UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999 Commission file number 1-9700
THE CHARLES SCHWAB CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 94-3025021
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
120 Kearny Street, San Francisco, CA 94108
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (415) 627-7000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes x No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
408,210,629* shares of $.01 par value Common Stock
Outstanding on April 30, 1999
* Reflects the December 1998 three-for-two common stock split. Excludes the
effects of the two-for-one common stock split declared April 22, 1999, payable
July 1, 1999, and contingent upon shareholder approval of a proposed amendment
to the Registrant's Certificate of Incorporation to increase the number of
authorized shares of the Registrant's common stock. Voting on this proposed
amendment will occur at the May 17, 1999 Annual Meeting of Stockholders.
<PAGE>
THE CHARLES SCHWAB CORPORATION
Quarterly Report on Form 10-Q
For the Quarter Ended March 31, 1999
Index
Page
Part I - Financial Information
Item 1. Condensed Consolidated Financial Statements:
Statement of Income 1
Balance Sheet 2
Statement of Cash Flows 3
Notes 4-7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 8-20
Item 3. Quantitative and Qualitative Disclosures About Market
Risk 20-21
Part II - Other Information
Item 1. Legal Proceedings 21
Item 2. Changes in Securities and Use of Proceeds 21
Item 3. Defaults Upon Senior Securities 21
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 5. Other Information 21
Item 6. Exhibits and Reports on Form 8-K 22
Signature 23
FORWARD-LOOKING STATEMENTS In addition to historical information, this interim
report contains forward-looking statements that reflect management's
expectations. These statements relate to, among other things, Company
contingencies, strategy, sources of liquidity, capital expenditures, and the
Year 2000 project. Achievement of the expressed expectations is subject to
certain risks and uncertainties that could cause actual results to differ
materially from those expectations. See "Forward-Looking Statements" in
Management's Discussion and Analysis of Financial Condition and Results of
Operations in this interim report for a discussion of important factors that may
cause such differences.
<PAGE>
THE CHARLES SCHWAB CORPORATION
THE CHARLES SCHWAB CORPORATION
Part 1 - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
<TABLE>
<CAPTION>
THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended
March 31,
1999 1998
---- ----
<S> <C> <C>
Revenues
Commissions $472,652 $297,845
Mutual fund service fees 169,295 125,382
Interest revenue, net of interest expense of
$173,545 in 1999 and $155,595 in 1998 149,851 104,591
Principal transactions 131,311 52,658
Other 28,476 23,930
- ----------------------------------------------------------------------------------------------------------
Total 951,585 604,406
- ----------------------------------------------------------------------------------------------------------
Expenses Excluding Interest
Compensation and benefits 390,214 265,873
Communications 66,763 47,044
Occupancy and equipment 59,975 45,170
Advertising and market development 52,591 40,150
Depreciation and amortization 34,869 34,195
Professional services 32,277 19,047
Commissions, clearance and floor brokerage 24,387 19,349
Other 54,417 21,244
- ----------------------------------------------------------------------------------------------------------
Total 715,493 492,072
- ----------------------------------------------------------------------------------------------------------
Income before taxes on income 236,092 112,334
Taxes on income 93,225 44,370
- ----------------------------------------------------------------------------------------------------------
Net Income $142,867 $ 67,964
==========================================================================================================
Weighted-average common shares outstanding - diluted (1) 419,251 412,240
==========================================================================================================
Earnings Per Share (1)
Basic $ .36 $ .17
Diluted $ .34 $ .16
==========================================================================================================
Dividends Declared Per Common Share (1) $ .0280 $ .0267
==========================================================================================================
Pro forma weighted-average common shares outstanding - diluted (2) 838,502 824,481
==========================================================================================================
Pro Forma Earnings Per Share (2)
Basic $ .18 $ .09
Diluted $ .17 $ .08
==========================================================================================================
Pro Forma Dividends Declared Per Common Share (2) $ .0140 $ .0133
==========================================================================================================
</TABLE>
(1) Reflects the December 1998 three-for-two common stock split. Excludes the
effects of the two-for-one common stock split declared April 22, 1999,
payable July 1, 1999, and contingent upon shareholder approval of a
proposed amendment to the Company's Certificate of Incorporation to
increase the number of authorized shares of the Company's common stock.
Voting on this proposed amendment will occur at the May 17, 1999 Annual
Meeting of Stockholders.
(2) Pro forma amounts include the effects of the two-for-one common stock split
declared April 22, 1999, payable July 1, 1999, and contingent upon
shareholder approval of a proposed amendment to the Company's Certificate
of Incorporation to increase the number of authorized shares of the
Company's common stock. Voting on this proposed amendment will occur at the
May 17, 1999 Annual Meeting of Stockholders.
See Notes to Condensed Consolidated Financial Statements.
- 1 -
<TABLE>
<CAPTION>
THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(In thousands, except per share amounts)
(Unaudited)
March 31, December 31,
1999 1998
---- ----
<S> <C> <C>
Assets
Cash and cash equivalents $ 1,039,963 $ 1,155,928
Cash and investments required to be segregated under federal or other
regulations (including resale agreements of $6,922,726 in 1999
and $7,608,067 in 1998) 9,073,760 10,242,943
Receivable from brokers, dealers and clearing organizations 494,500 334,334
Receivable from customers - net 11,816,585 9,646,140
Securities owned - at market value 316,656 242,115
Equipment, office facilities and property - net 418,890 396,163
Intangible assets - net 48,852 46,274
Other assets 230,073 200,493
- -----------------------------------------------------------------------------------------------------------------
Total $23,439,279 $22,264,390
=================================================================================================================
Liabilities and Stockholders' Equity
Drafts payable $ 261,732 $ 324,597
Payable to brokers, dealers and clearing organizations 1,499,503 1,422,300
Payable to customers 19,002,023 18,119,622
Accrued expenses and other liabilities 606,009 618,249
Borrowings 351,080 351,000
- -----------------------------------------------------------------------------------------------------------------
Total liabilities 21,720,347 20,835,768
- -----------------------------------------------------------------------------------------------------------------
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;
407,423 and 401,883 shares issued and outstanding in 1999 and
1998, respectively* 4,075 4,019
Additional paid-in capital 405,991 213,312
Retained earnings 1,386,533 1,254,953
Unearned ESOP shares (697) (1,088)
Unamortized restricted stock compensation (77,031) (43,882)
Foreign currency translation adjustment 61 1,308
- -----------------------------------------------------------------------------------------------------------------
Total stockholders' equity 1,718,932 1,428,622
- -----------------------------------------------------------------------------------------------------------------
Total $23,439,279 $22,264,390
=================================================================================================================
</TABLE>
* Reflects the December 1998 three-for-two common stock split. Excludes the
effects of the two-for-one common stock split declared April 22, 1999,
payable July 1, 1999, and contingent upon shareholder approval of a
proposed amendment to the Company's Certificate of Incorporation to
increase the number of authorized shares of the Company's common stock.
Voting on this proposed amendment will occur at the May 17, 1999 Annual
Meeting of Stockholders.
See Notes to Condensed Consolidated Financial Statements.
- 2 -
<TABLE>
<CAPTION>
THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
(Unaudited)
Three Months Ended
March 31,
1999 1998
---- ----
<S> <C> <C>
Cash flows from operating activities
Net income $ 142,867 $ 67,964
Noncash items included in net income:
Depreciation and amortization 34,869 34,195
Compensation payable in common stock 16,759 6,774
Deferred income taxes (2,402) 325
Other 3,717 173
Change in securities owned (74,541) 48,486
Change in other assets (25,951) 45,047
Change in accrued expenses and other liabilities 101,466 6,716
- ------------------------------------------------------------------------------------------------------------
Net cash provided before change in customer-related balances 196,784 209,680
- ------------------------------------------------------------------------------------------------------------
Change in customer-related balances:
Cash and investments required to be segregated under
federal or other regulations 1,156,233 (1,366,558)
Receivable from brokers, dealers and clearing organizations (164,219) (134,552)
Receivable from customers (2,175,730) (183,660)
Drafts payable (61,896) 19,675
Payable to brokers, dealers and clearing organizations 80,501 158,178
Payable to customers 897,245 1,499,537
- ------------------------------------------------------------------------------------------------------------
Net change in customer-related balances (267,866) (7,380)
- ------------------------------------------------------------------------------------------------------------
Net cash provided (used) by operating activities (71,082) 202,300
- ------------------------------------------------------------------------------------------------------------
Cash flows from investing activities
Purchase of equipment, office facilities and property - net (44,822) (37,776)
Costs of internal-use software (11,140)
Cash payments for business acquired, net of cash received (5,657)
- ------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (61,619) (37,776)
- ------------------------------------------------------------------------------------------------------------
Cash flows from financing activities
Dividends paid (11,287) (10,604)
Purchase of treasury stock (55,024)
Proceeds from stock options exercised and other 28,972 8,594
- ------------------------------------------------------------------------------------------------------------
Net cash provided (used) by financing activities 17,685 (57,034)
- ------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents (949) 265
- ------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents (115,965) 107,755
Cash and cash equivalents at beginning of period 1,155,928 797,447
- ------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $1,039,963 $ 905,202
============================================================================================================
</TABLE>
See Notes to Condensed Consolidated Financial Statements.
- 3 -
<PAGE>
THE CHARLES SCHWAB CORPORATION
NOTES TO CONDENSED
CONSOLIDATED FINANCIAL
STATEMENTS
(Unaudited)
1. Basis of Presentation
The accompanying unaudited condensed consolidated financial statements
include The Charles Schwab Corporation (CSC) and its subsidiaries (collectively
referred to as the Company). CSC is a holding company engaged, through its
subsidiaries, in securities brokerage and related financial services. CSC's
principal subsidiary, Charles Schwab & Co., Inc. (Schwab), is a securities
broker-dealer with 298 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.
These financial statements have been prepared pursuant to the rules and
regulations of the Securities and Exchange Commission (SEC) and, in the opinion
of management, reflect all adjustments necessary to present fairly the financial
position, results of operations and cash flows for the periods presented in
conformity with generally accepted accounting principles. All adjustments were
of a normal recurring nature. All material intercompany balances and
transactions have been eliminated. These financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in the Company's 1998 Annual Report to Stockholders, which are
incorporated by reference in the Company's 1998 Annual Report on Form 10-K. The
Company's results for any interim period are not necessarily indicative of
results for a full year.
Certain items in prior periods' financial statements have been
reclassified to conform to the 1999 presentation.
