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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002 Commission file number 1-9700
THE CHARLES SCHWAB CORPORATION
(Exact name of Registrant as specified in its charter)
Delaware 94-3025021
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
120 Kearny Street, San Francisco, CA 94108
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (415) 627-7000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes x No
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
1,343,647,397 shares of $.01 par value Common Stock
Outstanding on October 31, 2002
THE CHARLES SCHWAB CORPORATION
Quarterly Report on Form 10-Q
For the Quarter Ended September 30, 2002
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 - 10
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 11 - 27
Item 3. Quantitative and Qualitative Disclosures About Market Risk 27 - 29
Item 4. Controls and Procedures 29
Part II - Other Information
Item 1. Legal Proceedings 29 - 30
Item 2. Changes in Securities and Use of Proceeds 30
Item 3. Defaults Upon Senior Securities 30
Item 4. Submission of Matters to a Vote of Security Holders 30
Item 5. Other Information 31
Item 6. Exhibits and Reports on Form 8-K 31
Signature 32
Certifications 33 - 35
Part I - FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
THE CHARLES SCHWAB CORPORATION
Condensed Consolidated Statement of Income
(In millions, except per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
-----------------------------------------------------------------------------------------------------------------------------------
Revenues
Asset management and administration fees $ 434 $ 420 $1,325 $1,239
Commissions 309 276 906 1,025
Interest revenue 295 431 920 1,509
Interest expense (86) (201) (272) (790)
------- ------- ------- -------
Net interest revenue 209 230 648 719
Principal transactions 47 42 147 192
Other 32 55 113 119
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Total 1,031 1,023 3,139 3,294
-----------------------------------------------------------------------------------------------------------------------------------
Expenses Excluding Interest
Compensation and benefits 472 461 1,413 1,433
Other compensation - merger retention programs 14 22 44
Occupancy and equipment 113 127 349 372
Communications 63 79 200 264
Depreciation and amortization 79 85 243 252
Advertising and market development 51 41 156 185
Professional services 42 38 138 144
Commissions, clearance and floor brokerage 20 20 55 71
Goodwill amortization 17 49
Restructuring and other charges 160 99 190 244
Other 36 16 92 72
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Total 1,036 997 2,858 3,130
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Income (loss) before taxes on income (loss) and extraordinary gain (5) 26 281 164
Tax expense (benefit) on income (loss) (1) 13 105 73
-----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before extraordinary gain (4) 13 176 91
Extraordinary gain on sale of corporate trust business, net of tax 12 121
-----------------------------------------------------------------------------------------------------------------------------------
Net Income (Loss) $ (4) $ 13 $ 188 $ 212
===================================================================================================================================
Weighted-Average Common Shares Outstanding - Diluted 1,358 1,395 1,382 1,403
===================================================================================================================================
Earnings Per Share - Basic
Income (loss) before extraordinary gain $ .00 $ .01 $ .13 $ .07
Extraordinary gain, net of tax $ .01 $ .08
Net income (loss) $ .00 $ .01 $ .14 $ .15
Earnings Per Share - Diluted
Income (loss) before extraordinary gain $ .00 $ .01 $ .13 $ .07
Extraordinary gain, net of tax $ .01 $ .08
Net income (loss) $ .00 $ .01 $ .14 $ .15
===================================================================================================================================
Dividends Declared Per Common Share $.0110 $.0110 $.0330 $.0330
===================================================================================================================================
See Notes to Condensed Consolidated Financial Statements.
- 1 -
THE CHARLES SCHWAB CORPORATION
Condensed Consolidated Balance Sheet
(In millions, except share and per share amounts)
(Unaudited)
September 30, December 31,
2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Assets
Cash and cash equivalents $ 2,502 $ 4,407
Cash and investments segregated and on deposit for federal or other
regulatory purposes(1) (including resale agreements of $15,163 in 2002
and $14,811 in 2001) 19,216 17,741
Securities owned - at market value (including securities pledged of $406
in 2002 and $185 in 2001) 1,883 1,700
Receivables from brokers, dealers and clearing organizations 197 446
Receivables from brokerage clients - net 7,051 9,620
Loans to banking clients - net 4,334 4,046
Equipment, office facilities and property - net 917 1,058
Goodwill - net 627 628
Other assets 841 818
- ------------------------------------------------------------------------------------------------------------------------------------
Total $ 37,568 $ 40,464
====================================================================================================================================
Liabilities and Stockholders' Equity
Deposits from banking clients $ 4,700 $ 5,448
Drafts payable 218 396
Payables to brokers, dealers and clearing organizations 1,101 833
Payables to brokerage clients 24,776 26,989
Accrued expenses and other liabilities 1,218 1,327
Short-term borrowings 760 578
Long-term debt 652 730
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities 33,425 36,301
- ------------------------------------------------------------------------------------------------------------------------------------
Stockholders' equity:
Preferred stock - 9,940,000 shares authorized; $.01 par value per share;
none issued
Common stock - 3 billion shares authorized; $.01 par value per share;
1,391,990,776 and 1,391,673,494 shares issued in 2002 and 2001, respectively 14 14
Additional paid-in capital 1,737 1,726
Retained earnings 2,882 2,794
Treasury stock - 41,531,809 and 23,110,972 shares in 2002 and 2001,
respectively, at cost (431) (295)
Unamortized stock-based compensation (37) (39)
Accumulated other comprehensive loss (22) (37)
- ------------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 4,143 4,163
- ------------------------------------------------------------------------------------------------------------------------------------
Total $ 37,568 $ 40,464
====================================================================================================================================
(1) Amounts included represent actual balances on deposit, whereas cash and investments required to be segregated for federal or
other regulatory purposes were $19,151 million and $18,261 million at September 30, 2002 and December 31, 2001, respectively.
On October 2, 2002, the Company deposited an additional $309 million into its segregated cash portfolio. As of January 3, 2002,
the Company had deposited $710 million to meet its segregated cash requirement.
See Notes to Condensed Consolidated Financial Statements.
- 2 -
THE CHARLES SCHWAB CORPORATION
Condensed Consolidated Statement of Cash Flows
(In millions)
(Unaudited)
Nine Months Ended
September 30,
2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities
Net income $ 188 $ 212
Adjustments to reconcile net income to net cash used for operating activities:
Depreciation and amortization 243 252
Goodwill amortization 49
Compensation payable in common stock 19 25
Deferred income taxes 44 (25)
Tax benefits from stock options exercised and other stock-based compensation 3 27
Non-cash restructuring and other charges 17 49
Net gain on sale of an investment (26)
Extraordinary gain on sale of corporate trust business, net of tax (12) (121)
Other (4) 7
Net change in:
Cash and investments segregated and on deposit for federal or other
regulatory purposes (1,531) (6,231)
Securities owned (excluding securities available for sale) 42 36
Receivables from brokers, dealers and clearing organizations 245 7
Receivables from brokerage clients 2,540 7,000
Other assets (61) (11)
Drafts payable (177) (264)
Payables to brokers, dealers and clearing organizations 269 (263)
Payables to brokerage clients (2,134) (1,314)
Accrued expenses and other liabilities (69) (162)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash used for operating activities (378) (753)
- ------------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Purchases of securities available for sale (1,085) (871)
Proceeds from sales of securities available for sale 578 399
Proceeds from maturities, calls and mandatory redemptions of securities
available for sale 275 377
Net increase in loans to banking clients (483) (657)
Proceeds from sale of banking client loans 196
Purchase of equipment, office facilities and property - net (114) (266)
Cash payments for business combinations and investments, net of cash received (24)
Proceeds from sales of investments 49
Proceeds from sale of Canadian operations 26
Proceeds from sale of corporate trust business 273
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash used for investing activities (607) (720)
- ------------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities
Net change in deposits from banking clients (748) 64
Net increase in short-term borrowings 182 668
Proceeds from long-term debt 100
Repayment of long-term debt (203) (35)
Dividends paid (45) (46)
Purchase of treasury stock (230) (315)
Proceeds from stock options exercised 23 21
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) financing activities (921) 357
- ------------------------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents 1 1
- ------------------------------------------------------------------------------------------------------------------------------------
Decrease in Cash and Cash Equivalents (1,905) (1,115)
Cash and Cash Equivalents at Beginning of Period 4,407 4,876
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and Cash Equivalents at End of Period $ 2,502 $ 3,761
====================================================================================================================================
See Notes to Condensed Consolidated Financial Statements.
- 3 -
THE CHARLES SCHWAB CORPORATION
Notes to Condensed Consolidated Financial Statements
(Tabular Amounts in Millions, Except Per Share Amounts and Ratios)
(Unaudited)
1. Basis of Presentation
The Charles Schwab Corporation (CSC) is a financial holding company
engaged, through its subsidiaries, in securities brokerage and related financial
services. Charles Schwab & Co., Inc. (Schwab) is a securities broker-dealer with
394 domestic branch offices in 48 states, as well as a branch in the
Commonwealth of Puerto Rico. U.S. Trust Corporation (USTC, and with its
subsidiaries collectively referred to as U.S. Trust) is a wealth management firm
that through its subsidiaries also provides fiduciary services and private
banking services with 34 offices in 12 states. Other subsidiaries include
Charles Schwab Europe, a retail securities brokerage firm located in the United
Kingdom, Charles Schwab Investment Management, Inc., the investment advisor for
Schwab's proprietary mutual funds, Schwab Capital Markets L.P. (SCM), a market
maker in Nasdaq and other securities providing trade execution services
primarily to broker-dealers and institutional clients, and CyberTrader, Inc.
(CyberTrader), an electronic trading technology and brokerage firm providing
services to highly active, online investors.
The accompanying unaudited condensed consolidated financial statements
include CSC and its majority-owned subsidiaries (collectively referred to as the
Company). These financial statements have been prepared pursuant to the rules
and regulations of the Securities and Exchange Commission and, in the opinion of
management, reflect all adjustments necessary to present fairly the financial
position, results of operations, and cash flows for the periods presented in
conformity with accounting principles generally accepted in the U.S. All
adjustments were of a normal recurring nature, except as discussed in Note "2 -
Accounting Change." Certain items in prior periods' financial statements have
been reclassified to conform to the 2002 presentation. 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 2001 Annual Report to Stockholders on
Form 10-K and the Company's Quarterly Report on Form 10-Q for the periods ended
March 31, 2002 and June 30, 2002. The Company's results for any interim period
are not necessarily indicative of results for a full year or any other interim
period.
2. Accounting Change
Statement of Financial Accounting Standards (SFAS) No. 142 - Goodwill and
Other Intangible Assets, was issued in June 2001. Under the provisions of SFAS
No. 142, companies are no longer permitted to amortize goodwill and certain
intangible assets with an indefinite useful life. Instead, these assets must be
reviewed at least annually for possible impairment under new criteria. The
Company adopted SFAS No. 142 and accordingly discontinued the amortization of
goodwill as of January 1, 2002. During the second quarter of 2002, the Company
completed the transitional goodwill impairment test as required and did not
record any impairment charges. Except for the cessation of goodwill
amortization, the adoption of SFAS No. 142 did not have a material impact on the
Company's financial position, results of operations, earnings per share (EPS),
or cash flows.
The decrease in goodwill during the first nine months of 2002 was primarily
due to the sale of the Company's Canadian operations, partially offset by the
effects of foreign currency translation adjustments. The carrying amount of
goodwill, net of accumulated amortization, attributable to each of the Company's
reportable segments is presented in the following table:
- --------------------------------------------------------------------------------
September 30, December 31,
2002 2001
- --------------------------------------------------------------------------------
Individual Investor $ 438 $ 440
Institutional Investor 5 5
Capital Markets 25 25
U.S. Trust 159 158
- --------------------------------------------------------------------------------
Total $ 627 $ 628
================================================================================
The following table compares net income and EPS for the three and nine
months ended September 30, 2002, which excludes goodwill amortization, with net
income and EPS for the three and nine months ended September 30, 2001, which has
been adjusted to exclude goodwill amortization.
- 4 -
- --------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
2002 2001 2002 2001
(Reported) (Adjusted)(Reported)(Adjusted)
- --------------------------------------------------------------------------------
Net income:
Reported income (loss)
before extraordinary gain $ (4) $ 13 $ 176 $ 91
Add: Goodwill amortization,
net of tax 17 49
- --------------------------------------------------------------------------------
Reported/adjusted
income (loss) before
extraordinary gain (4) 30 176 140
Extraordinary gain, net of tax 12 121
- --------------------------------------------------------------------------------
Reported/adjusted
net income (loss) $ (4) $ 30 $ 188 $ 261
================================================================================
Basic and diluted EPS:
Reported EPS before
extraordinary gain $ .00 $ .01 $ .13 $ .07
Add: Goodwill amortization .01 .03
- --------------------------------------------------------------------------------
Reported/adjusted EPS before
extraordinary gain .00 .02 .13 .10
Extraordinary gain, net of tax .01 .08
- --------------------------------------------------------------------------------
Reported/adjusted EPS $ .00 $ .02 $ .14 $ .18
================================================================================
3. New Accounting Standards
Long-Lived Assets: SFAS No.144 - Accounting for the Impairment or Disposal
of Long-Lived Assets was issued in August 2001 and addresses the financial
accounting and reporting for the impairment or disposal of long-lived assets
(e.g., equipment and office facilities). This statement supersedes SFAS No. 121
- - Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of, and certain accounting and reporting provisions of Accounting
Principles Board Opinion No. 30 - Reporting the Results of Operations. The
Company adopted this statement on January 1, 2002. The adoption of SFAS No. 144
did not have a material impact on the Company's financial position, results of
operations, EPS, or cash flows.
SFAS No. 146 - Accounting for Costs Associated with Exit or Disposal
Activities was issued in June 2002 and addresses accounting for restructuring
and similar costs. SFAS No. 146 supersedes previous accounting guidance,
principally Emerging Issues Task Force Issue No. 94-3 - Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring). SFAS No. 146 may affect
the timing of recognizing future restructuring costs, as well as the amounts
recognized. The Company is required to adopt this statement for exit or disposal
activities initiated after December 31, 2002.
4. Restructuring
The Company recorded pre-tax restructuring charges for the third quarter of
2002 and the nine months ended September 30, 2002 as follows:
- --------------------------------------------------------------------------------
Three Nine
Period ended September 30, 2002 Months Months
- --------------------------------------------------------------------------------
2002 Initiatives $ 94 $ 94
2001 Initiatives 66 96
- --------------------------------------------------------------------------------
Total restructuring charges $ 160 $ 190
================================================================================
2002 Initiatives
In the third quarter of 2002, the Company commenced additional
restructuring initiatives due to continued difficult market conditions. These
initiatives are intended to reduce operating expenses and adjust the Company's
organizational structure to improve productivity, enhance efficiency, and
increase profitability. The restructuring initiatives include further reductions
in workforce and facilities. The Company recorded pre-tax restructuring charges
of $94 million in the third quarter of 2002 related to these restructuring
initiatives. The Company expects to recognize additional restructuring charges
during the fourth quarter of 2002 as it completes these restructuring
initiatives. The actual costs of these restructuring initiatives could differ
from the estimated costs, depending primarily on the Company's ability to
sublease properties.
