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optionsXpress Inc. (NASDAQ:OXPS)

Q4 2008 Earnings Call

January 29, 2009 9:00 am ET

Executives

Adam DeWitt − Chief Financial Officer

David Fisher − Chief Executive Officer

Analysts

Rich Repetto – Sandler O’Neill

Patrick O'Shaughnessy − Raymond James

Daniel Harris – Goldman Sachs

Brian Bedell − Bank of America Merrill Lynch

Mark Lane − William Blair

George Groves – American Capital Partners

Edward Ditmire − Fox-Pitt Kelton

Mike Vinciquerra − BMO Capital Markets

Operator

Welcome to the optionsXpress Holdings fourth quarter and full year 2008 financial results conference call. Today’s call is being recorded. At this time I would like to turn the conference over to Mr. Adam DeWitt, Chief Financial Officer.

Adam DeWitt

Thanks for joining us for our fourth quarter and full year 2008 earnings call. I’m Adam DeWitt the CFO of optionsXpress, and with me today is our CEO, David Fisher. By now you should have received a copy of our press release that was faxed or emailed to you. If you haven’t, please call Victoria Paris at 312-553-6715 and we’ll make sure you get one. Alternatively, you can view a copy of our release, listen to the call and submit any questions to us via our website at optionsxpress.com.

Before we begin, I would like to note that this call contains forward-looking statements that are made pursuant to the Safe Harbor provisions of the Federal Securities laws. These statements involve risks, uncertainties, and assumptions that may cause actual results to differ materially from those anticipated. Listeners to the call are advised to review the risk factors contained in our prospectus, most recent annual report on Form 10-K, and quarterly report on Form 10-Q for descriptions of risks, uncertainties, and assumptions related to forward-looking statements. Please note that this call is intended for investors and analysts and may not be reproduced in the media in whole or in part without our prior consent.

At this time, I’ll turn the call over to our CEO, David Fisher, who will recap the highlights from the fourth quarter. Following David’s remarks, I will walk through the financials and David will wrap up with our outlook before we finish with questions. David?

David Fisher

Clearly 2008 was an extremely challenging year for our economy and in particular the financial markets. However, amidst the sharp drop in global equities, rising unemployment and tremendous volatility, optionsXpress remained a safe and secure place for our customers and we emerged unharmed and a strong financial position.

As you can see in our release, despite unprecedented headwinds that affected many effects of our business, we were able to generate revenue of $247 million in 2008 while net income was $91 million and earnings per share were $1.49. We think these are solid results in a year in which our financial system went into severe distress with the credit markets all but closing and interest rates dipping to their lowest level in history.

Despite these conditions, we organically added 53,400 accounts, the second highest in our history. This resulted in over 20% account growth for the year. We attracted these customers to optionsXpress in the same ways as always. We continued to invest in smart grass roots marketing initiatives, we made or product platform even more compelling and we continued to educate customers to help make them more effective and resilient investors.

In particular, we generated strong new accounts in both October and November and we adjusted our messaging to highlight two key items, first, the safety and security of optionsXpress platform. With no debt, no toxic acid exposure and a safe vehicle for our customer’s cash with our FDIC sweep program we believe this was and will continue to be a strong selling point. And second, the benefits of using options and futures products in both volatile and declining markets. Clearly these messages resonated with new customers, and we saw significantly higher than normal asset flows in from full-service brokers.

As we look forward, we see two trends that should be very positive for optionsXpress. The first is the continued adoption of options and futures products by retail investors, and the second is the continued migration of investors from full-service brokers to self-directed accounts, which as I just mentioned, increased in the fourth quarter.

To position us well for this opportunity, we continue to focus on improving our platform with nine major site releases in 2008. These are releases focused on enhancing our customer’s ability to learn about options and futures, evaluate investment opportunities and execute their trades.

We also upgraded our platform with a new easier to use interface design and hubs centered around the core features that our customers use regularly. The broad feedback we have received on these enhancements has been overwhelmingly positive and reaffirms our commitment to an investment and constant innovation.

Since our inception, we have positioned our platform to cater to a wide range of investors, from beginners to experts. This strategy has served us well and we believe continues to be the right approach going forward. There are currently about 40 million online investing accounts and the majority of those customers are at large online brokers.

These customers are comfortable using online web-based platforms. Accordingly, as these customers add options and futures products to their portfolios, we believe it is easy an compelling for them to switch to a web-based platform like optionsXpress where they will receive the best overall experience while using these products and have very little learning on our platform.

In addition, our platform is not geared solely towards high volatile e-trading. It has a range of powerful future-rich tools, which help individual investors learn about the product, evaluate different strategies, find their trades and finally effectively execute on those strategies. Beyond improving our platform, we made significant strides in expanding our offerings both at home and abroad in 2008.

With the acquisition of Open E Cry in June, we extended our presence among high volume future traders. This increased traction among institutional traders helped drive 16,400 institutional darts in the fourth quarter. This was a strong 39% increase over the third quarter. The absolution of Open E Cry continued our successful expansion into futures.

On the retail side, we had a record fourth quarter for futures, which topped off a record year with retail future darts increasing 14% over last year. We also brought into our geographic reach by partnering with Reliance Money Limited introducing optionsXpress to the Indian marketplace where we had no previous experience. This agreement is another step forward in our ongoing plan of leveraging our platform through low cost expansion to international markets.

