Prepared by R.R. Donnelley Financial -- Form 10-Q for Period Ended 06/30/2002
Table of Contents
 
 
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-Q
 
 
x
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
¨
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2002
 
Commission file number 1-11921
 
 
E*TRADE Group, Inc.
(Exact name of registrant as specified in its charter)
 
 
Delaware
     
94-2844166
(State or other jurisdiction
of incorporation or organization)
     
(I.R.S. Employer
Identification Number)
 
4500 Bohannon Drive, Menlo Park, CA 94025
(Address of principal executive offices and zip code)
 
(650) 331-6000
(Registrant’s telephone number, including area code)
 
 
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 the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:
 
As of July 31, 2002, there were 365,445,155 shares of common stock and 1,661,383 shares exchangeable into common stock outstanding. The Exchangeable Shares, which were issued by EGI Canada Corporation in connection with the acquisition of VERSUS Technologies, Inc. (renamed E*TRADE Technologies Corporation effective January 2, 2001), are exchangeable at any time into common stock on a one-for-one basis and entitle holders to dividend, voting and other rights equivalent to holders of the registrant’s common stock.
 

Table of Contents
E*TRADE GROUP, INC.
 
FORM 10-Q QUARTERLY REPORT
For the Quarter Ended June 30, 2002
 
TABLE OF CONTENTS
 
         
Page
Part I—Financial Information
Item 1.
      
3
       
3
       
4
       
5
       
6
Item 2.
      
23
Item 3.
      
50
Part II—Other Information
Item 1.
      
53
Item 2.
      
55
Item 3.
      
56
Item 4.
      
56
Item 5.
      
57
Item 6.
      
57
  
58
 
The page numbers in this Table of Contents reflect actual page numbers, not EDGAR page tag numbers.
 
References to E*TRADE, Company, “we”, “us” and “our” in this Form 10-Q refer to E*TRADE Group, Inc. and its subsidiaries unless the context requires otherwise.
 
E*TRADE, the E*TRADE logo, etrade.com, E*TRADE Bank, ClearStation, Equity Edge, Equity Resource, OptionsLink, ShareData, Stateless Architecture, Power E*TRADE, Destination E*TRADE and TELE*MASTER are trademarks or registered trademarks of E*TRADE Group, Inc. or its subsidiaries in the United States. Some of these and other trademarks are registered outside the United States.

2

Table of Contents
 
PART I.    FINANCIAL INFORMATION
 
Item 1.    Financial Statements
 
E*TRADE GROUP, INC. AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
 
    
Three Months Ended
June 30,
     
Six Months Ended
June 30,
  
    
2002
     
2001
     
2002
     
2001
  
Revenues:
                                    
Brokerage revenues:
                                    
Commissions
   
$
71,352
 
   
$
100,173
 
   
$
153,879
 
   
$
215,998
 
Principal transactions
   
 
52,092
 
   
 
31,441
 
   
 
107,407
 
   
 
62,613
 
Other brokerage-related
   
 
43,799
 
   
 
43,650
 
   
 
80,560
 
   
 
92,610
 
Interest income
   
 
50,975
 
   
 
80,718
 
   
 
104,026
 
   
 
181,463
 
Interest expense
   
 
(3,089
)
   
 
(26,665
)
   
 
(6,982
)
   
 
(65,400
)
    
  
  
  
Net brokerage revenues
   
 
215,129
 
   
 
229,317
 
   
 
438,890
 
   
 
487,284
 
    
  
  
  
Banking revenues:
                                    
Gain on sales of originated loans
   
 
22,613
 
   
 
24,871
 
   
 
47,288
 
   
 
34,055
 
Gain on sale of loans held-for-sale and securities—net
   
 
17,054
 
   
 
8,314
 
   
 
38,676
 
   
 
27,424
 
Other banking-related
   
 
12,077
 
   
 
9,047
 
   
 
22,461
 
   
 
17,491
 
Interest income
   
 
191,424
 
   
 
217,797
 
   
 
394,092
 
   
 
434,482
 
Interest expense
   
 
(137,852
)
   
 
(179,511
)
   
 
(286,703
)
   
 
(359,877
)
Provision for loan losses
   
 
(4,383
)
   
 
(1,656
)
   
 
(7,765
)
   
 
(3,099
)
    
  
  
  
Net banking revenues
   
 
100,933
 
   
 
78,862
 
   
 
208,049
 
   
 
150,476
 
    
  
  
  
Total net revenues
   
 
316,062
 
   
 
308,179
 
   
 
646,939
 
   
 
637,760
 
    
  
  
  
Cost of services
   
 
133,795
 
   
 
150,458
 
   
 
274,547
 
   
 
292,893
 
    
  
  
  
Operating expenses:
                                    
Selling and marketing
   
 
49,014
 
   
 
55,399
 
   
 
117,978
 
   
 
149,097
 
Technology development
   
 
15,043
 
   
 
23,420
 
   
 
29,547
 
   
 
45,701
 
General and administrative
   
 
50,832
 
   
 
61,906
 
   
 
104,861
 
   
 
122,148
 
Amortization of goodwill and other intangibles
   
 
7,557
 
   
 
9,022
 
   
 
14,281
 
   
 
17,021
 
Acquisition-related expenses
   
 
7,406
 
   
 
517
 
   
 
8,666
 
   
 
517
 
Facility restructuring and other nonrecurring charges
   
 
1,628
 
   
 
—  
 
   
 
1,405
 
   
 
—  
 
Executive agreement
   
 
(23,485
)
   
 
—  
 
   
 
(23,485
)
   
 
—  
 
    
  
  
  
Total operating expenses
   
 
107,995
 
   
 
150,264
 
   
 
253,253
 
   
 
334,484
 
    
  
  
  
Total cost of services and operating expenses
   
 
241,790
 
   
 
300,722
 
   
 
527,800
 
   
 
627,377
 
    
  
  
  
Operating income
   
 
74,272
 
   
 
7,457
 
   
 
119,139
 
   
 
10,383
 
    
  
  
  
Non-operating income (expense):
                                    
Corporate interest income
   
 
3,569
 
   
 
5,220
 
   
 
7,149
 
   
 
10,998
 
Corporate interest expense
   
 
(11,803
)
   
 
(12,759
)
   
 
(24,199
)
   
 
(23,987
)
Loss on investments
   
 
(6,790
)
   
 
(10,969
)
   
 
(7,170
)
   
 
(15,573
)
Equity in income (losses) of investments
   
 
3,617
 
   
 
(1,811
)
   
 
3,901
 
   
 
(5,152
)
Unrealized losses on venture funds
   
 
(3,283
)
   
 
(11,031
)
   
 
(2,991
)
   
 
(20,569
)
Fair value adjustments of financial derivatives
   
 
769
 
   
 
(1,710
)
   
 
(222
)
   
 
(1,376
)
Other
   
 
(405
)
   
 
292
 
   
 
(1,359
)
   
 
(408
)
    
  
  
  
Total non-operating expenses
   
 
(14,326
)
   
 
(32,768
)
   
 
(24,891
)
   
 
(56,067
)
    
  
  
  
Pre-tax income (loss)
   
 
59,946
 
   
 
(25,311
)
   
 
94,248
 
   
 
(45,684
)
Income tax expense (benefit)
   
 
26,076
 
   
 
(12,655
)
   
 
40,827
 
   
 
(25,897
)
Minority interest in subsidiaries
   
 
180
 
   
 
(350
)
   
 
373
 
   
 
(315
)
    
  
  
  
Income (loss) before extraordinary items and cumulative effect of accounting change
   
 
33,690
 
   
 
(12,306
)
   
 
53,048
 
   
 
(19,472
)
Extraordinary gain (loss) on early extinguishment of debt, net of tax (See Note 6)
   
 
(900
)
   
 
2,111
 
   
 
3,174
 
   
 
74
 
Cumulative effect of accounting change (See Note 7)
   
 
—  
 
   
 
—  
 
   
 
(299,413
)
   
 
—  
 
    
  
  
  
Net income (loss)
   
$
32,790
 
   
$
(10,195
)
   
$
(243,191
)
   
$
(19,398
)
    
  
  
  
Income (loss) per share before extraordinary items and cumulative effect of accounting change:
                                    
Basic
   
$
0.09
 
   
$
(0.04
)
   
$
0.15
 
   
$
(0.06
)
    
  
  
  
Diluted
   
$
0.09
 
   
$
(0.04
)
   
$
0.15
 
   
$
(0.06
)
    
  
  
  
Net income (loss) per share:
                                    
Basic
   
$
0.09
 
   
$
(0.03
)
   
$
(0.69
)
   
$
(0.06
)
    
  
  
  
Diluted
   
$
0.09
 
   
$
(0.03
)
   
$
(0.69
)
   
$
(0.06
)
    
  
  
  
Shares used in computation of per share data (See Note 8):
                                    
Basic
   
 
356,760
 
   
 
321,550
 
   
 
351,822
 
   
 
319,405
 
    
  
  
  
Diluted
   
 
362,498
 
   
 
321,550
 
   
 
359,829
 
   
 
319,405
 
    
  
  
  
 
See notes to condensed consolidated financial statements.

3

Table of Contents
 
E*TRADE GROUP, INC. AND SUBSIDIARIES
 
CONSOLIDATED BALANCE SHEETS
(in thousands, except share amounts)
(unaudited)
 
   
June 30,
2002
     
December 31,
2001
  
A S S E T S
                 
Cash and equivalents
  
$
1,015,953
 
   
$
836,201
 
Cash and investments required to be segregated under Federal or other regulations
  
 
730,819
 
   
 
764,729
 
Brokerage receivables—net
  
 
1,888,055
 
   
 
2,139,153
 
Mortgage-backed securities
  
 
4,754,234
 
   
 
3,556,619
 
Loans receivable—net of allowance for loan losses of $15,709 at June 30, 2002 and $19,874 at December 31, 2001
  
 
7,222,742
 
   
 
6,394,368
 
Loans held-for-sale
  
 
542,468
 
   
 
1,616,089
 
Investments
  
 
1,188,728
 
   
 
1,168,623
 
Property and equipment—net
  
 
399,011
 
   
 
331,724
 
Goodwill
  
 
333,090
 
   
 
559,918
 
Other intangible assets
  
 
160,853
 
   
 
129,927
 
Other assets
  
 
590,964
 
   
 
675,063
 
   
  
Total assets
  
$
18,826,917
 
   
$
18,172,414
 
   
  
L I A B I L I T I E S   A N D   S H A R E O W N E R S ’   E Q U I T Y
                 
Liabilities:
                 
Brokerage payables
  
$
2,479,769
 
   
$
2,699,984
 
Banking deposits
  
 
8,334,718
 
   
 
8,082,859
 
Borrowings by bank subsidiary
  
 
5,103,858
 
   
 
4,170,440
 
Convertible subordinated notes
  
 
695,330
 
   
 
760,250
 
Accounts payable, accrued and other liabilities
  
 
620,409
 
   
 
818,464
 
   
  
Total liabilities
  
 
17,234,084
 
   
 
16,531,997
 
   
  
Company-obligated mandatorily redeemable preferred capital securities of subsidiary trusts holding solely junior subordinated debentures of ETFC (redemption value $97,375)
  
 
93,789
 
   
 
69,503
 
   
  
Commitments and contingencies
                 
Shareowners’ equity:
                 
Preferred stock, shares authorized: 1,000,000; issued and outstanding: none at June 30, 2002 and December 31, 2001
  
 
—  
 
   
 
—  
 
Shares exchangeable into common stock, $.01 par value, shares authorized: 10,644,223; issued and outstanding: 1,661,744 at June 30, 2002 and 1,825,632 at December 31, 2001
  
 
17
 
   
 
18
 
Common stock, $.01 par value, shares authorized: 600,000,000; issued and outstanding: 368,384,496 at June 30, 2002 and 347,592,480 at December 31, 2001
  
 
3,684
 
   
 
3,476
 
Additional paid-in capital
  
 
2,236,514
 
   
 
2,072,701
 
Shareowners’ notes receivable
  
 
(30,402
)
   
 
(32,707
)
Deferred stock compensation
  
 
(23,485
)
   
 
(28,110
)
Accumulated deficit
  
 
(490,278
)
   
 
(247,087
)
Accumulated other comprehensive loss
  
 
(197,006
)
   
 
(197,377
)
   
  
Total shareowners’ equity
  
 
1,499,044
 
   
 
1,570,914
 
   
  
Total liabilities and shareowners’ equity
  
$
18,826,917
 
   
$
18,172,414
 
   
  
 
See notes to condensed consolidated financial statements.

