UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2000 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.
1,380,621,962* shares of $.01 par value Common Stock
Outstanding on July 31, 2000
* Reflects the three-for-two common stock split declared May 3, 2000 and
distributed May 30, 2000.
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THE CHARLES SCHWAB CORPORATION
Quarterly Report on Form 10-Q
For the Quarter Ended June 30, 2000
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 4-8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9-21
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 21-22
Part II - Other Information
Item 1. Legal Proceedings 23
Item 2. Changes in Securities and Use of Proceeds 23
Item 3. Defaults Upon Senior Securities 23
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 24
Item 6. Exhibits and Reports on Form 8-K 24-25
Signature 26
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Forward-Looking Statements - This Quarterly Report on Form 10-Q contains
"forward-looking statements" within the meaning of Section 27A of the Securities
Act, and Section 21E of the Securities Exchange Act of 1934. Forward-looking
statements are identified by words such as "believe," "anticipate," "expect,"
"intend," "plan," "will," "may" and other similar expressions. In addition, any
statements that refer to expectations, projections or other characterizations of
future events or circumstances are forward-looking statements. These
forward-looking statements, which reflect management's beliefs, objectives and
expectations as of the date hereof, are necessarily estimates based on the best
judgment of the Company's senior management. These statements relate to, among
other things, the Company's status under the Bank Holding Company Act,
contingent liabilities, the ability to successfully pursue the Company's
strategy to attract and retain client assets, the ability of the Company to
realize the expected benefits of a merger, the potential for disruption to U.S.
Trust's ability to service its clients and the impact on the Company's results
of operations for replicating the operational support services of a third-party
provider, the decline in average revenue per share traded, sources of liquidity
and capital expenditures. Achievement of the expressed beliefs, objectives and
expectations is subject to certain risks and uncertainties that could cause
actual results to differ materially from those beliefs, objectives and
expectations. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date of this Quarterly
Report on Form 10-Q. See "Forward-Looking Statements" in Management's Discussion
and Analysis of Financial Condition and Results of Operations in this interim
report and in the Company's Current Report on Form 8-K as filed with the
Securities and Exchange Commission on July 18, 2000 for a discussion of
important factors that may cause such differences.
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Part I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
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THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
2000 1999 2000 1999
----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Revenues
Commissions $ 541,203 $ 467,068 $1,329,604 $ 942,507
Asset management and administration fees 389,798 295,396 761,623 575,516
Interest revenue, net of interest expense (1) 319,092 196,799 615,548 375,570
Principal transactions 127,709 136,837 372,989 268,148
Other 26,726 20,106 50,392 34,940
----------------------------------------------------------------------------------------------------------------------
Total 1,404,528 1,116,206 3,130,156 2,196,681
----------------------------------------------------------------------------------------------------------------------
Expenses Excluding Interest
Compensation and benefits 593,048 468,812 1,255,317 922,683
Other compensation - merger retention programs 6,601 6,601
Occupancy and equipment 99,356 71,016 188,757 140,310
Communications 86,851 72,364 177,175 141,987
Advertising and market development 77,104 56,042 180,808 110,234
Professional services 71,241 43,782 135,370 83,525
Depreciation and amortization 62,559 42,240 117,519 79,913
Commissions, clearance and floor brokerage 34,591 25,512 77,362 51,071
Merger-related (2) 49,924 68,658
Goodwill amortization 13,519 1,749 18,515 3,272
Other 56,197 52,810 138,982 115,392
----------------------------------------------------------------------------------------------------------------------
Total 1,150,991 834,327 2,365,064 1,648,387
----------------------------------------------------------------------------------------------------------------------
Income before taxes on income 253,537 281,879 765,092 548,294
Taxes on income 116,357 111,346 327,954 216,548
----------------------------------------------------------------------------------------------------------------------
Net Income $ 137,180 $ 170,533 $ 437,138 $ 331,746
======================================================================================================================
Weighted-Average Common Shares Outstanding - Diluted (3) 1,407,366 1,376,992 1,398,149 1,371,321
======================================================================================================================
Earnings Per Share (3)
Basic $ .10 $ .13 $ .33 $ .25
Diluted $ .09 $ .12 $ .31 $ .24
======================================================================================================================
Dividends Declared Per Common Share (3, 4) $ .0094 $ .0093 $ .0187 $ .0186
======================================================================================================================
All periods have been restated to reflect the merger of The Charles Schwab Corporation (CSC) with U.S. Trust Corporation (USTC).
(1) Interest revenue is presented net of interest expense. Interest expense for the three months ended June 30, 2000 and 1999
was $332,188 and $206,230, respectively. Interest expense for the six months ended June 30, 2000 and 1999 was $636,575
and $409,348, respectively.
(2) Merger-related costs include professional fees, compensation expense and other expenses relating to the merger of
CSC with USTC.
(3) All periods have been restated for the May 2000 three-for-two common stock split.
(4) Dividends declared per common share represent dividends declared by CSC prior to its merger with USTC.
See Notes to Condensed Consolidated Financial Statements.
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THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(In thousands, except per share amounts)
(Unaudited)
June 30, December 31,
2000 1999
------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Cash and cash equivalents $ 2,659,946 $ 2,612,451
Cash and investments required to be segregated under federal or other
regulations (including resale agreements of $3,895,088 in 2000
and $6,165,043 in 1999) 4,764,241 8,826,121
Securities owned - at market value 1,552,209 1,333,220
Receivable from brokers, dealers and clearing organizations 457,254 482,657
Receivable from brokerage clients - net 20,281,703 17,060,222
Loans to banking clients - net 2,952,474 2,689,205
Equipment, office facilities and property - net 839,150 678,208
Goodwill - net 515,933 53,723
Other assets 903,468 586,305
------------------------------------------------------------------------------------------------------------------
Total $34,926,378 $34,322,112
==================================================================================================================
Liabilities and Stockholders' Equity
Deposits from banking clients $ 3,962,319 $ 4,204,943
Drafts payable 438,265 467,758
Payable to brokers, dealers and clearing organizations 1,466,181 1,748,765
Payable to brokerage clients 22,807,838 23,422,592
Accrued expenses and other liabilities 1,354,859 1,243,121
Short-term borrowings 269,088 141,157
Long-term debt 829,120 518,000
------------------------------------------------------------------------------------------------------------------
Total liabilities 31,127,670 31,746,336
------------------------------------------------------------------------------------------------------------------
Stockholders' equity:
Preferred stock - 9,940 shares authorized; $.01 par value
per share; none issued
Common stock - 2,000,000 shares authorized; $.01 par value per share;
1,378,336 issued and outstanding in 2000 and 1,336,636 shares issued
in 1999* 13,786 13,366
Additional paid-in capital 1,422,539 595,282
Retained earnings 2,462,360 2,144,683
Treasury stock - 7,336 shares in 1999, at cost* (96,742)
Employee stock ownership plans (489) (967)
Unamortized restricted stock compensation (81,605) (70,926)
Accumulated other comprehensive loss (17,883) (8,920)
-----------------------------------------------------------------------------------------------------------------
Total stockholders' equity 3,798,708 2,575,776
------------------------------------------------------------------------------------------------------------------
Total $34,926,378 $34,322,112
==================================================================================================================
All periods have been restated to reflect the merger of The Charles Schwab Corporation with U.S. Trust Corporation.
* All periods have been restated for the May 2000 three-for-two common stock split.
See Notes to Condensed Consolidated Financial Statements.
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THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
(Unaudited)
Six Months Ended June 30, 2000 1999
---------------------------------------------------------------------------------------------------------
<S> <C> <C>
Cash Flows from Operating Activities
Net income $ 437,138 $ 331,746
Noncash items included in net income:
Depreciation and amortization 117,519 79,913
Goodwill amortization 18,515 3,272
Net amortization of premium on securities available for sale 1,915 2,489
Compensation payable in common stock 47,267 37,664
Deferred income taxes 12,137 3,605
Other 8,367 10,681
Net change in:
Cash and investments required to be segregated under federal or
other regulations 4,024,176 2,663,824
Securities owned (excluding securities available for sale) (52,856) (78,158)
Receivable from brokers, dealers and clearing organizations 24,670 (37,153)
Receivable from brokerage clients (3,221,597) (3,661,270)
Other assets (128,935) (16,548)
Drafts payable (24,456) (152,950)
Payable to brokers, dealers and clearing organizations (271,838) (20,544)
Payable to brokerage clients (585,938) 854,715
Accrued expenses and other liabilities 149,041 229,156
---------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 555,125 250,442
---------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Purchases of securities available for sale (275,751) (282,985)
Proceeds from sales of securities available for sale 10,019
Proceeds from maturities, calls and mandatory redemptions of
securities available for sale 107,879 252,459
Net change in loans to banking clients (263,334) (285,926)
Purchase of equipment, office facilities and property - net (273,749) (133,476)
Cash payments for business combinations and investments, net of
cash received (42,718) (5,747)
---------------------------------------------------------------------------------------------------------
Net cash used by investing activities (747,673) (445,656)
---------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities
Net change in deposits from banking clients (242,624) 97,235
Net change in short-term borrowings 127,931 11,444
Proceeds from long-term debt 311,000 60,000
Repayment of long-term debt (4,773)
Dividends paid (32,005) (30,083)
Purchase of treasury stock (27,331)
Proceeds from stock options exercised and other 83,289 43,697
---------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 247,591 150,189
---------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents (7,548) (638)
---------------------------------------------------------------------------------------------------------
Increase (Decrease) in Cash and Cash Equivalents 47,495 (45,663)
Cash and Cash Equivalents at Beginning of Period 2,612,451 1,720,908
---------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 2,659,946 $ 1,675,245
=========================================================================================================
All periods have been restated to reflect the merger of The Charles Schwab Corporation with U.S. Trust Corporation.
See Notes to Condensed Consolidated Financial Statements.
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The Charles Schwab Corporation
Notes to Condensed Consolidated Financial Statements
(Tabular Amounts in Thousands, Except Per Share Amounts and Ratios)
(Unaudited)
1. Basis of Presentation
Merger with U.S. Trust Corporation
On May 31, 2000, The Charles Schwab Corporation (CSC) completed its merger
(the Merger) with U.S. Trust Corporation (USTC). Under the terms of the merger
agreement, USTC became a wholly owned subsidiary of CSC and USTC shareholders
received 5.1405 shares of CSC's common stock for each common share of USTC. The
Merger was treated as a non-taxable stock-for-stock exchange and USTC's
shareholders received approximately 112,000,000 shares of CSC's common stock.
Upon consummation of the Merger, CSC became a financial holding company and bank
holding company subject to supervision and regulation by the Board of Governors
of the Federal Reserve System (Federal Reserve Board) under the Bank Holding
Company Act of 1956, as amended. The condensed consolidated financial statements
included in this Quarterly Report on Form 10-Q give retroactive effect to the
Merger, which was accounted for as a pooling of interests. The pooling of
interests method of accounting requires the restatement of all periods presented
as if CSC and USTC had been operating as a combined entity during such periods.
