Charles Schwab Corporation is an American company based in San Francisco, California. Charles Schwab offers commercial banking, stock brokerage, and wealth management advisory services to both retail and institutional clients. The company's chairman is its founder Charles Schwab.
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 September 30, 1995 Commission file number 1-9700 THE CHARLES SCHWAB CORPORATION (Exact name of Registrant as specified in its charter) Delaware 94-3025021 (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 101 Montgomery Street, San Francisco, CA 94104 (Address of principal executive offices and zip code) Registrant's telephone number, including area code: (415) 627-7000 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. 174,677,878* shares of $.01 par value Common Stock Outstanding on November 1, 1995 * Reflects the March 1995 three-for-two common stock split and the September 1995 two-for-one common stock split.
THE CHARLES SCHWAB CORPORATION Quarterly Report on Form 10-Q For the Quarter Ended September 30, 1995 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 4-5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 6-13 Part II - Other Information Item 1. Legal Proceedings 13 Item 2. Changes in Securities 13 Item 3. Defaults Upon Senior Securities 13 Item 4. Submission of Matters to a Vote of Security Holders 13 Item 5. Other Information 13 Item 6. Exhibits and Reports on Form 8-K 13-14 Signature 15
<TABLE> Part 1 - FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements THE CHARLES SCHWAB CORPORATION CONDENSED CONSOLIDATED STATEMENT OF INCOME (In thousands, except per share amounts) (Unaudited) <CAPTION> Three Months Ended Nine Months Ended September 30, September 30, 1995 1994 1995 1994 ---- ---- ---- ---- <S> <C> <C> <C> <C> Revenues Commissions $206,831 $121,574 $ 537,023 $414,008 Interest revenue, net of interest expense* 55,180 42,127 150,867 118,114 Principal transactions 51,985 34,180 148,020 124,645 Mutual fund service fees 58,745 41,365 156,585 113,810 Other 12,820 8,843 32,637 23,611 - -------------------------------------------------------------------------------------------------------------- Total 385,561 248,089 1,025,132 794,188 - -------------------------------------------------------------------------------------------------------------- Expenses Excluding Interest Compensation and benefits 161,456 103,506 423,801 331,140 Communications 34,214 25,639 90,674 81,819 Occupancy and equipment 28,233 22,185 79,062 64,895 Depreciation and amortization 17,773 14,080 46,465 40,472 Commissions, clearance and floor brokerage 22,877 11,385 57,728 35,080 Advertising and market development 10,888 7,346 34,081 28,184 Professional services 10,666 4,388 26,515 15,056 Other 21,396 7,966 52,080 29,185 - -------------------------------------------------------------------------------------------------------------- Total 307,503 196,495 810,406 625,831 - -------------------------------------------------------------------------------------------------------------- Income before taxes on income 78,058 51,594 214,726 168,357 Taxes on income 30,837 20,399 84,710 66,813 - -------------------------------------------------------------------------------------------------------------- Net Income $ 47,221 $ 31,195 $ 130,016 $101,544 ============================================================================================================== Weighted average number of common and common equivalent shares outstanding** 179,688 174,215 178,001 175,221 ============================================================================================================== Earnings per Common Equivalent Share** $ .26 $ .18 $ .73 $ .58 ============================================================================================================== Dividends Declared per Common Share** $ .040 $ .023 $ .100 $ .069 ============================================================================================================== * Interest revenue is presented net of interest expense. Interest expense for the three months ended September 30, 1995 and 1994 was $94,039 and $54,598, respectively. Interest expense for the nine months ended September 30, 1995 and 1994 was $260,908 and $132,928, respectively. ** Reflects the March 1995 three-for-two common stock split and the September 1995 two-for-one common stock split. See Notes to Condensed Consolidated Financial Statements. </TABLE> - 1 -
<TABLE> THE CHARLES SCHWAB CORPORATION CONDENSED CONSOLIDATED BALANCE SHEET (In thousands, except share data) <CAPTION> September 30, December 31, 1995 1994 ---- ---- (Unaudited) ----------- <S> <C> <C> Assets Cash and equivalents (including resale agreements of $242,500 in 1994) $ 474,610 $ 380,616 Cash and investments required to be segregated under Federal or other regulations (including resale agreements of $4,725,625 in 1995 and $3,787,984 in 1994) 4,943,103 4,206,466 Receivable from brokers, dealers and clearing organizations 146,435 86,028 Receivable from customers (less allowance for doubtful accounts of $4,497 in 1995 and $3,204 in 1994) 3,551,622 2,923,867 Equipment, office facilities and property (less accumulated depreciation and amortization of $196,615 in 1995 and $162,474 in 1994) 189,984 129,105 Intangible assets (less accumulated amortization of $149,260 in 1995 and $140,860 in 1994) 69,640 26,813 Other assets 208,445 164,967 - ---------------------------------------------------------------------------------------------------------------- Total $9,583,839 $7,917,862 ================================================================================================================ Liabilities and Stockholders' Equity Drafts payable $ 159,940 $ 117,383 Payable to brokers, dealers and clearing organizations 459,473 296,420 Payable to customers 7,870,512 6,670,362 Accrued expenses 256,373 195,320 