================================================================================
Exhibit 99.2
THE CHARLES SCHWAB CORPORATION
Condensed Consolidated Financial Statements
and Other Financial Information
Table of Contents
Page
Condensed Consolidated Financial Statements:
Statement of Income 1
Balance Sheet 2
Statement of Cash Flows 3
Notes to Condensed Consolidated Financial Statements 4-8
Management's Discussion and Analysis of
Results of Operations and Financial Condition 9-20
---------------------------------------------------
Forward-Looking Statements - This Current Report on Form 8-K 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 customer assets, the ability of the Company to
realize the expected benefits of a merger, 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 Current Report on Form 8-K. See "Forward-Looking Statements" in
Management's Discussion and Analysis of Financial Condition and Results of
Operations in this Current Report on Form 8-K for a discussion of important
factors that may cause such differences. Unless otherwise indicated, this report
speaks as of March 31, 2000.
================================================================================
<PAGE>
<TABLE>
<CAPTION>
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THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(In thousands, except per share amounts)
(Unaudited)
Three Months Ended March 31, 2000 1999
-------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Revenues
Commissions $ 788,401 $ 475,439
Asset management and administration fees 371,825 280,120
Interest revenue, net of interest expense of $304,387 in 2000
and $203,118 in 1999 296,456 178,771
Principal transactions 245,280 131,311
Other 23,666 14,834
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Total 1,725,628 1,080,475
-------------------------------------------------------------------------------------------------------------------
Expenses Excluding Interest
Compensation and benefits $ 662,269 453,871
Occupancy and equipment 89,401 69,294
Communications 90,324 69,623
Advertising and market development 103,704 54,192
Professional services 82,186 39,743
Depreciation and amortization 54,960 37,673
Commissions, clearance and floor brokerage 42,771 25,559
Goodwill amortization 4,996 1,523
Other 83,462 62,582
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Total 1,214,073 814,060
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Income before taxes on income 511,555 266,415
Taxes on income 211,597 105,202
-------------------------------------------------------------------------------------------------------------------
Net Income $ 299,958 $ 161,213
===================================================================================================================
Weighted-Average Common Shares Outstanding - Diluted (1) 1,390,037 1,365,631
===================================================================================================================
Earnings Per Share (1)
Basic $ .23 $ .12
Diluted $ .22 $ .12
===================================================================================================================
Dividends Declared Per Common Share (1, 2) $ .0093 $ .0093
===================================================================================================================
(1) All periods have been restated for the May 2000 three-for-two common stock split.
(2) Dividends declared per common share represent dividends declared by The Charles Schwab Corporation prior
to its merger with U.S. Trust Corporation.
See Notes to Condensed Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
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THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(In thousands, except per share amounts)
(Unaudited)
March 31, December 31,
2000 1999
--------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Cash and cash equivalents $ 2,391,819 $ 2,612,451
Cash and investments required to be segregated under federal or other
regulations (including resale agreements of $4,267,081 in 2000
and $6,165,043 in 1999) 7,234,131 8,826,121
Securities owned - at market value 1,539,272 1,333,220
Receivable from brokers, dealers and clearing organizations 673,928 482,657
Receivable from brokerage customers - net 22,021,513 17,060,222
Loans to banking customers - net 2,751,354 2,689,205
Equipment, office facilities and property - net 751,801 678,208
Goodwill - net 530,262 53,723
Other assets 723,011 586,305
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Total $38,617,091 $34,322,112
==============================================================================================================
Liabilities and Stockholders' Equity
Deposits from banking customers $ 3,994,479 $ 4,204,943
Drafts payable 476,270 467,758
Payable to brokers, dealers and clearing organizations 2,148,125 1,748,765
Payable to brokerage customers 26,203,756 23,422,592
Accrued expenses and other liabilities 1,452,268 1,243,121
Short-term borrowings 149,626 141,157
Long-term debt 718,129 518,000
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Total liabilities 35,142,653 31,746,336
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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;
1,364,861 and 1,336,636 shares issued in 2000 and 1999, respectively* 13,649 13,366
Additional paid-in capital 1,226,230 595,282
Retained earnings 2,428,986 2,144,683
Treasury stock - 6,882 shares in 2000 and 7,336 shares in 1999, at cost* (96,870) (96,742)
Employee stock ownership plans (453) (967)
Unamortized restricted stock compensation (83,282) (70,926)
Accumulated other comprehensive (loss) income (13,822) (8,920)
--------------------------------------------------------------------------------------------------------------
Total stockholders' equity 3,474,438 2,575,776
--------------------------------------------------------------------------------------------------------------
Total $38,617,091 $34,322,112
==============================================================================================================
* All periods have been restated for the May 2000 three-for-two common stock split.
