UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended March 31, 2001 OR [ ] 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 _____ THE NASDAQ STOCK MARKET, INC. (Exact name of registrant as specified in its charter) Delaware 52-1165937 (State or other jurisdiction of incorporation (IRS Employer or organization) Identification No.) One Liberty Plaza 10006 New York, New York (Zip code) (Address of principal executive offices) (212) 858-4750 (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required 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 [ ] No [ X] As of July 31, 2001, 110,761,355 shares of the Registrant's Common Stock, par value $.01 per share, were outstanding (including 530,350 shares of restricted Common Stock awarded to officers and employees of the Registrant). THE NASDAQ STOCK MARKET, INC. FORM 10-Q For the Quarter Ended March 31, 2001 INDEX Part I. FINANCIAL INFORMATION Page Number Item 1. Financial Statements - (unaudited) Condensed Consolidated Statement of Operations - Three Months Ended March 31, 2001 and 2000.............................. 3 Condensed Consolidated Statement of Financial Condition - March 31, 2001 and December 31, 2000..... 4 Condensed Consolidated Statement of Cash Flows - Three Months Ended March 31, 2001 and 2000.............................. 6 Notes to Condensed Consolidated Financial Statements. 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations........ 15 Item 3. Quantitative and Qualitative Disclosure of Market Risk.......................................... 21 Part II. OTHER INFORMATION ----------------- Item 2. Changes in Securities and Uses of Proceeds ........... 22 Item 6. Exhibits and Reports on Form 8-K ..................... 23 Signatures ............................................................... 24 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 ability to implement its strategic initiatives, economic, political and market conditions and fluctuations, government and industry regulation, interest rate risk, U.S. and global competition, and other factors. 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. 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. THE NASDAQ STOCK MARKET, INC. PART I - FINANCIAL INFORMATION ITEM I Financial Statements -------------------- The Nasdaq Stock Market, Inc. Condensed Consolidated (Unaudited) Statement of Operations (In thousands, except share amounts) <TABLE> <CAPTION> Three months ended ------------------------------------- March 31, March 31, 2001 2000 ----------------- ----------------- Revenues: <S> <C> <C> Transaction services $ 110,794 $ 107,797 Market information services 63,156 61,618 Issuer services 38,304 34,323 Other 10,513 3,277 ----------------- ----------------- Total revenues 222,767 207,015 ----------------- ----------------- Expenses: Compensation and benefits 39,096 28,594 Marketing and advertising 6,702 17,258 Depreciation and amortization 20,777 12,851 Professional and contract services 16,789 10,250 Computer operations and data communications 41,472 27,152 Bad debt expense 10,056 1,093 Occupancy 6,131 3,084 Other 13,239 5,147 ----------------- ----------------- Total direct expenses 154,262 105,429 ----------------- ----------------- Support costs from related parties, net 26,411 25,795 ----------------- ----------------- Total expenses 180,673 131,224 ----------------- ----------------- Net operating income 42,094 75,791 Interest income 6,170 2,200 Interest expense (480) (483) Minority interest 217 - Provision for income taxes (21,808) (31,158) ----------------- ----------------- Net income before cumulative effect of change in accounting principle 26,193 46,350 ----------------- ----------------- Cumulative effect of change in accounting principle, net of taxes of $67,956 - (101,090) ----------------- ----------------- Net income (loss) $ 26,193 $ (54,740) ================ ================= Basic and diluted earnings per share before cumulative effect of change in accounting principle $ 0.21 $ 0.46 ================ ================= Basic and diluted earnings (loss) per share for change in accounting $ - $ (1.01) principle ================ ================= Basic and diluted earnings (loss) per share $ 0.21 $ (0.55) ================ ================= See accompanying notes. </TABLE> <TABLE> <CAPTION> THE NASDAQ STOCK MARKET, INC. Condensed Consolidated Statement of Financial Condition (Unaudited) (In thousands, except share amounts) March 31, December 31, 2001 2000 ----------------- ------------------ Assets Current assets: <S> <C> <C> Cash and cash equivalents $ 245,111 $ 262,257 Investments: Available-for-sale, at fair value 297,445 232,090 Held-to-maturity, at amortized cost 22,165 21,967 Receivables, net 220,354 172,660 Receivables from related parties 31,591 8,250 Deferred tax asset 35,738 32,367 Other current assets 16,952 14,869 ----------------- ------------------ Total current assets 869,356 744,460 ----------------- ------------------ Investments: Held-to-maturity, at amortized cost 6,539 6,612 Property and equipment: Land, buildings and improvements 82,194 80,727 Data processing equipment and software 392,648 370,066 Furniture, equipment and leasehold improvements 170,431 134,638 ----------------- ------------------ 645,273 585,431 Less accumulated depreciation and amortization (276,584) (252,380) ----------------- ------------------ Total property and equipment, net 368,689 333,051 Non-current deferred tax asset 60,505 61,257 Other assets 30,107 25,753 ----------------- ------------------ Total assets $ 1,335,196 $ 1,171,133 ================= ================== </TABLE> See accompanying notes. <TABLE> <CAPTION> THE NASDAQ STOCK MARKET, INC. Condensed Consolidated Statement of Financial Condition - (continued) (Unaudited) (In thousands, except share amounts) March 31, December 31, 2001 2000 ----------------- ------------------ Liabilities Current liabilities: <S> <C> <C> Accounts payable and accrued expenses $ 125,590 $ 117,867 Accrued personnel costs 19,236 37,273 Deferred revenue 126,761 66,178 Other accrued liabilities 56,224 35,374 Due to banks 9,744 13,876 Payables to related