TRADESTATION GROUP INC - Annual Report: 2002 (Form 10-K)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

For the transition period from ____________ to ____________

Commission file number: 0-31049

TradeStation Group, Inc.

(Exact name of registrant as specified in its charter)

954-652-7000
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, par value $.01 per share
(Title of class)

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

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (17 CFR 229.405) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K x

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
Yes o No x

     The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant on June 28, 2002, based upon the closing market price of the registrant’s common stock on The Nasdaq National Market on such date, was approximately $27,329,000.

     The registrant had 39,590,042 shares of common stock, $.01 par value, outstanding as of March 10, 2003.

DOCUMENTS INCORPORATED BY REFERENCE
NONE.

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PART I

ITEM 1. BUSINESS

Overview and Recent Developments

     TradeStation Group, Inc., a Florida corporation formed in 2000, is the successor company to Omega Research, Inc., a Florida corporation that was formed in 1982. TradeStation Group is listed on The Nasdaq National Market under the symbol “TRAD.” TradeStation Securities, Inc. and TradeStation Technologies, Inc. are TradeStation Group’s two operating subsidiaries. See Note 3 of Notes to Consolidated Financial Statements – BUSINESS COMBINATIONS.

     TradeStation Securities, a leading direct-access brokerage firm serving the active trader and certain institutional trader markets, is the company’s principal operating subsidiary. By the end of 2002, TradeStation Securities had nearly 8,000 equities and futures accounts. The average equities account made more than 600 revenue trades during 2002, and the average futures account traded just under 500 round-turn contracts. During the 2002 fourth quarter, TradeStation Securities’ equities account base averaged just under 13,000 revenue trades per trading day, and its future accounts base traded, on average, more than 4,250 round-turn contracts per trading day. The average account asset balance of an equities account was more than $100,000 during the 2002 fourth quarter.

     In March 2003, we launched the latest version of our electronic trading platform: TradeStation 7. TradeStation 7 contains significant enhancements to TradeStation 6, including our award-winning RadarScreen and OptionStation technologies for equities and options traders, list/basket trading and multiple account allocation features for institutional traders, improved seamless direct-access order execution for electronic futures trades, and 10 years of historical one-minute-and-above intra-day equities data and 20 years of historical one-minute-and-above futures data.

     In the March 10, 2003 issue of Barron’s magazine, TradeStation Securities, based principally on the magazine’s review of the TradeStation 7 electronic trading platform, was named the Best Broker for the Active Trader. TradeStation Securities also won the Technical Analysis of Stocks and Commodities Readers’ Choice Awards for best Direct Access Stock Brokerage, best Direct Access Futures Brokerage, best Institutional Platform, and best Professional Platform in February 2003. TradeStation Securities has won similar first-place awards and ratings since the 2001 launch of the TradeStation electronic trading platform.

     The TradeStation electronic trading platform seamlessly integrates powerful strategy trading software tools, historical and streaming real-time market data, and “intelligent” direct-access order-routing and execution. Direct-access trading means, with respect to equity security and futures transactions, direct Internet connections to electronic marketplaces, such as electronic communication networks (ECNs) or E-Mini exchanges, where anonymous buyers and sellers participating on the network are matched. A formal patent application covering the TradeStation electronic trading platform has been filed with the United States Patent and Trademark Office.

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     We seek recurring revenues mainly by offering, through the TradeStation electronic trading platform, commission-based brokerage services. We have leveraged our historical success providing strategy trading software tools, and the unique quality and functionality of those tools, to build a high-quality brokerage customer base of institutional, professional and serious, active individual traders.

     We also continue to provide via our technologies subsidiary, TradeStation Technologies, subscription services for TradeStation. The subscription version of TradeStation is an institutional-quality service that offers strategy trading software tools that generate real-time buy and sell alerts based upon the subscriber’s programmed strategies, but does not include order execution. Subscribers are charged a monthly subscription fee. Domestically, we no longer offer our traditional software products, i.e., “client” software products delivered on disks.

     TradeStation Technologies also owns and operates TradeStationWorld.com, which was launched July 2002. TradeStationWorld.com is an interactive community for active traders who engage or have interest in the development, testing and use of objective trading strategies. The community provides numerous discussion forums on a variety of topics related to strategy development and technical trading as well as TradeStation product and service features, articles about trading from industry leaders, and a “library” of strategy indicators, rules and components written in our proprietary EasyLanguage, many of which are donated by third parties. The company believes that TradeStationWorld.com has generated and will continue to generate renewed and intensified interest in strategy traders who use TradeStation trading software, as well as a new generation of traders who wish to embrace strategy trading through a state-of-the-art trading platform.

     Our principal executive offices are located in The TradeStation Building, 8050 S.W. 10th Street, Suite 4000, Plantation, Florida 33324, and our telephone number is (954) 652-7000.

     THIS REPORT (PARTICULARLY “ITEM 1. BUSINESS” AND “ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS”) CONTAINS STATEMENTS THAT ARE FORWARD-LOOKING WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. SEE “ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS – ISSUES, UNCERTAINTIES AND RISK FACTORS.”

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Industry Background

Active Trader Market

     The active trader market is usually defined as retail individuals, which include intra-day or day traders, semi-professionals, active “self-directed” traders, people who trade for themselves as a full-time or part-time business endeavor, or any other individual that trades much more actively than the typical online trading account. An active trader has historically been defined as one who trades a minimum of 10 times per month.