See Notes to Condensed Consolidated Financial Statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
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THE CHARLES SCHWAB CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(In thousands)
(Unaudited)
Three Months Ended March 31, 2000 1999
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<S> <C> <C>
Cash Flows from Operating Activities
Net income $ 299,958 $ 161,213
Noncash items included in net income:
Depreciation and amortization 54,960 37,673
Goodwill amortization 4,996 1,523
Net amortization of premium on securities available for sale 1,045 1,199
Compensation payable in common stock 23,628 17,654
Deferred income taxes (3,465) (2,397)
Other 7,060 5,785
Net change in:
Cash and investments required to be segregated under federal or
other regulations 1,585,631 1,111,122
Securities owned (excluding securities available for sale) (73,431) (74,541)
Receivable from brokers, dealers and clearing organizations (187,649) (164,219)
Receivable from brokerage customers (4,958,103) (2,175,730)
Other assets (101,219) (33,404)
Drafts payable 8,695 (61,896)
Payable to brokers, dealers and clearing organizations 403,619 80,501
Payable to brokerage customers 2,779,572 897,245
Accrued expenses and other liabilities 250,233 81,621
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Net cash provided (used) by operating activities 95,530 (116,651)
---------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Purchases of securities available for sale (197,596) (211,387)
Proceeds from maturities, calls and mandatory redemptions of
securities available for sale 46,779 151,696
Net change in loans to banking customers (62,166) (28,238)
Purchase of equipment, office facilities and property - net (123,924) (58,797)
Cash payments for business combinations and investments, net of
cash received 9,673 (5,727)
---------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (327,234) (152,453)
---------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities
Net change in deposits from banking customers (210,464) (179,960)
Net change in short-term borrowings 8,469 6,546
Proceeds from long-term debt 200,000
Repayment of long-term debt (4,773)
Dividends paid (15,573) (14,615)
Purchase of treasury stock (10,438)
Proceeds from stock options exercised and other 29,212 33,923
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Net cash provided (used) by financing activities 11,644 (169,317)
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Effect of exchange rate changes on cash and cash equivalents (572) (949)
---------------------------------------------------------------------------------------------------------------
Decrease in Cash and Cash Equivalents (220,632) (439,370)
Cash and Cash Equivalents at Beginning of Period 2,612,451 1,720,908
---------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 2,391,819 $ 1,281,538
===============================================================================================================
See Notes to Condensed Consolidated Financial Statements.
</TABLE>
<PAGE>
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 (U.S. Trust). Under the terms of the
merger agreement, U.S. Trust became a wholly owned subsidiary of CSC and U.S.
Trust shareholders received 5.1405 shares of CSC's common stock for each common
share of U.S. Trust. The Merger was treated as a non-taxable stock-for-stock
exchange and U.S. Trust's shareholders received 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 consolidated financial
statements, included in this Current Report on Form 8-K, 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 U.S. Trust had been operating as a combined entity during such
periods. Stockholders' equity and other per share information as of March 31,
2000 and December 31, 1999 reflects the accounts of CSC and its subsidiaries
(collectively referred to as the Company) as if the common stock had been issued
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 the Company and U.S. Trust during
the periods preceding the Merger that are included in the Company's restated
condensed consolidated statement of income are as follows:
--------------------------------------------------------------------------------
Three Months Ended March 31,
2000 1999
--------------------------------------------------------------------------------
Revenues:
Company $1,571,876 $ 951,585
U.S. Trust 153,752 128,890
--------------------------------------------------------------------------------
Combined $1,725,628 $1,080,475
================================================================================
Net Income:
Company $ 284,247 $ 142,867
U.S. Trust 15,711 18,346
--------------------------------------------------------------------------------
Combined $ 299,958 $ 161,213
================================================================================
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 U.S. Trust 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. CSC's principal subsidiary, Charles Schwab & Co., Inc. (Schwab), is a
securities broker-dealer with 356 domestic branch offices in 48 states, as well
as branches in the Commonwealth of Puerto Rico and the U.S. Virgin Islands.
Another subsidiary, U.S. Trust, is an investment management firm that also
provides fiduciary services and private banking services with 29 offices in 10
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, and Schwab Capital Markets L.P. (SCM) (prior to March 1, 2000,
this business was known as Mayer & Schweitzer, Inc.), a market maker in Nasdaq
and other securities providing trade execution services to broker-dealers and
institutional customers. On March 1, 2000, the Company completed the acquisition
of CyBerCorp, Inc. (CyBerCorp), 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 included in Exhibit 99.1 of this Current Report on Form 8-K. The
Company's results for any interim period are not necessarily indicative of
results for a full year.
Certain items in prior periods' financial statements have been reclassified
to conform to the 2000 presentation.
2. New Accounting Standard
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.
3. Business Combination
On March 1, 2000, the Company acquired CyBerCorp for $517 million in a
non-taxable stock-for-stock exchange. Pursuant to the acquisition, CyBerCorp
became a wholly owned subsidiary of CSC which resulted in 17,570,000 shares of
CSC's common stock and 3,077,000 options to purchase CSC common stock being
exchanged for all of the outstanding shares, options and equity rights of
CyBerCorp. Because the acquisition is accounted for using the purchase method,
the operating results of CyBerCorp are included in the consolidated results of
the Company since the acquisition date. The historical results of CyBerCorp are
not included in periods prior to the acquisition. The net assets acquired are
recorded at fair value and the excess of the purchase price over the fair value
of net assets acquired is recorded as goodwill. The Company recorded intangible
assets acquired of approximately $512 million, including approximately $482
million of goodwill. The goodwill is amortized on a straight-line basis over a
period of ten years. Other intangible assets acquired, which consist primarily
of purchased technology and total $30 million, are amortized on a straight-line
basis over a period of three years.
