Overview

The following discussion and analysis of the financial condition and results of operations of Nasdaq should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included elsewhere in this Form 10-Q. Certain prior period amounts presented in the discussion and analysis have been reclassified to conform to the 2004 presentation.

This discussion and analysis may contain statements with respect to Nasdaq's financial condition, results of operations, future performance and business that are considered "forward-looking statements" as defined in the Private Securities Litigation Reform Act of 1995. Nasdaq's actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth under "Item 1. Business-Risk Factors" in The Nasdaq Stock Market, Inc.'s Annual Report on Form 10-K for the year ended December 31, 2003.

Nasdaq operates The Nasdaq Stock Market, the largest electronic screen-based equity securities market in the United States. In 2003, Nasdaq changed its organization structure from operating in one segment to operating in two segments. Under the new structure, Nasdaq's Chief Executive Officer has been identified as the Chief Operating Decision Maker as defined by SFAS 131. Nasdaq's two segments are managed and operated as strategic business units and organized by products and services. Reportable segments are Market Services and Issuer Services.

Market Services includes collecting, processing and disseminating price quotes of Nasdaq-listed securities, the routing and execution of buy and sell orders for Nasdaq-listed and exchange-listed securities and transaction reporting services. Market Services also provides price quotes and trade information to data vendors, who in turn sell the information to the public. Market participants in The Nasdaq Stock Market, consisting of market makers, ECNs, registered stock exchanges and order entry firms, are users of Nasdaq's Market Services. In March 2004, Nasdaq rebranded its execution services and ACT services as the Nasdaq Market Center, which is within the Market Services segment. The Nasdaq Market Center includes Nasdaq's quoting, trading and trade reporting services for both Nasdaq-listed and exchange-listed securities. Revenues from execution systems previously known as SuperMontage and CAES and revenues from the system previously known as ACT are included in the Nasdaq Market Center. Beginning with the quarter ended June 30, 2004 revenues from Access Services, ACES and Nasdaq InterMarket (revenues derived from the sale of tape data (Tape Fee revenues) for NYSE-listed and Amex-listed securities) were also included with Nasdaq Market Center revenues as these products and services are considered transaction-based services. In addition, revenues from Nasdaq's Level 1 Service, NQDS, TotalView and MFQS were rebranded as Nasdaq Market Services Subscription revenues as these products and services are considered subscription-based services. Revenues from SuperMontage, CAES, ACT, Access Services and ACES were previously reported as Transaction Services within the Market Services segment. Revenues from Nasdaq InterMarket, Level 1 Service, NQDS, TotalView and MFQS were previously reported as Market Information Services within the Market Services segment.

Issuer Services includes the Corporate Client Group and Nasdaq Financial Products. The Corporate Client Group provides customer services and information products to Nasdaq-listed companies and is responsible for obtaining new listings on The Nasdaq Stock Market. Nasdaq Financial Products is responsible for introducing products that extend and enhance the Nasdaq brand. Nasdaq Financial Products oversees the development and marketing of new Nasdaq financial products and associated derivatives, the licensing and listing of third-party structured products and the listing of third-party sponsored exchange traded funds.

For the three months ended June 30, 2004, Nasdaq's net income was $4.8 million compared with a net loss $49.0 million for the three months ended June 30, 2003, an increase of $53.8 million. For the six months ended June 30, 2004, Nasdaq's net income was $9.4 million compared with a net loss of $46.4 million for the six months ended June 30, 2003, an increase of $55.8 million. Included in the results for the three and six months ended June 30, 2003 was a net loss of $16.6 million and $19.9 million, respectively, from discontinued operations related to the transfer of Nasdaq's interest in Nasdaq Europe and the sale of IndigoMarkets. Accordingly, results from these subsidiaries have been reclassified as discontinued operations in Nasdaq's Condensed Consolidated Statements of Income for the three and six months ended June 30, 2003. See Note 3, "Discontinued Operations," to the condensed consolidated financial statements for further discussion.