     The vast majority of active traders are believed to be with “traditional” online brokerage firms (e.g., Schwab, E*Trade, Ameritrade, T.D. Waterhouse, Fidelity, etc.). It has been estimated that 5% (or more) of each traditional online brokerage firm’s client base consists of active traders. All of the large online brokerage firms have tried over the past two to three years to acquire direct-access firms or technology, and more sophisticated trading analysis platforms, in order to retain and grow this most valuable segment of their client bases. There are estimated to be approximately 20 million online accounts today, and direct-access accounts (many of which are active trader accounts) have grown dramatically over the last few years and account for a higher percentage of trading activity of both Nasdaq and listed securities. According to a Q1 2002 report by JPMorgan H&Q, during the 2001 fourth quarter ECNs gained market share for the eighth consecutive quarter and accounted for 51.2% of Nasdaq trades. ECNs, of course, are one of the avenues of electronic order placement and execution used by direct-access online traders. According to an April 2002 article in Traders magazine, “40% of all order flow – both listed and Nasdaq – [is] handled electronically today, [and] it could rise to as much as 75 percent in two years.” The article states that such electronic order flow was placed mostly by “self-directed and active traders.” Active traders are believed to account for more than half of online daily trades (approximately 1 million daily trades), and have larger account asset balances (under current regulations, a minimum account balance of $25,000 is required for “day trading”). In the 2002 fourth quarter, the average account asset balance of a TradeStation Securities equities account was more than $100,000.

     We believe an online brokerage focused on active traders, in order to maximize its potential for successful market penetration, needs to deliver:

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     TradeStation Securities offers each of the above-mentioned features, including an attractive per share (as opposed to per ticket) pricing structure.

Institutional Trader Market

     We see the institutional trader market, as it relates to potential client relationships for direct-access brokerage firms like TradeStation Securities, as hedge fund and money managers, registered investment advisers and commodity trading advisors who use short-term trading strategies, and institutional service bureau arrangements.

     There are approximately 6,000 hedge funds today (approximately 2,000 of which manage assets under $100 million), 1,680 commodity pool operators, 13,000 registered investment advisors, 800 registered commodity trading advisors and 8,000 unregistered commodity trading advisors. A service bureau arrangement is one in which the direct-access broker – the service bureau – provides mainly its technology and systems, and perhaps technical support and minor trade desk support services, to the institutional clients of the broker-dealer it serves, but no other brokerage or financial services. The firm-client relationship remains mostly (or solely) between the end-user institutional client and its prime broker-dealer (who is, in effect, the service bureau’s customer). We do not currently act as a service bureau. However, it is possible we may be offered, or pursue, such opportunities as we continue to add features attractive to institutional traders to the TradeStation electronic trading platform, as discussed in more detail in the next two paragraphs. We believe it is worth noting that without even taking into account the new institutional features that TradeStation 7 offers, TradeStation Securities’ electronic trading platform was rated the best Institutional Platform and the best Professional Platform in Technical Analysis of Stocks & Commodities magazine’s 2003 Readers’ Choice Awards.

     Many believe that buy side institutional traders have become less and less pleased with Wall Street (traditional sell side brokerage firms) and are moving, to one degree or another, towards using direct-access execution of their trading decisions. The biggest concern institutional traders are said to have today is that the cost of their trades – not just commissions, but mainly the costs that result from adverse market movement caused by large block trades – is no longer acceptable, particularly given the market conditions of the past three years. Accordingly, these institutional traders are looking for systems that provide the fastest execution at the best prices possible. The fastest execution is provided by robust direct-access technology, and the “best prices possible” means an exhaustive list of execution venues to ensure maximum access to liquidity through intelligent order routing. It also means that the direct-access platform offers “stealthy” execution of large block orders (anonymity) through advanced reserve order, hidden order, discretionary order and order pegging technology – technology that enables the trade to be completed with minimal market disturbance. These basics: (1) effective, robust speedy execution; (2) full liquidity (all avenues available); (3) advanced order capabilities; and (4) intelligent order routing, must be in place before an institutional fund manager or other institutional buy side trader will consider using a direct-access brokerage firm. These are all strengths of the TradeStation electronic trading platform.

     Other features and services that are important to many buy side institutional traders include sophisticated decision-support front ends, automated trading functionality, list/basket trading, multiple account trade allocation, and a broad scope of assets (stocks, options and futures). TradeStation 7 contains, arguably, the best decision-support and automated trading functionality

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on the market, list/basket trading, multiple account trade allocation, and state-of-the-art direct-access execution services for both stocks and futures. It also includes award-winning options trading research and analysis functionality.

Products and Services

     Overview – TradeStation

     Our main product/service offering is the TradeStation electronic trading platform, complete with direct-access order execution services, for institutional, professional and serious, active individual traders. A formal patent application covering what we believe to be the unique, powerful technology of TradeStation is pending. TradeStation does not provide investment or trading advice or recommendations, or recommend the use of any particular strategy, but rather enables the trader to design, test and automate his own, custom trading strategies. TradeStation is a registered trademark in the United States, Australia, Canada, the European Community, Indonesia, Korea, Singapore, South Africa and Taiwan.

     In addition to offering the TradeStation electronic trading platform to the brokerage customers of our TradeStation Securities subsidiary, we offer, through our TradeStation Technologies subsidiary, TradeStation subscriptions. The difference between the TradeStation electronic trading platform and the TradeStation subscription service is that the subscription service does not include order execution or account management capabilities.

