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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
Form 10-K
 
     
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the fiscal year ended September 29, 2006
 
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the transition period from          to          
 
Commission file number: 0-49992
 
 
TD AMERITRADE Holding Corporation
(Exact name of registrant as specified in its charter)
 
     
Delaware
(State or other jurisdiction of
incorporation or organization)
  82-0543156
(I.R.S. Employer
Identification Number)
 
4211 South 102nd Street,
Omaha, Nebraska 68127
(Address of principal executive offices and zip code)
 
(402) 331-7856
(Registrant’s telephone number, including area code)
 
 
Securities registered pursuant to Section 12(b) of the Act:
 
     
Title of Each Class
 
Name of Each Exchange on Which Registered
 
Common Stock — $0.01 par value   The NASDAQ Stock Market LLC
 
Securities registered pursuant to Section 12(g) of the Act:
 
Title of Class
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) under 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 þ     No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):
 
Large accelerated filer þ          Accelerated filer o          Non-accelerated filer o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o     No þ
 
The aggregate market value of the common stock held by non-affiliates of the registrant was approximately $4.9 billion computed by reference to the closing sale price of the stock on the Nasdaq Stock Market on March 31, 2006, the last trading day of the registrant’s most recently completed second fiscal quarter.
 
The number of shares of common stock outstanding as of November 30, 2006 was 600,538,184 shares.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Definitive Proxy Statement relating to the registrant’s 2007 Annual Meeting of Stockholders to be filed hereafter (incorporated into Part III hereof).
 


 

 
TD AMERITRADE HOLDING CORPORATION
 
INDEX
 
             
        Page
        No.
 
  Business   3
  Risk Factors   9
  Unresolved Staff Comments   16
  Properties   16
  Legal Proceedings   16
  Submission of Matters to a Vote of Security Holders   17
 
  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities   17
  Selected Financial Data   19
  Management’s Discussion and Analysis of Financial Condition and Results of Operations   20
  Quantitative and Qualitative Disclosures about Market Risk   42
  Financial Statements and Supplementary Data   44
  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure   79
  Controls and Procedures   79
  Other Information   81
 
  Directors and Executive Officers of the Registrant   81
  Executive Compensation   81
  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters   81
  Certain Relationships and Related Transactions   82
  Principal Accounting Fees and Services   82
 
  Exhibits, Financial Statement Schedules   82
    Exhibit Index   83
    Signatures   86


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Unless otherwise indicated, references to “we”, “us” or “Company” mean TD AMERITRADE Holding Corporation and its subsidiaries, and references to “fiscal” mean the Company’s fiscal year ended the last Friday of September.
 
PART I
 
Item 1.   Business
 
We are a leading provider of securities brokerage services, with retail brokerage representing the vast majority of our business. The Company was established in 1971 as a local investment banking firm. The Company began operations as a retail discount securities brokerage firm in 1975.
 
Operations
 
We are a leading provider of securities brokerage services and technology-based financial services to retail investors and business partners, predominantly through the Internet, a national branch network and relationships with one of the largest networks of independent registered investment advisors. Our services appeal to a broad market of independent, value conscious retail investors, traders, financial planners and institutions. We use our low-cost platform to offer brokerage services to retail investors and institutions under a low-cost commission structure that is generally simpler than that of most of our major competitors.
 
We have been an innovator in electronic brokerage services since entering the retail securities brokerage business in 1975. We believe that we were the first brokerage firm to offer the following products and services to retail clients: touch-tone trading; trading over the Internet; unlimited, streaming, free real-time quotes; extended trading hours; direct access; and commitment on the speed of execution. Since initiating online trading, we have substantially increased our number of brokerage accounts, average daily trading volume and total assets in client accounts. We have also built, and continue to invest in, a proprietary trade processing platform that is both cost efficient and highly scalable, significantly lowering our operating costs per trade. In addition, we have made significant and effective investments in building the TD AMERITRADE brand.
 
Strategy
 
We intend to capitalize on the growth and consolidation of the retail brokerage industry in the United States and leverage our low-cost infrastructure to grow market share and profitability. Our long-term growth strategy includes increasing our focus beyond active traders to obtain a greater market share from long-term investors and registered investment advisors. We strive to enhance the client experience while delivering greater value to stockholders. The key elements of our strategy are as follows:
 
  •  Focus on retail brokerage services.  We plan to focus on attracting active traders, long-term investors and registered investment advisors to our retail brokerage services. This focused strategy is designed to allow us to maintain our low operating cost structure and still offer our clients outstanding products and services.
 
  •  Leverage our infrastructure to add incremental revenue.  Through our proprietary technology, we are able to provide a very robust online experience for investors and traders. Our low-cost, scalable platform provides speed, reliability and quality trade execution services for clients. The scalable capacity of our trading system allows us to add a significant number of transactions while incurring minimal additional fixed costs.
 
  •  Continue to be a low-cost provider of quality services.  Our operating expense per trade is among the lowest of any of our publicly traded competitors. We intend to continue to lower our operating costs per trade by creating economies of scale, utilizing our single-platform proprietary system, continuing to automate processes and locating much of our operations in low-cost geographical areas. This low fixed-cost infrastructure provides us with significant financial leverage.
 
  •  Continue to offer innovative technologies and service enhancements to our clients.  We have been an innovator in our industry over our 30-year history. We continually strive to provide our clients with choice


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  and the ability to customize their trading experience. We provide greater choice by tailoring our features and functionality to meet the specific needs of investors.
 
  •  Continue to aggressively pursue growth through acquisitions.  When evaluating potential acquisitions, we look for transactions that will give us operational leverage, technological leverage, increased market share or other strategic opportunities. On January 24, 2006, we completed our acquisition of the U.S. brokerage business of TD Waterhouse Group, Inc. (“TD Waterhouse”). The transaction combined highly complementary franchises to create a retail broker with the scale, breadth and financial strength to be a leading player in the increasingly competitive and consolidating investor services industry. The acquisition of TD Waterhouse provided us with a national network of over 100 branches, as well as relationships with one of the largest networks of independent registered investment advisors. We also now provide our clients with an FDIC-insured money market sweep alternative for their cash through an arrangement with TD Bank USA, N.A. See “Acquisition of TD Waterhouse” below for further information about the acquisition of TD Waterhouse.
 
During fiscal 2004, we acquired Bidwell & Company and purchased the retail client accounts of BrokerageAmerica, LLC and Investex Securities Group, Inc. In fiscal 2005, we purchased the retail client accounts of JB Oxford & Company. These acquisitions followed the merger with Datek Online Holdings Corp. (“Datek”) in fiscal 2002 and the purchase of National Discount Brokers Corporation (“NDB”) in fiscal 2001. We intend to continue to be an acquirer by searching for other firms that fit one or more of our criteria.
 
  •  Leverage the TD AMERITRADE brand.  We believe that we have a superior brand identity and offering. Our advertising has established TD AMERITRADE as a significant brand in the retail brokerage market.
 
Acquisition of TD Waterhouse
 
On January 24, 2006, we completed the acquisition of TD Waterhouse, a Delaware corporation, pursuant to an Agreement of Sale and Purchase, dated June 22, 2005, as amended (the “Purchase Agreement”), with The Toronto-Dominion Bank (“TD”). We purchased from TD (the “Share Purchase”) all of the capital stock of TD Waterhouse in exchange for 196,300,000 shares of Company common stock, and $20,000 in cash. The shares of common stock issued to TD in the Share Purchase represented approximately 32.5 percent of the outstanding shares of the Company after giving effect to the transaction. Upon the completion of the transaction, we changed our name to TD AMERITRADE Holding Corporation and the authorized shares of common stock of the Company were increased from 650 million to one billion. Our consolidated financial statements include the results of operations for TD Waterhouse beginning January 25, 2006. In addition, on January 24, 2006, we completed the sale of Ameritrade Canada, Inc. to TD for $60 million in cash. We have agreed not to compete or own any portion of a business that competes with TD in Canada (including in the retail securities brokerage business) after the consummation of the Share Purchase. The purchase price for the acquisition of TD Waterhouse and the sale price for the sale of Ameritrade Canada were subject to cash adjustments based on the closing date balance sheets of the Company, TD Waterhouse and Ameritrade Canada. On May 5, 2006, we received approximately $45.9 million from TD for the settlement of cash adjustments related to the purchase of TD Waterhouse and the sale of Ameritrade Canada.
 
Pursuant to the Purchase Agreement, prior to the consummation of the Share Purchase, TD Waterhouse conducted a reorganization in which it transferred its Canadian retail securities brokerage business and TD Bank USA, N.A. (formerly TD Waterhouse Bank, N.A.) to TD such that, at the time of consummation of the Share Purchase, TD Waterhouse retained only its United States retail securities brokerage business. TD Waterhouse also distributed to TD excess capital of TD Waterhouse above certain thresholds prior to the consummation of the Share Purchase. As contemplated in the Purchase Agreement, on January 24, 2006, we commenced payment of a special cash dividend of $6.00 per share in respect of the shares of our common stock outstanding prior to the consummation of the Share Purchase. The total amount of the dividend was approximately $2.4 billion.
 
In connection with the Purchase Agreement, TD was given rights to have its shares of common stock of the Company registered for resale and TD licensed us the right to use the “TD” name in connection with the operation of our business. The parties also entered into agreements regarding bank sweep accounts and mutual funds.


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In connection with the Purchase Agreement, the Company, TD and J. Joe Ricketts, our Chairman and Founder, and certain of his affiliates also entered into a Stockholders Agreement, as amended (the “Stockholders Agreement”). The Stockholders Agreement sets forth certain governance arrangements and contains various provisions relating to stock ownership, voting, election of directors and other matters. Our certificate of incorporation and bylaws were amended and restated as of January 24, 2006, to give effect to and facilitate the provisions contained in the Stockholders Agreement.
 
At the time of the closing of the TD Waterhouse acquisition, we expected to realize approximately $678 million of annualized pre-tax synergies from the acquisition of TD Waterhouse within 18 months of the closing, consisting of $300 million in revenue opportunities primarily related to our new banking relationship with TD and $378 million in cost savings related to the elimination of duplicate expenditures. As of September 29, 2006, we estimate that we have realized annualized pre-tax revenue opportunities of over $300 million and annualized pre-tax cost savings of approximately $143 million.
 
Client Offerings
 
We deliver products and services aimed at providing a comprehensive, personalized experience for active traders, long-term investors and registered investment advisors. Our client offerings include:
 
  •  TD AMERITRADE® is our core offering for self-directed retail investors. We offer sophisticated tools and services, including Streamer Suitetm, TD AMERITRADE command center, SnapTickettm, Trade Triggerstm, QuoteScopetm, Advanced Analyzertm and Market Motion Detector. We offer Ameritrade Apextm for clients who place an average of five trades per month over a three-month period or have a $100,000 total account value. Apex clients receive free access to services that are normally available on a subscription basis and access to exclusive services and content.
 
  •  TD AMERITRADE Institutional is a leading provider of comprehensive brokerage and custody services to more than 4,000 independent Registered Investment Advisors (“RIAs”) and their clients. Our advanced technology platform coupled with personal support from our dedicated service teams, allows investment advisors to run their practices more effectively and efficiently, while optimizing time with clients. Additionally, TD AMERITRADE Institutional provides a robust offering of products, programs, and services. These services are all designed to help advisors build their business, and at the same time help their clients reach their financial goals.
 
  •  TD AMERITRADE Izone serves self-directed traders who are willing to forgo traditional support and service in favor of a purely electronic brokerage experience and lower commissions.
 
  •  Amerivesttm is an online advisory service introduced in October 2004 that tailors a portfolio of Exchange Traded Funds (“ETFs”) to help long-term investors pursue their financial goals. Our subsidiary, Amerivest Investment Management, LLC, recommends an investment portfolio based on a proprietary automated five-step process centered on an investor’s goals and risk tolerance.
 
  •  Ameritrade Corporate Services provides self-directed brokerage services to employees and executives of corporations, either directly in partnership with the corporation or through joint marketing relationships with third-party administrators, such as 401(k) providers and employee benefit consultants.
 
Products and Services
 
We strive to provide the best value of retail brokerage services to our clients. The products available to our clients include:
 
  •  Common and preferred stock.  Clients can purchase common and preferred stocks and American Depository Receipts traded on any United States exchange or quotation system.
 
  •  Exchange Traded Funds.  ETFs are baskets of securities (stocks or bonds) that track recognized indexes. They are similar to mutual funds, except they trade the same way that a stock trades, on a stock exchange. We have launched an online resource dedicated to ETFs, offering tools, education and information for active and long-term investors seeking alternatives for pursuing their investment strategies.


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  •  Option trades.  We offer a full range of option trades, including spreads, straddles and strangles. All option trades, including complex trades, are accessible on our Web site.
 
  •  Mutual funds.  Clients can compare and select from a portfolio of over 13,000 mutual funds from leading fund families, including a broad range of no transaction fee (NTF) funds. Clients can also easily exchange funds within the same mutual fund family.
 
  •  Fixed income.  We offer our clients access to a variety of treasury, corporate, government and municipal bonds as well as mortgage-backed securities and certificates of deposit.
 
  •  Margin lending.  We extend credit to clients who maintain margin accounts.
 
  •  Cash management services.  Through third-party banking relationships, we offer money market deposit accounts and money market mutual funds to our clients as cash sweep alternatives.
 
We provide our clients with an array of channels to access our products and services. These include Internet, our network of retail branches, wireless telephone or Personal Digital Assistant, Interactive Voice Response and registered representatives via telephone.
 
Client Service and Support
 
We endeavor to optimize our highly rated client service by:
 
  •  Ensuring prompt response to client service calls through adequate staffing with properly trained and motivated personnel in our client service departments, many of whom have a Series 7 license;
 
  •  Tailoring client service to the particular expectations of the clients of each of our client segments; and
 
  •  Expanding our use of technology to provide automated responses to the most typical inquiries generated in the course of clients’ securities trading and related activities.
 
We provide client service and support through a variety of access points, such as:
 
  •  Web sites.  Web sites provide basic information on how to use our services and an in-depth education center that includes a guide to online investing and an encyclopedia of finance.
 
  •  Branches.  We offer a nationwide network of over 100 retail branches, located primarily in large metropolitan areas.
 
  •  E-mail.  Clients are encouraged to use e-mail to contact our client service representatives. Our operating standards require a response within 24 hours of receipt of the e-mail; however, we strive to respond within four hours of the original message.
 
  •  Client service representatives.  For clients who choose to call or whose inquiries necessitate calling one of our client service representatives, we provide a toll-free number that connects to advanced call handling systems. These systems provide automated answering and directing of calls to the proper department. Our systems also allow linkage between caller identification and the client database to give the client service representative immediate access to the client’s account data at the time the call is received. Client service representatives are available 24 hours a day, seven days a week (excluding market holidays).
 
We strive to provide the best client service in the industry as measured by: (1) speed of response time on telephone calls; (2) turnaround time on responding to client inquiries; and (3) client satisfaction with the account relationship.
 
Technology and Information Systems
 
Technology is a core function for our business and is critical to our goal of providing the best execution at the best value to our clients. Our operations require reliable, scalable systems that can handle complex financial transactions for our clients with speed and accuracy. We maintain sophisticated and proprietary technology that automates traditionally labor-intensive securities transactions. Our ability to effectively leverage and adopt new technology to improve our services is a key component of our success.


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We continue to make investments in technology and information systems. Since 1999, we have spent a significant amount of resources to increase capacity and improve speed and reliability. To provide for system continuity during potential power outages, we also have equipped our data centers with uninterruptible power supply units, as well as back-up generators.
 
Our current capacity for trades is approximately 600,000 trades per day. During fiscal 2006, our clients averaged approximately 217,000 trades per day. Our highest average client trades per day for any single month occurred in May 2006, when clients averaged approximately 280,000 trades per day. The highest number of trades our clients have made in any single day is 349,000. Because of the scalability of our system, we believe that we would be able to increase capacity to approximately one million trades per day at an estimated technology cost of $5 million.
 
Advertising and Marketing
 
We intend to continue to grow and increase our market share by advertising through online avenues, television, print, direct mail and our own Web sites. We invest heavily in advertising programs designed to bring greater brand recognition to our services. We intend to continue to aggressively advertise our services. From time to time, we may choose to increase our advertising to target specific groups of investors or to decrease advertising in response to market conditions.
 
Advertising for retail clients is generally conducted through Web sites, financial news networks and other television and cable networks. We also place print advertisements in a broad range of business publications and use direct mail advertising. Advertising for institutional clients is significantly less than for retail clients and is generally conducted through highly targeted media.
 
To monitor the success of our various marketing efforts, we have installed a data gathering and tracking system. This system enables us to determine the type of advertising that best appeals to our target market so that we can invest future dollars in these programs and obtain a greater yield from our marketing dollars. Additionally, through the use of our database tools, we are working to more efficiently determine the needs of our various client segments and tailor our services to their individual needs. We intend to utilize this system to strengthen relationships with our clients and support marketing campaigns to attract new clients. All of our methods and uses of client information are disclosed in our privacy statement.
 
All of our brokerage-related communications with the public are regulated by the National Association of Securities Dealers, Inc. (“NASD”) or New York Stock Exchange, Inc. (“NYSE”).
 
Clearing Operations
 
Our subsidiaries, Ameritrade, Inc. and National Investor Services Corp. (“NISC”), provide clearing and execution services to our introducing broker-dealer subsidiary, TD AMERITRADE, Inc. Clearing services include the confirmation, receipt, settlement, delivery and record-keeping functions involved in the processing of securities transactions. Our clearing broker-dealer subsidiaries provide the following back office functions:
 
  •  Maintaining client accounts;
 
  •  Extending credit in a margin account to the client;
 
  •  Settling securities transactions with clearing houses such as The Depository Trust & Clearing Corporation and The Options Clearing Corporation;
 
  •  Settling commissions and transaction fees;
 
  •  Preparing client trade confirmations and statements;
 
  •  Performing designated cashiering functions, including the delivery and receipt of funds and securities to or from the client;
 
  •  Possession, control and safeguarding funds and securities in client accounts;


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  •  Transmitting tax accounting information to the client and to the applicable tax authority; and
 
  •  Forwarding prospectuses, proxies and other shareholder information to clients.
 
We make margin loans to clients collateralized by client securities. Our margin lending is subject to the margin rules of the Board of Governors of the Federal Reserve System (“Federal Reserve”), the margin requirements of the NASD and our own internal policies. By permitting clients to purchase on margin, we take the risk that a market decline could reduce the value of the collateral securing our loan to an amount that is less than the clients’ indebtedness to us. Under applicable securities laws and regulations, we are obligated to require the client to maintain net equity in the account equal to at least 25 percent of the value of the securities in the account. Our current internal requirement, however, is that the client’s net equity not be allowed to fall below 30 percent of the value of the securities in the account. If it does fall below 30 percent, we require the client to increase the account’s net equity to 35 percent of the value of the securities in the account. These requirements can be, and often are, raised as we deem necessary for certain accounts, groups of accounts, individual securities or groups of securities.
 
Competition
 
We believe that the principal determinants of success in the retail brokerage market are brand recognition, size of client base and client assets, client trading activity, efficiency of operations, technology infrastructure and access to financial resources. We also believe that the principal factors considered by clients in choosing a broker are price, client service, quality of trade execution, delivery platform capabilities, convenience and ease of use, breadth of services, innovation and overall value. Based on our experience, focus group research and the success we have enjoyed to date, we believe that we presently compete successfully in each of these categories.
 
The market for brokerage services, particularly electronic brokerage services, continues to evolve and is intensely competitive. We have seen intense competition during the past five years and expect this competitive environment to continue. We encounter direct competition from numerous other brokerage firms, many of which provide online brokerage services. These competitors include such brokerage firms as Charles Schwab & Co., Inc., E*TRADE Financial Corporation, Fidelity Investments and Scottrade, Inc. We also encounter competition from established full-commission brokerage firms including such full service brokerage firms as Merrill Lynch and Smith Barney as well as financial institutions, mutual fund sponsors and other organizations, some of which provide online brokerage services.
 
Regulation
 
The securities industry is subject to extensive regulation under federal and state law. In general, broker-dealers are required to register with the SEC and to be members of the NASD or the NYSE. Our broker-dealer subsidiaries are subject to the requirements of the Securities Exchange Act of 1934 (the “Exchange Act”) and the rules promulgated thereunder relating to broker-dealers. These regulations establish, among other things, minimum net capital requirements for our broker-dealer subsidiaries. We are also subject to regulation under various state laws in all 50 states and the District of Columbia, including registration requirements.
 
In their capacity as securities clearing firms, Ameritrade, Inc. and NISC are members of The Depository Trust & Clearing Corporation and The Options Clearing Corporation, each of which is registered as a clearing agency with the SEC. As members of these clearing agencies, Ameritrade, Inc. and NISC are required to comply with the rules of such clearing agencies, including rules relating to possession and control of client funds and securities, margin lending and execution and settlement of transactions.
 
Margin lending activities are subject to limitations imposed by regulations of the Federal Reserve and the NASD. In general, these regulations provide that in the event of a significant decline in the value of securities collateralizing a margin account, we are required to obtain additional collateral from the borrower.
 
Intellectual Property Rights
 
Our success and ability to compete are dependent to a significant degree on our intellectual property, which includes our proprietary technology, trade secrets and client base. We rely on numerous methods of intellectual property protection to protect our intellectual property, including copyright, trade secret, trademark, domain name,


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patent and contract law and have utilized the various methods available to us, including registrations with the United States Patent and Trademark office for various properties, as well as entry into written licenses and other technology agreements with third parties. The source and object code for our proprietary software is also protected using applicable methods of intellectual property protection and general protections afforded to confidential information. In addition, it is our policy to enter into confidentiality and intellectual property ownership agreements with our associates and confidentiality and noncompetition agreements with our independent contractors and business partners, and to control access to and distribution of our intellectual property.
 
Associates
 
As of September 29, 2006, we employed 3,947 full-time equivalent employees. The number of employees has increased from 2,052 full-time equivalent employees as of the end of fiscal 2005, primarily due to the acquisition of TD Waterhouse. None of our employees is covered under a collective bargaining agreement. We believe that our relations with our employees are good.
 
Financial Information about Segments and Geographic Areas
 
See Note 16 of the Notes to Consolidated Financial Statements included in Item 8 of this Form 10-K for financial information about the Company’s segments and geographic areas.
 
Internet Address
 
We maintain a Web site where additional information concerning our business can be found. The address of that Web site is www.amtd.com. We make available free of charge on our Web site our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports, as soon as reasonably practicable after we electronically file or furnish such materials to the SEC.
 
Item 1A.  Risk Factors
 
In addition to the other information set forth in this report, you should carefully consider the following factors which could materially affect our business, financial condition or future results of operations. Although the risks described below are those that management believes are the most significant, these are not the only risks facing our company. Additional risks and uncertainties not currently known to us or that we currently do not deem to be material also may materially affect our business, financial condition or future results of operations.
 
Risk Factors Relating to Our Business Operations
 
Stock market volatility and other securities industry risks could adversely affect our business.
 
Substantially all of our revenues are derived from our securities brokerage business. Like other securities brokerage businesses, we are directly affected by economic and political conditions, broad trends in business and finance and changes in volume and price levels of securities transactions. For example, events such as the terrorist attacks in the United States on September 11, 2001, the invasion of Iraq in 2003 and other events have resulted in substantial market volatility and reductions in trading volume and net revenues. In addition, any general economic downturn would adversely affect trading volumes and net revenues. Severe market fluctuations or weak economic conditions could reduce our trading volume and net revenues and adversely affect our profitability.
 