Stockholders' equity and other per share information as of June 30, 2000 and
December 31, 1999 reflects the accounts of CSC and its subsidiaries
(collectively referred to as the Company) as if the common stock issued in the
Merger had been outstanding during all of the periods presented. Dividends
declared per common share represent dividends declared by CSC prior to the
Merger.
The separate results of operations for U.S. Trust Corporation and its
subsidiaries (collectively referred to as U.S. Trust) and the Company (excluding
U.S. Trust) during the periods preceding the Merger that are included in the
Company's condensed consolidated statement of income are as follows:
--------------------------------------------------------------------------------
Three Months Three Months Six Months
Ended Ended Ended
March 31, 2000 June 30, 1999 June 30, 1999
--------------------------------------------------------------------------------
Revenues:
Company (excluding U.S. Trust) $1,571,876 $ 982,102 $1,933,687
U.S. Trust 153,752 134,104 262,994
--------------------------------------------------------------------------------
Combined $1,725,628 $1,116,206 $2,196,681
================================================================================
Net Income:
Company (excluding U.S. Trust) $ 284,247 $ 150,991 $ 293,858
U.S. Trust 15,711 19,542 37,888
--------------------------------------------------------------------------------
Combined $ 299,958 $ 170,533 $ 331,746
================================================================================
Stock Split
On May 3, 2000, the Board of Directors approved a three-for-two split of
CSC's common stock, which was effected in the form of a 50% stock dividend. The
stock dividend was distributed May 30, 2000 to stockholders of record May 12,
2000. Share and per share information presented in the financial statements and
related notes has been restated to reflect the common stock split, including the
additional common shares issued to USTC shareholders pursuant to the exchange
ratio described above.
The Company
The accompanying unaudited condensed consolidated financial statements
include CSC and its subsidiaries. CSC is a financial holding company engaged,
through its subsidiaries, in securities brokerage and related financial
services. Charles Schwab & Co., Inc. (Schwab) is a securities broker-dealer with
363 domestic branch offices in 48 states, as well as branches in the
Commonwealth of Puerto Rico and the U.S. Virgin Islands. U.S. Trust is an
investment management firm that through its subsidiaries also provides fiduciary
services and private banking services with 31 offices in 11 states. Other
subsidiaries include Charles Schwab Europe (CSE), a retail securities brokerage
firm located in the United Kingdom, Charles Schwab Investment Management, Inc.,
the investment advisor for Schwab's proprietary mutual funds, Schwab Capital
Markets L.P. (SCM), a market maker in Nasdaq and other securities providing
trade execution services to broker-dealers and institutional clients, and
CyBerCorp, Inc., an electronic trading technology and brokerage firm providing
Internet-based services to highly active, online investors.
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 accounting principles generally accepted in the U.S. 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 and the condensed consolidated financial statements and notes
thereto which are filed as Exhibit 99.1 and Exhibit 99.2, respectively, to the
Company's Current Report on Form 8-K, as filed with the SEC on July 18, 2000.
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 2000 presentation.
2. New Accounting Standards
Statement of Financial Accounting Standards (SFAS) No. 137, which amended
the effective date of SFAS No. 133 - Accounting for Derivative Instruments and
Hedging Activities, was issued in June 1999. SFAS No. 138, which also amended
SFAS No. 133, was issued in June 2000. The Company is required to adopt SFAS No.
133 by January 1, 2001. This statement establishes accounting and reporting
standards requiring that all derivative instruments are recorded on the balance
sheet as either an asset or a liability, measured at its fair value. The
statement requires that changes in the derivative's fair value are 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.
In December 1999, the SEC issued Staff Accounting Bulletin 101 (SAB 101) -
Revenue Recognition in Financial Statements, as amended, which summarizes
certain of the SEC staff's views in applying generally accepted accounting
principles to revenue recognition in financial statements. This bulletin
specifies that revenue should not be recognized until it is realized or
realizable and earned. The Company is required to adopt SAB 101 in the fourth
quarter of 2000, and its adoption is not expected to have an impact on the
Company's financial position, results of operations, earnings per share or cash
flows.
3. Business Combination
At the consummation of the merger with USTC, the Company incurred
merger-related costs of $50 million pre-tax, or $44 million after-tax, for
change in control related compensation payable to U.S. Trust employees and
professional fees. During the first half of 2000, merger-related costs totaled
$69 million pre-tax, or $63 million after-tax. Merger-related costs are recorded
separately on the condensed consolidated statement of income. In addition, under
the terms of the merger agreement, the Company established a retention program
for all U.S. Trust employees, whereby the employees will receive cash
compensation, contingent upon continued employment, at the end of the two-year
period following the consummation of the Merger. The Company plans to recognize
the $125 million cost of the cash component of the U.S. Trust retention program
over this two-year period. Accordingly, the Company is recognizing $16 million
pre-tax, or $9 million after-tax, per quarter for this other compensation
expense - merger retention programs, which is recorded separately on the
condensed consolidated statement of income. In addition, under the terms of the
merger agreement, U.S. Trust employees received an aggregate of 2,718,000 stock
options, of which 50% vest at the end of the three-year period following the
consummation of the Merger and 50% vest at the end of the four-year period
following the consummation of the Merger.
4. Allowance for Credit Losses on Banking Loans and Nonperforming Assets
An analysis of allowance for credit losses is as follows:
--------------------------------------------------------------------------------
Three Six
Months Ended Months Ended
June 30, June 30,
2000 1999 2000 1999
--------------------------------------------------------------------------------
Balance at beginning of period $20,185 $19,329 $20,169 $19,414
Recoveries 15 382 31 547
Charge-offs (250)
--------------------------------------------------------------------------------
Net recoveries 15 382 31 297
--------------------------------------------------------------------------------
Balance at end of period $20,200 $19,711 $20,200 $19,711
================================================================================
Nonperforming assets, which consist of non-accrual, or impaired, loans are
as follows:
--------------------------------------------------------------------------------
Jun. 30, Mar. 31, Dec. 31, Sep. 30, Jun. 30,
2000 2000 1999 1999 1999
--------------------------------------------------------------------------------
Non-accrual loans $428 $428 $1,673 $435 $637
================================================================================
5. Comprehensive Income
Comprehensive income includes net income and changes in equity except those
resulting from investments by, or distributions to, stockholders. Comprehensive
income is as follows:
--------------------------------------------------------------------------------
Three Six
Months Ended Months Ended
June 30, June 30,
2000 1999 2000 1999
--------------------------------------------------------------------------------
Net income $137,180 $170,533 $437,138 $331,746
Foreign currency
translation adjustment (5,245) (1,105) (9,100) (2,352)
Change in net unrealized
gain (loss) on securities
available for sale, net of tax 1,184 (7,893) 137 (10,350)
--------------------------------------------------------------------------------
Total comprehensive
income, net of tax $133,119 $161,535 $428,175 $319,044
================================================================================
6. Earnings Per Share
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:
--------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
2000 1999 2000 1999
--------------------------------------------------------------------------------
Net income $ 137,180 $ 170,533 $ 437,138 $ 331,746
================================================================================
Weighted-average common shares
outstanding - basic 1,359,169 1,310,277 1,344,526 1,305,414
Common stock equivalent shares
related to stock incentive plans 48,197 66,715 53,623 65,907
--------------------------------------------------------------------------------
Weighted-average common shares
outstanding - diluted 1,407,366 1,376,992 1,398,149 1,371,321
================================================================================
Basic earnings per share $ .10 $ .13 $ .33 $ .25
================================================================================
Diluted earnings per share $ .09 $ .12 $ .31 $ .24
================================================================================
The computation of diluted EPS for the six months ended June 30, 2000 and
1999, respectively, excludes stock options to purchase 7,101,000 and 864,000
shares, respectively, because the exercise prices for those options were greater
than the average market price of the common shares, and therefore the effect
would be antidilutive.
7. Regulatory Requirements
Upon consummation of the merger with USTC, CSC became a financial holding
company and bank holding company subject to supervision and regulation by the
Federal Reserve Board under the Bank Holding Company Act of 1956, as amended
(the Act).
The Gramm-Leach-Bliley Act (the GLB Act), which became effective in March
2000, permits qualifying bank holding companies to become financial holding
companies and thereby affiliate with a far broader range of financial companies
than has previously been permitted for a bank holding company. The GLB Act
identifies several activities as financial in nature, including securities
brokerage, underwriting, dealing in or making a market in securities, investment
management services and insurance activities. The Federal Reserve Board may
prohibit a financial holding company from engaging in new activities or
acquiring additional companies if the Federal Reserve Board concludes that the
financial holding company's capital or managerial resources are not adequate.
Federal Reserve Board regulations under the Act may also limit CSC's business or
impose additional costs or requirements.
Federal Reserve Board policy provides that a bank holding company generally
should not pay cash dividends unless its net income is sufficient to fully fund
the dividends and the Company's prospective retained earnings appear to be
sufficient to meet the capital needs, asset quality and overall financial
condition of the holding company and its bank subsidiaries.
CSC's primary bank subsidiary is United States Trust Company of New York
(U.S. Trust NY). The operations and financial condition of CSC's bank
subsidiaries are subject to regulation and supervision and to various
requirements and restrictions under Federal and state law, including
requirements governing: transactions with CSC and its nonbank subsidiaries,
loans and other extensions of credit, investments or asset purchases, or
otherwise financing or supplying funds to CSC; dividends; investments; and
aspects of CSC's operations. The Federal banking agencies have broad powers to
enforce these regulations, including the power to terminate deposit insurance,
impose substantial fines and other civil and criminal penalties and appoint a
conservator or receiver. The Company, U.S. Trust and their U.S. insured
depository institution subsidiaries must meet regulatory capital guidelines
adopted by the federal banking agencies. The Federal Reserve Board has not
indicated whether the guidelines will be modified with respect to a bank holding
company, such as CSC, that also qualifies as a financial holding company. Under
the Federal Deposit Insurance Act, the banking regulatory agencies are permitted
or, in certain cases, required to take certain substantial restrictive actions
with respect to institutions falling within one of the lowest three of five
capital categories.
The Company's, U.S. Trust's and U.S. Trust NY's regulatory capital and
ratios are as follows:
--------------------------------------------------------------------------------
2000 1999
------------------ -----------------
June 30, Amount Ratio(1) Amount Ratio(1)
--------------------------------------------------------------------------------
Tier 1 Capital:
Company $ 3,250,688 12.5% $ 2,123,881 11.6%
U.S. Trust $ 399,700 15.2% $ 253,560 12.1%
U.S. Trust NY $ 249,220 11.4% $ 170,429 9.7%
Total Capital:
Company $ 3,284,833 12.7% $ 2,159,705 11.8%
U.S. Trust $ 419,900 15.9% $ 273,271 13.0%
U.S. Trust NY $ 267,020 12.2% $ 187,915 10.7%
Leverage:
Company $ 3,250,688 9.2% $ 2,123,881 7.7%
U.S. Trust $ 399,700 8.2% $ 253,560 6.3%
U.S. Trust NY $ 249,220 6.5% $ 170,429 5.4%
================================================================================
(1) Minimum tier 1 capital, total capital and tier 1 leverage ratios are 4%, 8%
and 3%-5%, respectively, for bank holding companies and banks. Each of the
other bank subsidiaries of CSC currently has tier 1 capital, total capital
and leverage capital ratios at least equal to those of U.S. Trust and U.S.
