segment
includes the Company's domestic and international retail operations. The
Institutional Investor segment provides custodial, trading and support services
to independent investment managers, and serves company 401(k) plan sponsors and
third-party administrators. The Capital Markets segment provides trade execution
services in Nasdaq, exchange-listed and other securities primarily to
broker-dealers and institutional customers.
(CHART OMITTED)
The Company's strategy is to attract and retain customer assets by focusing
on a number of areas within the financial services industry -- retail brokerage,
mutual funds, support services for independent investment managers, 401(k)
defined contribution plans and equity securities market-making.
To pursue its strategy and its objective of long-term profitable growth, the
Company plans to continue to leverage its competitive advantages. These
advantages include a nationally recognized brand, a broad range of products and
services, multi-channel delivery systems and an ongoing investment in
technology.
The Company's nationwide advertising and marketing programs are designed to
strengthen the Schwab brand, as well as distinguish its products and services.
The Company primarily uses a combination of network, cable and local television,
national and local radio, print media, and athletic event sponsorship in its
advertising to investors. These programs helped the Company attract $80.8
billion in net new customer assets and open 1,380,000 new accounts during 1998.
The Company offers a broad range of value-oriented products and services to
meet customers' varying investment and financial needs, including access to
extensive investment news and information. The Company's representatives can
assist investors in developing asset allocation strategies and evaluating their
investment choices, and refer investors who desire additional guidance to
independent investment managers through the Schwab AdvisorSource service. The
Company's Mutual Fund Marketplace provides customers with the ability to invest
in over 1,600 mutual funds from 261 fund families, including 1,024 Mutual Fund
OneSource funds. Schwab also provides custodial, trading and support services to
approximately 5,400 independent investment managers. As of December 31, 1998,
these managers were guiding the investments of 690,000 Schwab customer accounts
containing $146.4 billion in assets.
The Company responds to changing customer needs with continued product,
technology and service innovations. In 1998, Schwab began to offer equity
research reports from Credit Suisse First Boston Corporation (CSFB) and
Hambrecht & Quist L.L.C. Additionally, Schwab expanded its offerings to certain
customers to include debt underwritings lead-managed by CSFB. Also in 1998,
Schwab announced alliances with Intuit, Inc. and Excite, Inc. to provide
investors with investment education, research and analysis tools. Schwab also
introduced the Managed Account Connection, which enables investment managers to
provide their clients with personalized equity portfolio management by a variety
of institutional asset managers.
2
<PAGE>
The Company's multi-channel delivery systems allow customers to choose how
they prefer to do business with the Company. To enable customers to obtain
services in person with a Company representative, the Company maintains a
network of branch offices. The Company's branch office network also provides
investors with access to the Internet. Telephonic access to the Company is
provided primarily through four regional customer telephone service centers and
two online customer support centers that operate both during and after normal
market hours. Additionally, customers are able to obtain financial information
on an automated basis through the Company's automated telephonic and online
channels. Automated telephonic channels include TeleBroker -- Schwab's
touch-tone telephone quote and trading service, and VoiceBroker -- Schwab's
voice recognition quote and trading service. While Schwab's automated telephonic
channels handled over 70% of customer calls received in both 1998 and 1997,
total calls received in 1998 were 104 million, down 5% from 1997, due to
significant growth in the use of online channels. Online channels include the
Charles Schwab Web Site(TM) -- an information and trading service on the
Internet, and PC-based services such as SchwabLink(R) -- a service for
investment managers. The Company's online channels handled 54% of total trades
during 1998, up from 37% of total trades in 1997. 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 expanding
its product and service offerings, 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 leader in driving technological advancements in the financial services
industry. In 1998, Schwab introduced a number of Internet-based investment
services, including: The Analyst Center, which connects customers to proprietary
and third-party investment research, guidance and decision-making tools; the
Positions Monitor, which tracks customers' mutual fund and equity holdings'
historical performance; the Mutual Fund Performance Profile(TM), which allows
customers to analyze the performance of their entire mutual fund portfolio; and
the Stock Screener, which allows customers to search over 9,000 equities on the
Web. Schwab also introduced two new services that provide investors with greater
access and flexibility in managing their finances: Schwab MoneyLink, which
allows customers to transfer funds electronically between Schwab and other
financial institutions via the Internet, automated telephone system or Schwab
representatives; and Schwab BillPay(TM), which allows customers to use the
Internet to initiate payments electronically instead of writing checks. In
addition, Schwab introduced the first Web site that enables investors to review
their accounts and trade securities in Chinese, and CSE launched the first Web
site in the United Kingdom to offer online trading in stocks listed on the
London Stock Exchange.
FORWARD-LOOKING STATEMENTS
In addition to historical information, this Annual Report contains
forward-looking statements that reflect management's beliefs, objectives and
expectations as of the date hereof. These statements relate to, among other
things, the Company's strategy (see Description of Business), average commission
per revenue trade (see Revenues - Commissions and Risk Management -
Competition), average revenue per share traded (see Revenues - Principal
Transactions), sources of liquidity (see Liquidity and Capital Resources --
Liquidity), development spending (see Liquidity and Capital Resources --
Development Spending), capitalization of certain costs incurred for developing
internal-use software (see Liquidity and Capital Resources -- Development
Spending, and note "2. Significant Accounting Policies" in the Notes to
Consolidated Financial Statements), capital expenditures and capital structure
(see Liquidity and Capital Resources -- Cash Flows and Capital Resources), the
Year 2000 project (see Year 2000), market risk (see Risk Management - Market
Risk), revenue growth, after-tax profit margin, and return on stockholders'
equity (see Results of Operations and Looking Ahead), and Company contingencies
(see note "12. Commitments and Contingent Liabilities" in the Notes to
Consolidated Financial Statements). Achievement of the expressed beliefs,
objectives and expectations described in these statements is subject to certain
risks and uncertainties that could cause actual results to differ materially
from the expressed objectives and expectations. Important factors that may cause
such differences are noted throughout this Annual Report and in the Company's
Annual Report on Form 10-K 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 systems conversions; the effects of competitors' pricing, product and
service decisions and intensified competition; evolving regulation and changing
industry practices adversely affecting the Company; adverse results of
litigation; changes in revenues and profit margin due to cyclical securities
markets and interest rates; the level and volatility of equity prices; and a
significant downturn in the securities markets over a short period of time or a
sustained decline in securities prices and trading volumes.
RESULTS OF OPERATIONS
Financial Overview
The Company achieved record revenues for the ninth consecutive year and
record earnings for the eighth consecutive year in 1998. One of the factors
contributing to this record performance was strong trading volumes in the
securities markets during the year. The combined daily average share volume for
the New York Stock Exchange (NYSE) and Nasdaq reached an all-time high of 1,460
million shares in 1998, a 24% increase over 1997. The Standard & Poor's 500
Index (on a dividend reinvested basis) rose 29% during 1998.
(CHART OMITTED)
3
<PAGE>
Other key factors that contributed to the Company's financial performance in
1998 include:
- -- Assets in Schwab customer accounts rose $137.4 billion, or 39%, to a record
$491.1 billion. This increase resulted from net new customer assets of
$80.8 billion and net market gains of $56.6 billion.
- -- A record 1,380,000 new Schwab customer accounts were opened, an increase of
19% from 1,164,000 opened in 1997.
Trading activity reached record levels as shown in the following table (in
thousands):
<TABLE>
<CAPTION>
- ------------------------------------------------------------
Daily Average Trades 1998 1997 1996
- ------------------------------------------------------------
<S> <C> <C> <C>
Revenue Trades
Online 56.3 26.8 11.8
TeleBroker and VoiceBroker 8.2 12.2 11.9
Regional customer telephone
service centers, branch offices
and other 32.7 32.8 30.3
- ------------------------------------------------------------
Total 97.2 71.8 54.0
============================================================
Mutual Fund OneSource Trades
Online 18.0 12.8 8.4
TeleBroker and VoiceBroker 1.0 1.3 1.2
Regional customer telephone
service centers, branch offices
and other 21.3 20.1 17.6
- ------------------------------------------------------------
Total 40.3 34.2 27.2
============================================================
Total Daily Average Trades
Online 74.3 39.6 20.2
TeleBroker and VoiceBroker 9.2 13.5 13.1
Regional customer telephone
service centers, branch offices
and other 54.0 52.9 47.9
- ------------------------------------------------------------
Total 137.5 106.0 81.2
============================================================
</TABLE>
Revenues increased mainly due to higher customer trading volume and an
increase in customer assets. Revenues of $2,736 million in 1998 grew 19% from
1997 due to increases in revenues of $280 million, or 17%, in the Individual
Investor segment, $115 million, or 35%, in the Institutional Investor segment,
and $42 million, or 14%, in the Capital Markets segment. See note "14. Segment
Information" in the Notes to Consolidated Financial Statements for financial
information by segment for the last three years.
The Company's 1998 earnings rose 29% to $348 million, or $.85 per share, up
from $270 million, or $.66 per share, in 1997. Share and per share information
throughout this report have been restated to reflect the December 1998
three-for-two common stock split, effected in the form of a 50% stock dividend.
All references to earnings per share information in this report reflect diluted
earnings per share unless otherwise noted.
The Company's 1997 results include charges for the settlement of a
class-action lawsuit involving M&S and other firms engaged in making markets in
Nasdaq securities. These charges totaled $24 million after-tax, or $.06 per
share. Excluding these charges, the Company's 1998 earnings would have increased
18% from 1997.
The Company's operating expenses increased 17% during 1998 to $2,160 million,
primarily due to a 21% increase in compensation and benefits, a 30% increase in
occupancy and equipment, and a 20% increase in advertising and market
development expenses. The Company's after-tax profit margin for 1998 was 12.7%,
which was higher than the 11.8% margin in 1997, and above the Company's annual
long-term objective of 10%. Excluding the litigation settlement charges, the
Company's after-tax profit margin would have been 12.8% in 1997. During 1998,
net income plus depreciation and amortization increased 23% to $487 million and
capital expenditures increased 33% to $185 million.
Return on stockholders' equity was 27% in 1998, exceeding the Company's
annual long-term objective of 20%. The Company's Board of Directors declared a
cash dividend increase during 1998, raising the effective annual dividend rate
5%.
REVENUES
Revenues grew $437 million, or 19%, in 1998 due to a 12% increase in
commission revenues and a 31% increase in mutual fund service fees, as well as a
35% increase in interest revenue, net of interest expense (referred to as net
interest revenue). The Company's revenue growth of 19% was slightly less than
management's annual long-term objective of 20% due to declines in average
commission per revenue trade (see Commissions) and average principal transaction
revenue per share traded (see Principal Transactions).
As the Company's mutual fund service fees and net interest revenue continued
to grow at rates that exceeded the growth rate of total revenues, non-trading
revenues increased to 42% of total revenues for 1998, up from 38% for 1997 and
34% for 1996 as shown in the table below.
<TABLE>
<CAPTION>
Composition of Revenues 1998 1997 1996
- -------------------------------------------------------------
<S> <C> <C> <C>
Commissions 48% 51% 52%
Principal transactions 10 11 14
- -------------------------------------------------------------
Total trading revenues 58 62 66
- -------------------------------------------------------------
Mutual fund service fees 20 19 17
Net interest revenue 17 15 14
Other 5 4 3
- -------------------------------------------------------------
Total non-trading revenues 42 38 34
- -------------------------------------------------------------
Total 100% 100% 100%
=============================================================
</TABLE>
Commissions
The Company earns commission revenues by executing customer trades primarily
through the Individual Investor and Institutional Investor segments. These
revenues are affected by the number of customer accounts that traded, the
average number of commission-generating trades per account, and the average
commission per trade. Commission revenues were $1,309 million in 1998, compared
to $1,174 million in 1997 and $954 million in 1996.
4
<PAGE>
As shown in the table below, from 1996 to 1998, the total number of customer
revenue trades executed by the Company has increased 79% as the Company's
customer base has grown and the average number of trades per account has
increased. From 1996 to 1998, average commission per revenue trade decreased
23%. The 7% decrease from 1996 to 1997 was mainly due to an increase in the
proportion of trades placed through online channels. The 16% decrease from 1997
to 1998 was mainly due to the Company's integration of its online and
traditional brokerage services and the resulting reduction of the price of
online trades for most of its customers in 1998. However, the increase in
trading activity more than offset the effect of the lower average commission per
revenue trade. As more customers migrate to online channels, average commission
per revenue trade is expected to continue to decline.
<TABLE>
<CAPTION>
Commissions Earned on
Customer Revenue Trades 1998 1997 1996
- ----------------------------------------------------------------
<S> <C> <C> <C>
Customer accounts that traded
during the year (in thousands) 2,783 2,380 2,037
Average customer revenue
trades per account 8.8 7.6 6.7
Total revenue trades (in thousands) 24,508 18,169 13,717
Average commission per revenue trade $ 53.44 $ 64.27 $ 69.08
Commissions earned on customer
revenue trades (in millions) (1) $ 1,309 $ 1,168 $ 947
================================================================
</TABLE>
(1) Includes certain non-commission revenues relating to the execution of
customer trades totaling $25 million in 1998, $16 million in 1997 and $12
million in 1996. Excludes commissions on trades relating to specialist
operations totaling $25 million in 1998, $22 million in 1997 and $19
million in 1996.
Mutual Fund Service Fees
The Company earns mutual fund service fees for record keeping and shareholder
services provided to third-party funds, and for transfer agent services,
shareholder services, administration and investment management provided to its
proprietary funds. These fees are based upon the daily balances of customer
assets invested in third-party funds and upon the average daily net assets of
Schwab's proprietary funds. Mutual fund service fees are earned primarily
through the Individual Investor and Institutional Investor segments.
