1
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 quarter ended February 28, 1995 Commission file number 0-15948
WATERHOUSE INVESTOR SERVICES, INC.
(Exact name of registrant as specified in its charter)
Delaware 13-3400568
(State or other jurisdiction of (I.R.S. Employer I.D. Number)
incorporation or organization)
100 Wall Street, New York, NY 10005
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (212) 806-3500
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.
X Yes No
------ ------
The number of shares outstanding of Common Stock (par value $.01 per share) as
of February 28, 1995 was 9,153,678.
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WATERHOUSE INVESTOR SERVICES, INC.
Quarterly Report on Form 10-Q
For the Quarter Ended February 28, 1995
Index
Part I - FINANCIAL INFORMATION PAGE
Item 1. Financial Statements:
Consolidated Statements of Financial Condition as of
February 28, 1995 and August 31, 1994 3
Consolidated Statements of Income for the Three and Six
Months Ended February 28, 1995 and February 28, 1994 4
Consolidated Statements of Cash Flows for the Six Months
Ended February 28, 1995 and February 28, 1994 5
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 7
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 11
Item 2. Changes in Securities 11
Item 3. Defaults upon Senior Securities 11
Item 4. Submission of Matters to a Vote of Security Holders 11
Item 5. Other Information 11
Item 6. Exhibits and Reports on Form 8-K 11
SIGNATURES 11
EXHIBIT A 12
EXHIBIT B 13
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PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
WATERHOUSE INVESTOR SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(unaudited)
February August
1995 1994
----------- ----------
ASSETS:
Cash and due from banks $ 9,988,074 $ 7,728,832
Interest bearing deposits with other banks 5,000,000 ---
Fed funds sold 21,600,000 ---
Investment securities 20,237,375 7,532,305
Receivable from brokers and dealers 9,460,768 10,260,515
Receivable from customers, net 284,952,364 275,821,544
Deposits with clearing organizations 3,547,104 3,527,517
Furniture, equipment and
leasehold improvements, net 6,560,701 7,382,326
Memberships in exchanges 698,000 698,000
Other assets 3,570,722 2,829,401
------------ ------------
Total assets $365,615,108 $315,780,440
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY:
Liabilities:
Broker loans and overdrafts $ 99,558,928 $ 76,283,181
Deposits 15,872,633 ---
Payable to brokers and dealers 13,347,788 17,502,736
Payable to customers 117,227,481 106,028,013
Dividends payable --- 1,830,736
6% convertible subordinated notes 48,500,000 48,500,000
Accounts payable, taxes payable,
accrued expenses and other liabilities 13,801,141 16,032,541
------------ ------------
Total liabilities 308,307,971 266,177,207
============ ============
Stockholders' Equity:
Common stock, $.01 par value,
20,000,000 shares authorized
and 9,403,680 shares issued 94,038 94,038
Additional paid in capital 9,167,551 9,167,551
Retained earnings 49,053,918 41,350,014
Less:
Treasury Stock, 250,002 shares, at cost (1,008,370) (1,008,370)
----------- -----------
Total stockholders' equity 57,307,137 49,603,233
----------- -----------
Total liabilities and stockholders' equity $365,615,108 $315,780,440
============ ============
The accompanying notes are an integral part of these financial statements.