4

Table of Contents
 
E*TRADE GROUP, INC. AND SUBSIDIARIES
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
 
    
Six Months Ended
June 30,
  
    
2002
     
2001
  
Net cash provided (used in) operating activities
   
$
745,747
 
   
$
(71,106
)
    
  
CASH FLOWS FROM INVESTING ACTIVITIES:
                  
Purchase of mortgage-backed securities, available-for-sale securities and other investments
   
 
(5,748,128
)
   
 
(5,086,576
)
Proceeds from sales, maturities of and principal payments on mortgage-backed securities, available-for-  sale securities and other investments
   
 
4,828,639
 
   
 
5,566,323
 
Net increase in loans receivable
   
 
(715,085
)
   
 
(1,250,753
)
Decrease in restricted deposits
   
 
71,888
 
   
 
165
 
Purchases of property and equipment, net of property and equipment received in business acquisitions
   
 
(98,753
)
   
 
(96,234
)
Investing derivative activity
   
 
(66,746
)
   
 
(93,050
)
Other
   
 
(1,194
)
   
 
6,505
 
    
  
Net cash used in investing activities
   
 
(1,729,379
)
   
 
(953,620
)
    
  
CASH FLOWS FROM FINANCING ACTIVITIES:
                  
Net increase in banking deposits
   
 
251,859
 
   
 
1,936,797
 
Advances from the Federal Home Loan Bank
   
 
987,055
 
   
 
1,175,300
 
Payments on advances from the Federal Home Loan Bank
   
 
(1,037,055
)
   
 
(1,925,839
)
Net increase (decrease) in securities sold under agreements to repurchase
   
 
680,008
 
   
 
(45,927
)
Net increase in other borrowed funds
   
 
303,388
 
   
 
—  
 
Proceeds from issuance of trust preferred securities
   
 
24,260
 
   
 
—  
 
Proceeds from issuance of common stock from associate stock transactions
   
 
12,019
 
   
 
20,497
 
Payments on bank loans and lines of credit
   
 
(12,276
)
   
 
(28,498
)
Repayment of capital lease obligations
   
 
(8,653
)
   
 
(6,359
)
Repurchase of treasury stock
   
 
(15,089
)
   
 
—  
 
Issuance of shareowners’ notes receivable
   
 
—  
 
   
 
(12,500
)
(Issuances) repayments of loans to related parties and associates, net of loans repaid/issued
   
 
(3,194
)
   
 
2,465
 
Financing derivative activity
   
 
(20,509
)
   
 
—  
 
Net proceeds from convertible subordinated notes
   
 
—  
 
   
 
315,250
 
Other
   
 
1,571
 
   
 
7
 
    
  
Net cash provided by financing activities
   
 
1,163,384
 
   
 
1,431,193
 
    
  
INCREASE IN CASH AND EQUIVALENTS
   
 
179,752
 
   
 
406,467
 
CASH AND EQUIVALENTS—Beginning of period
   
 
836,201
 
   
 
456,878
 
    
  
CASH AND EQUIVALENTS—End of period
   
$
1,015,953
 
   
$
863,345
 
    
  
SUPPLEMENTAL DISCLOSURES:
                  
Selected adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
                  
Depreciation and amortization
   
$
68,127
 
   
$
69,233
 
    
  
Amortization of premium of investment securities
   
$
34,009
 
   
$
5,879
 
    
  
Non-cash investing and financing activities:
                  
Tax benefit on exercise of stock options
   
$
2,773
 
   
$
8,618
 
    
  
Transfer from loans to other real estate owned and repossessed assets
   
$
17,365
 
   
$
1,466
 
    
  
Assets acquired under capital lease obligations
   
$
763
 
   
$
2,148
 
    
  
Reclassification of loans held for investment to loans held for sale
   
$
65,035
 
   
$
802,865
 
    
  
Purchase acquisitions, net of cash acquired:
                  
Common stock issued and stock options assumed
   
$
83,073
 
   
$
96,202
 
Cash paid, less acquired (including acquisition costs)
   
 
—  
 
   
 
1,521
 
Net deferred tax liability
   
 
9,170
 
         
Net liabilities assumed
   
 
10,065
 
   
 
4,763
 
Reduction in payable for purchase of international subsidiary
   
 
—  
 
   
 
(12,341
)
Carrying value of joint-venture investment
   
 
—  
 
   
 
1,258
 
    
  
Fair value of assets acquired (including goodwill of $71,708 and $35,010)
   
$
102,308
 
   
$
91,403
 
    
  
 
See notes to condensed consolidated financial statements.

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Table of Contents
E*TRADE GROUP, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
NOTE 1.    ORGANIZATION AND BASIS OF PRESENTATION
 
The accompanying unaudited condensed consolidated financial statements include E*TRADE Group, Inc. (“the Parent”), a financial services holding company, and its subsidiaries, collectively (“the Company” or “E*TRADE”), including but not limited to E*TRADE Securities, Incorporated (“E*TRADE Securities”), a securities broker-dealer, TIR (Holdings) Limited (“E*TRADE Institutional”), a provider of global securities brokerage and other related services to institutional clients, E*TRADE Financial Corporation (“ETFC”), a provider of financial services whose primary business is conducted by E*TRADE Bank (“the Bank”) and E*TRADE Global Asset Management, Inc. (“ETGAM”), a funds manager and registered broker-dealer, and Dempsey and Company, LLC (“Dempsey”), a specialist and market-making firm. The Bank is a federally chartered savings bank that provides deposit accounts insured by the Federal Deposit Insurance Corporation (“FDIC”) to customers nationwide. Additional ETFC subsidiaries are E*TRADE Access, Inc. (“E*TRADE Access”), an independent network of centrally-managed automated teller machines (“ATMs”) in the United States and Canada, E*TRADE Advisory Services, Inc. (“E*TRADE Advisory Services”) and E*TRADE Mortgage Corporation (“E*TRADE Mortgage”), an Internet-based mortgage loan originator.
 
In September 2000, the Company entered into a joint venture with Ernst & Young LLP (“E&Y”) to form Enlight Holdings LLC (“Enlight Holdings”), which in turn owns eAdvisor, to develop an online personalized financial advice and planning tool for individuals. As of December 31, 2001, the Company owned 49% of Enlight Holdings. In February 2002, the Company determined that as a result of additional contributions and changes in the number of board of director seats, the Company has the ability to control the operations of Enlight Holdings and therefore the Company has consolidated its financial position and results of operations into the Company’s consolidated financial statements. Prior to consolidation, the income (loss) from equity investments related to eAdvisor were not material. In addition, the Company sold its Norwegian subsidiary in May 2002. The sale was for cash and the gain on the sale was not material.
 
Beginning in January 2002, the Company changed its presentation of revenue from that previously presented; however, no changes to its accounting policies or methods were made. Under the new format, net brokerage revenues consist of commissions, principal transactions, other brokerage-related revenues, interest income and interest expense. Commissions include domestic and international transaction revenues. Previously, international transactions were included under the caption “global and institutional.” Principal transactions include revenues from institutional activities, previously included in global and institutional, and market-making activities, previously included in other revenues. Other brokerage-related revenues include payments for order flow, E*TRADE Business Solutions Group, Inc. (“Business Solutions Group”) revenue, advertising revenue, mutual fund revenue and fees for brokerage-related services, including account maintenance fees and order handling fees. Except for payment for order flow, which was previously included in transaction revenues, other brokerage-related items were included in other revenues. Net banking revenues consist of gain on sale of originated loans, gain on sale of loans held-for-sale and securities-net, other banking-related revenues, interest income, interest expense and provision for loan losses. Other banking-related revenues are primarily comprised of ATM revenues.
 
On July 30, 1999, the Company entered into a lease agreement for its 164,500 square foot technology operation center located near Atlanta, Georgia. To secure the lease, the Company posted cash collateral, which was $71.9 million at December 31, 2001. On March 27, 2002, the Company exercised its purchase option and used the cash collateral to fund the purchase on April 29, 2002.
 
These unaudited condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”), and, in the opinion of management, reflect

6

Table of Contents
adjustments consisting only of normal recurring adjustments necessary to present fairly the financial position, results of operations and cash flows for the periods presented in conformity with accounting principles generally accepted in the United States of America. These unaudited condensed consolidated financial statements should be read in conjunction with the audited annual consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001.
 
In April 2002, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 145, Rescission of FASB Statement No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections. SFAS 145 requires that any gains or losses on extinguishment of debt that were classified as an extraordinary item in prior periods that are not unusual in nature and infrequent in occurrence be reclassified to other income (expense), beginning in fiscal 2003, with early adoption encouraged. The Company expects to adopt the requirements of SFAS No. 145 in the fourth quarter of fiscal 2002.
 
In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, which addresses accounting for restructuring and similar costs. SFAS 146 supersedes previous accounting guidance, principally Emerging Issues Task Force Issue No. 94-3. SFAS 146 requires that the liability for costs associated with an exit or disposal activity be recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost was recognized at the date of the Company’s commitment to an exit plan rather than when the liability is incurred. SFAS 146 also establishes that the liability should initially be measured and recorded at fair value. Accordingly, SFAS 146 may affect the timing of recognizing future restructuring costs as well as the amounts recognized. The Company will adopt the provisions of SFAS 146 for any restructuring activities which may be initiated after December 31, 2002.
 
Certain prior period items in these unaudited condensed consolidated financial statements have been reclassified to conform to the current period presentation.
 
NOTE 2.    BUSINESS ACQUISITIONS
 
On June 3, 2002, the Company acquired 100% of privately-held Tradescape Securities, LLC, a direct access brokerage firm for active online traders and a subsidiary of Tradescape Corp., together with Tradescape Technologies, LLC, including its high-speed direct access trading software, technology and network services, and Momentum Securities, LLC, an onsite brokerage firm for individual professional traders, collectively (“Tradescape”), in order to expand its brokerage business in onsite trading. The Company did not acquire any interest in, and exercises no management control over, Tradescape Corp. or Market XT, Inc., which remains a wholly owned subsidiary of Tradescape Corp. The Company acquired Tradescape for an aggregate purchase price of $96.2 million, comprised of approximately 11.8 million shares of the Company’s common stock valued at $83.1 million (based on the average of the closing prices of the Company’s common stock on the date the shares to be issued were determined and for the three days before and after) and acquisition costs of approximately $13.1 million. The acquisition costs include the fair value of operating leases assumed by the Company, duplicative property and equipment, legal costs and accounting costs. In addition, the Company agreed to pay additional contingent stock consideration of up to $180 million if Tradescape’s operating results exceed certain targets and revenue goals for the remainder of fiscal 2002 and for all of fiscal 2003. The Company also incurred $5.4 million of non-capitalizable costs, related to rebranding costs in connection with the Tradescape acquisition, which are included in acquisition-related expenses. The acquisition was accounted for using the purchase method of accounting and the results of Tradescape’s operations have been combined with those of the Company from the date of acquisition. The Company has not included in its operating results any revenue of Tradescape prior to the date of acquisition.

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The purchase price has been preliminarily allocated as follows (in thousands):
 
Net tangible assets of Tradescape
   
$
3,017
 
Proprietary agreements and other intangibles
   
 
30,600
 
Net deferred tax liability
   
 
(9,170
)
Goodwill
   
 
71,708
 
    
Total Purchase Price
   
$
96,155
 
    
 
The acquired net tangible assets of Tradescape were allocated in the accompanying condensed consolidated balance sheets as follows (in thousands):
 
Brokerage receivables—net
   
$
3,811
 
Investments
   
 
604
 
Property and equipment—net
   
 
7,906
 
Other assets
   
 
7,837
 
Accounts payable, accrued and other liabilities
   
 
(17,141
)
    
    
$
3,017
 
    
 
The value allocated to proprietary agreements will be amortized over seven years and other intangibles will be amortized over four to six years, all using a straight-line method. The value allocated to goodwill (all of which is included in the Domestic Retail Brokerage Segment) will not be amortized. This purchase price allocation is preliminary and has been allocated based on the estimated fair value of net tangible and intangible assets acquired. If contingent stock consideration is paid, the Company will increase the purchase price with a corresponding increase to goodwill. The Company has engaged an independent valuation firm to assist in the allocation and expects the finalization of these allocations to occur in the three months ended September 30, 2002.
 
The proforma information below assumes that the acquisitions of Tradescape, Dempsey (acquired in October 2001), Web Street, Inc. (“Web Street”) (acquired in May 2001) and E*TRADE Mortgage (acquired in February 2001) occurred at the beginning of fiscal 2001 and includes the effect of amortization of intangibles acquired from that date (in thousands, except per share amounts):
 
    
Six Months Ended
June 30,
  
    
2002
     
2001
  
Net revenues
   
$
679,366
 
   
$
762,555
 
Income (loss) before extraordinary items and cumulative effect of accounting change
   
$
44,619
 
   
$
(10,269
)
Net loss
   
$
(251,620
)
   
$
(10,195
)
Basic and diluted income (loss) per share before extraordinary items and cumulative effect of accounting change
   
$
0.12
 
   
$
(0.03
)
Basic and diluted net loss per share
   
$
(0.69
)
   
$
(0.03
)
 
The proforma information is for information purposes only and is not necessarily indicative of the results of future operations nor results that would have been achieved had these acquisitions taken place at the beginning of fiscal 2001.
 
NOTE 3.    FACILITY RESTRUCTURING CHARGES
 
On August 29, 2001, the Company announced a restructuring plan aimed at streamlining operations primarily by consolidating facilities in the United States and Europe. This restructuring resulted in a pre-tax charge of $202.8 million ($148.0 million after tax) in fiscal 2001. The restructuring was designed to consolidate certain facilities to bring together key decision-makers and streamline operations.

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The Company recorded a pre-tax restructuring charge of $128.5 million related to its facilities consolidation, representing the undiscounted value of ongoing lease commitments offset by anticipated third party subleases. The charge also includes a pre-tax write-off of leasehold improvements and furniture and fixtures totaling $38.6 million. The charge did not include relocation costs to be incurred over the next 12 months and expensed as incurred. The cash outflow related to this action is being paid out over the length of committed lease terms of 7 to 11 years. In the six months ended June 30, 2002, the Company adjusted its facilities charge by $1.5 million as management has determined that it will use more facility space and receive less from certain future subleases than originally estimated in the restructuring plan.
 
The Company also recorded a pre-tax restructuring charge of $52.5 million related to the write-off of capitalized software and hardware related to terminated technology projects and the write-off of other fixed assets. In calculating the charge related to its asset write-off, the Company calculated the amount of the write-offs as the net book value of assets less the amount of estimated proceeds upon disposition for certain saleable assets, including real estate properties owned. In the six months ended June 30, 2002, a related party, though not obligated, reimbursed the Company for the value of the impairment of one of these properties, which was recorded in the initial restructuring charge. The reimbursement of approximately $0.7 million was offset by an additional increase in the restructuring accrual resulting from the identification of additional excess equipment of approximately $0.2 million and an additional increase related to realized losses on other of the aforementioned real estate properties of $0.4 million not originally estimated in the restructuring plan.
 