We have exposure to interest rate risk.
 
As a fundamental part of our brokerage business, we invest in interest-earning assets and are obligated on interest-bearing liabilities. In addition, we earn fees on our money market deposit account (MMDA) sweep arrangement with TD Bank USA, which are based on the actual net yield earned at TD Bank USA. Changes in interest rates could affect the interest earned on assets differently than interest paid on liabilities. A rising interest rate environment generally results in our earning a larger net interest spread. Conversely, a falling interest rate environment generally results in our earning a smaller net interest spread.


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We have exposure to liquidity risk.
 
Substantially all of our interest-earning assets are readily convertible to cash or subject to immediate repayment by our clients and broker-dealer counterparties. Our liquidity needs to support interest-earning assets are primarily met by client credit balances or financing created from our securities lending activities. A reduction of funds available from client credit balances or securities lending may require us to seek other potentially more expensive forms of financing, such as borrowings on our uncommitted lines of credit. Because our broker-dealer lines of credit are uncommitted, there can be no assurance that such financing would be available.
 
We are exposed to credit risk with clients and counterparties.
 
We make margin loans to clients collateralized by client securities and periodically borrow and lend securities to cover trades. A significant portion of our net revenues is derived from interest on margin loans. By permitting clients to purchase securities on margin, we are subject to risks inherent in extending credit, especially during periods of rapidly declining markets in which the value of the collateral held by us could fall below the amount of a client’s indebtedness. To the extent that these margin loans exceed client cash balances maintained with us, we must obtain financing from third parties. We may not be able to obtain this financing on favorable terms or in sufficient amounts. In addition, in accordance with regulatory guidelines, we collateralize borrowings of securities by depositing cash or securities with lenders. Sharp changes in market values of substantial amounts of securities and the failure by parties to the borrowing transactions to honor their commitments could have a material adverse effect on our revenues and profitability.
 
Our clearing operations expose us to liability for errors in clearing functions.
 
Our broker-dealer subsidiaries, Ameritrade, Inc. and NISC, provide clearing and execution services to our introducing broker-dealer subsidiary. Clearing and execution services include the confirmation, receipt, settlement and delivery functions involved in securities transactions. Clearing brokers also assume direct responsibility for the possession and control of client securities and other assets and the clearance of client securities transactions. Self-clearing securities firms are subject to substantially more regulatory control and examination than brokers that rely on others to perform those functions. Errors in performing clearing functions, including clerical and other errors related to the handling of funds and securities held by us on behalf of clients, could lead to civil penalties imposed by applicable authorities as well as losses and liability in related lawsuits brought by clients and others.
 
Changes in payments for routing our clients’ orders could adversely affect our business.
 
We have arrangements with several execution agents to receive cash payments in exchange for routing trade orders to these firms for execution. Competition between execution agents and the implementation of order handling rules and decimalization of stock prices have made it less profitable for execution agents to offer order flow payments to broker-dealers. On a per trade basis, our payment for order flow revenue has decreased significantly over the past several years. These payments could continue to decrease on a per trade basis, which could have an adverse effect on our revenues and profitability. The SEC could take action to prohibit payment for order flow, which could have an adverse effect on our revenues and profitability.
 
Systems failures, delays and capacity constraints could harm our business.
 
We receive and process trade orders through a variety of electronic channels, including the Internet, wireless web, personal digital assistants and our interactive voice response system. These methods of trading are heavily dependent on the integrity of the electronic systems supporting them. Our systems and operations are vulnerable to damage or interruption from human error, natural disasters, power loss, computer viruses, distributed denial of service (“DDOS”) attacks, spurious spam attacks, intentional acts of vandalism and similar events. Though all of our core computer systems and applications are fully redundant and distributed over two sites, it could take several hours or more to restore full functionality in the event of an unforeseen disaster. Extraordinary trading volumes could cause our computer systems to operate at an unacceptably low speed or even fail. Extraordinary Internet traffic caused by DDOS or spam attacks could cause our Web site to be unavailable or slow to respond. While we have invested significant amounts to upgrade the reliability and scalability of our systems and added hardware to


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address extraordinary Internet traffic, there can be no assurance that our systems will be sufficient to handle such extraordinary circumstances. We may not be able to project accurately the rate, timing or cost of any increases in our business, or to expand and upgrade our systems and infrastructure to accommodate any increases in a timely manner. Systems failures and delays could occur and could cause, among other things, unanticipated disruptions in service to our clients, slower system response time resulting in transactions not being processed as quickly as our clients desire, decreased levels of client service and client satisfaction, and harm to our reputation. If any of these events were to occur, we could suffer:
 
  •  a loss of clients or a reduction in the growth of our client base;
 
  •  increased operating expenses;
 
  •  financial losses;
 
  •  additional litigation or other client claims; and
 
  •  regulatory sanctions or additional regulatory burdens.
 
Our networks and client information could be vulnerable to security risks.
 
The secure transmission of confidential information over public networks is a critical element of our operations. Our networks could be vulnerable to unauthorized access, computer viruses, phishing schemes and other security problems. We, along with the online brokerage industry in general, have experienced increased losses during fiscal 2006 related to clients’ login and password information being compromised while using public computers. Persons who circumvent security measures could wrongfully use our confidential information or our clients’ confidential information or cause interruptions or malfunctions in our operations. We could be required to expend significant additional resources to protect against the threat of security breaches or to alleviate problems caused by any breaches. We may not be able to implement security measures that will protect against all security risks. Because we provide a security guarantee under which we reimburse clients for losses resulting from unauthorized activity in their accounts, significant unauthorized activity could have a material adverse affect on our results of operations.
 
The success of our business will depend on continued development and maintenance of the Internet infrastructure.
 
The Internet has experienced, and is expected to continue to experience, significant growth in the number of users and amount of traffic. Our success will depend upon the ability of third parties to provide a reliable Internet infrastructure with the speed, data capacity, security and hardware necessary for reliable Internet access and services. To the extent that the Internet continues to experience increased numbers of users, increased frequency of use or increased bandwidth requirements, the Internet infrastructure may not be able to support the demands placed on it and the performance or reliability of the Internet could suffer.
 
Substantial competition could reduce our market share and harm our financial performance.
 
The market for electronic brokerage services is continually evolving and intensely competitive. There has been substantial price competition, including various free trade offers, in the industry recently. We expect the competitive environment to continue in the future. We face direct competition from numerous retail brokerage firms, including Charles Schwab & Co., Inc., E*TRADE Financial Corporation, Fidelity Investments and Scottrade, Inc. We also encounter competition from the broker-dealer affiliates of established full-commission brokerage firms as well as from financial institutions, mutual fund sponsors and other organizations, some of which provide online brokerage services. Some of our competitors have greater financial, technical, marketing and other resources, offer a wider range of services and financial products, and have greater name recognition and a more extensive client base than we do. We believe that the general financial success of companies within the retail securities industry will continue to attract new competitors to the industry, such as banks, software development companies, insurance companies, providers of online financial information and others. These companies may provide a more comprehensive suite of services than we do. Increased competition, including pricing pressure, could have a material adverse effect on our results of operations and financial condition.


11


 

We will need to introduce new products and services to remain competitive.
 
Our future success depends in part on our ability to develop and enhance our products and services. There are significant technical and financial risks in the development of new or enhanced products and services, including the risk that we might be unable to effectively use new technologies or adapt our services to emerging industry standards, or develop, introduce and market enhanced or new products and services. In addition, the adoption of new Internet, networking or telecommunications technologies or other technological changes could require us to incur substantial expenditures to modify or adapt our services or infrastructure.
 
Risk Factors Relating to the Regulatory Environment
 
Failure to comply with net capital requirements could adversely affect our business.
 
The SEC, NASD and various other regulatory agencies have stringent rules with respect to the maintenance of specific levels of net capital by securities broker-dealers. Net capital is a measure, defined by the SEC, of a broker-dealer’s readily available liquid assets, reduced by its total liabilities other than approved subordinated debt. All of our broker-dealer subsidiaries are required to comply with net capital requirements. If we fail to maintain the required net capital, the SEC could suspend or revoke our registration, or the NASD could expel us from membership, which could ultimately lead to our liquidation, or they could impose censures, fines or other sanctions. If the net capital rules are changed or expanded, or if there is an unusually large charge against net capital, then operations that require the intensive use of capital would be limited. A large operating loss or charge against net capital could adversely affect our ability to maintain or expand our business.
 
Regulatory and legal uncertainties could harm our business.
 
The securities industry is subject to extensive regulation and broker-dealers are subject to regulations covering all aspects of the securities business. The SEC, NASD and other self-regulatory organizations and state and foreign regulators can, among other things, censure, fine, issue cease-and-desist orders to, suspend or expel a broker-dealer or any of its officers or employees. While we neither actively solicit new accounts nor have established offices outside the United States, our websites are accessible world-wide over the Internet and we currently have account holders located outside the United States. These accounts make up approximately 1.5 percent of our accounts and are spread across many jurisdictions. Any adverse action by foreign regulators with respect to regulatory compliance by us in foreign jurisdictions could adversely affect our revenues from clients in such country or region.
 
Various regulatory and enforcement agencies have been reviewing mutual fund trading, regulatory reporting obligations, best execution practices, client privacy, system security and safeguarding practices and advertising claims as they relate to the brokerage industry. These reviews could result in enforcement actions or new regulations, which could adversely affect our operations.
 
In addition, we use the Internet as a major distribution channel to provide services to our clients. A number of regulatory agencies have adopted regulations regarding client privacy, system security and safeguarding practices and the use of client information by service providers. Additional laws and regulations relating to the Internet and safeguarding practices could be adopted in the future, including laws related to identity theft and regulations regarding the pricing, taxation, content and quality of products and services delivered over the Internet. Complying with these laws and regulations is expensive and time consuming and could limit our ability to use the Internet as a distribution channel.
 
Failure to maintain adequate internal controls could adversely affect our business.
 
We are subject to internal control requirements under the Sarbanes-Oxley Act of 2002, as well as rules and regulations adopted by the SEC and the Public Company Accounting Oversight Board. These laws, rules and regulations continue to evolve and could become increasingly stringent in the future. We have undertaken actions to enhance our ability to comply with the requirements of the Sarbanes-Oxley Act of 2002, including, but not limited to, the increased allocation of internal audit department resources, documentation of existing controls and implementation of new controls or modification of existing controls as deemed appropriate. Control deficiencies have been identified from time to time, and we have undertaken actions to remediate them.


12


 

We continue to devote substantial time and resources to the documentation and testing of our controls, and to planning for and implementation of remedial efforts in those instances where remediation is indicated. If we fail to maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we could be subject to regulatory actions, civil or criminal penalties or shareholder litigation. In addition, failure to maintain adequate internal controls could result in financial statements that do not accurately reflect our financial condition, results of operations and cash flows.
 
Risk Factors Relating to Strategic Acquisitions and the Integration of Acquired Operations
 
Acquisitions involve risks that could adversely affect our business.
 
We intend to pursue strategic acquisitions of businesses and technologies. Acquisitions may entail numerous risks, including:
 
  •  difficulties in the integration of acquired operations, services and products;
 
  •  failure to achieve expected synergies;
 
  •  diversion of management’s attention from other business concerns;
 
  •  assumption of unknown material liabilities of acquired companies;
 
  •  amortization of acquired intangible assets, which could reduce future reported earnings;
 
  •  potential loss of clients or key employees of acquired companies; and
 
  •  dilution to existing stockholders.
 
As part of our growth strategy, we regularly consider, and from time to time engage in, discussions and negotiations regarding strategic transactions such as acquisitions, mergers and combinations within our industry. The purchase price for possible acquisitions could be paid in cash, through the issuance of common stock or other of our securities, borrowings or a combination of these methods.
 
We cannot be certain that we will be able to continue to identify and to consummate strategic transactions and no assurance can be given with respect to the timing, likelihood or business effect of any possible transaction. For example, in many cases we begin negotiations that we subsequently decide to suspend or terminate for a variety of reasons. However, opportunities may arise from time to time that we will evaluate. Any transactions that we consummate would involve risks and uncertainties to us. These risks could cause the failure of any anticipated benefits of an acquisition to be realized, which could have a material adverse effect on our revenues and profitability.
 
Although we expect benefits to result from the acquisition of TD Waterhouse, we may not fully realize those benefits because of remaining integration challenges.
 
Our failure to meet the challenges involved in integrating the operations of Ameritrade and TD Waterhouse successfully or otherwise to realize any of the anticipated benefits of the acquisition of TD Waterhouse, including anticipated cost savings, could seriously harm our results of operations. Realizing the benefits of the acquisition of TD Waterhouse will depend in part on completing the integration of technology, operations and personnel. The integration of the companies is a complex, time-consuming and expensive process that, without proper planning and effective and timely implementation, could significantly disrupt our business.
 
The ongoing challenges in this integration include the following:
 
  •  demonstrating to the clients of Ameritrade and to the clients of TD Waterhouse that the integration of TD Waterhouse will not result in adverse changes in client service standards or business focus and helping clients conduct business easily with the combined company;
 
  •  consolidating and rationalizing technology platforms and administrative infrastructures;
 
  •  coordinating sales and marketing efforts to effectively communicate the capabilities of the combined company;


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  •  integrating and rationalizing clearing platforms;
 
  •  minimizing the diversion of management attention from ongoing business concerns; and
 
  •  combining the corporate cultures, maintaining employee morale and retaining key employees.
 
We may not successfully integrate the operations of Ameritrade and TD Waterhouse in a timely manner, or at all, and we may not realize the anticipated benefits or synergies of the acquisition of TD Waterhouse to the extent, or in the timeframe, forecasted. The anticipated benefits and synergies include cost savings associated with anticipated restructurings and other operational efficiencies, greater economies of scale and revenue enhancement opportunities. However, these anticipated benefits and synergies assume a successful integration and are based on projections, which are inherently uncertain, and other assumptions. Even if integration is successful, anticipated benefits and synergies may not be achieved. In addition to the integration risks discussed above, our ability to realize these benefits and synergies could be adversely impacted by practical or legal constraints on our ability to combine operations or implement workforce reductions.
 
Risk Factors Relating to Owning Our Stock
 
The market price of our common stock could fluctuate significantly.
 
Our common stock, and the U.S. securities markets in general, experience significant price fluctuations. The market prices of securities of Internet-related companies, in particular, have been especially volatile. The price of our common stock could decrease substantially. In addition, because the market price of our common stock tends to fluctuate significantly, we could become the object of securities class action litigation, which could result in substantial costs and a diversion of management’s attention and resources.
 
We are restricted by the terms of our senior credit facilities.
 
We entered into a credit agreement, as amended, on January 23, 2006 for $2.2 billion in senior credit facilities with a syndicate of lenders. These credit facilities contain various covenants and restrictions that may limit our ability to:
 
  •  incur additional indebtedness;
 
  •  create liens;
 
  •  sell assets and make capital expenditures;
 
  •  pay dividends or make distributions;
 
  •  repurchase our common stock;
 
  •  make investments;
 
  •  merge or consolidate with another entity; and
 
  •  conduct transactions with affiliates.
 
As a result of the covenants and restrictions contained in the credit facilities, we are limited in how we conduct our business. We cannot guarantee that we will be able to remain in compliance with these covenants or be able to obtain waivers for noncompliance in the future.
 
Our corporate debt level may limit our ability to obtain additional financing.
 
In connection with the payment of the special cash dividend of $6.00 per share and to fund working capital requirements after the acquisition of TD Waterhouse, we borrowed approximately $1.9 billion. Our ability to meet our cash requirements, including our debt service obligations, is dependent upon our future performance, which will be subject to financial, business and other factors affecting our operations, many of which are or may be beyond our control. We cannot provide assurance that our business will generate sufficient cash flows from operations to fund these cash requirements, including our debt service obligations. If we are unable to meet our cash requirements from operations, we would be required to fund these cash requirements by alternative financing. The degree to which we


14


 

may be leveraged as a result of the indebtedness incurred in connection with payment of the special dividend or otherwise could materially and adversely affect our ability to obtain financing for working capital, acquisitions or other purposes, could make us more vulnerable to industry downturns and competitive pressures or could limit our flexibility in planning for, or reacting to, changes and opportunities in our industry, which may place us at a competitive disadvantage. There can be no assurance that we would be able to obtain alternative financing, that any such financing would be on acceptable terms or that we would be permitted to do so under the terms of existing financing arrangements. In the absence of such financing, our ability to respond to changing business and economic conditions, make future acquisitions, react to adverse operating results, meet our debt service obligations, or fund required capital expenditures, could be materially and adversely affected.
 
TD and the Ricketts holders exercise significant influence over TD AMERITRADE.
 
As of September 29, 2006, TD and J. Joe Ricketts, our Chairman and Founder, members of his family and trusts held for their benefit, which we collectively refer to as the Ricketts holders, own approximately 39.6 percent and 20.4 percent of the outstanding voting securities of TD AMERITRADE, respectively. TD is permitted under the terms of a stockholders agreement to own up to 39.9 percent of the outstanding shares of TD AMERITRADE common stock during the three years following the January 24, 2006 closing of the transaction, up to 45 percent of the outstanding shares of TD AMERITRADE common stock for the remainder of the term of the stockholders agreement (a maximum of 10 years following the closing) and an unlimited number of shares of TD AMERITRADE following the termination of the stockholders agreement. The Ricketts holders are permitted under the terms of the stockholders agreement to own up to 29 percent of the outstanding shares of TD AMERITRADE. As a result, TD and the Ricketts holders generally have the ability to significantly influence the outcome of any matter submitted for the vote of TD AMERITRADE stockholders. The stockholders agreement also provides that TD will designate five of the twelve members of the TD AMERITRADE board of directors and the Ricketts holders will designate three of the twelve members of the TD AMERITRADE board of directors, subject to adjustment based on their respective ownership positions in TD AMERITRADE. Accordingly, TD and the Ricketts holders generally will be able to significantly influence the outcome of all matters that come before the TD AMERITRADE board. As a result of their significant interest in TD AMERITRADE, TD or the Ricketts holders may have the power, subject to applicable law, to significantly influence actions that might be favorable to TD or the Ricketts holders, but not necessarily favorable to other TD AMERITRADE stockholders. In addition, the ownership position and governance rights of TD and the Ricketts holders could discourage a third party from proposing a change of control or other strategic transaction concerning TD AMERITRADE. As a result, the common stock of TD AMERITRADE could trade at prices that do not reflect a “takeover premium” to the same extent as do the stocks of similarly situated companies that do not have a stockholder with an ownership interest as large as TD’s and the Ricketts holders’ combined ownership interest.
 
Conflicts of interest may arise between TD AMERITRADE and TD, which may be resolved in a manner that adversely affects TD AMERITRADE’s business, financial condition or results of operations.
 
Conflicts of interest may arise between TD AMERITRADE and TD in areas relating to past, ongoing and future relationships, including corporate opportunities, potential acquisitions or financing transactions, sales or other dispositions by TD of its interests in TD AMERITRADE and the exercise by TD of its influence over the management and affairs of TD AMERITRADE. Some of the directors on the TD AMERITRADE board are persons who are also officers or directors of TD or its subsidiaries. Service as a director or officer of both TD AMERITRADE and TD or its other subsidiaries could create conflicts of interest if such directors or officers are faced with decisions that could have materially different implications for TD AMERITRADE and for TD. Our amended and restated certificate of incorporation contains provisions relating to the avoidance of direct competition between TD AMERITRADE and TD. The parties have not established any other formal procedures for TD AMERITRADE and TD to resolve potential or actual conflicts of interest between them. There can be no assurance that any of the foregoing conflicts will be resolved in a manner that does not adversely affect the business, financial condition or results of operations of TD AMERITRADE. In addition, the provisions of the stockholders agreement related to non-competition are subject to numerous exceptions and qualifications and may not prevent TD AMERITRADE and TD from competing with each other to some degree in the future.


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The terms of the stockholders agreement, our charter documents and Delaware law could inhibit a takeover that stockholders may consider favorable.
 
Provisions in the stockholders agreement among TD and the Ricketts holders, our certificate of incorporation and bylaws and Delaware law will make it difficult for any party to acquire control of us in a transaction not approved by the requisite number of directors. These provisions include:
 
  •  the presence of a classified board of directors;
 
  •  the ability of the board of directors to issue and determine the terms of preferred stock;
 
  •  advance notice requirements for inclusion of stockholder proposals at stockholder meetings; and
 
  •  the anti-takeover provisions of Delaware law.
 
These provisions could delay or prevent a change of control or change in management that might provide stockholders with a premium to the market price of their common stock.
 
Item 1B.  Unresolved Staff Comments
 
None.
 
Item 2.   Properties
 
Our corporate headquarters is located in Omaha, Nebraska, and occupies approximately 74,000 square feet of leased space. The lease expires in April 2019. Also in the Omaha metropolitan area, we lease approximately 154,000 square feet for an operations center as well as other locations totaling approximately 23,000 square feet. The leases on these other Omaha-area locations expire on various dates from 2008 through 2009. We lease approximately 185,000 and 140,000 square feet for additional operations centers in Jersey City, New Jersey and Ft. Worth, Texas, respectively. The Jersey City and Ft. Worth leases expire in 2015. We lease smaller administrative and operational facilities in California, Florida, Illinois, Kansas, Maryland, Missouri, New Jersey, New York, Oregon, Pennsylvania, Texas and Utah. We also lease over 100 branch offices located in large metropolitan areas in 35 states. We believe that our facilities are suitable and adequate to meet our needs.
 
Item 3.   Legal Proceedings
 
Legal — The nature of the Company’s business subjects it to lawsuits, arbitrations, claims and other legal proceedings. We cannot predict with certainty the outcome of pending legal proceedings. A substantial adverse judgment or other resolution regarding the proceedings could have a material adverse effect on the Company’s financial condition, results of operations and cash flows. However, in the opinion of management, after consultation with legal counsel, the Company has adequate legal defenses with respect to the legal proceedings to which it is a defendant or respondent and the outcome of these pending proceedings is not likely to have a material adverse effect on the financial condition, results of operations or cash flows of the Company.
 
Net Capital Matter — In November 2004, the NASD initiated an inquiry into a transfer of client cash balances held at the Company’s broker-dealer subsidiary, Ameritrade, Inc., to FDIC-insured deposit accounts held at banks. On November 12, 2004, the Company’s broker-dealer subsidiary, Ameritrade, Inc., was notified by the staff of the NASD and the staff of the SEC Division of Market Regulation (collectively the “Staffs”) that they believed that for regulatory purposes certain funds held in banks on behalf of clients are liabilities and assets of Ameritrade, Inc. rather than liabilities and assets only of the banks. The resulting assets have not been allowed for purposes of Ameritrade, Inc.’s regulatory net capital calculation. Accordingly, in the Staffs’ view Ameritrade, Inc.’s net capital was below its minimum amount required under Exchange Act Rule 15c3-1. Ameritrade, Inc. cured the asserted deficiency on November 15, 2004, the first business day following the notification.
 