Trust NY.
Based on their respective regulatory capital ratios at June 30, 2000 and
1999, the Company, U.S. Trust and U.S. Trust NY are well capitalized (the
highest category). There are no conditions or events that management believes
have changed the Company's, U.S. Trust's and U.S. Trust NY's well-capitalized
status. The capital of the Company, U.S. Trust and U.S. Trust NY exceeded
minimum requirements at June 30, 2000.
To remain a financial holding company, each of CSC's bank subsidiaries must
be well capitalized, well managed and meet requirements relating to the
provision of public services to the communities in which CSC's bank subsidiaries
operate. If CSC ceases to qualify as a financial holding company it will be
subject to substantial additional restrictions on its activities.
Schwab and SCM are subject to the Uniform Net Capital Rule under the
Securities Exchange Act of 1934 (the Rule). Schwab and SCM 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 client 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 SCM is $1 million. Under the
alternative method, a broker-dealer may not repay subordinated borrowings, pay
cash dividends, or make any unsecured advances or loans to its parent or
employees if such payment would result in net capital of less than 5% of
aggregate debit balances or less than 120% of its minimum dollar amount
requirement. At June 30, 2000, Schwab's net capital was $2,188 million (11% of
aggregate debit balances), which was $1,778 million in excess of its minimum
required net capital and $1,163 million in excess of 5% of aggregate debit
balances. At June 30, 2000, SCM's net capital was $89 million, which was $88
million in excess of its minimum required net capital. Certain other
subsidiaries of CSC are subject to regulatory and other requirements of the
jurisdictions in which they operate. At June 30, 2000, these subsidiaries were
in compliance with their applicable requirements.
Schwab, SCM and CSE had portions of their cash and investments segregated
for the exclusive benefit of clients at June 30, 2000, in accordance with
applicable regulations.
8. Commitments and Contingent Liabilities
In June 2000, the Company entered into an operating lease to rent all of
the space in a San Francisco office building. The Company expects to begin
occupying this facility in the first quarter of 2001 and the lease payments,
totaling approximately $17 million annually, are expected to begin in the first
quarter of 2001. If the lease is not renewed at the end of the term, the Company
must either purchase the building for the outstanding amount of the lessor's
investment or sell the building on behalf of the lessor, in which case the
Company has provided the lessor with a residual value guarantee of
approximately $200 million.
For discussion of legal proceedings, see Part II - Other Information, Item
1 - Legal Proceedings.
9. Segment Information
The Company structures its segments according to its various types of
clients and the services provided to those clients. These segments have been
aggregated, based on similarities in economic characteristics, types of clients,
services provided, distribution channels and regulatory environment, into four
reportable segments - Individual Investor, Institutional Investor, Capital
Markets and U.S. Trust.
Financial information for the Company's reportable segments is presented in
the table below. Intersegment revenues are immaterial and are therefore not
disclosed. Total revenues and income before taxes on income are equal to the
Company's consolidated amounts as reported in the condensed consolidated
statement of income.
--------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
2000 1999 2000 1999
--------------------------------------------------------------------------------
Revenues
Individual Investor $ 897,890 $ 678,919 $1,985,129 $1,336,546
Institutional Investor 206,047 151,400 432,341 300,066
Capital Markets 139,039 151,783 397,382 297,075
U.S. Trust 161,552 134,104 315,304 262,994
--------------------------------------------------------------------------------
Total $1,404,528 $1,116,206 $3,130,156 $2,196,681
================================================================================
Income Before Taxes on Income
Individual Investor $ 191,793 $ 177,832 $ 524,097 $ 343,375
Institutional Investor 70,125 39,571 156,878 80,323
Capital Markets (5,144) 32,177 55,460 61,973
U.S. Trust (1) (3,237) 32,299 28,657 62,623
--------------------------------------------------------------------------------
Total $ 253,537 $ 281,879 $ 765,092 $ 548,294
================================================================================
(1) Includes merger-related costs recorded by U.S. Trust of $38 million pre-tax
in the second quarter of 2000 and $48 million pre-tax in the first half of
2000 related to professional fees and change of control related
compensation. Excluding these merger-related costs, income before taxes on
income for this segment would have been $35 million in the second quarter
of 2000 and $77 million in the first half of 2000.
10. Supplemental Cash Flow Information
Certain information affecting the cash flows of the Company follows:
--------------------------------------------------------------------------------
Six Months Ended
June 30,
2000 1999
--------------------------------------------------------------------------------
Income taxes paid $244,897 $ 56,716
================================================================================
Interest paid:
Brokerage clients cash balances $503,591 $316,722
Deposits from banking clients 72,885 54,334
Stock-lending activities 24,884 15,733
Long-term debt 18,098 14,337
Short-term borrowings 9,326 4,589
Other 1,602 2,005
--------------------------------------------------------------------------------
Total interest paid $630,386 $407,720
================================================================================
Non-cash investing and financing activities:
Common stock and options issued for
purchases of businesses $508,815 $ 7,558
================================================================================
11. Subsequent Event
On July 19, 2000, the Board of Directors increased the quarterly cash
dividend from $.0093 per share to $.0110 per share, payable August 24, 2000 to
stockholders of record August 10, 2000.
<PAGE>
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Description of Business
Merger with U.S. Trust Corporation: On May 31, 2000, The Charles Schwab
Corporation (CSC) completed its merger (the Merger) with U.S. Trust Corporation
(USTC). Under the terms of the merger agreement, USTC became a wholly owned
subsidiary of CSC and USTC shareholders received 5.1405 shares of CSC's common
stock for each common share of USTC. The Merger was treated as a non-taxable
stock-for-stock exchange and USTC's shareholders received approximately
112,000,000 shares of CSC's common stock. Upon consummation of the Merger, CSC
became a financial holding company and bank holding company subject to
supervision and regulation by the Board of Governors of the Federal Reserve
System (Federal Reserve Board) under the Bank Holding Company Act of 1956, as
amended (the Act). The condensed consolidated financial statements and financial
information in this Quarterly Report on Form 10-Q give retroactive effect to the
Merger, which was accounted for as a pooling of interests. The pooling of
interests method of accounting requires the restatement of all periods presented
as if CSC and USTC had been operating as a combined entity during such periods.
Certain reclassifications have been made to prior year amounts to conform
to the current presentation. All material intercompany balances and transactions
have been eliminated.
Stock Split: On May 3, 2000, the Board of Directors approved a
three-for-two split of CSC's common stock, which was effected in the form of a
50% stock dividend. The stock dividend was distributed May 30, 2000 to
stockholders of record May 12, 2000. Share and per share information presented
throughout this report has been restated to reflect the common stock split,
including the common shares issued to USTC shareholders pursuant to the exchange
ratio described above.
The Company: CSC and its subsidiaries (collectively referred to as the
Company) provide securities brokerage and related financial services for 7.2
million active client accounts(a). Client assets in these accounts totaled
$931.2 billion at June 30, 2000. Charles Schwab & Co., Inc. (Schwab), is a
securities broker-dealer with 363 domestic branch offices in 48 states, as well
as branches in the Commonwealth of Puerto Rico and the U.S. Virgin Islands. U.S.
Trust Corporation and its subsidiaries (U.S. Trust) is an investment management
firm that through its subsidiaries also provides fiduciary services and private
banking services with 31 offices in 11 states. Other subsidiaries include
Charles Schwab Europe (CSE), a retail securities brokerage firm located in the
United Kingdom, Charles Schwab Investment Management, Inc., the investment
advisor for Schwab's proprietary mutual funds, Schwab Capital Markets L.P.
(SCM), a market maker in Nasdaq and other securities providing trade execution
services to broker-dealers and institutional clients, and CyBerCorp, Inc.
(CyBerCorp), an electronic trading technology and brokerage firm providing
Internet-based services to highly active, online investors.
----------------------------
(a) Accounts with balances or activity within the preceding eight months.
The Company provides financial services to individuals, institutional
clients and broker-dealers through four segments - Individual Investor,
Institutional Investor, Capital Markets and U.S. Trust. 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 clients. The U.S. Trust segment provides
investment management, fiduciary services and private banking services to
individual and institutional clients.
The Company's strategy is to attract and retain client 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, equity securities market-making, investment
management, fiduciary services and private banking services.
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 nationally recognized brands, a broad range of products and
services, multi-channel delivery systems and an ongoing investment in
technology. While the Company's business continues to be predominantly conducted
in the U.S., the Company continues to selectively expand its international
presence.
Brands: The Company's nationwide advertising and marketing programs support
its strategy by continually reinforcing the strengths and key attributes of
Schwab's full-service offering and U.S. Trust's wealth management services. By
maintaining a consistent level of visibility in the market place, the Company
seeks to establish Schwab and U.S. Trust as leading and lasting financial
service brands in a focused and cost-effective manner. The Company primarily
uses a combination of network, cable and local television, print media, and
athletic event sponsorship in its advertising to investors.
Products and Services: The Company offers a broad range of value-oriented
products and services to meet clients' varying investment and financial needs,
including help and advice and access to extensive investment research, news and
information. The Company's approach to advice is based on long-term investment
strategies and guidance on portfolio diversification and asset allocation. The
Company strives to demystify investing by educating and assisting clients in the
development of investment plans. This approach is designed to be offered
consistently across all of Schwab's delivery channels and provides clients with
a wide selection of choices for their investment needs. Schwab's registered
representatives can assist investors in developing asset allocation strategies
and evaluating their investment choices, and refer investors who desire
additional guidance to independent investment managers through the Schwab
AdvisorSource(TM) service. Beginning in June 2000, Schwab clients and potential
clients in need of personalized wealth-management services are able to receive
referrals to U.S. Trust's investment management, trust and private banking
capabilities as part of the AdvisorSource referral services program. Schwab's
Mutual Fund Marketplace(R) provides clients with the ability to invest in 2,009
mutual funds from 332 fund families, including 1,189 Mutual Fund OneSource(R)
funds. Schwab also provides custodial, trading and support services to
independent investment managers. As of June 30, 2000, these managers were
guiding the investments of 943,000 Schwab client accounts containing $237.2
billion in assets.