Finally, Brokers Express, our wholesale business serving [inaudible] in RAAs continues to generate solid results and should really benefit from the struggles many full-service brokers are facing.

Before handing the call back over to Adam, I would like switch gears and spend a couple minutes talking about recent trends in the industry. There is little doubt that the volatility affecting financial markets has impacted all investors. However, our customers have in large part weathered these external conditions that none of us could have foreseen even six months ago.

While trading volumes are down across the industry, our customers have remained resilient and engaged with their investing, albeit at lower levels. They’re continuing their investing education at optionsXpress and using options and futures to navigate the difficult market environments. A great barometer of the resilience are our customer asset balances, which held up remarkably well, declining only 8% during the quarter and 15% during the year both better than the S&P 500 decline of 22% during the quarter and 38% for the year.

We believe the slower trading levels over the past couple of months are evidenced their customers are taking a thoughtful approach to their investing informed by both the optionsXpress education, which many take advantage of, as well as their own experiences. They are not panicking. They are not bailing out of the portfolio or needlessly speculating in these uncertain and volatile markets. This patient and thoughtful approach to investing will service our customers, and as a result optionsXpress, when market conditions stabilize and trading levels return to more historic levels.

With that, let me turn the call over to Adam who will review the fourth quarter and full year financials with you in greater detail. Adam?

Adam DeWitt

As David mentioned, by almost any measure 2008 was a challenging year and we performed well. Our earnings per share for 2008 were $1.49, only 4% lower than 2007 despite a 19% decline in net interest revenues from lower short-term interest rates. Our fourth quarter results were particularly impacted by lower interest rates as the Fed cut the target rate to between zero and 25 basis points.

Total net revenues for the quarter were $57.3 million, a 17% decrease versus the fourth quarter of 2007 and a 14% decrease versus last quarter. Commission revenues of $42.6 million for the fourth quarter were down 3% compared to last year and were down 6% from our results in the last quarter.

The small decrease from the prior year was due to lower trading activity as the fourth quarter of 2007 was an extremely strong trading quarter. This decline was mostly offset by the addition of institutional trades from Open E Cry. The decrease from the third quarter was due to fewer trades and a lower average commission. This is partially offset by a strong increase in institutional trades. Institutional commissions were approximately $4 million in the quarter.

Average commission for the quarter was $13.14 compared to $14.87 last quarter. As you may remember, we commented last quarter that average was at the high end of our expected range. That being said, most of the drop this quarter from that elevated level was due to a mix shift. We generated a higher percentage of institutional trades in Q4, which have a much lower average commission.

We also saw declines in the average commission within retail trades during the fourth quarter due to a mix shift to more stock and future trades as well as a decrease in the number of contracts per option trade. We also saw a decrease in the average commission within institutional trades in the fourth quarter, due to a shift towards more direct business but these lower commissions come with the corresponding lower payout, which shows up in brokerage and clearing costs being lower on a percentage basis.

Without a change in mix between institutional retail trades from Q4 levels, we expect our overall average commission this quarter of $13.14 to be pretty much the middle of the road, with the prior quarter being the high end of the range. Fourth quarter 2008 net interest income was $7.7 million, a 49% decrease compared to last year’s net interest income of $15.2 million, and a 37% decrease compared to last quarter.

Both decreases were primarily related to the series of Fed funds cuts to a current target of between zero and 25 basis points. The decline we saw in the fourth quarter was slightly greater than may have been expected, primarily due to margin balances being down over 35% and the Fed funds effective rate, which some of our assets are tied to, being significantly lower than the Fed funds target level in November and early December.

In this Fed funds rate environment, we still are in a decent spread on our margin balances but our earnings on cash balances are limited. Our estimate of our current run rate for net interest income is approximately $3 to $3.5 million per quarter but can vary based on a number of factors including actual Fed funds rates, cash balances and cash balance mix, and margin balance levels. That said, it is difficult to imagine an environment where interest revenues decline materially from here. We have far more room on the upside as rates rise.

Payments for order flow were $6.4 million for the quarter, which is down 27% from last year and also 27% from the third quarter of 2008. The decrease in the prior year was primarily due to a decrease in the number of option trades. The decrease from the prior quarter was due to fewer option trades and fewer option contracts traded per trade. There was also a small decrease in the payment rate mainly due to a higher percentage of trades and underlining symbols that we don’t receive payment on, such as indices and EPS, which is common in high volatility markets. On a symbol-by-symbol basis however, we did not see any significant change in payment rates.

On the expense side, total expenses were $28.2 million, up 21% from last year but down 3% from last quarter. Most of the increase in the year-over-year comparison is related to higher advertising spend and the addition of Open E Cry. Brokers and clearing costs for the fourth quarter were 58% higher than the fourth quarter last year but 10% lower than the third quarter. The primary driver in the year-over-year period was the addition of Open E Cry, most of whose expense flows through this line item in the form of payouts to IBs, much like the BX business.

The primary drivers in the decline from the third quarter were lower payouts to Brokers Express brokers and lower other volume related costs in the retail business. Payouts to brokers during the quarter were approximately $2.6 million for Open E Cry and $1.9 million for Brokers Express brokers. Compensation costs for the quarter were $6.9 million, 3% higher than the fourth quarter of 2007 and 14% lower than the third quarter of this year. The decline versus the prior quarter was related to a lower bonus accrual, which is tied to company performance. The fourth quarter was a little lower than the run rate due to this bonus adjustment.