Long-term borrowings 216,162 171,363 - ---------------------------------------------------------------------------------------------------------------- Total liabilities 8,962,460 7,450,848 - ---------------------------------------------------------------------------------------------------------------- Stockholders' equity: Preferred stock - 10,000,000 shares authorized; $.01 par value per share; none issued Common stock - 200,000,000 shares authorized; $.01 par value per share; 178,459,416 shares issued in 1995 and 1994* 1,785 595 Additional paid-in capital 184,479 166,103 Retained earnings 484,770 373,161 Treasury stock - 4,155,698 shares in 1995 and 7,563,990 shares in 1994, at cost* (38,973) (57,968) Unearned ESOP shares (5,081) (10,174) Unamortized restricted stock compensation (4,673) (4,703) Foreign currency translation adjustment (928) - ---------------------------------------------------------------------------------------------------------------- Stockholders' equity 621,379 467,014 - ---------------------------------------------------------------------------------------------------------------- Total $9,583,839 $7,917,862 ================================================================================================================ * Reflects the March 1995 three-for-two common stock split and the September 1995 two-for-one common stock split. See Notes to Condensed Consolidated Financial Statements. </TABLE> - 2 -
<TABLE> THE CHARLES SCHWAB CORPORATION CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (In thousands) (Unaudited) <CAPTION> Nine Months Ended September 30, 1995 1994 ---- ---- <S> <C> <C> Cash flows from operating activities Net income $ 130,016 $ 101,544 Noncash items included in net income: Depreciation and amortization 46,465 40,472 Deferred income taxes (9,553) 8,372 Other 15,275 2,662 Change in accrued expenses 76,211 27,578 Change in other assets (14,201) 5,013 - ----------------------------------------------------------------------------------------------------------------- Net cash provided before change in customer-related balances 244,213 185,641 - ----------------------------------------------------------------------------------------------------------------- Change in customer-related balances (excluding the effects of businesses acquired): Payable to customers 1,113,323 457,301 Receivable from customers (616,895) (239,994) Drafts payable 36,723 (11,922) Payable to brokers, dealers and clearing organizations 142,047 112,495 Receivable from brokers, dealers and clearing organizations (19,934) (21,151) Cash and investments required to be segregated under Federal or other regulations (672,478) (305,928) - ----------------------------------------------------------------------------------------------------------------- Net change in customer-related balances (17,214) (9,199) - ----------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 226,999 176,442 - ----------------------------------------------------------------------------------------------------------------- Cash flows from investing activities Purchase of equipment, office facilities and property - net (94,087) (26,547) Cash payments for businesses acquired, net of cash received (68,113) Other (1,898) - ----------------------------------------------------------------------------------------------------------------- Net cash used by investing activities (162,200) (28,445) - ----------------------------------------------------------------------------------------------------------------- Cash flows from financing activities Proceeds from long-term borrowings 40,000 20,000 Purchase of treasury stock (34,329) Dividends paid (17,261) (12,026) Other 7,110 1,796 - ----------------------------------------------------------------------------------------------------------------- Net cash provided (used) by financing activities 29,849 (24,559) - ----------------------------------------------------------------------------------------------------------------- Effect of exchange rate changes on cash and equivalents (654) - ----------------------------------------------------------------------------------------------------------------- Increase in cash and equivalents 93,994 123,438 Cash and equivalents at beginning of period 380,616 279,828 - ----------------------------------------------------------------------------------------------------------------- Cash and equivalents at end of period $ 474,610 $ 403,266 ================================================================================================================= See Notes to Condensed Consolidated Financial Statements. </TABLE> - 3 -
THE CHARLES SCHWAB CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Basis of Presentation The accompanying unaudited condensed consolidated financial statements include The Charles Schwab Corporation (CSC) and its subsidiaries (collectively the Company), including Charles Schwab & Co., Inc. (Schwab) and Mayer & Schweitzer, Inc. (M&S). These financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) and, in the opinion of management, reflect all adjustments necessary to present fairly the financial position, results of operations and cash flows for the periods presented in conformity with generally accepted accounting principles. All adjustments were of a normal recurring nature. All material intercompany balances and transactions have been eliminated. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's 1994 Annual Report to Stockholders, which are incorporated by reference in the Company's 1994 Annual Report on Form 10-K, and the Company's Quarterly Reports on Form 10-Q for the periods ended March 31, 1995 and June 30, 1995. Intangible assets represent goodwill and customer lists. Prior periods' financial statements have been reclassified to conform to the 1995 presentation. Foreign Currency Translation Assets and liabilities denominated in foreign currencies are translated at the exchange rate on the balance sheet date, while revenues and expenses are translated at average rates of exchange prevailing during the period. Translation adjustments are accumulated as a separate component of stockholders' equity. Stock Split On July 18, 1995, the Board of Directors approved a two-for-one stock split of the Company's common stock, effected in the form of a 100% stock dividend, paid September 1, 1995 to stockholders of record August 1, 1995. Share and per share data have been restated to reflect this transaction and the March 1995 three-for-two common stock split. The Board also increased the quarterly cash dividend from $.03 per share to $.04 per share paid August 15, 1995 to stockholders of record August 1, 1995. Commitments and Contingencies In September 1995, the Company entered into an agreement to purchase an office building located in Phoenix, Arizona for $32 million to be used for the expansion of its operations. The Company expects to close this transaction in April 1996. In the normal course of its margin lending activities, Schwab is contingently liable to the Options Clearing Corporation for the margin requirement of customer margin securities transactions. Such margin requirement is secured by a pledge of customers' margin securities. This contingent liability was $169 million at September 30, 1995. M&S has been named as one of thirty-three defendant market- making firms in a consolidated class action which is pending in Federal District Court in the Southern District of New York pursuant to an order of the Judicial Panel on Multidistrict Litigation. On December 16, 1994, the plaintiffs filed a consolidated amended complaint purportedly on behalf of certain persons who purchased or sold Nasdaq securities during the period May 1, 1989 through May 27, 1994. A second consolidated amended complaint was filed on August 22, 1995. The consolidated complaint does not set forth any specific conduct by M&S and does not request any specific amount of damages, although it requests that the actual damages be trebled where permitted by statute. The consolidated complaint generally alleges an illegal combination and conspiracy among the defendant market-making firms to fix and maintain the spreads between the bid and ask prices of Nasdaq securities. The ultimate outcome of this consolidated action cannot currently be determined. On June 30, 1995, a class was certified in Civil District Court for the Parish of Orleans in Louisiana for Louisiana residents who purchased or sold securities through Schwab between February 1, 1985 and February 1, 1995 for which Schwab received monetary payments from the market maker or stock dealer who executed the transaction. On August 16, 1995, another class was certified in Civil District Court for the Parish of Natchitoches in Louisiana for residents of all states who purchased or sold securities through Schwab since 1985 for which Schwab received monetary payments from the market maker or stock dealer who executed the transaction. Schwab has appealed both class certifications to the Louisiana Court of Appeals. Schwab has been named as a defendant in eight - 4 -
additional class action lawsuits filed in state courts in Minnesota, Illinois, New York, Texas, Florida and California. The class actions were filed between August 12, 1993 and October 13, 1995, and purport to be brought on behalf of customers of Schwab who purchased or sold securities for which Schwab received monetary payments from the market maker or stock dealer who executed the transaction. The complaints allege that Schwab failed to disclose and remit such payments to members of the class, and generally seek damages equal to the payments received by Schwab. The ultimate outcome of these actions cannot currently be determined. There are other various lawsuits pending against the Company which, in the opinion of management, will be resolved with no material impact on the Company's financial position or results of operations. Acquisition During the third quarter of 1995, the Company purchased the remaining outstanding common stock (approximately 7%) of ShareLink Investment Services plc (ShareLink), bringing the total year-to- date acquisition cost, including acquisition-related expenses, to $66 million. Regulatory Requirements Schwab and M&S are subject to the SEC's Uniform Net Capital Rule and each compute net capital under the alternative method permitted by this Rule, which requires the maintenance of minimum net capital, as defined, of the greater of 2% of aggregate debit balances arising from customer transactions or a minimum dollar amount, which is based on the type of business conducted by the broker-dealer. The minimum dollar amount for both Schwab and M&S is $1 million. Under the alternative method, a broker-dealer may not repay subordinated borrowings, pay cash dividends, or make any unsecured advances or loans to its parent or employees if such payment would result in net capital of less than 5% of aggregate debit balances or less than 120% of its minimum dollar amount requirement. At September 30, 1995, Schwab's net capital was $360 million (10% of aggregate debit balances), which was $285 million in excess of its minimum required net capital and $173 million in excess of 5% of aggregate debit balances. At September 30, 1995, M&S' net capital was $4 million (113% of aggregate debit balances), which was $3 million in excess of its minimum required net capital. Schwab and ShareLink had portions of their cash and investments segregated for the exclusive benefit of customers at September 30, 1995, in accordance with applicable regulations. M&S had no such cash reserve requirement at September 30, 1995. Cash Flow Information Certain information affecting the cash flows of the Company follows (in thousands): <TABLE> <CAPTION> Nine Months Ended September 30, 1995 1994 ---- ---- <S> <C> <C> Income taxes paid $ 61,895 $ 52,434 ======== ======== Interest paid: Customer cash balances $234,381 $117,682 Long-term borrowings 11,221 11,037 Other 13,687 4,924 -------- -------- Total interest paid $259,289 $133,643 ======== ======== </TABLE> - 5 -
