NASDAQ, Inc.
NASDAQ STOCK MARKET INC (Form: 10-Q, Received: 11/05/2004 16:44:40)      

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q

(Mark One)

x                               QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2004

OR

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 0-32651


 

THE NASDAQ STOCK MARKET, INC.

(Exact Name of Registrant as Specified in Its Charter)

Delaware

52-1165937

(State or Other Jurisdiction of
Incorporation or Organization)

(IRS Employer
Identification No.)

One Liberty Plaza
New York, New York

10006

(Address of Principal Executive Offices)

(Zip Code)

 

(212) 401-8700

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x     No  o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes  x     No  o

As of October 31, 2004, 78,621,393 shares of the Registrant’s common stock, par value $0.01 per share (“Common Stock”), were outstanding.

 




 

The Nasdaq Stock Market, Inc.
Form 10-Q
For the Quarter Ended September 30, 2004
INDEX

PART I.   FINANCIAL INFORMATION

 

Item 1.   Financial Statements—(unaudited)

1

Condensed Consolidated Statements of Income—Three and Nine Months Ended September 30, 2004 and 2003

1

Condensed Consolidated Balance Sheets—September 30, 2004 and December 31, 2003

2

Condensed Consolidated Statements of Cash Flows—Nine Months Ended September 30, 2004 and 2003

3

Notes to Condensed Consolidated Financial Statements

4

Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

21

Item 3.    Quantitative and Qualitative Disclosures About Market Risk

36

Item 4.    Controls and Procedures

36

PART II.    OTHER INFORMATION

 

Item 2.    Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

37

Item 6.    Exhibits and Reports on Form 8-K

37

SIGNATURES

38

 

i




 

Forward-looking statements in this Quarterly Report on Form 10-Q are subject to known and unknown risks, uncertainties and other factors which may cause our actual results, performance, or achievements to be materially different from any future results, performance, or achievements expressed or implied by such forward-looking statements. These forward-looking statements were based on various factors and were derived utilizing numerous assumptions and other factors that could cause actual results to differ materially from those in the forward-looking statements. These factors include, but are not limited to, The Nasdaq Stock Market, Inc.’s (“Nasdaq”) ability to implement its strategic initiatives, economic, political, and market conditions and fluctuations, government and industry regulation, interest rate risk, United States and global competition and other factors that are more fully described under the caption “Item 1. Business—Risk Factors” in The Nasdaq Stock Market, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2003. Most of these factors are difficult to predict accurately and are generally beyond our control. You should consider the areas of risk described in connection with any forward-looking statements that may be made herein. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of September 30, 2004. Except for our ongoing obligations to disclose material information under the Federal securities laws, we undertake no obligation to release publicly any revisions to any forward-looking statements, to report events, or to report the occurrence of unanticipated events. For any forward-looking statements contained in any document, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

ii




The Nasdaq Stock Market, Inc.  

PART I—FINANCIAL INFORMATION
 

Item 1.   Financial Statements  

The Nasdaq Stock Market, Inc.
Condensed Consolidated Statements of Income
(Unaudited)
(in thousands, except per share amounts)

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

Revenues

 

 

 

 

 

 

 

 

 

Market Services

 

$

73,304

 

$

89,687

 

$

218,361

 

$

297,374

 

Issuer Services

 

50,646

 

50,484

 

153,935

 

152,571

 

Other

 

20

 

1,729

 

91

 

1,890

 

Total revenues

 

123,970

 

141,900

 

372,387

 

451,835

 

Cost of revenues

 

(9,177

)

 

(9,177

)

 

Gross margin

 

114,793

 

141,900

 

363,210

 

451,835

 

Expenses

 

 

 

 

 

 

 

 

 

Compensation and benefits

 

38,094

 

36,745

 

112,424

 

129,039

 

Marketing and advertising

 

2,819

 

3,549

 

8,996

 

13,820

 

Depreciation and amortization

 

18,871

 

21,158

 

54,997

 

69,045

 

Professional and contract services

 

6,676

 

7,104

 

16,589

 

28,679

 

Computer operations and data communications

 

22,613

 

32,630

 

81,243

 

93,422

 

Provision for bad debts

 

772

 

 

1,321

 

1,584

 

Occupancy

 

7,146

 

7,613

 

21,326

 

23,143

 

General and administrative

 

15,648

 

6,657

 

23,820

 

24,797

 

Total direct expenses

 

112,639

 

115,456

 

320,716

 

383,529

 

Elimination of non-core product lines, initiatives and severance

 

 

23,803

 

 

69,551

 

Nasdaq Japan impairment loss

 

 

 

 

(5,000

)

Support costs from related parties, net

 

11,120

 

15,448

 

34,293

 

48,418

 

Total expenses

 

123,759

 

154,707

 

355,009

 

496,498

 

Operating (loss) income

 

(8,966

)

(12,807

)

8,201

 

(44,663

)

Interest income

 

1,519

 

2,488

 

4,578

 

7,860

 

Interest expense

 

(2,873

)

(5,182

)

(8,613

)

(15,634

)

Operating (loss) income from continuing operations before income
taxes

 

(10,320

)

(15,501

)

4,166

 

(52,437

)

Benefit (provision) for income taxes

 

4,835

 

7,758

 

(235

)

18,132

 

Net (loss) income from continuing operations

 

$

(5,485

)

$

(7,743

)

$

3,931

 

$

(34,305

)

Loss from discontinued operations (net of income tax benefit of $211 and $1,186 in the three and nine months ended September 30, 2003, respectively)

 

 

(30,836

)

 

(50,716

)

Gain on disposition of discontinued operations

 

 

571

 

 

571

 

Loss from discontinued operations

 

 

(30,265

)

 

(50,145

)

Net (loss) income

 

$

(5,485

)

$

(38,008

)

$

3,931

 

$

(84,450

)

Net loss applicable to common stockholders:

 

 

 

 

 

 

 

 

 

Net (loss) income

 

$

(5,485

)

$

(38,008

)

$

3,931

 

$

(84,450

)

Preferred stock dividends declared

 

(1,004

)

(2,542

)

(7,350

)

(5,736

)

Net loss applicable to common stockholders

 

$

(6,489

)

$

(40,550

)

$

(3,419

)

$

(90,186

)

Basic and diluted net loss per share:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

(0.08

)

$

(0.13

)

$

(0.04

)

$

(0.51

)

Discontinued operations

 

 

(0.39

)

 

(0.64

)

Total basic and diluted net loss per share

 

$

(0.08

)

$

(0.52

)

$

(0.04

)

$

(1.15

)

 

See accompanying notes.

1




 

The Nasdaq Stock Market, Inc.
Condensed Consolidated Balance Sheets
(in thousands, except share and par value amounts)

 

 

September 30,
2004

 

December 31,
2003

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

 

$

47,986

 

 

 

$

148,929

 

 

Investments:

 

 

 

 

 

 

 

 

 

Available-for-sale, at fair value

 

 

188,982

 

 

 

185,704

 

 

Held-to-maturity, at amortized cost

 

 

25,600

 

 

 

23,765

 

 

Receivables, net

 

 

92,282

 

 

 

111,405

 

 

Receivables from related parties

 

 

233

 

 

 

7,731

 

 

Deferred tax asset

 

 

29,633

 

 

 

40,460

 

 

Other current assets

 

 

14,134

 

 

 

11,623

 

 

Total current assets

 

 

398,850

 

 

 

529,617

 

 

Investments:

 

 

 

 

 

 

 

 

 

Held-to-maturity, at amortized cost

 

 

5,010

 

 

 

4,506

 

 

Property and equipment:

 

 

 

 

 

 

 

 

 

Land, buildings and improvements

 

 

96,708

 

 

 

96,578

 

 

Data processing equipment and software

 

 

313,359

 

 

 

346,928

 

 

Furniture, equipment and leasehold improvements

 

 

157,162

 

 

 

168,478

 

 

 

 

 

567,229

 

 

 

611,984

 

 

Less: accumulated depreciation and amortization

 

 

(361,894

)

 

 

(369,041

)

 

Total property and equipment, net

 

 

205,335

 

 

 

242,943

 

 

Non-current deferred tax asset

 

 

55,788

 

 

 

72,079

 

 

Goodwill

 

 

141,730

 

 

 

 

 

Intangible assets

 

 

42,399

 

 

 

871

 

 

Other assets

 

 

1,423

 

 

 

1,238

 

 

Total assets

 

 

$

850,535

 

 

 

$

851,254

 

 

Liabilities

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

Accounts payable and accrued expenses

 

 

$

37,288

 

 

 

$

29,959

 

 

Accrued personnel costs

 

 

45,933

 

 

 

48,817

 

 

Deferred revenue

 

 

84,013

 

 

 

59,739

 

 

Other accrued liabilities

 

 

64,299

 

 

 

75,951

 

 

Current obligation under capital lease

 

 

 

 

 

1,607

 

 

Payables to related parties

 

 

8,805

 

 

 

21,558

 

 

Total current liabilities

 

 

240,338

 

 

 

237,631

 

 

Senior notes

 

 

25,000

 

 

 

25,000

 

 

Subordinated notes

 

 

240,000

 

 

 

240,000

 

 

Accrued pension costs

 

 

24,185

 

 

 

26,831

 

 

Non-current deferred tax liability

 

 

35,316

 

 

 

40,917

 

 

Non-current deferred revenue

 

 

90,804

 

 

 

84,703

 

 

Other liabilities

 

 

37,810

 

 

 

35,476

 

 

Total liabilities

 

 

693,453

 

 

 

690,558

 

 

Stockholders’ equity

 

 

 

 

 

 

 

 

 

Common stock, $0.01 par value, 300,000,000 authorized, shares issued: 130,653,191 at September 30, 2004 and 130,611,221 at December 31, 2003; shares outstanding: 78,618,593 at September 30, 2004 and 78,483,919 at December 31, 2003

 

 

1,306

 

 

 

1,306

 

 

Preferred stock, 30,000,000 authorized, Series A: 1,338,402 shares issued and outstanding; Series B:
1 share issued and outstanding

 

 

133,840

 

 

 

133,840

 

 

Additional paid-in capital

 

 

358,535

 

 

 

358,923

 

 

Common stock in treasury, at cost: 52,034,598 shares at September 30, 2004 and 52,127,302 shares at December 31, 2003

 

 

(666,543

)

 

 

(667,765

)

 

Accumulated other comprehensive (loss) income

 

 

(593

)

 

 

86

 

 

Deferred stock compensation

 

 

(1,292

)

 

 

(1,102

)

 

Common stock issuable

 

 

2,721

 

 

 

2,881

 

 

Retained earnings

 

 

329,108

 

 

 

332,527

 

 

Total stockholders’ equity

 

 

157,082

 

 

 

160,696

 

 

Total liabilities and stockholders’ equity

 

 

$

850,535

 

 

 

$

851,254

 

 

 

See accompanying notes.

2




 

The Nasdaq Stock Market, Inc.
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(in thousands)

 

 

Nine months ended
September 30,

 

 

 

2004

 

2003

 

Reconciliation of net income (loss) to cash provided by operating activities

 

 

 

 

 

Net income (loss)

 

$

3,931

 

$

(84,450

)

Net loss from discontinued operations

 

 

(50,145

)

Net income (loss) from continuing operations

 

$

3,931

 

$

(34,305

)

Non-cash items included in net income (loss):

 

 

 

 

 

Depreciation and amortization

 

54,997

 

69,045

 

Amortization of restricted stock awards

 

409

 

122

 

Provision for bad debts

 

1,321

 

1,584

 

Loss from equity method affiliates

 

 

1,196

 

Deferred taxes

 

19,562

 

(473

)

Elimination of non-core product lines, initiatives and severance

 

 

46,033

 

Nasdaq Japan impairment loss

 

 

(5,000

)

Other non-cash items included in net income

 

2,975

 

9,955

 

Net change in:

 

 

 

 

 

Receivables, net

 

36,167

 

28,996

 

Receivables from related parties

 

8,100

 

4,566

 

Other current assets

 

(4,644

)

(3,487

)

Other assets

 

(394

)

12,244

 

Accounts payable and accrued expenses

 

(4,604

)

(23,429

)

Accrued personnel costs

 

(5,082

)

(11,377

)

Deferred revenue

 

30,375

 

1,806

 

Other accrued liabilities

 

(8,415

)

6,903

 

Obligation under capital leases

 

(1,607

)

(2,633

)

Payables to related parties

 

(13,355

)

(11,954

)

Accrued pension costs

 

(2,646

)

1,640

 

Other liabilities

 

2,334

 

4,927

 

Cash provided by continuing operations

 

119,424

 

96,359

 

Cash used in discontinued operations

 

 

(20,817

)

Cash provided by operating activities

 

119,424

 

75,542

 

Cash flow from investing activities

 

 

 

 

 

Proceeds from redemptions of available-for-sale investments

 

205,985

 

177,391

 

Purchases of available-for-sale investments

 

(213,233

)

(151,712

)

Proceeds from maturities of held-to-maturity investments

 

26,828

 

15,600

 

Purchases of held-to-maturity investments

 

(29,058

)

(15,452

)

Acquisition of Toll

 

(190,000

)

 

Capital contribution to Nasdaq LIFFE joint venture

 

 

(2,500

)

Purchases of property and equipment

 

(13,828

)

(25,638

)

Proceeds from sales of property and equipment

 

247

 

42

 

Cash used in investing activities

 

(213,059

)

(2,269

)

Cash flow from financing activities

 

 

 

 

 

Payments for treasury stock purchases

 

(85

)

(147

)

Decrease in long term debt

 

 

(150,000

)

Issuances of common stock

 

380

 

640

 

Preferred stock dividends

 

(7,350

)

(5,736

)

Contribution to the NASD

 

(253

)

(102

)

Cash used in financing activities

 

(7,308

)

(155,345

)

Decrease in cash and cash equivalents

 

(100,943

)

(82,072

)

Cash and cash equivalents at beginning of period

 

148,929

 

201,463

 

Cash and cash equivalents at end of period

 

$

47,986

 

$

119,391

 

Supplemental Disclosure of Non-Cash Flow Activities

 

 

 

 

 

Cash paid for (received):

 

 

 

 

 

Interest

 

$

8,615

 

$

16,408

 

Income tax refund, net of taxes paid

 

$

(51,517

)

$

(13,084

)

 

See accompanying notes.

3




The Nasdaq Stock Market, Inc.  

Notes to Condensed Consolidated Financial Statements

1.    Organization and Nature of Operations

Nasdaq ® operates The Nasdaq Stock Market ® , the largest electronic screen-based equity securities market in the United States. Nasdaq is a majority-owned subsidiary of the National Association of Securities Dealers, Inc. (the “NASD”). Nasdaq is the parent company of Nasdaq Global Holdings (“Nasdaq Global ® ”); Nasdaq Financial Products Services, Inc. (“Nasdaq Financial Products”); Nasdaq International Market Initiatives, Inc. (“NIMI SM ”); Nasdaq Europe Planning Company, Limited (“Nasdaq Europe Planning ® ”); Nasdaq International, Ltd. (“Nasdaq International SM ”); Nasdaq Canada, Inc. (“Nasdaq Canada ® ”); Nasdaq Technology Services, LLC (“Nasdaq Technology”); and as of September 7, 2004, Toll Associates LLC (“Toll”), collectively referred to as “Nasdaq.” These entities are wholly-owned by Nasdaq. Nasdaq Global, which is incorporated in Switzerland and served as a holding company for several corporations incorporated internationally, will be completely liquidated by the end of 2004. Nasdaq also has determined to dissolve or otherwise wind-down Nasdaq Europe Planning, which was formed to expand Nasdaq into the European community and is currently inactive. NIMI is an entity that employed Nasdaq’s expatriates assigned to Nasdaq’s international subsidiaries. Nasdaq International is a London-based marketing company. Nasdaq Financial Products is the sponsor of the Nasdaq-100 Trust SM . Nasdaq Financial Product Services (Ireland) Limited (“Nasdaq Ireland”) is a wholly-owned subsidiary of Nasdaq Financial Products. Nasdaq Ireland is the manager of The Nasdaq ETF Funds plc. Nasdaq Canada is an extension of Nasdaq’s North American trading platform within Canada, which has received regulatory approval to provide trading access in two provinces, Quebec and British Columbia. Nasdaq Technology is a company established in 2004 to provide software, hosting and disaster recovery services.

On September 7, 2004, Nasdaq completed its acquisition of Toll and affiliated entities from SunGard Data Systems Inc. (“SunGard”). Toll is a holding company that owns a 99.8% interest in Brut, LLC (“Brut”), the owner and operator of the Brut electronic communication network (“ECN”), a broker dealer registered pursuant to the Securities Exchange Act of 1934. Toll also has a 100.0% interest in Brut Inc. (“Brut Inc.”), which owns the remaining 0.2% interest in Brut and serves as its manager pursuant to an operating agreement. Brut also owns Brut Europe Limited (“Brut Europe”), a wholly-owned subsidiary set up to generate a European subscriber base, which is currently inactive.  See “Acquisition of Brut,” of Note 2, “Significant Transactions,” and Note 3, “Acquisition of Brut,” for further discussion.

On October 31, 2003, Quadsan Enterprises, Inc. (“Quadsan”), previously a wholly-owned subsidiary of Nasdaq that provided investment management services to Nasdaq, was merged with and into Nasdaq. Prior to December 18, 2003, Nasdaq owned a 63.0% interest in Nasdaq Europe S.A./N.V. (“Nasdaq Europe SM ”), which had previously operated an equity market licensed in Brussels, Belgium. On December 18, 2003, Nasdaq transferred its interest in Nasdaq Europe to a third party. See “Strategic Review,” of Note 2, “Significant Transactions,” for further discussion.

In 2003, Nasdaq changed its organizational structure from operating in one segment to operating in two segments. Under the new structure, Nasdaq’s Chief Executive Officer has been identified as the Chief Operating Decision Maker as defined by Statement of Financial Accounting Standards (“SFAS”) No. 131, “Disclosures About Segments of an Enterprise and Related Information” (“SFAS 131”). Nasdaq’s two segments are managed and operated as strategic business units and organized by products and services. Reportable segments are Market Services and Issuer Services. In March 2004, Nasdaq rebranded its execution services and trade reporting services—Automated Confirmation Transaction Service SM (“ACT SM ”) as the Nasdaq Market Center SM , which is within the Market Services segment. The Nasdaq Market Center includes Nasdaq’s quoting, trading and trade reporting services for securities listed on

4




Nasdaq and the New York Stock Exchange (“ NYSE”) and American Stock Exchange (“Amex”). Revenues from execution systems previously known as SuperMontage ® and Computer Assisted Execution System SM (“CAES SM ”) and revenues from ACT are included in the Nasdaq Market Center. Beginning with the quarter ended June 30, 2004, revenues from Access Services, Advanced Computer Execution Systems (“ACES”) and Nasdaq InterMarket ( revenues derived from the sale of tape data (Tape Fee revenues) for securities listed on exchanges ) were also included with Nasdaq Market Center revenues as these products and services are considered transaction-based services. In addition, beginning September 7, 2004 with the acquisition of Brut, execution revenues from transactions executed through Brut are included in Nasdaq Market Center revenues. Pursuant to Emerging Issues Task Force (“EITF”) Issue No. 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent,” (“EITF 99-19”) revenues from these transactions are recorded on a gross basis in revenues and expenses such as liquidity rebate payments are recorded in cost of revenues as Brut acts as principal. Nasdaq’s other execution revenues will continue to be reported net of the liquidity rebate as Nasdaq does not act as principal. Also, beginning with the quarter ended June 30, 2004, revenues from Nasdaq’s Level 1 Service, the Nasdaq Quotation Dissemination Service SM (“NQDS SM ”), TotalView SM and Mutual Fund Quotation Service SM (“MFQS SM ”) were rebranded as Nasdaq Market Services Subscriptions revenues as these products and services are considered subscription-based services. Revenues from SuperMontage, CAES, ACT, Access Services and ACES were previously reported as Transaction Services and revenues from Nasdaq InterMarket, Level 1 Service, NQDS, TotalView and MFQS were previously reported as Market Information Services both within the Market Services segment. See Note 10, “Segments,” for further discussion .

All material intercompany accounts and transactions have been eliminated in consolidation. Nasdaq’s financial statements have been prepared in accordance with the rules and regulations of the United States Securities and Exchange Commission (the “SEC”) with respect to the Form 10-Q and reflect all normal recurring adjustments that are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. Pursuant to such rules and regulations, certain footnote disclosures, which are normally required under accounting principles generally accepted in the United States (“GAAP”), have been omitted. It is recommended that these financial statements be read in conjunction with the Consolidated Financial Statements included in Nasdaq’s Annual Report filed on Form 10-K for the year ended December 31, 2003.

The nature of Nasdaq’s business is such that the results of any interim period may vary significantly from quarter to quarter and may not be indicative of the results to be expected for the fiscal year. Certain reclassifications have been made to prior period balances in order to conform to the current period’s presentation.

2.    Significant Transactions

Acquisition of Brut

On September 7, 2004, Nasdaq announced the completion of its acquisition of Brut, the owner of the Brut ECN and affiliated entities, from SunGard for a total consideration of $190.0 million in cash, subject to certain post-closing adjustments. See Note 1 “Organization and Nature of Operations” for further discussion of the entities acquired. Nasdaq financed the purchase from available cash and investments.  As a result of this acquisition, Nasdaq expects that its customers will benefit from enhanced execution quality, additional quote information and a deeper pool of liquidity in Nasdaq-listed securities and securities listed on other exchanges. Nasdaq’s customers also benefit from the ability to access liquidity from multiple destinations outside the Nasdaq Market Center through the use of Brut’s sophisticated order routing technology.

The integration of Brut’s services into Nasdaq is designed to be seamless to both Nasdaq and Brut customers. Brut continues to operate under the Brut name as a broker-dealer; however, it will operate as part of The Nasdaq Stock Market. Brut is subject to the SEC’s Uniform Net Capital Rule (the “Rule”),

5




which requires the maintenance of minimum net capital. Brut has elected to use the basic method permitted by the Rule to determine its net capital, which requires Brut maintain minimum net capital equal to the greater of $100,000 or 6 2 ¤ 3 % of aggregate indebtedness, as defined. The rule also requires that aggregate indebtedness not exceed 15 times net capital. At September 30, 2004, Brut had net capital of $13.1 million, which was $12.2 million in excess of its required net capital of $0.9 million.

In connection with the transaction, Nasdaq and SunGard entered into a hosting and multi-year processing agreement for SunGard to provide real-time securities clearance and settlement system for certain Nasdaq trades. See Note 11, “Commitments and Contingencies,” for further discussion.

Preferred Stock

On February 20, 2002, Nasdaq issued 1,338,402 shares of Series A Cumulative Preferred Stock (face and liquidation value of $100 per share, plus any accumulated unpaid dividends). The NASD owns all of the outstanding shares of Series A Preferred Stock. Dividends payable to the NASD on the Series A Preferred Stock began accruing in March 2003. The Series A Preferred Stock carried a 7.6% dividend rate for the year commencing March 2003 and a 10.6% dividend rate in all years commencing after March 2003, payable at the discretion of Nasdaq’s Board of Directors. On September 30, 2004, the NASD agreed to a waiver of a portion of the dividend for the third quarter of 2004 and accepted an aggregate amount of $1.0 million (calculated based on an annual rate of 3.0%) as payment in full of the dividend for this period. Both parties are currently in discussions on an amendment to the terms of the Series A Preferred Stock.