The restructuring accrual also included other pre-tax charges of $21.8 million in 2001 for committed expenses, termination of consulting agreements, severance and cancellation penalties on various services that will no longer be required in the facilities the Company is vacating. The Company increased the restructuring charge, included in Other below, by $2.9 million in the six months ended June 30, 2002 primarily for additional severance arrangements made with associates who were notified during the first and second quarters. Severance is recorded in the period in which affected associates are identified and communication is made to these individuals.
 
A summary of the facility restructuring charges is outlined as follows (in thousands):
 
    
Facility Consolidation
     
Asset Write-Off
     
Other
     
Total
  
Facility restructuring charges recorded in fiscal 2001
   
$
128,469
 
   
$
52,532
 
   
$
21,764
 
   
$
202,765
 
Activity for fiscal 2001:
                                    
Cash payments
   
 
(7,534
)
   
 
(49
)
   
 
(8,846
)
   
 
(16,429
)
Non-cash charges
   
 
(38,570
)
   
 
(52,483
)
   
 
(5,740
)
   
 
(96,793
)
    
  
  
  
Restructuring liabilities at December 31, 2001
   
 
82,365
 
   
 
—  
 
   
 
7,178
 
   
 
89,543
 
Activity for the six months ended June 30, 2002:
                                    
Adjustments and additional charges
   
 
(1,456
)
   
 
(72
)
   
 
2,933
 
   
 
1,405
 
Cash payments
   
 
(9,930
)
   
 
—  
 
   
 
(6,464
)
   
 
(16,394
)
Non-cash charges
   
 
(1,496
)
   
 
72
 
   
 
—  
 
   
 
(1,424
)
    
  
  
  
Restructuring liabilities at June 30, 2002
   
$
69,483
 
   
$
—  
 
   
$
3,647
 
   
$
73,130
 
    
  
  
  
 
NOTE 4.    EXECUTIVE AGREEMENT
 
In May 2002, the Company completed ongoing negotiations and executed a new two-year employment agreement (the “Employment Agreement”) with its Chairman of the Board and Chief Executive Officer (“CEO”). The Company previously disclosed the Employment Agreement on a Form 8-K filed on May 10, 2002. Among other terms (including, but not limited to, the reduction of the CEO’s salary to zero for at least the first year of the contract term and the limitations of any potential bonuses), the Employment Agreement and related

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arrangements with the CEO contain the following concessions by the CEO that resulted in an immediate benefit to the Company and which were recorded as a non-recurring credit:
 
 
•
 
The CEO waived his right to receive vested benefits in the Supplemental Executive Retirement Plan (“SERP”) totaling $16.1 million, previously deposited into a trust on his behalf on January 1, 2001 and 2002; these amounts had been previously recorded as part of general and administrative expenses in fiscal 2001. Of this amount, $14.0 million was returned to the Company and $2.1 million was paid out as a one-time bonus to non-executive associates of the Company.
 
 
•
 
The CEO waived his right to have the Company defray payment for the tax effect of his restricted stock grants. An accrued liability for unpaid estimated taxes of $9.5 million for unvested shares as of March 31, 2002 was reversed and credited to executive agreement. Such amounts had been accrued in general and administrative expenses as follows: $7.3 million in fiscal 2001 and $2.2 million in the three months ended March 31, 2002.
 
As of June 30, 2002, the Company has reduced its SERP obligation to the CEO by $16.1 million for vested SERP contributions waived by the CEO. The $14.0 million in reduced SERP benefits that was retained by the Company combined with $9.5 million related to the foregone tax reimbursements on the restricted stock award, have been recorded as a non-recurring credit totaling $23.5 million to operating expenses for the three and six months ended June 30, 2002. The $2.1 million that was previously credited to the CEO’s SERP account and distributed to associates had no net effect on the results of operations.
 
NOTE 5.    ACCOUNTING FOR DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
 
The Company enters into derivative transactions principally to protect against the risk of market price or interest rate movements on the value of certain assets and future cash flows. The Company is also required to recognize certain contracts and commitments as derivatives when the characteristics of those contracts and commitments meet the definition of a derivative as promulgated by SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities.
 
Fair Value Hedges
 
The Company uses a combination of interest rate swaps, caps and floors to substantially offset the change in value of certain fixed rate assets. In calculating the effective portion of the fair value hedges under SFAS 133, the change in the fair value of the derivative is recognized currently in earnings, as is the change in value of the hedged item attributable to the risk being hedged. Accordingly, the net difference or hedge ineffectiveness, if any, is recognized currently in the consolidated statements of operations as fair value adjustments of financial derivatives in other non-operating income (expense). Fair value hedge ineffectiveness resulted in a loss of $1.9 million for the three months ended June 30, 2002, income of $0.3 million for the three months ended June 30, 2001, loss of $5.6 million for the six months ended June 30, 2002 and income of $1.8 million for the six months ended June 30, 2001.
 
During the three and six months ended June 30, 2002 and June 30, 2001, certain fair value hedges were derecognized and therefore hedge accounting was discontinued during the period. Changes in the fair value of these derivative instruments after the discontinuance of fair value hedge accounting are recorded in gain on sale of loans held-for-sale and securities-net, in the consolidated statements of operations, which totaled $3.0 million of losses for the three months ended June 30, 2002, $3.5 million of losses for the three months ended June 30, 2001, $4.1 million of gains for the six months ended June 30, 2002 and $5.2 million of losses for the six months ended June 30, 2001. In addition, the Company recognized $0.3 million for the three months ended June 30, 2002, $1.0 million for the three months ended June 30, 2001, $5.5 million for the six months ended June 30, 2002 and $1.2 million for the six months ended June 30, 2001, of hedge ineffectiveness expense in fair value adjustments of financial derivatives, related to these derecognized fair value hedges during the fair value hedge accounting period.

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The following table summarizes information related to our financial derivatives in fair value hedge relationships as of June 30, 2002 (dollars in thousands):
 
Assets Hedged
  
Notional Amount
  
Fair Value
    
Asset
  
Liability
     
Weighted Average Pay Rate
     
Weighted Average Receive Rate
     
Weighted Average Strike Rate
     
Weighted Average Remaining Life (years)
Loans:
                                                      
Pay fixed interest rate swaps
  
$
2,061,973
  
$
(41,888
)
  
$
—  
  
$
(41,888
)
   
4.59
%
   
1.88
%
   
—  
%
   
3.13
Purchased interest rate options—caps
  
 
3,699,027
  
 
51,460
 
  
 
51,460
  
 
—  
 
   
—  
 
   
—  
 
   
5.30
 
   
4.21
Purchased interest rate options—floors
  
 
1,168,000
  
 
8,801
 
  
 
8,801
  
 
—  
 
   
—  
 
   
—  
 
   
4.52
 
   
3.98
   
 
 
 
                         
Total Loans
  
 
6,929,000
  
 
18,373
 
  
 
60,261
  
 
(41,888
)
   
4.59
 
   
1.88
 
   
5.11
 
   
3.85
   
 
 
 
                         
Mortgage-Backed Securities:
                                                      
Pay fixed interest rate swaps
  
 
800,527
  
 
(15,683
)
  
 
—  
  
 
(15,683
)
   
4.78
 
   
1.90
 
   
—  
 
   
4.72
Purchased interest rate options—caps
  
 
2,027,973
  
 
58,817
 
  
 
58,817
  
 
—  
 
   
—  
 
   
—  
 
   
5.46
 
   
5.39
Purchased interest rate options—floors
  
 
1,607,750
  
 
11,231
 
  
 
11,231
  
 
—  
 
   
—  
 
   
—  
 
   
4.58
 
   
5.11
   
 
 
 
                         
Total Mortgage-Backed Securities
  
 
4,436,250
  
 
54,365
 
  
 
70,048
  
 
(15,683
)
   
4.78
 
   
1.90
 
   
5.07
 
   
5.17
   
 
 
 
                         
Investment Securities:
                                                      
Pay fixed interest rate swaps
  
 
199,500
  
 
(3,070
)
  
 
—  
  
 
(3,070
)
   
5.30
 
   
1.86
 
   
—  
 
   
6.78
   
 
 
 
                         
Total Fair Value Hedges
  
$
11,564,750
  
$
69,668
 
  
$
130,309
  
$
(60,641
)
   
4.68
%
   
1.88
%
   
5.09
%
   
4.41
   
 
 
 
                         
 
Cash Flow Hedges
 
The Company also uses interest rate swaps to hedge the variability of future cash flows associated with existing variable rate liabilities and forecasted issuances of liabilities. These cash flow hedge relationships are treated as effective hedges as long as the future issuances of liabilities remain probable and the hedges continue to meet the requirements of SFAS 133. The Company expects to reclassify approximately a pre-tax amount of $96.3 million of net unrealized losses reported in other comprehensive income (“OCI”) to the consolidated statements of operations during the next twelve months. The Company expects to hedge the forecasted issuance of liabilities over a maximum term of seven years.
 
During the period ended June 30, 2002, the Company terminated $3.3 billion of notional amount of interest rate swaps in cash flow hedge relationships. The fair market value of the derivatives terminated was $(189.1) million as of their respective termination dates. The Company will reclassify the loss accumulated in OCI on the derivative instruments terminated to interest expense over the periods the hedged forecasted issuance of liabilities will affect earnings, which range from six months to 5.3 years. During the quarter ended June 30, 2002, the Company reclassified a pre-tax amount of $12.0 million from OCI to interest expense, related to the derivatives terminated.
 
The Company measures ineffectiveness for these cash flow hedges in accordance with SFAS 133 and reports this amount as fair value adjustments of financial derivatives in the non-operating income (expense) section of its consolidated statements of operations. The Company recognized $2.7 million of income for cash flow hedge ineffectiveness for the three months ended June 30, 2002 and $5.4 million for the six months ended June 30, 2002. The ineffectiveness for the three and six months ended June 30, 2001 did not have a material impact on earnings.

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Table of Contents
 
The following table summarizes information related to our financial derivatives in cash flow hedge relationships hedging variable rate liabilities and the forecasted issuances of liabilities, as of June 30, 2002 (dollars in thousands):
 
Liabilities Hedged
   
Notional Amount
   
Fair Value
     
Asset
   
Liability
     
Weighted Average Pay Rate
     
Weighted Average Receive
Rate
       
Weighted
Average
Remaining
Life (years)
Time Deposits:
                                                     
Pay fixed interest rate swaps
   
$
790,500
   
$
(55,249
)
   
$
—  
   
$
(55,249
)
   
6.46
%
   
2.38
%
     
2.82
Repurchase Agreements:
                                                     
Pay fixed interest rate swaps
   
 
878,500
   
 
(13,419
)
   
 
   —  
   
 
(13,419
)
   
4.59
 
   
1.86
 
     
3.36
Federal Home Loan Bank Advances:
                                                     
Pay fixed interest rate swaps
   
 
235,000
   
 
(21,125
)
   
 
—  
   
 
(21,125
)
   
7.02
 
   
1.88
 
     
3.12
    
  
  
  
  
  
    
Total Cash Flow Hedges
   
$
1,904,000
   
$
(89,793
)
   
$
—  
   
$
(89,793
)
   
5.67
%
   
2.08
%
     
3.11
    
  
  
  
  
  
    
 
Mortgage Banking Activities
 
The Company enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding; these commitments are referred to as Interest Rate Lock Commitments (“IRLCs”). IRLCs on loans that are intended to be sold are considered to be derivatives and are therefore recorded at fair value with changes in fair value recorded in earnings. The net change in the IRLCs and the related hedging instruments resulted in a net loss of $2.3 million for the three months ended June 30, 2002, losses of $4.6 million for the three months ended June 30, 2001, gains of $0.3 million for the six months ended June 30, 2002 and losses of $5.6 million for the six months ended June 30, 2001.
 
NOTE 6.    EXTRAORDINARY GAIN (LOSS) ON EARLY EXTINGUISHMENT OF DEBT
 
The Company recorded an extraordinary loss on early extinguishment of debt of $0.9 million (net of tax benefit of $0.5 million) for the three months ended June 30, 2002 and a $3.2 million gain (net of tax expense of $2.2 million) for the six months ended June 30, 2002. In the three months ended June 30, 2002, amounts recorded included $1.1 million gain (net of tax expense of $0.8 million) and for the six months ended June 30, 2002 amounts included a $5.2 million gain (net of tax expense of $3.5 million), on exchanges in the aggregate of $64.9 million of the Company’s 6% convertible subordinated notes for 6.5 million shares of common stock, offset by a $2.0 million loss (net of tax benefit of $1.3 million) for the three and six months ended June 30, 2002 as a result of the early redemptions of $100 million of adjustable rate advances from the Federal Home Loan Bank (“FHLB”). The FHLB advances were entered into as a result of normal funding requirements of the Company’s banking operations. The losses consisted primarily of prepayment penalties and costs associated with these early redemptions.
 
The Company recorded an extraordinary gain on early extinguishment of debt of $2.1 million (net of tax expense of $1.8 million) for the three months ended June 30, 2001 and $0.1 million gain (net of tax expense of $0.6 million) for the six months ended June 30, 2001. In the three and six months ended June 30, 2001, amounts recorded included a $5.0 million gain (net of tax expense of $3.4 million), on exchanges in the aggregate of $30.0 million of the Company’s 6% convertible subordinated notes for 2.7 million shares of common stock, offset by a $2.9 million loss (net of tax benefit of $1.6 million) for the three months ended June 30, 2001 and a $4.9 million loss (net of tax benefit of $2.8 million) for the six months ended June 30, 2001, recorded as a result of the early redemptions of $100 million and $600 million, respectively, of adjustable and fixed rate advances from the FHLB. The FHLB advances were entered into as a result of normal funding requirements of the Company’s banking operations. The losses consisted primarily of prepayment penalties and costs associated with these early redemptions.
 