Workforce: During the third quarter of 2002, the Company closed its telephone
service center in Austin, Texas, eliminating 300 jobs, and also eliminated 70
support and administrative positions across its four other service centers
located in Denver, Indianapolis, Orlando, and Phoenix. The Company recorded
charges of $12 million related to these workforce reductions in the third
quarter of 2002. Additionally, the Company expects that reductions in full-time
equivalent employees in the fourth quarter of 2002 will total approximately
1,900, including approximately 1,750 through mandatory staff reductions and
approximately 150 related to a reduction in contractors. The workforce reduction
encompasses employees from all of the Company's segments. In the third quarter
of 2002, the Company recorded charges of $32 million related to the 60-day
notice period provided to these impacted employees (excluding contractors). The
remaining severance pay and benefits, which become contractual obligations only
when the impacted employee signs a severance agreement, will be recorded in the
fourth quarter of 2002.
- 5 -
Facilities: The restructuring charges recognized in the third quarter of 2002
include facility exit costs which are net of estimated sublease income. The
restructuring charges also include write-downs of leasehold improvements,
telecommunications infrastructure, and fixed assets removed from service at
these facilities.
A summary of pre-tax restructuring charges related to the Company's 2002
restructuring initiatives for the third quarter of 2002 and the nine months
ended September 30, 2002 is as follows:
- --------------------------------------------------------------------------------
Three and nine months ended September 30, 2002
- --------------------------------------------------------------------------------
Workforce reduction:
Severance pay and benefits $ 43
Non-cash compensation expense for officers' stock options 1
- --------------------------------------------------------------------------------
Total workforce reduction 44
- --------------------------------------------------------------------------------
Facilities reduction:
Non-cancelable lease costs, net of estimated sublease income 37
Write-downs of leasehold improvements, telecommunications
infrastructure, and fixed assets removed from service 13
- --------------------------------------------------------------------------------
Total facilities reduction 50
- --------------------------------------------------------------------------------
Total restructuring charges $ 94
================================================================================
A summary of the activity in the restructuring liability related to the
Company's 2002 restructuring initiatives for the third quarter of 2002 and the
nine months ended September 30, 2002 is as follows:
- --------------------------------------------------------------------------------
Three and nine months Workforce Facilities
ended September 30, 2002 Reduction Reduction Total
- --------------------------------------------------------------------------------
Restructuring charges $ 44 $ 50 $ 94
Utilization:
Cash payments (8) (8)
Non-cash charges (1) (1) (13) (14)
- --------------------------------------------------------------------------------
Balance at September 30, 2002 $ 35 (2) $ 37 (3) $ 72
================================================================================
(1) Primarily includes charges for write-downs of leasehold improvements,
telecommunications infrastructure, and fixed assets removed from service,
as well as officers' stock-based compensation.
(2) The Company expects to substantially utilize the remaining workforce
reduction liability through cash payments for severance pay and benefits
over the respective severance periods through 2003.
(3) The Company expects to substantially utilize the remaining facilities
reduction liability through cash payments for the net lease expense over
the respective lease terms through 2013.
2001 Initiatives
In the second quarter of 2001, the Company initiated a restructuring plan
to reduce operating expenses. The restructuring plan included a workforce
reduction, a reduction in operating facilities, and the removal of certain
systems hardware, software, and equipment from service. Included in these
initiatives are costs associated with the withdrawal from certain international
operations. In the third quarter of 2002, the Company recorded pre-tax
restructuring charges related to its 2001 restructuring initiatives of $66
million, virtually all of which resulted from changes in estimates of sublease
income due to a continued deterioration of the commercial real estate market.
Total pre-tax restructuring charges related to the Company's 2001 restructuring
initiatives for the first nine months of 2002 were $96 million. The actual costs
of these initiatives could differ from the estimated costs, depending primarily
on the Company's ability to sublease properties.
A summary of the activity in the restructuring liability related to the
Company's 2001 restructuring initiatives for the third quarter of 2002 and the
nine months ended September 30, 2002 is as follows:
- --------------------------------------------------------------------------------
Three months ended Workforce Facilities Systems
September 30, 2002 Reduction Reduction Removal Total
- --------------------------------------------------------------------------------
Balance at
June 30, 2002 $ 31 $ 79 $ 1 $ 111
Restructuring charges 1 65 (1) 66
Utilization:
Cash payments (14) (9) (1) (24)
- --------------------------------------------------------------------------------
Balance at
September 30, 2002 $ 18 (2) $ 135 (3) $ 153
================================================================================
- --------------------------------------------------------------------------------
Nine months ended Workforce Facilities Systems
September 30, 2002 Reduction Reduction Removal Total
- --------------------------------------------------------------------------------
Balance at
December 31, 2001 $ 74 $ 97 $ 4 $ 175
Restructuring charges 19 76 (1) 1 96
Utilization:
Cash payments (72) (38) (5) (115)
Non-cash charges (4) (3) (3)
- --------------------------------------------------------------------------------
Balance at
September 30, 2002 $ 18 (2) $ 135 (3) $ 153
================================================================================
(1) Includes $65 million primarily due to changes in estimates of sublease
income resulting from a continued deterioration of the commercial real
estate market.
(2) The Company expects to substantially utilize the remaining workforce
reduction liability through cash payments for severance pay and benefits
over the respective severance periods through 2003.
(3) The Company expects to substantially utilize the remaining facilities
reduction liability through cash payments for the net lease expense over
the respective lease terms through 2017.
(4) Primarily includes charges for officers' stock-based compensation.
- 6 -
5. Sale of Corporate Trust Business
In June 2001, U.S. Trust sold its Corporate Trust business to The Bank of
New York Company, Inc. The Company recorded an extraordinary gain of $221
million, or $121 million after tax, on this sale in the second quarter of 2001.
During the first quarter of 2002, the Company recorded an extraordinary gain of
$22 million, or $12 million after tax, which represented the remaining proceeds
from this sale that were realized upon satisfaction of certain client retention
requirements.
6. Allowance for Credit Losses on Banking Loans and Nonperforming Assets
Loans to banking clients of $4.3 billion at September 30, 2002 and $4.0
billion at December 31, 2001 are presented net of the related allowance for
credit losses. The allowance for credit losses on banking loans was $23 million
at September 30, 2002 and $21 million at December 31, 2001. Recoveries and
charge-offs were not material for each of the three- and nine-month periods
ended September 30, 2002 and 2001.
Nonperforming assets consisted of non-accrual loans of $1 million at
September 30, 2002 and $5 million at December 31, 2001.
7. Loan Securitization
During the second quarter of 2002, U.S. Trust securitized and sold
residential mortgage loans originated through its private banking business. This
transaction was accounted for as a sale under the requirements of SFAS No. 140 -
Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities. U.S. Trust received $196 million in proceeds from the sale and
recognized a gain of $1 million. The senior mortgage pass-through certificates
that were created by the securitization process were sold to third parties. U.S.
Trust retained all other securities created by the process, primarily comprised
of subordinated securities with total par value of $5 million. Any credit losses
on the securitized loans will be assigned to U.S. Trust, as holder of the
subordinated securities, up to the $5 million par value. The estimated fair
value of the retained securities was $6 million at September 30, 2002 and was
included in securities owned on the Company's condensed consolidated balance
sheet. U.S. Trust has not guaranteed the mortgage loans as this transaction was
structured without recourse to U.S. Trust or the Company.
8. Comprehensive Income
Comprehensive income includes net income and changes in equity except those
resulting from investments by, or distributions to, stockholders. Comprehensive
income is presented in the following table:
- --------------------------------------------------------------------------------
Three Nine
Months Ended Months Ended
September 30, September 30,
2002 2001 2002 2001
- --------------------------------------------------------------------------------
Net income (loss) $ (4) $ 13 $ 188 $ 212
Other comprehensive income (loss):
Cumulative effect of accounting
change for adoption of
SFAS No. 133 (12)
Net loss on cash flow
hedging instruments (8) (17) (10) (24)
Foreign currency translation
adjustment 2 1 8 (5)
Change in net unrealized gain
on securities available for sale 10 13 17 16
- --------------------------------------------------------------------------------
Total comprehensive income,
net of tax $ 10 $ 203 $ 187
================================================================================
- 7 -
9. Earnings Per Share
Basic EPS excludes dilution and is computed by dividing net income by the
weighted-average number of common shares outstanding for the period. Diluted EPS
reflects the potential reduction in EPS that could occur if securities or other
contracts to issue common stock were exercised or converted into common stock.
EPS under the basic and diluted computations are presented in the following
table:
- --------------------------------------------------------------------------------
Three Nine
Months Ended Months Ended
September 30, September 30,
2002 2001 2002 2001
- --------------------------------------------------------------------------------
Net income (loss) $ (4) $ 13 $188 $212
================================================================================
Weighted-average common
shares outstanding - basic 1,358 1,373 1,364 1,376
Common stock equivalent shares
related to stock incentive plans 22 18 27
- --------------------------------------------------------------------------------
Weighted-average common
shares outstanding - diluted 1,358 1,395 1,382 1,403
================================================================================
Basic EPS:
Income (loss) before
extraordinary gain $.00 $.01 $.13 $.07
Extraordinary gain, net of tax $.01 $.08
Net income (loss) $.00 $.01 $.14 $.15
================================================================================
Diluted EPS:
Income (loss) before
extraordinary gain (1) $.00 $.01 $.13 $.07
Extraordinary gain, net of tax $.01 $.08
Net income (loss) $.00 $.01 $.14 $.15
================================================================================
(1) For the three months ended September 30, 2002 this computation excludes
common stock equivalent shares related to stock incentive plans of 14
million because inclusion of such shares would be antidilutive.
The computation of diluted EPS for the nine months ended September 30, 2002
and 2001, respectively, excludes outstanding stock options to purchase 114
million and 84 million shares, respectively, because the exercise prices for
those options were greater than the average market price of the common shares,
and therefore the effect would be antidilutive.
10. Regulatory Requirements
CSC is a financial holding company, which is a type of bank holding company
subject to supervision and regulation by the Board of Governors of the Federal
Reserve System (the Federal Reserve Board) under the Bank Holding Company Act of
1956, as amended (the Act).
Under the Act, the Federal Reserve Board has established consolidated
capital requirements for bank holding companies. CSC is subject to those
requirements. The regulatory capital and ratios of the Company, U.S. Trust, and
United States Trust Company of New York (U.S. Trust NY) are presented in the
following table:
- 8 -
- --------------------------------------------------------------------------------
2002 2001
-------------- --------------
September 30, Amount Ratio(1) Amount Ratio(1)
- --------------------------------------------------------------------------------
Tier 1 Capital:
Company $ 3,574 23.5% $ 3,662 20.5%
U.S. Trust $ 618 17.5% $ 572 16.9%
U.S. Trust NY $ 381 13.4% $ 333 12.5%
Total Capital:
Company $ 3,601 23.7% $ 3,689 20.6%
U.S. Trust $ 641 18.2% $ 593 17.6%
U.S. Trust NY $ 401 14.1% $ 351 13.2%
Tier 1 Leverage:
Company $ 3,574 9.6% $ 3,662 10.2%
U.S. Trust $ 618 9.5% $ 572 9.6%
U.S. Trust NY $ 381 7.3% $ 333 7.2%
- --------------------------------------------------------------------------------
(1) Minimum tier 1 capital, total capital, and tier 1 leverage ratios are 4%,
8%, and 3%-5%, respectively, for bank holding companies and banks.
Well-capitalized tier 1 capital, total capital, and tier 1 leverage ratios
are 6%, 10%, and 5%, respectively. Each of CSC's other depository
institution subsidiaries exceed the well-capitalized standards set forth by
the banking regulatory authorities.
Based on their respective regulatory capital ratios at September 30, 2002
and 2001, the Company, U.S. Trust, and U.S. Trust NY are considered well
capitalized (the highest category). There are no conditions or events that
management believes have changed the Company's, U.S. Trust's, or U.S. Trust NY's
well-capitalized status.
Schwab and SCM are subject to the Uniform Net Capital Rule under the
Securities Exchange Act of 1934 (the Rule). Schwab and SCM compute net capital
under the alternative method permitted by the Rule. This method requires the
maintenance of minimum net capital, as defined, of the greater of 2% of
aggregate debit balances arising from client transactions or a minimum dollar
requirement, which is based on the type of business conducted by the
broker-dealer. The minimum dollar requirement for both Schwab and SCM is $1
million. Under the alternative method, a broker-dealer may not repay
subordinated borrowings, pay cash dividends, or make any unsecured advances or
loans to its parent or employees if such payment would result in net capital of
less than 5% of aggregate debit balances or less than 120% of its minimum dollar
requirement. At September 30, 2002, Schwab's net capital was $1.2 billion (17%
of aggregate debit balances), which was $1.0 billion in excess of its minimum
required net capital and $825 million in excess of 5% of aggregate debit
balances. At September 30, 2002, SCM's net capital was $67 million,
- 8 -
which was $66 million in excess of its minimum required net capital.
11. Commitments and Contingent Liabilities
During 2001, the Company began occupying and making lease payments on a
newly renovated office building. The lease for the building was arranged by
working with a bank to create an unconsolidated special purpose trust (Trust).
The Trust, through an agent, raised the $245 million needed to acquire and
renovate the building by issuing long-term debt ($235 million) and raising
equity capital ($10 million). The Company's lease payments to the Trust vary
with fluctuations in interest rates and are structured to cover the interest on
the debt obligations and a specified return on the equity (defined in the Trust
Agreement as 1.75% above the one-month LIBOR rate). This financing arrangement
is known as a synthetic lease. Upon the expiration of the lease in June 2005,
the Company may renew the lease for an additional five years subject to certain
approvals and conditions, or arrange a sale of the office building to a third
party. The Company also has an option to purchase the office building for $245
million at any time after June 18, 2003. The Company has provided the Trust with
a residual value guarantee, which means that if the building is sold to a third
party the Company is responsible for making up any shortfall between the actual
sales price and the $245 million funded by the Trust, up to a maximum of $202
million. In March 2002, the Company secured an appraisal of the estimated fair
value of the building at the end of the initial lease term in June 2005. On the
basis of this appraisal, the Company determined that it was probable that the
value of the property at the end of the lease term would be less than the
residual value guaranteed by approximately $45 million. This deficiency of $45
million is being amortized as rent expense on a straight-line basis over the
period from January 2002 to June 2005. Adjustments to this amortization will be
made on a prospective basis if it is determined that the estimate of the
probable deficiency has changed.
