UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

Form 10-K

 

 

Commission file number: 001-32419

 

optionsXpress Holdings, Inc.

(Exact name of registrant as specified in its charter)

 

 

Securities Registered Pursuant to Section 12(b) of the Act:

 

 

Securities Registered Pursuant to Section 12(g) of the Act:
None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that it was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.  Yes o     No þ

 

The aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $660 million based on the closing sale price of such stock as reported by the Nasdaq Global Market on June 30, 2009, assuming that all shares beneficially held by executive officers and members of the registrant’s Board of Directors are shares owned by “affiliates,” a status which each of the executive officers and directors may individually disclaim.

 

The number of shares of common stock outstanding as of February 22, 2010 was 57,447,787 shares.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Definitive Proxy Statement relating to the registrant’s 2010 Annual Meeting of Stockholders to be filed hereafter (incorporated into Part III hereof).

 

 

TABLE OF CONTENTS

 

Forward-Looking Statements

 

This Annual Report on Form 10-K, including the sections “Business,” “Risk Factors,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contains forward-looking statements. These statements relate to future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. You are urged to carefully consider these risks and factors included in this Annual Report on Form 10-K. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continue” or the negative of these terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.

 

Forward-looking statements include, but are not limited to, the following:

 

 

The forward-looking statements made in this Annual Report on Form 10-K relate only to events as of the date on which the statements are made, and we undertake no ongoing obligation, other than any imposed by law, to update these any forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in any forward-looking statements, even if new information becomes available in the future.

 

 

Overview

 

Our brokerage services segment provides internet-based options, stock, bond, mutual fund and futures brokerage services to retail customers located throughout the United States and certain other countries. Our education services segment offers a full range of education products and services which cover a broad range of financial products including stock, market analysis, options, foreign exchange and financial planning. We

entered the education business on May 4, 2009, through the acquisition of Optionetics, Inc. and its affiliates (collectively, “Optionetics”).

 

Brokerage Services

 

We offer a comprehensive suite of brokerage services for option, futures, stock, mutual fund, and fixed-income investors. While our initial focus was on the rapidly expanding listed equity options market, we have been recognized as offering the leading online retail brokerage platform based on the quality of our proprietary technology and our customer experience. We received the highest category ranking for useability (“ease of use”) by Barron’s, in their 2009 annual survey. We were selected by Barron’s as “Best Online Broker” in its four annual surveys from 2003-2006, and selected by Kiplinger’s as “The Best Online Broker” in 2006. We commenced doing business as optionsXpress, Inc. (“optionsXpress”) in February 2000 and have grown to over 350,000 customer accounts.

 

Market Opportunity

 

Third party research estimates there are approximately 35-40 million online brokerage accounts accounting for approximately 30-35% of all U.S. retail brokerage assets. The total U.S. listed equity options market has grown at a compounded annual growth rate of 22% per year over the past 10 years. Despite this growth, it is estimated that only 10-20% of online accounts are authorized to trade options.

 

Our option trades represented approximately 2% of all listed U.S. options volume for the year ended December 31, 2009. We believe this makes us one of the largest retail online options brokers. The largest portion of our revenue consists of commissions from customers’ trades of options, futures, stocks, mutual funds and fixed-income products. For the year ended December 31, 2009, our daily average revenue trades, which are our total revenue-generating trades for a period divided by the number of trading days in that period, were approximately 44,100, compared to approximately 43,600 for the year ended December 31, 2008. In 2009, option trades represented approximately 42% of our customers’ trades, with approximately 38% coming from futures, 20% coming from stocks and less than 1% coming from mutual funds and fixed-income products.

 

Platform

 

Our cost efficient and scalable brokerage platform reflects the combination of our advanced technology and highly-responsive customer service. Our innovative browser-based technology delivers an array of differentiating trading tools, allowing investors to identify, analyze and execute a wide range of investment strategies. Many of these internally developed tools, which enhance our customers’ experience, are not available from other online or full service brokers. In addition, our real-time customer service approach, featuring what we call “point of contact resolution,” is designed to ensure that customer questions are answered quickly and during the initial contact, and yields a high degree of customer satisfaction and loyalty. We are a self-clearing member of both the Depository Trust & Clearing Corporation (“DTCC”) and the Options Clearing Corporation (“OCC”), which gives us a high degree of control over our customer accounts and helps us provide quality customer service.

 

Our business generates strong cash flows and attractive margins compared to many of our competitors. Our expense structure benefits from our low-cost platform, relatively low account acquisition cost and loyal customer base. In addition, all of our tools and services are offered online, eliminating the cost of maintaining retail locations. The options and futures trading portions of our business results in a recurring revenue stream because when options and futures expire, investors need to acquire new positions if they wish to remain invested. We generated $233.4 million of net revenues for the year ended December 31, 2009 with $94.3 million of income before income taxes and $60.8 million of net income.

Growth Strategy

 

We believe we have significant opportunities for customer growth. Key elements of our growth strategy are as follows:

 

Growing Share of Growing Market — Retail Online Options

 

We have created rapid growth since our inception by appealing to the growing retail options market. We aim to continue to expand our customer base by gaining market share, participating in market growth and accelerating the growth of retail options trading generally. Our strategy for gaining market share includes persistent innovation with respect to our customer-driven online brokerage platform and effective, targeted marketing. To accelerate the growth of options trading, we will continue to cultivate new retail options investors by making options trading more intuitive and accessible and through our educational initiatives.

 

On May 4, 2009, we acquired Optionetics, a leading provider of investment education services, including live seminars, proprietary software analytics, online and offline educational products and individual coaching to potential investors in a number of countries. The acquisition of Optionetics provides us access to additional potential brokerage customers as well as rich investor education content. See “Business Acquisitions” for further information about this acquisition.

 

Expand our Futures Business

 

In 2005, we launched a web-based retail futures trading platform enabling optionsXpress customers to trade futures side-by-side with other securities. Based on growth in futures industry volumes and innovation at the various futures exchanges, we believe retail trading in futures is poised for significant growth and that greater numbers of retail investors will incorporate futures as a part of their investing strategy. To help us capitalize on this trend, we have made two futures-related acquisitions in the last three years.

 

On January 24, 2007, we acquired XpressTrade, LLC (“XpressTrade”), a leading Internet-based futures broker, which offered self-directed retail customers 24-hour access to 25 exchanges and over 100 futures products worldwide, including electronic and open outcry, through a browser-based trading platform. By integrating the functionality of the XpressTrade platform into the optionsXpress platform, we believe we created the premiere browser-based online brokerage platform focused on derivatives. See “Business Acquisitions” for further information about this acquisition.

 

On July 1, 2008, we acquired Open E Cry, LLC (“OEC”, formerly known as Open E Cry), an innovative futures broker offering institutional and active traders direct access futures trading through its proprietary software platform, OEC Trader. The acquisition of OEC allows us to extend our reach into the active trader and institutional markets for futures, further capitalizing on the growth in that industry. See “Business Acquisitions” for further information about this acquisition.

 

Increased Penetration in Larger Markets — Retail Online Stocks, Mutual Funds and Fixed-Income Products

 

We plan to continue penetrating the much larger stock, mutual fund and fixed-income markets. The key components of our platform that have made us successful in the options markets are also applicable to these other markets. Furthermore, since customers who trade options often trade the underlying securities, we have ample opportunity to cross-sell stocks, mutual funds and fixed-income products.

 

brokersXpress — Expansion in Professional Advisor and Independent Representative Markets

 

brokersXpress offers an extension of our optionsXpress retail platform geared towards independent registered representatives and registered investment advisors. We offer these professionals a complete, easy-to-set-up account and execution management platform allowing them to serve their retail customers efficiently and cost effectively. Since inception, brokersXpress has attracted over 24,000 accounts and over $1.4 billion in customer assets under management.

This business continues to represent a significant growth opportunity. Total consumer household investable assets with independent representatives are estimated at $1.5 trillion. There were more than 100,000 registered representatives, registered investment advisors and dually registered advisors in 2009. Because of the size of the market and the quality of our platform, we believe that we can grow the number of registered representatives and registered investment advisors and the total assets managed on the brokersXpress platform.

 

International Expansion

 

We have taken several steps to leverage our brokerage platform internationally:

 

 

We intend to continue expanding our international customer base through cost-effective targeting of online customers in economically and legally compatible foreign jurisdictions where there is an interest in accessing U.S. markets.

 

Pursue Selective Strategic Acquisitions

 

We believe we can supplement our organic growth outlined above with selective strategic acquisitions. We generally seek out acquisition opportunities that allow us to leverage our brokerage platform and:

 

 

Our Brokerage Platform

 

We have developed an award-winning, comprehensive and technologically advanced, yet easy-to-use brokerage platform. Our brokerage platform caters to both novice and expert investors. Novice investors are provided with, among other things, both educational and research material and comprehensive customer support all via a customer-friendly interface. Trading features more relevant to expert traders include streaming quotes, charting services and advanced order services.

 

Our software is efficient and user-friendly:

 

 

Our efficient, in-house development capabilities allow us to continuously innovate and improve our platform with frequent enhancements such as:

 

 

We offer comprehensive educational content as part of our powerful brokerage platform to help our customers become successful, long-term investors, including:

 

 

Customer Service

 

Our customer service approach is embedded in our culture and has been a significant factor in our success. We strive to provide excellent service during the customer’s entire investing experience, from education to evaluation to execution to post-trade monitoring. For customers requiring more personalized attention, customer service is available 24 hours a day via live individual web chat, e-mail and telephone. We have over 100 dedicated customer service employees located in Chicago, Illinois and El Paso, Texas.

 

We are responsive to our customers, aiming for a real-time response to all customer inquiries. We respond to many of our customer inquiries via the Internet, facilitating individualized service in a timely and cost-effective manner. Customer e-mail inquiries are routed by managers to the appropriate business area for timely and accurate response. Communications with customers are continually reviewed and critiqued for quality assurance. The result is what we call “point-of-contact resolution,” which we define as providing each customer with an answer without having to speak to multiple people, repeat the question or call back.

 

We also continually update our technology to maximize the customer’s experience. Customer questions are tracked and, if repeated, analyzed to determine how best to clarify the point or answer the inquiry during the customer’s online experience. This analysis is used to improve and enhance our website.

 

Marketing

 

The retail online brokerage industry is competitive and will likely continue to become more competitive in the future. Despite the competitive environment, we believe our marketing programs can continue to cost-effectively attract new customers, while further developing the optionsXpress brand. Our marketing focuses on long-term investors who use or intend to use options or futures as a part of their investment strategy. To achieve our marketing objectives, we use a mix of “grass roots,” online and traditional advertising targeted at the types of customers we seek to attract. This strategy has enabled us to attract loyal customers at an attractive cost per net new account. Our “grass roots” marketing strategy, which has been crucial to our success, consists of a strategic public and media relations program and channel partnerships. Our public and media relations initiative has been successful in positioning us as an expert industry resource and broadening our customer base. We use channel partnerships, such as relationships with securities exchanges, options educators, investment publishers, software vendors and financial portals, to distribute our product to new customers. These relationships also allow us to reach existing and potential retail options and futures investors through a source that is familiar to them. In addition, we appear at various industry events, trade conferences and investor clubs. The largest component of our advertising is through third-party websites and e-mail campaigns, though we also place print advertisements in selected business, technology and financial publications. To keep costs low, our advertising is highly targeted to the types of investors we believe will be most profitable.

 

Our marketing and advertising directs interested prospects to our website where they can get detailed information on our platform and services, use an interactive demonstration system, request additional information and complete an account application online. As the final step in our account acquisition process,

we improve the conversion rate of prospective customers by enabling eligible applicants to complete their application using a digital signature. Customers who are ineligible for digital signature can print a pre-paid Federal Express label at the end of their registration process for easy submission of their applications.

 

Broker-Dealer Operations

 

Order Processing

 

We aim to provide customers with the best execution of each trade, which we define as the fastest fill at the best price. We believe we differentiate ourselves from our major competitors by incorporating our dynamic technology into our order management and execution review process. For example, we have designed monitors that warn us of any instances where an order can be filled on another exchange or if the best price was not achieved on a particular trade. These alerts allow us to proactively represent orders, seek adjustments on orders that were not completed at the best available price, and recognize exchange issues that might warrant a routing change.

 

Clearing and Custody

 

Our wholly owned subsidiary, optionsXpress, Inc., provides securities clearing and custody services directly for our customers. To facilitate our securities self-clearing operations, we use Sungard Financial Systems’ Phase3 trade processing and settlement software. As a clearing broker, optionsXpress, Inc. maintains custody and control over the assets in those customers’ accounts and provides back office functions including:

 

 

optionsXpress, Inc. provides securities clearing and execution services for optionsXpress, Inc. customers and to all of our introducing broker-dealer subsidiaries with the exception of optionsXpress Canada Corp., which receives clearing services from Penson Financial Services Canada, Inc.

