NASDAQ OMX Group, Inc. (NASDAQ: NDAQ) — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011; unaudited. Amounts are in U.S. dollars unless otherwise stated.
Business context
NASDAQ OMX operates exchange, trading, clearing, market-data, listing and market-technology businesses across the U.S., Europe and other markets. It reports three segments: Market Services, Issuer Services and Market Technology. Q3 trading activity strengthened in several areas, but management described investors as cautious amid concerns about global growth and sovereign debt.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Total revenues | $946 million | $757 million | $2.601 billion | $2.414 billion |
| Revenues less transaction rebates, brokerage, clearance and exchange fees | $438 million | $372 million | $1.269 billion | $1.121 billion |
| Operating income | $195 million | $165 million | $536 million | $456 million |
| Net income attributable to NASDAQ OMX | $110 million | $101 million | $306 million | $258 million |
| Diluted EPS | $0.61 | $0.50 | $1.70 | $1.23 |
| Operating income as a share of revenues net of rebates and fees | 44.5% | 44.4% | 42.2% | 40.7% |
- Q3 net revenues grew 17.7%; management attributed $50 million of the $66 million increase to operational growth and $16 million to favorable foreign exchange. Nine-month net revenues rose 13.2%, including $98 million operational growth and $50 million favorable FX.
- Q3 growth was led by Market Services net revenues, up 20.5% to $300 million; Issuer Services rose 8.2% to $92 million; and Market Technology rose 21.1% to $46 million. For the first nine months, those segments reported $858 million, $276 million and $135 million, respectively.
- Operating expenses increased 17.4% in Q3 to $243 million and 10.2% year to date to $733 million. Drivers included compensation, acquisitions, professional services, technology costs and, year to date, strategic transaction costs.
- Interest expense was $30 million in Q3 and $93 million for nine months, up from $25 million and $76 million, respectively, principally reflecting the 2018 notes issued in December 2010.
- Q3 effective tax rate was 36% versus 30% a year earlier; the nine-month rate was 33% in both years. The Q3 increase reflected earnings mix, tax-law changes and tax-return adjustments.
Cash flow, liquidity and debt
- Nine-month operating cash flow was $436 million, versus $257 million in 2010. Investing used $96 million and financing used $105 million. Cash and cash equivalents rose to $543 million from $315 million at year-end 2010.
- Working capital was $697 million at September 30, up from $279 million at December 31, 2010. Total financial assets were $993 million, including restricted cash and investments; not all are available for general use.
- Debt obligations totaled $2.213 billion, including $45 million current and $2.168 billion long-term. The company replaced its prior term loan with a $450 million funded term loan under a new $1.2 billion five-year unsecured facility, which also included a $750 million revolver. No revolver borrowings were outstanding at quarter-end.
- After quarter-end, $335 million principal amount of 2.50% convertible notes was tendered and cancelled for $346 million, including premium, interest and costs. The company borrowed $250 million under the revolver and used cash to fund the tender; it reported a $25 million pre-tax charge in October. Revolver availability then stood at $500 million.
- Management expected operating cash to fund near-term operating costs, capital spending, interest and the announced repurchase program. It also announced a planned $109 million voluntary debt prepayment in Q4, in addition to an $11 million required payment.
Material changes, outlook and risks
- Q3 U.S. cash equity market volumes improved, and equity options volume on its two U.S. exchanges increased 35.5% year over year. However, nine-month U.S. cash-equity net revenues declined 7.8%, reflecting lower industry volume and market share. Q3 U.S. cash-equity market share was steady overall at 22.4% across its markets.
- Nine-month merger and strategic initiatives expense was $38 million, largely related to the withdrawn joint proposal to acquire NYSE Euronext. The proposal was withdrawn in May after discussions with the U.S. Department of Justice.
- Management identified trading volumes, listing demand, pricing pressure, competition, regulation, technology investment and economic conditions as important business drivers. It specifically cited cautious investor sentiment, uncertain global recovery and sovereign-debt concerns. The filing refers to a 2011 outlook but does not provide a clear numerical earnings or revenue forecast in the supplied text.
- Key risks include volatile trading and listing activity, intense exchange competition, regulatory change, foreign-exchange and interest-rate movements, access to funding and integration of acquisitions. The company acts as legal counterparty in clearing activities; pledged customer collateral at NASDAQ OMX Commodities and Stockholm was $5.8 billion at quarter-end. Management said collateral and risk controls mitigate exposure.
- Contingencies include a Finnish tax challenge that could result in approximately $18 million of additional tax and penalties for 2008–2010; management considered an assessment unlikely. Swedish tax deductions also remain under appeal, while the company continued to record related tax benefits. No litigation was identified that management believed would materially harm results or financial condition.
- Other post-quarter events: the board authorized up to $300 million of share repurchases, and the company agreed to acquire Glide Technologies. The filing reported no goodwill impairment indicators at September 30; goodwill was $5.046 billion.
- Foreign-currency translation produced a $278 million Q3 other-comprehensive loss, primarily reflecting translation effects; comprehensive loss attributable to NASDAQ OMX was $174 million, despite positive net income.
Important facts for investors to verify
- Whether trading-volume and market-share trends—particularly the weakness in nine-month U.S. cash-equity net revenue—persist, and how they affect net revenue and margins.
- The full post-quarter debt position and costs following the convertible-note tender, revolver draw, planned debt prepayment and new share-repurchase authorization.
- Progress and costs associated with acquisitions and integration, including Glide Technologies, and whether Market Technology order value converts to revenue on the estimated schedule.
- Outcomes of the Finnish and Swedish tax matters and future effective tax rates; Q3 included tax adjustments and the company recorded Swedish-related tax benefits.
- Clearing-counterparty exposure, collateral sufficiency and regulatory liquidity requirements during periods of market stress.