-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, A4EWqfbX2jysP2lbNKTiZAV8+8y2Vd/BmwxCj7Canv2qugizgLSzsxs/dP28EnKK 7KGUAMo/W68paeTfUem+tQ== 0000316709-99-000009.txt : 19990512 0000316709-99-000009.hdr.sgml : 19990512 ACCESSION NUMBER: 0000316709-99-000009 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990511 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SCHWAB CHARLES CORP CENTRAL INDEX KEY: 0000316709 STANDARD INDUSTRIAL CLASSIFICATION: SECURITY BROKERS, DEALERS & FLOTATION COMPANIES [6211] IRS NUMBER: 943025021 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-09700 FILM NUMBER: 99616803 BUSINESS ADDRESS: STREET 1: 101 MONTGOMERY ST CITY: SAN FRANCISCO STATE: CA ZIP: 94104 BUSINESS PHONE: 4156277000 MAIL ADDRESS: STREET 1: 101 MONTGOMERY ST CITY: SAN FRANCISCO STATE: CA ZIP: 94104 10-Q 1 FORM 10-Q, FIRST QUARTER 1999 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1999 Commission file number 1-9700 THE CHARLES SCHWAB CORPORATION (Exact name of Registrant as specified in its charter) Delaware 94-3025021 (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 120 Kearny Street, San Francisco, CA 94108 (Address of principal executive offices and zip code) Registrant's telephone number, including area code: (415) 627-7000 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No --- --- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. 408,210,629* shares of $.01 par value Common Stock Outstanding on April 30, 1999 * Reflects the December 1998 three-for-two common stock split. Excludes the effects of the two-for-one common stock split declared April 22, 1999, payable July 1, 1999, and contingent upon shareholder approval of a proposed amendment to the Registrant's Certificate of Incorporation to increase the number of authorized shares of the Registrant's common stock. Voting on this proposed amendment will occur at the May 17, 1999 Annual Meeting of Stockholders. THE CHARLES SCHWAB CORPORATION Quarterly Report on Form 10-Q For the Quarter Ended March 31, 1999 Index Page Part I - Financial Information Item 1. Condensed Consolidated Financial Statements: Statement of Income 1 Balance Sheet 2 Statement of Cash Flows 3 Notes 4-7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 8-20 Item 3. Quantitative and Qualitative Disclosures About Market Risk 20-21 Part II - Other Information Item 1. Legal Proceedings 21 Item 2. Changes in Securities and Use of Proceeds 21 Item 3. Defaults Upon Senior Securities 21 Item 4. Submission of Matters to a Vote of Security Holders 21 Item 5. Other Information 21 Item 6. Exhibits and Reports on Form 8-K 22 Signature 23 FORWARD-LOOKING STATEMENTS In addition to historical information, this interim report contains forward-looking statements that reflect management's expectations. These statements relate to, among other things, Company contingencies, strategy, sources of liquidity, capital expenditures, and the Year 2000 project. Achievement of the expressed expectations is subject to certain risks and uncertainties that could cause actual results to differ materially from those expectations. See "Forward-Looking Statements" in Management's Discussion and Analysis of Financial Condition and Results of Operations in this interim report for a discussion of important factors that may cause such differences. THE CHARLES SCHWAB CORPORATION THE CHARLES SCHWAB CORPORATION 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) Three Months Ended March 31, 1999 1998 ---- ---- Revenues Commissions $472,652 $297,845 Mutual fund service fees 169,295 125,382 Interest revenue, net of interest expense of $173,545 in 1999 and $155,595 in 1998 149,851 104,591 Principal transactions 131,311 52,658 Other 28,476 23,930 - ---------------------------------------------------------------------------------------------------------- Total 951,585 604,406 - ---------------------------------------------------------------------------------------------------------- Expenses Excluding Interest Compensation and benefits 390,214 265,873 Communications 66,763 47,044 Occupancy and equipment 59,975 45,170 Advertising and market development 52,591 40,150 Depreciation and amortization 34,869 34,195 Professional services 32,277 19,047 Commissions, clearance and floor brokerage 24,387 19,349 Other 54,417 21,244 - ---------------------------------------------------------------------------------------------------------- Total 715,493 492,072 - ---------------------------------------------------------------------------------------------------------- Income before taxes on income 236,092 112,334 Taxes on income 93,225 44,370 - ---------------------------------------------------------------------------------------------------------- Net Income $142,867 $ 67,964 ========================================================================================================== Weighted-average common shares outstanding - diluted (1) 419,251 412,240 ========================================================================================================== Earnings Per Share (1) Basic $ .36 $ .17 Diluted $ .34 $ .16 ========================================================================================================== Dividends Declared Per Common Share (1) $ .0280 $ .0267 ========================================================================================================== Pro forma weighted-average common shares outstanding - diluted (2) 838,502 824,481 ========================================================================================================== Pro Forma Earnings Per Share (2) Basic $ .18 $ .09 Diluted $ .17 $ .08 ========================================================================================================== Pro Forma Dividends Declared Per Common Share (2) $ .0140 $ .0133 ==========================================================================================================
(1) Reflects the December 1998 three-for-two common stock split. Excludes the effects of the two-for-one common stock split declared April 22, 1999, payable July 1, 1999, and contingent upon shareholder approval of a proposed amendment to the Company's Certificate of Incorporation to increase the number of authorized shares of the Company's common stock. Voting on this proposed amendment will occur at the May 17, 1999 Annual Meeting of Stockholders. (2) Pro forma amounts include the effects of the two-for-one common stock split declared April 22, 1999, payable July 1, 1999, and contingent upon shareholder approval of a proposed amendment to the Company's Certificate of Incorporation to increase the number of authorized shares of the Company's common stock. Voting on this proposed amendment will occur at the May 17, 1999 Annual Meeting of Stockholders. See Notes to Condensed Consolidated Financial Statements. - 1 -
THE CHARLES SCHWAB CORPORATION CONDENSED CONSOLIDATED BALANCE SHEET (In thousands, except per share amounts) (Unaudited) March 31, December 31, 1999 1998 ---- ---- Assets Cash and cash equivalents $ 1,039,963 $ 1,155,928 Cash and investments required to be segregated under federal or other regulations (including resale agreements of $6,922,726 in 1999 and $7,608,067 in 1998) 9,073,760 10,242,943 Receivable from brokers, dealers and clearing organizations 494,500 334,334 Receivable from customers - net 11,816,585 9,646,140 Securities owned - at market value 316,656 242,115 Equipment, office facilities and property - net 418,890 396,163 Intangible assets - net 48,852 46,274 Other assets 230,073 200,493 - ----------------------------------------------------------------------------------------------------------------- Total $23,439,279 $22,264,390 ================================================================================================================= Liabilities and Stockholders' Equity Drafts payable $ 261,732 $ 324,597 Payable to brokers, dealers and clearing organizations 1,499,503 1,422,300 Payable to customers 19,002,023 18,119,622 Accrued expenses and other liabilities 606,009 618,249 Borrowings 351,080 351,000 - ----------------------------------------------------------------------------------------------------------------- Total liabilities 21,720,347 20,835,768 - ----------------------------------------------------------------------------------------------------------------- Stockholders' equity: Preferred stock - 9,940 shares authorized; $.01 par value per share; none issued Common stock - 500,000 shares authorized; $.01 par value per share; 407,423 and 401,883 shares issued and outstanding in 1999 and 1998, respectively* 4,075 4,019 Additional paid-in capital 405,991 213,312 Retained earnings 1,386,533 1,254,953 Unearned ESOP shares (697) (1,088) Unamortized restricted stock compensation (77,031) (43,882) Foreign currency translation adjustment 61 1,308 - ----------------------------------------------------------------------------------------------------------------- Total stockholders' equity 1,718,932 1,428,622 - ----------------------------------------------------------------------------------------------------------------- Total $23,439,279 $22,264,390 =================================================================================================================
* Reflects the December 1998 three-for-two common stock split. Excludes the effects of the two-for-one common stock split declared April 22, 1999, payable July 1, 1999, and contingent upon shareholder approval of a proposed amendment to the Company's Certificate of Incorporation to increase the number of authorized shares of the Company's common stock. Voting on this proposed amendment will occur at the May 17, 1999 Annual Meeting of Stockholders. See Notes to Condensed Consolidated Financial Statements. - 2 -
THE CHARLES SCHWAB CORPORATION CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (In thousands) (Unaudited) Three Months Ended March 31, 1999 1998 ---- ---- Cash flows from operating activities Net income $ 142,867 $ 67,964 Noncash items included in net income: Depreciation and amortization 34,869 34,195 Compensation payable in common stock 16,759 6,774 Deferred income taxes (2,402) 325 Other 3,717 173 Change in securities owned (74,541) 48,486 Change in other assets (25,951) 45,047 Change in accrued expenses and other liabilities 101,466 6,716 - ------------------------------------------------------------------------------------------------------------ Net cash provided before change in customer-related balances 196,784 209,680 - ------------------------------------------------------------------------------------------------------------ Change in customer-related balances: Cash and investments required to be segregated under federal or other regulations 1,156,233 (1,366,558) Receivable from brokers, dealers and clearing organizations (164,219) (134,552) Receivable from customers (2,175,730) (183,660) Drafts payable (61,896) 19,675 Payable to brokers, dealers and clearing organizations 80,501 158,178 Payable to customers 897,245 1,499,537 - ------------------------------------------------------------------------------------------------------------ Net change in customer-related balances (267,866) (7,380) - ------------------------------------------------------------------------------------------------------------ Net cash provided (used) by operating activities (71,082) 202,300 - ------------------------------------------------------------------------------------------------------------ Cash flows from investing activities Purchase of equipment, office facilities and property - net (44,822) (37,776) Costs of internal-use software (11,140) Cash payments for business acquired, net of cash received (5,657) - ------------------------------------------------------------------------------------------------------------ Net cash used by investing activities (61,619) (37,776) - ------------------------------------------------------------------------------------------------------------ Cash flows from financing activities Dividends paid (11,287) (10,604) Purchase of treasury stock (55,024) Proceeds from stock options exercised and other 28,972 8,594 - ------------------------------------------------------------------------------------------------------------ Net cash provided (used) by financing activities 17,685 (57,034) - ------------------------------------------------------------------------------------------------------------ Effect of exchange rate changes on cash and cash equivalents (949) 265 - ------------------------------------------------------------------------------------------------------------ Increase (decrease) in cash and cash equivalents (115,965) 107,755 Cash and cash equivalents at beginning of period 1,155,928 797,447 - ------------------------------------------------------------------------------------------------------------ Cash and cash equivalents at end of period $1,039,963 $ 905,202 ============================================================================================================