On November 14, 2005, the NASD advised Ameritrade, Inc. that the NASD Staff made a preliminary determination to recommend disciplinary action against the Company based on allegations that it violated SEC net capital and customer protection rules and NASD conduct rules. Ameritrade, Inc. submitted a response setting forth the reasons it believes that the NASD should not bring a disciplinary action. Conditioned upon the final agreement


16


 

of the NASD, the Company currently expects Ameritrade, Inc. to settle this matter for an amount that is not expected to have a material effect on the Company’s financial condition, results of operations, or cash flows. This matter had no impact on the Company’s results of operations or net cash flows for any period presented in this annual report on Form 10-K.
 
Other Regulatory Matters — The Company is in discussions with its regulators about other matters raised during regulatory examinations or otherwise subject to their inquiry. These matters could result in censures, fines or other sanctions. Management believes the outcome of any resulting actions will not be material to the Company’s financial condition, results of operations or cash flows. However, the Company is unable to predict the outcome of these matters.
 
Item 4.   Submission of Matters to a Vote of Security Holders
 
No matters were submitted to a vote of stockholders during the fourth quarter of fiscal 2006.
 
PART II
 
Item 5.   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Price Range of Common Stock
 
Our common stock trades on the Nasdaq Global Select Market under the symbol “AMTD”. The following table shows the high and low sales prices for the common stock for the periods indicated, as reported by the Nasdaq Global Select Market. The prices reflect inter-dealer prices and do not include retail markups, markdowns or commissions.
 
                                 
    Common Stock Price  
    For the Fiscal Year Ended
    For the Fiscal Year Ended
 
    September 29, 2006     September 30, 2005  
    High     Low     High     Low  
 
First Quarter
  $ 25.00     $ 18.93     $ 14.61     $ 11.21  
Second Quarter*
  $ 26.37     $ 18.86     $ 14.38     $ 10.02  
Third Quarter
  $ 22.19     $ 13.50     $ 19.00     $ 9.91  
Fourth Quarter
  $ 19.18     $ 13.30     $ 22.25     $ 18.04  
 
 
* In connection with the acquisition of TD Waterhouse during the second quarter of fiscal 2006, we declared and paid a special cash dividend of $6.00 per share.
 
The closing sale price of our common stock as reported on the Nasdaq Global Select Market on November 27, 2006 was $17.09 per share. As of that date there were 730 holders of record of our common stock based on information provided by our transfer agent. The number of stockholders of record does not reflect the actual number of individual or institutional stockholders that own our stock because most stock is held in the name of nominees. Based on information available to us, there are approximately 131,000 beneficial holders of our common stock.
 
Dividends
 
We have not declared or paid regular cash dividends on our common stock. In connection with our acquisition of TD Waterhouse in January 2006, we declared and paid a special cash dividend of $6.00 per share. We currently intend to retain all of our earnings, if any, for use in our business and do not anticipate paying any other cash dividends in the foreseeable future. Our credit agreement prohibits the payment of cash dividends. The payment of any future dividends will be at the discretion of our Board of Directors, subject to the provisions of the credit agreement, and will depend upon a number of factors, including future earnings, the success of our business activities, capital requirements, the general financial condition and future prospects of our business, general business conditions and such other factors as the Board of Directors may deem relevant.


17


 

Purchases of Equity Securities by the Issuer and Affiliated Purchasers
 
                                 
    Issuer Purchases of Equity Securities  
                Total Number of
    Maximum Number
 
                Shares Purchased as
    of Shares That May
 
    Total Number of
    Average Price
    Part of Publicly
    Yet be Purchased
 
Period
  Shares Purchased     Paid per Share     Announced Program     Under the Program  
 
July 1, 2006 — July 28, 2006
    7,951     $ 15.78             N/A  
July 29, 2006 — August 25, 2006
    1,080,000     $ 17.66       1,080,000       10,920,000  
August 26, 2006 — September 29, 2006
    2,720,000     $ 17.66       2,720,000       8,200,000  
                                 
Total — Three months ended September 29, 2006
    3,807,951     $ 17.66       3,800,000       8,200,000  
                                 
 
Our common stock repurchase program was authorized on August 2, 2006. Our Board of Directors originally authorized the Company to repurchase up to 12 million shares. On November 15, 2006, the Board of Directors added 20 million shares to the original authorization, increasing the total authorization from 12 million shares to 32 million shares. This program is the only program currently in effect and there were no programs that expired during the fourth quarter of fiscal 2006. The shares repurchased during July 2006 were repurchased from an employee for income tax withholding in connection with a stock distribution from the Company’s Executive Deferred Compensation Program.
 
J. Joe Ricketts, Chairman and Founder of the Company, made open-market purchases during the fourth quarter of fiscal 2006. The following table summarizes purchases reported by J. Joe Ricketts on Forms 4:
 
                                 
    Affiliate Purchases of Equity Securities  
                Total Number of
    Maximum Number
 
                Shares Purchased as
    of Shares That May
 
    Total Number of
    Average Price
    Part of Publicly
    Yet be Purchased
 
Period
  Shares Purchased     Paid per Share     Announced Program     Under the Program  
 
July 1, 2006 — July 28, 2006
    7,288,342     $ 15.62                
July 29, 2006 — August 25, 2006
    6,800,000     $ 17.90                
August 26, 2006 — September 29, 2006
                         
                                 
Total — Three months ended September 29, 2006
    14,088,342     $ 16.72             N/A  
                                 


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Item 6.   Selected Financial Data
 
                                         
    Fiscal Year Ended*  
    Sept. 29,
    Sept. 30,
    Sept. 24,
    Sept. 26,
    Sept. 27,
 
    2006     2005     2004     2003     2002  
    (In thousands, except per share amounts)  
 
Consolidated Statements of Operations Data:
                                       
Revenues:
                                       
Transaction-based revenues:
                                       
Commissions and transaction fees
  $ 727,407     $ 523,985     $ 560,052     $ 472,760     $ 252,526  
Asset-based revenues:
                                       
Interest revenue
    1,031,971       540,348       278,550       184,175       128,649  
Brokerage interest expense
    (335,820 )     (141,399 )     (41,861 )     (33,192 )     (24,564 )
                                         
Net interest revenue
    696,151       398,949       236,689       150,983       104,085  
Money market deposit account fees
    185,014                          
Money market and other mutual fund fees
    139,586       25,051       21,425       14,662       13,989  
                                         
Total asset-based revenues
    1,020,751       424,000       258,114       165,645       118,074  
Other revenues
    55,373       55,168       61,947       74,849       60,193  
                                         
Net revenues
    1,803,531       1,003,153       880,113       713,254       430,793  
                                         
Expenses:
                                       
Employee compensation and benefits
    350,079       180,579       154,792       172,159       133,897  
Fair value adjustments of compensation- related derivative instruments
    (1,715 )                        
Clearing and execution costs
    73,049       26,317       30,610       35,711       19,086  
Communications
    65,445       35,663       39,853       41,420       31,429  
Occupancy and equipment costs
    74,638       43,411       42,353       57,091       57,060  
Depreciation and amortization
    21,199       10,521       11,066       13,917       26,170  
Amortization of acquired intangible assets
    42,286       13,887       12,158       17,791       1,775  
Professional services
    87,521       30,630       27,381       31,121       25,753  
Interest on borrowings
    93,988       1,967       2,581       5,076       5,110  
Other
    45,383       22,689       17,798       15,205       12,986  
Advertising
    164,072       92,312       100,364       90,415       72,638  
Fair value adjustments of investment-related derivative instruments
    11,703       (8,315 )     (17,930 )     46,668        
Restructuring and asset impairment charges
                      5,991       63,406  
                                         
Total expenses
    1,027,648       449,661       421,026       532,565       449,310  
                                         
Income (loss) before other income and income taxes
    775,883       553,492       459,087       180,689       (18,517 )
Other income:
                                       
Gain on disposal of investments
    81,422                          
                                         
Pre-tax income (loss)
    857,305       553,492       459,087       180,689       (18,517 )
Provision for income taxes
    330,546       213,739       176,269       72,048       10,446  
                                         
Net income (loss)
  $ 526,759     $ 339,753     $ 282,818     $ 108,641     $ (28,963 )
                                         
Basic earnings (loss) per share
  $ 0.97     $ 0.84     $ 0.68     $ 0.25     $ (0.13 )
Diluted earnings (loss) per share
  $ 0.95     $ 0.82     $ 0.66     $ 0.25     $ (0.13 )
Weighted average shares outstanding — basic
    544,307       404,215       417,629       427,376       227,327  
Weighted average shares outstanding — diluted
    555,465       413,167       426,972       432,480       227,327  
Dividends declared per share
  $ 6.00     $ 0.00     $ 0.00     $ 0.00     $ 0.00  
 
 
* Fiscal 2005 was a 53-week year. All other periods presented are 52-week years.


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    As of  
    Sept. 29,
    Sept. 30,
    Sept. 24,
    Sept. 26,
    Sept. 27,
 
    2006     2005     2004     2003     2002  
    (In thousands)  
 
Consolidated Balance Sheet Data:
                                       
Cash and cash equivalents
  $ 363,650     $ 171,064     $ 137,392     $ 248,623     $ 198,398  
Short-term investments
    65,275       229,819       17,950              
Segregated cash and investments
    1,561,910       7,595,359       7,802,575       7,878,421       5,665,109  
Receivable from clients, net
    6,970,834       3,784,688       3,100,572       2,202,170       1,419,469  
Total assets
    16,558,469       16,417,110       15,277,021       14,404,268       9,800,841  
Payable to clients
    5,412,981       10,095,837       10,322,539       9,611,243       6,374,644  
Long-term obligations
    1,710,712       45,736       37,803       82,489       47,645  
Stockholders’ equity
    1,730,234       1,518,867       1,210,908       1,235,774       1,098,399  
 
Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
This discussion contains forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those anticipated in such forward-looking statements. Important factors that may cause such differences include, but are not limited to: general economic and political conditions, interest rates, stock market fluctuations and changes in client trading activity, increased competition, systems failures and capacity constraints, network security risks, ability to service debt obligations, integration associated with the TD Waterhouse acquisition, realization of synergies from the TD Waterhouse acquisition, regulatory and legal matters and uncertainties and the other risks and uncertainties set forth under Item 1A. — Risk Factors of this Form 10-K. The forward-looking statements contained in this report speak only as of the date on which the statements were made. We undertake no obligation to publicly update or revise these statements, whether as a result of new information, future events or otherwise.
 
In particular, forward-looking statements contained in this discussion include our expectations regarding: the amount of annualized pre-tax synergies to be realized from the integration of TD Waterhouse; the effect of changes in interest rates on our net interest spread; average commissions and transaction fees per trade; amounts of commissions and transaction fees, net interest revenue, money market deposit account fees, money market and other mutual fund fees and other revenues; amounts of employee compensation and benefits, clearing and execution costs, communications, occupancy and equipment costs, depreciation and amortization, amortization of acquired intangible assets, professional services, interest on borrowings, other operating expenses and advertising expenses; our effective income tax rate; our capital and liquidity needs and our plans to finance such needs; our stock repurchase program; and the impact of recently issued accounting pronouncements.


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Glossary of Terms
 
In discussing and analyzing our business, we utilize several metrics and other terms that are defined in the following Glossary of Terms. Italics indicate other defined terms that appear elsewhere in the Glossary. The term “GAAP” refers to U.S. generally accepted accounting principles.
 
Glossary of Terms
 
Activity rate — Average client trades per day during the period divided by the average number of total accounts during the period.
 
Asset-based revenues — Revenues consisting of (1) net interest revenue, (2) money market deposit account (“MMDA”) fees and (3) money market and other mutual fund fees. The primary factors driving our asset-based revenues are average client margin balances, average segregated cash balances, average client credit balances, average client MMDA balances and the average interest rates and fees earned and paid on such balances.
 
Average client trades per account (annualized) — Total trades divided by the average number of total accounts during the period, annualized based on the number of trading days in the fiscal year.
 
Average client trades per day — Total trades divided by the number of trading days in the period.
 
Average commissions and transaction fees per trade — Total commissions and transaction fee revenues as reported on the Company’s Consolidated Statements of Income divided by total trades for the period. Commissions and transaction fee revenues primarily consist of trading commissions and revenue-sharing arrangements with market destinations (also referred to as “payment for order flow”).
 
Basis point — When referring to interest rates, one basis point represents one one-hundredth of one percent.
 
Beneficiary accounts — Brokerage accounts managed by a custodian, guardian, conservator or trustee on behalf of one or more beneficiaries. Examples include Uniform Gift to Minors Act (UGMA), Uniform Transfer to Minors Act (UTMA), guardianship, conservatorship, trust, pension or profit plan for small business accounts.
 
Brokerage accounts — Accounts maintained by the Company on behalf of clients for securities brokerage activities. The primary types of brokerage accounts are cash accounts, margin accounts, IRA accounts and beneficiary accounts.
 
Cash accounts — Brokerage accounts that do not have margin account approval.
 
Clearing accounts — Accounts for which the Company serves as the clearing broker/dealer on behalf of an unaffiliated introducing broker/dealer. The Company charges a fee to the introducing broker/dealer to process trades in clearing accounts.
 
Client assets — The total value of cash and securities in brokerage accounts.
 
Client cash and money market assets — The sum of all client cash balances, including client credit balances and client cash balances swept into money market deposit accounts or money market mutual funds.
 
Client credit balances — Client cash held in brokerage accounts, excluding balances generated by client short sales, on which no interest is paid. Interest paid on client credit balances is a reduction of net interest revenue.  Client credit balances are included in “payable to clients” in the Consolidated Balance Sheets.
 
Client margin balances — The total amount of cash loaned to clients in margin accounts. Such loans are secured by client assets. Interest earned on client margin balances is a component of net interest revenue. Client margin balances are included in “receivable from clients” in the Consolidated Balance Sheets.
 
EBITDA and EBITDA Excluding Investment Gains — EBITDA (earnings before interest, taxes, depreciation and amortization) and EBITDA excluding investment gains are considered Non-GAAP financial measures as defined by SEC Regulation G. We consider EBITDA and EBITDA excluding investment gains important measures of our financial performance and of our ability to generate cash flows to service debt, fund capital expenditures and fund other corporate investing and financing activities. EBITDA is used as the denominator in the consolidated


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leverage ratio calculation for our senior credit facilities. The consolidated leverage ratio determines the interest rate margin charged on the senior credit facilities. EBITDA eliminates the non-cash effect of tangible asset depreciation and intangible asset amortization. EBITDA excluding investment gains also eliminates the effect of unusual gains that are not likely to be indicative of the ongoing operations of our business. EBITDA and EBITDA excluding investment gains should be considered in addition to, rather than as a substitute for, pre-tax income, net income and cash flows from operating activities.
 
EPS excluding investment gains/losses — EPS excluding investment gains/losses is a Non-GAAP financial measure as defined by SEC Regulation G. We define EPS excluding investment gains/losses as earnings (loss) per share, adjusted to remove the after-tax effect of investment-related gains and losses. We consider EPS excluding investment gains/losses an important measure of our financial performance. Gains/losses on investments and investment-related derivatives are excluded because we believe they are not likely to be indicative of the ongoing operations of our business. EPS excluding investment gains/losses should be considered in addition to, rather than as a substitute for, GAAP earnings per share.
 
EPS from ongoing operations — EPS from ongoing operations is considered a Non-GAAP financial measure as defined by SEC Regulation G. We define EPS from ongoing operations as earnings (loss) per share, adjusted to remove any significant unusual gains or charges. We consider EPS from ongoing operations an important measure of the financial performance of our ongoing business. Unusual gains and charges are excluded because we believe they are not likely to be indicative of the ongoing operations of our business. EPS from ongoing operations should be considered in addition to, rather than as a substitute for, GAAP earnings per share.
 
Expenses excluding advertising — Expenses excluding advertising is considered a Non-GAAP financial measure as defined by SEC Regulation G. Expenses excluding advertising consists of total expenses, adjusted to remove advertising expense. We consider expenses excluding advertising an important measure of the financial performance of our ongoing business. Advertising spending is excluded because it is largely at the discretion of the Company, varies significantly from period to period based on market conditions and generally relates to the acquisition of future revenues through new accounts rather than current revenues from existing accounts. Expenses excluding advertising should be considered in addition to, rather than as a substitute for, total expenses.
 
Investable assets — Client and brokerage-related asset balances, including client margin balances, segregated cash, money market deposit account (MMDA) balances, deposits paid on securities borrowing and other free cash and short-term investment balances. Investable assets is used in the calculation of our net interest margin.
 
IRA accounts (Individual Retirement Arrangements) — A personal trust account for the exclusive benefit of a U.S. individual (or his or her beneficiaries) that provides tax advantages in accumulating funds to save for retirement or other qualified purposes. These accounts are subject to numerous restrictions on additions to and withdrawals from the account, as well as prohibitions against certain investments or transactions conducted within the account. The Company offers traditional, Roth, Savings Incentive Match Plan for Employees (SIMPLE) and Simplified Employee Pension (SEP) IRA accounts.
 
Liquid assets — Liquid assets is considered a Non-GAAP financial measure as defined by SEC Regulation G. We define liquid assets as the sum of a) non broker-dealer cash and cash equivalents, b) non broker-dealer short-term investments and c) regulatory net capital of (i) our clearing broker-dealer subsidiaries in excess of five percent of aggregate debit items and (ii) our introducing broker-dealer subsidiary in excess of 81/3 percent of aggregate indebtedness. We consider liquid assets an important measure of our liquidity and of our ability to fund corporate investing and financing activities. Liquid assets should be considered as a supplemental measure of liquidity, rather than as a substitute for cash and cash equivalents.
 
Liquidation value — The net value of a client’s account holdings as of the close of a regular trading session. Liquidation value includes client cash and the value of long security positions, less margin balances and the cost to buy back short security positions.
 
Margin accounts — Brokerage accounts in which clients may borrow from the Company to buy securities or for any other purpose, subject to regulatory and Company-imposed limitations.


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Money market deposit account (“MMDA”) fees — Revenues resulting from the Money Market Deposit Account Agreement with TD Bank USA, N.A. (“TD Bank USA”), a subsidiary of TD, which became effective upon the closing of our acquisition of TD Waterhouse. Under the MMDA agreement, TD Bank USA makes available to clients of our broker-dealer subsidiaries money market deposit accounts as designated sweep vehicles. With respect to the MMDA accounts, our broker-dealer subsidiaries provide marketing and support services and act as recordkeeper for TD Bank USA, and act as agent for clients. In exchange for these services, TD Bank USA pays our broker-dealer subsidiaries a fee based on the actual yield earned by TD Bank USA on the client MMDA assets, less the actual interest cost paid to clients, actual interest cost incurred on borrowings, a flat fee to TD Bank USA of 20 basis points and certain direct expenses.
 
Net interest margin (“NIM”) — A measure of the net yield on our average investable assets. Net interest margin is calculated for a given period by dividing the annualized sum of net interest revenue and money market deposit account (MMDA) fees by average investable assets.
 
Net interest revenue — Net interest revenue is interest revenues less brokerage interest expense. Interest revenues are generated by charges to clients on margin balances maintained in margin accounts and the investment of cash from operations and segregated cash in short-term marketable securities. Brokerage interest expense consists of amounts paid or payable to clients based on credit balances maintained in brokerage accounts and other brokerage-related interest expense. Brokerage interest expense does not include interest on Company borrowings.
 
Net new accounts or Net account growth — The number of new client accounts (funded and unfunded) opened in a specified period minus the number of client accounts closed in the same period.
 
Non-GAAP net income and Non-GAAP EPS — Non-GAAP net income and Non-GAAP EPS are Non-GAAP financial measures as defined by SEC Regulation G. We define Non-GAAP net income as net income, adjusted to remove the after-tax effect of amortization of acquired intangible assets, interest on borrowings, fair value adjustments of investment-related derivative instruments and any unusual gains or charges. We consider Non-GAAP net income and Non-GAAP EPS important measures of our financial performance and of our ability to generate cash flows to service debt, fund capital expenditures and fund other corporate investing and financing activities. Amortization of acquired intangible assets and fair value adjustments of investment-related derivative instruments are excluded because they are non-cash expenses that do not require further cash investment. Interest on borrowings is excluded because we use these measures as an indicator of the earnings available to service debt. Unusual gains and charges are excluded because we believe they are not likely to be indicative of the ongoing operations of our business. Non-GAAP net income and EPS should be considered in addition to, rather than as a substitute for, GAAP net income and earnings per share.
 
Operating margin — Operating margin is considered a Non-GAAP financial measure as defined by SEC Regulation G. We define operating margin as pre-tax income, adjusted to remove advertising expense, fair value adjustments of investment-related derivative instruments and any unusual gains or charges. We consider operating margin an important measure of the financial performance of our ongoing business. Advertising spending is excluded because it is largely at the discretion of the Company, varies significantly from period to period based on market conditions and relates to the acquisition of future revenues through new accounts rather than current revenues from existing accounts. Fair value adjustments of investment-related derivative instruments and unusual gains and charges are excluded because we believe they are not likely to be indicative of the ongoing operations of our business. Operating margin should be considered in addition to, rather than as a substitute for, pre-tax income, net income and earnings per share.
 
Qualified accounts — All open client accounts with a total liquidation value greater than or equal to $2,000, except clearing accounts. Historically, qualified accounts have generated the vast majority of the Company’s revenues. The Company’s normal account-opening requirement for non-IRA accounts is $2,000. Additionally, accounts with $2,000 or more of liquidation value may be eligible for margin account approval.
 
Segregated cash — Client cash and investments segregated in compliance with SEC Rule 15c3-3 (the Customer Protection Rule) and other regulations. Interest earned on segregated cash is a component of net interest revenue.
 
Total accounts — All open client accounts (funded and unfunded), except clearing accounts.


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Total trades — All client securities trades, which are executed by the Company’s broker/dealer subsidiaries on an agency basis. Total trades are a significant source of the Company’s revenues. Such trades include, but are not limited to, trades in equities, options, mutual funds and debt instruments. Substantially all trades generate revenue from commissions, transaction fees and/or revenue-sharing arrangements with market destinations (also known as “payment for order flow”).
 
Trading days — Days in which the U.S. equity markets are open for a full trading session. Reduced exchange trading sessions are treated as half trading days.
 
Transaction-based revenues — Revenues generated from client trade execution, consisting primarily of commissions, transaction clearing fees and revenue sharing arrangements with market destinations (also known as “payment for order flow”).
 
Overview
 
We provide securities brokerage and clearing execution services to our clients through our introducing and clearing broker-dealers. Substantially all of our net revenues are derived from our brokerage activities and clearing and execution services.
 
Our primary focus is serving retail clients and registered investment advisors by providing services at low prices that are generally simpler than most of our competitors. Our brokerage clients are able to trade securities with us through a variety of channels, principally the Internet. We provide our clients with investment news and information as well as educational services. We also provide clearing and execution services to our brokerage operations.
 
Our largest sources of revenues are (1) asset-based revenues and (2) transaction-based revenues. The primary factors driving our asset-based revenues are average balances and average rates. Average balances consist primarily of average client margin balances, average segregated cash balances, average client credit balances, average client money market deposit account (“MMDA”) balances and average securities borrowing and lending balances. Average rates consist of the average interest rates and fees earned and paid on such balances. The primary factors driving our transaction-based revenues are total client trades and average commissions and transaction fees per trade. We also receive payment for order flow, which results from arrangements we have with many execution agents to receive cash payments in exchange for routing trade orders to these firms for execution and is included in commissions and transaction fees on the Consolidated Statements of Income.
 