2. New Accounting Standard
Statement of Financial Accounting Standards (SFAS) No. 133 -- Accounting
for Derivative Instruments and Hedging Activities, was issued in June 1998 and
the Company is required to adopt this statement by January 1, 2000. This
statement establishes accounting and reporting standards requiring that every
derivative instrument be recorded on the balance sheet as either an asset or
liability, measured at its fair value. The statement requires that changes in
the derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met and such hedge accounting treatment is
elected. While the Company is currently evaluating the effects of this
statement, its adoption is not expected to have a material impact on the
Company's financial position, results of operations, earnings per share or cash
flows.
3. Costs of Internal-Use Software
Statement of Position 98-1 -- Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use, was adopted by the Company
effective January 1, 1999. This statement requires that certain costs incurred
for purchasing or developing software for internal use be capitalized and
amortized over the software's estimated useful life of three years. In prior
periods, the Company capitalized costs incurred for purchasing internal-use
software, but expensed costs incurred for developing internal-use software. In
accordance with this statement, prior periods' financial statements were not
adjusted to reflect this accounting change. Adoption of this statement resulted
in the capitalization of $11 million of internal-use software development costs
during the first quarter of 1999, which increased net income by $7 million (net
of income taxes of $4 million), or $.02 diluted earnings per share. However, the
positive impact to earnings caused by capitalizing these costs versus expensing
them was substantially offset by an increase in the Company's development
spending in the first quarter of 1999.
4. Comprehensive Income
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 is as follows (in thousands):
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
1999 1998
- --------------------------------------------------------------------------------
<S> <C> <C>
Net income $ 142,867 $ 67,964
Foreign currency translation adjustment (1,247) 734
- --------------------------------------------------------------------------------
Total comprehensive income $ 141,620 $ 68,698
================================================================================
</TABLE>
5. Earnings Per Share
SFAS No. 128 -- Earnings Per Share, requires a dual presentation of basic
and diluted earnings per share (EPS). Basic EPS excludes dilution and is
computed by dividing net income by the weighted-average number of common shares
outstanding for the period. Diluted EPS reflects the potential reduction in EPS
that could occur if securities or other contracts to issue common stock were
exercised or converted into common stock. Earnings per share under the basic and
diluted computations are as follows (in thousands, except per share amounts):
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
Three Months Ended
March 31,
1999 1998
- --------------------------------------------------------------------------------
<S> <C> <C>
Net income $ 142,867 $ 67,964
================================================================================
Weighted-average common
shares outstanding - basic (1) 401,690 397,038
Common stock equivalent shares
related to stock incentive plans (1) 17,561 15,202
- --------------------------------------------------------------------------------
Weighted-average common
shares outstanding - diluted (1) 419,251 412,240
================================================================================
Basic earnings per share (1) $ .36 $ .17
================================================================================
Diluted earnings per share (1) $ .34 $ .16
================================================================================
</TABLE>
(1) Reflects the December 1998 three-for-two common stock split. Excludes the
effects of the two-for-one common stock split declared April 22, 1999,
payable July 1, 1999, and contingent upon shareholder approval of a
proposed amendment to the Company's Certificate of Incorporation to
increase the number of authorized shares of the Company's common stock.
Voting on this proposed amendment will occur at the May 17, 1999 Annual
Meeting of Stockholders.
The computation of diluted EPS for the three months ended March 31, 1998
excludes stock options to purchase 4,858,000 shares because the exercise prices
for those options were greater than the average market price of the common
shares, and therefore the effect would be antidilutive. There were no such
antidilutive stock options outstanding at March 31, 1999.
6. Regulatory Requirements
Schwab and M&S are subject to the Uniform Net Capital Rule under the
Securities Exchange Act of 1934 (the Rule) and each compute net capital under
the alternative method permitted by this Rule, which requires the maintenance of
minimum net capital, as defined, of the greater of 2% of aggregate debit
balances arising from customer transactions or a minimum dollar amount, which is
based on the type of business conducted by the broker-dealer. The minimum dollar
amount for both Schwab and M&S is $1 million. Under the alternative method, a
broker-dealer may not repay subordinated borrowings, pay cash dividends, or make
any unsecured advances or loans to its parent or employees if such payment would
result in net capital of less than 5% of aggregate debit balances or less than
120% of its minimum dollar amount requirement. At March 31, 1999, Schwab's net
capital was $1,158 million (10% of aggregate debit balances), which was $922
million in excess of its minimum required net capital and $570 million in excess
of 5% of aggregate debit balances. At March 31, 1999, M&S' net capital was $12
million, which was $11 million in excess of its minimum required net capital.
Schwab and CSE had portions of their cash and investments segregated for
the exclusive benefit of customers at March 31, 1999, in accordance with
applicable regulations. M&S had no such cash reserve requirement at March 31,
1999.
7. Commitments and Contingent Liabilities
The Company has recently been contacted by federal, self-regulatory and
state regulators as part of an industry-wide examination of online securities
trading. While none of these regulators has indicated that it believes the
Company has violated any applicable law or regulation relating to online
securities trading, these inquiries could possibly result in legislative or
regulatory changes or other actions that could adversely affect the Company's
financial condition or results of operations.
The nature of the Company's business subjects it to numerous regulatory
investigations, claims, lawsuits and other proceedings in the ordinary course of
its business. The ultimate outcome of these matters 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 matters will not have a material
adverse effect on the Company's results of operations in any future period,
depending partly on the results for that period, and a substantial judgment
could have a material adverse impact on the Company's financial condition and
results of operations. However, it is the opinion of management, after
consultation with outside legal counsel, that the ultimate outcome of these
matters will not have a material adverse impact on the financial condition or
operating results of the Company.
8. Segment Information
The Company adopted SFAS No. 131 -- Disclosures about Segments of an
Enterprise and Related Information in 1998. The Company structures its segments
according to its various types of customers and the services provided to those
customers. These segments have been aggregated based on similarities in economic
characteristics, types of customers, services provided, distribution channels
and regulatory environment, into three reportable segments -- Individual
Investor, Institutional Investor and Capital Markets.
Financial information for the Company's reportable segments is presented
in the table below (in thousands). Total revenues from external customers and
income before taxes on income are equal to the Company's consolidated amounts as
reported in the condensed consolidated statement of income.
<TABLE>
<CAPTION>
- --------------------------------------------------------
Three Months Ended
March 31,
1999 1998
- --------------------------------------------------------
<S> <C> <C>
Revenues
Individual Investor $ 681,104 $ 446,157
Institutional Investor 142,625 101,457
Capital Markets 145,635 64,877
- --------------------------------------------------------
Total $ 969,364 $ 612,491
========================================================
Intersegment Revenues
Individual Investor $ 16,343 $ 7,325
Institutional Investor 681 386
Capital Markets 755 374
- --------------------------------------------------------
Total $ 17,779 $ 8,085
========================================================
Revenues from External
Customers
Individual Investor $ 664,761 $ 438,832
Institutional Investor 141,944 101,071
Capital Markets 144,880 64,503
- --------------------------------------------------------
Total $ 951,585 $ 604,406
========================================================
Income (Loss) Before Taxes on
Income
Individual Investor $ 168,760 $ 92,307
Institutional Investor 37,078 24,482
Capital Markets 30,254 (4,455)
- --------------------------------------------------------
Total $ 236,092 $ 112,334
========================================================
</TABLE>
9. Supplemental Cash Flow Information
Certain information affecting the cash flows of the Company follows (in
thousands):
<TABLE>
<CAPTION>
- -------------------------------------------------------
Three Months Ended
March 31,
1999 1998
- -------------------------------------------------------
<S> <C> <C>
Income taxes paid $ 31,695 $ 999
=======================================================
Interest paid:
Customer cash balances $154,958 $134,402
Stock-lending activities 11,934 9,366
Borrowings 8,146 11,382
Other 5,204 3,783
- -------------------------------------------------------
Total interest paid $180,242 $158,933
=======================================================
</TABLE>
10. Subsequent Events
On April 29, 1999, the Company filed a Registration Statement under the
Securities Act of 1933 on Form S-3 relating to up to $250 million aggregate
principal amount of debt securities. As of the filing date of this quarterly
report on Form 10-Q, the Registration Statement has not yet been declared
effective by the SEC, and therefore these debt securities are not yet issuable.
On April 22, 1999, the Board of Directors approved a two-for-one split of
the Company's common stock, which will be effected in the form of a 100% stock
dividend. The stock dividend is payable July 1, 1999 to stockholders of record
June 1, 1999, and is contingent upon shareholder approval of a proposed
amendment to the Company's Certificate of Incorporation to increase the number
of authorized shares of the Company's common stock. Voting on this proposed
amendment will occur at the May 17, 1999 Annual Meeting of Stockholders. Share
and per share data throughout this report have not been restated to reflect this
transaction.
<PAGE>
THE CHARLES SCHWAB CORPORATION
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Description of Business
The Charles Schwab Corporation (CSC) and its subsidiaries (collectively
referred to as the Company) provide securities brokerage and related financial
services for 5.9 million active customer accounts(a). Customer assets in these
accounts totaled $542.0 billion at March 31, 1999. CSC's principal subsidiary,
Charles Schwab & Co., Inc. (Schwab), is a securities broker-dealer with 298
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) Accounts with balances or activity within the preceding eight months.
- --------------------------------------------------------------------------------
The Company provides financial services to individuals, institutional
customers and broker-dealers through three segments -- Individual Investor,
Institutional Investor and Capital Markets. The Individual Investor segment
includes the Company's domestic and international retail operations. The
Institutional Investor segment provides custodial, trading and support services
to independent investment managers, and serves company 401(k) plan sponsors and
third-party administrators. The Capital Markets segment provides trade execution
services in Nasdaq, exchange-listed and other securities primarily to
broker-dealers and institutional customers. The Company's mutual fund services
are considered a product and not a segment. Mutual fund service fees are
included in both the Individual Investor and Institutional Investor segments.
The Company's strategy is to attract and retain customer assets by
focusing on a number of areas within the financial services industry -- retail
brokerage, mutual funds, support services for independent investment managers,
401(k) defined contribution plans and equity securities market-making.
To pursue its strategy and its objective of long-term profitable growth,
the Company plans to continue to leverage its competitive advantages. These
advantages include a nationally recognized brand, a broad range of products and
services, multi-channel delivery systems and an ongoing investment in
technology.
The Company's nationwide advertising and marketing programs are designed
to strengthen the Schwab brand, as well as distinguish its products and
services. The Company primarily uses a combination of network, cable and local
television, national and local radio, print media, and athletic event
sponsorship in its advertising to investors. These programs helped the Company
attract $28.3 billion in net new customer assets and open 388,000 new accounts
during the first quarter of 1999.