The remainder of this discussion and analysis reflects results from continuing operations, unless otherwise noted. On this basis, Nasdaq's net income from continuing operations was $4.8 million and $9.4 million for the three and six months ended June 30, 2004, respectively, compared with a net loss of $32.4 million and $26.5 million for the three and six months ended June 30, 2003, respectively, an increase of $37.2 million and $35.9 million, respectively. For the three and six months ended June 30, 2004, results were positively impacted by lower operating expenses from corporate-wide cost reduction programs and Nasdaq's 2003 strategic review, which resulted in charges recorded during 2003.
Total expenses were $111.4 million and $231.3 million for the three and six months ended June 30, 2004, respectively, compared with $189.5 million and $341.8 million for the three and six months ended June 30, 2003, respectively, a decrease of $78.1 million or 41.2% and $110.5 million or 32.3%, respectively. However, total revenues decreased $27.6 million or 18.7% to $120.0 million for the three months ended June 30, 2004 compared with $147.6 million for the three months ended June 30, 2003 and total revenues decreased $61.6 million or 19.9% to $248.4 million for the six months ended June 30, 2004 compared with $310.0 million for the six months ended June 30, 2003. Continued competitive pressure resulted in lower market share, a decline in the percentage of share volume reported to Nasdaq's systems and higher Unlisted Trading Privileges ("UTP") Plan revenue sharing which decreased Market Services segment revenues by $27.2 million or 28.3% for the three months ended June 30, 2004 and $62.7 million or 30.2% for the six months ended June 30, 2004. These current and prior year items are discussed in more detail below.

Business and Operating Environment

Trading activity of Nasdaq-listed securities declined slightly during the three months ended June 30, 2004 compared to the three months ended June 30, 2003 and increased for the six months ended June 30, 2004 compared to the six months ended June 30, 2003. Average daily share volume was 1.75 billion shares in the three months ended June 30, 2004 compared to 1.79 billion shares in the three months ended June 30, 2003, a decrease of 2.2%. Average daily share volume was
1.89 billion shares in the six months ended June 30, 2004 compared to 1.63 billion shares in the six months ended June 30, 2003, an increase of 16.0%. However, while average daily share volume increased for the six months ended June 30, 2004, continued competitive pressures from regional exchanges and ECNs continued to draw activity away from Nasdaq's systems to other venues resulting in decreased market share. Also, the percentage of share volume reported to Nasdaq's systems fell from 68.9% in the three months ended June 30, 2003 to 47.9% in the three months ended June 30, 2004, and fell from 76.5% in the six months ended June 30, 2003 to 49.3% in the six months ended June 30, 2004. This continued competition along with continued decreases in certain fees, resulted in a significant decline in revenues from the Market Services segment.

Revenues from the Issuer Services segment declined slightly for the three months ended June 30, 2004 compared with the same period in 2003. Declines in Corporate Client Group revenues were partially offset by higher revenues from Nasdaq Financial Products for the three months ended June 30, 2004. For the six months ended June 30, 2004, Issuer Services revenues increased slightly compared with the six months ended June 30, 2003. Improved market conditions and consumer outlook continued to have a positive impact on the ability of companies to raise money in the equity markets in 2004. For the three months

ended June 30, 2004, there were 41 initial public offerings ("IPOs") on The Nasdaq Stock Market compared to two for the three months ended June 30, 2003. For the six months ended June 30, 2004, there were 69 IPOs on The Nasdaq Stock Market compared to five for the six months ended June 30, 2003. Secondary offerings also increased from 25 in the three months ended June 30, 2003 to 58 in the same period of 2004, and increased from 43 in the six months ended June 30, 2003 to 141 in the same period of 2004. The increase in IPOs and secondary listings during 2004 will primarily affect Nasdaq's revenues in future years as revenues from Initial listing fees (including IPOs) and LAS fees (including secondary offerings) are amortized over six and four years, respectively. Annual renewal fee revenues, which are amortized on a pro-rata basis over the calendar year, decreased in 2004 due to the decline in the number of companies listed on The Nasdaq Stock Market from 3,659 on January 1, 2003 to 3,333 on January 1, 2004, the date on which companies are billed their annual fees. During 2003, 460 companies delisted from The Nasdaq Stock Market primarily for failure to meet The Nasdaq Stock Market's listing standards and other reasons, including mergers and acquisitions. Partially offsetting this decline were 134 new listings in 2003.