4. Allowance for Credit Losses on Banking Loans and Nonperforming Assets
An analysis of allowance for credit losses is as follows:
--------------------------------------------------------------------------------
Three Months Ended March 31,
2000 1999
--------------------------------------------------------------------------------
Balance at beginning of period $20,169 $19,414
Recoveries 16 165
Charge-offs (250)
--------------------------------------------------------------------------------
Net (charge-offs) recoveries 16 (85)
--------------------------------------------------------------------------------
Balance at end of period $20,185 $19,329
================================================================================
Nonperforming assets, which consist of non-accrual, or impaired, loans are
as follows:
--------------------------------------------------------------------------------
Mar. 31, Dec. 31, Sep. 30, Jun. 30, Mar. 31,
2000 1999 1999 1999 1999
--------------------------------------------------------------------------------
Non-accrual loans $428 $1,673 $435 $637 $583
================================================================================
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 Months Ended March 31,
2000 1999
--------------------------------------------------------------------------------
Net income $299,958 $161,213
Foreign currency translation adjustment (3,855) (1,247)
Change in net unrealized gain (loss) on
securities available for sale (1,047) (2,457)
--------------------------------------------------------------------------------
Total comprehensive income, net of tax $295,056 $157,509
================================================================================
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 March 31,
2000 1999
--------------------------------------------------------------------------------
Net income $ 299,958 $ 161,213
================================================================================
Weighted-average common shares outstanding - basic 1,329,883 1,300,497
Common stock equivalent shares related to stock
incentive plans 60,154 65,134
--------------------------------------------------------------------------------
Weighted-average common shares outstanding - diluted 1,390,037 1,365,631
================================================================================
Basic earnings per share $ .23 $ .12
================================================================================
Diluted earnings per share $ .22 $ .12
================================================================================
The computation of diluted EPS for the three months ended March 31, 2000
and 1999, respectively, excludes stock options to purchase 4,892,000 and 7,000
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, 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,
including 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. CSC, 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
------------------ -------------------
March 31, Amount Ratio(1) Amount Ratio(1)
--------------------------------------------------------------------------------
Tier 1 Capital:
Company $2,896,523 10.0% $1,921,620 11.5%
U.S. Trust $ 304,462 12.3% $ 251,540 13.1%
U.S. Trust NY $ 201,792 9.9% $ 169,583 10.6%
Total Capital:
Company $2,929,629 10.1% $1,952,065 11.7%
U.S. Trust $ 324,647 13.2% $ 270,869 14.1%
U.S. Trust NY $ 219,601 10.8% $ 186,697 11.7%
Leverage:
Company $2,896,523 7.6% $1,921,620 7.0%
U.S. Trust $ 304,462 6.6% $ 251,540 6.3%
U.S. Trust NY $ 201,792 5.7% $ 169,583 5.5%
--------------------------------------------------------------------------------
(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 March 31, 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 March 31, 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 customer transactions or a minimum dollar
amount, which is based on the type of business conducted by the broker-dealer.
The minimum dollar amount for both Schwab and 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 March 31, 2000, Schwab's net capital was $2,228 million (10% of
aggregate debit balances), which was $1,781 million in excess of its minimum
required net capital and $1,111 million in excess of 5% of aggregate debit
balances. At March 31, 2000, SCM's net capital was $68 million, which was $67
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 March 31, 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 customers at March 31, 2000, in accordance with
applicable regulations.
8. Commitments and Contingent Liabilities
The nature of the Company's business subjects it to numerous regulatory
investigations, claims, lawsuits and other proceedings in the ordinary course of
its business. The results of these legal proceedings cannot be predicted with
certainty. There can be no assurance that these matters will not have a material
adverse effect on the Company's results of operations in any future period,
depending partly on the results for that period, and a substantial judgment
could have a material adverse impact on the Company's financial condition.
However, it is the opinion of management, after consultation with outside legal
counsel, that the ultimate outcome of the current matters will not have a
material adverse impact on the financial condition or operating results of the
Company.
9. Segment Information
The Company structures its segments according to its various types of
customers and the services provided to those customers. These segments have been
aggregated, based on similarities in economic characteristics, types of
customers, services provided, distribution channels and regulatory environment,
into 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 March 31,
2000 1999
--------------------------------------------------------------------------------
Revenues
Individual Investor $1,094,593 $ 664,723
Institutional Investor 218,602 141,996
Capital Markets 258,681 144,866
U.S. Trust 153,752 128,890
--------------------------------------------------------------------------------
Total $1,725,628 $1,080,475
================================================================================
Income Before Taxes on Income
Individual Investor $ 334,348 $ 167,072
Institutional Investor 78,878 33,985
Capital Markets 66,435 35,035
U.S. Trust (1) 31,894 30,323
--------------------------------------------------------------------------------
Total $ 511,555 $ 266,415
================================================================================
(1)Includes merger-related costs of $10 million pre-tax in the first quarter of
2000 related to investment banking and professional fees. Excluding these
merger-related costs, income before taxes on income for this segment would
have been $42 million.
10. Supplemental Cash Flow Information
Certain information affecting the cash flows of the Company follows:
--------------------------------------------------------------------------------
Three Months Ended March 31,
2000 1999
--------------------------------------------------------------------------------
Income taxes paid $ 68,557 $ 34,247
================================================================================
Interest paid:
Brokerage customer cash balances $240,857 $156,111
Deposits from banking customers 34,452 26,514
Stock-lending activities 12,011 8,146
Long-term debt 17,865 14,113
Short-term borrowings 4,399 2,766
Other 570 69
--------------------------------------------------------------------------------
Total interest paid $310,154 $207,719
================================================================================
Non-cash investing and financing activities:
Common stock and options issued for purchases
of businesses $504,433 $ 7,558
================================================================================
11. Subsequent Events
At consummation of the Merger, 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, these merger-related costs, including costs incurred at the
consummation, totaled $69 million pre-tax, or $63 million after-tax. 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 completion 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 plans to
recognize $16 million pre-tax, or $10 million after-tax, per quarter for this
merger-related compensation expense. In addition, U.S. Trust employees will
receive an aggregate of 2,718,000 stock options of which 50% vest at the end of
the three-year period following the completion of the Merger and 50% vest at the
end of the four-year period following the completion of the Merger.
During the first half of 2000, CSC issued the remaining $111 million in
Senior Medium-Term Notes, Series A available under its current prospectus
supplement on file with the SEC. On May 19, 2000, CSC's Registration Statement
under the Securities Act of 1933 on Form S-3 relating to the issuance of up to
$750 million aggregate principal amount of debt securities was declared
effective by the SEC. As of the filing date of this Current Report on Form 8-K,
no securities under this Registration Statement have been issued. The proceeds
from the sale of these securities will be used for general corporate purposes.