The Company offers a broad range of value-oriented products and services
to meet customers' varying investment and financial needs, including access to
extensive investment research, news and information. The Company's
representatives can assist investors in developing asset allocation strategies
and evaluating their investment choices, and refer investors who desire
additional guidance to independent investment managers through the Schwab
AdvisorSource(TM) service. The Company's Mutual Fund Marketplace(R) provides
customers with the ability to invest in 1,650 mutual funds from 263 fund
families, including 1,011 Mutual Fund OneSource(R) funds. Schwab also provides
custodial, trading and support services to approximately 5,500 independent
investment managers. As of March 31, 1999, these managers were guiding the
investments of 729,000 Schwab customer accounts containing $161.2 billion in
assets.
The Company responds to changing customer needs with continued product,
technology and service innovations. During the first quarter of 1999, the
Company launched the Schwab Signature Services(TM) program. This service
provides customers who either have at least $100,000 to invest or trade at least
12 times per year with access to a package of services designed to expand as
their relationship with Schwab grows. Also during the first quarter of 1999,
Schwab introduced the Equity Report Card(TM) and the Positions Monitor(TM),
which are Web-based investment evaluation tools that provide comparisons against
market benchmarks. Schwab also introduced Schwab Alerts(TM), which enables
customers to receive news relating to their investments via e-mail.
The Company's multi-channel delivery systems allow customers to choose how
they prefer to do business with the Company. To enable customers to obtain
services in person with a Company representative, the Company maintains a
network of branch offices. The Company's branch office network also provides
investors with access to the Internet. Telephonic access to the Company is
provided primarily through four regional customer telephone service centers and
two online customer support centers that operate both during and after normal
market hours. Additionally, customers are able to obtain financial information
on an automated basis through the Company's automated telephonic and online
channels. Automated telephonic channels include TeleBroker(R), Schwab's
touch-tone telephone quote and trading service, and VoiceBroker(TM), Schwab's
voice recognition quote and trading service. Online channels include the Charles
Schwab Web Site(TM), an information and trading service on the Internet at
www.schwab.com, and PC-based services such as SchwabLink(R), a service for
investment managers. Schwab provides every retail customer access to all
delivery channels and flat-fee pricing for Internet-based trades.
The Company's ongoing investment in technology is a key element in
expanding its product and service offerings, enhancing its delivery systems,
providing fast and consistent customer service, reducing processing costs, and
facilitating the Company's ability to handle significant increases in customer
activity without a corresponding rise in staffing levels. The Company uses
technology to empower its customers to manage their financial affairs and is a
leader in driving technological advancements in the financial services industry.
During the first quarter of 1999, the Company completed the acquisitions
of Canadian-based Priority Brokerage Inc. and Porthmeor Securities Inc. These
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.
Risk Management
For discussion on the Company's principal risks and some of the policies
and procedures for risk identification, assessment and mitigation, see
"Management's Discussion and Analysis of Results of Operations and Financial
Condition - Risk Management" in the Company's 1998 Annual Report to
Stockholders, which is filed as Exhibit 13.1 to the Company's Form 10-K for the
year ended December 31, 1998. See Liquidity and Capital Resources of this report
for a discussion on liquidity risk; and see Item 3 - Quantitative and
Qualitative Disclosures About Market Risk for additional information relating to
market risk.
Given the nature of the Company's revenues, expenses and risk profile, the
Company's earnings and common stock price may be subject to significant
volatility from period to period. The Company's results for any interim period
are not necessarily indicative of results for a full year. Risk is inherent in
the Company's business. Consequently, despite the Company's attempts to identify
areas of risk, oversee operational areas involving risk and implement policies
and procedures designed to mitigate risk, there can be no assurance that the
Company will not suffer unexpected losses due to operating or other risks.
Forward-Looking Statements
In addition to historical information, this interim report contains
forward-looking statements that reflect management's expectations as of the date
hereof. These statements relate to, among other things, Company contingencies
(see note "7 - Commitments and Contingent Liabilities" in the Notes to Condensed
Consolidated Financial Statements), the Company's strategy (see Description of
Business), sources of liquidity (see Liquidity and Capital Resources-Liquidity),
capital expenditures (see Liquidity and Capital Resources-Cash Flows and Capital
Resources), and the Year 2000 project (see Liquidity and Capital Resources-Year
2000). Achievement of the expressed expectations is subject to certain risks and
uncertainties that could cause actual results to differ materially from the
expressed expectations described in these statements. Important factors that may
cause such differences are noted throughout this interim report, the Company's
1998 Annual Report to Stockholders and the Company's Form 10-K for the year
ended December 31, 1998 and include, but are not limited to: the effect of
customer trading patterns on Company revenues and earnings; changes in
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; the availability of external financing; changes in revenues and
profit margin due to cyclical securities markets and interest rates; the level
and volatility of equity prices; and a significant downturn in the securities
markets over a short period of time or a sustained decline in securities prices
and trading volumes.
Three Months Ended March 31, 1999
Compared To Three Months Ended
March 31, 1998
Financial Overview
- ------------------
Net income for the first quarter of 1999 was a record $143 million, up
110% from first quarter 1998 net income of $68 million. Diluted earnings per
share for the first quarters of 1999 and 1998 were $.34 and $.16 per share,
respectively. Share and per share data throughout this report have been restated
to reflect the effects of the December 1998 three-for-two common stock split.
Share and per share data throughout this report have not been restated to
reflect the effects of the two-for-one common stock split declared April 22,
1999, payable July 1, 1999, and contingent upon shareholder approval of a
proposed amendment to the Company's Certificate of Incorporation to increase the
number of authorized shares of the Company's common stock. Voting on this
proposed amendment will occur at the May 17, 1999 Annual Meeting of
Stockholders.
Revenues increased mainly due to higher customer trading volume. Revenues
of $952 million in the first quarter of 1999 grew $347 million, or 57%, from the
first quarter of 1998 due to increases in revenues of $226 million, or 51%, in
the Individual Investor segment, $80 million, or 125%, in the Capital Markets
segment, and $41 million, or 40%, in the Institutional Investor segment. See
note "8 - Segment Information" in the Notes to Condensed Consolidated Financial
Statements for financial information by segment.
One of the factors contributing to the Company's record performance was
the number of online trades executed in the first quarter of 1999. The Company's
trading activity reached record levels as shown in the following table (in
thousands):
<TABLE>
<CAPTION>
- -------------------------------------------------------------
Three Months
Ended
March 31, Percent
Daily Average Trades 1999 1998 Change
- -------------------------------------------------------------
<S> <C> <C> <C>
Revenue Trades
Online 112.2 42.5 164%
TeleBroker(R)and VoiceBroker(TM) 10.1 9.2 10
Regional customer telephone
service centers, branch offices
and other 40.5 33.7 20
- -------------------------------------------------------------
Total 162.8 85.4 91%
=============================================================
Mutual Fund OneSource(R) Trades
Online 25.2 17.7 42%
TeleBroker and VoiceBroker 1.3 1.2 8
Regional customer telephone
service centers, branch offices
and other 23.4 21.9 7
- -------------------------------------------------------------
Total 49.9 40.8 22%
=============================================================
Total Daily Average Trades
Online 137.4 60.2 128%
TeleBroker and VoiceBroker 11.4 10.4 10
Regional customer telephone
service centers, branch offices
and other 63.9 55.6 15
- -------------------------------------------------------------
Total 212.7 126.2 69%
=============================================================
</TABLE>
Assets in Schwab customer accounts were $542.0 billion at March 31, 1999,
an increase of $135.3 billion, or 33%, from a year ago as shown in the table
below. This increase from March 31, 1998 resulted from net new customer assets
of $88.3 billion and net market gains of $47.0 billion.
<TABLE>
<CAPTION>
- -------------------------------------------------------------
Growth in Schwab Customer
Assets and Accounts
(In billions, at quarter end, March 31, Percent
except as noted) 1999 1998 Change
- -------------------------------------------------------------
Assets in Schwab customer accounts
<S> <C> <C> <C>
Schwab One(R) and other
cash equivalents $ 18.5 $ 13.7 35%
SchwabFunds(R):
Money market funds 74.4 53.3 40
Equity and bond funds 16.4 9.7 69
- -------------------------------------------------------------
Total SchwabFunds 90.8 63.0 44
- -------------------------------------------------------------
Mutual Fund Marketplace(R)(1):
Mutual Fund OneSource
Retail 39.0 35.4 10
Schwab Institutional(TM)(2) 34.2 31.0 10
- -------------------------------------------------------------
Total Mutual Fund
OneSource 73.2 66.4 10
All other 61.8 55.2 12
- ------------------------------------------------------------
Total Mutual Fund
Marketplace 135.0 121.6 11
- -------------------------------------------------------------
Total mutual fund
assets 225.8 184.6 22
- -------------------------------------------------------------
Equity and other securities(1) 272.2 185.4 47
Fixed income securities 37.2 30.9 20
Margin loans outstanding (11.7) (7.9) 48
- -------------------------------------------------------------
Total $ 542.0 $ 406.7 33%
=============================================================
Net growth in assets
in Schwab customer accounts
(for the quarter ended)
Net new customer assets $ 28.3 $ 20.8
Net market gains 22.6 32.2
- -------------------------------------------------------------
Net growth $ 59.9 $ 53.0
=============================================================
New Schwab customer accounts
(in thousands, for the
quarter ended) 388.2 358.1 8%
Active Schwab customer
accounts (in millions) (3) 5.9 5.0 18
=============================================================
Active online Schwab customer
accounts (in millions) (4) 2.5 1.6 56%
Online Schwab customer
assets $ 219.0 $ 112.4 95
=============================================================
</TABLE>
(1) Excludes money market funds and all of Schwab's proprietary money market,
equity and bond funds.
(2) Represents assets invested in Mutual Fund OneSource by independent
investment managers and retirement plans.
(3) Effective with the fourth quarter of 1998, active accounts are defined as
accounts with balances or activity within the preceding eight months
instead of twelve months as previously defined. This change in definition
had the effect of decreasing the number of active accounts by approximately
200,000. Prior quarters have not been restated.
(4) Active online accounts are defined as all active accounts within a
household that has had at least one online session within the past twelve
months.
Total operating expenses excluding interest during the first quarter of
1999 were $715 million, up 45% from $492 million for the first quarter of 1998,
primarily resulting from additional staff and related costs.
The after-tax profit margin for the first quarter of 1999 was 15.0%, up
from 11.3% for the first quarter of 1998. The annualized return on stockholders'
equity for the first quarter of 1999 was 36%, up from 23% for the first quarter
of 1998.
