1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
[X] ANNUAL REPORT Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended August 31, 1995.
OR
[ ] TRANSITION REPORT Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from _____ to ______.
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 Identification No.)
incorporation or organization)
100 Wall Street, New York, New York 10005
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (212) 806-3500
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
Common Stock, par value $.01 New York Stock Exchange
6% Convertible Subordinated New York Stock Exchange
Notes Due 2003
Securities registered pursuant to 12(g) of the Act: None
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 if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. [ ]
The aggregate market value of voting stock held by nonaffiliates of the
registrant was $134,373,213 as of October 31, 1995.
The number of shares of common stock outstanding as of October 31, 1995 was
11,451,538.
Documents Incorporated by Reference
-----------------------------------
Part III of this Form 10-K incorporates certain information contained in
the registrant's Proxy Statement for its Annual Meeting of Stockholders to
be held on February 6, 1996 by reference to that document.
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PART I
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Item 1. Business
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(a) General Development of Business
-------------------------------
Waterhouse Investor Services, Inc. ("Waterhouse" or the "Company"),
is a holding company engaged through its principal subsidiary, Waterhouse
Securities, Inc. in providing discount brokerage and related financial
services primarily to retail customers throughout the United States.
Waterhouse Securities, Inc., ("Waterhouse Securities") commenced
operations in March 1979 with four employees in a single office located in
New York City. Waterhouse Securities has grown steadily and employs
approximately 1,000 employees, including 551 Account Officers in 72 branch
offices located in 37 states and the District of Columbia. Waterhouse
Securities currently has over 450,000 customer accounts, of which
approximately 300,000 are active accounts, located throughout the United
States.
Waterhouse Securities is registered as a broker-dealer with the
Securities and Exchange Commission (the "SEC"), is a member of the National
Association of Securities Dealers, Inc. (the "NASD"), the Securities Investor
Protection Corporation ("SIPC"), and the New York Stock Exchange, Inc. (the
"NYSE"), is an associate member of the American Stock Exchange ("AMEX"), a
member of the Pacific and Chicago Stock Exchanges and is registered as a
broker-dealer under the laws of all fifty states of the United States, the
District of Columbia and the Commonwealth of Puerto Rico.
With the establishment of Waterhouse National Bank (the "Bank") as a
wholly owned subsidiary, the Company, as of October 13, 1994, has been
registered as a bank holding company under the Bank Holding Company Act of
1956, as amended (the "BHC Act"). The Bank was established to provide the
Company with the ability to offer expanded financial services and products
primarily to the customer base of Waterhouse Securities.
(b) Financial Information about Industry Segments
---------------------------------------------
The Company operates in a single industry segment, except for the
operations of certain of its subsidiaries which are not material, and has no
foreign operations. No material part of the Company's consolidated revenue is
received from a single customer or group of customers.
(c) Narrative Description of Business
---------------------------------
The Company, through its principal subsidiary, Waterhouse Securities, is
among the lowest cost providers of nationwide discount brokerage and related
financial services directed primarily to individual investors. Waterhouse
Securities has experienced rapid growth in customer accounts and trade
processing activity, and management believes it is currently the nation's 5th
leading provider of discount brokerage services in the United States, with 72
branch offices in 37 states and the District of Columbia.
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Since the abolishment of fixed commissions in 1975, the discount brokerage
business has evolved from what was regarded as a mere commission-saving service
to an important industry serving a growing number of investors who make their
own investment decisions and do not wish to pay for the assistance, advice
and research of a full-service brokerage firm. According to information
compiled by the Securities Industry Association, the demand for discount
brokerage services has increased substantially over the past 11 years, with
discount brokerage firms accounting for 14.5% of total retail commission
revenues generated in 1994 up from 4.6% in 1983.
Waterhouse Securities offers its customers a wide array of products and
services, including prompt and accurate execution of unsolicited orders to
purchase and sell securities, rapid access to pricing, volume and other market
information, related financial services provided by the Bank, free
investment information and professional and courteous service provided
through a personal Account Officer. By concentrating on the self-directed
investor, maintaining a low-cost structure and utilizing a highly-automated
order processing system, Waterhouse Securities can charge commission rates that
are substantially lower than those charged by full-service brokerage firms as
well as those of other leading nationwide discount brokers.
Products and Services
Discount Brokerage Services - Waterhouse Securities provides its customers
with a range of discount brokerage and related financial services including the
execution of customer orders in all listed and over the counter corporate
securities, all listed equity and index options and municipal and government
securities. In addition, Waterhouse Securities offers a daily sweep of cash
from customer accounts to both an FDIC insured money market fund offered by the
Bank and an unaffiliated money market mutual fund (not FDIC insured).
Waterhouse Securities also makes available for purchase or redemption
approximately 500 no-load and low-load mutual funds for a transaction fee and
offers over 225 no-load mutual funds for which its customers will not be
charged a fee. Dividend reinvestment is available at no cost to all customers
who hold their securities in their Waterhouse accounts. Over 4,000 U.S.
exchange-listed and NASDAQ stocks are eligible under this program.
Waterhouse does not offer investment advice, perform any research, provide
portfolio management, maintain inventories of securities for sale, engage in
principal or commodity transactions or underwrite securities.
Through Instanex, a high-speed, automated order processing system which is
linked to all major exchanges, Waterhouse Securities provides rapid
execution of customer orders, including execution of market orders in as few as
six seconds with confirmation generally given to customers while they are still
on the telephone. Waterhouse Securities has developed and introduced Trade
Direct, a touch-tone telephone trading system which enables customers to
enter orders and obtain real time quotes and account information using a
touch-tone telephone. The Company is also in the process of developing an
on-line, personal computer-based trading system that will enable its
customers to access account information and effect securities transactions
with minimal involvement from an Account Officer.
Waterhouse Securities offers a simple commission schedule, which is a
single level discount from the commission rates of a representative full-
service brokerage firm, with a minimum
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commission of $35 per transaction. Waterhouse Securities has not increased its
commission rate during the past 16 years and intends to maintain its position
as a low-cost nationwide provider of discount brokerage services. However,
Waterhouse Securities may change its commission schedule from time to time in
the future, as appropriate, in light of inflation, competition, profitability
and other factors. Based on current commission schedules, the Company believes
that, generally, the commission rates it charges its customers are 70% lower
than the rates charged by full-service brokerage firms and are, in many
cases, substantially lower than the rates charged by other nationwide
discount brokerage firms.
Waterhouse Securities considers a high level of customer service and
satisfaction to be among its most important objectives. Customer satisfaction
is measured daily through the mailing of hundreds of customer satisfaction
surveys. Of those customers responding during calendar year 1995, 99% rated
the courtesy they received as excellent or good and 98% rated the service they
received as excellent or good.
Management believes that an essential component of maintaining customer
satisfaction is providing effective communication and accountability.
Waterhouse Securities assigns to each customer a non-commissioned personal
Account Officer who provides customers with quotes and market information and
assists in the processing of customer orders. Account Officers are registered
with the NYSE and the NASD but do not offer investment advice or solicit
transactions.
Waterhouse Securities conducts all aspects of training for its Account
Officers, branch managers and other personnel. Training manuals covering
products and services and telephone techniques have been developed to help the
firm's Account Officers provide personal, courteous and professional service.
In addition to its low commission schedule, Waterhouse Securities considers
customer satisfaction to be a major reason for its success to date.
The Company believes that its training program and policy of promotion
from within, coupled with its compensation, stock option, 401K, and employee
stock ownership plans (the "ESOP") (approximately 12% of the Company is owned
by the ESOP), have resulted in motivated associates who are substantially
responsible for the high levels of customer satisfaction.
Investor Information Services - Waterhouse Securities provides free
investment information to its active customer base. This information
is provided to help the self-directed investor with his or her investment
decisions. Included in this package are Standard & Poor's Stock Guides
(investment data on over 7,000 securities) and Standard & Poor's Stock
Reports (two-page reports on all NYSE, AMEX and over 1,600 NASDAQ companies).
These reports are widely used by the individual investor for both current and
historical financial information. Available to customers free of charge, on
request, are a Stock Market Leaders Guide, prepared by Standard & Poor's, which
ranks stocks according to a variety of investment criteria, a Retirement
Planning Guide, a 20-page booklet to aid in planning for financial independence
in retirement, a Tax Planning Guide, a 30-page booklet outlining tax planning
strategies and tax-saving ideas, and Standard & Poor's The Outlook-the Mid
Year and Annual Forecast Editions which include investment ideas, strategy
and specific recommendations for a variety of investment objectives.
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The Individual Investor - a newsletter produced by Waterhouse Securities
containing interviews with investment advisors and money managers - is included
with each monthly statement. In addition, customers, on request, can receive
a free quarterly Mutual FundConnection Information & Comparison Guide. This
reference guide contains rankings compiled by Micropal, Inc., of over 900
mutual funds offered through Waterhouse Securities.
Waterhouse Securities makes available on request, for a fee, Standard &
Poor's Research Reports on over 3,000 publicly traded companies, these are
seven-page reports which include analysts' buy/sell/hold recommendations,
consensus earnings forecast, price and earnings history and other information.
Also on request, for a fee are Mutual Fund Reports by Morningstar. These are
one page reports which contain data and analytical information to help the
customer determine whether investment in a particular fund would be consistent
with their investment objective and level of risk.
Mutual Fund and Advisory Activities - The Company is in the process of
organizing an investment advisory subsidiary, Waterhouse Asset Management,
Inc., to be registered under the Investment Advisory Act of 1940. The
advisory firm, which will be a wholly-owned subsidiary of the Bank, will
principally be engaged in providing investment management services to the
Waterhouse Investors Cash Management Fund, a money market fund in the process
of organization, and other mutual funds.
Related Financial Services - Waterhouse Securities offers its customer
base related financial products and services provided by the Bank. These
products and services include an FDIC insured money market sweep account,
certificates of deposit and access to one's brokerage account by check and an
ATM/VISA check card. During fiscal 1996, the Company also intends to introduce
an Investors Prime Credit Card issued by the Bank.
Customer Financing Activities - The Company offers both cash and margin
accounts to its customers. In an account authorized for margin trading,
Waterhouse Securities may lend its customers an amount up to that permitted by
the Federal Reserve Board (the "FRB"), currently 50% of the market value of
securities purchased. Customer margin loans have grown steadily over the past
6 years, from $45 million in 1989 to $365 million at the end of fiscal year
1995. Interest earned on margin loans, which exceeds the cost of funds incurred
by Waterhouse Securities, has remained a major component of revenues and has
been a contributing factor to the growth and profitabilty of the Company.
The amount of the net interest income earned by Waterhouse Securities from
extending margin loans is affected by customer margin balances and changes in
prevailing interest rates.
