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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 March 31, 2003 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 by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). 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.
1,350,412,258 shares of $.01 par value Common Stock
Outstanding on April 30, 2003
THE CHARLES SCHWAB CORPORATION
Quarterly Report on Form 10-Q
For the Quarter Ended March 31, 2003
Index
Page
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Part I - Financial Information
Item 1. Condensed Consolidated Financial Statements:
Statement of Income 1
Balance Sheet 2
Statement of Cash Flows 3
Notes 4 - 11
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12 - 24
Item 3. Quantitative and Qualitative Disclosures About Market Risk 24 - 26
Item 4. Controls and Procedures 26
Part II - Other Information
Item 1. Legal Proceedings 27
Item 2. Changes in Securities and Use of Proceeds 27
Item 3. Defaults Upon Senior Securities 27
Item 4. Submission of Matters to a Vote of Security Holders 27
Item 5. Other Information 28
Item 6. Exhibits and Reports on Form 8-K 28
Signature 29
Certifications 30 - 31
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
March 31,
2003 2002
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Revenues
Asset management and administration fees $ 428 $ 441
Commissions 240 298
Interest revenue 239 309
Interest expense (64) (91)
----- -----
Net interest revenue 175 218
Principal transactions 33 51
Other 24 40
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Total 900 1,048
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Expenses Excluding Interest
Compensation and benefits 417 463
Other compensation - merger retention programs - 14
Occupancy and equipment 111 115
Depreciation and amortization 76 82
Communications 60 70
Advertising and market development 48 52
Professional services 37 47
Commissions, clearance and floor brokerage 13 17
Restructuring charges - 26
Impairment charges 5 -
Other 36 26
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Total 803 912
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Income from continuing operations before taxes on income and extraordinary gain 97 136
Taxes on income (23) (50)
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Income from continuing operations before extraordinary gain 74 86
Loss from discontinued operations, net of tax benefit (3) (4)
Extraordinary gain on sale of corporate trust business, net of tax expense - 12
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Net Income $ 71 $ 94
====================================================================================================================================
Weighted-Average Common Shares Outstanding - Diluted 1,357 1,389
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Earnings Per Share - Basic
Income from continuing operations before extraordinary gain $ .05 $ .06
Loss from discontinued operations, net of tax benefit - -
Extraordinary gain, net of tax expense - $ .01
Net income $ .05 $ .07
Earnings Per Share - Diluted
Income from continuing operations before extraordinary gain $ .05 $ .06
Loss from discontinued operations, net of tax benefit - -
Extraordinary gain, net of tax expense - $ .01
Net income $ .05 $ .07
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Dividends Declared Per Common Share $ .011 $ .011
- ------------------------------------------------------------------------------------------------------------------------------------
All periods have been adjusted to summarize the impact of The Charles Schwab Corporation's sale of its United Kingdom brokerage
subsidiary, Charles Schwab Europe, in loss from discontinued operations.
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)
March 31, December 31,
2003 2002
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Assets
Cash and cash equivalents $ 2,388 $ 3,114
Cash and investments segregated and on deposit for federal or other
regulatory purposes(1) (including resale agreements of $17,974 in 2003
and $16,111 in 2002) 22,255 21,005
Securities owned - at market value (including securities pledged of $336
in 2003 and $337 in 2002) 2,238 1,716
Receivables from brokers, dealers and clearing organizations 191 222
Receivables from brokerage clients - net 6,322 6,845
Loans to banking clients - net 4,651 4,555
Equipment, office facilities and property - net 1,048 868
Goodwill - net 604 603
Other assets 743 777
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Total $ 40,440 $ 39,705
====================================================================================================================================
Liabilities and Stockholders' Equity
Deposits from banking clients $ 5,207 $ 5,231
Drafts payable 273 134
Payables to brokers, dealers and clearing organizations 2,271 1,476
Payables to brokerage clients 25,754 26,401
Accrued expenses and other liabilities 1,254 1,302
Short-term borrowings 769 508
Long-term debt 856 642
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Total liabilities 36,384 35,694
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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;
1,392,091,084 and 1,391,991,180 shares issued in 2003 and 2002, respectively 14 14
Additional paid-in capital 1,743 1,744
Retained earnings 2,802 2,769
Treasury stock - 42,564,730 and 47,195,631 shares in 2003 and 2002,
respectively, at cost (416) (465)
Unamortized stock-based compensation (76) (33)
Accumulated other comprehensive loss (11) (18)
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Total stockholders' equity 4,056 4,011
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Total $ 40,440 $ 39,705
====================================================================================================================================
(1) Amounts included represent actual balances on deposit, whereas cash and investments required to be segregated for federal or
other regulatory purposes were $21,999 million and $21,252 million at March 31, 2003 and December 31, 2002, respectively. On
April 2 and January 2, 2003, the Company deposited $170 million and $655 million, respectively, into its segregated reserve
bank accounts.
See Notes to Condensed Consolidated Financial Statements.
- 2 -
THE CHARLES SCHWAB CORPORATION
Condensed Consolidated Statement of Cash Flows
(In millions)
(Unaudited)
Three Months Ended
March 31,
2003 2002
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Cash Flows from Operating Activities
Net income $ 71 $ 94
Adjustments to reconcile net income to net cash used for operating activities:
Depreciation and amortization 76 82
Impairment charges 5 -
Compensation payable in common stock 7 7
Deferred income taxes 15 27
Tax benefits from stock options exercised and other stock-based compensation - 3
Non-cash restructuring charges - 2
Extraordinary gain on sale of corporate trust business, net of tax expense - (12)
Loss (gain) on sales of subsidiaries 2 (4)
Other 2 (4)
Net change in:
Cash and investments segregated and on deposit for federal or other
regulatory purposes (1,978) (684)
Securities owned (excluding securities available for sale) (45) 11
Receivables from brokers, dealers and clearing organizations 13 (11)
Receivables from brokerage clients 520 52
Other assets 15 (74)
Drafts payable 139 (197)
Payables to brokers, dealers and clearing organizations 819 248
Payables to brokerage clients 49 (924)
Accrued expenses and other liabilities (216) (56)
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Net cash used for operating activities (506) (1,440)
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Cash Flows from Investing Activities
Purchases of securities available for sale (460) (612)
Proceeds from sales of securities available for sale 14 235
Proceeds from maturities, calls and mandatory redemptions of securities
available for sale 135 108
Net increase in loans to banking clients (97) (138)
Purchase of equipment, office facilities and property - net (32) (32)
Cash payments for investments and other (8) -
Proceeds from sales of subsidiaries 53 20
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Net cash used for investing activities (395) (419)
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Cash Flows from Financing Activities
Net decrease in deposits from banking clients (24) (1,332)
Net increase in short-term borrowings 261 635
Repayment of long-term debt (22) -
Dividends paid (15) (15)
Purchase of treasury stock (32) -
Proceeds from stock options exercised 7 15
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Net cash provided by (used for) financing activities 175 (697)
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Effect of exchange rate changes on cash and cash equivalents - (1)
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Decrease in Cash and Cash Equivalents (726) (2,557)
Cash and Cash Equivalents at Beginning of Period 3,114 4,407
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Cash and Cash Equivalents at End of Period $ 2,388 $ 1,850
====================================================================================================================================
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
374 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 33 offices in 13 states. Other subsidiaries include
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 traders.
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 generally accepted accounting principles in the U.S. (GAAP). All
adjustments were of a normal recurring nature, except as discussed in Note "6 -
Discontinued Operations." Certain items in prior periods' financial statements
have been reclassified to conform to the 2003 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 2002 Annual Report to
Stockholders, which is filed as Exhibit 13.1 to the Company's Form 10-K for the
year ended December 31, 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. New Accounting Standards
Financial Accounting Standards Board Interpretation (FIN) No. 45 -
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others, was issued in November 2002. This
interpretation addresses the disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under certain
guarantees. FIN No. 45 also clarifies that a guarantor is required to recognize,
at the inception of a guarantee, a liability for the fair value of the
obligation undertaken in issuing the guarantee. In accordance with FIN No. 45,
the Company adopted the disclosure requirements on December 31, 2002 and the
recognition requirements on January 1, 2003. The adoption of FIN No. 45 did not
have a material impact on the Company's financial position, results of
operations, earnings per share (EPS), or cash flows.
FIN No. 46 - Consolidation of Variable Interest Entities, an Interpretation
of Accounting Research Bulletin No. 51 - Consolidated Financial Statements, was
issued in January 2003. This interpretation provides new criteria for
determining whether a company is required to consolidate (i.e., record the
assets and liabilities on the balance sheet) a variable interest entity. Upon
adoption of this interpretation in the first quarter of 2003, the Company
consolidated a special purpose trust (Trust) that was formed in 2000 to finance
an office building and land. The Trust, through an agent, raised the $245
million needed to acquire and renovate the building and land by issuing
long-term debt ($235 million) and raising equity capital ($10 million). Upon
adoption, the Company recorded: the building and land at a cost of $245 million,
net of accumulated depreciation of $16 million; long-term debt of $235 million;
and a net reduction of accrued expenses and other liabilities of $7 million. The
cumulative effect of this accounting change was immaterial.
The building is being depreciated on a straight-line basis over twenty
years. The long-term debt consists of a variable-rate note maturing in June
2005. The interest rate on the note was 1.64% at March 31, 2003 and ranged from
1.64% to 1.82% during the quarter. The building and land have been pledged as
collateral for the long-term debt. Additionally, the Company has guaranteed the
debt of the Trust up to a maximum of $202 million. The lender does not have
recourse to any other assets of the Company.
