Annual Reports

 
Quarterly Reports

  • 10-Q (Aug 9, 2011)
  • 10-Q (May 10, 2011)
  • 10-Q (Nov 9, 2010)
  • 10-Q (Aug 9, 2010)
  • 10-Q (May 10, 2010)
  • 10-Q (Nov 9, 2009)

 
8-K

 
Other

OptionsXpress Holdings 10-Q 2011

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.1
e10vq
Table of Contents

 
 
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
     
þ   Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
     
    for the Quarterly Period Ended June 30, 2011
OR
     
o   Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
     
    for the transition period from                      to                     
Commission file number: 001-32419
optionsXpress Holdings, Inc.
(Exact name of registrant as specified in its charter)
     
Delaware   20-1444525
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification Number)
311 W. Monroe, Suite 1000, Chicago, Illinois
60606
(Address of principal executive offices)
(Zip Code)
(312) 630-3300
(Registrant’s telephone number, including area code)
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 twelve months, and (2) has been subject to such filing requirements for the past ninety 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 pursuit to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding twelve months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No 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):
             
Large accelerated filer þ   Accelerated filer o   Non-accelerated filer o   Smaller reporting company o
        (Do not check if a smaller reporting company)    
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
As of August 1, 2011, there were 57,534,943 outstanding shares of the registrant’s Common Stock.
 
 

 

 


 

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 EX-31.1
 EX-31.2
 EX-32.1
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT

 

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Part I — FINANCIAL INFORMATION
Item 1. — Condensed Consolidated Financial Statements
optionsXpress Holdings, Inc.
Condensed Consolidated Statements of Financial Condition
(Unaudited)

(In thousands, except per share data)
                 
    June 30,     December 31,  
    2011     2010  
ASSETS
               
Cash and cash equivalents
  $ 50,153     $ 100,875  
Cash and investments segregated in compliance with federal regulations
    1,127,398       945,870  
Receivables from brokerage customers, net
    252,241       235,589  
Receivables from brokers, dealers and clearing organizations
    13,441       25,686  
Investments in securities
    10,562       11,442  
Deposits with clearing organizations
    20,712       20,480  
Fixed assets, (net of accumulated depreciation and amortization of $30,373 and $26,904 at June 30, 2011 and December 31, 2010, respectively)
    11,062       11,345  
Goodwill
    87,489       85,360  
Other intangible assets, net
    3,691       4,837  
Other assets
    39,968       31,434  
 
           
 
               
Total assets
  $ 1,616,717     $ 1,472,918  
 
           
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
 
               
Payables to brokerage customers
  $ 1,322,206     $ 1,193,479  
Payables to brokers, dealers and clearing organizations
    4,551       1,711  
Accrued liabilities and accounts payable
    23,907       19,471  
Current and deferred income taxes
    562       651  
Other liabilities
    25,812       32,521  
Long-term debt
    110,400       120,000  
 
           
 
               
Total liabilities
    1,487,438       1,367,833  
 
           
 
               
Stockholders’ equity
               
Common stock, $0.0001 par value (250,000 shares authorized; 57,531 and 57,475 shares issued and outstanding at June 30, 2011 and December 31, 2010, respectively)
    6       6  
Preferred stock, $0.0001 par value (75,000 shares authorized; none issued)
           
Additional paid-in capital
    16,706       15,642  
Accumulated other comprehensive loss
    (839 )     (859 )
Non-controlling interests
    225       185  
Retained earnings
    113,181       90,111  
 
           
 
               
Total stockholders’ equity
    129,279       105,085  
 
           
 
               
Total liabilities and stockholders’ equity
  $ 1,616,717     $ 1,472,918  
 
           
See accompanying notes.

 

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optionsXpress Holdings, Inc.
Condensed Consolidated Statements of Operations
(Unaudited)

(In thousands, except per share data)
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2011     2010     2011     2010  
Revenues:
                               
Commissions
  $ 41,764     $ 44,713     $ 87,160     $ 84,311  
Other brokerage-related revenue
    4,730       5,243       10,581       9,741  
Interest revenue and fees
    3,857       4,826       8,140       9,593  
Interest expense
    (58 )     (56 )     (128 )     (107 )
 
                       
 
                               
Net interest revenue and fees
    3,799       4,770       8,012       9,486  
Education revenue
    5,524       7,707       10,907       15,237  
Other income
    3,374       3,067       8,428       3,756  
 
                       
 
                               
Net revenues
    59,191       65,500       125,088       122,531  
 
                               
Expenses:
                               
Compensation and benefits
    12,046       11,854       24,367       23,502  
Brokerage, clearing and other related expenses
    10,407       10,250       20,151       19,268  
Brokerage advertising
    4,600       5,747       9,983       10,116  
Education marketing and fulfillment
    3,849       4,986       6,892       10,281  
Depreciation and amortization
    2,180       2,277       4,346       4,568  
Loan interest and fees
    1,001             2,014        
Other general and administrative
    10,117       5,772       20,099       11,331  
 
                       
 
                               
Total expenses
    44,200       40,886       87,852       79,066  
 
                       
 
                               
Income before income taxes of consolidated companies
    14,991       24,614       37,236       43,465  
Income taxes
    6,133       9,005       14,126       15,951  
 
                       
 
                               
Net income of consolidated companies
    8,858       15,609       23,110       27,514  
Net income attributable to non-controlling interests
    16       22       40       39  
 
                       
 
                               
Net income
  $ 8,842     $ 15,587     $ 23,070     $ 27,475  
 
                       
 
                               
Earnings per common share:
                               
Basic
  $ 0.15     $ 0.27     $ 0.40     $ 0.48  
Diluted
  $ 0.15     $ 0.27     $ 0.40     $ 0.48  
 
                               
Weighted-average number of common shares:
                               
Basic
    57,497       57,403       57,477       57,434  
Diluted
    57,861       57,611       57,845       57,643  
Dividends declared per share
  $     $     $     $  
See accompanying notes.

 

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optionsXpress Holdings, Inc.
Condensed Consolidated Statements of Cash Flows
(Unaudited)

(In thousands, except per share data)
                 
    Six Months Ended  
    June 30,     June 30,  
    2011     2010  
Operating activities
               
Net income
  $ 23,070     $ 27,475  
Adjustments to reconcile net income to cash used in operating activities:
               
Depreciation and amortization
    4,346       4,568  
Stock-based compensation
    2,132       2,352  
(Reduction) excess of tax benefit for stock-based compensation
    (280 )     18  
Deferred income taxes
    865       1,078  
(Decrease) increase in contingent liability
    (6,275 )     112  
Unrealized (gain) loss, deferred rent and other
    (332 )     (231 )
Changes in operating assets and liabilities:
               
(Increase) decrease in:
               
Cash and investments segregated in compliance with federal regulations
    (181,528 )     (10,034 )
Receivables from brokerage customers, net
    (16,652 )     (45,535 )
Receivables from brokers, dealers and clearing organizations
    12,245       87,381  
Investments in securities
          27,750  
Deposits with clearing organizations
    (232 )     10,208  
Other assets
    (7,282 )     (6,765 )
Increase (decrease) in:
               
Payables to brokerage customers
    128,727       (104,255 )
Payables to brokers, dealers and clearing organizations
    2,840       4,820  
Accrued liabilities and accounts payable
    2,089       761  
Current income taxes
    (2,211 )     (914 )
Other liabilities
    310       (478 )
 
           
 
               
Net cash used in operating activities
    (38,168 )     (1,689 )
Investing activities
               