The Company responds to changing client needs with continued product,
technology and service innovations. Beginning in June 2000, U.S. Trust clients
who want to utilize Schwab's products and services are eligible for access to a
special version of the Schwab Signature Services(TM) offering. Additionally,
during the second quarter of 2000 Schwab invested in and formed an alliance with
E-LOAN, Inc., whereby Schwab clients have online access to E-LOAN's broad choice
of mortgage products from more than 70 lenders, as well as online rate search
and loan comparison, selection, application and tracking services, all supported
by client service representatives. Schwab also formed alliances in the second
quarter of 2000 with eSpeed, Inc. and Valubond to enhance Schwab's individual
and independent investment manager clients' ability to analyze and trade
fixed-income securities through the Schwab Web site. Further, during the second
quarter of 2000 Schwab improved the Velocity(TM) desktop trading software for
certain clients who trade frequently by adding real-time streaming quotes,
representing the first time that technology from CyBerCorp has been applied to
client needs in other parts of the Company. Schwab is also utilizing the
services of another subsidiary of CSC, Quris, Inc. , which is helping to support
client communications and marketing through e-mail, instant messaging, wireless
devices and other evolving Internet appliances. Additionally, during the second
quarter of 2000 Schwab created the Corporate and Executive Services Group to
provide a coordinated suite of services to companies and their employees needing
help in administering their equity-related benefit plans.
U.S. Trust provides an array of financial services for affluent individuals
and their families. These services include investment management, investment
consulting, trust, financial and estate planning and private banking, including
mortgage, personal lending and deposit products. U.S. Trust also provides
investment management, corporate trust and special fiduciary services for
corporations, endowments, foundations, pension plans and other institutional
clients.
Delivery Systems: The Company's multi-channel delivery systems allow
clients to choose how they prefer to do business with the Company. To enable
clients to obtain services in person with a Company representative, the Company
maintains a network of offices. Schwab's branch offices also provide investors
with access to the Internet. Telephonic access to Schwab is provided primarily
through four regional client telephone service centers and two online client
support centers that operate both during and after normal market hours. During
the second quarter of 2000, the Company entered into an operating lease to rent
space in Austin, Texas for a fifth regional client telephone service center
which is scheduled to begin handling calls later in 2000. Additionally, clients
are able to obtain financial information on an automated basis through Schwab'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, the CyBerCorp Web site, an Internet
service for professional traders, and PC-based services such as SchwabLink(R), a
service for investment managers. While the online channel is the Company's
fastest-growing channel, the Company continues to stress the importance of
Clicks and Mortar(TM) access - blending the power of the Internet with personal
service to create a full-service client experience. Schwab provides every retail
client access to all delivery channels and flat-fee pricing for Internet trades.
Technology: 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 client service, reducing processing costs, and
facilitating the Company's ability to handle significant increases in client
activity without a corresponding rise in staffing levels. The Company uses
technology to empower its clients to manage their financial affairs and is a
leader in driving technological advancements in the financial services industry.
International Expansion: During the second quarter of 2000, Schwab launched
a Korean language Web site that provides information about the U.S. financial
markets and Schwab products and services. Also in the second quarter of 2000,
Charles Schwab Canada, Co., a subsidiary of CSC, introduced Web-based trading in
Chinese, and Charles Schwab Hong Kong Securities Ltd., another subsidiary of
CSC, began to offer trading in Hong Kong dollar-based securities in addition to
U.S. dollar-based securities.
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" which is filed as Exhibit 99.1 to the Company's
Current Report on Form 8-K as filed with the Securities and Exchange Commission
(SEC) on July 18, 2000. 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. In addition to these risks, USTC has an outsourcing agreement with a third
party that provides data processing, security processing, custodial and other
operational support services. Under the terms of the outsourcing agreement, the
third-party provider has the right to terminate the contract upon a change in
control. The Company plans to repatriate to the Company's systems substantially
all of the service functions provided by this third party, and the Company and
U.S. Trust expect to be able to provide for an orderly repatriation of such
functions. The transition is expected to be completed before the end of the
third quarter of 2001. While management believes that there will be a successful
transition, there is a possibility that the transition could result in a
significant disruption to U.S. Trust's ability to service its clients. Further,
while it is currently anticipated that the cost of replicating the services
provided by the third-party provider will be greater than the amount presently
being charged under the outsourcing agreement, management believes that such an
increase will not have a material impact on the Company's results of operations.
Given the nature of the Company's revenues, expenses and risk profile, the
Company's earnings and CSC's 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
This Quarterly Report on Form 10-Q contains "forward-looking statements"
within the meaning of Section 27A of the Securities Act, and Section 21E of the
Securities Exchange Act of 1934. Forward-looking statements are identified by
words such as "believe," "anticipate," "expect," "intend," "plan," "will," "may"
and other similar expressions. In addition, any statements that refer to
expectations, projections or other characterizations of future events or
circumstances are forward-looking statements. These forward-looking statements,
which reflect management's beliefs, objectives and expectations as of the date
hereof, are necessarily estimates based on the best judgment of the Company's
senior management. These statements relate to, among other things, the Company's
status under the Bank Holding Company Act (see note "7 - Regulatory
Requirements" in the Notes to Condensed Consolidated Financial Statements),
contingent liabilities (see note "8 - Commitments and Contingent Liabilities" in
the Notes to Condensed Consolidated Financial Statements), the ability to
successfully pursue the Company's strategy to attract and retain client assets
(see Description of Business), the ability of the Company to realize the
expected benefits of a merger (see Description of Business: Merger with U.S.
Trust Corporation), the potential for a disruption to U.S. Trust's ability to
service its clients and the impact on the Company's results of operations for
replicating the operational support services of a third-party provider (see
Description of Business), sources of liquidity (see Liquidity and Capital
Resources - Liquidity), and capital expenditures (see Liquidity and Capital
Resources - Cash Flows and Capital Resources). Achievement of the expressed
expectations is subject to certain risks and uncertainties that could cause
actual results to differ materially from the expressed expectations described in
these statements. Important factors that may cause such differences are noted in
this interim report and the Company's Current Report on Form 8-K as filed with
the SEC on July 18, 2000, and include, but are not limited to: the effect of
client trading patterns on Company revenues and earnings; the inability to
assimilate acquired companies and to achieve the anticipated benefits; the
Company's inability to attract and retain key personnel; changes in the
Company's level of personnel hiring, investment in new or existing technology,
or utilization of public media for advertising; changes in technology; computer
system failures and security breaches; 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 inability to obtain external financing; changes in revenues
and profit margin due to cyclical securities markets and interest rates; the
level and volatility of equity prices; a significant downturn in the securities
markets over a short period of time or a sustained decline in securities prices
and trading volumes; a significant decline in the real estate market; and risks
associated with international expansion and operations.
Three Months Ended June 30, 2000 Compared To Three Months Ended June 30, 1999
Financial Overview
The Company's revenues increased in the second quarter of 2000 mainly due
to higher levels of average balances and rates earned on margin loans to
clients, an increase in client assets, and higher trading volumes. Revenues of
$1,405 million in the second quarter of 2000 grew $288 million, or 26%, from the
second quarter of 1999 due to increases in revenues of $219 million, or 32%, in
the Individual Investor segment, $55 million, or 36%, in the Institutional
Investor segment, and $27 million, or 20%, in the U.S. Trust segment, partially
offset by a decrease in revenues of $13 million, or 8%, in the Capital Markets
segment. See note "9 - Segment Information" in the Notes to Condensed
Consolidated Financial Statements for financial information by segment.
Total expenses excluding interest during the second quarter of 2000 were
$1,151 million, up 38% from $834 million for the second quarter of 1999. This
increase was primarily due to a 6,600, or 37%, increase in the Company's
full-time equivalent employees to 24,300 at June 30, 2000 and related costs,
professional fees and compensation related to the merger with USTC, and higher
consulting fees related to various information technology projects.
Net income for the second quarter of 2000 was $137 million, down 20% from
second quarter 1999 net income of $171 million. Income before taxes on income
for the second quarter of 2000 was $254 million, down $28 million, or 10%, from
the second quarter of 1999 due to decreases in income before taxes on income of
$37 million in the Capital Markets segment and $36 million in the U.S. Trust
segment, partially offset by increases of $14 million, or 8%, in the Individual
Investor segment and $31 million, or 77%, in the Institutional Investor segment.
The $37 million decrease in income before taxes on income in the Capital Markets
segment was primarily due to lower average revenue per share traded, partially
offset by greater share volume. The $36 million decrease in income before taxes
on income in the U.S. Trust segment was primarily due to $38 million of
merger-related costs recorded in the second quarter of 2000. Diluted earnings
per share for the second quarters of 2000 and 1999 were $.09 and $.12 per share,
respectively. All references to earnings per share information in this report
reflect diluted earnings per share unless otherwise noted.
The after-tax profit margin for the second quarter of 2000 was 9.8%, down
from 15.3% for the second quarter of 1999. The annualized return on
stockholders' equity for the second quarter of 2000 was 15%, down from 33% for
the second quarter of 1999 primarily due to the decline in net income related to
the charges recorded for the acquisition of CyBerCorp and the merger with USTC.
The Company's second quarter 2000 results include charges for goodwill and
intangible asset amortization relating to the acquisition of CyBerCorp and
professional fees and other expenses relating to the merger with USTC. These
charges totaled $62 million after-tax. Excluding these charges, the Company's
second quarter 2000 after-tax profit margin would have been 14.2% and earnings
would have been $199 million, up 17% from the second quarter of 1999.
The Company's client trading activity is shown in the following table (in
thousands):
--------------------------------------------------------------------------------
Three Months
Ended
June 30, Percent
Daily Average Trades 2000 1999 Change
--------------------------------------------------------------------------------
Revenue Trades
Online 199.0 114.7 73%
TeleBroker(R) and VoiceBroker(TM) 7.0 8.9 (21)
Regional client telephone service
centers, branch offices and other 28.7 36.5 (21)
--------------------------------------------------------------------------------
Total 234.7 160.1 47%
================================================================================
Mutual Fund OneSource(R) Trades
Online 33.2 22.0 51%
TeleBroker and VoiceBroker 1.0 1.0
Regional client telephone service
centers, branch offices and other 19.1 20.6 (7)
--------------------------------------------------------------------------------
Total 53.3 43.6 22%
================================================================================
Total Daily Average Trades
Online 232.2 136.7 70%
TeleBroker and VoiceBroker 8.0 9.9 (19)
Regional client telephone service
centers, branch offices and other 47.8 57.1 (16)
--------------------------------------------------------------------------------
Total 288.0 203.7 41%
================================================================================
Assets in client accounts were $931.2 billion at June 30, 2000, an increase
of $236.5 billion, or 34%, from a year ago as shown in the table below. This
increase from a year ago included net new client assets of $147.8 billion and
net market gains of $88.7 billion related to client accounts.