 

We clear our futures trades primarily through R. J. O’Brien & Associates, LLC, MF Global, Inc., and Prudential Bache Commodities, LLC on an omnibus basis.

 

Margin and Leverage

 

Margin credit involves the use of securities as collateral for a loan from the broker in order to purchase other securities. Leverage involves securing a large potential future obligation with a lesser amount of cash or securities. We and our clearing agents extend margin credit and leverage to eligible customers. Our margin lending and leverage is subject to the margin rules of the Securities and Exchange Commission (“SEC”), other Self-Regulatory Organizations (“SROs”) and our own internal policies. When we allow our customers to initiate securities positions using margin or leverage, we are taking the risk that impairments in the market value of the collateral may cause the value of the customers’ indebtedness to exceed the value of the collateral. As such, we make decisions regarding margin credit and leverage levels and we are responsible for the notification to customers of margin calls. We also take responsibility for supervising the risks associated with leverage and we monitor our customers’ margin positions to identify customer accounts that may need

additional collateral or liquidation. In general, our minimum margin credit requirements are more stringent than the SEC’s and SROs’ requirements.

 

Payment for Order Flow

 

Payment for order flow occurs when exchanges, options specialists, market makers, and other market centers make payments to broker-dealers in return for receiving customer orders. Like other retail brokerage firms, we receive payment for order flow from exchanges and liquidity providers where our customers’ orders are routed. Our automatic order routing software, known as XpressRouter, ensures that payment for order flow does not affect the routing of orders in a manner detrimental to our customers. In addition, customers can either rely on our automatic order routing or designate where to route their orders. We disclose our payment for order flow policies on our website. For more information regarding potential risks associated with payment for order flow, see “Risk Factors — Our business is primarily transaction-based, and decreases in trading or other changes in our revenue base could harm our business.”

 

Supervision and Compliance

 

The role of our compliance department is to provide education, supervision, surveillance, mediation and communication review. Many of our employees are registered principals with the Financial Industry Regulatory Authority Inc. (“FINRA”) with supervisory responsibility over options trading or other aspects of our business. In addition, many of our non-technology employees have successfully completed the FINRA licensing exams required for registered representatives. Each of these employees is trained and responsible for complying with securities regulations.

 

Our anti-money laundering screening is conducted using a mix of automated and manual review processes and has been structured to comply with appropriate regulations. We collect the required information through our new account process and then screen accounts with two third-party databases for the purposes of identity verification, and to review for negative information and for their appearance on the Office of Foreign Assets and Control’s, Specially Designated Nationals and Blocked Persons lists. Additionally, we have developed proprietary methods for risk control and continue to add upon specialized processes, queries and automated reports designed to identify money laundering, fraud and other suspicious activities.

 

Technology Systems and Architecture

 

We place emphasis on developing and building cost-effective, stable, scalable and redundant systems. Unlike a number of our direct competitors, we developed our platform to operate free from reliance on mainframe systems common in the brokerage industry. Our hardware and software have proven reliable and versatile and we believe they can be expanded more economically than our major competitors’ systems. We maintain three production data centers. Each center is linked to the others via redundant communication to minimize the likelihood of a data center being unable to serve customers. We replicate and synchronize our primary databases, ensuring a current copy of all customer data at each center. Our technology includes encryption and protective features to maintain investor confidence and protect our customers’ assets and information. In addition, our servers are load balanced, which prevents the failure of a single server or components from having a significant impact on our customers and allows for the easy addition of servers, resulting in the ability to quickly and cost-efficiently scale our platform.

 

Intellectual Property

 

Our success and ability to compete are dependent to a significant degree on our intellectual property, which includes our proprietary technology, trade secrets, and the details of our client base. We rely on a combination of patent, trademark, copyright, unfair competition and trade secret laws in the United States and other jurisdictions as well as confidentiality procedures and contractual provisions to protect our proprietary technology and intellectual property including our brand. Our Company’s employees and consultants are required to enter into confidentiality and invention assignment agreements with our Company. We also enter

into confidentiality agreements with other third parties when such agreements are appropriate. Overall, we endeavor to rigorously control access to our Company’s proprietary technology.

 

We have one Singapore patent, Singapore Patent No. 131292. We have an additional six patent applications pending in both the United States and foreign jurisdictions relating to various technology components of our platform. Internet-related software patents can be difficult to obtain. There is no assurance that we will obtain a patent at all or any patents broad enough in scope to have value. Our optionsXpress^® website is the subject of copyright protection.. We also have obtained trademark registrations for: the optionsXpress^® mark in the United States, Australia, Singapore, Hong Kong, New Zealand and the European Union; the brokersXpress^® mark in the United States, Australia, Singapore, Hong Kong, New Zealand, Canada, and the European Union; the OEC ^® mark in the United States; and the Optionetics^® mark in the United States. We have a pending trademark application for the optionsXpress mark in Canada. We have obtained registrations or have pending applications for numerous other marks both in the United States and in foreign jurisdictions. We use certain trademarks, trade names, and logos which have not been registered to which we claim common law trademark rights.

 

Competition

 

The market for brokerage services, particularly electronic brokerage services, is rapidly evolving and highly competitive. Our direct competitors in the online marketplace take the form of larger-scale broker-dealers that offer online services, including Charles Schwab & Co., Inc., Fidelity Brokerage Services, LLC, E*TRADE Group, Inc., TD Ameritrade, Inc., Scottrade, Inc., and smaller “niche-market” online or licensed software-based brokers, including TradeStation Group, Inc., TradeKing, optionsHouse, and TradeMonster. We also encounter competition from full commission brokerage firms including Merrill Lynch and Morgan Stanley Smith Barney, as well as mutual fund sponsors, including Fidelity, banks and other organizations that provide online brokerage services.

 

We attribute our competitive success to the overall customer experience we deliver, which results from our advanced technology and superior customer service. Although competition may increase if larger-scale online brokers become more aggressive in marketing options and futures, we believe we will maintain a competitive advantage due to the strength and flexibility of our platform and our focus on options and futures.

 

Education Services

 

Through our Optionetics subsidiary, we offer a comprehensive suite of investor education products and services for stock, option, contracts for difference, foreign exchange and futures investors and traders. Our products and services are primarily built around investing methods and systems that are designed to teach both experienced and beginning investors how to find and analyze investment opportunities and actively manage their investment portfolios using specific money management techniques. Classes are offered on a range of topics from beginning through advanced levels. Tools that assist in the process of finding investment opportunities are web-and/or software-based. Instruction techniques and ongoing service and support and are offered in a variety of formats, which solidify the students’ understanding of the investing process and help them manage risk in the markets and take control of their financial future.

 

We seek to offer students a full range of investor education products that provide lifelong learning, including lifetime access to a 2-day long course where foundations are built and money management is a major theme. Generally, customers are introduced to these products and services through a free 2-hour workshop event, either live or online. Customers may also be introduced to education services through free online introductory publications, newsletters or trials. Attendees of the 2-hour workshop also have the opportunity to attend a more comprehensive, instructor-led, live 2-day long class that includes a home study program and online strategy support. Following completion of the initial class, customers are offered additional tools and continuing education classes to build on what they have learned.

Course Offerings

 

2-hour Workshop - A free options introductory event, either live or online, that introduces customers and to options trading features and concepts. Workshop attendees are offered an opportunity to purchase a more comprehensive 2-day long class that includes home study course consisting of books, DVDs, and hours of online audio, a monthly newsletter, and strategy support. We cover fundamental investing concepts, risk management and provide a broad overview of the financial markets.

 

Classes-Live and Online — Classes that cover subjects ranging from fundamental investing to advanced trading, systems, options, foreign exchange and futures strategies.

 

Home Study — Multiple courses that contain combinations of books, CDs, DVDs, and online events which are designed for at-home learning. Video publications that include case studies are also available to support home learning.

 

Online Courses - Many courses at various levels in an online format, ranging from entry level through advanced strategies on stocks, options, foreign exchange and futures.

 

Coaching Programs - A combination of online and/or phone education on a one-to-one or one-to-many basis ranging from 4 week to 12 month programs. These events are offered live, and are recorded for customers to review in full at their own pace, to review just the sections that may be particularly complex or to review as a refresher. The coaching programs are built to fit within our education path and allow customers to progress at their own pace and within any number of specialties.

 

Education Services Brands:

 

Optionetics — risk management strategies regardless of market direction;

 

Safety in the Market — technical trading system and market forecasting;

 

Profit Strategies — technical and fundamental analysis and trading strategies;

 

FXTE — strategies for the FX markets including technical, economic and fundamentals analysis; and

 

Hubb — investment education through software applications, data services and financial software services.

 

Software tools

 

We sell a number of software tools designed to supplement the course material and empower students to conduct their own analysis of market opportunities using Optionetics methodologies. Software tools include ProfitSource, ValueGain, OptionGear, Integrated Investor, Platinum, and HUBB Investor.

 

Business Acquisitions

 

On May 4, 2009, we acquired 100 percent of the membership interests of Lanai Partners, LLC, the sole stockholder of Optionetics, for cash of $18.4 million and the assumption of certain liabilities. Optionetics, based in Redwood City, California and Sydney, Australia, is a leading provider of investment education services, including live seminars, proprietary software analytics, online and offline educational products and individual coaching to potential investors in 12 countries. There may also be additional consideration payable for five years, based on the profitability of the business acquired and the number of funded brokerage accounts referred to our brokerage services segment in the 12 month period that the contingent consideration is paid. Depending on the level of performance, the contingent consideration can range from zero to $7.0 million for each of the first five years following the acquisition. The sum total of this contingent consideration is currently valued at $11.9 million based on the projected future performance of Optionetics, the time remaining on the liability and our estimated market debt rates.

 

Our consolidated financial statements include the results of operations for Optionetics beginning on May 4, 2009. The purchase price of the Optionetics acquisition includes $33.9 million in acquired goodwill and $2.2 million in acquired intangible assets. The acquired intangible assets include $0.8 million in customer

lists, $0.7 million in customer relationships and $0.7 million in education course content that will be amortized on a straight-line basis over three, eleven and five years, respectively. We expensed approximately $0.4 million of acquisition-related costs in other general and administrative expenses on the consolidated statement of operations.

 

On July 1, 2008, we acquired 100% of the shareholder interests of Paragon Futures Group, Inc. (“Paragon”), the sole member of Open E Cry, a Delaware corporation based in Ohio. We purchased all of the shareholder interests for 235,158 shares of our common stock, cash of approximately $12.4 million, net of working capital acquired, and the assumption of certain liabilities. There may also be additional consideration earned based on future performance of OEC. OEC is an innovative futures broker offering direct access futures trading through its proprietary software platform, OEC Trader.

 

Our consolidated financial statements include the results of operations for OEC beginning on July 1, 2008. The purchase price of the OEC acquisition of $22.0 million, includes the first annual contingent payment of $3.5 million made in July 2009, $18.7 million in acquired goodwill and $1.7 million in fair value of intangible assets at the time of the acquisition. The acquired intangible assets included $1.3 million in customer relationships that are being amortized on a straight-line basis over five years and $0.4 million in a trade name that was deemed to have an indefinite life. The purchase price allocation for the OEC acquisition was finalized on June 30, 2009. Differences between the purchase price estimates and actual results that arose on or before June 30, 2009 resulted in adjustments to the purchase price allocation.

 

On January 24, 2007, we acquired 100% of the membership interests in XpressTrade, an Illinois limited liability company based in Chicago, for 504,546 shares of the Company’s common stock, cash of $24.8 million, net of cash acquired and the assumption of certain liabilities.

 

Our consolidated financial statements include the results of operations for XpressTrade beginning on January 25, 2007. The purchase price of the XpressTrade acquisition of $37.9 million includes $28.9 million in acquired goodwill and $4.8 million in fair value of intangible assets at the time of acquisition. The acquired intangible assets included $4.5 million in customer relationships that are being amortized over five years and $0.3 million in a trade name that was deemed to have an indefinite life. The purchase price allocation for the XpressTrade acquisition was finalized as of January 24, 2008. Differences between the purchase price estimates and actual results that arose on or before January 24, 2008 resulted in adjustments to the purchase price allocation.

 

Employees

 

At December 31, 2009, we had 423 full-time employees. Of these employees, 291 were employed in the brokerage services segment, approximately 111 of which were licensed brokers and 132 were employed by the education services segment. None of our employees are covered by a collective bargaining agreement. We consider our relations with our employees to be excellent.