parties 18,730 19,158 ----------------- ------------------ Total current liabilities 356,285 289,726 Long-term debt 36,957 25,000 Accrued pension costs 12,403 10,390 Non-current deferred tax liability 39,470 32,116 Non-current deferred revenue 129,969 138,166 Other liabilities 28,981 15,033 ----------------- ------------------ Total long-term liabilities 247,780 220,705 Total liabilities 604,065 510,431 Minority interests 12,279 15,543 Stockholders' Equity Common stock, $.01 par value, 300,000,000 authorized, 128,692,543 issued and outstanding at March 31, 2001 and 123,663,746 issued and outstanding at December 31, 2000 1,287 1,237 Additional paid-in capital 318,041 273,387 Unrealized gains on available-for-sale investments, net of tax 3,840 321 Foreign currency translation (3,362) (2,213) Deferred stock compensation (6,527) - Common stock issuable 6,953 - Retained earnings 398,620 372,427 ----------------- ------------------ Total stockholders' equity 718,852 645,159 ----------------- ------------------ Total liabilities, minority interest and stockholders' equity $ 1,335,196 $ 1,171,133 ================= ================== </TABLE> See accompanying notes. <TABLE> <CAPTION> THE NASDAQ STOCK MARKET, INC. Condensed Consolidated Statement of Cash Flows (Unaudited) (In thousands, except share amounts) Three months ended ------------------------------------- March 31, March 31, 2001 2000 ----------------- ------------------ Cash flow from operating activities <S> <C> <C> Cash received from customers $ 230,624 $ 229,915 Cash paid to suppliers and employees (128,110) (91,004) Cash paid to related parties, net (51,946) (30,993) Income taxes paid (14,107) (16,862) Interest received, net 5,692 1,444 Other (5,806) (5,492) ----------------- ------------------ Cash provided by operating activities 36,347 87,008 ----------------- ------------------ Cash flow from investing activities Proceeds from redemptions of available-for-sale investments 62,925 15,134 Purchases of available-for-sale investments (126,793) (7,907) Purchases of held-to-maturity investments (125) (48) Acquisition, net of cash acquired 558 (16,979) Proceeds from sales of property and equipment 3,349 670 Purchases of property and equipment (32,963) (20,027) ----------------- ------------------ Cash used in investing activities (93,049) (29,157) ----------------- ------------------ Cash flow from financing activities Decrease in due to banks (4,132) (8,819) Net proceeds from Phase II private placement 63,688 - Repayment of joint venture interests in Nasdaq Europe Planning Company Limited (20,000) - ----------------- ------------------ Cash provided by (used in) financing activities 39,556 (8,819) ----------------- ------------------ Increase (decrease) in cash and cash equivalents (17,146) 49,032 Cash and cash equivalents at beginning of period 262,257 10,598 ----------------- ------------------ Cash and cash equivalents at end of period $ 245,111 $ 59,630 ================= ================== </TABLE> See accompanying notes. <TABLE> <CAPTION> THE NASDAQ STOCK MARKET, INC. Condensed Consolidated Statement of Cash Flows - (continued) (Unaudited) (In thousands, except share amounts) Three months ended ------------------------------------- March 31, March 31, 2001 2000 ----------------- ------------------ Reconciliation of net income (loss) to cash provided by operating activities <S> <C> <C> Net income (loss) 26,193 (54,740) Non-cash items included in net income (loss): Cumulative effect of change in accounting principle, net - 101,090 Depreciation and amortization 20,777 13,274 Stock-based compensation 426 - Minority interests (217) - Other non-cash adjustments included in net income 3,349 - Net change in: Receivables, net (46,834) (51,083) Receivables from related parties (23,341) (11,317) Deferred tax assets 3,237 (4,953) Other current assets (716) (3,393) Other assets (4,331) 184 Accounts payable and accrued expenses (6,448) 5,527 Accrued personnel costs (18,464) (13,989) Deferred revenue 52,192 73,692 Other accrued liabilities 20,709 30,689 Payables to related parties (428) 3,236 Accrued pension costs 2,013 1,074 Deferred tax liability 3,475 - Other liabilities 11,229 (2,283) ----------------- ------------------ Cash provided by operating activities $ 36,347 $ 87,008 ----------------- ------------------ </TABLE> See accompanying notes. THE NASDAQ STOCK MARKET, INC. Notes to Condensed Consolidated Financial Statements 1. Basis of Presentation The Nasdaq Stock Market, Inc. ("Nasdaq") is the parent company of Nasdaq Global Holdings ("Nasdaq Global"); Quadsan Enterprises, Inc.; Nasdaq Tools, Inc. ("Nasdaq Tools"); Nasdaq Investment Product Services, Inc.; and Nasdaq International Market Initiatives, Inc.; collectively referred to as Nasdaq. These entities are wholly owned by Nasdaq. Nasdaq is a subsidiary of the National Association of Securities Dealers, Inc. (the "NASD"). Nasdaq operates in one segment as defined in the Statement of Financial Accounting Standards ("SFAS") No. 131 "Disclosures About Segments of an Enterprise and Related Information." Nasdaq uses a multiple market maker system to operate an electronic, screen-based equity market. Nasdaq's principal business products are issuer, transaction, and market information services. The majority of this business is transacted with listed companies, market data vendors and firms in the broker-dealer industry within the United States. 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 U.S. Securities and Exchange Commission (the "SEC") with respect to the Form 10-Q and reflect all normal recurring adjustments which 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 generally accepted accounting principles, have been omitted. It is recommended that these financial statements be read in conjunction with the Condensed Consolidated Financial Statements for the twelve months ended December 31, 2000 included in Nasdaq's Registration Statement filed on Form 10, as amended. Nasdaq plans to file promptly an amendment to its Registration Statement on Form 10 to give effect to the matters described in Note 3 below. 