Mutual fund service fees were $559 million in 1998, compared to $428 million
in 1997 and $311 million in 1996. The increases from 1996 to 1998 were primarily
due to significant increases in customer assets in Schwab's proprietary funds,
referred to as the SchwabFunds, and in funds purchased through Schwab's Mutual
Fund OneSource service.
The SchwabFunds include money market funds, equity index funds, bond funds,
asset allocation funds, and funds that primarily invest in stock, bond and money
market funds. Schwab customers may elect to have cash balances in their
brokerage accounts automatically invested in certain SchwabFunds money market
funds. Customer assets invested in the SchwabFunds were $81.5 billion, $55.8
billion and $43.1 billion at the end of 1998, 1997 and 1996, respectively.
At December 31, 1998, Schwab's Mutual Fund OneSource service enabled
customers to trade 1,024 mutual funds in 179 fund families without incurring
transaction fees. The service allows investors to access multiple mutual fund
companies, avoid brokerage transaction fees, and achieve investment diversity
among fund families. In addition, investors' record keeping and investment
monitoring are simplified through one consolidated statement. Customer assets
held by Schwab that have been purchased through the Mutual Fund OneSource
service, excluding SchwabFunds, were $69.9 billion, $56.6 billion and $39.2
billion at the end of 1998, 1997 and 1996, respectively.
Additionally, customer assets invested in the Mutual Fund Marketplace,
excluding the Mutual Fund OneSource service, were $59.2 billion, $48.0 billion
and $35.4 billion at the end of 1998, 1997 and 1996, respectively. Schwab
charges a transaction fee on trades placed in the funds included in the Mutual
Fund Marketplace (except on trades through the Mutual Fund OneSource service).
These fees are recorded as commission revenues.
Net Interest Revenue
Net interest revenue is the difference between interest earned on assets
(mainly margin loans to customers and investments) and interest paid on
liabilities (mainly customer cash balances). Net interest revenue is affected by
changes in the volume and mix of these assets and liabilities, as well as by
fluctuations in interest rates.
Substantially all of the Company's net interest revenue is earned by Schwab
through the Individual Investor and Institutional Investor segments. In clearing
its customers' trades, Schwab holds cash balances payable to customers. In most
cases, Schwab pays its customers interest on cash balances awaiting investment,
and may invest these funds and earn interest revenue. Schwab also may lend funds
to customers on a secured basis to purchase qualified securities -- a practice
commonly known as "margin lending." Pursuant to Securities and Exchange
Commission (SEC) regulations, customer cash balances that are not used for
margin lending are segregated into an investment account that is maintained for
the exclusive benefit of customers.
When investing segregated customer cash balances, Schwab must adhere to SEC
regulations that restrict investments to U.S. government securities,
participation certificates and mortgage-backed securities guaranteed by the
Government National Mortgage Association, certificates of deposit issued by U.S.
banks and thrifts, and resale agreements collateralized by qualified securities.
Schwab's policies for credit quality and maximum maturity requirements are more
restrictive than these SEC regulations. In each of the last three years, resale
agreements accounted for over 70% of Schwab's investments of segregated customer
cash balances. The average maturities of Schwab's total investments of
segregated customer cash balances were 66 days in 1998, 63 days in 1997 and 60
days in 1996.
Net interest revenue was $476 million in 1998, compared to $354 million in
1997 and $255 million in 1996, as shown in the following table (in millions):
5
<PAGE>
<TABLE>
<CAPTION>
1998 1997 1996
- -------------------------------------------------------------
<S> <C> <C> <C>
Interest Revenue
Margin loans to customers $ 671 $ 489 $ 339
Investments, customer-related 400 376 313
Other 57 35 29
- -------------------------------------------------------------
Total 1,128 900 681
- -------------------------------------------------------------
Interest Expense
Customer cash balances 580 481 368
Stock-lending activities 37 37 25
Borrowings 25 20 18
Other 10 8 15
- -------------------------------------------------------------
Total 652 546 426
- -------------------------------------------------------------
Net interest revenue $ 476 $ 354 $ 255
=============================================================
</TABLE>
The Company's interest-earning assets are financed primarily by
interest-bearing customer cash balances. Other funding sources include
noninterest-bearing customer cash balances, proceeds from stock-lending
activities, borrowings, and stockholders' equity. Customer-related daily average
balances, interest rates, and average net interest margin are summarized as
follows (dollars in millions):
<TABLE>
<CAPTION>
1998 1997 1996
- -----------------------------------------------------------------------
<S> <C> <C> <C>
Interest-Earning Assets (customer-related):
Margin loans to customers:
Average balance outstanding $ 8,772 $ 6,367 $ 4,482
Average interest rate 7.65% 7.68% 7.57%
Investments:
Average balance outstanding $ 7,687 $ 6,990 $ 5,883
Average interest rate 5.21% 5.38% 5.32%
Average yield on interest-earning assets 6.51% 6.48% 6.29%
Funding Sources (customer-related and other):
Interest-bearing customer cash balances:
Average balance outstanding $13,278 $10,661 $ 8,377
Average interest rate 4.37% 4.51% 4.40%
Other interest-bearing sources:
Average balance outstanding $ 1,299 $ 1,122 $ 775
Average interest rate 4.23% 4.44% 4.37%
Average noninterest-bearing portion $ 1,882 $ 1,574 $ 1,213
Average interest rate on funding sources 3.86% 3.97% 3.88%
Summary:
Average yield on interest-earning assets 6.51% 6.48% 6.29%
Average interest rate on funding sources 3.86% 3.97% 3.88%
- -----------------------------------------------------------------------
Average net interest margin 2.65% 2.51% 2.41%
=======================================================================
</TABLE>
The increases in net interest revenue from 1996 to 1998 were primarily due
to higher levels of margin loans to customers.
Since the Company establishes the rates paid on customer cash balances and
charged on margin loans, a substantial portion of its net interest margin is
managed by the Company. However, the margin is highly influenced by external
factors such as the interest rate environment and competition. The Company's
average net interest margin increased in 1998 as the average yield on
interest-earning assets increased and the average interest rate on funding
sources declined. As interest rates in general increased from 1996 to 1997, the
Company's average net interest margin increased in 1997.
Principal Transactions
Principal transaction revenues are primarily comprised of net gains from
market-making activities in Nasdaq and other securities through the Capital
Markets segment. Factors that influence principal transaction revenues include
the volume of customer trades, market price volatility, and changes in
regulations and industry practices as discussed below. As a market maker in
Nasdaq and other securities, M&S generally executes customer trades as
principal. While substantially all Nasdaq security trades originated by the
customers of Schwab are directed to M&S, the majority of M&S' trading volume
comes from parties other than Schwab.
Principal transaction revenues were $287 million in 1998, compared to $258
million in 1997 and $257 million in 1996. The increase from 1997 to 1998 was
primarily due to a significant increase in share volume handled by M&S,
partially offset by lower average revenue per share traded. Revenues were
essentially unchanged from 1996 to 1997, primarily due to greater share volume
handled by M&S being substantially offset by lower average revenue per share
traded.
Certain 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 NYSE, began quoting and
trading most securities in increments of one-sixteenth dollar per share instead
of one-eighth dollar per share. Mainly as a result of these regulatory changes
and changes in industry practices, M&S' average revenue per share traded
declined from 3.3 cents in 1997 to 2.5 cents in 1998. While M&S' average revenue
per share traded declined 24% from 1997 to 1998, M&S' share volume increased 41%
over the same period. Similarly, while M&S' average revenue per share traded
declined 28% from 1996 to 1997, M&S' share volume increased 32% over the same
period. The major U.S. securities markets have announced that at an unspecified
date after the beginning of 2000, they intend to begin quoting and trading
securities in decimal increments. This change is likely to cause further
decreases in average revenue per share traded.
See note "12. Commitments and Contingent Liabilities" in the Notes to
Consolidated Financial Statements regarding certain civil litigation relating to
various principal transaction activities.
6
<PAGE>
Revenues relating to Schwab's specialist operations were $29 million in 1998,
$21 million in 1997 and $14 million in 1996. Higher revenues related to Schwab's
specialist operations and gains from the sale of fixed income securities owned
by Schwab for the purpose of facilitating customer orders also contributed to
the increase in principal transaction revenues from 1997 to 1998.
Other Revenues
Other revenues include retirement plan services fees and other brokerage fees
(mainly minimum account balance fees, wire fees and related financial services
fees). Other revenues are earned primarily through the Individual Investor and
Institutional Investor segments. These revenues were $105 million in 1998,
compared to $86 million in 1997 and $74 million in 1996. The increase from 1997
to 1998 was due to higher revenue from minimum account balance and other
brokerage fees, 401(k) record keeping fees, Schwab AdvisorSource referral fees
and software maintenance fees. The increase from 1996 to 1997 was primarily due
to higher revenue from 401(k) record keeping and other retirement plan services
fees, as well as other brokerage fees.
<TABLE>
<CAPTION>
EXPENSES EXCLUDING INTEREST
Expenses Excluding Interest as a Percentage
of Revenues 1998 1997 1996
- ----------------------------------------------------------------
<S> <C> <C> <C>
Compensation and benefits 42% 42% 41%
Communications 8 8 9
Occupancy and equipment 7 7 7
Advertising and market development 6 6 5
Depreciation and amortization 5 5 5
Professional services 3 3 3
Commissions, clearance and floor brokerage 3 4 4
Other 5 6 5
- ----------------------------------------------------------------
Total 79% 81% 79%
================================================================
</TABLE>
Compensation and Benefits
Compensation and benefits expense includes salaries and wages, variable
compensation, and related employee benefits and taxes. Employees receive
variable compensation that is tied to the achievement of specified objectives
relating primarily to revenue growth, profit margin and growth in customer
assets. Therefore, a significant portion of compensation and benefits expense
will fluctuate with these measures.
(CHART OMITTED)
Compensation and benefits expense was $1,163 million in 1998, compared to
$962 million in 1997 and $766 million in 1996. The increases from 1996 to 1998
were generally due to a greater number of employees to support the Company's
growth. The increase from 1997 to 1998 was also due to higher variable
compensation expense resulting from the Company's financial performance. The
following table shows a comparison of certain compensation and benefits
components and employee data (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
- -----------------------------------------------------------------------
<S> <C> <C> <C>
Variable compensation as a
% of compensation and benefits expense 23% 23% 27%
Compensation for temporary employees,
contractors and overtime hours as a
% of compensation and benefits expense 14% 14% 11%
Full-time equivalent employees(1) 13.3 12.7 10.4
Revenues per average full-time equivalent
employee $ 208 $ 198 $ 190
- -----------------------------------------------------------------------
</TABLE>
(1) Includes full-time, part-time and temporary employees, and persons employed
on a contract basis.
The Company encourages and provides for employee ownership of the Company's
common stock through its profit sharing and employee stock ownership plan, its
stock incentive plans and an automatic investment plan. The Company's overall
compensation structure is intended to attract, retain and reward highly
qualified employees, and to align the interests of employees with those of
stockholders. To further this alignment and in recognition of the Company's
financial performance, the Company awarded all non-officer employees stock
option grants in 1997 for options to buy shares of common stock totaling
1,660,000 shares. The Company expects to grant such options annually with the
size of the grant based on Company and individual performance. The Company also
awarded all non-officer employees a stock grant in 1996 which totaled 378,000
shares of common stock.
At December 31, 1998, directors, management and employees, and their
respective families, trusts and foundations, owned, including stock held for
employees' benefit in the Company's profit sharing and employee stock ownership
plan, approximately 34% of the Company's outstanding common stock. In addition,
directors, management and employees held options to purchase common stock in an
amount equal to approximately 8% of the Company's outstanding common stock at
December 31, 1998.
7
<PAGE>
Communications
Communications expense includes telephone, postage, and news and quotation
costs. This expense was $206 million in 1998, compared to $183 million in 1997
and $165 million in 1996. The increases from 1996 to 1998 primarily resulted
from higher customer trading volumes, increased customer use of automated
telephonic and online channel news, quotation and information services,
additional leased telephone lines related to online service offerings, new
branch offices, and higher postage costs in connection with the growth in
customer accounts.
Occupancy and Equipment
Occupancy and equipment expense includes the costs of leasing and maintaining
the Company's office space, four regional customer telephone service centers,
two online customer support centers, two primary data centers and 291 domestic
branch offices. It also includes lease and rental expenses on computer and other
equipment. Occupancy and equipment expense was $201 million in 1998, compared to
$154 million in 1997 and $130 million in 1996. This trend reflects the Company's
continued growth and expansion, and its commitment to customer service and
investment in technology. The Company expanded its office space in 1998, 1997
and 1996, expanded its primary data center in 1996, and opened its second data
center in 1998. Schwab opened 19 new branch offices in 1998, 40 in 1997 and 9 in
1996. The increase in occupancy and equipment expense from 1997 to 1998 also
reflects higher lease and maintenance expenses on data processing equipment.
Advertising and Market Development
Advertising and market development expense includes media, print and direct
mail advertising expenses, and related production, printing and postage costs.
This expense was $155 million in 1998, compared to $130 million in 1997 and $84
million in 1996. The increases from 1996 to 1998 were primarily a result of the
Company's increased media spending and online advertising. The increase from
1996 to 1997 was also due to higher print and direct mail advertisements, as
well as the Company's role as the official investment firm for the Professional
Golf Association Tour.
Depreciation and Amortization
Depreciation and amortization includes expenses relating to equipment and
office facilities, property, goodwill, leasehold improvements and other
intangibles. This expense was $138 million in 1998, compared to $125 million in
1997 and $98 million in 1996. The increases from 1996 to 1998 were primarily due
to newly acquired data processing and telecommunication equipment that increased
the Company's customer service capacity. The increase from 1997 to 1998 also
reflects increased amortization of leasehold improvements for new branches and
expanded office space. Amortization expense related to intangible assets was $10
million in 1998, compared to $15 million in 1997 and $12 million in 1996.