Real Estate Consolidation

In 2001, Nasdaq signed a lease for expansion space on one of the floors it currently occupies at its One Liberty Plaza headquarters located in New York, which was to commence on October 1, 2004. Nasdaq’s management does not intend to occupy this space and began marketing the expansion space for sublease during the third quarter of 2004. Nasdaq is obligated under the terms of the expansion space lease to pay $33.9 million over the remaining life of the lease and recorded an estimated loss on the sublease of $12.8 million, which is included in General and administrative expenses on the Condensed Consolidated Statements of Income. The estimated loss was calculated using a 7.5% net discount rate and estimated 17-year sublease term commencing in January 2006 at estimated market rates. In addition, Nasdaq expects to record an additional estimated sublease loss reserve of approximately $5.0 million in the fourth quarter of 2004 for the remaining space on one of the floors it currently occupies but intends to vacate.

During 2003, Nasdaq decided to vacate part of the space it occupies in Rockville, Maryland located at 9600 Blackwell and recorded an estimated loss on the sublease of $2.3 million, which was included in general and administrative expenses on the Condensed Consolidated Statements of Income. Nasdaq’s management has re-evaluated its decision to vacate the space at 9600 Blackwell and decided instead to sell the building it owns and occupies in Rockville Maryland located at 9513 Key West Avenue. Based on Nasdaq’s management’s revised decision, Nasdaq released the sublease loss reserve recorded for 9600 Blackwell which totaled $1.9 million, net of rental payments, in September 30, 2004, which is recorded in general and administrative expense on the Condensed Consolidated Statements of Income. Nasdaq expects to begin marketing the 9513 Key West building for sale in the fourth quarter of 2004 and will classify the building as held-for-sale at such time. Accordingly, an estimated loss on the sale of the building of approximately $9.0 million will be recorded in the fourth quarter of 2004 and related depreciation on the building will cease at such time. Nasdaq plans on moving all employees from 9513 Key West Avenue to 9600 Blackwell beginning in the fourth quarter of 2005.

6




In September 2004, Nasdaq also evaluated its real estate needs in Trumbull, Connecticut. Nasdaq currently owns and occupies a building located at 80 Merritt Boulevard and leases and occupies another building located at 35 Nutmeg Drive. Nasdaq’s management determined that based on staff reductions, all employees in Trumbull will consolidate into Nasdaq’s building at 80 Merritt Boulevard. Although Nasdaq’s lease at 35 Nutmeg Drive terminates in July 2008, Nasdaq plans on moving all employees from 35 Nutmeg Drive to 80 Merritt Boulevard by the end of 2005. As a result, Nasdaq expects to record a charge of approximately $2.5 million in the fourth quarter of 2005 when it completely vacates 35 Nutmeg Drive for its remaining lease obligation. In order to accommodate all of the employees in the Merritt building, a data center will be converted into office space. The data center will cease being used by the end of February 2005, and accordingly, Nasdaq began accelerating the data center fixed assets and leasehold improvements over the new estimated useful life. Nasdaq recorded $1.1 million of accelerated depreciation for the data center assets in the three and nine months ending September 30, 2004 and will record an additional $5.5 million between the fourth quarter of 2004 and first quarter of 2005.

Reduction in Force

During the three and nine months ended September 30, 2004, 101 and 146 positions, respectively, were eliminated associated with staff reduction plans and Nasdaq recorded charges of $4.8 million and $7.6 million, respectively, for severance and outplacement costs. Nasdaq paid approximately $1.0 million and $2.3 million during the three and nine months ended September 30, 2004, respectively, for these severance and outplacement costs from the staff reduction plans. Nasdaq expects to pay the remainder of the severance and outplacement costs by the end of the fourth quarter of 2005. Total headcount decreased from 956 employees at December 31, 2003 to 891 employees at September 30, 2004.

Technology Migration

As a result of a continued review of its technology infrastructure, Nasdaq shortened the estimated useful life of certain assets and changed the lease terms on certain operating leases associated with its quoting platform and its trading and quoting network as it migrates to lower cost operating environments which resulted in incremental depreciation and amortization expense. The incremental depreciation and amortization expense associated with these assets and operating leases was $5.6 million and $17.5 million, during the three and nine months ended September 30, 2004, respectively. In the fourth quarter of 2004 Nasdaq expects to incur approximately $8.0 million in additional charges related to its continuing review of technology operations.

Strategic Review

During the second quarter of 2003, Nasdaq announced the results of a strategic review of its operations designed to position Nasdaq for improved profitability and growth. The strategic review included the elimination of non-core products and initiatives and resulted in a reduction in Nasdaq’s workforce. For the three and nine months ended September 30, 2003, a pre-tax charge to earnings of $49.3 million and $109.1 million, respectively, was recorded. The net impact to Nasdaq was a pre-tax charge for the three and nine months ended September 30, 2003 of $49.3 million and $107.1 million, respectively. The difference represented costs absorbed by minority shareholders of Nasdaq Europe. Additional charges were recorded in the fourth quarter of 2003 marking the completion of the charges associated with Nasdaq’s strategic review. The charges of $49.3 million and $109.1 million for the three and nine months ended September 30, 2003, respectively, included $23.8 million and $69.5 million, respectively, from continuing operations and $25.5 million and $39.6 million, respectively, from discontinued operations related to Nasdaq Europe and IndigoMarkets Ltd. (“IndigoMarkets”). See Note 4, “Discontinued Operations,” for further discussion . The charge was primarily recorded to Property and equipment,

7




Goodwill, Other intangible assets, Other accrued liabilities and Accrued personnel costs on the Condensed Consolidated Balance Sheets.

The following table summarizes the strategic review charges included in the Condensed Consolidated Statements of Income:

 

 

 

Three months ended
September 30, 2003

 

Nine months ended
September 30, 2003

 

 

 

(in millions)

 

Continuing Operations

 

 

 

 

 

 

 

 

 

Non-Core Product Lines and Initiatives :

 

 

 

 

 

 

 

 

 

Impairment of capitalized software and fixed assets

 

 

$

 

 

 

$

7.8

 

 

Impairment of goodwill and intangible assets

 

 

1.1

 

 

 

7.1

 

 

Contract cancellations

 

 

 

 

 

2.0

 

 

Other exit costs

 

 

0.8

 

 

 

10.0

 

 

Total non-core product lines and initiatives

 

 

1.9

 

 

 

26.9

 

 

Severance and benefit costs

 

 

8.7

 

 

 

29.4

 

 

Loss on early extinguishment of debt

 

 

13.2

 

 

 

13.2

 

 

Total continuing operations strategic review charge

 

 

$

23.8

 

 

 

$

69.5

 

 

Discontinued Operations

 

 

 

 

 

 

 

 

 

Nasdaq Europe :

 

 

 

 

 

 

 

 

 

Impairment of technology platform

 

 

$

25.4

 

 

 

$

25.4

 

 

Severance and benefit costs

 

 

 

 

 

1.8

 

 

Impairment of goodwill

 

 

 

 

 

8.1

 

 

Other exit costs including contract cancellations

 

 

0.7

 

 

 

4.9

 

 

Total Nasdaq Europe

 

 

26.1

 

 

 

40.2

 

 

Gain on disposition of IndigoMarkets

 

 

(0.6

)

 

 

(0.6

)

 

Total discontinued operations strategic review charge

 

 

$

25.5

 

 

 

$

39.6

 

 

Total strategic review charge

 

 

$

49.3

 

 

 

$

109.1

 

 

 

Continuing Operations

Non-core product lines and initiatives included in the strategic review were:

·                     Primex —Primex was an electronic auction system. Nasdaq ended its exclusive rights agreement with Primex Trading N.A., L.L.C. on December 31, 2003 and ceased offering Primex effective January 16, 2004. A charge was recorded for Primex in the fourth quarter of 2003.

·                     Nasdaq Tools —Nasdaq Tools was an order management system that ran on the Nasdaq Application Programming Interface using the Nasdaq Workstation II ® and was wound-down throughout 2003. Nasdaq Tools was a previously wholly-owned subsidiary of Nasdaq and was merged with and into Nasdaq on July 31, 2002.

·                     Nasdaq LIFFE Markets, LLC (“NQLX”) —NQLX was a joint venture with the London International Financial Futures Exchange (“LIFFE”) to create a market for single stock futures and other futures products. On July 24, 2003, Nasdaq redeemed its interest in the NQLX joint venture and transferred its ownership interest to LIFFE. LIFFE assumed financial and management responsibility for NQLX. This change did not have any impact on the operation of NQLX, but usage of the Nasdaq brand by the company ceased.

·                     The Bulletin Board Exchange (“BBX”) —BBX was a proposed platform for companies not eligible for The Nasdaq SmallCap Market SM to raise equity capital and increase the visibility of their stock. The Over the Counter Bulletin Board ® (“OTCBB”) continues its existing operations.

8




·                     Liquidity Tracker —Liquidity Tracker was an automated order routing system designed to allow traders to direct orders to specific market makers based on recent trading activity. Liquidity Tracker ceased operations as of June 30, 2003.

·                     MarketSite ® Tower —MarketSite Tower is located at Nasdaq’s Times Square, New York location. The video wall portion of the Tower was deemed impaired and a corresponding charge was recorded in the fourth quarter of 2003.

The charge related to the elimination of the above non-core products and initiatives was approximately $1.9 million and $26.9 million for the three and nine months ended September 30, 2003. The $1.9 million charge in the third quarter of 2003 primarily represented impairment of certain intangibles. Included in the charge for the nine months ended September 30, 2003, was the reduction of Nasdaq’s investment in NQLX of $6.3 million due to the redemption of Nasdaq’s interest in the NQLX joint venture, the impairment of goodwill of $4.1 million associated with Nasdaq Tools, the impairment of certain intangible assets of $3.0 million, impairment of various capitalized software and fixed assets of $7.8 million, contract cancellations of $2.0 million and other costs of $3.7 million.

In addition, the charges from continuing operations recorded in the three and nine months ended September 30, 2003 included severance costs of $8.7 million and $29.4 million, respectively, and the loss on early extinguishment of long-term debt of $13.2 million recorded in the three months ended September 30, 2003. The severance costs included $6.9 million and $11.2 million for the three and nine months ended September 30, 2003, respectively, related to the reductions in force of 100 and 210 employees, respectively. The remaining $1.8 million and $18.2 million of severance costs for the three and nine months ended September 30, 2003, respectively, related to the fulfillment of employment contracts and obligations associated with the retirement and departure of certain members of senior management. Total headcount was 1,004 as of September 30, 2003 versus 1,227 as of December 31, 2002. Nasdaq recorded additional severance costs in the fourth quarter of 2003 as a part of the strategic review. The extinguishment of debt costs relate to the redemption of $150.0 million in aggregate principal amount of Nasdaq’s 5.83% Senior Notes due 2007 (the “Senior Notes”). In conjunction with its strategic review, Nasdaq reassessed its capital needs and determined that it no longer needed the liquidity of the Senior Notes. See Long-term debt section below for further discussion.

The following table summarizes the strategic review accrual activity from December 31, 2003 through September 30, 2004. These accruals are recorded in Other accrued liabilities and Accrued personnel costs in the Current liabilities section and in Other liabilities in the Non-current liabilities section of the Condensed Consolidated Balance Sheets. Nasdaq expects to fund the majority of these reserves by the end of 2004, except for a $4.6 million contract payment that is due January 2006.

 

 

 

Severance for
U.S. Employees

 

Products
&
Other

 

Total

 

 

 

(in millions)

 

Accrued liabilities associated with the strategic review as of December 31, 2003

 

 

$

16.4

 

 

 

$

10.7

 

 

$

27.1

 

Cash payments

 

 

(8.7

)

 

 

(9.3

)

 

(18.0

)

Accrued liabilities associated with the strategic review as of September 30, 2004

 

 

$

7.7

 

 

 

$

1.4

 

 

$

9.1

 

 

9




Discontinued Operations

Discontinued operations included in the strategic review were:

·                     Nasdaq Europe —Nasdaq Europe was a pan-European stock market licensed in Belgium. See below for complete discussion of the wind-down and eventual transfer of shares of Nasdaq Europe.