For the full year, which is a better comparable period due to bonus accrual fluctuations quarter-by-quarter, compensation costs were up only 8% and, excluding the impact of Open E Cry, it was closer to 5%. Advertising costs for the quarter were $5.9 million, a 39% increase over the fourth quarter of last year and a 19% increase when compared to the third quarter. This spending was inline with our expectations for an increase in the fourth quarter.

Pre-tax margin for the quarter was 51%, which is down from 56% for the third quarter of 2008. However, most of this decline was due to the decline in net interest revenues. Resulting fourth quarter 2008 net income was $19.2 million and EPS was $0.32 for the quarter, $0.12 lower than last year and $0.08 lower than last quarter. Margin balances were $129 million at the end of the quarter, a 41% decrease versus last year and a 36% decrease versus the third quarter.

The decline during this quarter occurred mainly in October as our customers de-leveraged in the face of extreme volatility and lower overall assets levels. Margin balances appeared to have stabilized during November and December. At this point, we do not expect a significant change in margin balances as a percent of assets. During the quarter we repurchased $1.2 million in shares for approximately $14.4 million at an average price of $12.25. We have approximately $17 million still available under the current $100 million authorization approved early in 2008.

Last quarter, we announced the signing of an agreement to purchase Horwich & Associates, a small independent broker dealer for $4 million in cash. This acquisition was subject to additional closing conditions. At this point, we elected not to move forward with this transaction and close. We do not expect this to have any material impact on our financial results or our BX Brokers Express business strategy going forward. We retain a significant amount of financial flexibility to our strong balance sheet with over $200 million in cash or almost $3.50 per share and no debt. We have ample capital available to pursue other acquisitions, repurchase stock or pay dividends.

I will now turn the call back over to David Fisher for some final comments.

David Fisher

We anticipate 2009 will be a difficult year. Both a difficult year for the economy as a whole, and as a result our industry down line brokerage industry. However, while there are currently some short-term challenges, we see strong growth over the medium of long-term, as our industry expands and customers continue to add options and future products to their portfolios. We remain committed delivering the best overall experience to these customers from education to our platform and our world-class customer service, and we believe this strategy will result in strong long-term growth for optionsXpress.

During the near-term as markets remain challenged, we think our high margins and strong balance sheet position as well, could not only withstand this downturn but also take advantage of unique opportunities that may arise both organic growth opportunities as well as strategic acquisitions and consolidation.

At this time I will turn the call over to the operator and we’ll take some questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Rich Repetto – Sandler O’Neill.

.

Rich Repetto – Sandler O’Neill

I guess the first question is on the trading activity of just the retail side. I differ in what you said in the prepared remarks and the other e-brokers saw sequential increases as well as year-over-year increases, and I think we attribute to that because of the high volatility. Your customers don’t trade as much, and I guess the question, is that correct, is that what you attribute the modest decline in darts? And is there a positive lighting that if volatility went down, as it’s trending down a bit but no one can tell, but if it went down to say 30 or so do you think you did better than other e-brokers as volatility declined, in regards to darts?

Adam DeWitt

Sure Rich, I think you just can’t talk about kind of high volatility or low volatility in a vacuum because generally slightly elevated levels of volatility are very good for our customers. It helps them find opportunities in the market place, if they’re selling premiums it makes them more attractive. It’s usually a good opportunity for our customers, but you really have to look at the extreme volatility and market dislocation that we experienced during the fourth quarter.

And the fourth quarter is really where you kind of go back and look in time that our darts did kind of trend slower than the rest of the industry, it really started in September right when the credit prices really came into full bore. And so from that point on we really believe our customers took a more patient educated look at the markets, they didn’t panic, they weren’t rushing to sell everything, they were managing their positions in a frugal, albeit more conservative manner.

They certainly de-levered, you can see that in our margin balances, and took a cautious, what we believe, highly educated approach to what was going on with the extreme dislocation in the market place. The big payoff of that is our asset balances, which have been much stronger than everyone else in the industry, and that is where future revenue growth is generated from.

So, the biggest driver of trades across any brokerage firm is not number of accounts, its number of assets. And so when the market does turn around, when volatility does subside, we think that much higher level of assets puts us in a great position for strong growth.

Rich Repetto – Sandler O’Neill

Next on education, you mentioned your education platform, and there's certainly a lot more visibility on education with the AMERITRADE and Think or Swim transaction, but I'm just trying to see. How do you differentiate your education, say offering a platform versus Think or Swim or any of the other ones that are out there I guess.

Adam DeWitt

So, we've been doing education. Education's nothing new for us. We've been doing education since the day we opened the doors at optionsXpress. But we really divide education up into two parts here. A number of third-party partners, largely educators who go out and educate customers in a similar way that investors have, firms like Optioinetics, Wizetrade, DTI firms out there providing education to customers and partnering with us, and we combine that with our in-house education.

Our in-house education consists of webinar series, online content and in-person events where we go out and meet our customers. In 2008, for example we did 450 webinars, so more than a webinar a day, connecting with our customers, educating them about the market. And the great thing about doing that many webinars when you have volatile changes in the markets and dislocations like we saw in October and November, you can be communicating with them real time about what they should be looking at, about how they should be reacting to these environments.