- 4 -
The annual impact of the adoption of FIN No. 46 on the Company's Condensed
Consolidated Statement of Income is to cease both amortizing the shortfall of
the residual value guarantee and recording rent expense on the lease and to
record both the depreciation on the building and the interest expense associated
with the debt. The adoption of FIN No. 46 did not have and is not expected to
have a material impact on the Company's results of operations, EPS, or cash
flows.
Statement of Financial Accounting Standards (SFAS) No. 149 - Amendment of
Statement 133 on Derivative Instruments and Hedging Activities was issued in
April 2003. This statement amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments
embedded in other contracts and for hedging activities under SFAS No. 133 -
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 149 also
amends certain other existing pronouncements. The Company is required to adopt
this statement on a prospective basis effective on June 30, 2003 for contracts
entered into or modified after adoption, with certain exceptions. The Company is
evaluating the impact of this statement and does not expect it to have a
material impact on its financial position, results of operations, EPS, or cash
flows.
3. Stock Incentive Plans
The Company's stock incentive plans provide for granting options to
employees, officers, and directors. Options are granted for the purchase of
shares of common stock at an exercise price not less than market value on the
date of grant, and expire within ten years from the date of grant. Options
generally vest over a four-year period from the date of grant.
A summary of option activity follows:
- --------------------------------------------------------------------------------
2003 2002
------------------ ------------------
Weighted- Weighted-
Number Average Number Average
of Exercise of Exercise
Options Price Options Price
- --------------------------------------------------------------------------------
Outstanding at
beginning of year 156 $ 15.38 153 $ 16.20
Granted -(1) $ 9.26 7 $ 13.15
Exercised (1) $ 5.82 (3) $ 7.08
Canceled (6) $ 18.09 (2) $ 21.34
- --------------------------------------------------------------------------------
Outstanding at
March 31 149 $ 15.34 155 $ 16.11
================================================================================
Exercisable at
March 31 77 $ 13.30 59 $ 12.01
- --------------------------------------------------------------------------------
Available for future
grant at March 31 39 45
- --------------------------------------------------------------------------------
Weighted-average fair
value of options granted in
quarter ended March 31 $ 4.34 $ 6.33
- --------------------------------------------------------------------------------
(1) Less than 500,000 options were granted during the first quarter of 2003.
The fair value of each option granted is estimated as of the grant date
using the Black-Scholes option pricing model with the following assumptions:
- --------------------------------------------------------------------------------
Three Months Ended March 31, 2003 2002
- --------------------------------------------------------------------------------
Expected dividend yield .30% .30%
Expected volatility 52% 50%
Risk-free interest rate 2.9% 4.1%
Expected life (in years) 5 5
- --------------------------------------------------------------------------------
The Company applies Accounting Principles Board Opinion No. 25 - Accounting
for Stock Issued to Employees, and related interpretations, for its stock-based
employee compensation plans. Because the Company grants stock option awards at
market value, there is no compensation expense recorded, except for
restructuring-related expense for modifications of officers' stock options.
Had compensation expense for the Company's stock option awards been
determined based on the Black-Scholes fair value at the grant dates for awards
under those plans consistent with the fair value method of SFAS No. 123 -
Accounting for Stock-Based Compensation, the Company would have recorded
additional compensation expense and its net income and EPS would have been
reduced to the pro forma amounts presented in the following table:
- 5 -
- --------------------------------------------------------------------------------
Three Months Ended March 31, 2003 2002
- --------------------------------------------------------------------------------
Compensation expense for stock
options (after tax):
As reported $ - $ 2
Pro forma (1) $ 29 $ 40
- --------------------------------------------------------------------------------
Net Income:
As reported $ 71 $ 94
Pro forma $ 42 $ 56
- --------------------------------------------------------------------------------
Basic EPS:
As reported $ .05 $ .07
Pro forma $ .03 $ .04
Diluted EPS:
As reported $ .05 $ .07
Pro forma $ .03 $ .04
- --------------------------------------------------------------------------------
(1) Includes pro forma compensation expense related to stock options granted in
both current and prior periods. Pro forma stock option compensation is
amortized on a straight-line basis over the vesting period beginning with
the month in which the option was granted.
4. Restructuring
In 2001, the Company initiated a restructuring plan to reduce operating
expenses due to economic uncertainties and difficult market conditions. This
restructuring plan was completed in 2002 and 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 were costs
associated with the withdrawal from certain international operations.
In the third quarter of 2002, the Company commenced additional
restructuring initiatives due to continued difficult market conditions. These
initiatives were intended to reduce operating expenses and adjust the Company's
organizational structure to improve productivity, enhance efficiency, and
increase profitability. The restructuring initiatives were substantially
completed in 2002 and primarily included further reductions in the Company's
workforce and facilities.
The Company recorded pre-tax restructuring charges of $26 million in the
first quarter of 2002, all of which related to its 2001 restructuring
initiatives. There were no restructuring charges in the first quarter of 2003.
The actual costs of the Company's restructuring 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 reserve related to the
Company's 2001 and 2002 restructuring initiatives for the first quarter of 2003
is as follows:
- --------------------------------------------------------------------------------
Three months ended Workforce Facilities
March 31, 2003 Reduction Reduction Total
- --------------------------------------------------------------------------------
Balance at December 31, 2002 $ 68 $ 227 $ 295
Balance related to discontinued
operations (3) (3)
Cash payments (29) (10) (39)
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Balance at March 31, 2003 $ 39(1) $ 214(2) $ 253
================================================================================
(1) Includes $9 million and $30 million related to the Company's 2001 and 2002
restructuring initiatives, respectively. The Company expects to
substantially utilize the remaining workforce reduction reserve through
cash payments for severance pay and benefits over the respective severance
periods through 2004.
(2) Includes $116 million and $98 million related to the Company's 2001 and
2002 restructuring initiatives, respectively. The Company expects to
substantially utilize the remaining facilities reduction reserve through
cash payments for the net lease expense over the respective lease terms
through 2017.
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. (Bank of NY). 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. Discontinued Operations
On January 31, 2003, the Company sold its United Kingdom (U.K.) brokerage
subsidiary, Charles Schwab Europe (CSE), to Barclays PLC (Barclays) and
transferred client-related assets of approximately $760 million (consisting
primarily of cash and investments segregated and on deposit for federal or other
regulatory purposes and receivables from brokers, dealers and clearing
organizations) and liabilities of approximately $735 million (consisting
primarily of payables to brokerage clients) to Barclays. The results of the
operations of CSE, net of income taxes, have been presented as discontinued
operations on the Condensed Consolidated Statement of Income. Revenues for CSE
were $4 million and $12 million for the first quarters of 2003 and 2002,
respectively. Pre-tax losses for CSE were $5 million and $6 million for the
first quarters of 2003 and 2002, respectively. An after-tax loss of $2 million
on the sale was recorded in the first quarter of 2003 and included the estimated
costs associated with certain CSE obligations that
- 6 -
were retained by the Company, principally related to facilities lease and other
contracts.
CSE was included in the Company's restructuring initiatives and recorded
pre-tax restructuring charges totaling $15 million and $9 million in 2002 and
2001, respectively. The Company retained certain restructuring-related facility
lease obligations following the sale of CSE. The Company's facilities
restructuring reserve balance related to CSE, which is net of estimated sublease
income, is $12 million at March 31, 2003. This balance represents the December
31, 2002 balance of $3 million and additional charges of $9 million recorded at
the date of sale.
7. Sale of United Kingdom Joint Venture
On March 18, 2003, the Company entered into an agreement to sell its
investment in Aitken Campbell, a market-making joint venture in the U.K., to the
Company's joint venture partner, TD Waterhouse Group, Inc. The sale is expected
to close in May 2003 following regulatory and other approvals. Based upon the
terms of the sale, the Company recorded in the first quarter of 2003 an
impairment charge of $5 million pre tax to reduce the carrying value of its
investment and a deferred income tax benefit of $16 million that will be
realized following the completion of the sale. The Company's share of Aitken
Campbell's historical earnings, which was accounted for under the equity method,
has not been material to the Company's results of operations, EPS, or cash
flows.
8. Allowance for Credit Losses on Banking Loans and Nonperforming Assets
Loans to banking clients of $4.7 billion at March 31, 2003 and $4.6 billion
at December 31, 2002 are presented net of the related allowance for credit
losses. The allowance for credit losses on banking loans was $24 million at
March 31, 2003 and December 31, 2002. Recoveries and charge-offs were not
material for each of the three-month periods ended March 31, 2003 and 2002.
Nonperforming assets consisted of non-accrual loans of $1 million at March
31, 2003 and December 31, 2002.
9. 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
Months Ended
March 31,
2003 2002
- --------------------------------------------------------------------------------
Net income $ 71 $ 94
- --------------------------------------------------------------------------------
Other comprehensive income (loss):
Net gain on cash flow
hedging instruments 3 6
Foreign currency translation
adjustment 5 -
Change in net unrealized loss
on securities available for sale (1) (7)
- --------------------------------------------------------------------------------
Total comprehensive income,
net of tax $ 78 $ 93
================================================================================
- 7 -
10. 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
Months Ended
March 31,
2003 2002
- --------------------------------------------------------------------------------
Net income $ 71 $ 94
- --------------------------------------------------------------------------------
Weighted-average common
shares outstanding - basic 1,342 1,366
Common stock equivalent shares
related to stock incentive plans 15 23
- --------------------------------------------------------------------------------
Weighted-average common
shares outstanding - diluted 1,357 1,389
================================================================================
Basic EPS:
Income from continuing operations
before extraordinary gain $ .05 $ .06
Loss from discontinued operations,
net of tax benefit - -
Extraordinary gain, net of tax expense - $ .01
Net income $ .05 $ .07
- --------------------------------------------------------------------------------
Diluted EPS:
Income from continuing operations
before extraordinary gain $ .05 $ .06
Loss from discontinued operations,
net of tax benefit - -
Extraordinary gain, net of tax expense - $ .01
Net income $ .05 $ .07
- --------------------------------------------------------------------------------
The computation of diluted EPS for the three months ended March 31, 2003
and 2002, respectively, excludes outstanding stock options to purchase 118
million and 86 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.