Margin loans are collateralized by securities held in customer accounts
and are financed through the use of Waterhouse Securities' capital, convertible
subordinated notes (see Liquidity and Capital Resources), free credit balances,
deposits received for securities loaned and short term borrowings from banks,
using the margined securities as collateral. In connection with permitting a
customer to purchase securities on margin, a clearing firm takes the risk of a
market decline that may reduce the value of its collateral below the amount
of the customer's indebtedness which may result in a loss to the firm if
payment is not received from the customer.
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Under applicable rules and regulations, following the initial purchase of
securities in a margin account, the Company must require that a customer
deposit additional securities or cash to ensure that the amount owed by the
customer is never greater than 75% of the value of the securities in the
account. As a matter of policy, the Company generally requires additional
deposits if the amount owed by the customer exceeds 65% of the value of the
securities. To date, Waterhouse Securities has not incurred any substantial
loss as a result of its margin activities. To mitigate such risks, management
has established internal controls and safeguards which it believes are
adequate.
Through the performance of brokerage and related services, the Company
earns commissions and clearing fees, interest, mutual fund revenues and other
revenues. The following table sets forth consolidated revenues of the
Company and the number of branch offices of Waterhouse Securities in operation
at year end on a comparative basis for the last three fiscal years.
For the Fiscal Year Ended August 31,
------------------------------------
1995 1994 1993
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Commissions and clearing fees $103,450,001 $83,087,697 $68,261,835
Net Interest 16,363,433 9,902,365 6,883,101
Mutual fund revenues 9,786,638 6,887,828 4,891,221
Other 1,593,685 1,926,879 1,135,161
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Total income $131,193,757 $101,804,769 $81,171,318
============ ============ ===========
Number of Waterhouse Securities'
offices 72 60 48
Branch Office Network
From a single office in New York in 1979, Waterhouse Securities has
grown to a total of 72 offices in 37 states and the District of Columbia.
Waterhouse Securities intends to open an additional twelve offices in the
current fiscal year and twelve in fiscal year 1997.
Management believes that the existence of branch offices is important in
opening new customer accounts, and in maintaining a high level of customer
satisfaction. Customers generally prefer to conduct business with local
offices and personnel. A branch office provides Waterhouse Securities with a
presence in a particular market area and, in the past, this presence has
produced an increase in unsolicited customer referrals in that market area, and
has generally increased Waterhouse Securities' market penetration. Moreover,
since Waterhouse Securities primarily conducts nationwide advertising
campaigns, such market penetration has been achieved without incurring
significant additional advertising expenses. No assurance can be given,
however, that opening additional branch offices will result in increases in
the customer base of Waterhouse Securities, and marginal or unsuccessful branch
offices could adversely affect the Company's results of operations.
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The following table sets forth the growth of commission and clearing fee
revenues, Account Officers and branch offices over the last five years:
Fiscal Year Ended Commission Number of Total
August 31 Revenues Account Officers Branches
--------- -------- ---------------- --------
1995 $103,450,000 551 72
1994 83,088,000 375 60
1993 68,262,000 281 48
1992 44,243,000 174 38
1991 23,601,000 103 21
Advertising and Marketing
Advertising and marketing together have also played an important role in
the growth of new customer accounts and revenues. Waterhouse Securities'
advertisements appear on a regular basis in such national publications as The
Wall Street Journal, Barrons and Investors Business Daily, and run regularly on
CNBC and other cable television networks and radio.
The Company places most of its advertising through its in-house
advertising agency and employs various purchasing strategies to minimize the
expense of its advertising campaigns. In addition, the Company uses response
tracking systems, and maintains databases of customer responses to track the
effectiveness of each advertisement or campaign. By carefully tracking
customer responses, the Company can attribute the addition of each new
customer account to a specific advertisement or medium, and maximize the
effectiveness of its advertising expenditures.
Competition
All aspects of the Company's business are highly competitive. Competition
within the securities industry is principally based on the prices for the
products and services offered, the quality and type of services offered, the
amount of capital available to invest in offering new services and reputation
with customers. Waterhouse Securities competes directly with many larger,
diversified, well-capitalized national, regional and local full-service and
discount brokerage firms.
Waterhouse Securities competes primarily with other nationwide discount
brokers. Certain of these competing discount brokers offer services which
Waterhouse Securities does not presently offer, have a greater number of
offices and/or have greater financial resources. Waterhouse Securities
believes that because of its relatively low cost and variable expense
structure, its established reputation in the industry, its emphasis on the
highest quality customer service, and its ability to offer related financial
services provided by the Bank, it is, and will continue to be, able to
compete favorably with these competing discount brokers. As nationwide
discount brokers expand their branch office networks, it is possible that
saturation may occur in one or more areas, which may adversely affect the
customer base and commission revenues of Waterhouse Securities.
Full-service brokerage firms employ substantial funds in advertising and
direct solicitation of customers to increase their market share of securities-
related service income, such as
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commissions. If these firms choose to offer commission rates competitive with
Waterhouse Securities' commission rates, its customer base and commission
revenues may be adversely affected. Management believes, however, that the
account executive compensation arrangements, direct solicitation costs,
investment research costs, training costs and other costs which arise out of
the "full-service" concept associated with these firms, as opposed to the
"unsolicited execution" service concept associated with discount brokerage
firms, make it difficult for full-service brokerage firms to offer substantial
commission rate discounts to a large portion of their retail customers.
Laws, rules and regulations affecting the securities and banking industry
and changes in other laws, rules and regulations, such as tax laws, may change
the relative competitive positions of various segments of the industry. As a
result of these changes and other factors, banks, savings associations,
insurance companies, and other financial institutions not previously engaged in
the securities business but having substantial financial resources, have
acquired or formed securities firms, including discount brokerage firms. It
is not possible to predict the impact that these changes and other factors may
have on the securities industry generally or the Company specifically. In
addition, banks, savings associations, insurance companies and other
financial institutions compete aggressively with the Company for securities-
related service income, such as commission revenue, by offering a wide range
of financial services and products and by providing commission discounts to
their retail customers.
Securities Clearing Operation - Correspondent Clearing
Waterhouse Securities started its self-clearing operation in 1988.
Clearing activities involve the performance of the confirmation, settlement
and receive and deliver functions involved in all securities transactions.
Waterhouse Securities' self-clearing operations have generated additional
revenues, improved customer service, and reduced execution and clearance-
related operating expenses. Management believes that Waterhouse Securities'
clearing operation has been a contributing factor to the success and growth
of the Company.
Many brokerage firms offer trade execution and clearance services to
unaffiliated broker-dealers, usually referred to as introducing brokers. This
service has evolved over the years as a profitable segment of the securities
business. Clearing brokers maintain certain books and records and the capital
necessary to carry the accounts and margin loans of the introducing brokers.
They also provide execution, confirmation, and settlement of customer
transactions for the introducing broker. The Company believes that its
self-clearing operation can be adapted to profitably serve unaffiliated
broker-dealers as well.
Clearing operations require a substantial capital commitment and are
dependent upon the proper functioning of sophisticated equipment and the
services of a number of trained individuals and must be conducted in accordance
with complex and extensive laws, rules and regulations. Waterhouse Securities
assumes the risks associated with making such capital commitment and complying
with such laws, rules and regulations. Waterhouse Securities also assumes
responsibility for errors, omissions and misconduct in connection with
receiving, holding and delivering funds and securities of, and executing and
clearing transactions for, its customers.
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Margin loans made by a clearing firm which is a member organization of the
NYSE are subject to Regulation T of the FRB and the rules of the NYSE. In
connection with permitting a customer to purchase securities on margin, a
clearing firm takes the risk of a market decline that may reduce the value of
its collateral below the amount of the customer's indebtness which may result
in a loss to the firm if payment is not received from the customer.
Regulation T provides the purchase of eligible equity securities may not
exceed 50% of the purchase price. Under NYSE rules, if the market value of
the eligible securities in a margin account declines, a clearing firm must
require the customer to deposit additional eligible securities or cash in the
margin account so that at all times the amount loaned to the customer is not
greater than 75% of the market value of the eligible securities held in the
margin account. To date, Waterhouse Securities has not incurred any
substantial loss as a result of its margin activities. To mitigate such
risks, management has established internal controls and safeguards which it
believes are adequate.
To the extent that an introducing broker serviced by Waterhouse
Securities has a customer base similar to that of the Company, management
believes that the risks to itself of performing clearing operations, for
introducing brokers, will not be substantially different from those described
above. Accordingly, the Company intends to solicit brokers whose business is
substantially similar to that in which Waterhouse Securities is currently
engaged. Waterhouse Securities currently services customer accounts of two
correspondent broker dealers. The Company believes that its experience in
dealing with its own customer accounts and these broker-dealers will enable
it to successfully provide clearing services for introducing brokers.
On October 27, 1995, the Federal Reserve Bank of New York approved an
application by the Company to transfer the execution, clearing and other
services incidental to brokerage, which are presently performed by Waterhouse
Securities, to a new wholly owned subsidiary of the Company, National Investor
Services Corp. ("NISC"). NISC will be a separately capitalized broker-dealer
registered with the SEC and is applying for membership with the NYSE, the
NASD, the AMEX, the Chicago Stock Exchange and the Pacific Stock Exchange.
Technology
Waterhouse Securities has used technology to increase operating
efficiencies and to offer value-added services to its customers. This
technology includes an on-line, order management and execution system
(Instanex) which enables Account Officers to enter and report back the
execution of most customer orders within seconds, generally while the
customer remains on the telephone. In addition, Waterhouse Securities is in
the process of replacing basic quote terminals with intelligent work stations
throughout its branch network connected over a wide area network. This will
allow Account Officers to operate more efficiently and put in place a platform
from which additional services can be offered to its customers.
Other important areas in which Waterhouse Securities has developed
technology-based systems are: (i) a shareholder accounting and transaction
processing system which permits no-load mutual funds to be provided to its
customers; (ii) TradeDirect, which enables customers using a touch-tone
telephone to enter orders and obtain price quotes and account information; and
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(iii) an integrated telephone system which enables the Company to balance
customer telephone calls between branch offices and call centers and provide
faster response times.
Waterhouse Securities and the Bank use third-party service companies for
most back-office data processing systems. They believe that such service
companies' back-office systems are efficient and effective and have enabled
both organizations to avoid the high capital and manpower costs associated with
routine back-office processing. However, the use of third parties for back
office processing requires reliance on that third party for back-up systems
in the event of any systems failure.
Employees (Associates)
The Company has approximately 1,000 employees. The Company's executive
management team consists of 13 officers. All of the Company's employees are
salaried workers. The Company does not have any collective bargaining,
employment or non-competition agreements with any of its employees other than
with two members of its executive management team.