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Table of Contents
NOTE 7.    GOODWILL AND OTHER INTANGIBLE ASSETS
 
On January 1, 2002, the Company adopted SFAS No. 142, Goodwill and Other Intangible Assets, which requires that all intangible assets with finite useful lives be amortized and that goodwill and intangible assets with indefinite lives not be amortized, but rather tested upon adoption and at least annually for impairment. In accordance with SFAS 142, the Company discontinued the amortization of its recorded goodwill as of that date, identified its reporting units based on its current segment reporting structure and allocated all recorded goodwill, as well as other assets and liabilities, to the reporting units. The Company determined the fair value of its reporting units utilizing discounted cash flow models and relative market multiples for comparable businesses. The Company compared the fair value of each of its reporting units to its carrying value. This evaluation indicated that goodwill associated with its reporting units in the Global and Institutional and its Wealth Management segments were impaired. This impairment is primarily attributable to the change in the evaluation criteria for goodwill from an undiscounted cash flow approach, which was previously utilized under the guidance in Accounting Principle Board Opinion No. 17, to the fair value approach, which is stipulated in SFAS 142. A non-cash charge totaling $299.4 million has been recorded as a change in accounting principle effective January 1, 2002 to write-off goodwill of $292.6 million in the Global and Institutional segment and $6.8 million in the Wealth Management segment. The changes in carrying value of the remaining goodwill following this impairment write down, by segment, as of June 30, 2002 was (in thousands):
 
    
Domestic Retail
Brokerage and Other
   
Banking
   
Total
Balance as of January 1, 2002
   
$
147,336
   
$
114,046
   
$
261,382
Goodwill due to Tradescape acquisition
   
 
71,708
   
 
—  
   
 
71,708
    
  
  
Balance as of June 30, 2002
   
$
219,044
   
$
114,046
   
$
333,090
    
  
  
 
Other intangible assets, which will continue to be amortized on a straight-line basis, consist of the following (in thousands):
 
      
Weighted
Average
Useful
   
As of June 30, 2002
   
As of December 31, 2001
      
Life(1)
(years)
   
Gross Amount
   
Accumulated Amortization
   
Net Amount
   
Gross Amount
   
Accumulated Amortization
   
Net Amount
Specialist books
     
30
   
$
59,800
   
$
1,495
   
$
58,305
   
$
59,800
   
$
506
   
$
59,294
Active accounts(2)
     
  7
   
 
54,229
   
 
15,279
   
 
38,950
   
 
52,599
   
 
7,514
   
 
45,085
ATM contracts
     
  5
   
 
30,767
   
 
11,466
   
 
19,301
   
 
30,714
   
 
8,455
   
 
22,259
Deposit intangibles(2)
     
  3
   
 
14,634
   
 
2,431
   
 
12,203
   
 
3,165
   
 
549
   
 
2,616
Proprietary agreements
     
  7
   
 
13,500
   
 
85
   
 
13,415
   
 
—  
   
 
—  
   
 
—  
Other
     
  6
   
 
19,324
   
 
645
   
 
18,679
   
 
824
   
 
151
   
 
673
           
  
  
  
  
  
Total
          
$
192,254
   
$
31,401
   
$
160,853
   
$
147,102
   
$
17,175
   
$
129,927
           
  
  
  
  
  
(1)
 
The Company evaluated the useful lives of its other intangible assets and determined that they should continue to be amortized based on the original useful lives assigned on a straight-line basis.
(2)
 
Amortized using an accelerated method.
 
Amortization expense of other intangible assets was $7.6 million for the three months ended June 30, 2002, $14.3 million for the six months ended June 30, 2002, $1.1 million for the three months ended June 30, 2001 and $2.6 million for the six months ended June 30, 2001. Assuming no future impairments of these assets or additions as the result of acquisitions, annual amortization expense will be $15.0 million for the remainder of fiscal 2002, $28.4 million in fiscal 2003, $24.8 million in fiscal 2004, $16.2 million in fiscal 2005, $12.1 million in fiscal 2006 and $64.4 million thereafter.

13

Table of Contents
 
A reconciliation of previously reported net income and earnings per share to the amounts adjusted for the exclusion of goodwill amortization is provided below (in thousands except per share amounts):
 
    
Three Months Ended June 30,
  
    
2002
   
2001
  
           
Per Share
          
Per Share
  
    
Amount
     
Basic
   
Diluted
   
Amount
     
Basic
     
Diluted
  
Reported income (loss) before extraordinary items
   
$
33,690
 
   
$
0.09
   
$
0.09
   
$
(12,306
)
   
$
(0.04
)
   
$
(0.04
)
Add:  Goodwill amortization
   
 
—  
 
   
 
—  
   
 
—  
   
 
7,904
 
   
 
0.02
 
   
 
0.02
 
    
  
  
  
  
  
Adjusted income (loss) before extraordinary items
   
 
33,690
 
   
 
0.09
   
 
0.09
   
 
(4,402
)
   
 
(0.02
)
   
 
(0.02
)
Extraordinary gain (loss)
   
 
(900
)
   
 
0.00
   
 
0.00
   
 
2,111
 
   
 
0.01
 
   
 
0.01
 
    
  
  
  
  
  
Adjusted net income (loss)
   
$
32,790
 
   
$
0.09
   
$
0.09
   
$
(2,291
)
   
$
(0.01
)
   
$
(0.01
)
    
  
  
  
  
  
 
    
Six Months Ended June 30,
  
    
2002
   
2001
  
         
Per Share
          
Per Share
  
    
Amount
   
Basic
   
Diluted
   
Amount
     
Basic
     
Diluted
  
Reported income (loss) before extraordinary items and cumulative effect of accounting change
   
$
53,048
   
$
0.15
   
$
0.15
   
$
(19,472
)
   
$
(0.06
)
   
$
(0.06
)
Add:  Goodwill amortization
   
 
—  
   
 
—  
   
 
—  
   
 
14,396
 
   
 
0.04
 
   
 
0.04
 
    
  
  
  
  
  
Adjusted income (loss) before extraordinary items
   
 
53,048
   
 
0.15
   
 
0.15
   
 
(5,076
)
   
 
(0.02
)
   
 
(0.02
)
Extraordinary gain
  
 
3,174
   
 
0.01
   
 
0.01
   
 
74
 
   
 
0.00
 
   
 
0.00
 
    
  
  
  
  
  
Adjusted net income (loss)
   
$
56,222
   
$
0.16
   
$
0.16
   
$
(5,002
)
   
$
(0.02
)
   
$
(0.02
)
    
  
  
  
  
  
 
NOTE 8.    NET INCOME (LOSS) PER SHARE
 
The following table sets forth the computation of the numerator and denominator used in the computation of basic and diluted net income (loss) per share (in thousands):
 
    
Three Months Ended June 30,
     
Six Months Ended June 30,
  
    
2002
     
2001
     
2002
     
2001
  
    
Basic income
per share
     
Diluted
income
per share
     
Basic and
diluted loss
per share
     
Basic income
(loss)
per share
     
Diluted
income (loss)
per share
     
Basic and
diluted loss
per share
  
Numerator:
                                                      
Income (loss) before extraordinary items and cumulative effect of accounting change
   
$
33,690
 
   
$
33,690
 
   
$
(12,306
)
   
$
53,048
 
   
$
53,048
 
   
$
(19,472
)
Extraordinary gain (loss) on early extinguishment of debt, net of tax
   
 
(900
)
   
 
(900
)
   
 
2,111
 
   
 
3,174
 
   
 
3,174
 
   
 
74
 
Cumulative effect of accounting change
   
 
—  
 
   
 
—  
 
   
 
—  
 
   
 
(299,413
)
   
 
(299,413
)
   
 
—  
 
    
  
  
  
  
  
Net income (loss)
   
$
32,790
 
   
$
32,790
 
   
$
(10,195
)
   
$
(243,191
)
   
$
(243,191
)
   
$
(19,398
)
    
  
  
  
  
  
Denominator:
                                                      
Weighted average shares outstanding
   
 
356,760
 
   
 
356,760
 
   
 
321,550
 
   
 
351,822
 
   
 
351,822
 
   
 
319,405
 
Dilutive effect of options issued to associates
   
 
—  
 
   
 
4,567
 
   
 
—  
 
   
 
—  
 
   
 
7,244
 
   
 
—  
 
Dilutive effect of warrants outstanding
   
 
—  
 
   
 
1,171
 
   
 
—  
 
   
 
—  
 
   
 
763
 
   
 
—  
 
    
  
  
  
  
  
    
 
356,760
 
   
 
362,498
 
   
 
321,550
 
   
 
351,822
 
   
 
359,829
 
   
 
319,405
 
    
  
  
  
  
  

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Because the Company reported a loss before cumulative effect of accounting change for the three and six months ended June 30, 2001, the calculation of diluted loss per share does not include common stock equivalents as they are anti-dilutive and would result in a reduction of loss per share. If the Company had reported net income for the three months ended June 30, 2001, there would have been 6,535,000 additional shares for options outstanding and 198,000 additional shares for warrants outstanding. If the Company had reported net income for the six months ended June 30, 2001, there would have been 8,412,000 additional shares for options outstanding and 198,000 additional shares for warrants outstanding. Shares of common stock issuable under convertible subordinated notes were excluded from the calculations of diluted loss per share, as the effect of applying the treasury stock method on an as-if-converted basis would be anti-dilutive, of approximately 45,687,000 for the three months ended June 30, 2002, 46,564,000 for the six months ended June 30, 2002, 37,724,000 for the three months ended June 30, 2001 and 32,661,000 for the six months ended June 30, 2001.
 
The following options to purchase shares of common stock have not been included in the computation of diluted net income (loss) per share because the options’ exercise price was greater than the average market price of the Company’s common stock for the periods presented, and therefore, the effect would be anti-dilutive (in thousands, except exercise price data):
 
    
Three Months Ended
June 30,
   
Six Months Ended
June 30,
    
2002
   
2001
   
2002
   
2001
Options excluded from computation of diluted net loss per share
   
 
26,661
   
 
18,964
   
 
18,616
   
 
18,816
Exercise price ranges:
                            
High
   
$
58.19
   
$
58.19
   
$
58.19
   
$
58.19
Low
   
$
6.91
   
$
7.97
   
$
8.27
   
$
9.18
 
NOTE 9.    BROKERAGE RECEIVABLES—NET AND PAYABLES
 
Brokerage receivables—net and payables consist of the following (in thousands):
 
    
June 30,
2002
   
December 31, 2001
Receivable from customers and non-customers (less allowance for doubtful accounts of $2,817 at June 30, 2002 and $3,608 at December 31, 2001)
   
$
1,510,331
   
$
1,631,845
Receivable from brokers, dealers and clearing organizations:
              
Net settlement and deposits with clearing organizations
   
 
128,550
   
 
113,527
Deposits paid for securities borrowed
   
 
235,946
   
 
371,682
Securities failed to deliver
   
 
2,170
   
 
776
Other
   
 
11,058
   
 
21,323
    
  
Total brokerage receivables—net
   
$
1,888,055
   
$
2,139,153
    
  
Payable to customers and non-customers
   
$
2,018,879
   
$
2,018,352
Payable to brokers, dealers and clearing organizations:
              
Deposits received for securities loaned
   
 
426,656
   
 
648,168
Securities failed to receive
   
 
2,098
   
 
1,491
Other
   
 
32,136
   
 
31,973
    
  
Total brokerage payables
   
$
2,479,769
   
$
2,699,984
    
  
 
Receivable from and payable to brokers, dealers and clearing organizations result from the Company’s brokerage activities. Receivable from customers and non-customers represents credit extended to customers and non-customers to finance their purchases of securities on margin. Credit extended to customers and non-customers with respect to margin accounts was $1,299 million at June 30, 2002 and $1,537 million at

15

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December 31, 2001. Securities owned by customers and non-customers are held as collateral for amounts due on margin balances, the value of which is not reflected in the accompanying consolidated balance sheets. As of June 30, 2002, the Company has received collateral primarily in connection with securities borrowed and customer margin loans with a market value of $1,616 million, which it can sell or repledge. Of this amount, $590 million has been pledged or sold as of June 30, 2002 in connection with securities loans, bank borrowings and deposits with clearing organizations. Included in deposits paid for securities borrowed and deposits received for securities loaned at June 30, 2002 are amounts from transactions involving MJK Clearing and three other brokers. The parties in this transaction have a dispute over the amounts owed, as more fully described in Note 15 “Commitments, Contingencies and Other Regulatory Matters.” Payable to customers and non-customers represents free credit balances and other customer and non-customer funds pending completion of securities transactions. The Company pays interest on certain customer and non-customer credit balances.
 
NOTE 10.    INVESTMENTS
 
Investments are comprised of trading and available-for-sale debt and equity securities, as defined under the provisions of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. Also included in investments are investments in entities in which the Company owns between 20% and 50%, or in which there are other indicators of significant influence. These investments are generally accounted for using the equity method; those investments in which there is a less than 20% ownership are generally carried at cost. Investments consist of the following (in thousands):
 
    
June 30, 2002
   
December 31, 2001
Trading securities
   
$
280,418
   
$
87,392
Available-for-sale investment securities
   
 
782,711
   
 
998,487
Equity method and other investments:
              
Joint ventures
   
 
63,166
   
 
28,664
Venture capital funds
   
 
21,601
   
 
17,553
Other investments
   
 
40,832
   
 
36,527
    
  
Total investments
   
$
1,188,728
   
$
1,168,623
    
  
 
Included in available-for-sale securities are investments in several companies that are publicly traded and carried at fair value. Unrealized gains related to available-for-sale investments were $1.0 million at June 30, 2002 and $6.9 million at December 31, 2001. Unrealized losses related to available-for-sale investments were $23.5 million at June 30, 2002 and $19.9 million at December 31, 2001.
 
During the quarter ended June 30, 2002, the Company contributed approximately $6.5 million to a related party venture fund, E*TRADE eCommerce Fund, L.P. and $2.3 million to the ArrowPath Fund II, L.P. During the six months ended June 30, 2002, the Company recorded impairment write-downs of approximately $3.1 million associated with a privately-held equity investment and $2.1 million associated with E*TRADE eCommerce Fund, L.P.
 
