Charles Schwab 2006 Annual Report Download - page 30

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Neither Chuck nor I dwell much on the past. For
all of my 20 years at Schwab, we have concen-
trated our energies on the opportunities and
challenges that lie ahead, and once we have
reached a given objective, we have paused only
briefly to acknowledge it before moving on. Yet I
believe anyone wishing to understand the Schwab
of today – and grasp its potential for future
success – must take the time to understand
the chapter in our history that began in mid-
2004 and ran through the end of 2006. Why?
Because understanding how far we’ve come
gives tremendous insight into the power of the
Schwab organization when we’re all focused on
pursuing our core strategies, on improving the
client experience, and on maintaining financial
discipline.
Clients, stockholders, and employees who’ve
been with the company during this chapter
already know that 2004 was about coming to
grips with – and addressing – systemic issues of
complexity, high prices, and an unsustainably
large expense base. In turn, 2005 was about
committing to and delivering stronger client
relationships and financial per formance. Last
year, we set out to demonstrate our ability to
sustain profitable growth while continuing to
build client loyalty. So let’s take a look at how we
performed in 2006 relative to our financial objec-
tives, and then discuss how we did with clients.
Our planning scenario for 2006 included equity
market appreciation of about 4 percent and a
relatively flat interest rate environment. Under
those circumstances, we committed to delivering
low double-digit revenue growth, a pre-tax profit
margin of at least 30 percent, earnings per share
of “around” $0.70, and a return on equity of
at least 20 percent. Bear in mind that all of
these goals were set before we entered into the
agreement with Bank of America Corporation to
sell U.S. Trust and subsequently pulled all of U.S.
Trust’s financial results into separate “discontinued
operations” lines on the income statement and
balance sheet.
Despite some mid-year bumpiness, the equity
markets posted double-digit returns for 2006,
while the Fed Funds rate increased by 100 basis
points before leveling off mid-year. Against this
backdrop, we saw continued improvement in
client engagement, and we were able to exceed
all of our primary financial objectives for the year.
Revenue growth reached 19 percent for 2006,
our pre-tax profit margin was a record 34.3
percent, earnings per share hit $0.95, our net
income topped $1 billion for the first time in
company history, and we achieved a return on
equity of 26 percent. These results have been
impacted by the pending U.S. Trust sale, but
even after adjusting for those effects, we still
exceeded every one of our financial goals.
To me, what’s significant about our results for
2006 is that we achieved them by playing our
game – by continuing on the path that we think is
critical for Schwab’s long-term success. Our
reliance on transaction-based revenues contin-
ued to decline – with help from the interest rate
environment and continued client interest in our
mutual fund offerings – and our asset manage-
ment and administration fees, net interest, and
other non-trading revenues together rose 24
percent in 2006 and equaled 83 percent of total
net revenues during the fourth quarter, versus 79
percent in the fourth quarter of 2005. Sustained
cost discipline limited expense growth to just 9
percent in 2006, which led to our record pre-tax
margin. Capital management remained a priority
in 2006. We limited net capital expenditures to
just $59 million (after receiving $63 million
primarily from the sale of a data center), reduced
our long-term debt by $74 million, doubled our
dividend, and repurchased $859 million of
common stock. We continue to believe that our
business model is not particularly capital inten-
sive, and that we should – and will – return excess
capital to our stockholders.
By virtually any measure, our company is in
the best shape ever, and once again, both of our
core businesses contributed to the progress we
made in 2006. As is the case for the company
as a whole, we focus on three main financial
metrics – revenue growth, pre-tax profit margin,
and return on equity – with expectations for each
business based on its specific circumstances.
While Schwab Investor Services (Schwab IS) did
not face any major strategic shifts between 2005
and 2006, the significance of their challenge did
not diminish in any way. Their objective was to
continue improving the client experience and
LETT E R FRO M THE
CHIE F FINA NCIAL OFFIC ER
“LOOK HOW FAR WE’VE COME TOGETHER”