On June 23, 2000, CSC entered into a $1.2 billion committed, unsecured
credit facility with several banks. The funds under this facility are available
for general corporate purposes. This facility has replaced both CSC's $600
million committed, unsecured credit facility that was scheduled to expire in
June 2000, and CSC's $175 million committed, unsecured credit facility that was
scheduled to expire in June 2001. The financial convenants in the new facility
require CSC to maintain minimum levels of stockholders' equity, and Schwab and
SCM to maintain specified levels of net capital, as defined. As of the filing
date of this Current Report on Form 8-K, no amounts were borrowed under this
facility.
<PAGE>
The Charles Schwab Corporation
Management's Discussion and Analysis
of Results of Operations and Financial Condition
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
(U.S. Trust). Under the terms of the merger agreement, U.S. Trust became a
wholly owned subsidiary of CSC and U.S. Trust shareholders received 5.1405
shares of CSC's common stock for each common share of U. S. Trust. The Merger
was treated as a non-taxable stock-for-stock exchange and U.S. Trust's
shareholders received 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 consolidated financial statements
and financial information in this Current Report on Form 8-K 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 U.S. Trust 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 U.S. Trust 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 7.0
million active customer accounts(a). Customer assets in these accounts totaled
$952.2 billion at March 31, 2000. CSC's principal subsidiary, Charles Schwab &
Co., Inc. (Schwab), is a securities broker-dealer with 356 domestic branch
offices in 48 states, as well as branches in the Commonwealth of Puerto Rico and
the U.S. Virgin Islands. Another subsidiary, U.S. Trust, is an investment
management firm that also provides fiduciary services and private banking
services with 29 offices in 10 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, and Schwab Capital Markets L.P. (SCM) (prior to March
1, 2000, this business was known as Mayer & Schweitzer, Inc.), a market maker in
Nasdaq and other securities providing trade execution services to broker-dealers
and institutional customers. On March 1, 2000, the Company completed the
acquisition of 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
customers 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 customers. The U.S. Trust segment provides
investment management, fiduciary services and private banking services to
individual and institutional customers.
The Company's strategy is to attract and retain customer assets by focusing
on a number of areas within the financial services industry - retail brokerage,
mutual funds, support services for independent investment managers, 401(k)
defined contribution plans, 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 customers' 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 customers in
the development of investment plans. This approach is designed to be offered
consistently across all of Schwab's delivery channels and provides customers
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. Schwab's Mutual Fund Marketplace(R) provides
customers with the ability to invest in 1,987 mutual funds from 323 fund
families, including 1,165 Mutual Fund OneSource(R) funds. Schwab also provides
custodial, trading and support services to approximately 6,000 independent
investment managers. As of March 31, 2000, these managers were guiding the
investments of 902,000 Schwab customer accounts containing $235.9 billion in
assets.
The Company responds to changing customer needs with continued product,
technology and service innovations. During the first quarter of 2000, the
Company launched the Schwab Portfolio Consultation(TM), a package of analytical
services and individual consultations with Schwab investment specialists
designed to assist customers in evaluating their asset allocations and
determining whether, when and how to re-balance their investments. Schwab
introduced a number of Web-based service offerings during the first quarter of
2000, including the Schwab Learning Center, which provides access to interactive
courseware designed to help customers learn more about investing principles and
using the online channel. Additionally, Schwab introduced the Charles Schwab
Stock Analyzer(TM), a tool that guides customers through the basics of equity
research, and launched a comprehensive retirement planning Web site that
contains a variety of planning tools and educational materials. Further, Schwab
added Market Analysis and Trade Notification alerts to the SchwabAlerts(TM)
customer e-mail service, and also enhanced the Schwab Portfolio Check-Up(TM)
online asset allocation tool so that customers can include non-Schwab holdings
in their analyses. Schwab also introduced PocketBroker(TM), a wireless product
that enables U.S. investors to access account information and place orders
through cellular phones or other handheld devices.
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
customers to choose how they prefer to do business with the Company. To enable
customers to obtain services in person with a Company representative, the
Company maintains a network of offices. Schwab's branch offices also provide
investors with access to the Internet. Telephonic access to Schwab is provided
primarily through four regional customer telephone service centers and two
online customer support centers that operate both during and after normal market
hours. Additionally, customers are able to obtain financial information on an
automated basis through 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, 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 customer experience. Schwab provides every retail customer access
to all delivery channels and flat-fee pricing for Internet trades. During the
first quarter of 2000, Schwab announced reduced online pricing for more actively
trading investors and a plan to increase fees related to minimum account
balances.
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 customer service, reducing processing costs, and
facilitating the Company's ability to handle significant increases in customer
activity without a corresponding rise in staffing levels. The Company uses
technology to empower its customers to manage their financial affairs and is a
leader in driving technological advancements in the financial services industry.
International Expansion: In February 2000, the Company formed a joint
venture with ecorp Limited to provide financial services to investors in
Australia and New Zealand. Additionally during the first quarter of 2000, Schwab
expanded its international offering by announcing plans to work with Barclays
PLC to develop and operate an automated foreign exchange facility that will
enable non-U.S. investors to buy and sell securities in different foreign
markets through their Schwab account. Schwab also launched a new online service
that features research and information about U.S. financial markets in Chinese.
Risk Management
For discussion on the Company's principal risks and some of the policies
and procedures for risk identification, assessment and mitigation, see
"Management's Discussion and Analysis of Results of Operations and Financial
Condition-Risk Management" in Exhibit 99.1 included in this Current Report on
Form 8-K. See Liquidity and Capital Resources of this report for a discussion on
liquidity risk; and see Quantitative and Qualitative Disclosures About Market
Risk for additional information relating to market risk.