REVENUES
- --------
Revenues grew $347 million, or 57%, in the first quarter of 1999, due to a
$175 million, or 59%, increase in commission revenues and a $79 million, or
149%, increase in principal transaction revenues, as well as a $45 million, or
43%, increase in interest revenue, net of interest expense (referred to as net
interest revenue) and a $44 million, or 35%, increase in mutual fund service
fees.
<TABLE>
<CAPTION>
- -------------------------------------------------------------
Three Months
Ended
March 31,
Composition of Revenues 1999 1998
- -------------------------------------------------------------
<S> <C> <C>
Commissions 50% 49%
Principal transactions 14 9
- -------------------------------------------------------------
Total trading revenues 64 58
- -------------------------------------------------------------
Mutual fund service fees 18 21
Net interest revenue 16 17
Other 2 4
- -------------------------------------------------------------
Total non-trading revenues 36 42
- -------------------------------------------------------------
Total 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 for the Company were $473 million for the first
quarter of 1999, up $175 million, or 59%, from the first quarter of 1998. As
shown in the table below, the total number of revenue trades executed by the
Company has increased 90% as the Company's customer base, as well as customer
trading activity per account, has grown. Average commission per revenue trade
decreased 16%. This decrease was mainly due to an increase in the proportion of
trades placed through the Company's online channels, which charge lower
commission per revenue trade than the Company's other channels.
<TABLE>
<CAPTION>
- ---------------------------------------------------------
Three Months
Commissions Earned Ended
on Customer Revenue March 31, Percent
Trades 1999 1998 Change
- ---------------------------------------------------------
<S> <C> <C> <C>
Customer accounts that
traded during the quarter
(in thousands) 1,662 1,195 39%
Average customer
revenue trades
per account 5.98 4.37 37
Total revenue
trades (in thousands) 9,940 5,221 90
Average commission
per revenue trade $47.72 $56.88 (16)
Commissions earned
on customer revenue
trades (in millions) (1) $ 474 $ 297 60
=========================================================
</TABLE>
(1) Includes certain non-commission revenues relating to the execution of
customer trades totaling $8 million in the first quarter of 1999 and $5
million in the first quarter of 1998. Excludes commissions on trades
relating to specialist operations totaling $7 million in the first quarter
of 1999 and $6 million in the first quarter of 1998.
Mutual Fund Service Fees
- ------------------------
The Company earns mutual fund service fees for recordkeeping and
shareholder services provided to third-party funds, and for transfer agent
services, shareholder services, administration and investment management
provided to its proprietary funds. These fees are based upon the daily balances
of customer assets invested in third-party funds and upon the average daily net
assets of Schwab's proprietary funds. Mutual fund service fees are earned
primarily through the Individual Investor and Institutional Investor segments.
Mutual fund service fees were $169 million for the first quarter of 1999,
up $44 million, or 35%, from the first quarter of 1998. This increase was
primarily due to a significant increase in customer assets in Schwab's
proprietary funds, collectively referred to as the SchwabFunds(R), as well as an
increase in customer assets in funds purchased through Schwab's Mutual Fund
OneSource(R) service.
Net Interest Revenue
- --------------------
Net interest revenue is the difference between interest earned on assets
(mainly margin loans to customers and investments) and interest paid on
liabilities (mainly customer cash balances). Net interest revenue is affected by
changes in the volume and mix of these assets and liabilities, as well as by
fluctuations in interest rates. Substantially all of the Company's net interest
revenue is earned by Schwab through the Individual Investor and Institutional
Investor segments.
Net interest revenue was $150 million for the first quarter of 1999, up $45
million, or 43%, from the first quarter of 1998 as shown in the following table
(in millions):
<TABLE>
<CAPTION>
- ------------------------------------------------------------
Three Months
Ended
March 31,
1999 1998
- ------------------------------------------------------------
<S> <C> <C>
Interest Revenue
Margin loans to customers $198 $149
Investments, customer-related 111 98
Other 14 13
- ------------------------------------------------------------
Total 323 260
- ------------------------------------------------------------
Interest Expense
Customer cash balances 155 138
Stock-lending activities 9 10
Borrowings 6 6
Other 3 1
- ------------------------------------------------------------
Total 173 155
- ------------------------------------------------------------
Net interest revenue $150 $105
============================================================
</TABLE>
Customer-related daily average balances, interest rates and average net
interest margin for the first quarters of 1999 and 1998 are summarized in the
following table (dollars in millions):
<TABLE>
<CAPTION>
- ---------------------------------------------------------------
Three Months Ended
March 31,
1999 1998
- ---------------------------------------------------------------
<S> <C> <C>
Interest-Earning Assets (customer-related):
Margin loans to customers:
Average balance outstanding $ 9,694 $ 7,357
Average interest rate 4.65% 5.42%
Investments:
Average balance outstanding $11,083 $ 7,835
Average interest rate 7.25% 7.70%
Average yield on interest-earning assets 6.04% 6.60%
Funding Sources (customer-related
and other):
Interest-bearing customer cash balances:
Average balance outstanding $16,292 $12,295
Average interest rate 3.86% 4.54%
Other interest-bearing sources:
Average balance outstanding $ 1,709 $ 1,202
Average interest rate 3.36% 4.56%
Average noninterest-bearing portion $ 2,776 $ 1,695
Average interest rate on funding sources 3.30% 4.04%
Summary:
Average yield on interest-earning assets 6.04% 6.60%
Average interest rate on funding sources 3.30% 4.04%
- ---------------------------------------------------------------
Average net interest margin 2.74% 2.56%
===============================================================
</TABLE>
The increase in net interest revenue from the first quarter of 1998 was
primarily due to higher average earning asset balances, partially offset by
higher average customer cash balances.
Principal Transactions
- ----------------------
Principal transaction revenues are primarily comprised of net gains from
market-making activities in Nasdaq and other securities through the Capital
Markets segment. Factors that influence principal transaction revenues include
the volume of customer trades, market price volatility, average revenue per
share traded and changes in regulations and industry practices.
Principal transaction revenues were $131 million for the first quarter of
1999, up $79 million, or 149%, from the first quarter of 1998. This increase was
primarily due to higher average revenue per share traded, as well as greater
share volume handled by M&S.
Expenses Excluding Interest
- ---------------------------
Compensation and benefits expense was $390 million for the first quarter
of 1999, up $124 million, or 47%, from the first quarter of 1998 primarily due
to higher variable compensation expense resulting from the Company's financial
performance, as well as a greater number of employees. The following table shows
a comparison of certain compensation and benefits components and employee data
(in thousands):
<TABLE>
<CAPTION>
- -------------------------------------------------------------
Three Months
Ended
March 31,
1999 1998
- -------------------------------------------------------------
<S> <C> <C>
Compensation and benefits expense as a
% of revenues 41% 44%
Variable compensation as a
% of compensation and benefits expense 33% 18%
Compensation for temporary employees,
contractors and overtime hours as a
% of compensation and benefits expense 12% 15%
Full-time equivalent employees(1) 14.8 13.4
Revenues per average full-time equivalent
employee $67.7 $45.8
=============================================================
</TABLE>
(1) Includes full-time, part-time and temporary employees, and persons employed
on a contract basis.
Communications expense was $67 million in the first quarter of 1999, up
$20 million, or 42%, from the first quarter of 1998. The increase was primarily
due to higher customer trading volumes, increased customer use of automated
telephonic and online channel news, quotation and information services, higher
postage costs in connection with higher customer trading volume, and additional
leased telephone lines related to online service offerings.
Occupancy and equipment expense was $60 million in the first quarter of
1999, up $15 million, or 33%, from the first quarter of 1998. This increase was
primarily due to additional lease expenses on the Company's expanded office
space, as well as increased maintenance and lease expenses on data processing
equipment.
Other expenses were $54 million in the first quarter of 1999, up $33
million, or 156%, from the first quarter of 1998. This increase was primarily
due to higher volume-related trade errors and bad debts, and an increase in
business tax expense.
The Company's effective income tax rate for both the first quarter of 1999
and 1998 was 39.5%.
Liquidity and Capital Resources
Liquidity
Schwab
Liquidity needs relating to customer trading and margin borrowing
activities are met primarily through cash balances in customer accounts, which
were $18.5 billion and $17.5 billion at March 31, 1999 and December 31, 1998,
respectively. Management believes that customer cash balances and operating
earnings will continue to be the primary sources of liquidity for Schwab in the
future.
Schwab is subject to regulatory requirements that are intended to ensure
the general financial soundness and liquidity of broker-dealers. These
regulations prohibit Schwab from repaying subordinated borrowings to CSC, paying
cash dividends, or making unsecured advances or loans to its parent or employees
if such payment would result in net capital of less than 5% of aggregate debit
balances or less than 120% of its minimum dollar amount requirement of $1
million. At March 31, 1999, Schwab's net capital was $1,158 million (10% of
aggregate debit balances), which was $922 million in excess of its minimum
required net capital and $570 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
$750 million subordinated revolving credit facility maturing in September 2000,
of which $590 million was outstanding at March 31, 1999. At quarter end, Schwab
also had outstanding $25 million in fixed-rate subordinated term loans from CSC
maturing in 2000. Borrowings under these subordinated lending arrangements
qualify as regulatory capital for Schwab.
To manage short-term liquidity, Schwab maintains uncommitted, unsecured
bank credit lines totaling $545 million at March 31, 1999 (these lines are also
available for CSC to use). Schwab used such borrowings for 18 days during the
first quarter of 1999, with the daily amounts borrowed averaging $139 million.
These lines were unused at March 31, 1999.
To satisfy the margin requirement of customer option transactions with the
Options Clearing Corporation, Schwab had unsecured letter of credit agreements
with 10 banks totaling $845 million at March 31, 1999. Schwab pays a fee to
maintain these letter of credit agreements. No funds were drawn under these
agreements at March 31, 1999.
M&S
M&S' liquidity needs are generally met through earnings generated by its
operations. Most of M&S' assets are liquid, consisting primarily of marketable
securities, cash and cash equivalents, 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 March 31, 1999, M&S' net capital was $12
million, which was $11 million in excess of its minimum required net capital.
M&S may borrow up to $35 million under a subordinated lending arrangement
with CSC maturing in 2000. Borrowings under this arrangement qualify as
regulatory capital for M&S. This facility was unused during the first quarter of
1999.
