Overview

Instinet Group is the largest global electronic agency securities broker, and we have been providing investors with electronic trading solutions and execution services for more than 30 years. We provide sophisticated electronic trading solutions and execution services to enable buyers and sellers worldwide to trade securities directly and anonymously with each other. We also give our customers the opportunity to use our sales-trading expertise and sophisticated technology tools to interact with global securities markets, improve their trading and investment performance and lower their overall trading costs. Through our electronic platforms, our customers can access other U.S. trading venues, including NASDAQ and the NYSE and almost 30 securities markets throughout the world, including stock exchanges in Frankfurt, Hong Kong, London, Paris, Sydney, Tokyo, Toronto and Zurich. Our customers primarily consist of broker-dealers and institutional investors, such as mutual funds, pension funds, insurance companies and hedge funds.

Our total revenues, net of interest, were $280.0 million for the second quarter of 2004 comparable to $280.5 million in the second quarter of 2003. However, cost of revenues increased to $157.8 million in the second quarter of 2004 from $141.7 million in the comparable period in 2003, which resulted in our gross margin decreasing to $122.2 million in the second quarter of 2004 from $138.8 million in the comparable period in 2003.

Business Environment

U.S. equity market volumes decreased during the second quarter of 2004 with NASDAQ-listed equity share volume down 15% over the first quarter of 2004 and down 3% from the second quarter of 2003. Outside of the U.S., market volumes were lower during the second quarter of 2004 compared to the first quarter of 2004 with international market consideration, or total value traded, decreasing approximately 4% primarily due to weaker European markets partially offset by slightly stronger Asian markets. Total international market consideration increased 35% over the second quarter of 2003.

Strategic Developments

In the first quarter of 2004, we completed our business restructuring plan to establish two distinct business lines:

• Instinet, the Unconflicted Institutional Broker, which includes our U.S. and international institutional agency brokers as well as Lynch, Jones & Ryan, our commission recapture subsidiary, and Instinet Clearing Services, Inc. (ICS), our clearing broker.

• INET, the electronic marketplace, which represents the consolidation of the order flow of the former Instinet ECN and former Island ECN.

As we implemented our new segment reporting, we also reformatted our income statements and enhanced our operating data. We have presented similar historical data in order to provide meaningful comparison.

During the three months ended June 30, 2004, trading volumes in the U.S. equity markets decreased 1.4% to 236.0 billion shares from 239.4 billion shares in the comparable period in 2003. Total NASDAQ-listed share volume decreased 4.5% to 107.6 billion shares for the three months ended June 30, 2004 from 112.6 billion shares in the comparable period in 2003. U.S. exchange-listed share volume increased 1.3% to 128.5 billion shares for the three months ended June 30, 2004 from 126.8 billion shares in the comparable period in 2003.

Instinet's overall market share increased to 2.7% or 6.3 billion shares of total U.S. equity trading volume compared to 2.5% or 6.0 billion shares in the comparable period in 2003. Instinet's international market consideration increased approximately 34.5% from the three months ended June 30, 2003.

INET's overall market share decreased to 13.2% or 31.3 billion of total U.S. market share volume, which comprised 25.0% or 26.8 billion of NASDAQ-listed share volume, and 3.4% or 4.4 billion of U.S. exchange-listed share volume, for the three months ended June 30, 2004. In the comparable 2003 period, INET's overall market share was 13.6% or 29.3 billion of total U.S. market share volume, which comprised 26.0% or 29.3 billion of NASDAQ share volume, and 2.6% or 3.3 billion of U.S. exchange-listed share volume.

Critical Accounting Policies

Our accounting policies related to our strategic alliances and long term investments (investments), allowance for doubtful accounts, and goodwill and intangible assets are the most critical accounting policies that require us to make estimates and use judgments that could affect our results.

Investments

Our investments are stated at estimated fair value as determined in good faith by management. Generally, we will initially value investments at cost as a proxy for fair value, and require that changes in value be established by meaningful third-party transactions or a significant impairment in the financial condition or operating performance of the issuer, unless meaningful developments occur that otherwise warrant a change in the valuation of an investment. Factors considered in valuing individual investments include, without limitation, available market prices, type of security, purchase price, purchases of the same or similar securities by other investors, marketability, restrictions on disposition, current financial position and operating results, and other pertinent information.

We use our best judgment in estimating the fair value of these investments. There are inherent limitations to any estimation technique. The fair value estimates presented herein are not necessarily indicative of an amount that we could realize in a current transaction. Because of the inherent uncertainty of valuation, these estimated fair values do not necessarily represent amounts that might be ultimately realized, since such amounts depend on future circumstances, and the differences could be material. During the three and six months ended June 30, 2003, we wrote down our investments in NASDAQ Stock Market, Inc., Archipelago Holding LLC, TP Group LDC, Tradeware S.A. and, JapanCross Securities Co. Ltd. by an aggregate $4.9 million and $22.3 million, respectively, based upon management's best judgment of each investment's respective fair market value.

The allowance for doubtful accounts is based on our assessment of the collectibility of customer accounts. We regularly review the allowance by considering factors such as historical experience, credit quality, and age of the accounts receivable balances, and current economic conditions that may affect a customer's ability to pay. If a major customer's creditworthiness deteriorates, or if actual defaults are higher than our historical experience, or if other circumstances arise, our estimates of the recoverability of amounts due to us could be overstated, and additional allowances could be required, which could have an adverse impact on our revenue. The allowance for doubtful accounts as of June 30, 2004 and December 31, 2003 was $20.3 million and $21.7 million, respectively.

Accounting for Goodwill and Other Intangible Assets

Statement of Financial Accounting Standard (SFAS) No. 142 "Goodwill and Other Intangible Assets" requires that goodwill and certain intangible assets be assessed for impairment using fair value measurement techniques and that management perform a detailed review of the carrying value of the Company's tangible and intangible assets. In this process, management is required to make estimates and assumptions in order to determine the fair value of the Company's assets and liabilities and projected future earnings using various valuation techniques. Management uses its best judgment and information available to it at the time to perform this review, as well as the services of an expert valuation specialist. Because management's assumptions and estimates are used in the valuation, actual results may differ. There were no adjustments for the three and six months ended June 30, 2004 and 2003.

Key Statistical Information



The following table presents operating data and market share that reflects our
reorganization of the company into two separate business lines.



                                                              Three Months Ended June 30,                    Six Months Ended June 30,
                                                        ---------------------------------------          ----------------------------------
                                                             2004                     2003                   2004                   2003
                                                        --------------           --------------          -------------           ----------
U.S. Market
Trade Days                                                          62                       63                    124                  124

Average daily NASDAQ-listed equity share volume
(millions)                                                       1,735                    1,788                  1,882                1,626
Average daily U.S. exchange-listed equity share
volume (millions)                                                2,072                    2,012                  2,168                1,956
                                                        -- ----------- --        -- ----------- -        -- ---------- --        -- ------- -
Average daily U.S. equity share volume
(millions)                                                       3,807                    3,800                  4,050                3,582

Total U.S. equity share volume (millions)                      236,023                  239,387                502,152              444,195

Instinet, the Unconflicted Institutional Broker
A. U.S. Equities 1

Our total average daily volume (million shares)                    102                       96                    107                   94
Our share of total market                                          2.7 %                    2.5 %                  2.6 %                2.6 %

Our average daily volume (million shares) -
Institutional and Crossing                                          78                       79                     84                   78
Average amount charged to client per share
(cents per share) 2 - Institutional and Crossing                  1.50                     1.57                   1.50                 1.55

Our average daily volume (million shares) -
Institutional Correspondents                                        24                       17                     23                   16
Average amount charged to client per share
(cents per share) 2 - Institutional
Correspondents                                                    0.08                     0.09                   0.10                 0.07