 

Available Information

 

We are required to file reports with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q, and other reports from time to time. We are an electronic filer and the SEC maintains an Internet site at www.sec.gov that contains the reports, proxy and information statements, and other information filed electronically. Our website address is www.optionsXpress.com. Please note that these website addresses are provided as inactive textual references only. We make available free of charge through our website our Annual Report on Form 10-K, annual proxy statement, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. The information provided on our website is not part of this report, and is therefore, not incorporated by reference unless such information is otherwise specifically referenced elsewhere in this report.

Regulation

 

Overview

 

Our brokerage services business and the brokerage industry in general are highly regulated. As a matter of public policy, regulatory bodies in the United States are charged with safeguarding the integrity of the securities and other financial markets and with protecting the interest of customers participating in those markets, not with protecting the interests of creditors or stockholders of securities firms such as our broker-dealer subsidiaries. optionsXpress, Inc. is a broker-dealer registered with the SEC and is a member of FINRA, Securities Investor Protection Corporation, the National Securities Clearing Corporation and DTCC, and the OCC. optionsXpress, Inc. is also a member of various exchanges, including the Chicago Board Options Exchange (“CBOE”), the International Securities Exchange, the Boston Options Exchange, the American Stock Exchange, the NYSE Arca Exchange and the Philadelphia Stock Exchange. brokersXpress LLC is a broker-dealer and investment advisor registered with the SEC and a member of FINRA.

 

The commodity futures and futures options industry in the United States is subject to regulation under the Commodity Exchange Act. The Commodity Futures Trading Commission (“CFTC”) is the federal agency charged with the administration of this act and the respective regulations. optionsXpress, brokersXpress and OEC are registered as members of the CFTC and are also members of the National Futures Association (“NFA”), a self-regulatory organization. optionsXpress and OEC are registered with the CFTC as a non-clearing Futures Commission Merchant and brokersXpress is registered with the CFTC as an introducing broker.

 

optionsXpress Canada Corp. is registered with the Investment Industry Regulatory Organization of Canada (“IIROC”). optionsXpress Singapore Pte. Ltd. is registered with and licensed by the Monetary Authority of Singapore (“MAS”). optionsXpress Europe, B.V. is registered with and licensed by the Netherlands Authority for the Financial Markets (“AFM”). optionsXpress Australia Pty Limited is registered with and licensed by the Australian Securities and Investments Commission (“ASIC”).

 

Products and services offered through the Education Segment are not currently subject to the prior approval of any government regulatory body. However, certain foreign countries require that we register with their respective securities commissions before conducting investment-related workshops. For example, we have registered with ASIC.

 

Net Capital Rule

 

Our broker-dealer and futures commission merchant subsidiaries are subject to the SEC’s and CFTC’s Net Capital Rules. The Net Capital Rules, which specifies minimum net capital requirements for registered broker-dealers and futures commission merchants, is designed to measure the general financial integrity and liquidity of a broker-dealer. The Net Capital Rules require that at least a minimum part of a registered broker-dealer’s or futures commission merchant’s assets be kept in relatively liquid form. In general, net capital is defined as net worth, meaning assets minus liabilities, plus qualifying subordinated borrowings and discretionary liabilities, and less mandatory deductions that result from excluding assets that are not readily convertible into cash and from conservatively valuing other assets.

 

If a firm fails to maintain the required net capital, the SEC and the SROs or other regulatory bodies may suspend the firm or revoke its registration and ultimately could require the firm’s liquidation. The Net Capital Rule prohibits the payment of dividends, the redemption of stock, the prepayment of subordinated indebtedness and the making of any unsecured advance or loan to a stockholder, employee or affiliate, if the payment would reduce the firm’s net capital below required levels.

 

Foreign Jurisdictions and Regulation

 

While we effect brokerage transactions solely in the United States, our customers access our services through the Internet. In any foreign jurisdiction in which we have customers, there is a possibility that a regulatory authority could assert jurisdiction over our activities and seek to subject us to the laws, rules and

regulations of that jurisdiction. We are registered to conduct brokerage activities in Australia, Canada, Singapore and the European Union.

 

The laws, rules and regulations of each foreign jurisdiction differ. In the jurisdictions where we have the most foreign customers, we may be either licensed or registered or believe we are exempt from licensing or registration due to our limited conduct, lack of solicitation in those jurisdictions, and/or other factors. In any jurisdiction where we are relying on an exemption from registration, there remains the risk that we could be required to register, and therefore, be subject to regulation and enforcement action or, in the alternative, to reduce or terminate our activities in these jurisdictions.

 

Patriot Act

 

As required by the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, or the Patriot Act, we have established comprehensive anti-money laundering and customer identification procedures, designated an anti-money laundering compliance officer, trained our employees and retained an independent audit of our program. There are significant criminal and civil penalties that can be imposed for violations of the Patriot Act. For more information, see “Business — Broker-Dealer Operations — Supervision and Compliance.”

 

Segment Information

 

See Part II — Financial Statements and Supplementary Data, Item 8 Note 26 “SEGMENT REPORTING” to the Consolidated Financial Statements for financial information relating to our segments.

 

 

Important risk factors that could impact our ability to achieve our anticipated operating results and growth plan goals are presented below. You should read the following risk factors in conjunction with discussions of our business and the factors affecting our business located elsewhere in this Annual Report on Form 10-K and in our other filings with the SEC.

 

We may be unable to effectively manage our growth and retain our customers.

 

Our growth has placed significant demands on our management and other resources. If we continue to grow, we will need to attract, hire and retain highly skilled and motivated officers and employees. We cannot assure you that we will be able to attract or retain the officers and employees necessary to manage this growth effectively.

 

In addition, we may not be able to accurately project the rate, timing or cost of any increases in our business. Failure to make necessary expansions and upgrades to our systems and infrastructure, expand and upgrade the reliability and scalability of our transaction processing systems, network infrastructure and other aspects of our technology and maintain our customer service levels could lead to failures and delays, which could cause a loss of customers or a reduction in the growth of our customer base, increased operating expenses, financial losses, litigation or customer claims, and regulatory sanctions or additional regulatory burdens.

 

We operate in a highly regulated industry and compliance failures could adversely affect our business.

 

We operate under extensive regulation, which increases our cost of doing business and is a limiting factor on the operations and development of our business. Our business and operations are subject to regulation by the SEC, FINRA, the CBOE, the CFTC, the NFA and other SROs, and state securities commissions. Outside the United States, we are subject to regulation in those countries where we have sought and received licenses from the applicable regulatory bodies and we also may be subject to regulation by securities regulatory authorities in other foreign countries where our customers are located. The securities industry in the United States covers all aspects of the securities business, including:

 

 

 

Failure to comply with any of the laws, rules or regulations applicable to us, even inadvertently, could lead to adverse consequences including censure, fine, the issuance of cease-and-desist orders or the suspension or disqualification of directors, officers or employees. Any of these consequences could adversely affect our business. It is also possible that any noncompliance could subject us to criminal penalties and civil lawsuits. An adverse ruling against us or our officers or other employees could cause us or our subsidiaries or our officers and other employees to pay a substantial fine or settlement, and could result in their suspension or expulsion. Any of these events could have a material adverse effect on our business.

 

Changes in legislation or regulations may affect our ability to conduct our business or reduce our profitability.

 

The regulatory environment in which we operate may change. These changes may affect our ability to conduct our business or reduce our profitability. Our activities may be affected not only by legislation or regulations of general applicability, but also by industry-specific legislation or regulations. The SEC, other U.S. or foreign governmental authorities, FINRA or other SROs may adopt new or revised regulations which affect our business.

 

In recent years, firms in the financial services industry have been operating in a difficult regulatory environment. The industry has experienced increased scrutiny from a variety of regulators, both within and outside the United States. Penalties and fines sought by regulatory authorities have increased substantially over the last several years, and certain regulators have been more likely in recent years to commence enforcement actions. New laws or regulations or changes in enforcement of existing laws or regulations applicable to our businesses or those of our clients may adversely affect our businesses. Recent market disruptions have led to numerous proposals for changes in the regulation of the financial services industry, including significant additional regulation. Regulatory changes (including changes in the interpretation or enforcement of existing regulations) could lead to business disruptions, could impact the value of assets that we hold or the scope or profitability of our business activities, could require us to change certain of our business practices and could expose us to additional costs (including compliance costs) and liabilities as well as reputational harm, and, to the extent the regulations strictly control the activities of financial services firms, make it more difficult for us to distinguish ourselves from competitors.

 

In addition, we use the Internet as the distribution channel to provide services to our customers. A number of regulatory agencies have adopted regulations regarding customer privacy and the use of customer information by service providers. Additional laws and regulations relating to the Internet may be adopted in the future, including regulations regarding the pricing, taxation, content and quality of products and services delivered over the Internet. Complying with these laws and regulations is expensive, time consuming and could limit our ability to use the Internet as a distribution channel.

 

Servicing customers outside the United States involves special challenges that we may not be able to meet, which could negatively impact our financial results.

 

Since our services are available over the Internet in foreign countries and we have customers residing in foreign countries, foreign jurisdictions may claim that we are required to qualify to do business in their country. We believe that the number of our customers residing outside of the United States will increase over time. We may be required to comply with applicable laws and regulations of each country in which we conduct business, including laws and regulations currently in place or which may be enacted related to

brokerage services available to their citizens over the Internet from service providers located elsewhere. In addition, we have become licensed by a number of regulatory bodies in several foreign countries and are subject to their laws and regulations. Any failure to develop effective compliance and reporting systems could result in regulatory penalties in the applicable jurisdiction, which could have a material adverse effect on our business, financial condition and operating results. For more information, see “Regulation — Foreign Jurisdictions and Regulation.”

 

In addition, we have offered foreign securities brokerage services in Australia and may in the future choose to do so in Australia and additional countries. There are certain risks inherent in doing so. Among other risks, we may face less developed technological infrastructures, less developed automation in exchanges, depositories and national clearing systems, exchange rate fluctuations, increased credit risk and unexpected changes in regulatory requirements, tariffs and other trade barriers. Where we do business through an international entity, we may also face barriers to repatriation of foreign earnings. Any of these could have a material adverse effect on our future international operations and consequently on our business, financial condition and operating results.

 

Substantial competition could reduce our market share and harm our financial performance.

 

The market for electronic brokerage services is rapidly evolving and intensely competitive. We expect the competitive environment to continue in the future. We face direct competition from numerous online and software-based brokerage firms, including Charles Schwab & Co., Inc., Fidelity Brokerage Services, LLC, E*TRADE Group, Inc., TD Ameritrade, Inc., Scottrade, Inc., TradeStation Group, Inc., TradeKing, optionsHouse, and TradeMonster. We also encounter competition from the broker-dealer affiliates of established full commission brokerage firms as well as from mutual fund sponsors, banks and other organizations that provide online brokerage services. Some of our competitors have greater financial, technical, marketing and other resources, and have greater name recognition and a more extensive customer base than we do.

 

This intense competition has resulted in several trends that may adversely affect our financial condition and results of operation, including the implementation of new pricing strategies; the development by our competitors of products and services and enhancements; consolidation in the industry and increased emphasis on advertising and promotional efforts. In addition, some of our competitors are actively pursuing a larger share of the options trading market.

 

We believe that the general financial success of companies within the online brokerage industry will continue to attract new competitors to the industry, such as banks, software development companies, insurance companies, providers of online financial information and others. These companies may provide a more comprehensive suite of services than we do. We may not be able to compete effectively with our current or future competitors.

 

If we fail to attract brokerage customers and education students in a cost-effective manner, our profitability and growth may be impaired.

 

Our profitability and growth depends on increasing our customer base in a cost-effective manner. Although we have spent significant financial resources on advertising and related expenses and plan to continue to do so, there are no assurances that these efforts will be cost-effective at attracting new brokerage customers and education students or converting education students into brokerage customers. We believe that rates for desirable advertising and marketing placements are likely to increase in the foreseeable future, and we may be disadvantaged relative to our larger competitors in our ability to expand or maintain our advertising and marketing commitments. Additionally, filter software programs that limit or prevent our advertisements and other communications from being displayed on or delivered to our current and potential customers’ computers are becoming increasingly available. If this type of software becomes widely accepted, it would negatively affect our Internet advertising. Finally, our brokerage sales and marketing methods are subject to regulation by the CBOE, FINRA and the NFA. The rules and regulations of these organizations impose specific limitations on our sales methods, including our advertising and payments to nonbroker-dealers. If we do not achieve our advertising objectives, our profitability and growth may be impaired.

Our business is primarily transaction-based, and decreases in trading or other changes in our revenue base could harm our business.