Our largest operating expense generally is employee compensation and benefits. Employee compensation and benefits expense includes salaries, bonuses, stock-based compensation, group insurance, contributions to benefit programs, recruitment and other related employee costs. Fair value adjustments of compensation-related derivative instruments represent adjustments to equity swap agreements that are intended to economically offset TD Waterhouse stock-based compensation (assumed in the TD Waterhouse acquisition) that is based on the value of TD stock. See “Business Combination” below for a discussion of the acquisition of TD Waterhouse.
 
Clearing and execution costs include incremental third-party expenses that tend to fluctuate as a result of fluctuations in client accounts or trades. Examples of expenses included in this category are outsourced clearing services, statement and confirmation processing and postage costs and clearing expenses paid to the National Securities Clearing Corporation, option exchanges and other market centers. Communications expense includes telecommunications, other postage, news and quote costs. Occupancy and equipment costs include the costs of leasing and maintaining our office spaces and the lease expenses on computer and other equipment. Depreciation and amortization includes depreciation on property and equipment and amortization of leasehold improvements. Amortization of acquired intangible assets consists of amortization of amounts allocated to the value of intangible assets acquired in business combinations.
 
Professional services expense includes costs paid to outside firms for assistance with legal, accounting, technology, regulatory, marketing and general management issues. Interest on borrowings consists of interest expense on our long-term debt, capital leases, prepaid variable forward contracts and other borrowings. Other operating expenses include provision for bad debt losses, fraud losses, client trade execution price adjustments, gains or losses on disposal of property, travel expenses and other miscellaneous expenses. Advertising costs are


24


 

expensed as incurred and include production and placement of advertisements in various media, including online, television, print and direct mail, as well as client promotion and development costs. Advertising expenses may increase or decrease significantly from period to period. Fair value adjustments of investment-related derivative instruments consist of changes in the fair value of the embedded collars within our Knight prepaid variable forward contracts. In January 2006, we liquidated our position in Knight and the prepaid variable forward contracts.
 
Our fiscal year ends on the last Friday in September. References to fiscal year in this document or in the information incorporated herein by reference are to the fifty-two or fifty-three week period ended on any such Friday. For example, “fiscal 2006” refers to the fiscal year ended September 29, 2006. Fiscal years 2006 and 2004 were each fifty-two week years. Fiscal 2005 was a fifty-three week year.
 
Business Combination
 
On January 24, 2006, we completed the acquisition of TD Waterhouse Group, Inc. (“TD Waterhouse”), a Delaware corporation, pursuant to an Agreement of Sale and Purchase, dated June 22, 2005, as amended (the “Purchase Agreement”), with The Toronto-Dominion Bank (“TD”). We purchased from TD (the “Share Purchase”) all of the capital stock of TD Waterhouse in exchange for 196,300,000 shares of Company common stock, and $20,000 in cash. The shares of common stock issued to TD in the Share Purchase represented approximately 32.5 percent of the outstanding shares of the Company after giving effect to the transaction. Upon the completion of the transaction, we changed our name to TD AMERITRADE Holding Corporation and the authorized shares of common stock of the Company were increased from 650 million to one billion. Our consolidated financial statements include the results of operations for TD Waterhouse beginning January 25, 2006. In addition, on January 24, 2006, we completed the sale of Ameritrade Canada, Inc. to TD for $60 million in cash. We have agreed not to compete or own any portion of a business that competes with TD in Canada (including in the retail securities brokerage business) after the consummation of the Share Purchase. The purchase price for the acquisition of TD Waterhouse and the sale price for the sale of Ameritrade Canada were subject to cash adjustments based on the closing date balance sheets of the Company, TD Waterhouse and Ameritrade Canada. On May 5, 2006, we received approximately $45.9 million from TD for the settlement of cash adjustments related to the purchase of TD Waterhouse and the sale of Ameritrade Canada.
 
Pursuant to the Purchase Agreement, prior to the consummation of the Share Purchase, TD Waterhouse conducted a reorganization in which it transferred its Canadian retail securities brokerage business and TD Bank USA, N.A. (formerly TD Waterhouse Bank, N.A.) to TD such that, at the time of consummation of the Share Purchase, TD Waterhouse retained only its United States retail securities brokerage business. TD Waterhouse also distributed to TD excess capital of TD Waterhouse above certain thresholds prior to the consummation of the Share Purchase. As contemplated in the Purchase Agreement, on January 24, 2006, we commenced payment of a special cash dividend of $6.00 per share in respect of the shares of our common stock outstanding prior to the consummation of the Share Purchase. The total amount of the dividend was approximately $2.4 billion.
 
In connection with the Purchase Agreement, TD was given rights to have its shares of common stock of the Company registered for resale. TD licensed us the right to use the “TD” name in connection with the operation of our business. The parties also entered into agreements regarding bank sweep accounts and mutual funds.
 
In connection with the Purchase Agreement, the Company, TD and J. Joe Ricketts, our Chairman and Founder, and certain of his affiliates also entered into a Stockholders Agreement, as amended (the “Stockholders Agreement”). The Stockholders Agreement sets forth certain governance arrangements and contains various provisions relating to stock ownership, voting, election of directors and other matters. Our certificate of incorporation and bylaws were amended and restated as of January 24, 2006, to give effect to and facilitate the provisions contained in the Stockholders Agreement.
 
At the time of the closing of the TD Waterhouse acquisition, we expected to realize approximately $678 million of annualized pre-tax synergies from the acquisition of TD Waterhouse within 18 months of the closing, consisting of $300 million in revenue opportunities primarily related to our new banking relationship with TD and $378 million in cost savings related to the elimination of duplicate expenditures. As of September 29, 2006, we estimate that we have realized annualized pre-tax revenue opportunities of over $300 million and annualized pre-tax cost savings of approximately $143 million.


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Client Segmentation Strategy and New Client Offerings
 
The TD Waterhouse acquisition is part of our long-term growth strategy that includes increasing our focus beyond active traders to obtain greater market share from long-term investors and independent financial advisors. This acquisition gives us a nationwide branch network, a sales force that focuses on acquiring long-term investors and client assets and also gives us access to TD Waterhouse’s network of registered investment advisors.
 
Following a study, we announced new client offerings on April 24, 2006 that are intended to help increase market share from these three client segments. Our new client offerings include a $9.99 per trade flat-rate price for online equity trades and elimination of quarterly account maintenance fees. Our client survey research indicated that clients want simple, understandable pricing, coupled with innovative tools, comprehensive research, outstanding service and excellent execution. Our new flat-rate commission is not intended to compete solely based on price-point, but rather to be considered as a proposition for great value when combined with the products and services that we have designed with the goal of improving market share.
 
Critical Accounting Policies and Estimates
 
The preparation of our financial statements requires us to make judgments and estimates that may have a significant impact upon our financial results. Note 1 to the consolidated financial statements contains a summary of our significant accounting policies, many of which require the use of estimates and assumptions. We believe that the following areas are particularly subject to management’s judgments and estimates and could materially affect our results of operations and financial position.
 
Valuation of goodwill and acquired intangible assets
 
We test goodwill for impairment on at least an annual basis, or whenever events and circumstances indicate that the carrying value may not be recoverable. In performing the impairment tests, we utilize quoted market prices of our common stock to estimate the fair value of the Company as a whole. The estimated fair value is then allocated to our reporting units, if applicable, based on operating revenues, and is compared with the carrying value of the reporting units. No impairment charges have resulted from our annual impairment tests. We review our acquired intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such asset may not be recoverable. We evaluate recoverability by comparing the undiscounted cash flows associated with the asset to the asset’s carrying amount. We also evaluate the remaining useful lives of intangible assets each reporting period to determine if events or trends warrant a revision to the remaining period of amortization. We have had no events or trends that have warranted a revision to the originally estimated useful lives.
 
Valuation and accounting for derivative financial instruments
 
We may utilize derivative financial instruments to manage risks such as interest rate risk, foreign currency risk or market risk. Our derivatives policy prohibits us from using derivatives for speculative or trading purposes.
 
Accounting for derivatives differs significantly depending on whether a derivative is designated as a “hedge,” which is a transaction intended to reduce a risk associated with a specific balance sheet item or future expected cash flow at the time it is purchased. In order to qualify as a hedge, a derivative must be designated as such by management, who must also continue to evaluate whether the instrument effectively reduces the risk associated with that item.
 
To determine if a derivative instrument continues to be an effective hedge, we must make assumptions and judgments about the continued effectiveness of our hedging strategies and the nature and timing of forecasted transactions. If our hedging strategy were to become ineffective, we could no longer apply hedge accounting and our reported results of operations or financial condition could be materially affected.
 
Valuation of stock-based compensation
 
We account for stock-based compensation in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123 (Revised 2004), Share-Based Payment (“No. 123R”). Under the fair value recognition provisions of SFAS No. 123R, share-based compensation cost is measured at the grant date based on the value of the award and


26


 

is recognized as expense over the requisite service period based on the number of awards for which the requisite service is expected to be rendered. We must make assumptions regarding the number of share-based awards that will be forfeited. For performance-based awards, we must also make assumptions regarding the likelihood of achieving performance goals. If actual results differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially affected.
 
Estimates of effective income tax rates, deferred income taxes and valuation allowances
 
We estimate our income tax expense based on the various jurisdictions where we conduct business. This requires us to estimate our current income tax obligations and to assess temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities. Temporary differences result in deferred income tax assets and liabilities. We must evaluate the likelihood that deferred income tax assets will be realized. To the extent we determine that realization is not more likely than not, we establish a valuation allowance. Establishing or increasing a valuation allowance results in corresponding income tax expense in our Consolidated Statements of Income. Conversely, to the extent circumstances indicate that a valuation allowance is no longer necessary, that portion of the valuation allowance is reversed, reducing income tax expense.
 
We must make significant judgments to calculate our provision for income taxes, our deferred income tax assets and liabilities and any valuation allowance against our deferred income tax assets. We must also exercise judgment in determining the need for, and amount of, any accruals for taxes relating to results of examinations of current and prior years’ returns by taxing authorities. Because the application of tax laws and regulations to many types of transactions is subject to varying interpretations, amounts reported in the consolidated financial statements could be significantly changed at a later date upon final determinations by taxing authorities.
 
Results of Operations
 
Conditions in the U.S. equity markets significantly impact the volume of our clients’ trading activity. There is a direct correlation between the volume of our clients’ trading activity and our results of operations. We cannot predict future trading volumes in the U.S. equity markets. If client trading activity increases, we expect that it would have a positive impact on our results of operations. If client trading activity were to decline, we expect that it would have a negative impact on our results of operations.
 
Changes in average balances, especially client margin balances, client credit balances and client MMDA balances, may also significantly impact our results of operations. Changes in interest rates impact our results of operations to a lesser extent because we seek to mitigate interest rate risk by aligning the average duration of our interest-earning assets with that of our interest-bearing liabilities. We cannot predict the direction of interest rates or the levels of client balances. If interest rates rise, we generally expect to earn a larger net interest spread. Conversely, a falling interest rate environment generally would result in our earning a smaller net interest spread.
 
Financial Performance Metrics
 
Pre-tax income, net income, earnings per share, operating margin and EBITDA (earnings before interest, taxes, depreciation and amortization) and EBITDA excluding investment gains are key metrics we use in evaluating our financial performance. Operating margin, EBITDA and EBITDA excluding investment gains are considered non-GAAP financial measures as defined by SEC Regulation G.
 
We define operating margin as pre-tax income, adjusted to remove advertising expense, fair value adjustments of investment-related derivative instruments and any unusual gains or charges. We consider operating margin an important measure of the financial performance of our ongoing business. Advertising spending is excluded because it is largely at the discretion of the Company, varies significantly from period to period based on market conditions and generally relates to the acquisition of future revenues through new accounts rather than current revenues from existing accounts. Fair value adjustments of investment-related derivative instruments and unusual gains and charges are excluded because we believe they are not likely to be indicative of the ongoing operations of our business. Operating margin should be considered in addition to, rather than as a substitute for, pre-tax income, net income and earnings per share.


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We consider EBITDA and EBITDA excluding investment gains important measures of our financial performance and of our ability to generate cash flows to service debt, fund capital expenditures and fund other corporate investing and financing activities. EBITDA is used as the denominator in the consolidated leverage ratio calculation for our senior credit facilities. The consolidated leverage ratio determines the interest rate margin charged on the senior credit facilities. EBITDA eliminates the non-cash effect of tangible asset depreciation and intangible asset amortization. EBITDA excluding investment gains also eliminates the effect of unusual gains that are not likely to be indicative of the ongoing operations of our business. EBITDA and EBITDA excluding investment gains should be considered in addition to, rather than as a substitute for, pre-tax income, net income and cash flows from operating activities.
 
The following tables set forth operating margin, EBITDA and EBITDA excluding investment gains in dollars and as a percentage of net revenues for the periods indicated, and provide reconciliations to pre-tax income, which is the most directly comparable GAAP measure (dollars in thousands):
 
                                                 
    Fiscal Year Ended  
    September 29, 2006     September 30, 2005     September 24, 2004  
    $     % of Rev.     $     % of Rev.     $     % of Rev.  
 
Operating Margin
                                               
Operating margin
  $ 951,658       52.8 %   $ 637,489       63.5 %   $ 541,521       61.5 %
Less:
                                               
Advertising
    (164,072 )     (9.1 )%     (92,312 )     (9.2 )%     (100,364 )     (11.4 )%
Fair value adjustments of investment-related derivative instruments
    (11,703 )     (0.6 )%     8,315       0.8 %     17,930       2.0 %
                                                 
Income before other income and income taxes
    775,883       43.0 %     553,492       55.2 %     459,087       52.2 %
Gain on disposal of investments
    81,422       4.5 %     0       0.0 %     0       0.0 %
                                                 
Pre-tax income
  $ 857,305       47.5 %   $ 553,492       55.2 %   $ 459,087       52.2 %
                                                 
EBITDA and EBITDA Excluding Investment Gains
                                               
EBITDA excluding investment gains
  $ 933,356       51.8 %   $ 579,867       57.8 %   $ 484,892       55.1 %
Plus: Gain on disposal of investments
    81,422       4.5 %     0       0.0 %     0       0.0 %
                                                 
EBITDA
    1,014,778       56.3 %     579,867       57.8 %     484,892       55.1 %
Less:
                                               
Depreciation and amortization
    (21,199 )     (1.2 )%     (10,521 )     (1.0 )%     (11,066 )     (1.3 )%
Amortization of acquired intangible assets
    (42,286 )     (2.3 )%     (13,887 )     (1.4 )%     (12,158 )     (1.4 )%
Interest on borrowings
    (93,988 )     (5.2 )%     (1,967 )     (0.2 )%     (2,581 )     (0.3 )%
                                                 
Pre-tax income
  $ 857,305       47.5 %   $ 553,492       55.2 %   $ 459,087       52.2 %
                                                 
 
The dollar amounts of our pre-tax income, operating margin and EBITDA excluding investment gains increased for fiscal 2006, compared to fiscal 2005, primarily due to increased business resulting from the TD Waterhouse acquisition. However, pre-tax income, operating margin and EBITDA excluding investment gains all decreased as a percentage of net revenues for fiscal 2006 primarily due to the TD Waterhouse acquisition. Total expenses were higher as a percentage of net revenues in fiscal 2006 due to the effect of operating two back-office clearing platforms following the TD Waterhouse acquisition, higher interest on borrowings due to the debt issued to fund the special cash dividend and higher amortization of intangible assets due to the value assigned to the TD Waterhouse client relationships.


28


 

Operating Metrics
 
Our largest sources of revenues are (1) asset-based revenues and (2) transaction-based revenues. For fiscal 2006, asset-based revenues and commissions and transaction fees accounted for 57 percent and 40 percent of our net revenues, respectively. Asset-based revenues consist of (1) net interest revenue, (2) MMDA fees and (3) money market and other mutual fund fees. The primary factors driving our asset-based revenues are average balances and average rates. Average balances consist primarily of average client margin balances, average segregated cash balances, average client credit balances, average client MMDA balances and average securities borrowing and lending balances. Average rates consist of the average interest rates and fees earned and paid on such balances. The primary factors driving our transaction-based revenues are total client trades and average commissions and transaction fees per trade. We also consider client account and client asset metrics, although we believe they are generally of less significance to our results of operations for any particular period than our asset-based revenue and trading activity metrics.
 
Asset-Based Revenue Metrics
 
We calculate the return on our interest-earning assets and our MMDA balances using a measure we refer to as net interest margin. Net interest margin is calculated for a given period by dividing the annualized sum of net interest revenue and money market deposit account (MMDA) fees by average investable assets. Investable assets consist of client and brokerage-related asset balances, including client margin balances, segregated cash, money market deposit account (MMDA) balances, deposits paid on securities borrowing and other free cash and short-term investment balances. The following table sets forth net interest margin and average investable assets (dollar amounts in millions):
 
                                         
    Fiscal Year Ended     ’06 vs. ’05
    ’05 vs. ’04
 
    2006     2005     2004     Inc. (Dec.)     Inc. (Dec.)  
 
Average interest-earning assets
  $ 17,543     $ 15,355     $ 13,814     $ 2,188     $ 1,541  
Average money market deposit account balances
    5,734       N/A       N/A       5,734        
                                         
Average investable assets
  $ 23,277     $ 15,355     $ 13,814     $ 7,922     $ 1,541  
                                         
Net interest revenue
  $ 696.2     $ 398.9     $ 236.7     $ 297.3     $ 162.2  
Money market deposit account fee revenue
    185.0       N/A       N/A       185.0        
                                         
Net revenue earned on investable assets
  $ 881.2     $ 398.9     $ 236.7     $ 482.3     $ 162.2  
                                         
Net interest margin (NIM)
    3.74 %     2.52 %     1.69 %     1.22 %     0.83 %
                                         
 
The following tables set forth key metrics that we use in analyzing net interest revenue, which is a component of net interest margin:
 
                                         
    Interest Revenue (Expense)
             
    Fiscal Year Ended     ’06 vs. ’05
    ’05 vs. ’04
 
    2006     2005     2004     Inc. (Dec.)     Inc. (Dec.)  
    (millions)     (millions)     (millions)  
 
Segregated cash
  $ 324.9     $ 208.8     $ 84.5     $ 116.1     $ 124.3  
Client margin balances
    500.8       210.1       159.7       290.7       50.4  
Securities borrowing
    178.9       113.4       32.7       65.5       80.7  
Other free cash and short-term investments
    25.3       8.1       0.4       17.2       7.7  
Client credit balances
    (98.9 )     (45.9 )     (13.8 )     (53.0 )     (32.1 )
Securities lending
    (234.8 )     (95.6 )     (26.8 )     (139.2 )     (68.8 )
                                         
Net interest revenue
  $ 696.2     $ 398.9     $ 236.7     $ 297.3     $ 162.2  
                                         
 


29


 

                                         
    Average Balance
    ’06 vs. ’05
    ’05 vs. ’04
 
    Fiscal Year Ended     %
    %
 
    2006     2005     2004     Change     Change  
    (millions)              
 
Segregated cash
  $ 7,235     $ 7,801     $ 7,572       (7 )%     3 %
Client margin balances
    6,397       3,512       3,222       82 %     9 %
Securities borrowing
    3,435       3,824       2,868       (10 )%     33 %
Other free cash and short-term investments
    476       218       152       118 %     43 %
                                         
Interest-earning assets
  $ 17,543     $ 15,355     $ 13,814       14 %     11 %
                                         
Client credit balances
  $ 9,814     $ 9,482     $ 8,916       4 %     6 %
Securities lending
  $ 5,731     $ 4,621     $ 3,716       24 %     24 %
                                         
Interest-bearing liabilities
  $ 15,545     $ 14,103     $ 12,632       10 %     12 %
                                         
 
                                         
    Average Yield (Cost)
    ’06 vs. ’05
    ’05 vs. ’04
 
    Fiscal Year Ended     Net Yield
    Net Yield
 
    2006     2005     2004     Inc. (Dec.)     Inc. (Dec.)  
 
Segregated cash
    4.44 %     2.60 %     1.10 %     1.84 %     1.50 %
Client margin balances
    7.74 %     5.81 %     4.90 %     1.93 %     0.91 %
Securities borrowing
    5.15 %     2.88 %     1.13 %     2.27 %     1.75 %
Other free cash and short-term investments
    5.26 %     3.61 %     0.26 %     1.65 %     3.35 %
Client credit balances
    (1.00 )%     (0.47 )%     (0.15 )%     (0.53 )%     (0.32 )%
Securities lending
    (4.05 )%     (2.01 )%     (0.71 )%     (2.04 )%     (1.30 )%
Net interest revenue
    3.92 %     2.52 %     1.69 %     1.40 %     0.83 %
 
The following tables set forth key metrics that we use in analyzing other asset-based revenues:
 
                                         
    Fee Revenue
             
    Fiscal Year Ended     ’06 vs. ’05
    ’05 vs. ’04
 
    2006     2005     2004     Inc. (Dec.)     Inc. (Dec.)  
    (millions)     (millions)     (millions)  
 
Money market deposit account
  $ 185.0       N/A       N/A     $ 185.0       N/A  
Money market mutual fund
  $ 96.0     $ 21.0     $ 18.3     $ 75.0     $ 2.7  
Other mutual fund
  $ 43.6     $ 4.1     $ 3.1     $ 39.5     $ 1.0  
 
                                         
    Average Balance
    ’06 vs. ’05
    ’05 vs. ’04
 
    Fiscal Year Ended     %
    %
 
    2006     2005     2004     Change     Change  
    (millions)              
 
Money market deposit account
  $ 5,734       N/A       N/A       N/A       N/A  
Money market mutual fund
  $ 12,671     $ 2,735     $ 2,387       363 %     15 %
Other mutual fund
  $ 24,866     $ 3,247     $ 2,342       666 %     39 %
 
                                         
    Average Yield
    ’06 vs. ’05
    ’05 vs. ’04
 
    Fiscal Year Ended     Yield
    Yield
 
    2006     2005     2004     Inc. (Dec.)     Inc. (Dec.)  
 
Money market deposit account
    3.19 %     N/A       N/A       N/A       N/A  
Money market mutual fund
    0.75 %     0.74 %     0.76 %     0.01 %     (0.02 )%
Other mutual fund
    0.17 %     0.12 %     0.13 %     0.05 %     (0.01 )%

30


 

Trading Activity Metrics
 
The following table sets forth several metrics regarding client trading activity, which we utilize in measuring and evaluating performance and the results of our operations:
 
                                         
    Fiscal Year Ended     ’06 vs. ’05
    ’05 vs. ’04
 
    September 29,
    September 30,
    September 24,
    %
    %
 
    2006     2005     2004     Change     Change  
 
Total trades (in millions)
    54.24       39.94       41.74       36 %     (4 )%
Average commissions and transaction fees per trade
  $ 13.41     $ 13.12     $ 13.42       2 %     (2 )%
Average client trades per day
    216,970       155,696       167,958       39 %     (7 )%
Average client trades per account (annualized)
    10.1       11.0       12.4       (8 )%     (11 )%
Activity rate
    4.0 %     4.3 %     5.0 %     (7 )%     (14 )%
Trading days
    250.0       256.5       248.5       (3 )%     3 %
 
Client Account and Client Asset Metrics
 
The following table sets forth certain metrics regarding client accounts and client assets, which we use to analyze growth and trends in our client base:
 
                         
    Fiscal Year Ended  
    September 29,
    September 30,
    September 24,
 
    2006     2005     2004  
 
Qualified accounts (beginning of period)
    1,735,000       1,677,000       1,520,000  
Qualified accounts (end of period)
    3,242,000       1,735,000       1,677,000  
Percentage change during period
    87 %     3 %     10 %
             
Total accounts (beginning of period)
    3,717,000       3,520,000       3,171,000  
Total accounts (end of period)
    6,191,000       3,717,000       3,520,000  
Percentage change during period
    67 %     6 %     11 %
             
Client assets (beginning of period, in billions)
  $ 83.3     $ 68.8     $ 54.8  
Client assets (end of period, in billions)
  $ 261.7     $ 83.3     $ 68.8  
Percentage change during period
    214 %     21 %     26 %
 
Qualified accounts are all open client accounts with a total liquidation value of $2,000 or more, except clearing accounts. Qualified accounts are our most significant measure of client accounts because they have historically generated the vast majority of our revenues. Total accounts are all open client accounts (funded and unfunded), except clearing accounts.
 