Nasdaq is positioning itself to benefit from any improvement in investor confidence during 2004. In January 2004, Nasdaq implemented a new tiered pricing structure geared toward drawing increased liquidity to Nasdaq's trading platform. In April 2004, Nasdaq further enhanced its pricing structure by increasing the liquidity rebate, in which Nasdaq credits a portion of the per share execution charge to the market participant that provides the liquidity, for certain market participants. These changes resulted in the stabilization of Nasdaq's market share during the second quarter of 2004 as compared to the first quarter of 2004. However, competition from regional exchanges and ECNs remains strong and any additional future price reductions and/or a decrease in market share may put downward pressure on Nasdaq's revenues.

In January 2004, Nasdaq launched the dual-listing program, enabling NYSE-listed companies to dually list their stock on The Nasdaq Stock Market and the NYSE. While Nasdaq has agreed to waive its listing fees for one year, Nasdaq believes that the dual listing program will enhance competition, thereby benefiting investors and has the potential to generate revenues for Nasdaq from listing fees in subsequent years. As of June 30, 2004, seven NYSE-listed companies have agreed to dual list their stock on The Nasdaq Stock Market.

On May 25, 2004, Nasdaq announced it entered into a definitive agreement to acquire Brut, the owner and operator of the Brut ECN, and affiliated entities for a total consideration of $190.0 million in cash, from SunGard. Nasdaq intends to finance the purchase from available cash and investments, which totaled $445.3 million as of June 30, 2004. The board of directors of each company has approved the transaction, which is expected to close during the third quarter of 2004 subject to customary closing conditions and regulatory approvals. The Brut acquisition is intended to enhance Nasdaq's systems by providing Nasdaq with the ability to route orders via an internal broker-dealer to multiple liquidity pools in keeping with changes of the National Market System proposed by the SEC in Regulation NMS and to improve FIX connectivity. In addition to, and conditioned upon completion of the acquisition, Nasdaq and SunGard will enter into hosting and multi-year processing agreements for SunGard to provide real-time order-to-settlement securities processing system for trades on The Nasdaq Stock Market.

In June 2004, Nasdaq completed the rollout of the Closing Cross, a centralized order facility designed to provide a robust, orderly market close for Nasdaq-listed securities. Certain sponsors of stock indices are now utilizing the Closing Cross as a reference price for their stock indices and others are expected to do so as well. Also in June 2004, the SEC published for public comment Nasdaq's proposal for the implementation of an Opening Cross. Pending SEC approval, Nasdaq anticipates a complete rollout of the Opening Cross in the fourth quarter of 2004. The Opening and Closing Crosses are designed to establish prices more representative of the prevailing market at the open and close of trading in Nasdaq-listed securities and to increase trading activity at those critical periods. Nasdaq has agreed not to charge fees for transactions taking place on the Nasdaq Closing Cross until August 2004.

Key Statistical information

The following table sets forth key statistical information:

                                       Three months ended                   Six months ended
                                       June 30,                             June 30,
                                           2004               2003              2004              2003
Average daily share volume (in
billions)                                  1.75              1.79               1.89             1.63
Percentage of share volume reported
to Nasdaq systems                          47.9     %        68.9      %        49.3     %       76.5      %
Initial public offerings                   41                2                  69               5
Secondary Offerings                        58                25                 141              43
New listings(1)                            60                17                 119              40
Number of listed companies(2)              3,298             3,440              3,298            3,440

(2) Number of listed companies as of June 30, 2004 and 2003

Results of Operations

For the Three and Six Months Ended June 30, 2004 and 2003

Revenues

In 2003, Nasdaq changed its organizational structure from operating in one segment to operating in two segments. Nasdaq's two segments are managed and operated as strategic business units and organized by products and services. Reportable segments are Market Services and Issuer Services. Market Services primarily includes Nasdaq Market Center revenues and Nasdaq Market Services Subscription revenues. Nasdaq Market Center revenues includes Nasdaq's quoting, trading and trade reporting services for both Nasdaq-listed and exchange-listed securities. Revenues from execution systems previously known as SuperMontage, CAES and ACES and revenues from the system previously known as ACT as well as Access Services revenues and Nasdaq InterMarket revenues (revenues derived from the sale of tape data (Tape Fee revenues) for NYSE-listed and Amex-listed securities) are included in the Nasdaq Market Center. Nasdaq Market Services Subscription revenues includes revenues from Nasdaq's Level 1 Service, NQDS, TotalView and MFQS. Issuer Services includes Corporate Client Group revenues and Nasdaq Financial Products revenues. See Note 9, "Segments," to the condensed consolidated financial statements for further discussion.

The following table sets forth total revenues by segment:

                  Three months ended                      Six months ended
                  June 30,                                June 30,
                       2004                2003                2004                2003
                  (in millions)
Market Services       $  68.9            $  96.1             $  145.0            $  207.7
Issuer Services       51.1               51.4                103.3               102.1
Other                 -                  0.1                 0.1                 0.2
Total revenues        $  120.0           $  147.6            $  248.4            $  310.0

MARKET SERVICES

The following table sets forth revenues from Market Services:

                                      Three months ended                       Six months ended
                                      June 30,                                 June 30,
                                          2004                 2003                 2004                  2003
                                      (in millions)
Nasdaq Market Center:
Revenues                                  $   78.9           $  101.1             $  166.4              $  203.0
Liquidity rebate                          (31.2      )       (34.9        )       (64.6        )        (61.9        )
Tape Fee revenue sharing                  (1.9       )       (3.2         )       (4.7         )        (7.1         )
Nasdaq General Revenue Sharing
Program                                   (0.7       )       -                    (1.5         )        -
Total Nasdaq Market Center
revenues, net                             45.1               63.0                 95.6                  134.0
Nasdaq Market Services
Subscription:
Revenues(1)                               46.2               43.4                 93.4                  87.9
Nasdaq General Revenue Sharing
Program                                   (4.5       )       -                    (9.5         )        -
Unlisted Trading Privileges ("UTP")
Plan revenue sharing                      (20.2      )       (12.0        )       (39.1        )        (17.9        )
Total Nasdaq Market Services
Subscription revenues, net                21.5               31.4                 44.8                  70.0
Other Market Services revenues            2.3                1.7                  4.6                   3.7
Total Market Services revenues            $   68.9           $  96.1              $  145.0              $  207.7

Nasdaq Market Center

Nasdaq Market Center revenues decreased $22.2 million, or 22.0%, in the second quarter of 2004 and decreased $36.6 million, or 18.0%, for the six months ended June 30, 2004, compared with the same periods of 2003. These decreases were primarily due to declines in market share and the percentage of share volume reported to Nasdaq's systems, the effect of price reductions and a decline in the number of trader log-ons to Nasdaq's systems. Market share and share volume both declined as competitive pressures from regional exchanges and ECNs continued to draw activity away from Nasdaq's systems to other venues. In response to this continued competition, Nasdaq reduced certain fees. In January 2004, Nasdaq implemented a new tiered pricing structure geared toward drawing increased liquidity to Nasdaq's trading platform. In April 2004, Nasdaq further enhanced its pricing structure by increasing the liquidity rebate for certain market participants, which impacted the Nasdaq Market Center Liquidity rebate. The new tiered pricing structure lowers execution charges to market participants based on the amount of liquidity a participant provides. These price changes are in addition to price reductions implemented in the second, third and fourth quarters of 2003 for trades reported to the Nasdaq Market Center. The decline in trader log-ons is due to continued market participant consolidations and firms moving to other venues to access the market. The declines in Nasdaq Market Center revenues for the year-to-date period were partially offset by an increase in average daily share volume. Average daily share volume was 1.89 billion shares during the six months ended June 30, 2004 compared to 1.63 billion shares during the six months ended June 30, 2003.

Nasdaq Market Center Liquidity rebate, in which Nasdaq credits a portion of the per share execution charge to the market participant that provides the liquidity, decreased $3.7 million, or 10.6%, in the second quarter of 2004, compared with the same period of 2003. This decrease was primarily due to lower market share and lower overall share volume of market participants on The Nasdaq Stock Market. The elimination of the Liquidity rebate for all NYSE-listed and certain Amex-listed securities also contributed to this decline. These decreases were partially offset by an increase in the per share liquidity rebate in April 2004 for Nasdaq-listed securities.

Nasdaq Market Center Liquidity rebate increased $2.7 million, or 4.4%, in the six months ended June 30, 2004, compared with the same period of 2003. This increase was due to higher overall share volume of market participants on The Nasdaq Stock Market for the six months ended June 30, 2004 as compared with the same period of 2003 and an increase in the per share liquidity rebate in April 2004 for Nasdaq-listed securities.