 

Our revenues are derived primarily from securities brokerage services, and we expect this business to continue to account for almost all of our revenues. We are directly affected by economic and political conditions, broad trends in business and finance and changes in the conditions of the securities and futures markets in which our customers trade. Recent events in global financial markets, including failures and government bailouts of large financial services companies, have resulted in substantial market volatility. This market volatility and/or continuing weakened economic conditions could reduce our trading volume. During periods of low trading volume, our revenues are adversely affected. Severe decreases in market prices, such as those experienced in 2008 could also have an impact on our business because of the adverse impact on investor sentiment and losses in investor portfolios.

 

In addition, a portion of our revenue is derived from payment for order flow. We have arrangements with several execution agents to receive cash payments in exchange for routing trade orders to these firms for execution. By custom in the industry, these cash payments are not the subject of any written agreement. As a result, they could be changed or eliminated at any time. Competition between execution agents and the implementation of order handling rules and decimalization of stock prices have made it less profitable for execution agents to offer order flow payments to broker-dealers. If these payments were to be reduced or eliminated for competitive or other reasons, our business could be materially adversely affected. Payment for order flow represented approximately 11.5% of our net revenue for the year ended December 31, 2009.

 

In January 2007, all of the option exchanges, at the direction of the SEC, instituted a pilot program to allow the options of certain underlying symbols to be quoted and traded in $0.01 increments in lieu of the $0.05 increments previously used. The initial pilot program consisted of a total of 63 underlying securities and was completed in March 2008. The SEC subsequently approved expanding the pilot to an additional 300 underlying securities, to be implemented in increments of 75 underlying securities in each of November 2009, February 2010, May 2010 and August 2010. The pilot has resulted in a reduction to our payment for order flow. Additional extensions of the pilot program or other actions taken by the SEC related to payment for order flow may have an adverse effect on our revenues and profitability.

 

Our business may be adversely affected by conditions in the global financial markets and economic conditions generally.

 

Our business does not produce predictable earnings, and all of our businesses are materially affected by conditions in the global financial markets and economic conditions generally. Since mid-2007, and particularly during the second half of 2008, the financial services industry and the securities markets generally were materially and adversely affected by significant declines in the values of nearly all asset classes and by a serious lack of liquidity. Although equity markets have begun to recover, equity values still remain well below the values achieved in 2007. Further or continued turmoil in the financial markets could lead investors to withdraw from these markets, decrease their rates of investment or refrain from making new investments which may reduce our net income, revenues and have a material adverse effect on our business.

 

We have exposure to interest rate risk.

 

A significant portion of our revenue is generated from investing customer cash that is deposited with us in interest-earning assets offset by interest liabilities we pay our customers on those deposits. In addition, we earn fees on our customer’s cash sweeps to a third-party manager. Changes in interest rates could affect the interest earned on assets differently than interest paid on liabilities. A rising interest rate environment generally results in us earning a larger net interest spread. Conversely, a falling interest rate environment generally results in us earning a smaller net interest spread.

 

We have exposure to liquidity risk.

 

We fund customer margin loans with customer credit balances. A reduction of funds available from client credit balances may require us to seek other potentially more expensive forms of financing, such as borrowings

on lines of credit. In June 2007, we established an unsecured, uncommitted credit facility with JPMorgan Chase Bank, NA that is callable on demand, but we do not currently have a committed line of credit and there can be no assurance that such financing would be available.

 

We are subject to various forms of credit risk, and those risks could have a material adverse effect on our financial situation.

 

We extend margin credit and leverage to our customers, which are subject to various regulatory and clearing firm margin requirements. Margin credit balances are collateralized by cash and securities in the customers’ accounts. Leverage involves securing a large potential future obligation with a lesser amount of cash or securities. The risks associated with margin credit and leverage increase during periods of fast market movements or in cases where leverage or collateral is concentrated and market movements occur. During such times, customers who utilize margin credit or leverage and who have collateralized their obligations with securities may find that the securities have a rapidly depreciating value and may not be sufficient to cover their obligations in the event of liquidation. We are exposed to credit risk when our customers execute transactions, such as short sales of options and equities or futures transactions that can expose them to risk beyond their invested capital. At December 31, 2009, we had $148.5 million in credit extended to our customers. In addition, we may be obligated for margin extended to our customers by our third-party clearing agents on collateralized securities and futures positions.

 

The margin and leverage requirements that we impose on our customer accounts meet or exceed those required by various regulatory requirements and Regulation T of the Board of Governors of the Federal Reserve. The amount of this risk is not quantifiable since the risk is dependent upon analysis of a potential significant and undeterminable rise or fall in stock prices. As a result, we are exposed to significant off-balance sheet credit risk in the event customer collateral is not sufficient to fully cover losses that customers may incur. In the event customers fail to satisfy their obligations, we may be required to purchase or sell financial instruments at prevailing market prices to fulfill the customers’ obligations. We believe that it is unlikely that we will have to make any material payments under these arrangements, and no material losses related to these guarantees and indemnifications have been recognized in the accompanying consolidated financial statements.

 

We borrow securities temporarily from other broker-dealers in connection with our broker-dealer business. We deposit cash as collateral for the securities borrowed. Decreases in securities prices may cause the market value of the securities borrowed to fall below the amount of cash deposited as collateral. In the event the counterparty to these transactions does not return the cash deposited, we may be exposed to the risk of selling the securities at prevailing market prices. We seek to manage this risk by requiring credit approvals for counterparties, by monitoring the securities values on a daily basis.

 

Our risk management policies and procedures may not be effective and may leave us exposed to unidentified or unexpected risks.

 

Our policies, procedures and practices used to identify, monitor and control a variety of risks may fail to be effective. As a result, we face the risk of losses, including losses resulting from firm errors, customer defaults, market movements, fraud and money-laundering. Our risk management methods rely on a combination of technical and human controls and supervision that are subject to error and failure. Some of our methods of managing risk are based on internally developed controls and observed historical market behavior, and also involve reliance on industry standard practices. These methods may not adequately prevent future losses, particularly as they relate to extreme market movements, which may be significantly greater than the historical measures indicate. These methods also may not adequately prevent losses due to technical errors if our testing and quality control practices are not effective in preventing technical software or hardware failures.

 

In order to help us provide our customers with the most favorable trade execution, we sometimes take proprietary short-term positions in market-listed equities and equity options. We may incur trading losses related to these activities since they primarily involve the purchase or sale of securities for our own account. We attempt to manage this risk by hedging our proprietary positions so that changes in market prices do not

materially change the value of our securities, but we cannot assure you that we will be able to manage such risk successfully or that we will not experience losses from such activities.

 

We may suffer losses if our reputation is harmed.

 

Our ability to attract and retain customers and employees may be adversely affected to the extent our reputation is damaged. If we fail, or appear to fail, to deal with various issues that may give rise to reputational risk, we could harm our business prospects. These issues include, but are not limited to, appropriately dealing with potential conflicts of interest, legal and regulatory requirements, ethical issues, money-laundering, privacy, record-keeping, sales and trading practices, and the proper identification of the legal, credit, liquidity, and market risks inherent in our business. Failure to appropriately address these issues could also give rise to additional legal risk to us, which could, in turn, increase the size and number of claims and damages asserted against us or subject us to regulatory enforcement actions, fines, and penalties.

 

Systems failures and delays could harm our business.

 

We receive and process trade orders through a variety of electronic channels. Our online trading services are heavily dependent on the integrity of the systems supporting them. Our systems and operations, including our Web servers and those of our third-party service providers, are vulnerable to damage or interruption from human error, sabotage, encryption failures, break-ins, intentional acts of vandalism, earthquakes, terrorist attacks, floods, fires, power loss, telecommunications failures, computer viruses, computer denial of service attacks or other attempts to harm our systems and operations, and similar events. Our disaster recovery planning cannot account for all eventualities. In addition, extraordinary trading volumes could cause our computer systems to operate at an unacceptably low speed or even fail. While we have invested significant amounts to upgrade the reliability and scalability of our systems, there can be no assurance that our systems will be sufficient to handle such extraordinary trading volumes.

 

Systems failures or delays may occur in the future and could cause, among other things, unanticipated disruptions in service to our customers, slower system response time resulting in transactions not being processed as quickly as our customers desire, decreased levels of customer service and customer satisfaction and harm to our reputation. If any of these events were to occur, we could suffer:

 

 

Our business also depends on the continued reliability of the Internet infrastructure. This includes maintenance of a reliable network backbone with the necessary speed, data capacity and security for providing reliable Internet services. Internet infrastructure may be unable to support the demands placed on it if the number of Internet users continues to increase or if existing or future Internet users access the Internet more often or increase their bandwidth requirements. In addition, viruses, worms and similar programs may harm the performance of the Internet. The Internet has experienced a variety of outages and other delays as a result of damage to portions of its infrastructure, and it could face outages and delays in the future. These outages and delays could reduce the level of Internet usage and our business could be materially adversely affected.

 

Our networks and those of our third-party service providers may be vulnerable to security risks.

 

The secure transmission of confidential information over public networks is a critical element of our operations. Our networks and those of our third-party service providers may be vulnerable to unauthorized access, computer viruses and other security problems. Persons who circumvent security measures could wrongfully use our confidential information or our customers’ confidential information or cause interruptions or malfunctions in our operations. We or our service providers may be required to expend significant

additional resources to protect against the threat of security breaches or to alleviate problems caused by any breaches. We or our service providers may not be able to implement security measures that will protect against all security risks.

 

We will need to introduce new products and services to remain competitive.

 

Our future success depends in part on our ability to develop and enhance our products and services. The financial services industry is characterized by rapid technological change and the emergence of new industry standards and practices that could render our existing technology and systems obsolete. There are significant technical and financial risks in the development of new or enhanced products and services, including the risk that we will be unable to effectively use new technologies or adapt our services to emerging industry standards, or develop, introduce and market enhanced or new products and services. In addition, the adoption of new Internet, networking or telecommunications technologies or other technological changes could require us to incur substantial expenditures to modify or adapt our services or infrastructure.

 

Our inability to protect our intellectual property rights or our infringement of the intellectual property rights of others could adversely affect our business.

 

Patents of third parties may have an important bearing on our ability to offer certain of our products and services. Our major competitors as well as other companies and individuals may obtain and may have obtained patents related to the technologies for trading the types of products and providing the services we offer or plan to offer. We cannot assure you that we are or will be aware of all patents containing claims that may pose a risk of infringement by our products and services. In addition, some patent applications in the United States are confidential until a patent is issued and, therefore, we cannot evaluate the extent to which technology concerning our products and services may be covered or asserted to be covered by claims contained in pending patent applications. In general, if one or more of our products or services were found by a court to infringe patents held by others, we may be required to stop developing or marketing the products or services, to obtain licenses to develop and market the services from the holders of the patents or to redesign the products or services in such a way as to avoid infringing those patents. An adverse ruling arising out of any intellectual property dispute could also subject us to significant liability for damages.

 

We cannot assess the extent to which we may be required in the future to obtain licenses with respect to patents held by others, whether such licenses would be available or, if available, whether we would be able to obtain such licenses on commercially reasonable terms. If we are unable to obtain licenses with respect to patents held by others, and are unable to redesign our products or services to avoid infringement of any such patents, this could materially adversely affect our business, financial condition and operating results.

 

Also, protection may not be available for our intellectual property. Although we have patent applications and registered trademarks in the United States and other countries, there can be no assurance that we will be able to secure significant protection for this intellectual property. It is possible that our competitors will adopt technology or product or service names similar to ours, thereby impeding our ability to distinguish our technology and build brand identity, possibly leading to customer confusion. Our inability to adequately protect our marks would have a material adverse effect on our business, financial condition and operating results.

 

Acquisitions involve risks that could adversely affect our business.

 

We have completed a number of acquisitions and will continue to pursue strategic acquisitions of businesses and technologies. Acquisitions entail numerous risks, including:

 

 

 

As part of our growth strategy, we regularly consider strategic transactions such as acquisitions, mergers and combinations within our industry. We cannot be certain that we will be able to continue to identify and to consummate strategic transactions, and no assurance can be given with respect to the timing, likelihood or business effect of any possible transaction. Any transactions that we consummate would involve risks and uncertainties to us. These risks could cause the failure of any anticipated benefits of an acquisition to be realized, which could have a material adverse effect on our business.

 

Failure to comply with net capital requirements could adversely affect our business.