Our total and qualified accounts increased for the full fiscal year 2006, primarily due to the net addition of approximately 2.25 million total accounts in connection with the TD Waterhouse acquisition. However, our total number of qualified accounts decreased by approximately 1.5 percent during the second half of fiscal 2006. We are carefully monitoring the number of qualified accounts and are taking actions designed to increase the number of qualified accounts. Such actions include the realignment of our management team in September 2006 to further our client segmentation strategy and the implementation of our new pricing structure announced in April 2006. We also expect that the integration of the TD Waterhouse clearing platform into the legacy Ameritrade clearing platform during fiscal 2007 will enable us to offer more comprehensive product offerings. If we were to experience significant decreases in the number of qualified accounts, it could have a material adverse effect on our future results of operations.


31


 

Consolidated Statements of Income Data
 
The following table summarizes certain data from our Consolidated Statements of Income for analysis purposes (in millions, except percentages and interest days):
 
                                         
    Fiscal Year     ’06 vs. ’05
    ’05 vs. ’04
 
    2006     2005     2004     % Change     % Change  
 
Revenues:
                                       
Transaction-based revenues:
                                       
Commissions and transaction fees
  $ 727.4     $ 524.0     $ 560.1       39 %     (6 )%
Asset-based revenues:
                                       
Interest revenue
    1,032.0       540.3       278.6       91 %     94 %
Brokerage interest expense
    (335.8 )     (141.4 )     (41.9 )     137 %     238 %
                                         
Net interest revenue
    696.2       398.9       236.7       74 %     69 %
Money market deposit account fees
    185.0                   N/A       N/A  
Money market and other mutual fund fees
    139.6       25.1       21.4       457 %     17 %
                                         
Total asset-based revenues
    1,020.8       424.0       258.1       141 %     64 %
Other
    55.4       55.2       61.9       0 %     (11 )%
                                         
Net revenues
    1,803.5       1,003.2       880.1       80 %     14 %
                                         
Expenses:
                                       
Employee compensation and benefits
    350.1       180.6       154.8       94 %     17 %
Fair value adjustments of compensation-related derivative instruments
    (1.7 )                 N/A       N/A  
Clearing and execution costs
    73.0       26.3       30.6       178 %     (14 )%
Communications
    65.4       35.7       39.9       84 %     (11 )%
Occupancy and equipment costs
    74.6       43.4       42.4       72 %     2 %
Depreciation and amortization
    21.2       10.5       11.1       101 %     (5 )%
Amortization of acquired intangible assets
    42.3       13.9       12.2       205 %     14 %
Professional services
    87.5       30.6       27.4       186 %     12 %
Interest on borrowings
    94.0       2.0       2.6       4678 %     (24 )%
Other
    45.4       22.7       17.8       100 %     27 %
Advertising
    164.1       92.3       100.4       78 %     (8 )%
Fair value adjustments of investment-related derivative instruments
    11.7       (8.3 )     (17.9 )     (241 )%     (54 )%
                                         
Total expenses
    1,027.6       449.7       421.0       129 %     7 %
                                         
Income before other income and income taxes
    775.9       553.5       459.1       40 %     21 %
Other income:
                                       
Gain on disposal of investments
    81.4                   N/A       N/A  
                                         
Pre-tax income
    857.3       553.5       459.1       55 %     21 %
Provision for income taxes
    330.5       213.7       176.3       55 %     21 %
                                         
Net income
  $ 526.8     $ 339.8     $ 282.8       55 %     20 %
                                         
Other information:
                                       
Number of interest days in period
    364       371       364       (2 )%     2 %
Effective income tax rate
    38.6 %     38.6 %     38.4 %                
 
 
Note:  Details may not sum to totals and subtotals due to rounding differences. Change percentages are based on non-rounded Consolidated Statements of Income amounts.


32


 

 
Fiscal Year Ended September 29, 2006 Compared to Fiscal Year Ended September 30, 2005
 
Net Revenues
 
Commissions and transaction fees increased 39 percent to $727.4 million, primarily due to the addition of approximately 2.25 million accounts on January 24, 2006 in the TD Waterhouse acquisition. Total trades increased 36 percent and average client trades per day increased 39 percent to 216,970 for fiscal 2006 from 155,696 for fiscal 2005. Average client trades per account were 10.1 for fiscal 2006, compared to 11.0 for fiscal 2005. The number of qualified accounts, which have historically generated the vast majority of our revenues, has increased by 87 percent since September 2005, primarily due to the acquisition of TD Waterhouse. Average commissions and transaction fees per trade increased to $13.41 per trade for fiscal 2006 from $13.12 for fiscal 2005, primarily due to the acquired TD Waterhouse accounts earning higher average commissions and transaction fees per trade than existing Ameritrade accounts until the implementation of our new pricing structure in April 2006, which was partially offset by the effect of lowering our options contract pricing from $1.50 to $0.75 per contract in March 2005 and decreased payment for order flow revenue per trade. The increased revenue resulting from the increased number of accounts and higher commissions and transaction fees per trade was partially offset by three percent fewer trading days in fiscal 2006 compared to fiscal 2005, due to fiscal 2005 being a 53-week year. We expect average commissions and transaction fees to range from approximately $12.85 to $13.35 per trade during fiscal 2007, depending on the mix of client trading activity, level of payment for order flow revenue and other factors. We expect revenues from commissions and transaction fees to range from $738.5 million to $939.8 million for fiscal 2007, depending on the volume of client trading activity, average commissions and transaction fees per trade and other factors.
 
Net interest revenue increased 74 percent to $696.2 million, due primarily to an increase in average client margin balances to $6.4 billion for fiscal 2006 from $3.5 billion for fiscal 2005, an increase of 193 basis points in the average interest rate charged on client margin balances and an increase of 184 basis points in the average interest rate earned on segregated cash during fiscal 2006 compared to fiscal 2005. The increased client margin balances are primarily due to the TD Waterhouse acquisition. The increased net interest revenue resulting from these factors was partially offset by an increase of 53 basis points in the average interest rate paid on client credit balances and a $73.7 million decrease in net interest from our securities borrowing/lending program for fiscal 2006 compared to the fiscal 2005. The movement of over $6 billion in legacy Ameritrade client credit balances to our MMDA sweep product in late September 2006 will result in a shift in revenues from net interest revenue to money market deposit account fees in fiscal 2007. The MMDA product is described further in the next paragraph. We expect net interest revenue to range between $526.8 million and $560.5 million for fiscal 2007.
 
Money market deposit account (MMDA) fees is a new revenue category resulting from the Money Market Deposit Account Agreement with TD Bank USA, N.A. (a subsidiary of TD), which became effective upon the closing of our acquisition of TD Waterhouse. Under the MMDA agreement, TD Bank USA makes available to clients of our broker-dealer subsidiaries money market deposit accounts as designated sweep vehicles. With respect to the MMDA accounts, the broker-dealer subsidiaries provide marketing and support services and act as recordkeeper for TD Bank USA, and act as agent for clients. In exchange for these services, TD Bank USA pays the broker-dealer subsidiaries a fee based on the actual yield earned by TD Bank USA on the client MMDA assets, less the actual interest cost paid to clients, actual interest cost incurred on borrowings, a flat fee to TD Bank USA of 20 basis points and certain direct expenses. We expect money market deposit account fees to increase to between $515.6 million and $537.8 million for fiscal 2007, reflecting a full year of legacy TD Waterhouse MMDA balances and the transfer of over $6 billion of legacy Ameritrade client credit balances to the product in late September 2006.
 
Money market and other mutual fund fees increased to $139.6 million for fiscal 2006 compared to $25.1 million for fiscal 2005, primarily due to an increase in average money market and other mutual fund balances primarily resulting from the TD Waterhouse acquisition. We expect money market and other mutual fund fees to range between $222.0 million and $243.3 million for fiscal 2007.
 
Other revenues were virtually unchanged at $55.4 million for fiscal 2006, as increases in account maintenance, transfer and other fee revenue associated with additional accounts and transaction processing volumes resulting from the TD Waterhouse acquisition were offset by the effect of our elimination of account maintenance fees in


33


 

April 2006. We expect other revenues to decrease to $33.4 million to $41.4 million for fiscal 2007, reflecting the full year impact of eliminating account maintenance fees.
 
Expenses
 
Employee compensation and benefits expense increased 94 percent to $350.1 million, primarily due to the TD Waterhouse acquisition. Full-time equivalent employees increased to 3,947 at September 29, 2006, from 2,058 at September 30, 2005. The number of temporary employees also increased to 199 at September 29, 2006, from 120 at September 30, 2005, due to TD Waterhouse integration efforts. In fiscal 2006, we also incurred approximately $5.6 million in severance costs for legacy Ameritrade employees, primarily related to the TD Waterhouse integration. Stock-based compensation expense increased by $12.7 million, as we began recognizing additional compensation cost for the unvested portion of past stock option awards upon our adoption of SFAS No. 123R on October 1, 2005 and because we issued a broad-based grant of Restricted Stock Units in March 2006. We expect employee compensation and benefits expense to range between $392.3 million and $400.5 million for fiscal 2007.
 
Fair value adjustments of compensation-related derivative instruments of $1.7 million for fiscal 2006 represent adjustments to equity swap agreements that are intended to economically offset TD Waterhouse stock-based compensation that is based on the value of TD stock. Because the swap agreements were not designated for hedge accounting, the fair value adjustments are not recorded in the same category of the Consolidated Statements of Income as the stock-based compensation expense, which is recorded in the employee compensation and benefits category. The related $1.7 million of TD Waterhouse stock-based compensation expense is included in employee compensation and benefits in the Consolidated Statements of Income.
 
Clearing and execution costs increased 178 percent to $73.0 million, due primarily to increased expense for statement and confirmation processing, clearing expenses and order routing associated with additional accounts and transaction processing volumes resulting from the TD Waterhouse acquisition. We expect clearing and execution costs to range between $70.2 million and $72.2 million for fiscal 2007, as the full year effect of the TD Waterhouse business is expected to be offset by the elimination of the duplicate TD Waterhouse back-office clearing platform during fiscal 2007.
 
Communications expense increased 84 percent to $65.4 million, due primarily to increased expense for telephone, quotes and market information associated with the additional accounts and transaction processing volumes resulting from the TD Waterhouse acquisition. We expect communications expense to range between $68.7 million and $72.7 million for fiscal 2007, as the full year effect of the TD Waterhouse business is expected to be partially offset by the elimination of duplicate telephone, quotes, and market information costs during fiscal 2007.
 
Occupancy and equipment costs increased 72 percent to $74.6 million, due primarily to leased facilities added in the TD Waterhouse acquisition and a $2.3 million early lease termination fee associated with our facility in Jersey City, New Jersey during the fiscal 2006. Operations in the Jersey City facility have been moved into TD Waterhouse facilities. We expect occupancy and equipment costs to range between $79.7 million and $83.7 million for fiscal 2007.
 
Depreciation and amortization increased 101 percent to $21.2 million, due primarily to depreciation of assets recorded in the TD Waterhouse acquisition and increased software amortization related to recently developed functionality. We expect depreciation and amortization expense to range from $19.5 million to $21.9 million for fiscal 2007.
 
Amortization of acquired intangible assets increased 205 percent to $42.3 million due to amortization of client relationship intangible assets recorded in the TD Waterhouse acquisition. We expect amortization of acquired intangible assets outstanding as of September 29, 2006 to be approximately $54.6 million for fiscal 2007.
 
Professional services increased 186 percent to $87.5 million. This increase was primarily due to increased usage of consulting and contract services during fiscal 2006 in connection with the TD Waterhouse acquisition and integration. During fiscal 2006, there was also a $5.0 million reimbursement of professional services related to the TD Waterhouse acquisition pursuant to the terms of our Chairman’s employment agreement. We expect professional services expense to range between $69.2 million and $77.2 million for fiscal 2007.


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Interest on borrowings increased to $94.0 million for fiscal 2006, compared to $2.0 million for fiscal 2005, due primarily to interest on the $1.9 billion of long-term debt issued to fund a portion of the $6.00 per share special cash dividend paid in January 2006 and working capital needs in connection with the TD Waterhouse acquisition. We expect interest on borrowings to be approximately $105 million for fiscal 2007, depending on variability in short-term interest rates and the amount and timing of discretionary prepayments on our long-term debt.
 
Other expenses increased 100 percent to $45.4 million, due primarily to additional business resulting from the TD Waterhouse acquisition, client identity fraud losses of $4.2 million during the fourth quarter of fiscal 2006 reimbursed pursuant to our asset protection guarantee and the effect of a favorable litigation settlement during fiscal 2005. The online brokerage industry has experienced increased client identity fraud losses during the second half of fiscal 2006. We are implementing additional processes and technologies, as well as working with our peers, regulators and law enforcement to develop strategies to minimize such losses. We expect other expense to range between $36.5 million and $38.1 million for fiscal 2007. However, if client identity fraud losses were to continue at the rate experienced during the fourth quarter of fiscal 2006 or at an increased rate, we could experience higher other expenses.
 
Advertising expense increased 78 percent to $164.1 million, due primarily to the promotion of the new TD AMERITRADE brand and our new client offerings and pricing announced April 24, 2006. We expect approximately $136.2 million to $156.2 million of advertising expenditures for fiscal 2007, depending in part on market conditions. We generally adjust our level of advertising spending in relation to stock market activity, in an effort to maximize the number of new accounts while minimizing the advertising cost per new account.
 
Fair value adjustments of investment-related derivative instruments resulted in an $11.7 million charge for fiscal 2006 compared to an $8.3 million gain fiscal 2005, due to fluctuations in the market price of the Knight stock underlying the prepaid forward contracts. As discussed in Note 17 to the consolidated financial statements, we liquidated our investment in Knight and the related prepaid variable forward contracts in January 2006, resulting in a one-time pre-tax net gain of approximately $78.8 million, which is included in gains on sale of investments in the Consolidated Statements of Income.
 
Our effective income tax rate was 38.6 percent for both fiscal 2006 and fiscal 2005. The effect of a larger percentage of our payroll and assets being located in higher tax states in fiscal 2006 following the acquisition of TD Waterhouse was partially offset by the reversal of approximately $4 million of accruals for uncertain tax positions due to favorable resolution of such items in fiscal 2006. During fiscal 2005, we also recorded a $1.8 million benefit resulting from the amalgamation of our Canadian subsidiaries, which allowed previously unrealizable tax loss carryforwards to be realized. We expect our effective income tax rate to range from approximately 39 percent to 40 percent for fiscal 2007, depending in part on the timing and extent of the TD Waterhouse integration and our ability to realize related expense synergies.
 
Fiscal Year Ended September 30, 2005 Compared to Fiscal Year Ended September 24, 2004
 
Net Revenues
 
Commissions and transaction fees decreased six percent to $524.0 million, primarily due to a four percent decrease in total trades and a two percent decrease in average commissions and transaction fees per trade. Average trades per day decreased seven percent to 155,696 for fiscal 2005 from 167,958 for fiscal 2004. Average client trades per account were 11.0 during fiscal 2005, compared to 12.4 during fiscal 2004. The decreased revenue resulting from these factors was partially offset by three percent more trading days in fiscal 2005 compared to fiscal 2004, due to fiscal 2005 being a 53-week year. The number of qualified accounts increased three percent to 1.74 million as of September 30, 2005, compared to 1.68 million as of September 24, 2004. Historically, qualified accounts have generated the vast majority of our revenues. Average commissions and transaction fees per trade decreased to $13.12 for fiscal 2005 from $13.42 for fiscal 2004, due primarily to a decrease in our options contract pricing and decreased payment for order flow revenue per trade. In March 2005, we lowered our options contract pricing from $1.50 to $0.75 per contract.
 
Net interest revenue increased 69 percent to $398.9 million, due primarily to an increase of 150 basis points in the average interest rate earned on segregated cash, an increase of 91 basis points in the average interest rate charged


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on client margin balances, a nine percent increase in average client margin balances, seven more interest days due to fiscal 2005 being a 53-week year and an $11.9 million increase in net interest earned on our securities lending program in fiscal 2005 compared to fiscal 2004. The increased net interest revenue resulting from these factors was partially offset by an increase of 32 basis points in the average interest rate paid on client credit balances in fiscal 2005 from fiscal 2004.
 
Money market and other mutual fund fees increased 17 percent to $25.1 million, due primarily to a 15 percent increase in average money market mutual fund balances and a 39 percent increase in average other mutual fund balances.
 
Other revenues decreased 11 percent to $55.2 million, due primarily to a decrease in account maintenance, confirm and other fee revenue, partially offset by higher solicitation and tender offer fees. Prior to our elimination of quarterly account maintenance fees in April 2006, account maintenance fees were charged based on client assets and trading activity; therefore, fluctuations in client assets or trades per account resulted in fluctuations in revenues from account maintenance fees.
 
Expenses
 
Employee compensation and benefits expense increased 17 percent to $180.6 million, due primarily to an increase in full-time equivalent employees to 2,058 at September 30, 2005 from 1,961 at September 24, 2004, increased incentive compensation due to improved financial results, annual merit increases and approximately $5 million of severance costs for departing executives in the fourth quarter of fiscal 2005.
 
Clearing and execution costs decreased 14 percent to $26.3 million, due primarily to lower client trading volumes, decreased order routing costs resulting from our implementation of a single web architecture trading platform during fiscal 2004 and a non-recurring refund of Nasdaq trading activity fees of approximately $1 million during the first quarter of fiscal 2005.
 
Communications expense decreased 11 percent to $35.7 million, due primarily to reduced telecommunications costs resulting from contract negotiations in fiscal 2005.
 
Occupancy and equipment costs increased two percent to $43.4 million, due primarily to costs associated with moving technology employees to a larger facility in New Jersey during the third quarter of fiscal 2005, partially offset by slightly lower computer equipment leasing costs.
 
Amortization of acquired intangible assets increased 14 percent to $13.9 million, due primarily to additional amortization of acquired intangible assets related to the acquisition of client accounts from JB Oxford & Company in October 2004.
 
Professional services expense increased 12 percent to $30.6 million, due primarily to increased spending on corporate development initiatives in fiscal 2005 and increased legal fees incurred for regulatory matters, partially offset by decreased client communications consulting expenses.
 
Other operating expenses increased 27 percent to $22.7 million, due primarily to increased bad debt expense during fiscal 2005 and the effect of Datek-related litigation and arbitration matters that were resolved favorably during the fourth quarter of fiscal 2004.
 
Advertising expenses decreased eight percent to $92.3 million, as we reduced expenditures in response to lackluster stock market conditions.
 
Fair value adjustments of investment-related derivative instruments consisted of an $8.3 million unrealized gain for fiscal 2005 compared to a $17.9 million unrealized gain for fiscal 2004, due to decreases in the market price of the Knight stock underlying our prepaid variable forward contracts in both fiscal 2005 and fiscal 2004. Because the embedded collars within the prepaid variable forward contracts were accounted for as non-hedging derivatives, changes in the fair value of the embedded collars were recognized in the statement of income, along with the related income tax effects. We liquidated our investment in Knight and the related prepaid variable forward contracts in January 2006.


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Our effective income tax rate was approximately 38.6 percent for fiscal 2005 compared to 38.4 percent for fiscal 2004. The Datek integration resulted in a larger percentage of our payroll and assets being located in lower income tax states. An adjustment to our net deferred income tax liabilities to apply the lower income tax rate resulted in a lower than normal effective income tax rate for fiscal 2004.
 
Liquidity and Capital Resources
 
We have historically financed our liquidity and capital needs primarily through the use of funds generated from operations and from borrowings under our credit agreements. We have also issued common stock and long-term debt to finance mergers and acquisitions and for other corporate purposes. Our liquidity needs during fiscal 2006 have been financed primarily from our earnings, cash on hand, cash acquired in the acquisition of TD Waterhouse and the issuance of long-term debt. We plan to finance our operational capital and liquidity needs primarily from our earnings and cash on hand. In addition, we may utilize our revolving credit facility or issue equity or debt securities.
 
To complete our acquisition of the U.S. brokerage business of TD Waterhouse, we issued 196.3 million shares of common stock on January 24, 2006. We also paid a $6.00 per share special cash dividend. We funded the approximately $2.4 billion special dividend with approximately $0.4 billion from cash and short-term investments on hand, approximately $0.4 billion from excess capital in TD Waterhouse at closing and the remaining $1.6 billion by issuing private long-term debt. We also issued another $0.3 billion of private long-term debt, and entered into a $0.3 billion revolving credit agreement, for working capital purposes. As a result of these debt issuances and other debt assumed in connection with the acquisition of TD Waterhouse, our ratio of total debt to total stockholders’ equity increased from three percent as of September 30, 2005 to 99 percent as of September 29, 2006. See Note 2 of the Notes to Consolidated Financial Statements for further information about the TD Waterhouse acquisition.
 
Dividends from our subsidiaries are another source of liquidity for the holding company. Some of our subsidiaries are subject to requirements of the SEC and NASD relating to liquidity, capital standards, and the use of client funds and securities, which may limit funds available for the payment of dividends to the holding company.
 
Under the SEC’s Uniform Net Capital Rule (Rule 15c3-1 under the Securities Exchange Act of 1934), our broker-dealer subsidiaries are required to maintain at all times at least the minimum level of net capital required under Rule 15c3-1. This minimum net capital level is determined based upon an involved calculation described in Rule 15c3-1 that is primarily based on each broker-dealer’s “aggregate debits”, which primarily are a function of client margin balances at our broker-dealer subsidiaries. Since our aggregate debits may fluctuate significantly, our minimum net capital requirements may also fluctuate significantly from period to period. The holding company may make cash capital contributions to broker-dealer subsidiaries, if necessary, to meet net capital requirements.


