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Here’s the entire text of the prepared remarks from Ameritrade’s (ticker: AMZN) Q3 2005 conference call. The Q&A is here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.

Executives

Donna Kush, Managing Director, Corporate Communications

Joe Moglia, Chief Executive Officer

Randy McDonald, Chief Financial Officer

Bill Gerber, Managing Director, Finance

Analysts

Prashant Bhatia, Citigroup, Analyst

Richard Herr, KBW, Analyst

Rich Repetto, Sandler O'Neill, Analyst

Dave Chamberlain, Pemco, Analyst

Howard Chen, CSFB, Analyst

Mike Vinciquerra, Raymond James, Analyst

Michael Hecht, Banc of America Securities, Analyst

Matt Snowlling, Friedman, Billings, Ramsey, Analyst

Operator

Good morning. My name is Lee and I will be your conference facilitator. At this time I would like to welcome everyone to the Ameritrade September quarter and fiscal quarter 2005 earnings call. All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer period. Operator Instructions Thank you. Miss Kush, you may begin.

Donna Kush, Managing Director, Corporate Communications

Thank you, Lee. Good morning, everyone.

By now you should have received a copy of our press release that was faxed or Emailed to you this morning. If you have not, please call our Investor Relations department and we will fax or Email one to you immediately. Otherwise you can view a copy of our release and slides, listen to the call, and submit any questions to us via our website at amtd.com. Also, if you want to contact us directly after the conference call, please call Investors Relations at 800-237-8692.

Before we begin, I would like to note that this call contains forward-looking statements that are made pursuant to the Safe Harbor Provisions of the Federal Securities laws. These statements involve risks, uncertainties, and assumptions that may cause actual results to differ materially from those anticipated. Listeners to the call are advised to review the risk factors contained in our most recent annual report on form 10-Q, 10-K, and quarterly report on 10-Q for descriptions of risks, uncertainties, and assumptions related to the forward-looking statements.

In this call, Ameritrade management will discuss some non-GAAP financial measures, specifically, operating margins, EBITDA, expenses excluding advertising, and liquid assets. Listeners to the call can find a reconciliation of these financial measures to the most comparable GAAP financial measures and the other required disclosures in the slide presentation during this call, which can be found, again, on our website at amtd.com.

Please note that this call is intended for investors and analysts and may not be reproduced in the media, in whole or in part, without prior consent of Ameritrade.

At this time I'll turn the call over to Ameritrade CEO Joe Moglia, who will be followed by Ameritrade's CFO and CAO, Randy McDonald. Joe?

Joe Moglia, Chief Executive Officer

Thank you, Donna. Good morning, everybody. Welcome to the call.

This is our third consecutive record year in a row. We finished the year at $0.81, with $335 million in net income. That's up 27% from where we were a year ago. And over the span of the last three years, Ameritrade has generated $744 million in bottom line net income. That's something, frankly, in a difficult market environment, that we are really very proud of.

When you take a look at the actual quarter itself, there were a number of records that were set. We set records for EPS, net income, pre-tax income, operating margin, EBITDA, and net revenue. When you look at the entire year, I've already alluded to the fact the $0.81 and the $335 million were both records. Our pre-tax income, also a record of $545 million or 54%. That was up 24% from where we were a year ago. Our operating margin is at $637 million or 64%, up 17% from where we were a year ago. EBITDA, $572 million, 57%. And net revenue is just about $1 billion.

As far as the rest of the quarter goes, we did average trades per day of 146,000. For the year, we came in at 156,000. So, for October, it is 154. Our ROE for the year came in at 25%. And new accounts, we opened up 372,000. Now, of the 372,000, 327 were opened organically through our advertising and 45,000 through our M&A and acquisition of JB Oxford.

The net account growth for the year was 197,000. We finished the year with 1.735 million qualified accounts. Our client access were 83 billion. And our liquid assets were almost 400 million.

Now, I want to spend a minute and I want to talk about, frankly, where we're headed over the span of the next couple of years. Our scalability and our operating leverage have been, I believe, to a great degree, our competitive advantages, and they are the reasons why we've achieved what we've achieved over the span the last three years. If, however, we're going to maximize our potential and accomplish something really significant over the span of the next several years, we're if effect going to have to be able to focus on long-term growth and we will do that through our client segmentation strategy and our movement from a marketing organization to a marketing and a sales organization.

With regard to the client segmentation strategy, and we've talked about this before. We will continue to emphasize our efforts in the active trader space. But we will very much intensify our efforts in the long-term investor area. The big effort for us is that of the $83 billion of assets that we have, or the almost quarter of a trillion that we're going to have after we close the deal, the majority of our clients' assets are still held away from us. So we think by having a legitimate long-term investor suite of products and services, we will significantly have an opportunity to be able to grow our share of wallet. That will help us with our prospects. But we think it will also help us garner greater yield from our current account base. It will make us more of an asset gatherer, and we believe that should command a higher premium with regard to our PE in the marketplace. It will help us with our retention. And it will help us with new accounts. And as far as our clients go, we will offer them now the full spectrum of -- going forward, the full spectrum of customization and choice, whether you're do-it-yourself and you want an electronic execution to simply buy or sell a stock, or whether you want somebody else to actually manage your money or you want a relationship with the branch.

The movement from marketing organization to a marketing and sales will become apparent over the span of the next 12 months or so, especially after we close the deal. A simple example of what that means is just how we will focus on Amerivest. Today the entire effort on Amerivest has dominantly been internal and has been all from a marketing perspective. Moving forward, there will be a much greater effort from the branches and from our investment consultants to sell Amerivest works appropriate for our clients.

We just recently relaunched the Amerivest site. We've added auto-balancing and auto-investing. For those of you that haven't seen it, it would only take you a few minutes. I would encourage you to do it. And again, while this has been our dream and our vision all along, the TD acquisition, frankly, leapfrogs our ability to implement our strategy by several years because of the different assets and the products and services that we are getting from them.

Now I want to focus a little bit on what is going to take place as far as the close goes. There are three things that have to take place. First, we've got to be able to finance the dividend. We will be doing $2.2 billion, 1.6 of which will be used to pay the dividend itself. We'll have 300 million of working capital. And we're going to increase our revolver that's currently at 105 million to 300 million.

We have already made our presentation to the rating agencies and we're waiting for them to come back with their final determination of those rates. Citibank will lead the deal and co-led by Merrill, UBS, and JP Morgan.

Second thing that has got to take place is regulatory approval. We're already done with Hart-Scott-Rodino. And we are awaiting on the New York City Stock Exchange and the NESD. We don't anticipate any issues as far as they are concerned.

Lastly, we need to be able to come up -- provide shareholder approval. Now, on September 12th, we filed the proxy. That was returned to us about a week ago. We're going to get that refiled within about a week. Now, once the SEC is satisfied, i.e., that means they send the proxy back with no more comments, at that moment we will be ready to go within 24 hours. A mailing will take place immediately, and then there will be a 20-business day wait from the time the proxy gets out to the shareholders' vote. The vote takes place, and then there is approximately ten business days after that that is basically an administrative waiting period for the New York Stock Exchange. Once that is done, we pay the dividend and then actually close it. We want to get this deal done as soon as possible. But my best guess with regards to an estimate is probably going to be sometime in January.

Now, with regards to the specific SEC comments: eventually all of that information will be a public document. But there's one thing that we want to be able to highlight and share with you ahead of time. And that is that the SEC has questioned the documentation supporting the accounting treatment of the hedge that we've used on our night stock on the actual day that we entered into the transaction back in February '03. From day one, we have been running both the hedge and the night stock through our balance sheet. If it is determined that our documentation is inadequate, we may need to run that hedge through our P&L. If so, there will be no economic impact to either cash flow or our stockholders' equity, but we will record noncash gains in '05 of a penny; '04 of two pennies, or 5 and $10 million, respectively; and a noncash charge in '03 of $0.07 or $28 million.

We've put together a slide, just so this is crystal clear for everybody, and I would like to run you through this now. The heading of the slide is The Night Position. Now, this is the way that the night stock and the night hedge has been on our balance sheet all along. The night stock in '05 lost $4 million in terms of mark to market. But the hedge gained $5 million. The net impact on stockholders' equity was $1 million. Remember, this was all on our balance sheet. However, if we had to run the hedge itself through the P & L, we would record a noncash charge of $5 million -- I'm sorry, a noncash gain of $5 million and an improvement of a penny.

In '04, on our balance sheet, the night stock lost about 10 million bucks. The night hedge gained about that. The net impact to stockholders' equity was around $1 million. But if we needed to run that through our P & L, we'd achieve a $10 million or a $0.02 noncash gain.

In '03 the night stock went up about 31 million. The hedge was down about 28 million. So the impact of stockholders' equity was a positive 3 million and change, but again, if we have to run the hedge through our P & L, we would take a $28 million or $0.07 noncash charge.

I reiterate, there is no economic impact here in terms of our overall cash flow. And we are currently working with the SEC to try to get this wrapped up and resolved.

Now, with regards to our integration preparation, there are some decisions that we have already made that we've communicated internally and with TD Waterhouse and we are happy to share with everybody now. We said with regards to personnel and management, we wanted to make sure that we kept the best talent on both teams and consequently, Tom Bradley from Waterhouse will be running our advisory business going forward. John Bunch from Waterhouse will be running our branches and investment consultants, going forward. At Ameritrade, Bryce Engel, who is in charge of all of our brokerage operations, will continue to do that going forward. And Jerry Bartlett, whom we've just promoted at Ameritrade to Chief Information Officer, will continue in that role going forward.

With regard to functionality, we made a decision that we are going to operate the call centers and clearing efforts out of both Omaha and Fort Worth, and we will be closing down the TD Waterhouse efforts in Harborside, New Jersey.

We said when we announced the deal we thought 378 in terms synergies and 200 in terms of revenue opportunities, i.e, a 578 number was what we thought was realistic. We still think that number is realistic. And the next update with regard to the integration and all the things associated with that will take place right after the close. Now remember, a number of you have asked me questions on this, because of the people that are involved in many of these decisions, we will not announce anything externally until it is handled internally first. Hopefully everybody understands why that is the case. So I would anticipate the next update shortly after our close.

With regards to outlook for '06, we know that everybody is most interested in what TD/Ameritrade is going to look like. But for the time being, we thought it would be far more simpler and far more accurate to report Ameritrade only and we will update TD/Ameritrade again after the close. If you have any interest in looking at Waterhouse has been doing over the span of the last several months, their information is on the TD website. You can find that by going to td.com; investor relations; financial reports; and then TDW trading volumes. Again, td.com; investor relations; financial reports; and TDW trading volumes.

As always, we've given you a sensitivity analysis on the outlook statement that ranges anywhere from 3 to 7% activity rate. But our more specific guidance for the quarter will be 3.8 to 4.8%. And as a point of reference, in '05 our activity rate was 4.3%.

I would ask you to go to the slide on our EPS growth. If we come in at 3.8% activity rate for the entire year, we generate around $0.83. If we come in at a 4.8% activity rate for the year, we would generate $1.02. If we repeated the 4.3% activity rate, we come in at $0.93, which is up 15% ahead of last year.

As far as your models go, one thing you may want to keep in mind, in '06, we will have a 52-week year. In '05, if you recall, we had a 53-week year.

That's it, as far as our numbers go. Let me turn it over to Randy for greater detail.

Randy McDonald, Chief Financial Officer

All right. Thanks, Joe.

Let's start with operating leverage. As Joe mentioned, this year was the best in the Company's history. It also included three of the four best quarters in Ameritrade's history.

We generated a record $572 million in EBITDA or 57%. When you combine that with $467 million that was earned in fiscal year '04, the firm generated more than $1 billion in EBITDA.

Net revenues increased from the same quarter last year by $87 million or 47%, from 187 million to 274 million. That was driven by almost a 100% increase in net interest income and a 26% increase in commission income.

Now, I'll note that we continue to deliver on our promise of operating leverage, as our revenues increased 47%, yet our earnings per share increased 64%.

Let's review the income statement and look at the quarter-over-quarter results. Again, this quarter, we move to a more diversified revenue stream. Last year, commissions versus asset and fee-based revenues were a split of 55, 45. This quarter, the split is 47, 53.

Turning specifically to commission income, the commission revenues increased 26% or $27 million over the same quarter last year as a result of an 18% increase in trades per day and five additional trading days in the current quarter.

The commission rate was $13.01 for the September quarter, which was 1% lower than the same quarter last year. That's slightly higher than what we expect in our outlook statement, and that would be primarily due to greater activity and options trading.

Turning now to net interest income, the net interest revenue approximately doubled, to $126 million from $63 million in the same quarter last year. The net interest revenue growth is comprised of three things: larger loans plus segregated cash balances earned an extra 69 million. Ameritrade's securities lending business and other interest earned an extra 26 million. And all of that was offset by an increase in expense from securities lending and interest paid on client credits of $33 million.

Let me drill down, starting with marginal loans, and looking at interest from marginal loans, which increased 26 million to 66 million this quarter. That was primarily due to increased rates. Additionally, balances improved slightly, to $3.6 billion from 3.2 billion, which was at the higher end of our guidance.

The average margin rate earned was 6.86%, which was slightly in excess of our guidance. We typically don't forecast Fed rate increases, and we experienced two increases in the quarter. So this resulted in interest revenues from margin balances being at the upper end of our range.

Now, the margin rates increased to 6.86% from the same quarter last year of 4.93%. That's a 193 basis point increase. However, we did not increase the rates we paid on the client cash at the same velocity. Those rates only improved by 43 basis points. Therefore, this resulted in 150 basis points, wider spreads on margin loans from 4.67% in fiscal year '04 to 6.17% in fiscal year '05.

Turning now to segregated cash, the interest from seg cash increased by 43 million to 70 million this quarter. And that was almost entirely due to increased rates. The average seg cash balances increased only 100 million from the same quarter last year to 7.7 billion this quarter. The average seg cash balances of 7.7 billion were within our guidance, and the average rate earned of 3.35% was up from 1.45% in fiscal year '04, or 190 basis points, and that was slightly above our guidance. So for both these reasons, interest revenues from seg cash balanced were at the upper end of our range.

Similar to the spreads on margin loans, our spread on seg cash also widened. They widened by 147 basis points to 266 basis points in fiscal year '05 from 119 basis points in fiscal year '04.

Now looking at the client credits, client credit interest increased by 12 million to 18 million in the September quarter from 6 million in the same quarter last year. The average client credit balances were 9.4 billion and were at the upper end of our range. The average client credit rates were 69 basis points. They were at the lower end of our range. So that resulted in client credit interest expense of approximately 18 million, which was within our guidance.

The client credit rates increased 43 basis points from 26 basis points in fiscal year '04 to 69 basis points this year. So the result is the Company did a great job in controlling interest expense and widening our overall spreads.

Securities lending, the interest revenue earned there and the interest expense paid on the securities lending business increased over the same quarter last year by 24 and $22 million, respectively. So that resulted in a net increase of $2 million over the same quarter last year.

Finally, with regard to other revenue, it was down about 2 million, which primarily resulted from a nonrecurring gain last year from selling a repo instrument.

When looking at the sequential quarter results, so when comparing the September quarter to the June quarter, the net revenues were up 40 million or 17%. The commission revenue increased 16 million or 14%. That was primarily due to 7,000 more trades per day and four more trading days in the current quarter. Additionally, commission per trade increased 2%, primarily due to higher options activity.

Net interest income was up 27 million or 27%. There were three reasons: There were seven more interest days; slightly higher average margin in seg cash balances; and higher spreads earned on these balances.

Other income was down 3 million due to certain reorganization fees received in the June quarter, not recurring this quarter.

Expenses before advertising were 96 million. That was up 23 million or 32% over the same quarter last year. I'll remind you the starting point of 73 million in the same quarter last year was actually 82 million because of some one-time credits in that quarter. What that means is the comparative increase was actually 14 million.

Then we had some unusual items this quarter. The September quarter this year was one week longer. That resulted in an additional 6 million of expense. There is $5 million of severance payments to some former executives. And we had increased bad debt expense this quarter of $4 million. Then we add $4 million of variable expenses from 23,000 more trades per day this quarter, and the sum of all of this is 19 million. So, effectively, rather than a $14 million increase in operating cost, we actually experienced a $5 million decrease.

With regard to the bad debt expense, we had transaction review controls over employee trades that were circumvented, which resulted in some unsecured debits. The employees who were involved were terminated or otherwise disciplined. We've added controls over employee trades designed to prevent this type of activity.

Looking at expenses relative to the outlook, there were four items outside of our guidance. Employee comp was slightly above our range, due to the severance that I mentioned. Clearing and execution was slightly below the range, as we continue to benefit from favorable rates we've negotiated with our vendors. Professional services was below range, as we capitalized the costs related to our electronic asset management and procurement projects; and lastly, other expense was above our range, due to the additional bad debt expense I just mentioned.

Looking at the year-over-year expenses, last year's expenses, excluding advertising, were $339 million. And this year, they were $366 million. The increase was almost entirely related to annual increases in salaries, the severance that I mentioned above, and about 90 additional associates in our call center for improved service levels.

I'll now reference you to a slide we have called Dividend Funding. And at the end of September, Joe mentioned we had liquid assets at $397 million. Ameritrade has added over 125 million to liquid assets since the TD transaction was announced at the end of June. This is an historical high, as Ameritrade continues to build its cash position for its share of the $6.00 special dividend.

The purchase agreement calls for both firms to deliver their brokers with excess regulatory capital of 6%. Because liquid assets only includes 5% excess capital, then Ameritrade needs to encumber liquid assets by another 1% or 44 million. We then add to that the net of tax proceeds from the sale of our Canada business. So at close, Ameritrade will need 406 million to fund the first dollar of the $6.00 dividend. So we'd need to earn another 17 million in the December quarter. TD is obligated to also fund $1.00, with another 406 million of contributed capital. So that means the remaining $4.00 of dividend will be funded via committed borrowing of 1.6 billion. That will then get us to the total 2.4 billion we need to fund the $6.00 dividend.

So we had an excellent year of many records and we're confident that the TD merger has positioned us to continue our strong growth, with active traders, long-term investors, and registered investment advisors.

At this time, Operator, I'd like to turn the call back to you and we'll take questions.

Question-and-Answer Session

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