B. Non-US Equities 3
Our average daily consideration (millions)              $          896           $          666          $         914           $      729
Average basis points charged to client per
consideration traded                                               5.1                      5.7                    5.2                  5.2

INET, the Electronic Marketplace
A. Our Matched Average Daily Volume 4
Our NASDAQ-listed equity share volume (million
shares)                                                            433                      465                    470                  434
Our share of total market                                         25.0 %                   26.0 %                 25.0 %               26.7 %

Our U.S. exchange-listed equity share volume
(million shares)                                                    71                       52                     67                   54
Our share of total market                                          3.4 %                    2.6 %                  3.1 %                2.7 %
Our total U.S. equity share volume (million
shares)                                                            504                      517                    537                  488
Our share of total market                                         13.2 %                   13.6 %                 13.3 %               13.6 %

B. Our Routed Average Daily Volume (million
shares) 5                                                          115                       28                    103                   25
Headcount 6                                                      1,090                    1,311                  1,090                1,311

2 The amount charged per share is the average cents per share charged net of soft dollar and commission recapture expenses.

3 Commissions on international transactions are presented as basis points (one hundred of one percent) of the total value (consideration) of the transaction.

4 For a description of how we calculate INET's share volumes, see - "Calculation of Volume - INET, the Electronic Marketplace."

5 Routed volume reflects transactions where the trade was not matched on INET.

6 Instinct Group headcount is as of the end of the reporting period.

Instinet, the Unconflicted Institutional Broker

Instinet average daily U.S. equity share volume is counted as the sum of our customers share volume per side related to a trade. For example a matched trade where one customer buys 100 shares and the other sells 100 shares is counted as 200 shares; if the buy or sell order were routed out we would count 100 shares on the customer side. Upon completion of our reorganization, we identified two primary customer groups and as a result, we changed methods in recognizing customer activity and prior quarter statistics have been recalculated.

Institutional and Crossing comprise certain U.S. buy-side clients, all of the clients of Lynch, Jones & Ryan and our international business. They include fund managers, pension plans, hedge funds and other clients. Crossing includes order flow from both buy-side and sell-side clients who execute though our after hours cross. Institutional Correspondents represent our direct market access U.S. buy-side clients.

INET, the Electronic Marketplace

In computing our U.S. share volume for INET in either NASDAQ-listed or U.S. exchange-listed equities, we count the customer share volume on one side of the matched trade. Matched volume reflects transactions where the buyer and seller are matched on INET.

For example, where a customer sells 100 shares to another customer as a matched trade, we count 100 shares. INET share volume includes transactions sent to it by Instinet, the Institutional Broker and prior quarters have been recalculated to include this volume.

In computing our total market share, our numerator share volume is counted as described above for each market where we disclose a market share statistic. The denominator for NASDAQ market share is total NASDAQ share volume as published by NASDAQ. For U.S. exchange-listed market share, the denominator is the total share volume of U.S. listed markets obtained from a widely recognized market data vendor. Listed markets include the New York Stock Exchange, American Stock Exchange, Boston Stock Exchange, Philadelphia Stock Exchange, National Stock Exchange, Chicago Stock Exchange and Pacific Stock Exchange. Historical amounts may be restated due to updates of volume information from these sources.

Overview

Our net income was $8.4 million for the three months ended June 30, 2004 compared to a net loss of $5.2 million in the comparable period in 2003. Our total revenues, net were $280.0 million for the three months ended June 30, 2004 compared to $280.5 million in the three months ended June 30, 2003. Total expenses decreased $20.1 million to $264.8 million for the three months ended June 30, 2004 from $284.9 million in the comparable period in 2003 primarily due to lower direct expenses, a $7.3 million contractual settlement partially offset by an increase in cost of revenues. Cost of revenues increased 11.4% to $157.8 million for the three months ended June 30, 2004 from $141.7 million in the comparable period in 2003 and cost of revenues as a percentage of total revenues increased to 56.4% from 50.5% primarily due to increased routed average daily volume and higher rebate rates. Direct expenses were down 21.8% to $114.2 million from $146.1 million due to lower overall expenses as a result of our reduced headcount, cost reduction initiatives, impairment and restructuring charge in the fourth quarter of 2003.

Revenues

Transaction fees

Transaction fee revenue increased 0.3% to $276.6 million for the three months ended June 30, 2004 from $275.9 million for the three months ended June 30, 2003. The increase was primarily due to higher average daily consideration in our international markets and higher routed volumes partially offset by lower average daily NASDAQ-listed volume and average amount charged to clients.

Interest income, net

Interest income, net decreased 24.4% to $3.4 million for the three months ended June 30, 2004 from $4.5 million in the comparable period in 2003. This decrease was primarily due to a shift to shorter-term investments and a decrease in stock borrowings partially offset by higher cash balances compared to the prior year.

Cost of Revenues

Soft dollar and commission recapture

Soft dollar and commission recapture expense increased 7.1% to $53.1 million for the three months ended June 30, 2004 from $49.6 million in the comparable period in 2003. This expense is offset by soft dollar revenues and revenues that are subject to commission recapture. The increase was primarily due to increases in volume from our soft dollar and commission recapture clients.

Broker-dealer rebates

Broker-dealer rebates expense increased 6.5% to $62.4 million for the three months ended June 30, 2004 from $58.6 million in the comparable period in 2003. The increase was primarily due to higher rebate rates.

Brokerage, clearing and exchange fees increased 26.6% to $42.3 million for the three months ended June 30, 2004 from $33.4 million in the comparable period in 2003. The increase was primarily due to the impact of higher routed volume as a result of our price reduction for routing orders partially offset by lower clearing costs, mainly in the U.S., due to a decline in trade reporting expenses and benefits realized from technology efficiencies.

Gross Margin

Gross margin decreased 11.9% to $122.2 million for the three months ended June 30, 2004 from $138.8 million in the comparable period in 2003. The decrease was primarily due to higher charges for routing shares and higher rebate rates partially offset by higher international consideration traded.

Expenses

Compensation and benefits expense

Compensation and benefits expense decreased 8.1% to $55.8 million for the three months ended June 30, 2004 from $60.7 million in the comparable period in 2003. This decrease was primarily due to a decrease in our worldwide headcount as part of our cost reduction initiatives and lower severance charge of $3.7 million for the three months ended June 30, 2004 and $7.9 million for the three months ended June 30, 2003. Partially offsetting this decrease was an increase in incentive compensation due to increased profitability for the three months ended June 30, 2004. Our total headcount decreased to 1,090 as of June 30, 2004 from 1,311 employees as of June 30, 2003.

Communications and equipment

Communications and equipment expense decreased 46.2% to $17.0 million for the three months ended June 30, 2004 from $31.6 million in the comparable period in 2003. This decrease was primarily due to the migration of clients to a third-party network, which was substantially completed during the third quarter of 2003.

Depreciation and amortization

Depreciation and amortization expense decreased 32.3% to $15.9 million for the three months ended June 30, 2004 from $23.5 million in the comparable period in 2003. This decrease was primarily due to lower amortization of intangible assets resulting from our impairment charge in the fourth quarter of 2003 and lower amortization of leasehold improvements due to our restructuring charge in the fourth quarter of 2003.

Occupancy

Occupancy expense decreased 29.5% to $9.3 million for the three months ended June 30, 2004 from $13.2 million in the comparable period in 2003. This decrease was primarily due to space consolidation as part of our restructuring.

Professional fees increased 13.9% to $8.2 million for the three months ended June 30, 2004 from $7.2 million in the comparable period in 2003. This increase was primarily due to higher consultant and legal fees.

Marketing and business development

Marketing and business development expenses increased 52.3% to $5.3 million for the three months ended June 20, 2004 from $3.5 million in the comparable period in 2003. This increase was primarily due to higher advertising costs.