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 prior period amounts reflect reclassifications to conform to the current period's presentation. 2. Significant Transactions Phase II Private Placement The NASD's plan to broaden the ownership in Nasdaq was executed through a two-phase private placement (1) by Nasdaq of newly-issued shares of Nasdaq's common stock, par value $0.01 per share (the "Common Stock"), and (2) by the NASD of shares of outstanding Common Stock and warrants to purchase outstanding shares of Common Stock owned by the NASD. The second phase of the private placement closed on January 18, 2001 with Nasdaq selling approximately 5.0 million shares, yielding net proceeds of approximately $63.7 million. As of May 4, 2001, the NASD owned approximately 70.0% of Nasdaq. On a fully-diluted basis, the NASD's ownership would be decreased to approximately 28.0%. THE NASDAQ STOCK MARKET, INC. Notes to Condensed Consolidated Financial Statements 2. Significant Transactions (continued) Nasdaq Europe S.A./N.V. On March 27, 2001, Nasdaq acquired a majority ownership interest in the European Association of Securities Dealers Automated Quotation S.A./N.V., a pan-European stock market headquartered in Brussels, for approximately $12.5 million. Nasdaq has renamed the company Nasdaq Europe S.A./N.V. ("Nasdaq Europe") and plans to restructure it into a globally linked, pan-European market. Nasdaq's acquisition has been accounted for under the purchase method of accounting, resulting in the recording of goodwill of approximately $4.9 million that is reflected in other assets on the Condensed Consolidated Statement of Financial Condition. Nasdaq Europe Planning Company Limited In February and March 2001, Nasdaq repurchased the ownership interests of certain minority shareholders in Nasdaq Europe Planning Company Limited for a total of $20.0 million as the proposed joint venture was abandoned, due to the acquisition of Nasdaq Europe described above. LIFFE In March 2001, Nasdaq entered into a non-binding letter of intent with the London International Financial Futures and Options Exchange ("LIFFE") to create a U.S. joint venture company to list and trade single stock futures. The products of this joint venture are expected to be traded through a modified version of the LIFFE CONNECT(TM) electronic system. Nasdaq has committed up to $15.0 million plus the rights to use certain trademarks in this venture. 3. Change in Accounting Principle On August 17, 2001, Nasdaq concluded discussions with the SEC with respect to the implementation in its financial statements of Staff Accounting Bulletin 101, "Revenue Recognition in Financial Statements" ("SAB 101"), which became effective for SEC public reporting companies in the fourth quarter of 2000. Nasdaq became a SEC public reporting company on June 29, 2001, the effective date of its Registration Statement on Form 10. As a result of the discussions with the SEC, Nasdaq changed its method of accounting for revenue recognition for certain components of its issuer services revenues. In accordance and consistent with generally accepted accounting principles, as SAB 101 was adopted effective the fourth quarter of 2000, the change in accounting principle has been applied as of January 1, 2000. In accordance with applicable accounting guidance prior to SAB 101, Nasdaq recognized revenue for issuer initial listing fees and listing of additional shares ("LAS") fees in the month the listing occurred or in the period additional shares were issued, respectively. Nasdaq now recognizes revenue related to initial listing fees and LAS fees on a straight line basis over estimated service periods, which are six and four years, respectively. As a result of this change in accounting principle, first quarter 2000 pro forma net income, excluding the cumulative effect of the change in accounting principle on prior years' results, decreased $7.3 million ($0.07 per share) to $46.4 million ($0.46 per share). In addition, Nasdaq recognized a one-time cumulative effect of a change in accounting principle in the first quarter of 2000. This cumulative effect of a change in accounting principle decreased net income in the first quarter 2000 by $101.1 million ($1.01 per share) resulting in a $54.7 million ($0.55 per share) net loss. The adjustment to first quarter 2000 net income for the cumulative change to prior years' results consists of the following: THE NASDAQ STOCK MARKET, INC. Notes to Condensed Consolidated Financial Statements 3. Change in Accounting Principle (continued) (amounts in millions) Deferred initial listing fees $ 108.5 Deferred LAS fees 60.6 ------ Total deferred fees 169.1 Deferred income tax benefit (68.0) ------ Cumulative effect of change in accounting principle $ 101.1 ====== For the three months ended March 31, 2001 and 2000, Nasdaq recognized $12.3 million and $15.0 million in revenue, respectively, that was included in the cumulative effect adjustment as of January 1, 2000. This revenue contributed $7.4 million (after income taxes of $4.9 million) and $9.0 million (after income taxes of $6.0 million) to net income for the three months ended March 31, 2001 and 2000, respectively. 4. Deferred Revenue The Company's deferred revenue as of March 31, 2001 relating to issuer services fees will be recognized in the following years: <TABLE> <CAPTION> (amounts in thousands) Fiscal year ended Initial LAS Annual Total -------------- -------------- ----------------- ------------- <S> <C> <C> <C> <C> 2001 $ 26,045 $ 23,798 $62,108 $111,951 2002 30,358 24,220 - 54,578 2003 25,717 17,322 - 43,039 2004 20,991 6,770 - 27,761 2005 and thereafter 19,264 137 - 19,401 -------------- -------------- ----------------- ------------- $ 122,375 $ 72,247 $62,108 $256,730 ============== ============== ================= ============= </TABLE> Nasdaq's deferred revenue for the quarters ended March 31, 2001 and 2000 is reflected in the following tables. The additions reflect the issuer services fees charged during the quarter while the amortization reflects the issuer services fee revenues recognized during the period based on the accounting methodology described in Note 3 