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Liquid Assets
 
We consider liquid assets an important measure of our liquidity and of our ability to fund corporate investing and financing activities. Liquid assets is considered a Non-GAAP financial measure as defined by SEC Regulation G. We define liquid assets as the sum of a) non broker-dealer cash and cash equivalents, b) non broker-dealer short-term investments and c) regulatory net capital of (i) our clearing broker-dealer subsidiaries in excess of five percent of aggregate debit items and (ii) our introducing broker-dealer subsidiary in excess of 81/3 percent of aggregate indebtedness. We include the excess regulatory net capital of our broker-dealer subsidiaries in liquid assets rather than simply including broker-dealer cash and cash equivalents, because regulatory net capital requirements may limit the amount of cash available for dividend from the broker-dealer subsidiaries to the holding company. Liquid assets should be considered as a supplemental measure of liquidity, rather than as a substitute for cash and cash equivalents. The following table sets forth a reconciliation of cash and cash equivalents to liquid assets for the periods indicated (in thousands):
 
                         
    September 29,
    September 30,
       
    2006     2005     Change  
 
Cash and cash equivalents
  $ 363,650     $ 171,064     $ 192,586  
Less: Broker-dealer cash and cash equivalents
    (263,054 )     (107,236 )     (155,818 )
                         
Non broker-dealer cash and cash equivalents
    100,596       63,828       36,768  
Plus: Non broker-dealer short term investments
    65,275       229,819       (164,544 )
Plus: Excess broker-dealer regulatory net capital
    333,514       103,061       230,453  
                         
Liquid assets
  $ 499,385     $ 396,708     $ 102,677  
                         
 
The increase in liquid assets from September 30, 2005 to September 29, 2006 is primarily due to $527 million of net income, approximately $46 million of excess broker-dealer net capital acquired in the TD Waterhouse acquisition, approximately $407 million of non broker-dealer cash provided by TD Waterhouse to fund approximately $1.00 of the $6.00 per share special dividend and a decrease in aggregate debit items that resulted in decreased regulatory net capital required of $16 million, offset by $1,036 million of net cash used in financing activities (see “Cash Flow” below). The remaining $142 million of the positive net change in liquid assets is due to timing of income tax and other payments, non-cash gains and expenses that are reflected in net income, and other miscellaneous changes in excess regulatory net capital.
 
Cash Flow
 
Cash provided by operating activities was $485.0 million for fiscal 2006, compared to $330.0 million for fiscal 2005. The increase was primarily due to higher net income in fiscal 2006, partially offset by changes in broker-dealer working capital.
 
Cash provided by investing activities was $743.5 million for fiscal 2006, compared to cash used in investing activities of $245.1 million for fiscal 2005. The cash provided by investing activities in fiscal 2006 consisted primarily of $580.1 million of net cash acquired in the TD Waterhouse acquisition and $164.5 million of net sales of short-term investments in auction rate securities. The cash used in investing activities in fiscal 2005 consisted primarily of $211.9 million of net short-term investments in auction rate securities and $25.9 million paid in the acquisition of the online retail client accounts of JB Oxford & Company.
 
Cash used in financing activities was $1.0 billion for fiscal 2006, compared to $51.6 million for fiscal 2005. The financing activities in fiscal 2006 consisted primarily of $2.4 billion for payment of the $6.00 per share special cash dividend, $496.6 million of principal payments on debt and $67.7 million of stock repurchases, partially offset by $1.9 billion of proceeds from issuance of long-term debt. The financing activities in fiscal 2005 included $77.2 million of stock repurchases.
 
Loan Facilities
 
We entered into a credit agreement, as amended, on January 23, 2006 for $2.2 billion in senior credit facilities with a syndicate of lenders. The senior credit facilities include: (a) a senior secured term loan facility in the


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aggregate principal amount of $250 million (the “Term A Facility”), (b) a senior secured term loan facility in the aggregate principal amount of $1.65 billion (the “Term B Facility”) and (c) a senior secured revolving credit facility in the aggregate principal amount of $300 million (the “Revolving Facility”) (together, the “Financings”). The maturity date of the Term A Facility is December 31, 2011. The maturity date of the Term B Facility is December 31, 2012. The maturity date of the Revolving Facility is December 31, 2010. The Financings are subject to certain mandatory prepayments, which include prepayments based on leverage ratios and amounts of excess cash flow and from the net cash proceeds of asset sales and debt issuances, subject to certain exceptions. Under the terms of the Financings, the Company may prepay these borrowings without penalty.
 
We used $1.6 billion of the proceeds from the Term A Facility and Term B Facility to fund a portion of the $6 per share special cash dividend paid in connection with the acquisition of TD Waterhouse and $300 million for working capital purposes. No initial borrowings were made on the Revolving Facility, which was established for general corporate purposes.
 
The applicable interest rate under the Revolving Facility and the Term A Facility is calculated as a per annum rate equal to, at our option, (a) LIBOR plus an interest rate margin (“LIBOR loans”) or (b) (i) the greater of (x) the prime rate or (y) the federal funds effective rate plus 0.50 percent plus (ii) an interest rate margin (“Base Rate loans”). With respect to the Revolving Facility and the Term A Facility the interest rate margin for LIBOR loans is 1.50 percent if the consolidated leverage ratio (as defined in the Financings) of the Company is 1.75 to 1.00 or higher, 1.25 percent if the consolidated leverage ratio of the Company is less than 1.75 to 1.00 but greater than or equal to 1.00 to 1.00, and 1.00 percent if the consolidated leverage ratio of the Company is less than 1.00 to 1.00. The interest rate margin for Base Rate loans under the Revolving Facility and the Term A Facility is 1.00 percent less than the interest rate margin for LIBOR loans. The applicable interest rate under the Term B Facility is calculated as a per annum rate equal to (a) LIBOR plus 1.50 percent or (b) (i) the greater of (x) the prime rate or (y) the federal funds effective rate plus 0.50 percent plus (ii) 0.50 percent. On September 29, 2006, the applicable interest rate on the Term A Facility and the Term B Facility was 6.57 percent and 6.82 percent, respectively, based on 30-day LIBOR. As of September 29, 2006, we had outstanding indebtedness of $0.2 billion, $1.5 billion and $0 under the Term A Facility, Term B Facility and Revolving Facility, respectively. We have not made any borrowings under the Revolving Facility. The Financings also provide that we are obligated to pay from time to time letter of credit fees equal to the applicable margin in respect of LIBOR advances on each outstanding letter of credit under the Revolving Credit Facility. In addition, the Financings provide that we pay fees to the issuing bank in respect of the Letters of Credit in an amount agreed to by us and the issuing bank. A commitment fee at the rate of 0.375 percent per annum accrues on any unused amount of the Revolving Facility.
 
The obligations under the Financings are guaranteed by certain of our subsidiaries, other than broker-dealer subsidiaries, with certain exceptions, and are secured by a lien on substantially all of the assets of each guarantor, including a pledge of the ownership interests in each first-tier broker-dealer subsidiary held by a guarantor and 65 percent of the ownership interests in each first-tier foreign subsidiary held by a guarantor, with certain exceptions.
 
The Financings contain certain covenants that limit or restrict the incurrence of liens, investments (including acquisitions), sales of assets, indebtedness and mergers and consolidations, subject to certain exceptions. The Financings also restrict the payment of dividends on our outstanding capital stock and repurchases or redemptions of our outstanding capital stock, subject to certain exceptions. We are also required to maintain compliance with a maximum consolidated leverage ratio covenant and a minimum consolidated interest coverage ratio covenant, and our broker-dealer subsidiaries are required to maintain compliance with a minimum regulatory net capital covenant. We were in compliance with all covenants under the Financings as of September 29, 2006, except for a failure to timely notify the lenders of name changes of certain guarantor subsidiaries. We have requested a waiver from the lenders for the lack of timely notification.
 
Prior to the closing of our acquisition of TD Waterhouse, TD Waterhouse and an affiliate of TD executed a promissory note whereby TD Waterhouse borrowed $270 million from TD (the “Bridge Loan”). The purpose of the Bridge Loan was to monetize non-cash assets of TD Waterhouse to enable TD Waterhouse to retain cash equal to $1.00 per share of the $6.00 per share special cash dividend declared by us, as required by the Purchase Agreement. We assumed the Bridge Loan obligation upon the closing of our acquisition of TD Waterhouse. The Bridge Loan


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was scheduled to mature on July 24, 2006 and bore interest at the daily effective federal funds rate until the completion of the closing date balance sheet adjustments as specified in the Purchase Agreement, and after that time bore interest at the federal funds rate plus 150 basis points. We repaid $200 million of the Bridge Loan during March 2006 and the remaining $70 million balance during June 2006.
 
Upon the closing of our acquisition of TD Waterhouse, we assumed $30 million of Subordinated Debt Series B Notes (the “Subordinated Notes”), which were payable to an affiliate of TD. The Subordinated Notes were unsecured and were redeemable in November 2012. The Subordinated Notes bore interest at a fixed rate of 6.64 percent. During June 2006, we repaid the entire $30 million of Subordinated Notes.
 
Our wholly owned broker-dealer subsidiaries had access to secured uncommitted credit facilities with financial institutions of up to $740 million and $180 million as of September 29, 2006 and September 30, 2005, respectively. The broker-dealer subsidiaries also had access to unsecured uncommitted credit facilities of up to $435 million and $310 million as of September 29, 2006 and September 30, 2005, respectively. The financial institutions may make loans under line of credit arrangements or, in some cases, issue letters of credit under these facilities. The secured credit facilities require us to pledge qualified client securities to secure outstanding obligations under these facilities. Borrowings under the secured and unsecured credit facilities bear interest at a variable rate based on the federal funds rate. Covenants under the Financings limit the broker-dealer subsidiaries to an aggregate outstanding principal balance of $1.0 billion in borrowings on uncommitted lines of credit, excluding securities lending. There were no borrowings outstanding or letters of credit issued under the secured or unsecured credit facilities as of September 29, 2006 and September 30, 2005. As of September 29, 2006 and September 30, 2005, approximately $1.0 billion and $490 million, respectively, was available to our broker-dealer subsidiaries pursuant to uncommitted credit facilities for either loans or, in some cases, letters of credit.
 
Prepaid Variable Forward Contracts
 
During fiscal 2003, we executed a series of prepaid variable forward contracts (the “forward contracts”) with a total notional amount of approximately $41.4 million on 7.9 million underlying Knight shares. The forward contracts each contained a zero-cost embedded collar on the value of the Knight shares, with a weighted average floor price of $5.13 per share and a weighted average cap price of $6.17 per share. At the inception of the forward contracts, we received cash of approximately $35.5 million, equal to approximately 86 percent of the notional amount. The forward contracts were scheduled to mature on various dates in fiscal years 2006 and 2007. We liquidated our position in Knight and the prepaid variable forward contracts in January 2006, resulting in a one-time pre-tax net gain of approximately $78.8 million.
 
The embedded collars did not qualify for hedge accounting treatment, and were therefore accounted for as non-hedging derivatives in the consolidated financial statements. The total fair value of the embedded collars was included under the caption “Prepaid variable forward derivative instrument” in the Consolidated Balance Sheets and changes in the fair value of the embedded collars were included under the caption “Fair value adjustments of investment-related derivative instruments” in the Consolidated Statements of Income.
 
The $35.5 million of cash received on the forward contracts was accounted for as an obligation in the Consolidated Balance Sheets. We were accreting interest on the obligation to the notional maturity amount of $41.4 million over the terms of the forward contracts using effective interest rates with a weighted average of approximately 4.3 percent. Upon settlement of each forward contract in January 2006, the realized gain on the Knight stock delivered to the counterparty or otherwise sold was reclassified from other comprehensive income into earnings, net of taxes.
 
Stock Repurchase Program
 
On August 2, 2006, our Board of Directors authorized a program to repurchase up to 12 million shares of our common stock in the open market and in block trades. On November 15, 2006, the Board of Directors added 20 million shares to the original authorization, increasing the total authorization from 12 million shares to 32 million shares. In fiscal 2006, we repurchased approximately 3.8 million shares under the plan at a weighted average purchase price of $17.66 per share. See “Contractual Obligations” below for information regarding our obligation to repurchase common stock pursuant to the Stockholders Agreement.


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Off-Balance Sheet Arrangements
 
The Company does not have any obligations that meet the definition of an off-balance sheet arrangement and have, or are reasonably likely to have, a material effect on our financial statements.
 
Contractual Obligations
 
The following table summarizes our contractual obligations as of September 29, 2006 (amounts in thousands):
 
                                         
          Payments Due by Period (Fiscal Years):  
          Less Than
                More Than
 
          1 Year     1-3 Years     3-5 Years     5 Years  
Contractual Obligations
  Total     2007     2008-09     2010-11     After 2011  
 
Long-term debt obligations(1)
  $ 2,397,818     $ 143,755     $ 302,725     $ 335,832     $ 1,615,506  
Capital lease obligations
    8,088       4,134       3,954              
Operating lease obligations
    200,631       42,127       64,328       43,426       50,750  
Purchase obligations
    47,876       38,063       6,979       2,834        
Deferred compensation(2)
    16,087       16,087                    
Employee severance and involuntary termination costs(3)
    26,676       23,526       1,200       1,200       750  
Contract termination costs(3)
    11,407       11,407                    
Stock repurchase obligation(4)
    71,022       71,022                    
                                         
Total
  $ 2,779,605     $ 350,121     $ 379,186     $ 383,292     $ 1,667,006  
                                         
 
 
(1) Represents scheduled principal payments, estimated interest payments and commitment fees pursuant to the Financings. The Financings are also subject to certain mandatory prepayments, which include prepayments based on amounts of excess cash flow and from the net cash proceeds of asset sales and debt issuances, subject to certain exceptions. Pursuant to the Financings, we may prepay borrowings without penalty. Because mandatory prepayments are based on future operating results and events, we cannot predict the amount or timing of such prepayments. Actual amounts of interest may vary depending on principal prepayments and changes in variable interest rates.
 
(2) Our obligation to our CEO for deferred compensation will become payable not sooner than the day after the CEO’s employment with the Company terminates. The obligation is presented in the fiscal 2007 column as the entire amount of the compensation has already been earned by the CEO.
 
(3) Represents exit and involuntary termination costs incurred in connection with the planned consolidation of certain facilities and functions following the TD Waterhouse acquisition.
 
(4) Pursuant to the Stockholders Agreement, as amended, we are obligated to repurchase our common stock from time to time to offset dilution resulting from stock option exercises and other stock awards subsequent to the acquisition of TD Waterhouse on January 24, 2006. Based on stock options exercised from January 24, 2006 through September 29, 2006, we were obligated to repurchase approximately 8.0 million shares of common stock. Through September 29, 2006, we had repurchased approximately 3.8 million shares. The repurchase obligation presented in the table is based on the actual repurchase of 4.2 million additional shares of our common stock at a weighted-average price of $16.91 per share from October 2, 2006 through November 3, 2006. As of November 3, 2006, we have fulfilled the stock repurchase obligation that existed at September 29, 2006. We cannot estimate the amount and timing of repurchases that may be required as a result of future stock option exercises.
 
New Accounting Pronouncements
 
FIN No. 48 — In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN No. 48”). FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement


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No. 109, Accounting for Income Taxes. FIN No. 48 prescribes a recognition threshold and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN No. 48 establishes a two-step process for evaluation of tax positions. The first step is recognition, under which the enterprise determines whether it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The enterprise is required to presume the position will be examined by the appropriate taxing authority that has full knowledge of all relevant information. The second step is measurement, under which a tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. Therefore, FIN No. 48 will be effective for our fiscal year beginning September 29, 2007. The cumulative effect of adopting FIN No. 48 is required to be reported as an adjustment to the opening balance of retained earnings (or other appropriate components of equity) for that fiscal year, presented separately. We are analyzing the impact of adopting FIN No. 48.
 
SFAS No. 157 — In September 2006, FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 clarifies the definition of fair value and the methods used to measure fair value and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. Therefore, SFAS No. 157 will be effective for our fiscal year beginning September 27, 2008. Adoption of SFAS No. 157 is not expected to have a material impact on our consolidated financial statements.
 
Item 7A.   Quantitative and Qualitative Disclosures About Market Risk
 
Market risk generally represents the risk of loss that may result from the potential change in the value of a financial instrument as a result of fluctuations in interest rates and market prices. We have established policies, procedures and internal processes governing our management of market risks in the normal course of our business operations. We do not hold any material market risk-sensitive instruments for trading purposes.
 
Credit Risk
 
Two primary sources of credit risk inherent in our business are client margin lending and securities lending. We manage risk on client margin lending by requiring clients to maintain margin collateral in compliance with regulatory and internal guidelines. We monitor required margin levels daily and, pursuant to such guidelines, require our clients to deposit additional collateral, or to reduce positions, when necessary. We assess and monitor the suitability of investors to engage in various trading activities. We continuously monitor client accounts to detect excessive concentration, large orders or positions, patterns of day trading and other activities that indicate increased risk to us. We manage risks associated with our securities lending and borrowing activities by requiring credit approvals for counterparties, by monitoring the market value of securities loaned and collateral values for securities borrowed on a daily basis and requiring additional cash as collateral for securities loaned or return of collateral for securities borrowed when necessary, and by participating in a risk-sharing program offered through a securities clearinghouse.
 
Interest Rate Risk
 
As a fundamental part of our brokerage business, we invest in interest-earning assets and are obligated on interest-bearing liabilities. In addition, we earn fees on our money market deposit account (MMDA) sweep arrangement with TD Bank USA, which are based on the actual net yield earned at TD Bank USA. Changes in interest rates could affect the interest earned on assets differently than interest paid on liabilities. A rising interest rate environment generally results in our earning a larger net interest spread. Conversely, a falling interest rate environment generally results in our earning a smaller net interest spread.
 
Our most prevalent form of interest rate risk is referred to as “gap” risk. This risk occurs when the interest rates we earn on our assets change at a different frequency or amount than the interest rates we pay on our liabilities. We


42


 

have established an Asset/Liability Committee (“ALCO”) as the governance body with the responsibility of managing interest rate risk, including gap risk.
 
We use net interest simulation modeling techniques to evaluate the effect that changes in interest rates might have on pre-tax income. Our model includes all interest-sensitive assets and liabilities of the Company and interest-sensitive assets and liabilities associated with the MMDA agreement with TD Bank USA. The simulations involve assumptions that are inherently uncertain, and as a result, cannot precisely predict the impact that changes in interest rates will have on pre-tax income. Actual results may differ from simulated results due to differences in timing and frequency of rate changes, changes in market conditions, and changes in management strategy that lead to changes in the mix of interest-sensitive assets and liabilities.
 
The simulations assume that the asset and liability structure of the Consolidated Balance Sheet and the MMDA arrangement would not be changed as a result of simulated changes in interest rates. The results of the simulations as of September 29, 2006 indicate that an immediate one percent (100 basis point) increase or decrease in short-term interest rates would result in approximately $43 million more or less annual pre-tax income, respectively.
 
Other Market Risks
 
Our revenues and financial instruments are denominated in U.S. dollars, and we generally do not invest, except for economic hedging purposes, in derivative instruments.


43


 

 
Item 8.   Financial Statements and Supplementary Data
 
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
         
  45
  46
  47
  48
  49
  50
  51


44


 

 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
The Board of Directors and Shareholders
TD AMERITRADE Holding Corporation
 
We have audited the accompanying consolidated balance sheet of TD AMERITRADE Holding Corporation (the “Company”) as of September 29, 2006, and the related consolidated statements of income, stockholders’ equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit.
 
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
 
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of TD AMERITRADE Holding Corporation at September 29, 2006, and the consolidated results of their operations and their cash flows for the year then ended, in conformity with U.S. generally accepted accounting principles.
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of TD AMERITRADE Holding Corporation’s internal control over financial reporting as of September 29, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated November 15, 2006, expressed an unqualified opinion thereon.
 
/s/  ERNST & YOUNG LLP
 
Chicago, Illinois
November 15, 2006


45


 

 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Stockholders of
TD AMERITRADE Holding Corporation
Omaha, Nebraska
 
We have audited the accompanying consolidated balance sheet of TD AMERITRADE Holding Corporation and subsidiaries, formerly Ameritrade Holding Corporation, (collectively the “Company”) as of September 30, 2005, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the fiscal years ended September 30, 2005 and September 24, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of TD AMERITRADE Holding Corporation as of September 30, 2005 and the results of their operations and their cash flows for each of the fiscal years ended September 30, 2005 and September 24, 2004, in conformity with accounting principles generally accepted in the United States of America.
 
/s/  DELOITTE & TOUCHE LLP
 
Omaha, Nebraska
December 13, 2005


46


 

TD AMERITRADE HOLDING CORPORATION
 
CONSOLIDATED BALANCE SHEETS
As of September 29, 2006 and September 30, 2005
 
                 
    2006     2005  
    (In thousands)  
 
ASSETS
Cash and cash equivalents
  $ 363,650     $ 171,064  
Short-term investments
    65,275       229,819  
Cash and investments segregated in compliance with federal regulations
    1,561,910       7,595,359  
Receivable from brokers, dealers and clearing organizations
    4,566,525       3,420,226  
Receivable from clients — net of allowance for doubtful accounts: 2006 — $20.3 million; 2005 — $12.9 million
    6,970,834       3,784,688  
Receivable from affiliate
    19,191        
Other receivables
    89,038       70,036  
Property and equipment — net of accumulated depreciation and amortization: 2006 — $96.3 million; 2005 — $75.9 million
    57,346       33,259  
Goodwill
    1,731,718       769,215  
Acquired intangible assets — net of accumulated amortization:
               
2006 — $80.6 million; 2005 — $38.3 million
    1,056,899       259,759  
Investments in equity securities
    16,536       68,575  
Other assets
    59,547       15,110  
                 
Total assets
  $ 16,558,469     $ 16,417,110  
                 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
               
Payable to brokers, dealers and clearing organizations
  $ 7,022,601     $ 4,449,686  
Payable to clients
    5,412,981       10,095,837  
Accounts payable and accrued liabilities
    368,996       171,290  
Payable to affiliate
    1,596        
Securities sold, not yet purchased
    2,028       26,002  
Prepaid variable forward derivative instrument
          20,423  
Prepaid variable forward contract obligation
          39,518  
Long-term debt
    1,703,375        
Capitalized lease obligations
    7,337       6,218  
Deferred income taxes, net
    309,321       89,269  
                 
Total liabilities
    14,828,235       14,898,243  
                 
Stockholders’ equity:
               
Preferred Stock, $0.01 par value, 100,000,000 shares authorized; none issued
           
Common Stock, $0.01 par value, 1,000,000,000 shares authorized;
2006 — 631,381,860 shares issued and 607,626,040 outstanding;
2005 — 435,081,860 shares issued and 406,058,970 outstanding
    6,314       4,351  
Additional paid-in capital
    1,591,610       1,184,004  
Retained earnings
    440,762       652,742  
Treasury stock, common, at cost: 2006 — 23,755,820 shares;
2005 — 29,022,890 shares
    (312,410 )     (364,794 )
Deferred compensation
    662       952  
Accumulated other comprehensive income
    3,296       41,612  
                 
Total stockholders’ equity
    1,730,234       1,518,867  
                 
Total liabilities and stockholders’ equity
  $ 16,558,469     $ 16,417,110  
                 
 
See notes to consolidated financial statements.