Given the nature of the Company's revenues, expenses and risk profile, the
Company's earnings and 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 Current Report on Form 8-K, 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 customer 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 decline in average revenue per share traded (see
Revenues - Principal Transactions), 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 include, but are not limited to: the effect
of customer 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 March 31, 2000 Compared To Three Months Ended March 31, 1999
Financial Overview
The Company's revenues increased in the first quarter of 2000 mainly due to
higher customer trading volume and an increase in customer assets. Revenues of
$1,726 million in the first quarter of 2000 grew $645 million, or 60%, from the
first quarter of 1999 due to increases in revenues of $430 million, or 65%, in
the Individual Investor segment, $76 million, or 54%, in the Institutional
Investor segment, $114 million, or 79%, in the Capital Markets segment, and $25
million, or 19%, 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 operating expenses excluding interest during the first quarter of
2000 were $1,214 million, up 49% from $814 million for the first quarter of
1999, primarily resulting from additional staff and related costs.
Net income for the first quarter of 2000 was a record $300 million, up 86%
from first quarter 1999 net income of $161 million. Diluted earnings per share
for the first quarters of 2000 and 1999 were $.22 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 first quarter of 2000 was 17.4%, up
from 14.9% for the first quarter of 1999. The annualized return on stockholders'
equity for the first quarter of 2000 was 40%, up from 35% for the first quarter
of 1999.
The Company's first quarter 2000 results include charges for goodwill and
intangible asset amortization, professional fees and other expenses relating to
the acquisition of CyBerCorp and the Merger. These charges totaled $23 million
after-tax, or $.02 per share. Excluding these charges, the Company's first
quarter 2000 after-tax profit margin would have been 18.7% and earnings would
have been $323 million, up 100% from the first quarter of 1999.
Trading activity reached record levels in the first quarter of 2000, as
shown in the following table (in thousands):
--------------------------------------------------------------------------------
Three Months Ended March 31,
Daily Average Trades 2000 1999
--------------------------------------------------------------------------------
Revenue Trades
Online 256.5 112.2
TeleBroker(R)and VoiceBroker(TM) 11.6 10.1
Regional customer telephone service centers,
branch offices and other 42.0 40.5
--------------------------------------------------------------------------------
Total 310.1 162.8
================================================================================
Mutual Fund OneSource(R) Trades
Online 47.5 25.2
TeleBroker and VoiceBroker 1.9 1.3
Regional customer telephone service centers,
branch offices and other 27.1 23.4
--------------------------------------------------------------------------------
Total 76.5 49.9
================================================================================
Total Daily Average Trades
Online 304.0 137.4
TeleBroker and VoiceBroker 13.5 11.4
Regional customer telephone service centers,
branch offices and other 69.1 63.9
--------------------------------------------------------------------------------
Total 386.6 212.7
================================================================================
Assets in customer accounts were $952.2 billion at March 31, 2000, an
increase of $308.2 billion, or 48%, from a year ago as shown in the table below.
This increase from a year ago included net new customer assets of $132.8 billion
and net market gains of $175.4 billion related to customer accounts.
--------------------------------------------------------------------------------
Growth in Customer Assets and Accounts March 31, Percent
(In billions, at quarter end, except as noted) 2000 1999 Change
--------------------------------------------------------------------------------
Assets in Schwab customer accounts
Schwab One(R) and other cash equivalents $ 26.0 $ 18.5 41%
SchwabFunds(R):
Money market funds 92.6 74.4 24
Equity and bond funds 23.8 16.4 45
--------------------------------------------------------------------------------
Total SchwabFunds 116.4 90.8 28
--------------------------------------------------------------------------------
Mutual Fund Marketplace(R)(1):
Mutual Fund OneSource
Retail 69.7 39.0 79
Schwab Institutional(TM)(2) 52.4 34.2 53
-----------------------------------------------------------------------------
Total Mutual Fund OneSource 122.1 73.2 67
All other 78.1 61.8 26
--------------------------------------------------------------------------------
Total Mutual Fund Marketplace 200.2 135.0 48
--------------------------------------------------------------------------------
Total mutual fund assets 316.6 225.8 40
--------------------------------------------------------------------------------
Equity and other securities (1) 450.2 272.2 65
Fixed income securities 52.2 37.2 40
Margin loans outstanding (21.8) (11.7) 86
--------------------------------------------------------------------------------
Total 823.2 542.0 52
Assets in U.S. Trust customer accounts 129.0 102.0 26
--------------------------------------------------------------------------------
Total $952.2 $644.0 48%
================================================================================
Net growth in assets in customer accounts(3)
(for the quarter ended)
Net new customer assets $ 53.3 $ 27.4
Net market gains 52.9 22.3
--------------------------------------------------------------------------------
Net growth $106.2 $ 49.7
================================================================================
New customer accounts
(in thousands, for the quarter ended) 497.1 390.8 27%
Active customer accounts (in millions) 7.0 5.9 19%
================================================================================
Active online Schwab customer accounts
(in millions) (4) 3.7 2.5 48%
Online Schwab customer assets $417.7 $219.0 91%
================================================================================
(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 invest-
ment managers and retirement plans.
(3) Net new customer assets in 2000 include U.S. Trust. For 1999, U.S. Trust
net new customer 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 $645 million, or 60%, in the first quarter of 2000 compared
to the first quarter of 1999, due to a $313 million, or 66%, increase in
commission revenues, a $117 million, or 65%, increase in interest revenue, net
of interest expense (referred to as net interest revenue), and a $114 million,
or 87%, increase in principal transaction revenues, as well as a $92 million, or
33%, increase in asset management and administration fees. Non-trading revenues
represented 40% of total revenues for the first quarter of 2000, down from 44%
for the first quarter of 1999 as shown in the table below.