We also did 55 in-person events. So, we're constantly in touch with our customers, events that can have anywhere in between 150 and 450 people at a time all around the country. So, the key to our in-house education is really that constant contact, that constant communication, and it's free. There's no charge for any of our internal education.

Rich Repetto – Sandler O’Neill

Quick question for Adam, on the tax rate it was 30, at least we're calculating 34.1% a little bit down from it appears last year's rate and in the prior quarters, just trying to guidance on tax rate going forward.

Adam DeWitt

There was an additional one time credit in the quarter. It's going to be much closer to the third quarter rate, but a little bit lower, so much closer to that 36% rate than the 34% that you're calculating in the fourth quarter.

Operator

Your next question comes from Patrick O'Shaughnessy − Raymond James.

Patrick O'Shaughnessy − Raymond James

I wanted to make sure I understood your thoughts on net interest income going forward. Just to clarify did you say you're expecting 30 million to 33.5 million net interest income per month or was that quarter? I'm not sure if I heard correctly.

Adam DeWitt

That's on a third quarter basis.

Patrick O'Shaughnessy − Raymond James

Third quarter, that's compared to the 7.8 million that we saw in the fourth quarter.

Adam DeWitt

That's correct. The additional 75 basis points cost brings you down from that 7.5 to the 3, 3.5 range.

Patrick O'Shaughnessy − Raymond James

The next question I have would be, going back to the trading volumes and kind of building off of what Rich was talking about. So, given that you didn't see a lot of spike in your trend because of the volatility and your assets held up. Would you expect that your trades per account metric would get back in your historical 30 to 40 range in 2009? Or kind of what are your thoughts on your customer trading patterns for the next year?

Adam DeWitt

It's really difficult to project 2009 obviously. But if I had to guess I would say, yes, I think they will revert to those normal levels as the markets slow down. January was a very choppy month. It wasn't I don't think a very good trading month for anyone. Volumes were okay across the industry but clearly very choppy. I think if we can settle into a little range people can get a little comfort, then yes. I think absolutely our customers will get more comfortable with where the markets are and they'll revert to their strategies. And remember their strategies are in general very conservative, but recurring in nature.

So selling covered calls on a monthly basis, kind of using quick writing strategies. I like those two strategies as they performed a very well last year compared to just owning long equities. So, we think absolutely once the markets kind of return to more stable levels people gain a little confidence in the market, they'll absolutely return to those levels, especially given the higher level of assets we were able to maintain in optionsXpress versus others of our competitors.

Patrick O'Shaughnessy − Raymond James

And then the last question I had was we saw options as a percentage of your trades drop a little bit this quarter, just kind of curious on your take on why that is and what you expect the long term trend to be going forward.

Adam DeWitt

I think this really is consistent with what I've been saying about kind of the options customers really taking it a step back, being cautious, not wanting to get whipsawed by those extreme levels of volatility, evict that 80 plus with them pulling back. On the equity side, it was more customers liquidating positions I think as you saw a lot of the larger online brokers wanting to protect their downside.

But also the other advantage we have is our futures customers. Our futures customers remain more resilient in the fourth quarter, a little bit more short-term to trading, but also moving into products like gold and some of the interest rate futures trying to hedge what was going on on the equity side. That's a great advantage of having these multiple product on one easy to use platform.

Customers can shift somewhat between two products as market conditions dictate. Since I mentioned in our prepared remarks, we had a record quarter in the fourth quarter on the futures side, which topped off a record year for us in the future side.

Operator

(Operator Instructions) Your next question comes from Daniel Harris – Goldman Sachs.

Daniel Harris – Goldman Sachs

I was wondering if you guys could give a little bit more color on the account transfer side from the full-service broker dealers. Are these accounts generally trading on optionsXpress similarly to how your other accounts have in the past? Are they more in the equities and future side or options or could you just give a little bit more color on what we're seeing there on those transfers.

David Fisher

I think we're seeing two different things. We're seeing some smaller accounts moving over from full-service brokers. For them there's a little bit more of a learning curve and their used to trading online. They get used to trading different products. But the second we're seeing some substantial large customers move over.

There was an article written last week, I think it was a Reuters article maybe, and it highlighted one of our customers who moved a fairly large account over from Lehman. He was a more sophisticated investor. He wasn’t a professional. He was a business man who had been successful and made some money, and he did use options as part of his investment strategy at Lehman. With all the troubles at Lehman and the conversion his account over he just got completely frustrated with it.

They had done a terrible job with his account during the year. He moved over to optionsXpress and he's had an amazing experience. He talked about it in that article about how easy it was to get going in optionsXpress, how great the customer service was, how he could see all his positions real time, of how inexpensive it was for him versus what he was paying at Lehman.

So, that's one example. But we're seeing many, many other stories like that where customers are becoming very dissatisfied with the cost and the service they're receiving at their full-service brokers. And they're really starting to see the advantages of doing it themselves online.

Daniel Harris – Goldman Sachs

One of your peers on the discount broker side said the other day that what some of their clients had seen in the option space, or some of their activity was certainly curtailed in the fourth quarter because of the high volatility, which is something you're seeing or something that you said as well. But how do you see that your clients changing their trading strategies during the quarter given that high vol. Were they doing more interesting strategies, covered calls than they were in the past or were the strategies relatively unchanged?