Amortization expense decreased from 1997 to 1998 due to certain intangibles
becoming fully amortized in 1998.
Professional Services
Professional services expense includes fees paid to consultants engaged to
support product, service and systems development, and legal and accounting fees.
This expense was $88 million in 1998, compared to $70 million in 1997 and $52
million in 1996. The increases from 1996 to 1998 were primarily due to higher
levels of consulting fees in many areas, including new and expanded products and
services, systems development, and capacity expansion.
Commissions, Clearance and Floor Brokerage
Commissions, clearance and floor brokerage expense includes fees paid to
stock and option exchanges for trade executions, fees paid by M&S to
broker-dealers for orders received for execution, and fees paid to clearing
entities for trade processing. This expense was $83 million in 1998, compared to
$92 million in 1997 and $81 million in 1996. The decrease from 1997 to 1998 was
primarily due to a decrease in the fees paid per share traded by M&S to
broker-dealers for orders received for execution, partially offset by an
increase in trading volume processed by M&S and Schwab. The increase from 1996
to 1997 was due to an increase in trading volume processed by M&S and Schwab.
Other Expenses
Other expenses include those relating to errors and bad debts, travel and
entertainment, registration fees for employees, and other miscellaneous
expenses. These other expenses were $126 million in 1998, compared to $137
million in 1997 and $80 million in 1996. The decrease from 1997 to 1998 was
primarily due to the $39 million pre-tax litigation settlement charges in 1997,
partially offset by higher trade errors and other volume-related expenses in
1998 reflecting the Company's continued growth. The increase from 1996 to 1997
was primarily due to the litigation settlement charges, as well as higher travel
and entertainment and volume-related expenses.
Taxes on Income
The Company's effective income tax rate was 39.6% in both 1998 and 1997, and
40.7% in 1996.
LIQUIDITY AND CAPITAL RESOURCES
CSC operates as a holding company, conducting virtually all business through
its wholly owned subsidiaries. The capital structure among CSC and its
subsidiaries is designed to provide each entity with capital and liquidity
consistent with its operations. A description of significant aspects of this
structure for CSC and its two principal subsidiaries, Schwab and M&S, follows.
Liquidity
Schwab
Most of Schwab's assets are liquid, consisting primarily of short-term (i.e.,
less than 90 days) investment-grade, interest-earning investments (the majority
of which are segregated for the exclusive benefit of customers pursuant to
regulatory requirements), receivable from customers, and receivable from
brokers, dealers and clearing organizations. Customer margin loans are demand
loan obligations secured by readily marketable securities. Receivable from and
payable to brokers, dealers and clearing organizations primarily represent
current open transactions, which usually settle, or can be closed out, within a
few business days.
8
<PAGE>
Liquidity needs relating to customer trading and margin borrowing activities
are met primarily through cash balances in customer accounts, which were $17.5
billion, $12.7 billion and $10.9 billion at December 31, 1998, 1997 and 1996,
respectively. Management believes that customer cash balances and operating
earnings will continue to be the primary sources of liquidity for Schwab in the
future.
Schwab is subject to regulatory requirements that are intended to ensure the
general financial soundness and liquidity of broker-dealers. These regulations
prohibit Schwab from repaying subordinated borrowings to CSC, paying cash
dividends, or making unsecured advances or loans to its parent or employees if
such payment would result in net capital of less than 5% of aggregate debit
balances or less than 120% of its minimum dollar amount requirement of $1
million. At December 31, 1998, Schwab's net capital was $987 million (10% of
aggregate debit balances), which was $793 million in excess of its minimum
required net capital and $503 million in excess of 5% of aggregate debit
balances. Schwab has historically targeted net capital to be 10% of its
aggregate debit balances, which primarily consist of customer margin loans. To
achieve this target, as customer margin loans have grown, an increasing amount
of cash flows have been retained to support aggregate debit balances.
To manage Schwab's regulatory capital position, CSC provides Schwab with a
$450 million subordinated revolving credit facility maturing in September 2000,
of which $405 million was outstanding at December 31, 1998. At year 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.
To manage short-term liquidity, Schwab maintains uncommitted, unsecured bank
credit lines totaling $545 million at December 31, 1998 (these lines are also
available for CSC to use). The need for short-term borrowings arises primarily
from timing differences between cash flow requirements and the scheduled
liquidation of interest-bearing investments. Schwab used such borrowings for six
days in 1998, eleven days in 1997 and five days in 1996, with the daily amounts
borrowed averaging $87 million, $85 million and $52 million, respectively.
These lines were unused at December 31, 1998.
To satisfy the margin requirement of customer option transactions with the
Options Clearing Corporation, Schwab had unsecured letter of credit agreements
with seven banks totaling $670 million at December 31, 1998. Schwab pays a fee
to maintain these letter of credit agreements. No funds were drawn under these
agreements at December 31, 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, marketable securities, and receivable from brokers, dealers
and clearing organizations.
M&S' liquidity is affected by the same net capital regulatory requirements as
Schwab (see discussion above). At December 31, 1998, M&S' net capital was $14
million, which was $13 million in excess of its minimum required net capital.
M&S may borrow up to $35 million under a subordinated lending arrangement
with CSC maturing in 2000. Borrowings under this arrangement qualify as
regulatory capital for M&S. This facility was unused in 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 $351
million Senior Medium-Term Notes, Series A (Medium-Term Notes), as well as from
the funding of cash dividends, common stock repurchases and acquisitions. The
Medium-Term Notes have maturities ranging from 1999 to 2008 and fixed interest
rates ranging from 5.78% 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.
In July 1998, the 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. At December 31,
1998, all of these notes remained unissued.
CSC may borrow under its $350 million committed, unsecured credit facility
with a group of ten banks. One-half of the commitments under this facility
expires in June 1999, and the other half expires in June 2001. CSC plans to
renegotiate the terms for the portion that is due to expire in June 1999. The
funds are available for general corporate purposes and CSC pays a commitment fee
on the unused balance of this facility. The terms of this facility 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. This facility was unused in 1998.
CSC also has access to the $545 million uncommitted, unsecured bank credit
lines that are primarily utilized by Schwab to manage short-term liquidity.
These lines were not used by CSC in 1998.
9
<PAGE>
Development Spending
A significant portion of the Company's liquidity needs arises from ongoing
investments to support future growth. These investments, which the Company
refers to as development spending, are comprised of two categories: media
spending (including media and production expenses) and project spending. Project
spending is generally targeted towards enhancing future revenue growth, such as
branch expansion, new proprietary SchwabFunds, or improvements to the Company's
Web site; enhancing the Company's infrastructure, such as investments to improve
customer statements or its systems integration; and improving the firm's
productivity, such as enhancements to its telecommunications systems or
operations processes. This spending is imbedded throughout certain categories of
the Company's non-interest expenses.
Development spending in 1998 was approximately $270 million and management
currently anticipates an increase of approximately 35% in 1999, reflecting
management's belief that development spending is critical to strengthening the
Company's competitive advantages. Due to new accounting standards covering
internal-use software development costs, certain 1999 development expenses will
be capitalized and amortized over the software's estimated useful life (see note
"2. Significant Accounting Policies" in the Notes to Consolidated Financial
Statements). In prior years, these costs, as well as virtually all development
costs, were expensed as incurred. The Company estimates that $40 million to $60
million in software development costs will be capitalized in 1999. However, the
positive impact to earnings caused by capitalizing these costs versus expensing
them is expected to be substantially offset by the Company's anticipated
increase in development spending in 1999.
(CHART OMITTED)
As has been the case in recent years, the Company may adjust its development
spending from period to period as business conditions change. In general, the
level of future spending will be influenced by the rate of growth in customer
assets and trading activities, the opportunities to invest in technology that
improve capacity, productivity or the customer experience, and the expected
return on these investments as compared to the Company's financial objectives
and cost of capital. While development spending is discretionary and can be
altered in response to business conditions, the Company views its development
spending as essential for future growth and therefore prefers to avoid major
adjustments in such spending unless faced with a sustained slowdown in revenue
growth.
Cash Flows and Capital Resources
Net income plus depreciation and amortization was $487 million in 1998, up
23% from $395 million in 1997, allowing the Company to finance the majority of
its growth with internally generated funds. Depreciation and amortization
expense related to equipment, office facilities and property was $128 million in
1998 and $110 million in 1997. Amortization expense related to intangible assets
was $10 million in 1998 and $15 million in 1997.
(CHART OMITTED)
The Company's capital expenditures were $190 million in 1998 and $140 million
in 1997. The Company's capital expenditures net of proceeds from the sale of
fixed assets were $185 million in 1998 and $139 million in 1997, or 7% and 6% of
revenues, respectively. Capital expenditures in 1998 were for equipment relating
to the Company's information technology systems, leasehold improvements, and
additional office furniture and equipment to support the Company's growth. In
addition, the Company opened 19 new branch offices during 1998, compared to 40
branch offices opened in 1997, and continues to view new branches as important
to pursuing its strategy of attracting customer assets.
Management currently anticipates that 1999 capital expenditures will be
approximately 40% higher than 1998 spending. Approximately 75% of the 1999
planned expenditures relate to capacity and information technology and
approximately 25% relate to facilities expansion and improvements. The
significant increase in 1999 planned expenditures is primarily due to the
Company's plans to enhance its systems capacity. As has been the case in recent
years, the Company may adjust its capital expenditures from period to period as
business conditions change.
During 1998, the Company:
-- Issued $30 million and repaid $40 million of Medium-Term Notes;
-- Paid common stock dividends of $43 million;
-- Repurchased 6,254,500 shares of its common stock for $150 million.
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 December 31, 1998 was $1,780 million, up $273 million,
or 18%, from a year ago. At December 31, 1998, the Company had borrowings of
$351 million, or 20% of total financial capital, bearing interest at a
weighted-average rate of 6.7%. At December 31, 1998, the Company's stockholders'
equity was $1,429 million, or 80% of total financial capital. Management
currently anticipates that borrowings will remain below 30% of total financial
capital.
10
<PAGE>
Share Repurchases
The Company repurchased 6,254,500 shares of its common stock for $150 million
in 1998, 1,230,000 shares for $18 million in 1997 and 2,432,200 shares for $28
million in 1996. Since the inception of the repurchase plan in 1988, the Company
has repurchased 66,415,400 shares of its common stock for $314 million. At
December 31, 1998, authorization granted by the Company's Board of Directors
allows for future repurchases of 1,225,300 shares. The Company will continue to
monitor opportunities to repurchase common stock in cases where the Company
believes stockholder value would be enhanced. In considering opportunities to
repurchase stock, the Company takes into account the dilutive effects of stock
option exercises and stock grants, although management expects that some
increase in shares outstanding is likely to occur despite share repurchases.
Dividend Policy
As a result of the Company's continued earnings growth, the Board of
Directors increased the quarterly dividend 5% to $.0280 per share in 1998. Since
the initial dividend in 1989, the Company has paid 39 consecutive quarterly
dividends and has increased the dividend 11 times. Since 1989, dividends have
increased by a 38% compounded annual growth rate. The Company paid common stock
dividends of $.1080 per share in 1998, $.0933 per share in 1997 and $.0800 per
share in 1996. While the payment and amount of dividends are at the discretion
of the Company's Board of Directors, the Company has historically targeted its
cash dividend at approximately 10% of net income plus depreciation and
amortization.
International Expansion
In December 1998, the Company entered into agreements to purchase
Canadian-based Priority Brokerage Inc. and Porthmeor Securities Inc. The
acquisitions were completed in early 1999 and the two companies were combined to
create Charles Schwab Canada, Co., a subsidiary of CSC. The cost of these
acquisitions was not material to the Company's financial position.
YEAR 2000
Many existing computer programs use only two digits to identify a specific
year and therefore may not accurately recognize the upcoming change in the
century. If not corrected, many computer applications could fail or create
erroneous results by or at the year 2000. Due to the Company's dependence on
computer technology to operate its business, and the dependence of the financial
services industry on computer technology, the nature and impact of Year 2000
processing failures on the Company's business, financial position, results of
operations or cash flows could be material. The Company 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. Because systems critical to the Company's functioning other than
its computer systems may be affected by the century change, the Company's Year
2000 compliance efforts also encompass facilities and equipment which rely on
date-dependent technology, such as building equipment that contains embedded
technology.
Status of Compliance Efforts
The Company's Year 2000 compliance efforts are directed towards defined
categories of actions, which include awareness, inventory, assessment,
remediation, testing, installation, contingency planning and vendor management.
With respect to particular business units, the work associated with those
categories may be performed in phases or simultaneously with other categories of
Year 2000 tasks, depending on the nature of the work to be performed and the
technology and business requirements of the specific business unit. For
instance, the Company's contingency planning efforts continue simultaneously
with testing efforts. Assuring that the Company's mission critical systems
achieve Year 2000 compliance, that is, that they will operate without material
errors or interruptions when processing data and transactions incorporating year
2000 dates, has received the highest priority in the Company's Year 2000
compliance efforts. "Mission critical" systems means systems critical to the
ongoing operation of the business.
Currently, the focus of the Company's efforts is testing, continuing
contingency planning and vendor management. The Company anticipates that work on
the awareness, contingency planning and vendor management phases of the project
will continue through the century change. The Company anticipates that
installation, remediation and testing will be completed by mid-1999. The
Company's domestic broker-dealer subsidiaries are implementing plans to be
prepared to participate in the industry-wide tests sponsored by the Securities
Industry Association in the first half of 1999.