above. <TABLE> <CAPTION> (amounts in thousands) Initial LAS Annual Total -------------- --------------- -------------- ------------- <S> <C> <C> <C> <C> Balance at January 1, 2001 $127,693 $76,651 $ - $204,344 Additions 3,711 4,409 82,570 90,690 Amortization (9,029) (8,813) (20,462) (38,304) -------------- --------------- -------------- ------------- Balance at March 31, 2001 $122,375 $72,247 $62,108 $256,730 ============== =============== ============== ============= </TABLE> <TABLE> <CAPTION> THE NASDAQ STOCK MARKET, INC. Notes to Condensed Consolidated Financial Statements 4.Deferred Revenue (continued) (amounts in thousands) Initial LAS Annual Total -------------- -------------- -------------- ------------- <S> <C> <C> <C> <C> Balance at January 1, 2000 $ 108,476 $60,570 $ - $ 169,046 Additions 15,094 12,977 77,488 105,559 Amortization (7,926) (7,824) (18,573) (34,323) -------------- -------------- -------------- ------------- Balance at March 31, 2000 $ 115,644 $65,723 $58,915 $ 240,282 ============== ============== ============== ============= </TABLE> 5. Long-term debt During the three months ended March 31, 2001, Nasdaq's consolidated long-term debt increased by approximately $12.0 million to $37.0 million. The increase reflects the long-term debt of Nasdaq Europe, $3.0 million of which matures in 2003 with the remaining $9.0 million maturing in 2004. The debt is Euro-denominated with $4.0 million containing contractual fixed interest rates and $8.0 million containing interest rates based on a fixed premium above London Interbank Offered Rates. 6. Commitments and Contingencies In October 2000, Nasdaq entered into a contract with OptiMark, Inc. under which OptiMark was engaged to provide software development services in connection with the development of the SuperMontage system. Nasdaq will pay OptiMark for the SuperMontage development for a period not to exceed 12 months. Additionally, OptiMark will be entitled to receive incentive payments if it meets certain delivery milestones agreed to in the contract. If Nasdaq uses OptiMark's services for the full 12 months of expected development effort and OptiMark meets all of its deliverables, Nasdaq will be required to pay up to $14.9 million. Nasdaq may be subject to claims arising out of the conduct of its business. Currently, there are certain legal proceedings pending against Nasdaq. Management 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. THE NASDAQ STOCK MARKET, INC. Notes to Condensed Consolidated Financial Statements 7. Comprehensive Income Comprehensive income is calculated in accordance with Statement of Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income." Comprehensive income combines net income and certain items that directly affect stockholders' equity, such as foreign currency translation adjustments. The components of comprehensive income for the three months ended March 31, 2001 and 2000 were as follows: <TABLE> <CAPTION> (amounts in millions) Three months ended March 31, 2001 March 31, 2000 -------------------- --------------------- <S> <C> <C> Net income (loss) $ 26.2 $ (54.7) Unrealized gains on available-for-sale investments 3.5 (0.7) Foreign currency translation adjustment (1.1) - -------------------- --------------------- Total comprehensive income (loss) $ 28.6 $ (55.4) ==================== ===================== </TABLE> 8. Capital Stock and Earnings Per Share In February 2001, Nasdaq granted 9,659,290 stock options and 534,850 shares of restricted Common Stock to certain employees and officers pursuant to its Equity Incentive Plan. Under the plan, Nasdaq is entitled to grant stock options with an exercise price equal to the fair market value of the stock at the date of the grant. Nasdaq is authorized to issue up to 20.0 million shares under the plan. Nasdaq accounts for stock option grants in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," ("APB No. 25") and accordingly, recognizes no compensation expense related to such grants. The options vest over a period of three years and are exercisable over a ten-year period. Restricted stock awards are awarded in the name of the employee or officer at fair value at the date of the grant. The awards contain restrictions on sales and transfers, and are subject to a five-year vesting period. The 534,850 shares of restricted stock were awarded at a fair value of $13.00 per share, and are being expensed over the vesting period. THE NASDAQ STOCK MARKET, INC. Notes to Condensed Consolidated Financial Statements 8. Capital Stock and Earnings Per Share (continued) The following table sets forth the computation of basic and diluted earnings per share: <TABLE> <CAPTION> Three months ended ----------------------------- March 31, March 31, ----------- ---------- (amounts in thousands, except share and per share data) 2001 2000 ----------- ---------- Numerator: <S> <C> <C> <C> Net income before cumulative effect of change in accounting principle $ 26,193 $ 46,350 Numerator for basic and diluted earnings per share before cumulative effect of change in accounting principle 26,193 46,350 Cumulative effect of change in accounting principle, net of taxes - (101,090) Numerator for basic and diluted earnings per share for accounting change - (101,090) Net income (loss) 26,193 (54,740) Numerator for basic and diluted earnings per share after cumulative effect of change in accounting principle 26,193 (54,740) Denominator: Weighted average shares 127,742,659 100,000,000 Denominator for basic earnings per share 127,742,659 100,000,000 Effect of dilutive securities: Employee restricted stock 32,757 - Denominator for diluted earnings per share 127,775,416 100,000,000 Basic earnings per share before cumulative effect of change in accounting principle $ 0.21 $ 0.46 Diluted earnings per share before cumulative effect of change in accounting principle $ 0.21 $ 0.46 =============== =============== Basic earnings (loss) per share for accounting adjustment - $ (1.01) =============== =============== Diluted earnings (loss) per share for accounting adjustment - $ (1.01) =============== =============== Basic earnings (loss) per share $ 0.21 $ (0.55) =============== =============== Diluted earnings (loss) per share $ 0.21 $ (0.55) =============== =============== </TABLE> The option awards granted during the first quarter of 2001 were not included in computing diluted earnings per share as their effect was not dilutive. THE NASDAQ STOCK MARKET, INC. Notes to Condensed Consolidated Financial Statements 9. Subsequent Events Debt issuance On May 3, 2001, Nasdaq issued and sold $240.0 million in aggregate principal amount of its 4% convertible subordinated debentures due 2006 (the "Subordinated Debentures") to Hellman & Friedman Capital Partners IV, L.P. and certain of its affiliated limited partnerships (collectively, "Hellman & Friedman"). The annual 4% coupon will be payable in arrears in cash and the Subordinated Debentures will be convertible at any time into 12.0 million shares of Common Stock at $20.00 per share, subject to adjustment. On a fully diluted basis, Hellman & Friedman owns an approximate 9.8% equity interest in Nasdaq. Nasdaq has agreed to use its best efforts to seek stockholder approval of a charter amendment that would provide for voting debt in order to permit holders of Subordinated Debentures to vote on an as-converted basis on all matters on which common stockholders have the right to vote, subject to the current five percent voting limitation in Nasdaq's Restated Certificate of Incorporation. Nasdaq has granted Hellman & Friedman certain registration rights with respect to the shares of Common Stock underlying the Subordinated Debentures. Additionally, Hellman & Friedman is permitted to designate one person reasonably acceptable to Nasdaq for nomination as a director of Nasdaq for so long as Hellman & Friedman owns Subordinated Debentures and/or shares of Common Stock issued upon conversion representing at least 50% of the shares of Common Stock issuable upon conversion of the Subordinated Debentures initially purchased. Effective May 3, 2001, F. Warren Hellman was elected to Nasdaq's Board of Directors pursuant to the foregoing provision. Treasury stock repurchase On May 3, 2001, Nasdaq used the net proceeds from the sale of the Subordinated Debentures to purchase 18,461,538 shares of Common Stock from the NASD for $13.00 per share or an aggregate purchase price of approximately $240.0 million. THE NASDAQ STOCK MARKET, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion of the financial condition and results of operations of Nasdaq should be read in conjunction with the condensed consolidated financial statements and notes thereto included elsewhere in this Form 10-Q. Change in Accounting Principle On August 17, 2001, Nasdaq concluded discussions with the SEC with respect to the implementation in its financial statements of SAB 101. SAB 101 became effective for SEC public reporting companies in the fourth quarter of 2000. Nasdaq became an SEC public reporting company on June 29, 2001, the effective date of its Registration Statement on Form 10. As a result of the discussions with the SEC, Nasdaq changed its method of accounting for revenue recognition for certain components of its issuer services revenues. In accordance and consistent with generally accepted accounting principles, as SAB 101 was adopted effective the fourth quarter of 2000, the change in accounting principle has been applied as of January 1, 2000. In accordance with applicable accounting guidance prior to SAB 101, Nasdaq recognized revenue for issuer initial listing fees and LAS fees in the month the listing occurred or in the period additional shares were issued, respectively. Nasdaq now recognizes revenue related to initial listing fees and LAS fees on a straight line basis over estimated service periods, which are six and four years, respectively. As a result of this change in accounting principle, first quarter 2000 net income, excluding the cumulative effect of the change in accounting principle on prior year's results, decreased $7.3 million ($0.07 per share) to $46.4 million ($0.46 per share). In addition, Nasdaq recognized a one-time cumulative effect of a change in accounting principle in the first quarter of 2000. This cumulative effect of a change in accounting principle decreased net income in the first quarter 2000 by $101.1 million ($1.01 per share) resulting in a $54.7 million ($0.55 per share) net loss. The adjustment to first quarter 2000 net income for the cumulative change to prior years' results consists of the following: (amounts in millions) Deferred initial listing fees $ 108.5 Deferred LAS fees 60.6 -------- Total deferred fees 169.1 Deferred income tax benefit (68.0) -------- Cumulative effect of change in accounting principle $ 101.1 ======== For the three months ended March 31, 2001 and 2000, Nasdaq recognized $12.3 million and $15.0 million in revenue, respectively, that was included in the cumulative effect adjustment as of January 1, 2000. This revenue contributed $7.4 million (after income taxes of $4.9 million) and $9.0 million (after income taxes of $6.0 million) to net income for the three months ended March 31, 2001 and 2000, respectively. THE NASDAQ STOCK MARKET, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations Change in Accounting Principle (continued) The following table compares net income under the previous accounting method to net income under the new accounting method: <TABLE> <CAPTION> Three months ended Three months ended (amounts in millions) March 31, 2001 March 31, 2000 ----------------------- ---------------------- <S> <C> <C> Net income, before implementation of SAB 101 $ 20.9 $ 53.7 Increase due to recognition of prior period fees, included in the cumulative effect adjustment as of January 1, 2000, net of taxes 7.4 9.0 Increase due to recognition of prior period fees, subsequent to the cumulative effect adjustment, net of taxes 3.1 - Decrease due to deferral of current period fees, net of taxes (5.2) (16.3) Cumulative effect of change in accounting principle, net of taxes - (101.1) ----------------------- ---------------------- Net income (loss) $ 26.2 $ (54.7) ======================= ====================== </TABLE> Business Environment