 

The SEC, FINRA, CBOE, CFTC, NFA and other self-regulatory agencies or organizations have stringent rules with respect to the maintenance of specific levels of net capital by securities broker-dealers and futures commission merchants (“FCM”). Our broker-dealer and FCM subsidiaries are required to comply with these net capital requirements. If we fail to maintain the required net capital, the SEC or CFTC could fine us or even suspend or revoke our registration, or the applicable SRO could sanction us, including by limiting our growth or expelling us from membership. Any of these actions could have a material adverse effect on our business. If such net capital rules are changed or expanded, or if there is an unusually large charge against net capital, operations that require the use of capital would be restricted. A large operating loss or charge against net capital could adversely affect our ability to expand or even maintain our then present levels of business, which could have a material adverse effect on our business, financial condition, results of operations and prospects. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources” for a discussion of our net capital position.

 

As a holding company, we access the earnings of our broker-dealer subsidiaries through receipt of dividends from those subsidiaries. Net capital requirements may limit our ability to access those earnings.

 

Our self-clearing operations for securities expose us to liability for errors in clearing functions.

 

Clearing and execution services include the confirmation, receipt, settlement and delivery functions involved in securities transactions. Clearing brokers also assume direct responsibility for the possession and control of client securities and other assets and the clearance of client securities transactions. However, clearing brokers also must rely on third-party clearing organizations such as the DTCC and the OCC in settling client securities transactions. Self-clearing securities firms are subject to substantially more regulatory control and examination than introducing brokers that rely on others to perform clearing functions. Errors in performing clearing functions, including clerical and other errors related to the handling of funds and securities held by us on behalf of our clients, could lead to civil penalties as well as losses and liability in related lawsuits brought by clients and others.

 

We are dependent on clearing agents for executing and processing our futures transactions and any failures by them or difficulties in our relationships could materially harm our business.

 

We are dependent on certain clearing agents for the orderly processing of futures and options on futures transactions. Our clearing agreements with our clearing firms may be terminated by any of the parties upon prior written notice. Breaches or termination of these agreements or the clearing firms’ agreements with their third-party suppliers could harm our business. Termination of our relationship with our clearing firms could expose us to certain capital reserve requirements and other complex regulatory requirements imposed by federal and state securities laws, which could have a material adverse effect on our business. Moreover, we have agreed to indemnify and hold harmless our clearing firms from certain liabilities or claims, including claims arising from the transactions of our customers, and may incur significant costs as a result.

The loss of or change in our third-party vendors and service providers may adversely affect our business.

 

We rely on a number of third parties for various services. These include the services of market makers and exchanges to execute customer orders and other third parties for back office services and other information necessary to run our business, including transaction summaries, data feeds for compliance and risk management, execution reports and trade confirmations. Third-party content providers provide us with all of the financial information, market news, charts, option and stock quotes, research reports and other fundamental data that we offer to customers. Furthermore, we have offsite third-party data center operations that are critical to our business. To facilitate our securities self-clearing operations, we rely on third-party software and systems, including Sungard Financial Systems’ Phase3 securities trade processing and settlement software system. Our customers also rely on cash sweeps from their customer accounts to third-party managers.

 

We cannot assure you that any of these providers will be able to continue to provide these services in an efficient, cost-effective manner or that they will be able to adequately expand their services to meet our needs. An interruption in or the cessation of service by any third-party service provider as a result of systems failures, capacity constraints, unanticipated trading market closures or for any other reason, and our inability to make alternative arrangements in a smooth and timely manner, if at all, may impact our ability to process trades and have other material adverse effect on our business, financial condition and operating results.

 

We are subject to litigation and legal compliance risks.

 

Because of the extent and complexity of our regulatory environment and the products we offer, many aspects of our business involve substantial risks of liability. In recent years, there has been an increasing incidence of litigation involving the securities brokerage industry, including class action and other suits that generally seek substantial damages, including in some cases punitive damages. Any such litigation brought in the future could have a material adverse effect on our business, financial condition and operating results. We also face potential indirect liability for claims of defamation, negligence, copyright, patent or trademark infringement, violation of the securities laws and other claims based upon the third-party content that we distribute online. Computer failures may also result in our widely publishing and distributing incorrect data. Our insurance may not necessarily cover any of these claims or may not be adequate to protect us against all liability that may be imposed. Any such litigation brought in the future could have a material adverse effect on our business, financial condition and operating results.

 

In addition, we and our subsidiaries, our business and the industries in which we operate are at times being reviewed or investigated by regulators, which could lead to enforcement actions, fines and penalties or the assertion of private litigation claims and damages. While we believe that we have adopted appropriate risk management and compliance programs, the nature of our operations means that legal compliance risk will continue to exist and additional legal proceedings and other contingencies, the outcome of which cannot be predicted with certainty, will arise from time to time.

 

Losses due to employee or customer fraud could have an adverse effect on our business.

 

We are exposed to potential losses resulting from fraud and other misconduct by employees, customers or third parties. Employees may bind us to transactions that exceed authorized limits or present unacceptable risks, hide from us unauthorized or unsuccessful activities or improperly use confidential information. Third parties may engage in fraudulent activities, including fraudulent access to legitimate customer accounts, the use of a false identity to open an account, or the use of forged or counterfeit checks for payment. Such types of fraud may be difficult to prevent or detect, and we may not be able to recover the losses caused by such activities. Any such losses could have a material adverse effect on our business, financial condition and operating results.

 

Procedures and requirements of the Patriot Act may expose us to significant costs or penalties.

 

As participants in the financial services industry, our subsidiaries are subject to laws and regulations, including the Patriot Act, that require that they know their customers and monitor transactions for suspicious

financial activities. The cost of complying with the Patriot Act and related laws and regulations is significant. We face the risk that our policies, procedures, technology and personnel directed toward complying with the Patriot Act are insufficient and that we could be subject to significant criminal and civil penalties due to noncompliance. Such penalties could have a material adverse effect on our business, financial condition and operating results. As an online broker with customers worldwide, we may face particular difficulties in identifying our customers and monitoring their activities.

 

The market price of our common stock could fluctuate significantly.

 

Our common stock and the U.S. securities markets in general, have experienced significant price fluctuations in recent years. The market prices of securities of financial services and Internet-related companies, in particular, have been especially volatile. The price of our common stock could decrease substantially. In addition, because the market price of our common stock tends to fluctuate significantly, we could become the object of securities class action litigation which could result in substantial costs and a diversion of management’s attention and resources.

 

Market volatility may cause our stock price and the value of your investment to decline.

 

Broad market and industry factors may adversely affect the market price of our common stock, regardless of our actual operating performance. Factors that could cause fluctuations in our stock price may include, among other things:

 

 

Our officers, directors and largest stockholders will maintain the ability to control all matters submitted to stockholders for approval.

 

Our officers, directors and holders of 5% or more of our outstanding common stock beneficially own approximately 43% of our outstanding common stock. As a result, these stockholders, acting together, will have significant influence over the election of our directors, the appointment of new management and the potential outcome of all matters submitted to a vote of our stockholders, including entering into mergers, the sale of substantially all of our assets and other extraordinary items. The interests of this group of stockholders may not always coincide with our interests or the interests of other stockholders.

 

The future sale of shares of our common stock may negatively impact our stock price.

 

If our shareholders sell substantial amounts of our common stock, the market price of our common stock could fall. A reduction in ownership by our largest shareholder or any other large shareholders could cause the market price of our common stock to fall.

Provisions in our charter documents and Delaware law could discourage potential acquisition proposals, could delay, deter or prevent a change in control and could limit the price certain investors might be willing to pay for our stock.

 

Certain provisions of our certificate of incorporation and by-laws may inhibit changes in control of our company not approved by our board of directors or changes in the composition of our board of directors, which could result in the entrenchment of current management. These provisions include:

 

 

We are also afforded the protections of Section 203 of the Delaware General Corporation Law, which prevents us from engaging in a business combination with a person who becomes a 15% or greater stockholder for a period of three years from the date such person acquired such status unless certain board or stockholder approvals are obtained. These provisions could limit the price that certain investors might be willing to pay in the future for shares of our common stock.

 

Our investments in auction rate securities are subject to risks that may cause losses and affect the liquidity of these investments.

 

We hold tax-free municipal auction rate securities (“ARS”) backed by student loans issued under the Federal Family Education Loan Program (“FFELP”). Our ARS are marketable securities with long-term stated maturities (during years 2025-2041) for which the interest rates are reset through periodic short-term auctions every 7 or 35 days, depending on the issue. As a result of the liquidity issues in the global credit and capital markets, all of the auctions for all our ARS have failed since February 2008. Failed auctions limit liquidity for ARS holders until there is a successful auction, the issuer redeems the security, or another market for ARS develops.

 

Of the $72.7 million par value of ARS held by us as of December 31, 2009, approximately $48.7 million were sold by UBS AG (“UBS”) and have been classified as trading securities. In November 2008, we accepted an offer from UBS, entitling us to sell at par value ARS originally purchased from UBS at anytime during a two-year period from June 30, 2010 through July 2, 2012 (“UBS Put Right”). Prior to June 30, 2010, UBS is offering no net cost loans using our eligible ARS as collateral to provide interim liquidity. In accepting the offer, we granted UBS the authority to sell or auction the ARS at par at any time up until the expiration date of the offer and released UBS from any claims relating to the marketing and sale of ARS. ARS will continue to accrue and pay interest as determined by the auction process or the terms specified in the prospectus of the ARS if the auction process fails.

 

UBS’s obligations under the offer are not secured by its assets and do not require UBS to obtain any financing to support its performance obligations under the offer. UBS has disclaimed any assurance that it will have sufficient financial resources to satisfy its obligations under the offer. The reduction in associated market value of the UBS ARS during the year ended December 31, 2009 of approximately $2.5 million has been recorded as a charge to earnings, which has been substantially offset by a gain in the value of the UBS Put Right. If UBS has insufficient funding to buy back the ARS and the auction process continues to fail, we may incur losses on these ARS.

 

The remaining $24.0 million in par value of ARS were sold by another investment advisor, who has not made an offer similar to UBS and we have continued to classify such ARS as available-for-sale securities. Accordingly, the reduction in associated market value during the year ended December 31, 2009 of

approximately $1.9 million has been recorded in other comprehensive income. If market conditions deteriorate further, we may be required to record additional unrealized losses in other comprehensive income or take impairment charges. We may not be able to liquidate these investments unless the issuer calls the security, a successful auction occurs, a buyer is found outside of the auction process, or the security matures.

 

For additional information regarding our ARS, please see Item 7 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, “Liquidity and Capital Resources”.

 

 

None.

 

 

We lease our corporate headquarters and primary data center, located in Chicago, Illinois. We also lease office space in several cities throughout the United States and Australia. The following table sets forth certain information with respect to our main facilities:

 

 

We believe that our facilities are suitable and adequate to meet our needs.

 

 

We are not, nor are our subsidiaries, currently a party to any litigation that we believe could have a material adverse effect on our business, financial condition or operating results. However, many aspects of our business involve substantial risk of liability. In recent years, there has been an increasing incidence of litigation involving the securities brokerage industry, including class action suits that generally seek substantial damages, including punitive damages in some cases. Like other securities and futures brokerage firms, we have been named as a respondent in arbitrations, and from time to time we have been threatened with litigation, or named as a defendant in administrative proceedings. Compliance and trading problems that are reported to federal, state and provincial securities regulators, securities exchanges or other self-regulatory organizations by dissatisfied customers are investigated by such regulatory bodies, and, if pursued by such regulatory body or such customers, may rise to the level of arbitration or disciplinary action. We are also subject to periodic regulatory audits, inquiries and inspections.

 

 

No matters were submitted to a vote of stockholders during the fourth quarter of 2009.

 

 

Our common stock began trading on the Nasdaq Global Market under the symbol “OXPS” on January 27, 2005. Prior to that date, there was no established public trading market for our common stock. The following table shows the high and low closing sales prices for our common stock based on actual transaction on The Nasdaq Global Market during each of the quarters presented. The prices do not include retail markups, markdowns or commissions.

 

 

The closing sale price of our common stock as reported on the Nasdaq Global Market on February 22, 2010 was $15.75 per share. As of that date, there were 36 holders of record of our Common Stock based on information provided by our transfer agent. The number of stockholders of record does not reflect the actual number of individual or institutional stockholders that own our stock because most stock is held in the name of nominees. Based on information previously provided to us by depositories and brokers, we believe there are more than 14,000 beneficial owners.

 

Performance Graph

 

The Company performance information is not deemed to be “soliciting material” or to be “filed” with the SEC or subject to the SEC’s proxy rules or to the liabilities of Section 18 of the Exchange Act, and the Company performance information shall not be deemed to be incorporated by reference into any prior or subsequent filing by the Company under the Securities Act of 1933 Act, as amended, or the Exchange Act. Our Common Stock has been listed on the Nasdaq Global Market under the symbol “OXPS” and registered under Section 12 of the Securities and Exchange Act of 1934 since January 27, 2005, the date of our initial public offering. The following graph shows the cumulative stockholder return on our common stock with the Russell 2000 Stock Index and stock making up an industry peer group, in each case assuming an initial investment of $100 and full dividend reinvestment, for the period beginning on January 27, 2005 and ending on December 31, 2009.