CSC
CSC's liquidity needs are generally met through cash generated by its
subsidiaries, as well as cash provided by external financing. As discussed
above, Schwab and M&S are subject to regulatory requirements that may restrict
them from certain transactions with CSC. Management believes that funds
generated by the operations of CSC's subsidiaries will continue to be the
primary funding source in meeting CSC's liquidity needs and maintaining Schwab's
and M&S' net capital.
CSC has liquidity needs that arise from its issued and outstanding $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.
As of March 31, 1999, CSC had a prospectus supplement on file with the
Securities and Exchange Commission enabling CSC to issue up to $205 million in
Senior or Senior Subordinated Medium-Term Notes, Series A. At March 31, 1999,
all of these notes remained unissued. See note "10 - Subsequent Events" in Item
1 - Notes to Condensed Consolidated Financial Statements.
CSC may borrow under its $350 million committed, unsecured credit facility
with a group of nine 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 during the first
quarter of 1999.
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 during the first quarter of 1999.
Cash Flows and Capital Resources
Net income plus depreciation and amortization was $178 million for the
first quarter of 1999, up 75% from $102 million for the first quarter of 1998,
allowing the Company to finance its operations primarily with internally
generated funds. Depreciation and amortization expense related to equipment,
office facilities and property was $33 million for the first quarter of 1999, as
compared to $31 million for the first quarter of 1998, or 3% and 5% of revenues
for each period, respectively. Amortization expense related to intangible assets
was $2 million for the first quarter of 1999, as compared to $3 million for the
first quarter of 1998.
The Company's capital expenditures net of proceeds from the sale of fixed
assets were $45 million in the first quarter of 1999 and $38 million in the
first quarter of 1998, or 5% and 6% of revenues for each period, respectively.
Capital expenditures in the first quarter of 1999 were for equipment relating to
the Company's information technology systems, telecommunications equipment,
leasehold improvements, and additional office furniture and equipment. The
Company opened seven new domestic branch offices during the first quarter of
1999, compared to three domestic branch offices opened during the first quarter
of 1998. Capital expenditures may vary from period to period as business
conditions change.
During the first quarter of 1999, 5,028,400 of the Company's stock
options, with a range of exercise prices from $1.94 to $28.29, were exercised
with cash proceeds received by the Company of $29 million and a related tax
benefit of $114 million. This tax benefit is recorded as a reduction in income
taxes payable and a corresponding increase in stockholders' equity.
During the first quarter of 1999, the Company did not repurchase any
common stock. During the first quarter of 1998, the Company repurchased
2,376,000 shares of its common stock for $61 million. Since the inception of the
repurchase plan in 1988 through March 31, 1999, the Company has repurchased
66,415,400 shares of its common stock for $314 million. At March 31, 1999,
authorization granted by the Company's Board of Directors allows for future
repurchases of 1,225,300 shares.
In April 1999, the Board of Directors approved a two-for-one split of the
Company's common stock, which will be effected in the form of a 100% stock
dividend. The stock dividend is payable July 1, 1999 to stockholders of record
June 1, 1999, and is contingent upon shareholder approval of a proposed
amendment to the Company's Certificate of Incorporation to increase the number
of authorized shares of the Company's common stock. Voting on this proposed
amendment will occur at the May 17, 1999 Annual Meeting of Stockholders. Share
and per share data throughout this report have not been restated to reflect this
transaction.
During both the first quarter of 1999 and 1998, the Company paid common
stock cash dividends totaling $11 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 March 31, 1999 was $2,070 million, up $290 million, or
16% from December 31, 1998. At March 31, 1999, the Company had borrowings of
$351 million, or 17% of total financial capital, that bear interest at a
weighted-average rate of 6.70%. At March 31, 1999, the Company's stockholders'
equity was $1,719 million, or 83% of total financial capital.
Year 2000
Many existing computer programs use only two digits to identify a specific
year and therefore may not accurately recognize the upcoming change in the
century. If not corrected, many computer applications could fail or create
erroneous results by or at the year 2000. Due to the Company's dependence on
computer technology to operate its business, and the dependence of the financial
services industry on computer technology, the nature and impact of Year 2000
processing failures on the Company's business, financial position, results of
operations or cash flows could be material. The Company 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. Attempting to assure that the Company's mission critical
systems achieve Year 2000 compliance, that is, that they will operate without
material errors or interruptions when processing data and transactions
incorporating year 2000 dates, has received the highest priority in the
Company's Year 2000 compliance efforts. "Mission critical" systems means systems
critical to the ongoing operation of the business.
Currently, the focus of the Company's efforts is testing, continuing
contingency planning and vendor management. The Company anticipates that work on
the contingency planning and vendor management phases of the project will
continue through the century change. The Company anticipates that installation,
remediation and associated required testing will be completed by mid-1999. The
Company's domestic broker-dealer subsidiaries are participating in the
industry-wide test sponsored by the Securities Industry Association which began
in March 1999 and extended into the second quarter of 1999. As of March 31,
1999, no material exceptions had been encountered in the course of such tests.
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. 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. As of December 31, 1998, the Company had contacted all
significant vendors to ascertain the Year 2000 compliance status of such
vendors' products and services. Vendor management 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
March 31, 1999, more than 80% 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 material vendor compliance efforts for mission critical
third-party products and services is July 31, 1999, except for contingency
planning efforts which by their nature will be continuing until the century
change is completed, and except to the extent of efforts for which completion is
dependent on third parties whose actions are beyond the Company's control.
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 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 March 31, 1999, Schwab had completed the Year 2000 compliance code
modifications of its mainframe legacy systems, and had installed all such
modified code into its production systems. Year 2000 compliance code
modifications and pre-installation testing for all mission critical Schwab
systems were more than 90% complete as of March 31, 1999, and installation into
production of such modified code is anticipated to be completed by July 31,
1999. Installation into production of mission critical legacy 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 March 31, 1999, CSE had completed the code modification for all of
the code of its mission critical systems. More than 65% of such modified code
has been future date tested and installed into CSE's production systems and the
remainder is currently undergoing testing. The testing 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 Schwab, 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.
The Company's cost estimate excludes the time that may be spent by staff not
specifically dedicated to the Year 2000 project. As of March 31, 1999, the
Company had incurred approximately $60 million of the estimated cost of the
entire project.
The estimated cost and timing of the project are based on the Company's
estimates, which make numerous assumptions about future events. However, there
can be no assurance that these estimates will be correct and actual costs and
timing could differ materially from these estimates. The Company has funded and
expects to fund all Year 2000 related costs through operating cash flows and a
reallocation of the Company's overall developmental spending. This reallocation
did not result in the delay of any critical information technology projects. In
accordance with generally accepted accounting principles, Year 2000 expenditures
are expensed as incurred.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Financial Instruments Held For Trading Purposes
The Company held government securities and certificates of deposit with a
fair value of approximately $23 million and $7 million at March 31, 1999 and
1998, respectively. These securities, and the associated interest rate risk, are
not material to the Company's financial position, results of operations or cash
flows.
Through Schwab and M&S, the Company maintains inventories in
exchange-listed and Nasdaq equity securities on both a long and short basis. The
fair value of these securities at March 31, 1999 was $50 million in long
positions and $32 million in short positions. The fair value of these securities
at March 31, 1998 was $32 million in long positions and $38 million in short
positions. Using a hypothetical 10% increase or decrease in prices, the
potential loss or gain in fair value, respectively, is estimated to be
approximately $1,800,000 and $600,000, respectively, due to the offset of change
in fair value in long and short positions. In addition, the Company generally
enters into exchange-traded option contracts to hedge against potential losses
in equity inventory positions, thus reducing this potential loss exposure. This
hypothetical 10% change in fair value of these securities at March 31, 1999 and
1998 would not be material to the Company's financial position, results of
operations or cash flows. The notional amount and fair value of option contracts
were not material to the Company's consolidated balance sheets at March 31, 1999
and 1998.
Financial Instruments Held For Purposes Other Than Trading
For its working capital and reserves required to be segregated under
federal or other regulations, the Company invests in money market funds, resale
agreements, certificates of deposit, and commercial paper. Money market funds do
not have maturity dates and do not present a material market risk. The other
financial instruments, as shown in the following table, are fixed rate
investments with short maturities and are not subject to material changes in
value due to interest rate movements (dollars in millions):
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------
Principal Amount
by Maturity Date Fair Value
March 31, 2000 Thereafter 1999 1998
- --------------------------------------------------------------------------
<S> <C> <C> <C>
Resale agreements (1) $ 6,923 $6,923 $5,956
Weighted-average interest rate 4.76%
Certificates of deposit $ 1,753 $1,753 $1,820
Weighted-average interest rate 4.84%
Commercial paper $ 375 $ 375 $ 319
Weighted-average interest rate 5.03%
==========================================================================
</TABLE>
(1) Fair value at March 31, 1998 includes resale agreements of $5,846 million
included in cash and investments required to be segregated under federal or
other regulations and $110 million included in cash and cash equivalents.
At March 31, 1999, CSC had $351 million aggregate principal amount of
Medium-Term Notes, with fixed interest rates ranging from 5.78% to 7.72%. At
March 31, 1998, CSC had $361 million aggregate principal amount of Medium-Term
Notes, with fixed interest rates ranging from 5.67% to 7.72%. The Company has
fixed cash flow requirements regarding these Medium-Term Notes due to the fixed
rate of interest. The fair value of these Medium-Term Notes at March 31, 1999
and 1998, based on estimates of market rates for debt with similar terms and
remaining maturities, approximated their carrying amount. The table below
presents the principal amount of these Medium-Term Notes by year of maturity
(dollars in millions):
<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 $45 million at March 31, 1999 and 1998, respectively, to fund
obligations under its deferred compensation plan, which is available to certain
employees. Any decrease in the fair value of these investments would result in a
comparable decrease in the deferred compensation plan obligation and would not
affect the Company's financial position, results of operations or cash flows.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The discussions of legal proceedings in Notes to Condensed Consolidated
Financial Statements, under note "7 - Commitments and Contingent Liabilities" in
Part I - Financial Information, Item 1., is incorporated herein by reference.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
As of April 1, 1999, the Company's Management Committee was expanded from
12 to 16 members. The four new members are as follows:
Christopher V. Dodds Executive Vice President - Finance
Carrie E. Dwyer Executive Vice President, General Counsel and
Corporate Secretary
John P. McGonigle Executive Vice President - Mutual Funds
George A. Rich Executive Vice President - Human Resources
The Company's 1999 Annual Meeting of Stockholders will be held on Monday,
May 17, 1999 at 2:00 p.m. at the Yerba Buena Center for the Arts Theater, 700
Howard Street, San Francisco, California. Any questions concerning the Annual
Meeting should be directed to the Assistant Corporate Secretary at (415)
636-1406.