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WATERHOUSE INVESTOR SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three Months Ended Six Months Ended
Feb 28, Feb 28, Feb 28, Feb 28,
1995 1994 1995 1994
----------- ----------- ----------- -----------
INTEREST INCOME:
Margin loans $ 5,867,553 $ 3,523,489 $ 10,904,630 $ 6,792,515
Short-term investments 531,744 14,879 576,730 15,038
Other interest income 145,188 59,267 243,027 103,508
--------- ---------- ---------- ----------
Total interest income 6,544,485 3,597,635 11,724,387 6,911,061
========== ========== ========== ==========
INTEREST EXPENSE:
Broker loans
and overdrafts 1,620,475 656,957 2,646,925 1,501,642
6% convertible
subordinated notes 727,500 591,667 1,455,000 591,667
Other 333,513 45,071 501,990 87,763
---------- ---------- ---------- ---------
Total interest expense 2,681,488 1,293,695 4,603,915 2,181,072
---------- ---------- ---------- ----------
Net interest income 3,862,997 2,303,940 7,120,472 4,729,989
---------- ---------- ---------- ----------
NONINTEREST INCOME:
Commissions and
clearing fees 19,568,675 21,060,918 38,027,604 40,845,595
Mutual fund revenues 2,229,899 1,751,193 4,198,927 3,320,239
Other 2,911,861 2,440,724 5,450,501 4,860,019
---------- ---------- ---------- ----------
Total noninterest income 24,710,435 25,252,835 47,677,032 49,025,853
---------- ---------- ---------- ----------
Total income 28,573,432 27,556,775 54,797,504 53,755,842
---------- ---------- ---------- ----------
OPERATING EXPENSES:
Employee comp and benefits 9,293,711 8,673,120 18,045,185 16,645,390
Communications and
data processing 4,411,334 3,841,475 8,455,480 7,486,227
Advertising and promotion 1,908,567 1,047,113 3,293,528 1,923,873
Clearing fees 1,084,356 1,105,091 2,093,562 2,090,677
Occupancy 1,029,329 920,069 2,024,943 1,786,068
Stationery and postage 1,016,071 1,162,278 1,869,852 2,116,004
Depreciation and amort 558,852 399,301 1,098,925 686,775
Professional fees 557,164 315,057 1,501,615 652,797
Other 1,713,575 1,094,998 3,145,313 2,572,445
---------- ---------- ---------- ----------
Total operating expenses 21,572,959 18,558,502 41,528,403 35,960,256
---------- ---------- ---------- ----------
Income before income taxes 7,000,473 8,998,273 13,269,101 17,795,586
Income tax provision 2,961,093 3,970,840 5,565,197 7,807,176
---------- ---------- ---------- ----------
Net income $ 4,039,380 $ 5,027,433 $ 7,703,904 $ 9,988,410
=========== =========== =========== ===========
Weighted average shares
outstanding 9,202,008 9,167,868 9,202,008 9,168,081
Primary earnings per share $ .44 $ .55 $.84 $1.09
Fully diluted earnings
per share $ .41 $ .51 $.79 $1.05
The accompanying notes are an integral part of these financial statements.
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WATERHOUSE INVESTOR SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
February 28, February 28,
1995 1994
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 7,703,904 $ 9,988,410
Non cash items included in net income:
Amortization of debt issuance costs 70,236 ---
Depreciation and amortization 1,028,689 686,775
(Increases) decreases in operating assets:
Receivable from brokers and dealers 799,747 (4,597,873)
Receivable from customers, net (9,130,820) (47,547,865)
Deposits with clearing organizations (19,587) (915,970)
Other assets (811,557) (306,169)
Increases (decreases) in operating liabilities:
Broker loans and overdrafts 23,275,747 (25,188,893)
Deposits 15,872,633 ---
Payable to brokers and dealers (4,154,948) 4,523,561
Payable to customers 11,199,468 26,514,734
Accounts payable, taxes payable,
accrued expenses, and other liabilities (2,231,400) (3,168,512)
----------- -----------
CASH PROVIDED BY (USEDIN) OPERATING ACTIVITIES 43,602,112 (40,011,802)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
6% convertible subordinated notes --- 50,000,000
Debt issuance costs, net --- (1,412,775)
Dividends paid (1,830,736) (1,521,494)
Exercise of stock options --- 90,544
----------- -----------
CASH (USEDIN) PROVIDED BY FINANCING ACTIVITIES (1,830,736) 47,156,275
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Interest bearing deposits with other banks (5,000,000) ---
Fed funds sold (21,600,000) ---
Investment securities (12,705,070) ---
Purchase of furniture, equipment and
leasehold improvements (207,064) (3,038,608)
----------- -----------
CASH (USED IN) INVESTING ACTIVITIES (39,512,134) (3,038,608)
----------- -----------
INCREASE IN CASH AND DUE FROM BANKS 2,259,242 4,105,865
CASH AND DUE FROM BANKS, beginning of period 7,728,832 5,806,314
----------- -----------
CASH AND DUE FROM BANKS, end of period $ 9,988,074 $ 9,912,179
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest $ 4,079,908 $ 1,621,629
=========== ===========
Cash paid for income taxes $ 6,466,888 $ 8,422,277
=========== ===========
The accompanying notes are an integral part of these financial statements.