 

The Peer Group is comprised of the following companies whose primary business is online brokerage:

 

 

Dividends

 

We paid a quarterly dividend of $0.08 per share in the first quarter of 2009 and did not pay any additional dividends in 2009. This compares to total dividends of $0.32 per share paid in 2008.

 

The declaration of any future dividends and, if declared, the amount of any such dividend, will be subject to our actual future earnings, capital requirements, regulatory restrictions and to the discretion of our board of directors. Our board of directors may take into account such matters as general business conditions, our financial results, capital requirements, alternative uses of capital, contractual, legal and regulatory restrictions on the payment of dividends by us to our stockholders or by our subsidiaries to us, and such other factors as our board of directors may deem relevant.

 

Recent Sales of Unregistered Securities; Use of Proceeds from Registered Securities

 

In July 2009, in connection with the first annual contingent payment for the OEC acquisition in July 2008, we issued 82,208 shares of our common stock to the members of OEC and approximately $2.2 million in cash. We relied on Section 4(2) of the Securities Act of 1933, as amended, and Regulation D promulgated thereunder to issue such shares of common stock. There were no underwriters involved in our issuance of common stock to members of OEC.

 

Purchases of Equity Securities by the Issuer

 

The following table provides information about our repurchases of our common stock during the three months ended December 31, 2009:

 

 

 

 

 

The following summary consolidated financial and operating data should be read together with our consolidated financial statements and the related notes included elsewhere in this Annual Report and the discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The financial information for the years ended December 31, 2009, 2008, 2007, 2006 and 2005 set forth below was derived from our audited consolidated financial statements and related notes. The historical financial and operating information may not be indicative of our future performance.

 

 

 

 

 

Overview

 

We offer a comprehensive suite of brokerage services for option, futures, stock, mutual fund, and fixed-income investors. While our initial focus was on the rapidly expanding listed equity options market, we have been recognized as offering the leading online retail brokerage platform based on the quality of our proprietary technology and our customer experience. Our option trades represented approximately 2% of all listed U.S. options volume for the year ended December 31, 2009. Our revenue consists primarily of commissions from customers’ trades of options, futures, stocks, mutual funds and fixed-income products, payment for our order flow from exchanges and liquidity providers, interest revenue and fees from customer and company cash and investments and education services from our Optionetics subsidiary.

 

Sources of Revenue

 

Our largest source of revenue is commissions earned from our brokerage activities, which are driven largely by our customers’ trading activities. Commissions and their related clearing costs and payment for order flow are recorded on a trade date basis as transactions occur. Like other retail brokerage firms, we receive payment for order flow from exchanges and liquidity providers where our customers’ orders are routed. By custom in the

industry, these cash payments are not the subject of any written agreement. As a result, they could be changed or eliminated at any time. Payment for order flow is included in other brokerage related revenue.

 

Interest revenue and fees consists of the income generated by charges to customers on margin balances and customer cash held and invested by us, net of interest paid to customers on their credit balances, fees earned on customer assets invested in our FDIC-insured sweep programs and money market funds and income generated by our cash held in investments. In conjunction with the FDIC insured sweep programs, the fee we earn is interest paid to us by banks in the program, net of interest paid to customers on their sweep balances. Education revenue consists of the sales of seminars, online study courses, coaching sessions and software products in the Education services segment, including the change in the deferred balance of education revenue being recognized.

 

Commissions represented 68.3%, 68.0% and 62.3% of our total revenues in 2009, 2008 and 2007, respectively. Other brokerage related revenue represented 11.5%, 12.5% and 14.3% of our total revenues in 2009, 2008 and 2007, respectively. Net interest revenue and fees represented 7.5%, 18.3% and 22.5% of our total revenues in 2009, 2008 and 2007, respectively. Education revenue represented 10.5%, 0.0% and 0.0% of our total revenues in 2009, 2008 and 2007, respectively. Other income represented 2.2%, 1.2% and 0.9% of our total revenues in 2009, 2008 and 2007, respectively.

 

Operating Expenses

 

In 2009, our largest expense item was employee compensation and benefits, which includes salaries, bonuses, contributions to benefit programs and other related employee costs. Due to the efficiencies created by our technology and brokerage platform, our employee compensation expense is a lower percentage of revenue than our major online competitors and other traditional, full service brokerage firms. Brokerage, clearing and other related expenses include commission payouts to introducing brokers at OEC and commission payouts to independent registered representatives on the brokersXpress platform. Brokerage, clearing and other related expenses also include back office software and other third-party services we use to support our self-clearing operations, fees to clearing organizations, exchanges and third-party broker-dealers.

 

Advertising costs are expensed as incurred, except for the production of broadcast advertising, which is expensed when the first broadcast airs, and includes production and communication of advertising and other marketing activities. Education marketing and fulfillment includes costs associated with promoting and hosting our education events, costs required to obtain the content for our online subscription services and other third party costs to produce the products we sell from our education segment. Depreciation and amortization includes depreciation on property and equipment, as well as amortization of capitalized software and other intangible assets. Other general and administrative expenses include securities and futures quotation costs, technology and telecommunication expenses, lease expenses on office space, professional fees, travel expenses and other miscellaneous expenses.

 

Results of Operations

 

The following table sets forth our total revenues and consolidated statements of operations data for the periods presented as a percentage of total revenues:

 

Year Ended December 31, 2009 versus Year Ended December 31, 2008

 

Overview

 

Our results for the year ended December 31, 2009 reflect the following principal factors:

 

 

Commissions

 

Our commissions decreased $8.1 million, or 4.8%, for the year ended December 31, 2009 to $159.5 million compared to $167.6 million for the year ended December 31, 2008. The decrease in commissions was the result of the 14.0% decrease in the number of retail trades, which was partially offset by a 77% increase in the number of institutional trades due to the full year of OEC institutional trades, which were included in our results beginning July 1, 2008. These institutional trades have a significantly lower average commission per trade than our retail business, resulting in a 5.6% decrease in our overall average commission per trade.

 

Other brokerage-related revenue

 

Other brokerage-related revenue decreased $4.0 million, or 13.2%, for the year ended December 31, 2009 to $26.8 million compared to $30.8 million for the year ended December 31, 2008. The decrease in other brokerage-related revenue was due to a reduction in the rate per contract collected, primarily as a result of the expansion of the penny pilot program and the reduction in total option contracts traded as a result of fewer trades.

 

Net interest revenue and fees

 

Net interest revenue and fees decreased $27.7 million, or 61.2%, to $17.5 million for the year ended December 31, 2009 compared to $45.2 million for the year ended December 31, 2008. The decrease in net interest revenue and fees was primarily the result of the decline in short-term interest rates, which was partially offset by higher balances.

 

Education revenue

 

Education revenue was $24.4 million for the year ended December 31, 2009. Prior to the acquisition of Optionetics on May 4, 2009, we did not have any material education revenue.

 

Other income

 

Other income increased $2.2 million, or 72.5%, for the year ended December 31, 2009 to $5.2 million compared to $3.0 million for the year ended December 31, 2008. The increase in other income was due to the adjustments in fair value of certain acquired liabilities and an increase of a number of miscellaneous items.

 

Compensation and benefits

 

Compensation and benefits expenses increased $13.9 million, or 48.6%, to $42.5 million for the year ended December 31, 2009 from $28.6 million for the year ended December 31, 2008. Increased compensation and benefits expenses were primarily due to an increase in the number of employees from 305 at December 31, 2008 to 423 at December 31, 2009. This increase was primarily driven by the acquisition of Optionetics on May 4, 2009.

Brokerage, clearing, and other related expenses

 

Brokerage, clearing, and other related expenses increased $4.2 million, or 15.4%, to $31.9 million for the year ended December 31, 2009 from $27.7 million for the year ended December 31, 2008. Brokerage, clearing and other related expenses were higher primarily due to the full year of results from OEC, which was included in our financial statements beginning July 1, 2008, and higher payouts to the independent registered representatives of our brokersXpress subsidiary.

 

Brokerage advertising

 

Brokerage advertising expenses decreased $3.1 million, or 15.0%, to $17.6 million for the year ended December 31, 2009 from $20.7 million for the year ended December 31, 2008. The decrease in advertising expense was due to a decrease in spending across all advertising channels. Advertising expense per net new account increased to $540 for the year ended December 31, 2009 from $388 for the year ended December 31, 2008.

 

Education marketing and fulfillment

 

Education marketing and fulfillment expenses were $15.8 million for the year ended December 31, 2009. Prior to the acquisition of Optionetics on May 4, 2009, we did not have any material education marketing and fulfillment expenses.

 

Depreciation and amortization

 

Depreciation and amortization expenses increased $1.5 million, or 19.6%, to $8.9 million for the year ended December 31, 2009 from $7.4 million for the year ended December 31, 2008. Increased depreciation and amortization expenses were primarily due to the intangible and fixed assets related to our acquisitions of Optionetics on May 4, 2009 and OEC on July 1, 2008.

 

Other general and administrative

 

Other general and administrative expenses increased $1.9 million, or 9.3%, to $22.5 million for the year ended December 31, 2009 from $20.6 million for the year ended December 31, 2008. Increased other general and administrative expenses were primarily due to the incorporation of other general and administrative costs resulting from the acquisition of Optionetics on May 4, 2009.

 

Income taxes

 

Income taxes decreased $17.6 million, or 34.4%, to $33.4 million for the year ended December 31, 2009 from $51.0 million for the year ended December 31, 2008. Lower income taxes were primarily due to the 33.4% reduction of income before income taxes.

 

Net income

 

As a result of the foregoing, we reported $60.8 million in net income for the year ended December 31, 2009, as compared to $90.3 million in net income for the year ended December 31, 2008, a decrease of $29.5 million, or 32.7%.

 

Segment information

 

Brokerage Services

 

Brokerage services net revenues decreased $37.6 million, or 15.2% for the year ended December 31, 2009 compared to the year ended December 31, 2008 primarily due to the decrease in net interest revenues and fees, which was driven by a decline in short term interest rates and lower commissions due to lower retail trade volume. Income before income taxes decreased $45.0 million, or 31.9% for the year ended December 31,

2009 compared to the year ended December 31, 2008 primarily due to the decline in revenues, and the increase in expenses that resulted from a full year of OEC expenses, which began July 1, 2008.

 

Education Services

 

Education services net revenues were $25.5 million and the loss before taxes was $2.1 million for the year ended December 31, 2009. The Company began reporting revenues and losses before taxes in Education services as a result of the acquisition of Optionetics, which closed on May 4, 2009.

 

Year Ended December 31, 2008 versus Year Ended December 31, 2007

 

Overview

 

Our results for the year ended December 31, 2008 reflect the following principal factors:

 

 

Commissions

 

Our commissions increased $13.7 million, or 8.9%, for the year ended December 31, 2008 to $167.6 million compared to $153.9 million for the year ended December 31, 2007. The increase in brokerage commissions was primarily the result of the 23.9% increase in the number of total trades processed during the year ended December 31, 2008 as a result of our acquisition of OEC and organic account growth. The increase in the number of trades was partially offset by the 12.1% decrease in the average commission per trade primarily as a result of the inclusion of OEC trades, which have a significantly lower average commission than our retail business, the increase in the number of futures trades, and our introduction of a reduced commission rate on option spread trades in August 2007.

 

Other brokerage-related revenue

 

Other brokerage-related revenue decreased $4.6 million, or 12.9%, for the year ended December 31, 2008 to $30.8 million compared to $35.4 million for the year ended December 31, 2007. The decrease in other brokerage-related revenue was due to a reduction in the payment for order flow rate per contract paid by exchanges and liquidity providers, which was partially offset by an increase in the number of customer option contracts that we processed.

 

Net interest revenue and fees

 

Net interest revenue and fees decreased $10.3 million, or 18.6%, to $45.2 million for the year ended December 31, 2008 compared to $55.5 million for the year ended December 31, 2007. The decrease in net interest revenue and fees was the result of the decline in short-term interest rates.

 

Education revenue

 

Prior to the acquisition of Optionetics on May 4, 2009, we did not have any material education revenue.

 

Other income

 

Other income increased $0.7 million, or 33.4%, for the year ended December 31, 2008 to $3.0 million compared to $2.3 million for the year ended December 31, 2007. The increase in other income was primarily

the result of growth in a revenue sharing program with a third party that provides fee-based personal investing coaching for our customers.

