NASDAQ, INC. quarterly report, Q3 FY2014

Business context and reporting period

The NASDAQ OMX Group, Inc. (Nasdaq) filed this unaudited Form 10-Q for the quarter ended September 30, 2014. Nasdaq operates trading, clearing, listing, market-data, index, and technology businesses through four segments: Market Services, Listing Services, Information Services, and Technology Solutions. Unless noted otherwise, amounts below are in millions of dollars.

Financial performance and liquidity

• Q3 revenue increased 1.6%, but revenue after transaction-related costs declined 1.8%. Nine-month revenue after those costs increased 12.7%, reflecting acquired businesses and growth in several operations.
• Calculated operating margin on revenue after transaction-related costs was approximately 41.6% in Q3 2014 versus 39.9% in Q3 2013, and 37.5% versus 32.7% for the nine-month periods.
• Nine-month capital expenditures were $93; operating cash flow less capital expenditures was approximately $314, compared with $257 in 2013. Cash and cash equivalents fell to $286 from $398 at year-end 2013.
• At September 30, debt obligations were $2,345, down from $2,634 at year-end. Nasdaq had $750 of undrawn revolving credit capacity and reported compliance with debt covenants. Working capital was $363.
• Net interest expense was $28 in Q3 and $84 for nine months. The effective tax rate was 31% for Q3 and 34% for the nine-month period.
• Q3 comprehensive income attributable to Nasdaq was a loss of $60, despite net income of $123, principally reflecting foreign-currency translation losses. Accumulated other comprehensive loss was $325.

Material changes versus comparable periods

• Nine-month growth was partly acquisition-driven: Technology Solutions revenue rose 32.6%, including the contribution from the 2013 Thomson Reuters Corporate businesses; Market Services revenue also included the eSpeed acquisition. These acquisitions affect year-over-year comparability.
• Q3 revenue after transaction-related costs declined mainly because of lower market-data, fixed-income trading, Corporate Solutions, and derivatives results, partly offset by stronger U.S. cash-equity trading, index licensing, and Market Technology.
• U.S. cash-equity matched market share increased to 19.6% in Q3 from 18.4% a year earlier, while U.S. options market share was 26.6% versus 26.7%. European derivatives volumes declined; Nordic and Baltic cash-equity activity improved.
• Operating expenses were 4.6% lower in Q3, but 4.6% higher for the nine months. The nine-month comparison reflects acquisition-related costs and a $9 debt-extinguishment charge in 2014, against 2013 expenses that included a $62 voluntary accommodation program, $10 SEC matter, $10 impairment, and $9 restructuring charge.
• Nasdaq issued $500 of 4.25% notes due 2024 and used proceeds and cash to repay $400 of 2015 notes and prepay part of its term loan. Share repurchases totaled $121 in the first nine months; the company announced a further $500 repurchase authorization in October.

Outlook, management commentary, and risks

• Management described the global recovery as cautiously optimistic, with modest growth in many non-transaction businesses and stronger U.S. IPO activity. It cautioned that economic instability could return, affecting volatility and trading volumes. The filing provides no specific numerical earnings or revenue guidance.
• Management expected operations and available revolving credit to fund operating expenses, capital spending, debt repayments, repurchases, and dividends in the near term. Funding cost and availability were described as healthy.
• Key business risks include competitive pressure on transaction pricing and market share, changes in trading volumes and listing demand, regulatory developments, technology demands, foreign-exchange exposure, and the ability to integrate acquisitions. A 10% adverse currency move was estimated to reduce nine-month revenue after transaction-related costs by about $52 and operating income by about $18, based on the disclosed sensitivities.
• Clearing operations involve substantial collateral and counterparty exposure: clearing-member contributions and margin deposits totaled $8.9 billion, including $6.4 billion of non-cash contributions. Nasdaq reported no recorded liability for its clearinghouse performance guarantee, which it assessed as nominal.
• Nasdaq was defending Facebook IPO-related proceedings, a high-frequency-trading class action, and market-data timing lawsuits; it said it could not estimate potential liability for the newer cases. The filing also discusses disputed Finnish and Swedish tax positions and pending appeals. Management expected no material impact from anticipated tax-audit settlements, but outcomes remain uncertain.
• Nasdaq disclosed approximately $1,706 of fees and a $2,343 prepaid deposit received during Q3 from a designated Armenian bank through its Armenian exchange subsidiary, and said it had voluntarily notified the U.S. government and sought authorization to wind down the activity.

Most important facts for investors to verify

1. How much of nine-month revenue and operating-income growth is sustainable and organic versus attributable to the eSpeed and Thomson Reuters acquisitions.
2. Whether the improvement in cash-equity share and listing activity can offset weaker derivatives, market-data, and other trading-related performance.
3. Debt repayment capacity and capital allocation after the expanded $500 repurchase authorization, dividends, and remaining debt maturities.
4. Potential cash, earnings, and reputational consequences of the litigation, tax disputes, clearing guarantees, and Armenian activity disclosed in the filing.
5. Foreign-currency sensitivity, particularly the concentration of foreign net assets in Swedish krona, and the effect of further currency movements.