The Company's employee relations are good and the Company's compensation
and employee benefits, which include medical, disability, 401K, ESOP and life
insurance benefits, are competitive with the compensation and employee benefits
offered by other discount brokerage firms.
Fraud and misconduct by employees and the possibility of theft and loss of
securities are risks inherent in the securities industry. Management believes,
however, that the Company's internal controls and safeguards are adequate.
The Company's principal subsidiaries carry fidelity bonds providing for
coverage with respect to forgery, theft, loss, embezzlement and similar
occurrences. Management believes that present insurance coverage is adequate.
Regulation
With the establishment of the Bank on October 13, 1994, the Company became
subject to regulation as a registered bank holding company under the BHC Act.
As such, the Company is subject to examination by the FRB, regulatory
reporting requirements, minimum capital requirements and ratios, certain
restrictions on securities and 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 the Bank and to commit resources
to support the Bank.
The securities industry in the United States is subject to extensive
regulation under both federal and state laws. The SEC is the primary federal
agency responsible for the administration of the federal securities laws.
Waterhouse Securities is registered as a broker-dealer with the SEC and the
NASD. Much of the regulation of broker-dealers has been delegated to
self-regulatory organizations, principally the NYSE and the NASD. The NYSE
has been designated by the SEC as Waterhouse Securities' designated examinating
authority.
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In addition to rules adopted by the SEC, the self-regulatory organizations
adopt rules (subject to approval by the SEC) that govern the operations of
broker-dealers. Such organizations also conduct periodic examinations to
monitor compliance with such rules. Broker-dealers are also subject to
regulation by the state securities law administrators of those states in which
they conduct business. Waterhouse Securities is registered as a broker-dealer
in all fifty states of the United States, the District of Columbia and the
Commonwealth of Puerto Rico. In addition, the Company has registered its
employees in each of the states in which the Company believes such registration
is necessary. However, state broker-dealer registration requirements are often
subject to ambiguous statutory language and the exercise of broad discretionary
powers by the administrators of the various state regulatory agencies and the
failure by the Company to register its representatives in certain states could
have an adverse effect on the Company's business. Moreover, the FRB and other
federal agencies adopt rules that govern various aspects of the securities
industry.
As a registered broker-dealer and a member corporation of the NYSE doing
business with the public, Waterhouse Securities is subject to SEC Rule 15c3-1
(commonly known as the "Net Capital Rule"), which has also been adopted by the
NYSE through incorporation by reference in NYSE Rule 325, which specifies the
minimum amount of net capital required to be maintained by broker-dealers, and
is designed to measure the general financial integrity and liquidity of broker-
dealers and requires that a certain part of broker-dealers' assets be kept in
relatively liquid form. The Net Capital Rule imposes financial restrictions on
broker-dealers which generally are not imposed with respect to organizations
engaged in other businesses. 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 of
such rules.
For purposes of the Net Capital Rule, net capital is essentially defined
as net worth (total assets minus liabilities), plus qualifying subordinated
indebtedness, less certain mandatory deductions that result from excluding
assets that are not readily convertible into cash and from valuing certain
other assets, such as positions in securities, conservatively. Waterhouse
Securities has at all times maintained net capital in excess of the minimum
amount of net capital required.
The Office of the Comptroller of the Currency (the "OCC") is the primary
regulator of the Bank. As such, the Bank is subject to both their monitoring
and examination. The OCC has issued guidelines that impose upon national
banks certain risk-based capital and leverage standards. Failure to meet
applicable capital guidelines could subject a national bank to a variety of
enforcement remedies available to the federal regulatory authorities.
Depending upon circumstances, the regulatory agencies may require an
institution to surpass minimum capital ratios established and may also take
more restrictive action.
As a newly chartered bank, the Bank has committed not to pay dividends
to the Company during its first three years of operation. Thereafter, the
National Bank Act and the regulations promulgated thereunder impose various
restrictions on the amount of dividends that may be paid by the Bank to the
Company based upon the Bank's net earnings, capital, undivided profits, bad
debts and losses.
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The Bank assumes the usual risks associated with the management of a
banking operation including possible fraud. The Bank's operations are
highly regulated. There are various legal limitations on the extent to which
banks insured by the FDIC can finance or otherwise supply funds to certain of
their affiliates. In particular, the Bank is subject to certain restrictions
on any extensions of credit, or other covered transactions, such as certain
purchases of assets, with the Company or its affiliates. Such restrictions
prevent the Bank from lending to the Company or any of its affiliates unless
such extensions of credit are secured by U.S. Treasury obligations or other
specified collateral.
d) Financial Information about Foreign and Domestic Operations and Export Sales
----------------------------------------------------------------------------
Not applicable.
Item 2. Properties
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In January 1993, the Company moved its corporate headquarters to 100 Wall
Street, New York, New York 10005. The office also houses the main New York
branch office and consists of approximately 60,000 square feet of space and
is occupied under a lease which expires in 2002. The Company's clearing
operations are located at 44 Street, New York, New York 10005 and consists of
27,000 square feet of space under a lease that expires in 1997. The Company
is currently evaluating various options with respect to the location of its
clearing operations, including possibly relocating such operations to new
office space.
Waterhouse Securities' other 71 branch offices, each of which consist of
between approximately 800 and 2,100 square feet of space, are located on
premises covered by leases which expire on various dates through 2004.
Waterhouse National Bank operates out of its main office in White Plains,
New York. It occupies 5,085 square feet under a lease that expires in 1997.
Item 3. Legal Proceedings
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Many aspects of the Company's business involve risks of substantial
liability. There has been an increased incidence of litigation involving
securities firms in recent years, including class action suits which generally
seek substantial damages. Although Waterhouse Securities has not been named
as a defendant in any class action suit to date, no assurance can be given
that it will not be named in the future. Waterhouse Securities has in the
past been involved in regulatory proceedings, none of which has had a
materially adverse effect on its business. In addition, in the ordinary
course of business, Waterhouse Securities is occasionally involved in routine
arbitration proceedings and civil actions arising out of its activities as a
broker-dealer, an employer or a purchaser of goods and services or arising
out of alleged employee misconduct, none of which, individually or in the
aggregate, has had or is expected to have a materially adverse effect on
its business.
Item 4. Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------
No matters were submitted to a vote of the Company's security holders
during the last quarter of the fiscal year ended August 31, 1995.
13
PART II
- -------
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
- ------------------------------------------------------------------------------
On December 1, 1992, the Company's common stock was listed for trading on
the NYSE. For the period from February 24, 1992 to November 30, 1992, the
Company's common stock traded on the AMEX and prior thereto, the Company's
common stock traded in the over-the-counter market and was included in the
NASDAQ National Market System ("NASDAQ"). Its current symbol is WHO and
there are approximately 8,500 holders of record of the common stock.
The following table sets forth the high and low closing prices on the
NYSE for the periods indicated. The Company declared a 25% stock dividend paid
September 14, 1995 to stockholders of record August 17, 1995, and a 50% stock
dividend paid November 8, 1993 to stockholders of record October 12, 1993.
The prices on the table below have been adjusted to reflect the stock dividends
for the applicable periods (rounded to nearest 1/8).
Fiscal Year 1995 High Low
---------------- ---- ---
First Quarter $13 5/8 $10 7/8
Second Quarter 14 1/4 9 3/4
Third Quarter 14 1/4 12 1/4
Fourth Quarter 22 7/8 14 1/8
Fiscal Year 1994 High Low
---------------- ---- ---
First Quarter 28 1/8 20 1/4
Second Quarter 22 1/8 15 3/4
Third Quarter 19 1/4 12
Fourth Quarter 13 5/8 9 1/2
Dividends. The Company declared a dividend of $.20 per share of common
stock paid September 7, 1995 to stockholders of record August 17, 1995, a
dividend of $.16 per share of common stock paid September 9, 1994 to
stockholders of record August 16, 1994, and a dividend of $.14 per share of
common stock paid September 9, 1993 to stockholders of record August 16, 1993.
Such amounts have been adjusted to reflect the stock dividends described
above.
The parent company's primary sources of income are management fees,
interest, dividends and the distribution of other amounts by its subsidiaries,
primarily Waterhouse Securities. However, the payment of cash dividends and
the distribution of other amounts to the Company by Waterhouse Securities are
restricted by the rules of the various regulatory agencies as well as various
state securities law administrators and there is no assurance that dividends
will be declared and paid or other distributions will be made in the future.
Additionally, the Company is restricted from receiving dividends from the Bank
(see Regulation).
14
Item 6. Selected Financial Data
- --------------------------------
The following tables set forth certain consolidated financial information
with respect to the Company which has been derived from the audited
consolidated financial statements of the Company for the five fiscal years in
the period ended August 31, 1995. This selected consolidated financial
information should be read in conjunction with the consolidated financial
statements of the Company included in Item 8 herein.
For the Fiscal Year Ended August 31,
-----------------------------------------------------------------
1995 1994 1993 1992 1991
---- ---- ---- ---- ----
Total income $131,193,757 $101,804,769 $81,171,318 $53,594,577 $30,029,563
Total operating
expenses 97,746,453 73,795,592 55,379,512 38,431,525 24,340,429
Income before
income taxes 33,447,304 28,009,177 25,791,806 15,163,052 5,689,134
Net Income $19,357,226 $15,726,483 $14,356,870 $8,473,052 $3,162,134
Earnings per share(1) $1.68 $1.37 $1.26 $ .75 $ .30
Fully diluted earnings
per share(1) $1.54 $1.30 $1.26 $.75 $.30
Dividends per share(2) $ .20 $ .16 $ .14 $.09 $.05
As of August 31,
-----------------------------------------------------------------
1995 1994 1993 1992 1991
---- ---- ---- ---- ----
Total assets $665,612,983 $315,780,440 $241,085,338 $148,974,412 $71,680,190
Total liabilities $598,898,938 $266,177,207 $205,492,396 $127,942,965 $60,140,454
Stockholders'equity $66,714,045 $49,603,233 $35,592,942 $21,031,447 $11,539,736
___________________
(1) Earnings per share have been computed based upon weighted average shares of
common stock outstanding and common stock equivalents for the years presented,
adjusted for stock dividends referred to in Note 2 below.
(2) Dividends per share have been adjusted to reflect a 25% stock dividend paid
September 1995, a 50% stock dividend paid November 1993, a 25% stock dividend
paid March 1993, a 50% stock dividend paid February 1992 and a 25% stock
dividend paid June 1991.