See Notes to Condensed Consolidated Financial Statements. - 3 - THE CHARLES SCHWAB CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 1. Basis of Presentation The accompanying unaudited condensed consolidated financial statements include The Charles Schwab Corporation (CSC) and its subsidiaries (collectively referred to as the Company). CSC is a holding company engaged, through its subsidiaries, in securities brokerage and related financial services. CSC's principal subsidiary, Charles Schwab & Co., Inc. (Schwab), is a securities broker-dealer with 298 domestic branch offices in 47 states, as well as branches in the Commonwealth of Puerto Rico, the United Kingdom and the U.S. Virgin Islands. Another subsidiary, Charles Schwab Europe (CSE) is a retail securities brokerage firm located in the United Kingdom. Other subsidiaries include Charles Schwab Investment Management, Inc., the investment advisor for Schwab's proprietary mutual funds, and Mayer & Schweitzer, Inc. (M&S), a market maker in Nasdaq and other securities providing trade execution services to broker-dealers and institutional customers. These financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) and, in the opinion of management, reflect all adjustments necessary to present fairly the financial position, results of operations and cash flows for the periods presented in conformity with generally accepted accounting principles. All adjustments were of a normal recurring nature. All material intercompany balances and transactions have been eliminated. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's 1998 Annual Report to Stockholders, which are incorporated by reference in the Company's 1998 Annual Report on Form 10-K. The Company's results for any interim period are not necessarily indicative of results for a full year. Certain items in prior periods' financial statements have been reclassified to conform to the 1999 presentation. 2. New Accounting Standard Statement of Financial Accounting Standards (SFAS) No. 133 -- Accounting for Derivative Instruments and Hedging Activities, was issued in June 1998 and the Company is required to adopt this statement by January 1, 2000. This statement establishes accounting and reporting standards requiring that every derivative instrument be recorded on the balance sheet as either an asset or liability, measured at its fair value. The statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met and such hedge accounting treatment is elected. While the Company is currently evaluating the effects of this statement, its adoption is not expected to have a material impact on the Company's financial position, results of operations, earnings per share or cash flows. 3. Costs of Internal-Use Software Statement of Position 98-1 -- Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, was adopted by the Company effective January 1, 1999. This statement requires that certain costs incurred for purchasing or developing software for internal use be capitalized and amortized over the software's estimated useful life of three years. In prior periods, the Company capitalized costs incurred for purchasing internal-use software, but expensed costs incurred for developing internal-use software. In accordance with this statement, prior periods' financial statements were not adjusted to reflect this accounting change. Adoption of this statement resulted in the capitalization of $11 million of internal-use software development costs during the first quarter of 1999, which increased net income by $7 million (net of income taxes of $4 million), or $.02 diluted earnings per share. However, the positive impact to earnings caused by capitalizing these costs versus expensing them was substantially offset by an increase in the Company's development spending in the first quarter of 1999. 4. Comprehensive Income The Company adopted SFAS No. 130 -- Reporting Comprehensive Income, in 1998. This statement establishes standards for the reporting and display of comprehensive income, which includes net income and changes in equity except those resulting from investments by, or distributions to, stockholders. Comprehensive income is as follows (in thousands):
- -------------------------------------------------------------------------------- Three Months Ended March 31, 1999 1998 - -------------------------------------------------------------------------------- Net income $ 142,867 $ 67,964 Foreign currency translation adjustment (1,247) 734 - -------------------------------------------------------------------------------- Total comprehensive income $ 141,620 $ 68,698 ================================================================================
5. Earnings Per Share SFAS No. 128 -- Earnings Per Share, requires a dual presentation of basic and diluted earnings per share (EPS). Basic EPS excludes dilution and is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential reduction in EPS that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Earnings per share under the basic and diluted computations are as follows (in thousands, except per share amounts):
- -------------------------------------------------------------------------------- Three Months Ended March 31, 1999 1998 - -------------------------------------------------------------------------------- Net income $ 142,867 $ 67,964 ================================================================================ Weighted-average common shares outstanding - basic (1) 401,690 397,038 Common stock equivalent shares related to stock incentive plans (1) 17,561 15,202 - -------------------------------------------------------------------------------- Weighted-average common shares outstanding - diluted (1) 419,251 412,240 ================================================================================ Basic earnings per share (1) $ .36 $ .17 ================================================================================ Diluted earnings per share (1) $ .34 $ .16 ================================================================================
(1) Reflects the December 1998 three-for-two common stock split. Excludes the effects of the two-for-one common stock split declared April 22, 1999, payable July 1, 1999, and contingent upon shareholder approval of a proposed amendment to the Company's Certificate of Incorporation to increase the number of authorized shares of the Company's common stock. Voting on this proposed amendment will occur at the May 17, 1999 Annual Meeting of Stockholders. The computation of diluted EPS for the three months ended March 31, 1998 excludes stock options to purchase 4,858,000 shares because the exercise prices for those options were greater than the average market price of the common shares, and therefore the effect would be antidilutive. There were no such antidilutive stock options outstanding at March 31, 1999. 6. Regulatory Requirements Schwab and M&S are subject to the Uniform Net Capital Rule under the Securities Exchange Act of 1934 (the Rule) and each compute net capital under the alternative method permitted by this Rule, which requires the maintenance of minimum net capital, as defined, of the greater of 2% of aggregate debit balances arising from customer transactions or a minimum dollar amount, which is based on the type of business conducted by the broker-dealer. The minimum dollar amount for both Schwab and M&S is $1 million. Under the alternative method, a broker-dealer may not repay subordinated borrowings, pay cash dividends, or make any unsecured advances or loans to its parent or employees if such payment would result in net capital of less than 5% of aggregate debit balances or less than 120% of its minimum dollar amount requirement. At March 31, 1999, Schwab's net capital was $1,158 million (10% of aggregate debit balances), which was $922 million in excess of its minimum required net capital and $570 million in excess of 5% of aggregate debit balances. At March 31, 1999, M&S' net capital was $12 million, which was $11 million in excess of its minimum required net capital. Schwab and CSE had portions of their cash and investments segregated for the exclusive benefit of customers at March 31, 1999, in accordance with applicable regulations. M&S had no such cash reserve requirement at March 31, 1999. 7. Commitments and Contingent Liabilities The Company has recently been contacted by federal, self-regulatory and state regulators as part of an industry-wide examination of online securities trading. While none of these regulators has indicated that it believes the Company has violated any applicable law or regulation relating to online securities trading, these inquiries could possibly result in legislative or regulatory changes or other actions that could adversely affect the Company's financial condition or results of operations. The nature of the Company's business subjects it to numerous regulatory investigations, claims, lawsuits and other proceedings in the ordinary course of its business. The ultimate outcome of these matters cannot be determined at this time, and the results of these legal proceedings cannot be predicted with certainty. There can be no assurance that these matters will not have a material adverse effect on the Company's results of operations in any future period, depending partly on the results for that period, and a substantial judgment could have a material adverse impact on the Company's financial condition and results of operations. However, it is the opinion of management, after consultation with outside legal counsel, that the ultimate outcome of these matters will not have a material adverse impact on the financial condition or operating results of the Company. 8. Segment Information The Company adopted SFAS No. 131 -- Disclosures about Segments of an Enterprise and Related Information in 1998. The Company structures its segments according to its various types of customers and the services provided to those customers. These segments have been aggregated based on similarities in economic characteristics, types of customers, services provided, distribution channels and regulatory environment, into three reportable segments -- Individual Investor, Institutional Investor and Capital Markets. Financial information for the Company's reportable segments is presented in the table below (in thousands). Total revenues from external customers and income before taxes on income are equal to the Company's consolidated amounts as reported in the condensed consolidated statement of income.
- -------------------------------------------------------- Three Months Ended March 31, 1999 1998 - -------------------------------------------------------- Revenues Individual Investor $ 681,104 $ 446,157 Institutional Investor 142,625 101,457 Capital Markets 145,635 64,877 - -------------------------------------------------------- Total $ 969,364 $ 612,491 ======================================================== Intersegment Revenues Individual Investor $ 16,343 $ 7,325 Institutional Investor 681 386 Capital Markets 755 374 - -------------------------------------------------------- Total $ 17,779 $ 8,085 ======================================================== Revenues from External Customers Individual Investor $ 664,761 $ 438,832 Institutional Investor 141,944 101,071 Capital Markets 144,880 64,503 - -------------------------------------------------------- Total $ 951,585 $ 604,406 ======================================================== Income (Loss) Before Taxes on Income Individual Investor $ 168,760 $ 92,307 Institutional Investor 37,078 24,482 Capital Markets 30,254 (4,455) - -------------------------------------------------------- Total $ 236,092 $ 112,334 ========================================================
9. Supplemental Cash Flow Information Certain information affecting the cash flows of the Company follows (in thousands):
- ------------------------------------------------------- Three Months Ended March 31, 1999 1998 - ------------------------------------------------------- Income taxes paid $ 31,695 $ 999 ======================================================= Interest paid: Customer cash balances $154,958 $134,402 Stock-lending activities 11,934 9,366 Borrowings 8,146 11,382 Other 5,204 3,783 - ------------------------------------------------------- Total interest paid $180,242 $158,933 =======================================================
10. Subsequent Events On April 29, 1999, the Company filed a Registration Statement under the Securities Act of 1933 on Form S-3 relating to up to $250 million aggregate principal amount of debt securities. As of the filing date of this quarterly report on Form 10-Q, the Registration Statement has not yet been declared effective by the SEC, and therefore these debt securities are not yet issuable. On April 22, 1999, the Board of Directors approved a two-for-one split of the Company's common stock, which will be effected in the form of a 100% stock dividend. The stock dividend is payable July 1, 1999 to stockholders of record June 1, 1999, and is contingent upon shareholder approval of a proposed amendment to the Company's Certificate of Incorporation to increase the number of authorized shares of the Company's common stock. Voting on this proposed amendment will occur at the May 17, 1999 Annual Meeting of Stockholders. Share and per share data throughout this report have not been restated to reflect this transaction. THE CHARLES SCHWAB CORPORATION Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Description of Business The Charles Schwab Corporation (CSC) and its subsidiaries (collectively referred to as the Company) provide securities brokerage and related financial services for 5.9 million active customer accounts(a). Customer assets in these accounts totaled $542.0 billion at March 31, 1999. CSC's principal subsidiary, Charles Schwab & Co., Inc. (Schwab), is a securities broker-dealer with 298 domestic branch offices in 47 states, as well as branches in the Commonwealth of Puerto Rico, the United Kingdom and the U.S. Virgin Islands. Another subsidiary, Charles Schwab Europe (CSE), is a retail securities brokerage firm located in the United Kingdom. Other subsidiaries include Charles Schwab Investment Management, Inc. (CSIM), the investment advisor for Schwab's proprietary mutual funds, and Mayer & Schweitzer, Inc. (M&S), a market maker in Nasdaq and other securities providing trade execution services to broker-dealers and institutional customers. - -------------------------------------------------------------------------------- (a) Accounts with balances or activity within the preceding eight months. - -------------------------------------------------------------------------------- The Company provides financial services to individuals, institutional customers and broker-dealers through three segments -- Individual Investor, Institutional Investor and Capital Markets. The Individual Investor segment includes the Company's domestic and international retail operations. The Institutional Investor segment provides custodial, trading and support services to independent investment managers, and serves company 401(k) plan sponsors and third-party administrators. The Capital Markets segment provides trade execution services in Nasdaq, exchange-listed and other securities primarily to broker-dealers and institutional customers. The Company's mutual fund services are considered a product and not a segment. Mutual fund service fees are included in both the Individual Investor and Institutional Investor segments. The Company's strategy is to attract and retain customer assets by focusing on a number of areas within the financial services industry -- retail brokerage, mutual funds, support services for independent investment managers, 401(k) defined