Business Context and Reporting Period
Company: The Nasdaq Stock Market, Inc. (Nasdaq)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2001
Business Overview: Nasdaq operates the world's largest electronic, screen-based equity securities market. Its revenue is derived from three primary categories: Transaction Services (47.7% of revenue), Market Information Services (28.1%), and Corporate Client Group Services (18.2%). The company is in the process of restructuring to separate from the National Association of Securities Dealers (NASD) and seeking registration as a national securities exchange.
Key Financial Metrics
| Metric ($ in millions) | 2001 | 2000 |
|---|---|---|
| Total Revenue | $857.2 | $832.7 |
| Net Income | $40.5 | $23.3 |
| Net Operating Income | $60.1 | $196.0 |
| EBITDA | $153.5 | $261.7 |
| Cash from Operating Activities | $65.0 | $255.6 |
| Cash and Cash Equivalents (Year End) | $293.7 | $262.3 |
| Working Capital | $521.6 | $440.3 |
| Total Long-Term Obligations | $508.9 | $221.5 |
| Capital Expenditures | $73.3 | $119.0 |
Note: 2000 Net Income includes a one-time cumulative effect of a change in accounting principle of $101.1 million. Pro forma 2000 Net Income excluding this item was $124.4 million.
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 2.9% to $857.2 million, driven by a 3.5% increase in Transaction Services revenue ($408.8 million) and a 4.6% increase in Corporate Client Group revenue ($156.1 million). Market Information Services revenue declined 6.9% to $240.5 million due to weaker economic conditions and reduced demand for non-professional data services.
- Profitability: Net income increased 73.8% to $40.5 million. However, on a pro forma basis excluding the 2000 accounting adjustment, net income decreased 67.4% compared to 2000. Net operating income dropped significantly from $196.0 million in 2000 to $60.1 million in 2001.
- Expense Increases: Total direct expenses rose 36.8% to $695.3 million. Key drivers included:
- Disaster Related Expenses: $23.2 million incurred due to the September 11, 2001 terrorist attacks, including a $21.5 million loss on the sublease of the One Liberty Plaza headquarters.
- Compensation: Increased 33.6% to $183.4 million due to restructuring transfers from the NASD and severance costs.
- Technology Costs: Computer operations and data communications expenses increased 26.6% to $174.9 million.
- Market Activity: Average daily share volume increased 8% to 1.9 billion, but average daily dollar volume fell more than 45% due to lower stock prices. IPO activity collapsed from 397 in 2000 to 63 in 2001.
Guidance, Outlook, Risks, and Unusual Items
Outlook and Strategic Initiatives
- 2002 Outlook: Management faces economic and competitive challenges. Trading volume was flat in early 2002. The company anticipates that a sustained rebound in equity markets is necessary to drive new listings and secondary offerings.
- Product Launches: Plans to launch "SuperMontage" (an improved user interface) in Q3 2002 and "Primex" (an auction trading platform) following its pilot phase. Both are expected to generate revenue in the second half of 2002.
- Global Expansion: Continued investment in Nasdaq Europe and Nasdaq Japan, both of which have operated at a loss since inception.
Risks and Contingencies
- Exchange Registration: Nasdaq's application to become a national securities exchange is pending SEC approval. Approval is linked to the NASD's ability to provide an "Alternative Display Facility," which was not expected to be operational until Q2 2002.
- Competition: Increased competition from regional exchanges (e.g., Cincinnati Stock Exchange) and Electronic Communication Networks (ECNs) for trade reporting business. Nasdaq's market share in trade reporting dropped from 97.6% in January 2002 to 77.3% in March 2002.
- September 11 Impact: The company recorded $23.2 million in disaster-related expenses. Future expenses and insurance recoveries related to the attacks remain uncertain.
- Accounting Change: Adoption of SAB 101 required deferring initial listing and LAS fees over 6 and 4 years respectively, significantly altering revenue recognition patterns compared to prior years.
Investor Verification Checklist
- Pro Forma Comparability: Verify that 2000 financial results are adjusted for the $101.1 million cumulative effect of the accounting change to accurately assess year-over-year operational performance.
- Disaster Expense Impact: Confirm the final insurance recoveries and total costs associated with the September 11 attacks and the One Liberty Plaza relocation.
- Exchange Registration Status: Monitor the SEC's decision on Nasdaq's exchange registration application and the operational status of the NASD's Alternative Display Facility.
- Competitive Market Share: Track the erosion of Nasdaq's trade reporting market share to regional exchanges and ECNs, and the effectiveness of Nasdaq's fee-sharing responses.
- International Losses: Review the ongoing operating losses of Nasdaq Europe and Nasdaq Japan and the capital commitments required to sustain these ventures.
- Debt Structure: Note the issuance of $240 million in convertible subordinated notes to Hellman & Friedman and the subsequent repurchase of NASD shares.