David Fisher

I think in a large part what you saw them do was back away from any speculate strategies whatsoever. Any of the more risky strategies, any of the truly speculate strategies, completely backed away from really focused on conservative strategies using primarily indexes and ETF. Adam mentioned one of the reasons the payment [inaudible] closed down was that there was a move toward indexes and ETF's where we receive lower rates.

And that was part of it, and then using very conservative strategies around that, selling covered calls, buying in ETF and selling a call against it was an extremely popular strategy during the hype of the volatility you could by the Spiders or the Diamonds and write a near month call against it and generate a 10% one-month yield on that cover of call because of how high the volatility was. So cultures were still engaged, obviously we still generated trades, but really what they did was scale back on anything beyond those most conservative strategies.

Daniel Harris – Goldman Sachs

Okay, and then just lastly from me, and it's two different parts but probably the same answer. So you’re advertising went way up in line with what you guys thought. So first of all is that seasonal should we be thinking of that in the fourth quarter next year that would probably repeat, but then also probably included with that, given all the dislocations in the industry you’ve got a lot of probably former traders out of work. Are you seeing, within your education programs, a rise in interest from people that traded options in the past, or how should we be thinking about those education programs leading to net new accounts, which is obviously is also tied with advertising?

David Fisher

Two very good questions, first on the advertising side, there are a lot of dislocations in our business right now and there’s a lot of movement and so clearly we’re trying to be more aggressive with our advertising. Fourth quarter is always a quarter where we spend a little bit more, October Novembers are good months historically for generating new accounts they were again this year. December is a month where you like to start talking about IRAs so you spend a little bit more there.

Looking forward to 2009, we’re going week to week really seeing what’s going on in the marketplace, are there opportunities, but I would say if we have a bias. The bias is clearly to be a little bit more aggressive with the advertising because we do think that kind of level of dislocation is continuing and that there are opportunities in the marketplace, although that spend might be a little bit more of a long-term investment as opposed to generating accounts on a more targeted basis as were used to historically.

On the education side, we’re definitely seeing a pickup of our education being a new account driver for us, especially our internal education. Our events so far this year have been very well attended, no issues selling them out at all. We’ve done four in-person events already in 2009. They’ve all sold out and some very positive momentum there about customers wanting to learn about optionsXpress and many of the people at those events are potential customers.

Operator

Your next question comes from Brian Bedell − Bank of America Merrill Lynch.

Brian Bedell − Bank of America Merrill Lynch

Just to go back through the account growth, for the month of December the drop off in net new accounts would you attribute that to more of a seasonal factor or more of an ongoing trend of people being more cautious in opening new options accounts?

David Fisher

I think there’s definitely a seasonal component to it. December, with the way the holidays rolled out the last two weeks of the year were extremely quiet. If you remember the markets around that time, volume was almost nonexistent. I know my office was extremely quiet my phone didn’t ring for two weeks. So I’d just say people were very tired after a difficult 2008 and those last two weeks of December were basically shut down. So I think there’s a big component to that.

Looking forward to 2009, I think new account growth will be there. How strong it will be will depend a lot on what kind of confidence people have in the market and the confidence people have in the economy. January is a little bit choppy, but certainly it didn’t hurt things anymore. We’ll have to see where we go forth from here. We always think we can generate solid new account growth, to generate more strong account growth I definitely think we’ll need to see a pick up in either the general consumer sentiment or the markets.

Brian Bedell − Bank of America Merrill Lynch

Is January looking more like October and November or more like December so far?

David Fisher

It’s been choppy so we’re not getting the high levels we saw back in specifically October.

Brian Bedell − Bank of America Merrill Lynch

Come back to advertising, sounds like you certainly do want to be more aggressive here, you take the earnings hit for having expenses but obviously it’s much more important to build a long-term growth, but are you looking at ways that you can do that more inexpensively? You mentioned that testimonial from the Lehman client and that would seem to be a pretty inexpensive way to really get the word out. Are you looking at doing a lot more of those types of things? And then on top of that, are you looking at targeting Swim customers via the Ameritrade deals or any kind of attrition strategy there?

David Fisher

Sure, first time, in terms of advertising spend we’re always looking for ways to spend more cost effectively. Fortunately advertising rates are coming down right now. I think one of our competitors talked about that in their call and we’re seeing it as well. Everything from online keyword search, which has been on the straight up trend for the last three years, has certainly reversed course, banner ads, print ads, trying a recent print ad campaign was much more cost effective than we thought. And I think some of the biggest decreases, which we will probably be using later in this year, is TV, TV rates have come down significantly.

So advertising is less expensive than it has been over the last year or two, and then you combine that with our internal education, which is a fairly low cost source of new accounts as well. Clearly trying to offset some of the more aggressive spend it’s really try to grab market share in difficult times with lower advertising rates across the board.

Which respected to Think or Swim, obviously many of their customers are customers that we think would be very successful and would really like the optionsXpress platform. We respect the guys who run Think or Swim, they do a very good job and I’m sure they’re working extremely hard to retain their customers, but anytime there’s a merger of that size there’s some dislocation. There’s going to be some customers who just don’t want any part of Ameritrade, had a bad experience with Ameritrade in the past, and clearly we’re working extremely hard internally that if any of those customers come to us to have the doors wide open and make the optionsXpress platform as welcoming for them as possible.