--------------------------------------------------------------------------------
Growth in Client Assets and Accounts
(In billions, at quarter end, June 30, Percent
except as noted) 2000 1999 Change
--------------------------------------------------------------------------------
Assets in Schwab client accounts
Schwab One(R) and other cash equivalents $ 22.3 $ 18.6 20%
SchwabFunds(R):
Money market funds 91.9 75.1 22
Equity and bond funds 24.0 18.8 28
--------------------------------------------------------------------------------
Total SchwabFunds 115.9 93.9 23
--------------------------------------------------------------------------------
Mutual Fund Marketplace(R)(1):
Mutual Fund OneSource
Retail 66.7 42.5 57
Schwab Institutional(TM) (2) 51.0 37.6 36
--------------------------------------------------------------------------------
Total Mutual Fund OneSource 117.7 80.1 47
All other 78.3 68.2 15
--------------------------------------------------------------------------------
Total Mutual Fund Marketplace 196.0 148.3 32
--------------------------------------------------------------------------------
Total mutual fund assets 311.9 242.2 29
--------------------------------------------------------------------------------
Equity and other securities (1) 426.8 303.5 41
Fixed income securities 57.3 40.6 41
Margin loans outstanding (20.2) (13.2) 53
--------------------------------------------------------------------------------
Total 798.1 591.7 35
Assets in U.S. Trust client accounts 133.1 103.0 29
--------------------------------------------------------------------------------
Total $931.2 $694.7 34%
================================================================================
Net growth in assets in client accounts (3)
(for the quarter ended)
Net new client assets $ 36.6 $ 21.6
Net market gains (losses) (57.6) 29.1
-----------------------------------------------------------------------
Net growth (decline) $(21.0) $ 50.7
=======================================================================
New client accounts
(in thousands, for the quarter ended) 400.1 424.2 (6%)
Active client accounts (in millions) 7.2 6.2 16%
================================================================================
Active online Schwab client
accounts (in millions) (4) 4.1 2.8 46%
Online Schwab client assets $413.5 $251.3 65%
================================================================================
(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) Net new client assets in 2000 include U.S. Trust. For 1999, U.S. Trust net
new client assets are included in net market gains.
(4) Active online accounts are defined as all accounts within a household that
has had at least one online session within the past twelve months.
REVENUES
Revenues grew $288 million, or 26%, in the second quarter of 2000 compared
to the second quarter of 1999, due to a $123 million, or 62%, increase in
interest revenue, net of interest expense (referred to as net interest revenue),
a $95 million, or 32%, increase in asset management and administration fees, and
a $74 million, or 16%, increase in commission revenues. As the Company's
non-trading revenues grew at a rate that exceeded the growth rate of total
revenues, non-trading revenues represented 52% of total revenues for the second
quarter of 2000, up from 46% for the second quarter of 1999 as shown in the
table below.
--------------------------------------------------------------------------------
Three Months
Ended June 30,
Composition of Revenues 2000 1999
--------------------------------------------------------------------------------
Commissions 39% 42%
Principal transactions 9 12
--------------------------------------------------------------------------------
Total trading revenues 48 54
--------------------------------------------------------------------------------
Asset management and administration fees 28 26
Net interest revenue 23 18
Other 1 2
--------------------------------------------------------------------------------
Total non-trading revenues 52 46
--------------------------------------------------------------------------------
Total 100% 100%
================================================================================
Commissions
The Company earns commission revenues by executing client trades primarily
through the Individual Investor and Institutional Investor segments. These
revenues are affected by the number of client accounts that trade, the average
number of commission-generating trades per account, and the average commission
per trade.
Commission revenues for the Company were $541 million for the second
quarter of 2000, up $74 million, or 16%, from the second quarter of 1999. As
shown in the table below, the total number of revenue trades executed by the
Company has increased 47% as the Company's client base, as well as client
trading activity per account, has grown. Average commission per revenue trade
decreased 21%. This decline was mainly due to an increase in the proportion of
trades placed through the Company's online channels, which have lower commission
rates than the Company's other channels, and reduced pricing for certain clients
who trade frequently.
--------------------------------------------------------------------------------
Three Months
Commissions Earned Ended
on Client Revenue June 30, Percent
Trades 2000 1999 Change
--------------------------------------------------------------------------------
Client accounts that traded during the
quarter (in thousands) 1,898 1,666 14%
Average client revenue trades per account 7.78 6.05 29
Total revenue trades (in thousands) 14,772 10,079 47
Average commission per revenue trade $ 36.65 $ 46.44 (21)
Commissions earned on client revenue
trades (in millions) (1) $ 541 $ 468 16
================================================================================
(1) Includes certain non-commission revenues relating to the execution of
client trades totaling $12 million in the second quarter of 2000 and $10
million in the second quarter of 1999. Excludes commissions on trades
relating to specialist operations totaling $8 million in the second quarter
of 2000 and $6 million in the second quarter of 1999. Excludes U.S. Trust
commissions on trades totaling $4 million in the second quarter of 2000 and
$3 million in the second quarter of 1999.
Asset Management and Administration Fees
Asset management and administration fees include mutual fund service fees,
as well as fees for other asset-based financial services provided to individual
and institutional clients. 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 client 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. The Company also earns asset management and administration fees for
financial services, including investment management and consulting, trust and
fiduciary services, financial and estate planning, and private banking services,
provided to individual and institutional clients. These fees are primarily based
on the value and composition of assets under management and are earned primarily
through the U.S. Trust segment, as well as the Individual Investor and
Institutional Investor segments.
Asset management and administration fees were $390 million for the second
quarter of 2000, up $95 million, or 32%, from the second quarter of 1999, as
shown in the following table (in millions):
--------------------------------------------------------------------------------
Three Months
Ended
Asset Management June 30, Percent
and Administration Fees 2000 1999 Change
--------------------------------------------------------------------------------
Mutual fund service fees:
SchwabFunds(R) $152 $121 26%
Mutual Fund OneSource(R) 81 55 47
Excelsior Funds(R) 12 9 33
Other 6 3 100
Asset management and related services 139 107 30
--------------------------------------------------------------------------------
Total $390 $295 32%
================================================================================
The increase in asset management and administration fees was primarily due
to an increase in client assets in Schwab's proprietary funds, collectively
referred to as the SchwabFunds, an increase in client assets in funds purchased
through Schwab's Mutual Fund OneSource service, and an increase in U.S. Trust's
client assets.
Net Interest Revenue
Net interest revenue is the difference between interest earned on assets
(mainly margin loans to clients, investments required to be segregated for
clients, securities available for sale, and private banking loans) and interest
paid on liabilities (mainly brokerage client cash balances and banking
deposits). 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 and
hedging strategies. Most of the Company's net interest revenue is earned by
Schwab through the Individual Investor and Institutional Investor segments, as
well as by U.S. Trust through the U.S. Trust segment.
Net interest revenue was $320 million for the second quarter of 2000, up
$123 million, or 62%, from the second quarter of 1999 as shown in the following
table (in millions):
--------------------------------------------------------------------------------
Three Months
Ended
June 30, Percent
2000 1999 Change
--------------------------------------------------------------------------------
Interest Revenue
Margin loans to clients $464 $235 97%
Investments, client-related 69 88 (22)
Private banking loans 54 41 32
Securities available for sale 18 15 20
Other 47 24 96
--------------------------------------------------------------------------------
Total 652 403 62
--------------------------------------------------------------------------------
Interest Expense
Brokerage client cash balances 263 161 63
Deposits from banking clients 38 27 41
Long-term debt 15 8 88
Stock-lending activities 11 7 57
Short-term borrowings 5 2 150
Other 1 (100)
--------------------------------------------------------------------------------
Total 332 206 61
--------------------------------------------------------------------------------
Net interest revenue $320 $197 62%
================================================================================
Client-related and other daily average balances, interest rates and average
net interest spread for the second quarters of 2000 and 1999 are summarized in
the following table (dollars in millions):
--------------------------------------------------------------------------------
Three Months Ended
June 30,
2000 1999
--------------------------------------------------------------------------------
Interest-Earning Assets (client-related and other):
Margin loans to clients:
Average balance outstanding $20,756 $13,174
Average interest rate 8.99% 7.16%
Investments (client-related):
Average balance outstanding $ 5,573 $ 7,866
Average interest rate 4.95% 4.51%
Private banking loans:
Average balance outstanding $ 2,832 $ 2,323
Average interest rate 7.61% 7.13%
Securities available for sale:
Average balance outstanding $ 1,164 $ 1,012
Average interest rate 6.14% 5.77%
Average yield on interest-earning assets 8.01% 6.24%
Funding Sources (client-related and other):
Interest-bearing brokerage client cash balances:
Average balance outstanding $20,724 $16,757
Average interest rate 5.10% 3.84%
Interest-bearing banking deposits:
Average balance outstanding $ 3,050 $ 2,668
Average interest rate 4.99% 4.05%
Other interest-bearing sources:
Average balance outstanding $ 1,841 $ 1,503
Average interest rate 4.80% 3.62%
Average noninterest-bearing portion $ 4,710 $ 3,447
Average interest rate on funding sources 4.28% 3.31%
Summary:
Average yield on interest-earning assets 8.01% 6.24%
Average interest rate on funding sources 4.28% 3.31%
--------------------------------------------------------------------------------
Average net interest spread 3.73% 2.93%
================================================================================
The increase in net interest revenue from the second quarter of 1999 was
primarily due to higher levels of margin loans to clients, partially offset by
higher average brokerage client cash balances.
Principal Transactions
Principal transaction revenues are primarily comprised of net gains from
market-making activities in Nasdaq and other securities transactions effected
through the Capital Markets segment. Factors that influence principal
transaction revenues include the volume of client trades, market price
volatility, average revenue per share traded and changes in regulations and
industry practices.
Principal transaction revenues were $128 million for the second quarter of
2000, down $9 million, or 7%, from the second quarter of 1999. This decrease was
primarily due to lower average revenue per share traded, partially offset by
greater share volume handled by SCM.
Expenses Excluding Interest
Compensation and benefits expense was $593 million for the second quarter
of 2000, up $124 million, or 27%, from the second quarter of 1999 primarily due
to a greater number of employees and higher incentive and variable compensation
expense resulting from the Company's financial performance. The following table
shows a comparison of certain compensation and benefits components and employee
data (in thousands):
--------------------------------------------------------------------------------
Three Months
Ended
June 30,
2000 1999
--------------------------------------------------------------------------------
Compensation and benefits expense as a % of total revenues 42% 42%
Incentive and variable compensation as a % of compensation
and benefits expense 26% 33%
Compensation for temporary employees, contractors and
overtime hours as a % of compensation and benefits
expense 11% 11%
Full-time equivalent employees(1) (at end of quarter) 24.3 17.7
Revenues per average full-time equivalent employee $59.6 $64.2
================================================================================
(1) Includes full-time, part-time and temporary employees, and persons employed
on a contract basis.
Occupancy and equipment expense was $99 million for the second quarter of
2000, up $28 million, or 40%, from the second quarter of 1999. This increase was
primarily due to facilities expansion to support the Company's growth in
employees and enhancements in systems capacity.
Professional services expense was $71 million for the second quarter of
2000, up $27 million, or 63%, from the second quarter of 1999. This increase was
primarily due to consulting fees related to various information technology
projects.
Merger-related expense was $50 million for the second quarter of 2000, up
$50 million from the second quarter of 1999. Merger-related expense consists of
professional fees and change in control related compensation from the merger
with USTC.