The Company's vendor management initiatives include creating inventories of
vendors, analyzing the results of the inventories to assess the criticality of
specific vendor relationships in order to formulate plans for dealing with
possible Year 2000 issues, inquiring directly as to the status of vendors' Year
2000 compliance efforts, and continuing contacts with vendors to monitor the
progress of vendors who may not yet have achieved Year 2000 compliance. As of
December 31, 1998, the Company has contacted all significant vendors to
ascertain the Year 2000 compliance status of such vendors' products and
services. These initiatives also include joint testing with selected critical
vendors, joint contingency planning with selected critical vendors, and
addressing Year 2000 concerns with new vendors. As of December 31, 1998, more
than 50% of all testable mission critical third-party products and services
which vendors have represented to be Year 2000 compliant have been tested by the
Company to confirm such compliance. Testing of the remainder of such products
and services is continuing. The anticipated completion date for all vendor
compliance efforts for mission critical third-party products and services is
July 31, 1999. The vendor management initiatives include computer system vendors
as well as vendors of goods and services that comprise or rely upon
date-dependent technology, such as embedded technology.
11
<PAGE>
The success of the Company's Year 2000 compliance efforts depends in part on
parallel efforts being undertaken by vendors and other third parties with which
the Company's systems interact, and therefore the Company is taking steps to
determine the status of critical third parties' Year 2000 compliance. There can
be no assurance that all such third parties will provide accurate and complete
information, or that all of their systems in fact will achieve full Year 2000
compliance. Third parties' Year 2000 processing failures might have a material
adverse impact on the Company's systems and operations. The Company's plan may
be affected by regulatory changes, changes in industry 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 progress of the Company's Year 2000 compliance efforts is managed and
reviewed by senior management and the Company's Year 2000 Corporate Steering
Committee, which is responsible for maintaining awareness of Year 2000 issues
throughout the Company, monitoring overall progress of the project, resolving
issues, and providing strategic direction. The Company's Board of Directors
receives regular status reports on the project.
Subsidiaries Status Reports
Schwab
As of December 31, 1998, Schwab had completed the Year 2000 compliance code
modifications of its mainframe legacy systems, and had installed approximately
95% of such modified code into its production systems. The installation into
production systems of the remaining 5% of such modified code is anticipated to
be completed during the first quarter of 1999. Year 2000 compliance code
modifications and pre-installation testing for all mission critical Schwab
systems were more than 90% complete as of December 31, 1998, and installation
into production of such modified code is anticipated to be completed by July 31,
1999. Installation into production of systems which are being replaced, rather
than modified, to achieve Year 2000 compliance is scheduled for completion by
July 31, 1999.
Schwab's testing strategy includes testing both prior to, and subsequent to,
installation of remediated software into its production systems. The
post-installation testing includes testing of selected systems to confirm Year
2000 readiness, and testing with certain third parties, including vendors and
industry tests.
CSE
As of December 31, 1998, CSE had completed the code modification for all of
the code of its mission critical systems. One-half of such modified code has
been future date tested and installed into CSE's production systems and the
remainder is currently undergoing testing, which is anticipated to be completed
during the second quarter of 1999.
CSIM
As of December 31, 1998, CSIM had completed the code modification and future
date testing for all of the code of its mission critical systems, and such code
had been installed into its production systems.
M&S
As of December 31, 1998, M&S had completed the code modification and future
date testing for all of the code of its mission critical systems, and such code
had been installed into its production systems.
Post-installation testing for CSE, CSIM and M&S will continue through July
31, 1999.
Contingency Planning and Risks
The Company commenced its contingency planning efforts in 1997. Its
contingency planning process is intended to create, update, and implement, as
necessary, plans in the event of Year 2000 errors or failures of third parties
with whom the Company interacts or who supply critical services or goods to the
Company, or of the Company itself.
In management's opinion, currently there is not sufficient reliable
information available to enable the Company to determine whether any specific
Year 2000 failures are reasonably likely to occur. The Company continues to take
steps to reduce this uncertainty through its testing strategy and by
participating in industry conferences, communicating with business alliance
partners, monitoring the progress of critical vendors, monitoring national and
international governmental and industry initiatives, and working with
professional consultants and advisors. Given the uncertainty of predicting at
this point which, if any, Year 2000 errors or failures are reasonably likely to
occur, the Company's contingency planning process targets systems, transactions,
processes, and third parties that are deemed to be critical to the Company's
business, results of operations, or financial condition.
Compliance Cost Estimates
The Company currently estimates that the cost of completing its Year 2000
project, including mission critical and other core brokerage computer systems,
distributed applications, facilities, and systems in subsidiaries other than
Schwab, but excluding potential costs related to the implementation of
contingency plans that address possible Year 2000 failures of third-party
systems or the Company's systems, is approximately $80 million to $95 million.
This estimate is $20 million higher than the estimate in the Company's Quarterly
Report on Form 10-Q for the period ended September 30, 1998, due to the adoption
of a highly centralized Year 2000 project management and reporting structure.
This structure has enabled the Company to more comprehensively isolate and
account for the costs of existing management and administrative staff dedicated
to the Year 2000 project. Previously, the costs of these personnel were included
in their respective business units. The Company's cost estimate excludes the
time that may be spent by staff not specifically dedicated to the Year 2000
project. As of December 31, 1998, the Company had incurred approximately $43
million of the estimated cost of the project.
12
<PAGE>
The estimated cost and timing of the project are based on the Company's
estimates, which make numerous assumptions about future events. However, there
can be no assurance that these estimates will be correct and actual costs and
timing could differ materially from these estimates. The Company expects to fund
all Year 2000 related costs through operating cash flows and a reallocation of
the Company's overall development spending. This reallocation did not result in
the delay of any critical information technology projects. In accordance with
generally accepted accounting principles, Year 2000 expenditures are expensed as
incurred.
EUROPEAN ECONOMIC AND MONETARY UNION
On January 1, 1999, eleven of the fifteen member countries of the European
Union (referred to as the participating countries) established fixed conversion
rates between their existing national currencies and the euro and adopted the
euro as their common legal currency. The United Kingdom is not a participating
country and did not change its national currency. As a retail securities
brokerage firm in the United Kingdom, CSE will continue to trade securities in
sterling, and does not need to modify its information technology systems to
accommodate the euro conversion for its current business operations. Therefore,
the euro conversion did not have a material financial impact on the Company
given its current business operations.
RISK MANAGEMENT
Overview
The Company's business and activities expose it to different types of risks
including, but not limited to, those discussed below. Proper identification,
assessment and management of these risks are essential to the success and
financial soundness of the Company. Managing risk at the Company begins with the
expertise and experience of management at the business unit level. To supplement
risk management at the business unit level, the Company has formed several risk
committees consisting of members of senior management. These committees include
the Global Risk Management Committee, which reviews existing risk management
programs, identifies key risk areas, and works with the business units to assess
and address these exposures; the Financial Risk Committee, which focuses on
liquidity and capital resources, interest rate risk, and securities owned; and
the Customer Risk and Credit Committee, which focuses on margin lending
activities to customers, customer option activities, and short selling by
customers. Additionally, the Finance, Compliance, and Internal Audit Departments
and the Office of Corporate Counsel assist management and the various risk
committees in evaluating and monitoring the Company's risk profile.
The following discussion highlights the Company's principal risks and some of
the policies and procedures for risk identification, assessment and mitigation.
See Liquidity and Capital Resources for a discussion on liquidity risk and note
"13. Financial Instruments with Off-Balance-Sheet and Credit Risk" in the Notes
to Consolidated Financial Statements for additional discussion on credit risk.
Given the nature of the Company's revenues, expenses and risk profile, the
Company's earnings and common stock price may be subject to significant
volatility from period to period. The Company's results for any period are not
necessarily indicative of results for a future period. Risk is inherent in the
Company's business. Consequently, despite the Company's attempts to identify
areas of risk, oversee operational areas involving risk and implement policies
and procedures designed to mitigate risk, there can be no assurance that the
Company will not suffer unexpected losses due to operating or other risks.
Competition
The Company faces significant competition from companies seeking to attract
customer financial assets, including full-commission brokerage firms, discount
brokerage firms, online brokerage firms, mutual fund companies and banks.
Certain of these competitors have significantly greater financial resources than
the Company, particularly given the consolidation trend within the financial
services industry. 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. The Company
experienced declines in its average commission per revenue trade in 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,
resulting in an increase in the proportion of trades placed through its online
channels. As the Company focuses on further enhancements to its electronic
service offering and online trades increase, average commission per revenue
trade is expected to continue to decline.
13
<PAGE>
Business Environment
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. While the
Company's non-trading revenues have grown, transaction-based revenues continue
to represent a majority of the Company's revenues and 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
contractors, temporary employees, overtime hours, advertising and market
development, and professional services are adjustable over the short term to
help the Company achieve its financial objectives. Additionally, development
spending 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 development spending as
essential for future growth and therefore prefers to avoid major adjustments in
such spending unless faced with a sustained slowdown in revenue growth.
Operating Risk
Operating risk is the potential for loss due to deficiencies in control
processes or computer and technological systems. 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. Additionally, rapid increases in customer demand
may strain the Company's ability to enhance its technology and expand its
operating capacity. To minimize business interruptions, the Company has built a
second data center intended, in part, to further improve the recovery of
business processing in the event of an emergency. The Company attempts to
mitigate operating risk by maintaining a comprehensive internal control system,
employing experienced personnel and maintaining backup and recovery functions.
Credit Risk
Credit risk is the potential for loss due to a customer or counterparty
failing to perform its contractual obligations. The Company's exposure to credit
risk mainly results from its margin lending activities, securities lending
activities, role as a counterparty in financial contracts, investing activities,
and the investing activities of certain of the Company's proprietary funds. To
mitigate the risks of such losses, the Company has established policies and
procedures which include: establishing and reviewing credit limits, and
monitoring of credit limits and quality of counterparties. In addition, many of
the Company's credit extensions, such as margin loans to customers and resale
agreements, are supported by collateral arrangements. These arrangements are
subject to requirements to provide additional collateral in the event that
market fluctuations result in declines in the value of collateral received.
Market Risk
Market risk is the potential for loss due to a change in the value of a
financial instrument held by the Company as a result of fluctuations in currency
exchange and interest rates, and equity prices. The Company's exposure to
currency exchange rate risk through its operations in Europe is not material.
The Company is exposed to interest rate risk primarily from changes in the
interest rates on its interest-earning assets (mainly margin loans to customers
and investments) and its funding sources (including customer cash balances,
proceeds from stock-lending activities, borrowings, and stockholders' equity)
which finance these assets. The Company attempts to mitigate this risk by
monitoring the net interest margin and average maturity of its investments, and
has the ability to adjust the rates paid on customer balances and charged on
margin loans.
The Company is exposed to equity price risk through its role as a financial
intermediary in customer-related transactions, and by holding financial
instruments mainly in its capacity as a market maker and relating to its
specialists operations. To mitigate the risk of losses, these financial
instruments are marked to market daily and are monitored by management to assure
compliance with limits established by the Company. Additionally, the Company may
purchase exchange-traded option contracts to reduce market risk on these
inventories.
Additional qualitative and quantitative disclosures about market risk are
summarized as follows.
Financial Instruments Held For Trading Purposes
The Company held government securities with a fair value of approximately $13
million and $5 million at December 31, 1998 and 1997, respectively. These
securities, and the associated interest rate risk, are not material to the
Company's financial position, results of operations or cash flows.
Through Schwab and M&S, the Company maintains inventories in exchange-listed
and Nasdaq securities on both a long and short basis. The fair value of these
securities at December 31, 1998, was $60 million in long positions and $35
million in short positions. The fair value of these securities at December 31,
1997 was $52 million in long positions and $28 million in short positions. The
potential loss in fair value, using a hypothetical 10% decline in prices, is
estimated to be approximately $3 million for both years due to the offset of
losses in long positions with gains in short positions. In addition, the Company
generally enters into exchange-traded option contracts to hedge against
potential losses in inventory positions, thus reducing this potential loss
exposure. This hypothetical 10% decline in prices would not be material to the
Company's financial position, results of operations or cash flows. The notional
amount of option contracts was approximately $74 million and $39 million at
December 31, 1998 and 1997, respectively. The fair value of such option
contracts was not material to the Company's consolidated balance sheets at
December 31, 1998 and 1997.
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 and are not subject to material changes in
value due to interest rate movements (dollars in millions):
14
<PAGE>
<TABLE>
<CAPTION>
Principal Amount
by Maturity Date Fair Value
December 31, 1999 Thereafter 1998 1997
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Resale agreements (1) $7,608 $7,608 $5,107
Weighted-average interest rate 4.96%
Certificates of deposit $2,004 $2,004 $1,499
Weighted-average interest rate 5.04%
Commercial paper $ 525 $ 525 $ 221
Weighted-average interest rate 5.35%
================================================================================
</TABLE>
(1) 1997 includes resale agreements of $4,707 million included in cash and
investments required to be segregated under federal or other regulations and
$400 million included in cash and cash equivalents.
At December 31, 1998, CSC had $351 million aggregate principal amount of
Medium-Term Notes issued and outstanding, with fixed interest rates ranging from
5.78% to 7.72%. At December 31, 1997, CSC had $361 million aggregate principal
amount of Medium-Term Notes issued and outstanding, 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 December 31, 1998 and 1997, 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):
<TABLE>
<CAPTION>
Year Ending Weighted-Average Principal
December 31, Interest Rate Amount
- -----------------------------------------------------------
<S> <C> <C>
1999 6.8% $ 40
2000 6.3% 48
2001 7.0% 39
2002 7.0% 40
2003 6.4% 43
Thereafter 6.7% 141
===========================================================
</TABLE>
The Company maintains investments in mutual funds, approximately $50 million
and $32 million at December 31, 1998 and 1997, respectively, to fund obligations
under its deferred compensation plan, which is available to certain employees.
Any decrease in the fair value of these investments would result in a comparable
decrease in the deferred compensation plan obligation and would not affect the
Company's financial position, results of operations or cash flows.