--------------------------------------------------------------------------------
Three Months Ended March 31,
Composition of Revenues 2000 1999
--------------------------------------------------------------------------------
Commissions 46% 44%
Principal transactions 14 12
--------------------------------------------------------------------------------
Total trading revenues 60 56
--------------------------------------------------------------------------------
Asset management and administration fees 22 26
Net interest revenue 17 17
Other 1 1
--------------------------------------------------------------------------------
Total non-trading revenues 40 44
--------------------------------------------------------------------------------
Total 100% 100%
================================================================================
Commissions
The Company earns commission revenues by executing customer trades
primarily through the Individual Investor and Institutional Investor segments.
These revenues are affected by the number of customer accounts that trade, the
average number of commission-generating trades per account, and the average
commission per trade.
Commission revenues for the Company were $788 million for the first quarter
of 2000, up $313 million, or 66%, from the first quarter of 1999. As shown in
the table below, the total number of revenue trades executed by the Company has
increased 97% as the Company's customer base, as well as customer trading
activity per account, has grown. Average commission per revenue trade decreased
16%. 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.
--------------------------------------------------------------------------------
Commissions Earned on Three Months Ended March 31, Percent
Customer Revenue Trades 2000 1999 Change
--------------------------------------------------------------------------------
Customer accounts that traded
during the quarter (in thousands) 2,360 1,662 42%
Average customer revenue trades
per account 8.28 5.98 38
Total revenue trades (in thousands) 19,543 9,940 97
Average commission per revenue trade $40.12 $47.72 (16)
Commissions earned on customer
revenue trades (in millions) (1) $ 784 $ 474 65
================================================================================
(1) Includes certain non-commission revenues relating to the execution of
customer trades totaling $14 million in the first quarter of 2000 and $8
million in the first quarter of 1999. Excludes commissions on trades
relating to specialist operations totaling $13 million in the first quarter
of 2000 and $7 million in the first quarter of 1999. Excludes U.S. Trust
commissions on trades totaling $5 million in the first quarter of 2000 and
$2 million in the first 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 customers. The Company earns mutual fund service fees for
recordkeeping and shareholder services provided to third-party funds, and for
transfer agent services, shareholder services, administration and investment
management provided to its proprietary funds. These fees are based upon the
daily balances of customer assets invested in third-party funds and upon the
average daily net assets of Schwab's proprietary funds. Mutual fund service fees
are earned primarily through the Individual Investor and Institutional Investor
segments. 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 customers. 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 $372 million for the first
quarter of 2000, up $92 million, or 33%, from the first quarter of 1999, as
shown in the following table (in millions):
--------------------------------------------------------------------------------
Asset Management and Three Months Ended March 31, Percent
Administration Fees 2000 1999 Change
--------------------------------------------------------------------------------
Mutual fund service fees:
SchwabFunds(R) $148 $115 29%
Mutual Fund OneSource(R) 83 52 60
Excelsior Funds(R) 12 7 71
Other 6 3 100
Asset management and related services 123 103 19
--------------------------------------------------------------------------------
Total $372 $280 33%
================================================================================
The increase in asset management and administration fees was primarily due
to an increase in customer assets in Schwab's proprietary funds, collectively
referred to as the SchwabFunds, an increase in customer assets in funds
purchased through Schwab's Mutual Fund OneSource service, and an increase in
U.S. Trust's customer assets.
Net Interest Revenue
Net interest revenue is the difference between interest earned on assets
(mainly margin loans to customers, investments required to be segregated for
customers, securities available for sale, and private banking loans) and
interest paid on liabilities (mainly brokerage customer 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 $296 million for the first quarter of 2000, up
$117 million, or 65%, from the first quarter of 1999 as shown in the following
table (in millions):
--------------------------------------------------------------------------------
Three Months Ended March 31, Percent
2000 1999 Change
--------------------------------------------------------------------------------
Interest Revenue
Margin loans to customers $401 $198 103%
Investments, customer-related 100 111 (10)
Private banking loans 50 40 25
Securities available for sale 17 15 13
Other 32 18 78
--------------------------------------------------------------------------------
Total 600 382 57
--------------------------------------------------------------------------------
Interest Expense
Brokerage customer cash balances 237 155 53
Deposits from banking customers 35 27 30
Stock-lending activities 14 9 56
Long-term debt 10 7 43
Short-term borrowings 7 3 133
Other 1 2 (50)
--------------------------------------------------------------------------------
Total 304 203 50
--------------------------------------------------------------------------------
Net interest revenue $296 $179 65%
================================================================================
Customer-related daily average balances, interest rates and average net
interest spread for the first quarters of 2000 and 1999 are summarized in the
following table (dollars in millions):
--------------------------------------------------------------------------------
Three Months Ended March 31,
2000 1999
--------------------------------------------------------------------------------
Interest-Earning Assets (customer-related and other):
Margin loans to customers:
Average balance outstanding $19,666 $11,083
Average interest rate 8.21% 7.25%
Investments (customer-related):
Average balance outstanding $ 7,955 $ 9,694
Average interest rate 5.06% 4.65%
Private banking loans:
Average balance outstanding $ 2,694 $ 2,179
Average interest rate 7.47% 7.36%
Securities available for sale:
Average balance outstanding $ 1,147 $ 1,015
Average interest rate 5.92% 5.82%
Average yield on interest-earning assets 7.27% 6.15%
Funding Sources (customer-related and other):
Interest-bearing brokerage customer cash balances:
Average balance outstanding $20,724 $16,292
Average interest rate 4.61% 3.86%
Interest-bearing banking deposits:
Average balance outstanding $ 3,037 $ 2,654
Average interest rate 4.66% 4.09%
Other interest-bearing sources:
Average balance outstanding $ 2,367 $ 1,709
Average interest rate 4.10% 3.36%
Average noninterest-bearing portion $ 5,334 $ 3,316
Average interest rate on funding sources 3.79% 3.31%
Summary:
Average yield on interest-earning assets 7.27% 6.15%
Average interest rate on funding sources 3.79% 3.31%
--------------------------------------------------------------------------------
Average net interest spread 3.48% 2.84%
================================================================================
The increase in net interest revenue from the first quarter of 1999 was
primarily due to higher levels of margin loans to customers, partially offset by
higher average customer cash balances.