The Company's effective income tax rate was 45.9% for the second quarter of
2000, up from 39.5% for the second quarter of 1999. This change was primarily
due to charges, which are non-deductible for tax purposes, for certain
professional fees relating to the merger with USTC and goodwill amortization
relating to the acquisition of CyBerCorp.
Six Months Ended June 30, 2000 Compared To Six Months Ended June 30, 1999
Financial Overview
The Company's revenues increased in the first half of 2000 mainly due to
higher client trading volume, higher levels of average balances and rates earned
on margin loans to clients, and an increase in client assets. Revenues of $3,130
million in the first half of 2000 grew $933 million, or 42%, from the first half
of 1999 due to increases in revenues of $649 million, or 49%, in the Individual
Investor segment, $132 million, or 44%, in the Institutional Investor segment,
$100 million, or 34%, in the Capital Markets segment, and $52 million, or 20%,
in the U.S. Trust segment. See note "9 - Segment Information" in the Notes to
Condensed Consolidated Financial Statements for financial information by
segment.
Total expenses excluding interest during the first half of 2000 were $2,365
million, up 43% from $1,648 million for the first half of 1999, primarily
resulting from additional staff and related costs, higher advertising and market
development, professional fees and compensation related to the merger with USTC,
and higher consulting fees related to various information technology projects.
Net income for the first half of 2000 was $437 million, up 32% from the
first half of 1999 net income of $332 million. Diluted earnings per share for
the first halves of 2000 and 1999 were $.31 and $.24 per share, respectively.
The after-tax profit margin for the first half of 2000 was 14.0%, down from
15.1% for the first half of 1999. The annualized return on stockholders' equity
for the first half of 2000 was 27%, down from 35% for the first half of 1999.
The Company's results for the first half of 2000 include charges for
goodwill and intangible asset amortization relating to the acquisition of
CyBerCorp and professional fees and other expenses relating to the merger with
USTC. These charges totaled $85 million after-tax. Excluding these charges, the
Company's after-tax profit margin for the first half of 2000 would have been
16.7% and earnings would have been $522 million, up 57% from the first half of
1999.
The Company's trading activity is shown in the following table (in
thousands):
--------------------------------------------------------------------------------
Six Months
Ended
June 30, Percent
Daily Average Trades 2000 1999 Change
--------------------------------------------------------------------------------
Revenue Trades
Online 227.8 113.5 101%
TeleBroker(R) and VoiceBroker(TM) 9.3 9.5 (2)
Regional client telephone service centers, branch
offices and other 35.3 38.4 (8)
--------------------------------------------------------------------------------
Total 272.4 161.4 69%
================================================================================
Mutual Fund OneSource(R) Trades
Online 40.3 23.5 71%
TeleBroker and VoiceBroker 1.5 1.1 36
Regional client telephone service centers, branch
offices and other 23.1 22.1 5
--------------------------------------------------------------------------------
Total 64.9 46.7 39%
================================================================================
Total Daily Average Trades
Online 268.1 137.0 96%
TeleBroker and VoiceBroker 10.8 10.6 2
Regional client telephone service centers, branch
offices and other 58.4 60.5 (3)
--------------------------------------------------------------------------------
Total 337.3 208.1 62%
================================================================================
Assets in client accounts were $931.2 billion at June 30, 2000, an increase
of $236.5 billion, or 34%, from a year ago. During the first half of 2000, net
new client assets and new accounts increased from the first half of 1999 as
shown in the table below.
--------------------------------------------------------------------------------
Six Months
Ended
Growth in Client Assets and Accounts June 30, Percent
(In billions, except as noted) 2000 1999 Change
--------------------------------------------------------------------------------
Net growth in assets in client accounts(1)
Net new client assets $ 89.9 $ 49.0
Net market gains (losses) (4.7) 51.4
---------------------------------------------------------------------
Net growth $ 85.2 $100.4
=====================================================================
New client accounts (in thousands) 897.2 815.0 10%
================================================================================
(1) Net new client assets in 2000 include U.S. Trust. For 1999, U.S. Trust net
new client assets are included in net market gains.
REVENUES
Revenues grew $933 million, or 42%, in the first half of 2000, due to a
$387 million, or 41%, increase in commission revenues, a $240 million, or 64%,
increase in net interest revenue and a $186 million, or 32%, increase in asset
management and administration fees, as well as a $105 million, or 39%, increase
in principal transaction revenues. As the Company's non-trading revenues grew at
a rate that exceeded the growth rate of total revenues, non-trading revenues
represented 46% of total revenues for the first half of 2000, up from 45% for
the first half of 1999 as shown in the table below.
--------------------------------------------------------------------------------
Six Months
Ended
June 30,
Composition of Revenues 2000 1999
--------------------------------------------------------------------------------
Commissions 42% 43%
Principal transactions 12 12
--------------------------------------------------------------------------------
Total trading revenues 54 55
--------------------------------------------------------------------------------
Asset management and administration fees 24 26
Net interest revenue 20 17
Other 2 2
--------------------------------------------------------------------------------
Total non-trading revenues 46 45
--------------------------------------------------------------------------------
Total 100% 100%
================================================================================
Commissions
Commission revenues for the Company were $1,330 million for the first half
of 2000, up $387 million, or 41%, from the first half of 1999. As shown in the
table below, the total number of revenue trades executed by the Company has
increased 71% as the Company's client base, as well as client trading activity
per account, has grown. Average commission per revenue trade decreased 18%. This
decline was attributable to the factors described in the comparison between the
three-month periods.
--------------------------------------------------------------------------------
Six Months
ended
June 30, Percent
Commissions Earned on Client Revenue Trades 2000 1999 Change
--------------------------------------------------------------------------------
Client accounts that traded during the period
(in thousands) 3,016 2,375 27%
Average client revenue trades per account 11.38 8.43 35
Total revenue trades (in thousands) 34,315 20,020 71
Average commission per revenue trade $ 38.63 $ 47.07 (18)
Commissions earned on client revenue trades
(in millions) (1) $ 1,325 $ 942 41
================================================================================
(1) Includes certain non-commission revenues relating to the execution of
client trades totaling $26 million in the first half of 2000 and $19
million in the first half of 1999. Excludes commissions on trades relating
to specialist operations totaling $22 million in the first half of 2000 and
$14 million in the first half of 1999. Excludes U.S. Trust commissions on
trades totaling $9 million in the first half of 2000 and $6 million for the
first half of 1999.
Asset Management and Administration Fees
Asset management and administration fees were $762 million for the first
half of 2000, up $186 million, or 32%, from the first half of 1999. This
increase was attributable to the factors described in the comparison between the
three-month periods.
--------------------------------------------------------------------------------
Six Months
Ended
Asset Management June 30, Percent
and Administration Fees 2000 1999 Change
--------------------------------------------------------------------------------
Mutual fund service fees:
SchwabFunds(R) $300 $236 27%
Mutual Fund OneSource(R) 164 107 53
Excelsior Funds(R) 24 16 50
Other 12 7 71
Asset management and related services 262 210 25
--------------------------------------------------------------------------------
Total $762 $576 32%
================================================================================
Net Interest Revenue
Net interest revenue was $616 million for the first half of 2000, up $240
million, or 64%, from the first half of 1999 as shown in the following table (in
millions):
--------------------------------------------------------------------------------
Six Months
Ended
June 30, Percent
2000 1999 Change
--------------------------------------------------------------------------------
Interest Revenue
Margin loans to clients $ 865 $433 100%
Investments, client-related 169 199 (15)
Private banking loans 104 81 28
Securities available for sale 35 30 17
Other 79 42 88
--------------------------------------------------------------------------------
Total 1,252 785 60
--------------------------------------------------------------------------------
Interest Expense
Brokerage client cash balances 504 317 59
Deposits from banking clients 73 54 35
Long-term debt 25 15 67
Stock-lending activities 24 16 50
Short-term borrowings 7 4 75
Other 3 3
--------------------------------------------------------------------------------
Total 636 409 56
--------------------------------------------------------------------------------
Net interest revenue $ 616 $376 64%
================================================================================
Client-related and other daily average balances, interest rates and average
net interest spread for the first halves of 2000 and 1999 are summarized in the
following table (dollars in millions):
--------------------------------------------------------------------------------
Six Months Ended
June 30,
2000 1999
--------------------------------------------------------------------------------
Interest-Earning Assets (client-related and other):
Margin loans to clients:
Average balance outstanding $20,211 $12,134
Average interest rate 8.61% 7.20%
Investments (client-related):
Average balance outstanding $ 6,764 $ 8,775
Average interest rate 5.01% 4.58%
Private banking loans:
Average balance outstanding $ 2,763 $ 2,252
Average interest rate 7.54% 7.24%
Securities available for sale:
Average balance outstanding $ 1,155 $ 1,014
Average interest rate 6.03% 5.80%
Average yield on interest-earning assets 7.63% 6.20%
Funding Sources (client-related and other):
Interest-bearing brokerage client cash balances:
Average balance outstanding $20,841 $16,526
Average interest rate 4.87% 3.86%
Interest-bearing banking deposits:
Average balance outstanding $ 3,043 $ 2,661
Average interest rate 4.83% 4.07%
Other interest-bearing sources:
Average balance outstanding $ 2,104 $ 1,605
Average interest rate 4.40% 4.32%
Average noninterest-bearing portion $ 4,905 $ 3,383
Average interest rate on funding sources 4.06% 3.38%
Summary:
Average yield on interest-earning assets 7.63% 6.20%
Average interest rate on funding sources 4.06% 3.38%
--------------------------------------------------------------------------------
Average net interest spread 3.57% 2.82%
================================================================================
The increase in net interest revenue from the first half of 1999 was
primarily due to higher levels of margin loans to clients, partially offset by
higher average brokerage client cash balances.
Principal Transactions
Principal transaction revenues were $373 million for the first half of
2000, up $105 million, or 39%, from the first half of 1999. This increase was
primarily due to greater share volume handled by SCM, partially offset by lower
average revenue per share traded.
Expenses Excluding Interest
Compensation and benefits expense was $1,255 million for the first half of
2000, up $333 million, or 36%, from the first half of 1999 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):
--------------------------------------------------------------------------------
Six Months
Ended
June 30,
2000 1999
--------------------------------------------------------------------------------
Compensation and benefits expense as a % of revenues 40% 42%
Variable compensation as a % of compensation and
benefits expense 32% 33%
Compensation for temporary employees, contractors and
overtime hours as a % of compensation and benefits expense 10% 11%
Full-time equivalent employees(1) 24.3 17.7
Revenues per average full-time equivalent employee $139.3 $131.9
================================================================================
(1) Includes full-time, part-time and temporary employees, and persons employed
on a contract basis.
Occupancy and equipment expense was $189 million for the first half of
2000, up $48 million, or 35%, from the first half of 1999. This increase was
attributable to the factors described in the comparison between the three-month
periods.