     TradeStation has, since its initial release as a strategy trading software program in 1991, been our flagship product. From 1996 until October 2001 it was marketed worldwide to institutional traders on a monthly subscription basis by Telerate, Inc. as a premium tool for the Telerate data feed service. It has also served, and continues to serve, as a strategy trading platform for numerous third-party software applications. Its state-of-the-art technology empowers the trader to design and develop a trading strategy based upon the trader’s objective rules and criteria, test the potential profitability of that trading strategy against historical data, and then computer-automate it to monitor the applicable market and alert the trader in real-time when the criteria of the trading strategy have been met and an order should, therefore, be placed. The principal features of TradeStation which enable the trader to design and develop trading strategies are EasyLanguage and the PowerEditor. EasyLanguage is a proprietary computer language we developed consisting of English-like statements and trading terms which can be input by the trader to describe particular objective rules and criteria. The PowerEditor is a compiler of EasyLanguage statements that provides the trader with considerable flexibility to modify and combine different trading rules and criteria, which ultimately result in the design of the trader’s trading strategies. EasyLanguage and PowerEditor are also registered trademarks.

Brokerage Services

     TradeStation Securities’ principal offering today is online brokerage services, covering both equity security and futures transactions, through the TradeStation electronic trading platform. TradeStation Securities’ targeted customer base for equity securities and futures brokerage services includes active individual, professional and institutional traders, including hedge fund and money managers and investment advisors who use short-term trading strategies. In addition to providing direct-access online services through the TradeStation electronic trading platform,

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the brokerage firm offers personal services by its registered representatives who execute customers’ orders through direct-access order execution systems. Having a “direct-access” order execution system, whether accessed directly by the brokerage client through the TradeStation electronic trading platform or by a TradeStation Securities broker on behalf of the brokerage client, means that both the online services and the firm’s trading desks are directly connected to stock and futures exchanges and ECN’s. ECN’s, such as Archipelago, BRUT and Island, directly match anonymous buyers and sellers participating on the network. This system often results in the simplest, most direct and speediest execution of orders for equity securities at the best available price. With respect to futures, the TradeStation electronic trading platform is directly connected to the futures clearing firm’s online execution system which, depending on the type of futures contract, either sends the order directly to the trading pit or, for electronic futures markets, implements an electronic order placement and execution. In the case of telephone orders, the brokerage’s registered representatives are committed to using the firm’s trading desks and direct-access technology to obtain the fastest execution and best possible price at the time the clients’ equity securities orders are taken. The TradeStation electronic trading platform offers brokerage clients a new level of online trading empowerment by enabling them to design, test and automate simple or complex trading strategies that instantaneously produce direct-access buy or sell orders when the strategies’ buy or sell conditions are triggered in the markets.

     Client accounts for equity securities and futures are carried on a “fully disclosed” basis by the brokerage’s clearing firms, Bear, Stearns Securities Corp. and Refco, LLC, respectively. TradeStation Securities executes its clients’ transactions on an agency basis only, as opposed to a principal basis. That is, it acts as the agent for its clients directly in the market. When brokerage firms perform transactions on a principal basis, they are permitted to accept a client’s order to purchase, purchase the securities in the market for the brokerage firm, and then sell the securities to the client. TradeStation Securities does not mark-up its clients’ equities or futures transactions. It always charges only an agreed-upon commission and never earns income from marking up or marking down its clients’ equities or futures transactions.

     For financial information concerning the brokerage services segment of our operations, see MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS and Note 17 of Notes to Consolidated Financial Statements – SEGMENT AND RELATED INFORMATION.

Software Products and Services

     In December 2000, we launched the TradeStation electronic subscription service. The TradeStation electronic subscription service includes our award-winning strategy trading features and functions, streaming real-time charts and quotes, streaming news, state-of-the-art analytical charting, Level II data, time and sales data, quote lists, option chains, market leaders data, Internet SmartSearch (a feature that enables the trader to access relevant Internet research services), live ticker, portfolio management, profit/loss tracking, and wireless access. During 2002, the TradeStation electronic subscription service was offered to new subscribers at monthly rates of $49.95 for an end-of-day version and $199.95 for a real-time version, and to legacy customers who “upgraded” at monthly rates ranging from $79.95 to $99.95. We evaluate our approach to subscription fee pricing on an ongoing basis, which has resulted and will likely continue to result in different price offerings during 2003. The 2003 version of TradeStation

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released in March 2003 (TradeStation 7) also offers our OptionStation and RadarScreen functions and features, which are described below, as optional services for an increased monthly fee.

     From our formation in 1982 until the end of 1999, our business consisted mainly of the licensing of strategy trading software products produced and distributed to end-user customers on disks. Our most recent version of those client software products, the 2000i line, which includes TradeStation 2000i, OptionStation 2000i, RadarScreen 2000i and ProSuite 2000i (a combination of the three), was released in February 1999. We discontinued active marketing efforts of the 2000i line in May 2000 as we focused on the marketing of our then-new Internet-based services, and the completion of our change in business model to a direct-access online brokerage founded on our award-winning TradeStation technology. The 2000i line is no longer available in the United States. OptionStation 2000i, also an award-winning technology, is an options trading analysis product for equities, index and futures options that enables traders to explore options trading strategies. RadarScreen 2000i enables traders to scan up to hundreds or thousands, depending upon the data service and computer hardware used, of equities or other securities to identify potential buying or selling opportunities based upon the traders’ own trading strategies. Internet-based versions of both the RadarScreen and OptionStation technology have been incorporated into the recently-launched TradeStation 7. For our 2000 and 2001 fiscal years, our software products and services operations have been responsible for the majority of our revenues. In particular, client software products accounted for approximately 12% and 35% of our total revenues in 2001 and 2000, respectively. However, in 2002, and, we expect, for the foreseeable future, our brokerage operations produced and should continue to produce the majority of our revenues. In 2002, brokerage revenues accounted for approximately 80% of our total revenues, and subscription fee revenues accounted for approximately 14% of our total revenues.

     For financial information concerning the software products and services segment of our operations, see MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS and Note 17 of Notes to Consolidated Financial Statements – SEGMENT AND RELATED INFORMATION.