Despite market fluctuations, Nasdaq experienced record average daily share volume in the first quarter of 2001 of 2.1 billion shares per day compared to 1.8 billion shares per day in the first quarter of 2000, a 16.7% increase. However, a general downward trend in the market and an uncertain and slowing economy led to a slowing in the number of initial public offerings ("IPOs"), higher delistings, and fewer listed companies issuing additional shares. During the remainder of 2001, all revenue sources may face challenging environments. Daily share volume growth is expected to flatten, while the number of IPOs is expected to remain down from a year ago. In addition, pressure to restructure and reduce transaction and market information service fees is anticipated to continue. The combination of these factors could result in flat or declining revenues for the year. Results of Operations For the Three Months Ended March 31, 2001 and 2000 - -------------------------------------------------- Nasdaq reported net income of $26.2 million for the quarter ended March 31, 2001, compared to a loss of $54.7 million (including the cumulative effect of the change in accounting) for the quarter ended March 31, 2000. Compared to pro forma net income for the first quarter of 2000 of $46.4 million, net income decreased by $20.2 million, or 43.5%. Revenues Nasdaq's revenues increased from $207.0 million for the quarter ended March 31, 2000 to $222.8 million for the quarter ended March 31, 2001, a 7.6% increase. Transaction Services For the quarter ended March 31, 2001, transaction services revenues of $110.8 million increased $3.0 million from $107.8 million for the quarter ended March 31, 2000, an increase of 2.8%. Transaction services consist of SelectNet, Small Order Execution System ("SOES(sm)"), Automated Confirmation Transaction Service ("ACT(sm)"), the Nasdaq Workstation II, and other related execution services. THE NASDAQ STOCK MARKET, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations Revenues (continued) SelectNet, the high-volume automated execution service, provided revenues of $32.4 million, an increase of $3.5 million or 12.1% for the quarter ended March 31, 2001 from $28.9 million for the quarter ended March 31, 2000, due to an increase in trade volume. SelectNet fees are charged on a per transaction basis. SOES, a system providing for the automatic execution of small orders, provided revenues of $9.7 million, an increase of $1.8 million or 22.8% for the quarter ended March 31, 2001 from $7.9 million for the quarter ended March 31, 2000, due to an increase in volume of SOES executions. SOES fees are charged on a per transaction basis. ACT, an automated service that provides the post-execution steps of reporting price, volume comparison and clearing of pre-negotiated trades as well as risk management services, provided revenues of $25.1 million, a decrease of $8.3 million or 24.9% for the quarter ended March 31, 2001 from $33.4 million for the quarter ended March 31, 2000, due to various pricing changes enacted subsequent to March 31, 2000. These changes include a cap on risk management fees, price reductions on certain existing services, and a rule change that eliminated charges for certain transactions. The Nasdaq Workstation II is the trader's direct connection to Nasdaq's quote and trade execution facilities, providing quotation services, automated trade executions, real-time reporting, trade negotiations and clearing. This trading device, along with application programming interfaces, provided revenues of $36.3 million, an increase of $8.6 million or 31.1% for the quarter ended March 31, 2001 from $27.7 million for the quarter ended March 31, 2000. This increase is due to a larger customer base as well as higher fees associated with expanded network capacity. Nasdaq Workstation II fees are charged monthly based upon the number of authorized logon identifications. Market Information Services For the quarter ended March 31, 2001, market information services revenues of $63.2 million increased $1.6 million from $61.6 million for the quarter ended March 31, 2000, or 2.6%. Market information services consist of Nasdaq's Level 1 service, Nasdaq Quotation Dissemination Service, Nasdaq InterMarket tape revenues and other related services. Nasdaq's Level 1 service provides subscribers with the current inside quote and most recent price at which the last sale or purchase was transacted for a specific security. Fees for professional users are based on monthly subscriptions to terminals or access lines. Non-professional users have the option to access this information through either a flat monthly rate or a per query usage charge. Level 1 revenues increased by approximately $1.4 million or 3.7% to $38.8 million for the quarter ended March 31, 2001 from $37.4 million for the quarter ended March 31, 2000. This increase was driven by increased demand for the professional service offset by a decrease in demand for the non-professional per query service. Nasdaq Quotation Dissemination Service provides subscribers with the quotes of each individual market maker and electronic communication networks, in addition to the inside quotes and last transaction prices. Nasdaq Quotation Dissemination Service revenues decreased by approximately $2.2 million or 12.4% to $15.6 million for the quarter ended March 31, 2001 from $17.8 million for the quarter ended March 31, 2000. This reduction reflects the introduction of the non-professional service fee. Although the number of subscribers increased in total, those eligible for the new reduced non-professional fee led to a decrease in total revenues. THE NASDAQ STOCK MARKET, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations Market Information Services (continued) Nasdaq InterMarket tape revenues are derived from data revenue generated by the Consolidated Quotation Plan and Consolidated Tape Association Plan (collectively, the "CQ/CTA Plans"). The information collected under the CQ/CTA Plans is sold to data vendors, who in turn sell it to the public. Nasdaq's InterMarket revenue is directly related to the percentage