Advertising and market development expense was $181 million for the first
half of 2000, up $71 million, or 64%, from the first half of 1999. This increase
was primarily a result of increased Schwab brand-focused television and print
media spending.
Professional services expense was $135 million for the first half of 2000,
up $52 million, or 62%, from the first half of 1999. This increase was
attributable to the factors described in the comparison between the three-month
periods.
Merger-related expense was $69 million for the first half of 2000, up $69
million from the first half of 1999. This increase was attributable to the
factors described in the comparison between the three-month periods.
The Company's effective income tax rate was 42.9% for the first half of
2000, up from 39.5% for the first half of 1999. This change was primarily due to
charges, which are non-deductible for tax purposes, for certain professional
fees relating to the merger with USTC and goodwill amortization relating to the
acquisition of CyBerCorp.
Liquidity and Capital Resources
Upon consummation of the merger with USTC, CSC became a financial holding
company and bank holding company subject to supervision and regulation by the
Federal Reserve Board under the Act. CSC conducts virtually all business through
its wholly owned subsidiaries. The capital structure among CSC and its
subsidiaries is designed to provide each entity with capital and liquidity
consistent with its operations. See note "7 - Regulatory Requirements" in the
Notes to Condensed Consolidated Financial Statements. A description of
significant aspects of this structure for CSC and four of its subsidiaries,
Schwab, U.S. Trust, SCM and CSE follows.
Liquidity
CSC
CSC's liquidity needs are generally met through cash generated by its
subsidiaries, as well as cash provided by external financing. As discussed
below, Schwab, SCM, CSE and CSC's bank subsidiaries 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,
maintaining CSC's bank subsidiaries' capital guidelines and maintaining Schwab's
and SCM's net capital. Based on their respective regulatory capital ratios at
June 30, 2000 and 1999, the Company and its bank subsidiaries are well
capitalized.
CSC has liquidity needs that arise from its issued and outstanding $766
million Senior Medium-Term Notes, Series A (Medium-Term Notes), as well as from
the funding of cash dividends, acquisitions and other investments. The
Medium-Term Notes have maturities ranging from 2000 to 2010 and fixed interest
rates ranging from 5.96% to 8.05% with interest payable semiannually. The
Medium-Term Notes are rated A3 by Moody's Investors Service and A by Standard &
Poor's Ratings Group. On May 19, 2000, the Securities and Exchange Commission
declared effective CSC's Registration Statement covering the issuance of $750
million in Senior or Senior Subordinated Medium-Term Notes, Series A. At June
30, 2000, all of these notes remained unissued.
CSC maintains a $1.2 billion committed, unsecured credit facility with a
group of banks which is scheduled to expire in June 2001. The funds under this
facility are available for general corporate purposes and CSC pays a commitment
fee on the unused balance of this facility. The financial covenants in this
facility require CSC to maintain minimum levels of stockholders' equity, and
Schwab and SCM to maintain specified levels of net capital, as defined. The
Company believes that these restrictions will not have a material effect on its
ability to meet foreseeable dividend or funding requirements. This facility was
unused during the first half of 2000.
CSC also has direct access to $605 million of the $765 million uncommitted,
unsecured bank credit lines, provided by nine banks, that are primarily utilized
by Schwab to manage short-term liquidity. The amount available to CSC under
these lines is lower than the amount available to Schwab because the credit line
provided by one of these banks is only available to Schwab, while the credit
line provided by another one of these banks includes a sub-limit on credit
available to CSC. These lines were not used by CSC during the first half of
2000.
Schwab
Liquidity needs relating to client trading and margin borrowing activities
are met primarily through cash balances in brokerage client accounts, which were
$22.3 billion and $23.0 billion at June 30, 2000 and December 31, 1999,
respectively. Management believes that brokerage client cash balances and
operating earnings will continue to be the primary sources of liquidity for
Schwab in the future.
Schwab is subject to regulatory requirements that are intended to ensure
the general financial soundness and liquidity of broker-dealers. These
regulations prohibit Schwab from repaying subordinated borrowings to CSC, paying
cash dividends, or making unsecured advances or loans to its parent or employees
if such payment would result in net capital of less than 5% of aggregate debit
balances or less than 120% of its minimum dollar amount requirement of $1
million. At June 30, 2000, Schwab's net capital was $2,188 million (11% of
aggregate debit balances), which was $1,778 million in excess of its minimum
required net capital and $1,163 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 client margin loans. To
achieve this target, as client margin loans have grown, an increasing amount of
cash flows have been retained to support aggregate debit balances.
To manage Schwab's regulatory capital position, CSC provides Schwab with a
$1,400 million subordinated revolving credit facility maturing in September
2001, of which $805 million was outstanding at June 30, 2000. At quarter end,
Schwab also had outstanding $25 million in fixed-rate subordinated term loans
from CSC maturing in 2002. 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 $765 million at June 30, 2000 ($605 million of these
lines are also available for CSC to use). The need for short-term borrowings
arises primarily from timing differences between cash flow requirements and the
scheduled liquidation of interest-bearing investments. Schwab used such
borrowings for 22 days during the first half of 2000, with the daily amounts
borrowed averaging $77 million. These lines were unused at June 30, 2000.
To satisfy the margin requirement of client option transactions with the
Options Clearing Corporation (OCC), Schwab had unsecured letter of credit
agreements with twelve banks in favor of the OCC aggregating $1,005 million at
June 30, 2000. Schwab pays a fee to maintain these letters of credit. No funds
were drawn under these letters of credit at June 30, 2000.
U.S. Trust
U.S. Trust's liquidity needs are generally met through earnings generated
by its operations.
U.S. Trust's liquidity is affected by the Federal Reserve Board's risk-
based and leverage capital guidelines. In addition, CSC's bank subsidiaries
are subject to limitations on the amount of dividends they can pay to U.S.
Trust without prior approval of the bank regulatory authorities.
U.S. Trust previously had credit facilities totaling $80 million which
were based on LIBOR or Prime and were expected to mature in March 2002. Upon
completion of the merger with USTC, these facilities were terminated.
In addition to traditional funding sources such as deposits, federal funds
purchased and repurchase agreements, CSC's bank subsidiaries have established
their own external funding sources. At June 30, 2000, U.S. Trust had $50 million
Trust Preferred Capital Securities outstanding with a fixed interest rate of
8.41%. Certain of CSC's bank subsidiaries have established credit facilities
with the Federal Home Loan Bank System (FHLB) totaling approximately $509
million. At June 30, 2000, $150 million in short-term borrowings and $13 million
in long-term debt were outstanding under these facilities.
SCM
SCM's liquidity needs are generally met through earnings generated by its
operations. Most of SCM's assets are liquid, consisting primarily of marketable
securities, cash and cash equivalents, and receivable from brokers, dealers and
clearing organizations.
SCM's liquidity is affected by the same net capital regulatory requirements
as Schwab (see discussion above). At June 30, 2000, SCM's net capital was $89
million, which was $88 million in excess of its minimum required net capital.
SCM may borrow up to $35 million under a subordinated lending arrangement
with CSC maturing in 2001. Borrowings under this arrangement qualify as
regulatory capital for SCM. At June 30, 2000, $35 million was outstanding under
this arrangement. In addition, CSC provides SCM with a $25 million short-term
credit facility. Borrowings under this arrangement do not qualify as regulatory
capital for SCM. This facility was unused during the first half of 2000.
CSE
CSE's liquidity needs are generally met through earnings generated by its
operations. Most of CSE's assets are liquid, consisting primarily of cash and
investments required to be segregated, receivable from brokers, dealers and
clearing organizations, and receivable from brokerage clients and others.
CSE may borrow up to (pound)70 million, equivalent to $106 million at June
30, 2000, under subordinated lending arrangements with CSC. At June 30, 2000,
CSE had outstanding (pound)18 million under these arrangements, equivalent to
$27 million, with (pound)5 million maturing in 2001 and (pound)13 million
maturing in 2003.
Cash Flows and Capital Resources
Net income plus depreciation and amortization, including goodwill
amortization, was $573 million for the first half of 2000, up 38% from $415
million for the first half of 1999, allowing the Company to finance its
operations primarily with internally generated funds. Depreciation and
amortization expense related to equipment, office facilities and property was
$110 million for the first half of 2000, as compared to $76 million for the
first half of 1999, or 4% and 3% of revenues for each period, respectively.
Amortization expense related to intangible assets was $8 million for the first
half of 2000, as compared to $4 million for the first half of 1999. Goodwill
amortization expense was $19 million for the first half of 2000, as compared to
$3 million for the first half of 1999. This increase was primarily due to
goodwill amortization related to the acquisition of CyBerCorp.
The Company's capital expenditures net of proceeds from the sale of fixed
assets were $274 million in the first half of 2000 and $133 million in the first
half of 1999, or 9% and 6% of revenues for each period, respectively. Capital
expenditures in the first half of 2000 were for equipment relating to the
Company's information technology systems, leasehold improvements and software.
Capital expenditures as described above include the capitalized costs for
developing internal-use software of $46 million in the first half of 2000 and
$27 million in the first half of 1999. Schwab opened 23 new domestic branch
offices during the first half of 2000, compared to 12 during the first half of
1999. Capital expenditures may vary from period to period as business conditions
change.
The Company issued $311 million of long-term debt during the first half of
2000.
During the first half of 2000, 13,693,400 of the Company's stock options,
with a weighted-average exercise price of $2.42, were exercised with cash
proceeds received by the Company of $33 million and a related tax benefit of
$109 million. (These stock options were granted prior to the merger with USTC,
and therefore did not include U.S. Trust employees). During the first five
months of 2000, 4,800,200 of U.S. Trust's stock options, with a weighted-average
exercise price of $7.06, were exercised with cash proceeds received by the
Company of $34 million and a related tax benefit of $13 million. The cash
proceeds are recorded as an increase in cash and a corresponding increase in
stockholders' equity. The tax benefit is recorded as a reduction in income taxes
payable and a corresponding increase in stockholders' equity.
During the first half of 2000, the Company did not repurchase any common
stock. During the first half of 1999, the Company repurchased 1,675,200 shares
of its common stock for $27 million. There is no current authorization for share
repurchases.
During the first halves of 2000 and 1999, the Company paid common stock
cash dividends of $32 million and $30 million, respectively.
The Company monitors both the relative composition and absolute level of
its capital structure. The Company's total financial capital (long-term debt
plus stockholders' equity) at June 30, 2000 was $4,628 million, up $1,534
million, or 50% from December 31, 1999. At June 30, 2000, the Company had
long-term debt of $829 million, or 18% of total financial capital, that bear
interest at a weighted-average rate of 7.26%. At June 30, 2000, the Company's
stockholders' equity was $3,799 million, or 82% of total financial capital.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Financial Instruments Held For Trading Purposes
The Company held municipal, other fixed income and government securities
and certificates of deposit with a fair value of approximately $27 million and
$19 million at June 30, 2000 and 1999, 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 SCM, the Company maintains inventories in
exchange-listed, Nasdaq and other equity securities on both a long and short
basis. The fair value of these securities at June 30, 2000 was $123 million in
long positions and $112 million in short positions. The fair value of these
securities at June 30, 1999 was $71 million in long positions and $47 million in
short positions. Using a hypothetical 10% increase or decrease in prices, the
potential loss or gain in fair value is estimated to be approximately $1,100,000
and $2,400,000 at June 30, 2000 and 1999, 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
June 30, 2000 and 1999 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 June 30, 2000 and 1999.