15
WATERHOUSE INVESTOR SERVICES, INC. AND SUBSIDIARIES
AVERAGE BALANCES, INTEREST AND AVERAGE RATES
FOR THE YEAR ENDED AUGUST 31, 1995
Average Average
Balances Interest Rates
-------- -------- -----
ASSETS:
Loans
Receivable from customers $300,408,481 $23,645,545 7.87%
Short-term investments
Treasury bills and agencies 34,397,954 1,722,796 5.01%
Federal funds sold 21,350,000 1,079,641 5.06%
Interest bearing deposits with other banks 19,750,000 1,124,232 5.69%
---------- ---------
Total short-term investments 75,497,954 3,926,669 5.20%
Other
Other interest bearing assets 10,905,390 596,994 5.47$
----------- -------
Total earning assets 386,811,825 $28,169,208 7.28%
Other assets 28,351,972 ===========
------------
TOTAL ASSETS
LIABILITIES: $415,163,797
============
Short-term debt
Broker loans 77,259,569 4,797,246 6.21%
Deposits received for securities loaned 11,981,110 628,256 5.24%
---------- ---------
Total short-term debt 89,240,679 5,425,502 6.08%
Interest bearing deposits
Interest bearing deposits 47,625,203 2,440,187 5.12%
Interest earning credit balances 19,865,691 1,030,086 5.19%
---------- ---------
Total interest bearing deposits 67,490,894 3,470,273
Long-term debt
6% Convertible notes $48,500,000 $2,910,000 6.00%
----------- ----------
Total interest bearing liabilities 205,231,573 $11,805,775 5.75%
===========
Other liabilities 151,149,421
-----------
TOTAL LIABILITIES 356,380,994
STOCKHOLDERS' EQUITY 58,782,803
----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $415,163,797
============
Net Yield on Interest Earning Assets 4.23%
Average balances were computed on a month-end basis.
16
WATERHOUSE INVESTOR SERVICES, INC. AND SUBSIDIARIES
INVESTMENT PORTFOLIO
MATURITIES AT AUGUST 31, 1995
($000)
(Securities Held To Maturity)
---------------------------
Estimated
Amortized Market Weighted Average
Cost Value Yield To Maturity
---- ----- -----------------
U.S. Treasury bills
- -------------------
In one year or less $7,018 $7,029 5.92%
U.S. agencies
- -------------
In one year or less 102,496 102,477 5.83%
After one year through five years 35,192 35,186 5.86%
------ ------
137,688 137,663
Over investments
- ----------------
In one year or less 1,000 1,000 6.20%
------- -------
Total held to maturity portfolio 145,706 145,692 5.84%
Federal Reserve Bank Stock 810 810 n/a
-------- --------
Total investment portfolio $146,516 $146,502 5.84%
======== ========
KEY FINANCIAL RATIOS
FOR THE YEAR ENDED AUGUST 31, 1995
Return on assets 4.7%
Return on equity 32.9%
Dividend payout ratio 11.9%
Equity to assets 14.2%
Average balances were computed on a month-end basis.
17
The following tables list the deposit mix and the maturity of time certificates
of deposit ("CD's") of $100,000 and over, maintained by the Bank:
Deposit Mix
For The Year Ended August 31, 1995
Average Average
Balances Interest Rate
-------- -------- ----
Demand deposits $ 88,571 $ --- ---
----------- ---------- ---
Interest checking 53,505 708 1.32%
Money market deposits 36,639,725 1,817,779 4.96%
Time deposits 10,931,973 621,700 5.69%
---------- -------
Total interest bearing deposits 47,625,203 2,440,187 5.12%
---------- ---------
Total deposits $47,713,774 $2,440,187 5.11%
----------- ----------
Maturity of CD's
over $100,000
August 31, 1995
Balance Percent
------- -------
Three months or less $ 301,280 20%
Over three through six months 607,004 39%
Over six through twelve months 625,000 41%
Over twelve months --- ---
---------- ----
$1,533,284 100%
========== ====
Item 7. Management's Discussion and Analysis of Financial Condition and
--------------------------------------------------------------
Results of Operations
---------------------
The Company has experienced rapid growth in customer accounts, trade
processing activity and revenues. 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 development of the Bank, 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 Securities derives substantial 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
18
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.
The Company's largest expense category is employee compensation. The
Company does not employ commissioned sales representatives, therefore these
expenses do not vary directly with changes in the Company's trade processing
activity or commission revenues. During the past four years, increases in the
Company's profitability reflect, in part, greater productivity by the Company's
employees, as total revenues continued to grow more rapidly than the Company's
employment requirements.
Communications and data processing charges represent the Company's next
largest expense category. However, because the Company uses third party
vendors to support its order processing activity, these expenses are largely
variable in nature and fluctuate with changes in the Company's order processing
activity.
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:
Percentage to total income Period to period change
-------------------------- -----------------------
1995 1994
compared compared
1995 1994 1993 to 1994 to 1993
---- ---- ---- ------- -------
Interest Income:
Total interest income 21.5% 15.4% 12.2% 79.5% 58.1%
Total interest expense 9.0% 5.7% 3.7% 103.8% 90.3%
---- ---- ----
Net interest income 12.5% 9.7% 8.5% 65.2% 43.9%
----- ---- ----
Non interest income:
Commissions and clearing fees 78.9% 81.6% 84.1% 24.5% 21.7%
Mutual fund revenues 7.5% 6.8% 6.0% 42.1% 40.8%
Other non interest income 1.1% 1.9% 1.4% -17.3% 69.7%
----- ----- -----
87.5% 90.3% 91.5% 24.9% 23.7%
----- ----- -----
Total income 100.0% 100.0% 100.0% 28.9% 25.4%
------ ------ ------
Expenses:
Employee compensation and
benefits 32.9% 32.8% 30.8% 29.5% 33.3%
Communications and data
processing 14.9% 15.0% 14.5% 28.2% 29.4%
Advertising and promotion 5.3% 4.2% 4.2% 61.5% 24.5%
Stationery & postage 3.8% 3.1% 3.5% 60.0% 9.5%
Floor brokerage, exchange and
clearing fees 3.5% 4.0% 4.6% 10.2% 9.5%
Occupancy 3.3% 3.6% 3.3% 18.8% 34.2%
All other expenses 10.8% 9.8% 7.3% 41.8% 72.8%
----- ---- ----
74.5% 72.5% 68.2% 32.5% 33.3%
----- ----- -----
Earnings before income taxes 25.5% 27.5% 31.8% 19.4% 8.6%
Income taxes 10.7% 12.1% 14.1% 14.7% 7.4%
----- ----- -----
Net earnings 14.8% 15.4% 17.7% 23.1% 9.5%
===== ===== =====
19
Income
Commissions and Clearing Fees. Waterhouse Securities acts 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. For the fiscal years ended
August 31, 1995 and 1994, the number of trades executed and cleared by
Waterhouse Securities increased over the previous year by 26% and 23%,
respectively, as a result of activity from the addition of new accounts added
during the periods and increased trading activity from existing accounts.
Commissions and clearing fees in fiscal year 1995, which amounted to 79%
of total income, grew to a record $103.5 million, which represented a 25%
increase over commissions and clearing fees of $83.1 million in fiscal year
1994. This trend was a continuation of the growth in commissions and clearing
fees experienced during fiscal year 1994, which was a 22% increase over fiscal
year 1993's commissions and clearing fees of $68.3 million. Included in
commissions and clearing fees are commissions for directing order execution.
Due to recent changes in the Securities Industry and the issuance of new
disclosure requirements by the SEC, no assurance can be given that these
commissions will continue or that a change in regulations would not have an
adverse affect on the Company's revenue.
Net Interest Income. Waterhouse Securities' primary source of interest
income is margin loans to customers. These loans are financed primarily through
capital, bank loans, deposits received for securities loaned, 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 broker call rate, and the cost of financing. The Bank
has contributed to the increase in net interest income due to interest earned
on short term investments in excess of interest paid to depositors. Net
interest income increased for fiscal years 1995 and 1994 by 65% and 44%,
respectively, from that of the prior years. Such increase in net interest
income is a result of an increase in average customer margin loans and a
lower cost of funds.
Mutual Fund Revenues. Included in mutual fund revenues are commission
fees and loads on mutual fund and money market transfers. Such revenues
increased 42% and 41% for fiscal year 1995, and 1994, respectively, over the
prior years, primarily due to a corresponding increase in volume in mutual
fund transactions.
Expenses
Employee Compensation and Benefits. Employee compensation represented
approximately 44% of total operating expenses in fiscal 1995 -- the Company's
largest expense. This expense primarily includes salaries, bonuses, ESOP
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
ESOP are dependent on income before taxes.
20
Employee compensation increased 30% in fiscal 1995 over fiscal 1994, and
increased 33% in fiscal 1994 over fiscal 1993 primarily as a result of an
increase in the number of employees from 606 as of August 31, 1993 to 756 as
of August 31, 1994 to 949 as of August 31, 1995. These increases were
necessary to support the rapid branch expansion from 48 as of August 31, 1993
to 60 as of August 31, 1994 to 72 as of August 31, 1995, as well as increased
activity from the customer base of the existing branches. As a percentage of
total income, employee compensation has remained relatively constant, 33% in
fiscal 1995, 33% in fiscal 1994 and 31% in fiscal 1993.
Communications and Data Processing. This category is primarily composed
of variable charges related to executing and clearing customer transactions,
telephone, computer service, and quotation charges. These charges increased
28% and 29% for the fiscal years ended August 31, 1995 and 1994, respectively,
primarily due to the corresponding increase in the volume of transactions
processed by the Company and, to a lesser extent, the related increases in the
number of branch offices.
Advertising and Promotion. As the branch network expanded at a rapid rate
over the past two years, Waterhouse Securities increased its advertising
campaign with larger and more frequent advertising in national publications,
such as The Wall Street Journal, Barrons and Investors Business Daily. In
addition, Waterhouse Securities did a number of direct mail campaigns during
1995 as well as increased its television advertising campaign on national cable
television stations that began during fiscal year 1993. As a result,
advertising and promotion increased 62% and 25% for fiscal years 1995 and 1994,
respectively, over the prior years.
Stationery & Postage. This includes envelopes, postage charges and
stationery for our brokerage operations. This expense increased 60% in
fiscal 1995 from fiscal 1994, and increased 10% from fiscal 1993.
The 1995 increase is attributable to the large increase in trade volume, as
well as the development of new customer statements, both of which caused a
large increase in postage expense.
Clearing Fees. This expense increased 10% in fiscal 1995 from fiscal
1994 as well as 10% in fiscal 1994 from fiscal 1993. This includes both
clearance and floor brokerage expense and was affected by the increase in
the trade volume.
Occupancy. Occupancy expense increased 19% in fiscal 1995 from fiscal
1994 and 34% in fiscal 1994 from fiscal 1993. These increases were primarily
attributable to an increase in rental expense attributable to the expansion of
the Company's branch office network and an increase in space required for the
Company's clearing operations and corporate headquarters during fiscal years
1995 and 1994.