Proceeds from sales and maturities of investments in securities
    700       3,200  
Purchases and development of computer software
    (1,380 )     (2,103 )
Purchases of fixed assets
    (1,708 )     (817 )
 
           
 
               
Net cash (used in) provided by investing activities
    (2,388 )     280  
Financing activities
               
Payment of long-term debt
    (9,600 )      
Exercise of stock options
    605       81  
Excess tax benefit for stock-based compensation
    280       (18 )
Purchases through employee stock purchase plan
    24       24  
Stock repurchases
    (1,560 )     (2,874 )
 
           
 
               
Net cash used in financing activities
    (10,251 )     (2,787 )
Effect of exchange rates on cash and cash equivalents
    85       (94 )
 
           
 
               
Net decrease in cash and cash equivalents
    (50,722 )     (4,290 )
 
           
 
               
Cash and cash equivalents, beginning of period
    100,875       178,989  
 
           
 
               
Cash and cash equivalents, end of period
  $ 50,153     $ 174,699  
 
           
 
               
Supplemental disclosure of cash flow information:
               
Income taxes paid
  $ 15,293     $ 15,830  
Interest paid
    1,893       107  
Supplemental disclosure of non-cash activity:
               
Non-cash foreign currency translation gain
    134       88  
Non-cash change in unrealized (loss) gain on available for sale investments in securities
    51       340  
Non-cash gain from CBOE seat exchanged for initial public offering stock
          2,053  
See accompanying notes.

 

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optionsXpress Holdings, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

(In thousands, except per share data)
1. Basis of Presentation and Nature of Operations
Basis of Presentation
The condensed consolidated financial statements include the accounts of optionsXpress Holdings, Inc. and its subsidiaries (collectively, the “Company”). All significant intercompany balances and transactions have been eliminated in consolidation.
The Company follows United States generally accepted accounting principles (“GAAP”) including certain accounting guidance used by the brokerage industry. Certain notes and other information normally included in financial statements prepared in accordance with United States GAAP have been condensed or omitted. The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes to the consolidated financial statements included in the Annual Report on Form 10-K of the Company for the year ended December 31, 2010.
In the opinion of management, all adjustments necessary to present fairly the Company’s consolidated financial position at June 30, 2011 and the consolidated results of operations and cash flows for each of the periods presented have been recorded. The results of operations and cash flows for an interim period are not necessarily indicative of the results of operations or cash flows that may be reported for the year or any subsequent period.
Nature of Operations
The Company’s principal business segments include broker services and education services.
The Company’s 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 foreign countries. Except for trades placed by its Canadian customers, all securities trades are cleared through the Company’s internal self-clearing operations. The Company clears its futures accounts transactions as a non-clearing futures commission merchant through an omnibus account arrangement with several futures commission merchants.
optionsXpress, Inc. is a broker-dealer registered with the Securities and Exchange Commission (“SEC”) and is a member of the Financial Industry Regulatory Authority Inc. (“FINRA”), the Securities Investor Protection Corporation (“SIPC”), the National Securities Clearing Corporation and the Depository Trust Company (together, the Depository Trust & Clearing Corporation or “DTCC”), and the Options Clearing Corporation (“OCC”). optionsXpress, Inc. is also a member of various exchanges, including the Chicago Board Options Exchange (“CBOE”), the International Securities Exchange, the BATS Exchange, the NYSE Amex Options Exchange, the NASDAQ Options Market, the NYSE Arca Exchange, and the NASDAQ OMX PHLX Exchange. brokersXpress LLC is a broker-dealer registered with the SEC and a member of FINRA and SIPC. In addition, optionsXpress, Inc., brokersXpress LLC and Open E Cry, LLC (“OEC”, formerly known as Open E Cry) are registered with the Commodity Futures Trading Commission (“CFTC”) and are members of the National Futures Association (“NFA”). optionsXpress Canada Corp. is provincially registered and registered with the Investment Industry Regulatory Organization of Canada. optionsXpress Singapore Pte. Ltd. is registered with and licensed by the Monetary Authority of Singapore. optionsXpress Europe, B.V. is registered with and licensed by the Netherlands Authority for the Financial Markets and has obtained passport licensure in various European Union countries. optionsXpress Australia Pty Limited is registered with and licensed by the Australian Securities & Investments Commission. Xpresstrade, LLC became a registered Retail Foreign Exchange Dealer (“RFED”) with the National Futures Association in July 2011.
The Company’s 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. The education services business is conducted through Optionetics, Inc., a subsidiary of the Company and its affiliates (collectively, “Optionetics”).
2. Summary of Significant Accounting Policies
Except as described in the following paragraph, there have been no changes in the significant accounting policies from those included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.
Fair Value of Financial Instruments — 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, Fair Value Measurements and Disclosures (“ASC 820”) , by requiring additional disclosures regarding fair value measurements. As a supplement to the additional required fair value measurement disclosures regarding assets and liabilities that were effective for the Company’s fiscal year beginning January 1, 2010, FASB requires further disclosures effective for fiscal periods beginning after December 15, 2010. Specifically, the additional amendment requires the purchases, sales, issuances and settlements of Level 3 assets and liabilities to be shown on a gross basis in a roll forward table. This amendment to ASU 2010-06 is effective for the Company’s fiscal year beginning January 1, 2011. The adoption of ASU 2010-06 did not have a material impact on the Company’s condensed consolidated financial statements.

 

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3. The Charles Schwab Corporation Merger
On March 18, 2011, optionsXpress Holdings, Inc. (“optionsXpress”) entered into an Agreement and Plan of Merger (the “Merger Agreement”) by and among optionsXpress, The Charles Schwab Corporation, a Delaware corporation (“Schwab”), and Neon Acquisition Corp., a Delaware corporation and wholly-owned direct subsidiary of Schwab (“Merger Sub”). Pursuant to the Merger Agreement, Merger Sub will be merged with and into optionsXpress, and as a result, optionsXpress will continue as the surviving corporation and as a wholly-owned subsidiary of Schwab (the “Schwab Merger”).
Pursuant to the Merger Agreement, at the effective time of the Schwab Merger, each issued and outstanding share of common stock of optionsXpress, other than shares owned by optionsXpress, Schwab, or any subsidiary of optionsXpress or Schwab, will be cancelled and retired and automatically converted into the right to receive 1.02 fully paid and nonassessable shares of common stock of Schwab.
As part of the Schwab Merger, Schwab has entered into retention agreements with certain members of optionsXpress’ management. Consummation of the Schwab Merger is subject to certain conditions, including, among others, the approval of the Merger Agreement by optionsXpress’ stockholders and the receipt of required regulatory and antitrust approvals. The Merger Agreement contains customary representations, warranties and covenants of optionsXpress, Schwab and Merger Sub, including, among others things, optionsXpress’ covenants (i) to have its board of directors (the “Board”) recommend approval of the Merger Agreement by optionsXpress’ stockholders, subject to a “fiduciary-out” provision that allows optionsXpress under certain circumstances to provide information and participate in discussions with respect to unsolicited alternative acquisition proposals, (ii) not to solicit alternate transactions and (iii) to conduct its business in the ordinary course during the period between the date of the Merger Agreement and the effectiveness of the Schwab Merger and refrain from taking various non-ordinary course actions during that period.
The Merger Agreement contains certain termination rights for both optionsXpress and Schwab and, further provides that, upon the termination of the Merger Agreement under specified circumstances, generally including an alternative business combination transaction, optionsXpress will owe Schwab a cash termination fee of $41,900.
Transaction costs of approximately $5.5 million were incurred related to the pending Schwab Merger for the six months ended June 30, 2011.
4. Goodwill
The Company has recorded goodwill for purchase business combinations to the extent the purchase price of each completed acquisition exceeded the fair value of the net identifiable tangible and intangible assets of the acquired company. The following table summarizes changes in the carrying amount of goodwill:
         