Brian Bedell − Bank of America Merrill Lynch

Just on the net interest income rates the $3 to $3.5 million, Adam, what does that assume for margin balances and cash as well?

Adam DeWitt

That assumes current balances so in terms of the margin balances are right around that $130 million level. Cash balances, historically we’ve said are typically 35% to 40% of our total assets with the market declines in the fourth quarter, it’s actually picked up a little bit so it’s a little bit north the 40% in terms of total cash balances. So that’s what that $3 to $3.5 million is anchored around.

Brian Bedell − Bank of America Merrill Lynch

Right and your corporate cash balances are on top of that right?

Adam DeWitt

That’s correct.

Brian Bedell − Bank of America Merrill Lynch

In addition, and then is that do you have another couple of quarters before we get to that run rate or are you basically sort of there this quarter?

Adam DeWitt

Yes. We were there day one so pretty much end of December we were there, and we’re there now.

Brian Bedell − Bank of America Merrill Lynch

The Horwich acquisition, why did you back away from that? And you’re defiantly not doing that or you might revisit that?

Adam DeWitt

No, we’re not doing it. I don’t have a lot to say about it. It was a small $4 million deal, we basically had the right not to proceed with the transaction and we decided not to proceed.

Brian Bedell − Bank of America Merrill Lynch

Lastly, more strategically, if we’re in this tough environment for a while, obviously we could be in a prolonged low interest rate backdrop for at least a year or maybe even two years. So you’re running at that net interest income level, if you have some other headwinds that stick against you for a few quarters, such as did a payment for order flow, if customers do de-leverage even more and we get the foot in options trading. What do you think strategically you might consider for optionsXpress, would you consider partnering with a larger full-service broker or another options broker?

David Fisher

Sure, so let me answer that question two different ways. First of all, we don’t anticipate a lot of additional headwinds, we actually think this is kind of as bad as it can get absent just a major collapse of the financial markets and there’s really upside from here as some of those tailwinds resume, like higher interest rates, more stable markets, difficulties among other brokers, etc.

That being said, we view difficult markets as a time to be aggressive not a time to be passive, and so we’re certainly looking for all those different types of opportunities you mentioned. We saw the first consolidation in our industry that we’ve seen in several years.

I think many of us were surprised that it’s taken this long, but I think a few of us will be surprised if a number of deals followed that. And certainly with us being now kind of the largest of the non-super brokers out there, we still see ourselves in a great position to be able to acquire some of the smaller guys out there and really get the benefit of the tremendous synergy that can be involved in those types of deals.

Brian Bedell – Merrill Lynch

So benefiting from, I guess really compressed prices and can you just remind us of what your sort of accretion targets would be or your deal parameters would be for doing such and acquisition?

David Fisher

Sure. I think it would be extremely unlikely that we would do a deal, especially a deal that was revolved around consolidation that wasn't accretive. And I think if you look at the recently announced AmeriTrade Think or Swim deal, you can see that these deals can be very accretive. I think they forecasted kind of 10% to 15% accretion in that deal.

I think if we had merged with Think or Swim, that deal would have been even more accretive. I think there would have been higher cost savings. So you can see there can be very accretive, and I think in most cases these deals can be accretive year one.

Operator

Your next question comes from Mark Lane – William Blair & Company.

Mark Lane – William Blair & Company

I just had a question about capital. Your balance sheet's in a pretty unique position despite profitability being down, it's still pretty high. So are there bigger acquisition opportunities out there that you want to keep your powder dry? Or why not be a little bit more aggressive on share repurchase? I understand it's a difficult environment, but you don't have any debt you have a lot of excess cash.

David Fisher

Sure. That's a very good question. I think with respect to share repurchases, obviously in October and November we wanted to be a little bit cautious with cash. I mean, kind of no one knew where the world was going, how bad it was going to get, how quickly. And it was certainly good environments to be a little bit more cautious just like our customers were being. Near the end of the quarter as things stabilized we did begin repurchasing stock. It's a little difficult repurchasing stock right now because there's not a lot of liquidity out there throughout the marketplace. So it's just given our limit of trading windows in which we could be buying stock. It's hard to get a lot of it.

That being said, looking forward to 2009, we do see some larger acquisitions north of $100 million. Some north of $200 million that could really makes sense for us next year. We also see several smaller acquisitions that could add up to that kind of range that could all get done within the year. I mean, everyone is looking for something to do.

The phone is ringing off the hook from potential partners. And so it's a very active time and the question is which deals make sense and can people come together in price. I mean, that's the biggest struggle right now given how much prices have moved over the last six months to a year. Obviously our first goal with that cash would be to find the best of the best of these acquisition opportunities, use some of our cash in those deals, if we can.

Mark Lane – William Blair & Company

Most of your deals have been more strategic. Would you do a larger, I guess, more financially driven deal just to buy accounts? Are there larger deals out there that are possible that are more financially oriented?

David Fisher

Sure. I think in this market we would, absolutely. Brokers with say more than say 20,000 accounts, there’s probably 10 to 1,000 of them out there. So the fair number of opportunities where we can grow our account base by 10% or more through one acquisition. We look at that as a very good opportunity where we can generate significant synergies and hopefully reach a price that that could get done.

But as I said, again, kind of getting everyone onboard with prices is still the hurdle. It's still really fairly recent that prices have moved down so much. And so especially when one company's public and the other company's private, as in many cases they are, it's a little bit of a challenge today but we think that'll get easier as the year moves on.

To the extent that we don't find that we have the ability to move forward with a number of acquisitions for any reason, or we do an acquisition that might be more stock-based as opposed to cash-based just because that's the only way you can reach agreement of valuation. We certainly want to make good use of our excess cash and we think buybacks with where our stock prices now are an excellent use of our cash.

Operator

Your next question comes from George Groves – American Capital Partners.

George Groves – American Capital Partners

Just to dovetail a little bit more on your M&A strategy. If I hear correctly, it sounds like you're more looking to grow the assets rather than add functionality that you could cross sell into your existing base.

David Fisher

Well, I think fortunately, especially with some of the more attractive targets, you get a little bit of both. So let me just throw up a couple online broker names which everyone knows about giving any intent about whether or now we'll buy. Well even use Think or Swim, for an example, who we won't be buying because AmeriTrade is buying them. Clearly there would have been tremendous synergies in that deal.

But in addition to that and in addition of picking up their 100,000 accounts, we would have merged an active trader platform with our web-based platform. We would have also increased our educational offering through investors. So while a large portion of that deal is buying accounts, and I think you can justify the deal in the price AmeriTrade paid for that deal largely on the accounts, you get some nice technology and you get the education alongside it.

You take a company like Trade Station as another example. You get their accounts as well, but you also get a little bit more exposure to a very active day trader segment of the industry and their great rural-based trading that they’ve demoted for, so especially the top of these other deals are out there. They're good firms in large part and they've done some good things, they've built some nice niches and that's certainly additive to beyond just adding the accounts.

George Groves – American Capital Partners

Then I guess would you prepare to take on debt to a larger deal or was it you'll be looking at cash and stock here?

David Fisher

Well we certainly have a couple hundred million dollars in cash and that goes a long way with many of these deals that are out there in terms of the size. We would be comfortable taking on a small amount of debt given the very low interest rates that are out there to the extent it was an all cash deal. The other option is to do exactly what AmeriTrade did with Think or Swim. Use some equity and then go out back in the marketplace and buyback your stock. Basically turn an equity deal into a cash deal. Those are all things we would consider.

George Groves – American Capital Partners

I guess with respect to Think or Swim, do you have any thoughts as to why they were a seller in the current depressed market?

David Fisher

I really don't have any comment on that.

George Groves – American Capital Partners

Did you take a look at them?

David Fisher

I don't have any comment on that either.

Operator

Your next question from Edward Ditmire – Fox-Pitt Kelton.

Edward Ditmire – Fox-Pitt Kelton

I have two questions on two tacks. First of all it looks like really the stock buyback and the normal dividend that you guys maybe somewhere in the order of returned all the cash you made this quarter, is that something that comes into play about the way you think about things? And is that something that we should think of as long as stock price remains depressed?

David Fisher

I don't think that's an absolute statement. I think we currently consider how much additional cash we're adding in a year when we're looking at our capital strategy. But we also look at how much cash we have on our balance sheet. We certainly are not of the opinion that our balance sheet is as efficient as it could be and that we need to maintain that level we have. In fact, I think in general we believe we have more cash in our balance sheet than we need and either through acquisitions or buybacks, potentially dividends, we would be using up some of that cash over the upcoming year.

Edward Ditmire – Fox-Pitt Kelton

And the second question on account acquisition, if you look at revenue per account and strip out the net interest margin, which I know is highly cyclical based on the rates, the simple fact is that revenue per account has been going down but acquisition costs per account have been going up. And when we started a few years ago there was almost no acquisition cost and very high revenue per account.

With the idea that it's been trending higher and you guys continue to see good returns on those investments, is there something we should think about an upper limit on where account acquisition costs could go as we think over the next two years of modeling the company?

David Fisher

I mean, again, this is a very difficult time to make those kinds of judgments because if you just look back a year ago, and again, a 300,000 customer base doesn't turn over in a year. We were generating very, very high revenue per account and pre-tax profit per account. And we're in a very difficult market environment that we don’t think is going to be predictive of what the future looks like.

We do think over time, and again as the markets return, that trades per account, which is the biggest driver of that revenue per account number that you were talking about, especially if you strip out interest revenue, will return to more historic levels, because average commissions have remained very, very stable. But they shot up to very high levels and they were low in the second quarter, they shot up to very high levels in the third quarter and they've kind of returned to medium levels in the fourth quarter. But kind of they've been very, very stable over time. So really the only driver we're talking about here is trades per account and we're only one year away in the past from very, very high levels of transfer accounts.

So we think when we do return to more normal levels that those trading levels will improve and the revenue and the pre-tax profits per account will improve to historic levels as well. So when we look at advertising we are focused more on what we believe are historic and future levels, not necessarily what happened today or last week or last month. Although, certainly if we think trends are changing, we'll kind of readjust our thought.

So in our minds, again, short-term we do want to be more aggressive with our advertising. We can clearly spend many multiples of what we're spending today and still be able to show a very healthy return on our advertising investment. But in terms of kind of an upper limit that I think would really be a dramatic shift for us, I think if we were looking at a spend that was higher than say our annualized revenue per account in the short-term, I think was something that you would, I think would certainly want to hear us explain why we were being quite so aggressive.

But below that, spending less than you can generate a year in revenue, while we just don't think it's necessary, we certainly don't think it's excessive at all. And while we're not forecasting that for the next year, I think that's a number that at least I would be very comfortable with when just kind of talking about theoretical financial model.

Operator

Your next question from Mike Vinciquerra − BMO Capital Markets.

Mike Vinciquerra – BMO Capital Markets

I'd like to return to the trading activity, if I could for a minute. While I can understand, David, you comments regarding maybe your clients were a bit more prudent in terms of their trading during the quarter. It's not a one quarter trend we see in terms of your darts relatively underperforming the industry, which leads me to the only conclusion I can come to is that either a lot of the new accounts that are coming in are trading at a much lower level or you're actually losing some of your higher end accounts to some competitors. Can you talk about that a little bit more in depth?

David Fisher

We can compare numbers, Mike, but I think first of all I would disagree with your assumptions. I think if you look prior to September '08 when really the credit crisis kicked in at full force for the first eight months of 2008 I think if you average the month-over-month changes in darts, we’re right on with the rest of the industry, almost exact.

Mike Vinciquerra – BMO Capital Markets

On a retail basis?

Adam DeWitt

So we're really talking about September, October, November, and December. We're talking about the month in the midst of the credit crisis and the extreme levels of volatility in the marketplace. And, again, as I mentioned before, if you kind of look at two other data points, I think it kind of goes back to proving out the point. First is, just a year ago our customers traded at extremely high activity rate. And, again, that 300,000 customer account base did not turn itself over that rapidly.

Second, our asset performance has much outperformed our larger online peers, and we think it's that more patient, conservative trading on behalf of our customers. It was smart that they step back from their trading were smart, were educated about what they were doing and allowed them to conserve assets. And clearly at optionsXpress, the leading driver of the level of trading, let’s take an individual account and we tried to look at what metric if you determine how much that account's going to trade. The biggest driver is asset level. Larger asset levels lead to more trade and so we think that positions us very well going forward when there's a return to more stable markets, more normal levels of volatility.

Mike Vinciquerra – BMO Capital Markets

Maybe we can talk a little more offline as well. When you talk about the asset level, has it been more that they held up better because of significant inflows over the last quarter, or simply because your clients have had less position losses than maybe some of the piers?

Adam DeWitt

I think it's a combination, Mike. If you look at the asset flows, they're definitely positive. I think we've talked about this in the past. The October net asset inflows we had one of our best months ever. But we also saw, and I mentioned this earlier, percentage of cash as a percentage of total assets was a little bit higher. This coincides with David's comments about option trading being a little slower and so customer out performance, so to speak, in part because they weren't engaged in a highly volatile markets combined with the net asset inflows to outperform the market.

Mike Vinciquerra – BMO Capital Markets

And just finally can you share any thought on Open E Cry? Has there been any clients or account growth in Open E Cry, or is most of your account growth just in the core retail?

David Fisher

The account growth you see is small because what they're generally adding is big institutional clients. So they'll add just a couple at a time. It's more like the BX model. But the growth in that business has been great. I mean, part of the reason they wanted to do the deal was they were having trouble going out and attracting larger clients with their small balance sheet. Now being part of optionsXpress, that's a much easier sale for them. They've brought on some large institutional clients already. Their pipeline is very, very strong and you can see the solid results they had in fourth quarter with those institutional trades, up almost 40%.

Mike Vinciquerra – BMO Capital Markets

So we're still kind on in the 1,100, 1,200 type of account numbers for Open E Cry. Is that in the ballpark?

David Fisher

Did you say 1,100 to 1,200 total?

Mike Vinciquerra – BMO Capital Markets

Yes.

David Fisher

I think it was closer to 3,000 when we took it over, like 2,800, 2,900 and it's very close to that.

Mike Vinciquerra – BMO Capital Markets

My apologies. Thanks for the correction.

Operator

Your next question comes from Rich Repetto – Sandler O'Neill.

Rich Repetto – Sandler O'Neill

Just a quick follow-up. On the net interest income, David and Adam, you talked about the sensitivity, the $0.02 per quarter per 50 basis points and so I guess the incremental what you're guiding to is much more wider than that. And I guess the incremental difference, is that just the margin balance decline?

Adam DeWitt

Rich, yes, it's a good question. It's a combination of a couple things. One is the impact as we get closer to zero increased because part of the interest income that we receive is on customer sweep program and we start eating into our fees as we get closer and closer to zero. So you see a little bit of pick up there, but you're right in that the 35% plus decline in margin balance is quarter-over-quarter also had a material impact. If you just multiply out that 70 million times expected spread you can see the impact there.

David Fisher

On the positive side as we look forward, again, with maintaining those higher level of balances, is that when the market does return, when interest rates do rise, and I'm very uncertain that will happen, but when they do rise we have higher levels of balances on which to generate that spread income on and that's money that's money that’s almost 100% margin to us.

Operator

Ladies and gentlemen, that concludes today's optionsXpress Holdings fourth quarter and full year 2008 financial results conference call. We thank you for your participation and please have an enjoyable day.

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Source: optionsXpress Holdings Inc. Q4 2008 Earnings Call Transcript
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