Faced with its weakest quarterly revenue level in over four years and running out of room to cut costs, Charles Schwab said it would look at other ways to increase income and shore up profits.

Schwab is exploring a couple of options, Christopher V. Dodds, its chief financial officer, said in an interview last Tuesday after the San Francisco-based company reported its first-quarter results. It is scouting acquisitions that would boost revenues and is considering ways to alter the pricing of certain services, a tactic it has already used on certain clients, Dodds said.

Supermarket Not Spared

But the fund supermarket recently raised fee on assets from 35 basis points to 40 basis points. Earlier this month, Schwab co-chief executive David Pottruck tried to justify the mutual fund platform increase by saying the volume of phone calls the company receives from investors has increased to 45,000 a day, and Schwab needs a way to cover these servicing costs.

Meanwhile, Schwab is sticking to its previously announced program to eliminate $40 million of expenses per quarter. In that effort, it has already suspended its matching of employee 401(k) contributions until yearend.

On Tuesday, Schwab reported revenues of $900 million for the first quarter, 14% less than a year earlier, as profits fell 24%, to $71 million. Earnings of five cents a share matched an analyst consensus that had come down more than a couple of times during the quarter, after executives warned that the war in Iraq was compounding the trading weakness already being fed by the ongoing bear market.

A drop in retail activity in February and early March, when daily trade totals ranged between 90,000 and 181,000, meant trading-related revenues fell 22% from the first quarter of last year.

"Revenues were the lowest they've been since the fourth quarter of 1998," Dodds said. "We are most challenged in our trading and capital markets business."

Schwab has cut most of the expenses it can. The head count has dropped 37.5% since the beginning of 2001, though Dodds said there would continue to be some "fine-tuning" of the employee base. However, he also said that his company must now look beyond cost cuts for ways to boost revenues. Pottruck, however, also remarked when defending the supermarket fee increase that Schwab had done all the layoffs possible.

Dodds would not say specifically what kind of company Schwab is looking to acquire, but said it could make an acquisition that would allow it to consolidate operations, or one that added a product capability. "The best time to make acquisitions is in a down market," he said.

That assessment fit in with a remark earlier this month by Donald Putnam, CEO and managing director of Putnam Lovell NBF Securities, who said divestiture rather than acquisitions is going to be the prime driver of the M&A business for the foreseeable future (see MFMN 4/7/03).

Analysts said it looks like the struggling company may not be ruling anything out on the acquisition front, including the possibility of an outright acquisition of a banking company.

Schwab is on the verge of approval for a national bank charter that would allow it to offer FDIC-insured deposits, mortgages and other bank products. It has cleared every regulatory hurdle except for receiving the final nod from the Office of the Comptroller of the Currency, which, according to Dodds, could come any day. Schwab could roll out the new services in a matter of weeks, he said.

But not everyone agrees that expanding its bank offerings will help Schwab dig out of its current situation. "I don't see it as having a significant contribution to the bottom line," said Daniel Goldberg, an analyst with Bear Stearns in New York. "It's not a core business."

Recurring Revenue

Henry McVey, an analyst with New York-based Morgan Stanley, said that Schwab "will probably look for something that can generate recurring revenue and offset the slowdown" in trading. "They could build scale in the capital markets, where they are a mid-size player, or they could move toward building fee-based revenues, including processing and asset management."

Despite its talk of acquisitions, Schwab actually did some divesting during the first quarter. Last month it announced a plan to sell its stake in the British market maker Aitken Campbell to its former partner, Toronto-Dominion Bank's TD Waterhouse Group of New York. In February it sold Charles Schwab Europe, a London brokerage that sells sterling-listed securities to investors, to Barclays, also of London.

Schwab's results included a $3 million loss from discontinued operations in the United Kingdom, and a tax benefit from the Aitken Campbell sale.

The bear market has taken its toll on Schwab's stock, whose value has dropped 69% since the beginning of 2001 and 20% since the beginning of this year.

Copyright 2003 Thomson Media Inc. All Rights Reserved.

http://www.thomsonmedia.com, http://www.mfmarketnews.com

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