Principal Transactions
Principal transaction revenues are primarily comprised of net gains from
market-making activities in Nasdaq and other securities transactions effected
through the Capital Markets segment. Factors that influence principal
transaction revenues include the volume of customer trades, market price
volatility, average revenue per share traded and changes in regulations and
industry practices.
Principal transaction revenues were $245 million for the first quarter of
2000, up $114 million, or 87%, from the first quarter of 1999. This increase was
primarily due to greater share volume handled by SCM, partially offset by lower
average revenue per share traded.
During the first quarter of 2000, SCM implemented midpoint pricing, a
practice whereby most customer orders at market opening are matched or crossed
at the price that represents the midpoint between the prevailing bid and offer
prices. This change, which eliminates any potential spread that could be earned
by a market maker on trades executed at the market opening, is likely to cause
decreases in average revenue per share traded, will only affect the Capital
Markets segment and, based on management's expectations, will not have a
material impact on that segment's revenues.
Expenses Excluding Interest
Compensation and benefits expense was $662 million for the first quarter of
2000, up $208 million, or 46%, from the first 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 March 31,
2000 1999
--------------------------------------------------------------------------------
Compensation and benefits expense as a % of
total revenues 38% 42%
Incentive and variable compensation as a %
of compensation and benefits expense 38% 33%
Compensation for temporary employees,
contractors and overtime hours as a % of
compensation and benefits expense 9% 11%
Full-time equivalent employees(1)
(at end of quarter) 22.4 16.6
Revenues per average full-time equivalent
employee $80.8 $67.9
================================================================================
(1) Includes full-time, part-time and temporary employees, and persons employed
on a contract basis.
Advertising and market development expense was $104 million for the first
quarter of 2000, up $50 million, or 91%, from the first quarter of 1999. This
increase was primarily a result of the Company's increased brand-focused
television and print media spending.
Professional services expense was $82 million for the first quarter of
2000, up $42 million, or 107%, from the first quarter of 1999. This increase was
primarily due to consulting fees related to various information technology
projects and professional fees relating to the Merger.
The Company's effective income tax rate was 41.4% for the first quarter of
2000, up from 39.5% for the first 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 and goodwill amortization relating to the
acquisition of CyBerCorp.
Liquidity and Capital Resources
Upon consummation of the Merger, 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. 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
March 31, 2000 and 1999, CSC and its bank subsidiaries are well capitalized. See
note "7 - Regulatory Requirements" in the Notes to Condensed Consolidated
Financial Statements.
CSC has liquidity needs that arise from its issued and outstanding $655
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. The rating by Standard & Poor's was raised to A from A- on
April 14, 2000.
CSC has a prospectus supplement on file with the Securities and Exchange
Commission pursuant to which as of March 31, 2000, up to $111 million in Senior
or Senior Subordinated Medium-Term Notes, Series A remained available for
issuance. See note "11 - Subsequent Events" in the Notes to Condensed
Consolidated Financial Statements.
CSC may borrow under its committed, unsecured credit facilities. CSC
maintains a $600 million facility with a group of fourteen banks which is
scheduled to expire in June 2000 and a $175 million facility with a group of
nine banks which is scheduled to expire in June 2001. See note "11 - Subsequent
Events" in the Notes to Condensed Consolidated Financial Statements. The funds
under both of these facilities are available for general corporate purposes and
CSC pays a commitment fee on the unused balance of these facilities. The
financial covenants in these facilities 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. These facilities were unused during the first quarter of 2000.
CSC also has direct access to $635 million of the $795 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 quarter of
2000.
Schwab
Liquidity needs relating to customer trading and margin borrowing
activities are met primarily through cash balances in brokerage customer
accounts, which were $26.0 billion and $23.0 billion at March 31, 2000 and
December 31, 1999, respectively. Management believes that brokerage customer
cash balances and operating earnings will continue to be the primary sources of
liquidity for Schwab in the future.
Schwab is subject to regulatory requirements that are intended to ensure
the general financial soundness and liquidity of broker-dealers. These
regulations prohibit Schwab from repaying subordinated borrowings to CSC, paying
cash dividends, or making unsecured advances or loans to its parent or employees
if such payment would result in net capital of less than 5% of aggregate debit
balances or less than 120% of its minimum dollar amount requirement of $1
million. At March 31, 2000, Schwab's net capital was $2,228 million (10% of
aggregate debit balances), which was $1,781 million in excess of its minimum
required net capital and $1,111 million in excess of 5% of aggregate debit
balances. Schwab has historically targeted net capital to be 10% of its
aggregate debit balances, which primarily consist of customer margin loans. To
achieve this target, as customer margin loans have grown, an increasing amount
of cash flows have been retained to support aggregate debit balances.