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WATERHOUSE INVESTOR SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. SUMMARY OF ACCOUNTING PRINCIPLES
The accompanying consolidated financial statements include the accounts
of Waterhouse Investor Services, Inc. (the "Company") and its wholly-owned
subsidiaries, the most significant of which is Waterhouse Securities, Inc.
("Waterhouse Securities"), a securities brokerage firm which is registered
with the Securities and Exchange Commission (the "SEC"). Effective
October 13, 1994, the Company became registered as a bank holding company.
Such statements have been prepared by the Company, without audit, pursuant
to the Rules and Regulations of the SEC and reflect all adjustments (which
include only normal recurring adjustments) which are necessary to present
a fair statement of the results for the interim periods reported. Certain
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been
condensed or omitted pursuant to such rules and regulations, although the
Company believes that the disclosures are adequate to make the information
presented not misleading. It is suggested that these consolidated
financial statements be read in conjunction with the financial statements
and notes thereto included in the Company's Annual Report on Form 10-K for
the year ended August 31, 1994.
2. CAPITAL ADEQUACY
Since being approved as a bank holding company, the Company closely monitors
its capital levels to provide for normal business needs and to comply with
regulatory requirements. As summarized below the Company's capital ratios
were in excess of the regulatory requirements to be deemed "Well
Capitalized" for the period ended February 28, 1995.
Regulatory Waterhouse
Minimum to be Company's National Bank's
"Well Capitalized" Capital Ratio Capital Ratios
------------------ ------------- ---------------
Total Capital Ratio 10.0% 18.14% 105.90%
Tier 1 Capital Ratio 6.0% 18.14% 105.90%
Tier 1 Leverage Ratio 5.0% 16.50% 26.43%
As a broker-dealer, Waterhouse Securities is subject to the SEC's Uniform
Net Capital Rule. Waterhouse Securities has elected the alternative
method allowed by the Rule under which net capital, as defined, shall not
be less than 2% of aggregate debit items, as defined. At February 28,
1995, Waterhouse Securities had net capital in excess of its required net
capital.
3. RECLASSIFICATION
The consolidated statements of income and cash flows for the three and
six months ended February 28, 1994 have been reclassified to conform with
the presentation adopted for the three and six months ended February 28,
1995 because of the Company's registration as a bank holding company.
4. INVESTMENT SECURITIES
The following is a comparison of the carrying amount and approximate
market values:
February 28, 1995 August 31, 1994
Carrying Approximate Carrying Approximate
Amount Market Value Amount Market Value
---------- ------------ ---------- ------------
U.S. Treasury $18,787,375 $18,809,000 $7,082,305 $7,075,863
Other securities 1,450,000 1,450,000 450,000 450,000
----------- ----------- ---------- ----------
Total $20,237,375 $20,259,000 $7,532,305 $7,525,863
=========== =========== ========== ==========
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Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
GENERAL
Waterhouse Investor Services, Inc. was formed in 1987 as a holding company and
became registered as a bank holding company in 1994. The principal operating
subsidiary of the Company is Waterhouse Securities, Inc. which was established
in 1978. Waterhouse Securities, a member firm of the NYSE and other principal
exchanges, conducts business as a discount broker offering reduced commission
rates to individual investors. Waterhouse National Bank was established in
1994 as a wholly-owned subsidiary of the Company and will provide the Company
with the ability to offer expanded financial services and products to the
customer base of Waterhouse Securities.
The securities industry has always been subject to volatility and sizable
market swings. In the past, this volatility has had little effect on the
financial condition of Waterhouse Securities. In addition, management feels
that the effect of this volatility on the results of the Company's operations
for any specific period of time may not be representative of the general trend
in the securities industry or operations of Waterhouse Securities.
RESULTS OF OPERATIONS
The Company has experienced rapid growth in customer accounts, trade processing
activity and revenues during the past several years. The Company believes that
favorable market conditions and increasing participation of individual
investors have contributed substantially to this growth. However, the Company
also believes that its historical growth is attributable in large measure to
the expansion of its branch office network, the introduction of new products
and services, increased advertising and marketing expenditures, and growth in
the number of individuals comprising the Company's target market.
Waterhouse has historically derived nearly all its revenue from commissions
charged on securities transactions and from interest earned on customer margin
balances. As a result, the revenues and earnings of the Company are directly
and materially affected by changes in the volume and price level of securities
transactions, the amount of customer margin loans and the Company's cost of
funds used to finance such loans. Accordingly, the Company's revenues and
earnings have fluctuated materially from quarter to quarter. Shortly after
the Federal Reserve Board (the "FRB") began raising interest rates in February
1994, trading activity slowed. This slowdown, along with the Company's added
expenses from expansion of services, the branch office network, and
Waterhouse National Bank had a negative impact on its earnings in the second
quarter.
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The following table sets forth selected consolidated financial data as
percentages of total revenues and the percentage increase in each item over
the amount for the previous period:
Second Quarter
FY 1995
compared to
Second Quarter Second Quarter Second Quarter
FY 1995 FY 1994 FY 1994
-------------- -------------- -----------------
Income:
Net interest income 13.5% 8.4% 67.7%
Commissions and clearing fees 68.5% 76.4% -7.1%
Mutual fund revenues 7.8% 6.4% 27.3%
Other noninterest income 10.2% 8.8% 19.3%
------ ------
100.0% 100.0% 3.7
------ ------
Operating Expenses:
Employee compensation 32.5% 31.5% 7.2%
Communications, clearing
and stationery 22.8% 22.2% 6.6%
Advertising 6.7% 3.8% 82.3%
Occupancy 3.6% 3.3% 11.9%
Other operating expenses 9.9% 6.5% 56.4%
------ ------
75.5% 67.3% 16.2%
------- ------
Income before income taxes 24.5% 32.7% -22.2%
Income tax provision 10.4% 14.4% -25.4%
------ ------
Net income 14.1% 18.3% -19.7%
====== ======
INCOME
NET INTEREST INCOME. Currently, Waterhouse Securities' primary source of
interest income is margin loans to customers. These loans are financed
primarily through bank loans, credit balances in customer accounts (known as
free credit balances) and subordinated debt. Net interest income (interest
income less interest expense) is directly affected by the level of such loans,
the interest rate charged on those loans, which is based on the then-applicable
broker call rate, and the cost of financing. Net interest income increased for
the second quarter of fiscal year 1995 by 68% from that of the same period in
the prior year. Such increase in net interest income is primarily a result of
a 10% increase in average customer margin loans, and an increase in the broker
call rate from 5% to 7.75% during the period. As Waterhouse National Bank
becomes fully operational, net interest income is expected to further increase
and become a greater percentage of total income.
COMMISSIONS AND CLEARING FEES. Waterhouse Securities acts primarily as an
agent for customer trading activity, and therefore, the commissions earned by
Waterhouse Securities are directly affected by the number of trades executed
and cleared, as well as the average commission rate per trade. During the
second quarter of fiscal year 1995, the number of trades executed and cleared
by Waterhouse Securities was relatively constant while the average commission
per trade dropped approximately 8% as compared with the second quarter of
fiscal 1994.