 

Compensation and benefits

 

Compensation and benefits expenses increased $2.1 million, or 7.8%, to $28.6 million for the year ended December 31, 2008 from $26.5 million for the year ended December 31, 2007. Increased compensation and benefits expenses were primarily due to an increase in the number of employees from 265 at December 31, 2007 to 305 at December 31, 2008 driven by the growth in our accounts and the addition of OEC employees.

 

Brokerage, clearing, and other related expenses

 

Brokerage, clearing, and other related expenses increased $7.8 million, or 39.0%, to $27.7 million for the year ended December 31, 2008 from $19.9 million for the year ended December 31, 2007. Brokerage, clearing and other related expenses were higher primarily due to the incorporation of results from OEC and higher payouts to the independent representatives of our brokersXpress subsidiary, along with higher other variable costs associated with the increased trade volume and customer accounts.

 

Brokerage advertising

 

Brokerage advertising expenses increased $5.9 million, or 39.8%, to $20.7 million for the year ended December 31, 2008 from $14.8 million for the year ended December 31, 2007. The increase in advertising expense was due to an increase in spending across all advertising channels. Advertising expense per net new account increased to $388 for the year ended December 31, 2008 from $304 for the year ended December 31, 2007.

 

Education marketing and fulfillment

 

Prior to the acquisition of Optionetics on May 4, 2009, we did not have any material education marketing and fulfillment expenses.

 

Depreciation and amortization

 

Depreciation and amortization expenses increased $1.7 million, or 30.0%, to $7.4 million for the year ended December 31, 2008 from $5.7 million for the year ended December 31, 2007. Increased depreciation and amortization expenses were due to increased amortization costs incurred from the indentified intangibles of our recent acquisitions, capitalized costs relating to the continued development of our brokerage platform and technology infrastructure, and capitalized costs incurred as a result of the move into our new corporate offices in June 2007.

 

Other general and administrative

 

Other general and administrative expenses increased $0.3 million, or 1.3%, to $20.6 million for the year ended December 31, 2008 from $20.3 million for the year ended December 31, 2007. Increased other general and administrative expenses were primarily due to the additional costs associated with the overall growth of our business.

 

Income taxes

 

Income taxes decreased $10.8 million, or 17.5%, to $51.0 million for the year ended December 31, 2008 from $61.8 million for the year ended December 31, 2007. Decreased income taxes are the result of the 11.4% decrease in income before income taxes and the result of a change in state income apportionment laws.

Net income

 

As a result of the foregoing, we reported $90.3 million in net income for the year ended December 31, 2008, as compared to $97.7 million in net income for the year ended December 31, 2007, a decrease of $7.4 million, or 7.6%.

 

Segment information

 

Brokerage Services

 

Brokerage services net revenues decreased $0.4 million, or 0.2% for the year ended December 31, 2008 compared to the year ended December 31, 2007 primarily due to the decrease in net interest revenues and fees, which was largely offset by higher commissions. Income before income taxes decreased $18.2 million, or 11.4% for the year ended December 31, 2008 compared to the year ended December 31, 2007 primarily due to the increase in expenses that resulted from the acquisition of OEC.

 

Education Services

 

The Company began reporting revenues and losses before taxes in education services as a result of the acquisition of Optionetics, which closed on May 4, 2009.

 

Liquidity and Capital Resources

 

As a holding company, almost all of the funds generated from our operations are earned by our operating subsidiaries. We access these funds through receipt of dividends from these subsidiaries. Some of our subsidiaries are subject to requirements of various regulatory bodies, including the SEC, FINRA, the CBOE, the CFTC and the NFA, relating to liquidity and capital standards, which may limit the funds available for the payment of dividends to us.

 

We invest company cash in a variety of high credit quality investment vehicles including U.S. Government Treasury Bills, bank-issued commercial paper, AAA-rated institutional money market funds and tax-free ARS backed by United States Department of Education-guaranteed student loans issued under the FFELP. Our ARS are marketable securities with long-term stated maturities (during years 2025-2041) for which the interest rates are reset through periodic short-term auctions every 7 or 35 days, depending on the issue. As a result of the liquidity issues in the global credit and capital markets, all of the auctions for all our ARS have failed since February 2008. Failed auctions limit liquidity for ARS holders until there is a successful auction, the issuer redeems the security, or another market for ARS develops.

 

Our ARS portfolio consists entirely of securities backed by student loans issued under the FFELP program, which are individually guaranteed by the United States Department of Education. All of our ARS are AAA-rated with the exception of two issues totaling $6.0 million in par value, and all of our ARS are current with respect to receipt of interest payments according to the stated terms of each ARS indenture. As of the date of this report, we have no reason to believe that any of the underlying issuers of our ARS will be unable to satisfy the terms of the indentures or that the underlying credit quality of the assets backing our ARS investments has deteriorated. Since the ARS markets began failing on February 14, 2008, $34.9 million of our ARS securities have been redeemed by issuers or our brokers at par. We believe we have the ability, if necessary, to hold our ARS investments until such time as the auctions are successful, the issuer redeems the securities, or another market for ARS develops.

 

At December 31, 2009, there was insufficient observable ARS market information available to determine the market value of our investments in ARS. Therefore, we have continued to designate the ARS as Level 3 financial assets under Financial Accounting Standards Board (“FASB”) ASC Topic 820, Fair Value Measurements and Disclosures (“ASC 820”) and estimated the Level 3 fair values for these securities by using the income method, incorporating assumptions that market participants would use in their estimates of fair value. We calculate the income by developing a discounted cash flow model based on the expected cash flows from the ARS compared to a market rate.

For the economic life of the ARS, we relied on estimates based in part on issuer statements regarding the intent and likelihood of the ARS being redeemed or refinanced, the economic life of the loans currently outstanding in the trusts and observed redemption and refinance activity throughout 2009. Based on our analysis, the weighted average economic life was estimated to be approximately four years. We used the current yield of the ARS, which we then adjusted for the expected tax benefit. For the fair market interest rates used in our discounting analysis, we used a current market rate for liquid debt instruments of similar underlying assets and credit quality, with spreads of approximately 200bps-300bps over the London Interbank Offered Rate (“LIBOR”). We also relied upon the indentures underlying the ARS and other market information in determining these assumptions.

 

Of the $72.7 million par value of ARS as of December 31, 2009, approximately $48.7 million were sold by UBS and have been classified as trading securities. In November 2008, we accepted an offer from UBS, entitling us to sell at par value ARS originally purchased from UBS at anytime during a two-year period from June 30, 2010 through July 2, 2012, (the “UBS Put Right”). Prior to June 30, 2010, UBS is offering no net cost loans using our eligible ARS as collateral to provide interim liquidity. In accepting the offer, we granted UBS the authority to sell or auction the ARS at par at any time up until the expiration date of the offer and released UBS from any claims relating to the marketing and sale of ARS. ARS will continue to accrue and pay interest as determined by the auction process or the terms specified in the prospectus of the ARS if the auction process fails.

 

UBS’s obligations under the offer are not secured by its assets and do not require UBS to obtain any financing to support its performance obligations under the offer. UBS has disclaimed any assurance that it will have sufficient financial resources to satisfy its obligations under the offer. We have adopted the fair value option under FASB ASC Topic 825, Financial Instruments, to classify the UBS Put Right and the ARS sold by UBS as trading securities. Our calculation of fair value of the UBS ARS at December 31, 2009 implied an impairment of fair value of approximately $2.5 million, which has been recorded as an unrealized loss in other income on the consolidated statement of operations. This impairment has been substantially offset by a realized gain in the value of the UBS Put Right. The fair value of the ARS held at UBS is approximately $46.2 million. If UBS has insufficient funding to buy back the ARS and the auction process continues to fail, we may incur losses on these ARS.

 

The remaining $24.0 million in par value ARS were sold by another investment advisor, who has not made an offer similar to UBS, and therefore, we have continued to classify them as available-for-sale securities. Our calculation of fair value of the ARS not held at UBS at December 31, 2009 implied an impairment of fair value of approximately $1.9 million, which has been recorded through accumulated other comprehensive income on the statement of financial condition, and the carrying fair value of those ARS was approximately $22.1 million. If the market conditions deteriorate further, we may be required to record additional unrealized losses in other comprehensive income or impairment charges. We may not be able to liquidate these investments unless the issuer calls the security, a successful auction occurs, a buyer is found outside of the auction process, or the security matures.

 

optionsXpress, Inc. is subject to the Securities and Exchange Commission Uniform Net Capital Rule (“Rule 15c3-1”) under the Securities Exchange Act of 1934, administered by the SEC and FINRA, which requires the maintenance of minimum net capital. Under Rule 15c3-1, optionsXpress, Inc. is required to maintain net capital of 2% of “aggregate debits” or $0.25 million, whichever is greater, as these terms are defined.

 

optionsXpress, Inc. is also subject to the CFTC Regulation 1.17 (“Reg. 1.17”) under the Commodity Exchange Act, administered by the CFTC and the NFA, which also requires the maintenance of minimum net capital. optionsXpress, Inc., as a futures commission merchant, is required to maintain minimum net capital equal to the greater of its net capital requirement under Rule 15c3-1 ($0.5 million), or the sum of 8% of the total risk margin requirements for all positions carried in customer accounts and 4% of the total risk margin requirements for all positions carried in non-customer accounts, as defined in Reg. 1.17.

 

As of December 31, 2009, optionsXpress, Inc. had net capital requirements of $17.9 million and net capital of $97.5 million. As of December 31, 2008, optionsXpress, Inc. had net capital requirements of

$8.9 million and net capital of $76.0 million. All of our other broker-dealers also exceeded the net capital requirements for their respective jurisdictions. We believe that we currently have sufficient capital to satisfy these ongoing requirements.

 

In addition to net capital requirements, as a self-clearing broker-dealer, optionsXpress, Inc. is subject to Depository Trust & Clearing Corporation (“DTCC”), Options Clearing Corporation (“OCC”), and other cash deposit requirements, which may fluctuate significantly from time to time based upon the nature and size of our customers’ trading activity. As of December 31, 2009, we had interest-bearing security deposits and short-term treasury bills totaling $30.2 million deposited with clearing organizations for the self-clearing of equities and option trades.

 

As of December 31, 2009, we had $881.2 million of cash segregated in compliance with federal regulations in special reserve bank accounts for the exclusive benefit of customers under Rule 15c3-3 of the Securities Exchange Act of 1934 and other regulations. Liquidity needs relating to client trading and margin borrowing activities are met primarily through cash balances in customer brokerage accounts, which were $1,179.2 million at December 31, 2009.

 

Credit Facility

 

We generally finance our operating liquidity and capital needs through the use of funds generated from operations and the issuance of common stock.

 

To support our self-clearing activities, we have an unsecured, uncommitted credit facility with JPMorgan Chase Bank, NA that is callable on demand. We anticipate that the credit facility will only be used occasionally, addressing potential timing issues with the flow of customer funds, and will only be used to facilitate transactions for which customers already have sufficient funds in brokerage accounts. As of December 31, 2009, there was no balance outstanding on this credit facility.

 

Although we have no current plans to do so, we may issue equity or debt securities or enter into secured or additional unsecured lines of credit from time to time.

 

Cash Flow

 

Cash provided by operating activities was $105.8 million for the year ended December 31, 2009, compared to cash provided by operating activities of $106.5 million for the year ended December 31, 2008. Cash provided by operating activities decreased 0.6% due to the increase of cash segregated in compliance with federal regulations and receivables from brokers, dealers and clearing organizations which was partially offset by the increase of payables to brokerage customers and the 32.7% decrease in net income.

 

Cash used in investing activities was $17.8 million for the year ended December 31, 2009, compared to cash provided by investing activities of $44.0 million for the year ended December 31, 2008. The primary reason for the decrease in cash provided by investing activities was primarily due to the decreased redemptions of investments in securities.

 

Cash used in financing activities was $23.5 million for the year ended December 31, 2009, compared to cash used in financing activities of $106.5 million for the year ended December 31, 2008. The decrease of cash used in financing activities was primarily due to the reduction of cash used to repurchase our outstanding common stock.

 

Capital Expenditures

 

Capital expenditures were $4.9 million for the year ended December 31, 2009, compared to $5.7 million for the year ended December 31, 2008. The decrease in capital expenditures was related to a decreased level of fixed asset additions. Capital expenditures for the years ended December 31, 2009 and 2008 included capitalized software development costs, which we capitalized in accordance with FASB ASC Topic 350-50, Website Development Costs (“ASC 350-50”), primarily related to the development of our technology.