Sales and Marketing

     No significant marketing of the TradeStation electronic trading platform was commenced until February 2002, when we began daily television advertising of our brokerage services. We also use print advertising in Investor’s Business Daily, Technical Analysis of Stocks & Commodities and Active Trader, direct mail and e-mail, sales seminars, and our Web sites. The mix and use frequency of television, print, Web-site, direct-mail and in-person marketing methods we use to try to achieve results will likely be continually modified as we test such methods and mixtures and analyze and interpret the results.

     Also, TradeStationWorld.com, a Web site owned and operated by TradeStation Technologies, is an interactive community for active traders who engage or have interest in the development, testing and use of objective trading strategies. The community provides numerous discussion forums on a variety of topics related to strategy development and technical trading as well as TradeStation product and service features, articles about trading from industry leaders, and a “library” of strategy indicators, rules and components written in our proprietary

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EasyLanguage, many of which are donated by third parties. The company believes that TradeStationWorld.com has generated and will continue to generate renewed and intensified interest in strategy traders who use TradeStation trading software, as well as a new generation of traders who wish to embrace strategy trading through state-of-the-art trading software.

     Less than 10% of our revenues were derived from customers outside of the United States for the years ended December 31, 2002, 2001 and 2000. International revenues are collected in U.S. dollars.

Strategic Relationships

     Clearing Services. Our brokerage’s clearing services for equities and equities options, and for futures and futures options, are currently provided by Bear, Stearns Securities Corp. and Refco, LLC, respectively, pursuant to industry-standard clearing agreements.

     Market Data Services. The real-time market data included in TradeStation are licensed from S&P Comstock, Inc.

Technology Development

     We believe that our success depends, in large part, on our ability to offer unique, Internet-based strategy trading technologies with state-of-the-art, intelligent direct-access order execution technologies, and continuously enhance those technologies, as well as develop and implement well-designed and user-friendly Web sites. To date, we have relied primarily on internal development of our products and services. We currently perform all quality assurance and develop user education and other training materials internally. In 2002, 2001 and 2000, technology development expenses were approximately $8.9 million, $9.3 million and $8.1 million, respectively. As of December 31, 2002, our technology development team was comprised of 79 persons, as compared to 98 as of December 31, 2001, a 20% decrease.

     We view our technology development cycle as a four-step process to achieve technical feasibility. The first step is to conceptualize in detail the defining features and functions that we believe our targeted market requires from the product or service, and to undertake a cost-benefit analysis to determine the proper scope and integration of such features and functions. Once the functional requirements of the product or service have been determined, the second step is to technically design the product or service. The third step is the detailed implementation, or engineering, of this technical design. The fourth step is rigorous quality assurance testing to ensure that the final product or service generally meets the functional requirements determined in the first step. Several refinements are typically added and tested in the quality assurance phase of development. Once this process is completed, technological feasibility has been achieved and the working model is available for release to our customers.

     The market for strategy trading software tools, streaming real-time market data and news services, and online order execution services is characterized by: rapidly changing technology; evolving industry standards in computer hardware, programming tools and languages, operating systems, database technology and information delivery systems; changes in customer requirements; and frequent new product and service introductions and enhancements. Our success will depend in part upon our ability to develop and maintain competitive technologies

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and to develop and introduce new products, services and enhancements in a timely and cost-effective manner that meets changing conditions such as evolving customer needs, existing and new competitive product and service offerings, emerging industry standards and changing technology. There can be no assurance that we will be able to develop and market, on a timely basis, if at all, products, services or enhancements that respond to changing market conditions or that will be accepted by customers. Any failure by us to anticipate or to respond quickly to changing market conditions, or any significant delays in the introduction of new products and services or enhancements, could cause customers to delay using, or decide against the use of, our products and services and could have a material adverse effect on our business, financial condition and results of operations.

Client Services and Support and Training

     We provide client services and support and product-use training in the following ways:

     Client Services and Support. TradeStation Securities provides telephone client services to its brokerage customers through a trained client services team. Technical support to subscription and brokerage customers who use the TradeStation electronic platform is provided by TradeStation Technologies’ technical support team. Customers of the 2000i line of products may also receive technical support from TradeStation Technologies’ technical support team. Advanced EasyLanguage consulting services (services that technically assist customers in the use of EasyLanguage to write the customers’ own trading strategies) are also available from internal resources and unaffiliated, independent EasyLanguage consultants. A substantial amount of technical support information is also provided on our Web sites, TradeStationWorld.com and the TradeStation Securities client support Web site. We try to closely coordinate our brokerage client and technical support services for our brokerage customers who use the TradeStation electronic trading platform.

     Product-use Training. We consider user education important to try to help our customers increase their ability to use our products and services fully and effectively. The majority of our training materials consist of extensive online documentation and technical assistance information on our Web sites, including online tutorials, and in-person training seminars, so that our customers may learn to use and take full advantage of the sophisticated technology of the TradeStation electronic trading platform.

Competition

     The market for online brokerage services is intensely competitive and rapidly evolving, and there appears to be substantial consolidation in the industry of online brokerage services, Internet-based real-time market data services, and trading analysis software tools. With the TradeStation electronic trading platform, we have embraced this evolution and consolidation. However, we believe that due to the current and anticipated rapid growth of the market for integrated trading tools, real-time market data and online brokerage services, competition, as well as consolidation, will substantially increase and intensify in the future. We believe our ability to compete will depend upon many factors both within and outside our control, including: pricing and price pressure; the timing and market acceptance of new products and services and enhancements developed by us and our competitors; our ability to design and support efficient, materially error-free Internet-based systems; market conditions, such as recession; the size of the

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active trader market today and in the future; the extent to which institutional traders are willing to use direct-access brokerage services offered by firms that have traditionally served mostly retail clients; product and service functionality; data availability and cost; clearing costs; ease of use; reliability; customer service and support; and sales and marketing decisions and efforts.