11. 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. 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:
- --------------------------------------------------------------------------------
2003 2002
---------------- -----------------
March 31, Amount Ratio(1) Amount Ratio(1)
- --------------------------------------------------------------------------------
Tier 1 Capital:
Company $ 3,526 25.4% $ 3,717 22.2%
U.S. Trust $ 604 16.4% $ 583 17.2%
U.S. Trust NY $ 356 11.8% $ 369 13.7%
Total Capital:
Company $ 3,554 25.6% $ 3,744 22.3%
U.S. Trust $ 629 17.1% $ 605 17.8%
U.S. Trust NY $ 378 12.5% $ 388 14.4%
Tier 1 Leverage:
Company $ 3,526 9.0% $ 3,717 9.7%
U.S. Trust $ 604 8.8% $ 583 9.0%
U.S. Trust NY $ 356 6.4% $ 369 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 March 31, 2003 and
2002, 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.
In the first quarter of 2003, the Company implemented a value-at-risk (VAR)
model to estimate the risks associated with its inventory portfolios. Since VAR
is considered to be a comprehensive measurement tool for estimating market risk,
the Federal Reserve Board requires certain bank holding companies to incorporate
VAR in determining their Tier 1 Capital and Total Capital ratios. The
implementation of VAR had the effect of increasing both the Company's Tier 1
Capital and Total Capital ratios by 1.3% at March 31, 2003.
Schwab and SCM are subject to the Uniform Net Capital Rule under the
Securities Exchange Act of 1934 (the Rule). Schwab and SCM compute net capital
under the alternative method permitted by this Rule. 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
- 8 -
than 5% of aggregate debit balances or less than 120% of its minimum dollar
requirement. At March 31, 2003, Schwab's net capital was $1.2 billion (20% of
aggregate debit balances), which was $1.1 billion in excess of its minimum
required net capital and $929 million in excess of 5% of aggregate debit
balances. At March 31, 2003, SCM's net capital was $89 million, which was $88
million in excess of its minimum required net capital.
12. Commitments and Contingent Liabilities
Guarantees: The Company provides certain indemnifications (i.e., protection
against damage or loss) to counterparties in connection with the disposition of
certain of its assets. Such indemnifications typically relate to title to the
assets transferred, ownership of intellectual property rights (e.g., patents),
accuracy of financial statements, compliance with laws and regulations, failure
to pay, satisfy or discharge any liability, or to defend claims, as well as
errors, omissions, and misrepresentations. These indemnification agreements have
various expiration dates and the Company's liability under these agreements is
generally limited to certain maximum amounts. The Company, however, remains
subject to certain uncapped potential liabilities, for example regarding the
transfer of trust assets and related obligations in connection with the sale of
its Corporate Trust business to Bank of NY. Other than the possible uncapped
obligations, at March 31, 2003, the Company's maximum potential liability under
these indemnification agreements is limited to approximately $215 million.
During the first quarter of 2003, the Company entered into two additional
indemnification agreements relating to the pending sale of its U.K.
market-making operation and the sale of its U.K. brokerage subsidiary. These
indemnification agreements have various expiration dates through 2010 and a
maximum potential liability of approximately $74 million.
Standby letters of credit (LOCs) are conditional commitments issued by U.S.
Trust to guarantee the performance of a client to a third party. For example,
LOCs can be used to guarantee performance under lease and other agreements by
professional business corporations and for other purposes. The credit risk
involved in issuing LOCs is essentially the same as that involved in extending
loans. LOCs are generally partially or fully collateralized by cash, marketable
equity securities, marketable debt securities (including corporate and U.S.
Treasury debt securities), and other assets. At March 31, 2003, U.S. Trust had
LOCs outstanding totaling $68 million, which are short-term in nature and
generally expire within one year.
The Company has clients that sell (i.e., write) listed option contracts
that are cleared by various clearing houses. The clearing houses establish
margin requirements on these transactions. The Company satisfies the margin
requirements by arranging LOCs, in favor of the clearing houses, that are
guaranteed by multiple banks. At March 31, 2003, the outstanding value of these
LOCs totaled $630 million. No funds were drawn under these LOCs at March 31,
2003.
In accordance with FIN No. 45, the Company recognizes, at the inception of
a guarantee, a liability for the estimated fair value of the obligation
undertaken in issuing the guarantee. The fair values of the obligations relating
to LOCs are estimated based on fees charged to enter into similar agreements,
considering the creditworthiness of the counterparties. The fair values of the
obligations relating to other guarantees are estimated based on transactions for
similar guarantees or expected present value measures. The Company does not
believe that any material loss related to indemnification agreements, including
the uncapped indemnification obligations, or LOCs is likely and therefore at
March 31, 2003, the liabilities recorded for these guarantees are immaterial.
The Company also provides guarantees to securities clearing houses and
exchanges under their standard membership agreement, which requires members to
guarantee the performance of other members. Under the agreement, if another
member becomes unable to satisfy its obligations to the clearing houses and
exchanges, other members would be required to meet shortfalls. The Company's
liability under these arrangements is not quantifiable and may exceed the cash
and securities it has posted as collateral. However, the potential requirement
for the Company to make payments under these arrangements is remote.
Accordingly, no liability has been recognized for these transactions.
The Company has provided residual value guarantees to the lessors in
connection with operating leases used to finance two corporate aircraft and a
fractional interest in a third airplane. These guarantees mean that if the
airplanes are sold to third parties at the expiration of the leases, the Company
is responsible for making up any shortfalls between the actual sales prices and
specified amounts. At March 31, 2003, the maximum amounts of residual value
guarantees under these leases totaled $14 million expiring in 2004 and $20
million expiring in 2007. The Company believes that proceeds from the sales of
these airplanes would be sufficient to cover the residual value guarantees and
therefore no liabilities for these guarantees have been recognized.
Legal contingencies: 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.
- 9 -
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.
13. 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 (a non-GAAP income measure), which
excludes restructuring charges, acquisition-related charges, impairment charges,
discontinued operations, and extraordinary gains. Intersegment revenues are not
material and are therefore not disclosed. Total revenues, income from continuing
operations before taxes on income and extraordinary gain, and net income are
equal to the amounts as reported on the Company's Condensed Consolidated
Statement of Income.
- --------------------------------------------------------------------------------
Three
Months Ended
March 31,
2003 2002
- --------------------------------------------------------------------------------
Revenues:
Individual Investor $ 507 $ 604
Institutional Investor 187 212
Capital Markets 57 65
U.S. Trust 149 167
- --------------------------------------------------------------------------------
Total $ 900 $1,048
================================================================================
Adjusted operating income (loss) before taxes:
Individual Investor $ 27 $ 67
Institutional Investor 53 67
Capital Markets (4) 9
U.S. Trust (1) 26 35
- --------------------------------------------------------------------------------
Adjusted operating income before taxes 102 178
Excluded items (2) (5) (42)
- --------------------------------------------------------------------------------
Income from continuing operations before
taxes on income and extraordinary gain 97 136
Tax expense on income (23) (50)
Loss from discontinued operations, net of tax benefit (3) (3) (4)
Extraordinary gain on sale of corporate trust
business, net of tax expense - 12
- --------------------------------------------------------------------------------
Net Income $ 71 $ 94
================================================================================
(1) Excludes an extraordinary pre-tax gain of $22 million for the three months
ended March 31, 2002 relating to the sale of USTC's Corporate Trust
business.
(2) Represents an impairment charge related to the Company's investment in its
U.K. market-making operation for the three months ended March 31, 2003 (see
note "7 - Sale of United Kingdom Joint Venture"). Includes restructuring
charges of $26 million (see note "4 - Restructuring") and
acquisition-related charges of $16 million for the three months ended March
31, 2002.
(3) Represents the impact of the Company's sale of its U.K. brokerage
subsidiary, which was previously included in the Individual Investor
segment (see note "6 - Discontinued Operations").
- 10 -
14. Supplemental Cash Flow Information
Certain information affecting the cash flows of the Company is presented in
the following table:
- --------------------------------------------------------------------------------
Three
Months Ended
March 31,
2003 2002
- --------------------------------------------------------------------------------
Income taxes paid $ 12 $ 11
- --------------------------------------------------------------------------------
Interest paid:
Brokerage client cash balances $ 24 $ 53
Deposits from banking clients 21 22
Long-term debt 15 26
Short-term borrowings 5 7
Other 3 -
- --------------------------------------------------------------------------------
Total interest paid $ 68 $ 108
================================================================================
Non-cash investing and financing activities:
Consolidation of special purpose trust:(1)
Building and land $ 229 -
Long-term debt and other liabilities $ 228 -
- --------------------------------------------------------------------------------
(1) Upon adoption of FIN No. 46 in the first quarter of 2003, the Company
consolidated a special purpose trust. See note "2 - New Accounting
Standards."
15. Subsequent Event
In April 2003, the Company received approval from the Office of the
Comptroller of the Currency for a national bank charter. The Company commenced
banking operations through Charles Schwab Bank, N.A. in the second quarter of
2003, with the first phase of its product offering focused on mortgage and
deposit products and other banking services.