Balance, January 1, 2011
  $ 85,360  
Contingent consideration for OEC acquisition
    2,129  
 
     
 
       
Balance, June 30, 2011
  $ 87,489  
 
     
In performing the annual impairment test, the Company utilized quoted market prices of the Company’s common stock to estimate the fair value of the Company as a whole. The estimated fair value was then allocated to the Company’s reporting units based on operating revenues, and was compared to the carrying value of the respective reporting unit. No impairment of goodwill was determined for the six months ended June 30, 2011. All of the goodwill has been allocated to the brokerage services segment. The Company amortizes goodwill for income tax purposes on a straight-line basis over a period of fifteen years with the exception of the goodwill recognized from the Optionetics acquisition, which is non-deductible for income tax purposes.
5. Capitalization
Common Stock
At June 30, 2011, the Company had 250,000 shares of $0.0001 par value common stock authorized. Of the authorized common stock, 57,531 shares were issued and outstanding.
On February 24, 2009, the Company’s Board of Directors approved a stock repurchase program that authorized the Company to repurchase up to $20,000 of the Company’s outstanding common stock (the “2009 Repurchase Program”). On February 12, 2008, the Company’s Board of Directors approved a stock repurchase program that authorized the Company to repurchase up to $100,000 of the Company’s outstanding common stock (the “2008 Repurchase Program”).

 

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In addition, on February 14, 2008, the Company entered into an agreement with Ned W. Bennett, Executive Vice Chairman and founder of optionsXpress, pursuant to which, the Company may repurchase up to an additional 200 shares annually from Mr. Bennett (the “Bennett Stock Purchase Agreement”). The Bennett Stock Purchase Agreement does not create an obligation for the Company to buy, or Mr. Bennett to sell to the Company, any of his shares of our common stock. The number of shares the Company may purchase under the Bennett Stock Purchase Agreement is limited to 200 shares per year, but the total number of shares is limited only by the number of shares of our common stock that Mr. Bennett may hold from time to time.
The repurchase programs have no expiration date and the Company’s Board of Directors may terminate any or all of the stock repurchase programs at any time.
For the six months ended June 30, 2011, the Company has repurchased 100 shares of its common stock in aggregate under these programs at a total cost of $1,560, or an average cost of $15.60 per share. Since inception, the Company has repurchased 6,350 shares of its common stock in aggregate under these programs at a total cost of $111,350, or an average cost of $17.53 per share. The repurchased shares were retired to authorized, but unissued shares. The Company does not plan on repurchasing any additional shares pending the consummation of the Schwab Merger.
6. Fair Value Measurements
As defined in ASC 820, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction. ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy under which assets and liabilities measured at fair value will be classified are as follows:
Level 1: Quoted market prices in active markets for identical assets or liabilities.
Level 2: Observable market based inputs or unobservable inputs that are corroborated by market data.
Level 3: Unobservable inputs that are not corroborated by market data.
As required by ASC 820, assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.
Financial Assets and Liabilities
The following table sets forth by level within the fair value hierarchy the Company’s assets and liabilities owned, at fair value, including $5,212 of money market funds included in cash and cash and equivalents that are pledged as collateral for a letter of credit, and financial instruments sold but not yet purchased at fair value as of June 30, 2011 and December 31, 2010:
                                 
June 30, 2011   Level 1(1)     Level 2(2)     Level 3(3)     Total  
Financial assets, at fair value:
                               
 
                               
Money market funds included in cash and cash equivalents
  $ 10,413     $     $     $ 10,413  
U.S. treasury securities included in deposits with clearing organizations
    11,000                   11,000  
Corporate equities and derivatives included in other assets
    27,926                   27,926  
Investments in securities
                10,562       10,562  
 
                       
 
                               
 
  $ 49,339     $     $ 10,562     $ 59,901  
 
                       
 
                               
Financial liabilities, at fair value:
                               
 
                               
Corporate equities and derivatives included in other liabilities
  $ 17,046     $     $     $ 17,046  
 
                       
 
                               
 
  $ 17,046     $     $     $ 17,046  
 
                       

 

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December 31, 2010   Level 1(1)     Level 2(2)     Level 3(3)     Total  
Financial assets, at fair value:
                               
 
                               
Money market funds included in cash and cash equivalents
  $ 9,674     $     $     $ 9,674  
U.S. treasury securities included in deposits with clearing organizations
    11,960                   11,960  
Corporate equities and derivatives included in other assets
    20,143       823             20,966  
Investments in securities
                11,442       11,442  
 
                       
 
                               
 
  $ 41,777     $ 823     $ 11,442     $ 54,042  
 
                       
 
                               
Financial liabilities, at fair value:
                               
 
                               
Corporate equities and derivatives included in other liabilities
  $ 17,661     $     $     $ 17,661  
 
                       
 
                               
 
  $ 17,661     $     $     $ 17,661  
 
                       
 
     
(1)  
All of the Company’s assets and liabilities included in Level 1 of the fair value hierarchy are exchange traded securities or have quoted market prices in active markets for identical assets or liabilities.
 
(2)  
Level 2 assets represent publicly traded shares that are restricted as part of an initial public offering and are valued based on the quoted market price less any discount for that restriction.
 
(3)  
Level 3 assets represent 17.6% and 21.2% of all financial assets measured at fair value at June 30, 2011 and December 31, 2010, respectively (see below for further information).
The following table provides a reconciliation of the beginning and ending balances for the major classes of financial assets and liabilities measured at fair value using significant unobservable inputs (Level 3):
         
    Investments  
    in  
    Securities  
    Assets  
Balance, January 1, 2011
  $ 11,442  
Total gains/(losses), realized and unrealized
    (180 )
Redemptions
    (700 )
 
     
 
       
Balance, June 30, 2011
  $ 10,562  
 
     
The Company’s Level 3 financial assets are comprised of auction rate securities (“ARS”). The Company’s ARS are backed by United States Department of Education-guaranteed student loans issued under the Federal Family Education Loan Program (“FFELP”). The Company’s ARS are marketable securities with long-term stated maturities (during years 2034-2040) for which the interest rates are reset through periodic short-term auctions every 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 of the Company’s ARS have failed since February 2008. A failed auction is not a default of the debt instrument and the ARS holder continues to receive interest payments when the auctions fail. All of the Company’s ARS are current with respect to the receipt of interest payments according to the stated terms of each ARS indenture. The Company believes that it has the ability and intent, if necessary, to hold its ARS investments until such time as the auctions are successful, the issuer redeems the securities, or another market for ARS develops. Since the ARS markets began failing on February 14, 2008, $96,275 of the Company’s ARS securities have been redeemed by issuers or the Company’s brokers at par.
At June 30, 2011, there was insufficient observable ARS market information available to determine the market value of the Company’s investments in ARS. Therefore, the Company has continued to designate the ARS as Level 3 financial assets under 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. The Company calculated income by developing a discounted cash flow model based on the expected cash flows from the ARS compared to a market rate. Based on the Company’s analysis, the weighted average economic life was estimated to be approximately four years. For the fair market interest rates used in its discounted cash flow, the Company used a current market rate for liquid debt instruments of similar underlying assets and credit quality, with spreads of approximately 150bps-250bps over the London Interbank Offered Rate.