Off-Balance-Sheet Arrangements

 

In the ordinary course of business, there are certain customer activities that may result in contingencies that are not reflected in the consolidated financial statements. These activities may expose us to off-balance-sheet credit risk in the event the customers are unable to fulfill their contractual obligations. Many of our customer accounts are margin accounts. In margin transactions, we may be obligated for credit extended to our customers by our clearing firms and subject to various regulatory and clearing firm margin requirements. See “Risk Factors — We are subject to various forms of credit risk, and those risks could have a material adverse effect on our financial situation” for a more detailed discussion of this risks associated with these arrangements.

 

Summary Disclosures about Contractual Obligations and Commercial Commitments

 

The following table reflects a summary of our contractual cash obligations and other commercial commitments at December 31, 2009:

 

 

The amounts presented in the table above may not necessarily reflect our actual future cash funding requirements, since the actual timing of the future payments made may vary from the stated contractual obligations.

 

Critical Accounting Policies

 

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses. We review our estimates on an ongoing basis. We base our estimates on our experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. While our significant accounting policies are described in more detail in the notes to our consolidated financial statements included in this Annual Report on Form 10-K, we believe the accounting policies that have a material impact on our consolidated financial statements and require management to make assumptions and estimates involving significant judgment related to the valuation of our goodwill, the fair value of our contingent liability, the fair value of our investments in securities, specifically our investments in ARS, and capitalization our of software development.

 

Valuation of Goodwill

 

We test goodwill for impairment on at least an annual basis, or whenever events and circumstances indicate that the carrying value may not be recoverable. In performing the impairment tests, we utilize quoted market prices of our common stock to estimate the fair value of the Company as a whole. The estimated fair value is then allocated to our reporting units, if applicable, based on operating revenues, and is compared with the carrying value of the reporting units.

 

Contingent Consideration

 

We fair value the contingent consideration on at least a quarterly basis, or whenever events and circumstances indicate that the fair value has materially changed. In performing the fair value valuation, we use a discounted cash flow model to value our contingent consideration liability. Our valuation model is based

on both the estimated future profitability and the number of new customer accounts generated by the business unit.

 

Investments in Securities

 

Our investments in securities consist of ARS backed by student loans issued under the FFELP program and the UBS Put Right associated with ARS held at UBS. We determine the fair value of our ARS and the UBS Put Right using the income method. We calculate the income by developing a discounted cash flow model based on the expected cash flows from the ARS compared to a market rate. For additional information regarding our ARS and our valuation methodology and assumptions, please see Item 7 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, “Liquidity and Capital Resources”

 

For the available-for-sale ARS, if the calculated fair value is below the carrying amount of the securities, we then determine if the decline in value is other-than-temporary. We consider various factors in determining whether an impairment is other-than temporary, including the severity and duration of the impairment, changes in underlying credit ratings, forecasted recovery, our ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery in market value and the probability that the scheduled cash payments will continue to be made. When we conclude that an impairment is other-than-temporary, the difference between the fair value and the carrying value is recorded as an impairment charge in the consolidated statement of operations. Impairments that we conclude are temporary are recorded in accumulated other comprehensive loss in the consolidated statement of financial condition.

 

Software

 

Costs associated with software developed for internal use include capitalized costs based on ASC 350-50. Capitalized costs include external direct costs of materials and services consumed in developing or obtaining internal-use software and payroll for employees directly associated with, and who devote time to, the development of the internal-use software. Costs incurred in development and enhancement of the software that does not meet the capitalization criteria are expensed as incurred. These capitalized costs are amortized on a straight-line basis over three years. The critical estimate related to this process is the determination of the amount of time devoted by employees to specific stages of internal-use software development projects. We utilize a project management system to assist in validating the underlying estimates used in the determination of time devoted. We periodically review the capitalized costs for impairment.

 

Recently Issued Accounting Pronouncements

 

In January 2010, the FASB issued Accounting Standards Update (“ASU”) 2010-06, Improving Disclosures about Fair Value Measurements (“ASU 2010-06”). ASU 2010-06 amends ASC 820 by requiring additional disclosures regarding fair value measurements. Specifically, the amendment requires additional disclosures of i) the input and valuation techniques used to measure fair value for both recurring and nonrecurring fair value measurements of Level 2 and Level 3 positions, ii) the transfers between all levels (including Level 1 and Level 2) will be required to be disclosed on a gross basis as well as the reasons for the transfers and iii) the purchases, sales, issuances and settlements must be shown on a gross basis in the Level 3 roll forward table. ASU 2010-06 is effective for fiscal years beginning after December 15, 2010. Therefore, ASU 2010-06 will be effective for our fiscal year beginning January 1, 2011. The adoption of ASU 2010-06 is not expected to have a material impact on our financial statements.

 

 

Market risk generally represents the risk of loss that may result from the potential change in the value of a financial instrument as a result of fluctuations in interest rates and market prices. We have established policies, procedures and internal processes governing our management of market risks in the normal course of our business operations. We do not have material exposure to commodity price changes, foreign currency

fluctuations or similar market risks other than the effect they may have on trading volumes. Accordingly, we have not entered into any derivative contracts to mitigate such risks.

 

Interest Rate Risk

 

As a self-clearing broker-dealer, we hold interest-earning assets, which mainly consist of customer funds required to be segregated in compliance with federal regulations. Interest-earning assets are financed primarily by short-term interest-bearing liabilities in the form of customer cash balances. We earn a net interest spread on the customer balances, as well as on the difference between amounts earned on customer margin loans and amounts paid on customer cash balances. Since we set the rate paid on customer cash balances and the rate charged on customer margin loans, we are able to manage a portion of our interest rate risk. However, a rising interest rate environment generally results in our earning a larger net interest spread while a falling interest rate environment generally results in our earning a smaller net interest spread. We also earn fees on our customer cash balances that are swept to a third-party FDIC program. These fees generally increase in a rising rate environment and decline in falling rate environment.

 

We have estimated the additional impact to pretax income that hypothetical interest rate changes would have to balances as of December 31, 2009. We estimate that as of December 31, 2009, an immediate 100 basis point increase in short-term rates would result in an addition of approximately $24 million in annual pre-tax income from current levels. Although it is difficult to anticipate the behavior of money market participants if the Federal Funds Target rate is lowered from a range of 0 bps — 25 bps to 0 bps, we estimate that a Federal Funds rate of 0 bps would result in approximately $4 million less in annual pretax income from current levels.

 

Credit Risk

 

We extend margin credit and leverage to our customers, which are subject to various regulatory and clearing firm margin requirements. Margin credit balances are collateralized by cash and securities in the customers’ accounts. Leverage involves securing a large potential future obligation with a lesser amount of cash or securities. The risks associated with margin credit and leverage increase during periods of fast market movements or in cases where leverage or collateral is concentrated and market movements occur. During such times, customers who utilize margin credit or leverage and who have collateralized their obligations with securities may find that the securities have a rapidly depreciating value and may not be sufficient to cover their obligations in the event of liquidation. We are exposed to credit risk when our customers execute transactions, such as short sales of options and equities or futures transactions that can expose them to risk beyond their invested capital. At December 31, 2009, we had $148.5 million in credit extended to our customers. In addition, we may be obligated for margin extended to our customers by our third-party clearing agents on collateralized securities and futures positions.

 

The margin and leverage requirements that we impose on our customer accounts meet or exceed those required by various regulatory requirements and Regulation T of the Board of Governors of the Federal Reserve. The amount of this risk is not quantifiable since the risk is dependent upon analysis of a potential significant and undeterminable rise or fall in stock prices. As a result, we are exposed to significant off-balance sheet credit risk in the event customer collateral is not sufficient to fully cover losses that customers may incur. In the event customers fail to satisfy their obligations, we may be required to purchase or sell financial instruments at prevailing market prices to fulfill the customers’ obligations. We believe that it is unlikely that we will have to make any material payments under these arrangements, and no liabilities related

to these guarantees and indemnifications have been recognized in the accompanying consolidated financial statements.

 

We borrow securities temporarily from other broker-dealers in connection with our broker-dealer business. We deposit cash as collateral for the securities borrowed. Decreases in securities prices may cause the market value of the securities borrowed to fall below the amount of cash deposited as collateral. In the event the counterparty to these transactions does not return the cash deposited, we may be exposed to the risk of selling the securities at prevailing market prices. We seek to manage this risk by requiring credit approvals for counterparties, by monitoring the securities values on a daily basis, and by requiring additional collateral as needed.

 

Securities Risk

 

In order to help us provide our customers with the most favorable trade execution, we sometimes take proprietary short-term positions in listed equity and option securities. We attempt to manage this risk by hedging our proprietary positions so that changes in market prices do not materially change the value of our securities. However, our hedging strategy may not be effective and may expose us to losses on these securities.

 

 

The Report of Independent Registered Public Accounting Firm, Consolidated Financial Statements and Selected Quarterly Financial Data are set forth in the index on page F-1 of this Annual Report on Form 10-K.

 

 

None

 

 

MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

 

Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934) that are designed to provide reasonable assurance that information required to be disclosed in our filings under the Securities Exchange Act is recorded, processed, summarized and reported within the periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

Prior to filing this report, we completed an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2009. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of December 31, 2009.

 

Management’s Report on Internal Control over Financial Reporting

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control system has been designed to provide reasonable assurance to management and the Board of Directors regarding the preparation and fair presentation of published financial statements.

 

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009. Management based this assessment on criteria for effective internal control over financial reporting described in Internal Control — Integrated Framework issued by the Committee of Sponsoring

Organizations of the Treadway Commission. Management’s assessment included evaluating the design of the Company’s internal control over financial reporting and testing the operational effectiveness of the Company’s internal control over financial reporting. The results of its assessment were reviewed with the Audit Committee of the Board of Directors.

 

Based on this assessment, management believes that the Company’s internal control over financial reporting was effective as of December 31, 2009.

 

Ernst & Young LLP, our independent registered public accounting firm, has audited the consolidated financial statements included in this Annual Report on Form 10-K and, as part of its audit, has issued its attestation report on the effectiveness our internal controls over financial reporting as of December 31, 2009. The attestation report is included in this section of the Annual Report on Form 10-K.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

The Board of Directors and Shareholders

optionsXpress Holdings, Inc.:

 

We have audited optionsXpress Holdings, Inc.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). optionsXpress Holdings, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, optionsXpress Holdings, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the COSO criteria.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the 2009 consolidated financial statements of optionsXpress Holdings, Inc. and our report dated March 1, 2010 expressed an unqualified opinion thereon.

 

 

Chicago, Illinois

March 1, 2010

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting during the quarter ended December 31, 2009 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

None.

 

The Company’s Proxy Statement for its Annual Meeting of Shareholders, to be held May 27, 2010, which, when filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, will be incorporated by reference in this Annual Report on Form 10-K pursuant to General Instruction G(3) of Form 10-K, provides the information required under Part III (Items 10, 11, 12, 13 and 14).

 

 

(a)(1) The following documents are filed as part of this Annual Report on Form 10-K:

 

 

(a)(2) Financial Statement Schedules

 

The following financial statement schedule is filed as part of this Annual Report on Form 10-K:

 

 

All other schedules have been omitted because the information required to be set forth in those schedules is not applicable, or is shown in the consolidated financial statements or notes thereto.

 

(a)(3) See attached Exhibit Index.

 

(b) Exhibits. See attached Exhibit Index.

 

(c) none

 

Pursuant to the requirements of Section 13 or 15(d) 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 on March 1, 2010.

 

OPTIONSXPRESS HOLDINGS, INC.

 

David A. Fisher

Chief Executive Officer (Principal Executive Officer)

 

Adam J. DeWitt

Chief Financial Officer (Principal Financial and

Accounting Officer)

 

Ronald L. Wetzel

Controller

 

Pursuant to the requirements of the Securities Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 1, 2010.

 

Exhibits

 

 

 

 

optionsXpress Holdings, Inc.

 

Consolidated Financial Statements

Years Ended December 31, 2009, 2008 and 2007

 

Contents

 

 

The Board of Directors and Stockholders

optionsXpress Holdings, Inc.

 

We have audited the accompanying consolidated statements of financial condition of optionsXpress Holdings, Inc. as of December 31, 2009 and 2008, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of optionsXpress Holdings, Inc. at December 31, 2009 and 2008, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2009, in conformity with U.S. generally accepted accounting principles.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), optionsXpress Holdings, Inc.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 1, 2010 expressed an unqualified opinion thereon.

 

 

Chicago, Illinois

March 1, 2010

optionsXpress Holdings, Inc.

 

 

See accompanying notes.

optionsXpress Holdings, Inc.

 

 

See accompanying notes.

optionsXpress Holdings, Inc.