- 11 -
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 $762.6 billion at March 31, 2003. Charles
Schwab & Co., Inc. (Schwab) is a securities broker-dealer with 374 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
33 offices in 13 states. Other subsidiaries include 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 traders.
The Company provides financial services to individuals, institutional
clients, and broker-dealers through four segments - Individual Investor,
Institutional Investor, Capital Markets, and U.S. Trust. The Individual Investor
segment includes the Company's domestic and international retail operations. The
Institutional Investor segment provides custodial, trading and support services
to independent investment advisors (IAs), serves company 401(k) plan sponsors
and third-party administrators, and supports company stock option plans. 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,
wealth management, custody, fiduciary, and private banking services to
individual and institutional clients.
Business Strategy: The Company's primary strategy is to serve the needs of
individual investors either directly or indirectly through intermediaries, IAs,
or corporate retirement plan sponsors. The Company's products and services are
designed to meet clients' varying investment and financial needs, including help
and advice and access to extensive investment research, news and information.
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 emerging affluent clients -
those with less than $250,000 in assets;
- - 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 2002
Annual Report to Stockholders, which is filed as Exhibit 13.1 to the Company's
Form 10-K for the year ended December 31, 2002. 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, 2002. Significant
recent developments relating to certain of these strategic priorities, as well
as other significant developments, follows:
Services for Affluent Investors: The Company's full-service advice and
relationship service offering includes Schwab Advisor Network(TM), Schwab
Private Client, and Schwab Equity Ratings(TM). The Schwab Advisor Network is a
referral program that provides investors who want the assistance of an
independent professional with access to approximately 340 participating IAs who
have an average of 17 years of experience and $500 million of assets under
management. Schwab Private Client is a fee-based service designed to help
clients who want access to an ongoing, face-to-face advice relationship with a
designated Schwab consultant while retaining day-to-day responsibility for their
investment decisions. Schwab Equity Ratings provide clients with an objective
stock rating system on more than 3,000 stocks, assigning each equity a single
grade: A, B, C, D, or F.
For self-directed affluent investors, the Company enhanced its Schwab
Signature Platinum(R) service by introducing a series of exclusive online panel
discussions
- --------------
(a) Accounts with balances or activity within the preceding eight months.
- 12 -
that offer perspectives on topics ranging from macroeconomic conditions to
international investing.
Schwab is focused on enhancing the support services it offers to IAs. IAs
provide customized and personalized portfolio management and financial planning
services to investors who prefer to delegate their financial management
responsibilities to an independent professional. IAs can access improved Web
trading functionality - including streamlined allocations - as well as fixed
income new issue alerts through schwabinstitutional.com. During the first
quarter of 2003, the Company also introduced a custody and administrative
support offering at U.S. Trust designed specifically for IAs desiring access to
bank trust capabilities.
Services for Active Traders: In the first quarter of 2003, the Company
enhanced the services available to clients trading at least 120 times a year by
providing access to specialized trading consultants for help in crafting more
effective trading strategies. Also in the first quarter of 2003, StreetSmart
Pro(R), Schwab's direct access desktop application with real-time streaming
Level II quotes, interactive charting and customizable watch lists, was made
available to actively trading clients based in Hong Kong.
Services for Emerging Affluent Clients: In the first quarter of 2003, the
Company introduced the Fresh Start program, an offer that included a customized
investment plan and all recommended equity rebalancing trades for a $95 fee. The
Fresh Start offer generated over 30,000 qualified leads and nearly $1.4 billion
in net new assets from new and existing clients in the first quarter of 2003.
For clients with less than $100,000, the Company completed a pilot of its
Foundational Consultation service, a for-fee advice interaction that provides
professional assistance to investors who traditionally may not have had access
to tailored advice.
Corporate Services: In the first quarter of 2003, the Company introduced an
online investment management platform that is designed to help plan sponsors and
investment consultants perform detailed fund screening, rebalance holdings, view
plan positions and transactions, and monitor investment performance.
Additionally, to help defined benefit plan participants gain a better
understanding of their benefits, the Company initiated quarterly statements for
defined benefit plans and introduced a Web site that includes benefit
information and interactive retirement planning tools. Corporate Services also
expanded its Executive Services offering by introducing a Web-based reporting
system that enables public companies to report insider transactions within new
federal guidelines. For those 401(k) plan sponsors and their employees utilizing
the Schwab Personal Choice Retirement Account(R) option, the Company introduced
an online account opening capability which significantly reduces the time
required to open and fund an account.
Capital Markets: In the first quarter of 2003, the Company introduced the
Schwab Liquidity Network(TM), a system that pools the orders of the Company's
individual investor client base with those of hundreds of broker-dealers and
institutional investment firms in a manner designed to offer greater
opportunities for the best possible price on most stock trades. This new
approach combines automated electronic execution of small orders with the
professional handling of large blocks of 10,000 shares or more.
Other Significant Developments: The Company continued to combine people and
technology through several important technology-based initiatives during the
first quarter of 2003. To help clients gain perspective on current geopolitical
uncertainties, the Company introduced an online Webcast that features regularly
updated commentary from Schwab's Washington Research Group. In addition,
schwab.com was redesigned to deliver more targeted messaging - clients view home
pages that contain information that is tailored to them. The Company also
created a new page on its Web site where clients can access the most frequently
used application forms online. The Company leveraged technology to support
advice interactions by making improvements to its internal MarketPlace Web site,
which provides Schwab investment consultants with a suite of investment
viewpoints and advice tools. MarketPlace includes Schwab Equity Ratings(TM)
Commentary, a plain-English description that provides context to A to F ratings
on over 3,000 stocks. MarketPlace also features a new Weekly Strategy Call that
delivers perspectives on current market and industry trends.
The Company introduced in the first quarter of 2003 the Schwab GNMA
Fund(TM), a core fixed income mutual fund which invests primarily in Government
National Mortgage Association bonds and is designed to help provide investors
with income and credit safety.
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 2002 Annual Report to
Stockholders, which is filed as Exhibit 13.1 to the Company's Form 10-K for the
year ended December 31, 2002. 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.
- 13 -
The Company expects to continue to evaluate and consider potential
strategic transactions, including business combinations, acquisitions and
dispositions of businesses, services, and other assets. At any given time, the
Company may be engaged in discussions or negotiations with respect to one or
more of such transactions. Any such transaction could have a material impact on
the Company's financial position, results of operations, earnings per share
(EPS), or cash flows. There is no assurance that any such discussions or
negotiations will result in the consummation of any transaction. In addition,
the process of integrating any acquisition may create unforeseen operating
difficulties, expenditures, and other risks.
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 potential impact of future strategic transactions (see
Risk Management), the impact of the sales of its United Kingdom operations on
the Company's results of operations (see Financial Overview), sources of
liquidity and capital (see Liquidity and Capital Resources - Liquidity and -
Commitments), the Company's cash position, cash flows, and capital expenditures
(see Liquidity and Capital Resources - Cash and Capital Resources), the impact
of the Company's trading risk as estimated by a value-at-risk measurement
methodology (see Item 3 - Quantitative and Qualitative Disclosures About Market
Risk - Financial Instruments Held For Trading Purposes), 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 beliefs,
objectives and expectations described in these statements is subject to certain
risks and uncertainties that could cause actual results to differ materially
from the expressed beliefs, objectives and expectations.
Important factors that may cause such differences are noted in this interim
report and include, but are not limited to: the Company's success in building
fee-based relationships with its clients; 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; geopolitical developments affecting
the securities markets, the economy, and investor sentiment; 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 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 2002 Annual Report to Stockholders, which is filed as
Exhibit 13.1 to the Company's Form 10-K for the year ended December 31, 2002.
There have been no material changes to these critical accounting policies during
the first three months of 2003.
- 14 -
Three Months Ended March 31, 2003 Compared To
Three Months Ended March 31, 2002
All references to EPS information in this report reflect diluted earnings
per share unless otherwise noted.
FINANCIAL OVERVIEW
The Company's financial performance in the first quarter of 2003 was
significantly affected by heightened geopolitical uncertainties, mixed economic
news, and weak securities market returns which placed continued pressure on
client asset valuations and trading activity. In the difficult market
environment that prevailed during the first quarter of 2003, the Company's
trading revenues decreased 22% from the first quarter of 2002. The decrease in
trading revenues was primarily due to lower client trading activity (reflected
in commission revenues) and lower average revenue per equity share traded
(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 10% in the first quarter of 2003
compared to the year-ago level. The decrease in non-trading revenues was
primarily due to a 20% decrease in net interest revenue, a 40% decrease in other
revenue and a 3% decrease in asset management and administration fees. Average
margin loans to clients in the first quarter of 2003 decreased 31% from year-ago
levels, which primarily caused the decline in net interest revenue. The decrease
in other revenues was primarily due to net losses on investments in 2003,
compared to net gains on investments in 2002. The decrease in asset management
and administration fees primarily resulted from decreases in average assets in
Schwab's Mutual Fund OneSource(R) service.
Total expenses excluding interest during the first quarter of 2003 were
$803 million, down 12% from the first quarter of 2002. This decrease resulted
primarily from decreases in almost all expense categories as a result of the
Company's continued expense reduction measures.
On January 31, 2003, the Company sold its United Kingdom (U.K.) brokerage
subsidiary, Charles Schwab Europe (CSE), to Barclays PLC (Barclays). The results
of CSE's operations have been summarized as loss from discontinued operations,
net of tax benefit, on the Condensed Consolidated Statement of Income. The
reported loss was $3 million for the first quarter of 2003, compared to $4
million for the first quarter of 2002. The Company's consolidated prior period
revenues, expenses, and taxes on income have been adjusted to reflect this
presentation. For further information, see note "6 - Discontinued Operations" in
the Notes to Condensed Consolidated Financial Statements.