 

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The Company has classified the remaining $11,300 in par value ARS as available-for-sale securities. At June 30, 2011, the Company’s calculation of fair value of the ARS implied an impairment of fair value of approximately $738, which has been recorded through accumulated other comprehensive loss on the condensed consolidated statement of financial condition, and the carrying fair value of the ARS was approximately $10,562.
Non-Financial Assets and Liabilities
Non-financial assets and liabilities subject to fair value measurements include customer relationships included in other intangible assets and a contingent liability included in other liabilities. At June 30, 2011 and December 31, 2010, there was significant unobservable information used to determine the market value for these non-financial assets and liabilities. Therefore, the Company has continued to designate the customer relationships’ intangible assets and the contingent liability as Level 3 non-financial assets and liabilities, respectively, under ASC 820.
The Company reviews other intangible assets for impairment on an annual basis and whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. Recoverability of the Company’s finite-lived intangible assets is evaluated by comparing the current and forecasted cash flows associated with the assets to the assets’ carrying values. The fair value of the Company’s customer relationships’ intangible assets were $3,569 at December 31, 2010 and $2,517 at June 30, 2011. For the six months ended June 30, 2011, the Company determined that one of its customer relationships’ intangible assets was deemed to be non-recoverable. The Company used the market approach to determine the fair value of this intangible asset and, as a result, recorded $337 of impairment charges in other general and administrative expenses. For the six months ended June 30, 2010, no impairment was recorded against the Company’s customer relationships intangible assets.
The Company’s non-financial liabilities include a contingent liability for accrued contingent consideration related to the acquisition of Optionetics. The accrued contingent consideration is payable for a period of five years following the acquisition and is based on the profitability of the business acquired and the number of funded brokerage accounts referred to the Company’s brokerage services segment in the year the contingent consideration is paid. Depending on the level of performance, the contingent consideration can range from zero to $7,000 for each of the first five years following the acquisition date of May 4, 2009. The fair value is based on the estimated projected future performance of Optionetics, the time remaining on the liability and the estimated market debt rate for the Company. The fair value of the contingent liability was $8,876 at December 31, 2010 and $2,601 at June 30, 2011.
7. Derivative Instruments
To help provide customers with improved trade execution, the Company at times enters into proprietary short-term positions in equity option and equity securities. The Company attempts to hedge these positions so that changes in market prices do not materially change the value of its securities. Any gains/losses from this trading activity are recognized as part of other brokerage-related revenue in the condensed consolidated statement of operations. For the six months ended June 30, 2011 and 2010, the total gains from the Company’s proprietary trading activities were $1,890 and $1,603, respectively.
8. Contingencies and Guarantees
General Contingencies
The Company extends margin credit and leverage to its customers, which are subject to various regulatory and clearing firm margin requirements. Cash and securities in customers’ accounts collateralize margin credit balances. 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. The Company is exposed to credit risk when its customers execute transactions, such as short sales of options, equities or futures transactions that can expose them to risk beyond their invested capital. As of June 30, 2011 and December 31, 2010, the Company had $245,074 and $231,170, respectively, in credit extended to its customers. In addition, the Company may be obligated for margin extended to the Company’s customers by its third-party clearing agents on collateralized securities and futures positions.
The margin and leverage requirements that the Company imposes on its 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, the Company is 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, the Company may be required to purchase or sell financial instruments at prevailing market prices to fulfill customers’ obligations. The Company believes that it is unlikely that it 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 condensed consolidated financial statements.

 

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The Company borrows securities temporarily from other broker-dealers in connection with its broker-dealer business. The Company deposits 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, the Company may be exposed to the risk of selling the securities at prevailing market prices. The Company seeks to manage this risk by requiring credit approvals for counterparties, by monitoring the securities’ value on a daily basis and by requiring additional collateral as needed.
Other assets and other liabilities on the condensed consolidated statement of financial condition include premiums on unrealized gains and losses for written and purchased options contracts. These contracts are subject to varying degrees of market risk. In addition, the Company has sold securities that it does not currently own (see Note 7), and therefore will be obligated to purchase such securities at a future date. The Company has recorded these obligations in the condensed consolidated financial statements as of June 30, 2011, at the fair values of the related securities, and will incur losses if the fair values of these securities increase subsequent to June 30, 2011.
Legal Contingencies
In the ordinary course of business, the Company is subject to lawsuits, arbitrations, claims, administrative or regulatory examinations and other legal or regulatory proceedings. Management cannot predict with certainty the outcome of pending legal and regulatory proceedings. A substantial adverse judgment or other resolution regarding the proceedings could have a material adverse effect on the Company’s financial condition, results of operations and cash flows. However, in the opinion of management, after consultation with legal counsel, the outcome of any pending proceedings is not likely to have a material adverse effect on the financial condition, results of operations or cash flows of the Company.
As previously disclosed in the Company’s Quarterly Report on Form 10Q filed with the SEC on May 10, 2011, a number of purported class action lawsuits were filed by optionsXpress stockholders challenging Schwab’s proposed acquisition of optionsXpress. These suits name as defendants optionsXpress, members of optionsXpress’ board of directors, Schwab and Neon Acquisition Corp. (collectively referred to as defendants).
On July 29, 2011, the parties entered into a settlement agreement to resolve all claims related to the merger. Per the terms of the Memorandum of Understanding entered into by the parties on June 22, 2011, the parties agreed that, in exchange for full releases of all claims related to the Schwab Merger, defendants would provide supplemental disclosures to the amended Registration Statement on Form S-4, which was filed by Schwab with the SEC on July 22, 2011. Defendants have also agreed not to oppose any fee application by plaintiffs’ counsel that does not exceed $650. The settlement is subject to final documentation and court approval and is conditioned on consummation of the Schwab Merger. Defendants deny any wrongdoing in connection with the Schwab Merger and believe the claims lack merit. In the event the settlement is not finalized, the remaining defendants will continue to defend the claims vigorously.
Guarantees
The Company introduces its Canadian securities customers’ accounts to a clearing broker who clears and carries all customer securities account activity. The Company clears its futures and foreign exchange transactions on an omnibus account basis through several futures commission merchants and a third-party RFED. The Company has agreed to indemnify its third-party clearing broker, all of its clearing futures commission merchants and its clearing RFED for any losses that they may sustain for the customer accounts introduced to them by the Company.
The Company provides guarantees to its clearing organizations and exchanges under their standard membership agreements, which require members to guarantee the performance of other members. Under the agreements, if another member becomes unable to satisfy its obligations to the clearing organization or exchange, the other members would be required to meet any shortfalls. The Company’s liability under these arrangements is not quantifiable and may exceed the cash and securities it has posted as collateral. However, the Company believes that it is unlikely that it will have to make any material payments under these arrangements, and no liabilities related to these guarantees have been recognized in the accompanying condensed consolidated financial statements.
9. Earnings Per Share
The computations of basic and diluted EPS were as follows for the following periods:
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2011     2010     2011     2010  
Net income
  $ 8,842     $ 15,587     $ 23,070     $ 27,475  
 
                               
Weighted-average number of common shares outstanding — basic
    57,497       57,403       57,477       57,434  
Effect of dilutive securities
    364       208       368       209  
 
                       
 
                               
Weighted-average number of common shares outstanding — diluted
    57,861       57,611       57,845       57,643  
 
                       
 
                               
Basic EPS
  $ 0.15     $ 0.27     $ 0.40     $ 0.48  
Diluted EPS
  $ 0.15     $ 0.27     $ 0.40     $ 0.48  

 

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10. Stock-Based Compensation
The Company maintains three stock compensation plans: the 2001 Equity Incentive Plan, the 2005 Equity Incentive Plan, and the 2008 Equity Incentive Plan, or collectively, the equity incentive plans. All of the options outstanding pursuant to the stock compensation plans at June 30, 2011 are options to buy common stock of the Company granted to employees or directors of the Company.
Stock-based compensation for the six months ended June 30, 2011 and June 30, 2010 was $2,435 and $2,352, respectively. As of June 30, 2011, the total compensation cost related to stock options and deferred shares not yet vested and recognized was estimated to be $6,016. This compensation cost related to stock options and deferred shares is expected to be recognized over a weighted average period of 2.91 years and 3.74 years, respectively. As of June 30, 2011, the aggregate intrinsic value of the total outstanding stock options and deferred shares was $5,875 and $8,529, respectively, and the aggregate intrinsic value of the total exercisable stock options was $3,537. During the six months ended June 30, 2011, 155 shares were issued pursuant to the Company’s equity incentive plans.
11. Regulatory Requirements
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 $250, 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 Reg. 1.17 ($20,000), or the sum of 8% of the total risk margin requirements for all positions carried in customer accounts, as defined in Reg. 1.17 and 8% of the total risk margin requirements for all positions carried in non-customer accounts.
As of June 30, 2011, optionsXpress, Inc. had net capital requirements of $20,000 and net capital of $84,325. As of June 30, 2010, optionsXpress, Inc. had net capital requirements of $14,392 and net capital of $103,993. All of the Company’s other broker-dealers also exceeded the net capital requirements for their respective jurisdictions. The net capital rules may effectively restrict the payment of cash distributions or other equity withdrawals.
12. Segment Reporting
The Company operates in the following two principal business segments:
Brokerage services segment- Brokerage services offers a comprehensive suite of services for option, futures, stock, mutual fund, and fixed-income investors.
Education services segment- Education services provides a full range of investor education products and services that educate customers on stock market analysis, options, foreign exchange and financial planning.
Information concerning the Company’s operations by reportable segment is as follows:
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
Net Revenues   2011     2010     2011     2010  
Brokerage Services
  $ 53,859     $ 57,797     $ 114,550     $ 107,288  
Education Services
    6,003       8,186       11,867       16,200  
Eliminations
    (671 )     (483 )     (1,329 )     (957 )
 
                       
 
                               
Total
  $ 59,191     $ 65,500     $ 125,088     $ 122,531  
 
                       
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
Income (Loss) before Income Taxes   2011     2010     2011     2010  
Brokerage Services
  $ 16,776     $ 25,637     $ 40,352     $ 45,973  
Education Services
    (1,801 )     (1,045 )     (3,156 )     (2,547 )
Non-controlling interests
    16       22       40       39  
 
                       
 
                               
Total
  $ 14,991     $ 24,614     $ 37,236     $ 43,465  
 
                       

 

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    As of     As of  
    June 30,     December 31,  
    2011     2010  
Assets
               
Brokerage Services
  $ 1,607,790     $ 1,465,944  
Education Services
    12,963       10,008  
Eliminations
    (4,036 )     (3,034 )
 
           
 
               
Total
  $ 1,616,717     $ 1,472,918  
 
           
Item 2. — Management’s Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
The following discussion of the financial condition and results of operations of the Company should be read in conjunction with the Selected Financial Data and the Consolidated Financial Statements and Notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010, and the Condensed Consolidated Financial Statements and Notes thereto contained in this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements that 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 Quarterly Report on Form 10-Q. 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. The forward-looking statements made in this Quarterly Report on Form 10-Q 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 statements. 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.
Important factors that may cause such differences include, but are not limited to: risks related to general economic conditions, regulatory developments, the competitive landscape, the volume of securities trading generally or by our customers specifically, competition, systems failures and capacity constraints and the other risks and uncertainties set forth under the heading “Risk Factors” in Item 1A of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010.
Forward-looking statements include, but are not limited to, the following:
 
the statements about our intention to pay dividends;
 
 
the statements about future growth in online brokerage accounts, options trading, futures trading, online options trading, and online futures trading;
 
 
the statement that on a per trade basis, brokerage, clearing and other related expenses generally decrease as the number of customer trades increase;
 
 
the statements about continuing to expand our product offering and our customer base and the costs associated with such expansion;
 
 
the statements concerning future growth of our futures business, international operations, brokersXpress and our institutional business;
 
 
the statements about the impact of changes in interest rates on our earnings;
 
 
the statements concerning continued financing options;
 
 
the statements regarding scalability of our systems and the cost of capacity increases;
 
 
the statements concerning uncertainties and deteriorations in the credit and capital markets and the credit quality of our auction rate securities (“ARS”);
 
 
the statements concerning the number of students receiving education services and our ability to convert those students into brokerage customers; and,
 
 
the statements about the pending Schwab Merger.

 

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Results of Operations
The following table sets forth our total net revenues and condensed consolidated statements of operations data for the periods presented as a percentage of total net revenues:
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2011     2010     2011     2010  
Results of Operations
                               
Net revenues (in thousands)
  $ 59,191     $ 65,500     $ 125,088     $ 122,531  
Compensation and benefits
    20.3 %     18.1 %     19.5 %     19.2 %
Brokerage, clearing, and other related expenses
    17.6       15.6       16.1       15.7  
Brokerage advertising
    7.8       8.8       8.0       8.3  
Education marketing and fulfillment
    6.5       7.6       5.5       8.4  
Depreciation and amortization
    3.7       3.5       3.5       3.7  
Loan interest and fees
    1.7             1.6        
Other general and administrative
    17.1       8.8       16.1       9.3  
Income before income taxes
    25.3       37.6       29.7       35.4  
Income taxes
    10.4       13.8       11.3       13.0  
Net income
    14.9       23.8       18.4       22.4  
Statistical Data
The following table sets forth our statistical data for the periods presented below:
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2011     2010     2011     2010  
Statistical Data
                               
Number of customer accounts (at period end) (1)
    397,400       365,500       397,400       365,500  
Daily average revenue trades (“DARTs”) (2) Retail DARTs
    32,200       32,700       34,400       31,500  
Institutional DARTs
    15,300       17,100       14,700       15,700  
 
                       
 
                               
Total DARTs
    47,500       49,800       49,100       47,200  
Customer trades per account (3)
    30       35       32       33  
Average commission per trade
  $ 13.94     $ 14.26     $ 14.23     $ 14.40  
Option trades as a % of total trades
    43 %     40 %     44 %     41 %
Brokerage advertising expense per net new customer account (4)
  $ 568     $ 737     $ 556     $ 707  
Total client assets (000s)
  $ 8,403,112     $ 7,030,199     $ 8,403,112     $ 7,030,199  
Client margin balances (000s)
  $ 227,595     $ 204,194     $ 227,595     $ 204,194  
 
     
(1)  
Customer accounts are open, numbered accounts.
 
(2)  
DARTs are total revenue-generating trades for a period divided by the number of trading days in that period.
 
(3)  
Customer trades per account are total trades divided by the average number of total customer accounts during the period. Customer trades are annualized.
 
(4)  
Calculated based on total net new customer accounts opened during the period.

 

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Three Months Ended June 30, 2011 versus Three Months Ended June 30, 2010
Overview
Our results for the period reflect the following principal factors:
 
total customer accounts increased by 31,900 to 397,400, or 8.7%;
 
 
total trades decreased by 140,200 to 2,995,200, or 4.5% and
 
 
average commission per trade decreased by $0.32 to $13.94, or 2.2%.
Commissions
Commissions decreased $2.9 million, or 6.6%, for the three months ended June 30, 2011 to $41.8 million compared to $44.7 million for the three months ended June 30, 2010. The decrease in commissions was primarily the result of the 4.5% decrease in the total number of trades and the 2.2% decrease of the average commission per trade.
Other brokerage-related revenue
Other brokerage-related revenue decreased $0.5 million, or 9.8%, to $4.7 million for the three months ended June 30, 2011 compared to $5.2 million for the three months ended June 30, 2010. The decrease in other brokerage-related revenue was due to a decrease in the payment for order flow rate per contract captured for our option order flow and a decrease in the number of option contracts traded.
Net interest revenue and fees
Net interest revenue and fees decreased $1.0 million, or 20.4%, to $3.8 million for the three months ended June 30, 2011 compared to $4.8 million for the three months ended June 30, 2010. The decrease in net interest revenue and fees was primarily the result of a decline in short-term interest rates.
Education revenue
Education revenue decreased $2.2 million, or 28.3%, to $5.5 million for the three months ended June 30, 2011 compared to $7.7 million for the three months ended June 30, 2010. The decrease in education revenue was primarily due to lower revenue from seminar sales.
Other income
Other income increased $0.3 million, or 10.0%, to $3.4 million for the three months ended June 30, 2011 compared to $3.1 million for the three months ended June 30, 2010. The increase in other income is due primarily to the reduction in fair value of the contingent liability from the Optionetics acquisition which was largely offset by the gain recognized from the CBOE initial public offering in June 2010.
Compensation and benefits
Compensation and benefits expenses increased $0.1 million, or 1.6%, to $12.0 million for the three months ended June 30, 2011 from $11.9 million for the three months ended June 30, 2010. The increase in compensation and benefits expenses was largely due to an increased bonus accrual.
Brokerage, clearing, and other related expenses
Brokerage, clearing and other related expenses increased $0.1 million, or 1.5%, to $10.4 million for the three months ended June 30, 2011 from $10.3 million for the three months ended June 30, 2010. Brokerage, clearing and other related expenses increased primarily due to higher payouts to the independent registered representatives and advisors of our OEC subsidiary.
Brokerage advertising
Brokerage advertising expenses decreased $1.1 million, or 20.0%, to $4.6 million for the three months ended June 30, 2011 from $5.7 million for the three months ended June 30, 2010. Brokerage advertising expenses decreased due to reduced spending across all marketing channels. Brokerage advertising expenses per net new customer account decreased to $568 for the three months ended June 30, 2011 from $737 for the three months ended June 30, 2010.

 

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Education marketing and fulfillment
Education marketing and fulfillment expenses decreased $1.2 million, or 22.8%, to $3.8 million for the three months ended June 30, 2011 compared to $5.0 million for the three months ended June 30, 2010. Education marketing and fulfillment expenses decreased primarily due to lower marketing expenses incurred for preview events.
Depreciation and amortization
Depreciation and amortization expenses decreased $0.1 million, or 4.3%, to $2.2 million for the three months ended June 30, 2011 from $2.3 million for the three months ended June 30, 2010. Lower depreciation and amortization expenses were due to a reduced level of fixed assets being depreciated and amortized.
Loan interest and fees
Loan interest and fees was $1.0 million for the three months ended June 30, 2011. Prior to the long-term debt we acquired on November 22, 2010, we did not have any expenses related to loan interest and fees.
Other general and administrative
Other general and administrative expenses increased $4.3 million, or 75.3%, to $10.1 million for the three months ended June 30, 2011 from $5.8 million for the three months ended June 30, 2010 primarily due to one-time costs to resolve a legal matter related to a customer of approximately $2.6 million and costs pertaining to the pending merger with The Charles Schwab Corporation.
Income taxes
Income taxes decreased $2.9 million, or 31.9%, to $6.1 million for the three months ended June 30, 2011 from $9.0 million for the three months ended June 30, 2010. Lower income taxes were primarily due to the 39.1% decrease in income before income taxes.
Net income
As a result of the foregoing, we reported $8.8 million in net income for the three months ended June 30, 2011, compared to $15.6 million in net income for the three months ended June 30, 2010, a decrease of $6.8 million, or 43.3%.
Segment information
Brokerage Services
Brokerage services net revenues decreased $3.9 million, or 6.8% to $53.9 million for the three months ended June 30, 2011 compared to the $57.8 million for the three months ended June 30, 2010 due to the decrease in commissions, other brokerage-related revenue and net interest revenue and fees. Income before income taxes decreased $8.8 million, or 34.6%, to $16.8 million for the three months ended June 30, 2011 compared to the $25.6 million for the three months ended June 30, 2010 primarily due to the overall decrease in net revenues and the increase in other general and administrative expenses.
Education Services
Education services net revenues decreased $2.2 million, or 26.7% to $6.0 million for the three months ended June 30, 2011 compared to the $8.2 million for the three months ended June 30, 2010 primarily due to lower seminar sales. The loss before income taxes increased $0.8 million, or 72.3%, to $(1.8) million for the three months ended June 30, 2011 compared to the $(1.0) million for the three months ended June 30, 2010 due to lower revenues from seminar sales, which were partially offset by lower marketing expenses for preview events.
Six Months Ended June 30, 2011 versus Six Months Ended June 30, 2010
Overview
Our results for the period reflect the following principal factors:
 
total customer accounts increased by 31,900 to 397,400, or 8.7%;
 
 
total trades increased by 270,200 to 6,126,800, or 4.6% and
 
 
average commission per trade decreased by $0.17 to $14.23, or 1.2%.

 

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Commissions
Commissions increased $2.9 million, or 3.4%, for the six months ended June 30, 2011 to $87.2 million compared to $84.3 million for the six months ended June 30, 2010. The increase in commissions was primarily the result of the 4.6% increase in the total number of trades which was partially offset by the 1.2% decrease of the average commission per trade.
Other brokerage-related revenue
Other brokerage-related revenue increased $0.9 million, or 8.6%, to $10.6 million for the six months ended June 30, 2011 compared to $9.7 million for the six months ended June 30, 2010. The increase in other brokerage-related revenue was due to an increase in the payment for order flow rate per contract captured for our option order flow and an increase in the number of option contracts traded.
Net interest revenue and fees
Net interest revenue and fees decreased $1.5 million, or 15.5%, to $8.0 million for the six months ended June 30, 2011 compared to $9.5 million for the six months ended June 30, 2010. The decrease in net interest revenue and fees was primarily the result of a decline in short-term interest rates.
Education revenue
Education revenue decreased $4.3 million, or 28.4%, to $10.9 million for the six months ended June 30, 2011 compared to $15.2 million for the six months ended June 30, 2010. The decrease in education revenue was primarily due to lower revenue from seminar sales.
Other income
Other income increased $4.6 million, or 124.4%, to $8.4 million for the six months ended June 30, 2011 compared to $3.8 million for the six months ended June 30, 2010. The increase in other income is due primarily to the reduction in fair value of the contingent liability from the Optionetics acquisition.
Compensation and benefits
Compensation and benefits expenses increased $0.9 million, or 3.7%, to $24.4 million for the six months ended June 30, 2011 from $23.5 million for the six months ended June 30, 2010. The increase in compensation and benefits expenses was largely due to an increased bonus accrual.
Brokerage, clearing, and other related expenses
Brokerage, clearing and other related expenses increased $0.9 million, or 4.6%, to $20.2 million for the six months ended June 30, 2011 from $19.3 million for the six months ended June 30, 2010. Brokerage, clearing and other related expenses increased primarily due to higher payouts to the independent registered representatives and advisors of our brokersXpress subsidiary.
Brokerage advertising
Brokerage advertising expenses decreased $0.1 million, or 1.3%, to $10.0 million for the six months ended June 30, 2011 from $10.1 million for the six months ended June 30, 2010. Brokerage advertising expenses decreased due to reduced spending across all marketing channels. Brokerage advertising expenses per net new customer account decreased to $556 for the six months ended June 30, 2011 from $707 for the six months ended June 30, 2010.
Education marketing and fulfillment
Education marketing and fulfillment expenses decreased $3.4 million, or 33.0%, to $6.9 million for the six months ended June 30, 2011 compared to $10.3 million for the six months ended June 30, 2010. Education marketing and fulfillment expenses decreased primarily due to lower marketing expenses incurred for preview events.
Depreciation and amortization
Depreciation and amortization expenses decreased $0.3 million, or 4.9%, to $4.3 million for the six months ended June 30, 2011 from $4.6 million for the six months ended June 30, 2010. Lower depreciation and amortization expenses were due to a reduced level of fixed assets being depreciated and amortized.
Loan interest and fees
Loan interest and fees was $2.0 million for the six months ended June 30, 2011. Prior to the long-term debt we acquired on November 22, 2010, we did not have any expenses related to loan interest and fees.

 

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Other general and administrative
Other general and administrative expenses increased $8.8 million, or 77.4%, to $20.1 million for the six months ended June 30, 2011 from $11.3 million for the six months ended June 30, 2010 primarily due to the transaction costs pertaining to the pending merger with The Charles Schwab Corporation and one-time costs to resolve a legal matter related to a customer of approximately $2.6 million.
Income taxes
Income taxes decreased $1.9 million, or 11.4%, to $14.1 million for the six months ended June 30, 2011 from $16.0 million for the six months ended June 30, 2010. Lower income taxes were primarily due to the 14.3% decrease in income before income taxes.
Net income
As a result of the foregoing, we reported $23.1 million in net income for the six months ended June 30, 2011, compared to $27.5 million in net income for the six months ended June 30, 2010, a decrease of $4.4 million, or 16.0%.
Segment information
Brokerage Services
Brokerage services net revenues increased $7.3 million, or 6.8% to $114.6 million for the six months ended June 30, 2011 compared to the $107.3 million for the six months ended June 30, 2010 due to the increase in commissions and other income. Income before income taxes decreased $5.6 million, or 12.2%, to $40.4 million for the six months ended June 30, 2011 compared to the $46.0 million for the six months ended June 30, 2010 primarily due to the overall increase in net revenues from trading activity and the increase in other general and administrative expenses.
Education Services
Education services net revenues decreased $4.3 million, or 26.7% to $11.9 million for the six months ended June 30, 2011 compared to the $16.2 million for the six months ended June 30, 2010 primarily due to lower seminar sales. The loss before income taxes increased $0.7 million, or 23.9%, to $(3.2) million for the six months ended June 30, 2011 compared to the $(2.5) million for the six months ended June 30, 2010 due to lower revenues from seminar sales, which were partially offset by marketing expenses for preview events.
Liquidity and Capital Resources
As a holding company, almost all of our funds generated from 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 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. 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. All of our ARS are AAA-rated and 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, $96.3 million of our ARS securities have been redeemed by issuers or our brokers at par. We believe we have the ability and intent, if necessary, to hold our remaining ARS investments until such time as the auctions are successful, the issuer redeems the securities, or another market for ARS develops.
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 Reg. 1.17 ($20.0 million), or the sum of 8% of the total risk margin requirements for all positions carried in customer accounts and 8% of the total risk margin requirements for all positions carried in non-customer accounts, as defined in Reg. 1.17.

 

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As of June 30, 2011, optionsXpress, Inc. had net capital requirements of $20.0 million and net capital of $84.3 million. As of June 30, 2010, optionsXpress, Inc. had net capital requirements of $14.4 million and net capital of $104.0 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. At June 30, 2011, we had interest-bearing security deposits and short-term treasury bills totaling $20.7 million deposited with clearing organizations for the self-clearing of equities and option trades.
At June 30, 2011, we had $1,127.4 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 $1,322.2 million as of June 30, 2011.
We generally finance our operating liquidity and capital needs through the use of funds generated from operations and the issuance of common stock.
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 used in operating activities was $38.2 million for the six months ended June 30, 2011, compared to cash used in operating activities of $1.7 million for the six months ended June 30, 2010. The primary reason for the increase of cash used in our operating activities was due to the increase of cash and investments segregated in compliance with federal regulations, which was largely offset by the increase of payables to brokerage customers.
Cash used in investing activities was $2.4 million for the six months ended June 30, 2011, compared to cash provided by investing activities of $0.3 million for the six months ended June 30, 2010. The primary reason for the increase of cash used in operating activities was due to the reduction of proceeds received from sales and maturities of investments in securities.
Cash used in financing activities was $10.3 million for the six months ended June 30, 2011, compared to cash used in financing activities of $2.8 million for the six months ended June 30, 2010. Cash used in financing activities increased primarily due to the principal payments on our long-term debt, which we acquired on November 22, 2010, which was partially offset by the reduction of cash used to repurchase our outstanding common stock during the current period.
Capital Expenditures
Capital expenditures were $1.7 million for the three months ended June 30, 2011, compared to $1.5 million for the three months ended June 30, 2010. The increase in capital expenditures was related to an increase in purchases of technology resources. Capital expenditures for the periods ended June 30, 2011 and 2010 included capitalized software development costs, which we capitalized in accordance with Financial Accounting Standards Board Accounting Standards Codification TM Topic 350-50, Website Development Costs, primarily related to the development of our technology.
The Charles Schwab Corporation Merger
On March 18, 2011, optionsXpress Holdings, Inc. entered into an Agreement and Plan of Merger by and among optionsXpress, The Charles Schwab Corporation, a Delaware corporation, and Neon Acquisition Corp., a Delaware corporation and wholly-owned direct subsidiary of Schwab. Pursuant to the Merger Agreement, Merger Sub will be merged with and into optionsXpress, and as a result, optionsXpress will continue as the surviving corporation and as a wholly-owned subsidiary of Schwab.
Pursuant to the Merger Agreement, at the effective time of the Merger, each issued and outstanding share of common stock of optionsXpress, other than shares owned by optionsXpress, Schwab, or any subsidiary of optionsXpress or Schwab, will be cancelled and retired and automatically converted into the right to receive 1.02 fully paid and nonassessable shares of common stock of Schwab.
As part of the Schwab Merger, Schwab has entered into retention agreements with certain members of optionsXpress’ management.
Consummation of the Schwab Merger is subject to certain conditions, including, among others, the approval of the Merger Agreement by optionsXpress’ stockholders and the receipt of required regulatory and antitrust approvals. The Merger Agreement contains customary representations, warranties and covenants of optionsXpress, Schwab and Merger Sub, including, among others things, optionsXpress’ covenants (i) to have its board of directors recommend approval of the Merger Agreement by optionsXpress’ stockholders, subject to a “fiduciary-out” provision that allows optionsXpress under certain circumstances to provide information and participate in discussions with respect to unsolicited alternative acquisition proposals, (ii) not to solicit alternate transactions and (iii) to conduct its business in the ordinary course during the period between the date of the Merger Agreement and the effectiveness of the Schwab Merger and refrain from taking various non-ordinary course actions during that period.
The Merger Agreement contains certain termination rights for both optionsXpress and Schwab and, further provides that, upon the termination of the Merger Agreement under specified circumstances, generally including an alternative business combination transaction, optionsXpress will owe Schwab a cash termination fee of $41.9 million.

 

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Item 3. — Quantitative and Qualitative Disclosures about Market Risk
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.
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 our 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.
We expect this kind of exposure to increase with the growth in our overall business. The use of margin credit, leverage and short sales may expose us to significant off-balance-sheet risk in the event that collateral requirements are not sufficient to fully cover losses that customers may incur and those customers fail to satisfy their obligations. As of June 30, 2011, we had $245.1 million in credit extended to our customers either directly or through our clearing firms. The amount of risk to which we are exposed from the leverage we extend to our customers and from short sale transactions by our customers is unlimited and not quantifiable as the risk is dependent upon analysis of a potential significant and undeterminable rise or fall in stock or futures prices. Our account level margin credit and leverage requirements meet or exceed those required by Regulation T of the Board of Governors of the Federal Reserve. We have a comprehensive policy implemented in accordance with SRO standards to assess and monitor the suitability of investors to engage in various trading activities. To mitigate our risk, we also continuously monitor customer accounts to detect excessive concentration, large orders or positions, patterns of day trading and other activities that indicate increased risk to us.
Please see Item 2. — “Liquidity and Capital Resources” for additional information.
Item 4. — Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms 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. Our management, including our Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on the evaluation of these disclosure controls and procedures, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during the six months ended June 30, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Part II — OTHER INFORMATION
Item 1. — Legal Proceedings
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, or other regulatory actions.

 

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Schwab Merger Litigation
As previously disclosed in the Company’s Quarterly Report on Form 10Q filed with the SEC on May 10, 2011, a number of purported class action lawsuits were filed by optionsXpress stockholders challenging Schwab’s proposed acquisition of optionsXpress. These suits name as defendants optionsXpress, members of optionsXpress’ board of directors (whom we refer to as the individual defendants), Schwab and Neon Acquisition Corp. (collectively referred to as defendants).
Seven lawsuits were filed in the Circuit Court of Cook County, Illinois. By orders dated April 6, 2011 and April 27, 2011, the Illinois lawsuits were consolidated under the caption Kolton v. Gray, et al. (Civ. Action No. 11CH10657) (which we refer to as the Consolidated Illinois Action). On May 9, 2011, the Illinois plaintiffs filed a consolidated amended complaint (which we refer to as the Illinois Amended Complaint).
Three lawsuits were filed in the Court of Chancery of the State of Delaware. By order dated April 25, 2011, the Delaware lawsuits were consolidated under the caption In re optionsXpress Holdings, Inc. Shareholder Litigation, Consolidated C.A. No. 6314-VCL (which we refer to as the Consolidated Delaware Action). The Delaware plaintiffs filed a consolidated amended complaint on April 25, 2011. On April 28, 2011, the Delaware court stayed the Consolidated Delaware Action in favor of the Consolidated Illinois Action.
The complaints generally allege that (i) the individual defendants breached fiduciary duties owed to optionsXpress’ stockholders by allegedly approving the merger agreement at an unfair price and through an unfair process and by agreeing to certain deal protection devices; and (ii) the transaction unfairly benefits certain members of optionsXpress’ board of directors, including the chief executive officer, to the disadvantage of other optionsXpress stockholders. The complaints also allege that Schwab and Neon Acquisition Corp. aided and abetted the alleged fiduciary breaches by the individual defendants. The complaints seek, among other relief, to enjoin the transaction, rescission in the event the transaction is consummated, an order directing defendants to account to plaintiff and other members of the putative class for all damages caused by their breaches, and an award of costs and disbursements, including reasonable attorneys’ and expert fees.
On May 20, 2011, defendants moved to dismiss the Illinois Amended Complaint. On June 16, 2011, the Illinois court dismissed with prejudice all claims against Schwab and Neon Acquisition Corp. in the Consolidated Illinois Action.
On July 29, 2011, the parties entered into a settlement agreement to resolve all claims related to the Schwab Merger. Per the terms of the Memorandum of Understanding entered into by the parties on June 22, 2011, the parties agreed that, in exchange for full releases of all claims related to the Schwab Merger, defendants would provide supplemental disclosures to the amended Registration Statement on Form S-4, which was filed by Schwab with the SEC on July 22, 2011. Defendants have also agreed not to oppose any fee application by plaintiffs’ counsel that does not exceed $0.7 million. The settlement is subject to final documentation and court approval and is conditioned on consummation of the Schwab Merger. Defendants deny any wrongdoing in connection with the Schwab Merger and believe the claims lack merit. In the event the settlement is not finalized, the remaining defendants will continue to defend the claims vigorously.
Item 1A. — Risk Factors
Our Annual Report on Form 10-K for the fiscal year ended December 31, 2010 lists in more detail various important risk factors facing our business in Part I, Item 1A under the heading “Risk Factors.” Except as set forth below, there have been no material changes from the risk factors disclosed in that section of our Annual Report on Form 10-K. We encourage you to review that information and to review our other reports filed periodically with the Securities and Exchange Commission for any further information regarding risks facing our business.
Uncertainty about the Schwab Merger and diversions of management could harm us, whether or not the Schwab Merger is completed.
In response to the announcement of the Schwab Merger, existing or prospective customers and counterparties of ours may delay or defer decisions concerning us or they may seek to change their existing business relationships with us. In addition, as a result of the Schwab Merger, current and prospective employees could experience uncertainty about their future with us or the combined company. These uncertainties may impair our ability to retain, recruit or motivate key personnel. Completion of the Schwab Merger will also require a significant amount of time and attention from management. The diversion of management attention away from ongoing operations could adversely affect our business relationships. If the Schwab Merger is not completed as anticipated, the adverse effects of these uncertainties and the diversion of management could be exacerbated by the delay.
Failure to complete the Schwab Merger for regulatory or other reasons could adversely affect our stock price and our future business and financial results.
Completion of the Schwab Merger is conditioned upon, among other things, the receipt of certain regulatory approvals and approval of our stockholders. There is no assurance that we will receive the necessary approvals or satisfy the other conditions necessary for completion of the Schwab Merger. If we fail to complete the Schwab Merger, we will remain liable for significant transaction costs, including legal and accounting fees, and may be required, in certain circumstances, to pay a termination fee of $41.9 million. In addition, the current market price of our common stock may reflect a market assumption that the Schwab Merger will occur, and a failure to complete the Schwab Merger could result in a negative perception by the market of us generally and a resulting decline in the market price of our common stock.

 

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Item 2. — Unregistered Sales of Equity Securities and Use of Proceeds
(c) Purchases of Equity Securities by the Issuer
We did not repurchase any of our common stock during the three months ended June 30, 2011.

 

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Item 6. — Exhibits
         
Exhibit   Description
       
 
  31.1    
Certification of David A. Fisher, Principal Executive Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       
 
  31.2    
Certification of Adam J. DeWitt, Principal Financial Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       
 
  32.1    
Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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Signatures
Pursuant to the requirements of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
         
Dated: August 9, 2011   optionsXpress Holdings, Inc.
(Registrant)
 
 
  By:   /s/ DAVID A. FISHER    
    David A. Fisher   
    Chief Executive Officer
(Principal Executive Officer) 
 
 
     
  By:   /s/ ADAM J. DEWITT    
    Adam J. DeWitt   
    Chief Financial Officer
(Principal Financial and Accounting Officer) 
 

 

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Exhibit Index
         
Exhibit   Description
       
 
  31.1    
Certification of David A. Fisher, Principal Executive Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       
 
  31.2    
Certification of Adam J. DeWitt, Principal Financial Officer, as required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       
 
  32.1    
Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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