The nature of the Company's business subjects it to claims, lawsuits,
regulatory examinations, and other proceedings in the ordinary course of
business. The results of these matters 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, results of operations, and
cash flows. However, it is the opinion of management, after consultation with
legal counsel, that the ultimate outcome of existing claims and proceedings will
not have a material adverse impact on the financial condition, results of
operations, or cash flows of the Company. For further discussion of legal
proceedings, see Part II - Other Information, Item 1 - Legal Proceedings.
12. Segment Information
The Company structures its segments according to its various types of
clients and the services provided to those clients. These segments have been
aggregated, based on similarities in economic characteristics, types of clients,
services provided, distribution channels, and regulatory environment, into four
reportable segments - Individual Investor, Institutional Investor, Capital
Markets, and U.S. Trust.
Financial information for the Company's reportable segments is presented in
the following table. The Company periodically reallocates certain revenues and
expenses among the segments to align them with the changes in the Company's
organizational structure. Previously-reported segment information has been
revised to reflect changes during the year in the Company's internal
organization. The Company evaluates the performance of its segments based on
adjusted operating income before taxes, which excludes restructuring and other
charges, merger- and acquisition-related charges, and extraordinary gains.
Intersegment revenues are not material and are therefore not disclosed. Total
revenues, income before taxes on income and extraordinary gain, and net income
are equal to the Company's consolidated amounts as reported in the condensed
consolidated statement of income.
- 9 -
- --------------------------------------------------------------------------------
Three Nine
Months Ended Months Ended
September 30, September 30,
2002 2001 2002 2001
- -------------------------------------------------------------------------------
Revenues:
Individual Investor $ 593 $ 576 $1,804 $1,893
Institutional Investor 214 200 638 616
Capital Markets 64 58 194 264
U.S. Trust 160 163 503 495
- --------------------------------------------------------------------------------
Operating revenues 1,031 997 3,139 3,268
Non-operating revenues (1) 26 26
- --------------------------------------------------------------------------------
Total $1,031 $1,023 $3,139 $3,294
================================================================================
Operating income before taxes:
Individual Investor $ 64 $ 35 $ 193 $ 147
Institutional Investor 61 64 182 203
Capital Markets (1) (2) 12 28
U.S. Trust (2) 31 33 111 95
- --------------------------------------------------------------------------------
Operating income before taxes 155 130 498 473
Non-operating revenues (1) 26 26
Restructuring and other charges (3) (160) (99) (190) (244)
Merger- and acquisition-related
charges (4) (31) (27) (91)
- --------------------------------------------------------------------------------
Income (loss) before taxes on income
(loss) and extraordinary gain (5) 26 281 164
Tax expense (benefit) on income (1) 13 105 73
Extraordinary gain on sale of
corporate trust business, net of tax 12 121
- --------------------------------------------------------------------------------
Net Income (Loss) $ (4) $ 13 $ 188 $ 212
================================================================================
(1) Primarily consists of a gain on the sale of an investment.
(2) Excludes an extraordinary pre-tax gain of $22 million for the nine months
ended September 30, 2002 and $221 million for the nine months ended
September 30, 2001.
(3) Restructuring charges include costs relating to workforce, facilities,
systems hardware, software, and equipment reductions. In 2001, other
charges include a regulatory fine, professional service fees for
operational and risk management remediation, and the write-off of certain
software development costs.
(4) Includes retention program compensation related to the merger with USTC,
and intangible asset amortization and retention program compensation
related to the acquisition of CyberTrader. The retention programs related
to the acquisition of CyberTrader and the merger with USTC ended in March
2002 and May 2002, respectively. For 2001, amount also includes goodwill
amortization, which ceased on January 1, 2002 upon the adoption of SFAS No.
142 (see note "2 - Accounting Change").
13. Supplemental Cash Flow Information
Certain information affecting the cash flows of the Company is presented in
the following table:
- --------------------------------------------------------------------------------
Nine
Months Ended
September 30,
2002 2001
- --------------------------------------------------------------------------------
Income taxes paid $ 81 $ 84
================================================================================
Interest paid:
Brokerage client cash balances $ 143 $ 614
Deposits from banking clients 65 104
Long-term debt 51 56
Stock-lending activities 3 19
Short-term borrowings 19 15
Other 5
- --------------------------------------------------------------------------------
Total interest paid $ 281 $ 813
================================================================================
Non-cash investing and financing activities:
Common stock and options issued
for purchase of businesses $ 4 $ 36
================================================================================
- 10 -
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations
Description of Business
The Company: The Charles Schwab Corporation (CSC) and its subsidiaries
(collectively referred to as the Company) provide securities brokerage and
related financial services for 8.0 million active client accounts(a). Client
assets in these accounts totaled $726.8 billion at September 30, 2002. Charles
Schwab & Co., Inc. (Schwab) is a securities broker-dealer with 394 domestic
branch offices in 48 states, as well as a branch in the Commonwealth of Puerto
Rico. U.S. Trust Corporation (USTC, and with its subsidiaries collectively
referred to as U.S. Trust) is a wealth management firm that through its
subsidiaries also provides fiduciary services and private banking services with
34 offices in 12 states. Other subsidiaries include Charles Schwab Europe, a
retail securities brokerage firm located in the United Kingdom, Charles Schwab
Investment Management, Inc., the investment advisor for Schwab's proprietary
mutual funds, Schwab Capital Markets L.P. (SCM), a market maker in Nasdaq and
other securities providing trade execution services primarily to broker-dealers
and institutional clients, and CyberTrader, Inc. (CyberTrader), an electronic
trading technology and brokerage firm providing services to highly active,
online investors.
The Company provides financial services to individuals, institutional
clients, and broker-dealers through four segments - Individual Investor,
Institutional Investor, Capital Markets, and U.S. Trust. The Individual Investor
segment includes the Company's domestic and international retail operations. The
Institutional Investor segment provides custodial, trading, and support services
to independent financial advisors, serves company 401(k) plan sponsors and
third-party administrators, and supports company stock option plans and stock
purchase programs. The Capital Markets segment provides trade execution services
in Nasdaq, exchange-listed, and other securities primarily to broker-dealers,
including Schwab, and institutional clients. The U.S. Trust segment provides
investment and wealth management, fiduciary services, and private banking
services to individual and institutional clients.
Business Strategy: The Company's infrastructure and resources are focused
on pursuing six strategic priorities:
- - providing the spectrum of affluent investors with the advice,
relationships, and choices that support their desired investment outcomes;
- - delivering the information, technology, service, and pricing needed to
remain a leader in serving active traders;
- - continuing to provide high quality service to clients with smaller
investment portfolios;
- - providing individual investing services through employers, including
retirement and option plans as well as personal brokerage accounts;
- - offering selected banking services and developing investment products that
give clients greater control and understanding of their finances; and
- - retaining a strong capital markets business to address investors' financial
product and trade execution needs.
For further discussion of the Company's business strategy, see
"Management's Discussion and Analysis of Results of Operations and Financial
Condition - Description of Business - Business Strategy" in the Company's 2001
Annual Report to Stockholders, which is filed as Exhibit 13.1 to the Company's
Form 10-K for the year ended December 31, 2001. See also Item 1 - Business -
Narrative Description of Business - "Products, Services, and Advice Offerings"
in the Company's Form 10-K for the year ended December 31, 2001. Significant
recent developments relating to certain of these strategic priorities, as well
as other significant developments, follows:
Services for Affluent Investors: Schwab Private Client is a fee-based
service designed to help clients who want access to an ongoing, one-on-one
advice relationship with a designated Schwab consultant while retaining control
over their investment decisions. Schwab Private Client was expanded nationwide
in May 2002. In the third quarter of 2002, 3,000 clients signed up for this
service, bringing the total number of participants to over 5,000 as of September
30, 2002. The Schwab Private Client service includes over 150 designated Schwab
consultants and their support teams, serving 360 branch offices nationwide, at
September 30, 2002.
For self-directed affluent investors, the Company introduced Schwab
Signature Platinum(R), the successor to the Schwab Signature Services(TM)
program. Schwab Signature Platinum enables Schwab to provide a select group of
its larger clients with a tailored set of benefits and services, including
priority access, an enhanced suite of investing resources, and preferred
pricing.
The Schwab Advisor Network(TM) is the successor to the Schwab
AdvisorSource(R) referral program, with over 330 participating independent,
fee-based investment advisors (IAs) at September 30, 2002. These IAs provide
customized and personalized portfolio management and financial planning services
to investors who prefer to delegate their financial management responsibilities
to an independent
- --------
(a) Accounts with balances or activity within the preceding eight months.
- 11 -
professional. During the third quarter of 2002, Schwab conducted advisor
education workshops on operational, trading, and technology solutions to help
IAs grow their businesses efficiently. These workshops were held in 18 cities
and attracted 1,100 attendees.
Services for Active Traders: The Company made several technological,
pricing, and service improvements to its offerings for actively trading
investors in the third quarter of 2002. The Company enhanced its CyberTrader(R)
Web Trading platform to include real-time market data, direct access technology,
intelligent order routing, options trading, and premium stock research. The
Company also reduced pricing across all of CyberTrader's platforms; prices now
range from $9.95 for trades executed through the CyberTrader Web site to $12.95
for trades executed through the CyberX2(TM) platform. Additionally, the
CyberTrader offering was expanded to include a broader client base - the
enhanced pricing and technology are available to clients who trade as few as ten
times per month. To support representatives' conversations with actively trading
clients, the Company introduced Active Trader Street, an internal Web site that
provides Schwab representatives with a comprehensive suite of investing
perspectives, trading strategies, and educational tools.
Corporate Services: In the third quarter of 2002, the Company introduced a
monthly online report that allows retirement plan sponsors to monitor activity
and investment performance in their plans against customized criteria and
benchmarks. If a fund deviates from the pre-established criteria, plan sponsors
receive an email alert automatically. The report also provides plan asset
allocations and trend data, market commentary, industry data, fund summaries and
the most recent mutual fund Schwab Focus List(TM), which is specifically
designed for retirement plan sponsors.
Banking and Other Financial Products: In the second quarter of 2002, the
Company filed applications with the Office of the Comptroller of the Currency
and the Federal Deposit Insurance Corporation to establish a national bank and
to obtain deposit insurance for the bank. The Company is awaiting preliminary
approval from the Comptroller of the Currency in order to file applications with
the Board of Governors of the Federal Reserve System (Federal Reserve Board).
Subject to regulatory approvals, the Company expects to commence banking
operations in early 2003.
Capital Markets: The Company expanded its Schwab BondSource(TM) platform in
the third quarter of 2002 to provide additional information, new analytical
tools, and enhanced fixed income securities price quotes to support more
efficient client service. Client assets in fixed income securities were a record
$117.5 billion at September 30, 2002, an increase of $19.3 billion, or 20%, from
a year ago.
Other Significant Developments: The Company continued to combine people and
technology through several important technology-based initiatives during the
third quarter of 2002. Representatives from the Schwab Center for Investment
Research(R), Schwab Equity Research, and Schwab Investment Center hosted a
Webcast designed to help investors navigate the current markets. Along with
advice on investment objectives, diversification, and risk management, the
representatives shared their perspectives on the current downturn and possible
investment opportunities. Also, Schwab added a feature to its Web site to guide
prospective clients to selected service offerings, based on their individual
investing behavior and needs.
In the third quarter of 2002, Schwab expanded its proprietary funds
offering by introducing the Schwab Hedged Equity Fund(TM), which invests in both
long and short positions and is designed to provide investors with long-term
capital appreciation with less volatility than the broad market. This fund,
along with the Schwab Core Equity Fund(TM) introduced in the second quarter of
2002, combines the equity selection capabilities of Schwab Equity Ratings(TM)
with the diversification and convenience of a mutual fund.
Restructuring: The Company recorded pre-tax restructuring charges for the
third quarter of 2002 and the nine months ended September 30, 2002 as follows
(in millions):
- --------------------------------------------------------------------------------
Three Nine
Period ended September 30, 2002 Months Months
- --------------------------------------------------------------------------------
2002 Initiatives:
Workforce reduction $ 44 $ 44
Facilities reduction 50 50
- --------------------------------------------------------------------------------
Total 2002 Initiatives 94 94
- --------------------------------------------------------------------------------
2001 Initiatives:
Workforce reduction 1 19
Facilities reduction 65 76
Systems removal 1
- --------------------------------------------------------------------------------
Total 2001 Initiatives 66 96
- --------------------------------------------------------------------------------
Total restructuring charges $ 160 $ 190
================================================================================
2002 Initiatives
In the third quarter of 2002, the Company commenced additional
restructuring initiatives due to continued difficult market conditions. These
initiatives are intended to reduce operating expenses and adjust the Company's
organizational structure to improve productivity, enhance efficiency, and
increase profitability. The restructuring initiatives include further reductions
in workforce and facilities. The Company recorded pre-tax restructuring charges
of $94 million in the third quarter of 2002 related to these restructuring
initiatives. This amount includes
- 12 -
$12 million for workforce reductions related to the closure of the Company's
telephone service center in Austin, Texas, in the third quarter of 2002, and a
reduction of phone-based client support staff at the remaining four service
centers. Additionally, the Company expects that reductions in full-time
equivalent employees in the fourth quarter of 2002 will total approximately
1,900, including approximately 1,750 through mandatory staff reductions and
approximately 150 related to a reduction in contractors. In the third quarter of
2002, the Company recorded charges of $32 million related to the 60-day notice
period provided to these impacted employees (excluding contractors). The
remaining severance pay and benefits, which become contractual obligations only
when the impacted employee signs a severance agreement, will be recorded in the
fourth quarter of 2002. The Company expects to recognize additional pre-tax
restructuring charges in the fourth quarter of 2002 of approximately $90 million
for workforce reductions. As the Company works toward completing these
restructuring initiatives and assesses the impact of its workforce reductions,
additional charges for further reductions in operating facilities are possible.
The Company estimates that its 2002 restructuring initiatives will reduce
pre-tax operating expenses for full-year 2003 by approximately $250 million
compared to annualized second quarter 2002 operating expenses. Expected
reductions include approximately $150 million in compensation and benefits for
mandatory staff reductions, approximately $50 million in professional services
and other expenses, and approximately $50 million in spending for development
projects and advertising. A portion of these reductions in operating expenses,
however, will likely be used to enhance employee bonuses.
2001 Initiatives
In addition, the Company recorded pre-tax restructuring charges related to
the Company's 2001 restructuring initiatives of $66 million in the third quarter
of 2002, virtually all of which resulted from changes in estimates of sublease
income due to a continued deterioration of the commercial real estate market.