Joint Ventures
 
In June 1998, the Company entered into a joint venture agreement with SOFTBANK Corporation, a related party, forming E*TRADE Japan K.K. to provide online securities trading services to residents of Japan. As part of its commitment to the joint venture, the Company was required to provide a continuing level of systems support to E*TRADE Japan K.K. In April 2002, the Company entered into a definitive agreement to terminate its systems support obligations and agreed to provide transition services through July 2003. The Company incurred system support costs of $0.9 million in the three months ended June 30, 2002, $2.4 million in the six months ended June 30, 2002, $0.8 million in the three months ended June 30, 2001 and $1.0 million in the six months ended June 30, 2001.

16

Table of Contents
 
In May 2002, the Company purchased 31,250 of newly issued shares in E*TRADE Japan K.K. in exchange for 3.4 million shares of the Company’s common stock in a private transaction, valued based on the fair market value of the Company’s common stock on that day at $30.7 million. Following the transaction, the Company’s ownership in E*TRADE Japan K.K. increased from 29% to 36%.
 
NOTE 11.    RELATED PARTY TRANSACTION
 
As of June 30, 2002, the Company had outstanding advances of $4.5 million to a founder and director of the Company, which were fully repaid by the director as of August 12, 2002. These advances accrued interest at a rate of 3.75% annually (based on the applicable federal rate) and were collateralized by shares of the Company’s common stock currently held in the name of the director. Proceeds from these advances were used as additional collateral for securities of the director.
 
NOTE 12.    LINE OF CREDIT AND OTHER BORROWINGS
 
In November 2001, the Company renewed a $50 million line of credit under an agreement with a bank that expires in October 2002. Utilizations under the line of credit are collateralized by investment securities that are owned by the Company. Borrowings under the line of credit bear interest at 0.35% above LIBOR (2.19% at June 30, 2002). As of June 30, 2002, the Company had less than $1.0 million in a standby letter of credit outstanding under this line.
 
The Company has one installment purchase contract and term loans from financial institutions which are collateralized by equipment owned by the Company. Borrowings under these term loans bear interest at 3.00% to 3.25% above LIBOR (4.84% to 5.09% at June 30, 2002). The Company had approximately $9.5 million outstanding under these loans at June 30, 2002, which is included in accounts payable, accrued and other liabilities.
 
NOTE 13.    OTHER BORROWINGS
 
In June 2002, ETFC formed ETFC Capital Trust V (“ETFCCT V”), a business trust formed solely for the purpose of issuing capital securities, which ETFCCT V sold at par, 15,000 shares of Floating Rate Cumulative Preferred Securities, with a liquidation amount of $1,000 per capital security, for a total of $15.0 million and invested the net proceeds in ETFC’s Floating Rate Junior Subordinated Debentures. These subordinated debentures mature in 2032 and have a variable annual dividend rate at 3.65% above the three-month LIBOR, payable quarterly, beginning in September 2002. The net proceeds were invested in the Bank and used for the Bank’s general corporate purposes, which include funding the Bank’s continued growth.
 
In April 2002, ETFC formed ETFC Capital Trust IV (“ETFCCT IV”), a business trust formed solely for the purpose of issuing capital securities, which ETFCCT IV sold at par, 10,000 shares of Floating Rate MMCapS, with a liquidation amount of $1,000 per capital security, for a total of $10.0 million and invested the net proceeds in ETFC’s Floating Rate Junior Subordinated Debentures. These subordinated debentures mature in 2032 and have a variable annual dividend rate at 3.70% above the six-month LIBOR, payable semi-annually, beginning in October 2002. The net proceeds were invested in the Bank and used for the Bank’s general corporate purposes, which include funding the Bank’s continued growth.
 
NOTE 14.    COLLATERALIZED DEBT OBLIGATION
 
In September 2001, the Company entered into a Warehousing Agreement with a financial advisor for the purpose of acquiring a portfolio of investment grade asset-backed securities (“Collateral”). The financial advisor and the Company intend to transfer this Collateral into one or more newly formed special purpose entities which will sell certain classes of notes to be secured by the Collateral. The terms of the agreement required the Company to make a $10 million deposit which can be applied against any net loss realized by the advisor if

17

Table of Contents
certain defined events occur, which result in the notes not being sold and the Collateral being liquidated; the Company has no liability for net losses in excess of the deposit in the event of liquidation of the Collateral. At June 30, 2002, the financial advisor had purchased $171.1 million of Collateral, which had unrealized gains of $0.3 million at June 30, 2002.
 
NOTE 15.    COMMITMENTS, CONTINGENCIES AND OTHER REGULATORY MATTERS
 
In the ordinary course of its business, E*TRADE Securities engaged in certain stock loan transactions with MJK Clearing, Inc. (“MJK”), involving the lending of Nasdaq-listed common stock of GenesisIntermedia, Inc. (“GENI”) and other securities from MJK to E*TRADE Securities. Subsequently, E*TRADE Securities redelivered the GENI and/or other securities received from MJK to three other broker-dealers: Wedbush Morgan Securities (“Wedbush”), Nomura Securities, Inc. (“Nomura”) and Fiserv Securities, Inc. (“Fiserv”). On September 25, 2001, Nasdaq halted trading in the stock of GENI, which had last traded at a price of $5.90 before the halt. Subsequently, MJK was ordered to cease operations by the SEC.
 
Wedbush, Nomura and Fiserv have commenced separate legal actions against E*TRADE Securities. These actions seek various forms of equitable relief and seek repayment of a total of approximately $60.0 million, plus interest, received by E*TRADE Securities in connection with the GENI and other stock loan transactions. Such amounts are included in deposits paid for securities borrowed and deposits received for securities loaned at June 30, 2002 in the accompanying consolidated balance sheets. E*TRADE Securities believes that the plaintiffs must look to MJK as the debtor for repayment, and that it has defenses in each of these actions and will vigorously defend itself in all matters. E*TRADE Securities is unable to predict the ultimate outcome or the amount of any potential losses.
 
As of June 30, 2002, the Bank had commitments to purchase $273.7 million in fixed rate and $278.2 million in variable rate loans, commitments to originate $509.6 million in fixed rate and $68.9 million in variable rate loans and commitments to sell $181.0 million in mortgage-backed securities. In addition, the Bank had certificates of deposit approximating $2.8 billion scheduled to mature in less than one year. In the normal course of business, the Bank makes various commitments to extend credit and incur contingent liabilities that are not reflected in the accompanying consolidated balance sheets.
 
The Company is a defendant in civil actions arising in the normal course of business. These currently include, among other actions, putative class actions alleging various causes of action for “unfair or deceptive business practices” that were filed against the Company between November 21, 1997 and March 11, 1999, as a result of various systems interruptions that the Company previously experienced. To date, only one of these putative class actions has been certified. The Company believes that these actions are without merit and intends to defend against them vigorously. An unfavorable outcome in any of these matters for which the Company’s pending insurance claims are rejected could harm the Company’s business.
 
The securities and banking industries are subject to extensive regulation under federal, state and applicable international laws. As a result, the Company is required to comply with many complex laws and rules and its ability to so comply is dependent in large part upon the establishment and maintenance of a qualified compliance system. From time to time, the Company has been threatened with, or named as a defendant in, lawsuits, arbitrations and administrative claims involving securities, banking and other matters. The Company is also subject to periodic regulatory audits and inspections. Compliance and trading problems that are reported to regulators such as the SEC, the National Association of Securities Dealers Regulation, Inc. (“NASDR”) or the Office of Thrift Supervision (“OTS”) by dissatisfied customers or others are investigated by such regulators, and may, if pursued, result in formal claims being filed against the Company by customers and/or disciplinary action being taken against the Company by regulators. Any such claims or disciplinary actions that are decided against the Company could harm the Company’s business.

18

Table of Contents
 
The Company maintains insurance coverage in such amounts and with such coverages, deductibles and policy limits as management believes are reasonable and prudent. The principal insurance coverage it maintains covers comprehensive general liability, commercial property damage, hardware/software damage, directors and officers, certain criminal acts against the Company and errors and omissions. The Company believes that such insurance coverage is adequate for the purpose of its business. The Company’s ability to maintain this level of insurance coverage in the future, however, is subject to the availability of affordable insurance in the market place, and world events, including the terrorist attacks of September 11, 2001, may impair the Company’s ability to obtain insurance in the future.
 
NOTE 16.     SHAREOWNERS’ EQUITY
 
Deferred Stock Compensation
 
Amortization of deferred stock compensation was $1.7 million for the three months ended June 30, 2002, $4.6 million for the six months ended June 30, 2002, $2.6 million for the three months ended June 30, 2001 and $4.1 million for the six months ended June 30, 2001.
 
Stock Repurchase
 
During the three months ended June 30, 2002, the Company repurchased approximately 2.7 million shares of common stock for an aggregate purchase price of approximately $15.1 million. These shares were purchased under a multi-year stock buyback program approved by the Company’s Board of Directors in September 2001 authorizing the Company to repurchase up to 50.0 million shares of common stock. In July 2002, the Company purchased approximately 3.4 million shares of its common stock from SOFTBANK Holdings, Inc. in a private transaction at a purchase price of $3.60 per share. Pursuant to the stock buyback program, the Company remains authorized to repurchase up to 13.4 million additional shares, subsequent to the shares purchased in July.
 
NOTE 17.    COMPREHENSIVE INCOME (LOSS)
 
The reconciliation of net income (loss) to comprehensive income (loss) is as follows (in thousands):
 
    
Three Months Ended
June 30,
     
Six Months Ended
June 30,
  
    
2002
     
2001
     
2002
     
2001
  
Net income (loss)
   
$
32,790
 
   
$
(10,195
)
   
$
(243,191
)
   
$
(19,398
)
Changes in other comprehensive income (loss):
                                    
Unrealized loss on available-for-sale securities, net of tax
   
 
(4,309
)
   
 
(19,322
)
   
 
(23,245
)
   
 
(26,673
)
Reclassification of realized (gains) losses on available-for-sale securities, net of tax
   
 
41,883
 
   
 
(1,166
)
   
 
30,907
 
   
 
(21,263
)
Unrealized gain (loss) on derivative instruments, net of tax, and reclassification adjustments (see Note 5)
   
 
(19,272
)
   
 
26,158
 
   
 
(3,711
)
   
 
(24,810
)
Amortization of de-designated and terminated hedges and transition adjustments, net of tax
   
 
(9,363
)
   
 
9,490
 
   
 
(9,100
)
   
 
10,910
 
Cumulative translation adjustments
   
 
5,766
 
   
 
277
 
   
 
5,520
 
   
 
(4,020
)
    
  
  
  
Total comprehensive income (loss)
   
$
47,495
 
   
$
5,242
 
   
$
(242,820
)
   
$
(85,254
)
    
  
  
  

19

Table of Contents
 
NOTE 18.    SEGMENT INFORMATION
 
Segment Information
 
The Company has separated its financial services into four categories: Domestic Retail Brokerage; Banking; Global and Institutional; and Wealth Management and Other. There have been no changes to these categories from fiscal 2001. As the Wealth Management and Other operations business represents emerging activities which are not currently material to the consolidated results and has characteristics comparable to the offerings of other retail brokerage firms, management has aggregated Wealth Management and Other with Domestic Retail Brokerage to form one of three reportable segments. Corporate administration costs are included in Domestic Retail Brokerage and Other.
 
Financial information for the Company’s reportable segments is presented in the table below, and the totals are equal to the Company’s consolidated amounts as reported in the unaudited condensed consolidated financial statements (in thousands):
 
    
Domestic Retail
Brokerage &
Other
     
Banking
   
Global and
Institutional
     
Total
  
Three Months Ended June 30, 2002:
                                  
Interest income—net of interest expense
   
$
45,598
 
   
$
53,572
   
$
2,288
 
   
$
101,458
 
Non-interest revenue—net of provision for loan losses
   
 
129,541
 
   
 
47,361
   
 
37,702
 
   
 
214,604
 
    
  
  
  
Net revenues
   
$
175,139
 
   
$
100,933
   
$
39,990
 
   
$
316,062
 
    
  
  
  
Operating income (loss)
   
$
34,686
 
   
$
43,886
   
$
(4,300
)
   
$
74,272
 
Three Months Ended June 30, 2001:
                                  
Interest income—net of interest expense
   
$
51,920
 
   
$
38,286
   
$
2,133
 
   
$
92,339
 
Non-interest revenue—net of provision for loan losses
   
 
138,185
 
   
 
40,576
   
 
37,079
 
   
 
215,840
 
    
  
  
  
Net revenues
   
$
190,105
 
   
$
78,862
   
$
39,212
 
   
$
308,179
 
    
  
  
  
Operating income (loss)
   
$
(4,369
)
   
$
22,373
   
$
(10,547
)
   
$
7,457
 
Six Months Ended June 30, 2002:
                                  
Interest income—net of interest expense
   
$
92,723
 
   
$
107,389
   
$
4,321
 
   
$
204,433
 
Non-interest revenue—net of provision for loan losses
   
 
266,698
 
   
 
100,660
   
 
75,148
 
   
 
442,506
 
    
  
  
  
Net revenues
   
$
359,421
 
   
$
208,049
   
$
79,469
 
   
$
646,939
 
    
  
  
  
Operating income (loss)
   
$
32,520
 
   
$
95,338
   
$
(8,719
)
   
$
119,139
 
Cumulative effect of accounting change
   
$
(6,823
)
   
$
—  
   
$
(292,590
)
   
$
(299,413
)
Six Months Ended June 30, 2001:
                                  
Interest income—net of interest expense
   
$
111,568
 
   
$
74,605
   
$
4,495
 
   
$
190,668
 
Non-interest revenue—net of provision for loan losses
   
 
296,879
 
   
 
75,871
   
 
74,342
 
   
 
447,092
 
    
  
  
  
Net revenues
   
$
408,447
 
   
$
150,476
   
$
78,837
 
   
$
637,760
 
    
  
  
  
Operating income (loss)
   
$
(12,550
)
   
$
46,833
   
$
(23,900
)
   
$
10,383
 
As of June 30, 2002:
                                  
Segment assets
   
$
3,507,367
 
   
$
14,627,858
   
$
691,692
 
   
$
18,826,917
 
As of December 31, 2001:
                                  
Segment assets
   
$
4,272,345
 
   
$
13,458,433
   
$
441,636
 
   
$
18,172,414
 
 
No single customer accounted for greater than 10% of total revenues in the three and six months ended June 30, 2002 or 2001.