contribution plans and equity securities market-making. To pursue its strategy and its objective of long-term profitable growth, the Company plans to continue to leverage its competitive advantages. These advantages include a nationally recognized brand, a broad range of products and services, multi-channel delivery systems and an ongoing investment in technology. The Company's nationwide advertising and marketing programs are designed to strengthen the Schwab brand, as well as distinguish its products and services. The Company primarily uses a combination of network, cable and local television, national and local radio, print media, and athletic event sponsorship in its advertising to investors. These programs helped the Company attract $28.3 billion in net new customer assets and open 388,000 new accounts during the first quarter of 1999. The Company offers a broad range of value-oriented products and services to meet customers' varying investment and financial needs, including access to extensive investment research, news and information. The Company's representatives can assist investors in developing asset allocation strategies and evaluating their investment choices, and refer investors who desire additional guidance to independent investment managers through the Schwab AdvisorSource(TM) service. The Company's Mutual Fund Marketplace(R) provides customers with the ability to invest in 1,650 mutual funds from 263 fund families, including 1,011 Mutual Fund OneSource(R) funds. Schwab also provides custodial, trading and support services to approximately 5,500 independent investment managers. As of March 31, 1999, these managers were guiding the investments of 729,000 Schwab customer accounts containing $161.2 billion in assets. The Company responds to changing customer needs with continued product, technology and service innovations. During the first quarter of 1999, the Company launched the Schwab Signature Services(TM) program. This service provides customers who either have at least $100,000 to invest or trade at least 12 times per year with access to a package of services designed to expand as their relationship with Schwab grows. Also during the first quarter of 1999, Schwab introduced the Equity Report Card(TM) and the Positions Monitor(TM), which are Web-based investment evaluation tools that provide comparisons against market benchmarks. Schwab also introduced Schwab Alerts(TM), which enables customers to receive news relating to their investments via e-mail. The Company's multi-channel delivery systems allow customers to choose how they prefer to do business with the Company. To enable customers to obtain services in person with a Company representative, the Company maintains a network of branch offices. The Company's branch office network also provides investors with access to the Internet. Telephonic access to the Company is provided primarily through four regional customer telephone service centers and two online customer support centers that operate both during and after normal market hours. Additionally, customers are able to obtain financial information on an automated basis through the Company's automated telephonic and online channels. Automated telephonic channels include TeleBroker(R), Schwab's touch-tone telephone quote and trading service, and VoiceBroker(TM), Schwab's voice recognition quote and trading service. Online channels include the Charles Schwab Web Site(TM), an information and trading service on the Internet at www.schwab.com, and PC-based services such as SchwabLink(R), a service for investment managers. Schwab provides every retail customer access to all delivery channels and flat-fee pricing for Internet-based trades. The Company's ongoing investment in technology is a key element in expanding its product and service offerings, enhancing its delivery systems, providing fast and consistent customer service, reducing processing costs, and facilitating the Company's ability to handle significant increases in customer activity without a corresponding rise in staffing levels. The Company uses technology to empower its customers to manage their financial affairs and is a leader in driving technological advancements in the financial services industry. During the first quarter of 1999, the Company completed the acquisitions of Canadian-based Priority Brokerage Inc. and Porthmeor Securities Inc. These two companies were combined to create Charles Schwab Canada, Co., a subsidiary of CSC. The cost of these acquisitions was not material to the Company's financial position. Risk Management For discussion on the Company's principal risks and some of the policies and procedures for risk identification, assessment and mitigation, see "Management's Discussion and Analysis of Results of Operations and Financial Condition - Risk Management" in the Company's 1998 Annual Report to Stockholders, which is filed as Exhibit 13.1 to the Company's Form 10-K for the year ended December 31, 1998. See Liquidity and Capital Resources of this report for a discussion on liquidity risk; and see Item 3 - Quantitative and Qualitative Disclosures About Market Risk for additional information relating to market risk. Given the nature of the Company's revenues, expenses and risk profile, the Company's earnings and common stock price may be subject to significant volatility from period to period. The Company's results for any interim period are not necessarily indicative of results for a full year. Risk is inherent in the Company's business. Consequently, despite the Company's attempts to identify areas of risk, oversee operational areas involving risk and implement policies and procedures designed to mitigate risk, there can be no assurance that the Company will not suffer unexpected losses due to operating or other risks. Forward-Looking Statements In addition to historical information, this interim report contains forward-looking statements that reflect management's expectations as of the date hereof. These statements relate to, among other things, Company contingencies (see note "7 - Commitments and Contingent Liabilities" in the Notes to Condensed Consolidated Financial Statements), the Company's strategy (see Description of Business), sources of liquidity (see Liquidity and Capital Resources-Liquidity), capital expenditures (see Liquidity and Capital Resources-Cash Flows and Capital Resources), and the Year 2000 project (see Liquidity and Capital Resources-Year 2000). Achievement of the expressed expectations is subject to certain risks and uncertainties that could cause actual results to differ materially from the expressed expectations described in these statements. Important factors that may cause such differences are noted throughout this interim report, the Company's 1998 Annual Report to Stockholders and the Company's Form 10-K for the year ended December 31, 1998 and include, but are not limited to: the effect of customer trading patterns on Company revenues and earnings; changes in technology; computer system failures; risks associated with the Year 2000 computer systems conversions; the effects of competitors' pricing, product and service decisions and intensified competition; evolving regulation and changing industry practices adversely affecting the Company; adverse results of litigation; the availability of external financing; changes in revenues and profit margin due to cyclical securities markets and interest rates; the level and volatility of equity prices; and a significant downturn in the securities markets over a short period of time or a sustained decline in securities prices and trading volumes. Three Months Ended March 31, 1999 Compared To Three Months Ended March 31, 1998 Financial Overview - ------------------ Net income for the first quarter of 1999 was a record $143 million, up 110% from first quarter 1998 net income of $68 million. Diluted earnings per share for the first quarters of 1999 and 1998 were $.34 and $.16 per share, respectively. Share and per share data throughout this report have been restated to reflect the effects of the December 1998 three-for-two common stock split. Share and per share data throughout this report have not been restated to reflect the effects of the two-for-one common stock split declared April 22, 1999, payable July 1, 1999, and contingent upon shareholder approval of a proposed amendment to the Company's Certificate of Incorporation to increase the number of authorized shares of the Company's common stock. Voting on this proposed amendment will occur at the May 17, 1999 Annual Meeting of Stockholders. Revenues increased mainly due to higher customer trading volume. Revenues of $952 million in the first quarter of 1999 grew $347 million, or 57%, from the first quarter of 1998 due to increases in revenues of $226 million, or 51%, in the Individual Investor segment, $80 million, or 125%, in the Capital Markets segment, and $41 million, or 40%, in the Institutional Investor segment. See note "8 - Segment Information" in the Notes to Condensed Consolidated Financial Statements for financial information by segment. One of the factors contributing to the Company's record performance was the number of online trades executed in the first quarter of 1999. The Company's trading activity reached record levels as shown in the following table (in thousands):
- ------------------------------------------------------------- Three Months Ended March 31, Percent Daily Average Trades 1999 1998 Change - ------------------------------------------------------------- Revenue Trades Online 112.2 42.5 164% TeleBroker(R)and VoiceBroker(TM) 10.1 9.2 10 Regional customer telephone service centers, branch offices and other 40.5 33.7 20 - ------------------------------------------------------------- Total 162.8 85.4 91% ============================================================= Mutual Fund OneSource(R) Trades Online 25.2 17.7 42% TeleBroker and VoiceBroker 1.3 1.2 8 Regional customer telephone service centers, branch offices and other 23.4 21.9 7 - ------------------------------------------------------------- Total 49.9 40.8 22% ============================================================= Total Daily Average Trades Online 137.4 60.2 128% TeleBroker and VoiceBroker 11.4 10.4 10 Regional customer telephone service centers, branch offices and other 63.9 55.6 15 - ------------------------------------------------------------- Total 212.7 126.2 69% =============================================================
Assets in Schwab customer accounts were $542.0 billion at March 31, 1999, an increase of $135.3 billion, or 33%, from a year ago as shown in the table below. This increase from March 31, 1998 resulted from net new customer assets of $88.3 billion and net market gains of $47.0 billion.
- ------------------------------------------------------------- Growth in Schwab Customer Assets and Accounts (In billions, at quarter end, March 31, Percent except as noted) 1999 1998 Change - ------------------------------------------------------------- Assets in Schwab customer accounts Schwab One(R) and other cash equivalents $ 18.5 $ 13.7 35% SchwabFunds(R): Money market funds 74.4 53.3 40 Equity and bond funds 16.4 9.7 69 - ------------------------------------------------------------- Total SchwabFunds 90.8 63.0 44 - ------------------------------------------------------------- Mutual Fund Marketplace(R)(1): Mutual Fund OneSource Retail 39.0 35.4 10 Schwab Institutional(TM)(2) 34.2 31.0 10 - ------------------------------------------------------------- Total Mutual Fund OneSource 73.2 66.4 10 All other 61.8 55.2 12 - ------------------------------------------------------------ Total Mutual Fund Marketplace 135.0 121.6 11 - ------------------------------------------------------------- Total mutual fund assets 225.8 184.6 22 - ------------------------------------------------------------- Equity and other securities(1) 272.2 185.4 47 Fixed income securities 37.2 30.9 20 Margin loans outstanding (11.7) (7.9) 48 - ------------------------------------------------------------- Total $ 542.0 $ 406.7 33% ============================================================= Net growth in assets in Schwab customer accounts (for the quarter ended) Net new customer assets $ 28.3 $ 20.8 Net market gains 22.6 32.2 - ------------------------------------------------------------- Net growth $ 59.9 $ 53.0 ============================================================= New Schwab customer accounts (in thousands, for the quarter ended) 388.2 358.1 8% Active Schwab customer accounts (in millions) (3) 5.9 5.0 18 ============================================================= Active online Schwab customer accounts (in millions) (4) 2.5 1.6 56% Online Schwab customer assets $ 219.0 $ 112.4 95 =============================================================
(1) Excludes money market funds and all of Schwab's proprietary money market, equity and bond funds. (2) Represents assets invested in Mutual Fund OneSource by independent investment managers and retirement plans. (3) Effective with the fourth quarter of 1998, active accounts are defined as accounts with balances or activity within the preceding eight months instead of twelve months as previously defined. This change in definition had the effect of decreasing the number of active accounts by approximately 200,000. Prior quarters have not been restated. (4) Active online accounts are defined as all active accounts within a household that has had at least one online session within the past twelve months. Total operating expenses excluding interest during the first quarter of 1999 were $715 million, up 45% from $492 million for the first quarter of 1998, primarily resulting from additional staff and related costs. The after-tax profit margin for the first quarter of 1999 was 15.0%, up from 11.3% for the first quarter of 1998. The annualized return on stockholders' equity for the first quarter of 1999 was 36%, up from 23% for the first quarter of 1998. REVENUES - -------- Revenues grew $347 million, or 57%, in the first quarter of 1999, due to a $175 million, or 59%, increase in commission revenues and a $79 million, or 149%, increase in principal transaction revenues, as well as a $45 million, or 43%, increase in interest revenue, net of interest expense (referred to as net interest revenue) and a $44 million, or 35%, increase in mutual fund service fees.