Legal and Compliance Risk
Legal and compliance risk refers to the possibility that the Company will be
found, by a court, arbitration panel or regulatory authority, not to have
complied with an applicable legal or regulatory requirement. The Company may be
subject to lawsuits or arbitration claims by customers, employees or other third
parties in the different jurisdictions in which it conducts business. In
addition, the Company is subject to extensive regulation by the SEC, the
National Association of Securities Dealers, Inc., the NYSE, and other federal,
state and market regulators, as well as certain foreign regulatory authorities.
The Company attempts to mitigate legal and compliance risk through policies and
procedures that it believes are reasonably designed to prevent or detect
violations of applicable statutory and regulatory requirements (see note "12.
Commitments and Contingent Liabilities" in the Notes to Consolidated Financial
Statements).
LOOKING AHEAD
The consolidation trend in financial services continued during 1998, in some
cases creating competitors that have significantly greater financial resources
than the Company. However, management believes that the Company's competitive
advantages will enable the firm to pursue its strategy of attracting and
retaining customer assets. As described more fully in the Description of
Business section above, these competitive advantages include: a nationally
recognized brand, a broad line of products and services offered at prices that
management believes represent superior value, multi-channel delivery systems,
and the commitment and skills necessary to invest in technology intended to
empower customers and reduce costs. Additionally, the Company's significant
level of employee ownership aligns the interests of management with those of
stockholders.
During 1999, the Company expects to remain focused primarily on serving
individual investors in the U.S., either directly or through independent
investment managers. Management also expects to continue a process of selective
international expansion.
While certain competitors, especially brokerage firms focused on trading via
online channels, are expected to continue price-based competition, management
believes that providing superior service and value are crucial to appealing to a
broad set of investors. Management believes that the key to the Company's future
success will be its ability to combine people and technology in ways that
provide investors with the access, information, guidance and advice they expect,
as well as superior service, all at a significantly lower cost than traditional
providers of financial services. As a result, the Company expects to
increasingly compete with full-commission brokerage firms, banks and other
traditional providers of financial products and services.
Capitalizing on and strengthening the Company's competitive advantages
requires significant development spending and capital expenditures. Management
believes that these ongoing investments are critical to increasing the Company's
market share and achieving its long-term financial objectives, which include
annual growth in revenues of 20%, an after-tax profit margin of 10%, and a
return on stockholders' equity of 20%.
15
<PAGE>
The Charles Schwab Corporation
Consolidated Statement of Income
(In Thousands, Except Per Share Amounts)
<TABLE>
<CAPTION>
Year Ended December 31, 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues
Commissions $1,309,383 $1,174,023 $ 954,129
Mutual fund service fees 559,241 427,673 311,067
Interest revenue, net of interest expense of $651,881 in 1998,
$546,483 in 1997 and $425,872 in 1996 475,617 353,552 254,988
Principal transactions 286,754 257,985 256,902
Other 105,226 85,517 73,836
- ------------------------------------------------------------------------------------------------------------------------------
Total 2,736,221 2,298,750 1,850,922
- ------------------------------------------------------------------------------------------------------------------------------
Expenses Excluding Interest
Compensation and benefits 1,162,823 961,824 766,377
Communications 206,139 182,739 164,756
Occupancy and equipment 200,951 154,181 130,494
Advertising and market development 154,981 129,550 83,987
Depreciation and amortization 138,477 124,682 98,342
Professional services 87,504 69,583 52,055
Commissions, clearance and floor brokerage 82,981 91,933 80,674
Other 125,821 137,011 80,174
- ------------------------------------------------------------------------------------------------------------------------------
Total 2,159,677 1,851,503 1,456,859
- ------------------------------------------------------------------------------------------------------------------------------
Income before taxes on income 576,544 447,247 394,063
Taxes on income 228,082 176,970 160,260
- ------------------------------------------------------------------------------------------------------------------------------
Net Income $ 348,462 $ 270,277 $ 233,803
==============================================================================================================================
Weighted-Average Common Shares Outstanding - Diluted* 411,505 408,863 403,652
==============================================================================================================================
Earnings Per Share*
Basic $ .88 $ .69 $ .60
Diluted $ .85 $ .66 $ .58
==============================================================================================================================
Dividends Declared Per Common Share* $ .1080 $ .0933 $ .0800
==============================================================================================================================
</TABLE>
*Reflects the December 1998 three-for-two common stock split.
See Notes to Consolidated Financial Statements.
16
<PAGE>
The Charles Schwab Corporation
Consolidated Balance Sheet
(In Thousands, Except Per Share Amounts)
<TABLE>
<CAPTION>
December 31, 1998 1997
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Cash and cash equivalents $ 1,155,928 $ 797,447
Cash and investments required to be segregated under federal or other regulations
(including resale agreements of $7,608,067 in 1998 and $4,707,187 in 1997) 10,242,943 6,774,024
Receivable from brokers, dealers and clearing organizations 334,334 267,070
Receivable from customers - net 9,646,140 7,751,513
Securities owned - at market value 242,115 282,569
Equipment, office facilities and property - net 396,163 342,273
Intangible assets - net 46,274 55,854
Other assets 200,493 210,957
- ----------------------------------------------------------------------------------------------------------------------------------
Total $ 22,264,390 $ 16,481,707
==================================================================================================================================
Liabilities and Stockholders' Equity
Drafts payable $ 324,597 $ 268,644
Payable to brokers, dealers and clearing organizations 1,422,300 1,122,663
Payable to customers 18,119,622 13,106,202
Accrued expenses and other liabilities 618,249 478,032
Borrowings 351,000 361,049
- ----------------------------------------------------------------------------------------------------------------------------------
Total liabilities 20,835,768 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; 401,883
shares issued and outstanding in 1998 and 401,533 shares issued in 1997* 4,019 2,677
Additional paid-in capital 213,312 241,422
Retained earnings 1,254,953 955,496
Treasury stock - 2,630 shares in 1997, at cost* (35,401)
Unearned ESOP shares (1,088) (2,769)
Unamortized restricted stock compensation (43,882) (17,228)
Foreign currency translation adjustment 1,308 920
- ----------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 1,428,622 1,145,117
- ----------------------------------------------------------------------------------------------------------------------------------
Total $ 22,264,390 $ 16,481,707
==================================================================================================================================
</TABLE>
* Reflects the December 1998 three-for-two common stock split.
See Notes to Consolidated Financial Statements.
17
<PAGE>
The Charles Schwab Corporation
Consolidated Statement of Cash Flows
(In Thousands)
<TABLE>
<CAPTION>
December 31, 1998 1997 1996
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities
Net income $ 348,462 $ 270,277 $ 233,803
Noncash items included in net income:
Depreciation and amortization 138,477 124,682 98,342
Compensation payable in common stock 28,189 24,385 26,693
Deferred income taxes (6,219) (29,074) (5,214)
Other 4,714 3,047 4,526
Change in securities owned 40,454 (154,699) (14,344)
Change in other assets 16,547 (25,934) (2,396)
Change in accrued expenses and other liabilities 208,783 153,234 48,964
- ------------------------------------------------------------------------------------------------------------------------
Net cash provided before change in customer-related balances 779,407 365,918 390,374
- ------------------------------------------------------------------------------------------------------------------------
Change in customer-related balances:
Cash and investments required to be segregated under
federal or other regulations (3,466,062) 456,662 (1,796,722)
Receivable from brokers, dealers and clearing organizations (65,978) (37,449) (81,517)
Receivable from customers - net (1,893,821) (2,741,796) (1,066,802)
Drafts payable 56,028 43,908 11,069
Payable to brokers, dealers and clearing organizations 298,411 245,327 292,699
Payable to customers 5,010,081 1,935,507 2,608,577
- ------------------------------------------------------------------------------------------------------------------------
Net change in customer-related balances (61,341) (97,841) (32,696)
- ------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 718,066 268,077 357,678
- ------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities
Purchase of equipment, office facilities and property - net (185,494) (139,416) (159,812)
Cash payments for businesses acquired (1,400) (1,200) (4,709)
- ------------------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (186,894) (140,616) (164,521)
- ------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities
Proceeds from borrowings 30,000 111,000 64,000
Repayment of borrowings (40,049) (33,649) (27,459)
Dividends paid (43,068) (37,091) (31,495)
Purchase of treasury stock (150,180) (18,234) (28,171)
Proceeds from stock options exercised and other 30,766 14,530 7,839
- ------------------------------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities (172,531) 36,556 (15,286)
- ------------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents (160) 113 450
- ------------------------------------------------------------------------------------------------------------------------
Increase in cash and cash equivalents 358,481 164,130 178,321
Cash and cash equivalents at beginning of year 797,447 633,317 454,996
- ------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 1,155,928 $ 797,447 $ 633,317
========================================================================================================================
</TABLE>
See Notes to Consolidated Financial Statements.
18
<PAGE>
The Charles Schwab Corporation
Consolidated Statement of Stockholders' Equity
(In Thousands)
<TABLE>
<CAPTION>
Unamortized Foreign
Common Stock Additional Unearned Restricted Currency
---------------- Paid-In Retained Treasury ESOP Stock Translation
Shares* Amount Capital Earnings Stock Shares Compensation Adjustment Total
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995 391,571 $1,785 $180,302 $ 520,532 $ (50,968) $ (9,397) $ (7,074) $(2,286) $ 632,894
Comprehensive income:
Net income 233,803 233,803
Foreign currency translation
adjustment 5,566 5,566
-----------
Total comprehensive income 239,369
Dividends declared on common stock (31,495) (31,495)
Purchase of treasury stock (2,432) (28,171) (28,171)
Stock options exercised and restricted
stock compensation awards 4,763 10,180 18,862 (5,068) 23,974
Amortization of restricted stock
compensation awards 3,484 3,484
ESOP shares released for allocation 10,375 245 3,880 14,500
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 393,902 1,785 200,857 723,085 (60,277) (5,517) (8,658) 3,280 854,555
- ------------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income 270,277 270,277
Foreign currency translation
adjustment (2,360) (2,360)
-----------
Total comprehensive income 267,917
Dividends declared on common stock (37,091) (37,091)
Purchase of treasury stock (1,230) (18,234) (18,234)
Stock options exercised and restricted
stock compensation awards 6,231 25,830 43,110 (14,179) 54,761
Three-for-two stock split effected in
the form of a 50% stock dividend 892 (892)
Amortization of restricted stock
compensation awards 5,609 5,609
ESOP shares released for allocation 14,735 117 2,748 17,600
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 398,903 2,677 241,422 955,496 (35,401) (2,769) (17,228) 920 1,145,117
- ------------------------------------------------------------------------------------------------------------------------------------
Comprehensive income:
Net income 348,462 348,462
Foreign currency translation
adjustment 388 388
-----------
Total comprehensive income 348,850
Dividends declared on common stock (43,068) (43,068)
Purchase of treasury stock (6,255) (150,180) (150,180)
Stock options exercised and restricted
stock compensation awards 9,245 4 (40,872) (4,375) 185,581 (42,153) 98,185
Three-for-two stock split effected in
the form of a 50% stock dividend 1,338 (1,338)
Cash paid in lieu of fractional shares
as a result of the stock split (10) (364) (364)
Amortization of restricted stock
compensation awards 15,499 15,499
ESOP shares released for allocation 12,762 140 1,681 14,583
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998 401,883 $4,019 $213,312 $1,254,953 $ (1,088) $(43,882) $ 1,308 $1,428,622
====================================================================================================================================
</TABLE>
* Share amounts are presented net of treasury shares and reflect the December
1998 three-for-two common stock split.
See Notes to Consolidated Financial Statements.
19
<PAGE>
The Charles Schwab Corporation
Notes to Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Per Share and Option Price Amounts)
1. Basis of Presentation
The 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 291 domestic branch offices in
47 states, as well as branches in the Commonwealth of Puerto Rico, the United
Kingdom and the U.S. Virgin Islands. Another subsidiary, Charles Schwab Europe
(CSE), is a retail securities brokerage firm located in the United Kingdom.
Other subsidiaries include Charles Schwab Investment Management, Inc., the
investment advisor for Schwab's proprietary mutual funds, and Mayer &
Schweitzer, Inc. (M&S), a market maker in Nasdaq and other securities providing
trade execution services to broker-dealers and institutional customers.
Certain items in prior years' financial statements have been reclassified to
conform to the 1998 presentation. All material intercompany balances and
transactions have been eliminated.
2. Significant Accounting Policies
Securities transactions: Customers' securities transactions are recorded on the
date that they settle, while the related commission revenues and expenses are
recorded on the date that the trade occurs. Principal transactions are recorded
on a trade date basis.
Use of estimates: The preparation of the financial statements in conformity with
generally accepted accounting principles requires management to make certain
estimates and assumptions that affect the reported amounts in the accompanying
financial statements. Such estimates relate to useful lives of equipment, office
facilities, buildings and intangible assets, fair value of financial
instruments, allowance for doubtful accounts, future tax benefits and legal
reserves. Actual results could differ from such estimates.
Cash and investments required to be segregated under federal or other
regulations consist primarily of securities purchased under agreements to resell
(resale agreements) and certificates of deposit. Resale agreements are accounted
for as collateralized financing transactions and are recorded at their
contractual amounts. Certificates of deposit are stated at cost, which
approximates market.
Receivable from customers that remain unsecured or partially secured for more
than 90 days are fully reserved for, and are stated net of allowance for
doubtful accounts of $8 million at December 31, 1998 and 1997.
Equipment, office facilities and property: Equipment and office facilities are
depreciated on a straight-line basis over the estimated useful life of the asset
of three to seven years. Buildings are depreciated on a straight-line basis over
twenty years. Leasehold improvements are amortized on a straight-line basis over
the lesser of the estimated useful life of the asset or the life of the lease.
Equipment, office facilities and property are stated at cost net of accumulated
depreciation and amortization of $452 million and $366 million at December 31,
1998 and 1997, respectively.