of trades in exchange listed securities that are executed in a Nasdaq facility and reported through the CQ/CTA Plans. Nasdaq InterMarket tape revenues increased by approximately $2.3 million or 38.3% to $8.3 million for the quarter ended March 31, 2001, from $6.0 million for the quarter ended March 31, 2000. Issuer Services Issuer services revenues increased to $38.3 million for the quarter ended March 31, 2001 from $34.3 million for the quarter ended March 31, 2000, an increase of $4.0 million or 11.7%. Issuer revenues are derived from fees for initial listings, LAS, and annual fees for companies listed on Nasdaq. Fees are generally calculated based upon total shares outstanding for the issuing firm. These fees are initially deferred and amortized over the estimated periods for which the services are provided. Revenues from initial listings and listings of additional shares are amortized over six and four years, respectively, and annual fees are amortized on a pro-rata basis over the calendar year. Initial listing revenues increased $1.1 million or 13.9% from $7.9 million in the quarter ended March 31, 2000 to $9.0 million in the quarter ended March 31, 2001. LAS revenue increased $1.0 million or 12.8% from $7.8 million in the quarter ended March 31, 2000 to $8.8 million in the quarter ended March 31, 2001. Excluding the cumulative effect of prior period revenue from the change in accounting principle described in Note 3, revenues from the initial listings and LAS decreased. Actual initial listing and LAS fees charged during the quarter ended March 31, 2001 decreased due to significantly reduced IPO activity and capital raising activity by current issuers. The amortization of deferred initial and LAS fees exceeded new fees charged during the quarter ended March 31, 2001 by $9.7 million due to the significant decrease in initial listings on Nasdaq from 165 companies in the quarter ended March 31, 2000 to 31 companies in the quarter ended March 31, 2001. Annual revenues increased by $1.9 million or 10.2% from $18.6 million for the quarter ended March 31, 2000 to $20.5 million for the quarter ended March 31, 2001. Other Revenues Other revenues for the quarter ended March 31, 2001 totalled $10.5 million, up significantly from $3.3 million in the first quarter of 2000, an increase of 218.2%. This growth is primarily attributable to increased revenues related to the Nasdaq 100 Trust and the incorporation of Nasdaq Tools. Direct Expenses Direct expenses increased 46.4% to $154.3 million for the first quarter of 2001 from $105.4 million for the first quarter of 2000. THE NASDAQ STOCK MARKET, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations Direct Expenses (continued) Compensation and benefits expense increased $10.5 million or 36.7% to $39.1 million for the quarter ended March 31, 2001 from $28.6 for the quarter ended March 31, 2000. The increase is due to a number of factors, including the transfer of positions from the NASD associated with the restructuring, new positions required to support strategic initiatives, and new positions required to support expanded market operations. Marketing and advertising expense decreased $10.6 million to $6.7 million for the first quarter of 2001 from $17.3 million for the first quarter of 2000, a decrease of 61.3%, due to the elimination of the spring advertising campaign. Depreciation and amortization expense increased $7.9 million or 61.2% to $20.8 million for the quarter ended March 31, 2001 from $12.9 million for the quarter ended March 31, 2000 due to a higher overall asset base to support capacity growth for increase in daily volume and hardware to begin development of SuperMontage. Professional and contract services expense increased to $16.8 million for the first quarter of 2001 from $10.3 million for the first quarter of 2000, an increase of $6.5 million or 63.1%, in support of SuperMontage and Primex development, future technology design planning, and potential acquisitions. SuperMontage is an improved user interface designed to refine how market participants can access, process, display, and integrate orders and quotes in Nasdaq. Primex is a new electronic trading platform. Computer operations and data communications expense increased to $41.5 million for the first quarter of 2001 from $27.2 million for the first quarter of 2000, an increase of $14.3 million or 52.6%. The computer operations component of the costs increased $4.3 million from the first quarter of 2000 to the first quarter of 2001 due to increases in maintenance to support a larger asset, base which is required to support higher transaction levels. Data communications costs increased $10.0 million due to increased charges for upgraded bandwidth and processing speed that is commensurate with the increase in Nasdaq Workstation II revenues as discussed above. Bad debt expense increased to $10.1 million for the first quarter of 2001 from $1.1 million for the first quarter of 2000 reflecting an increase in bad debt reserves commensurate with growth in Nasdaq's account receivables and a reserve relating to the bankruptcy filing by Bridge Information Systems, Inc. Occupancy costs increased $3.0 million to $6.1 million for the first quarter of 2001 from $3.1 million for the first quarter of 2000 primarily due to an increase in occupancy costs related to Nasdaq's new corporate offices located at One Liberty Plaza, New York, NY and the addition of office space in Trumbull, CT. The remaining direct expenses increased $8.1 million to $13.2 million for the quarter ended March 31, 2001 from $5.1 million for the quarter ended March 31, 2000, due primarily to foreign losses and also to increased education, training, travel and supply expenses from the expanded Nasdaq workforce. THE NASDAQ STOCK MARKET, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations Support Costs Support costs from related parties increased by $0.6 million to $26.4 million for the quarter ended March 31, 2001 from $25.8 million for the quarter ended March 31, 2000. Surveillance and other regulatory charges from NASD Regulation, Inc. increased by $1.0 million or 