MUTUAL FUND REVENUES. Included in mutual fund revenues are commission fees on
mutual fund and money market transfers. Such revenues increased 27% for the
second quarter of fiscal year 1995 over the same period in the prior year,
primarily due to a corresponding increase in money market balances.
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OTHER NONINTEREST INCOME. Included in other noninterest income are payments
received for order flow and other miscellaneous revenues. The increase of 19%
for the second quarter of fiscal year 1995 was primarily a result of increased
participation by the Company in the order flow rebate market. The SEC has
issued new regulations requiring additional disclosure of fees received by
brokers for order flow. No assurance can be given that any such additional
disclosure will not have an adverse effect on the Company's revenues.
EXPENSES
EMPLOYEE COMPENSATION. Employee compensation represented approximately 43% of
total pre-tax operating expenses in the second quarter of fiscal 1995, the
Company's largest expense. This expense primarily includes salaries, bonuses,
profit sharing plan contributions and other related benefits and taxes.
Employee compensation expense is directly impacted by the number of employees,
and partially impacted by the profits of the Company, as the bonuses and
contributions to the profit sharing plan are dependent on income before taxes.
Employee compensation increased 7% in the second quarter of fiscal 1995 over
the second quarter of fiscal 1994, primarily as a result of an increase in
the number of employees from February 28, 1994 to February 28, 1995. These
increases were necessary to support the rapid branch expansion from 56 as of
February 28, 1994 to 64 as of February 28, 1995, as well as the staffing of
Waterhouse National Bank.
COMMUNICATIONS AND DATA PROCESSING, CLEARING FEES AND STATIONERY AND POSTAGE.
These categories are primarily composed of variable charges related to
executing and clearing customer transactions, telephone, computer service,
quotation, clearance, floor brokerage, envelopes and postage charges. These
charges increased 7% for the second quarter of fiscal year 1995 primarily due
to the continuous upgrading of the company's technology, which includes
Trade Direct and a nationwide telephone system.
ADVERTISING. As the branch network expanded at its rapid rate over the past
several years, Waterhouse Securities increased its advertising campaign with
larger and more frequent advertising. The Company's advertisements appear on
a regular basis in national publications, such as The Wall Street Journal,
Barron's and Investor's Daily, and run regularly on CNBC and other cable
television networks. As a result, advertising and promotion expense increased
82% for the second quarter of fiscal year 1995 over the second quarter of the
prior year.
OCCUPANCY. Occupancy expense increased 12% in the second quarter of fiscal
1995 vs. the second quarter of fiscal 1994. This increase was primarily
attributable to an increase in rental expense resulting from the expansion of
the Company's branch office network and corporate headquarters.
OTHER OPERATING EXPENSES. Included in other operating expenses are
depreciation and amortization, insurance, professional fees and other
miscellaneous expenses. Other operating expenses amounted to $2.8 million
in the second quarter of fiscal year 1995, resulting in an increase of 56%
as compared to the second quarter of fiscal 1994. This increase is primarily
attributable to equipment purchased used in the general expansion of the
Company's business during the period.
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FINANCIAL CONDITION
As of February 28, 1995, the Company's financial position remained strong with
over 97% of total assets consisting of cash, fed funds sold, investment
securities and receivables. The Company's assets primarily consist of
receivables from other broker-dealers and customers. Customer receivables
of $285 million at February 28, 1995 are secured by readily marketable
securities, some of which are used to collateralize bank loans of $99 million.
The Company's other assets consist principally of office and operating
equipment.
Stockholders' equity as of February 28, 1995 was over $57 million, an increase
in excess of $7 million since August 31, 1994. Such increase was due to
earnings during the first six months of fiscal 1995.