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General The Charles Schwab Corporation (CSC) and its subsidiaries (collectively referred to as the Company) provide brokerage and related investment services to customers with 3.3 million active(a) accounts and assets that totaled $169.6 billion at September 30, 1995. With a network of over 200 branch offices, the Company's principal subsidiary, Charles Schwab & Co., Inc. (Schwab), is physically represented in 46 states, the Commonwealth of Puerto Rico and the United Kingdom. Mayer & Schweitzer, Inc. (M&S), a market maker in Nasdaq securities, provides trade execution services to broker-dealers and institutional customers. The Company's business, like that of other securities brokerage firms, is directly affected by fluctuations in volumes and price levels in securities markets, which are in turn affected by many national and international economic and political factors that cannot be predicted. Transaction-based revenues, primarily commission and principal transaction revenues, represent the majority of the Company's revenues. In the short term, most of the Company's expenses do not vary directly with fluctuations in securities trading volume and do not increase or decrease quickly, which could result in the Company experiencing increased profitability with rapid increases in revenues, or reduced profitability (or losses) in the event of a material reduction in revenues. Due to the factors discussed above, the results of any interim period are not necessarily indicative of results for a full year, and it is not unusual for the Company to experience significant variations in quarterly revenue growth. In addition, these factors may subject the Company's future earnings and common stock price to significant volatility. The Company has historically used discount pricing as a tactic in its efforts to gain market share and enhance the value of its services. In recent years, Schwab has introduced additional price- competitive product offerings such as its No-Annual-Fee IRA, its Mutual Fund OneSource (registered trademark) service and its Schwab 500 Brokerage (trademark) service, which includes commission discounts from Schwab's standard rates. Schwab's on-line brokerage services such as TeleBroker (registered trademark) and StreetSmart (registered trademark) also provide customers with discounts on commissions. Management expects to continue aggressive use of this value-pricing philosophy in the marketing of new products and services. Three Months Ended September 30, 1995 Compared To Three Months Ended September 30, 1994 Summary Net income for the third quarter of 1995 totaled $47 million or $.26 per share, up 51% from third quarter 1994 net income of $31 million or $.18 per share. All share and per share amounts reflect the March 1995 three-for-two common stock split and the September 1995 two-for-one common stock split. Third quarter 1995 revenues were $386 million, up 55% from $248 million for the third quarter of 1994, due to increases in all revenue categories primarily resulting from higher trading volume and an increase in customer assets. Assets in customer accounts totaled $169.6 billion at September 30, 1995, $52.9 billion, or 45%, more than a year ago primarily resulting from increases in customers' equity securities of $22.6 billion, or 48%, and increases in customer assets in Schwab's Mutual Fund Marketplace (registered trademark) of $14.5 billion, or 45%. Customer assets in cash and money market funds (a) Accounts with balances or activity within the preceding twelve months. - 6 -
at September 30, 1995 increased 37% over the year-ago level to $35.4 billion. Schwab added 164,400 new customer accounts during the third quarter of 1995, compared to 145,400 new accounts during the third quarter of 1994. Total operating expenses excluding interest during the third quarter of 1995 were $308 million, up 56% from $196 million for the third quarter of 1994, primarily resulting from additional staff to support the Company's continued growth and expansion, higher variable compensation and higher transaction-related expenses. In the third quarter of 1995, the Company continued the expansion of its customer telephone service centers and opened three new branch offices. In 1994's third quarter, the Company instituted certain cost reduction measures, mainly relating to reductions in staffing and capacity expenses, to respond to declines in customer trading activity. Such cost reduction measures were not in place during the third quarter of 1995 as customer trading levels were significantly higher resulting in higher expenses for 1995's third quarter compared to 1994's third quarter. The profit margin for the third quarter of 1995 was 12%, down from 13% for the third quarter of 1994. The return on stockholders' equity for the third quarter of 1995 was 32%, up from 29% for the third quarter of 1994. Commissions Schwab executes commission transactions for customers on an agency basis. Commission revenues totaled $207 million for the third quarter of 1995, up $85 million, or 70%, from the third quarter of 1994. Commissions earned on retail agency trades, which exclude commissions from institutional customers, totaled $194 million on a daily average retail agency trade level of 41,100 in the third quarter of 1995, compared with commission revenues of $116 million on a daily average retail agency trade level of 25,800 for the comparable period in 1994. The following table shows a comparison of certain factors that influence retail agency commission revenues: <TABLE> <CAPTION> - ------------------------------------------------------------------- Three Months Ended September 30, Percent 1995 1994 Change - ------------------------------------------------------------------- <S> <C> <C> <C> Number of customer accounts that traded during the quarter (in thousands) 720 559 29% Average number of retail agency transactions per account that traded 3.59 2.95 22 Total number of retail agency transactions (in thousands) 2,588 1,651 57 Average commission per retail agency transaction $74.85 $70.52 6 Total retail agency commission revenues (in millions) $ 194 $ 116 67 ================================================================== Note: The above table excludes customer transactions in Schwab's Mutual Fund OneSource (registered trademark) service. </TABLE> The increase in average commission per retail agency transaction was due to a higher proportion of equity transactions, which carry a higher average commission per trade. Schwab continues to experience significant commission price competition and expects to continue to develop price-competitive products and services that address the needs of customers for whom pricing is a primary factor in their selection of financial services. Interest Revenue, Net of Interest Expense Interest revenue, net of interest expense, increased $13 million, or 31%, to $55 million from the prior year's third quarter as shown in the following table (in millions): - 7 -
<TABLE> <CAPTION> - ----------------------------------------------------------- Three Months Ended September 30, 1995 1994 - ----------------------------------------------------------- <S> <C> <C> Interest Revenue Investments, customer-related $ 76 $ 46 Margin loans to customers 68 49 Other 5 2 - ----------------------------------------------------------- Total 149 97 - ----------------------------------------------------------- Interest Expense Customer cash balances 84 49 Long-term borrowings 3 3 Other 7 3 - ----------------------------------------------------------- Total 94 55 - ----------------------------------------------------------- Interest Revenue, Net of Interest Expense $55 $42 =========================================================== </TABLE> Customer-related daily average balances, interest rates and average net interest margin for the third quarters of 1995 and 1994 are summarized in the following table (dollars in millions): <TABLE> <CAPTION> - ------------------------------------------------------------------- Three Months Ended September 30, 1995 1994 - ------------------------------------------------------------------- <S> <C> <C> Earning Assets (customer-related): Investments: Average balance outstanding $5,188 $3,919 Average interest rate 5.95% 4.60% Margin loans to customers: Average balance outstanding $3,306 $2,777 Average interest rate 8.31% 6.95% Average yield on earning assets 6.86% 5.58% Funding Sources (customer-related and other): Interest-bearing customer cash balances: Average balance outstanding $6,891 $5,484 Average interest rate 4.95% 3.53% Other interest-bearing sources: Average balance outstanding $ 449 $ 385 Average interest rate 4.46% 3.16% Average noninterest-bearing portion $1,154 $ 827 Average interest rate on funding sources 4.25% 3.08% Summary: Average yield on earning assets 6.86% 5.58% Average interest rate on funding sources 4.25% 3.08% - ------------------------------------------------------------------ Average net interest margin 2.61% 2.50% ================================================================== </TABLE> The increase in interest revenue, net of interest expense, from the prior year's third quarter was primarily due to higher levels of average earning assets compared to funding sources, and to sharper increases in average interest rates on earning assets compared to funding sources. Principal Transactions During the third quarter of 1995, principal transaction revenues increased $18 million, or 52%, from the comparable period in 1994 to $52 million. This increase was due to higher trading volume handled by M&S and higher revenues relating to specialist posts. During the end of 1994's third quarter, Schwab commenced operation of specialist posts on the Pacific Stock Exchange. At September 30, 1995, Schwab had nine posts that collectively made markets in over 420 securities. The increase in principal transaction revenues was partially offset by providing price improvement to customers on certain trades in Nasdaq securities beginning in August 1995 (see discussion below). During 1994, the Department of Justice, the Securities and Exchange Commission (SEC) and the National Association of Securities Dealers, Inc. (NASD) commenced a series of investigations and regulatory actions involving the activities of many market makers in Nasdaq securities. These investigations and regulatory actions have continued into 1995. During the third quarter of 1995, Nasdaq's daily average share volume was 443 million shares, of which orders handled by M&S totaled approximately 8% of such shares. Thus, M&S is a significant participant in the Nasdaq market. Current and proposed rulemaking, regulatory actions, improvements in technology, changes in market practices and new market systems, if approved, could significantly impact the manner in which business is currently conducted in the Nasdaq market. For example, the Company's new service, Assurance Trading (trademark), provides an opportunity for price improvement to customers - 8 -