Financial Instruments Held For Purposes Other Than Trading
The Company maintains investments primarily in mutual funds to fund
obligations under its deferred compensation plan, which is available to certain
employees. These investments were approximately $63 million and $56 million at
June 30, 2000 and 1999, respectively. 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.
Debt Issuances
At June 30, 2000, CSC had $766 million aggregate principal amount of
Medium-Term Notes, with fixed interest rates ranging from 5.96% to 8.05%. At
June 30, 1999, CSC had $411 million aggregate principal amount of Medium-Term
Notes, with fixed interest rates ranging from 5.78% to 7.72%. At June 30, 2000
and 1999, U.S. Trust had $50 million Trust Preferred Capital Securities
outstanding, with a fixed interest rate of 8.41%. In addition at June 30, 2000
and 1999, U.S. Trust had $13 million FHLB long-term debt outstanding. The FHLB
long-term debt had fixed interest rates ranging from 6.59% to 6.76% at both
June 30, 2000 and 1999.
The Company has fixed cash flow requirements regarding these long-term debt
obligations due to the fixed rate of interest. The fair value of these
obligations at June 30, 2000 and 1999, based on estimates of market rates for
debt with similar terms and remaining maturities, approximated their carrying
amount.
Net Interest Revenue Simulation
The Company uses net interest revenue simulation modeling techniques to
evaluate and manage the effect of changing interest rates. The simulation model
(the model) includes all interest-sensitive assets and liabilities and Swaps
utilized by U.S. Trust to hedge its interest rate risk. Key variables in the
model include assumed margin loan and brokerage client cash balance growth,
changes to the level and term structure of interest rates, the repricing of
financial instruments, prepayment and reinvestment assumptions, loan, banking
deposit, and brokerage client cash balance pricing and volume assumptions. The
simulations involve assumptions that are inherently uncertain and as a result,
the simulations cannot precisely estimate net interest revenue or precisely
predict the impact of changes in interest rates on net interest revenue. Actual
results may differ from simulated results due to the timing, magnitude and
frequency of interest rate changes as well as changes in market conditions and
management strategies, including changes in asset and liability mix.
The simulations in the table below assume that the asset and liability
structure of the consolidated balance sheet would not be changed as a result of
the simulated changes in interest rates. As the Company actively manages its
consolidated balance sheet and interest rate exposure, in all likelihood the
Company would take steps to manage any additional interest rate exposure that
could result from changes in the interest rate environment. During the second
quarter of 2000, the Company revised the interest rate scenarios for the model
to more closely reflect the risks inherent in the balance sheet resulting from
the merger with USTC. The interest rate scenarios were changed from an immediate
100 basis point change to a gradual 200 basis point change in equal monthly
increments over twelve months. The following table shows the results of a
gradual 200 basis point increase or decrease in interest rates and the effect on
simulated net interest revenue over the next twelve months at June 30, 2000 and
1999 (dollars in millions). The change in simulated net interest revenue
sensitivity from 1999 to 2000 was primarily due to increases in the overall size
of the balance sheet, driven by the growth in brokerage client cash balances.
--------------------------------------------------------------------------------
Impact on Net Interest Revenue
Increase (Decrease)
2000 1999
------------- --------------
June 30, Amount % Amount %
--------------------------------------------------------------------------------
Increase of 200 basis points $123 8.7% $68 8.0%
Decrease of 200 basis points ($123) (8.7%) ($70) (8.2%)
================================================================================
As demonstrated by the simulations presented, the Company manages the
consolidated balance sheet to produce increases in net interest revenue when
interest rates rise. This position partially offsets the potential for decreases
in trading activity, and therefore commission revenue, that may result during
periods of rising interest rates.
The impact of the Company's hedging activities upon net interest revenue
for the quarters ended June 30, 2000 and 1999 was immaterial to the Company's
results of operations.
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
On July 21, 2000, a federal district court in New Orleans, Louisiana
approved a settlement between Charles Schwab & Co., Inc. (Schwab) and plaintiffs
in two class action lawsuits. The lawsuits that are being settled were filed on
behalf of a class consisting of all individuals nationwide who purchased or sold
securities through Schwab from 1985 until July 1999. These lawsuits alleged that
Schwab improperly retained monetary payments for routing orders to market makers
and other third parties, and did not provide best execution to client orders.
Schwab vigorously contested the allegations and had successfully obtained
dismissal of many of the plaintiffs' claims. However, in the interests of
avoiding the expense of further litigation, Schwab agreed to settle the cases on
the following terms: plaintiffs will dismiss the complaints with prejudice in
return for certain non-monetary relief from Schwab, including commitments to
implement various enhancements to its computerized trade handling and execution
systems; Schwab will adopt certain internal procedures to review order routing
arrangements and execution quality; and Schwab will conduct an investor
education campaign on trading and execution-related issues. In addition, Schwab
agreed to pay up to $900,000 in plaintiffs' attorneys' fees and costs, an amount
that will be subject to judicial review. The judgment expected to be entered as
part of the settlement precludes any other claims on best execution or payment
for order flow issues during the class period, except for claimants who
affirmatively opt out of the settlement. Attorneys representing four Schwab
clients who have brought separate class action lawsuits against Schwab that are
now pending in federal court in California (the objectors) objected to approval
of the settlement. Their objections were overruled and their motion to intervene
was denied. Schwab believes that all class claims in the objectors' four
purported lawsuits on best execution issues, consolidated for pretrial
proceedings in the federal district court in San Francisco but in which no class
has been certified, will be precluded as a result of the Louisiana judgment.
Schwab recognized the cost of the attorneys' fees included in the settlement in
the second quarter of 1999.
In December 1998, a class action complaint was filed against U.S. Trust
Company, N.A. (USTC, N.A.) in the United States District Court for the Southern
District of Texas, alleges that USTC, N.A., in its capacity as ESOP trustee,
breached its fiduciary duty to the MidCon Corp.'s Employee Stock Ownership Plan
(ESOP) in connection with Occidental Petroleum Corporation's (Occidental) sale
of its subsidiary, MidCon Corp., to KN Energy, Inc. in December 1997. The
complaint seeks damages exceeding $200 million, and alleges that the ESOP was
underpaid in the transaction and inappropriately paid certain transaction costs.
The court has certified a class consisting of the participants in the ESOP. The
case is scheduled for trial in 2001. USTC N.A., which under certain
circumstances is indemnified by Occidental for its actions as trustee, intends
to vigorously defend against these claims.
In March 2000, three purported class action complaints were filed against
USTC, N.A., all of which are now pending in the United States District Court for
the Middle District of Louisiana. All three suits are brought on behalf of
participants in an employee stock ownership plan (the Plan) sponsored by United
Companies Financial Corporation (United Companies), which is currently in
chapter 11 bankruptcy proceedings in Delaware. Plaintiffs allege that USTC,
N.A., which acted as directed trustee of the Plan, breached its fiduciary duties
under ERISA by failing to diversify the assets of the Plan. Damages have not yet
been specified. USTC, N.A. intends to vigorously defend against these claims.
The ultimate outcome of the legal proceedings described above and the
various other lawsuits, arbitration proceedings, and claims pending against the
Company cannot be determined at this time, and the results of these legal
proceedings cannot be predicted with certainty. There can be no assurance that
these legal proceedings will not have a material adverse effect on the Company's
results of operations in any future period, depending partly on the results for
that period, and a substantial judgment could have a material adverse impact on
the Company's financial condition and results of operations. However, it is the
opinion of management, after consultation with outside legal counsel, that the
ultimate outcome of these actions will not have a material adverse impact on the
financial condition or operating results of the Company.
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
The Company's Annual Meeting of Stockholders was held on May 3, 2000, and a
total of 774,622,931 shares were present in person or by proxy at the Annual
Meeting. The Company's stockholders voted upon the following proposals:
Proposal No. 1 - Election of Four Directors:
Shares Shares
For Withheld
--- --------
Nancy H. Bechtle 760,470,527 14,152,404
C. Preston Butcher 760,514,125 14,108,806
David S. Pottruck 760,543,801 14,079,130
George P. Shultz 760,257,482 14,365,449
There were no broker non-votes with respect to the election of directors.
Proposal No. 2 - Re-approval of Corporate Executive Bonus Plan, As Amended:
Shares Shares
For Against Abstentions
--- ------- -----------
734,792,164 35,029,737 4,801,030
There were no broker non-votes with respect to the re-approval of the
Corporate Executive Bonus Plan, as amended.
Voting share information related to the annual meeting of stockholders has
not been restated to reflect the effects of the three-for-two common stock split
declared May 3, 2000, distributed May 30, 2000.
Item 5. Other Information
Upon consummation of the merger with U.S. Trust Corporation (USTC), H.
Marshall Schwarz, USTC Chief Executive Officer, and Jeffrey S. Maurer, USTC
President and Chief Operating Officer, were appointed to The Charles Schwab
Corporation's (CSC) Board of Directors, expanding the membership to fourteen.
Additionally, upon consummation of the merger with USTC, CSC's Management
Committee was expanded from 17 to 21 members. The four new members are as
follows:
H. Marshall Schwarz USTC Chief Executive Officer
Jeffrey S. Maurer USTC President and Chief
Operating Officer
Maribeth S. Rahe USTC Vice Chairman
Frederick B. Taylor USTC Vice Chairman and Chief
Investment Officer
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
--------------------------------------------------------------------------------
1.3 The Charles Schwab Corporation Medium-Term Notes
Distribution Agreement.
10.213 The Charles Schwab Corporation 1992 Stock Incentive Plan, restated
to include amendments through April 19, 2000 (supersedes Exhibit
10.208).
12.1 Computation of Ratio of Earnings to Fixed Charges.
27.1 Financial Data Schedule (electronic only).
--------------------------------------------------------------------------------
(b) Reports on Form 8-K
On May 23, 2000, the Registrant filed a Current Report on Form 8-K
relating to up to $750 million aggregate principal amount of debt securities
issuable by the Registrant pursuant to Registration Statement Number 333-36410
declared effective by the Securities and Exchange Commission (SEC) on May 19,
2000. Certain exhibits relating to the Medium-Term Notes, Series A, which are
issuable pursuant to the Registration Statement, are contained in the Current
Report on Form 8-K as filed with the SEC on July 18, 2000.
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE CHARLES SCHWAB CORPORATION
(Registrant)
Date: August 11, 2000 /s/ Christopher V. Dodds
------------------------- ---------------------------
Christopher V. Dodds
Executive Vice President and
Chief Financial Officer