·                     IndigoMarkets —IndigoMarkets was a joint venture with SSI Limited (“SSI”) to develop international trading platforms. On September 30, 2003, Nasdaq Global sold its interest in the joint venture to SSI and recognized a gain on the sale of approximately $0.6 million.

Europe

As a result of the strategic review, Nasdaq supported the closing of the market operated by Nasdaq Europe, in which Nasdaq owned a 63.0% interest through December 18, 2003. At an Extraordinary General Meeting held on June 26, 2003, the shareholders of Nasdaq Europe voted to discontinue operations of the market and, as a result, market operations were wound-down pursuant to a Transition Plan approved by the Belgian Banking and Finance Commission. During the third quarter of 2003, the losses incurred by Nasdaq Europe exceeded the minority shareholders’ interests. Therefore, once the minority shareholders reached this point, Nasdaq absorbed 100.0% of Nasdaq Europe’s losses and strategic review charges.

As Nasdaq Europe was winding-down its market operations, Nasdaq reached an agreement to transfer all of Nasdaq’s shares in Nasdaq Europe to one of that company’s original investors; the cash consideration for the transaction was nominal. The transfer of Nasdaq’s shares of Nasdaq Europe was completed on December 18, 2003. The entity ceased using the Nasdaq Europe name after the transaction. As part of the transaction, Nasdaq Europe’s new owner committed to seek to restructure that company’s obligations and, in that context, to request from certain major creditors releases of any claims they might have against Nasdaq Europe’s former directors, officers and shareholders (if such claims are related to Nasdaq’s prior ownership interest in Nasdaq Europe).

At the time of the transfer, Nasdaq Europe had approximately $15 million of external debt, accrued interest and other liabilities. Nasdaq has recorded liabilities of approximately $15 million that management continues to believe are sufficient to satisfy any potential claims against Nasdaq. Nasdaq and Nasdaq Europe, now known as Easdaq SA/NV (“Easdaq”), entered into an agreement dated as of October 27, 2004, providing in relevant part that Easdaq is to reach agreements with certain of its creditors to settle these creditors’ existing claims against Easdaq. Nasdaq will be a third party beneficiary of these creditor agreements and expects to be able to release the $15 million reserve it currently maintains in connection with such claims and liabilities.

Also, as part of Nasdaq’s strategic review, during the third quarter of 2003, Nasdaq supported Nasdaq Europe’s position in favor of the decision of the shareholders of Nasdaq Deutschland AG (“Nasdaq Deutschland”), a German exchange in which Nasdaq Europe had a 50.0% interest, to suspend that company’s trading operations effective August 29, 2003. Nasdaq Europe transferred all of its shares in Nasdaq Deutschland to one of the other shareholders, BWB Holding AG, as of August 29, 2003.

The charges related to the orderly wind-down and liquidation of market operations in Belgium and Germany were approximately $26.1 million and $40.2 million (excluding the minority interest benefit of $2.0 million) for the three and nine months ended September 30, 2003, respectively. The $26.1 million charge for the three months ended September 30, 2003 primarily represented the $25.4 million impairment of certain technology platforms held for sale and owned by Nasdaq Europe. The $40.2 million charge for the nine months ended September 30, 2003, included the $25.4 million impairment of the technology platforms, the impairment of goodwill of $8.1 million, severance costs of $1.8 million and other costs including contract cancellations of $4.9 million.

10




In October 2002, Nasdaq Europe’s strategic investors committed to converting the majority of Nasdaq Europe’s external debt to equity. The conversion was formally approved by Nasdaq Europe’s Board of Directors in March 2003. On May 26, 2003 the strategic investors converted approximately $17.9 million or 63.3% of Nasdaq Europe’s external debt to equity ($51.5 million or 83.2% including intercompany debt with Nasdaq). After the conversion, Nasdaq had a 63.0% ownership interest in Nasdaq Europe.

Long-term Debt

On September 30, 2003, Nasdaq redeemed $150.0 million of its Senior Notes. In conjunction with its strategic review, Nasdaq reassessed its capital needs and determined that it no longer needed the liquidity of the Senior Notes. Nasdaq paid the holders of the Senior Notes $150.0 million in outstanding principal amount, accrued interest of $1.2 million and an aggregate make-whole payment of approximately $12.6 million (representing the net present value of future payments). The repayment amounts reflected the terms of the Senior Notes, except that the parties agreed to a reduced make-whole amount equal to the excess of the discounted value of the remaining scheduled payments discounted at a factor equal to 100 basis points over the yield to maturity of United States Treasury securities having a maturity equal to the remaining average life of the redeemed amount. This represented a renegotiation of the 50 basis points over the yield to maturity required by the terms of the Senior Notes. Nasdaq recorded a $13.2 million pre-tax charge in the third quarter of 2003 related to the redemption of the Senior Notes. This charge included the make-whole payment and capitalized costs related to the issuance of the Senior Notes. Nasdaq used funds from available cash and investments to finance the redemption.

Nasdaq Member Revenue Sharing

In August 2003, Nasdaq implemented the Nasdaq General Revenue Sharing Program, which like the General Revenue Sharing Program of The National Stock Exchange, a regional stock exchange, shares operating revenue from multiple business lines in addition to Tape Fee revenue. The new discretionary program shares operating revenue, which is interpreted to mean net revenue after expenses from all services that derive revenue from member trading and trade-reporting activity in Nasdaq-listed securities. As such, the program is designed to provide an incentive for quoting market participants to send orders and report trades to the Nasdaq Market Center. Nasdaq did not share any revenues during 2003 under the General Revenue Sharing Program. For the three and nine months ended September 30, 2004, Nasdaq shared approximately $5.1 million and $16.0 million, respectively, under this new program which is shown net within Market Services revenues. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” Market Services, for further discussion.

Nasdaq Japan

During the second quarter of 2002, Nasdaq recognized an other-than-temporary impairment charge on its equity investment in Nasdaq Japan ® . Nasdaq recognized this impairment as a result of the depressed level of market activity in Japan, combined with the suspension of Nasdaq Japan’s hybrid trading system due to the inability to gain exchange approval of market rules and industry participation. The net impact of the other-than-temporary impairment on Nasdaq’s pre-tax income was $15.2 million.

On August 16, 2002, the Board of Directors of Nasdaq Japan voted to take the company to dormant status, effectively ceasing operations. Nasdaq Japan entered into liquidation status in late November 2002 and was completely dissolved by the end of May 2003. During the second quarter of 2003, Nasdaq reversed $5.0 million of the reserves related to Nasdaq Japan due to favorable contract negotiations and lower legal costs resulting from the complete liquidation of Nasdaq Japan.

11




3.    Acquisition of Brut

As previously discussed, on September 7, 2004 (See “Acquisition of Brut,” of Note 2, “Significant Transactions”), Nasdaq announced the completion of its acquisition of Brut and related entities, including Toll, from SunGard for a total consideration of $190.0 million in cash, subject to certain post-closing adjustments. In addition, Nasdaq incurred direct costs of $3.3 million associated with the acquisition. Brut and related affiliated are included within the Market Services segment.

Nasdaq had not finalized the allocation of the purchase price as of September 30, 2004. Nasdaq expects future adjustments related to taxes and settlement of post-closing adjustments. An estimation of the purchase price allocation was prepared and included as part of these financial statements. The purchase price has been allocated as follows: $6.3 million to net assets, $42.0 million to identifiable intangible assets, and $141.7 million to goodwill.

The following table presents details of the identifiable intangible assets acquired in the Brut acquisition:

 

 

 

Amount

 

Estimated Average 
Useful Life

 

 

 

(in millions)

 

(in years)

 

Identifiable intangible assets

 

 

 

 

 

 

 

 

 

Technology

 

 

$

15.7

 

 

 

10.0

 

 

Customer relationships

 

 

26.3

 

 

 

10.0

 

 

Total

 

 

$

42.0

 

 

 

 

 

 

 

The unaudited pro forma combined historical results for the three and nine months ended September 30, 2004 and 2003, as if Nasdaq had acquired Toll and related entities at the beginning of fiscal 2004 and 2003, are estimated to be:

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

(in millions, except per share amounts)

 

Revenues

 

$

136.7

 

$

178.3

 

$

481.2

 

$

537.5

 

Gross margin

 

119.4

 

147.8

 

380.9

 

465.0

 

Net (loss) income

 

(5.4

)

(7.4

)

5.5

 

(37.0

)

Basic and diluted loss per share

 

$

(0.08

)

$

(0.13

)

$

(0.02

)

$

(0.55

)

 

The pro forma results include amortization of the intangibles presented above and the elimination of intercompany transactions had Nasdaq and Toll acted as a combined company. The pro forma results are not necessarily indicative of what actually would have occurred if the acquisition had been completed as of the beginning of each fiscal period presented, nor are they necessarily indicative of future consolidated results. Nasdaq does not expect future adjustments to the purchase price within the next year to be significant.

Brut results are included as of September 7, 2004 in the Condensed Consolidated Statements of Income.

4.    Discontinued Operations

On September 30, 2003, Nasdaq Global sold its interest in IndigoMarkets to its partner, SSI, and recognized a gain of approximately $0.6 million on the sale. In addition, on December 18, 2003, Nasdaq transferred its interest in Nasdaq Europe to one of that company’s original investors for nominal cash consideration . See “Strategic Review,” of Note 2, “Significant Transactions,” for further discussion.

12




In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets” (“SFAS 144”), both Nasdaq Europe and IndigoMarkets are reflected as discontinued operations for the three and nine months ended September 30, 2003. As discontinued operations, the revenues, costs and expenses and cash flows of Nasdaq Europe and IndigoMarkets have been excluded from the respective captions in the Condensed Consolidated Statements of Income and Condensed Consolidated Statements of Cash Flows, and have been presented separately as “Loss from discontinued operations” and as “Cash used in discontinued operations,” respectively. There were no assets and liabilities of Nasdaq Europe and IndigoMarkets at December 31, 2003.

The following table presents condensed, combined results of operations for Nasdaq Europe and IndigoMarkets:

 

 

 

Three months ended
September 30, 2003

 

Nine months ended
September 30, 2003

 

 

 

(in millions)

 

Revenues

 

 

$

2.9

 

 

 

$

10.2

 

 

Pre-tax loss

 

 

(30.5

)

 

 

(51.4

)

 

Benefit for income taxes

 

 

0.2

 

 

 

1.2

 

 

Loss from discontinued operations

 

 

$

(30.3

)

 

 

$

(50.2

)

 

 

The remainder of the notes to the condensed consolidated financial statements reflects results from continuing operations, unless otherwise noted.

5.    Deferred Revenue

Nasdaq’s deferred revenue as of September 30, 2004 related to Corporate Client Group fees will be recognized in the following years:

 

 

 

Initial

 

LAS

 

Annual and 
Other

 

Total

 

 

 

(in thousands)

 

Fiscal year ended:

 

 

 

 

 

 

 

 

 

 

 

2004

 

$

7,616

 

$

8,906

 

 

$

23,195

 

 

$

39,717

 

2005

 

26,098

 

30,364

 

 

 

 

56,462

 

2006

 

15,906

 

20,007

 

 

 

 

35,913

 

2007

 

10,883

 

13,736

 

 

 

 

24,619

 

2008 and thereafter

 

14,388

 

3,718

 

 

 

 

18,106

 

 

 

$

74,891

 

$

76,731

 

 

$

23,195

 

 

$

174,817

 

 

Nasdaq’s deferred revenue for the nine months ended September 30, 2004 and 2003 is reflected in the following tables. The additions reflect Corporate Client Group revenues charged during the period while the amortization reflects Corporate Client Group revenues recognized during the period in accordance with GAAP. Nasdaq recognizes revenue related to Initial listing fees and Listing of additional shares (“LAS”) fees on a straight-line basis over estimated service periods, which are six and four years, respectively.