Intangible assets, including goodwill and customer lists, are amortized on a
straight-line basis over three to fifteen years. Intangible assets are stated at
cost net of accumulated amortization of $196 million and $186 million at
December 31, 1998 and 1997, respectively.
Estimated fair value of financial instruments: The Company considers the amounts
recorded for financial instruments on the consolidated balance sheet to be
reasonable estimates of fair value.
Derivatives: The Company's derivatives activities were limited to
exchange-traded option contracts to reduce market risk on inventories in Nasdaq
and exchange-listed securities. The notional amount of such derivatives was $74
million and $39 million at December 31, 1998 and 1997, respectively. The fair
value of such derivatives was not material to the Company's consolidated balance
sheets at December 31, 1998 and 1997.
Securities lending activities: Securities loaned are recorded at the amount of
cash collateral received and included in payable to brokers, dealers and
clearing organizations. The Company monitors the market value of securities
loaned on a daily basis and requires additional cash as collateral when
necessary.
Foreign currency translation: Assets and liabilities denominated in foreign
currencies are translated at the exchange rate on the balance sheet date, while
revenues and expenses are translated at average rates of exchange prevailing
during the year. Translation adjustments are accumulated as a separate component
of stockholders' equity.
Income taxes: The Company files a consolidated U.S. federal income tax return
and uses the asset and liability method in providing for income tax expense.
Under this method, deferred tax assets and liabilities are recorded for
temporary differences between the tax basis of assets and liabilities and their
recorded amounts for financial reporting purposes, using currently enacted tax
law.
Common stock split: Share and per share information presented in the financial
statements and related notes have been restated to reflect the December 1998
three-for-two common stock split, effected in the form of a 50% stock dividend.
20
<PAGE>
Cash flows: For purposes of reporting cash flows, the Company considers all
highly liquid investments (including resale agreements) with original maturities
of three months or less that are not required to be segregated under federal or
other regulations to be cash equivalents.
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.
The Company adopted SFAS No. 130 -- Reporting Comprehensive Income in 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, which includes net income and foreign currency translation
adjustments, is disclosed in the Consolidated Statement of Stockholders' Equity.
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 a liability, measured at its fair value. The statement
requires that changes in the derivative's fair value be recognized currently in
earnings unless specific hedge accounting criteria are met and such hedge
accounting treatment is elected. While the Company is currently evaluating the
effects of this statement, its adoption is not expected to have a material
impact on the Company's financial position, results of operations, earnings per
share or cash flows.
Statement of Position 98-1 -- Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use, was issued in March 1998 and the Company
is required to adopt this statement by January 1, 1999. This statement requires
that certain costs incurred for purchasing or developing software for internal
use be capitalized and amortized over the software's estimated useful life. In
prior years, the Company capitalized costs incurred for purchasing internal-use
software, but expensed costs incurred for developing internal-use software. In
accordance with the statement, prior years' financial statements will not be
adjusted to reflect this accounting change. The Company estimates that $40
million to $60 million in software development costs will be capitalized in
1999. However, the positive impact to earnings caused by capitalizing these
costs versus expensing them is expected to be substantially offset by the
Company's anticipated increase in development spending in 1999.
3. Securities Owned
Securities owned are recorded at market value and consist of the following:
<TABLE>
<CAPTION>
December 31, 1998 1997
- -----------------------------------------------------------
<S> <C> <C>
SchwabFunds money market funds $ 88,131 $161,175
Equity and bond mutual funds 80,758 63,504
Equity and other securities 73,226 57,890
- -----------------------------------------------------------
Total securities owned $242,115 $282,569
===========================================================
</TABLE>
The Company's positions in SchwabFunds money market funds arise from certain
overnight funding of customers' redemption, check-writing and debit card
activities. Equity and bond mutual funds include investments made by the Company
for funding obligations under its deferred compensation plan and for overnight
funding of certain SchwabFunds customers' transactions. Equity and other
securities include M&S' inventories in Nasdaq securities and Schwab's
inventories in exchange-listed securities relating to its specialist operations.
Securities sold, but not yet purchased, of $35 million and $28 million at
December 31, 1998 and 1997, respectively, consist of equity and other
securities, and are recorded at market value in accrued expenses and other
liabilities.
4. Payable to Brokers, Dealers and Clearing Organizations
Payable to brokers, dealers and clearing organizations consist primarily of
securities loaned of $1,201 million and $998 million at December 31, 1998 and
1997, respectively. Securities loaned are recorded at the amount of cash
collateral received. The market value of securities pledged under securities
lending transactions approximated amounts due.
5. Payable to Customers
The principal source of funding for Schwab's margin lending is cash balances
in customer accounts. At December 31, 1998, Schwab was paying interest at 4.1%
on $15,143 million of cash balances in customer brokerage accounts, which were
included in payable to customers. At December 31, 1997, Schwab was paying
interest at 4.7% on $11,161 million of such cash balances.
6. Borrowings
Borrowings consist of the following:
<TABLE>
<CAPTION>
December 31, 1998 1997
- -----------------------------------------------------------
<S> <C> <C>
Medium-Term Notes $ 351,000 $ 361,000
Other 49
- -----------------------------------------------------------
Total borrowings $ 351,000 $ 361,049
===========================================================
</TABLE>
21
<PAGE>
At December 31, 1998, CSC had $351 million aggregate principal amount of
Senior Medium-Term Notes, Series A (Medium-Term Notes) outstanding, with fixed
interest rates ranging from 5.78% to 7.72% and maturities ranging from 1999 to
2008 as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------
<S> <C>
1999 $ 40,000
2000 48,000
2001 39,000
2002 40,000
2003 43,000
Thereafter 141,000
============================================================
</TABLE>
The Medium-Term Notes carry a weighted-average interest rate of 6.70%. The
fair value of the Medium-Term Notes at December 31, 1998 and 1997, based on
estimates of market rates for debt with similar terms and remaining maturities,
approximated their carrying amounts.
At December 31, 1998, CSC had $205 million in Senior or Senior Subordinated
Medium-Term Notes, Series A available to be issued.
CSC may borrow under its $350 million committed, unsecured credit facility
with a group of ten banks. One-half of the commitments under this facility
expires in June 1999, and the other half expires in June 2001. The funds are
available for general corporate purposes and CSC pays a commitment fee on the
unused balance of this facility. The terms of this facility 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. This facility was unused in 1998.
To manage short-term liquidity, CSC and Schwab maintain uncommitted,
unsecured bank credit lines totaling $545 million and $595 million at December
31, 1998 and 1997, respectively. There were no borrowings outstanding under
these lines at December 31, 1998 and 1997.
To satisfy the margin requirement of customer option transactions with the
Options Clearing Corporation, Schwab had unsecured letter of credit agreements
with seven banks totaling $670 million at December 31, 1998. Schwab pays a fee
to maintain these letter of credit agreements. No funds were drawn under these
agreements at December 31, 1998 and 1997.
7. Taxes on Income
Income tax expense is as follows:
<TABLE>
<CAPTION>
Year Ended December 31, 1998 1997 1996
- -------------------------------------------------------------
<S> <C> <C> <C>
Current:
Federal $206,500 $179,110 $138,990
State 27,801 26,934 26,484
- -------------------------------------------------------------
Total current 234,301 206,044 165,474
- -------------------------------------------------------------
Deferred:
Federal (6,343) (26,484) (4,881)
State 124 (2,590) (333)
- -------------------------------------------------------------
Total deferred (6,219) (29,074) (5,214)
- -------------------------------------------------------------
Total taxes on income $228,082 $176,970 $160,260
=============================================================
</TABLE>
The above amounts do not include tax benefits from the exercise of stock
options and the vesting of restricted stock awards, which for accounting
purposes are credited directly to additional paid-in capital. Such tax benefits
reduced income taxes paid by $69 million in 1998, $34 million in 1997 and $15
million in 1996.
The temporary differences that created deferred tax assets and liabilities,
included in other assets, and accrued expenses and other liabilities, are
detailed below:
<TABLE>
<CAPTION>
December 31, 1998 1997
- ------------------------------------------------------------
<S> <C> <C>
Deferred Tax Assets:
Deferred compensation $40,963 $33,142
Reserves and allowances 22,264 33,456
Asset valuation differences 3,017 (1,101)
Other 3,081 (4,479)
- ------------------------------------------------------------
Total deferred assets 69,325 61,018
- ------------------------------------------------------------
Deferred Tax Liabilities:
State and local taxes (2,407) (2,622)
Depreciation and amortization (1,713) 735
- ------------------------------------------------------------
Total deferred liabilities (4,120) (1,887)
- ------------------------------------------------------------
Net deferred tax asset $65,205 $59,131
============================================================
</TABLE>
The Company determined that no valuation allowance against deferred tax
assets at December 31, 1998 and 1997 was necessary.
The effective income tax rate differs from the amount computed by applying
the federal statutory income tax rate as follows:
<TABLE>
<CAPTION>
Year Ended December 31, 1998 1997 1996
- ------------------------------------------------------------
<S> <C> <C> <C>
Federal statutory income tax rate 35.0% 35.0% 35.0%
State income taxes, net of
federal tax benefit 3.2 3.5 4.3
Other 1.4 1.1 1.4
- ------------------------------------------------------------
Effective income tax rate 39.6% 39.6% 40.7%
============================================================
</TABLE>
22
<PAGE>
8. Stock Options and Restricted Stock Awards
The Company's stock incentive plans provide for granting options to
employees, officers and directors, and restricted stock awards to employees and
officers.
Under the Company's stock incentive plan for granting options and restricted
stock awards to non-officer employees, the Company granted 1,660,000 options in
1998 to non-officer employees employed as of December 31, 1997. The Company
expects to grant such options annually with the size of the grant based on
Company and individual performance.
Options are granted for the purchase of shares of common stock at not less
than market value on the date of grant, and expire within either eight or ten
years from the date of grant. Options generally vest over a four-year period
from the date of grant. A summary of option activity follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------------------- ------------------------- -------------------------
Weighted- Weighted- Weighted-
Average Average Average
Number Exercise Number Exercise Number Exercise
of Options Price of Options Price of Options Price
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning of year 32,575 $ 8.12 32,358 $ 5.05 34,746 $ 4.13
Granted (1) 10,070 $30.09 6,050 $20.02 3,205 $11.22
Exercised (7,963) $ 3.99 (5,210) $ 2.80 (4,256) $ 1.76
Canceled (1,284) $19.21 (623) $ 8.79 (1,337) $ 6.50
- ---------------------------------------------------------------------------------------------------------
Outstanding at
end of year 33,398 $15.30 32,575 $ 8.12 32,358 $ 5.05
=========================================================================================================
Exercisable at
end of year 17,261 $ 6.49 20,038 $ 4.20 20,807 $ 3.11
=========================================================================================================
Available for
future grant at
end of year 17,381 23,972 6,633
=========================================================================================================
Weighted-average
fair value of
options granted
during the year (1) $ 10.95 $ 8.89 $ 4.94
=========================================================================================================
</TABLE>
(1)In 1998, 1,800,000 options were granted with an exercise price greater than
the fair market value of the Company's common stock on the date of grant. The
weighted-average exercise price of these options is $50.00 and the
weighted-average fair value is $8.53. The remaining 8,270,000 options were
granted with an exercise price equal to the fair market value of the
Company's common stock on the date of grant. The weighted-average exercise
price of these options is $25.76 and the weighted-average fair value is
$11.48.
The fair value of each option granted is estimated as of the grant date using
the Black-Scholes option-pricing model with the following assumptions:
<TABLE>
<CAPTION>
1998 1997 1996
- ----------------------------------------------------------
<S> <C> <C> <C>
Dividend yield .65% .75% .75%
Expected volatility 45% 44% 44%
Risk-free interest rate 5.6% 6.2% 6.0%
Expected life (in years) 5 - 8 5 5
- ----------------------------------------------------------
</TABLE>
The following table summarizes information about options outstanding and
exercisable:
<TABLE>
<CAPTION>
December 31, 1998
- --------------------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
------------------------------------------ ---------------------------
Weighted-
Average Weighted- Weighted-
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Prices of Options Life (in years) Price of Options Price
- --------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 1.00 to $ 5.00 11,594 3.3 $ 3.32 11,594 $ 3.32
$ 5.01 to $ 21.00 10,783 7.3 $13.52 5,293 $12.06
$ 21.01 to $ 67.00 11,021 9.2 $29.64 374 $25.92
- --------------------------------------------------------------------------------------------------
$ 1.00 to $ 67.00 33,398 6.6 $15.30 17,261 $ 6.49
==================================================================================================
</TABLE>
The Company applies Accounting Principles Board Opinion No. 25 -- Accounting
for Stock Issued to Employees, and related Interpretations in accounting for its
stock option plans. Accordingly, no compensation expense has been recognized for
the Company's options. Had compensation expense for the Company's options been
determined based on the fair value at the grant dates for awards under those
plans consistent with the fair value method of SFAS No. 123 -- Accounting for
Stock-Based Compensation, the Company's net income and earnings per share would
have been reduced to the pro forma amounts presented below:
<TABLE>
<CAPTION>
Year Ended December 31, 1998 1997 1996
- ----------------------------------------------------------
<S> <C> <C> <C>
Net Income: As reported $348,462 $270,277 $233,803
Pro forma $320,779 $255,850 $227,401
==========================================================
Basic Earnings
Per Share: As reported $ .88 $ .69 $ .60
Pro forma $ .81 $ .65 $ .58
Diluted Earnings
Per Share: As reported $ .85 $ .66 $ .58
Pro forma $ .78 $ .63 $ .56
==========================================================
</TABLE>
The pro forma effect on net income increased in 1998 due to the 66% increase
in options granted in 1998 and due to the fully reflected pro forma effect on
net income resulting from SFAS No. 123 applying only to options granted after
December 31, 1994.