LIQUIDITY AND CAPITAL RESOURCES
With the establishment of the Waterhouse National Bank on October 13, 1994, the
Company became subject to regulation as a registered bank holding company,
under the Bank Holding Company Act. As such, the Company is subject to
examination by the FRB, regulatory reporting requirements, minimum capital
requirements and ratios, certain restrictions on non-banking activities,
transactions with affiliates, tie-in arrangements, changes in control,
dividend payments, redemptions and other payments to security holders, and
other restrictions. Under FRB policy, the Company, as a bank holding company,
will be expected to act as a source of financial strength to Waterhouse
National Bank and to commit resources to support the Bank. Currently, both
the Company and the Bank have adequate capital, in excess of minimum
requirements.
Waterhouse Securities is subject to rules adopted by the SEC, the NASD,
the NYSE and various state securities law administrators which are designed
to measure the general financial integrity and liquidity of broker-dealers by
determining the amount of their net capital. Waterhouse Securities may not
pay dividends, distribute capital, prepay subordinated indebtedness or redeem
or repurchase shares of its capital stock if, thereafter, it would be in
violation of any such rules. In the past, Waterhouse Securities has at all
times maintained net capital in excess of the minimum amount of net capital
required to be maintained by such rules, and, as of February 28, 1995,
Waterhouse Securities had net capital in excess of the minimum amount of net
capital required to be so maintained.
The Company had available formal and informal lines of credit of approximately
$235 million (of which $99 million was utilized) at February 28, 1995, which
require collateralization upon utilization. These lines of credit, payables to
customers, and the convertible subordinated notes are the primary sources of
liquidity for the Company. Management believes that these primary sources of
liquidity, along with the equity of the Company, are sufficient to meet the
working capital needs of its subsidiaries including expansion of the
securities, clearing and banking operations, as well as any possible future
acquisitions.
EFFECTS OF INFLATION
For the six month period ended February 28, 1995, there was no material effect
on the Company due to inflation.
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PART II - OTHER INFORMATION
Item 1. Legal Proceedings
In the ordinary course of its business the Company is involved in
certain routine legal matters in which, in the opinion of management,
based on its discussions with counsel, are not expected to have a
material adverse effect on the Company's consolidated financial
condition.
Item 2. Changes in Securities
Not applicable
Item 3. Defaults Upon Senior Securities
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
On February 7, 1995, the Company held its Annual Meeting of Stock-
holders. A proposal to approve the appointment of Price Waterhouse
LLP as the Company's independent accountants for the fiscal year
ending August 31,1995, was presented to the Stockholders for
ratification. The Stockholders approved such proposal with 8,537,127
votes cast for, 62,580 votes cast against, and 33,030 abstentions.
In addition, the Company nominated four directors to serve until
the Annual Meeting of Stockholders in 1998. Proxy statements listing
such nominations were solicited pursuant to Regulation 14A under the
Securities Exchange Act of 1934 and there was no solicitation in
opposition to management's nominees. All such nominees were elected
with the following votes cast:
For Authority to Vote Withheld
--------- ---------------------------
Lawrence M. Waterhouse, Jr. 8,510,129 122,608
Jerome Belson 8,519,756 112,981
George F. Staudter 8,517,907 114,830
Peter A. Wigger 8,517,489 115,248
Item 5. Other Information
Not applicable
Item 6. Exhibits and Reports on Form 8-K
Exhibit A - Computation of Earnings Per Common and Common
Equivalent Shares
Exhibit B - Computation of Ratio of Earnings to Fixed Charges
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
WATERHOUSE INVESTOR SERVICES, INC.
Date: April 12, 1995 By: /s/ Lawrence M. Waterhouse Jr.
-------------------------------
Lawrence M. Waterhouse, Jr.
Chairman & Chief Executive Officer
Date: April 12, 1995 By: /s/ Bernard Siegel
--------------------------------
M. Bernard Siegel
Chief Financial Officer
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