20

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NOTE 19.    REGULATORY REQUIREMENTS
 
E*TRADE Securities is subject to the Uniform Net Capital Rule (the “Rule”) under the Securities Exchange Act of 1934 administered by the SEC and the NASDR, which requires the maintenance of minimum net capital. E*TRADE Securities has elected to use the alternative method permitted by the Rule, which requires that E*TRADE Securities maintain minimum net capital equal to the greater of $250,000 or two percent of aggregate debit balances arising from customer transactions, as defined. E*TRADE Securities had amounts in relation to the Rule as follows (dollars in thousands):
 
    
June 30, 2002
     
December 31, 2001
  
Net capital
   
$
125,535
 
   
$
240,141
 
Percentage of aggregate debit balances
   
 
9
%
   
 
14
%
Required net capital
   
$
27,775
 
   
$
34,208
 
Excess net capital
   
$
97,760
 
   
$
205,933
 
 
Under the alternative method, a broker-dealer may not repay subordinated borrowings, pay cash dividends or make any unsecured advances or loans to its parent or employees if such payment would result in net capital of less than 5% of aggregate debit balances or less than 120% of its minimum dollar amount requirement. In January 2002, E*TRADE Securities paid a dividend to E*TRADE Group in the amount of $50 million.
 
The table below summarizes the minimum capital requirements for the Company’s other U.S. broker-dealer subsidiaries (in thousands):
 
    
June 30, 2002
   
December 31, 2001
    
Required Net Capital
   
Net Capital
   
Excess Net Capital
   
Required Net Capital
   
Net Capital
   
Excess Net Capital
E*TRADE Institutional Securities, Inc.
   
$
271
   
$
7,104
   
$
6,833
   
$
250
   
$
6,407
   
$
6,157
E*TRADE Global Asset Management, Inc.
   
$
100
   
$
20,865
   
$
20,765
   
$
282
   
$
8,999
   
$
8,717
E*TRADE Canada Securities Corporation
   
$
100
   
$
260
   
$
160
   
$
100
   
$
283
   
$
183
GVR Company, LLC
   
$
1,000
   
$
4,012
   
$
3,012
   
$
1,000
   
$
4,100
   
$
3,100
Dempsey & Company, LLC
   
$
549
   
$
17,279
   
$
16,730
   
$
802
   
$
8,787
   
$
7,985
Tradescape Securities, LLC
   
$
100
   
$
148
   
$
48
   
$
N/A
   
$
N/A
   
$
N/A
Momentum Securities, LLC
   
$
688
   
$
906
   
$
218
   
$
N/A
   
$
N/A
   
$
N/A
E*TRADE Marquette Securities, Inc.
   
$
N/A
   
$
N/A
   
$
N/A
   
$
250
   
$
532
   
$
282
Web Street and subsidiary
   
$
N/A
   
$
N/A
   
$
N/A
   
$
250
   
$
796
   
$
546
 
In June 2002, the Company discovered that Momentum Securities, LLC (“Momentum”) was deficient on its net capital for the month ending May 31, 2002. This deficiency was prior to the Company’s acquisition of Momentum effective June 3, 2002. Since its acquisition of Momentum, the Company has contributed a total of approximately $8 million to Momentum so that it may meet all of its operational and capital requirements.
 
In April 2002, the Company withdrew and closed E*TRADE Marquette Securities, Inc. and Web Street and subsidiary broker-dealers and has consolidated the activities into the Company’s other broker-dealer subsidiaries. The Company’s broker-dealer subsidiaries, located in Canada, Europe and South East Asia, have various and differing capital requirements, all of which were met at June 30, 2002 and December 31, 2001. At June 30, 2002, these companies had an aggregate net capital of $79.4 million, required net capital of $28.3 million and excess net capital of $51.1 million. At December 31, 2001, these companies had an aggregate net capital of $69.7 million, required net capital of $29.7 million and excess net capital of $40.0 million.
 
The Bank is also subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory—and possibly additional discretionary—actions by regulators that, if undertaken, could have a direct material effect on the Bank’s

21

Table of Contents
financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
 
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of Total and Tier I Capital to risk-weighted assets, Core Capital to adjusted tangible assets and Tangible Capital to tangible assets. Management believes that, as of June 30, 2002 the Bank has met all capital adequacy requirements to which it was subject. As of June 30, 2002 and December 31, 2001, the OTS categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum Total and Tier I Capital to risk-weighted assets and Core Capital to adjusted tangible assets as set forth in the following table. There are no conditions or events since that notification that management believes have changed the institution’s category. Events beyond management’s control, such as fluctuations in interest rates or a downturn in the economy in areas in which the Bank’s loans or securities are concentrated, could adversely affect future earnings and consequently, the Bank’s ability to meet its future capital requirements.
 
The Bank’s required and actual capital amounts and ratios are presented in the table below (dollars in thousands):
 
    
Actual
   
Required for Capital Adequacy Purposes
   
Required to be Well Capitalized Under Prompt Corrective Action Provisions
  
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
As of June 30, 2002:
                                    
Total Capital to risk-weighted assets
   
$
914,721
   
12.46%
   
>$
587,084
   
>8.0%
   
>$
733,855
   
>10.0%
Tier I Capital to risk-weighted assets
   
$
899,117
   
12.25%
   
 
N/A
   
N/A
   
>$
440,313
   
>6.0%
Core Capital to adjusted tangible
assets
   
$
899,117
   
6.19%
   
>$
581,307
   
>4.0%
   
>$
726,633
   
>5.0%
Tangible Capital to tangible assets
   
$
899,117
   
6.19%
   
>$
217,990
   
>1.5%
   
 
N/A
   
N/A
As of December 31, 2001:
                                    
Total Capital to risk-weighted assets
   
$
836,866
   
11.52%
   
>$
580,986
   
>8.0%
   
>$
726,233
   
>10.0%
Tier I Capital to risk-weighted assets
   
$
819,367
   
11.28%
   
 
N/A
   
N/A
   
>$
435,740
   
>6.0%
Core Capital to adjusted tangible
assets
   
$
819,367
   
6.07%
   
>$
539,671
   
>4.0%
   
>$
674,588
   
>5.0%
Tangible Capital to tangible assets
   
$
819,367
   
6.07%
   
>$
202,377
   
>1.5%
   
 
N/A
   
N/A

22

Table of Contents
 
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Forward-Looking Statements
 
Statements made in this document, other than statements of historical information, are forward-looking statements that are made pursuant to the safe harbor provisions of Section 21E of the Securities Exchange Act of 1934. These forward-looking statements may sometimes be identified by words such as “expect”, “may”, “looking forward”, “we plan”, “we believe”, “are planned”, “could be” and “currently anticipate”. Although we believe these statements, as well as other oral and written forward-looking statements made by us or on behalf of E*TRADE Group, Inc. from time to time, to be true and reasonable, we can give no assurance that these plans, intentions or expectations will be achieved. Actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements. Important factors that could cause actual results to differ materially from our forward-looking statements are set forth in our other filings with the SEC, and in this document under the heading “Risk Factors”, beginning in the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. We caution that the risks and factors discussed below and in such filings are not exclusive. We do not undertake to update any forward-looking statement that may be made from time to time by or on behalf of E*TRADE.
 
Critical Accounting Policies and Estimates
 
The preparation of our financial results of operations and financial position require us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and related notes for the period presented, and actual results could differ from our estimates. The critical accounting estimates, which are both important to the portrayal of our financial condition and which require complex, subjective judgments, are accrued restructuring costs, determination of the allowance for loan losses, the classification and carrying value of investments, accounting for financial derivatives, the recognition of deferred tax assets and the valuation of goodwill; these areas are more fully described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2001.
 
Results of Operations
 
Key Performance Indicators
 
The following tables set forth several key performance indicators, including the operations of Tradescape since the date of acquisition on June 3, 2002, which management utilizes in measuring our performance and in explaining the results of our operations for the comparative three and six months presented and as of June 30, 2002 and December 31, 2001 (dollars in thousands except cost per net new account and average commission per global brokerage transaction):
 
    
June 30,
2002
   
December 31,
2001
     
Percentage
Change
  
Active global brokerage accounts(1)(2)
   
 
3,648,234
   
 
3,511,941
     
4
%
Active banking accounts(3)
   
 
503,830
   
 
490,913
     
3
%
    
  
        
Total active accounts at period end
   
 
4,152,064
   
 
4,002,854
     
4
%
    
  
        
Total assets in global brokerage accounts(2)
   
$
38,012,376
   
$
44,764,197
     
(15
)%
Total deposits in banking accounts
   
 
8,334,718
   
 
8,082,859
     
3
%
    
  
        
Total assets/deposits in customer accounts at period end
   
$
46,347,094
   
$
52,847,056
     
(12
)%
    
  
        

23

Table of Contents
 
    
Three Months Ended
June 30,
   
Percentage
Change
     
Six Months Ended
June 30,
     
Percentage
Change
  
    
2002
     
2001
      
2002
   
2001
     
Net new global brokerage accounts(1)(2)
   
 
50,018
 
   
 
73,450
   
(32
)%
   
 
136,293
   
 
197,414
     
(31
)%
Net new banking accounts(3)
   
 
(15,324
)
   
 
30,039
   
(151
)%
   
 
12,917
   
 
72,187
     
(82
)%
    
  
         
  
        
Total net new accounts
   
 
34,694
 
   
 
103,489
   
(66
)%
   
 
149,210
   
 
269,601
     
(45
)%
    
  
         
  
        
Cost per net new account
   
$
496
 
   
$
232
   
114
%
   
$
324
   
$
328
     
(1
)%
Total global brokerage transactions(2)
   
 
6,954,474
 
   
 
7,424,353
   
(6
)%
   
 
13,099,139
   
 
15,834,366
     
(17
)%
    
  
         
  
        
Daily average global brokerage transactions(2)
   
 
108,664
 
   
 
117,847
   
(8
)%
   
 
105,638
   
 
126,675
     
(17
)%
    
  
         
  
        
Average commission per global brokerage transaction(2)
   
$
10.26
 
   
$
13.49
   
(24
)%
   
$
11.75
   
$
13.64
     
(14
)%
    
  
         
  
        
(1)
 
Global brokerage accounts are considered active if the account has a positive asset balance, or if a trade has been made in the account in the past six months or if the account was opened in connection with a corporate employee stock benefit program. Customers may have separate or multiple accounts for each relationship they maintain with us, including separate or multiple brokerage and banking accounts.
(2)
 
Global brokerage account, transaction and asset data includes domestic and international information.
(3)
 
Bank deposit accounts are considered active if a customer has made an initial deposit and the account is not considered abandoned or dormant under applicable Federal and State laws, and the account has not been closed. Bank loan accounts are considered active if the Company owns marketing rights to the account or customer.
 
The following table sets forth the increases and decreases in average customer margin balances, average customer money market fund balances, average stock borrow balances, average stock loan balances and average customer credit balances for the three and six months indicated (dollars in millions):
 
    
Three Months Ended
June 30,
     
Percentage
Change
     
Six Months Ended
June 30,
     
Percentage
Change
  
    
    2002    
   
    2001    
        
    2002    
   
    2001    
     
Average customer margin balances
   
$
1,451
   
$
2,057
     
(29
)%
   
$
1,496
   
$
2,486
     
(40
)%
Average customer money market fund balances
   
$
7,917
   
$
8,634
     
(8
)%        
   
$
8,183
   
$
8,615
     
(5
)%
Average stock borrow balances
   
$
245
   
$
1,954
     
(87
)%    
   
$
250
   
$
1,741
     
(86
)%
Average stock loan balances
   
$
389
   
$
2,321
     
(83
)%
   
$
452
   
$
2,457
     
(82
)%
Average customer credit balances
   
$
1,426
   
$
1,304
     
9
%
   
$
1,463
   
$
1,315
     
11
%

24

Table of Contents
 
The following table sets forth the components of both gross and net revenues and percentage change information related to certain items on our consolidated statements of operations for the periods indicated (dollars in thousands):
 
    
Three Months Ended
June 30,
       
Percentage
Change
     
Six Months Ended
June 30,
       
Percentage
Change
  
    
2002
     
2001
          
2002
     
2001
       
Brokerage revenues:
                                                      
Commission
   
$
71,352
 
   
$
100,173
 
     
(29
)%
   
$
153,879
 
   
$
215,998
 
     
(29
)%
Principal transactions
   
 
52,092
 
   
 
31,441
 
     
66
%
   
 
107,407
 
   
 
62,613
 
     
72
%
Other brokerage-related
   
 
43,799
 
   
 
43,650
 
     
0
%
   
 
80,560
 
   
 
92,610
 
     
(13
)%
Interest income
   
 
50,975
 
   
 
80,718
 
     
(37
)%
   
 
104,026
 
   
 
181,463
 
     
(43
)%
Interest expense
   
 
(3,089
)
   
 
(26,665
)
     
(88
)%
   
 
(6,982
)
   
 
(65,400
)
     
(89
)%
    
  
           
  
        
Net brokerage revenues
   
 
215,129
 
   
 
229,317
 
     
(6
)%
   
 
438,890
 
   
 
487,284
 
     
(10
)%
    
  
           
  
        
Banking revenues:
                                                      
Gain on sales of originated loans
   
 
22,613
 
   
 
24,871
 
     
(9
)%
   
 
47,288
 
   
 