Restricted stock awards are restricted from sale and generally vest over a
four-year period, but some vest based upon the Company achieving certain
financial measures. The fair market value of shares associated with the
restricted stock awards is recorded as unamortized restricted stock compensation
in stockholders' equity and is amortized to compensation expense over the
vesting periods.
23
<PAGE>
Restricted stock information is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
- -----------------------------------------------------------------------
<S> <C> <C> <C>
Restricted stock awards 1,532 1,158 452
Average market price of awarded shares $ 27.51 $ 16.94 $10.70
Restricted shares outstanding (at year end) 2,639 2,324 1,712
Restricted stock expense and amortization $19,516 $10,285 $4,369
- -----------------------------------------------------------------------
</TABLE>
9. Employee Benefit Plans
The Company has a profit sharing and employee stock ownership plan (Profit
Sharing Plan), including a 401(k) salary deferral component, for eligible
employees who have met certain service requirements. The Company matches certain
employee contributions; additional contributions to this plan are at the
discretion of the Company. Total Company contribution expense was $46 million in
1998, $44 million in 1997 and $36 million in 1996.
In 1993, the Profit Sharing Plan borrowed $15 million from the Company to
purchase approximately 5 million shares of the Company's common stock. The note
receivable from the Profit Sharing Plan had a balance of $1 million and $2
million at December 31, 1998 and 1997, respectively, bears interest at 7.9% and
is due in annual installments through 2007. Shares are released for allocation
to eligible employees' accounts based on the proportion of principal and
interest payments made during the year as compared to the total of these
payments and the remaining principal and interest. In accordance with Statement
of Position No. 93-6 -- Employers' Accounting for Employee Stock Ownership Plans
(the Statement), the fair value of shares released for allocation to employees
through the employee stock ownership plan (ESOP) is recognized by the Company as
compensation and benefits expense -- $15 million in 1998, $17 million in 1997
and $14 million in 1996. Only released ESOP shares are considered outstanding
for basic and diluted earnings per share computations. Dividends on allocated
shares and unallocated shares are charged to retained earnings and are used to
make principal and interest payments on the ESOP note receivable, respectively.
The unallocated shares are recorded as unearned ESOP shares on the consolidated
balance sheet. Under the "grandfather" provisions of the Statement, the Company
did not apply the Statement to shares purchased by the ESOP prior to 1993.
The ESOP share information is as follows:
<TABLE>
<CAPTION>
December 31, 1998 1997
- -----------------------------------------------------------
<S> <C> <C>
Allocated shares:
Purchased prior to 1993 15,862 18,959
Purchased in 1993 and after 5,446 4,424
Shares released for allocation:
Purchased in 1993 and after 604 1,022
Unreleased shares:
Purchased in 1993 and after 356 895
- -----------------------------------------------------------
Total ESOP shares 22,268 25,300
===========================================================
Fair value of unreleased shares $20,028 $25,020
===========================================================
</TABLE>
The Company is the beneficiary of a life insurance program covering the
majority of its employees. Under the program, the cash surrender value of
insurance policies is recorded net of policy loans in other assets. At December
31, 1998 and 1997, policy loans with an interest rate of 7.1% and 8.0%,
respectively, totaled $81 million.
10. 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:
<TABLE>
<CAPTION>
Year Ended December 31, 1998 1997 1996
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income $348,462 $270,277 $233,803
======================================================================================
Weighted-average common
shares outstanding - basic 397,028 393,821 389,863
Common stock equivalent shares
related to stock option plans 14,477 15,042 13,789
- --------------------------------------------------------------------------------------
Weighted-average common
shares outstanding - diluted 411,505 408,863 403,652
======================================================================================
Basic earnings per share $ .88 $ .69 $ .60
======================================================================================
Diluted earnings per share $ .85 $ .66 $ .58
======================================================================================
</TABLE>
Stock options to purchase 10,103,000 shares in 1998, 2,635,000 shares in 1997
and 4,925,000 shares in 1996 were outstanding at each respective year end, but
were not included in the computation of diluted earnings per share because the
options' exercise price was greater than the average market price of the common
shares, and therefore the effect would be antidilutive.
24
<PAGE>
11. 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 December 31, 1998, Schwab's
net capital was $987 million (10% of aggregate debit balances), which was $793
million in excess of its minimum required net capital and $503 million in excess
of 5% of aggregate debit balances. At December 31, 1998, M&S' net capital was
$14 million, which was $13 million in excess of its minimum required net
capital.
Schwab and CSE had portions of their cash and investments segregated for the
exclusive benefit of customers at December 31, 1998, in accordance with
applicable regulations. M&S had no such cash reserve requirement at December 31,
1998.
12. Commitments and Contingent Liabilities
The Company has noncancelable operating leases for office space and
equipment. Future minimum rental commitments under these leases at December 31,
1998 are as follows:
<TABLE>
<CAPTION>
- -----------------------------------------------------------
<S> <C>
1999 $101,433
2000 85,472
2001 81,732
2002 73,625
2003 51,524
Thereafter 346,511
===========================================================
</TABLE>
Certain leases contain provisions for renewal options and rent escalations
based on increases in certain costs incurred by the lessor. Rent expense was
$138 million in 1998, $104 million in 1997 and $92 million in 1996.
On November 9, 1998, the United States District Court for the Southern
District of New York granted final approval of the settlement agreement in the
consolidated class action, In re: Nasdaq Market-Makers Antitrust Litigation. The
settlement fully resolves alleged claims on behalf of certain persons who
purchased or sold Nasdaq securities during the period May 1, 1989 through July
17, 1996 concerning the width of spreads between the bid and ask prices of
certain Nasdaq securities. An appeal of the court's approval order is pending.
The Company recognized settlement charges in 1997 of $39 million ($24 million
after-tax), and does not expect to incur any further charges relating to this
settlement.
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 December 1998, one of the actions was voluntarily dismissed
and seven were resolved favorably to Schwab on the grounds that the claims
asserted are preempted by federal law. The remaining three cases are pending in
state courts in Texas and Louisiana. The Texas action and one of the two
Louisiana actions are stayed and there has been no recent activity in the other
Louisiana action.
On January 11, 1999, the SEC announced the institution and settlement of an
administrative proceeding in which the SEC found that M&S and 25 other Nasdaq
market-making firms, in 1994, had violated certain trading practice rules. M&S
settled the proceeding, without admitting or denying the SEC's findings, by
consenting to pay $588,000 in penalties and disgorgement, and certain other
non-monetary relief.
The ultimate outcome of the legal proceedings described above and the various
other lawsuits, 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.
13. Financial Instruments with Off-Balance-Sheet and Credit Risk
Through Schwab and M&S, the Company loans customer securities temporarily to
other brokers in connection with its securities lending activities. The Company
receives cash as collateral for the securities loaned. Increases in security
prices may cause the market value of the securities loaned to exceed the amount
of cash received as collateral. In the event the counterparty to these
transactions does not return the loaned securities, the Company may be exposed
to the risk of acquiring the securities at prevailing market prices in order to
satisfy its customer obligations. The Company mitigates this risk by requiring
credit approvals for counterparties, by monitoring the market value of
securities loaned on a daily basis and by requiring additional cash as
collateral when necessary.
25
<PAGE>
The Company is obligated to settle transactions with brokers and other
financial institutions even if its customers fail to meet their obligations to
the Company. Customers are required to complete their transactions on settlement
date, generally three business days after trade date. If customers do not
fulfill their contractual obligations, the Company may incur losses. The Company
has established procedures to reduce this risk by requiring deposits from
customers in excess of amounts prescribed by regulatory requirements for certain
types of trades.
In the normal course of its margin lending activities, Schwab may be liable
for the margin requirement of customer margin securities transactions. As
customers write option contracts or sell securities short, the Company may incur
losses if the customers do not fulfill their obligations and the collateral in
customer accounts is not sufficient to fully cover losses which customers may
incur from these strategies. To mitigate this risk, the Company monitors
required margin levels daily and customers are required to deposit additional
collateral, or reduce positions, when necessary.
In its capacity as market maker, M&S maintains inventories in Nasdaq
securities on both a long and short basis. While long inventory positions
represent M&S' ownership of securities, short inventory positions represent M&S'
obligations to deliver specified securities at a contracted price, which may
differ from market prices prevailing at the time of completion of the
transaction. Accordingly, both long and short inventory positions may result in
losses or gains to M&S as market values of securities fluctuate. Also, Schwab
maintains inventories in exchange-listed securities on both a long and short
basis relating to its specialist operations and could incur losses or gains as a
result of changes in the market value of these securities. To mitigate the risk
of losses, long and short positions are marked to market daily and are monitored
by management to assure compliance with limits established by the Company.
Additionally, the Company may purchase exchange-traded option contracts to
reduce market risk on these inventories.
Schwab enters into collateralized resale agreements principally with other
broker-dealers, which could result in losses in the event the counterparty to
the transaction does not purchase the securities held as collateral for the cash
advanced and the market value of these securities declines. To mitigate this
risk, Schwab requires that the counterparty deliver securities to a custodian,
to be held as collateral, with a market value in excess of the resale price.
Schwab also sets standards for the credit quality of the counterparty, monitors
the market value of the underlying securities as compared to the related
receivable, including accrued interest, and requires additional collateral where
deemed appropriate.
14. Segment Information
The Company adopted SFAS No. 131 -- Disclosures about Segments of an
Enterprise and Related Information during the fourth quarter of 1998. The
adoption of this statement did not have an effect on the Company's financial
position, results of operations, earnings per share or cash flows. This
statement establishes standards for disclosures related to business operating
segments (segments) in annual financial statements and requires selected
information about segments to be disclosed in interim financial reports issued
to stockholders. This statement also establishes standards for related
disclosures about products and services and geographic areas. Segments are
defined as components of a company about which separate financial information is
available that is evaluated regularly by the chief operating decision maker, or
decision-making group, in deciding how to allocate resources and in assessing
performance.
The Company structures its segments according to its various types of
customers and the services provided to those customers. These segments have been
aggregated based on similarities in economic characteristics, types of
customers, services provided, distribution channels and regulatory environment,
into three reportable segments -- Individual Investor, Institutional Investor
and Capital Markets. The Individual Investor segment includes Schwab's domestic
and international retail operations. The Institutional Investor segment provides
custodial, trading and support services to independent investment managers, and
serves company 401(k) plan sponsors and third-party administrators. (The
Company's mutual fund services are considered a product and not a segment.
Mutual fund service fees are included in both the Individual Investor and
Institutional Investor segments.) The Capital Markets segment provides trade
execution services in Nasdaq, exchange-listed and other securities primarily to
broker-dealers and institutional customers.
The accounting policies of the segments are the same as those described in
note 2. Significant Accounting Policies. The Company evaluates the performance
of its segments based on income before taxes on income. Segment assets are not
disclosed because they are not used for evaluating segment performance and
deciding how to allocate resources to segments. However, capital expenditures
are used in evaluating segment performance and are therefore disclosed. Revenues
from transactions with other segments within the Company (referred to as
intersegment revenues) are recorded at market prices, as if the transactions
were to third parties. Technology, corporate and general administrative expenses
are allocated to segments generally in proportion to either their respective
revenues or average full-time equivalent employees.
Fees received from Schwab's proprietary mutual funds represented
approximately 14% of the Company's consolidated revenues in 1998 and 12% in both
1997 and 1996. No single customer, except for Schwab's proprietary mutual funds,
accounted for more than 10% of the Company's consolidated revenues in 1998, 1997
and 1996. Substantially all of the Company's revenues and assets are attributed
to or located in the U.S. The percentage of Schwab's total customer accounts
located in California were approximately 25%, 28% and 27% as of December 31,
1998, 1997 and 1996, respectively.
26
<PAGE>
Financial information for the Company's reportable segments is presented in
the table below, and the totals are equal to the Company's consolidated amounts
as reported in the consolidated financial statements. Capital expenditures are
reported in total, as opposed to net of proceeds from the sale of fixed assets.
<TABLE>
<CAPTION>
Year Ended December 31, 1998 1997 1996
- -----------------------------------------------------------
<S> <C> <C> <C>
Revenues
Individual investor $1,992,316 $1,735,129 $1,377,587
Institutional investor 446,639 331,984 252,516
Capital markets 338,295 298,454 284,042
- -----------------------------------------------------------
Total $2,777,250 $2,365,567 $1,914,145
===========================================================
Intersegment Revenues
Individual investor $ 37,130 $ 59,658 $ 57,808
Institutional investor 1,954 3,140 3,043
Capital markets 1,945 4,019 2,372
- -----------------------------------------------------------
Total $ 41,029 $ 66,817 $ 63,223
============================================================
Revenues from External
Customers
Individual investor $1,955,186 $1,675,471 $1,319,779
Institutional investor 444,685 328,844 249,473
Capital markets 336,350 294,435 281,670
- -----------------------------------------------------------
Total $2,736,221 $2,298,750 $1,850,922
===========================================================
Interest Revenue, Net of
Interest Expense
Individual investor $ 397,355 $ 300,741 $ 217,827
Institutional investor 65,950 43,662 32,374
Capital markets 12,312 9,149 4,787
- -----------------------------------------------------------
Total $ 475,617 $ 353,552 $ 254,988
===========================================================
Income Before Taxes on
Income
Individual investor $ 402,150 $ 331,514 $ 273,966
Institutional investor 92,842 43,315 47,623
Capital markets 81,552 72,418 72,474
- -----------------------------------------------------------
Total $ 576,544 $ 447,247 $ 394,063
===========================================================
Capital Expenditures
Individual investor $ 145,394 $ 110,047 $ 121,909
Institutional investor 24,944 18,633 19,876
Capital markets 19,905 11,518 22,246
- -----------------------------------------------------------
Total $ 190,243 $ 140,198 $ 164,031
===========================================================
Depreciation and
Amortization
Individual investor $ 102,903 $ 92,074 $ 71,550
Institutional investor 21,115 18,617 14,855
Capital markets 14,459 13,991 11,937
- -----------------------------------------------------------
Total $ 138,477 $ 124,682 $ 98,342
===========================================================
</TABLE>
15. Supplemental Cash Flow Information
<TABLE>
<CAPTION>
Year Ended December 31, 1998 1997 1996
- -----------------------------------------------------------
<S> <C> <C> <C>
Cash paid:
Income taxes $128,723 $166,773 $ 145,113
===========================================================
Interest:
Customer cash balances $579,406 $479,504 $ 369,960
Stock-lending activities 38,118 36,939 24,302
Borrowings 24,114 18,790 16,931
Other 12,934 10,749 9,670
- -----------------------------------------------------------
Total interest $654,572 $545,982 $ 420,863
===========================================================
</TABLE>
27
<PAGE>
Management's Report
To Our Stockholders:
Management of the Company is responsible for the preparation, integrity and
objectivity of the consolidated financial statements and the other financial
information presented in this annual report. To meet these responsibilities we
maintain a system of internal control that is designed to provide reasonable
assurance as to the integrity and reliability of the financial statements, the
protection of Company and customer assets from unauthorized use, and the
execution and recording of transactions in accordance with management's
authorization. The system is augmented by careful selection of our managers, by
organizational arrangements that provide an appropriate division of
responsibility and by communications programs aimed at assuring that employees
adhere to the highest standards of personal and professional integrity. The
Company's internal audit function monitors and reports on the adequacy of and
compliance with our internal controls, policies and procedures. Although no
cost-effective internal control system will preclude all errors and
irregularities, we believe the Company's system of internal control is adequate
to accomplish the objectives set forth above.