47


 

TD AMERITRADE HOLDING CORPORATION
 
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended September 29, 2006, September 30, 2005 and September 24, 2004
 
                         
    2006     2005     2004  
    (In thousands, except per share amounts)  
 
Revenues:
                       
Transaction-based revenues:
                       
Commissions and transaction fees
  $ 727,407     $ 523,985     $ 560,052  
Asset-based revenues:
                       
Interest revenue
    1,031,971       540,348       278,550  
Brokerage interest expense
    (335,820 )     (141,399 )     (41,861 )
                         
Net interest revenue
    696,151       398,949       236,689  
Money market deposit account fees
    185,014              
Money market and other mutual fund fees
    139,586       25,051       21,425  
                         
Total asset-based revenues
    1,020,751       424,000       258,114  
Other revenues
    55,373       55,168       61,947  
                         
Net revenues
    1,803,531       1,003,153       880,113  
                         
Expenses:
                       
Employee compensation and benefits
    350,079       180,579       154,792  
Fair value adjustments of compensation-related derivative instruments
    (1,715 )            
Clearing and execution costs
    73,049       26,317       30,610  
Communications
    65,445       35,663       39,853  
Occupancy and equipment costs
    74,638       43,411       42,353  
Depreciation and amortization
    21,199       10,521       11,066  
Amortization of acquired intangible assets
    42,286       13,887       12,158  
Professional services
    87,521       30,630       27,381  
Interest on borrowings
    93,988       1,967       2,581  
Other
    45,383       22,689       17,798  
Advertising
    164,072       92,312       100,364  
Fair value adjustments of investment-related derivative instruments
    11,703       (8,315 )     (17,930 )
                         
Total expenses
    1,027,648       449,661       421,026  
                         
Income before other income and income taxes
    775,883       553,492       459,087  
Other income:
                       
Gain on sale of investments
    81,422              
                         
Pre-tax income
    857,305       553,492       459,087  
Provision for income taxes
    330,546       213,739       176,269  
                         
Net income
  $ 526,759     $ 339,753     $ 282,818  
                         
Earnings per share — basic
  $ 0.97     $ 0.84     $ 0.68  
Earnings per share — diluted
  $ 0.95     $ 0.82     $ 0.66  
Weighted average shares outstanding — basic
    544,307       404,215       417,629  
Weighted average shares outstanding — diluted
    555,465       413,167       426,972  
Dividends declared per share
  $ 6.00     $ 0.00     $ 0.00  
 
See notes to consolidated financial statements.


48


 

TD AMERITRADE HOLDING CORPORATION
 
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
For the Years Ended September 29, 2006, September 30, 2005 and September 24, 2004
 
                                                                 
    Total
                                        Accumulated
 
    Common
    Total
          Additional
                      Other
 
    Shares
    Stockholders’
    Common
    Paid-In
    Retained
    Treasury
    Deferred
    Comprehensive
 
    Outstanding     Equity     Stock     Capital     Earnings     Stock     Compensation     Income  
    (In thousands)  
 
Balance, September 26, 2003
    429,785     $ 1,235,774     $ 4,351     $ 1,188,444     $ 30,171     $ (41,452 )   $ 708     $ 53,552  
Net income
          282,818                   282,818                    
Net unrealized investment loss, net of $7.7 million tax
          (9,686 )                                   (9,686 )
Foreign currency translation
          (449 )                                   (449 )
                                                                 
Total comprehensive income
            272,683                                                  
                                                                 
Repurchases of common stock
    (25,760 )     (323,660 )                       (323,660 )            
Issuances of common stock
    8       111             59             52              
Options exercised, including tax benefit
    3,177       24,981             5,837             19,144              
Stockholder loan activity
          428             428                          
Deferred compensation
          285             144             (144 )     285        
Stock-based compensation expense
          306             306                          
                                                                 
Balance, September 24, 2004
    407,210       1,210,908       4,351       1,195,218       312,989       (346,060 )     993       43,417  
Net income
          339,753                   339,753                    
Net unrealized investment loss, net of $2.1 million tax
          (2,418 )                                   (2,418 )
Foreign currency translation
          613                                     613  
                                                                 
Total comprehensive income
            337,948                                                  
                                                                 
Repurchases of common stock
    (6,052 )     (77,229 )                       (77,229 )            
Issuances of common stock
    14       214             54             160              
Options exercised, including tax benefit
    4,874       45,258             (12,903 )           58,161              
Deferred compensation
    13       146             13             174       (41 )      
Stock-based compensation expense
          1,622             1,622                          
                                                                 
Balance, September 30, 2005
    406,059       1,518,867       4,351       1,184,004       652,742       (364,794 )     952       41,612  
Net income
          526,759                   526,759                    
Net unrealized investment gain, net of $5.9 million tax
          9,591                                     9,591  
Reclassification adjustment for realized gain on investment securities included in net income, net of $29.8 million tax
          (47,647 )                                   (47,647 )
Amount transferred from cumulative foreign currency translation adjustments due to disposal of Ameritrade Canada, Inc. 
          (513 )                                   (513 )
Foreign currency translation
          253                                     253  
                                                                 
Total comprehensive income
            488,443                                                  
                                                                 
Acquisition of TD Waterhouse Group, Inc. 
    196,300       2,123,181       1,963       2,121,218                          
Dividend on common stock, $6.00 per share
          (2,442,780 )           (1,704,041 )     (738,739 )                  
Repurchases of common stock
    (3,827 )     (67,697 )                       (67,697 )            
Issuances of common stock
    3       72             29             43              
Options exercised, including tax benefit
    9,020       95,270             (24,125 )           119,395              
Deferred compensation
    71       549             196             643       (290 )      
Stock-based compensation expense
          14,329             14,329                          
                                                                 
Balance, September 29, 2006
    607,626     $ 1,730,234     $ 6,314     $ 1,591,610     $ 440,762     $ (312,410 )   $ 662     $ 3,296  
                                                                 
 
See notes to consolidated financial statements.


49


 

TD AMERITRADE HOLDING CORPORATION
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended September 29, 2006, September 30, 2005 and September 24, 2004
 
                         
    2006     2005     2004  
    (In thousands)  
 
Cash flows from operating activities:
                       
Net income
  $ 526,759     $ 339,753     $ 282,818  
Adjustments to reconcile net income to net cash provided by operating activities:
                       
Depreciation and amortization
    21,199       10,521       11,066  
Amortization of intangible assets
    42,286       13,887       12,158  
Deferred income taxes
    45,475       2,277       17,127  
Gain on sale of investments in equity securities
    (81,422 )            
Gain on sale of businesses
    (2,382 )            
(Gain) loss on disposal of property
    (769 )     (428 )     1,166  
Fair value adjustments of derivative instruments
    9,988       (8,315 )     (17,930 )
Stock-based compensation
    14,329       1,622       306  
Other
    (1,946 )     1,875       3,124  
Changes in operating assets and liabilities:
                       
Cash and investments segregated in compliance with federal regulations
    6,109,449       207,216       75,846  
Receivable from brokers, dealers and clearing organizations
    (997,662 )     (601,500 )     106,673  
Receivable from clients
    685,055       (684,083 )     (755,876 )
Receivable from/payable to affiliate, net
    31,939              
Other receivables
    (10,481 )     193,892       (222,717 )
Other assets
    21,639       2,257       (3,154 )
Payable to brokers, dealers and clearing organizations
    526,103       1,007,884       293,017  
Payable to clients
    (6,314,596 )     (226,702 )     573,754  
Accounts payable and accrued liabilities
    (113,593 )     43,866       (47,764 )
Securities sold, not yet purchased
    (26,391 )     26,002        
                         
Net cash provided by operating activities
    484,979       330,024       329,614  
                         
Cash flows from investing activities:
                       
Purchase of property and equipment
    (21,697 )     (7,981 )     (9,810 )
Cash received (paid) in business combinations, net
    580,056       (25,919 )     (56,735 )
Proceeds from sale of businesses
    9,382              
Purchase of short-term investments
    (1,001,250 )     (605,924 )     (102,450 )
Proceeds from sale of short-term investments
    1,165,794       394,055       84,500  
Proceeds from sale of investments in equity securities
    11,239       807        
Other
    18       (175 )     (10 )
                         
Net cash provided by (used in) investing activities
    743,542       (245,137 )     (84,505 )
                         
Cash flows from financing activities:
                       
Proceeds from issuance of long-term debt
    1,900,000              
Payment of debt issuance costs
    (20,992 )            
Principal payments on long-term debt and notes payable
    (496,625 )           (46,828 )
Principal payments on capitalized lease obligations
    (3,903 )     (2,545 )      
Proceeds from exercise of stock options
    46,881       28,142       13,806  
Payment of cash dividend
    (2,442,780 )            
Purchase of treasury stock
    (67,697 )     (77,229 )     (323,660 )
Excess tax benefits on stock-based compensation
    48,864              
Payments received on stockholder loans
                428  
                         
Net cash used in financing activities
    (1,036,252 )     (51,632 )     (356,254 )
                         
Effect of exchange rate changes on cash and cash equivalents
    317       417       (86 )
                         
Net increase (decrease) in cash and cash equivalents
    192,586       33,672       (111,231 )
Cash and cash equivalents at beginning of period
    171,064       137,392       248,623  
                         
Cash and cash equivalents at end of period
  $ 363,650     $ 171,064     $ 137,392  
                         
Supplemental cash flow information:
                       
Interest paid
  $ 423,468     $ 131,249     $ 44,442  
Income taxes paid
  $ 241,163     $ 167,399     $ 166,547  
Tax benefit on exercises and distributions of stock-based compensation
  $ 49,256     $ 18,471     $ 12,465  
Noncash investing and financing activities:
                       
Issuance of capitalized lease obligations
  $ 5,022     $ 8,763     $  
Settlement of prepaid variable forward contract liabilities in exchange for investment
  $ 72,077     $     $  
Issuance of common stock in acquisition
  $ 2,123,181     $     $  
 
See notes to consolidated financial statements.


50


 

TD AMERITRADE HOLDING CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the Years Ended September 29, 2006, September 30, 2005 and September 24, 2004
(Columnar amounts in thousands, except percentages and per share amounts)
 
1.   Nature of Operations and Summary of Significant Accounting Policies
 
Basis of Presentation — The consolidated financial statements include the accounts of TD AMERITRADE Holding Corporation (formerly Ameritrade Holding Corporation), a Delaware corporation, and its wholly owned subsidiaries (collectively, the “Company”). Intercompany balances and transactions have been eliminated. The Company reports on a fifty-two/fifty-three week year. Each fiscal year ends on the last Friday of the month of September. Fiscal years 2006 and 2004 were each fifty-two week years. Fiscal year 2005 was a fifty-three week year.
 
Nature of Operations — The Company provides securities brokerage services, including trade execution, clearing services and margin lending, through its broker-dealer subsidiaries. The Company also provides cash sweep products through third-party banking relationships. The Company’s broker-dealer subsidiaries are subject to regulation by the Securities and Exchange Commission (“SEC”), the National Association of Securities Dealers, Inc. (“NASD”), the New York Stock Exchange, Inc. (“NYSE”) and the various exchanges in which they maintain membership. Dividends from the Company’s broker-dealer subsidiaries are a source of liquidity for the holding company. Requirements of the SEC, NASD and NYSE relating to liquidity, net capital standards, and the use of client funds and securities may limit funds available for the payment of dividends from the broker-dealer subsidiaries to the holding company.
 
Capital Stock — The authorized capital stock of the Company consists of a single class of common stock and one or more series of preferred stock as may be authorized for issuance by the Company’s Board of Directors.
 
Voting, dividend, conversion and liquidation rights of the preferred stock would be established by the Board of Directors upon issuance of such preferred stock.
 
Use of Estimates — The preparation of consolidated financial statements in conformity with U.S generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
 
Securities Transactions — Client securities transactions are recorded on a settlement-date basis with such transactions generally settling three business days after the trade date. Revenues and expenses related to securities transactions, including revenues from execution agents (also referred to as payment for order flow), are recorded on a trade-date basis. Revenues related to securities transactions are recorded net of promotional allowances. Securities owned by clients, including those that collateralize margin or similar transactions, are not reflected in the accompanying consolidated financial statements.
 
Depreciation and Amortization — Depreciation is provided on a straight-line basis using estimated useful service lives of three to seven years. Leasehold improvements are amortized over the lesser of the economic useful life of the improvement or the term of the lease.
 
Amortization of Acquired Intangible Assets — Acquired intangible assets are amortized on a straight-line basis over their estimated useful lives, ranging from three to 23 years. The acquired intangible asset associated with a trademark license agreement is not subject to amortization because the term of the agreement is considered to be indefinite.
 
Long-Lived Assets and Acquired Intangible Assets — The Company reviews its long-lived assets and acquired intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such asset may not be recoverable. The Company evaluates recoverability by comparing the undiscounted cash flows associated with the asset to the asset’s carrying amount. Long-lived assets classified as “held for sale,” if any, are reported at the lesser of carrying amount or fair value less cost to sell.


51


 

TD AMERITRADE HOLDING CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Cash and Cash Equivalents — The Company considers temporary, highly liquid investments with an original maturity of three months or less to be cash equivalents, except for amounts required to be segregated in compliance with federal regulations.
 
Short-term Investments — Short-term investments generally consist of investments in auction rate securities. Auction rate securities are long-term variable rate bonds tied to short-term interest rates that are reset through a “Dutch auction” process which occurs every seven to 35 days. Holders of auction rate securities may liquidate their holdings to prospective buyers by participating in the auctions. Auction rate securities do not qualify as cash equivalents because they have long-term maturity dates and there is no guarantee that holders will be able to liquidate their holdings through the auction process. Purchases and sales of auction rate securities are presented as investing activities in the Consolidated Statements of Cash Flows.
 
Segregated Cash and Investments — Cash and investments, consisting primarily of reverse repurchase agreements, fixed-rate U.S. Treasury securities and other qualified securities, at the Company’s clearing subsidiaries of $1.6 billion and $7.6 billion as of September 29, 2006 and September 30, 2005, respectively, have been segregated in special reserve bank accounts for the exclusive benefit of clients under Rule 15c3-3 of the Securities Exchange Act of 1934 (the “Exchange Act”) and other regulations. Reverse repurchase agreements (securities purchased under agreements to resell), generally collateralized by U.S. government and agency obligations, are treated as collateralized financing transactions and are carried at amounts at which the securities will be subsequently resold, plus accrued interest.
 
Securities Borrowed and Securities Loaned — Securities borrowed and securities loaned transactions are recorded at the amount of cash collateral advanced or received. Securities borrowed transactions require the Company to provide the counterparty with collateral in the form of cash. The Company receives collateral in the form of cash for securities loaned transactions. For these transactions, the fees received or paid by the Company are recorded as interest revenue and brokerage interest expense, respectively, in the Consolidated Statements of Income.
 
Securities Owned and Securities Sold, Not Yet Purchased — Securities owned and securities sold, not yet purchased in the Company’s securities brokerage business are carried at fair value and the resulting unrealized gains or losses are included in other revenues in the Consolidated Statements of Income.
 
Fair Value of Financial Instruments — The Company considers the amounts presented for financial instruments on the Consolidated Balance Sheets to be reasonable estimates of fair value based on maturity dates, repricing characteristics and, where applicable, quoted market prices.
 
Goodwill — The Company has recorded goodwill for purchase business combinations to the extent the purchase price of each acquisition exceeded the fair value of the net identifiable assets of the acquired company. The Company tests goodwill for impairment on at least an annual basis. In performing the impairment tests, the Company utilizes quoted market prices of the Company’s common stock to estimate the fair value of the Company as a whole. The estimated fair value is then allocated to the Company’s reporting units, if applicable, based on operating revenues, and is compared with the carrying value of the reporting units. No impairment charges have resulted from the annual impairment tests.
 
Investments in Equity Securities — Investments in equity securities are accounted for under the equity method when the Company has the ability to exercise significant influence over the investee’s operating and financial policies. The cost method is used for non-marketable investments that do not meet equity method criteria. Declines in fair value of cost method investments that are considered other than temporary are accounted for as realized losses. The Company’s investments in marketable equity securities are carried at fair value and are designated as available-for-sale, except for investments held by the Company’s broker-dealer subsidiaries, which are accounted for as trading investments. Unrealized gains and losses on available-for-sale investments, net of deferred income taxes, are reflected as accumulated other comprehensive income. Realized gains and losses on available-for-sale investments are determined on the specific identification method and are reflected in the Consolidated Statements


52


 

TD AMERITRADE HOLDING CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

of Income. Unrealized gains and losses on investments accounted for as trading investments are reflected currently in the Consolidated Statements of Income.
 
Software Development — Software development costs are capitalized and included in property and equipment at the point technological feasibility has been established until beta testing is complete. Once the product is fully functional, such costs are amortized in accordance with the Company’s normal accounting policies. Software development costs that do not meet capitalization criteria are expensed as incurred.
 
Deferred Compensation — Company common stock held in a rabbi trust pursuant to a Company deferred compensation plan is recorded at the fair value of the stock at the time it is transferred to the rabbi trust and is classified as treasury stock. The corresponding deferred compensation liability is recorded as a component of stockholders’ equity.
 
Advertising — The Company expenses advertising costs the first time the advertising takes place.
 
Income Taxes — The Company files a consolidated U.S. income tax return with its subsidiaries on a calendar year basis, combined returns for state tax purposes where required and certain of its subsidiaries file separate state income tax returns where required. Deferred tax assets and liabilities are determined based on the differences between the financial statement carrying amounts and tax bases of assets and liabilities using enacted tax rates. Accruals for expected tax deficiencies are recorded in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 5, Accounting for Contingencies, when management determines that a tax deficiency is both probable and reasonably estimable.
 
Earnings Per Share — Basic earnings per share (“EPS”) is computed by dividing net income by the weighted average common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock, except when such assumed exercise or conversion would have an antidilutive effect on EPS.
 
Stock-Based Compensation — Effective September 27, 2003, the Company adopted the fair value based method of accounting for stock-based compensation under SFAS No. 123, Accounting for Stock-Based Compensation, using the prospective transition method of SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure, an amendment of FASB Statement No. 123. Effective October 1, 2005, the Company adopted SFAS No. 123 (revised 2004), Share-Based Payment (“No. 123R”) using a modified version of the prospective transition method. Under the transition method, compensation cost is recognized on or after the required effective date for the portion of outstanding awards for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards calculated under SFAS No. 123 for either recognition or pro forma disclosures. Stock-based compensation expense for fiscal 2006, fiscal 2005 and fiscal 2004 was $14.3 million ($8.9 million net of tax), $1.6 million ($1.0 million net of tax) and $0.3 million ($0.2 million net of tax), respectively. Pro forma information regarding stock-based compensation expense, net income and earnings per share is required for periods prior to the adoption of SFAS No. 123R. This information is presented as if the


53


 

TD AMERITRADE HOLDING CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Company had accounted for its stock-based awards to employees under the fair value based method for all periods presented. Pro forma net income and earnings per share are as follows for the fiscal years ended:
 
                 
    2005     2004  
 
Net income, as reported
  $ 339,753     $ 282,818  
Add: Stock-based compensation expense included in reported net income, net of related income tax effects
    998       186  
Less: Total stock-based compensation determined under the fair value based method, net of related income tax effects
    (9,830 )     (14,782 )
                 
Pro forma net income
  $ 330,921     $ 268,222  
                 
Basic earnings per share, as reported
  $ 0.84     $ 0.68  
Basic earnings per share, pro forma
  $ 0.82     $ 0.64  
Diluted earnings per share, as reported
  $ 0.82     $ 0.66  
Diluted earnings per share, pro forma
  $ 0.80     $ 0.63  
 
Foreign Currency Translation — Assets and liabilities of the Company’s Canadian subsidiaries that are denominated in Canadian dollars are translated into U.S. dollars using the exchange rate in effect at each period end. Revenues and expenses are translated at the average exchange rate during the period. The functional currency of our Canadian subsidiaries is the local currency; therefore the effects of foreign currency translation adjustments arising from differences in exchange rates from period to period are included in accumulated other comprehensive income in the Consolidated Balance Sheets.
 
Comprehensive Income — Comprehensive income consists of net income; unrealized gains (losses) on securities available-for-sale, net of related income taxes; and foreign currency translation adjustments. These results are incorporated into the Consolidated Statements of Stockholders’ Equity.
 
Derivatives and Hedging Activities — The Company utilizes derivative instruments to manage risks, which may include market price, interest rate and foreign currency risks. The Company does not use derivative instruments for speculative or trading purposes. Derivatives are recorded on the Consolidated Balance Sheets as assets or liabilities at fair value. Derivative instruments properly designated to hedge exposure to changes in the fair value of assets or liabilities are accounted for as fair value hedges. Derivative instruments properly designated to hedge exposure to the variability of expected future cash flows or other forecasted transactions are accounted for as cash flow hedges. The Company formally documents the risk management objective and strategy for each hedge transaction. Derivative instruments that do not qualify for hedge accounting are carried at fair value on the Consolidated Balance Sheets with unrealized gains and losses recorded currently in the Consolidated Statements of Income.
 
Reclassifications — Other receivables of approximately $70.0 million as of September 30, 2005 have been reclassified from other assets in the Consolidated Balance Sheet. Money market and other mutual fund fees of approximately $25.1 million and $21.4 million for fiscal 2005 and 2004, respectively, have been reclassified from other revenues in the Consolidated Statements of Income. Amortization of acquired intangible assets of approximately $13.9 million and $12.2 million for fiscal 2005 and 2004, respectively, has been reclassified from depreciation and amortization in the Consolidated Statements of Income. Gains on disposal of property of approximately $0.4 million for fiscal 2005 and losses on disposal of property of approximately $1.1 million for fiscal 2004 have been reclassified to other expense in the Consolidated Statements of Income. Each of the aforementioned reclassifications was made in order to conform to the current financial statement presentation.
 
Recently Issued Accounting Pronouncements:
 
FIN No. 48 — In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN No. 48”). FIN No. 48 clarifies the accounting for


54


 

TD AMERITRADE HOLDING CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes. FIN No. 48 prescribes a recognition threshold and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN No. 48 establishes a two-step process for evaluation of tax positions. The first step is recognition, under which the enterprise determines whether it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The enterprise is required to presume the position will be examined by the appropriate taxing authority that has full knowledge of all relevant information. The second step is measurement, under which a tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. Therefore, FIN No. 48 will be effective for the Company’s fiscal year beginning September 29, 2007. The cumulative effect of adopting FIN No. 48 is required to be reported as an adjustment to the opening balance of retained earnings (or other appropriate components of equity) for that fiscal year, presented separately. The Company is analyzing the impact of adopting FIN No. 48.
 
SFAS No. 157 — In September 2006, FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 clarifies the definition of fair value and the methods used to measure fair value and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. Therefore, SFAS No. 157 will be effective for the Company’s fiscal year beginning September 27, 2008. Adoption of SFAS No. 157 is not expected to have a material impact on the Company’s consolidated financial statements.
 
2.   Business Combinations
 
On January 24, 2006, the Company completed the acquisition of TD Waterhouse Group, Inc. (“TD Waterhouse”), a Delaware corporation, pursuant to an Agreement of Sale and Purchase, dated June 22, 2005, as amended (the “Purchase Agreement”), with The Toronto-Dominion Bank (“TD”). The Company purchased from TD (the “Share Purchase”) all of the capital stock of TD Waterhouse in exchange for 196,300,000 shares of Company common stock and $20,000 in cash. The shares of common stock issued to TD in the Share Purchase represented approximately 32.5 percent of the outstanding shares of the Company after giving effect to the transaction. Upon the completion of the transaction, the Company changed its name to TD AMERITRADE Holding Corporation and the authorized shares of common stock of the Company were increased from 650 million to one billion. The Company’s consolidated financial statements include the results of operations for TD Waterhouse beginning January 25, 2006. In addition, on January 24, 2006, the Company completed the sale of Ameritrade Canada, Inc. to TD for $60 million in cash. The Company has agreed not to compete or own any portion of a business that competes with TD in Canada (including in the retail securities brokerage business) after the consummation of the Share Purchase. The purchase price for the acquisition of TD Waterhouse and the sale price for the sale of Ameritrade Canada were subject to cash adjustments based on the closing date balance sheets of the Company, TD Waterhouse and Ameritrade Canada. On May 5, 2006, the Company received approximately $45.9 million from TD for the settlement of cash adjustments related to the purchase of TD Waterhouse and the sale of Ameritrade Canada.
 
