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”).
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.
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.
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.
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.
We have taken several steps to leverage our brokerage platform internationally:
In 2004, we purchased a minority interest in an Australian registered broker. We subsequently acquired the remaining ownership of this broker in 2009 with our acquisition of Optionetics;
In 2005, we obtained a license to provide brokerage services in Canada;
In 2006, we obtained a license to provide brokerage services in Singapore and we received approval to provide brokerage services in the European Union; and
In 2008, we entered into an exclusive marketing agreement with Reliance Money Limited of India
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:
Expand our product offering;
Grow our account base at an attractive cost;
Accelerate the growth of one of our developing businesses like brokersXpress, futures, international, or institutional; or
Provide technology capabilities that allow us to continue to provide superior differentiating tools to our customers.
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:
We empower our customers by making accessible cutting-edge position management and order execution technology, advanced analytical tools, education and real-time financial information from any web browser.
Our software was designed to ensure an efficient customer experience, beginning with a highly automated account opening process and ending with fast trade execution and thorough, real-time position monitoring.
Our user-friendly interface provides interactive real-time views of account balances, positions, profits or losses and buying power to enable our customers to more easily make informed investment decisions. Customers are able to access all features from any web browser.
Our efficient, in-house development capabilities allow us to continuously innovate and improve our platform with frequent enhancements such as:
Portfolio Margining. With Portfolio Margining, qualified investor margin requirements are based on the theoretical risks of the eligible securities in investors’ accounts instead of traditional Regulation T requirements. This results in significantly more efficient capital usage by customers in the program.
OX Mobile. OX Mobile gives retail investors an easy and convenient way to monitor and trade any equity, option or future, at any time, from any place and on most smart phones. The mobile application includes powerful trading tools, comprehensive options chains, streaming quotes, market news, updated account balances, pending orders and current positions.
Xtend. Xtend is a downloadable software trading platform that is geared towards more active derivatives traders. It provides users with a high level of flexibility in controlling their trading experience, building on common features of active trader platforms such as streaming quotes and one-click trading while adding innovative new features like drag-and-drop symbols, detailed trade views and ladder trading.
IDEAS. Ideas is fully integrated into a customer’s positions screen and is designed to help customers manage their existing portfolios. The tool scans a customer’s existing positions looking for new trading opportunities based on their holdings and their current views of the marketplace.
Integrated Futures. In January 2007, we acquired online futures broker XpressTrade. We took the best features from that platform and made them available on the optionsXpress platform, allowing customers to trade futures side-by-side with other securities. optionsXpress customers can now trade futures products at over 20 exchanges, 24-hours a day.
Strategy Scan®. Strategy Scan enables an investor to transform a trading idea into an executable trade. It accomplishes this by identifying up to three trading opportunities for our customers based upon their bullish, bearish or neutral opinion of a specific stock over a specified time frame. We clearly identify the range of potential gain or loss for each trading opportunity.
Xecute® (patent pending). We pioneered online auto-trading for the retail investor. Our Xecute product allows our customers who subscribe to specified third-party advisory newsletters and other financial publications to automate the trading of the third-party recommendations. This not only benefits our customers who subscribe to these newsletters, but also makes us the logical brokerage platform for other subscribers to such newsletters.
Advanced Order Management (patent pending). Our software allows our retail customers to automate professional trading strategies involving order sequencing without manual intervention. Our customers are able to enter contingent orders which are executed in accordance with specified time, price or other triggers. A significant advantage of this feature is that our customers do not have to constantly monitor the market in order to execute their orders.
Virtual Trading. Virtual trading provides our customers with a mock trading environment where they can practice strategies and educate themselves without risk, utilizing current market information. This provides our customers with a practical method of gaining real market experience without putting money at risk. Our customers can mock trade almost any strategy involving stocks, options and mutual funds, including spreads, straddles, and covered calls. We believe virtual trading provides our customers with a better environment to learn versus simply studying trading strategies myOX. myOX allows customers to take greater control of how they view market and account information by customizing the optionsXpress website to their specific interests and preferences. The adaptable modular interface allows customers to select information that they want to see, its location on the screen and how it is displayed.
We offer comprehensive educational content as part of our powerful brokerage platform to help our customers become successful, long-term investors, including:
Over 595 live internet webinars in 2009 and 65 downloadable on demand webinars covering topics from account setup through complex order placing, for investors ranging from beginner to advanced skill levels.
Live events throughout the country covering site demonstrations and options investing strategies.
Personal coaching services, with a program that is custom-developed for each investor, designed to help customers use options and the optionsXpress’ toolset to become better investors.
Rich content woven throughout the website, including a self-help library of user guides and customer message boards.
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.
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.
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:
Maintaining customer accounts;
Extending credit for margin accounts;
Settling stock and bond transactions with the DTCC and option transactions with the OCC;
Settling commissions and clearing fees; preparing customer trade confirmations and statements;
Performing designated cashier functions, including the delivery and receipt of funds and securities to or from the customer;
Possession or control of customer securities, safeguarding customer funds and transmitting tax accounting information to the customer and to the applicable tax authorities; and
Forwarding prospectuses, proxies and other shareholder information to customers.
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.
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.