34,055
 
     
39
%
Gain on sale of loans held-for-sale and securities—net
   
 
17,054
 
   
 
8,314
 
     
105
%
   
 
38,676
 
   
 
27,424
 
     
41
%
Other banking-related
   
 
12,077
 
   
 
9,047
 
     
33
%
   
 
22,461
 
   
 
17,491
 
     
28
%
Interest income
   
 
191,424
 
   
 
217,797
 
     
(12
)%
   
 
394,092
 
   
 
434,482
 
     
(9
)%
Interest expense
   
 
(137,852
)
   
 
(179,511
)
     
(23
)%
   
 
(286,703
)
   
 
(359,877
)
     
(20
)%
Provision for loan losses
   
 
(4,383
)
   
 
(1,656
)
     
165
%
   
 
(7,765
)
   
 
(3,099
)
     
151
%
    
  
           
  
        
Net banking revenues
   
 
100,933
 
   
 
78,862
 
     
28
%
   
 
208,049
 
   
 
150,476
 
     
38
%
    
  
           
  
        
Total net revenues
   
$
316,062
 
   
$
308,179
 
     
3
%
   
$
646,939
 
   
$
637,760
 
     
1
%
    
  
           
  
        
 
Revenues
 
Beginning in January 2002, we changed our presentation of revenue from that previously presented; however, no changes to our accounting policies or methods were made. Under the new format, net brokerage revenues consist of commissions, principal transactions, other brokerage-related revenues, interest income and interest expense. Commissions include domestic and international transaction revenues. Previously, international transactions were included under the caption “global and institutional.” Principal transactions include revenues from institutional activities, previously included in global and institutional, and market-making activities, previously included in other revenues. Other brokerage-related revenues include payments for order flow, Business Solutions Group revenue, advertising revenue, mutual fund revenue and fees for brokerage-related services, including account maintenance fees and order handling fees. Except for payments for order flow, which was previously included in transaction revenues, other brokerage-related items were included in other revenues. Net banking revenues consist of gain on sale of originated loans, gain on sale of loans held-for-sale and securities—net, other banking-related revenues, interest income, interest expense and provision for loan losses. Other banking-related revenues are primarily comprised of automated teller machine revenues.
 
Total net revenues increased 3% for the three months ended June 30, 2002 and 1% for the six months ended June 30, 2002 from the comparable periods in 2001. Net brokerage revenues decreased 6% for the three months June 30, 2002 and 10% for the six months ended June 30, 2002 from the comparable periods in 2001. The decrease in brokerage revenues for both periods was mainly due to decreases in commission revenues, other brokerage-related revenues and net interest income, offset by an increase in principal transactions reflecting our acquisition of Dempsey in October 2001. Net banking revenues increased 28% for the three months ended  June 30, 2002 and 38% for the six months ended June 30, 2002 from the comparable periods in 2001. The increase in net banking revenues for both periods was mainly due to increases in net interest income, gain on sale of loans held-for-sale and securities—net and other banking-related revenues.

25

Table of Contents
 
Brokerage Revenues
 
Commission revenues, which are earned as customers execute securities transactions, decreased 29% for the three months and six months ended June 30, 2002 from the comparable periods in 2001. These revenues are primarily affected by global brokerage transaction volume, the average commission per global brokerage transaction and the transaction mix.
 
Daily average global brokerage transactions decreased 8% for the three months ended June 30, 2002 and 17% for the six months ended June 30, 2002 from the comparable periods in 2001, largely reflective of a continuing market decline. A decrease in the average commission per global brokerage transaction from $13.49 for the three months ended June 30, 2001 to $10.26 for the three months ended June 30, 2002 also affected the decrease in commission revenues. For the six months ended June 30, 2002, as compared to the comparable period in 2001, the average commission per global brokerage transaction decreased 14% from $13.64 for the six months ended June 30, 2001 to $11.75 for the six months ended June 30, 2002. Contributing to the decrease in commissions per global brokerage transaction is the acquisition of Tradescape which alone provided approximately 83,000 average daily global transactions for the month of June 2002, and typically has lower commissions per transaction. The decrease in commission revenues was also affected by transaction mix, with option transactions, which have higher commissions than equity transactions, representing a smaller percentage of total transactions for the three and six months ended June 30, 2002 compared to the same periods in 2001.
 
Principal transactions, which comprise our institutional and market-making revenues, increased 66% for the three months ended June 30, 2002 and 72% for the six months ended June 30, 2002, from the comparable periods in 2001. These increases are primarily due to market-making revenues from Dempsey. There were no revenues from market-making activities prior to our acquisition of Dempsey in October 2001.
 
Other brokerage-related revenues, which are mainly comprised of payments for order flow, Business Solutions Group revenue, advertising revenue, mutual fund revenues and fees for brokerage-related services, including account maintenance fees and order handling fees, remained flat for the three months ended June 30, 2002 and decreased 13% for the six months ended June 30, 2002, from the comparable periods in 2001. The decrease for the six months ended June 30, 2001 is primarily due to a decrease in payment for order flow revenue partially offset by an increase in other brokerage-related fees. The decrease in payment for order flow revenue is primarily due to competitive forces and the advent of decimalization in the major market exchanges beginning in January 2001 and implemented by Nasdaq in March 2001. Further, following the acquisition of Dempsey in October 2001, revenues from order flow executed through Dempsey is eliminated in our consolidation of operating results.
 
Interest income from brokerage-related activities is primarily comprised of interest earned by our brokerage subsidiaries on credit extended to customers to finance their purchases of securities on margin and fees on customer assets invested in money market accounts. Brokerage interest income decreased 37% for the three months ended June 30, 2002 and 43% for the six months ended June 30, 2002, from the comparable periods in 2001. The decrease in brokerage interest income primarily reflects the decrease in average customer margin balances, which decreased 29% for the three months ended June 30, 2002 and 40% for the six months ended June 30, 2002. The continued market decline over the past year and the economic recession has reduced borrowing on margin by customers as a means of leveraging their investments.
 
Interest expense from brokerage-related activities is primarily comprised of interest paid to customers on certain credit balances, interest paid to banks and interest paid to other broker-dealers through our brokerage subsidiary’s stock loan program. Brokerage interest expense decreased 88% for the three months ended June 30, 2002 and 89% for the six months ended June 30, 2002, from the comparable periods in 2001. The decrease in brokerage interest expense primarily reflects an overall decrease in average customer credit rates and average stock loan balances, which decreased 83% for the three months ended June 30, 2002 and 82% for the six months ended June 30, 2002, from the comparable periods in 2001.

26

Table of Contents
 
Banking Revenues
 
Gain on sales of originated loans decreased 9% for the three months ended June 30, 2002 and increased 39% for the six months ended June 30, 2002, from the comparable periods in 2001. The decrease for the three months ended June 30, 2002, is due to a decreased level of volume of originations as compared to the prior year quarter. The increase for the six months ended June 30, 2002, is due to an increased level of volume of originations in the March 2002 quarter as compared to the prior year quarter, primarily as a result of our acquisition of E*TRADE Mortgage in February 2001. The March 2002 quarter benefited from a full three months of activity as compared to two months in the March 2001 quarter.
 
Gain on sale of loans held-for-sale and securities-net consist primarily of gains on sales of Bank loans held-for-sale, available-for-sale mortgage-backed and investment securities, trading activity, impairment of Bank securities and gains and losses related to market value adjustments and sales of derivative financial instruments. Gains on sales of loans held-for-sale and securities-net increased 105% for the three months ended June 30, 2002 and 41% for the six months ended June 30, 2002, from the comparable periods in 2001. These changes relate primarily to gains on sales of mortgage-backed and investment securities, which increased 51% for the three months ended June 30, 2002, from the prior year quarter. In addition, losses on derivative financial instruments, which occurred after discontinuance of hedge accounting, decreased 76% for the three months ended June 30, 2002, from the prior year quarter and 123% for the six months ended June 30, 2002 to the prior six-month period. Losses on derivative financial instrument sales decreased to $3.1 million for the three months ended June 30, 2002, from $13.0 million for the prior year quarter. For the six months ended June 30, 2002, gains on derivative financial instruments were $4.0 million compared to losses of $17.3 million in the prior year six-month period. The increases noted above were partially offset by a decrease in gains on sales of Bank loans purchased from correspondents which decreased 101% for the three months ended June 30, 2002 and 56% for the six months ended June 30, 2002, from the comparable periods in 2001. As of June 30, 2002, we held approximately $14 million of corporate bonds issued by the Qwest Corporation (“Qwest”), as part of our investment portfolio. As of August 5, 2002, the market value of this investment was $11.6 million, as determined using quoted market prices. We continue to monitor any developments related to Qwest’s ability to repay these bonds in accordance with their contractual repayment terms.
 
Other banking-related revenues are comprised of ATM fees and miscellaneous fees imposed on deposit accounts. Other banking-related revenues increased 33% for the three months ended June 30, 2002 and 28% for the six months ended June 30, 2002, from the comparable periods in 2001. These increases are due to higher ATM transaction surcharge volume, primarily caused by a 14% increase in the number of ATMs in our network from June 30, 2001 to June 30, 2002.
 
Interest income from banking-related activities reflects interest earned on assets, consisting primarily of loans receivable and mortgage-backed securities. Banking interest income decreased 12% for the three months ended June 30, 2002 and 9% for the six months ended June 30, 2002, from the comparable periods in 2001. Decreases in banking interest income reflect decreases in average yield, partially offset by increases in average interest-earning banking asset balances and increase in higher yielding interest-earning assets such as our increase in our automobile loan portfolio. Average interest-earning banking assets increased 8% for the three months ended June 30, 2002 and 12% for the six months ended June 30, 2002, from the comparable periods in 2001. The average yield on interest-earning banking assets decreased to 5.81% for the three months ended June 30, 2002 from 7.14% for the three months ended June 30, 2001 and decreased to 5.91% for the six months ended June 30, 2002 from 7.30% for the six months ended June 30, 2001.
 
Interest expense from banking-related activities is incurred through interest-bearing banking liabilities that include customer deposits, advances from the FHLB and other borrowings. Banking interest expense decreased 23% for the three months ended June 30, 2002 and 20% for the six months ended June 30, 2002, from the comparable periods in 2001. The decrease in banking interest expense reflects a decrease in the average cost of borrowings partially offset by an increase in average interest-bearing banking liability balances. Average interest-bearing banking liability balances increased 10% for the three months ended June 30, 2002 and 12% for the six

27

Table of Contents
months ended June 30, 2002, from the comparable periods in 2001. The average cost of borrowings decreased to 4.37% for the three months ended June 30, 2002 from 6.26% for the three months ended June 30, 2001 and decreased to 4.58% for the six months ended June 30, 2002 from 6.44% for the six months ended June 30, 2001. Net interest spread increased from 0.88% for the three months ended June 30, 2001 to 1.44% for the three months ended June 30, 2002 and an increase from 0.86% for the six months ended June 30, 2001 to 1.33% for the six months ended June 30, 2002. This increase is the result of several initiatives put in place to improve overall spreads. The Bank has purchased assets which have higher yields, evidenced by the growth of its automobile loan portfolio to $2.1 billion and the home equity loan portfolio to $124.0 million. Additionally, the net interest spread also increased because the Bank’s funding costs decreased because of a shift in the structure of our deposit base from time deposits to transactional accounts that carry a lower cost of funds than certificates of deposits. Decreases in wholesale funding rates also contributed to the decrease in the Bank’s funding costs.
 
The following tables present average balance data and income and expense data for our banking operations and the related interest yields and rates for the three and six months ended June 30, 2002 and 2001. The tables also present information with respect to net interest margin, an indicator of profitability. Another indicator of profitability is net interest spread, which is the difference between the weighted average yield earned on interest-earning banking assets and weighted average rate paid on interest-bearing banking liabilities (dollars in thousands):
 
   
Three Months Ended
June 30, 2002
    
Three Months Ended
June 30, 2001
  
   
Average
Balance
  
Interest
Income/
Expense
   
Average
Annualized
Yield/Cost
    
Average
Balance
  
Interest
Income/
Expense
   
Average
Annualized
Yield/Cost
  
Interest-earning banking assets:
                                      
Loans receivable, net
  
$
7,112,457
  
$
112,890
   
6.35
%
  
$
6,787,799
  
$
127,975
   
7.54
%
Interest-bearing deposits
  
 
160,498
  
 
996
   
2.49
%
  
 
213,246
  
 
2,855
   
5.37
%
Mortgage-backed and related available-for-sale securities
  
 
4,733,777
  
 
63,324
   
5.35
%
  
 
3,879,478
  
 
63,431
   
6.54
%
Available-for-sale investment securities
  
 
939,294
  
 
12,137
   
5.21
%
  
 
1,190,537
  
 
21,938
   
7.37
%
Investment in FHLB stock
  
 
80,482
  
 
704
   
3.51
%
  
 
65,175
  
 
1,049
   
6.46
%
Trading securities
  
 
158,716
  
 
1,373
   
3.46
%
  
 
70,028
  
 
549
   
3.14
%
   
 
        
 
      
Total interest-earning banking assets
  
 
13,185,224
  
$
191,424
   
5.81
%
  
 
12,206,263
  
$
217,797
   
7.14
%
         
              
      
Non-interest-earning banking assets
  
 
569,239
               
 
534,732
             
   
              
            
Total banking assets
  
$
13,754,463
               
$
12,740,995
             
   
              
            
Interest-bearing banking liabilities:
                                      
Retail deposits
  
$
8,570,648
  
$
86,517
   
4.05
%
  
$
6,919,219
  
$
107,441
   
6.22
%
Brokered callable certificates of deposit
  
 
83,801
  
 
633
   
3.03
%
  
 
26,628
  
 
384
   
5.79
%
FHLB advances
  
 
856,476
  
 
13,804
   
6.38
%
  
 
1,281,064
  
 
20,334
   
6.28
%
Other borrowings
  
 
3,133,854
  
 
36,898
   
4.66
%
  
 
3,278,114
  
 
51,352
   
6.20
%
   
 
        
 
      
Total interest-bearing banking liabilities
  
 
12,644,779
  
$
137,852
   
4.37
%
  
 
11,505,025
  
$
179,511
   
6.26
%
         
              
      
Non-interest bearing banking liabilities
  
 
349,805
               
 
514,466
             
   
              
            
Total banking liabilities
  
 
12,994,584
               
 
12,019,491
             
Total banking shareowner’s equity
  
 
759,879
               
 
721,504
             
   
              
            
Total banking liabilities and shareowner’s equity
  
$
13,754,463
               
$
12,740,995
             
   
              
            
Excess of interest-earning banking assets over
interest-bearing banking liabilities/net interest income
  
$
540,445
  
$
53,572
         
$
701,238
  
$
38,286
       
   
 
        
 
      
Net interest spread
               
1.44
%
               
0.88
%
                
              
Net interest margin (net yield on interest-earning banking assets)
               
1.63
%
               
1.26
%
                
              
Ratio of interest-earning banking assets to interest-bearing banking liabilities
               
104.27
%
               
106.10
%
                
              
Return on average total banking assets
               
0.70
%
               
0.31
%
                
              
Return on average banking equity
               
12.69
%
               
5.44
%
                
              
Average equity to average total banking assets
               
5.52
%
               
5.97
%
                
              

28

Table of Contents
 
    
Six Months Ended
June 30, 2002
     
Six Months Ended
June 30, 2001
  
    
Average
Balance
   
Interest
Income/
Expense
   
Average
Annualized
Yield/Cost
     
Average
Balance
   
Interest
Income/
Expense
   
Average
Annualized
Yield/Cost
  
Interest-earning banking assets:
                                          
Loans receivable, net
   
$
7,554,742
   
$
245,276
   
6.49
%
   
$
6,252,358
   
$
239,317
   
7.66
%
Interest-bearing deposits
   
 
234,419
   
 
2,684
   
2.31
%
   
 
191,440
   
 
5,820
   
6.13
%
Mortgage-backed and related available-for-sale securities
   
 
4,358,476
   
 
116,111
   
5.33
%
   
 
4,338,892
   
 
148,869
   
6.86
%
Available-for-sale investment securities
   
 
1,030,846
   
 
26,455
   
5.17
%
   
 
953,966
   
 
35,102
   
7.36
%
Investment in FHLB stock
   
 
69,559
   
 
1,843
   
5.34
%
   
 
74,216
   
 
2,539
   
6.90
%
Trading securities
   
 
106,525
   
 
1,723
   
3.23
%
   
 
99,250
   
 
2,835
   
5.71
%
    
  
         
  
      
Total interest-earning banking assets
   
 
13,354,567
   
$
394,092
   
5.91
%
   
 
11,910,122
   
$
434,482
   
7.30
%
           
                
      
Non-interest-earning banking assets
   
 
574,106
                 
 
405,417
              
    
                
             
Total banking assets
   
$
13,928,673
                 
$
12,315,539
              
    
                
             
Interest-bearing banking liabilities:
                                          
Retail deposits
   
$
8,489,022
   
$
180,987
   
4.30
%
   
$
6,554,078
   
$
207,509
   
6.38
%
Brokered callable certificates of deposit
   
 
52,207
   
 
758
   
2.93
%
   
 
58,956
   
 
1,809
   
6.19
%
FHLB advances
   
 
890,167
   
 
28,482
   
6.36
%
   
 
1,452,242
   
 
47,933
   
6.56
%
Other borrowings
   
 
3,217,448
   
 
76,476
   
4.73
%
   
 
3,210,668
   
 
102,626
   
6.36
%
    
  
         
  
      
Total interest-bearing banking liabilities
   
 
12,648,844
   
$
286,703
   
4.58
%
   
 
11,275,944
   
$
359,877
   
6.44
%
           
                
      
Non-interest bearing banking liabilities
   
 
537,218
                 
 
352,735
              
    
                
             
Total banking liabilities
   
 
13,186,062
                 
 
11,628,679
              
Total banking shareowner’s equity
   
 
742,611
                 
 
686,860
              
    
                
             
Total banking liabilities and shareowner’s equity
   
$
13,928,673
                 
$
12,315,539
              
    
                
             
Excess of interest-earning banking assets over
interest-bearing banking liabilities/net interest income
   
$
705,723
   
$
107,389
          
$
634,178
   
$
74,605
       
    
  
         
  
      
Net interest spread
                 
1.33
%
                 
0.86
%
                  
                
Net interest margin (net yield on interest-earning banking assets)
                 
1.61
%
                 
1.26
%
                  
                
Ratio of interest-earning banking assets to interest-bearing banking liabilities
                 
105.58
%
                 
105.62
%
                  
                
Return on average total banking assets
                 
0.78
%
                 
0.37
%
                  
                
Return on average banking equity
                 
14.58
%
                 
6.60
%
                  
                
Average equity to average total banking assets
                 
5.33
%
                 
5.97
%
                  
                
 
Loans Receivable and Provision for Loan Losses
 
The provision for loan losses recorded reflects adjustments in our allowance for loan losses based upon management’s review and assessment of the risk in our loan portfolio. The provision for loan losses was $4.4 million for the three months ended June 30, 2002, $7.8 million for the six months ended June 30, 2002, $1.7 million for the three months ended June 30, 2001 and $3.1 million for the six months ended June 30, 2001. The increase in the provision for loan losses primarily reflects the growth in and composition of our Banking loan portfolio as well as the Bank’s decision to invest a greater portion of its assets in loans with higher yields, and therefore, increased credit risk, such as automobile loans. As of June 30, 2002, the total loan loss allowance was $15.7 million, or 0.22% of total loans held-for-investment and 66.5% of total non-performing loans of $23.6 million. As of December 31, 2001, the total loan loss allowance was $19.9 million, or 0.31% of total loans held-for-investment and 96.1% of total non-performing loans of $20.7 million. The decrease in the loan loss allowance as a percentage of total held-for-investment loans outstanding relates to two factors. The

29

Table of Contents
December 31, 2001 allowance for loan losses included approximately $4.7 million of purchased allowance for loan losses recorded in the fourth quarter of 2001 related to the purchase of an automobile portfolio. During the six months ended June 30, 2002, the Company had significant charge-offs against the recorded allowance for the acquired delinquent loans. Secondly, the decrease is reflective of a large automobile loan portfolio acquisition made during the three months ended June 30, 2002. The pool consisted of newly originated loans, underwritten to high FICO score standards.
 
The following table presents information concerning our banking loan portfolio, by type of loan, as of June 30, 2002 and December 31, 2001 (dollars in thousands):
 
    
June 30, 2002
  
    
Held-for-
Investment
     
Held-for- Sale
     
Total Loans
  
Real estate loans:
                           
One- to four-family
   
$
4,926,119
 
   
$
542,471
 
   
$
5,468,590
 
Multi-family
   
 
111
 
   
 
—  
 
   
 
111
 
Commercial
   
 
13,452
 
   
 
—  
 
   
 
13,452
 
Mixed-use
   
 
554
 
   
 
—  
 
   
 
554
 
Consumer and other loans:
                           
Automobiles, mobile homes and recreational vehicles
   
 
2,086,904
 
   
 
—  
 
   
 
2,086,904
 
Home equity lines of credit and second mortgage loans
   
 
160,687
 
   
 
103
 
   
 
160,790
 
Other
   
 
4,510
 
   
 
—  
 
   
 
4,510
 
    
  
  
Total loans
   
 
7,192,337
 
   
 
542,574
 
   
 
7,734,911
 
Unamortized premiums (discounts), net
   
 
46,114
 
   
 
(106
)
   
 
46,008
 
Less allowance for loan losses
   
 
(15,709
)
   
 
—  
 
   
 
(15,709
)
    
  
  
Total
   
$
7,222,742
 
   
$
542,468
 
   
$
7,765,210
 
    
  
  
    
December 31, 2001
  
    
Held-for- Investment
     
Held-for- Sale
     
Total Loans
  
Real estate loans:
                           
One- to four-family
   
$
4,696,681
 
   
$
1,621,783
 
   
$
6,318,464
 
Multi-family
   
 
183
 
   
 
—  
 
   
 
183
 
Commercial
   
 
1,981
 
   
 
—  
 
   
 
1,981
 
Mixed-use
   
 
635
 
   
 
—  
 
   
 
635
 
Consumer and other loans:
                           
Automobiles, mobile homes and recreational vehicles
   
 
1,635,050
 
   
 
—  
 
   
 
1,635,050
 
Home equity lines of credit and second mortgage
   
 
22,720
 
   
 
339
 
   
 
23,059
 
Other
   
 
12,188
 
   
 
49
 
   
 
12,237
 
    
  
  
Total loans
   
 
6,369,438
 
   
 
1,622,171
 
   
 
7,991,609
 
Unamortized premiums (discounts), net
   
 
44,804
 
   
 
(6,082
)
   
 
38,722
 
Less allowance for loan losses
   
 
(19,874
)
   
 
—  
 
   
 
(19,874
)
    
  
  
Total
   
$
6,394,368
 
   
$
1,616,089
 
   
$
8,010,457
 
    
  
  

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Table of Contents
 
The following table presents information about our non-accrual loans and repossessed assets as of the periods indicated (dollars in thousands):
 
    
June 30, 2002
     
December 31, 2001
  
Loans accounted for on a non-accrual basis:
                  
Real estate loans:
                  
One- to four-family
   
$
21,853
 
   
$
20,595
 
Commercial
   
 
—  
 
   
 
—  
 
Automobiles, mobile homes and recreational vehicles
   
 
1,787
 
   
 
91
 
    
  
Total non-performing loans
   
 
23,640
 
   
 
20,686
 
Repossessed assets
   
 
3,714
 
   
 
3,328
 
    
  
Total non-performing assets
   
$
27,354
 
   
$
24,014
 
    
  
Total non-performing loans as a percentage of held-for-investment loans
   
 
0.33
%
   
 
0.32
%
    
  
Total non-performing assets as a percentage of held-for-investment loans
   
 
0.38
%
   
 
0.37
%
    
  
Total non-performing assets as a percentage of total banking assets
   
 
0.19
%
   
 
0.18
%
    
  
Total loan loss allowance as a percentage of total non-performing loans
   
 
66.45
%
   
 
96.07
%
    
  
 
The total loan loss allowance, as a percentage of total non-performing loans, decreased from 96.1% as of December 31, 2001, to 66.5% as of June 30, 2002. The Bank’s portfolio of held-for-investment loans increased to $7.2 billion from $6.4 billion during the six-month period ended June 30, 2002, due to several large bulk loan purchases. Allocations to the total loan loss allowance are a function of both the performing and non-performing loans. During the quarter, net charge-offs exceeded the loan loss provision by approximately $1.0 million. This was due to expected losses on the Bank’s automobile loan portfolio as several large pools reached their peak loss period.
 
Interest income is not accrued for loans classified as non-performing and any income accrued through the initial 90-day delinquency is reversed. Had these loans performed, additional income of $435,000 for the three months ended June 30, 2002, $869,000 for the six months ended June 30, 2002, $319,000 for the three months ended June 30, 2001 and $635,000 for the six months ended June 30, 2001, would have been recognized. As of June 30, 2002 and December 31, 2001, there were no commitments to lend additional funds to these borrowers.
 
Activity in the allowance for loan losses is summarized as follows (in thousands):
 
    
Three Months Ended
June 30,
     
Six Months Ended
June 30,
  
    
2002
     
2001
     
2002
     
2001
  
Allowance for loan losses, beginning of the period
   
$
16,699
 
   
$
13,821
 
   
$
19,874
 
   
$
12,565
 
Provision for loan losses
   
 
4,383
 
   
 
1,656
 
   
 
7,765
 
   
 
3,099
 
Charge-offs, net
   
 
(5,373
)
   
 
(397
)
   
 
(11,930
)
   
 
(584
)
    
  
  
  
Allowance for loan losses, end of period
   
$
15,709
 
   
$
15,080
 
   
$
15,709
 
   
$
15,080
 
    
  
  
  
 
The average recorded investment in impaired loans was $2.8 million for the three months ended June 30, 2002, $2.2 million for the six months ended June 30, 2002, $1.9 million for the three months ended June 30, 2001 and $1.9 million for the six months ended June 30, 2001. The Company’s charge-off policy for impaired loans is consistent with its charge-off policy for other loans; impaired loans are charged-off when, in the opinion of management, all principal and interest due on the impaired loan will not be fully collected. Consistent with the Company’s method for non-accrual loans, payments received on impaired loans are recognized as interest income or applied to principal when it is doubtful that full payment will be collected. As of June 30, 2002 and December 31, 2001, the Company had no restructured loans.

31

Table of Contents
 
Cost of Services and Operating Expenses
 
The following table sets forth the components of cost of services and operating expenses and percentage change information for the three and six months ended June 30, 2002 and 2001 (dollars in thousands):
 
    
Three Months Ended
June 30,
     
Percentage
Change
     
Six Months Ended
June 30,
     
Percentage
Change
  
    
2002
     
2001
        
2002
     
2001
     
Cost of services
   
$
133,795
 
   
$
150,458
 
   
(11
)%
   
$
274,547
 
   
$
292,893
 
   
(6
)%
    
  
         
  
      
Cost of services as a percentage of net revenues
   
 
42
%
   
 
49
%
          
 
42
%
   
 
46
%
       
    
  
         
  
      
Operating expenses:
                                                  
Selling and marketing
   
$
49,014
 
   
$
55,399
 
   
(12
)%
   
$
117,978
 
   
$
149,097
 
   
(21
)%
Technology development
   
 
15,043
 
   
 
23,420
 
   
(36
)%
   
 
29,547
 
   
 
45,701
 
   
(35
)%
General and administrative
   
 
50,832</