 

 

 

Initial

 

LAS

 

Annual and 
Other

 

Total

 

 

 

(in thousands)

 

Balance at January 1, 2004

 

$

78,485

 

$

65,957

 

 

$

 

 

$

144,442

 

Additions

 

19,727

 

38,401

 

 

95,214

 

 

153,342

 

Amortization

 

(23,321

)

(27,627

)

 

(72,019

)

 

(122,967

)

Balance at September 30, 2004

 

$

74,891

 

$

76,731

 

 

$

23,195

 

 

$

174,817

 

 

13




 

 

 

 

Initial

 

LAS

 

Annual and 
Other

 

Total

 

 

 

(in thousands)

 

Balance at January 1, 2003

 

$

93,857

 

$

72,841

 

 

$

 

 

$

166,698

 

Additions

 

10,601

 

19,879

 

 

96,396

 

 

126,876

 

Amortization

 

(24,312

)

(27,847

)

 

(72,911

)

 

(125,070

)

Balance at September 30, 2003

 

$

80,146

 

$

64,873

 

 

$

23,485

 

 

$

168,504

 

 

6.    Long-term Debt

Nasdaq had $265.0 million of outstanding long-term debt ($25.0 million of senior notes and $240.0 million of subordinated notes) at September 30, 2004. Debt is scheduled to begin to mature in May 2006.

Long-term subordinated notes represent $240.0 million of 4.0% convertible subordinated notes due 2006 (the “Subordinated Notes”) issued and sold to Hellman & Friedman Capital Partners IV, L.P. and certain of its affiliated limited partnerships (collectively, “Hellman & Friedman”) during 2001. The annual 4.0% coupon is payable quarterly in arrears in cash and the Subordinated Notes are convertible at any time into an aggregate of 12.0 million shares of Common Stock at $20.00 per share, subject to adjustment, in general, for any stock split, dividend, combination, recapitalization or other similar event. On an as-converted basis as of September 30, 2004, Hellman & Friedman owned an approximate 13.8% equity interest in Nasdaq as a result of its ownership of the Subordinated Notes and 500,000 shares of Common Stock.

On September 30, 2003, Nasdaq redeemed the $150.0 million outstanding principal amount of the Senior Notes. Under the terms of the Senior Notes, Nasdaq paid the holders of the Senior Notes $150.0 million in outstanding principal amount, accrued interest of $1.2 million and an aggregate make-whole payment of approximately $12.6 million (representing the net present value of future payments). Nasdaq recorded a $13.2 million pre-tax charge in the third quarter of 2003 related to the redemption of the Senior Notes. This charge included the make-whole payment and capitalized costs related to the issuance of the Senior Notes. Nasdaq used funds from available cash and investments to finance the redemption. See “Long-term Debt” of Note 2, “Significant Transactions,” for further discussion.

7.    Employee Benefits

Nasdaq is a participating employer in a noncontributory, defined-benefit pension plan that the NASD sponsors for the benefit of its eligible employees and the eligible employees of its subsidiaries. As of January 1, 2004, the benefits are primarily based on years of service and the employees’ career-average salary during employment, subject to a phase-in period. Prior to 2004, the benefits were primarily based on years of service and the employees’ average salary during the highest 60 consecutive months of employment.

Until November 1, 2003, Nasdaq participated in a Supplemental Executive Retirement Plan (“SERP”) that was maintained by the NASD for certain senior executives. On November 1, 2003, Nasdaq formed its own SERP and transferred all amounts to this new plan. Also during 2003, Nasdaq changed the accrual of benefits from age 65 to the later of age 55 or 10 years of service, except in the case of an executive who has a contract with a SERP provision, then benefits are accrued in accordance with the contract terms.

14




The following table sets forth the combined plans’ amounts recognized in the Condensed Consolidated Statements of Income recorded in compensation and benefits expense:

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2004

 

2003 (1)

 

2004

 

2003 (1)

 

 

 

(in thousands)

 

Components of net periodic benefit cost

 

 

 

 

 

 

 

 

 

Service cost

 

$

1,567

 

$

2,456

 

$

4,759

 

$

8,224

 

Interest cost

 

1,115

 

1,122

 

3,384

 

4,041

 

Expected return on plan assets

 

(751

)

(746

)

(2,255

)

(2,236

)

Recognized net actuarial loss

 

291

 

130

 

873

 

990

 

Prior service cost recognized

 

(84

)

67

 

(234

)

5,069

 

Amortization of unrecognized transition asset

 

(15

)

(14

)

(43

)

(43

)

Settlement loss recognized

 

54

 

928

 

235

 

2,415

 

Benefit cost

 

$

2,177

 

$

3,943

 

$

6,719

 

$

18,460

 

 

 


(1)              Includes strategic review amounts related to the fulfillment of employment SERP contracts and obligations associated with the retirement and departure of certain members of senior management. See “Strategic Review,” of Note 2, “Significant Transactions,” for further discussion.

Nasdaq previously disclosed in its financial statements for the year ended December 31, 2003, that it expected to contribute $10.6 million to the pension plan in 2004 for the 2003 and 2004 plan years. In June 2004, Nasdaq contributed $6.0 million to fund its plan for the 2003 plan year. As a result of the passage of the Pension Funding Equity Act of 2004, signed into law on April 10, 2004, Nasdaq is now exempt from required quarterly contributions for the 2004 plan year and will fund the 2004 plan year in 2005.

8.    Stock-Based Compensation

In the first quarter of 2003, Nasdaq adopted SFAS No. 148 “Accounting for Stock-Based Compensation—Transition and Disclosure” (“SFAS 148”). SFAS 148 amends the disclosure requirements of SFAS No. 123 “Accounting for Stock-Based Compensation” (“SFAS 123”) and requires disclosure in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results.

Nasdaq grants stock options with an exercise price equal to the estimated fair value of the Common Stock on the date of the grant. Nasdaq accounts for stock options in accordance with Accounting Principles Board Opinion No. 25 “Accounting for Stock Issued to Employees” (“APB 25”) and accordingly recognizes no compensation expense related to such grants.

15




Pro forma information regarding net income and earnings per share is required under SFAS 148 and has been determined as if Nasdaq had accounted for all stock options based on a fair value method. The fair value of each stock option grant was estimated at the date of grant using the Black-Scholes valuation model. Pro forma net income includes the amortization of the fair value of stock options over the vesting period. The pro forma information for the three and nine months ended September 30, 2004 and 2003 is as follows:

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

(in thousands, except per share amounts)

 

Reported net (loss) income from continuing operations

 

$

(5,485

)

$

(7,743

)

$

3,931

 

$

(34,305

)

Stock-based compensation cost (net of tax of $643, $2,163, $1,803 and $5,388, respectively)

 

(997

)

(3,351

)

(2,794

)

(8,348

)

Pro forma net (loss) income

 

$

(6,482

)

$

(11,094

)

$

1,137

 

$

(42,653

)

Reported basic and diluted loss per share

 

$

(0.08

)

$

(0.13

)

$

(0.04

)

$

(0.51

)

Pro forma basic and diluted loss per share

 

$

(0.10

)

$

(0.17

)

$

(0.08

)

$

(0.62

)

 

9.    Comprehensive Income

Comprehensive income is calculated in accordance with SFAS No. 130, “Reporting Comprehensive Income.”  Comprehensive income is composed of net (loss) income and other comprehensive (loss) income, which includes the after-tax change in unrealized gains and losses on available-for-sale securities, minimum pension liability and foreign currency translation adjustments.

The following table outlines the changes in other comprehensive income for the three and nine months ended September 30, 2004 and 2003:

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

(in thousands)

 

Net (loss) income

 

$

(5,485

)

$

(7,743

)

$

3,931

 

$

(34,305

)

Unrealized gains (losses) on available-for-sale securities

 

984

 

(1,111

)

(720

)

(549

)

Foreign currency translation adjustment

 

68

 

(2,776

)

41

 

1,268

 

Total comprehensive (loss) income

 

$

(4,433

)

$

(11,630

)

$

3,252

 

$

(33,586

)

 

10.    Segments

In 2003, Nasdaq changed its organizational structure from operating under one segment to operating under two segments. Under the new structure, Nasdaq’s Chief Executive Officer has been identified as the Chief Operating Decision Maker as defined by SFAS 131. Nasdaq’s two segments are managed and operated as strategic business units and organized by products and services. Reportable segments are Market Services and Issuer Services.

Market Services includes collecting, processing and disseminating price quotes of Nasdaq-listed securities, the routing and execution of buy and sell orders for Nasdaq-listed and exchange-listed securities and transaction reporting services. Market Services also provides price quotes and trade information to data vendors, who in turn sell the information to the public. Market participants in The Nasdaq Stock Market, consisting of market makers, ECNs, registered stock exchanges and order entry firms, are users of Nasdaq’s Market Services. In March 2004, Nasdaq rebranded its execution services and ACT services as the Nasdaq Market Center, which is within the Market Services segment. The Nasdaq Market Center

16




includes Nasdaq’s quoting, trading and trade reporting services for securities listed on Nasdaq and the NYSE and Amex. Revenues from execution systems previously known as SuperMontage and CAES and revenues from ACT are included in the Nasdaq Market Center. Beginning with the quarter ended June 30, 2004 revenues from Access Services, ACES and Nasdaq InterMarket ( revenues derived from the sale of tape data for securities listed on exchanges ) were also included with Nasdaq Market Center revenues as these products and services are considered transaction-based services. In addition, beginning September 7, 2004 with the acquisition of Brut, execution revenues from transactions executed through Brut are included in Nasdaq Market Center revenues. Pursuant to EITF 99-19, revenues from these transactions are recorded on a gross basis in revenues and expenses such as liquidity rebate payments are recorded in cost of revenues as Brut acts as principal. Nasdaq’s other execution revenues will continue to be reported net of the liquidity rebate as Nasdaq does not act as principal. Also, beginning with the quarter ended June 30, 2004, revenues from Nasdaq’s Level 1 Service, NQDS, TotalView and MFQS were rebranded as Nasdaq Market Services Subscriptions revenues as these products and services are considered subscription-based services. Revenues from SuperMontage, CAES, ACT, Access Services and ACES were previously reported as Transaction Services and revenues from Nasdaq InterMarket, Level 1 Service, NQDS, TotalView and MFQS were previously reported as Market Information Services both within the Market Services segment.

Issuer Services includes the Corporate Client Group and Nasdaq Financial Products. The Corporate Client Group provides customer services and information products to Nasdaq-listed companies and is responsible for obtaining new listings on The Nasdaq Stock Market. Nasdaq Financial Products is responsible for introducing products that extend and enhance the Nasdaq brand. Nasdaq Financial Products oversees the development and marketing of new Nasdaq financial products and associated derivatives, the licensing and listing of third-party structured products and the listing of third-party sponsored exchange traded funds.

Nasdaq evaluates the performance of its segments based on several factors, of which the primary financial measure is pre-tax income. Results of individual businesses are presented based on Nasdaq’s management accounting practices and Nasdaq’s current management structure. Certain charges are allocated to corporate items in Nasdaq’s management reports based on the decision that those activities should not be used to evaluate the segment’s operating performance. These charges primarily include all activities and exit costs related to elimination of Nasdaq’s non-core products and other initiatives as well as Nasdaq Japan.