Item 6. Exhibits and Reports on Form 8-K
(a) The following exhibits are filed as part of this quarterly report on Form
10-Q.
- --------------------------------------------------------------------------------
Exhibit
Number Exhibit
- --------------------------------------------------------------------------------
10.204 The Charles Schwab Corporation Deferred Compensation Plan, as
amended through January 20, 1999 (supersedes Exhibit 10.199 to the
Registrant's Form 10-Q for the quarter ended September 30, 1998).
12.1 Computation of Ratio of Earnings to Fixed Charges.
27.1 Financial Data Schedule (electronic only).
- --------------------------------------------------------------------------------
(b) Reports on Form 8-K
None.
<PAGE>
THE CHARLES SCHWAB CORPORATION
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE CHARLES SCHWAB CORPORATION
(Registrant)
Date: May 11, 1999 /s/ Steven L. Scheid
------------ ------------------------------------------
Steven L. Scheid
Executive Vice President and
Chief Financial Officer
Exhibit 10.204
THE CHARLES SCHWAB CORPORATION
DEFERRED COMPENSATION PLAN
(AS AMENDED THROUGH JANUARY 20, 1999)
<PAGE>
THE CHARLES SCHWAB CORPORATION
DEFERRED COMPENSATION PLAN
TABLE OF CONTENTS
Section Page
Article I. Purpose
1.1 Establishment of the Plan 2
1.2 Purpose of the Plan 2
Article II. Definitions
2.1 Definitions 3
2.2 Gender and Number 4
Article III. Administration
3.1 Committee and Administrator 5
Article IV. Participants
4.1 Participants 6
Article V. Deferrals
5.1 Salary Deferrals 7
5.2 Deferrals of Bonuses and Other Cash Incentive Compensation 7
5.3 Deferral Procedures 8
5.4 Election of Time and Manner of Payment 8
5.5 Accounts and Earnings 10
5.6 Maintenance of Accounts 11
5.7 Change in Control 11
5.8 Payment of Deferred Amounts 14
5.9 Acceleration of Payment 14
<PAGE>
Section
Article VI. General Provisions
6.1 Unfunded Obligation 15
6.2 Informal Funding Vehicles 15
6.3 Beneficiary 16
6.4 Incapacity of Participant or Beneficiary 17
6.5 Nonassignment 17
6.6 No Right to Continued Employment 17
6.7 Tax Withholding 17
6.8 Claims Procedure and Arbitration 17
6.9 Termination and Amendment 19
6.10 Applicable Law 19
<PAGE>
THE CHARLES SCHWAB CORPORATION
DEFERRED COMPENSATION PLAN
Article I. Purpose
1.1 Establishment of the Plan. Effective as of July 1, 1994, The
Charles Schwab Corporation (hereinafter, the "Company") hereby establishes The
Charles Schwab Corporation Deferred Compensation Plan (the "Plan"), as set forth
in this document.
1.2 Purpose of the Plan. The Plan permits participating employees to
defer the payment of certain cash compensation that they may earn. The
opportunity to elect such deferrals is provided in order to help the Company
attract and retain key employees. This Plan is unfunded and is maintained
primarily for the purpose of providing deferred compensation for a select group
of management or highly compensated employees. It is accordingly intended to be
exempt from the participation, vesting, funding, and fiduciary requirements set
forth in Title I of the Employee Retirement Income Security Act of 1974.
<PAGE>
Article II. Definitions
2.1 Definitions. The following definitions are in addition to any other
definitions set forth elsewhere in the Plan. Whenever used in the Plan, the
capitalized terms in this section shall have the meanings set forth below unless
otherwise required by the context in which they are used:
(a) "Administrator" the administrator described in section 3.1
that is selected by the Committee to assist in the
administration of the Plan.
(b) "Beneficiary" means a person entitled to receive any benefit
payments that remain to be paid after a Participant's death,
as determined under section 6.3.
(c) "Board" means the Board of Directors of the Company.
(d) "Company" means The Charles Schwab Corporation, a Delaware
corporation.
(e) "Category 1 Participant" and "Category 2 Participant" each
refer to a specific Participant group and have the
meaning set forth in section 4.1.
(f) "Committee" means the Compensation Committee of the Board.
(g) "Deferral Account" means the account representing deferrals
of cash compensation, plus investment adjustments, as
described in sections 5.5 and 5.6.
(h) "Participant" means any employee who meets the eligibility
requirements of the Plan, as set forth in Article 4, and
includes, where appropriate to the context, any former
employee who is entitled to benefits under this Plan.
(i) "Plan" means The Charles Schwab Corporation Deferred
Compensation Plan, as in effect from time to time.
(j) "Plan Year" means the calendar year.
(k) "Retirement" shall mean any termination of employment
with the Company and its Subsidiaries for any reason other
than death at any time after the Participant has attained
age 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. Provided,
however, that with respect to any payments made on account
of a deferral election made prior to November 1, 1994,
Retirement shall also mean any termination of employment
with the Company and its Subsidiaries for any reason other
than death after the Participant has attained age 55.
(l) "Subsidiary" means a corporation or other business entity in
which the Company owns, directly or indirectly, securities
with more than 80 percent of the total voting power.
(m) "Valuation Date" means each December 31 and any other date
designated from time to time by the Committee for the
purpose of determining the value of a Participant's Deferral
Account balance pursuant to section 5.5.
2.2 Gender and Number. Except when otherwise indicated by the context,
any masculine or feminine terminology shall also include the neuter and other
gender, and the use of any term in the singular or plural shall also include the
opposite number.
<PAGE>
Article III. Administration
3.1 Committee and Administrator. The Committee shall administer the
Plan and may select one or more persons to serve as the Administrator. The
Administrator shall perform such administrative functions as the Committee may
delegate to it from time to time. Any person selected to serve as the
Administrator may, but need not, be a Committee member or an officer or employee
of the Company. However, if a person serving as Administrator or a member of the
Committee is a Participant, such person may not vote on a matter affecting his
interest as a Participant.
The Committee shall have discretionary authority to construe and
interpret the Plan provisions and resolve any ambiguities thereunder; to
prescribe, amend, and rescind administrative rules relating to the Plan; to
select the employees who may participate and to terminate the future
participation of any such employees; to determine eligibility for benefits under
the Plan; and to take all other actions that are necessary or appropriate for
the administration of the Plan. Such interpretations, rules, and actions of the
Committee shall be final and binding upon all concerned and, in the event of
judicial review, shall be entitled to the maximum deference allowable by law.
Where the Committee has delegated its responsibility for matters of
interpretation and Plan administration to the Administrator, the actions of the
Administrator shall constitute actions of the Committee.
<PAGE>
Article IV. Participants
4.1 Participants. Officers and other key employees of the Company and
each of its Subsidiaries shall be eligible to participate in this Plan upon
selection by the Committee. To be nominated for participation, an employee must
be highly compensated or have significant responsibility for the management,
direction and/or success of the Company as a whole or a particular business unit
thereof. Directors of the Company who are full-time employees of the Company
shall be eligible to participate in the Plan. Participating employees of the
Company in the position of executive vice president or above shall be "Category
1 Participants." All other participating employees shall be "Category 2
Participants."
<PAGE>
Article V. Deferrals
5.1 Salary Deferrals. Each Category 2 Participant selected under
section 4.1 may elect to defer up to 50 percent of his regular base salary
(subject to the provisions of this Article V). Any such election must be made by
entering a deferred compensation agreement with the employer, as evidenced by a
form approved by and filed with the Administrator on or before the deadline
specified by the Committee (which shall be no earlier than one month prior to
the beginning of the election period for which the deferred salary is to be
earned). For this purpose, the election period shall be the calendar year;
provided, however, that during periods in which the Plan is not in effect for a
full calendar year or an employee is not a Participant for a full calendar year,
the election period shall be the portion of the calendar year during which the
Plan is in effect and the employee is an eligible Participant. Notwithstanding
the foregoing, a person who is not a Participant at the beginning of a calendar
year shall not be allowed to elect a deferral of compensation that takes effect
during that year without the consent of the Committee. Salary deferrals that
have been elected shall occur throughout the election period in equal increments
for each payroll period.
5.2 Deferrals of Bonuses and Other Cash Incentive Compensation. Each
Category 1 Participant and each Category 2 Participant may elect to defer all or
any portion (subject to the provisions of this Article V) of any amount that he
subsequently earns under an annual cash bonus program and/or a long-term cash
incentive compensation program of the Company or a participating Subsidiary. Any
such election must be made by entering a deferred compensation agreement with
the employer, as evidenced by a form approved by the Committee that is filed
with the Administrator on or before the deadline specified by the Committee. For
annual cash bonuses, this deadline shall be no earlier than one month prior to
the beginning of year (or portion thereof) for which the bonus will be earned.
For other cash incentive compensation, this deadline shall be a date no later
than six months before the end of the year or other period for which the
incentive compensation will be earned. Rules similar to those in section 5.1
shall apply in cases where the Plan is not in existence or an employee is not a
Participant for the full period in which an annual cash bonus or long-term
incentive compensation award is earned.
5.3 Deferral Procedures. Participants eligible to elect salary
deferrals under section 5.1 shall have an opportunity to do so each year.
Participants eligible to elect deferrals under section 5.2 shall have a separate
opportunity to do so for each cash bonus under an annual bonus program and for
each other cash bonus or incentive payment under a long-term incentive plan that
they may earn. Unless the Committee specifies other rules for the deferrals that
may be elected, the minimum deferral shall be 20 percent of the compensation to
which a deferral election applies; and, subject to the maximum percentage
allowed under section 5.1 or 5.2, as applicable, deferrals in excess of the
minimum allowable percentage may be made only in increments of 10 percent.
If a deferral is elected, the election shall be irrevocable with
respect to the particular compensation that is subject to the election. Deferral
elections shall be made on a form prescribed by the Committee or the
Administrator. As provided in section 6.7, any deferral is subject to
appropriate tax withholding measures and may be reduced to satisfy tax
withholding requirements.
5.4 Election of Time and Manner of Payment. At the time a Participant
makes a deferral election under section 5.1 or 5.2, the Participant shall also
designate the manner of payment and the date on which payments from his or her
Deferral Account shall begin, from among the following options:
(i) a lump sum payable by the end of February of any year that the
Participant specifies;
(ii) a lump sum payable by the end of February in the year immediately
following the Participant's Retirement;
(iii) a series of annual installments, commencing in any year selected
by the Participant and payable each year on or before the end of February, over
a period of four years; or
(iv) a series of annual installments, commencing in the year following
the Participant's Retirement and payable each year on or before the end of
February, over a period of five, ten, or fifteen years, as designated by the
Participant.
However, if a Participant terminates employment for any reason other
than Retirement, the payment of the Participant's entire Deferral Account,
including any unpaid installments pursuant to clause (iii) above, shall be made
in a single lump sum by the end of February in the year next following the year
in which the Participant terminates employment, notwithstanding the terms of the
Participant's election.
Any election of a specified payment date pursuant to clauses (i) or
(iii) shall be subject to any restrictions that the Committee may, in its sole
discretion, choose to establish in order to limit the number of different
payment dates that a Participant may have in effect at one time.
A Participant may modify an election of the time for payment under
circumstances determined by the Committee, provided that (i) a payment election
may not be modified in a manner that would cause payments to commence earlier
than the date payments would have commenced absent such modification, and (ii)
all payment elections shall become irrevocable one year prior to the date on
which payment will commence under the election.
If payment is due in the form of a lump sum, the payment shall equal
the balance of the Deferral Account being paid, determined as of the Valuation
Date coincident with or immediately preceding the payment date. If payment is
due in the form of installments, the amount of each installment payment shall be
equal to the quotient determined by dividing (A) the value of the portion of the
Deferral Account to which the installment payment election applies (determined
as of the Valuation Date coincident with or immediately preceding the date the
payment is to be made), by (B) the number of years over which the installment
payments are to be made, less the number of years in which prior payments
attributable to such installment payment election have been made.
Notwithstanding the foregoing, however, if earnings or any other
amounts credited to a Participant's Deferral Account are not considered
performance-based compensation, within the meaning of Section 162(m) of the
Internal Revenue Code, and do not otherwise meet Internal Revenue Code
conditions allowing the Company and its Subsidiaries to receive a federal income
tax deduction for such amounts upon paying them at the time provided under the
Participant's election, the payment of such amounts, to the extent in excess of
the amount that would be currently tax deductible, shall automatically be
deferred until the earliest year that the payment can be deducted.
5.5 Accounts and Earnings. The Company shall establish a Deferral
Account for each Participant who has elected a deferral under section 5.1 or 5.2
above, and its accounting records for the Plan with respect to each such
Participant shall include a separate Deferral Account or subaccount for each
deferral election of the Participant that could cause a payment made at a
different time or in a different form from other payments of deferrals elected
by the same Participant. Each Deferral Account balance shall reflect the
Company's obligation to pay a deferred amount to a Participant or Beneficiary as
provided in this Article V. Under procedures approved by the Committee and
communicated to Participants, a Participant's Deferral Account balance shall be
increased periodically (not less frequently than annually) to reflect an assumed
earnings increment, based on an interest rate or other benchmark selected by the
Committee and in effect at the time. Until the time for determining the amount
to be paid to the Participant or Beneficiary, such assumed earnings shall accrue
from each Valuation Date on the Deferral Account balance as of that date and
shall be credited to the account as of the next Valuation Date.
The rate of earnings may, but need not, be determined with reference to
the actual rate of earnings on assets held under any existing grantor trust or
other informal funding vehicle that is in effect pursuant to section 6.2. Any
method of crediting earnings that is followed from time to time may, with
reasonable advance notice to affected Participants, be revoked or revised
prospectively as of the beginning of any new Plan Year. Earnings that have been
credited for any Plan Year, like deferred amounts that have been previously
credited to a Participant, shall not be reduced or eliminated retroactively
unless they were credited in error. The crediting of assumed earnings shall not
mean that any deferred compensation promise to a Participant is secured by
particular investment assets or that the Participant is actually earning
interest or any other form of investment income under the Plan.
Consistent with the foregoing authority to exercise flexibility in
establishing a method for crediting assumed earnings on account balances, the
Committee may, but need not, consult with Participants about their investment
preferences and may, but need not, institute a program of assumed earnings that
tracks the investment performance in a Participant's qualified defined
contribution plan account or in an assumed participant-directed investment
arrangement.
5.6 Maintenance of Accounts. The Accounts of each Participant shall be
entered on the books of the Company and shall represent a liability, payable
when due under this Plan, out of the general assets of the Company. Prior to
benefits becoming due hereunder, the Company shall expense the liability for
such accounts in accordance with policies determined appropriate by the
Company's auditors. Except to the extent provided pursuant to the second
paragraph of this section 5.6, the Accounts created for a Participant by the
Company shall not be funded by a trust or an insurance contract; nor shall any
assets of the Company be segregated or identified to such account; nor shall any
property or assets of the Company be pledged, encumbered, or otherwise subjected
to a lien or security interest for payment of benefits hereunder.
Notwithstanding that the amounts to be paid hereunder to Participants
constitute an unfunded obligation of the Company, the Company may direct that an
amount equal to any portion of the Accounts shall be invested by the Company as
the Company, in its sole discretion, shall determine. The Committee may in its
sole discretion determine that all or any portion of an amount equal to the
Accounts shall be paid into one or more grantor trusts that may be established
by the Company for the purpose of providing a potential source of funds to pay
Plan benefits. The Company may designate an investment advisor to direct the
investment of funds that may be used to pay benefits, including the investment
of the assets of any grantor trusts hereunder.
5.7 Change in Control. In the event of a Change in Control (as defined
below), the following rules shall apply:
(a) All Participants shall continue to have a fully vested,
nonforfeitable interest in their Deferral Accounts.
(b) Deferrals of amounts for the year that includes the Change
in Control shall cease beginning with the first payroll
period that follows the Change in Control.
(c) A special allocation of earnings on all Deferral Accounts
shall be made under section 5.5 as of the date of the Change
in Control on a basis no less favorable to Participants than
the method being followed prior to the Change in Control.
(d) All payments of deferred amounts following a Change in
Control, whether or not they have previously begun, shall be
made in a cash lump sum no later than 30 days following the
Change in Control and, except as provided in section 5.4
with respect to installment payments in progress, shall be
in an amount equal to the full Deferral Account balance, as
adjusted pursuant to paragraph (c) above, as of the date of
the Change in Control.
(e) Nothing in this Plan shall prevent a Participant from
enforcing any rules in a contract or another plan of the
Company or any Subsidiary concerning the method of
determining the amount of a bonus, incentive compensation,
or other form of compensation to which a Participant may
become entitled following a change in control, or the time
at which that compensation is to be paid in the event of a
change in control. For purposes of this Plan, a "Change in
Control" means any of the following:
(1) Any "person" who, alone or together with all
"affiliates" and "associates" of such person, is or
becomes (1) an "acquiring person" or (2) the
"beneficial owner" of 35% of the outstanding voting
securities of the Company (the terms "person",
"affiliates", "associates" and "beneficial owner"
are used as such terms are used in the Securities
Exchange Act of 1934 and the General Rules and
Regulations thereunder); provided, however, that a
"Change in Control" shall not be deemed to have
occurred if such "person" is Charles R. Schwab, the
Company, any subsidiary or any employee benefit
plan or employee stock plan of the Company or of
any Subsidiary, or any trust or other entity
organized, established or holding shares of such
voting securities by, for or pursuant to, the terms
of any such plan; or
(2) Individuals who at the beginning of any period of
two consecutive calendar years constitute the Board
cease for any reason, during such period, to
constitute at least a majority thereof, unless the
election, or the nomination for election by the
Company's Shareholders, of each new Board Member
was approved by a vote of at least three-quarters
(3/4) of the Board members then still in office who
were Board members at the beginning of such period;
or
(3) Approval by the shareholders of the Company of:
(A) the dissolution or liquidation of the
Company;
(B) the sale or transfer of substantially all
of the Company's business and/or assets to
a person or entity which is not a
"subsidiary" (any corporation or other
entity a majority or more of whose
outstanding voting stock or voting power is
beneficially owned directly or indirectly
by the Company); or
(C) an agreement to merge or consolidate, or
otherwise reorganize, with one or more
entities which are not subsidiaries (as
defined in (B) above), as a result of which
less than 50% of the outstanding voting
securities of the surviving or resulting
entity are, or are to be, owned by former
shareholders of the Company; or
(4) The Board agrees by a majority vote that an event
has or is about to occur that, in fairness to the
Participants, is tantamount to a Change in Control.
A Change of Control shall occur on the first day on
which any of the preceding conditions has been satisfied.
However, notwithstanding the foregoing, this section 5.7
shall not apply to any Participant who alone or together
with one or more other persons acting as a partnership,
limited partnership, syndicate, or other group for the
purpose of acquiring, holding or disposing of securities of
the Company, triggers a "Change in Control" within the
meaning of paragraphs (1) and (2) above.
5.8 Payment of Deferred Amounts. A Participant shall have a fully
vested, nonforfeitable interest in his or her Deferral Account balance at all
times. However, vesting does not confer a right to payment other than in the
manner elected by the Participant pursuant to section 5.4 (subject to any
modification that may occur pursuant to section 5.5, 5.7 or 5.9). Upon the
expiration of a deferral period selected by the Participant in one or more
deferral elections, the Company shall pay to such Participant (or to the
Participant's Beneficiary, in the case of the Participant's death) an amount
equal to the balance of the Participant's Account attributable to such expiring
deferral elections, plus assumed earnings (determined by the Company pursuant to
section 5.5) thereon.
5.9 Acceleration of Payment. The Committee, in its discretion, upon
receipt of a written request from a Participant, may accelerate the payment of
all or any portion of the unpaid balance of a Participant's Deferral Account in
the event of the Participant's Retirement, death, permanent disability,
resignation or termination of employment, or upon its determination that the
Participant (or his Beneficiary in the case of his death) has incurred a severe,
unforeseeable financial hardship creating an immediate and heavy need for cash
that cannot reasonably be satisfied from sources other than an accelerated
payment from this Plan. The Committee in making its determination may consider
such factors and require such information as it deems appropriate.
<PAGE>
Article VI. General Provisions
6.1 Unfunded Obligation. The deferred amounts to be paid to
Participants pursuant to this Plan constitute unfunded obligations of the
Company. Except to the extent specifically provided hereunder, the Company is
not required to segregate any monies from its general funds, to create any
trusts, or to make any special deposits with respect to this obligation. Title
to and beneficial ownership of any investments, including any grantor trust
investments which the Company has determined and directed the Administrator to
make to fulfill obligations under this Plan shall at all times remain in the
Company. Any investments and the creation or maintenance of any trust or
Accounts shall not create or constitute a trust or a fiduciary relationship
between the Administrator or the Company and a Participant, or otherwise create
any vested or beneficial interest in any Participant or his or her Beneficiary
or his or her creditors in any assets of the Company whatsoever. The
Participants shall have no claim for any changes in the value of any assets
which may be invested or reinvested by the Company in an effort to match its
liabilities under this Plan.
6.2 Informal Funding Vehicles. Notwithstanding section 6.1, the Company
may, but need not, arrange for the establishment and use of a grantor trust or
other informal funding vehicle to facilitate the payment of benefits and to
discharge the liability of the Company and participating Affiliates under this
Plan to the extent of payments actually made from such trust or other informal
funding vehicle.
Any investments and any creation or maintenance of memorandum accounts
or a trust or other informal funding vehicle shall not create or constitute a
trust or a fiduciary relationship between the Committee or the Company or an
affiliate and a Participant, or otherwise confer on any Participant or
Beneficiary or his or her creditors a vested or beneficial interest in any
assets of the Company or any Affiliate whatsoever. Participants and
Beneficiaries shall have no claim against the Company or any Affiliate for any
changes in the value of any assets which may be invested or reinvested by the
Company or any Affiliate with respect to this Plan.
6.3 Beneficiary. The term "Beneficiary" shall mean the person or
persons to whom payments are to be paid pursuant to the terms of the Plan in the
event of the Participant's death. A Participant may designate a Beneficiary on a
form provided by the Administrator, executed by the Participant, and delivered
to the Administrator. The Administrator may require the consent of the
Participant's spouse to a designation if the designation specifies a Beneficiary
other than the spouse. Subject to the foregoing, a Participant may change a
Beneficiary designation at any time. Subject to the property rights of any prior
spouse, if no Beneficiary is designated, if the designation is ineffective, or
if the Beneficiary dies before the balance of the Account is paid, the balance
shall be paid to the Participant's surviving spouse, or if there is no surviving
spouse, to the Participant's estate.
6.4 Incapacity of Participant or Beneficiary. Every person receiving or
claiming benefits under the Plan shall be conclusively presumed to be mentally
competent and of age until the date on which the Administrator receives a
written notice, in a form and manner acceptable to the Administrator, that such
person is incompetent or a minor, for whom a guardian or other person legally
vested with the care of his person or estate has been appointed; provided,
however, that if the Administrator finds that any person to whom a benefit is
payable under the Plan is unable to care for his or her affairs because of
incompetency, or because he or she is a minor, any payment due (unless a prior
claim therefor shall have been made by a duly appointed legal representative)
may be paid to the spouse, a child, a parent, a brother or sister, or to any
person or institution considered by the Administrator to have incurred expense
for such person otherwise entitled to payment. To the extent permitted by law,
any such payment so made shall be a complete discharge of liability therefor
under the Plan.
If a guardian of the estate of any person receiving or claiming
benefits under the Plan is appointed by a court of competent jurisdiction,
benefit payments may be made to such guardian provided that proper proof of
appointment and continuing qualification is furnished in a form and manner
acceptable to the Administrator. In the event a person claiming or receiving
benefits under the Plan is a minor, payment may be made to the custodian of an
account for such person under the Uniform Gifts to Minors Act. To the extent
permitted by law, any such payment so made shall be a complete discharge of any
liability therefor under the Plan.
6.5 Nonassignment. The right of a Participant or Beneficiary to the
payment of any amounts under the Plan may not be assigned, transferred, pledged
or encumbered nor shall such right or other interests be subject to attachment,
garnishment, execution, or other legal process.
6.6 No Right to Continued Employment. Nothing in the Plan shall be
construed to confer upon any Participant any right to continued employment with
the Company, nor shall the Plan interfere in any way with the right of the
Company to terminate the employment of such Participant at any time without
assigning any reason therefor.
6.7 Tax Withholding. Appropriate taxes shall be withheld from cash
payments made to Participants pursuant to the Plan. To the extent tax
withholding is payable in connection with the Participant's deferral of income
rather than in connection with the payment of deferred amounts, such withholding
may be made from other wages and salary currently payable to the Participant,
or, as determined by the Administrator, the amount of the deferral elected by
the Participant may be reduced in order to satisfy required tax withholding for
employment taxes and any other taxes.
6.8 Claims Procedure and Arbitration. The Company shall establish a
reasonable claims procedure consistent with the requirements of the Employee
Retirement Income Security Act of 1974, as amended. Following a Change in
Control of the Company (as determined under section 5.8) the claims procedure
shall include the following arbitration procedure.
Since time will be of the essence in determining whether any payments
are due to the Participant under this Plan following a Change in Control, a
Participant may submit any claim for payment to arbitration as follows: On or
after the second day following the termination of the Participant's employment
or other event triggering a right to payment, the claim may be filed with an
arbitrator of the Participant's choice by submitting the claim in writing and
providing a copy to the Company. The arbitrator must be:
(a) a member of the National Academy of Arbitrators or one who
currently appears on arbitration panels issued by the
Federal Mediation and Conciliation Service or the American
Arbitration Association; or
(b) a retired judge of the State in which the claimant is a
resident who served at the appellate level or higher. The
arbitration hearing shall be held within 72 hours (or as
soon thereafter as possible) after filing of the claim
unless the Participant and the Company agree to a later
date. No continuance of said hearing shall be allowed
without the mutual consent of the Participant and the
Company. Absence from or nonparticipation at the hearing by
either party shall not prevent the issuance of an award.
Hearing procedures which will expedite the hearing may be
ordered at the arbitrator's discretion, and the arbitrator
may close the hearing in his or her sole discretion upon
deciding he or she has heard sufficient evidence to satisfy
issuance of an award. In reaching a decision, the arbitrator
shall have no authority to ignore, change, modify, add to or
delete from any provision of this Plan, but instead is
limited to interpreting this Plan. The arbitrator's award
shall be rendered as expeditiously as possible, and unless
the arbitrator rules within seven days after the close of
the hearing, he will be deemed to have ruled in favor of the
Participant. If the arbitrator finds that any payment is
due to the Participant from the Company, the arbitrator
shall order the Company to pay that amount to the
Participant within 48 hours after the decision is rendered.
The award of the arbitrator shall be final and binding upon
the Participant and the Company. Judgment upon the award
rendered by the arbitrator may be entered in any court in
any State of the United States. In the case of any
arbitration regarding this Agreement, the Participant shall
be awarded the Participant's costs, including attorney's
fees. Such fee award may not be offset against the deferred
compensation due hereunder. The Company shall pay the
arbitrator's fee and all necessary expenses of the hearing,
including stenographic reporter if employed.
6.9 Termination and Amendment. The Committee may from time to time
amend, suspend or terminate the Plan, in whole or in part, and if the Plan is
suspended or terminated, the Committee may reinstate any or all of its
provisions. Except as otherwise required by law, the Committee may delegate to
the Administrator all or any of its foregoing powers to amend, suspend, or
terminate the Plan. Any such amendment, suspension, or termination may affect
future deferrals without the consent of any Participant or Beneficiary. However,
with respect to deferrals that have already occurred, no amendment, suspension
or termination may impair the right of a Participant or a designated Beneficiary
to receive payment of the related deferred compensation in accordance with the
terms of the Plan prior to the effective date of such amendment, suspension or
termination, unless the affected Participant or Beneficiary gives his express
written consent to the change.
6.10 Applicable Law. The Plan shall be construed and governed in
accordance with applicable federal law and, to the extent not preempted by such
federal law, the laws of the State of California.
EXHIBIT 12.1
<TABLE>
<CAPTION>
THE CHARLES SCHWAB CORPORATION
Computation of Ratio of Earnings to Fixed Charges
(Dollar amounts in thousands, unaudited)
Three Months Ended
March 31,
1999 1998
---- ----
<S> <C> <C>
Earnings before taxes on income $ 236,092 $ 112,334
- ------------------------------------------------------------------------------------------------------------------
Fixed charges
Interest expense - customer 155,000 137,672
Interest expense - other 18,545 17,923
Interest portion of rental expense 9,255 7,399
- ------------------------------------------------------------------------------------------------------------------
Total fixed charges (A) 182,800 162,994
- ------------------------------------------------------------------------------------------------------------------
Earnings before taxes on income and fixed charges (B) $ 418,892 $ 275,328
==================================================================================================================
Ratio of earnings to fixed charges (B) divided by (A)* 2.3 1.7
==================================================================================================================
Ratio of earnings to fixed charges excluding customer interest expense** 9.5 5.4
==================================================================================================================
* 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.
</TABLE>
<TABLE> <S> <C>
<ARTICLE> BD
<LEGEND>
This schedule contains summary financial information extracted from the
Condensed Consolidated Statement of Income and Condensed Consolidated Balance
Sheet of the Company's Quarterly Report on Form 10-Q for the quarterly period
ended March 31, 1999, and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 3-mos
<FISCAL-YEAR-END> Dec-31-1999
<PERIOD-END> Mar-31-1999
<CASH> 3,190,997
<RECEIVABLES> 12,311,085
<SECURITIES-RESALE> 6,922,726
<SECURITIES-BORROWED> 0
<INSTRUMENTS-OWNED> 316,656
<PP&E> 418,890
<TOTAL-ASSETS> 23,439,279
<SHORT-TERM> 261,732
<PAYABLES> 20,501,526
<REPOS-SOLD> 0
<SECURITIES-LOANED> 0
<INSTRUMENTS-SOLD> 0
<LONG-TERM> 351,080
0
0
<COMMON> 4,075
<OTHER-SE> 1,714,857
<TOTAL-LIABILITY-AND-EQUITY> 23,439,279
<TRADING-REVENUE> 131,311
<INTEREST-DIVIDENDS> 323,396
<COMMISSIONS> 472,652
<INVESTMENT-BANKING-REVENUES> 0
<FEE-REVENUE> 169,295
<INTEREST-EXPENSE> 173,545
<COMPENSATION> 390,214
<INCOME-PRETAX> 236,092
<INCOME-PRE-EXTRAORDINARY> 142,867
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 142,867
<EPS-PRIMARY> .36<F1>
<EPS-DILUTED> .34<F1>
<FN>
<F1> The information has been prepared in accordance with SFAS No. 128.
Basic and diluted EPS have been entered in place of primary and fully
diluted, respectively. Excludes the effects of the two-for-one common stock
split declared April 22, 1999, payable July 1, 1999, and contingent upon
shareholder approval of a proposed amendment to the Company's Certificate
of Incorporation to increase the number of authorized shares of the
Company's common stock. Voting on this proposed amendment will occur at the
May 17, 1999 Annual Meeting of Stockholders.
</FN>
</TABLE>