All Other Expenses. Included in other expenses are equipment purchases,
depreciation and amortization, insurance, professional fees and other
miscellaneous expenses. Other expenses, amounted to $14.2 million, $10.0
million and $5.8 million in fiscal years 1995, 1994, and 1993, respectively,
resulting in increases of 42% and 73% in fiscal years 1995 and 1994,
respectively. These increases are primarily attributable to the general
expansion of the Company's business during the period.
21
Financial Condition
As of August 31, 1995, the Company's financial position remained strong
with over 97% of total assets consisting of cash, deposits, investment
securities and receivables. The Company's assets primarily consist of
investment securities, deposits and receivables from broker-dealers and
customers. Customer receivables of $369 million at August 31, 1995 are
secured by readily marketable securities, some of which are used to
collateralize bankloans of $40 million and deposits received for securities
loaned of $108 million. The Company's other assets consist principally of
office and operating equipment.
Stockholders' equity as of August 31, 1995 was $66.7 million, an increase
of $17.1 million since August 31, 1994. Such increase was primarily due to
earnings less dividends during the year.
Liquidity and Capital Resources
The Company had available formal and informal lines of credit of
approximately $255 million (of which $40 million was utilized) at August 31,
1995, which require collateralization upon utilization. These lines of credit,
along with deposits received for securities loaned and free credit balances,
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 short and long-term financing needs of the Company based
on its present and anticipated future operations.
On December 21, 1993, the Company issued $50,000,000 of 6% Convertible
Subordinated Notes (the "Notes") due December 15, 2003. The Notes are
convertible by the holders into the Company's common stock at any time prior
to maturity, at a conversion price of $23.40, subject to adjustment. The notes
are also redeemable at the option of the Company, in whole or in part, at any
time on or after December 15, 1996.
The following chart sets forth the redemption prices (expressed as
percentages of the principal amount), if redeemed by the Company during the
twelve-month period beginning December 15 of the year indicated.
Year Percentage
---- ----------
1996 104.00
1997 103.33
1998 102.67
1999 102.00
2000 101.33
2001 100.67
2002 100.00
22
Proceeds from the offering, which amounted to $48,551,000, are being used
to increase the working capital of the Company's subsidiaries. The $1,449,000
in issuance costs are being amortized over the life of the Notes. In
addition, the Company retired $1,500,000 in Notes during the third quarter
fiscal 1994. This purchase resulted in a net capital gain of $242,000.
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 August 31, 1995.
Regulatory Waterhouse
Minimum to be Company's National Bank's
"Well Capitalized" Capital Ratios Capital Ratios
---------------- -------------- --------------
Total Risk Based Capital Ratio 10.0% 14.78% 27.58%
Tier 1 Risk Based Capital Ratio 6.0% 14.78% 27.58%
Tier 1 Leverage Ratio 5.0% 10.02% 5.51%
Waterhouse Securities is subject to rules adopted by the SEC, the NYSE,
the NASD 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 of 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 August 31, 1995, Waterhouse
Securities had net capital in the amount of $39,415,877, which exceeded the
minimum amount of net capital required to be maintained by $31,495,253.
Effects of Inflation
For the three year period ended August 31, 1995, there was no material
effect on the Company due to inflation.
23
Item 8. Financial Statements and Supplementary Data
- ----------------------------------------------------
RESPONSIBILITY FOR FINANCIAL STATEMENTS
The management of Waterhouse Investor Services, Inc. is responsible for
the financial statements and other financial information contained in this
report. The Company believes that the financial statements have been prepared
in conformity with generally accepted accounting principles appropriate under
the circumstances to reflect, in all material respects, the substance of
applicable events and transactions. In preparing the financial statements,
it is necessary that management make informed estimates and judgments.
The other financial information in this annual report is consistent with
the financial statements.
The Company maintains a system of internal accounting control designed to
provide reasonable assurance that financial records are reliable for purposes
of preparing financial statements and that assets are properly accounted for
and safeguarded. The concept of reasonable assurance is based on the
recognition that the cost of the system must be related to the benefits to
be derived. The Company believes its system provides an appropriate balance
in this regard. The Company maintains compliance and internal auditing
departments which review the adequacy and test the application of internal
accounting controls.
The financial statements have been audited by Price Waterhouse LLP,
independent accountants, for the fiscal years ended August 31, 1995, 1994, and
1993. Their reports express opinions that the Company's financial statements
are fairly stated in conformity with generally accepted accounting principles,
and that their audits were performed in accordance with generally accepted
auditing standards which are designed to obtain reasonable assurance that the
financial statements are free of material misstatement.
The Audit Committee of the Board of Directors of the Company, consisting
solely of outside directors, meets with the independent accountants,
compliance personnel, internal auditors and management to discuss, among
other things, the audit scopes and results. The independent accountants and
the internal auditors have full and free access to the Audit Committee,
with or without the presence of management.
24
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Waterhouse Investor Services, Inc.
In our opinion, the accompanying consolidated statements of financial
condition and the related consolidated statements of income, changes in
stockholders' equity and cash flows present fairly, in all material respects,
the financial position of Waterhouse Investor Services, Inc. and its
subsidiaries at August 31, 1995 and 1994, and the results of their operations
and their cash flows for each of the three years in the period ended August
31, 1995, in conformity with generally accepted accounting principles. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
generally accepted auditing standards which require that we plan and perform
the audits to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
New York, New York
October 23, 1995
25
WATERHOUSE INVESTOR SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
August 31,
--------------------------
1995 1994
---- ----
ASSETS:
Cash and due from banks $13,090,043 $7,728,832
Interest bearing deposits with other banks 50,000,000 ---
Federal funds sold 54,100,000 ---
Investment securities (Note 3) 146,516,037 7,532,305
Receivable from brokers and dealers (Note 4) 10,576,815 9,699,739
Receivable from customers, net (Note 5) 368,974,021 275,821,544
Deposits with clearing organizations 4,384,568 3,527,517
Furniture and equipment at cost, less accumulated
depreciation of $4,171,790 in 1995 and $2,611,216 in 1994 6,716,497 7,382,326
Other assets 11,255,002 4,088,177
---------- ---------
Total assets $665,612,983 $315,780,440
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Broker loans and overdrafts (Note 6) $39,682,966 $76,283,181
Interest bearing deposits 231,046,433 ---
Deposits received for securities loaned 107,683,494 12,142,842
Payable to brokers and dealers (Note 4) 4,625,829 5,359,894
Payable to customers (Note 5) 135,975,485 106,028,013
Dividends payable 2,288,920 1,830,736
6% convertible subordinated notes (Note 7) 48,500,000 48,500,000
Accounts payable, taxes payable, accrued expenses and other
liabilities 29,095,811 16,032,541
---------- ----------
Total liabilities 598,898,938 266,177,207
----------- -----------
Commitments and contingent liabilities (Note 9)
Stockholders' equity (Notes 8 and 10):
Common stock, $.01 par value, 20,000,000
shares authorized and 11,694,729 shares issued in 1995 and
9,403,809 shares issued in 1994 116,947 94,038
Additional paid-in capital 9,210,037 9,167,551
Retained earnings 58,395,431 41,350,014
Less:
- ----
Treasury stock, 250,002 shares, at cost (1,008,370) (1,008,370)
--------- ---------
Total stockholders' equity 66,714,045 49,603,233
----------- ----------
Total liabilities and stockholders' equity $665,612,983 $315,780,440
============ ============
The accompanying notes are an integral part of these consolidated financial
statements.
26
WATERHOUSE INVESTOR SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Year Ended August 31,
-----------------------------------------
1995 1994 1993
---- ---- ----
INTEREST INCOME:
Margin loans $23,645,545 $15,378,486 $9,762,254
Investment securities 3,926,669 65,720 13,722
Other interest income 596,994 249,958 150,695
---------- ---------- ---------
Total interest income 28,169,208 15,694,164 9,926,671
---------- ---------- ---------
INTEREST EXPENSE:
Broker loans and overdrafts 4,797,246 3,460,988 2,871,167
6% convertible subordinated notes 2,910,000 2,061,667 ---
Interest paid on deposits 2,440,187 --- ---
Other 1,658,342 269,144 172,403
---------- --------- ---------
Total interest expense 11,805,775 5,791,799 3,043,570
---------- --------- ---------
Net interest income 16,363,433 9,902,365 6,883,101
---------- --------- ---------
NONINTEREST INCOME:
Commissions and clearing fees 103,450,001 83,087,697 68,261,835
Mutual fund revenue 9,786,638 6,887,828 4,891,221
Other 1,593,685 1,926,879 1,135,161
----------- ---------- ----------
Total noninterest income 114,830,324 91,902,404 74,288,217
----------- ---------- ----------
OPERATING EXPENSES:
Employee compensation and benefits 43,206,540 33,363,332 25,030,186
Communications and data processing 19,517,354 15,226,201 11,766,275
Advertising and promotion 6,919,217 4,283,991 3,441,366
Stationery and postage 5,035,338 3,146,185 2,872,759
Floor brokerage, exchange and clearing fees 4,539,129 4,119,546 3,762,327
Occupancy 4,299,493 3,619,591 2,698,112
Equipment 3,290,222 1,775,781 776,718
Professional fees 2,923,497 1,780,815 983,339
Depreciation and amortization 2,313,420 1,724,872 799,570
Other 5,702,243 4,755,278 3,248,860
--------- --------- ---------
Total operating expenses 97,746,453 73,795,592 55,379,512
---------- ---------- ----------
Income before income taxes 33,447,304 28,009,177 25,791,806
Income tax provision 14,090,078 12,282,694 11,434,936
---------- ---------- ----------
Net income $19,357,226 $15,726,483 $14,356,870
=========== =========== ===========
Primary earnings per share $1.68 $1.37 $1.26
===== ===== =====
Fully diluted earnings per share $1.54 $1.30 $1.26
===== ===== =====
The accompanying notes are an integral part of these consolidated financial
statements.
27
WATERHOUSE INVESTOR SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended August 31, 1995, 1994 and 1993
Additional Deferred
Common Stock Paid-In Retained Treasury Stock Compensation
Shares Amount Capital Earnings Shares Amount ESOP Total
------ ------ ------- -------- ------ ------ ---- -----
Balance at August 31, 1992 5,099,476 $50,995 $7,612,999 $14,663,679 250,002 ($1,008,370) ($287,856) $21,031,447
Stock options exercised 22,248 222 41,823 --- --- --- --- 42,045
Stock dividend declared 4,257,241 42,573 --- (42,573) --- --- --- ---
ESOP loan repayment --- --- --- --- --- --- 287,856 287,856
Cash dividends declared --- --- --- (1,523,709) --- --- --- (1,523,709)
Federal income tax credit
stock options --- --- 1,398,433 --- --- --- --- 1,398,433
Net income --- --- --- 14,356,870 --- --- --- 14,356,870
--------- ------ --------- ---------- ------- ------- ------- ----------
Balance at August 31, 1993 9,378,965 93,790 9,053,255 27,454,267 250,002 (1,008,370) --- 35,592,942
Stock options exercised 24,844 248 114,296 --- --- --- --- 114,544
Cash dividends declared --- --- --- (1,830,736) --- --- --- (1,830,736)
Net income --- --- --- 15,726,483 --- --- --- 15,726,483
--------- ------ --------- ---------- ------- ------- ------ ----------
Balance at August 31, 1994 9,403,809 94,038 9,167,551 41,350,014 250,002 (1,008,370) --- 9,603,233
Stock options exercised 2,000 20 42,486 --- --- --- --- 42,506
Stock dividend declared 2,288,920 22,889 --- (22,889) --- --- --- ---
Cash dividends declared --- --- --- (2,288,920) --- --- --- (2,288,920)
Net income --- --- --- 19,357,226 --- --- --- 19,357,226
--------- ------ --------- ---------- ------- ------- ------ ----------
Balance at August 31,1995 11,694,729 $116,947 $9,210,037 $58,395,431 250,002 ($1,008,370) $ --- $66,714,045
========== ======== ========== =========== ======= ========== ====== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
28
Waterhouse Investor Services, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Year Ended August 31,
---------------------------------------
1995 1994 1993
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $19,357,226 $15,726,483 $14,356,870
Non cash items included in net income:
Depreciation 2,313,420 1,724,872 799,570
Debt issuance cost 140,472 199,583 ---
Increase (decrease) in allowance for
doubtful accounts 107,821 (81,382) 56,449
(Increase) in operating assets:
Receivable from brokers and dealers (877,076) (2,341,783) (4,134,108)
Receivable from customers (93,260,298) (56,756,748) (86,285,543)
Deposits with clearing organizations (857,051) (760,030) (1,012,769)
Other assets (7,307,297) (885,446) (773,183)
Increases (decreases) in operating liabilities:
Broker loans and overdrafts (36,600,215) (22,664,555) 24,911,170
Deposits received for securities loaned 95,540,652 7,085,722 3,007,345
Payable to brokers and dealers (734,065) 717,698 3,369,693
Payable to customers 29,947,472 25,341,086 39,713,071
Accounts payable, taxes payable, accrued
expenses, and other liabilities 13,063,271 1,395,618 5,996,493
---------- --------- ---------
CASH PROVIDED BY (USED IN)OPERATING ACTIVITIES 20,834,332 (31,298,882) 5,058
---------- ---------- -----
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of furniture and equipment (1,647,592) (4,840,345) (3,185,459)
Interest bearing deposits with other banks (50,000,000) --- ---
Federal funds sold (54,100,000) --- ---
Investment securities purchased
Proceeds from maturities of investment
securities 203,041,130 --- ---
----------- ---------- ---------
CASH (USED IN) INVESTING ACTIVITIES: (244,731,324) (12,372,650) (3,185,459)
----------- ---------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
6% Convertible Subordinated Notes --- 48,500,000 ---
Interest bearing deposits 231,046,433 --- ---
Debt issuance costs
Deferred compensation - ESOP --- --- 287,856
Cash dividends paid (1,830,736) (1,521,494) (972,050)
Exercise of stock options and warrants 42,506 114,544 42,045
Federal income tax credit - stock options --- --- 1,398,433
--------- --------- ---------
CASH PROVIDED BY FINANCING ACTIVITIES 229,258,203 45,594,050 756,284
----------- ---------- -------
INCREASE (DECREASE) IN CASH AND DUE FROM BANKS 5,361,211 1,922,518 (2,424,117)
CASH AND DUE FROM BANKS, beginning of year 7,728,832 5,806,314 8,230,431
--------- --------- ---------
CASH AND DUE FROM BANKS, end of year $13,090,043 $7,728,832 $5,806,314
=========== ========== ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid for interest $11,608,903 $5,024,724 $2,771,423
=========== =========== ==========
Cash paid for income taxes $12,590,306 $10,790,699 $8,246,613
=========== =========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
29
Waterhouse Investor Services, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 1 - Organization and Summary of Significant Accounting Policies
- --------------------------------------------------------------------
Waterhouse Investor Services, Inc. (the "Company") was formed under the
laws of the State of Delaware on April 10, 1987, and became registered as a
bank holding company on October 13, 1994 under the Bank Holding Company Act of
1956. The consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. Waterhouse Securities, Inc. (the
"Broker"), a securities brokerage firm, which is registered with the Securities
and Exchange Commission (the "SEC") and is a member firm of the New York Stock
Exchange, Inc. (the "NYSE") and other exchanges, provides discount brokerage
and mutual fund services to individual investors. Waterhouse National Bank
(the "Bank"), is a federally chartered banking institution which provides
expanded financial services primarily to the customers of Waterhouse
Securities. All significant intercompany transactions have been eliminated.
Customers' securities transactions are recorded on a settlement date basis
with commission income and related expenses recorded on a trade date basis.
Included in commissions and clearing fees are commissions for directing order
execution.
Deposits paid for securities borrowed and deposits received for securities
loaned are recorded at the amount of cash collateral advanced or received.
Deposits paid for securities borrowed transactions require the Company to
deposit cash with the lender. With respect to deposits received for securities
loaned, the Company receives collateral in the form of cash in an amount
generally in excess of the market value of the securities loaned. The Company
monitors the market value of the securities borrowed and loaned on a daily
basis, with additional collateral obtained or refunded, as necessary.
Furniture and equipment are stated at cost, less accumulated
depreciation. Furniture and equipment are depreciated on a straight-line
basis over their estimated useful lives, between two and five years.
All share and per share amounts have been restated to give retroactive
effect to a 25% stock dividend paid September 14, 1995 to shareholders of
record August 17, 1995, a 50% stock dividend paid November 8, 1993 to
stockholders of record October 12, 1993, and a 25% stock dividend paid by the
Company March 3, 1993 to stockholders of record February 10, 1993. However,
the number of shares outstanding, the related common stock and retained
earnings amounts as shown on the Consolidated Statements of Financial
Condition and Consolidated Statements of Changes in Stockholders' Equity for
the years ended August 31, 1994 and 1993 have not been retroactively restated
for the stock dividends subsequent to the respective fiscal year ends.
Primary earnings per share and fully diluted earnings per share have been
computed based upon a total of 11,512,427 and 13,669,937 respectively, weighted
average shares of common stock outstanding and common stock equivalents for the
year ended August 31, 1995, 11,461,829
30
and 12,960,629 respectively, weighted average shares of common stock
outstanding and common stock equivalents for the year ended August 31, 1994
and 11,439,441 weighted average shares of common stock outstanding and common
stock equivalents for the year ended August 31, 1993.
Statement of Financial Accounting Standards No. 107, "Disclosure about
Fair Value of Financial Instruments" requires the disclosure of the fair
value of financial instruments, including assets and liabilities recognized
in the Consolidated Statement of Financial Condition. The Company's 6%
Convertible Subordinated Notes, which are reflected on the Consolidated
Statement of Financial Condition at the principal value of $48,500,000, are
listed on the NYSE, and, as of August 31, 1995 and August 31, 1994, had an
aggregate fair market value of $49,833,750 and $38,254,375, respectively.
Additionally, investment securities held by the bank are carried at amortized
cost, which as of August 31, 1995 and 1994, approximates their market values
(Note 3). Management estimates that the aggregate net fair value of all
other financial instruments recognized on the Consolidated Statement of
Financial Condition (including deposits received for securities loaned and
deposits paid for securities borrowed, receivables and payables and broker
loans) approximates their carrying value, as such financial instruments are
short term in nature, bear interest at current market rates or are subject
to repricing.
NOTE 2 - RECLASSIFICATION
- -------------------------
The consolidated statements of income and cash flows for the years
ended August 31, 1994 and August 31, 1993 have been reclassified to conform
with the presentation adopted for the year ended August 31, 1995 because of the
Company's registration as a bank holding company. Certain prior period amounts
have been reclassified to conform to the current period presentation.
NOTE 3 - INVESTMENT SECURITIES
- ------------------------------
The Investment securities are held by Waterhouse National Bank and carried
at amortized cost since the bank has the intent and the ability to hold these
instruments to maturity. The maturity of these instruments range from
September 6, 1995 to June 26, 2000. The following is a comparison of the
carrying amount and approximate market values:
August 31, 1995 August 31, 1994
------------------------------ --------------------------
Carrying Appropriate Carrying Appropriate
Amount Market Value Amount Market Value
------ ------------ ------ ------------
U.S. Government and Agency
Securities $144,706,037 $144,692,000 $7,082,305 $7,075,863
Other Securities 1,810,000 1,810,000 450,000 450,000
------------ ------------ ---------- ----------
Total $146,516,037 $146,502,000 $7,532,305 $7,525,863
============ ============ ========== ==========
31
NOTE 4 - RECEIVABLE FROM AND PAYABLE TO BROKERS AND DEALERS
- -----------------------------------------------------------
Receivable from and payable to brokers and dealers, which are recorded at
contract value, comprise the following:
August 31,
--------------------------------
1995 1994
---- ----
Receivable:
Deposits paid for securities borrowed $7,522,900 $6,273,700
Securities failed to deliver 1,088,001 2,798,646
Other 1,965,914 627,393
----------- ----------
$10,576,815 $9,699,739
=========== ==========
Payable:
Securities failed to receive $3,548,320 $4,412,947
Other 1,077,509 946,947
---------- ----------
$4,625,829 $5,359,894
========== ==========
NOTE 5 - RECEIVABLE FROM AND PAYABLE TO CUSTOMERS
- -------------------------------------------------
Receivables from customers are generally collateralized by marketable
securities. Payable to customers primarily represent free credit balances of
customers. As of August 31, 1995 and 1994, receivable from customers includes
$3,909,872 and $3,740,477, respectively, representing accounts of executive
officers and directors. As of August 31, 1995 and 1994, payable to customers
includes $215,020 and $1,028,302, respectively, representing accounts of
executive officers and directors.
Receivables from customers is reported net of an allowance for doubtful
accounts of $231,819 and $123,998 as of August 31, 1995 and August 31, 1994,
respectively.
NOTE 6 - BROKER LOANS AND OVERDRAFTS
- ----------------------------------
Broker loans and overdrafts primarily represent short-term borrowings
which bear interest at a fluctuating rate based on the Federal funds rate.
The loans are collateralized by customers' margin securities valued at
$94,000,000 and $125,000,000 as of August 31, 1995 and 1994, respectively.
The following is a summary of comparative broker loan data:
August 31,
----------------------------------
1995 1994
---- ----
Average amount outstanding during the year $77,260,000 $83,375,000
Maximum amount outstanding during the year $130,900,000 $112,600,000
Weighted average interest rate at year-end 6.21% 5.02%
Weighted average interest rate during the year 6.21% 4.13%
32
NOTE 7 - CONVERTIBLE SUBORDINATED NOTES
- ---------------------------------------
On December 21, 1993, the Company issued $50,000,000 of 6% Convertible
Subordinated Notes (the "Notes") due December 15, 2003. The Notes are
convertible by the holders into the Company's common stock at any time prior to
the maturity, at a conversion price of $23.40 per share, subject to
adjustment. The Notes are also redeemable at the option of the Company, in
whole or in part, at any time on and after December 15, 1996. The following
chart sets forth the redemption prices (expressed as percentages of the
principal amount), if redeemed by the Company during the twelve-month period
beginning December 15 of the year indicated.
Year Percentage
---- ----------
1996 104.00
1997 103.33
1998 102.67
1999 102.00
2000 101.33
2001 100.67
2002 100.00
Proceeds from the offering, which amounted to $48,551,000, have been used
to increase the working capital of the Company's subsidiaries. The remaining
$1,449,000 in issuance costs are being amortized over the life of the Notes.
In addition, the Company retired $1,500,000 in Notes during the third quarter
of fiscal 1994. This purchase resulted in a net capital gain of $242,000.
NOTE 8 - STOCK OPTIONS
- ----------------------
Certain key employees of the Company are granted options to purchase the
Company's common stock at prices equal to market value at the date of grant.
Share information regarding these options is as follows:
1995 1994 1993
---- ---- ----
Outstanding, beginning of year 554,441 58,153 87,188
Granted 390,856 561,093 16,406
Exercised (2,500) (31,055) (45,441)
Forfeited (69,410) (33,750) ---
------ ------ ------
Outstanding, end of year 873,387 554,441 58,153
======= ======= ======
Options were granted in fiscal 1987, 1989, 1991, twice in 1993 ranging
from $.70 to $11.04, nine times in 1994 ranging from $9.50 to $25.26 and six
times in 1995 ranging from $11.80 to $19.00. Options were exercised in 1995
at $16.20, in 1994 at prices ranging from $.70 to $5.12 and in 1993 at prices
ranging from $.70 to $1.54. Options were exercisable at August 31, 1995 and
August 31, 1994 at prices ranging from $.70 to $25.26, and at August 31,
1993 at prices ranging from $.70 to $11.04. The options expire at various
times during the period from fiscal 1996 to fiscal 2005.
33
NOTE 9 - COMMITMENTS AND CONTINGENT LIABILITIES
- -----------------------------------------------
The Company leases office space and equipment under noncancellable
operating leases extending for periods in excess of one year. Rent expense
for each of the years in the three year period ended August 31, 1995 was as
follows:
Year Ended August 31,
---------------------
1995 $3,478,374
1994 2,977,503
1993 2,278,942
Future minimum rental commitments under such leases are as follows:
Year Ended August 31,
---------------------
1996 $4,546,508
1997 4,482,940
1998 3,084,052
1999 2,622,465
2000 2,110,312
Thereafter 3,787,300
---------
$20,633,577
===========
NOTE 10 - CAPITAL ADEQUACY
- --------------------------
As a registered broker-dealer and member firm of the NYSE, the Broker is
subject to the SEC's Uniform Net Capital Rule (the "Rule") which requires the
maintenance of minimum net capital. The Broker has elected to use the
alternative method, permitted by the Rule, which requires that the Broker
maintain minimum net capital equal to the greater of $250,000 or 2% of
aggregate debit items arising from customer transactions. Additionally, the
NYSE may require a member firm to reduce its business if its net capital is
less than 4% of aggregate debit items and may prohibit the Broker from
expanding its business and declaring dividends if its net capital is less
than 5% of aggregate debit items.
At August 31, 1995, the Broker had net capital of $39,415,877, which was
10% of aggregate debit items and $31,495,253 in excess of required net
capital. Further, the amounts in excess of 4% and 5% of aggregate debit
items were $23,574,629 and $19,614,317, respectively.
As a bank holding company, the Company closely monitors its capital levels
and the capital levels of the Bank to provide for normal business needs and to
comply with regulatory requirements. Both the Company's and the Bank's capital
ratios were in excess of the regulatory requirements to be deemed "Well
Capitalized" for the period ended August 31, 1995.
34
NOTE 11 - EMPLOYEE STOCK OWNERSHIP PLAN
- ---------------------------------------
The Company has an Employee Stock Ownership Plan ("ESOP") which enables
employees, who have completed at least one year of service, to acquire shares
of the Company's common stock. In the past, the acquisition of the Company's
common stock by the ESOP has been funded by (1) discretionary contributions by
the Company, (2) loans to the ESOP from banks, which are guaranteed by the
Company, and (3) loans to the ESOP from the Company. Common stock purchased by
the ESOP with loan proceeds was pledged as collateral against the loan and
allocated to individual participant accounts as the principal balance of the
loan was repaid. All shares are held by the ESOP for the accounts of
participants until such time as the participant retires or otherwise ceases
to be employed by the Company. The Company is required to make contributions
to the ESOP in amounts which are sufficient to meet the ESOP's current
obligations, including principal and interest payments on the ESOP's debt,
as applicable. As of August 31, 1995 the ESOP had no outstanding loans.
The ESOP held 1,419,148 and 1,459,008 shares of the Company's common stock
at August 31, 1995 and 1994, respectively and $2,155,000 principal value of 6%
Convertible Subordinated Notes of the Company at August 31, 1995.
The Company had recorded deferred compensation - ESOP for the cost of the
shares purchased with the proceeds of the loans to the ESOP. The Company
reduced deferred compensation - ESOP as the loans were repaid and the
related shares allocated to participants' accounts and recognized expense to
the extent of contributions to the ESOP. The total expense recognized by
the Company with respect to the ESOP, excluding dividends used for debt
service, for the years ended August 31, 1995, 1994 and 1993 was $2,188,011,
$1,840,042 and $768,958, respectively.
NOTE 12 - INCOME TAXES
- ----------------------
The Company and its subsidiaries file a consolidated Federal income tax
return on a fiscal year basis. The Company's income taxes are computed under
the provisions of Statement of Financial Accounting Standards No. 109
"Accounting for Income Taxes". The following is a reconciliation of the
provision for income taxes and the amount computed by applying the Federal
statutory rate to income before income taxes.
Years Ended August 31,
----------------------------------
1995 1994 1993
Federal statutory income tax rate 35.0% 35.0% 34.7%
State and local income taxes, net of
Federal income tax benefit 7.6% 7.6% 8.0%
Other, net -0.5% 1.3% 1.6%
----- ---- ----
42.1% 43.9% 44.3%
===== ===== =====
35
During the fiscal year ended August 31, 1993, the Company reduced the
amount of its current tax liability and increased its additional paid in
capital by $1,398,433, due to a Federal income tax credit arising from the
exercise of certain stock options. This credit had no effect on the
Company's tax expense or net income for that year.
NOTE 13 - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATION
- -----------------------------------------------------------------------------
OF CREDIT RISK
--------------
In the normal course of business, the Broker executes, as agent,
securities transactions on behalf of its customers. If either counterparty
fails to perform, the Broker may be required to discharge the obligations of
the nonperforming party. In such circumstances, the Broker may sustain a
loss if the market value of the security is different from the contract value
of the transaction.
In the normal course of business, the Broker may deliver securities as
collateral in support of various secured financing sources such as bank loans
and deposits paid for securities loaned. Additionally, the Broker delivers
customer securities as collateral to satisfy margin deposits of various
clearing organizations. In the event the counterparty is unable to meet its
contract obligation to return customer securities delivered as collateral,
the Broker may be obligated to purchase the securities in order to return
them to the owner. In such circumstances, the Broker may incur a loss up to
the amount by which the market value of the securities exceeds the value of
the loan or other collateral received or in the possession or control of the
Broker.
For transactions in which the Broker extends credit to customers, the
Broker seeks to control the risks associated with these activities by requiring
customers to maintain margin collateral in compliance with various regulatory
and internal guidelines. The Broker monitors required margin levels daily and,
pursuant to such guidelines, requests customers to deposit additional
collateral or reduce securities positions, when necessary.
The Broker has a nationwide retail customer base. The Broker conducts
business with brokers and dealers, clearing organizations and depositories that
are primarily located in the New York area. Banking activities are conducted
mainly with commercial banks to support customer securities activities at
branch office locations. The majority of the Broker's transactions and,
consequently, the concentration of its credit exposures are with customers,
broker-dealers and other financial institutions in the United States. These
result in credit exposure in the event that the counterparty fails to fulfill
its contractual obligations, the Broker's exposure to credit risk can be
directly impacted by volatile securities markets which may impair the ability
of counterparties to satisfy their contractual obligations. The Broker seeks
to control its credit risk through a variety of reporting and control
procedures, including establishing credit limits based upon a review of the
counterparties' financial condition and credit ratings. The Broker monitors
collateral levels on a daily basis for compliance with regulatory and internal
guidelines and requests changes in collateral levels, as appropriate.