17




The following tables present certain information regarding these operating segments for each of the three and nine months then ended September 30, 2004 and 2003:

 

 

 

Market
Services

 

Issuer
Services

 

Corporate Items
and Eliminations

 

Consolidated

 

 

 

(in thousands)

 

Three months ended September 30, 2004

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

73,304

 

$

50,646

 

 

$

20

 

 

 

$

123,970

 

 

Cost of revenues

 

(9,177

)

 

 

 

 

 

(9,177

)

 

Gross margin

 

64,127

 

50,646

 

 

20

 

 

 

114,793

 

 

Pre-tax (loss) income

 

(24,502

)

15,590

 

 

(1,408

)

 

 

(10,320

)

 

Three months ended September 30, 2003

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

89,687

 

$

50,484

 

 

$

1,729

 

 

 

$

141,900

 

 

Pre-tax (loss) income

 

(6,576

)

19,208

 

 

(28,133

)

 

 

(15,501

)

 

Nine months ended September 30, 2004

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

218,361

 

$

153,935

 

 

$

91

 

 

 

$

372,387

 

 

Cost of revenues

 

(9,177

)

 

 

 

 

 

(9,177

)

 

Gross margin

 

209,184

 

153,935

 

 

91

 

 

 

363,210

 

 

Pre-tax (loss) income

 

(47,309

)

55,419

 

 

(3,944

)

 

 

4,166

 

 

Nine months ended September 30, 2003

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

297,374

 

$

152,571

 

 

$

1,890

 

 

 

$

451,835

 

 

Pre-tax income (loss)

 

586

 

41,872

 

 

(94,895

)

 

 

(52,437

)

 

 

11.    Commitments and Contingencies

Brut Agreements

Brut contracted with a subsidiary of SunGard, SunGard Financial Systems Inc. (“SunGard Financial”), for SunGard Financial to provide Brut on-line processing, report services and related services in connection with the clearance of trades. The term of the agreement is five years and is automatically renewed at yearly intervals thereafter until terminated by Brut or SunGard Financial. The annual service fee is $10.0 million in the first year, dropping to $8.0 million in the second year and $6.0 million in the third year of the agreement. The annual service fee is subject to price review in years four and five based market rates, but will not be less than $4.0 million per year. Some additional fees may be assessed based on services needed or requested.

Nasdaq Europe

As a result of the transfer of Nasdaq’s shares of Nasdaq Europe, Nasdaq Europe’s new owner committed to seek to restructure that company’s obligations and, in that context, to request from certain major creditors releases of any claims they might have against Nasdaq Europe’s former directors, officers and shareholders (if such claims are related to Nasdaq’s prior ownership interest in Nasdaq Europe). At the time of the transfer, Nasdaq Europe had approximately $15 million of external debt, accrued interest and other liabilities. Nasdaq has recorded liabilities of approximately $15 million that management continues to believe are sufficient to satisfy any potential claims against Nasdaq. Nasdaq and Nasdaq Europe, now known as Easdaq SA/NV (“Easdaq”), entered into an agreement dated as of October 27, 2004, providing in relevant part that Easdaq is to reach agreements with certain of its creditors to settle these creditors’ existing claims against Easdaq. Nasdaq will be a third party beneficiary of these creditor agreements and expects to be able to release the $15 million reserve it currently maintains in connection with such claims and liabilities.

18




Nasdaq Insurance Agency

In December 2002, Nasdaq purchased the NASD’s 50.0% interest in the NASD Insurance Agency (subsequently renamed the Nasdaq Insurance Agency, LLC (“NIA”)). Nasdaq’s consideration for the NASD’s 50.0% interest consisted of an upfront payment of $0.5 million and up to $5.1 million based on NIA’s stream of contingent cash flow through 2011. Nasdaq will pay the NASD up to: (a) 20% of NIA’s cash flows until Nasdaq has paid the NASD $2.3 million from cash flows; (b) 10% of NIA’s cash flows until Nasdaq has paid the NASD a cumulative amount of $3.0 million from cash flows; (c) 5% of NIA’s cash flows until the earlier to occur of Nasdaq paying the NASD the full cumulative amount of $5.1 million from cash flows or December 31, 2011. As of September 30, 2004, Nasdaq recorded a $0.40 million dividend to the NASD for the NIA’s cash flows. The dividend was reflected as a reduction in Additional paid-in capital on Nasdaq’s Condensed Consolidated Balance Sheets.

MCI

On January 30, 2004, Nasdaq and MCI WorldCom Communications, Inc., formerly, WorldCom, Inc., (“MCI”) entered into a global services agreement, effective May 31, 2004 (the “GSA”), related to the data network that connects Nasdaq’s market facilities to market participants. The GSA terminated the prior agreement between the two parties. The GSA, which expires on December 31, 2005, requires usage charges for certain GSA services to be at least $20.0 million during the period from June 1, 2004 to December 31, 2004 and $20.0 million in 2005.

General Litigation

Nasdaq may be subject to claims arising out of the conduct of its business. Currently, there are certain legal proceedings pending against Nasdaq. Nasdaq believes, based upon the opinion of counsel, that any liabilities or settlements arising from these proceedings will not have a material effect on the financial position or results of operations of Nasdaq. Management is not aware of any unasserted claims or assessments that would have a material adverse effect on the financial position and the results of operations of Nasdaq.

19




12.    Capital Stock and Earnings Per Share

The following table sets forth the computation of basic and diluted earnings per share:

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

2004

 

2003

 

2004

 

2003

 

 

 

(in thousands, except per share amounts)

 

Numerator:

 

 

 

 

 

 

 

 

 

Net loss applicable to common stockholders:

 

 

 

 

 

 

 

 

 

Net (loss) income

 

$

(5,485

)

$

(38,008

)

$

3,931

 

$

(84,450

)

Loss from discontinued operations

 

 

(30,265

)

 

(50,145

)

Net (loss) income from continuing operations

 

(5,485

)

(7,743

)

3,931

 

(34,305

)

Preferred stock dividends declared (1)

 

(1,004

)

(2,542

)

(7,350

)

(5,736

)

Net loss applicable to common stockholders from continuing operations for basic and diluted earnings per share

 

(6,489

)

(10,285

)

(3,419

)

$

(40,041

)

Loss from discontinued operations for basic and diluted earnings per share  

 

 

(30,265

)

 

(50,145

)

Net loss available to common stockholders for basic and diluted earnings per share

 

$

(6,489

)

$

(40,550

)

$

(3,419

)

$

(90,186

)

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average common shares for basic and diluted earnings per share  

 

78,618,389

 

78,431,581

 

78,551,705

 

78,360,187

 

Basic and diluted net loss per share:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

(0.08

)

$

(0.13

)

$

(0.04

)

$

(0.51

)

Discontinued operations

 

 

(0.39

)

 

(0.64

)

Total basic and diluted net loss per share

 

$

(0.08

)

$

(0.52

)

$

(0.04

)

$

(1.15

)

 


(1)     Dividends payable to the NASD as a holder of Nasdaq’s Series A Preferred Stock began accruing in March 2003. The Series A Preferred Stock carried a 7.6% dividend rate for the year commencing March 2003 and carried a 10.6% dividend rate in all subsequent years. The NASD is entitled to receive cash dividends when, as and if declared by Nasdaq’s Board of Directors out of the funds legally available. On September 30, 2004, the NASD agreed to a waiver of a portion of the dividend for the third quarter of 2004 and accepted an aggregate amount of $1.0 million (calculated based on an annual rate of 3.0%) as payment in full of the dividend for this period. Both parties are currently in discussions on an amendment to the terms of the Series A Preferred Stock.

Options to purchase 13,667,664 shares of Common Stock, 12,000,000 shares underlying Subordinated Notes and 239,824 shares underlying warrants issued by Nasdaq were outstanding at September 30, 2004. For the three and nine months ended September 30, 2004, all of the options, all of the shares underlying the warrants issued by Nasdaq and the 12,000,000 shares underlying Subordinated Notes outstanding were considered antidilutive and were properly excluded.

20




 

Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

The following discussion and analysis of the financial condition and results of operations of Nasdaq should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included elsewhere in this Form 10-Q. Certain prior period amounts presented in the discussion and analysis have been reclassified to conform to the 2004 presentation.

This discussion and analysis may contain statements with respect to Nasdaq’s financial condition, results of operations, future performance and business that are considered “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995. Nasdaq’s actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth under “Item 1. Business—Risk Factors” in The Nasdaq Stock Market, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2003.

Nasdaq operates The Nasdaq Stock Market, the largest electronic screen-based equity securities market in the United States. In 2003, Nasdaq changed its organization structure from operating in one segment to operating in two segments. Under the new structure, Nasdaq’s Chief Executive Officer has been identified as the Chief Operating Decision Maker as defined by SFAS 131. Nasdaq’s two segments are managed and operated as strategic business units and organized by products and services. Reportable segments are Market Services and Issuer Services.

Market Services includes collecting, processing and disseminating price quotes of Nasdaq-listed securities, the routing and execution of buy and sell orders for Nasdaq-listed and exchange-listed securities and transaction reporting services. Market Services also provides price quotes and trade information to data vendors, who in turn sell the information to the public. Market participants in The Nasdaq Stock Market, consisting of market makers, ECNs, registered stock exchanges and order entry firms, are users of Nasdaq’s Market Services. In March 2004, Nasdaq rebranded its execution services and ACT services as the Nasdaq Market Center, which is within the Market Services segment. The Nasdaq Market Center includes Nasdaq’s quoting, trading and trade reporting services for securities listed on Nasdaq and the NYSE and Amex. Revenues from execution systems previously known as SuperMontage and CAES and revenues from ACT are included in the Nasdaq Market Center. Beginning with the quarter ended June 30, 2004 revenues from Access Services, ACES and Nasdaq InterMarket ( revenues derived from the sale of tape data (Tape Fee revenues) for securities listed on exchanges) were also included with Nasdaq Market Center revenues as these products and services are considered transaction-based services. In addition, beginning September 7, 2004 with the acquisition of Brut, execution revenues from transactions executed through Brut are included in Nasdaq Market Center revenues. Pursuant to EITF 99-19, revenues from these transactions are recorded on a gross basis in revenues and expenses such as liquidity rebate payments are recorded in cost of revenues as Brut acts as principal. Nasdaq’s other execution revenues will continue to be reported net of the liquidity rebate as Nasdaq does not act as principal. Also, beginning with the quarter ended June 30, 2004, revenues from Nasdaq’s Level 1 Service, NQDS, TotalView and MFQS were rebranded as Nasdaq Market Services Subscriptions revenues as these products and services are considered subscription-based services. Revenues from SuperMontage, CAES, ACT, Access Services and ACES were previously reported as Transaction Services within the Market Services segment and revenues from Nasdaq InterMarket, Level 1 Service, NQDS, TotalView and MFQS were previously reported as Market Information Services both within the Market Services segment.

Issuer Services includes the Corporate Client Group and Nasdaq Financial Products. The Corporate Client Group provides customer services and information products to Nasdaq-listed companies and is responsible for obtaining new listings on The Nasdaq Stock Market. Nasdaq Financial Products is responsible for introducing products that extend and enhance the Nasdaq brand. Nasdaq Financial Products oversees the development and marketing of new Nasdaq financial products and associated

21




derivatives, the licensing and listing of third-party structured products and the listing of third-party sponsored exchange traded funds.

On September 7, 2004, Nasdaq completed its acquisition of Brut and paid total cash consideration of $190.0 million, subject to certain post-closing adjustments. Nasdaq financed the purchase from available cash and investments. Accordingly, 2004 results include activity related to Brut from September 7, 2004 through September 30, 2004. See “Acquisition of Brut,” of Note 2, “Significant Transactions,” to the condensed consolidated financial statements for further discussion.

For the three months ended September 30, 2004, Nasdaq’s net loss was $5.5 million compared with a $38.0 million net loss for the three months ended September 30, 2003, a decrease of $32.5 million, or 85.5%. For the nine months ended September 30, 2004, Nasdaq’s net income was $3.9 million compared with a net loss of $84.5 million for the nine months ended September 30, 2003, an increase of $88.4 million. Included in the results for the three and nine months ended September 30, 2003 was a net loss of $30.3 million and $50.2 million, respectively, from discontinued operations related to the transfer of Nasdaq’s interest in Nasdaq Europe and the sale of IndigoMarkets. Accordingly, results from these subsidiaries have been reclassified as discontinued operations in Nasdaq’s Condensed Consolidated Statements of Income for the three and nine months ended September 30, 2003. See Note 4, “Discontinued Operations,” to the condensed consolidated financial statements for further discussion.

The remainder of this discussion and analysis reflects results from continuing operations, unless otherwise noted. On this basis, Nasdaq’s net loss from continuing operations was $5.5 million for the three months ended September 30, 2004 compared with a net loss of $7.7 million for the three months ended September 30, 2003, a decrease of $2.2 million or 28.6%. For the nine months ended September 30, 2004, Nasdaq’s net income from continuing operations was $3.9 million compared with a net loss of $34.3 million for the nine months ended September 30, 2003, an increase of $38.2 million.

For the three and nine months ended September 30, 2004, results were positively impacted by lower operating expenses from corporate-wide cost reduction programs and Nasdaq’s 2003 strategic review, which resulted in charges recorded during 2003. Total expenses were $123.7 million and $355.0 million for the three and nine months ended September 30, 2004, respectively, compared with $154.7 million and $496.5 million for the three and nine months ended September 30, 2003, respectively, a decrease of $31.0 million or 20.0% and $141.5 million or 28.5%, respectively. However, three and nine months 2004 total revenues and gross margin (total revenues less cost of revenues) both decreased when compared with the same periods in 2003. Total revenues were $124.0 million and $372.4 million for the three and nine months ended September 30, 2004, respectively, compared with $141.9 million and $451.8 million for the three and nine months ended September  30, 2003, respectively, a decrease of $17.9 million or 12.6% and $79.4 million or 17.6%, respectively. Gross margin was $114.8 million and $363.2 million for the three and nine months ended September 30, 2004, respectively, compared with $141.9 million and $451.8 million for the three and nine months ended September  30, 2003, respectively, a decrease of $27.1 million or 19.1% and $88.6 million or 19.6%, respectively. The decline in total revenues was primarily due to continued competitive pressure on Market Services segment revenues and gross margin due to a decline in the percentage of share volume reported to Nasdaq’s systems and higher Unlisted Trading Privileges (“UTP”) Plan revenue sharing. Market Services segment revenues decreased $16.4 million or 18.3% for the three months ended September 30, 2004 and $79.0 million or 26.6% for the nine months ended September 30, 2004 and Market Services segment gross margin decreased $25.6 million or 28.5% for the three months ended September 30, 2004 and $88.2 million or 29.7% for the nine months ended September 30, 2004. These current and prior year items are discussed in more detail below.

22




Business and Operating Environment

As discussed above, on September 7, 2004, Nasdaq completed its acquisition of Brut. The Brut acquisition will accelerate Nasdaq’s growth initiatives and enhance Nasdaq’s competitive position. Nasdaq and Brut customers will benefit from enhanced execution quality, additional quote information and a deeper pool of liquidity in securities listed on The Nasdaq Stock Market and other trading venues such as the NYSE and the Amex. Nasdaq’s customers also will benefit from the ability to access liquidity from multiple destinations outside the Nasdaq Market Center through the use of Brut’s sophisticated order routing technology.

Trading activity of Nasdaq-listed securities declined during the three months ended September 30, 2004 compared to the three months ended September 30, 2003 and increased for the nine months ended September 30, 2004 compared to the nine months ended September 30, 2003. Average daily share volume was 1.56 billion shares in the three months ended September 30, 2004 compared to 1.73 billion shares in the three months ended September 30, 2003, a decrease of 9.8%. Average daily share volume was 1.78 billion shares in the nine months ended September 30, 2004 compared to 1.66 billion shares in the nine months ended September 30, 2003, an increase of 7.2%. While average daily share volume increased for the nine months ended September 30, 2004, continued competitive pressures from regional exchanges and ECNs drew activity away from Nasdaq’s systems to other venues resulting in decreased share volume reported to Nasdaq’s systems. As a result, the percentage of share volume reported to Nasdaq’s systems fell from 62.0% in the three months ended September 30, 2003 to 48.4% in the three months ended September 30, 2004, and fell from 70.7% in the nine months ended September 30, 2003 to 49.1% in the nine months ended September 30, 2004. This continued competition along with decreases in certain fees and increases in certain rebates resulted in a significant decline in revenues from the Market Services segment.

Revenues from the Issuer Services segment increased slightly for the three months ended September 30, 2004 compared with the same period in 2003. For the nine months ended September 30, 2004, Issuer Services revenues increased $1.4 million, or 0.9%, compared with the nine months ended September 30, 2003 due to an increase in licensing revenues. Improved market conditions and consumer outlook continued to have a positive impact on the ability of companies to raise money in the equity markets in 2004. For the three months ended September 30, 2004, there were 42 initial public offerings (“IPOs”) on The Nasdaq Stock Market compared to 14 for the three months ended September 30, 2003. For the nine months ended September 30, 2004, there were 111 IPOs on The Nasdaq Stock Market compared to 19 for the nine months ended September 30, 2003. Although secondary offerings decreased from 60 in the three months ended September 30, 2003 to 47 in the same period of 2004, secondary offerings increased from 103 in the nine months ended September 30, 2003 to 188 in the same period of 2004. The increase in IPOs and secondary listings during 2004 will primarily affect Nasdaq’s revenues in future years as r evenues from Initial listing fees (including IPOs) and LAS fees (including secondary offerings) are amortized over six and four years, respectively. Annual renewal fee revenues, which are amortized on a pro-rata basis over the calendar year, decreased in 2004 due to the decline in the number of companies listed on The Nasdaq Stock Market from 3,659 on January 1, 2003 to 3,333 on January 1, 2004, the date on which companies are billed their annual fees. During 2003, 460 companies delisted from The Nasdaq Stock Market primarily for failure to meet The Nasdaq Stock Market’s listing standards and other reasons, including mergers and acquisitions. Partially offsetting this decline were 134 new listings in 2003.

Nasdaq is positioning itself to benefit from any improvement in investor confidence during the remaining quarter of 2004. In January 2004, Nasdaq implemented a new tiered pricing structure geared toward drawing increased liquidity to Nasdaq’s trading platform. In April 2004, Nasdaq further enhanced its pricing structure by increasing the liquidity rebate , in which Nasdaq credits a portion of the per share execution charge to the market participant that provides the liquidity, for large market participants. These changes resulted in the stabilization of Nasdaq’s market share beginning in the first quarter of 2004.

23




Nasdaq’s acquisition of Brut on September 7, 2004, has improved Nasdaq’s market share for the three months ended September 30, 2004. Effective September 1, 2004, Brut began to report its trades to the Nasdaq Market Center ending its reporting of trades to the Boston Stock Exchange. However, competition from regional exchanges and ECNs remains strong and any additional future price reductions and/or a decrease in market share may continue to put downward pressure on Nasdaq’s revenues.

In January 2004, Nasdaq launched the dual-listing program, enabling NYSE-listed companies to dually list their stock on The Nasdaq Stock Market and the NYSE. While Nasdaq has agreed to waive its listing fees for one year, Nasdaq believes that the dual-listing program will enhance competition, thereby benefiting investors and has the potential to generate revenues for Nasdaq from listing fees in subsequent years. As of September 30, 2004, seven NYSE-listed companies have agreed to dual-list their stock on The Nasdaq Stock Market.

To establish prices more representative of the prevailing market at the open and close of trading in Nasdaq-listed securities and to increase trading activity at those critical periods, Nasdaq implemented The Opening and Closing Crosses this year. In June 2004, Nasdaq completed the rollout of the Closing Cross, a centralized order facility designed to provide a robust, orderly, single price, market close for Nasdaq-listed securities. Certain sponsors of stock indices, including the sponsors of the Russell, Dow Jones, and Standard & Poors Indices are now utilizing the Closing Cross as a reference price for their stock indices and others are expected to do so as well. Nasdaq began charging fees for transactions taking place in the Closing Cross in August 2004. In September 2004, Nasdaq received SEC approval for the implementation of an Opening Cross. Nasdaq will begin to rollout the Opening Cross in the fourth quarter of 2004.

In July 2004, Nasdaq announced plans to improve access to the Nasdaq Market Center by creating a more streamlined and efficient protocol, QIX, expanding Financial Information Exchange (“FIX”) functionality, and introducing a new Nasdaq workstation. These enhancements will be rolled out beginning in the first quarter of 2005. As a result, Nasdaq will discontinue support for the Nasdaq Workstation II and the Application Program Interface connectivity via the Service Delivery Platform in the fourth quarter of 2005. QIX is a proprietary protocol for submitting transactions to the Nasdaq Market Center. FIX functionality will be enhanced to include capabilities currently available only through the Application Program Interface. The new Nasdaq workstation will provide a more intuitive and streamlined product as compared to its predecessors, the Nasdaq Workstation II and Application Program Interface. These enhancements are expected to reduce customer costs while improving their experience with the Nasdaq Market Center. These initiatives are expected to have an immaterial impact on Nasdaq’s operating results.

Key Statistical information

The following table sets forth key statistical information:

 

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

   2004   

 

   2003   

 

   2004   

 

   2003   

 

Average daily share volume (in billions)

 

 

1.56

 

 

 

1.73

 

 

 

1.78

 

 

 

1.66

 

 

Percentage of share volume reported to Nasdaq systems

 

 

48.4

%

 

 

62.0

%

 

 

49.1

%

 

 

70.7

%

 

Initial public offerings

 

 

42

 

 

 

14

 

 

 

111

 

 

 

19

 

 

Secondary Offerings

 

 

47

 

 

 

60

 

 

 

188

 

 

 

103

 

 

New listings (1)

 

 

69

 

 

 

32

 

 

 

188

 

 

 

72

 

 

Number of listed companies (2)

 

 

3,287

 

 

 

3,367

 

 

 

3,287

 

 

 

3,367

 

 


(1)              Includes IPOs

(2)              Number of listed companies as of September 30, 2004 and 2003

24




Results of Operations

For the Three and Nine Months Ended September 30, 2004 and 2003

Revenues

In 2003, Nasdaq changed its organizational structure from operating in one segment to operating in two segments. Nasdaq’s two segments are managed and operated as strategic business units and organized by products and services. Reportable segments are Market Services and Issuer Services. Market Services primarily includes Nasdaq Market Center revenues and Nasdaq Market Services Subscriptions revenues. Nasdaq Market Center revenues includes Nasdaq’s quoting, trading and trade reporting services for both Nasdaq-listed and exchange-listed securities. Revenues from execution systems previously known as SuperMontage, CAES and ACES and revenues from ACT as well as Access Services revenues and Nasdaq InterMarket revenues (revenues derived from the sale of tape data (Tape Fee revenues) for securities listed on exchanges) were also included with Nasdaq Market Center revenues. In addition, beginning September 7, 2004 with the acquisition of Brut, and in accordance with EITF 99-19, Nasdaq has recorded execution revenues from transactions executed through Brut on a gross basis in Nasdaq Market Center revenues and expenses such as liquidity rebate payments, as cost of revenues as Brut acts as principal. Nasdaq’s other execution revenues will continue to be reported net of the liquidity rebate as Nasdaq does not act as principal. See “Acquisition of Brut,” of Note 2, “Significant Transactions,” to the condensed consolidated financial statements for further discussion. Nasdaq Market Services Subscriptions revenues includes revenues from Nasdaq’s Level 1 Service, NQDS, TotalView and MFQS. Issuer Services includes Corporate Client Group revenues and Nasdaq Financial Products revenues. See Note 10, “Segments,” to the condensed consolidated financial statements for further discussion.

The following table sets forth total revenues by segment, cost of revenues and gross margin:

 

 

 

Three months ended
September 30,

 

Nine months ended 
September 30,

 

 

 

   2004   

 

   2003   

 

  2004  

 

  2003  

 

 

 

(in millions)

 

Market Services

 

$

73.3

 

$

89.7

 

$

218.4

 

$

297.4

 

Issuer Services

 

50.7

 

50.5

 

153.9

 

152.5

 

Other

 

 

1.7

 

0.1

 

1.9

 

Total revenues

 

124.0

 

141.9

 

372.4

 

451.8

 

Cost of revenues

 

(9.2

)

 

(9.2

)

 

Gross margin

 

$

114.8

 

$

141.9

 

$

363.2

 

$

451.8

 

 

25




 

MARKET SERVICES

The following table sets forth revenues, cost of revenues and gross margin from Market Services:

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

    2004    

 

    2003    

 

2004

 

2003

 

 

 

(in millions)

 

Nasdaq Market Center:

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

 

$

83.2

 

 

 

$

93.2

 

 

$

249.6

 

$

296.2

 

Liquidity rebate

 

 

(28.2

)

 

 

(32.9

)

 

(92.8

)

(94.8

)

Tape Fee revenue sharing

 

 

(1.7

)

 

 

(3.3

)

 

(6.4

)

(10.4

)

Nasdaq General Revenue Sharing Program

 

 

(0.5

)

 

 

 

 

(1.9

)

 

Total Nasdaq Market Center revenues, net

 

 

52.8

 

 

 

57.0

 

 

148.5

 

191.0

 

Nasdaq Market Services Subscriptions:

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues (1)

 

 

44.5

 

 

 

45.9

 

 

137.9

 

133.8

 

Nasdaq General Revenue Sharing Program

 

 

(4.6

)

 

 

 

 

(14.1

)

 

Unlisted Trading Privileges (“UTP”) Plan revenue sharing

 

 

(21.6

)

 

 

(15.2

)

 

(60.7

)

(33.2

)

Total Nasdaq Market Services Subscriptions revenues, net

 

 

18.3

 

 

 

30.7

 

 

63.1

 

100.6

 

Other Market Services revenues

 

 

2.2

 

 

 

2.0

 

 

6.8

 

5.8

 

Total Market Services revenues

 

 

$

73.3

 

 

 

$

89.7

 

 

$

218.4

 

$

297.4

 

Cost of revenues

 

 

(9.2

)

 

 

 

 

(9.2

)

 

Gross margin from Market Services

 

 

$

64.1

 

 

 

$

89.7

 

 

$

209.2

 

$

297.4

 


(1)              Includes eligible and non-eligible UTP Plan revenues. Eligible UTP Plan revenues are associated with the calculation and dissemination of the consolidated national best bid and best offer (“inside quote”) and last sale information. These revenues are shared among UTP Plan participants. Non-eligible UTP Plan revenues are associated with the calculation and dissemination of proprietary Nasdaq information and are not shared among UTP Plan participants.

Nasdaq Market Center

Nasdaq Market Center revenues decreased $10.0 million, or 10.7%, in the third quarter of 2004 compared with the same period of 2003. The decrease was primarily due to declines in the percentage of share volume reported to Nasdaq’s systems and the number of trader log-ons to Nasdaq’s systems, the effect of price reductions and lower overall average daily share volume of market participants on The Nasdaq Stock Market for the three months ended September 30, 2004. Share volume declined as competitive pressures from regional exchanges drew trade reporting activity away from Nasdaq’s systems to other venues. In response to this continued competition, Nasdaq reduced certain fees. In January 2004, Nasdaq implemented a new tiered pricing structure geared toward drawing increased liquidity to Nasdaq’s trading platform. In April 2004, Nasdaq further enhanced its pricing structure by increasing the liquidity rebate for certain market participants, which impacted the Nasdaq Market Center liquidity rebate. The new tiered pricing structure lowers execution charges to market participants based on the amount of liquidity a participant provides. These price changes are in addition to price reductions implemented in the second, third and fourth quarters of 2003 for trades reported to the Nasdaq Market Center. The decline in trader log-ons was due to market participant consolidations and firms moving to alternative venues to access the market. The decline in Nasdaq Market Center revenues in the third quarter of 2004 versus the third quarter of 2003 was partially offset by an increase in market share as a result of the acquisition of Brut on September 7, 2004. See “Acquisition of Brut,” of Note 2, “Significant Transactions,” to the condensed consolidated financial statements for further discussion.

26




Nasdaq Market Center revenues decreased $46.6 million, or 15.7%, for the nine months ended September 30, 2004, compared with the same periods of 2003. The decline in Nasdaq Market Center revenues for the year-to-date period of 2004 was also due to declines in the percentage of share volume reported to Nasdaq’s systems and the number of trader log-ons to Nasdaq’s systems and the effect of price reductions. These decreases were partially offset by the additional activity from Brut and an increase in average daily share volume. Average daily share volume was 1.78 billion shares during the nine months ended September 30, 2004 compared to 1.66 billion shares during the nine months ended September 30, 2003.

Nasdaq Market Center liquidity rebate, in which Nasdaq credits a portion of the per share execution charge to the market participant that provides the liquidity, decreased $4.7 million, or 14.3%, in the third quarter of 2004 and decreased $2.0 million, or 2.1%, for the nine months ended September 30, 2004, compared with the same periods of 2003. These decreases were primarily due to the elimination of the liquidity rebate for all NYSE-listed securities in December 2003 and certain Amex-listed securities in May 2004. Lower average daily share volume of market participants on The Nasdaq Stock Market during the third quarter of 2004 as compared to the same period in 2003, contributed to the quarterly decline. These decreases were partially offset by an increase in the per share liquidity rebate in April 2004 for Nasdaq-listed securities. Nasdaq Market Center liquidity rebate for the year-to-date period was also impacted by higher overall average daily share volume of market participants on The Nasdaq Stock Market for the nine months ended September 30, 2004 as compared with the same period of 2003. Average daily share volume was 1.78 billion shares during the nine months ended September 30, 2004 compared to 1.66 billion shares during the nine months ended September 30, 2003.

Nasdaq shares Tape Fee revenues from NYSE-listed and Amex-listed securities through Nasdaq Market Center Tape Fee revenue sharing. Nasdaq records Tape Fee revenues from NYSE-listed and Amex-listed securities based upon both the percentage of trades reported to the Nasdaq Market Center for securities listed on these exchanges and the size of NYSE and Amex revenue sharing pools. Nasdaq Market Center Tape Fee revenue sharing decreased $1.6 million, or 48.5%, in the third quarter of 2004 and decreased $4.0 million, or 38.5%, for the nine months ended September 30, 2004, compared with the same periods of 2003. These decreases were primarily due to the INET ECN reporting additional trading activity to The National Stock Exchange beginning in the first quarter of 2004. This change reduced both Nasdaq Market Center revenues and the amount of Tape Fee revenues Nasdaq was obligated to share with INET, resulting in an overall decline in Nasdaq Market Center revenues, net.

In January 2004, the Nasdaq Market Center began sharing revenues under a new program, the Nasdaq General Revenue Sharing Program. During the third quarter of 2004 and for the nine months ended September 30, 2004, Nasdaq shared $0.5 million and $1.9 million, respectively, of Nasdaq Market Center revenues under this program. See “Nasdaq Member Revenue Sharing,” of Note 2, “Significant Transactions,” to the condensed consolidated financial statements for further discussion.

Nasdaq Market Services Subscriptions

Nasdaq provides subscribers with inside quote and last trade information through Level 1, the best quote information for each market participant through NQDS and all price levels for each market participant through TotalView. These services are provided for securities listed on The Nasdaq Stock Market to both professional and non-professional users. Nasdaq also provides MFQS, a service that collects and disseminates daily price and related data for unit investment trusts, mutual funds and money market funds that are subscribers to this service. These subscription revenues, which include eligible and non-eligible UTP Plan revenues, decreased $1.4 million, or 3.1%, in the third quarter of 2004 compared with the same period of 2003. This decrease was primarily due to firms moving to lower cost alternatives to access market information.

27




Nasdaq Market Services Subscriptions revenues increased $4.1 million, or 3.1%, for the nine months ended September 30, 2004, compared with the same periods of 2003. This increase was primarily due to an increase in professional and non-professional Level 1 subscriptions resulting from increased interest in the equity markets during 2004.

In January 2004, Nasdaq began sharing Market Services Subscriptions revenues under the new program, the Nasdaq General Revenue Sharing Program. During the third quarter of 2004 and for the nine months ended September 30, 2004, Nasdaq shared $4.6 million and $14.1 million, respectively, of Nasdaq Market Services Subscriptions revenues under this program. See “Nasdaq Member Revenue Sharing,” of Note 2, “Significant Transactions,” to the condensed consolidated financial statements for further discussion.

Nasdaq also shares Tape Fee revenues (i.e., revenues from the sale of tape data) for Nasdaq-listed securities through the UTP Plan. Under the revenue sharing provision of the UTP Plan, Nasdaq is permitted to deduct certain costs associated with acting as the exclusive Securities Information Process (“SIP”) from the total amount of Tape Fees collected. After these costs are deducted from the Tape Fees, Nasdaq distributes to the respective UTP Plan participants, including Nasdaq, their share of Tape Fees based on a combination of their respective trade volume and share volume. Nasdaq Tape Fee revenue sharing allocated to UTP Plan participants increased $6.4 million, or 42.1%, in the third quarter of 2004 and increased $27.5 million, or 82.8%, for the nine months ended September 30, 2004, compared with the same periods of 2003. These increases were primarily due to a decline in the percentage of share volume reported to Nasdaq’s systems as continued competitive pressures from ECNs continued to draw activity away from Nasdaq’s systems to regional exchanges that are members of the UTP Plan and that trade Nasdaq-listed securities. These increases were partially offset by a decline in trade reporting activity from The Boston Stock Exchange after Brut began to report its trades to the Nasdaq Market Center on September 1, 2004. This change resulted in a decrease to UTP Plan revenue sharing of approximately $1.5 million for September 2004. See “Acquisition of Brut,” of Note 2, “Significant Transactions,” to the condensed consolidated financial statements for further discussion.

Cost of Revenues

Cost of revenues were $9.2 million for three and the nine months ended September 30, 2004 and relate to the acquisition of Brut. Pursuant to EITF 99-19, Nasdaq has recorded execution revenues from transactions executed through Brut on a gross basis in revenues and has recorded expenses such as liquidity rebate payments as cost of revenues as Brut acts as principal. Nasdaq’s other execution revenues will continue to be reported net of the liquidity rebate as Nasdaq does not act as principal.  

ISSUER SERVICES

The following table sets forth revenues from Issuer Services:

 

 

Three months ended
September 30,

 

Nine months ended
September 30,

 

 

 

    2004    

 

    2003    

 

   2004   

 

   2003   

 

 

 

(in millions)

 

Issuer Services:

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate Client Group

 

 

$

41.3

 

 

 

$

41.2

 

 

$

122.9

 

$

125.0

 

Nasdaq Financial Products

 

 

9.4

 

 

 

9.3

 

 

31.0

 

27.5

 

Total Issuer Services revenues

 

 

$

50.7

 

 

 

$

50.5

 

 

$

153.9

 

$

152.5

 

 

28



 

Corporate Client Group

The following table sets forth the revenues from the Corporate Client Group as reported in accordance with GAAP (“as reported”) and as would be reported on a non-GAAP basis (“billed basis”). Nasdaq believes that the presentation of billed basis revenues, as they relate to LAS and Initial listing fees, is a good indicator of current Corporate Client Group activity as billed basis information excludes the effects of recognizing revenues related to Initial listing fees and LAS fees over the six and four year periods, respectively.

 

 

Three months ended 
September 30,

 

 

Nine months ended 
September 30,

 

 

 

2004

  <