On March 18, 2003, the Company entered into an agreement to sell its
investment in Aitken Campbell, a market-making joint venture in the U.K., to the
Company's joint venture partner, TD Waterhouse Group, Inc. The sale is expected
to close in May 2003 following regulatory and other approvals. Based upon the
terms of the sale, the Company recorded in the first quarter of 2003 an
impairment charge of $5 million pre tax to reduce the carrying value of its
investment and a deferred income tax benefit of $16 million that will be
realized following the completion of the sale. The Company's share of Aitken
Campbell's historical earnings, which was accounted for under the equity method,
has not been material to the Company's results of operations, EPS, or cash
flows.
Income from continuing operations before taxes on income and extraordinary
gain was $97 million for the first quarter of 2003, down 29% from the first
quarter of 2002. This decrease was primarily due to the combination of factors
discussed separately above - lower revenues, partially offset by declines in
almost all expense categories. Net income for the first quarter of 2003 was $71
million, or $.05 per share, down 24% from $94 million, or $.07 per share, for
the first quarter of 2002. This decline was primarily due to lower income from
continuing operations before taxes on income and extraordinary gain as discussed
above and an extraordinary gain recorded in 2002. The Company's after-tax profit
margin for the first quarter of 2003 was 7.9%, down from 9.0% for the first
quarter of 2002. The annualized return on stockholders' equity for the first
quarter of 2003 was 7%, down from 9% for the first quarter of 2002.
In the first quarter of 2003, net income of $71 million included the
following items which in total had the effect of increasing after-tax income by
$8 million: a $3 million loss from discontinued operations, an investment
write-down of $5 million related to the Company's U.K. market-making operation,
and a $16 million tax benefit associated with the Company's announced sale of
its U.K. market-making operation. In the first quarter of 2002, net income of
$94 million included the following items which in total had the effect of
decreasing after-tax income by $17 million: a $4 million loss from discontinued
operations, a $22 million extraordinary gain on the sale of U.S. Trust's
corporate trust business, $26 million of restructuring charges, and $16 million
of acquisition-related charges.
- 15 -
In evaluating the Company's financial performance, management uses adjusted
operating income, a non-generally accepted accounting principles (non-GAAP)
income measure which excludes the items described above. Management believes
that adjusted 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. As detailed in note "13 - Segment
Information" in the Notes to Condensed Consolidated Financial Statements,
adjusted operating income was $102 million for the first quarter of 2003, down
$76 million, or 43%, from the first quarter of 2002 primarily due to decreases
of $40 million, or 60%, in the Individual Investor segment, $14 million, or 21%,
in the Institutional Investor segment, and $9 million, or 26%, in the U.S. Trust
segment. Additionally, the Capital Markets segment had a loss before taxes and
excluded items of $4 million in the first quarter of 2003, compared to income
before taxes and excluded items of $9 million in the first quarter of 2002. The
decrease in the Individual Investor and Institutional Investor segments were
primarily due to lower client trading activity. The decrease in the U.S. Trust
segment was primarily due to lower average client assets related to declines in
market valuations. The decrease in the Capital Markets segment was primarily due
to lower average revenue per equity share traded, as well as higher expenses.
Restructuring: In 2001, the Company initiated a restructuring plan to reduce
operating expenses due to economic uncertainties and difficult market
conditions. The restructuring plan was completed in 2002 and 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 were costs associated with the withdrawal from certain
international operations.
In the third quarter of 2002, the Company commenced additional
restructuring initiatives due to continued difficult market conditions. These
initiatives were intended to reduce operating expenses and adjust the Company's
organizational structure to improve productivity, enhance efficiency, and
increase profitability. These restructuring initiatives were substantially
completed in 2002 and primarily included further reductions in the Company's
workforce and facilities.
The Company recorded pre-tax restructuring charges of $26 million in the
first quarter of 2002, all of which related to its 2001 restructuring
initiatives. There were no restructuring charges in the first quarter of 2003.
As of March 31, 2003, the remaining facilities restructuring reserve of
$214 million related to the Company's 2001 and 2002 restructuring initiatives is
net of estimated future sublease income of approximately $360 million. This
estimated future sublease income amount is determined based upon a number of
factors, including current and expected commercial real estate lease rates in
the respective properties' real estate markets, and estimated vacancy periods
prior to execution of tenant subleases. At March 31, 2003, approximately 30% of
the total square footage covered under the 2001 and 2002 restructuring
initiatives has been subleased, up from approximately 20% at December 31, 2002.
For further information on the Company's restructuring initiatives, see
note "4 - Restructuring" in the Notes to Condensed Consolidated Financial
Statements.
REVENUES
Revenues decreased by $148 million, or 14%, to $900 million in the first
quarter of 2003 compared to the first quarter of 2002, due to a $58 million, or
19%, decrease in commission revenues, a $43 million, or 20%, decrease in net
interest revenue, an $18 million, or 35%, decrease in principal transaction
revenues, a $16 million, or 40%, decrease in other revenues, and a $13 million,
or 3%, decrease in asset management and administration fees. The Company's
non-trading revenues represented 70% of total revenues for the first quarter of
2003, as compared to 67% for the first quarter of 2002 as shown in the following
table:
- --------------------------------------------------------------------------------
Three Months
Ended
March 31,
Composition of Revenues 2003 2002
- --------------------------------------------------------------------------------
Commissions 26% 28%
Principal transactions 4 5
- --------------------------------------------------------------------------------
Total trading revenues 30 33
- --------------------------------------------------------------------------------
Asset management and administration fees 48 42
Net interest revenue 19 21
Other 3 4
- --------------------------------------------------------------------------------
Total non-trading revenues 70 67
- --------------------------------------------------------------------------------
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 $148 million decrease in revenues from the first
quarter of 2002 was due to decreases in revenues of $97 million, or 16%, in the
Individual Investor segment, $25 million, or 12%, in the Institutional Investor
segment, $8 million, or 12%, in the Capital Markets segment, and $18 million, or
11%, in the U.S. Trust segment. See note "13 - Segment Information" in the Notes
- 16 -
to Condensed Consolidated Financial Statements for financial information by
segment.
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, custody 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 $428 million for the first
quarter of 2003, down $13 million, or 3%, from the first quarter of 2002, as
shown in the following table (in millions):
- --------------------------------------------------------------------------------
Three Months
Ended
March 31, Percent
Asset Management and Administration Fees 2003 2002 Change
- --------------------------------------------------------------------------------
Mutual fund service fees:
Proprietary funds
(SchwabFunds(R) and Excelsior(R)) $217 $220 (1%)
Mutual Fund OneSource(R) 59 71 (17)
Other 10 10 -
Asset management and related services 142 140 1
- --------------------------------------------------------------------------------
Total $428 $441 (3%)
================================================================================
The decrease in asset management and administration fees was primarily due
to decreases in average assets in Schwab's Mutual Fund OneSource service and
average U.S. Trust client assets, partially offset by higher account fees.
Assets in client accounts were $762.6 billion at March 31, 2003, a decrease
of $95.1 billion, or 11%, from a year ago as shown in the following table. This
decrease from a year ago included net new client assets of $46.4 billion, offset
by net market losses of $141.5 billion related to client accounts.
- --------------------------------------------------------------------------------
Change in Client Assets and Accounts
(In billions, at quarter end, March 31, Percent
except as noted) 2003 2002 Change
- --------------------------------------------------------------------------------
Assets in client accounts
Schwab One(R), other cash
equivalents and deposits
from banking clients $ 31.1 $ 29.2 7%
Proprietary funds (SchwabFunds(R)
and Excelsior(R)):
Money market funds 132.4 130.0 2
Equity and bond funds 27.4 33.2 (17)
- --------------------------------------------------------------------------------
Total proprietary funds 159.8 163.2 (2)
- --------------------------------------------------------------------------------
Mutual Fund Marketplace(R) (1):
Mutual Fund OneSource(R) 71.8 90.3 (20)
Mutual fund clearing services 21.4 22.3 (4)
All other 71.6 78.8 (9)
- --------------------------------------------------------------------------------
Total Mutual Fund Marketplace 164.8 191.4 (14)
- --------------------------------------------------------------------------------
Total mutual fund assets 324.6 354.6 (8)
- --------------------------------------------------------------------------------
Equity and other securities (1) 287.9 374.7 (23)
Fixed income securities (2) 125.2 108.4 15
Margin loans outstanding (6.2) (9.2) (33)
- --------------------------------------------------------------------------------
Total client assets $762.6 $857.7 (11%)
================================================================================
Net change in assets
in client accounts
(for the quarter ended)
Net new client assets $ 14.2 $ 15.4
Net market losses (16.4) (3.6)
- --------------------------------------------------------------------------------
Net growth (decline) $ (2.2) $ 11.8
================================================================================
New client accounts
(in thousands, for the
quarter ended) 171.0 232.3 (26%)
Active client accounts
(in millions) (3) 8.0 7.9 1%
- --------------------------------------------------------------------------------
Active online Schwab client
accounts (in millions) (4) 4.2 4.3 (2%)
Online Schwab client assets $295.7 $341.9 (14%)
- --------------------------------------------------------------------------------
(1) Excludes money market funds and all proprietary money market, equity, and
bond funds.
(2) Includes $18.1 billion and $16.4 billion at March 31, 2003 and 2002,
respectively, of certain other securities serviced by Schwab's fixed income
division, including exchange-traded unit investment trusts, real estate
investment trusts, and corporate debt.
(3) Active accounts are defined as accounts with balances or activity within
the preceding eight months.
(4) Active online accounts are defined as all active individual and U.S.
dollar-based international accounts within a household that has had at
least one online session within the past twelve months. Excludes
independent investment advisor accounts and U.S. Trust accounts.
- 17 -
Commissions
The Company earns revenues by executing client trades primarily through the
Individual Investor and Institutional Investor segments, as well as the Capital
Markets segment. These revenues are affected by the number of client accounts
that trade, the average number of revenue-generating trades per account, and the
average revenue earned per revenue trade. As shown in the following table,
commission revenues for the Company were $240 million for the first quarter of
2003, down $58 million, or 19%, from the first quarter of 2002. This decrease
was primarily due to lower daily average trades, partially offset by higher
revenue per revenue trade and number of trading days.
- --------------------------------------------------------------------------------
Three Months
Ended
March 31, Percent
Commissions 2003 2002 Change
- --------------------------------------------------------------------------------
Exchange-listed securities $ 99 $ 118 (16%)
Nasdaq and other equity securities 94 127 (26)
Mutual funds 26 27 (4)
Options 21 26 (19)
- --------------------------------------------------------------------------------
Total $ 240 $ 298 (19%)
================================================================================
Total commission revenues include $17 million in the first quarter of 2003
and $16 million in the first quarter of 2002 related to certain securities
serviced by Schwab's fixed income division, including exchange-traded unit
investment trusts, real estate investment trusts, and corporate debt. Schwab's
fixed income division also generates principal transaction revenues.
Additionally, commission revenues include $20 million in the first quarter of
2003 and $6 million in the first quarter of 2002 related to Schwab's
institutional trading business. Schwab's institutional trading business also
generates principal transaction revenues, as well as other revenues.
The Company's client trading activity is shown in the following table (in
thousands):
- --------------------------------------------------------------------------------
Three Months
Ended
March 31, Percent
Daily Average Trades 2003 2002 Change
- --------------------------------------------------------------------------------
Revenue Trades (1)
Online 95.8 123.9 (23%)
TeleBroker(R) and Schwab by Phone(TM) 4.2 6.7 (37)
Regional client telephone service
centers, branch offices, and other 14.6 16.8 (13)
- --------------------------------------------------------------------------------
Total 114.6 147.4 (22%)
================================================================================
Mutual Fund OneSource(R) and
Other Asset-Based Trades
Online 48.6 46.4 5%
TeleBroker and Schwab by Phone .4 .5 (20)
Regional client telephone service
centers, branch offices, and other 5.3 11.6 (54)
- --------------------------------------------------------------------------------
Total 54.3 58.5 (7%)
================================================================================
Total Daily Average Trades
Online 144.4 170.3 (15%)
TeleBroker and Schwab by Phone 4.6 7.2 (36)
Regional client telephone service
centers, branch offices, and other 19.9 28.4 (30)
- --------------------------------------------------------------------------------
Total 168.9 205.9 (18%)
================================================================================
(1) Includes all client trades (both individuals and institutions) that
generate either commission revenue or revenue from principal markups (i.e.,
fixed income).
- 18 -
As shown in the following table, the total number of client revenue trades
executed by the Company has decreased 21% as the number of client accounts that
traded during the quarter and the trading activity per account that traded have
decreased.
- --------------------------------------------------------------------------------
Three Months
Ended
March 31, Percent
Trading Activity 2003 2002 Change
- --------------------------------------------------------------------------------
Total revenue trades
(in thousands) (1) 6,989 8,851 (21%)
Accounts that traded during
the quarter (in thousands) 1,108 1,374 (19)
Average revenue trades
per account that traded 6.3 6.4 (2)
Trading frequency proxy (2) 3.5 3.9 (10)
Number of trading days 61 60 2
Average revenue earned
per revenue trade $37.30 $36.03 4
- --------------------------------------------------------------------------------
(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 total client assets.
Net Interest Revenue
Net interest revenue is the difference between interest earned on assets
(mainly margin loans to clients, investments of segregated client cash balances,
private banking loans, and securities available for sale) and interest paid on
liabilities (mainly brokerage client cash balances and deposits from banking
clients). 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.
Net interest revenue was $175 million for the first quarter of 2003, down
$43 million, or 20%, from the first quarter of 2002 as shown in the following
table (in millions):
- --------------------------------------------------------------------------------
Three Months
Ended
March 31, Percent
2003 2002 Change
- --------------------------------------------------------------------------------
Interest Revenue
Margin loans to clients $ 82 $ 133 (38%)
Investments, client-related 75 86 (13)
Private banking loans 56 60 (7)
Securities available for sale 16 17 (6)
Other 10 13 (23)
- --------------------------------------------------------------------------------
Total 239 309 (23)
- --------------------------------------------------------------------------------
Interest Expense
Brokerage client cash balances 24 50 (52)
Deposits from banking clients 24 22 9
Long-term debt 10 13 (23)
Short-term borrowings 3 6 (50)
Other 3 - n/m
- --------------------------------------------------------------------------------
Total 64 91 (30)
- --------------------------------------------------------------------------------
Net interest revenue $ 175 $ 218 (20%)
================================================================================
n/m Not meaningful
- 19 -
Client-related daily average balances, interest rates, and average net
interest spread for the first quarters of 2003 and 2002 are summarized in the
following table (dollars in millions):
Three Months Ended
March 31,
2003 2002
- --------------------------------------------------------------------------------
Interest-Earning Assets (client-related and other):
Investments (client-related):
Average balance outstanding $ 21,231 $ 17,253
Average interest rate 1.44% 2.02%
Margin loans to clients:
Average balance outstanding $ 6,399 $ 9,280
Average interest rate 5.21% 5.80%
Private banking loans:
Average balance outstanding $ 4,546 $ 4,063
Average interest rate 5.02% 5.99%
Securities available for sale:
Average balance outstanding $ 1,517 $ 1,445
Average interest rate 4.39% 4.86%
Average yield on interest-earning assets 2.77% 3.74%
Funding Sources (client-related and other):
Interest-bearing brokerage client cash balances:
Average balance outstanding $ 23,003 $ 22,978
Average interest rate .41% .89%
Interest-bearing banking deposits:
Average balance outstanding $ 4,570 $ 3,866
Average interest rate 2.09% 2.30%
Other interest-bearing sources:
Average balance outstanding $ 2,164 $ 1,009
Average interest rate 1.25% 2.24%
Average noninterest-bearing portion $ 3,956 $ 4,188
Average interest rate on funding sources .65% .99%
Summary:
Average yield on interest-earning assets 2.77% 3.74%
Average interest rate on funding sources .65% .99%
- --------------------------------------------------------------------------------
Average net interest spread 2.12% 2.75%
================================================================================
The decrease in net interest revenue from the first quarter of 2002 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
Capital Markets, 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 revenue per equity share traded, and changes in regulations
and industry practices.
Principal transaction revenues were $33 million for the first quarter of
2003, down $18 million, or 35%, from the first quarter of 2002, as shown in the
following table (in millions):
- --------------------------------------------------------------------------------
Three Months
Ended
March 31, Percent
Principal Transactions 2003 2002 Change
- --------------------------------------------------------------------------------
Fixed income securities $ 21 $ 22 (5%)
Nasdaq and other equity securities 10 26 (62)
Other 2 3 (33)
- --------------------------------------------------------------------------------
Total (1) $ 33 $ 51 (35%)
================================================================================
(1) Includes $3 million in each of the first quarters of 2003 and 2002 related
to Schwab's institutional trading business.
The decrease in principal transaction revenues was primarily due to lower
average revenue per equity share traded, partially offset by higher equity share
volume handled by SCM as a result of increased institutional trading activity.
Other Revenues
Other revenues include fees for services (such as order handling fees),
account service fees, net gains and losses on certain investments, and software
maintenance fees. Other revenues are earned primarily through the Individual
Investor, Institutional Investor, and U.S. Trust segments. These revenues were
$24 million for the first quarter of 2003, down $16 million, or 40%, from the
first quarter of 2002. This decrease was primarily due to net losses on
investments in 2003, compared to net gains on investments in 2002.
EXPENSES EXCLUDING INTEREST
Total expenses excluding interest for the first quarter of 2003 was $803
million, down $109 million, or 12%, from the first quarter of 2002, primarily
due to decreases in almost all expense categories as a result of the Company's
continued expense reduction measures.
Compensation and benefits expense was $417 million for the first quarter of
2003, down $46 million, or 10%, from the first quarter of 2002 primarily due to
lower levels of employee benefits, discretionary bonuses to employees, and
incentive compensation, as well as a reduction in full-time equivalent
employees.
- 20 -
The following table shows a comparison of certain compensation and benefits
components and employee data (dollars in millions, except as noted):
- --------------------------------------------------------------------------------
Three Months
Ended
March 31, Percent
Compensation and Benefits 2003 2002 Change
- --------------------------------------------------------------------------------
Salaries and wages $ 305 $ 316 (3%)
Incentive and variable compensation 49 63 (22)
Employee benefits and other 63 84 (25)
- --------------------------------------------------------------------------------
Total $ 417 $ 463 (10%)
================================================================================
Compensation and benefits expense as a
% of total revenues 46% 44%
Incentive and variable compensation as a
% of compensation and benefits expense 12% 14%
Compensation for temporary employees,
contractors and overtime hours as a
% of compensation and benefits expense 6% 5%
Full-time equivalent employees
(at end of quarter, in thousands) (1) 16.5 19.4 (15%)
Revenues per average full-time equivalent
employee (in thousands) $54.3 $54.2 -
- --------------------------------------------------------------------------------
(1) Includes full-time, part-time and temporary employees, and persons employed
on a contract basis.
Employee benefits and other expenses decreased by $21 million, or 25%, from
the first quarter of 2002 primarily due to the suspension of the Company's
401(k) employer contribution in the first quarter of 2003, as well as a
reduction in full-time equivalent employees.
The Company's effective income tax expense rate was 22.8% for the first
quarter of 2003, down from 38.2% for the first quarter of 2002. The decrease was
primarily due to a tax benefit associated with the Company's sale of its U.K.
market-making operation, which was announced in March 2003.
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 "11 - 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 March 31, 2003, the Company and its
depository institution subsidiaries are considered well capitalized.
CSC has liquidity needs that arise from its issued and outstanding $544
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 2003 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 - Financial
Instruments Held For Purposes Other Than Trading - 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 March 31, 2003, 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 March 31, 2003, 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 scheduled to expire in June 2003. CSC plans
to establish a replacement facility when the current facility expires. This
facility was unused during the first three months of 2003. Any issuances under
CSC's commercial paper program (see above) 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
- 21 -
on its ability to meet foreseeable dividend or funding requirements.
CSC also has direct access to $670 million of the $820 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, and the credit line
provided by another one of these banks includes a sublimit on credit available
to CSC. These lines were not used by CSC during the first three months of 2003.
Schwab
Liquidity needs relating to client trading and margin borrowing activities
are met primarily through cash balances in brokerage client accounts, which were
$26.1 billion and $24.9 billion at March 31, 2003 and December 31, 2002,
respectively. Management believes that brokerage client cash balances and
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
March 31, 2003, Schwab's net capital was $1.2 billion (20% of aggregate debit
balances), which was $1.1 billion in excess of its minimum required net capital
and $929 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 requirement, 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 March
31, 2003 was $220 million. During the first quarter of 2003, Schwab repaid its
$25 million in fixed-rate subordinated term loans from CSC. Borrowings under
these subordinated lending arrangements qualify as regulatory capital for
Schwab.
Upon adoption of Financial Accounting Standards Board Interpretation (FIN)
No. 46 - Consolidation of Variable Interest Entities, an Interpretation of
Accounting Research Bulletin No. 51 - Consolidated Financial Statements in the
first quarter of 2003, the Company consolidated a special purpose trust (Trust)
that was formed in 2000 to finance an office building and land. See note "2 -
New Accounting Standards" in the Notes to the Condensed Consolidated Financial
Statements. Upon adoption of FIN No. 46 in the first quarter of 2003, Schwab
recorded long-term debt totaling $235 million, which was outstanding at March
31, 2003. The long-term debt consists of a variable-rate note maturing in June
2005. The interest rate on the note was 1.64% at March 31, 2003 and ranged from
1.64% to 1.82% during the quarter. The building and land have been pledged as
collateral for the long-term debt. Additionally, the Company has guaranteed the
debt of the Trust up to a maximum of $202 million. The lender does not have
recourse to any other assets of the Company.
To manage short-term liquidity, Schwab maintains uncommitted, unsecured
bank credit lines with a group of eight banks totaling $820 million at March 31,
2003 (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 4 days during the
first three months of 2003, with the daily amounts borrowed averaging $28
million. There were no borrowings outstanding under these lines at March 31,
2003.
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 March
31, 2003. Schwab pays a fee to maintain these letters of credit. No funds were
drawn under these letters of credit at March 31, 2003.
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 March 31, 2003, 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 $700 million. There were no borrowings outstanding under
these facilities at March 31, 2003. Additionally, at March 31, 2003, U.S. Trust
had $439 million of federal funds purchased and $326 million of repurchase
agreements outstanding.
- 22 -
CSC provides U.S. Trust with a $300 million short-term credit facility
maturing in December 2003. Borrowings under this facility do not qualify as
regulatory capital for U.S. Trust. The amount outstanding under this facility
was $55 million at March 31, 2003.
SCM
SCM's liquidity needs are generally met through its equity capital and
borrowings from CSC. Most of SCM's assets are liquid, consisting primarily of
cash and cash equivalents, marketable securities, and receivables from brokers,
dealers and clearing organizations.
SCM's liquidity is affected by the same net capital regulatory requirements
as Schwab (see discussion above). At March 31, 2003, SCM's net capital was $89
million, which was $88 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 March 31, 2003 was $50 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 March 31, 2003.
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 2002 Annual Report to Stockholders, which is filed as Exhibit
13.1 to the Company's Form 10-K for the year ended December 31, 2002. There have
been no material changes to these liquidity risk factors in the first three
months of 2003.
Cash and Capital Resources
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, payment of dividends, and repurchases
of CSC's common stock.
In the first three months of 2003, cash and cash equivalents decreased
$726 million, or 23%, to $2.4 billion primarily due to movements of brokerage
client-related funds to meet segregation requirements and increases in
investments in securities available for sale. Management does not believe that
this decline in cash and cash equivalents is an indication of a trend.
The Company's capital expenditures were $32 million for each of the first
quarters of 2003 and 2002, or 4% and 3% of revenues for each period,
respectively. Capital expenditures in the first three months of 2003 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 $14 million in the
first three months of 2003 and $16 million in the first three months of 2002.
During the first three months of 2003, 1 million of the Company's stock options,
with a weighted-average exercise price of $5.82, were exercised with cash
proceeds received by the Company of $7 million and a related tax benefit of $1
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 increased its long-term debt by $235 million (see discussion
above in "Liquidity - Schwab") and repaid $22 million of long-term debt during
the first three months of 2003.
During the first three months of 2003, CSC repurchased 4 million shares of
its common stock for $32 million. CSC did not repurchase any common stock during
the first three months of 2002. On March 14, 2003, the Board of Directors
authorized the repurchase of up to an additional $250 million of CSC's common
stock. Including the amount remaining under an authorization granted by the
Board of Directors on September 20, 2001, CSC now has authority to repurchase a
total of $318 million.
During each of the first quarters of 2003 and 2002, the Company paid common
stock cash dividends of $15 million.
The Company monitors both the relative composition and absolute level of
its capital structure. The Company's total financial capital (long-term debt
plus stockholders' equity) at March 31, 2003 was $4.9 billion, up $259 million,
or 6%, from December 31, 2002 due primarily to a net increase in long-term debt.
At March 31, 2003, the Company had long-term debt of $856 million, or 17% of
total financial capital, that bears interest at a weighted-average rate of
5.81%. At March 31, 2003, the Company's
- 23 -
stockholders' equity was $4.1 billion, or 83% of total financial capital.
Commitments
A summary of the Company's principal contractual obligations and other
commitments as of March 31, 2003 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) $ 199 $ 583 $ 305 $ 628 $1,715
Long-term debt (2) 78 440 53 259 830
Credit-related financial
instruments (3) 541 129 670
Other commitments (4) 5 5
- --------------------------------------------------------------------------------
Total $ 823 $1,152 $ 358 $ 887 $3,220
================================================================================
(1) Includes minimum rental commitments, net of sublease 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 - Financial Instruments Held For
Purposes Other Than Trading - 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 according
to 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 needs. The
fair value of such inventory was approximately $42 million and $34 million at
March 31, 2003 and December 31, 2002, 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 March 31, 2003 and December 31, 2002 are shown in the following
table (in millions):
- --------------------------------------------------------------------------------
March 31, December 31,
Equity Securities 2003 2002
- --------------------------------------------------------------------------------
Long positions $ 70 $ 79
Short positions (12) (7)
- --------------------------------------------------------------------------------
Net long positions $ 58 $ 72
================================================================================
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 $7 million
at March 31, 2003 and December 31, 2002, respectively.
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):
- --------------------------------------------------------------------------------
March 31, December 31,
Exchange-traded Contracts 2003 2002
- --------------------------------------------------------------------------------
Net Short Futures (1):
Notional Amount $ 50 $ 63
Fair Value $ 48 $ 61
Long Put Options:
Notional Amount $ 4 $ 4
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 March 31, 2003 and December 31,
2002.
Using a hypothetical 10% increase or decrease in the underlying indices,
the potential loss or gain in fair value is estimated to be approximately $5
million and $6 million at March 31, 2003 and December 31, 2002, respectively,
which would substantially offset the potential loss or gain on the equity
securities previously discussed.
Value-at-risk
All trading activities are subject to market risk limits established by the
Company's businesses and approved by senior management who are independent of
the businesses. The Company manages trading risk through position policy limits,
value-at-risk (VAR) measurement methodology, and other market sensitivity
measures. Based on certain assumptions and historical relationships, VAR
estimates a potential loss from adverse changes in the fair values of the
Company's overnight trading positions. To calculate VAR, the Company uses a 99%
confidence level with a one-day holding period for most instruments. Stress
testing is
- 24 -
performed on a regular basis to estimate the potential loss from severe market
conditions. It is the responsibility of the Company's Risk Management
department, in conjunction with the businesses, to develop stress scenarios and
use the information to assess the ongoing appropriateness of exposure levels and
limits.
The Company holds fixed income securities and equities for trading
purposes. The estimated VAR for both fixed income securities and equities at
March 31, 2003 and the high, low, and daily average during the first quarter of
2003 was $1 million or less for each category and stated period.
The VAR model is a risk analysis tool that attempts to measure the
potential losses in fair value, earnings, or cash flows from changes in market
conditions and may not represent actual losses in fair value that may be
incurred by the Company. The Company believes VAR provides an indication as to
the Company's loss exposure in future periods. However, VAR relies on historical
data and statistical relationships. As a result, VAR must be interpreted with an
understanding of the method's strengths and limitations. The Company actively
works to improve its measurement and use of VAR.
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 $54 million and $49 million at March 31, 2003 and December
31, 2002, 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 March 31, 2003, CSC had $544 million aggregate principal amount of
Medium-Term Notes, with fixed interest rates ranging from 6.04% to 8.05%. At
December 31, 2002, CSC had $566 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 March 31, 2003 and December 31, 2002, U.S. Trust had $50 million Trust
Preferred Capital Securities outstanding, with a fixed interest rate of 8.41%.
The Company has fixed cash flow requirements regarding these long-term debt
obligations due to the fixed rate of interest. The fair value of these
obligations at March 31, 2003 and December 31, 2002, 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 swap agreements (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. The Swaps are structured for U.S.
Trust to receive a variable rate of interest and pay a fixed rate of interest.
Information on these Swaps is summarized in the following table:
- --------------------------------------------------------------------------------
March 31, December 31,
2003 2002
- --------------------------------------------------------------------------------
Notional principal amount (in millions) $ 735 $ 790
Weighted-average variable interest rate 1.33% 1.57%
Weighted-average fixed interest rate 6.41% 6.38%
Weighted-average maturity (in years) 1.7 1.8
- --------------------------------------------------------------------------------
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 March 31, 2003 and December 31, 2002, U.S. Trust
recorded a derivative liability of $58 million and $64 million, respectively,
for these Swaps. Based on current interest rate assumptions and assuming no
additional Swaps are entered into, U.S. Trust expects to reclassify
approximately $36 million, or $21 million after tax, from other comprehensive
loss to interest expense over the next twelve months.
CSC uses Swaps to effectively convert the interest rate characteristics of
a portion of its Medium-Term Notes from fixed to variable. These Swaps are
structured for CSC to receive a fixed rate of interest and pay a variable rate
of interest based on the three-month LIBOR rate. The variable interest rates
reset every three months. Information on these Swaps is summarized in the
following table:
- --------------------------------------------------------------------------------
March 31, December 31,
2003 2002
- --------------------------------------------------------------------------------
Notional principal amount (in millions) $ 293 $ 293
Weighted-average variable interest rate 3.78% 3.87%
Weighted-average fixed interest rate 7.57% 7.57%
Weighted-average maturity (in years) 6.0 6.3
- --------------------------------------------------------------------------------
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
- 25 -
Swaps are completely offset by changes in fair value of the hedged Medium-Term
Notes. Therefore, there is no effect on net income. At March 31, 2003, CSC
recorded a derivative asset of $26 million for these Swaps. Concurrently, the
carrying value of the Medium-Term Notes was increased by $26 million.
Value-at-risk
The estimated VAR for equities held for purposes other than trading, which
primarily consist of mutual funds related to the Company's deferred compensation
plan and an equity investment, was $1 million at March 31, 2003 with a high,
low, and daily average of $2 million, $1 million, and $1 million, respectively,
during the first quarter of 2003. The estimated VAR for short-term investments,
which are subject to interest rate risk, held for purposes other than trading at
March 31, 2003 and the high, low, and daily average during the first quarter of
2003 was $1 million or less for each. The estimated VAR for foreign exchange
investments, which consist of equity investments in the Company's international
subsidiaries, at March 31, 2003 and the high, low, and daily average during the
first quarter of 2003 was $1 million or less.
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 loan and brokerage client cash balance growth
or decline, changes in 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 interest rates fall (i.e., interest-earning assets are
repricing more quickly than interest-bearing liabilities). The Swaps entered
into during 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 results 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 March 31, 2003 and December 31,
2002.
- --------------------------------------------------------------------------------
Impact on Net Interest Revenue March 31, December 31,
Percentage Increase (Decrease) 2003 2002
- --------------------------------------------------------------------------------
Increase of 100 basis points 7.4% 5.3%
Decrease of 100 basis points (11.1%) (12.1%)
- --------------------------------------------------------------------------------
Item 4. Controls and Procedures
An evaluation was performed under the supervision and with the
participation of the Company's management, including the Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design 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 Chief Executive Officer 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.
- 26 -
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 were 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. On
February 13, 2003, the Court issued a Final Judgement approving a settlement of
the case. Plaintiffs had alleged 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. Under
the terms of the settlement, plaintiffs released USTC, N.A. of all liability.
Other than an insignificant deductible, the settlement will be paid from
insurance coverage.
Between October 2001 and March 2003, a total of nine individual and class
action lawsuits have been filed against U.S. Trust Company of Texas, N.A. (U.S.
Trust Texas) and other defendants, including, in some instances, USTC. The class
actions have been consolidated into one action, which, in turn, has been
consolidated with two of the individual actions in the United States District
Court for the Central District of California. There is one individual action
pending in California state court and one individual action pending in Texas
state court. In each of these actions, plaintiffs seek to hold the defendants
liable for losses that the plaintiffs sustained in connection with the defaults
of certain bond offerings (Heritage Bond Offerings). U.S. Trust Texas was
Indenture Trustee under various Indentures executed in connection with the
Heritage Bonds Offerings. Although USTC sold its corporate trust business in
2001, under the sale agreement, USTC retains responsibility for certain
litigation, including these cases. In the complaints, the plaintiffs allege
that, as Indenture Trustee, U.S. Trust Texas breached certain duties owed to the
plaintiffs. In these cases, the plaintiffs seek compensatory damages in excess
of $125 million, punitive damages and other relief. U.S. Trust Texas and USTC
intend to defend the 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 on 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
plaintiffs claim that as a result of the alleged breaches, they suffered losses,
including 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.
In April 2001, an action was filed against USTC, N.A. in the U.S. District
Court for the Central District of Illinois. Plaintiffs are participants in an
employee stock ownership plan (the ESOP) sponsored by Foster & Gallagher, Inc.
(F&G), a now-bankrupt company. Plaintiffs allege that USTC, N.A. breached
fiduciary duties under the Employee Retirement Income Security Act of 1974 when,
as trustee of the ESOP, it caused the ESOP to purchase stock of F&G in 1995 and
1997. Also named as defendants are numerous individuals who sold stock to the
ESOP in the 1995 and 1997 transactions. The plaintiffs claim that as a result of
the alleged breaches, they suffered losses in the amount of $200 million. USTC,
N.A. has answered, denying all liability, and is vigorously defending the
lawsuit. The case is scheduled to go to trial in May 2003.
The nature of the Company's business subjects it to claims, lawsuits,
regulatory examinations, and other proceedings in the ordinary course of
business. The ultimate outcome of the matters described above and the various
other lawsuits, arbitration proceedings, and claims pending against the Company
cannot be determined at this time, and the results of these 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 these 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.
- 27 -
Item 5. Other Information
On March 14, 2003, The Charles Schwab Corporation (CSC)'s Board of
Directors (Board) appointed Robert N. Wilson to the Board. This appointment will
become effective on May 9, 2003, the date of the annual meeting of stockholders.
Mr. Wilson is Senior Vice Chairman of the Board of Directors of Johnson &
Johnson, which he will be retiring from in May 2003, and is also a director of
U.S. Trust Corporation and United States Trust Company of New York.
On April 23, 2003, the Board appointed David B. Yoffie to the Board.
Professor Yoffie's appointment will also become effective on May 9, 2003.
Professor Yoffie is the Max and Doris Starr Professor of International Business
Administration at Harvard Business School and a Visiting Scholar at Stanford
Business School.
In the first quarter of 2003, Mr. Arun Sarin announced that he will resign
from the Board effective on May 9, 2003. Mr. Sarin's decision to retire from the
Board was prompted by his appointment to be Chief Executive Officer of Vodafone
PLC (Vodafone), requiring his relocation to London where Vodafone is
headquartered.
The authorized number of directors on the Board is fourteen. After the
changes described above, there will be thirteen directors and one vacant seat on
the Board.
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
- --------------------------------------------------------------------------------
12.1 Computation of Ratio of Earnings to Fixed Charges.
99.1 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant
to Section 906 of The Sarbanes-Oxley Act of 2002.**
99.2 Certification Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant
to Section 906 of The Sarbanes-Oxley Act of 2002.**
** Furnished as an exhibit to this quarterly report on Form 10-Q.
- --------------------------------------------------------------------------------
(b) Reports on Form 8-K
On January 31, 2003, the Registrant filed a Current Report on Form 8-K
announcing under Item 5 the appointment of David S. Pottruck as President and
Chief Executive Officer of the Company effective May 9, 2003, the date of the
annual meeting of stockholders. Mr. Pottruck had previously served as co-CEO
with founder Charles R. Schwab, who remains Chairman of the Board. The Company
also announced that on January 30, 2003, the Company's Board approved amendments
to the Company's bylaws, effective May 9, 2003, which specify the roles of the
Company's Chairman of the Board, Chief Executive Officer, and President.
On February 3, 2003, the Registrant filed a Current Report on Form 8-K
announcing under Item 9 the agreement to sell its British pound sterling
brokerage business - Charles Schwab Europe - to Barclays PLC.
On March 21, 2003, the Registrant filed a Current Report on Form 8-K which
included certifications 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 18 U.S.C. Section 1350
(as adopted by Section 906 of the Sarbanes-Oxley Act of 2002) with respect to
the Company's Annual Report on Form 10-K for the year ended December 31, 2002.
- 28 -
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE CHARLES SCHWAB CORPORATION
(Registrant)
Date: May 13, 2003 /s/ Christopher V. Dodds
---------------- -----------------------------
Christopher V. Dodds
Executive Vice President and
Chief Financial Officer
- 29 -
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: May 13, 2003 /s/ David S. Pottruck
--------------- -------------------------------------
David S. Pottruck
President and Chief Executive Officer
- 30 -
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: May 13, 2003 /s/ Christopher V. Dodds
--------------- ----------------------------------------------------
Christopher V. Dodds
Executive Vice President and Chief Financial Officer
- 31 -