36
NOTE 14 - PARENT COMPANY ONLY FINANCIAL STATEMENTS
- --------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME Year Ended August 31,
- --------------------------------- ----------------------------------
1995 1994 1993
---- ---- ----
INTEREST INCOME:
Intercompany interest $3,921,082 $3,928,364 $286,061
Short term investments 40,898 32,305 ---
--------- --------- -------
Total interest income 3,961,980 3,960,669 286,061
--------- --------- -------
INTEREST EXPENSE:
6% convertible subordinated notes 2,910,000 2,061,667 ---
--------- --------- -------
Total interest expense 2,910,000 2,061,667 ---
--------- --------- -------
Net interest income 1,051,980 1,899,002 286,061
--------- --------- -------
NONINTEREST INCOME:
Equity and earning of investment in
subsidiaries 18,904,111 14,446,745 13,965,857
Other 688,524 750,261 617,429
---------- ---------- ----------
Total noninterest income 19,592,635 15,197,006 14,583,286
---------- ---------- ----------
OPERATING EXPENSES 955,346 431,731 225,942
---------- ---------- ----------
Income before income taxes 19,689,269 16,664,277 14,643,405
Income tax provision 332,043 937,794 286,535
---------- ---------- ----------
Net income $19,357,226 $15,726,483 $14,356,870
=========== =========== ===========
STATEMENTS OF FINANCIAL CONDITION August 31,
- --------------------------------- ----------
1995 1994 1993
---- ---- ----
ASSETS:
Cash and due from banks $ 376,401 $ 1,198,456 $ 116,795
Investment in bank subsidiaries 13,878,793 7,532,305 ---
Investment in non-bank subsidiaries 56,495,870 40,296,619 27,887,486
Advances to bank subsidiaries 5,506,061 --- ---
Advances to non-bank subsidiaries 40,968,679 50,204,368 9,087,096
Other assets 1,204,292 1,341,966 45,485
---------- ---------- ----------
Total assets $118,430,096 $100,573,714 $37,136,862
============ ============ ===========
LIABILITIES:
6% convertible subordinated notes $48,500,000 $48,500,000 $ ---
Accrued expenses and other liabilities 3,216,051 2,470,481 1,543,920
--------- --------- ---------
Total liabilities 51,716,051 50,970,481 1,543,920
---------- ---------- ---------
STOCKHOLDERS' EQUITY 66,714,045 49,603,233 35,592,942
---------- ---------- ----------
Total liabilities and stockholders' equity $118,430,096 $100,573,714 $37,136,862
============ ============ ===========
37
STATEMENTS OF CASH FLOWS
- ------------------------
Year Ended August 31,
--------------------------------------
1995 1994 1993
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $19,357,226 $15,726,483 $14,356,870
Noncash items included in net income:
Debt issuance cost 140,472 199,583 ---
(Increase) decrease in operating assets:
Prepaids and other assets (2,798) 2,936 (26,036)
Debt issue costs --- (1,499,000) ---
Increase (decrease) in operating liabilities:
Accrued expenses and other liabilities 287,386 (6,223) (13,007)
------- ----- ------
CASH PROVIDED BY OPERATING ACTIVITIES: 19,782,286 14,423,779 14,317,827
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
6% Convertible Subordinated Notes --- 48,500,000 ---
Bond interest payable --- 623,542 ---
Investment in bank subsidiaries (6,346,488) (7,532,305) ---
Investment in non-bank subsidiaries (16,199,251) (12,409,133) (13,852,918)
Advances to bank subsidiaries (5,506,061) --- ---
Advances to non-bank subsidiaries 9,235,689 (41,117,272) (1,113,820)
--------- ---------- ---------
CASH (USED IN) INVESTING ACTIVITIES: (18,816,111) (11,935,168) (14,966,738)
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Exercise of stock options and warrants 42,506 114,544 42,045
Deferred compensation - ESOP --- --- 287,856
Dividends paid (1,830,736) (1,521,494) (972,050)
Federal income tax credit - stock options --- --- 1,398,433
--------- --------- ---------
CASH (USED IN) PROVIDED BY FINANCING ACTIVITIES (1,788,230) (1,406,950) 756,284
--------- --------- -------
(DECREASE) INCREASE IN CASH AND DUE FROM BANKS (822,055) 1,081,661 107,373
CASH AND DUE FROM BANKS, beginning of year 1,198,456 116,795 9,422
--------- --------- -------
CASH AND DUE FROM BANKS, end of year $ 376,401 $1,198,456 $116,795
========== ========== ========
38
Item 9. Changes in and Disagreements with Accountants on Accounting and
---------------------------------------------------------------
Financial Disclosure
--------------------
Not applicable.
39
Part III
--------
Item 10. Directors and Executive Officers of the Registrant
- ------------------------------------------------------------
The information required herein will be reported in the Company's Proxy
Statement for the Annual Meeting of Stockholders to be held February 6, 1996,
which will be filed on or before December 28, 1995 and is incorporated herein
by reference.
Item 11. Executive Compensation
- --------------------------------
The information required herein will be reported in the Company's Proxy
Statement for the Annual Meeting of Stockholders to be held February 6, 1996,
which will be filed on or before December 28, 1995, and is incorporated herein
by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
- ------------------------------------------------------------------------
The information required herein will be reported in the Company's Proxy
Statement for the Annual Meeting of Stockholders to be held February 6, 1996,
which will be filed on or before December 28, 1995, and is incorporated
herein by reference.
Item 13. Certain Relationships and Related Transactions
- --------------------------------------------------------
The information required herein will be reported in the Company's Proxy
Statement for the Annual Meeting of Stockholders to be held February 6, 1996,
which will be filed on or before December 28, 1995, and is incorporated herein
by reference.
40
PART IV
-------
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
- --------------------------------------------------------------------------
(a)(1) Financial Statements
--------------------
The following financial statements of Waterhouse Investor Services,
Inc. and subsidiaries are included in Part II, Item 8:
Page
----
Report of Independent Accountants 24
Consolidated Statements of Financial
Condition as of August 31, 1995 and 1994 25
Consolidated Statements of Income for the
Years Ended August 31, 1995, 1994 and 1993 26
Consolidated Statements of Changes in
Stockholders' Equity for the Years Ended
August 31, 1995, 1994 and 1993 27
Consolidated Statements of Cash Flows for the
Years Ended August 31, 1995, 1994 and 1993 28
Notes to Consolidated Financial Statements 29-37
(a)(2) Financial Statement Schedules Required Under Article 12 for 1994 and
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1993
----
Page
----
Report of Independent Accountants 41
Schedule III - Condensed Financial Information of
Registrant for each of the Three Years in the
Period Ended August 31, 1995 42
Schedule VIII - Valuation Account for each of the
Three Years in the Period Ended August 31, 1995 43
(a)(3) Financial Statement Schedules Required Under Article 9 for 1995
---------------------------------------------------------------
Schedule I - Indebtness to Related Parties n/a
Schedule II - Guarantees of Securities of Other Issuers n/a
All other schedules called for by Regulation S-X are not submitted because
they are not applicable or not required or because the required information is
not material or is included in the financial statements or notes thereto.
(b) Reports on Form 8-K
-------------------
There were no reports on Form 8-K filed for the quarter ended August
31, 1995
(c) Exhibits
--------
21 - Subsidiaries of the Registrant
23 - Consent of Independent Accountants
41
REPORT OF INDEPENDENT ACCOUNTANTS
---------------------------------
To the Board of Directors and Stockholders of
Waterhouse Investor Services, Inc.
Our audits of the consolidated financial statements referred to in our
report dated October 23, 1995 appearing in this Form 10-K also included an
audit of the financial statement schedules listed in Item 14(a)2 of this
Form 10-K. In our opinion, these financial statement schedules present
fairly, in all material respects, the information set forth therein when
read in conjunction with the related consolidated financial statements.
PRICE WATERHOUSE LLP
New York, New York
October 23, 1995
42
SCHEDULE III
WATERHOUSE INVESTOR SERVICES, INC. (UNCONSOLIDATED)
--------------------------------------------------
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
--------------------------------------------
FOR EACH OF THE THREE YEARS IN THE
----------------------------------
PERIOD ENDED AUGUST 31, 1995
----------------------------
Dividends paid to Waterhouse Investor Services, Inc.
Subsidiary 1995 1994 1993
- ---------- ---- ---- ----
Waterhouse Nicoll & Assoc. $ --- $1,150,000 $ ---
========== ========== =======
Waterhouse Securities, Inc. $2,288,920 $ --- $ ---
========== ========== =======
43
SCHEDULE VIII
WATERHOUSE INVESTOR SERVICES, INC. AND SUBSIDIARIES
---------------------------------------------------
VALUATION ACCOUNT
-----------------
FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED AUGUST 31, 1995
---------------------------------------------------------------
1995 1994 1993
---- ---- ----
Allowance for customer receivables
doubtful of collection
Balance, beginning of year $123,998 $205,380 $148,931
Write-offs during the year (6,753) (148,721) (49,890)
Charge to profit and loss 114,574 67,339 106,339
-------- -------- -------
Balance, end of year $231,819 $123,998 $205,380
======== ======== ========
44
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities 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.
By: Lawrence M. Waterhouse, Jr.
---------------------------
Lawrence M. Waterhouse, Jr.
Chairman of the Board
Dated: November 17, 1995
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
SIGNATURES TITLE OR CAPACITIES DATE
---------- ------------------- ----
Chairman of the Board and Chief
Lawrence M. Waterhouse, Jr. Executive Officer November 17, 1995
- ---------------------------
Lawrence M. Waterhouse, Jr.
President, Chief Operating
Frank J. Petrilli Officer and Director November 17, 1995
- ---------------------------
Frank J. Petrilli
Jerome Belson Director and Chairman Emeritus November 17, 1995
- ---------------------------
Jerome Belson
Edward J. Nicoll Director and President Emeritus November 17, 1995
- ---------------------------
Edward J. Nicoll
Executive Vice President, General
Richard H. Neiman Counsel, Secretary and Director November 17, 1995
- ---------------------------
Richard H. Neiman
John H. Chapel Senior Vice President and Director November 17, 1995
- ---------------------------
John H. Chapel
45
SIGNATURES TITLE OR CAPACITIES DATE
---------- ------------------- ----
Senior Vice President, Treasurer,
Kenneth I. Coco Assistant Secretary and Director November 17, 1995
- ---------------------------
Kenneth I. Coco
Senior Vice President and
Frank E. Conti Director November 17, 1995
- ---------------------------
Frank E. Conti
Senior Vice President and
Peter A. Wigger Director November 17, 1995
- ---------------------------
Peter A. Wigger
William J. Cardew Director November 17, 1995
- ---------------------------
William J. Cardew
Thomas J. Hartman Director November 17, 1995
- ---------------------------
Thomas J. Hartman
Arthur J. Radin Director November 17, 1995
- ---------------------------
Arthur J. Radin
James F. Rittinger Director November 17, 1995
- ---------------------------
James F. Rittinger
George F. Staudter Director November 17, 1995
- ---------------------------
George F. Staudter
Senior Vice President and Chief
M. Bernard Siegel Financial Officer November 17, 1995
- ---------------------------
M. Bernard Siegel
46
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
------------------------------
ORGANIZED UNDER
NAME THE LAWS OF:
---- ------------
Waterhouse Securities, Inc. New York
L.M. Waterhouse & Co., Inc. New York
Waterhouse, Nicoll & Associates, Inc. New York
Washington Discount Brokerage Corp. New York
Waterhouse National Bank United States
National Investor Services Corp. Delaware
Waterhouse Asset Management, Inc. Delaware
47
Exhibit 23
CONSENT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of
Waterhouse Investor Services, Inc.
We hereby consent to the incorporation by reference in the Prospectus
constituting part of the Registration Statement on Form S-8 (No. 33-41446)
of Waterhouse Investor Services, Inc. of our reports dated October 23, 1995
appearing on pages 24 and 41 of this Form 10-K.
PRICE WATERHOUSE LLP
New York, New York
November 20, 1995