For further information on the Company's restructuring initiatives, see
note "4 - Restructuring" in the Notes to Condensed Consolidated Financial
Statements.
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 2001 Annual Report to
Stockholders, which is filed as Exhibit 13.1 to the Company's Form 10-K for the
year ended December 31, 2001. 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.
The Company entered into a number of new insurance policies during the
quarter ended September 30, 2002 to replace and renew policies that were
expiring. Given the current state of the insurance market, the Company was
confronted with higher levels of rates and deductibles for coverages similar to
those which were replaced. These rates and deductibles were comparable to those
available to other participants in the insurance market. The increases in
deductibles could have a material adverse effect on the Company's results of
operations in any future period, depending partly on the results for that
period.
Given the nature of the Company's revenues, expenses, and risk profile, the
Company's earnings and CSC's common stock price have been and may continue to 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
or any other interim period. Risk is inherent in the Company's business.
Consequently, despite the Company's attempts to identify areas of risk, oversee
operational areas involving risk, and implement policies and procedures designed
to mitigate risk, there can be no assurance that the Company will not suffer
unexpected losses due to operating or other risks.
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains "forward-looking statements"
within the meaning of Section 27A of the Securities Act, and Section 21E of the
Securities Exchange Act of 1934. Forward-looking statements are identified by
words such as "believe," "expect," "intend," "plan," "will," "may," and other
similar expressions. In addition, any statements that refer to expectations,
projections or other characterizations of future events or circumstances are
forward-looking statements. These forward-looking statements, which reflect
management's beliefs, objectives, and expectations as of the date hereof, are
necessarily estimates based on the best judgment of the Company's senior
management. These statements relate to, among other things, the Company's
ability to achieve its strategic priorities (see Description of Business -
Business Strategy), the impact of the restructuring plan on the Company's
results of operations (see Description of Business - Restructuring), insurance
coverage (see Description of Business - Risk Management), sources of liquidity
and capital (see Liquidity and Capital Resources - Liquidity and - Commitments),
the Company's cash position, cash flows, capital expenditures, and development
spending (see Liquidity and Capital Resources
- 13 -
- - Cash Flows and Capital Resources), net interest expense under interest rate
swaps (see Item 3 - Quantitative and Qualitative Disclosures About Market Risk -
Financial Instruments Held For Purposes Other Than Trading - Interest Rate
Swaps), and contingent liabilities (see Part II - Other Information, Item 1 -
Legal Proceedings). Achievement of the expressed expectations is subject to
certain risks and uncertainties that could cause actual results to differ
materially from the expressed expectations described in these statements.
Important factors that may cause such differences are noted in this interim
report and include, but are not limited to: the effect of client trading
patterns on Company revenues and earnings; changes in revenues and profit margin
due to cyclical securities markets and fluctuations in interest rates; the level
and continuing volatility of equity prices; a significant downturn in the
securities markets over a short period of time or a sustained decline in
securities prices, trading volumes, and investor confidence; the size and number
of the Company's insurance claims; and a significant decline in the real estate
market, including the Company's ability to sublease certain properties. Other
more general factors that may cause such differences include, but are not
limited to: the Company's inability to attract and retain key personnel; the
timing and impact of changes in the Company's level of investments in personnel,
technology, or advertising; changes in technology; computer system failures and
security breaches; evolving legislation, regulation, accounting pronouncements,
and changing industry practices adversely affecting the Company; adverse results
of litigation; the inability to obtain external financing at acceptable rates;
the effects of competitors' pricing, product, and service decisions; and
intensified industry competition and consolidation.
Critical Accounting Policies
Certain of the Company's accounting policies that involve a higher degree
of judgment and complexity are discussed in "Management's Discussion and
Analysis of Results of Operations and Financial Condition - Critical Accounting
Policies" in the Company's 2001 Annual Report to Stockholders, which is filed as
Exhibit 13.1 to the Company's Form 10-K for the year ended December 31, 2001.
There have been no material changes to these critical accounting policies during
the first nine months of 2002.
Three Months Ended September 30, 2002 Compared To
Three Months Ended September 30, 2001
All references to earnings per share information in this report reflect
diluted earnings per share unless otherwise noted.
FINANCIAL OVERVIEW
The Company's financial performance in the third quarter of 2002 was
adversely affected by decreases in client trading activity as investor
confidence continued to be weighed down by persistent securities market
declines, concerns about corporate governance, and geopolitical developments.
Despite the difficult market environment that prevailed during the third quarter
of 2002, the Company's trading revenues increased 12% from the third quarter of
2001. The increase in trading revenues was partially due to a higher number of
trading days in the third quarter of 2002, as well as higher revenue per share
traded (reflected in commission revenues) and higher client fixed income
securities trading activity (reflected in principal transactions revenues).
Non-trading revenues, which include asset management and administration
fees, interest revenue, net of interest expense (referred to as net interest
revenue), and other revenues, decreased 4% in the third quarter of 2002 compared
to the year-ago level. The decrease in non-trading revenues was primarily due to
a 42% decrease in other revenue and a 9% decrease in net interest revenue,
partially offset by a 3% increase in asset management and administration fees.
The decrease in other revenues was primarily due to a gain on the sale of an
investment recorded in the third quarter of 2001. Average margin loans to
clients in the third quarter of 2002 decreased 33% from year-ago levels, which
primarily caused the decline in net interest revenue. The increase in asset
management and administration fees primarily resulted from higher account fees.
Total expenses excluding interest during the third quarter of 2002 were
$1.0 billion, up 4% from the third quarter of 2001. This increase resulted
primarily from higher restructuring charges in the third quarter of 2002,
partially offset by decreases in certain expenses as a result of the Company's
continued expense reduction measures.
In evaluating the Company's financial performance, management uses adjusted
operating income, which excludes non-operating items as detailed in the
following table. Management believes that operating income is a useful indicator
of its ongoing financial performance, and a tool that can provide meaningful
insight into financial performance without the effects of certain material items
that are not expected to be an ongoing part of operations (e.g., extraordinary
gains, restructuring and other charges, and merger- and acquisition-related
charges). In this
- 14 -
manner, operating income assists both management and investors in assessing the
Company's financial performance over extended periods of time. The Company's
after-tax operating income for the third quarter of 2002 was $96 million, up 19%
from the third quarter of 2001, and its after-tax operating profit margin for
the third quarter of 2002 was 9.4%, up from 8.2% for the third quarter of 2001.
A reconciliation of the Company's operating income to net income is shown in the
following table (in millions):
- --------------------------------------------------------------------------------
Three Months
Ended
September 30, Percent
2002 2001 Change
- --------------------------------------------------------------------------------
Operating income, after tax $ 96 $ 81 19%
Non-operating items:
Other income (1) 26
Restructuring charges (2) (160) (99) 62
Merger- and acquisition-related charges (3) (31)
- --------------------------------------------------------------------------------
Total non-operating items (160) (104) 54
Tax effect 60 36 67
- --------------------------------------------------------------------------------
Total non-operating items, after tax (100) (68) 47
- --------------------------------------------------------------------------------
Net income (loss) $ (4) $ 13 n/m
================================================================================
(1) Primarily consists of a gain on the sale of an investment.
(2) Restructuring charges include costs relating to workforce, facilities,
systems hardware, software, and equipment reductions.
(3) Includes retention program compensation related to the merger with USTC,
and intangible asset amortization and retention program compensation
related to the acquisition of CyberTrader. The retention programs related
to the acquisition of CyberTrader and the merger with USTC ended in March
2002 and May 2002, respectively. For the three months ended September 30,
2001, amount also includes goodwill amortization, which ceased on January
1, 2002 upon the adoption of Statement of Financial Accounting Standards
No. 142.
n/m Not meaningful
The Company's operating income before taxes for the third quarter of 2002
was $155 million, up $25 million, or 19%, from the third quarter of 2001
primarily due to an increase of $29 million, or 83%, in the Individual Investor
segment, partially offset by a decrease of $3 million, or 5%, in the
Institutional Investor segment. The increase in the Individual Investor segment
was primarily due to lower expenses resulting from the Company's workforce
reduction under its restructuring plan. As certain technology, corporate, and
general administrative expenses are allocated to segments based upon their
full-time equivalent employees, a proportionately larger allocation of expenses
was assigned to the Institutional Investor segment for the third quarter of
2002, which, along with an increase in certain direct costs, resulted in the
operating income decline in that segment.
The Company recognized a net loss of $4 million for the third quarter of
2002, compared to net income of $13 million, or $.01 per share, for the third
quarter of 2001. The Company's after-tax profit margin for the third quarter of
2002 was (.3%), down from 1.3% for the third quarter of 2001.
The annualized return on stockholders' equity for the third quarter of 2002
was 0%, down from 1% for the third quarter of 2001.
REVENUES
Revenues increased by $8 million, or 1%, to $1.0 billion in the third
quarter of 2002 compared to the third quarter of 2001, due to a $33 million, or
12%, increase in commission revenues, a $14 million, or 3%, increase in asset
management and administration fees and a $5 million, or 12%, increase in
principal transaction revenues. These increases were partially offset by a $21
million, or 9%, decrease in net interest revenue and a $23 million, or 42%,
decrease in other revenues. The Company's non-trading revenues represented 65%
of total revenues for the third quarter of 2002, as compared to 69% for the
third quarter of 2001 as shown in the following table:
- --------------------------------------------------------------------------------
Three Months
Ended
September 30,
Composition of Revenues 2002 2001
- --------------------------------------------------------------------------------
Commissions 30% 27%
Principal transactions 5 4
- --------------------------------------------------------------------------------
Total trading revenues 35 31
- --------------------------------------------------------------------------------
Asset management and administration fees 42 41
Net interest revenue 20 22
Other 3 6
- --------------------------------------------------------------------------------
Total non-trading revenues 65 69
- --------------------------------------------------------------------------------
Total 100% 100%
================================================================================
While the Individual Investor and Institutional Investor segments generate
both trading and non-trading revenues, the Capital Markets segment generates
primarily trading revenues and the U.S. Trust segment generates primarily
non-trading revenues. The $8 million increase in revenues from the third quarter
of 2001 was due to increases in operating revenues of $17 million, or 3%, in the
Individual Investor segment, $14 million, or 7%, in the Institutional Investor
segment, and $6 million, or 10%, in the Capital Markets segment, partially
offset by a decrease of $3 million, or 2%, in the U.S. Trust segment.
Additionally, the Company had non-operating revenues of $26 million in the third
quarter of 2001, consisting primarily of a gain on the sale of an investment.
See note "12 - Segment Information" in the Notes to Condensed Consolidated
Financial Statements for financial information by segment.
- 15 -
Asset Management and Administration Fees
Asset management and administration fees include mutual fund service fees,
as well as fees for other asset-based financial services provided to individual
and institutional clients. The Company earns mutual fund service fees for
recordkeeping and shareholder services provided to third-party funds, and for
transfer agent services, shareholder services, administration, and investment
management provided to its proprietary funds. These fees are based upon the
daily balances of client assets invested in third-party funds and upon the
average daily net assets of the Company's proprietary funds. Mutual fund service
fees are earned through the Individual Investor, Institutional Investor, and
U.S. Trust segments. The Company also earns asset management and administration
fees for financial services, including investment management and consulting,
trust and fiduciary services, financial and estate planning, and private banking
services, provided to individual and institutional clients. These fees are
primarily based on the value and composition of assets under management and are
earned through the U.S. Trust, Individual Investor, and Institutional Investor
segments.
Asset management and administration fees were $434 million for the third
quarter of 2002, up $14 million, or 3%, from the third quarter of 2001, as shown
in the following table (in millions):
- --------------------------------------------------------------------------------
Three Months
Ended
Asset Management September 30, Percent
and Administration Fees 2002 2001 Change
- --------------------------------------------------------------------------------
Mutual fund service fees:
Proprietary funds
(SchwabFunds(R)and Excelsior(R)) $218 $209 4%
Mutual Fund OneSource(R) 61 69 (12)
Other 10 13 (23)
Asset management and related services 145 129 12
- --------------------------------------------------------------------------------
Total $434 $420 3%
================================================================================
The increase in asset management and administration fees was primarily due
to higher account fees and increases in assets in Schwab's proprietary funds
(collectively referred to as the SchwabFunds), which led to an increase in
service fees, partially offset by a decrease in assets in Schwab's Mutual Fund
OneSource service.
Assets in client accounts were $726.8 billion at September 30, 2002, a
decrease of $41.6 billion, or 5%, from a year ago as shown in the following
table. This decrease from a year ago included net new client assets of $51.0
billion, offset by net market losses of $92.6 billion related to client
accounts.
- --------------------------------------------------------------------------------
Change in Client Assets and Accounts
(In billions, at quarter end, September 30, Percent
except as noted) 2002 2001 Change
- --------------------------------------------------------------------------------
Assets in client accounts
Schwab One(R), other cash
equivalents and deposits
from banking clients $ 29.0 $ 28.1 3%
Proprietary funds (SchwabFunds(R)
and Excelsior(R)):
Money market funds 129.2 130.0 (1)
Equity and bond funds 26.8 27.5 (3)
- --------------------------------------------------------------------------------
Total proprietary funds 156.0 157.5 (1)
- --------------------------------------------------------------------------------
Mutual Fund Marketplace(R)(1):
Mutual Fund OneSource(R) 70.0 76.6 (9)
Mutual fund clearing services 19.8 18.2 9
All other 68.5 66.8 3
- --------------------------------------------------------------------------------
Total Mutual Fund Marketplace 158.3 161.6 (2)
- --------------------------------------------------------------------------------
Total mutual fund assets 314.3 319.1 (2)
- --------------------------------------------------------------------------------
Equity and other securities (1) 272.9 332.0 (18)
Fixed income securities (2) 117.5 98.2 20
Margin loans outstanding (6.9) (9.0) 23
- --------------------------------------------------------------------------------
Total client assets $ 726.8 $ 768.4 (5%)
================================================================================
Net change in assets
in client accounts
(for the quarter ended)
Net new client assets $ 10.6 $ 17.9
Net market losses (80.8) (107.8)
- ------------------------------------------------------------------
Net decline $ (70.2) $ (89.9)
==================================================================
New client accounts
(in thousands, for the
quarter ended) 159.6 184.2 (13%)
Active client accounts
(in millions) (3) 8.0 7.8 3%
- --------------------------------------------------------------------------------
Active online Schwab client
accounts (in millions) (4) 4.1 4.3 (5%)
Online Schwab client assets $ 270.1 $ 306.3 (12%)
- --------------------------------------------------------------------------------
(1) Excludes money market funds and all proprietary money market, equity, and
bond funds.
(2) Includes $15.1 billion and $15.7 billion at September 30, 2002 and 2001,
respectively, of other securities serviced by Schwab's fixed income
division, including exchange-traded unit investment trusts, real estate
investment trusts, preferred debt, and preferred equities.