To manage Schwab's regulatory capital position, CSC provides Schwab with a
$1,400 million subordinated revolving credit facility maturing in September
2001, of which $905 million was outstanding at March 31, 2000. At quarter end,
Schwab also had outstanding $25 million in fixed-rate subordinated term loans
from CSC - $10 million maturing in 2001 and $15 million 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 $795 million at March 31, 2000 ($635 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 16 days during the first quarter of 2000, with the daily amounts
borrowed averaging $80 million. These lines were unused at March 31, 2000.
To satisfy the margin requirement of customer 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
March 31, 2000. Schwab pays a fee to maintain these letters of credit. No funds
were drawn under these letters of credit at March 31, 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. See note "7 - Reg-
ulatory Requirements" in the Notes to Condensed Consolidated Financial
Statements.
U.S. Trust has credit facilities totaling $80 million which are based on
LIBOR or Prime and mature in March 2002. At March 31, 2000, there was $35
million outstanding under these facilities. Upon completion of the Merger, 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 March 31, 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
$502 million. At March 31, 2000, $10 million was outstanding under these credit
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 March 31, 2000, SCM's net capital was $68
million, which was $67 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. 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. These facilities were unused during the first
quarter 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 customers and others.
CSE may borrow up to (pound)70 million, equivalent to $111 million at March
31, 2000, under subordinated lending arrangements with CSC. At March 31, 2000,
CSE had outstanding (pound)18 million under these arrangements, equivalent to
$29 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 $360 million for the first quarter of 2000, up 80% from $200
million for the first quarter 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
$52 million for the first quarter of 2000, as compared to $36 million for the
first quarter of 1999, or 3% of revenues for each period, respectively.
Amortization expense related to intangible assets was $3 million for the first
quarter of 2000, as compared to $2 million for the first quarter of 1999.
Goodwill amortization expense was $5 million for the first quarter of 2000, as
compared to $2 million for the first quarter 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 $124 million in the first quarter of 2000 and $59 million in the
first quarter of 1999, or 7% and 5% of revenues for each period, respectively.
Capital expenditures in the first quarter of 2000 were for equipment relating to
the Company's information technology systems, software, and leasehold
improvements. Capital expenditures as described above include the capitalized
costs for developing internal-use software of $21 million in the first quarter
of 2000 and $11 million in the first quarter of 1999. Schwab opened 16 new
domestic branch offices during the first quarter of 2000, compared to 7 during
the first quarter of 1999. Capital expenditures may vary from period to period
as business conditions change.
The Company issued $200 million of long-term debt during the first quarter
of 2000.
During the first quarter of 2000, 6,343,100 of the Company's stock options,
with a weighted-average exercise price of $2.54, were exercised with cash
proceeds received by the Company of $17 million and a related tax benefit of $33
million. (These stock options were granted prior to the Merger, and therefore
did not include U.S. Trust employees). During the first quarter of 2000,
2,776,800 of U.S. Trust's stock options, with a weighted-average exercise price
of $10.97, were exercised with cash proceeds received by the Company of $17
million and a related tax benefit of $7 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 quarter of 2000, the Company did not repurchase any common
stock. During the first quarter of 1999, the Company repurchased 702,600 shares
of its common stock for $10 million. There is no current authorization for share
repurchases.
During the first quarters of 2000 and 1999, the Company paid common
stock cash dividends of $16 million and $15 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 March 31, 2000 was $4,192 million, up $1,099
million, or 36% from December 31, 1999. At March 31, 2000, the Company had
long-term debt of $718 million, or 17% of total financial capital, that bear
interest at a weighted-average rate of 7.20%. At March 31, 2000, the Company's
stockholders' equity was $3,474 million, or 83% of total financial capital.
Year 2000 Century Change
The Company's mission critical systems operated throughout the Year 2000
century change, including the February 2000 leap year, without material errors
or interruptions when processing data and transactions incorporating year 2000
dates, including leap year dates, and the Company did not encounter any material
problems with any of its mission critical vendor-supplied systems, services or
products. Mission critical systems, services and products means those systems,
services and products critical to the ongoing operation of the business.
Compliance Costs
As of March 31, 2000, the Company spent approximately $99 million for its
Year 2000 project.
The Company funded all Year 2000 related costs through operating cash flows
and a reallocation of the Company's overall developmental spending. This
reallocation did not result in the delay of any critical information technology
projects. In accordance with generally accepted accounting principles, Year 2000
expenditures were expensed as incurred.
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 $35 million and
$23 million at March 31, 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 March 31, 2000 was $95 million in
long positions and $68 million in short positions. The fair value of these
securities at March 31, 1999 was $50 million in long positions and $32 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 $2,700,000
and $1,800,000 at March 31, 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
March 31, 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 March 31, 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 $65 million and $50 million at
March 31, 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 March 31, 2000, CSC had $655 million aggregate principal amount of
Medium-Term Notes, with fixed interest rates ranging from 5.96% to 8.05%. At
March 31, 1999, CSC had $351 million aggregate principal amount of Medium-Term
Notes, with fixed interest rates ranging from 5.78% to 7.72%. At March 31, 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 March 31, 2000
and 1999, U.S. Trust had $13 million FHLB borrowings outstanding. The FHLB
borrowings had fixed interest rates ranging from 6.59% to 6.76% at both March
31, 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 March 31, 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 customer 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 customer 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. The following table
shows the results of a 100 basis point increase or decrease in interest rates
and the effect on simulated net interest revenue over the next twelve months at
March 31, 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
customer cash balances.
--------------------------------------------------------------------------------
Impact on Net Interest Revenue
Increase (Decrease)
2000 1999
--------------- ----------------
March 31, Amount % Amount %
--------------------------------------------------------------------------------
Increase of 100 basis points $96 7.2% $49 6.3%
Decrease of 100 basis points ($97) (7.3%) ($50) (6.4%)
================================================================================
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 March 31, 2000 and 1999 was immaterial to the Company's
results of operations.