on certain trades in certain Nasdaq securities through technological innovation by scanning multiple computer systems for a price better than the current quoted Nasdaq inside price. The above factors may, individually or in the aggregate, have a material adverse impact on M&S' future revenues from principal transactions. Mutual Fund Service Fees Mutual fund service fees increased $17 million, or 42%, to $59 million in the third quarter of 1995 from the comparable period in 1994. The increase was primarily attributable to significant increases in customer assets in Schwab's proprietary funds, collectively referred to as the SchwabFunds (registered trademark), and customer assets in funds purchased through Schwab's Mutual Fund OneSource (registered trademark) service. Most of these fees are earned for transfer agent, shareholder and investment management services provided to proprietary money market funds, and for record keeping and shareholder services provided to funds in the Mutual Fund OneSource service. Customer assets invested in the SchwabFunds, substantially all of which are in money market funds, were $29.5 billion at September 30, 1995, compared to $21.0 billion at September 30, 1994, a 40% increase. Customer assets held by Schwab that have been purchased through the Mutual Fund OneSource service, excluding SchwabFunds, totaled $21.8 billion at September 30, 1995, compared to $12.8 billion at September 30, 1994, a 70% increase. Expenses Excluding Interest Total operating expenses excluding interest for the third quarter of 1995 were $308 million, up 56% from $196 million for the third quarter of 1994. Compensation and benefits expense for the third quarter of 1995 increased $58 million, or 56%, to $161 million primarily due to increases in salaries and wages, and variable compensation. At September 30, 1995, the Company had full- time, part-time and temporary employees, and persons employed on a contract basis that represented the equivalent of approximately 8,400 full-time employees, compared to approximately 6,000 at September 30, 1994. Communications expense increased $9 million, or 33%, to $34 million from the prior year's third quarter primarily due to higher customer trading and call volumes, which contributed to higher telephone, financial news and securities quotation services expenses. Occupancy and equipment expense increased $6 million, or 27%, to $28 million from the prior year's third quarter primarily due to increased data processing equipment expense, and to customer telephone service center and branch network expansions. Commissions, clearance and floor brokerage expense increased $11 million, or 101%, to $23 million from the prior year's third quarter primarily due to increases in the number of trades processed by M&S and Schwab. Professional services expense increased $6 million, or 143%, to $11 million from the prior year's third quarter primarily due to increases in consulting fees relating to various company development projects. Other expenses increased $13 million, or 169%, to $21 million from the prior year's third quarter due in part to increases in travel-related expenses, losses relating to trading system problems experienced on two occasions during the quarter, and the handling of customer orders for a security following its initial public offering. The Company's effective income tax rate for the third quarter of 1995 and the third quarter of 1994 was 39.5%. - 9 -
Nine Months Ended September 30, 1995 Compared To Nine Months Ended September 30, 1994 Summary Net income for the first nine months of 1995 totaled $130 million or $.73 per share, compared with net income of $102 million or $.58 per share for the first nine months of 1994. Revenues for the first nine months of 1995 were $1.0 billion, up 29% from $794 million for the first nine months of 1994, due to increases in all revenue categories primarily resulting from higher trading volume and an increase in customer assets. Total operating expenses excluding interest during the first nine months of 1995 were $810 million, up 29% from $626 million for the first nine months of 1994, primarily resulting from additional staff to support the Company's continued growth and expansion, higher variable compensation and higher-transaction related expenses. In the first nine months of 1995, Schwab's trading volume was 11.1 million trades, up 26% from the first nine months of 1994. Also during this period, the Company continued the expansion of its customer telephone service centers and opened five new branch offices. The profit margin for the first nine months of 1995 and the first nine months of 1994 was 13%. The return on stockholders' equity for the first nine months of 1995 was 32%, down from 33% for the first nine months of 1994. Commissions Commission revenues totaled $537 million for the first nine months of 1995, up $123 million, or 30%, from the first nine months of 1994. Commissions earned on retail agency trades, which exclude commissions from institutional customers, totaled $510 million on a daily average retail agency trade level of 36,700 in the first nine months of 1995, compared with commission revenues of $397 million on a daily average retail agency trade level of 29,100 for the comparable period in 1994. The following table shows a comparison of certain factors that influence retail agency commission revenues: <TABLE> <CAPTION> - -------------------------------------------------------------------- Nine Months Ended September 30, Percent 1995 1994 Change - -------------------------------------------------------------------- <S> <C> <C> <C> Number of customer accounts that traded during the period (in thousands) 1,326 1,163 14% Average number of retail agency transactions per account that traded 5.29 4.73 12 Total number of retail agency transactions (in thousands) 7,008 5,506 27 Average commission per retail agency transaction $72.81 $72.08 1 Total retail agency commission revenues (in millions) $ 510 $ 397 28 ==================================================================== Note: The above table excludes customer transactions in Schwab's Mutual Fund OneSource (registered trademark) service. </TABLE> Schwab added 508,200 new customer accounts during the first nine months of 1995, compared to 589,700 new accounts during the first nine months of 1994. The decrease was due in part to the $1,000 minimum opening balance requirement implemented in July 1994 for basic brokerage accounts. Interest Revenue, Net of Interest Expense Interest revenue, net of interest expense, increased $33 million, or 28%, to $151 million from the prior year's first nine months as shown in the following table (in millions): - 10 -
<TABLE> <CAPTION> - ------------------------------------------------------- Nine Months Ended September 30, 1995 1994 - ------------------------------------------------------- <S> <C> <C> Interest Revenue Investments, customer-related $209 $115 Margin loans to customers 188 130 Other 15 6 - ------------------------------------------------------- Total 412 251 - ------------------------------------------------------- Interest Expense Customer cash balances 235 118 Long-term borrowings 9 9 Other 17 6 - ------------------------------------------------------- Total 261 133 - ------------------------------------------------------- Interest Revenue, Net of Interest Expense $151 $118 ======================================================= </TABLE> Customer-related daily average balances, interest rates, and average net interest margin for the first nine months of 1995 and 1994 are summarized in the following table (dollars in millions): <TABLE> <CAPTION> - -------------------------------------------------------------------- Nine Months Ended September 30, 1995 1994 - -------------------------------------------------------------------- <S> <C> <C> Earning Assets (customer-related): Investments: Average balance outstanding $4,701 $3,929 Average interest rate 6.00% 3.91% Margin loans to customers: Average balance outstanding $3,038 $2,704 Average interest rate 8.31% 6.44% Average yield on earning assets 6.91% 4.94% Funding Sources (customer-related and other): Interest-bearing customer cash balances: Average balance outstanding $6,312 $5,413 Average interest rate 5.01% 2.92% Other interest-bearing sources: Average balance outstanding $ 400 $ 351 Average interest rate 4.31% 2.80% Average noninterest-bearing portion $1,027 $ 869 Average interest rate on funding sources 4.31% 2.53% Summary: Average yield on earning assets 6.91% 4.94% Average interest rate on funding sources 4.31% 2.53% - -------------------------------------------------------------------- Average net interest margin 2.60% 2.41% ==================================================================== </TABLE> The increase in interest revenue, net of interest expense, from the first nine months of 1994 was primarily due to higher levels of average earning assets compared to funding sources, and to sharper increases in average interest rates on earning assets compared to funding sources. Principal Transactions Principal transaction revenues increased $23 million, or 19%, from prior year's first nine months to $148 million. This increase was due to higher trading volume handled by M&S and higher revenues relating to specialist posts. The increase in principal transaction revenues was partially offset by the continuing impact, beginning in July 1994, of the NASD Interpretation to its Rules of Fair Practice governing the way in which market makers in Nasdaq securities handle the execution of customer limit orders. The increase in principal transaction revenues was also partially offset by providing price improvement to customers on certain trades in Nasdaq securities beginning in August 1995. Mutual Fund Service Fees and Expenses Excluding Interest The changes in mutual fund service fees and expenses excluding interest between the nine-month periods are generally attributable to the changes described in the comparisons between the three-month periods. The Company's effective income tax rate for the first nine months of 1995 was 39.5% compared to 39.7% for the comparable period in 1994. - 11 -
Liquidity and Capital Resources Liquidity Schwab Liquidity needs relating to customer trading and margin borrowing activities are met primarily through cash balances in customer accounts, which totaled $7.8 billion at September 30, 1995, up 18% from the December 31, 1994 level of $6.7 billion. Earnings from Schwab's operations are the primary source of liquidity for capital expenditures and investments in new services, marketing and technology. Management believes that customer cash balances and operating earnings will continue to be the primary sources of liquidity for Schwab in the future. To manage Schwab's regulatory capital position, CSC provides Schwab with a $180 million subordinated revolving credit facility maturing in September 1996, of which $99 million was outstanding at September 30, 1995. At quarter end, Schwab also had outstanding $25 million in fixed-rate subordinated term loans from CSC maturing in 1997. Borrowings under these subordinated lending arrangements qualify as regulatory capital for Schwab. For use in its brokerage operations, Schwab maintains uncommitted bank credit lines totaling $505 million, of which $425 million is available on an unsecured basis. Schwab used such borrowings for eight days during the first nine months of 1995, with the daily amounts borrowed averaging $24 million. These lines were unused at September 30, 1995. The Charles Schwab Corporation CSC's liquidity needs are generally met through cash generated by its subsidiaries. Schwab and M&S are subject to regulatory requirements that are intended to ensure the general financial soundness and liquidity of broker-dealers. These regulations would prohibit Schwab and M&S from repaying subordinated borrowings to CSC, paying cash dividends, or making any unsecured advances or loans to their parent or employees if such payment would result in net capital of less than 5% of their aggregate debit balances or less than 120% of their minimum dollar amount requirement of $1 million. At September 30, 1995, Schwab had $360 million of net capital (10% of aggregate debit balances), which was $285 million in excess of its minimum required net capital. At September 30, 1995, M&S had $4 million of net capital (113% of aggregate debit balances), which was $3 million in excess of its minimum required net capital. Management believes that funds generated by the operations of CSC's subsidiaries will continue to be the primary funding source in meeting CSC's liquidity needs and maintaining Schwab's and M&S' net capital. CSC has individual liquidity needs that arise from its issued and outstanding $210 million Senior Medium-Term Notes, Series A (Medium-Term Notes), as well as from the funding of cash dividends, common stock repurchases and acquisitions. The Medium-Term Notes have maturities ranging from 1996 to 2003 and fixed interest rates ranging from 4.95% to 7.72% with interest payable semiannually. In August 1995, a prospectus supplement covering the issuance of up to $140 million in Senior or Senior Subordinated Medium-Term Notes, Series A, was filed with the SEC. At September 30, 1995, all $140 million in securities remain unissued under the prospectus supplement. In June 1995, CSC's committed unsecured credit facility with a group of ten banks was increased to $250 million from $225 million. This facility expires in June 1996. The funds are available for general corporate purposes for which CSC pays a commitment fee on the unused balance. The terms of this facility require CSC to maintain minimum levels of stockholders' equity and Schwab and M&S to maintain minimum levels of net capital, as defined. This facility has never been used. - 12 -
See "Commitments and Contingencies" note in the Notes to Condensed Consolidated Financial Statements. Cash Flows Net cash provided by operating activities was $227 million for the first nine months of 1995, up 29% from $176 million for the first nine months of 1994. This increase was primarily due to increases in accrued expenses and net income. During the first nine months of 1995, the Company invested $94 million in equipment and office facilities as it continued to enhance its data processing and telecommunications systems. The Company also continued the expansion of its customer telephone service centers and opened five new branch offices. Capital expenditures may vary significantly from period to period depending upon such factors as general business conditions, the growth in the Company's customer base, and the rate of development of new products and services. In addition, the Company paid approximately $68 million, net of cash received, for businesses acquired, and issued $40 million in Medium- Term Notes during the first nine months of 1995. In addition, the Company paid common stock cash dividends totaling $17 million, up from $12 million paid during the first nine months of 1994. Capital Adequacy The Company's stockholders' equity at September 30, 1995 totaled $621 million. In addition to its equity, the Company had long-term borrowings of $216 million that bear interest at a weighted average rate of 6.22%. These borrowings, together with the Company's equity, provided total financial capital of $837 million at September 30, 1995, up $199 million, or 31% from December 31, 1994. At September 30, 1995, the ratio of total assets to total stockholders' equity was 15 to 1 compared to a ratio of 17 to 1 at December 31, 1994. Over 94% of the Company's total assets relate to customer activity (primarily segregated investments and margin loans). Management believes that the Company's present level of equity could support up to $6.9 billion of additional assets relating to customer activity. PART II - OTHER INFORMATION Item 1. Legal Proceedings Discussed in Notes to Condensed Consolidated Financial Statements, under "Commitments and Contingencies" in Part I, Item 1, and in Management's Discussion and Analysis of Financial Condition and Results of Operations, under "Principal Transactions" in Part I, Item 2, and incorporated herein by reference. Also, see the Company's Quarterly Report on Form 10-Q for the period ended June 30, 1995. Item 2. Changes in Securities None. Item 3. Defaults Upon Senior Securities None. Item 4. Submission of Matters to a Vote of Security Holders None. Item 5. Other Information None. Item 6. Exhibits and Reports on Form 8-K (a) The following exhibits are filed as part of this quarterly report on Form 10-Q. - 13 -
<TABLE> <CAPTION> Exhibit Number Exhibit <S> <C> 10.155 Forms of Restricted Share Award Agreements, incorporating performance vesting provisions and/or supplemental cash payment provisions. 10.156 Agreement of Sale, dated as of September 18, 1995, as amended by letter agreement dated September 21, 1995 and by Second Amendment to Agreement of Sale dated September 22, 1995, between American Express Company and Charles Schwab & Co., Inc., regarding American Express Western Regional Operations Center located at 2423 Lincoln Drive, Phoenix, Arizona. 11.1 Computation of Earnings per Common Equivalent Share. 12.1 Computation of Ratio of Earnings to Fixed Charges. 27.1 Financial Data Schedule (electronic only). </TABLE> (b) Reports on Form 8-K On September 25, 1995, the Registrant filed a Current Report on Form 8-K relating to up to $140 million aggregate principal amount of debt securities issuable by the Registrant pursuant to Registration Statement Numbers 33-61943 and 33-50923 declared effective by the SEC on August 18, 1995 and April 12, 1994, respectively. Certain exhibits relating to Medium-Term Notes, Series A, issuable pursuant to the Registration Statements are contained in the Current Report. - 14 -
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: November 9, 1995 /s/ A. John Gambs ---------------- ------------------------------------- A. John Gambs Executive Vice President - Finance, and Chief Financial Officer - 15 -