(3) Active accounts are defined as accounts with balances or activity within
the preceding eight months.
(4) Active online accounts are defined as all accounts within a household that
has had at least one online session within the past twelve months.
- 16 -
Commissions
The Company earns revenues by executing client trades primarily through the
Individual Investor and Institutional Investor segments. These revenues are
affected by the number of accounts that trade, the average number of
revenue-generating trades per account, and the average revenue earned per trade.
Commission revenues for the Company were $309 million for the third quarter of
2002, up $33 million, or 12%, from the third quarter of 2001. This increase was
primarily due to higher revenue per trade and trading days, partially offset by
lower daily average trades.
The Company's client trading activity is shown in the following table (in
thousands):
- --------------------------------------------------------------------------------
Three Months
Ended
September 30, Percent
Daily Average Trades 2002 2001 Change
- --------------------------------------------------------------------------------
Revenue Trades (1)
Online 107.3 109.3 (2%)
TeleBroker(R)and Schwab by PhoneTM 5.4 6.6 (18)
Regional client telephone service
centers, branch offices, and other 16.4 17.9 (8)
- --------------------------------------------------------------------------------
Total 129.1 133.8 (4%)
================================================================================
Mutual Fund OneSource(R) and
Other Asset-Based Trades
Online 47.9 33.3 44%
TeleBroker and Schwab by Phone .3 .4 (25)
Regional client telephone service
centers, branch offices, and other 8.3 20.3 (59)
- --------------------------------------------------------------------------------
Total 56.5 54.0 5%
================================================================================
Total Daily Average Trades
Online 155.2 142.6 9%
TeleBroker and Schwab by Phone 5.7 7.0 (19)
Regional client telephone service
centers, branch offices, and other 24.7 38.2 (35)
- --------------------------------------------------------------------------------
Total 185.6 187.8 (1%)
================================================================================
(1) Includes all client trades (both individuals and institutions) that
generate either commission revenue or revenue from principal markups (i.e.,
fixed income).
As shown in the following table, the total number of revenue trades
executed by the Company has increased 4% as the client trading activity per
account that traded has increased.
- --------------------------------------------------------------------------------
Three Months
Ended
September 30, Percent
Trading Activity 2002 2001 Change
- --------------------------------------------------------------------------------
Total revenue trades
(in thousands) (1) 8,263 7,908 4%
Accounts that traded during
the quarter (in thousands) 1,284 1,339 (4)
Average revenue trades
per account that traded 6.4 5.9 8
Trading frequency proxy (2) 3.9 3.8 3
Number of trading days 64 59 8
Average revenue earned
per revenue trade $39.71 $36.35 9
- --------------------------------------------------------------------------------
(1) Includes all client trades (both individuals and institutions) that
generate either commission revenue or revenue from principal markups (i.e.,
fixed income).
(2) Represents annualized revenue trades per $100,000 in client assets.
Net Interest Revenue
Net interest revenue is the difference between interest earned on assets
(mainly margin loans to clients, investments required to be segregated for
clients, private banking loans, and securities available for sale) and interest
paid on liabilities (mainly brokerage client cash balances and banking
deposits). Net interest revenue is affected by changes in the volume and mix of
these assets and liabilities, as well as by fluctuations in interest rates and
hedging strategies.
Substantially all of the Company's net interest revenue is earned through
the Individual Investor, Institutional Investor, and U.S. Trust segments.
- 17 -
Net interest revenue was $209 million for the third quarter of 2002, down
$21 million, or 9%, from the third quarter of 2001 as shown in the following
table (in millions):
- --------------------------------------------------------------------------------
Three Months
Ended
September 30, Percent
2002 2001 Change
- --------------------------------------------------------------------------------
Interest Revenue
Margin loans to clients $ 108 $ 185 (42%)
Investments, client-related 87 128 (32)
Private banking loans 59 61 (3)
Securities available for sale 21 20 5
Other 20 37 (46)
- --------------------------------------------------------------------------------
Total 295 431 (32)
- --------------------------------------------------------------------------------
Interest Expense
Brokerage client cash balances 43 147 (71)
Deposits from banking clients 26 29 (10)
Long-term debt 10 13 (23)
Short-term borrowings 6 8 (25)
Stock-lending activities 1 3 (67)
Other 1 n/m
- --------------------------------------------------------------------------------
Total 86 201 (57)
- --------------------------------------------------------------------------------
Net interest revenue $ 209 $ 230 (9%)
================================================================================
n/m Not meaningful
Client-related and other daily average balances, interest rates, and
average net interest spread for the third quarters of 2002 and 2001 are
summarized in the following table (dollars in millions):
- --------------------------------------------------------------------------------
Three Months Ended
September 30,
2002 2001
- --------------------------------------------------------------------------------
Interest-Earning Assets (client-related and other):
Investments (client-related):
Average balance outstanding $ 18,973 $ 13,751
Average interest rate 1.83% 3.71%
Margin loans to clients:
Average balance outstanding $ 7,346 $ 10,910
Average interest rate 5.79% 6.73%
Private banking loans:
Average balance outstanding $ 4,139 $ 3,645
Average interest rate 5.69% 6.65%
Securities available for sale:
Average balance outstanding $ 1,568 $ 1,365
Average interest rate 5.29% 5.80%
Average yield on interest-earning assets 3.40% 5.28%
Funding Sources (client-related and other):
Interest-bearing brokerage client cash balances:
Average balance outstanding $ 22,917 $ 21,883
Average interest rate .73% 2.66%
Interest-bearing banking deposits:
Average balance outstanding $ 3,908 $ 3,259
Average interest rate 2.62% 3.57%
Other interest-bearing sources:
Average balance outstanding $ 1,021 $ 972
Average interest rate 2.18% 3.57%
Average noninterest-bearing portion $ 4,180 $ 3,557
Average interest rate on funding sources .91% 2.47%
Summary:
Average yield on interest-earning assets 3.40% 5.28%
Average interest rate on funding sources .91% 2.47%
- --------------------------------------------------------------------------------
Average net interest spread 2.49% 2.81%
================================================================================
The decrease in net interest revenue from the third quarter of 2001 was
primarily due to lower levels of, and lower rates received on, margin loans to
clients, as well as lower rates received on client-related investments,
partially offset by lower rates paid on brokerage client cash balances and
higher average balances of client-related investments.
Principal Transactions
Principal transaction revenues are primarily comprised of revenues from
client fixed income securities trading activity, which are included in the
Individual Investor and Institutional Investor segments, and net gains from
market-making activities in Nasdaq and other equity securities, which are
included in the Capital Markets segment. Factors that influence principal
transaction revenues include the volume of client trades, market price
volatility, average
- 18 -
revenue per share traded, and changes in regulations and industry practices.
Principal transaction revenues were $47 million for the third quarter of
2002, up $5 million, or 12%, from the third quarter of 2001, as shown in the
following table (in millions):
- --------------------------------------------------------------------------------
Three Months
Ended
September 30, Percent
Principal Transactions 2002 2001 Change
- --------------------------------------------------------------------------------
Fixed income securities $ 25 $ 18 39%
Nasdaq and other equity securities 19 22 (14)
Other 3 2 50
- --------------------------------------------------------------------------------
Total $ 47 $ 42 12%
================================================================================
The increase in principal transaction revenues was primarily due to higher
revenues from client fixed income securities trading activity and higher equity
share volume handled by SCM, partially offset by lower average revenue per
equity share traded.
Other Revenues
Other revenues were $32 million for the third quarter of 2002, down $23
million, or 42%, from the third quarter of 2001. This decrease was primarily due
to a gain recorded on the sale of an investment in 2001.
EXPENSES EXCLUDING INTEREST
Total expenses excluding interest for the third quarter of 2002 increased
$39 million, or 4%, from the third quarter of 2001, primarily due to
restructuring charges, partially offset by decreases in certain expenses as a
result of the Company's continued expense reduction measures. The Company
recorded total pre-tax restructuring charges of $160 million in the third
quarter of 2002. In the third quarter of 2001, the Company recorded total
pre-tax restructuring charges of $99 million.
Compensation and benefits expense was $472 million for the third quarter of
2002, up $11 million, or 2%, from the third quarter of 2001 primarily due to the
accrual of discretionary bonuses to employees and higher incentive compensation
and employee benefits, partially offset by a reduction in full-time equivalent
employees in the third quarter of 2002.
The following table shows a comparison of certain compensation and benefits
components and employee data (dollars in millions, except as noted):
- --------------------------------------------------------------------------------
Three Months
Ended
September 30, Percent
2002 2001 Change
- --------------------------------------------------------------------------------
Compensation and benefits:
Salaries and wages $ 326 $ 345 (6%)
Incentive and variable compensation 73 52 40
Employee benefits and other 73 64 14
- --------------------------------------------------------------------------------
Total compensation and benefits $ 472 $ 461 2%
- --------------------------------------------------------------------------------
Compensation and benefits expense as a
% of total revenues 46% 45%
Incentive and variable compensation as a
% of compensation and benefits expense 15% 11%
Compensation for temporary employees,
contractors and overtime hours as a
% of compensation and benefits expense 6% 6%
Full-time equivalent employees
(at end of quarter, in thousands) (1) 18.8 21.9 (14%)
Revenues per average full-time equivalent
employee (in thousands) $54.5 $46.3 18%
- --------------------------------------------------------------------------------
(1) Includes full-time, part-time, and temporary employees, and persons
employed on a contract basis.
Employee benefits and other expenses increased by $9 million, or 14%, from
the third quarter of 2001 primarily due to an increase in the obligations under
the Company's deferred compensation plan, and higher health insurance costs and
employee claims. Additionally, employee benefits and other expense includes net
pension expense (income) related to U.S. Trust's defined benefit pension plan,
which totaled less than $1 million and ($3) million in the third quarters of
2002 and 2001, respectively. The increase in pension expense from the third
quarter of 2001 was primarily due to a decline in the fair value of pension plan
assets, as well as an increase in the service cost resulting from a greater
number of employees covered under the pension plan, and a lower assumed discount
rate used in the expense calculation.
Goodwill amortization expense for the third quarter of 2001 was $17
million. On January 1, 2002, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 142 - Goodwill and Other Intangible Assets. Upon
adoption of SFAS No. 142, amortization of the existing goodwill ceased and
therefore there was no such expense in the third quarter of 2002.
The Company's effective income tax benefit rate was 34.2% for the third
quarter of 2002, compared to an effective income tax expense rate of 49.4% for
the third quarter of 2001. The decrease was primarily due to the
- 19 -
cessation of goodwill amortization, which was nondeductible for tax purposes,
upon the adoption of SFAS No. 142 in 2002.
Nine Months Ended September 30, 2002 Compared To
Nine Months Ended September 30, 2001
FINANCIAL OVERVIEW
In the difficult market environment that prevailed during the first nine
months of 2002, daily average revenue trades decreased 18% and average revenue
per equity share traded in the Capital Markets segment decreased 44% from
year-earlier levels. As a result of these two factors, the Company's trading
revenues in the first nine months of 2002 decreased 13% from the first nine
months of 2001 and total revenues decreased 5% for the same period.
Non-trading revenues in the first nine months of 2002 were comparable to
the year-ago level. Asset management and administration fees increased 7% in the
first nine months of 2002 compared to the year-ago level, primarily resulting
from an increase in assets in, and service fees earned on, SchwabFunds, as well
as higher account fees. This increase was substantially offset by a 10% decrease
in net interest revenue, as average margin loans to clients in the first nine
months of 2002 decreased 30% from year-ago levels, as well as a 5% decrease in
other revenues.
Total expenses excluding interest during the first nine months of 2002 were
$2.9 billion, down 9% from $3.1 billion during the first nine months of 2001.
This decrease resulted primarily from the Company's continued expense reduction
measures, including the restructuring initiatives implemented during 2001.
In June 2001, U.S. Trust sold its Corporate Trust business to The Bank of
New York Company, Inc. (Bank of NY). The Company recorded an extraordinary gain
of $221 million, or $121 million after tax, on this sale in the second quarter
of 2001. During the first quarter of 2002, the Company recorded an extraordinary
gain of $22 million, or $12 million after tax, which represented the remaining
proceeds from this sale that were realized upon satisfaction of certain client
retention requirements.
The Company's after-tax operating income for the first nine months of 2002
was $310 million, up 4% from the first nine months of 2001, and its after-tax
operating profit margin for the first nine months of 2002 was 9.9%, up from 9.1%
for the first nine months of 2001. A reconciliation of the Company's operating
income to net income is shown in the following table (in millions):
- --------------------------------------------------------------------------------
Nine Months
Ended
September 30, Percent
2002 2001 Change
- --------------------------------------------------------------------------------
Operating income, after tax $ 310 $ 298 4%
Non-operating items:
Extraordinary gain (1) 22 221 (90)
Other income(2) 26
Restructuring charges (3) (190) (216) (12)
Other charges (4) (28)
Merger- and acquisition-related charges (5) (27) (91) (70)
- --------------------------------------------------------------------------------
Total non-operating items (195) (88) 122
Tax effect 73 2 n/m
- --------------------------------------------------------------------------------
Total non-operating items, after tax (122) (86) 42
- --------------------------------------------------------------------------------
Net income $ 188 $ 212 (11%)
================================================================================
(1) The Company recorded an extraordinary pre-tax gain, net of closing and exit
costs, from the sale of USTC's Corporate Trust business to The Bank of New
York Company, Inc. in June 2001. In March 2002, the Company recorded an
extraordinary pre-tax gain for the remaining proceeds related to client
retention requirements for this sale.
(2) Primarily consists of a gain on the sale of an investment.
(3) Restructuring charges include costs relating to workforce, facilities,
systems hardware, software, and equipment reductions.
(4) Includes a regulatory fine, professional service fees for operational and
risk management remediation, and the write-off of certain software
development costs.
(5) Includes retention program compensation related to the merger with USTC,
and intangible asset amortization and retention program compensation
related to the acquisition of CyberTrader. The retention programs related
to the acquisition of CyberTrader and the merger with USTC ended in March
2002 and May 2002, respectively. For the nine months ended September 30,
2001, amount also includes goodwill amortization, which ceased on January
1, 2002 upon the adoption of SFAS No. 142.
n/m Not meaningful
The Company's operating income before taxes for the first nine months of
2002 was $498 million, up $25 million, or 5%, from the first nine months of 2001
due to increases of $46 million, or 31%, in the Individual Investor segment and
$16 million, or 17%, in the U.S. Trust segment, partially offset by decreases of
$21 million, or 10%, in the Institutional Investor segment and $16 million, or
57%, in the Capital Markets segment. These fluctuations were primarily due to
the factors described in the comparison between the three-month periods, as well
as higher net interest revenue in the U.S. Trust segment due to an increase in
loans to banking clients, and lower average revenue per equity share traded and
lower levels of trading activity in the Capital Markets segment.