Pursuant to the Purchase Agreement, prior to the consummation of the Share Purchase, TD Waterhouse conducted a reorganization in which it transferred its Canadian retail securities brokerage business and TD Bank USA, N.A. (formerly TD Waterhouse Bank, N.A.) to TD such that, at the time of consummation of the Share Purchase, TD Waterhouse retained only its United States retail securities brokerage business. TD Waterhouse also distributed to TD excess capital of TD Waterhouse above certain thresholds prior to the consummation of the Share Purchase. As contemplated in the Purchase Agreement, on January 24, 2006, the Company commenced payment of a special cash dividend of $6.00 per share in respect of the shares of Company common stock outstanding prior to the consummation of the Share Purchase. The total amount of the dividend was approximately $2.4 billion.


55


 

TD AMERITRADE HOLDING CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

In connection with the Purchase Agreement, TD was given rights to have its shares of common stock of the Company registered for resale. TD licensed the Company the right to use the “TD” name in connection with the operation of the Company’s business. The parties also entered into agreements regarding bank sweep accounts and mutual funds. See Note 18 for discussion of related party transactions.
 
In connection with the Purchase Agreement, the Company, TD and J. Joe Ricketts, the Company’s Chairman and Founder, and certain of his affiliates also entered into a Stockholders Agreement, as amended (the “Stockholders Agreement”). The Stockholders Agreement sets forth certain governance arrangements and contains various provisions relating to stock ownership, voting, election of directors and other matters. The Company’s certificate of incorporation and bylaws were amended and restated as of January 24, 2006 to give effect to and facilitate the provisions contained in the Stockholders Agreement.
 
The Company’s board of directors considered various factors in approving the acquisition of TD Waterhouse and the related agreements, including significant synergy opportunities identified by the Company’s management, the likelihood that the acquisition would enhance the Company’s strategic goal of increasing the scale of the Company’s business and expanding its operations into the long-term investor and registered investment advisor markets, the financial terms of the transaction and the financial analysis and fairness opinion of the transaction performed by the Company’s investment banking firm.
 
The preliminary purchase price for TD Waterhouse was comprised of the following:
 
         
TD AMERITRADE common stock issued
  $ 2,123,181  
Cash acquired, net of cash paid
    (580,056 )
Closing date capital adjustments
    (45,915 )
Acquisition costs
    20,740  
Exit and involuntary termination costs
    118,078  
         
Total preliminary purchase price
  $ 1,636,028  
         
 
The value of the 196,300,000 shares of common stock issued is calculated using the $16.816 average closing market price of Company common stock for the period beginning two business days before and ending two business days after June 22, 2005, the date the proposed acquisition of TD Waterhouse was agreed to and announced, less the $6.00 per share special cash dividend. The special dividend is deducted from the average market price because the shares issued to TD did not include the right to receive the special dividend.


56


 

TD AMERITRADE HOLDING CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The preliminary purchase price allocation for TD Waterhouse is summarized as follows:
 
         
Cash and investments segregated in compliance with federal regulations
  $ 76,000  
Receivable from broker, dealers and clearing organizations
    148,637  
Receivable from clients, net
    3,871,184  
Receivable from affiliate
    5,712  
Other receivables
    8,521  
Property and equipment
    18,735  
Goodwill
    969,253  
Acquired intangible assets
    839,426  
Investments in equity securities
    9,420  
Other assets
    70,065  
         
Total assets acquired
    6,016,953  
         
Payable to brokers, dealers and clearing organizations
    (2,046,812 )
Payable to clients
    (1,631,740 )
Accounts payable and accrued liabilities
    (188,308 )
Payable to affiliate
    (2,093 )
Securities sold, not yet purchased
    (2,417 )
Notes payable to affiliate
    (300,000 )
Deferred income taxes
    (210,068 )
         
Total liabilities assumed
    (4,381,438 )
         
Other comprehensive income
    513  
         
Total preliminary purchase price allocated
  $ 1,636,028  
         
 
Approximately $134.5 million of the goodwill associated with the TD Waterhouse acquisition is expected to be deductible for income tax purposes, resulting from the carryover tax basis of businesses previously acquired by TD Waterhouse. The remainder of the goodwill is not expected to be deductible for income tax purposes because the transaction was not treated as a purchase of assets for income tax purposes. The purchase price is preliminary, primarily due to estimates included for exit and involuntary termination costs and deferred income taxes. Differences between these estimates and actual results may result in adjustments to the purchase price. The Company began formulating plans to consolidate certain facilities and functions prior to the closing of the acquisition of TD Waterhouse. Although the Company believes its plans are reasonable, minor changes may still be made to the scope or timing of such plans, which may result in changes to estimated exit and involuntary termination costs. Exit and involuntary termination costs consist primarily of severance and other involuntary termination costs for approximately 900 TD Waterhouse employees, costs associated with unfavorable leases and other contract termination costs. See Note 8 for a summary of acquisition exit cost activity.
 
The following table summarizes the major classes of TD Waterhouse acquired intangible assets and the respective amortization periods:
 
                 
          Amortization
 
    Amount     Period (Years)  
 
Client relationships
  $ 693,752       17  
Trademark license — TD
    145,674       None  
                 
    $ 839,426          
                 


57


 

TD AMERITRADE HOLDING CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The amounts allocated to acquired intangible assets were based on the results of an independent valuation. The weighted average amortization period of the acquired intangible assets subject to amortization is 17 years. The initial term of the trademark license agreement with TD is ten years and the agreement is automatically renewable for additional ten-year periods. The acquired intangible asset associated with the trademark license agreement is not subject to amortization because the term of the agreement is considered to be indefinite.
 
The following unaudited pro forma financial information sets forth the results of operations of the Company as if the acquisition of TD Waterhouse had occurred at the beginning of the periods presented. The pro forma results for periods prior to the acquisition date do not reflect any potential operating cost savings that may result from the consolidation of operations of the Company with the acquired company and are not necessarily indicative of the results of future operations.
 
Pro forma financial information (unaudited) for the fiscal years ended:
 
                 
    2006     2005  
 
Net revenues
  $ 2,101,574     $ 1,828,084  
Net income
  $ 555,531     $ 366,088  
Basic earnings per share
  $ 0.92     $ 0.61  
Diluted earnings per share
  $ 0.90     $ 0.60  
 
On October 8, 2004, the Company completed the purchase of approximately 45,000 retail client accounts from JB Oxford & Company, a subsidiary of JB Oxford Holdings, Inc. The purchase price was approximately $25.9 million. The entire purchase price has been allocated to acquired intangible assets for the fair value of the JB Oxford client relationships. This intangible asset is being amortized over a 20-year period.
 
On January 2, 2004, the Company completed the acquisition of Bidwell & Company (“Bidwell”) for $55 million. The Company utilized cash on hand to fund the acquisition. The Company allocated approximately $19.8 million of the Bidwell purchase price to acquired intangible assets for the fair value of the Bidwell client relationships, to be amortized over 10- to 15-year periods; and $0.3 million to the fair value of a noncompete agreement, to be amortized over a three-year period. Amounts allocated to Bidwell acquired intangible assets, and their respective amortization periods, were based on an independent valuation.
 
On February 13, 2004, the Company completed its purchase of approximately 11,000 retail brokerage accounts from BrokerageAmerica, LLC. The purchase price was $1.25 million. The entire purchase price has been allocated to acquired intangible assets for the fair value of the BrokerageAmerica, LLC client relationships. This intangible asset is being amortized over a 20-year period.
 
3.   Goodwill and Acquired Intangible Assets
 
The Company has recorded goodwill for purchase business combinations to the extent the purchase price of each acquisition exceeded the fair value of the net identifiable tangible and intangible assets of the acquired company. The following table summarizes changes in the carrying amount of goodwill:
 
         
Balance as of September 24, 2004
  $ 770,094  
Purchase accounting adjustments, net of income taxes(1)
    476  
Tax benefit of option exercises(2)
    (1,355 )
         
Balance as of September 30, 2005
    769,215  
Goodwill recorded in purchase of TD Waterhouse (see Note 2)
    969,253  
Purchase accounting adjustments(3)
    (6,358 )
Tax benefit of option exercises(2)
    (392 )
         
Balance as of September 29, 2006
  $ 1,731,718  
         


58


 

TD AMERITRADE HOLDING CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

(1) Purchase accounting adjustments for fiscal year 2005 consist of approximately $1.2 million of adjustments to liabilities relating to the acquisition of Bidwell, partially offset by an adjustment to reclassify approximately $0.7 million of the purchase price of the Bidwell acquisition to acquired intangible assets for the Bidwell client relationships.
 
(2) Represents the tax benefit of exercises of replacement stock options that were issued in connection with the Datek Online Holdings Corp. (“Datek”) merger in fiscal 2002. The tax benefit of an option exercise is recorded as a reduction of goodwill to the extent the Company recorded fair value of the replacement option in the purchase accounting. To the extent any gain realized on an option exercise exceeds the fair value of the replacement option recorded in the purchase accounting, the tax benefit on the excess is recorded as additional paid-in capital.
 
(3) Purchase accounting adjustments for fiscal year 2006 consist of reductions to accruals for uncertain tax positions relating to the Datek merger.
 
Acquired intangible assets consist of the following as of the fiscal years ended:
 
                                                 
    2006     2005  
    Gross
          Net
    Gross
          Net
 
    Carrying
    Accumulated
    Carrying
    Carrying
    Accumulated
    Carrying
 
    Amount     Amortization     Amount     Amount     Amortization     Amount  
 
Client relationships
  $ 991,522     $ (80,323 )   $ 911,199     $ 297,770     $ (38,137 )   $ 259,633  
Non-competition agreement
    300       (274 )     26       300       (174 )     126  
Trademark license — TD
    145,674             145,674                    
                                                 
    $ 1,137,496     $ (80,597 )   $ 1,056,899     $ 298,070     $ (38,311 )   $ 259,759  
                                                 
 
Amortization expense on acquired intangible assets was $42.3 million, $13.9 million and $12.2 million for fiscal years 2006, 2005 and 2004, respectively. The Company estimates amortization expense on acquired intangible assets outstanding as of September 29, 2006 will be approximately $54.6 million for each of the five succeeding fiscal years.
 
4.   Receivable from and Payable to Brokers, Dealers and Clearing Organizations
 
Amounts receivable from and payable to brokers, dealers and clearing organizations consist of the following as of the fiscal years ended:
 
                 
    2006     2005  
 
Receivable:
               
Deposits paid for securities borrowed
  $ 4,441,896     $ 3,366,645  
Broker-dealers
    16,449        
Clearing organizations
    85,999       48,298  
Securities failed to deliver
    22,181       5,283  
                 
Total
  $ 4,566,525     $ 3,420,226  
                 
Payable:
               
Deposits received for securities loaned
  $ 6,942,123     $ 4,429,518  
Broker-dealers
    44,423        
Clearing organizations
    7,663       13,855  
Securities failed to receive
    28,392       6,313  
                 
Total
  $ 7,022,601     $ 4,449,686  
                 


59


 

TD AMERITRADE HOLDING CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

5.   Allowance for Doubtful Accounts on Receivable from Clients
 
The following table summarizes activity in the Company’s allowance for doubtful accounts on receivable from clients for the fiscal years indicated:
 
                         
    2006     2005     2004  
 
Beginning balance
  $ 12,925     $ 9,812     $ 10,948  
Provision for doubtful accounts
    2,647       8,773       2,547  
Acquired in business combinations
    8,795              
Write-off of doubtful accounts
    (4,077 )     (5,660 )     (3,683 )
                         
Ending balance
  $ 20,290     $ 12,925     $ 9,812  
                         
 
6.   Property and Equipment
 
Property and equipment consists of the following as of the fiscal years ended:
 
                 
    2006     2005  
 
Leasehold improvements
  $ 24,340     $ 15,824  
Software
    73,769       60,921  
Computer equipment
    29,059       15,282  
Other equipment, furniture and fixtures
    26,485       17,088  
                 
      153,653       109,115  
Less: Accumulated depreciation and amortization
    (96,307 )     (75,856 )
                 
Property and equipment — net
  $ 57,346     $ 33,259  
                 
 
7.   Investments in Equity Securities
 
The Company’s investments in equity securities are summarized in the following table:
 
                 
    September 29,
    September 30,
 
    2006     2005  
 
Available-for-sale investments, at fair value:
               
Marketable equity securities
  $ 6,040     $ 68,354  
Trading investments, at fair value:
               
Marketable equity securities
    10,404        
Other investments, at cost
    92       221  
                 
Total investments in equity securities
  $ 16,536     $ 68,575  
                 
 
As of September 30, 2005, the Company owned approximately 7.9 million common shares of Knight Capital Group, Inc. (“Knight”), representing approximately eight percent of Knight’s outstanding common shares. In January 2006, the Company liquidated its position in Knight and the prepaid variable forward contracts described in Note 17, resulting in a one-time pre-tax net gain of approximately $78.8 million. The Company accounted for its investment in Knight as a marketable equity security available-for-sale; therefore, the unrealized gain was reflected in other comprehensive income, net of taxes, in the Consolidated Balance Sheets. Upon the sale of the Knight investment, the unrealized gain was reclassified from other comprehensive income into earnings, net of taxes. See the Consolidated Statements of Stockholders’ Equity for a complete summary of comprehensive income.


60


 

TD AMERITRADE HOLDING CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Available-for-sale investments in equity securities included gross unrealized gains of $5.2 million and $67.2 million as of September 29, 2006 and September 30, 2005, respectively, which are included in accumulated other comprehensive income on the Consolidated Balance Sheets.
 
8.   Acquisition Exit Liabilities
 
The Company has recorded exit liabilities associated with acquisitions, which are included in accounts payable and accrued liabilities in the Consolidated Balance Sheets. These exit liabilities consist principally of severance pay and other termination benefits and contract termination costs. The following is a summary of the activity in the Company’s acquisition exit liabilities:
 
                                         
    Employee
    Clearing and
    Occupancy
    Professional
       
    Compensation     Execution     and Equipment     Services     Total  
 
Balance, Sept 26, 2003
  $ 2,707     $     $ 4,913     $     $ 7,620  
Fiscal 2004 activity:
                                       
Exit costs recorded
    4,172             1,016             5,188  
Utilized
    (6,302 )           (816 )           (7,118 )
                                         
Balance, Sept 24, 2004
    577             5,113             5,690  
Fiscal 2005 activity:
                                       
Exit costs recorded
                226             226  
Utilized
    (456 )           (2,122 )           (2,578 )
                                         
Balance, Sept 30, 2005
    121             3,217             3,338  
Fiscal 2006 activity:
                                       
Exit costs recorded
    59,335       8,850       46,936       2,957       118,078  
Utilized
    (32,780 )           (26,985 )     (400 )     (60,165 )
                                         
Balance, Sept 29, 2006
  $ 26,676     $ 8,850     $ 23,168     $ 2,557     $ 61,251  
                                         
 
The exit costs recorded during fiscal 2006 relate to the acquisition of TD Waterhouse described in Note 2. Acquisition employee compensation liabilities and professional services contract termination costs are expected to be substantially paid over the course of the TD Waterhouse integration during fiscal 2007. Remaining acquisition occupancy and equipment exit liabilities are expected to be utilized over the respective lease periods through fiscal 2015.
 
9.   Credit Facilities
 
The Company entered into a credit agreement, as amended, on January 23, 2006 for $2.2 billion in senior credit facilities with a syndicate of lenders. The senior credit facilities include: (a) a senior secured term loan facility in the aggregate principal amount of $250 million (the “Term A Facility”), (b) a senior secured term loan facility in the aggregate principal amount of $1.65 billion (the “Term B Facility”) and (c) a senior secured revolving credit facility in the aggregate principal amount of $300 million (the “Revolving Facility”) (together, the “Financings”). The maturity date of the Term A Facility is December 31, 2011. The maturity date of the Term B Facility is December 31, 2012. The maturity date of the Revolving Facility is December 31, 2010. The Financings are subject to certain mandatory prepayments, which include prepayments based on leverage ratios and amounts of excess cash flow and from the net cash proceeds of asset sales and debt issuances, subject to certain exceptions. Under the terms of the Financings, the Company may prepay borrowings without penalty.
 
The Company used $1.6 billion of the proceeds from the Term A Facility and Term B Facility to fund a portion of the $6 per share special cash dividend paid in connection with the acquisition of TD Waterhouse and $300 million


61


 

TD AMERITRADE HOLDING CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

for working capital purposes. No initial borrowings were made on the Revolving Facility, which was established for general corporate purposes.
 
The applicable interest rate under the Revolving Facility and the Term A Facility is calculated as a per annum rate equal to, at the Company’s option, (a) LIBOR plus an interest rate margin (“LIBOR loans”) or (b) (i) the greater of (x) the prime rate or (y) the federal funds effective rate plus 0.50 percent plus (ii) an interest rate margin (“Base Rate loans”). With respect to the Revolving Facility and the Term A Facility the interest rate margin for LIBOR loans is 1.50 percent if the consolidated leverage ratio (as defined in the Financings) of the Company is 1.75 to 1.00 or higher, 1.25 percent if the consolidated leverage ratio of the Company is less than 1.75 to 1.00 but greater than or equal to 1.00 to 1.00, and 1.00 percent if the consolidated leverage ratio of the Company is less than 1.00 to 1.00. The interest rate margin for Base Rate loans under the Revolving Facility and the Term A Facility is 1.00 percent less than the interest rate margin for LIBOR loans. The applicable interest rate under the Term B Facility is calculated as a per annum rate equal to (a) LIBOR plus 1.50 percent or (b) (i) the greater of (x) the prime rate or (y) the federal funds effective rate plus 0.50 percent plus (ii) 0.50 percent. On September 29, 2006, the applicable interest rate on the Term A Facility and the Term B Facility was 6.57 percent and 6.82 percent, respectively, based on 30-day LIBOR. As of September 29, 2006, the Company had outstanding indebtedness of $0.2 billion, $1.5 billion and $0 under the Term A Facility, Term B Facility and Revolving Facility, respectively. The Company has not made any borrowings under the Revolving Facility. The Financings also provide that the Company is obligated to pay from time to time letter of credit fees equal to the applicable margin in respect of LIBOR advances on each outstanding letter of credit under the Revolving Credit Facility. In addition, the Financings provide that the Company pays fees to the issuing bank in respect of the Letters of Credit in an amount agreed to by the Company and the issuing bank. A commitment fee at the rate of 0.375 percent per annum accrues on any unused amount of the Revolving Facility.
 
The obligations under the Financings are guaranteed by certain of the Company’s subsidiaries, other than broker-dealer subsidiaries, with certain exceptions, and are secured by a lien on substantially all of the assets of each guarantor, including a pledge of the ownership interests in each first-tier broker-dealer subsidiary held by a guarantor and 65 percent of the ownership interests in each first-tier foreign subsidiary held by a guarantor, with certain exceptions.
 
The Financings contain certain covenants that limit or restrict the incurrence of liens, investments (including acquisitions), sales of assets, indebtedness and mergers and consolidations, subject to certain exceptions. The Financings also restrict the payment of dividends on the Company’s outstanding capital stock and repurchases or redemptions of the Company’s outstanding capital stock, subject to certain exceptions. The Company is also required to maintain compliance with a maximum consolidated leverage ratio covenant and a minimum consolidated interest coverage ratio covenant, and the Company’s broker-dealer subsidiaries are required to maintain compliance with a minimum regulatory net capital covenant. The Company was in compliance with all covenants under the Financings as of September 29, 2006, except for a failure to timely notify the lenders of name changes of certain guarantor subsidiaries. The Company has requested a waiver from the lenders for the lack of timely notification.
 
Fiscal year maturities on long-term debt outstanding at September 29, 2006 are as follows:
 
         
2007
  $ 25,000  
2008
    34,375  
2009
    37,500  
2010
    56,250  
2011
    62,500  
Thereafter
    1,487,750  
         
Total
  $ 1,703,375  
         


62


 

TD AMERITRADE HOLDING CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

The Company, through its wholly owned broker-dealer subsidiaries, had access to secured uncommitted credit facilities with financial institutions of up to $740 million and $180 million as of September 29, 2006 and September 30, 2005, respectively. The broker-dealer subsidiaries also had access to unsecured uncommitted credit facilities of up to $435 million and $310 million as of September 29, 2006 and September 30, 2005, respectively. The financial institutions may make loans under line of credit arrangements or, in some cases, issue letters of credit under these facilities. The secured credit facilities require the Company to pledge qualified client securities to secure outstanding obligations under these facilities. Borrowings under the secured and unsecured credit facilities bear interest at a variable rate based on the federal funds rate. Covenants under the Financings limit the broker-dealer subsidiaries to an aggregate outstanding principal balance of $1.0 billion in borrowings on uncommitted lines of credit. There were no borrowings outstanding or letters of credit issued under the secured or unsecured credit facilities as of September 29, 2006 and September 30, 2005. As of September 29, 2006 and September 30, 2005, approximately $1.0 billion and $490 million, respectively, was available to the Company’s broker-dealer subsidiaries pursuant to uncommitted credit facilities for either loans or, in some cases, letters of credit.
 
10.   Income Taxes
 
Provision for income taxes is comprised of the following for fiscal years ended:
 
                         
    2006     2005     2004  
 
Current expense:
                       
Federal
  $ 242,511     $ 180,733     $ 132,315  
State
    42,392       29,479       25,543  
Foreign
    168       1,250       1,284  
                         
      285,071       211,462       159,142  
                         
Deferred expense (benefit):
                       
Federal
    35,518       2,813       20,374  
State
    9,225       325       (3,338 )
Foreign
    732       (861 )     91  
                         
      45,475       2,277       17,127  
                         
Provision for income taxes
  $ 330,546     $ 213,739     $ 176,269  
                         
 
The Company is subject to examination by the Internal Revenue Service, states in which the Company has significant business operations, and other taxing authorities. The tax years subject to examination vary by jurisdiction. The Company regularly assesses the likelihood of additional tax deficiencies in each of the taxing jurisdictions resulting from ongoing and subsequent years’ examinations. Included in current income tax expense are changes to accruals for expected tax deficiencies, along with applicable interest and penalties, in accordance with SFAS No. 5.
 
A reconciliation of the federal statutory tax rate to the effective tax rate applicable to pre-tax income follows for the fiscal years ended:
 
                         
    2006     2005     2004  
 
Federal statutory rate
    35.0 %     35.0 %     35.0 %
State taxes, net of federal tax effect
    4.0       3.6       3.3  
Reversal of accruals for contingent tax liabilities
    (0.3 )            
Other
    (0.1 )           0.1  
                         
      38.6 %     38.6 %     38.4 %
                         


63


 

TD AMERITRADE HOLDING CORPORATION
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Deferred tax assets (liabilities) are comprised of the following as of the fiscal years ended:
 
                 
    2006     2005  
 
Deferred tax assets:
               
Accrued liabilities
  $ 48,979     $ 14,877  
Stock-based compensation
    15,001       688  
Allowance for doubtful accounts
    7,609       4,976  
Operating loss carryforwards
    6,348       6,502  
Other deferred tax assets
          2,205  
                 
Gross deferred tax assets
    77,937       29,248  
Less: Valuation allowance
    (6,174 )     (5,164 )
                 
Net deferred tax assets
    71,763       24,084  
                 
Deferred tax liabilities: