NDAQ

Business Context and Reporting Period

Company: The Nasdaq Stock Market, Inc.
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Three months ended March 31, 2002
Business Overview: Nasdaq operates the world's largest electronic, screen-based equity securities market. The company operates in one segment, deriving revenue primarily from Transaction Services, Market Information Services, and Corporate Client Group Services.

Key Financial Metrics

Note: Working capital decreased significantly from $521.6 million at December 31, 2001, to $235.5 million at March 31, 2002, primarily due to the repurchase of shares from the NASD.

Material Changes vs. Prior Period

• Revenue Decline: Total revenues decreased 5.2% to $211.3 million. Transaction Services revenue fell 5.5% due to lower trading volumes and the migration of volume to the SuperSoes system. Market Information Services revenue dropped 17.7% driven by reduced demand for data services and new revenue-sharing programs with members.
• Profitability: Net income decreased 18.7% to $21.3 million. While expenses remained relatively flat (Total expenses decreased slightly to $172.6 million), the revenue decline and increased compensation costs (up 18.4%) pressured margins.
• Share Repurchase: A major capital event occurred on March 8, 2002, when Nasdaq repurchased 33.8 million shares of common stock from the NASD for $305.2 million in cash and issued Series A and Series B Preferred Stock. This transaction significantly reduced cash reserves and outstanding common shares.
• Accounting Change: Nasdaq adopted SAB 101, changing revenue recognition for listing fees from immediate recognition to straight-line amortization over 4-6 years. This change reduced reported revenue in the current period compared to prior periods where fees were recognized upfront.

Guidance, Outlook, and Risks

• Market Conditions: Management notes a slowdown in the rebound of U.S. equity markets. Average daily share volume declined 15% year-over-year to 1.82 billion shares. Economic pressures continue to limit IPO activity (7 IPOs in Q1 2002 vs. 13 in Q1 2001).
• Competitive Landscape: Nasdaq faces competition from Electronic Communication Networks (ECNs) and regional exchanges seeking to establish themselves as national securities exchanges. Cost-saving initiatives at investment firms have reduced demand for access services.
• Liquidity: Despite the cash outflow for the share repurchase, management believes existing cash, investments, and operating cash flows are sufficient to meet current and future requirements. Nasdaq is exploring alternative financing sources.
• Contingencies:
  • WorldCom Deposit: An $8.0 million deposit with WorldCom has been fully reserved as it is unlikely to be returned during contract renegotiations.
  • Amex Separation: Nasdaq has committed to funding up to $14.5 million for the separation of technology from the American Stock Exchange.
  • Legal Proceedings: Management believes pending legal proceedings will not have a material effect on financial position.

Investor Verification Checklist

• Share Repurchase Impact: Verify the dilution effects of the new Preferred Stock issued to the NASD and the reduction in outstanding common shares.
• Revenue Recognition: Confirm the long-term impact of the SAB 101 accounting change on future revenue recognition patterns for listing fees.
• Trading Volume Trends: Monitor average daily share volume and the success of the SuperSoes system in retaining transaction revenue amidst lower overall market activity.
• Liquidity Position: Assess the sustainability of the reduced cash balance ($172.4 million) given the $305 million cash outflow for the NASD repurchase and ongoing capital expenditures.
• Deferred Revenue: Review the $256.3 million in deferred revenue to understand the backlog of future earnings from listing and annual fees.