- 20 -
The Company's net income for the first nine months of 2002 was $188
million, or $.14 per share, compared to $212 million, or $.15 per share, for the
first nine months of 2001. The Company's after-tax profit margin for the first
nine months of 2002 was 6.0%, down from 6.4% for the first nine months of 2001.
The annualized return on stockholders' equity for the first nine months of
2002 was 6%, down from 7% for the first nine months of 2001.
REVENUES
Revenues declined $155 million, or 5%, to $3.1 billion in the first nine
months of 2002 compared to the first nine months of 2001, due to a $119 million,
or 12%, decrease in commission revenues, a $71 million, or 10%, decrease in net
interest revenue, a $45 million, or 23%, decrease in principal transaction
revenues, and a $6 million, or 5%, decrease in other revenues. These declines
were partially offset by an $86 million, or 7%, increase in asset management and
administration fees. As trading volumes decreased during the first nine months
of 2002, the Company's non-trading revenues represented 66% of total revenues as
compared to 63% for the first nine months of 2001 as shown in the following
table:
- --------------------------------------------------------------------------------
Nine Months
Ended
September 30,
Composition of Revenues 2002 2001
- --------------------------------------------------------------------------------
Commissions 29% 31%
Principal transactions 5 6
- --------------------------------------------------------------------------------
Total trading revenues 34 37
- --------------------------------------------------------------------------------
Asset management and administration fees 42 38
Net interest revenue 21 22
Other 3 3
- --------------------------------------------------------------------------------
Total non-trading revenues 66 63
- --------------------------------------------------------------------------------
Total 100% 100%
================================================================================
The $155 million decline in revenues from the first nine months of 2001 was
primarily due to decreases in revenues of $89 million, or 5%, in the Individual
Investor segment and $70 million, or 27%, in the Capital Markets segment. The
decrease in the Capital Markets segment was primarily due to lower average
revenue per equity share traded and lower equity share volume handled by SCM,
partially offset by higher revenues from client fixed income securities trading
activity. See note "12 - Segment Information" in the Notes to Condensed
Consolidated Financial Statements for financial information by segment.
Asset Management and Administration Fees
Asset management and administration fees were $1.3 billion for the first
nine months of 2002, up $86 million, or 7%, from the first nine months of 2001,
as shown in the following table (in millions):
- --------------------------------------------------------------------------------
Nine Months
Ended
Asset Management September 30, Percent
and Administration Fees 2002 2001 Change
- --------------------------------------------------------------------------------
Mutual fund service fees:
Proprietary funds
(SchwabFunds(R)and Excelsior(R)) $ 655 $ 599 9%
Mutual Fund OneSource(R) 204 214 (5)
Other 30 30
Asset management and related services 436 396 10
- --------------------------------------------------------------------------------
Total $ 1,325 $ 1,239 7%
================================================================================
The increase in asset management and administration fees was due to the
factors described in the comparison between the three-month periods.
During the first nine months of 2002, net new client assets and new
accounts decreased from the first nine months of 2001 as shown in the following
table.
- --------------------------------------------------------------------------------
Nine Months
Ended
Change in Client Assets and Accounts September 30, Percent
(In billions, except as noted) 2002 2001 Change
- --------------------------------------------------------------------------------
Net change in assets
in client accounts
Net new client assets $ 37.5 $ 60.1
Net market losses (156.6) (163.4)
- -----------------------------------------------------------------
Net decline $(119.1) $(103.3)
=================================================================
New client accounts
(in thousands) 616.5 730.5 (16%)
================================================================================
Commissions
Commission revenues for the Company were $906 million for the first nine
months of 2002, down $119 million, or 12%, from the first nine months of 2001.
- 21 -
The Company's client trading activity is shown in the following table (in
thousands):
- --------------------------------------------------------------------------------
Nine Months
Ended
September 30, Percent
Daily Average Trades 2002 2001 Change
- --------------------------------------------------------------------------------
Revenue Trades (1)
Online 112.8 136.9 (18%)
TeleBroker(R)and Schwab by PhoneTM 5.9 7.7 (23)
Regional client telephone service
centers, branch offices, and other 16.2 19.2 (16)
- --------------------------------------------------------------------------------
Total 134.9 163.8 (18%)
================================================================================
Mutual Fund OneSource(R) and
Other Asset-Based Trades
Online 47.0 35.7 32%
TeleBroker and Schwab by Phone .4 .5 (20)
Regional client telephone service
centers, branch offices, and other 10.2 18.6 (45)
- --------------------------------------------------------------------------------
Total 57.6 54.8 5%
================================================================================
Total Daily Average Trades
Online 159.8 172.6 (7%)
TeleBroker and Schwab by Phone 6.3 8.2 (23)
Regional client telephone service
centers, branch offices, and other 26.4 37.8 (30)
- --------------------------------------------------------------------------------
Total 192.5 218.6 (12%)
================================================================================
(1) Includes all client trades (both individuals and institutions) that
generate either commission revenue or revenue from principal markups (i.e.,
fixed income).
As shown in the following table, the total number of revenue trades
executed by the Company has decreased 16% as the number of accounts that traded
and client trading activity per account that traded have declined.
- --------------------------------------------------------------------------------
Nine Months
Ended
September 30, Percent
Trading Activity 2002 2001 Change
- --------------------------------------------------------------------------------
Total revenue trades (1)
(in thousands) 25,367 30,155 (16%)
Accounts that traded during
the period (in thousands) 2,474 2,642 (6)
Average revenue trades
per account that traded 10.3 11.4 (10)
Trading frequency proxy (2) 3.8 4.3 (12)
Number of trading days 188 184 2
Average revenue earned
per revenue trade $37.87 $34.71 9
- --------------------------------------------------------------------------------
(1) Includes all client trades (both individuals and institutions) that
generate either commission revenue or revenue from principal markups (i.e.,
fixed income).
(2) Represents annualized revenue trades per $100,000 in client assets.
Net Interest Revenue
Net interest revenue was $648 million for the first nine months of 2002,
down $71 million, or 10%, from the first nine months of 2001 as shown in the
following table (in millions):
- --------------------------------------------------------------------------------
Nine Months
Ended
September 30, Percent
2002 2001 Change
- --------------------------------------------------------------------------------
Interest Revenue
Margin loans to clients $ 370 $ 698 (47%)
Investments, client-related 255 448 (43)
Private banking loans 178 177 1
Securities available for sale 59 62 (5)
Other 58 124 (53)
- --------------------------------------------------------------------------------
Total 920 1,509 (39)
- --------------------------------------------------------------------------------
Interest Expense
Brokerage client cash balances 141 606 (77)
Deposits from banking clients 72 104 (31)
Long-term debt 37 42 (12)
Short-term borrowings 19 18 6
Stock-lending activities 3 17 (82)
Other 3 n/m
- --------------------------------------------------------------------------------
Total 272 790 (66)
- --------------------------------------------------------------------------------
Net interest revenue $ 648 $ 719 (10%)
================================================================================
n/m Not meaningful
- 22 -
Client-related and other daily average balances, interest rates, and
average net interest spread for the first nine months of 2002 and 2001 are
summarized in the following table (dollars in millions):
- --------------------------------------------------------------------------------
Nine Months Ended
September 30,
2002 2001
- --------------------------------------------------------------------------------
Interest-Earning Assets (client-related and other):
Investments (client-related):
Average balance outstanding $ 18,112 $ 13,367
Average interest rate 1.89% 4.48%
Margin loans to clients:
Average balance outstanding $ 8,507 $ 12,203
Average interest rate 5.78% 7.64%
Private banking loans:
Average balance outstanding $ 4,099 $ 3,328
Average interest rate 5.81% 7.12%
Securities available for sale:
Average balance outstanding $ 1,524 $ 1,341
Average interest rate 5.22% 6.15%
Average yield on interest-earning assets 3.57% 6.12%
Funding Sources (client-related and other):
Interest-bearing brokerage client cash balances:
Average balance outstanding $ 23,142 $ 22,209
Average interest rate .82% 3.65%
Interest-bearing banking deposits:
Average balance outstanding $ 3,857 $ 3,296
Average interest rate 2.48% 4.20%
Other interest-bearing sources:
Average balance outstanding $ 1,035 $ 1,189
Average interest rate 2.23% 4.36%
Average noninterest-bearing portion $ 4,208 $ 3,545
Average interest rate on funding sources .96% 3.31%
Summary:
Average yield on interest-earning assets 3.57% 6.12%
Average interest rate on funding sources .96% 3.31%
- --------------------------------------------------------------------------------
Average net interest spread 2.61% 2.81%
================================================================================
The decrease in net interest revenue from the first nine months of 2001 was
due to the factors described in the comparison between the three-month periods.
Principal Transactions
Principal transaction revenues were $147 million for the first nine months
of 2002, down $45 million, or 23%, from the first nine months of 2001, as shown
in the following table (in millions):
- --------------------------------------------------------------------------------
Nine Months
Ended
September 30, Percent
Principal Transactions 2002 2001 Change
- --------------------------------------------------------------------------------
Fixed income securities $ 72 $ 47 53%
Nasdaq and other equity securities 66 131 (50)
Other 9 14 (36)
- --------------------------------------------------------------------------------
Total $147 $192 (23%)
================================================================================
The decrease in principal transaction revenues was due to the change to
decimal pricing, which was fully implemented in the second quarter of 2001, and
lower equity share volume handled by SCM, partially offset by higher revenues
from client fixed income securities trading activity.
Other Revenues
Other revenues were $113 million for the first nine months of 2002, down $6
million, or 5%, from the first nine months of 2001. This decrease was due to
lower investment gains, partially offset by higher trade-related service fees.
EXPENSES EXCLUDING INTEREST
Total expenses excluding interest for the first nine months of 2002
declined $272 million, or 9%, from the first nine months of 2001. The Company's
initiatives under its restructuring plan and other expense reduction measures
have resulted in decreases in most expense categories during the first nine
months of 2002 when compared to the first nine months of 2001. The Company
recorded total pre-tax charges of $190 million in the first nine months of 2002
for restructuring charges under its restructuring initiatives. In the first nine
months of 2001, the Company recorded total pre-tax restructuring and other
charges of $244 million.
Compensation and benefits expense was $1.4 billion for the first nine
months of 2002, down $20 million, or 1%, from the first nine months of 2001
primarily due to a reduction in full-time equivalent employees, partially offset
by the accrual of discretionary bonuses to employees in the first nine months of
2002, and higher incentive compensation and employee benefits.
The following table shows a comparison of certain compensation and benefits
components and employee data (dollars in millions, except as noted):
- 23 -
- --------------------------------------------------------------------------------
Nine Months
Ended
September 30, Percent
2002 2001 Change
- --------------------------------------------------------------------------------
Compensation and benefits:
Salaries and wages $ 974 $1,062 (8%)
Incentive and variable compensation 204 154 32
Employee benefits and other 235 217 8
- --------------------------------------------------------------------------------
Total compensation and benefits $1,413 $1,433 (1%)
- --------------------------------------------------------------------------------
Compensation and benefits expense as a
% of total revenues 45% 44%
Incentive and variable compensation as a
% of compensation and benefits expense 14% 11%
Compensation for temporary employees,
contractors and overtime hours as a
% of compensation and benefits expense 6% 6%
Full-time equivalent employees
(at end of period, in thousands) (1) 18.8 21.9 (14%)
Revenues per average full-time equivalent
employee (in thousands) $163.3 $139.5 17%
- --------------------------------------------------------------------------------
(1) Includes full-time, part-time, and temporary employees, and persons
employed on a contract basis.
Employee benefits and other expenses increased by $18 million, or 8%, from
the first nine months of 2001 primarily due to the factors discussed in the
comparison between the three-month periods. Additionally, employee benefits and
other expense includes net pension income related to U.S. Trust's defined
benefit pension plan, which totaled less than $1 million and $9 million for the
first nine months of 2002 and 2001, respectively. The decrease in net pension
income from the prior period was primarily due to the factors described in the
comparison between the three-month periods.
Communications expense was $200 million for the first nine months of 2002,
down $64 million, or 24%, from the first nine months of 2001. This decrease was
primarily due to lower client trading volumes and the Company's expense
reduction measures.
Goodwill amortization expense for the first nine months of 2001 was $49
million. Upon adoption of SFAS No. 142 on January 1, 2002, amortization of the
existing goodwill ceased and therefore there was no such expense in the first
nine months of 2002. The Company did not record any goodwill impairment charges
in the first nine months of 2002 upon completion of the initial transitional
impairment test under SFAS No. 142.
The Company's effective income tax rate was 37.8% for the first nine months
of 2002, down from 44.9% for the first nine months of 2001. The decrease was
primarily due to the factors described in the comparison between the three-month
periods.
Liquidity and Capital Resources
CSC is a financial holding company, which is a type of bank holding company
subject to supervision and regulation by the Federal Reserve Board under the
Bank Holding Company Act of 1956, as amended. CSC conducts virtually all
business through its wholly owned subsidiaries. The capital structure among CSC
and its subsidiaries is designed to provide each entity with capital and
liquidity consistent with its operations. See note "10 - Regulatory
Requirements" in the Notes to Condensed Consolidated Financial Statements.
Liquidity
CSC
CSC's liquidity needs are generally met through cash generated by its
subsidiaries, as well as cash provided by external financing. As discussed
below, Schwab, CSC's depository institution subsidiaries, and SCM 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, meeting CSC's depository institution subsidiaries' capital
guidelines, and maintaining Schwab's and SCM's net capital. Based on their
respective regulatory capital ratios at September 30, 2002, the Company and its
depository institution subsidiaries are considered well capitalized.
CSC has liquidity needs that arise from its issued and outstanding $577
million Senior Medium-Term Notes, Series A (Medium-Term Notes), as well as from
the funding of cash dividends, acquisitions, and other investments. The
Medium-Term Notes have maturities ranging from 2002 to 2010 and fixed interest
rates ranging from 6.04% to 8.05% with interest payable semiannually (see Item 3
- - Quantitative and Qualitative Disclosures About Market Risk - Interest Rate
Swaps). The Medium-Term Notes are rated A2 by Moody's Investors Service
(Moody's), A- by Standard & Poor's Ratings Group (S&P), and A by Fitch IBCA,
Inc. (Fitch).
CSC has a prospectus supplement on file with the Securities and Exchange
Commission enabling CSC to issue up to $750 million in Senior or Senior
Subordinated Medium-Term Notes, Series A. At September 30, 2002, all of these
notes remained unissued.