Other expenses

Other expenses decreased 55.6% to $2.8 million for the three months ended June 30, 2004 from $6.3 million in the comparable period in 2003. The decrease was due to lower bad debt expense as well as lower discretionary and office related expenses.

Contractual settlement

We received $7.3 million associated with the mutual release of Instinet Group, Zone Trading Partners and affiliated parties of obligations in final settlement of an execution contract.

Investments

Unrealized mark to market losses on securities owned were offset by gains on shares we own in various stock exchanges for the three months ended June 30, 2004. This compares with a gain of $2.8 million in the comparable period in 2003 when gains on the stock exchanges and other investments were partially offset by write-downs of $5.0 million on our investments in TP Group LDC and e-Xchange Advantage Corporation for the three months ended June 30, 2003.

Income tax provision (benefit)

For the three months ended June 30, 2004 our income tax provision was $6.8 million and $1.0 million in the comparable period in 2003. The effective tax rate was 44.0% for the three months ended June 30, 2004 and benefit of 16.0% in the comparable period in 2003. The effective tax rate in 2003 was reflective of investment impairments and accrued severance for which full tax benefits will not be realized.

OPERATING RESULTS BY SEGMENT



                                                              Three Months Ended June 30, 2004                                   Three Months Ended June 30, 2003
                                                -------------------------------------------------------------      ------------------------------------------------------------
                                                                               Eliminations &                                                   Eliminations &
                                                Instinet         INET            Corporate            Total        Instinet         INET          Corporate             Total
                                                ---------      ---------      ----------------      ---------      ---------      ---------    ----------------       ---------
Revenues
Transaction fees                                $ 169,636      $ 111,059      $         (4,095 )    $ 276,600      $ 168,291      $ 111,736    $         (4,118 )     $ 275,909
Interest income, net                                3,001            443                   -            3,444          4,419            126                 -             4,545
                                                - ------- -    - ------- -    -- ------------- -    - ------- -    - ------- -    - -------    -- ------------- -     - ------- -
Total revenue, net                                172,637        111,502                (4,095 )      280,044        172,710        111,862              (4,118 )       280,454
                                                - ------- -    - ------- -    -- ------------- -    - ------- -    - ------- -    - -------    -- ------------- -     - ------- -
Cost of revenues
Soft dollar and commission recapture               53,103            -                     -           53,103         49,604            -                   -            49,604
Broker-dealer rebates                                 -           62,388                   -           62,388            -           58,630                 -            58,630
Brokerage, clearing and exchange fees              26,825         19,591                (4,095 )       42,321         26,311         11,253              (4,118 )        33,446
                                                - ------- -    - ------- -    -- ------------- -    - ------- -    - ------- -    - -------    -- ------------- -     - ------- -
Total cost of revenues                             79,928         81,979                (4,095 )      157,812         75,915         69,883              (4,118 )       141,680
                                                - ------- -    - ------- -    -- ------------- -    - ------- -    - ------- -    - -------    -- ------------- -     - ------- -
Gross margin                                       92,709         29,523                   -          122,232         96,795         41,979                 -           138,774
                                                - ------- -    - ------- -    -- ------------- -    - ------- -    - ------- -    - -------    -- ------------- -     - ------- -
Direct Expenses
Compensation and benefits                          47,647          3,072                 5,125         55,844         39,466          3,565              17,718          60,749
Communications and equipment                       14,957          1,501                   492         16,950         27,373          3,419                 825          31,617
Depreciation and amortization                      13,206          2,411                   238         15,855         13,998          7,160               2,376          23,534
Occupancy                                           7,862            384                 1,014          9,260          6,830          1,225               5,120          13,175
Professional fees                                   4,925            603                 2,644          8,172          4,683            228               2,317           7,228
Marketing and business development                  3,068          1,346                   888          5,302          1,480             42               1,958           3,480
. . .