5.6% to $18.9 million for the quarter ended March 31, 2001 from $17.9 million for the quarter ended March 31, 2000. Support costs from the NASD decreased $1.3 million or 12.3% to $9.3 million for the quarter ended March 31, 2001 from $10.6 million for the quarter ended March 31, 2000. In addition, the reduction in the amount of Nasdaq costs charged to the American Stock Exchange, LLC of $0.9 million to $1.8 million for the quarter ended March 31, 2001 from $2.7 million for the quarter ended March 31, 2000 contributed to the increase in support costs. Amounts charged to related parties are netted against charges from related parties in the "Support cost from related parties, net" line item on the Condensed Consolidated Statements of Operations. Income Taxes Nasdaq's income tax provision was $21.8 million for the first quarter of 2001 versus $31.2 million for the first quarter of 2000. The effective tax rate was 45.4% for the first quarter of 2001 compared to 40.2% for the first quarter of 2000. The increase in Nasdaq's effective tax rate was primarily due to its foreign losses for which no tax benefit is taken. Liquidity and Capital Resources March 31, 2001 compared to December 31, 2000 Cash and cash equivalents and available-for-sale securities totaled $542.6 million at March 31, 2001, an increase of $48.3 million from $494.3 million at December 31, 2000. Working capital increased $58.1 million to $490.9 million as of March 31, 2001, from $432.8 million as of December 31, 2000. Cash and cash equivalents decreased $17.1 million from December 31, 2000 to $245.1 million as of March 31, 2001, primarily due to cash used in investing activities of $93.0 million, partially offset by cash provided by operating activities of $36.3 million and cash provided by financing activities of $39.6 million. For the quarter ended March 31, 2001, operating activities provided net cash inflows of $36.3 million, primarily due to cash received from customers of $230.6 million less cash paid to suppliers, employees, and related parties of $180.1 million and income taxes paid of $14.1 million. Net cash used in investing activities was $93.0 million for the quarter ended March 31, 2001, due in part to capital expenditures related to SuperMontage, Primex, global initiatives and general capacity increases. The remaining cash used in investing activities is attributable to purchases of investments with the proceeds of the private placement offering and receipts from the sales and maturities of investments. Cash provided by financing activities was approximately $39.6 million for the quarter ended March 31, 2001, primarily due to the net proceeds received from the second phase of Nasdaq's private placement offering that equaled approximately $63.7 million. Offsetting these proceeds was the repayment of approximately $20.0 million to the venture partners who participated in Nasdaq Europe Planning Company Limited. Nasdaq will use the proceeds to invest in new technology, implement and form strategic alliances, implement competitive pricing of its services, and build its brand through marketing programs. THE NASDAQ STOCK MARKET, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations March 31, 2001 compared to December 31, 2000 (continued) Additionally, in connection with the sale of its Subordinated Debentures to Hellman & Friedman on May 3, 2001, Nasdaq yielded net proceeds of approximately $240.0 million. Nasdaq used the proceeds to purchase 18,461,538 shares of common stock from the NASD for $13.00 per share for an aggregate purchase price of approximately $240.0 million. Nasdaq believes that the liquidity provided by existing cash and cash equivalents, investments, and cash generated from operations will provide sufficient capital to meet both short and long term operating requirements. Quantitative and Qualitative Disclosure of Market Risk Nasdaq is exposed to potential loss from financial market risks that may occur as a result of changes in interest rates. Its exposure to these risks has not materially changed since December 31, 2000. For a further discussion, refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations - Quantitative and Qualitative Disclosure About Market Risk" included in Nasdaq's Form 10 for the year ended December 31, 2000, as amended. THE NASDAQ STOCK MARKET, INC. PART II - OTHER INFORMATION ITEM 2 Changes in Securities and Use of Proceeds ----------------------------------------- (c) On January 18, 2001, Nasdaq sold an aggregate of 5,028,797 shares of Common Stock at $13.00 per share yielding aggregate gross proceeds of $65,374,361 to investors consisting of NASD members, issuers with securities listed on Nasdaq and institutional investment firms. No underwriter was used in the private placement. The number of shares of Common Stock offered to each category of investor was based upon a variety of factors, including the offeree's contributions to Nasdaq's growth. The shares of Common Stock sold by Nasdaq were issued to "accredited investors" in private transactions exempt under Regulation D of the Securities Act of 1933, as amended. THE NASDAQ STOCK MARKET, INC. PART II - OTHER INFORMATION ITEM 6 Exhibits and Reports on Form 8-K -------------------------------- (a) Exhibits: The following exhibit is filed as part of this Quarterly Report. 11.01 Computation of Per Share Earnings (omitted in accordance with section (b)(11) of Item 601 of Regulation S-K. The calculation of per share earnings is set forth in Part I, Item 1, in Note 8 to the Condensed Consolidated Financial Statements (Capital Stock and Earnings Per Share). (b) Reports on Form 8-K: Nasdaq did not file any reports on Form 8-K during the three months ended March 31, 2001. Signatures - ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. THE NASDAQ STOCK MARKET, INC. (Registrant) Date: August 20, 2001 By: /s/ David P. Warren -------------------------- Name: David P. Warren Title: Executive Vice President and Acting Chief Financial Officer Date: August 20, 2001 By: /s/ Edward S. Knight --------------------------- Name: Edward S. Knight Title: Executive Vice President and General Counsel