CSC has authorization from its Board of Directors to issue up to $1.0
billion in commercial paper. At September 30, 2002, no commercial paper has been
issued. CSC's ratings for these short-term borrowings are P-1 by Moody's, A-2 by
S&P, and F1 by Fitch.
CSC maintains a $1.0 billion committed, unsecured credit facility with a
group of twenty-two banks which is
- 24 -
scheduled to expire in June 2003. This facility was unused during the first nine
months of 2002. Any issuances under CSC's commercial paper program will reduce
the amount available under this facility. The funds under this facility are
available for general corporate purposes and CSC pays a commitment fee on the
unused balance of this facility. The financial covenants in this facility
require CSC to maintain a minimum level of tangible net worth, and Schwab and
SCM to maintain specified levels of net capital, as defined. Management believes
that these restrictions will not have a material effect on its ability to meet
foreseeable dividend or funding requirements.
CSC also has direct access to $670 million of the $770 million uncommitted,
unsecured bank credit lines, provided by eight banks that are primarily utilized
by Schwab to manage short-term liquidity. The amount available to CSC under
these lines is lower than the amount available to Schwab because the credit line
provided by one of these banks is only available to Schwab. These lines were not
used by CSC during the first nine months of 2002.
Schwab
Liquidity needs relating to client trading and margin borrowing activities
are met primarily through cash balances in brokerage client accounts, which were
$23.3 billion and $25.0 billion at September 30, 2002 and December 31, 2001,
respectively. Management believes that brokerage client cash balances and
operating earnings will continue to be the primary sources of liquidity for
Schwab in the future.
Schwab is subject to regulatory requirements that are intended to ensure
the general financial soundness and liquidity of broker-dealers. These
regulations prohibit Schwab from repaying subordinated borrowings to CSC, paying
cash dividends, or making unsecured advances or loans to its parent or employees
if such payment would result in net capital of less than 5% of aggregate debit
balances or less than 120% of its minimum dollar requirement of $1 million. At
September 30, 2002, Schwab's net capital was $1.2 billion (17% of aggregate
debit balances), which was $1.0 billion in excess of its minimum required net
capital and $825 million in excess of 5% of aggregate debit balances. Schwab has
historically targeted net capital to be at least 10% of its aggregate debit
balances, which primarily consist of client margin loans.
To manage Schwab's regulatory capital position, CSC provides Schwab with a
$1.4 billion subordinated revolving credit facility which is scheduled to expire
in September 2003. The amount outstanding under this facility at September 30,
2002 was $220 million. At quarter end, Schwab also had outstanding $25 million
in fixed-rate subordinated term loans from CSC maturing in 2004. Borrowings
under these subordinated lending arrangements qualify as regulatory capital for
Schwab.
To manage short-term liquidity, Schwab main tains uncommitted, unsecured
bank credit lines with a group of eight banks totaling $770 million at September
30, 2002 (as noted previously, $670 million of these lines are also available
for CSC to use). The need for short-term borrowings arises primarily from timing
differences between cash flow requirements and the scheduled liquidation of
interest-bearing investments. Schwab used such borrowings for 11 days during the
first nine months of 2002, with the daily amounts borrowed averaging $39
million. There were no borrowings outstanding under these lines at September 30,
2002.
To satisfy the margin requirement of client option transactions with the
Options Clearing Corporation (OCC), Schwab had unsecured letter of credit
agreements with nine banks in favor of the OCC aggregating $630 million at
September 30, 2002. Schwab pays a fee to maintain these letters of credit. No
funds were drawn under these letters of credit at September 30, 2002.
U.S. Trust
U.S. Trust's liquidity needs are generally met through earnings generated
by its operations.
U.S. Trust is subject to the Federal Reserve Board's risk-based and
leverage capital guidelines. These regulations require banks and bank holding
companies to maintain minimum levels of capital. In addition, CSC's depository
institution subsidiaries are subject to limitations on the amount of dividends
they can pay to USTC.
In addition to traditional funding sources such as deposits, federal funds
purchased, and repurchase agreements, CSC's depository institution subsidiaries
have established their own external funding sources. At September 30, 2002, U.S.
Trust had $50 million in Trust Preferred Capital Securities outstanding with a
fixed interest rate of 8.41%. Certain of CSC's depository institution
subsidiaries have established credit facilities with the Federal Home Loan Bank
System (FHLB) totaling $699 million. There were no borrowings outstanding under
these facilities at September 30, 2002. Additionally, at September 30, 2002,
U.S. Trust had $362 million of federal funds purchased and $387 million of
repurchase agreements outstanding.
CSC provides U.S. Trust with a $300 million short-term credit facility
maturing in 2003. Borrowings under this facility do not qualify as regulatory
capital for U.S. Trust. The amount outstanding under this facility was $35
million at September 30, 2002.
SCM
SCM's liquidity needs are generally met through earnings generated by its
operations. Most of SCM's assets are liquid, consisting primarily of cash and
cash
- 25 -
equivalents, receivables from brokers, dealers and clearing organizations, and
marketable securities.
SCM's liquidity is affected by the same net capital regulatory requirements
as Schwab (see discussion above). At September 30, 2002, SCM's net capital was
$67 million, which was $66 million in excess of its minimum required net
capital.
SCM may borrow up to $150 million under a subordinated lending arrangement
with CSC which is scheduled to expire in August 2003. Borrowings under this
arrangement qualify as regulatory capital for SCM. The amount outstanding under
this facility at September 30, 2002 was $60 million. The advances under this
facility satisfy increased intra-day capital needs at SCM to support the
expansion of its institutional equities and trading businesses. In addition, CSC
provides SCM with a $50 million short-term credit facility. Borrowings under
this arrangement do not qualify as regulatory capital for SCM. No funds were
drawn under this facility at September 30, 2002.
Liquidity Risk Factors
Specific risk factors which may affect the Company's liquidity position are
discussed in "Management's Discussion and Analysis of Results of Operations and
Financial Condition - Liquidity and Capital Resources - Liquidity Risk Factors"
in the Company's 2001 Annual Report to Stockholders, which is filed as Exhibit
13.1 to the Company's Form 10-K for the year ended December 31, 2001. There have
been no material changes to these liquidity risk factors in the first nine
months of 2002.
Cash Flows and Capital Resources
Net income plus depreciation and amortization including goodwill
amortization was $431 million for the first nine months of 2002, down 16% from
$513 million for the first nine months of 2001. Depreciation and amortization
expense related to equipment, office facilities and property was $234 million
for the first nine months of 2002, as compared to $244 million for the first
nine months of 2001, or 7% of revenues for both periods. Amortization expense
related to intangible assets was $9 million for the first nine months of 2002
and $8 million for the first nine months of 2001. Goodwill amortization expense
was $49 million for the first nine months of 2001.
The Company's cash position (reported as cash and cash equivalents on the
condensed consolidated balance sheet) and cash flows are affected by changes in
brokerage client cash balances and the associated amounts required to be
segregated under federal or other regulatory guidelines. Timing differences
between cash and investments actually segregated on a given date and the amount
required to be segregated for that date may arise in the ordinary course of
business and are addressed by the Company in accordance with applicable
regulations. Other factors which affect the Company's cash position and cash
flows include investment activity in securities owned, levels of capital
expenditures, banking client deposit and loan activity, financing activity in
short-term borrowings and long-term debt, and repurchases of CSC's common stock.
In the first nine months of 2002, cash and cash equivalents decreased $1.9
billion, or 43%, to $2.5 billion primarily due to movements of brokerage
client-related funds to meet segregation requirements, decreases in brokerage
client cash balances, increases in investments in securities available for sale,
and decreases in deposits from banking clients. Management does not believe that
this decline in cash and cash equivalents is an indication of a trend.
The Company's capital expenditures were $114 million in the first nine
months of 2002 and $266 million in the first nine months of 2001, or 4% and 8%
of revenues for each period, respectively. Capital expenditures in the first
nine months of 2002 were for software and equipment relating to the Company's
information technology systems and certain facilities. Capital expenditures as
described above include the capitalized costs for developing internal-use
software of $53 million in the first nine months of 2002 and $62 million in the
first nine months of 2001. As discussed in the Company's 2001 Annual Report to
Stockholders, which is filed as Exhibit 13.1 to the Company's Form 10-K for the
year ended December 31, 2001, management anticipated that 2002 capital
expenditures would be approximately 10% to 20% lower than 2001 spending of $301
million. Additionally, management anticipated that 2002 development spending
(i.e., media and project spending) would be approximately 5% to 10% lower than
2001 spending of $406 million. Due to a continued economic slowdown and
management's continued focus on cost containment, the Company further reduced
its capital expenditures and development spending in the first nine months of
2002. Management currently anticipates that full-year 2002 capital expenditures
will be approximately 45% to 55% lower than 2001 levels and that full-year 2002
development spending will be approximately 15% to 25% lower than 2001 levels.
During the first nine months of 2002, 4 million of the Company's stock
options, with a weighted-average exercise price of $6.53, were exercised with
cash proceeds received by the Company of $23 million and a related tax benefit
of $3 million. The cash proceeds are recorded as an increase in cash and a
corresponding increase in stockholders' equity. The tax benefit is recorded as a
reduction in income taxes payable and a corresponding increase in stockholders'
equity.
The Company borrowed $100 million and repaid $203 million of long-term debt
during the first nine months of 2002.
- 26 -
During the first nine months of 2002, CSC repurchased 24 million shares of
its common stock for $230 million. During the first nine months of 2001, CSC
repurchased 23 million shares of its common stock for $315 million. At September
30, 2002, the authorization granted by the Board of Directors allows for future
repurchases of CSC's common stock totaling up to $169 million of the original
$500 million authorization.
During the first nine months of 2002 and 2001, the Company paid common
stock cash dividends of $45 million and $46 million, respectively.
The Company monitors both the relative composition and absolute level of
its capital structure. The Company's total financial capital (long-term debt
plus stockholders' equity) at September 30, 2002 was $4.8 billion, down $98
million, or 2%, from December 31, 2001 due to a net decline in long-term debt.
At September 30, 2002, the Company had long-term debt of $652 million, or 14% of
total financial capital, that bears interest at a weighted-average rate of
7.37%. At September 30, 2002, the Company's stockholders' equity was $4.1
billion, or 86% of total financial capital.
Commitments
A summary of the Company's principal contractual obligations and other
commitments as of September 30, 2002 is shown in the following table (in
millions). Management believes that funds generated by its operations, as well
as cash provided by external financing, will continue to be the primary funding
sources in meeting these obligations and commitments.
- --------------------------------------------------------------------------------
Less than 1 - 3 4 - 5 After 5
1 Year Years Years Years Total
- --------------------------------------------------------------------------------
Operating leases (1) $ 102 $ 889 $ 267 $ 773 $2,031
Long-term debt (2) 11 237 106 273 627
Short-term borrowings 760 760
Credit-related financial
instruments (3) 599 120 719
Other commitments (4) 6 6
- --------------------------------------------------------------------------------
Total $1,478 $1,246 $ 373 $1,046 $4,143
================================================================================
(1) Includes minimum rental commitments and maximum guaranteed residual values
under noncancelable leases for office space and equipment.
(2) Excludes the effect of interest rate swaps, see Item 3 - Quantitative and
Qualitative Disclosures About Market Risk - Interest Rate Swaps.
(3) Includes U.S. Trust firm commitments to extend credit primarily for
mortgage loans to private banking clients and standby letters of credit.
(4) Includes committed capital contributions to venture capital funds.
In addition to the commitments summarized above, in the ordinary course of
its business the Company has entered into various agreements with third-party
vendors, including agreements for advertising, sponsorships of sporting events,
data processing equipment purchases, licensing, and software installation. These
agreements typically can be canceled by the Company if notice is given within
the terms specified in the agreements.
Item 3. Quantitative and Qualitative Disclosures
About Market Risk
Financial Instruments Held For Trading Purposes
The Company holds municipal, other fixed income and government securities,
and certificates of deposit in inventory to meet clients' trading activities.
The fair value of such inventory was approximately $59 million and $36 million
at September 30, 2002 and December 31, 2001, respectively. These securities, and
the associated interest rate risk, are not material to the Company's financial
position, results of operations, or cash flows.
The Company maintains inventories in exchange-listed, Nasdaq, and other
equity securities on both a long and short basis. The fair value of these
securities at September 30, 2002 and December 31, 2001 are shown in the
following table (in millions):
- --------------------------------------------------------------------------------
September 30, December 31,
Equity Securities 2002 2001
- --------------------------------------------------------------------------------
Long positions $ 69 $167
Short positions 12 27
- --------------------------------------------------------------------------------
Net long positions $ 57 $140
================================================================================
Using a hypothetical 10% increase or decrease in prices, the potential loss
or gain in fair value is estimated to be approximately $6 million and $14
million at September 30, 2002 and December 31, 2001.
In addition, the Company generally enters into exchange-traded futures and
options contracts based on equity market indices to hedge potential losses in
equity inventory positions. The notional amounts and fair values of these
futures and options contracts are shown in the following table (in millions):
- --------------------------------------------------------------------------------
September 30, December 31,
Exchange-traded Contracts 2002 2001
- --------------------------------------------------------------------------------
Net Short Futures (1):
Notional Amount $ 59 $125
Fair Value $ 55 $125
Long Put Options:
Notional Amount $ 8 $ 23
Fair Value (2)
- --------------------------------------------------------------------------------
(1) Notional amount represents original contract price of the futures. Fair
value represents the index price. The difference between the notional and
fair value amounts are settled daily in accordance with futures market
requirements.
(2) Amount was less than $1 million at both September 30, 2002 and December 31,
2001.
- 27 -
Using a hypothetical 10% increase or decrease in the underlying indices,
the potential loss or gain in fair value is estimated to be approximately $6
million and $13 million at September 30, 2002 and December 31, 2001,
respectively, which would substantially offset the potential loss or gain on the
equity securities previously discussed.
Financial Instruments Held For Purposes Other Than Trading
Deferred Compensation
The Company maintains investments in mutual funds related to its deferred
compensation plan, which is available to certain employees. These investments
were approximately $46 million and $61 million at September 30, 2002 and
December 31, 2001, respectively. These securities, and the associated market
risk, are not material to the Company's financial position, results of
operations, or cash flows.
Debt Issuances
At September 30, 2002, CSC had $577 million aggregate principal amount of
Medium-Term Notes, with fixed interest rates ranging from 6.04% to 8.05%. At
December 31, 2001, CSC had $679 million aggregate principal amount of
Medium-Term Notes, with fixed interest rates ranging from 6.04% to 8.05%. See
"Interest Rate Swaps" below.
At September 30, 2002 and December 31, 2001, U.S. Trust had $50 million
Trust Preferred Capital Securities outstanding, with a fixed interest rate of
8.41%. In addition at December 31, 2001, U.S. Trust had $1 million FHLB
long-term debt outstanding with a fixed interest rate of 6.69%.
The Company has fixed cash flow requirements regarding these long-term debt
obligations due to the fixed rate of interest. The fair value of these
obligations at September 30, 2002 and December 31, 2001, based on estimates of
market rates for debt with similar terms and remaining maturities, approximated
their carrying amount.
Interest Rate Swaps
As part of its consolidated asset and liability management process, the
Company utilizes interest rate swaps (Swaps) to manage interest rate risk.
U.S. Trust uses Swaps to hedge the interest rate risk associated with its
variable rate deposits from banking clients. These Swaps call for U.S. Trust to
receive a variable rate of interest and pay a fixed rate of interest. At
September 30, 2002, these Swaps had a weighted-average variable interest rate of
1.84%, a weighted-average fixed interest rate of 6.36%, a weighted-average
maturity of 1.9 years, and an aggregate notional principal amount of $880
million. At December 31, 2001, the notional principal amount of such Swaps
totaled $905 million, and they carried a weighted-average variable interest rate
of 2.15%, a weighted-average fixed interest rate of 6.37%, and a
weighted-average maturity of 2.6 years. These Swaps have been designated as cash
flow hedges under SFAS No. 133 - Accounting for Derivative Instruments and
Hedging Activities, and are recorded on the condensed consolidated balance
sheet, with changes in their fair values primarily recorded in other
comprehensive income (loss), a component of stockholders' equity. At September
30, 2002 and December 31, 2001, U.S. Trust recorded a derivative liability of
$69 million and $54 million, respectively, for these Swaps. Based on current
interest rate assumptions and assuming no additional swap agreements are entered
into, U.S. Trust expects to reclassify approximately $21 million, or $14 million
after tax, from other comprehensive loss to interest expense over the next
twelve months. Using Swaps to hedge variable rate deposits enables U.S. Trust to
fund long-term fixed-rate financial instruments with a fixed-rate source,
effectively creating a positive interest rate spread over the life of the Swaps.
As a result, U.S. Trust expects that the long-term fixed-rate financial
instruments will generate interest income that will offset the amount of
interest expense that is anticipated to be reclassified from other comprehensive
loss over the period.
During the second quarter of 2002, CSC entered into Swaps with an aggregate
notional principal amount of $293 million that effectively alter the interest
rate characteristics of a like amount of its Medium-Term Notes. These Swaps call
for CSC to receive a fixed rate of interest and pay a variable rate of interest
based on the three-month LIBOR rate. At September 30, 2002, the net effect of
the Swaps converted the Medium-Term Notes from a weighted-average fixed interest
rate of 7.57% to a weighted-average variable interest rate of 4.26%. The
variable interest rates reset every three months. These Swaps have been
designated as fair value hedges under SFAS No. 133, and are recorded on the
condensed consolidated balance sheet. Changes in fair value of the Swaps are
completely offset by changes in fair value of the hedged Medium-Term Notes,
resulting in no effect on earnings. At September 30, 2002, CSC recorded a
derivative asset of $25 million for these Swaps. Concurrently, the carrying
value of the Medium-Term Notes was increased by $25 million.
Net Interest Revenue Simulation
The Company uses net interest revenue simulation modeling techniques to
evaluate and manage the effect of changing interest rates. The simulation model
(the model) includes all interest-sensitive assets and liabilities, as well as
Swaps utilized by the Company to hedge its interest rate risk. Key variables in
the model include assumed margin
- 28 -
loan and brokerage client cash balance growth or decline, changes to the level
and term structure of interest rates, the repricing of financial instruments,
prepayment and reinvestment assumptions, loan, banking deposit, and brokerage
client cash balance pricing and volume assumptions. The simulations involve
assumptions that are inherently uncertain and as a result, the simulations
cannot precisely estimate net interest revenue or precisely predict the impact
of changes in interest rates on net interest revenue. Actual results may differ
from simulated results due to the timing, magnitude, and frequency of interest
rate changes as well as changes in market conditions and management strategies,
including changes in asset and liability mix.
As demonstrated by the simulations presented below, the Company is
positioned so that the consolidated balance sheet produces an increase in net
interest revenue when interest rates rise and, conversely, a decrease in net
interest revenue when rates fall (i.e., interest-earning assets are repricing
more quickly than interest-bearing liabilities). The Swaps entered into during
the second quarter of 2002 have the effect of increasing the repricing frequency
of interest-bearing liabilities, thereby reducing the Company's consolidated
interest-rate sensitivity.
The simulations in the following table assume that the asset and liability
structure of the consolidated balance sheet would not be changed as a result of
the simulated changes in interest rates. As the Company actively manages its
consolidated balance sheet and interest rate exposure, in all likelihood the
Company would take steps to manage any additional interest rate exposure that
could result from changes in the interest rate environment. The following table
shows the effect of a gradual 100 basis point increase or decrease in interest
rates relative to the Company's current base rate forecast on simulated net
interest revenue over the next twelve months at September 30, 2002 and December
31, 2001.
- --------------------------------------------------------------------------------
Impact on Net Interest Revenue September 30, December 31,
Percentage Increase (Decrease) 2002 2001
- --------------------------------------------------------------------------------
Increase of 100 basis points 2.3% 3.8%
Decrease of 100 basis points (2.6%) (7.0%)
- --------------------------------------------------------------------------------
The impact of the Company's hedging activities upon net interest revenue
for the quarters ended September 30, 2002 and December 31, 2001 was immaterial
to the Company's results of operations.
Item 4. Controls and Procedures
An evaluation was performed under the supervision and with the
participation of the Company's management, including the Co-Chief Executive
Officers and Chief Financial Officer, of the effectiveness of the design,
maintenance, and operation of the Company's disclosure controls and procedures
within 90 days before the filing date of this quarterly report. Based on that
evaluation, the Company's management, including the Co-Chief Executive Officers
and Chief Financial Officer, concluded that the Company's disclosure controls
and procedures were effective. There have been no significant changes in the
Company's internal controls or in other factors that could significantly affect
internal controls subsequent to their evaluation.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
In March 2000, three purported class action complaints were filed against
U.S. Trust Company, N.A. (USTC N.A.) in U.S. District Court in Louisiana. All
three suits are brought on behalf of participants in an employee stock ownership
plan (UC ESOP) sponsored by United Companies Financial Corporation (United
Companies), which is currently in bankruptcy proceedings in Delaware. Plaintiffs
allege that USTC N.A., as directed trustee of the UC ESOP, breached its
fiduciary duties under the Employee Retirement Income Security Act of 1974 by
failing to diversify the assets of the UC ESOP. In December 2001, plaintiffs and
USTC N.A. reached a tentative settlement of $10 million. Under the terms of this
settlement, plaintiffs would release USTC N.A. of all liability. Other than an
insignificant deductible, the settlement would be paid from insurance coverage.
The parties are in the process of finalizing the proposed settlement
documentation and are preparing to file a motion for a preliminary approval of
the settlement with the U. S. District Court in Louisiana. If and when
preliminary approval is granted, notice of the settlement will be distributed to
members of the class and a final fairness hearing will be held for final
approval of the settlement.
In January 2001, three purported class action complaints and a number of
related individual cases were filed against U.S. Trust NY and other defendants.
In some of these cases, USTC N.A. was also named as a defendant. The plaintiffs
in all of these cases are former personal injury plaintiffs (Payees) who are
entitled to future payments under "structured settlement" agreements. The
settlement payments are obligations of Stanwich Financial Services Corp.
(Stanwich), as Trustor of certain Trusts, and Stanwich has defaulted on certain
of those obligations. USTC N.A.
- 29 -
served as Trustee of the Trusts from approximately December 1992 to March 1994,
and U.S. Trust NY served as Trustee from approximately September 1998 until its
resignation in April 2001. During the period from March 1994 to September 1998,
while an unrelated trust company was the Trustee of the Trusts, the U.S.
Treasury securities held by the trusts were pledged as collateral for a loan or
loans and then lost through foreclosure. The class actions and all but two of
the individual cases have been filed in California (the California cases), and
have been consolidated. The other two individual cases have been filed in
Montana. In the complaints now applicable to these cases, the plaintiffs allege
that, as Trustee during their respective tenures, U.S. Trust NY and USTC N.A.
owed certain duties to the Payees, and breached those duties in various ways.
The plaintiffs in these cases seek unspecified compensatory damages, punitive
damages and other relief. In the cases, U.S. Trust NY and USTC N.A. have
answered the complaints, denying the allegations and raising certain affirmative
defenses, and have filed cross-complaints for indemnity against other defendants
in the cases. In the California cases, the Court ordered the class certified on
February 13, 2002. U.S. Trust NY and USTC N.A. intend to defend the cases
vigorously.
In October 2001, partnership and individual plaintiffs filed a complaint
against U.S. Trust Company of Texas, N.A. (U.S. Trust Texas), USTC and other
defendants, relating to defaults that have occurred under bonds issued in a
series of eleven bond offerings (Heritage Bonds). The proceeds of the Heritage
Bonds, issued between December 1996 and March 1999, were for the purpose of
financing the acquisition and/or renovation of a long-term care facility or
hospital. U.S. Trust Texas was indenture trustee under various trust indentures
executed in connection with the Heritage Bonds. Although U.S. Trust sold its
corporate trust business in 2001, under the sale agreement, U.S. Trust retains
responsibility for certain litigation, including these cases. The first Heritage
Bond complaint was followed by the filing of five more complaints, four of them
purported class actions. Five of the six actions, including the four class
actions, have been filed in state or federal courts in California (the
California cases); the remaining action has been filed in federal court in
Illinois (the Illinois case). In these complaints, the plaintiffs allege that,
as indenture trustee, U.S. Trust Texas owed certain duties to the plaintiffs,
and breached those duties in various ways. In the California cases, the putative
plaintiff class seeks compensatory damages in excess of $100 million, punitive
damages and other relief. In the Illinois case, the plaintiff seeks compensatory
damages in excess of $4.8 million, punitive damages and other relief. U.S. Trust
Texas and/or USTC have filed motions seeking dismissal of two of the five
California cases and the Illinois case. U.S. Trust Texas and USTC filed a motion
with the Judicial Panel on Multidistrict Litigation to consolidate the Illinois
case and the federal California cases and that motion was granted. U.S. Trust
Texas and USTC intend to defend all of these cases vigorously.
U.S. Trust NY was Escrow Agent and Indenture Trustee in connection with an
offering of approximately $130 million in senior secured redeemable notes issued
in July 1998 by Epic Resorts, LLC (Epic Notes). In January 2002, certain
noteholders filed a complaint in the Supreme Court of New York, New York County
against U.S. Trust NY alleging that U.S. Trust NY failed to comply with its
obligations as Escrow Agent and Indenture Trustee for the Epic Notes. Although
USTC sold its Corporate Trust business in 2001, under the sale agreement, USTC
retains responsibility for certain litigation, including this case. The
plaintiff noteholders claim that as a result of the alleged breaches, they
suffered financial losses, including losing their investment in the Epic Notes,
in the amount of $88 million. U.S. Trust NY has answered the complaint, denying
plaintiffs' allegations and asserting affirmative defenses, and intends to
vigorously defend the lawsuit.
The nature of the Company's business, including its new products and
services, subjects it to claims, lawsuits, regulatory examinations, and other
proceedings in the ordinary course of business. The results of these matters
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, results of operations, and cash flows. However, it is the
opinion of management, after consultation with legal counsel, that the ultimate
outcome of existing claims and proceedings will not have a material adverse
impact on the financial condition, results of operations, or cash flows of the
Company.
Item 2. Changes in Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
- 30 -
Item 5. Other Information
Effective October 1, 2002, the Board of Directors of U.S. Trust Corporation
(U.S. Trust) appointed Alan J. Weber as Chief Executive Officer of U.S. Trust.
Mr. Weber succeeds Jeffrey S. Maurer, who will remain as Chairman of U.S. Trust
for a transitional period and will become chairman of Schwab's Affluent Client
Strategy and Policy Committee. Mr. Maurer will also remain on the Company's
Executive Committee. In addition to his role as chief executive of U.S. Trust,
Mr. Weber will serve on the Company's Executive Committee.
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
- --------------------------------------------------------------------------------
10.242 The Charles Schwab Corporation 1987 Stock Option Plan, amended and
restated as of September 25, 2002, with form of Non-Qualified Stock
Option Agreement attached (supersedes Exhibit 10.222).
10.243 The Charles Schwab Corporation 1987 Executive Officer Stock Option
Plan, amended and restated as of September 25, 2002, with form of
Non-Qualified Stock Option Agreement attached (supersedes Exhibit
10.223).
10.244 The Charles Schwab Corporation 1992 Stock Incentive Plan, amended and
restated as of September 25, 2002 (supersedes Exhibit 10.224).
10.245 The Charles Schwab Corporation 2001 Stock Incentive Plan, amended and
restated as of September 25, 2002 (supersedes Exhibit 10.225).
10.246 Executive Employment Agreement by and among The Charles Schwab
Corporation, Schwab Capital Markets L.P., and Lon Gorman, and
Supplemental Agreement thereto.
10.247 The Charles Schwab Severance Pay Plan, restated as of August 1, 2002.
12.1 Computation of Ratio of Earnings to Fixed Charges.
- --------------------------------------------------------------------------------
(b) Reports on Form 8-K
On August 13, 2002, the Registrant filed a Current Report on Form 8-K which
included sworn statements under oath executed by the Chairman of the Board and
Co-Chief Executive Officer, President and Co-Chief Executive Officer, and
Executive Vice President and Chief Financial Officer in accordance with the
Securities and Exchange Commission Order No. 4-460 Requiring the Filing of Sworn
Statements Pursuant to Section 21(a)(1) of the Securities Exchange Act of 1934.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE CHARLES SCHWAB CORPORATION
(Registrant)
Date: November 12, 2002 /s/ Christopher V. Dodds
-------------------- ------------------------------
Christopher V. Dodds
Executive Vice President and
Chief Financial Officer
- 32 -
CERTIFICATION
I, Charles R. Schwab, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Charles Schwab
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the Evaluation Date); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 12, 2002 /s/ Charles R. Schwab
----------------- ----------------------------------------------------
Charles R. Schwab
Chairman of the Board and Co-Chief Executive Officer
- 33 -
CERTIFICATION
I, David S. Pottruck, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Charles Schwab
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the Evaluation Date); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 12, 2002 /s/ David S. Pottruck
----------------- ----------------------------------------
David S. Pottruck
President and Co-Chief Executive Officer
- 34 -
CERTIFICATION
I, Christopher V. Dodds, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Charles Schwab
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the Evaluation Date); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 12, 2002 /s/ Christopher V. Dodds
----------------- -----------------------------------------------------
Christopher V. Dodds
Executive Vice President and Chief Financial Officer
- 35 -