The consolidated financial statements have been prepared in conformity with
generally accepted accounting principles and necessarily include some amounts
that are based on estimates and our best judgments. The financial statements
have been audited by the independent accounting firm of Deloitte & Touche LLP,
who were given unrestricted access to all the Company's financial records and
related data. We believe that all representations made to Deloitte & Touche LLP
during their audit were valid and appropriate.
The Board of Directors through its Audit Committee, which is comprised
entirely of nonmanagement directors, has an oversight role in the area of
financial reporting and internal control. The Audit Committee periodically meets
with Deloitte & Touche LLP, our internal auditors and Company management to
discuss accounting, auditing, internal controls over financial reporting and
other matters.
/s/Charles R. Schwab
Charles R. Schwab
Chairman of the Board and Co-Chief Executive Officer
/s/David S. Pottruck
David S. Pottruck
President and Co-Chief Executive Officer
/s/Steven L. Scheid
Steven L. Scheid
Executive Vice President and Chief Financial Officer
Independent Auditors' Report
To the Stockholders and Board of Directors of The Charles Schwab Corporation:
We have audited the accompanying consolidated balance sheets of The Charles
Schwab Corporation and subsidiaries (the Company) as of December 31, 1998 and
1997, and the related consolidated statements of income, stockholders' equity
and cash flows for each of the three years in the period ended December 31,
1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of The Charles Schwab Corporation
and subsidiaries at December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.
/s/DELOITTE & TOUCHE LLP
San Francisco, California
February 22, 1999
28
<PAGE>
The Charles Schwab Corporation
Quarterly Financial Information (Unaudited)
(In Millions, Except Per Share Data and Ratios)
<TABLE>
<CAPTION>
Weighted-
Average Basic
Expenses Common Earnings
Excluding Net Shares - Per
Revenues(1) Interest Income Diluted Share
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1998 by Quarter
Fourth dividend increase / stock split $788.6 $ 612.8 $106.4 413.9 $.27
Third 705.2 542.7 97.8 410.2 .25
Second 638.0 512.2 76.3 409.7 .19
First 604.4 492.0 68.0 412.2 .17
- ------------------------------------------------------------------------------------------------------------
1997 by Quarter (3)
Fourth dividend increase $620.6 $ 516.3 $ 63.1 411.6 $.16
Third stock split 611.8 484.9 76.5 409.5 .20
Second 530.7 424.9 64.0 407.5 .16
First 535.7 425.4 66.7 406.9 .17
- ------------------------------------------------------------------------------------------------------------
1996 by Quarter
Fourth $482.3 $ 383.1 $ 59.7 404.7 $.15
Third dividend increase 430.0 333.4 57.1 404.0 .15
Second 491.8 373.1 70.1 403.3 .18
First 446.8 367.2 46.9 402.5 .12
- ------------------------------------------------------------------------------------------------------------
1995 by Quarter
Fourth $394.8 $ 332.4 $ 42.6 404.7 $.11
Third dividend increase / stock split 385.5 307.5 47.2 404.3 .12
Second 342.7 269.4 44.4 400.8 .12
First dividend increase / stock split 296.9 233.5 38.4 396.3 .10
- ------------------------------------------------------------------------------------------------------------
1994 by Quarter
Fourth $270.4 $ 214.4 $ 33.8 394.1 $.08
Third 248.1 196.5 31.2 392.0 .09
Second 258.2 205.1 32.1 393.9 .08
First dividend increase 287.9 224.3 38.2 396.9 .10
- ------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Dividends
Diluted Declared Range Range
Earnings Per of Common of Price/
Per Common Stock Price Earnings
Share Share Per Share Ratio (2)
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1998 by Quarter
Fourth dividend increase / stock split $.26 $.0280 $68.50 - 21.08 81 - 25
Third .24 .0266 30.67 - 18.50 41 - 25
Second .19 .0267 26.67 - 19.75 39 - 29
First .16 .0267 27.96 - 22.75 42 - 34
- --------------------------------------------------------------------------------------------------------
1997 by Quarter (3)
Fourth dividend increase $.15 $.0267 $29.50 - 19.50 45 - 30
Third stock split .19 .0222 24.38 - 17.78 37 - 27
Second .16 .0222 19.06 - 13.50 31 - 22
First .16 .0222 18.67 - 13.50 30 - 22
- --------------------------------------------------------------------------------------------------------
1996 by Quarter
Fourth $.15 $.0222 $14.61 - 10.00 25 - 17
Third dividend increase .14 .0222 11.94 - 8.83 22 - 16
Second .17 .0178 11.78 - 9.72 23 - 19
First .12 .0178 12.17 - 8.28 27 - 18
- --------------------------------------------------------------------------------------------------------
1995 by Quarter
Fourth $.11 $.0178 $11.86 - 7.39 28 - 17
Third dividend increase / stock split .11 .0178 12.89 - 9.22 32 - 23
Second .11 .0133 10.17 - 6.56 27 - 18
First dividend increase / stock split .10 .0133 7.33 - 4.91 21 - 14
- --------------------------------------------------------------------------------------------------------
1994 by Quarter
Fourth $.08 $.0104 $ 5.48 - 4.09 16 - 12
Third .08 .0104 4.57 - 3.76 14 - 11
Second .08 .0104 5.02 - 3.67 16 - 12
First dividend increase .10 .0104 4.89 - 3.85 16 - 13
- --------------------------------------------------------------------------------------------------------
</TABLE>
All share and per share data reflect the December 1998 three-for-two common
stock split.
(1) Revenues are presented net of interest expense.
(2) Price/earnings ratio is computed by dividing the high and low market prices
by diluted earnings per share for the 12-month period ended on the last day
of the quarter presented. The extraordinary charge in 1993 (described below)
has been excluded.
(3) 1997 includes charges for a litigation settlement of $23.6 million after-tax
($.06 per share for both basic and diluted earnings per share).
29
<PAGE>
THE CHARLES SCHWAB CORPORATION
Chart Appendix List
In this appendix, the following descriptions of certain charts in
portions of the Company's 1998 Annual Report to Stockholders that are omitted
from the EDGAR Version are more specific with respect to the actual numbers,
amounts and percentages than is determinable from the charts themselves. The
Company submits such more specific descriptions only for the purpose of
complying with the requirements for transmitting portions of this Annual Report
on Form 10-K electronically via EDGAR; such more specific descriptions are not
intended in any way to provide information that is additional to the information
otherwise provided in portions of the Company's 1998 Annual Report to
Stockholders.
EDGAR Chart Description
Version
Page Number
2 Stacked bar chart titled "Assets in Schwab Customer
Accounts" representing the composition of assets in Schwab
customer accounts at year end 1998, 1997, 1996, 1995 and
1994 (shown on the bottom axis) as follows (billions of
dollars): Schwab One and Other Cash Equivalents $17.5,
$12.6, $10.6, $8.2 and $6.5, respectively; SchwabFunds
$81.5, $55.8, $43.1, $31.7 and $23.3, respectively; Mutual
Fund Marketplace $129.1, $104.6, $74.6, $50.0 and $31.0,
respectively; Stocks and Other (Net of Margin Loans)
$227.2, $150.8, $98.5, $71.6 and $46.1, respectively; Fixed
Income Securities $35.8, $29.9, $26.4, $20.2 and $15.7,
respectively; Assets in Schwab Customer Accounts (bar
labeled) $491.1, $353.7, $253.2, $181.7 and $122.6,
respectively.
3 Stacked bar chart titled "Revenues by Segment" representing
the composition of revenues by segment for the years ended
December 31, 1998, 1997 and 1996 (years shown on the bottom
axis) as follows (millions of dollars): Individual Investor
$1,955, $1,676 and $1,320, respectively; Institutional
Investor $445, $329 and $249, respectively; Capital Markets
$336, $294 and $282, respectively; Revenues by Segment (bar
labeled) $2,736, $2,299 and $1,851, respectively.
7 Stacked bar chart titled "Compensation and Benefits"
representing the composition of compensation and benefits
for the years ended December 31, 1998, 1997 and 1996 (years
shown on the bottom axis) as follows (millions of dollars):
Salaries and Wages $728, $601 and $451, respectively;
Variable Compensation $267, $217 and $205, respectively;
Other Benefits $168, $144 and $110, respectively;
Compensation and Benefits (bar labeled) $1,163, $962 and
$766, respectively.
10 Pie chart titled "Development Spending for 1999"
representing the composition of estimated development
spending for the year ended December 31, 1999 as follows
(percentage of total): (pie pieces labeled) Project
Spending 55% and Media Spending 45%.
10 Line chart titled "Net Income Plus Depreciation and
Amortization" representing the net income plus depreciation
and amortization for the years ended December 31, 1998,
1997 and 1996 (years shown on the bottom axis) as follows
(millions of dollars) (line labeled): $487, $395 and $332,
respectively.
30
Exhibit 21.1
THE CHARLES SCHWAB CORPORATION
Subsidiaries of the Registrant
The following is a listing of the significant subsidiaries of the Registrant:
Schwab Holdings, Inc., a Delaware corporation
Charles Schwab & Co., Inc., a California corporation
Charles Schwab Investment Management, Inc., a Delaware corporation
Mayer & Schweitzer, Inc., a New Jersey corporation
The following is a listing of certain other subsidiaries of the Registrant:
The Charles Schwab Trust Company, a California corporation
Charles Schwab Europe, an England and Wales corporation
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
We consent to the incorporation by reference in the following Registration
Statements of The Charles Schwab Corporation of our reports dated February 22,
1999 appearing in and incorporated by reference in this Annual Report on Form
10-K of The Charles Schwab Corporation for the year ended December 31, 1998.
Filed on Form S-8:
Registration Statement No. 33-30260 (1987 Stock Option Plan)
Registration Statement No. 33-45356 (Executive Officer Stock Option
Plan (1987))
Registration Statement No. 33-54701 (1992 Stock Incentive Plan)
Registration Statement No. 333-44793 (Charles Schwab Profit Sharing and
Employee Stock Ownership Plan)
Registration Statement No. 333-48335 (The Charles Schwab Corporation Employee
Stock Incentive Plan)
Filed on Form S-3:
Registration Statement No. 333-12727 (Debt Securities)
Registration Statement No. 333-54001 (Debt Securities)
Registration Statement No. 333-47107 (The Charles Schwab Corporation Employee
Stock Incentive Plan)
/s/DELOITTE & TOUCHE LLP
San Francisco, California
March 25, 1999
<TABLE> <S> <C>
<ARTICLE> BD
<LEGEND>
This schedule contains summary financial information extracted from the
Consolidated Statement of Income and Consolidated Balance Sheet of the Company's
1998 Annual Report to Stockholders, which are incorporated herein by reference
to Exhibit No. 13.1 of this report, for the period ended December 31, 1998, and
is qualified in its entirety by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> Year
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 3,790,804
<RECEIVABLES> 9,980,474
<SECURITIES-RESALE> 7,608,067
<SECURITIES-BORROWED> 0
<INSTRUMENTS-OWNED> 242,115
<PP&E> 396,163
<TOTAL-ASSETS> 22,264,390
<SHORT-TERM> 324,597
<PAYABLES> 19,541,922
<REPOS-SOLD> 0
<SECURITIES-LOANED> 0
<INSTRUMENTS-SOLD> 0
<LONG-TERM> 351,000
0
0
<COMMON> 4,019
<OTHER-SE> 1,424,603
<TOTAL-LIABILITY-AND-EQUITY> 22,264,390
<TRADING-REVENUE> 286,754
<INTEREST-DIVIDENDS> 1,127,498
<COMMISSIONS> 1,309,383
<INVESTMENT-BANKING-REVENUES> 0
<FEE-REVENUE> 559,241
<INTEREST-EXPENSE> 651,881
<COMPENSATION> 1,162,823
<INCOME-PRETAX> 576,544
<INCOME-PRE-EXTRAORDINARY> 348,462
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 348,462
<EPS-PRIMARY> 0.88 <F1>
<EPS-DILUTED> 0.85 <F1>
<FN>
<F1> Reflects the December 1998 three-for-two common stock split and prior
Financial Data Schedules have not been restated for the recapitalization. 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>