     We face direct competition from several publicly-traded and privately-held companies, principally online brokerages, including providers of direct-access order execution services. Our competitors include the many online brokerages currently active in the United States, including Ameritrade, Inc. (which recently acquired Datek Online Financial Services LLC), Charles Schwab & Co., Inc. (including the CyberTrader and StreetSmartPro direct-access services), CSFBdirect (formerly DLJdirect), E*Trade Securities, Incorporated, Fidelity Brokerage Services, Inc., Instinet Corporation (a Reuters subsidiary, and an ECN that also provides direct-access brokerage service), Interactive Brokers, JPMorgan, Merrill Lynch Direct, Morgan Stanley Online, Quick & Reilly, Inc., Redi Products, a division of Spear, Leeds & Kellogg (which is owned by Goldman Sachs), Scottrade, TD Waterhouse Investor Services, Inc., and Terra Nova. Those brokers currently serve, in the aggregate, more than 90% of existing online accounts, and many are focusing on attracting and retaining active traders to and who use their services. Many online brokerages currently claim to offer direct-access service. Even though we are rated as one of the best, if not the best, direct-access brokerage firm in the United States, there can be no assurance that we will be able to maintain such ratings, be rated that highly in the future, compete effectively with our competitors, adequately educate potential customers about the benefits our products and services provide, or continue to offer such products and services.

     Many of our existing and potential competitors, which include large, online discount and traditional national brokerages, and financial institutions that are focusing more closely on online services, including direct-access services for active traders, have longer operating histories, significantly greater financial, technical and marketing resources, greater name recognition and a larger installed customer base than do we. Further, there is the risk that larger financial institutions which offer online brokerage services as only one of many financial services may decide to use extremely low commission pricing as a “loss leader” to acquire and accumulate customer accounts and assets to derive interest income and income from their other financial services. We do not offer other financial services, and have no plans to do so; therefore, such pricing techniques, should they become common in our industry, could have a material, adverse effect on our results of operations, financial condition and business model.

     Generally, competitors may be able to respond more quickly to new or emerging technologies or changes in customer requirements or to devote greater resources to the development, promotion and sale of their products and services than do we. There can be no assurance that our existing or potential competitors will not develop products and services comparable or superior to those developed and offered by us or adapt more quickly than us to new technologies, evolving industry trends or changing customer requirements, or that we will be able to timely and adequately complete the implementation, and appropriately maintain and enhance the operation, of our new business model. Increased competition could result in price reductions, reduced margins, failure to obtain any significant market share, or loss of market share, any of which could materially adversely affect our business, financial condition and results of operations. There can be no assurance that we will be able to compete successfully against current or future competitors, or that competitive pressures faced by us will not have a material adverse effect on our business, financial condition and results of operations.

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Intellectual Property

     Our success is and will be heavily dependent on proprietary software technology, including certain technology currently in development. We view our software technology as proprietary, and rely, and will be relying, on a combination of copyright, trade secret and trademark laws, nondisclosure agreements and other contractual provisions and technical measures to establish and protect our proprietary rights. We have a formal patent application pending for the TradeStation trading platform, but software patents, particularly Internet-related software patents, are increasingly difficult to obtain, and there can be no assurance that we will obtain a patent or patents broad enough in scope to have value, or obtain a patent at all. We have registered copyright rights in our EasyLanguage dictionary and documentation and TradeStation software.

     We have obtained trademark registrations for the TradeStation mark in the United States, Australia, Canada, the European Community, Indonesia, Korea, Singapore, South Africa and Taiwan. We have obtained registrations for the OptionStation mark in the United States, Canada and the European Community. We have obtained registrations in the United States for the marks ActivityBar, EasyLanguage, PositionGraphs, PowerEditor, ProbabilityMap, ProSuite, RadarScreen, Test Before You Trade and other marks.

     We use an online subscription agreement for our Internet trading software and data services between TradeStation Technologies and each of the users (whether the users are brokerage customers or monthly subscribers) in order to protect our copyrights and trade secrets and to prevent such users from commercially exploiting such copyrights and trade secrets for their own gain. Since these licenses are not physically signed by the licensees, it is possible their enforceability is limited under certain state laws and the laws of many foreign jurisdictions.

     Despite our efforts to protect our proprietary rights, unauthorized parties copy or otherwise obtain, use or exploit our software or technology independently. Policing unauthorized use of our software technology is difficult, and we are unable to determine the extent to which piracy of our software technology exists. Piracy can be expected to be a persistent problem, particularly in international markets and as a result of the growing use of the Internet. In addition, effective protection of intellectual property rights may be unavailable or limited in certain countries, including some in which we may attempt to expand sales efforts. There can be no assurance that the steps taken by us to protect our proprietary rights will be adequate or that our competitors will not independently develop technologies that are substantially equivalent or superior to ours.

     There has been substantial litigation in the software industry involving intellectual property rights. We do not believe that we are infringing, or that any technology in development will infringe, the intellectual property rights of others. The risk of infringement by us is heightened with respect to our TradeStation 6 and TradeStation 7 technology, as that technology has not stood any significant “test of time” as has our legacy client software technology. There can be no assurance that infringement claims would not have a material adverse effect on our business, financial condition and results of operations. In addition, to the extent that we acquire or license a portion of the software or data included in our products or services from third parties (all data is licensed from third parties), or market products licensed from others generally, our exposure to infringement actions may increase because we must rely upon such third parties for information

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as to the origin and ownership of such acquired or licensed software or data technology. In the future, litigation may be necessary to establish, define, enforce and protect trade secrets, copyrights, trademarks and other intellectual property rights. We may also be subject to litigation to defend against claimed infringement of the rights of others or to determine the scope and validity of the intellectual property rights of others. Any such litigation could be costly and divert management’s attention, which could have a material adverse effect on our business, financial condition and results of operations. Adverse determinations in such litigation could result in the loss of proprietary rights, subject us to significant liabilities, require us to seek licenses from third parties, which could be expensive, or prevent us from selling our products or services or using our trademarks, any one of which could have a material adverse effect on our business, financial condition and results of operations.