- ------------------------------------------------------------- Three Months Ended March 31, Composition of Revenues 1999 1998 - ------------------------------------------------------------- Commissions 50% 49% Principal transactions 14 9 - ------------------------------------------------------------- Total trading revenues 64 58 - ------------------------------------------------------------- Mutual fund service fees 18 21 Net interest revenue 16 17 Other 2 4 - ------------------------------------------------------------- Total non-trading revenues 36 42 - ------------------------------------------------------------- Total 100% 100% =============================================================
Commissions - ----------- The Company earns commission revenues by executing customer trades primarily through the Individual Investor and Institutional Investor segments. These revenues are affected by the number of customer accounts that traded, the average number of commission-generating trades per account, and the average commission per trade. Commission revenues for the Company were $473 million for the first quarter of 1999, up $175 million, or 59%, from the first quarter of 1998. As shown in the table below, the total number of revenue trades executed by the Company has increased 90% as the Company's customer base, as well as customer trading activity per account, has grown. Average commission per revenue trade decreased 16%. This decrease was mainly due to an increase in the proportion of trades placed through the Company's online channels, which charge lower commission per revenue trade than the Company's other channels.
- --------------------------------------------------------- Three Months Commissions Earned Ended on Customer Revenue March 31, Percent Trades 1999 1998 Change - --------------------------------------------------------- Customer accounts that traded during the quarter (in thousands) 1,662 1,195 39% Average customer revenue trades per account 5.98 4.37 37 Total revenue trades (in thousands) 9,940 5,221 90 Average commission per revenue trade $47.72 $56.88 (16) Commissions earned on customer revenue trades (in millions) (1) $ 474 $ 297 60 =========================================================
(1) Includes certain non-commission revenues relating to the execution of customer trades totaling $8 million in the first quarter of 1999 and $5 million in the first quarter of 1998. Excludes commissions on trades relating to specialist operations totaling $7 million in the first quarter of 1999 and $6 million in the first quarter of 1998. Mutual Fund Service Fees - ------------------------ The Company earns mutual fund service fees for recordkeeping and shareholder services provided to third-party funds, and for transfer agent services, shareholder services, administration and investment management provided to its proprietary funds. These fees are based upon the daily balances of customer assets invested in third-party funds and upon the average daily net assets of Schwab's proprietary funds. Mutual fund service fees are earned primarily through the Individual Investor and Institutional Investor segments. Mutual fund service fees were $169 million for the first quarter of 1999, up $44 million, or 35%, from the first quarter of 1998. This increase was primarily due to a significant increase in customer assets in Schwab's proprietary funds, collectively referred to as the SchwabFunds(R), as well as an increase in customer assets in funds purchased through Schwab's Mutual Fund OneSource(R) service. Net Interest Revenue - -------------------- Net interest revenue is the difference between interest earned on assets (mainly margin loans to customers and investments) and interest paid on liabilities (mainly customer cash balances). Net interest revenue is affected by changes in the volume and mix of these assets and liabilities, as well as by fluctuations in interest rates. Substantially all of the Company's net interest revenue is earned by Schwab through the Individual Investor and Institutional Investor segments. Net interest revenue was $150 million for the first quarter of 1999, up $45 million, or 43%, from the first quarter of 1998 as shown in the following table (in millions):
- ------------------------------------------------------------ Three Months Ended March 31, 1999 1998 - ------------------------------------------------------------ Interest Revenue Margin loans to customers $198 $149 Investments, customer-related 111 98 Other 14 13 - ------------------------------------------------------------ Total 323 260 - ------------------------------------------------------------ Interest Expense Customer cash balances 155 138 Stock-lending activities 9 10 Borrowings 6 6 Other 3 1 - ------------------------------------------------------------ Total 173 155 - ------------------------------------------------------------ Net interest revenue $150 $105 ============================================================
Customer-related daily average balances, interest rates and average net interest margin for the first quarters of 1999 and 1998 are summarized in the following table (dollars in millions):
- --------------------------------------------------------------- Three Months Ended March 31, 1999 1998 - --------------------------------------------------------------- Interest-Earning Assets (customer-related): Margin loans to customers: Average balance outstanding $ 9,694 $ 7,357 Average interest rate 4.65% 5.42% Investments: Average balance outstanding $11,083 $ 7,835 Average interest rate 7.25% 7.70% Average yield on interest-earning assets 6.04% 6.60% Funding Sources (customer-related and other): Interest-bearing customer cash balances: Average balance outstanding $16,292 $12,295 Average interest rate 3.86% 4.54% Other interest-bearing sources: Average balance outstanding $ 1,709 $ 1,202 Average interest rate 3.36% 4.56% Average noninterest-bearing portion $ 2,776 $ 1,695 Average interest rate on funding sources 3.30% 4.04% Summary: Average yield on interest-earning assets 6.04% 6.60% Average interest rate on funding sources 3.30% 4.04% - --------------------------------------------------------------- Average net interest margin 2.74% 2.56% ===============================================================
The increase in net interest revenue from the first quarter of 1998 was primarily due to higher average earning asset balances, partially offset by higher average customer cash balances. Principal Transactions - ---------------------- Principal transaction revenues are primarily comprised of net gains from market-making activities in Nasdaq and other securities through the Capital Markets segment. Factors that influence principal transaction revenues include the volume of customer trades, market price volatility, average revenue per share traded and changes in regulations and industry practices. Principal transaction revenues were $131 million for the first quarter of 1999, up $79 million, or 149%, from the first quarter of 1998. This increase was primarily due to higher average revenue per share traded, as well as greater share volume handled by M&S. Expenses Excluding Interest - --------------------------- Compensation and benefits expense was $390 million for the first quarter of 1999, up $124 million, or 47%, from the first quarter of 1998 primarily due to higher variable compensation expense resulting from the Company's financial performance, as well as a greater number of employees. The following table shows a comparison of certain compensation and benefits components and employee data (in thousands):
- ------------------------------------------------------------- Three Months Ended March 31, 1999 1998 - ------------------------------------------------------------- Compensation and benefits expense as a % of revenues 41% 44% Variable compensation as a % of compensation and benefits expense 33% 18% Compensation for temporary employees, contractors and overtime hours as a % of compensation and benefits expense 12% 15% Full-time equivalent employees(1) 14.8 13.4 Revenues per average full-time equivalent employee $67.7 $45.8 =============================================================
(1) Includes full-time, part-time and temporary employees, and persons employed on a contract basis. Communications expense was $67 million in the first quarter of 1999, up $20 million, or 42%, from the first quarter of 1998. The increase was primarily due to higher customer trading volumes, increased customer use of automated telephonic and online channel news, quotation and information services, higher postage costs in connection with higher customer trading volume, and additional leased telephone lines related to online service offerings. Occupancy and equipment expense was $60 million in the first quarter of 1999, up $15 million, or 33%, from the first quarter of 1998. This increase was primarily due to additional lease expenses on the Company's expanded office space, as well as increased maintenance and lease expenses on data processing equipment. Other expenses were $54 million in the first quarter of 1999, up $33 million, or 156%, from the first quarter of 1998. This increase was primarily due to higher volume-related trade errors and bad debts, and an increase in business tax expense. The Company's effective income tax rate for both the first quarter of 1999 and 1998 was 39.5%. Liquidity and Capital Resources Liquidity Schwab Liquidity needs relating to customer trading and margin borrowing activities are met primarily through cash balances in customer accounts, which were $18.5 billion and $17.5 billion at March 31, 1999 and December 31, 1998, respectively. Management believes that customer cash balances and operating earnings will continue to be the primary sources of liquidity for Schwab in the future. Schwab is subject to regulatory requirements that are intended to ensure the general financial soundness and liquidity of broker-dealers. These regulations prohibit Schwab from repaying subordinated borrowings to CSC, paying cash dividends, or making unsecured advances or loans to its parent or employees if such payment would result in net capital of less than 5% of aggregate debit balances or less than 120% of its minimum dollar amount requirement of $1 million. At March 31, 1999, Schwab's net capital was $1,158 million (10% of aggregate debit balances), which was $922 million in excess of its minimum required net capital and $570 million in excess of 5% of aggregate debit balances. Schwab has historically targeted net capital to be 10% of its aggregate debit balances, which primarily consist of customer margin loans. To achieve this target, as customer margin loans have grown, an increasing amount of cash flows have been retained to support aggregate debit balances. To manage Schwab's regulatory capital position, CSC provides Schwab with a $750 million subordinated revolving credit facility maturing in September 2000, of which $590 million was outstanding at March 31, 1999. At quarter end, Schwab also had outstanding $25 million in fixed-rate subordinated term loans from CSC maturing in 2000. Borrowings under these subordinated lending arrangements qualify as regulatory capital for Schwab. To manage short-term liquidity, Schwab maintains uncommitted, unsecured bank credit lines totaling $545 million at March 31, 1999 (these lines are also available for CSC to use). Schwab used such borrowings for 18 days during the first quarter of 1999, with the daily amounts borrowed averaging $139 million. These lines were unused at March 31, 1999. To satisfy the margin requirement of customer option transactions with the Options Clearing Corporation, Schwab had unsecured letter of credit agreements with 10 banks totaling $845 million at March 31, 1999. Schwab pays a fee to maintain these letter of credit agreements. No funds were drawn under these agreements at March 31, 1999. M&S M&S' liquidity needs are generally met through earnings generated by its operations. Most of M&S' assets are liquid, consisting primarily of marketable securities, cash and cash equivalents, and receivable from brokers, dealers and clearing organizations. M&S' liquidity is affected by the same net capital regulatory requirements as Schwab (see discussion above). At March 31, 1999, M&S' net capital was $12 million, which was $11 million in excess of its minimum required net capital. M&S may borrow up to $35 million under a subordinated lending arrangement with CSC maturing in 2000. Borrowings under this arrangement qualify as regulatory capital for M&S. This facility was unused during the first quarter of 1999. CSC CSC's liquidity needs are generally met through cash generated by its subsidiaries, as well as cash provided by external financing. As discussed above, Schwab and M&S are subject to regulatory requirements that may restrict them from certain transactions with CSC. Management believes that funds generated by the operations of CSC's subsidiaries will continue to be the primary funding source in meeting CSC's liquidity needs and maintaining Schwab's and M&S' net capital. CSC has liquidity needs that arise from its issued and outstanding $351 million Senior Medium-Term Notes, Series A (Medium-Term Notes), as well as from the funding of cash dividends, common stock repurchases and acquisitions. The Medium-Term Notes have maturities ranging from 1999 to 2008 and fixed interest rates ranging from 5.78% to 7.72% with interest payable semiannually. The Medium-Term Notes are rated A3 by Moody's Investors Service and A- by Standard & Poor's Ratings Group. As of March 31, 1999, CSC had a prospectus supplement on file with the Securities and Exchange Commission enabling CSC to issue up to $205 million in Senior or Senior Subordinated Medium-Term Notes, Series A. At March 31, 1999, all of these notes remained unissued. See note "10 - Subsequent Events" in Item 1 - Notes to Condensed Consolidated Financial Statements. CSC may borrow under its $350 million committed, unsecured credit facility with a group of nine banks. One-half of the commitments under this facility expires in June 1999, and the other half expires in June 2001. CSC plans to renegotiate the terms for the portion that is due to expire in June 1999. The funds are available for general corporate purposes and CSC pays a commitment fee on the unused balance of this facility. The terms of this facility require CSC to maintain minimum levels of stockholders' equity, and Schwab and M&S to maintain specified levels of net capital, as defined. The Company believes that these restrictions will not have a material effect on its ability to meet future dividend or funding requirements. This facility was unused during the first quarter of 1999. CSC also has access to the $545 million uncommitted, unsecured bank credit lines that are primarily utilized by Schwab to manage short-term liquidity. These lines were not used by CSC during the first quarter of 1999. Cash Flows and Capital Resources Net income plus depreciation and amortization was $178 million for the first quarter of 1999, up 75% from $102 million for the first quarter of 1998, allowing the Company to finance its operations primarily with internally generated funds. Depreciation and amortization expense related to equipment, office facilities and property was $33 million for the first quarter of 1999, as compared to $31 million for the first quarter of 1998, or 3% and 5% of revenues for each period, respectively. Amortization expense related to intangible assets was $2 million for the first quarter of 1999, as compared to $3 million for the first quarter of 1998. The Company's capital expenditures net of proceeds from the sale of fixed assets were $45 million in the first quarter of 1999 and $38 million in the first quarter of 1998, or 5% and 6% of revenues for each period, respectively. Capital expenditures in the first quarter of 1999 were for equipment relating to the Company's information technology systems, telecommunications equipment, leasehold improvements, and additional office furniture and equipment. The Company opened seven new domestic branch offices during the first quarter of 1999, compared to three domestic branch offices opened during the first quarter of 1998. Capital expenditures may vary from period to period as business conditions change. During the first quarter of 1999, 5,028,400 of the Company's stock options, with a range of exercise prices from $1.94 to $28.29, were exercised with cash proceeds received by the Company of $29 million and a related tax benefit of $114 million. This tax benefit is recorded as a reduction in income taxes payable and a corresponding increase in stockholders' equity. During the first quarter of 1999, the Company did not repurchase any common stock. During the first quarter of 1998, the Company repurchased 2,376,000 shares of its common stock for $61 million. Since the inception of the repurchase plan in 1988 through March 31, 1999, the Company has repurchased 66,415,400 shares of its common stock for $314 million. At March 31, 1999, authorization granted by the Company's Board of Directors allows for future repurchases of 1,225,300 shares. In April 1999, the Board of Directors approved a two-for-one split of the Company's common stock, which will be effected in the form of a 100% stock dividend. The stock dividend is payable July 1, 1999 to stockholders of record June 1, 1999, and is contingent upon shareholder approval of a proposed amendment to the Company's Certificate of Incorporation to increase the number of authorized shares of the Company's common stock. Voting on this proposed amendment will occur at the May 17, 1999 Annual Meeting of Stockholders. Share and per share data throughout this report have not been restated to reflect this transaction. During both the first quarter of 1999 and 1998, the Company paid common stock cash dividends totaling $11 million. The Company monitors both the relative composition and absolute level of its capital structure. The Company's total financial capital (borrowings plus stockholders' equity) at March 31, 1999 was $2,070 million, up $290 million, or 16% from December 31, 1998. At March 31, 1999, the Company had borrowings of $351 million, or 17% of total financial capital, that bear interest at a weighted-average rate of 6.70%. At March 31, 1999, the Company's stockholders' equity was $1,719 million, or 83% of total financial capital. Year 2000 Many existing computer programs use only two digits to identify a specific year and therefore may not accurately recognize the upcoming change in the century. If not corrected, many computer applications could fail or create erroneous results by or at the year 2000. Due to the Company's dependence on computer technology to operate its business, and the dependence of the financial services industry on computer technology, the nature and impact of Year 2000 processing failures on the Company's business, financial position, results of operations or cash flows could be material. The Company is currently modifying its computer systems in order to enable its systems to process data and transactions incorporating year 2000 dates without material errors or interruptions. Because systems critical to the Company's functioning other than its computer systems may be affected by the century change, the Company's Year 2000 compliance efforts also encompass facilities and equipment which rely on date-dependent technology, such as building equipment that contains embedded technology. Status of Compliance Efforts - ---------------------------- The Company's Year 2000 compliance efforts are directed towards defined categories of actions, which include awareness, inventory, assessment, remediation, testing, installation, contingency planning and vendor management. With respect to particular business units, the work associated with those categories may be performed in phases or simultaneously with other categories of Year 2000 tasks, depending on the nature of the work to be performed and the technology and business requirements of the specific business unit. For instance, the Company's contingency planning efforts continue simultaneously with testing efforts. Attempting to assure that the Company's mission critical systems achieve Year 2000 compliance, that is, that they will operate without material errors or interruptions when processing data and transactions incorporating year 2000 dates, has received the highest priority in the Company's Year 2000 compliance efforts. "Mission critical" systems means systems critical to the ongoing operation of the business. Currently, the focus of the Company's efforts is testing, continuing contingency planning and vendor management. The Company anticipates that work on the contingency planning and vendor management phases of the project will continue through the century change. The Company anticipates that installation, remediation and associated required testing will be completed by mid-1999. The Company's domestic broker-dealer subsidiaries are participating in the industry-wide test sponsored by the Securities Industry Association which began in March 1999 and extended into the second quarter of 1999. As of March 31, 1999, no material exceptions had been encountered in the course of such tests. The Company's vendor management initiatives include creating inventories of vendors, analyzing the results of the inventories to assess the criticality of specific vendor relationships in order to formulate plans for dealing with possible Year 2000 issues, inquiring directly as to the status of vendors' Year 2000 compliance efforts, and continuing contacts with vendors to monitor the progress of vendors who may not yet have achieved Year 2000 compliance. The vendor management initiatives include computer system vendors as well as vendors of goods and services that comprise or rely upon date-dependent technology, such as embedded technology. As of December 31, 1998, the Company had contacted all significant vendors to ascertain the Year 2000 compliance status of such vendors' products and services. Vendor management initiatives also include joint testing with selected critical vendors, joint contingency planning with selected critical vendors, and addressing Year 2000 concerns with new vendors. As of March 31, 1999, more than 80% of all testable mission critical third-party products and services which vendors have represented to be Year 2000 compliant have been tested by the Company to confirm such compliance. Testing of the remainder of such products and services is continuing. The anticipated completion date for all material vendor compliance efforts for mission critical third-party products and services is July 31, 1999, except for contingency planning efforts which by their nature will be continuing until the century change is completed, and except to the extent of efforts for which completion is dependent on third parties whose actions are beyond the Company's control. The success of the Company's Year 2000 compliance efforts depends in part on parallel efforts being undertaken by vendors and other third parties with which the Company's systems interact and therefore, the Company is taking steps to determine the status of critical third parties' Year 2000 compliance. There can be no assurance that all such third parties will provide accurate and complete information, or that all their systems in fact will achieve full Year 2000 compliance. Third parties' Year 2000 processing failures might have a material adverse impact on the Company's systems and operations. The Company's plan may be affected by regulatory changes, changes in industry practices, and significant systems modifications unrelated to the Year 2000 project including upgrades and additions to capacity, and the cost and continued availability of qualified personnel and other resources. The progress of the Company's Year 2000 compliance efforts is managed and reviewed by senior management and the Company's Year 2000 Corporate Steering Committee, which is responsible for maintaining awareness of Year 2000 issues throughout the Company, monitoring overall progress of the project, resolving issues, and providing strategic direction. The Company's Board of Directors receives regular status reports on the project. Subsidiaries Status Reports Schwab As of March 31, 1999, Schwab had completed the Year 2000 compliance code modifications of its mainframe legacy systems, and had installed all such modified code into its production systems. Year 2000 compliance code modifications and pre-installation testing for all mission critical Schwab systems were more than 90% complete as of March 31, 1999, and installation into production of such modified code is anticipated to be completed by July 31, 1999. Installation into production of mission critical legacy systems which are being replaced, rather than modified, to achieve Year 2000 compliance is scheduled for completion by July 31, 1999. Schwab's testing strategy includes testing both prior to, and subsequent to, installation of remediated software into its production systems. The post-installation testing includes testing of selected systems to confirm Year 2000 readiness, and testing with certain third parties, including vendors and industry tests. CSE As of March 31, 1999, CSE had completed the code modification for all of the code of its mission critical systems. More than 65% of such modified code has been future date tested and installed into CSE's production systems and the remainder is currently undergoing testing. The testing is anticipated to be completed during the second quarter of 1999. CSIM As of December 31, 1998, CSIM had completed the code modification and future date testing for all of the code of its mission critical systems, and such code had been installed into its production systems. M&S As of December 31, 1998, M&S had completed the code modification and future date testing for all of the code of its mission critical systems, and such code had been installed into its production systems. Post-installation testing for Schwab, CSE, CSIM and M&S will continue through July 31, 1999. Contingency Planning and Risks - ------------------------------ The Company commenced its contingency planning efforts in 1997. Its contingency planning process is intended to create, update, and implement, as necessary, plans in the event of Year 2000 errors or failures of third parties with whom the Company interacts or who supply critical services or goods to the Company, or of the Company itself. In management's opinion, currently there is not sufficient reliable information available to enable the Company to determine whether any specific Year 2000 failures are reasonably likely to occur. The Company continues to take steps to reduce this uncertainty through its testing strategy and by participating in industry conferences, communicating with business alliance partners, monitoring the progress of critical vendors, monitoring national and international governmental and industry initiatives, and working with professional consultants and advisors. Given the uncertainty of predicting at this point which, if any, Year 2000 errors or failures are reasonably likely to occur, the Company's contingency planning process targets systems, transactions, processes, and third parties that are deemed to be critical to the Company's business, results of operations, or financial condition. Compliance Cost Estimates - ------------------------- The Company currently estimates that the cost of completing its Year 2000 project, including mission critical and other core brokerage computer systems, distributed applications, facilities, and systems in subsidiaries other than Schwab, but excluding potential costs related to the implementation of contingency plans that address possible Year 2000 failures of third-party systems or the Company's systems, is approximately $80 million to $95 million. The Company's cost estimate excludes the time that may be spent by staff not specifically dedicated to the Year 2000 project. As of March 31, 1999, the Company had incurred approximately $60 million of the estimated cost of the entire project. The estimated cost and timing of the project are based on the Company's estimates, which make numerous assumptions about future events. However, there can be no assurance that these estimates will be correct and actual costs and timing could differ materially from these estimates. The Company has funded and expects to fund all Year 2000 related costs through operating cash flows and a reallocation of the Company's overall developmental spending. This reallocation did not result in the delay of any critical information technology projects. In accordance with generally accepted accounting principles, Year 2000 expenditures are expensed as incurred. Item 3. Quantitative and Qualitative Disclosures About Market Risk Financial Instruments Held For Trading Purposes The Company held government securities and certificates of deposit with a fair value of approximately $23 million and $7 million at March 31, 1999 and 1998, respectively. These securities, and the associated interest rate risk, are not material to the Company's financial position, results of operations or cash flows. Through Schwab and M&S, the Company maintains inventories in exchange-listed and Nasdaq equity securities on both a long and short basis. The fair value of these securities at March 31, 1999 was $50 million in long positions and $32 million in short positions. The fair value of these securities at March 31, 1998 was $32 million in long positions and $38 million in short positions. Using a hypothetical 10% increase or decrease in prices, the potential loss or gain in fair value, respectively, is estimated to be approximately $1,800,000 and $600,000, respectively, due to the offset of change in fair value in long and short positions. In addition, the Company generally enters into exchange-traded option contracts to hedge against potential losses in equity inventory positions, thus reducing this potential loss exposure. This hypothetical 10% change in fair value of these securities at March 31, 1999 and 1998 would not be material to the Company's financial position, results of operations or cash flows. The notional amount and fair value of option contracts were not material to the Company's consolidated balance sheets at March 31, 1999 and 1998. Financial Instruments Held For Purposes Other Than Trading For its working capital and reserves required to be segregated under federal or other regulations, the Company invests in money market funds, resale agreements, certificates of deposit, and commercial paper. Money market funds do not have maturity dates and do not present a material market risk. The other financial instruments, as shown in the following table, are fixed rate investments with short maturities and are not subject to material changes in value due to interest rate movements (dollars in millions):
- -------------------------------------------------------------------------- Principal Amount by Maturity Date Fair Value March 31, 2000 Thereafter 1999 1998 - -------------------------------------------------------------------------- Resale agreements (1) $ 6,923 $6,923 $5,956 Weighted-average interest rate 4.76% Certificates of deposit $ 1,753 $1,753 $1,820 Weighted-average interest rate 4.84% Commercial paper $ 375 $ 375 $ 319 Weighted-average interest rate 5.03% ==========================================================================
(1) Fair value at March 31, 1998 includes resale agreements of $5,846 million included in cash and investments required to be segregated under federal or other regulations and $110 million included in cash and cash equivalents. At March 31, 1999, CSC had $351 million aggregate principal amount of Medium-Term Notes, with fixed interest rates ranging from 5.78% to 7.72%. At March 31, 1998, CSC had $361 million aggregate principal amount of Medium-Term Notes, with fixed interest rates ranging from 5.67% to 7.72%. The Company has fixed cash flow requirements regarding these Medium-Term Notes due to the fixed rate of interest. The fair value of these Medium-Term Notes at March 31, 1999 and 1998, based on estimates of market rates for debt with similar terms and remaining maturities, approximated their carrying amount. The table below presents the principal amount of these Medium-Term Notes by year of maturity (dollars in millions):
- ------------------------------------------------------------ Year Ending Weighted-Average Principal December 31, Interest Rate Amount - ------------------------------------------------------------ 1999 6.8% $ 40 2000 6.3% 48 2001 7.0% 39 2002 7.0% 40 2003 6.4% 43 Thereafter 6.7% 141 ============================================================
The Company maintains investments in mutual funds, approximately $50 million and $45 million at March 31, 1999 and 1998, respectively, to fund obligations under its deferred compensation plan, which is available to certain employees. Any decrease in the fair value of these investments would result in a comparable decrease in the deferred compensation plan obligation and would not affect the Company's financial position, results of operations or cash flows. PART II - OTHER INFORMATION Item 1. Legal Proceedings The discussions of legal proceedings in Notes to Condensed Consolidated Financial Statements, under note "7 - Commitments and Contingent Liabilities" in Part I - Financial Information, Item 1., is incorporated herein by reference. Item 2. Changes in Securities and Use of Proceeds None. Item 3. Defaults Upon Senior Securities None. Item 4. Submission of Matters to a Vote of Security Holders None. Item 5. Other Information As of April 1, 1999, the Company's Management Committee was expanded from 12 to 16 members. The four new members are as follows: Christopher V. Dodds Executive Vice President - Finance Carrie E. Dwyer Executive Vice President, General Counsel and Corporate Secretary John P. McGonigle Executive Vice President - Mutual Funds George A. Rich Executive Vice President - Human Resources The Company's 1999 Annual Meeting of Stockholders will be held on Monday, May 17, 1999 at 2:00 p.m. at the Yerba Buena Center for the Arts Theater, 700 Howard Street, San Francisco, California. Any questions concerning the Annual Meeting should be directed to the Assistant Corporate Secretary at (415) 636-1406. Item 6. Exhibits and Reports on Form 8-K (a) The following exhibits are filed as part of this quarterly report on Form 10-Q. - -------------------------------------------------------------------------------- Exhibit Number Exhibit - -------------------------------------------------------------------------------- 10.204 The Charles Schwab Corporation Deferred Compensation Plan, as amended through January 20, 1999 (supersedes Exhibit 10.199 to the Registrant's Form 10-Q for the quarter ended September 30, 1998). 12.1 Computation of Ratio of Earnings to Fixed Charges. 27.1 Financial Data Schedule (electronic only). - -------------------------------------------------------------------------------- (b) Reports on Form 8-K None. THE CHARLES SCHWAB CORPORATION SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. THE CHARLES SCHWAB CORPORATION (Registrant) Date: May 11, 1999 /s/ Steven L. Scheid ------------ ------------------------------------------ Steven L. Scheid Executive Vice President and Chief Financial Officer EX-10 2 EXHIBIT 10.204 Exhibit 10.204 THE CHARLES SCHWAB CORPORATION DEFERRED COMPENSATION PLAN (AS AMENDED THROUGH JANUARY 20, 1999) THE CHARLES SCHWAB CORPORATION DEFERRED COMPENSATION PLAN TABLE OF CONTENTS Section Page Article I. Purpose 1.1 Establishment of the Plan 2 1.2 Purpose of the Plan 2 Article II. Definitions 2.1 Definitions 3 2.2 Gender and Number 4 Article III. Administration 3.1 Committee and Administrator 5 Article IV. Participants 4.1 Participants 6 Article V. Deferrals 5.1 Salary Deferrals 7 5.2 Deferrals of Bonuses and Other Cash Incentive Compensation 7 5.3 Deferral Procedures 8 5.4 Election of Time and Manner of Payment 8 5.5 Accounts and Earnings 10 5.6 Maintenance of Accounts 11 5.7 Change in Control 11 5.8 Payment of Deferred Amounts 14 5.9 Acceleration of Payment 14 Section Article VI. General Provisions 6.1 Unfunded Obligation 15 6.2 Informal Funding Vehicles 15 6.3 Beneficiary 16 6.4 Incapacity of Participant or Beneficiary 17 6.5 Nonassignment 17 6.6 No Right to Continued Employment 17 6.7 Tax Withholding 17 6.8 Claims Procedure and Arbitration 17 6.9 Termination and Amendment 19 6.10 Applicable Law 19 THE CHARLES SCHWAB CORPORATION DEFERRED COMPENSATION PLAN Article I. Purpose 1.1 Establishment of the Plan. Effective as of July 1, 1994, The Charles Schwab Corporation (hereinafter, the "Company") hereby establishes The Charles Schwab Corporation Deferred Compensation Plan (the "Plan"), as set forth in this document. 1.2 Purpose of the Plan. The Plan permits participating employees to defer the payment of certain cash compensation that they may earn. The opportunity to elect such deferrals is provided in order to help the Company attract and retain key employees. This Plan is unfunded and is maintained primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees. It is accordingly intended to be exempt from the participation, vesting, funding, and fiduciary requirements set forth in Title I of the Employee Retirement Income Security Act of 1974. Article II. Definitions 2.1 Definitions. The following definitions are in addition to any other definitions set forth elsewhere in the Plan. Whenever used in the Plan, the capitalized terms in this section shall have the meanings set forth below unless otherwise required by the context in which they are used: (a) "Administrator" the administrator described in section 3.1 that is selected by the Committee to assist in the administration of the Plan. (b) "Beneficiary" means a person entitled to receive any benefit payments that remain to be paid after a Participant's death, as determined under section 6.3. (c) "Board" means the Board of Directors of the Company. (d) "Company" means The Charles Schwab Corporation, a Delaware corporation. (e) "Category 1 Participant" and "Category 2 Participant" each refer to a specific Participant group and have the meaning set forth in section 4.1. (f) "Committee" means the Compensation Committee of the Board. (g) "Deferral Account" means the account representing deferrals of cash compensation, plus investment adjustments, as described in sections 5.5 and 5.6. (h) "Participant" means any employee who meets the eligibility requirements of the Plan, as set forth in Article 4, and includes, where appropriate to the context, any former employee who is entitled to benefits under this Plan. (i) "Plan" means The Charles Schwab Corporation Deferred Compensation Plan, as in effect from time to time. (j) "Plan Year" means the calendar year. (k) "Retirement" shall mean any termination of employment with the Company and its Subsidiaries for any reason other than death at any time after the Participant has attained age fifty (50), but only if, at the time of such termination, the Participant has been credited with at least seven (7) Years of Service under the Charles Schwab Profit Sharing and Employee Stock Ownership Plan. Provided, however, that with respect to any payments made on account of a deferral election made prior to November 1, 1994, Retirement shall also mean any termination of employment with the Company and its Subsidiaries for any reason other than death after the Participant has attained age 55. (l) "Subsidiary" means a corporation or other business entity in which the Company owns, directly or indirectly, securities with more than 80 percent of the total voting power. (m) "Valuation Date" means each December 31 and any other date designated from time to time by the Committee for the purpose of determining the value of a Participant's Deferral Account balance pursuant to section 5.5. 2.2 Gender and Number. Except when otherwise indicated by the context, any masculine or feminine terminology shall also include the neuter and other gender, and the use of any term in the singular or plural shall also include the opposite number. Article III. Administration 3.1 Committee and Administrator. The Committee shall administer the Plan and may select one or more persons to serve as the Administrator. The Administrator shall perform such administrative functions as the Committee may delegate to it from time to time. Any person selected to serve as the Administrator may, but need not, be a Committee member or an officer or employee of the Company. However, if a person serving as Administrator or a member of the Committee is a Participant, such person may not vote on a matter affecting his interest as a Participant. The Committee shall have discretionary authority to construe and interpret the Plan provisions and resolve any ambiguities thereunder; to prescribe, amend, and rescind administrative rules relating to the Plan; to select the employees who may participate and to terminate the future participation of any such employees; to determine eligibility for benefits under the Plan; and to take all other actions that are necessary or appropriate for the administration of the Plan. Such interpretations, rules, and actions of the Committee shall be final and binding upon all concerned and, in the event of judicial review, shall be entitled to the maximum deference allowable by law. Where the Committee has delegated its responsibility for matters of interpretation and Plan administration to the Administrator, the actions of the Administrator shall constitute actions of the Committee. Article IV. Participants 4.1 Participants. Officers and other key employees of the Company and each of its Subsidiaries shall be eligible to participate in this Plan upon selection by the Committee. To be nominated for participation, an employee must be highly compensated or have significant responsibility for the management, direction and/or success of the Company as a whole or a particular business unit thereof. Directors of the Company who are full-time employees of the Company shall be eligible to participate in the Plan. Participating employees of the Company in the position of executive vice president or above shall be "Category 1 Participants." All other participating employees shall be "Category 2 Participants." Article V. Deferrals 5.1 Salary Deferrals. Each Category 2 Participant selected under section 4.1 may elect to defer up to 50 percent of his regular base salary (subject to the provisions of this Article V). Any such election must be made by entering a deferred compensation agreement with the employer, as evidenced by a form approved by and filed with the Administrator on or before the deadline specified by the Committee (which shall be no earlier than one month prior to the beginning of the election period for which the deferred salary is to be earned). For this purpose, the election period shall be the calendar year; provided, however, that during periods in which the Plan is not in effect for a full calendar year or an employee is not a Participant for a full calendar year, the election period shall be the portion of the calendar year during which the Plan is in effect and the employee is an eligible Participant. Notwithstanding the foregoing, a person who is not a Participant at the beginning of a calendar year shall not be allowed to elect a deferral of compensation that takes effect during that year without the consent of the Committee. Salary deferrals that have been elected shall occur throughout the election period in equal increments for each payroll period. 5.2 Deferrals of Bonuses and Other Cash Incentive Compensation. Each Category 1 Participant and each Category 2 Participant may elect to defer all or any portion (subject to the provisions of this Article V) of any amount that he subsequently earns under an annual cash bonus program and/or a long-term cash incentive compensation program of the Company or a participating Subsidiary. Any such election must be made by entering a deferred compensation agreement with the employer, as evidenced by a form approved by the Committee that is filed with the Administrator on or before the deadline specified by the Committee. For annual cash bonuses, this deadline shall be no earlier than one month prior to the beginning of year (or portion thereof) for which the bonus will be earned. For other cash incentive compensation, this deadline shall be a date no later than six months before the end of the year or other period for which the incentive compensation will be earned. Rules similar to those in section 5.1 shall apply in cases where the Plan is not in existence or an employee is not a Participant for the full period in which an annual cash bonus or long-term incentive compensation award is earned. 5.3 Deferral Procedures. Participants eligible to elect salary deferrals under section 5.1 shall have an opportunity to do so each year. Participants eligible to elect deferrals under section 5.2 shall have a separate opportunity to do so for each cash bonus under an annual bonus program and for each other cash bonus or incentive payment under a long-term incentive plan that they may earn. Unless the Committee specifies other rules for the deferrals that may be elected, the minimum deferral shall be 20 percent of the compensation to which a deferral election applies; and, subject to the maximum percentage allowed under section 5.1 or 5.2, as applicable, deferrals in excess of the minimum allowable percentage may be made only in increments of 10 percent. If a deferral is elected, the election shall be irrevocable with respect to the particular compensation that is subject to the election. Deferral elections shall be made on a form prescribed by the Committee or the Administrator. As provided in section 6.7, any deferral is subject to appropriate tax withholding measures and may be reduced to satisfy tax withholding requirements. 5.4 Election of Time and Manner of Payment. At the time a Participant makes a deferral election under section 5.1 or 5.2, the Participant shall also designate the manner of payment and the date on which payments from his or her Deferral Account shall begin, from among the following options: (i) a lump sum payable by the end of February of any year that the Participant specifies; (ii) a lump sum payable by the end of February in the year immediately following the Participant's Retirement; (iii) a series of annual installments, commencing in any year selected by the Participant and payable each year on or before the end of February, over a period of four years; or (iv) a series of annual installments, commencing in the year following the Participant's Retirement and payable each year on or before the end of February, over a period of five, ten, or fifteen years, as designated by the Participant. However, if a Participant terminates employment for any reason other than Retirement, the payment of the Participant's entire Deferral Account, including any unpaid installments pursuant to clause (iii) above, shall be made in a single lump sum by the end of February in the year next following the year in which the Participant terminates employment, notwithstanding the terms of the Participant's election. Any election of a specified payment date pursuant to clauses (i) or (iii) shall be subject to any restrictions that the Committee may, in its sole discretion, choose to establish in order to limit the number of different payment dates that a Participant may have in effect at one time. A Participant may modify an election of the time for payment under circumstances determined by the Committee, provided that (i) a payment election may not be modified in a manner that would cause payments to commence earlier than the date payments would have commenced absent such modification, and (ii) all payment elections shall become irrevocable one year prior to the date on which payment will commence under the election. If payment is due in the form of a lump sum, the payment shall equal the balance of the Deferral Account being paid, determined as of the Valuation Date coincident with or immediately preceding the payment date. If payment is due in the form of installments, the amount of each installment payment shall be equal to the quotient determined by dividing (A) the value of the portion of the Deferral Account to which the installment payment election applies (determined as of the Valuation Date coincident with or immediately preceding the date the payment is to be made), by (B) the number of years over which the installment payments are to be made, less the number of years in which prior payments attributable to such installment payment election have been made. Notwithstanding the foregoing, however, if earnings or any other amounts credited to a Participant's Deferral Account are not considered performance-based compensation, within the meaning of Section 162(m) of the Internal Revenue Code, and do not otherwise meet Internal Revenue Code conditions allowing the Company and its Subsidiaries to receive a federal income tax deduction for such amounts upon paying them at the time provided under the Participant's election, the payment of such amounts, to the extent in excess of the amount that would be currently tax deductible, shall automatically be deferred until the earliest year that the payment can be deducted. 5.5 Accounts and Earnings. The Company shall establish a Deferral Account for each Participant who has elected a deferral under section 5.1 or 5.2 above, and its accounting records for the Plan with respect to each such Participant shall include a separate Deferral Account or subaccount for each deferral election of the Participant that could cause a payment made at a different time or in a different form from other payments of deferrals elected by the same Participant. Each Deferral Account balance shall reflect the Company's obligation to pay a deferred amount to a Participant or Beneficiary as provided in this Article V. Under procedures approved by the Committee and communicated to Participants, a Participant's Deferral Account balance shall be increased periodically (not less frequently than annually) to reflect an assumed earnings increment, based on an interest rate or other benchmark selected by the Committee and in effect at the time. Until the time for determining the amount to be paid to the Participant or Beneficiary, such assumed earnings shall accrue from each Valuation Date on the Deferral Account balance as of that date and shall be credited to the account as of the next Valuation Date. The rate of earnings may, but need not, be determined with reference to the actual rate of earnings on assets held under any existing grantor trust or other informal funding vehicle that is in effect pursuant to section 6.2. Any method of crediting earnings that is followed from time to time may, with reasonable advance notice to affected Participants, be revoked or revised prospectively as of the beginning of any new Plan Year. Earnings that have been credited for any Plan Year, like deferred amounts that have been previously credited to a Participant, shall not be reduced or eliminated retroactively unless they were credited in error. The crediting of assumed earnings shall not mean that any deferred compensation promise to a Participant is secured by particular investment assets or that the Participant is actually earning interest or any other form of investment income under the Plan. Consistent with the foregoing authority to exercise flexibility in establishing a method for crediting assumed earnings on account balances, the Committee may, but need not, consult with Participants about their investment preferences and may, but need not, institute a program of assumed earnings that tracks the investment performance in a Participant's qualified defined contribution plan account or in an assumed participant-directed investment arrangement. 5.6 Maintenance of Accounts. The Accounts of each Participant shall be entered on the books of the Company and shall represent a liability, payable when due under this Plan, out of the general assets of the Company. Prior to benefits becoming due hereunder, the Company shall expense the liability for such accounts in accordance with policies determined appropriate by the Company's auditors. Except to the extent provided pursuant to the second paragraph of this section 5.6, the Accounts created for a Participant by the Company shall not be funded by a trust or an insurance contract; nor shall any assets of the Company be segregated or identified to such account; nor shall any property or assets of the Company be pledged, encumbered, or otherwise subjected to a lien or security interest for payment of benefits hereunder. Notwithstanding that the amounts to be paid hereunder to Participants constitute an unfunded obligation of the Company, the Company may direct that an amount equal to any portion of the Accounts shall be invested by the Company as the Company, in its sole discretion, shall determine. The Committee may in its sole discretion determine that all or any portion of an amount equal to the Accounts shall be paid into one or more grantor trusts that may be established by the Company for the purpose of providing a potential source of funds to pay Plan benefits. The Company may designate an investment advisor to direct the investment of funds that may be used to pay benefits, including the investment of the assets of any grantor trusts hereunder. 5.7 Change in Control. In the event of a Change in Control (as defined below), the following rules shall apply: (a) All Participants shall continue to have a fully vested, nonforfeitable interest in their Deferral Accounts. (b) Deferrals of amounts for the year that includes the Change in Control shall cease beginning with the first payroll period that follows the Change in Control. (c) A special allocation of earnings on all Deferral Accounts shall be made under section 5.5 as of the date of the Change in Control on a basis no less favorable to Participants than the method being followed prior to the Change in Control. (d) All payments of deferred amounts following a Change in Control, whether or not they have previously begun, shall be made in a cash lump sum no later than 30 days following the Change in Control and, except as provided in section 5.4 with respect to installment payments in progress, shall be in an amount equal to the full Deferral Account balance, as adjusted pursuant to paragraph (c) above, as of the date of the Change in Control. (e) Nothing in this Plan shall prevent a Participant from enforcing any rules in a contract or another plan of the Company or any Subsidiary concerning the method of determining the amount of a bonus, incentive compensation, or other form of compensation to which a Participant may become entitled following a change in control, or the time at which that compensation is to be paid in the event of a change in control. For purposes of this Plan, a "Change in Control" means any of the following: (1) Any "person" who, alone or together with all "affiliates" and "associates" of such person, is or becomes (1) an "acquiring person" or (2) the "beneficial owner" of 35% of the outstanding voting securities of the Company (the terms "person", "affiliates", "associates" and "beneficial owner" are used as such terms are used in the Securities Exchange Act of 1934 and the General Rules and Regulations thereunder); provided, however, that a "Change in Control" shall not be deemed to have occurred if such "person" is Charles R. Schwab, the Company, any subsidiary or any employee benefit plan or employee stock plan of the Company or of any Subsidiary, or any trust or other entity organized, established or holding shares of such voting securities by, for or pursuant to, the terms of any such plan; or (2) Individuals who at the beginning of any period of two consecutive calendar years constitute the Board cease for any reason, during such period, to constitute at least a majority thereof, unless the election, or the nomination for election by the Company's Shareholders, of each new Board Member was approved by a vote of at least three-quarters (3/4) of the Board members then still in office who were Board members at the beginning of such period; or (3) Approval by the shareholders of the Company of: (A) the dissolution or liquidation of the Company; (B) the sale or transfer of substantially all of the Company's business and/or assets to a person or entity which is not a "subsidiary" (any corporation or other entity a majority or more of whose outstanding voting stock or voting power is beneficially owned directly or indirectly by the Company); or (C) an agreement to merge or consolidate, or otherwise reorganize, with one or more entities which are not subsidiaries (as defined in (B) above), as a result of which less than 50% of the outstanding voting securities of the surviving or resulting entity are, or are to be, owned by former shareholders of the Company; or (4) The Board agrees by a majority vote that an event has or is about to occur that, in fairness to the Participants, is tantamount to a Change in Control. A Change of Control shall occur on the first day on which any of the preceding conditions has been satisfied. However, notwithstanding the foregoing, this section 5.7 shall not apply to any Participant who alone or together with one or more other persons acting as a partnership, limited partnership, syndicate, or other group for the purpose of acquiring, holding or disposing of securities of the Company, triggers a "Change in Control" within the meaning of paragraphs (1) and (2) above. 5.8 Payment of Deferred Amounts. A Participant shall have a fully vested, nonforfeitable interest in his or her Deferral Account balance at all times. However, vesting does not confer a right to payment other than in the manner elected by the Participant pursuant to section 5.4 (subject to any modification that may occur pursuant to section 5.5, 5.7 or 5.9). Upon the expiration of a deferral period selected by the Participant in one or more deferral elections, the Company shall pay to such Participant (or to the Participant's Beneficiary, in the case of the Participant's death) an amount equal to the balance of the Participant's Account attributable to such expiring deferral elections, plus assumed earnings (determined by the Company pursuant to section 5.5) thereon. 5.9 Acceleration of Payment. The Committee, in its discretion, upon receipt of a written request from a Participant, may accelerate the payment of all or any portion of the unpaid balance of a Participant's Deferral Account in the event of the Participant's Retirement, death, permanent disability, resignation or termination of employment, or upon its determination that the Participant (or his Beneficiary in the case of his death) has incurred a severe, unforeseeable financial hardship creating an immediate and heavy need for cash that cannot reasonably be satisfied from sources other than an accelerated payment from this Plan. The Committee in making its determination may consider such factors and require such information as it deems appropriate. Article VI. General Provisions 6.1 Unfunded Obligation. The deferred amounts to be paid to Participants pursuant to this Plan constitute unfunded obligations of the Company. Except to the extent specifically provided hereunder, the Company is not required to segregate any monies from its general funds, to create any trusts, or to make any special deposits with respect to this obligation. Title to and beneficial ownership of any investments, including any grantor trust investments which the Company has determined and directed the Administrator to make to fulfill obligations under this Plan shall at all times remain in the Company. Any investments and the creation or maintenance of any trust or Accounts shall not create or constitute a trust or a fiduciary relationship between the Administrator or the Company and a Participant, or otherwise create any vested or beneficial interest in any Participant or his or her Beneficiary or his or her creditors in any assets of the Company whatsoever. The Participants shall have no claim for any changes in the value of any assets which may be invested or reinvested by the Company in an effort to match its liabilities under this Plan. 6.2 Informal Funding Vehicles. Notwithstanding section 6.1, the Company may, but need not, arrange for the establishment and use of a grantor trust or other informal funding vehicle to facilitate the payment of benefits and to discharge the liability of the Company and participating Affiliates under this Plan to the extent of payments actually made from such trust or other informal funding vehicle. Any investments and any creation or maintenance of memorandum accounts or a trust or other informal funding vehicle shall not create or constitute a trust or a fiduciary relationship between the Committee or the Company or an affiliate and a Participant, or otherwise confer on any Participant or Beneficiary or his or her creditors a vested or beneficial interest in any assets of the Company or any Affiliate whatsoever. Participants and Beneficiaries shall have no claim against the Company or any Affiliate for any changes in the value of any assets which may be invested or reinvested by the Company or any Affiliate with respect to this Plan. 6.3 Beneficiary. The term "Beneficiary" shall mean the person or persons to whom payments are to be paid pursuant to the terms of the Plan in the event of the Participant's death. A Participant may designate a Beneficiary on a form provided by the Administrator, executed by the Participant, and delivered to the Administrator. The Administrator may require the consent of the Participant's spouse to a designation if the designation specifies a Beneficiary other than the spouse. Subject to the foregoing, a Participant may change a Beneficiary designation at any time. Subject to the property rights of any prior spouse, if no Beneficiary is designated, if the designation is ineffective, or if the Beneficiary dies before the balance of the Account is paid, the balance shall be paid to the Participant's surviving spouse, or if there is no surviving spouse, to the Participant's estate. 6.4 Incapacity of Participant or Beneficiary. Every person receiving or claiming benefits under the Plan shall be conclusively presumed to be mentally competent and of age until the date on which the Administrator receives a written notice, in a form and manner acceptable to the Administrator, that such person is incompetent or a minor, for whom a guardian or other person legally vested with the care of his person or estate has been appointed; provided, however, that if the Administrator finds that any person to whom a benefit is payable under the Plan is unable to care for his or her affairs because of incompetency, or because he or she is a minor, any payment due (unless a prior claim therefor shall have been made by a duly appointed legal representative) may be paid to the spouse, a child, a parent, a brother or sister, or to any person or institution considered by the Administrator to have incurred expense for such person otherwise entitled to payment. To the extent permitted by law, any such payment so made shall be a complete discharge of liability therefor under the Plan. If a guardian of the estate of any person receiving or claiming benefits under the Plan is appointed by a court of competent jurisdiction, benefit payments may be made to such guardian provided that proper proof of appointment and continuing qualification is furnished in a form and manner acceptable to the Administrator. In the event a person claiming or receiving benefits under the Plan is a minor, payment may be made to the custodian of an account for such person under the Uniform Gifts to Minors Act. To the extent permitted by law, any such payment so made shall be a complete discharge of any liability therefor under the Plan. 6.5 Nonassignment. The right of a Participant or Beneficiary to the payment of any amounts under the Plan may not be assigned, transferred, pledged or encumbered nor shall such right or other interests be subject to attachment, garnishment, execution, or other legal process. 6.6 No Right to Continued Employment. Nothing in the Plan shall be construed to confer upon any Participant any right to continued employment with the Company, nor shall the Plan interfere in any way with the right of the Company to terminate the employment of such Participant at any time without assigning any reason therefor. 6.7 Tax Withholding. Appropriate taxes shall be withheld from cash payments made to Participants pursuant to the Plan. To the extent tax withholding is payable in connection with the Participant's deferral of income rather than in connection with the payment of deferred amounts, such withholding may be made from other wages and salary currently payable to the Participant, or, as determined by the Administrator, the amount of the deferral elected by the Participant may be reduced in order to satisfy required tax withholding for employment taxes and any other taxes. 6.8 Claims Procedure and Arbitration. The Company shall establish a reasonable claims procedure consistent with the requirements of the Employee Retirement Income Security Act of 1974, as amended. Following a Change in Control of the Company (as determined under section 5.8) the claims procedure shall include the following arbitration procedure. Since time will be of the essence in determining whether any payments are due to the Participant under this Plan following a Change in Control, a Participant may submit any claim for payment to arbitration as follows: On or after the second day following the termination of the Participant's employment or other event triggering a right to payment, the claim may be filed with an arbitrator of the Participant's choice by submitting the claim in writing and providing a copy to the Company. The arbitrator must be: (a) a member of the National Academy of Arbitrators or one who currently appears on arbitration panels issued by the Federal Mediation and Conciliation Service or the American Arbitration Association; or (b) a retired judge of the State in which the claimant is a resident who served at the appellate level or higher. The arbitration hearing shall be held within 72 hours (or as soon thereafter as possible) after filing of the claim unless the Participant and the Company agree to a later date. No continuance of said hearing shall be allowed without the mutual consent of the Participant and the Company. Absence from or nonparticipation at the hearing by either party shall not prevent the issuance of an award. Hearing procedures which will expedite the hearing may be ordered at the arbitrator's discretion, and the arbitrator may close the hearing in his or her sole discretion upon deciding he or she has heard sufficient evidence to satisfy issuance of an award. In reaching a decision, the arbitrator shall have no authority to ignore, change, modify, add to or delete from any provision of this Plan, but instead is limited to interpreting this Plan. The arbitrator's award shall be rendered as expeditiously as possible, and unless the arbitrator rules within seven days after the close of the hearing, he will be deemed to have ruled in favor of the Participant. If the arbitrator finds that any payment is due to the Participant from the Company, the arbitrator shall order the Company to pay that amount to the Participant within 48 hours after the decision is rendered. The award of the arbitrator shall be final and binding upon the Participant and the Company. Judgment upon the award rendered by the arbitrator may be entered in any court in any State of the United States. In the case of any arbitration regarding this Agreement, the Participant shall be awarded the Participant's costs, including attorney's fees. Such fee award may not be offset against the deferred compensation due hereunder. The Company shall pay the arbitrator's fee and all necessary expenses of the hearing, including stenographic reporter if employed. 6.9 Termination and Amendment. The Committee may from time to time amend, suspend or terminate the Plan, in whole or in part, and if the Plan is suspended or terminated, the Committee may reinstate any or all of its provisions. Except as otherwise required by law, the Committee may delegate to the Administrator all or any of its foregoing powers to amend, suspend, or terminate the Plan. Any such amendment, suspension, or termination may affect future deferrals without the consent of any Participant or Beneficiary. However, with respect to deferrals that have already occurred, no amendment, suspension or termination may impair the right of a Participant or a designated Beneficiary to receive payment of the related deferred compensation in accordance with the terms of the Plan prior to the effective date of such amendment, suspension or termination, unless the affected Participant or Beneficiary gives his express written consent to the change. 6.10 Applicable Law. The Plan shall be construed and governed in accordance with applicable federal law and, to the extent not preempted by such federal law, the laws of the State of California. EX-12 3 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES EXHIBIT 12.1
THE CHARLES SCHWAB CORPORATION Computation of Ratio of Earnings to Fixed Charges (Dollar amounts in thousands, unaudited) Three Months Ended March 31, 1999 1998 ---- ---- Earnings before taxes on income $ 236,092 $ 112,334 - ------------------------------------------------------------------------------------------------------------------ Fixed charges Interest expense - customer 155,000 137,672 Interest expense - other 18,545 17,923 Interest portion of rental expense 9,255 7,399 - ------------------------------------------------------------------------------------------------------------------ Total fixed charges (A) 182,800 162,994 - ------------------------------------------------------------------------------------------------------------------ Earnings before taxes on income and fixed charges (B) $ 418,892 $ 275,328 ================================================================================================================== Ratio of earnings to fixed charges (B) divided by (A)* 2.3 1.7 ================================================================================================================== Ratio of earnings to fixed charges excluding customer interest expense** 9.5 5.4 ================================================================================================================== * The ratio of earnings to fixed charges is calculated in a manner consistent with SEC requirements. For such purposes, "earnings" consist of earnings before taxes on income and fixed charges. "Fixed charges" consist of interest expense incurred on payable to customers, borrowings and one-third of rental expense, which is estimated to be representative of the interest factor. ** Because interest expense incurred in connection with payable to customers is completely offset by interest revenue on related investments and margin loans, the Company considers such interest to be an operating expense. Accordingly, the ratio of earnings to fixed charges excluding customer interest expense reflects the elimination of such interest expense as a fixed charge.
EX-27 4 EXHIBIT 27.1 FDS
BD This schedule contains summary financial information extracted from the Condensed Consolidated Statement of Income and Condensed Consolidated Balance Sheet of the Company's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1999, and is qualified in its entirety by reference to such financial statements. 1000 3-mos Dec-31-1999 Mar-31-1999 3,190,997 12,311,085 6,922,726 0 316,656 418,890 23,439,279 261,732 20,501,526 0 0 0 351,080 0 0 4,075 1,714,857 23,439,279 131,311 323,396 472,652 0 169,295 173,545 390,214 236,092 142,867 0 0 142,867 .36 .34 The information has been prepared in accordance with SFAS No. 128. Basic and diluted EPS have been entered in place of primary and fully diluted, respectively. Excludes the effects of the two-for-one common stock split declared April 22, 1999, payable July 1, 1999, and contingent upon shareholder approval of a proposed amendment to the Company's Certificate of Incorporation to increase the number of authorized shares of the Company's common stock. Voting on this proposed amendment will occur at the May 17, 1999 Annual Meeting of Stockholders.
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