Nasdaq shares Tape Fee revenues from NYSE-listed and Amex-listed securities through Nasdaq Market Center Tape Fee revenue sharing. Nasdaq records Tape Fee revenues from NYSE-listed and Amex-listed securities based upon both the percentage of trades reported to the Nasdaq Market Center for securities listed on these exchanges and the size of NYSE and Amex revenue sharing pools. Nasdaq Market Center Tape Fee revenue sharing decreased $1.3 million, or 40.6%, in the second quarter of 2004 and decreased $2.4 million, or 33.8%, for the six months ended June 30, 2004, compared with the same periods of 2003. These decreases were primarily due to the INET ECN reporting certain trading activity to The National Stock Exchange. This change reduced both Nasdaq Market Center revenues and the amount of revenues Nasdaq was obligated to share with INET, resulting in an overall decline in Nasdaq Market Center revenues, net.

In January 2004, the Nasdaq Market Center began sharing revenues under a new program, the Nasdaq General Revenue Sharing Program. During the second quarter of 2004 and for the six months ended June 30, 2004, Nasdaq shared $0.7 million and $1.5 million, respectively, of Nasdaq Market Center revenues under this program. See "Nasdaq Member Revenue Sharing," of Note 2, "Significant Transactions," to the condensed consolidated financial statements for further discussion.

Nasdaq Market Services Subscriptions

Nasdaq provides subscribers with inside quote and last trade information through Level 1, the best quote information for each market participant through NQDS and all price levels for each market participant through Total View. These services are provided for securities listed on The Nasdaq Stock Market to both professional and non-professional users. Nasdaq also provides MFQS, a service that collects and disseminates daily price and related data for unit investment trusts, mutual funds and money market funds that are subscribers to this service. These subscription revenues, which include eligible and non-eligible UTP Plan revenues, increased $2.8 million, or 6.5%, in the second quarter of 2004 and increased $5.5 million, or 6.3%, for the six months ended June 30, 2004, compared with the same periods of 2003. These increases were primarily due to an increase in non-professional Level 1 subscriptions resulting from increased consumer interest in the equity markets.

In January 2004, Nasdaq Market Services Subscriptions also began sharing revenues under the new program, the Nasdaq General Revenue Sharing Program. During the second quarter of 2004 and for the six months ended June 30, 2004, Nasdaq shared $4.5 million and $9.5 million, respectively, of Nasdaq Market Services Subscription revenues under this program. See "Nasdaq Member Revenue Sharing," of Note 2, "Significant Transactions," to the condensed consolidated financial statements for further discussion.

Nasdaq also shares Tape Fee revenues (i.e., revenues from the sale of tape data) for Nasdaq-listed securities through the UTP Plan. Under the revenue sharing provision of the UTP Plan, Nasdaq is

permitted to deduct certain costs associated with acting as the exclusive Securities Information Process ("SIP") from the total amount of Tape Fees collected. After these costs are deducted from the Tape Fees, Nasdaq distributes to the respective UTP Plan participants, including Nasdaq, their share of Tape Fees based on a combination of their respective trade volume and share volume. Nasdaq Tape Fee revenue sharing allocated to UTP Plan participants increased $8.2 million, or 68.3%, in the second quarter of 2004 and increased $21.2 million for the six months ended June 30, 2004, compared with the same periods of 2003. These increases were primarily due to a decline in the percentage of share volume reported to Nasdaq's systems as continued competitive pressures from ECNs continued to draw activity away from Nasdaq's systems to regional exchanges that are members of the UTP Plan and that trade Nasdaq-listed securities.

Other Market Services revenues increased $0.6 million, or 35.3%, in the second quarter of 2004 and increased $0.9 million, or 24.3% for the six months ended June 30, 2004, compared with the same periods of 2003. These increases were primarily due to an increase in Nasdaq's web-site revenues.

ISSUER SERVICES

The following table sets forth revenues from Issuer Services:

                                         Three months ended                    Six months ended
                                         June 30,                              June 30,
                                             2004               2003                2004                 2003
                                         (in millions)
Issuer Services:
Corporate Client Group                       $   41.2          $  42.1            $  81.7              $  83.8
Nasdaq Financial Products                    9.9               9.3                21.6                 18.3
Total Issuer Services revenues               $   51.1          $  51.4            $  103.3             $  102.1

Corporate Client Group

The following table sets forth the revenues from the Corporate Client Group as
reported in accordance with GAAP ("as reported") and as would be reported on a
. . .