Government Regulation

     Our brokerage subsidiary, TradeStation Securities, is subject to extensive securities and futures industry regulation under both federal and state laws as a broker-dealer with respect to its equities business and as an introducing broker with respect to its futures business. Broker-dealers and introducing brokers are subject to regulations covering all aspects of those businesses, including: sales methods; trade practices; use and safe-keeping of customers’ funds and securities; arrangements with clearing houses; capital structure; record keeping; conduct of directors, officers and employees; and supervision. To the extent TradeStation Securities solicits orders from customers or makes investment recommendations, it is subject to additional rules and regulations governing, among other things, sales practices and the suitability of recommendations to its customers.

     TradeStation Securities’ mode of operation and profitability may be directly affected by: additional legislation; changes in rules promulgated by the Securities and Exchange Commission (“SEC”), the National Association of Securities Dealers (“NASD”), the Commodity Futures Trading Commission (“CFTC”), the National Futures Association (“NFA”), the Board of Governors of the Federal Reserve System, the various stock and futures exchanges and other self-regulatory organizations; and changes in the interpretation or enforcement of existing rules and laws, particularly any changes focused on online brokerages that target an active trader customer base.

     With respect to active trading, the NASD has adopted rules that require firms to provide customers with a risk disclosure statement about active trading. Further, the NASD and NYSE’s margin rules impose more restrictive requirements for “pattern” active traders. Governmental concern is focused in two basic areas: that the customer has sufficient trading experience and has sufficient risk capital to engage in active trading. A minimum equities account balance of $25,000 is required. TradeStation Securities’ customer account documentation specifies that being a brokerage customer of TradeStation Securities is only for traders who have experience in active trading, are willing to risk considerable amounts of capital (at least $50,000), and are interested in engaging in high-risk, speculative trading activity. We believe our brokerage firm’s minimum suitability requirements, as well as the extensive user education documentation and tutorials offered on our Web site, are consistent with both the letter and the spirit of NASD rules and regulations concerning active trading.

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     The SEC, the NASD, the CFTC, the NFA and other self-regulatory organizations and state securities commissions can censure, fine, enjoin, suspend, expel or issue cease-and-desist orders to a broker-dealer or introducing broker or any of its officers or employees.

     Marketing campaigns by TradeStation Securities to bring brand name recognition to it and to promote the benefit of its services, such as the TradeStation electronic trading platform and its direct-access electronic order execution, are regulated by the NASD and NFA, and all marketing materials must be reviewed by an appropriately-licensed TradeStation Securities principal prior to release, and must conform to standards articulated by the SEC, NASD and NFA. The NASD or NFA may request that revisions be made to marketing materials, and can impose certain penalties for violations of its advertising regulations, including censures or fines, a requirement of advance regulatory approval of all advertising, the issuance of cease-and-desist orders, and the suspension or expulsion of a broker-dealer or introducing broker or any of its officers or employees.

     The SEC, the NASD, the CFTC and the NFA and various other regulatory agencies have stringent rules with respect to the maintenance of specific levels of net capital by securities broker-dealers and introducing brokers. Net capital is the net worth of a broker or dealer (assets minus liabilities), less deductions for certain types of assets as well as other charges. If a firm fails to maintain the required net capital it must cease conducting business and, if it does not do so, it may be subject to suspension or revocation of registration by the SEC or the CFTC and suspension or expulsion by the NASD or NFA, and it could ultimately lead to the firm’s liquidation.

     TradeStation Securities is registered as a broker-dealer in every U.S. state and the District of Columbia, and is subject to regulation under the laws of those jurisdictions, including registration requirements and being subject to sanctions if a determination of misconduct is made.

     TradeStation Securities is a member of the Securities Investor Protection Corporation (“SIPC”). SIPC provides protection of up to $500,000 for each equities account brokerage customer, subject to a limitation of $100,000 for cash balances, in the event of the financial failure of a broker-dealer. In addition, TradeStation Securities clears all of its custody and clearing issues associated with equities brokerage transactions through Bear, Stearns Securities Corp. Bear, Stearns has obtained an excess securities bond issued by Travelers Casualty and Surety Company which provides protection for any loss of securities and/or cash in excess of the primary SIPC protection up to the amount of the covered accounts’ net equity.

     It is possible that other federal or state agencies will attempt to regulate our current and planned online and other electronic service activities with rules that may include compliance requirements relating to record keeping, data processing, other operation methods, privacy, pricing, content and quality of goods and services as the market for online commerce evolves. Because of the growth in the electronic commerce market, Congress had held hearings on whether to regulate providers of services and transactions in the electronic commerce market. As a result, federal or state authorities could enact laws, rules or regulations, not only with respect to online brokerage services, but other online services we provide or may in the future provide. Such laws, rules and regulations, if and when enacted, could have a material adverse effect on our business, financial condition, results of operations and prospects.

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Employees

     As of December 31, 2002, we had 230 full-time equivalent employees consisting of 79 in technology development, including software engineering, product management, user education and quality assurance, 114 in sales and marketing relating to brokerage services, subscriptions and software products (including 31 in sales, 20 on the trading desk, 50 in client services and software support and 13 in marketing and fulfillment), and 37 in general and administrative, including executive management, finance, information technology services and human resources. Our employees are not represented by any collective bargaining organization, and we have never experienced a work stoppage and consider our relations with our employees to be good.

