Excluding the discontinued operations of Lynch Jones & Ryan (LJR), Instinet Group incurred a net loss of $5 million or $(0.02) per diluted share for the third quarter of 2005 compared to net income of $8 million or $0.02 per diluted share for the third quarter of 2004 and net income of $7 million or $0.02 per diluted share for the second quarter of 2005. Discontinued operations for the third quarter of 2005 included an after-tax gain on the sale of LJR of $90 million.

The third quarter 2005 results included $20 million in charges related to facility and asset write-offs, $9 million in severance charges and $6 million in merger related advisory fees, partially offset by $9 million in net investment gains. Excluding these items and the related tax effects, pro forma net income from continuing operations for the third quarter of 2005 was $11 million, or $0.03 per diluted share compared to pro forma net income from continuing operations of $5 million or $0.02 per diluted share for the third quarter of 2004 and pro forma net income from continuing operations of $6 million, or $0.02 per diluted share for the second quarter of 2005.(1)

Financial Performance

Instinet Group

Revenues

Total consolidated revenues for Instinet Group, net of interest, were $254 million for the third quarter of 2005, up 2% from the third quarter of 2004 and down 2% from the second quarter of 2005.

Expenses

Total expenses for the third quarter of 2005 were $269 million, up 12% from $240 million in the third quarter of 2004 and up 9% from $246 million in the second quarter of 2005. The third quarters of 2005 and 2004 and second quarter of 2005 included net investment gains of $9 million, $4 million and $25 million, respectively. Excluding these gains, total expenses were $278 million in the third quarter of 2005, up 14% from $244 million in the third quarter of 2004 and up 3% from $271 million in the second quarter of 2005.

Cost of revenues was $154 million for the third quarter of 2005, down 4% from the second quarter of 2005 primarily due to lower transaction volumes.

Direct expenses were $124 million for the third quarter of 2005, up 12% from the second quarter of 2005.

Compensation and benefits expense was $57 million for the third quarter of 2005, down 6% from the previous quarter primarily due to lower severance charges partially offset by higher variable compensation. The third quarter of 2005 included a $9 million severance charge while the second quarter of 2005 included $16 million in severance expense. These severance charges are part of our ongoing efforts to streamline the institutional broker business. These cost reductions are not related to the pending transaction with The Nasdaq Stock Market, Inc. (NASDAQ).

Depreciation and amortization expense was $14 million, up 34% from the previous quarter primarily due to $5 million of asset write-offs associated with facility consolidation in the U.S.

Occupancy expense was $23 million for the third quarter of 2005, up $13 million from the previous quarter due to $15 million in facility write-offs associated with the consolidation of space in the U.S. and the move to new space in London.

At September 30, 2005, Instinet Group had net cash (cash and cash equivalents and securities owned less short-term borrowings) of approximately $938 million, up $2 million from $936 million at December 31, 2004. The increase in cash was primarily due to proceeds received from the sale of LJR partially offset by a special dividend paid to shareholders, firm cash used in customer settlement activities and seasonal payments related to incentive compensation. At September 30, 2005, total assets were approximately $1.8 billion and shareholders' equity was approximately $1.1 billion. There were approximately 341 million shares of common stock outstanding as of September 30, 2005.

On September 30, 2005, Instinet Group's total headcount was 785 employees compared to 938 on June 30, 2005. Headcount at September 30, 2005 included 614 employees from Instinet, 82 employees from INET and 89 employees from Instinet Group.

Business Segments

Instinet, The Institutional Broker

• Instinet reported a net loss from continuing operations before income taxes of $28 million for the third quarter of 2005, 32% lower than the second quarter of 2005.
• Total revenues, net of interest, were $142 million for the third quarter of 2005, 2% lower than the second quarter of 2005, primarily due to lower U.S. revenues partially offset by higher revenues from our international business.
• Instinet's customers traded an average of 99 million U.S. shares a day in the third quarter of 2005, up 6% from 93 million shares a day during the second quarter of 2005. Average daily consideration in non-U.S. equities for the third quarter of 2005 was $1,011 million, a 11% increase from the second quarter of 2005.
• Gross margin of $71 million for the third quarter of 2005 was level with the second quarter of 2005.
• Direct expenses of $99 million for the third quarter of 2005 were up 8% from the second quarter of 2005.

INET, The electronic marketplace

• INET reported net income before income taxes of $4 million for the third quarter of 2005, down 54% from $10 million in the second quarter of 2005.
• Total revenues, net of interest, were $116 million for the third quarter of 2005, 2% lower than the previous quarter primarily due to lower U.S. equity market volumes in the third quarter of 2005.
• INET reported NASDAQ-listed average matched equity share volume of 416 million shares per day in the third quarter of 2005, down 8% from the previous quarter. INET's share of the total market in NASDAQ-listed equity trading was 25.8% in the third quarter of 2005, down from 26.0% in the previous quarter.
• INET reported U.S. exchange-listed average matched equity share volume of 100 million shares per day in the third quarter of 2005, up from 85 million in the previous quarter. INET's share of the total market in U.S. exchange-listed equity trading was 4.5% in the third quarter of 2005, up from 3.9% in the previous quarter.
• Cost of revenues as a percentage of total transaction fees was 80% in the third quarter of 2005 compared to 79% in the second quarter of 2005.
• Gross margin was $24 million for the third quarter of 2005, 3% lower than the previous quarter.
• Direct expenses of $20 million for the third quarter of 2005 were up 29% from the second quarter of 2005.

Company Announcements and Updates

Instinet Group announced on April 22, 2005 that it has entered into a definitive agreement pursuant to which NASDAQ will acquire Instinet Group.

NASDAQ will acquire all outstanding shares of Instinet Group for an aggregate purchase price of approximately $1.88 billion in cash, or $5.10 per share (on a fully diluted basis) (reflecting a reduction of the purchase price for the special cash dividend) subject to certain adjustments. The $1.88 billion included proceeds from a separate sale of Lynch Jones and Ryan to The Bank of New York for $174 million. Instinet Group paid a special cash dividend of $0.32 per common share to Instinet Group stockholders on August 15, 2005, based upon the net after-tax proceeds of the sale of Lynch Jones and Ryan.

The merger agreement was adopted on September 21, 2005 by a majority of Instinet Group shareholders. Instinet Group expects that the merger will be completed during the fourth quarter of 2005, at which time each shareholder will have the right to receive approximately $5.10 per share (on a fully diluted basis) (reflecting a reduction of the purchase price for the special cash dividend) subject to certain adjustments. Completion of the transaction is still subject to customary conditions, including regulatory approvals.

On June 17, 2005 the Department of Justice (DOJ) issued a Request for Additional Information and Documentary Materials (a "second request") to Instinet Group and NASDAQ in connection with the DOJ's investigation under the Hart-Scott Rodino Antitrust Improvements Act of the pending acquisition of Instinet Group by NASDAQ. Based on discussions with the DOJ staff responsible for reviewing the NASDAQ/Instinet transaction, we understand that the staff has forwarded its recommendation to senior DOJ officials and that we anticipate a formal decision from the DOJ soon.

In April and May 2005, four purported class action lawsuits were filed in the Court of Chancery in the State of Delaware against Instinet Group, each of our directors and Reuters alleging, among other things, that defendants breached their fiduciary duties as to our public stockholders in connection with the proposed merger by approving the transaction at an allegedly unfair and inadequate price. On June 22, 2005, plaintiffs filed a consolidated amended complaint consolidating three of the lawsuits while voluntarily dismissing the fourth lawsuit. The amended complaint seeks, among other things, class action status, an injunction against consummation of the transaction, invalidation of certain provisions of the Merger Agreement, damages in an unspecified amount, rescission in the event the transaction is consummated and attorney's fees.

On September 9, 2005, the parties entered into a proposed settlement of the action pursuant to a Stipulation and Agreement of Compromise, Settlement and Release. Pursuant to the proposed settlement: (i) Instinet revised the definitive proxy statement to include certain disclosures that have been agreed upon and reviewed by plaintiffs; (ii) Nasdaq and Instinet agreed to reduce by 15%, from $66,500,000 to $56,525,000, the break-up fee that Instinet would pay to Nasdaq under certain conditions pursuant to Section 8.6(a) of the merger agreement; and (iii) Nasdaq agreed to waive, with respect to members of the purported plaintiff class only, the provisions of the merger agreement pursuant to which the aggregate merger consideration was to have been reduced by up to $2.5 million based on the total amount of certain of our transaction liabilities, the net effect of which is an increase of approximately $0.007 per share (or approximately $1.0 million in the aggregate) in the merger consideration that will be received by Instinet stockholders other than the defendants.

On September 16, 2005, Instinet mailed a notice of settlement to its stockholders. On October 25, 2005, the Delaware Court of Chancery certified the class of Instinet Group shareholders and approved the proposed settlement as fair and reasonable. Separately, on November 30, 2005, the Court will hold a hearing to consider plaintiffs' counsel's application for an award of attorneys' fees and reimbursement of expenses. The settlement is still subject to the entry of a final and non-appealable judgment dismissing the consolidated action with prejudice and the delivery of appropriate releases.Download the document now 58 kb (Adobe Acrobat Document)