     Our future success depends, in significant part, upon the continued service of our key senior management, technology and sales and marketing personnel. The loss of the services of one or more of these key employees could have a material adverse effect on us. There can be no assurance that we will be able to retain our key personnel. Departures and additions of personnel, to the extent disruptive, could have a material adverse effect on our business, financial condition and results of operations.

ITEM 2. PROPERTIES

     In November 2001, we signed a ten-year lease (with two 5-year renewal options) that commenced in the summer of 2002 for an approximately 70,000 square-foot corporate headquarters in Plantation, Florida. Plantation is just west of Ft. Lauderdale, Florida (Broward County). This headquarters consolidated personnel and operations of the Miami and Boca Raton offices.

     Our former corporate headquarters was located in Miami, Florida, in a leased facility consisting of approximately 60,500 square feet of office space that expired in August 2002. Our brokerage operations were formerly conducted chiefly from 11,800 square feet of office facilities in Boca Raton, Florida pursuant to a lease that expires in 2007 (part of which is now being subleased). We also had leased a second facility in Boca Raton, Florida, consisting of approximately 6,000 square feet of space, for additional technology development and data services operations. That lease was terminated as of December 31, 2002.

     The brokerage had small branch offices in Osterville, Massachusetts, Pittsburgh, Pennsylvania, and Hudson and Cincinnati, Ohio, all of which have been, or are in the process of being, closed.

     The technologies subsidiary has an approximately 13,500 square foot leased facility in Richardson, Texas from which certain data services development and technical operations are conducted. Commencing January 2003, a portion of those facilities serve as a branch office for TradeStation Securities. That lease expires July 31, 2007. We also lease space for our data server farms at two sites, one in Richardson, Texas, and one in Miami, Florida. None of the facilities described in this paragraph were affected by the consolidation of the south Florida operations in Plantation last summer.

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     We believe that our existing facilities are adequate to support our existing operations and that, if needed, we will be able to obtain suitable additional facilities on commercially reasonable terms.

ITEM 3. LEGAL PROCEEDINGS

     In October 2002, we received information about alleged fraudulent conduct by an executive of a company that referred individual accounts to TradeStation Securities. The executive of the referral company was authorized to trade on behalf of such individuals and allegedly issued fraudulent account statements to them. The referred account holders incurred several million dollars of trading losses, in the aggregate, during the time the executive of the referral company traded on their behalves. On February 2, 2003, the referral company communicated to TradeStation Securities in writing that it believes TradeStation Securities shares responsibility for some or all of the alleged losses incurred by the referred account holders and/or the referral company and wishes to make an amicable settlement. The referral company further stated that if an amicable settlement is not reached it intends to initiate legal action of some kind against TradeStation Securities in the United States. We believe the referral company’s claims are without merit and, to date, no legal action has been commenced against TradeStation Securities by any of the referred account holders or the referral company.

     During January 2003, the bankruptcy estate of Bridge Information Systems, Inc. demanded that we return payments made to us by a Bridge subsidiary in December 2000 and January 2001 totaling approximately $1.0 million, claiming such payments were preferential under the Bankruptcy Code. We have refused the demands on various grounds, and believe the demands are without merit.

     We are also engaged in routine litigation or other dispute resolution proceedings, such as arbitration, incidental to, and part of the ordinary course of, our business (two arbitrations are currently pending, one claiming $250,000 in actual damages and $250,000 in punitive damages, and one claiming $560,000 in damages).

     We decided, as of June 1, 2002, to no longer carry errors or omissions insurance that covers third-party claims made by brokerage clients or software subscribers as a result of alleged human or system errors, failures, acts or omissions. This decision was made based upon our assessment of the potential risks and benefits, including significant increases in premium rates, deductibles and coinsurance amounts, reductions in available per occurrence and aggregate coverage amounts, and the unavailability of policies that sufficiently cover the types of risks that relate to our business.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

     No matters were submitted to a vote of security holders during the fourth quarter of 2002.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Common Stock Information

     Since January 2, 2001, our common stock, par value $.01 per share, has been listed on The Nasdaq National Market under the symbol “TRAD.” Prior to that time, the predecessor company’s common stock was listed under the symbol “OMGA.”

     The high and low closing sales prices based on actual transactions on The Nasdaq National Market during each of the quarters presented are as follows:

     As of March 10, 2003, there were 128 holders of record of our common stock, and, based upon information previously provided to us by depositories and brokers, we believe there are more than 4,000 beneficial owners.

Dividend Policy

     We intend to retain future earnings to finance our growth and development and therefore do not anticipate paying any cash dividends in the foreseeable future. Payment of any future dividends will depend upon our future earnings and capital requirements and other factors we consider appropriate. We did not distribute any dividends during the years ended December 31, 2002, 2001, or 2000.

Recent Sales of Unregistered Securities

     During the three months ended December 31, 2002, we issued to 211 employees (including 3 executive officers) options to purchase an aggregate of approximately 647,000 shares of common stock. Such options vest ratably in annual increments over a five-year period and are exercisable at prices ranging from $1.34 to $1.39 per share, which was the fair market value (as defined in our Incentive Stock Plan) of our common stock on the date the options were granted. All of the options were granted under our Incentive Stock Plan in the ordinary course, and expire, if they remain unexercised, on the tenth anniversary of the date on which they were granted.

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     All the foregoing options were issued by us in reliance upon the exemption from registration available under Section 4(2) of the Securities Act of 1933, as amended. Other than as described above, we did not issue or sell any unregistered securities during the fourth quarter of 2002.

ITEM 6. SELECTED FINANCIAL DATA

     The following selected consolidated financial data is qualified by reference to, and should be read in conjunction with, “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS,” and the Consolidated Financial Statements and Notes thereto included in this report. The Consolidated Statement of Operations Data presented below for the year ended December 31, 2002, and the Consolidated Balance Sheet Data as of December 31, 2002, have been derived from our Consolidated Financial Statements included on pages F-1 through F-29 of this report, which have been audited by Ernst & Young LLP, independent certified public accountants. The Consolidated Statement of Operations Data presented below for each of the years in the two-year period ended December 31, 2001, and the Consolidated Balance Sheet Data as of December 31, 2001 have been derived from our Consolidated Financial Statements included on pages F-1 through F-29 of this report, which were audited by Arthur Andersen LLP, independent certified public accountants. The Consolidated Statement of Operations Data presented below for each of the years in the two-year period ended December 31, 1999, and the Consolidated Balance Sheet Data as of December 31, 2000, 1999, and 1998, have been derived from audited financial statements not included in this report. See also Note 18 of Notes to Consolidated Financial Statements — UNAUDITED QUARTERLY FINANCIAL INFORMATION for quarterly financial information for fiscal years 2002 and 2001.

(Continued)

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CONSOLIDATED STATEMENT OF OPERATIONS DATA (1):

(Continued)

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This discussion should be read in conjunction with Selected Financial Data and the Consolidated Financial Statements and Notes to Consolidated Financial Statements contained in this report.

Overview

     TradeStation Group, Inc., a Florida corporation formed in 2000, is the successor company to Omega Research, Inc., a Florida corporation that was formed in 1982. TradeStation Group is listed on The Nasdaq National Market under the symbol “TRAD.” TradeStation Securities, Inc. and TradeStation Technologies, Inc. are TradeStation Group’s two operating subsidiaries. See Note 3 of Notes to Consolidated Financial Statements – BUSINESS COMBINATIONS.

     TradeStation Securities, a leading direct-access brokerage firm serving the active trader and certain institutional trader markets, is the company’s principal operating subsidiary. By the end of 2002, TradeStation Securities had nearly 8,000 equities and futures accounts. The average equities account made more than 600 revenue trades during 2002, and the average futures account traded just under 500 round-turn contracts. During the 2002 fourth quarter, TradeStation Securities’ equities account base averaged just under 13,000 revenue trades per trading day, and its futures accounts base traded, on average, more than 4,250 round-turn contracts per trading day. The average account asset balance of an equities account was more than $100,000 during the 2002 fourth quarter.

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     In March 2003, we launched the next version of our electronic trading platform: TradeStation 7. TradeStation 7 contains significant enhancements to TradeStation 6, including our award-winning RadarScreen and OptionStation technologies for equities and options traders, list/basket trading and multiple account allocation features for institutional traders, improved seamless direct-access order execution for electronic futures trades, and 10 years of historical one-minute-and-above intra-day equities data and 20 years of historical one-minute-and-above futures data.

     In the March 10, 2003 issue of Barron’s magazine, TradeStation Securities, based principally on the magazine’s review of the TradeStation 7 electronic trading platform, was named the Best Broker for the Active Trader. TradeStation Securities also won the Technical Analysis of Stocks and Commodities Readers’ Choice Awards for best Direct Access Stock Brokerage, best Direct Access Futures Brokerage, best Institutional Platform, and best Professional Platform in February 2003. TradeStation Securities has won similar first-place awards and ratings since the 2001 launch of the TradeStation electronic trading platform.

     The TradeStation electronic trading platform seamlessly integrates powerful strategy trading software tools, historical and streaming real-time market data, and “intelligent” direct-access order-routing and execution. Direct-access trading means, with respect to equity security and futures transactions, direct Internet connections to electronic marketplaces, such as electronic communication networks (ECNs) or E-Mini exchanges, where anonymous buyers and sellers participating on the network are matched. A formal patent application covering the TradeStation electronic trading platform has been filed with the United States Patent and Trademark Office.

     We seek recurring revenues mainly by offering, through the TradeStation electronic trading platform, commission-based brokerage services. We have leveraged our historical success providing strategy trading software tools, and the unique quality and functionality of those tools, to build a high-quality brokerage customer base of institutional, professional and serious, active individual traders.

     We also continue to provide via our technologies subsidiary, TradeStation Technologies, subscription services for TradeStation. The subscription version of TradeStation is an institutional-quality service that offers strategy trading software tools that generate real-time buy and sell alerts based upon the subscriber’s programmed strategies, but does not include order execution. Subscribers are charged a monthly subscription fee. Domestically, we no longer offer our traditional software products, i.e., “client” software products delivered on disks.

     TradeStation Technologies also owns and operates TradeStationWorld.com, which was launched July 2002. TradeStationWorld.com is an interactive community for active traders who engage or have interest in the development, testing and use of objective trading strategies. The community provides numerous discussion forums on a variety of topics related to strategy development and technical trading as well as TradeStation product and service features, articles about trading from industry leaders, and a “library” of strategy indicators, rules and components written in our proprietary EasyLanguage, many of which are donated by third parties. The company believes that TradeStationWorld.com has generated and will continue to generate renewed and intensified interest in strategy traders who use TradeStation trading software, as well as a new generation of traders who wish to embrace strategy trading through a state-of-the-art trading platform.

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Results of Operations

     For the three years ended December 31, 2002, we operated in two principal business segments: (i) brokerage services and (ii) software products and services. The brokerage services segment represents the operations of TradeStation Securities and the software products and services segment represents the operations of TradeStation Technologies. For the periods indicated, the following table presents certain items in our consolidated statements of operations broken down by segment: