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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------



For the quarterly period ended September 30, 2005



or



| ̈ | 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 001-32435



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International Securities Exchange, Inc.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 01-0681729                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|60 Broad Street, New York, New York                            |  | 10004                               
|(Address of principal executive offices)                       |  | (Zip Code)                          



(212) 943-2400

(Registrants telephone number, including area code)



N/A

(Former name, former address and former fiscal year, if changed since last report)



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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 ̈



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



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



As of November 10, 2005, there were 37,390,431 shares of the registrants Class A common stock outstanding (voting).



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##### Table of Contents

INTERNATIONAL SECURITIES EXCHANGE, INC.

FORM 10-Q QUARTERLY REPORT

For the Quarter Ended September 30, 2005



Table of Contents



|                              |  |                                                                                                           |  |   
|----------------------------- |  | --------------------------------------------------------------------------------------------------------- |  | --
|Part I.
FINANCIAL INFORMATION |  |                                                                                                          
|                              |  | Item 1.
Financial Statements                                                                              |  |   
|                              |  | Consolidated Statements of Income for the Three Months and Nine Months Ended September 30, 2005 and 2004  |  | 3 
|                              |  | Consolidated Statements of Financial Condition as of September 30, 2005 and December 31, 2004             |  | 4 
|                              |  | Consolidated Statements of Changes in Stockholders Equity as of September 30, 2005 and December 31, 2004 |  | 5 
|                              |  | Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2005 and 2004               |  | 6 
|                              |  | Notes to Consolidated Financial Statements                                                                |  | 7 
|                              |  | Item 2.
Managements Discussion and Analysis of Financial Condition and Results of Operations             |  | 17
|                              |  | Item 3.
Quantitative and Qualitative Disclosure about Market Risk                                         |  | 34
|                              |  | Item 4.
Controls and Procedures                                                                           |  | 35
|                              | 
|Part II.
OTHER INFORMATION    |  |                                                                                                          
|                              |  | Item 1.
Legal Proceedings                                                                                 |  | 36
|                              |  | Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds                                       |  | 36
|                              |  | Item 5.
Other Information                                                                                 |  | 36
|                              |  | Item 6.
Exhibits                                                                                          |  | 36
|                              |  |                                                                                                          
|                              |  | Signatures                                                                                                |  | 37



2



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##### Table of Contents

Part I. FINANCIAL INFORMATION



Item 1. Financial Statements



INTERNATIONAL SECURITIES EXCHANGE, INC.



CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share amounts)



|                                               |  |                                 |        |                                |   |        |  |      |         |  |   |       
|---------------------------------------------- |  | ------------------------------- | ------ | ------------------------------ | - | ------ |  | ---- | ------- |  | - | ------
|                                               |  | Three Months EndedSeptember 30, |        | Nine Months EndedSeptember 30,
|                                               |  | 2005                            |        | 2004                           |   | 2005   |  | 2004
|                                               |  | (Unaudited)                     |        | (Unaudited)                   
|Revenues:                                      |  |                                 |        |                                |   |        |  |      |         |  |   |       
|Transaction fees                               |  | $                               | 25,217 |                                | $ | 18,973 |  | $    | 73,195  |  | $ | 60,404
|Other member fees                              |  |                                 | 5,345  |                                |   | 5,584  |  |      | 16,105  |  |   | 16,567
|Market data                                    |  |                                 | 4,367  |                                |   | 4,376  |  |      | 13,779  |  |   | 12,605
|Other                                          |  |                                 | 1,319  |                                |   | 155    |  |      | 2,668   |  |   | 974   
|                                               |  |                                 |        |                                |   |        |  |      |         |  |   |       
|Total revenues                                 |  | $                               | 36,248 |                                | $ | 29,088 |  | $    | 105,747 |  | $ | 90,550
|                                               |  |                                 |        |                               
|Expenses:                                      |  |                                 |        |                                |   |        |  |      |         |  |   |       
|Compensation and benefits                      |  | $                               | 9,293  |                                | $ | 7,572  |  | $    | 27,426  |  | $ | 22,887
|Technology and communication                   |  |                                 | 3,602  |                                |   | 2,953  |  |      | 10,235  |  |   | 11,769
|Occupancy                                      |  |                                 | 1,169  |                                |   | 1,106  |  |      | 3,327   |  |   | 2,909 
|Professional fees                              |  |                                 | 1,718  |                                |   | 799    |  |      | 4,512   |  |   | 2,397 
|Marketing and business development             |  |                                 | 1,157  |                                |   | 961    |  |      | 2,836   |  |   | 2,555 
|Depreciation and amortization                  |  |                                 | 1,519  |                                |   | 1,455  |  |      | 4,528   |  |   | 2,476 
|Other                                          |  |                                 | 2,124  |                                |   | 1,570  |  |      | 6,287   |  |   | 4,311 
|Reorganization                                 |  |                                 | 203    |                                |   | 971    |  |      | 203     |  |   | 1,548 
|                                               |  |                                 |        |                                |   |        |  |      |         |  |   |       
|Total expenses                                 |  | $                               | 20,785 |                                | $ | 17,387 |  | $    | 59,354  |  | $ | 50,852
|                                               |  |                                 |        |                               
|Income before provision for income taxes       |  |                                 | 15,463 |                                |   | 11,701 |  |      | 46,393  |  |   | 39,698
|Provision for income taxes                     |  |                                 | 7,072  |                                |   | 5,951  |  |      | 21,006  |  |   | 19,589
|                                               |  |                                 |        |                                |   |        |  |      |         |  |   |       
|Net income                                     |  | $                               | 8,391  |                                | $ | 5,750  |  | $    | 25,387  |  | $ | 20,109
|                                               |  |                                 |        |                                |   |        |  |      |         |  |   |       
|                                               |  |                                 |        |                               
|Earnings per share:                            |  |                                 |        |                                |   |        |  |      |         |  |   |       
|Basic                                          |  | $                               | 0.23   |                                | $ | 0.18   |  | $    | 0.71    |  | $ | 0.63  
|Diluted                                        |  | $                               | 0.22   |                                | $ | 0.17   |  | $    | 0.68    |  | $ | 0.59  
|Weighted average number of shares outstanding: |  |                                 |        |                                |   |        |  |      |         |  |   |       
|Basic                                          |  |                                 | 36,742 |                                |   | 32,139 |  |      | 35,527  |  |   | 32,139
|Diluted                                        |  |                                 | 38,843 |                                |   | 33,920 |  |      | 37,574  |  |   | 33,921



The accompanying notes
are an integral part of these financial statements.



3



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##### Table of Contents

INTERNATIONAL SECURITIES EXCHANGE, INC.



CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(in thousands, except per share amounts)



|                                                                                                                                                                                          |  |                   |         |   |                  |   |         |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                                                                                                                          |  | September 30,2005 |         |   | December 31,2004 |  
|                                                                                                                                                                                          |  | (Unaudited)       |         |   |                  |  
|ASSETS                                                                                                                                                                                    |  |                   |         |   |                  |   |         |  
|Current assets:                                                                                                                                                                           |  |                   |         |   |                  |   |         |  
|Cash and cash equivalents                                                                                                                                                                 |  | $                 | 155,120 |   |                  | $ | 44,847  |  
|Accounts receivable, net                                                                                                                                                                  |  |                   | 32,215  |   |                  |   | 29,787  |  
|Income tax receivable                                                                                                                                                                     |  |                   |        |   |                  |   | 11,332  |  
|Securities owned                                                                                                                                                                          |  |                   | 4,951   |   |                  |   | 4,980   |  
|Other current assets                                                                                                                                                                      |  |                   | 3,883   |   |                  |   | 6,655   |  
|                                                                                                                                                                                          |  |                   |         |   |                  |   |         |  
|Total current assets                                                                                                                                                                      |  |                   | 196,169 |   |                  |   | 97,601  |  
|Securities owned                                                                                                                                                                          |  |                   | 13,144  |   |                  |   | 22,199  |  
|Accounts receivable                                                                                                                                                                       |  |                   | 574     |   |                  |   | 6,426   |  
|Fixed assets, net                                                                                                                                                                         |  |                   | 30,171  |   |                  |   | 32,757  |  
|Deferred tax asset, net                                                                                                                                                                   |  |                   | 21,489  |   |                  |   | 15,835  |  
|Other assets                                                                                                                                                                              |  |                   | 2,483   |   |                  |   | 2,761   |  
|                                                                                                                                                                                          |  |                   |         |   |                  |   |         |  
|Total assets                                                                                                                                                                              |  |                   | 264,030 |   |                  |   | 177,579 |  
|                                                                                                                                                                                          |  |                   |         |   |                  |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                      |  |                   |         |   |                  |   |         |  
|LIABILITIES                                                                                                                                                                               |  |                   |         |   |                  |   |         |  
|Current liabilities:                                                                                                                                                                      |  |                   |         |   |                  |   |         |  
|Accounts payable and accrued expenses                                                                                                                                                     |  |                   | 8,704   |   |                  |   | 8,434   |  
|Compensation and benefits payable                                                                                                                                                         |  |                   | 8,451   |   |                  |   | 14,520  |  
|Deferred revenue                                                                                                                                                                          |  |                   | 4,814   |   |                  |   | 4,365   |  
|Income taxes payable                                                                                                                                                                      |  |                   | 3,105   |   |                  |   |        |  
|Payment for order flow payable                                                                                                                                                            |  |                   | 14,076  |   |                  |   | 13,258  |  
|                                                                                                                                                                                          |  |                   |         |   |                  |   |         |  
|Total current liabilities                                                                                                                                                                 |  |                   | 39,150  |   |                  |   | 40,577  |  
|Deferred revenue                                                                                                                                                                          |  |                   | 51,410  |   |                  |   | 50,594  |  
|Other liabilities                                                                                                                                                                         |  |                   | 4,398   |   |                  |   | 4,949   |  
|                                                                                                                                                                                          |  |                   |         |   |                  |   |         |  
|Total liabilities                                                                                                                                                                         |  |                   | 94,958  |   |                  |   | 96,120  |  
|                                                                                                                                                                                          |  |                   |         |   |                  |   |         |  
|Commitments and contingencies (Note 4)                                                                                                                                                    |  |                   |         |   |                  |   |         |  
|                                                                                                                                                                                          |  |                  
|STOCKHOLDERS EQUITY                                                                                                                                                                      |  |                   |         |   |                  |   |         |  
|Class A common stock, $0.01 par value, 150,000 and 45,000 shares authorized, 36,745 and 32,139 shares issued and outstanding as of
September 30, 2005 and December 31, 2004, respectively |  |                   | 367     |   |                  |   | 321     |  
|Additional paid-in capital                                                                                                                                                                |  |                   | 130,987 |   |                  |   | 57,011  |  
|Retained earnings                                                                                                                                                                         |  |                   | 37,783  |   |                  |   | 24,180  |  
|Unearned compensation                                                                                                                                                                     |  |                   |        |   |                  |   | (14     | )
|Accumulated other comprehensive income                                                                                                                                                    |  |                   | (65     | ) |                  |   | (39     | )
|                                                                                                                                                                                          |  |                   |         |   |                  |   |         |  
|Total stockholders equity                                                                                                                                                                |  |                   | 169,072 |   |                  |   | 81,459  |  
|                                                                                                                                                                                          |  |                   |         |   |                  |   |         |  
|Total liabilities and stockholders equity                                                                                                                                                |  | $                 | 264,030 |   |                  | $ | 177,579 |  
|                                                                                                                                                                                          |  |                   |         |   |                  |   |         |  



The accompanying notes
are an integral part of these financial statements.



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INTERNATIONAL SECURITIES EXCHANGE, INC.



CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY

(in thousands)



|                                                                           |  |        |  |             |     |                          |   |                  |  |   |                      |   |  |                                            |     |   |             |   |     |   |  |   |         |  
|-------------------------------------------------------------------------- |  | ------ |  | ----------- | --- | ------------------------ | - | ---------------- |  | - | -------------------- | - |  | ------------------------------------------ | --- | - | ----------- | - | --- | - |  | - | ------- | -
|                                                                           |  | Shares |  | CommonStock |     | AdditionalPaid InCapital |   | RetainedEarnings |  |   | UnearnedCompensation |   |  | AccumulatedOtherComprehensiveIncome/(Loss) |     |   | TotalEquity |  
|As of December 31, 2003                                                    |  | 32,139 |  | $           | 321 |                          | $ | 57,011           |  | $ | 9,087                |   |  | $                                          | (99 | ) |             |   |    |   |  | $ | 66,320  |  
|                                                                           |  |        |  |             |     |                          |  
|Net income                                                                 |  |       |  |             |    |                          |   |                 |  |   | 26,163               |   |  |                                            |    |   |             |   |    |   |  |   | 26,163  |  
|Amortization of stock based plan                                           |  |       |  |             |    |                          |   |                 |  |   |                     |   |  |                                            | 85  |   |             |   |    |   |  |   | 85      |  
|Dividend                                                                   |  |       |  |             |    |                          |   |                 |  |   | (11,070              | ) |  |                                            |    |   |             |   |    |   |  |   | (11,070 | )
|Change in net unrealized gain/(loss) on available for sale securities, net |  |       |  |             |    |                          |   |                 |  |   |                     |   |  |                                            |    |   |             |   | (39 | ) |  |   | (39     | )
|                                                                           |  |        |  |             |     |                          |   |                  |  |   |                      |   |  |                                            |     |   |             |   |     |   |  |   |         |  
|As of December 31, 2004                                                    |  | 32,139 |  |             | 321 |                          |   | 57,011           |  |   | 24,180               |   |  |                                            | (14 | ) |             |   | (39 | ) |  |   | 81,459  |  
|                                                                           |  |        |  |             |     |                          |  
|Net income                                                                 |  |       |  |             |    |                          |   |                 |  |   | 25,387               |   |  |                                            |    |   |             |   |    |   |  |   | 25,387  |  
|Amortization of stock based plan                                           |  |       |  |             |    |                          |   | 3,344            |  |   |                     |   |  |                                            | 14  |   |             |   |    |   |  |   | 3,358   |  
|Stock option exercise                                                      |  | 4      |  |             |    |                          |   | 5                |  |   |                     |   |  |                                            |    |   |             |   |    |   |  |   | 5       |  
|Dividend                                                                   |  |       |  |             |    |                          |   |                 |  |   | (11,784              | ) |  |                                            |    |   |             |   |    |   |  |   | (11,784 | )
|Net proceeds from initial public offering                                  |  | 4,602  |  |             | 46  |                          |   | 70,627           |  |   |                     |   |  |                                            |    |   |             |   |    |   |  |   | 70,673  |  
|Change in net unrealized gain/(loss) on available for sale securities, net |  |       |  |             |    |                          |   |                 |  |   |                     |   |  |                                            |    |   |             |   | (26 | ) |  |   | (26     | )
|                                                                           |  |        |  |             |     |                          |   |                  |  |   |                      |   |  |                                            |     |   |             |   |     |   |  |   |         |  
|As of September 30, 2005 (Unaudited)                                       |  | 36,745 |  | $           | 367 |                          | $ | 130,987          |  | $ | 37,783               |   |  |                                            |    |   |             | $ | (65 | ) |  | $ | 169,072 |  
|                                                                           |  |        |  |             |     |                          |   |                  |  |   |                      |   |  |                                            |     |   |             |   |     |   |  |   |         |  



The accompanying notes
are an integral part of these financial statements.



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INTERNATIONAL SECURITIES EXCHANGE, INC.



CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)



|                                                                                        |  |                                |         |   |      |   |         |  
|--------------------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ---- | - | ------- | -
|                                                                                        |  | Nine Months EndedSeptember 30, |        
|                                                                                        |  | 2005                           |         |   | 2004 |  
|                                                                                        |  | (Unaudited)                    |        
|Cash flows from operating activities:                                                   |  |                                |         |   |      |   |         |  
|Net income                                                                              |  | $                              | 25,387  |   |      | $ | 20,109  |  
|Adjustments to reconcile net income to cash provided by/(used in) operating activities: |  |                                |         |   |      |   |         |  
|Depreciation and amortization                                                           |  |                                | 4,528   |   |      |   | 2,476   |  
|Stock based compensation                                                                |  |                                | 3,358   |   |      |   | 77      |  
|Deferred taxes                                                                          |  |                                | (5,654  | ) |      |   | (4,787  | )
|Unrealized loss on securities owned, net                                                |  |                                | (429    | ) |      |   | (211    | )
|(Increase)/decrease in operating assets:                                                |  |                                |         |   |      |   |         |  
|Accounts receivable, net                                                                |  |                                | 3,424   |   |      |   | 2,647   |  
|Income tax receivable                                                                   |  |                                | 11,332  |   |      |   | (6,071  | )
|Securities owned                                                                        |  |                                | 4,496   |   |      |   | (6,121  | )
|Other assets                                                                            |  |                                | 2,997   |   |      |   | (5,366  | )
|Increase/(decrease) in operating liabilities:                                           |  |                                |         |   |      |   |         |  
|Accounts payable and accrued expenses                                                   |  |                                | 270     |   |      |   | 441     |  
|Compensation and benefits payable                                                       |  |                                | (6,069  | ) |      |   | 2,744   |  
|Income tax payable                                                                      |  |                                | 3,105   |   |      |   |        |  
|Deferred revenue                                                                        |  |                                | 1,265   |   |      |   | 15,194  |  
|Payment for order flow payable                                                          |  |                                | 818     |   |      |   | 848     |  
|Other liabilities                                                                       |  |                                | (551    | ) |      |   | 633     |  
|                                                                                        |  |                                |         |   |      |   |         |  
|Net cash provided by operating activities                                               |  |                                | 48,277  |   |      |   | 22,613  |  
|                                                                                        |  |                                |         |   |      |   |         |  
|Cash flows from investing activities:                                                   |  |                                |         |   |      |   |         |  
|Purchase of fixed assets                                                                |  |                                | (1,888  | ) |      |   | (3,401  | )
|Purchase of available securities                                                        |  |                                |        |   |      |   | (14,946 | )
|Maturities of available for sale securities                                             |  |                                | 4,990   |   |      |   |        |  
|                                                                                        |  |                                |         |   |      |   |         |  
|Net cash provided by/(used in) investing activities                                     |  |                                | 3,102   |   |      |   | (18,347 | )
|                                                                                        |  |                                |         |   |      |   |         |  
|Cash flows from financing activities:                                                   |  |                                |         |   |      |   |         |  
|Dividend                                                                                |  |                                | (11,784 | ) |      |   | (11,070 | )
|Net proceeds from initial public offering                                               |  |                                | 70,673  |   |      |   |        |  
|Proceeds from common stock                                                              |  |                                | 5       |   |      |   |        |  
|                                                                                        |  |                                |         |   |      |   |         |  
|Net cash provided by/(used in) financing activities                                     |  |                                | 58,894  |   |      |   | (11,070 | )
|                                                                                        |  |                                |         |   |      |   |         |  
|Increase in cash and cash equivalents                                                   |  |                                | 110,273 |   |      |   | (6,804  | )
|Cash and cash equivalents, beginning of period                                          |  |                                | 44,847  |   |      |   | 65,687  |  
|                                                                                        |  |                                |         |   |      |   |         |  
|Cash and cash equivalents, end of period                                                |  | $                              | 155,120 |   |      | $ | 58,883  |  
|                                                                                        |  |                                |         |   |      |   |         |  



Non-cash activities:



In February 2005, the Company declared and paid a stock dividend of eight
shares of Class A common stock per share of Class A common stock outstanding.



The accompanying notes are an integral part of these financial statements.



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INTERNATIONAL SECURITIES EXCHANGE, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



(in thousands, except share and per share amounts)



(Information as of September 30, 2005 and for the Nine Months

and Three Months Ended September 30, 2005 and
2004 is unaudited)



1. ORGANIZATION AND DESCRIPTION OF BUSINESS



The International Securities Exchange, Inc. (the
Company or ISE), a Delaware corporation, operates a fully electronic exchange for equity and index options and related services utilizing a market structure which combines the efficiencies of electronic trading with auction
market principles. The Company was founded in September 1997 as a limited liability company. In February 2000, the Company received regulatory approval to become an exchange and in May 2000, the Company formally commenced trading on its exchange.
The Company reorganized into a corporation in April 2002. The Company is regulated by the U.S. Securities and Exchange Commission (SEC). On March 14, 2005, the Company completed its initial public offering.



2. SIGNIFICANT ACCOUNTING POLICIES



Basis of Presentation



The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiary. All transactions and balances between the Company and its subsidiary have been eliminated in consolidation. The Company has one subsidiary, ETC Acquisition Corp., which has remained dormant since April
2002. These financial statements have been prepared pursuant to the rules and regulations of the SEC and, in the opinion of management, reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the
financial position, results of operations and cash flows for the periods presented in conformity with generally accepted accounting principles in the United States of America. Certain footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles in the U.S. have been condensed or omitted pursuant to SEC rules and regulations, although the Company believes that the disclosures are adequate to make the information presented
not misleading. The nature of the Companys business is such that the results of an interim period are not necessarily indicative of the results for the full year. These unaudited financial statements should be read in conjunction with the
Companys audited financial statements and notes thereto included elsewhere herein.



Use of Estimates



The preparation of the Companys consolidated financial statements in conformity with accounting principles generally accepted in the United States of America necessarily requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the balance sheet date and the reported amounts of revenues and expenses for the period presented. Actual results could differ from those estimates.



Revenue Recognition



Transaction fees are earned based on contracts executed on the
Companys exchange and are recorded as transactions occur on a trade date basis. Transaction fees are recorded net of discounts of $6,748 and $4,921 for the three months ended September 30, 2005 and 2004, respectively, and $19,735 and
$15,057 for the nine months ended September 30, 2005 and 2004, respectively. The Company waives or discounts certain trading fees.



Market data revenues are earned from the sale of the Companys buy and sell transaction information and quotes through the Options Price Reporting
Authority (OPRA). The Company earns a portion of OPRAs revenue based on its pro-rata share of industry trade (not contract) volume. Revenue is recorded as transactions occur on a trade date basis.



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INTERNATIONAL SECURITIES EXCHANGE, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



(in thousands, except share and per share amounts)



(Information as of September 30, 2005 and for the Nine
Months

and Three Months Ended September 30, 2005 and 2004 is unaudited)



Other member fees are comprised of revenues earned for connectivity and access to the Companys
exchange; revenue from the sale of Class B-2 memberships; fees for use of the Companys communication network, equipment and trading software; and regulatory and administrative fees. Connectivity and access fees and communications, equipment
and trading software fees are charged and recognized on a monthly basis based upon a specific fixed fee for each service. Revenue from the sale of Class B memberships is deferred and recognized on a straight-line basis over 14 years. Administrative
fees are charged and recognized as incurred. Regulatory fees are charged on an annual basis and recognized over a twelve-month period.



Deferred Revenue



The Company has sold 46 Class B-2 memberships as of September 30, 2005. The Class B-2 memberships were sold pursuant to a purchase agreement for $1.5
million each. Certain Class B-2 memberships were paid in full on the purchase date, while others are payable in annual installments; however, the agreement grants immediate membership upon execution of the agreement. The Company currently recognizes
revenue from the sale over 14 years, the estimated useful life, on a straight-line basis. The estimated useful life was determined based upon an analysis of certain factors driving the securities industry that could have an effect on the
Companys operations in providing services to its members. Such factors included significant historical operating, regulatory and technology changes which have affected market participants and trading venues. Based upon the analysis, the
Company estimated a life of 14 years; however, this period may be subject to change in the future.



On a periodic basis, or if certain circumstances come to its attention, the Company reviews the original factors or assumptions used in determining the
estimated service period to ascertain the effect, if any, current events may have on those factors and assumptions. If the current facts warrant a change in the estimated service period, the Company will adjust the remaining revenue to be recognized
in accordance with the new estimated service life using the prospective method. The service period may increase or decrease from the current estimate of 14 years based upon the facts and circumstances.



Cash Equivalents



The Company considers all highly liquid investments with a maturity of less
than 90 days from the statement of financial condition date to be classified as cash equivalents.



|                                            |  |                   |         |                  |   |       
|------------------------------------------- |  | ----------------- | ------- | ---------------- | - | ------
|                                            |  | September 30,2005 |         | December 31,2004
|Company funds                               |  | $                 | 149,880 |                  | $ | 38,776
|Reserved for payment for order flow program |  |                   | 5,240   |                  |   | 6,071 
|                                            |  |                   |         |                  |   |       
|Total                                       |  | $                 | 155,120 |                  | $ | 44,847
|                                            |  |                   |         |                  |   |       



Securities Owned



The Company has, through a Rabbi Trust, investments
in various mutual funds in connection with the Companys previous long-term deferred compensation plan. Investments are carried at market value with realized and unrealized gains or losses reported in other revenue on the Consolidated
Statements of Income. The Company has since replaced this plan with a stock-based plan (Note 8).



8



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##### Table of Contents

INTERNATIONAL SECURITIES EXCHANGE, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



(in thousands, except share and per share amounts)



(Information as of September 30, 2005 and for the Nine
Months

and Three Months Ended September 30, 2005 and 2004 is unaudited)



The Company also invests cash in excess of short-term operating needs in U.S. treasury securities
with maturities ranging from three to 24 months which it classifies as available for sale. Unrealized gains and losses are included in accumulated other comprehensive income on the statement of changes in stockholders equity until realized. On
a periodic basis, the Company reviews its portfolio for impairment. If a decline in fair value is deemed to be other than temporary, the security is written down to its fair value through earnings. Securities owned consist of the following:



|              |  |                   |        |                  |   |       
|------------- |  | ----------------- | ------ | ---------------- | - | ------
|              |  | September 30,2005 |        | December 31,2004
|U.S. treasury |  | $                 | 9,865  |                  | $ | 14,892
|Mutual funds  |  |                   | 8,230  |                  |   | 12,287
|              |  |                   |        |                  |   |       
|Total         |  | $                 | 18,095 |                  | $ | 27,179
|              |  |                   |        |                  |   |       



Income Taxes



The Company files a consolidated tax return for
federal, state and local income tax purposes. In addition, the Company records deferred tax assets and liabilities for differences between the financial statement and income tax basis of assets and liabilities, using currently enacted tax rates.
Deferred tax benefits and expenses are recognized for changes in deferred tax assets and liabilities.



Payment for Order Flow



The Company imposes fees upon its Primary Market Makers (PMMs) and Competitive Market Makers (CMMs) to fund payment for order flow
to Electronic Access Members (EAMs) under a program administered by the Company. These fees are distributed to certain EAMs as an economic inducement for EAMs to route their customer orders to the Companys exchange. The PMMs have
full discretion regarding the payment. Pursuant to Emerging Issues Task Force (EITF) Issue No. 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent, the Company reflects the assessments and payments on a
net basis, with no impact on revenues or expenses. When fees are assessed, the Company records an asset (Accounts Receivable) with a corresponding liability (Payment for Order Flow Payable).



Payment for order flow cash is reflected in cash and cash equivalents on the
Companys Consolidated Statements of Financial Condition. These funds are not legally restricted and can be used for general corporate purposes.



Stock-Based Compensation



Effective January 1, 2005 and in connection with its initial public offering, the Company began to account for stock-based employee compensation in
accordance with SFAS No. 123(R), Share-Based Payment, using the modified prospective adoption method. Under this method of adoption, compensation expense is recognized over the relevant service period based on the fair value of
stock options and restricted stock awards granted on or after January 1, 2005 and future years. In addition, compensation cost is recognized in 2005 for awards granted prior to the adoption date for which the requisite service period has not
been rendered. No unearned compensation is included in stockholders equity for such stock options and restricted stock awards granted. Rather, such stock options and restricted stock units are included in stockholders equity under SFAS
No. 123(R) when services required from employees in exchange for the awards are rendered and expensed.



9



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##### Table of Contents

INTERNATIONAL SECURITIES EXCHANGE, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



(in thousands, except share and per share amounts)



(Information as of September 30, 2005 and for the Nine
Months

and Three Months Ended September 30, 2005 and 2004 is unaudited)



Compensation expense resulting from stock options granted prior to the adoption of SFAS
No. 123(R) were accounted for under the intrinsic-value-based method prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees, as permitted by SFAS No. 123, and accordingly, compensation expense was
measured as the excess of the estimated fair value per share of the Company at the date of grant over the options exercise price and is recognized over the vesting period.



As a result of adopting SFAS No. 123(R), the Companys income before income taxes and net income for the three
months ended September 30, 2005 were $286 and $157 lower, respectively, and for the nine months ended September 30, 2005 were $630 and $346 lower, respectively, than if it had continued to account for share-based compensation under APB
Opinion No. 25.



Had the Company determined compensation
cost based on the estimated fair value at the grant dates for its stock options granted prior to adoption of SFAS No. 123(R), the Companys net income would have been as follows:



|                                                                                                                                |  |                                      |       |   |                                     |   |        |  
|------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------ | ----- | - | ----------------------------------- | - | ------ | -
|                                                                                                                                |  | Three Months EndedSeptember 30, 2004 |       |   | Nine Months EndedSeptember 30, 2004 |  
|Net income, as reported                                                                                                         |  | $                                    | 5,750 |   |                                     | $ | 20,109 |  
|Add: Stock based employee compensation expense, net of related tax benefits, included in reported net income                    |  |                                      | 9     |   |                                     |   | 40     |  
|Deduct: Stock based employee compensation, net of related tax effects, determined under fair value based methods for all
awards |  |                                      | (11   | ) |                                     |   | (52    | )
|                                                                                                                                |  |                                      |       |   |                                     |   |        |  
|Proforma net income                                                                                                             |  | $                                    | 5,748 |   |                                     | $ | 20,097 |  
|                                                                                                                                |  |                                      |       |   |                                     |   |        |  
|As reported:                                                                                                                    |  |                                      |       |   |                                     |   |        |  
|Earnings per sharebasic                                                                                                        |  | $                                    | 0.18  |   |                                     | $ | 0.63   |  
|Earnings per sharediluted                                                                                                      |  | $                                    | 0.17  |   |                                     | $ | 0.59   |  
|Proforma:                                                                                                                       |  |                                      |       |   |                                     |   |        |  
|Earnings per sharebasic                                                                                                        |  | $                                    | 0.18  |   |                                     | $ | 0.63   |  
|Earnings per sharediluted                                                                                                      |  | $                                    | 0.17  |   |                                     | $ | 0.59   |  



Fixed Assets



Fixed assets consist of software licenses, computer
hardware, furniture and fixtures, equipment and leasehold improvements. Capitalized fixed assets are depreciated utilizing the straight-line method over the estimated useful lives as follows:



|                                  |  |             
|--------------------------------- |  | ------------
|Trading related software licenses |  | 5 to 7 years
|Other software licenses           |  | 3 to 5 years
|Hardware and equipment            |  | 3 to 5 years
|Furniture and fixtures            |  | 7 years     



Leasehold improvements
are amortized on a straight-line basis over the lesser of the lease term or its estimated useful life.



10



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##### Table of Contents

INTERNATIONAL SECURITIES EXCHANGE, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



(in thousands, except share and per share amounts)



(Information as of September 30, 2005 and for the Nine
Months

and Three Months Ended September 30, 2005 and 2004 is unaudited)



Software Costs



Costs for internal software are assessed to determine whether they should be capitalized or expensed in accordance with
American Institute of Certified Public Accountants Statement of Position (SOP) 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, and other related guidance. Software development
costs incurred during the preliminary project stage are expensed as incurred, while costs incurred during the application development stage are capitalized and amortization is computed using the straight-line method over the softwares
estimated useful life, generally three to seven years, depending on the type of software. Amortization of these capitalized costs begins only when the software becomes ready for its intended use. Capitalization of costs ceases when the post
implementation/operation stage of the software development process is reached.



The Company capitalized $1,152 and $27,512 for software licenses and software developed for internal use during the nine months ended September 30, 2005 and the year ended December 31, 2004, respectively.



Marketing and Promotional Fees



Advertising costs, including media advertising and production costs, are
expensed when incurred.



Intellectual Property



All costs related to internally developed patents are
expensed as incurred.



Impairment of Long-Lived Assets



On a periodic basis, the Company performs a review
for the impairment of long-lived assets when events or changes in circumstances indicate that the estimated undiscounted future cash flows expected to be generated by the assets are less than their carrying amounts or when other events occur which
may indicate that the carrying amount of an asset may not be recoverable.



Fair Value of Financial Instruments



SFAS No. 107, Disclosure about Fair Value of Financial Instruments, requires the disclosure of the fair value of financial instruments, including assets and liabilities recognized on the Consolidated
Statements of Financial Condition. Management estimates that the aggregate net fair value of all financial instruments recognized on the Consolidated Statements of Financial Condition approximates their carrying value, as such financial instruments
are short term in nature and bear interest at current market rates.



3.
INITIAL PUBLIC OFFERING



On March 14, 2005 the
Company completed its initial public offering in which it sold 4,602,115 shares of Class A common stock at $18.00 per share. Proceeds to the Company, less commissions and other direct selling expenses, were $70,673.



11



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##### Table of Contents

INTERNATIONAL SECURITIES EXCHANGE, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



(in thousands, except share and per share amounts)



(Information as of September 30, 2005 and for the Nine
Months

and Three Months Ended September 30, 2005 and 2004 is unaudited)



4. COMMITMENTS AND CONTINGENCIES



Litigation



From time to time, the Company is involved in various routine reviews, regulatory audits and inspections by the SEC as well as legal proceedings arising
in the ordinary course of business. While any litigation contains an element of uncertainty, it is the opinion of management, after consultation with counsel, that the outcomes of such proceedings or claims are unlikely to have a material adverse
effect on the business, financial condition or operating results of the Company.



Contractual Obligations



The Company has entered into obligations under operating leases with initial non-cancelable terms in excess of one year for office space and computer equipment. Expenses recorded under these agreements for the three months ended
September 30, 2005 and 2004 were $1,732 and $1,316, respectively, and for the nine months ended September 30, 2005 and 2004 were $4,766 and $3,165, respectively. The Company also has entered into a contractual agreement for technology
enhancements and support with OMX (US) Inc. and its affiliates (collectively OMX). Expenses related to OMX were $1,988 and $1,582 for the three months ended September 30, 2005 and 2004, respectively, and $5,842 and $5,572 for the
nine months ended September 30, 2005 and 2004, respectively. In addition, the Company has entered into contractual agreements with certain index providers for the rights to list index products. At September 30, 2005, future minimum
payments for commitments are as follows:



|                                      |  |                     |  |       |  |       |  |       
|------------------------------------- |  | ------------------- |  | ----- |  | ----- |  | ------
|                                      |  | Operating    Leases |  | OMX   |  | Other |  | Total 
|Three months ending December 31, 2005 |  | 1,676               |  | 650   |  | 250   |  | 2,576 
|Year ending December 31, 2006         |  | 5,984               |  | 3,492 |  | 1,000 |  | 10,476
|Year ending December 31, 2007         |  | 3,864               |  | 3,517 |  | 500   |  | 7,881 
|Year ending December 31, 2008         |  | 2,025               |  | 3,102 |  | 900   |  | 6,027 
|Year ending December 31, 2009         |  | 1,353               |  | 2,587 |  |      |  | 3,940 
|Thereafter                            |  | 7,522               |  | 2,587 |  |      |  | 10,019



Letter of Credit



In the normal course of business, the Company
collateralizes certain leases through standby letters of credit. As of September 30, 2005 and December 31, 2004, the Company provided letters of credit totaling $421 and $646, respectively, collateralized by certificates of deposit at a
financial institution which are included in other assets.



Line of Credit



As of
September 30, 2005 and December 31, 2004, the Company had access to a $10,000 uncommitted credit line from a commercial banking institution to be used to meet the Companys normal short-term capital needs. There were no borrowings
outstanding under this credit line at any of those dates.



12



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##### Table of Contents

INTERNATIONAL SECURITIES EXCHANGE, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



(in thousands, except share and per share amounts)



(Information as of September 30, 2005 and for the Nine
Months

and Three Months Ended September 30, 2005 and 2004 is unaudited)



Guarantees



The Company applies the provisions of the FASB Interpretation No. 45, Guarantors Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, which provides accounting and disclosure requirements for certain guarantees. The Companys trading rules, which Class B members are bound by, limit the
Companys liability for losses suffered while conducting business on the Companys exchange. The Companys trading rules do not extend to the customers of its Class B members. However, contractually the Company agrees to indemnify its
Class B members for losses they suffer in very limited circumstances. The potential for the Company to be required to make payments related to such contractual indemnifications is deemed remote.



5. ACCOUNTS RECEIVABLE



Accounts receivable consists of the following:



|                                |  |                   |        |   |                  |   |        |  
|------------------------------- |  | ----------------- | ------ | - | ---------------- | - | ------ | -
|                                |  | September 30,2005 |        |   | December 31,2004 |  
|Trading related fees            |  | $                 | 16,911 |   |                  | $ | 16,332 |  
|Payment for order flow program  |  |                   | 8,836  |   |                  |   | 7,187  |  
|Class B-2 memberships:          |  |                   |        |   |                  |   |        |  
|Current                         |  |                   | 6,000  |   |                  |   | 6,900  |  
|Non-current                     |  |                   | 600    |   |                  |   | 6,600  |  
|Unamortized discount            |  |                   | (297   | ) |                  |   | (898   | )
|Other                           |  |                   | 774    |   |                  |   | 127    |  
|Allowance for doubtful accounts |  |                   | (35    | ) |                  |   | (35    | )
|                                |  |                   |        |   |                  |   |        |  
|Total                           |  | $                 | 32,789 |   |                  | $ | 36,213 |  
|                                |  |                   |        |   |                  |   |        |  



6. OTHER MEMBER FEES



Other member fees are comprised of the following:



|                                                               |  |                                 |       |                                |   |       |  |      |        |  |   |       
|-------------------------------------------------------------- |  | ------------------------------- | ----- | ------------------------------ | - | ----- |  | ---- | ------ |  | - | ------
|                                                               |  | Three Months EndedSeptember 30, |       | Nine Months EndedSeptember 30,
|                                                               |  | 2005                            |       | 2004                           |   | 2005  |  | 2004
|Connectivity and access fees                                   |  | $                               | 2,937 |                                | $ | 3,030 |  | $    | 8,904  |  | $ | 8,748 
|Communication, equipment and software fees                     |  |                                 | 753   |                                |   | 942   |  |      | 2,322  |  |   | 3,138 
|Regulatory and administrative fees                             |  |                                 | 388   |                                |   | 309   |  |      | 915    |  |   | 1,039 
|Revenue from sale of Class B-2 memberships                     |  |                                 | 1,145 |                                |   | 1,064 |  |      | 3,363  |  |   | 2,925 
|Imputed interest on installment sales of Class B-2 memberships |  |                                 | 122   |                                |   | 239   |  |      | 601    |  |   | 717   
|                                                               |  |                                 |       |                                |   |       |  |      |        |  |   |       
|Total                                                          |  | $                               | 5,345 |                                | $ | 5,584 |  | $    | 16,105 |  | $ | 16,567
|                                                               |  |                                 |       |                                |   |       |  |      |        |  |   |       



7. DIVIDEND



In January 2005, the Company declared and paid a special dividend of $0.37
per share of Class A common stock to stockholders of record as of January 7, 2005, which represented a distribution of $11,784 related to the sale of its Class B-2 memberships.



13



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##### Table of Contents

INTERNATIONAL SECURITIES EXCHANGE, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



(in thousands, except share and per share amounts)



(Information as of September 30, 2005 and for the Nine
Months

and Three Months Ended September 30, 2005 and 2004 is unaudited)



In February 2005, the Company declared and paid a stock dividend of eight shares of Class A
common stock per share of Class A common stock outstanding. The stock dividend was designed to have the effect of a stock split at a ratio of nine shares per share or a 9-1 stock split. Accordingly, all share and per share amounts have been
adjusted to give effect to this event.



8. STOCK-BASED PLANS



Stock Options



The Company has two stock option plansthe 2002 Stock Option Plan,
which was adopted in connection with its reorganization in 2002, and the Omnibus Stock Plan, which was adopted in connection with its initial public offering. Under the plans, options on the Companys common stock are issued for terms of 10
years and generally vest over three years. Options issued in connection with the Companys reorganization were issued with an exercise price significantly less than the estimated fair market value of the Company on the date of grant. Options
issued under the Omnibus Stock Plan were issued with an exercise price equal to the estimated fair market value of the Company on the date of grant. Options expire on dates ranging from May 2012 to May 2015. A summary of the stock option activity as
of September 30, 2005 is as follows:



|                                |  |           |   |  |                                        |       |                                      |     |                    |           |                                                   |   |     
|------------------------------- |  | --------- | - |  | -------------------------------------- | ----- | ------------------------------------ | --- | ------------------ | --------- | ------------------------------------------------- | - | ----
|                                |  | Options   |   |  | WeightedAverageExercisePrice PerOption |       | WeightedAverageRemainingLife (years) |     | OptionsExercisable |           | WeightedAverageExercisePrice PerExercisableOption
|Outstanding, December 31, 2003  |  | 3,661,650 |   |  | $                                      | 1.39  |                                      | 8.4 |                    | 3,607,947 |                                                   | $ | 1.39
|Granted                         |  | 36,000    |   |  |                                        | 12.08 |                                      | 9.3 |                    |          |                                                   |   |    
|Forfeited                       |  |          |   |  |                                        |      |                                      |     |                    |           |                                                   |   |    
|Exercised                       |  |          |   |  |                                        |      |                                      |     |                    |           |                                                   |   |    
|                                |  |           |   |  |                                        |       |                                      |     |                    |           |                                                   |   |     
|Outstanding, December 31, 2004  |  | 3,697,650 |   |  |                                        | 1.49  |                                      | 7.4 |                    | 3,610,944 |                                                   |   | 1.39
|Granted                         |  | 544,884   |   |  |                                        | 18.75 |                                      | 9.5 |                    |          |                                                   |   |    
|Forfeited                       |  |          |   |  |                                        |      |                                      |     |                    |           |                                                   |   |    
|Exercised                       |  | (4,000    | ) |  |                                        | 1.39  |                                      |     |                    |           |                                                   |   | 1.39
|                                |  |           |   |  |                                        |       |                                      |     |                    |           |                                                   |   |     
|Outstanding, September 30, 2005 |  | 4,238,534 |   |  | $                                      | 3.71  |                                      | 7.2 |                    | 3,663,650 |                                                   | $ | 1.42
|                                |  |           |   |  |                                        |       |                                      |     |                    |           |                                                   |   |     



The weighted average
estimated fair value of the options granted during the year ended December 31, 2004 was $0.09 and the nine months ended September 30, 2005 was $5.95 per option. Prior to its initial public offering, the Company used the minimum value method to
value the options. For options granted subsequent to its initial public offering, the Company used a binomial model to value the options. The following assumptions were used:



|      |  |                |   |  |                        |   |  |                |   |  |                         
|----- |  | -------------- | - |  | ---------------------- | - |  | -------------- | - |  | ------------------------
|Grant |  | Dividend Yield |   |  | Expected    Volatility |   |  | Risk-Free Rate |   |  | Expected Life (in years)
|2004  |  | 2.9            | % |  |                       |   |  | 3.02           | % |  | 5                       
|2005  |  | 1.8            | % |  | 31.3                   | % |  | 3.94           | % |  | 5                       



14



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##### Table of Contents

INTERNATIONAL SECURITIES EXCHANGE, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



(in thousands, except share and per share amounts)



(Information as of September 30, 2005 and for the Nine
Months

and Three Months Ended September 30, 2005 and 2004 is unaudited)



Restricted Stock



The Company issued restricted stock awards (RSAs) to employees and certain directors under its Omnibus Stock
Plan primarily in connection with year-end compensation and its initial public offering. All of the restricted stock outstanding as of September 30, 2005 required future service as a condition to the delivery of the underlying shares of common
stock along with certain other requirements outlined in the award agreements. The RSAs vest over a period of two or three years. Information related to these RSAs is set forth below:



|                                |  |                        |  
|------------------------------- |  | ---------------------- | -
|Grant                           |  | Restricted StockAwards |  
|Outstanding, December 31, 2004  |  |                       |  
|Granted                         |  | 662,794                |  
|Forfeited                       |  | (13,211                | )
|Outstanding, September 30, 2005 |  | 649,583                |  



Stock compensation
expenses related to RSAs were $1,201 and $2,722 for the three months and nine months ended September 30, 2005, respectively.



9. EARNINGS PER SHARE (shares in thousands)



Basic earnings per share, or EPS, is computed by dividing net income by the weighted average number of common stock outstanding for the period. Diluted
EPS reflects the potential reduction in earnings per share that could occur if securities or contracts to issue common stock were exercised or converted into common stock. EPS under the basic and diluted computations are as follows:



|                                                                                               |  |                                 |        |                                |   |        |  |      |        |  |   |       
|---------------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | ------------------------------ | - | ------ |  | ---- | ------ |  | - | ------
|                                                                                               |  | Three Months EndedSeptember 30, |        | Nine Months EndedSeptember 30,
|                                                                                               |  | 2005                            |        | 2004                           |   | 2005   |  | 2004
|Basic earnings per share:                                                                      |  |                                 |        |                                |   |        |  |      |        |  |   |       
|Net income                                                                                     |  | $                               | 8,391  |                                | $ | 5,750  |  | $    | 25,387 |  | $ | 20,109
|Weighted average shares outstanding                                                            |  |                                 | 36,742 |                                |   | 32,139 |  |      | 35,527 |  |   | 32,139
|Basic earnings per share                                                                       |  | $                               | 0.23   |                                | $ | 0.18   |  | $    | 0.71   |  | $ | 0.63  
|                                                                                               |  |                                 |        |                               
|Diluted earnings per share:                                                                    |  |                                 |        |                                |   |        |  |      |        |  |   |       
|Net income                                                                                     |  | $                               | 8,391  |                                | $ | 5,750  |  | $    | 25,387 |  | $ | 20,109
|Weighted average shares outstanding                                                            |  |                                 | 36,742 |                                |   | 32,139 |  |      | 35,527 |  |   | 32,139
|Diluted effect of common stock equivalent shares related to stock options and restricted stock |  |                                 | 2,101  |                                |   | 1,781  |  |      | 2,047  |  |   | 1,782 
|                                                                                               |  |                                 |        |                                |   |        |  |      |        |  |   |       
|Weighted average shares outstandingdiluted                                                    |  |                                 | 38,843 |                                |   | 33,920 |  |      | 37,574 |  |   | 33,921
|                                                                                               |  |                                 |        |                                |   |        |  |      |        |  |   |       
|Diluted earnings per share                                                                     |  | $                               | 0.22   |                                | $ | 0.17   |  | $    | 0.68   |  | $ | 0.59  



Diluted EPS
computation does not include the anti-dilutive effect of 548 and 405 options and RSAs for the three months and nine months ended September 30, 2005, respectively.



15



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##### Table of Contents

INTERNATIONAL SECURITIES EXCHANGE, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



(in thousands, except share and per share amounts)



(Information as of September 30, 2005 and for the Nine
Months

and Three Months Ended September 30, 2005 and 2004 is unaudited)



10. COMPREHENSIVE INCOME



Comprehensive income includes net income and changes in stockholders equity except those resulting from investments
by, or distributions to, stockholders. Comprehensive income is as follows:



|                                                             |  |                                 |       |   |                                |   |       |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------ |  | ------------------------------- | ----- | - | ------------------------------ | - | ----- | ---- |  | - | ------ | - |  | - | ------ | -
|                                                             |  | Three Months EndedSeptember 30, |       |   | Nine Months EndedSeptember 30, |  
|                                                             |  | 2005                            |       |   | 2004                           |   |       | 2005 |  |   | 2004   |  
|Net income                                                   |  | $                               | 8,391 |   |                                | $ | 5,750 |      |  | $ | 25,387 |   |  | $ | 20,109 |  
|Change in other comprehensive income:                        |  |                                 |       |   |                                |   |       |      |  |   |        |   |  |   |        |  
|Unrealized loss on available for sale securities, net of tax |  |                                 | (3    | ) |                                |   | (7    | )    |  |   | (26    | ) |  |   | (7     | )
|                                                             |  |                                 |       |   |                                |   |       |      |  |   |        |   |  |   |        |  
|Total comprehensive income                                   |  | $                               | 8,388 |   |                                | $ | 5,743 |      |  | $ | 25,361 |   |  | $ | 20,102 |  
|                                                             |  |                                 |       |   |                                |   |       |      |  |   |        |   |  |   |        |  



11. SEGMENT, GEOGRAPHIC AND
CUSTOMER INFORMATION



The Company operates as one business
segment, as an electronic exchange for equity and index options and related services. Revenues are derived in the U.S. and all of the Companys assets are located in the U.S. The Company considers significant customers to be those who account
for more than 10% of the Companys transaction fee revenue. The following is customer concentration information:



|                                      |  |                                 |   |  |                                |   |  |      |   |  |      |  
|------------------------------------- |  | ------------------------------- | - |  | ------------------------------ | - |  | ---- | - |  | ---- | -
|                                      |  | Three Months EndedSeptember 30, |   |  | Nine Months EndedSeptember 30, |  
|                                      |  | 2005                            |   |  | 2004                           |   |  | 2005 |   |  | 2004 |  
|Members                               |  | 2                               |   |  | 1                              |   |  | 2    |   |  | 1    |  
|Approximate percent of total revenues |  | 22                              | % |  | 11                             | % |  | 21   | % |  | 11   | %



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##### Table of Contents

Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations



You should read the following discussions together with the consolidated financial statements and related notes. Except for the historical information
and discussions contained herein, statements contained in this Form 10-Q may constitute forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. You can identify these statements by the fact
that they do not relate strictly to historic or current facts. They use words such as anticipate, estimate, expect, project, intend, plan, believe, will,
and other words and terms of similar meaning in connection with any discussion of future operating or financial performance. These statements involve a number of risks, uncertainties and other factors that could cause actual results to differ
materially, including market and general economic conditions in the U.S. and elsewhere in the world, growth of our market share, our ability to keep up with rapid technological change, our business strategy, our offering of new products including
index options and market data products, consolidation in our member base and within our industry and legislative and regulatory changes relating to our business and operations or activities, and other risks, uncertainties and factors discussed
elsewhere in this Form 10-Q, in the Companys other filings with the SEC or in materials incorporated therein by reference.



Overview



We are a fully electronic securities exchange. Our exchange provides a trading platform in listed equity and index options and related services that are
designed to improve the market for options and the speed and quality of trade execution for our members.



On March 14, 2005, we completed our initial public offering, in which we sold 4,602,115 shares and certain of our stockholders sold 6,954,590 shares of
our Class A common stock at $18.00 per share. The proceeds to us, less commissions and other direct selling expenses, were $70.7 million.



Business Environment



The options industry continues to operate in an increasingly competitive environment. Our business is impacted by macroeconomic factors impacting the U.S.
economy as well as factors specific to the securities industry.



The pace of economic growth in the U.S. continues and the U.S. Federal Reserve continued to raise its federal funds rate target. For the first nine months of 2005, the equities markets have been relatively flatthe NASDAQ
Composite Index decreased 1.1%; the Dow Jones Industrial Average decreased 2.0%; and the S&P 500 Index increased 1.4%. Average daily volume for New York Stock Exchange-, or NYSE-listed and Nasdaq-quoted stocks increased 4.5% in the first nine
months of 2005 compared to the comparable period in 2004.



In
the options industry, average daily equity and index options volume increased 23.8% to 5.6 million for the first nine months of 2005 from 4.5 million in the comparable period in 2004. Average daily volume for equity options increased 22.8%
and average daily volume for index options increased 34.3% over this period. Our average daily equity options volume increased 21.3% from 1.4 million to 1.7 million over the same period; however, our market share decreased to 32.7% from
33.1%. Our average daily index volume was 16,000 in the first nine months of 2005. We began to actively market our index trading initiative in 2005. Prior to 2005, our trading volumes in index options were negligible.



Our operating results for the first nine months of 2005 reflected strong
trading levels. We continue to see this favorable trend into the fourth quarter. On October 25, 2005, The Options Clearing Corporation, or OCC, announced that the total number of equity and index options traded for the year reached
1,184,267,123 contracts, passing the annual volume record of 1,182,040,096 contracts in 2004, an increase of 26.3% for the comparable period in 2004. On November 1, 2005, we announced our average daily volume in equity and index options for
October 2005 was a record 2.3 million.





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##### Table of Contents

Our Trading Volumes and Market Share



Our average daily volume, or ADV, of equity options has grown significantly.
However, we have experienced seasonal fluctuations in our volumes on a quarterly basis. While our trading volumes have generally been increasing, over the same time period our market share has been decreasing. The following chart depicts our average
daily volume of equity options and our market share since 2004 on a quarterly basis:





LOGO



|                                           |  |       |   |  |       |   |  |       |   |  |       |   |  |       |   |  |       |   |  |       |  
|------------------------------------------ |  | ----- | - |  | ----- | - |  | ----- | - |  | ----- | - |  | ----- | - |  | ----- | - |  | ----- | -
|                                           |  | Q1-04 |   |  | Q2-04 |   |  | Q3-04 |   |  | Q4-04 |   |  | Q1-05 |   |  | Q2-05 |   |  | Q3-05 |  
|Industry equity options ADV (in thousands) |  | 4,697 |   |  | 4,062 |   |  | 3,747 |   |  | 4,699 |   |  | 5,223 |   |  | 4,923 |   |  | 5,203 |  
|Our equity options ADV (in thousands)      |  | 1,485 |   |  | 1,360 |   |  | 1,290 |   |  | 1,590 |   |  | 1,727 |   |  | 1,598 |   |  | 1,694 |  
|Our equity options market share            |  | 31.6  | % |  | 33.5  | % |  | 34.4  | % |  | 33.8  | % |  | 33.1  | % |  | 32.5  | % |  | 32.6  | %



While we do monitor
our market share, we do not believe it is the primary indicator of the health of our business relative to absolute volume growth, which is what drives our revenues. Our market share can be negatively impacted by the execution of large crossing
transactions on the floor-based exchanges, which attract trades through fee caps and market structures that allow greater control of executions in a non-anonymous environment. We believe profitable market share growth comes through the introduction
of innovative functionality and new products. We continue to believe our strategy will support this growth.



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##### Table of Contents

Our Index Initiative



We have expanded our offerings and beginning in 2003, we implemented the technological and regulatory foundation to trade
index options. In 2005, we began to actively market our index trading initiative which includes both proprietary and licensed indexes. Prior to 2005, our volume in index options trading was minimal. We currently have listed options on 19 indexes.
The following chart reflects the growth in our index options volume in 2005:



LOGO



|                                          |  |       |   |  |       |   |  |       |  
|----------------------------------------- |  | ----- | - |  | ----- | - |  | ----- | -
|                                          |  | Q1-05 |   |  | Q2-05 |   |  | Q3-05 |  
|Industry index options ADV (in thousands) |  | 477   |   |  | 516   |   |  | 531   |  
|Our index options ADV (in thousands)      |  | 5     |   |  | 18    |   |  | 23    |  
|Our index options market share            |  | 1.1   | % |  | 3.6   | % |  | 4.2   | %



The following are the key index
options that have been approved or listed:



| |  |  | In August 2003, we obtained licenses to list options on four indexes associated with NYSE: NYSE US 100 Index®, NYSE International 100 Index®, NYSE World Leaders Index® and NYSE TMT Index®, and our members expect to begin trading some of these indexes in 2006, based on market conditions.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In November 2004, we obtained licenses to list options on Mini FTSE 100®, Micro FTSE 100®, Mini FTSE 250® and Micro FTSE 250®
and are awaiting SEC approval to enable our members to trade these products.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In February 2005, we listed options on NASDAQ-100® and Mini NASDAQ-100® and our members began trading options on these indexes.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------



| |  |  | In May 2005, we listed options on Russell 1000® Index, Russell 2000® Index and Mini-Russell 2000® Index. Previously, options on the Russell family of indexes were exclusively listed on Chicago Board Options Exchange, or CBOE.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The following is a list of key proprietary index
options we have listed:



| |  |  | In June 2005, we launched options on five proprietary sector indexes: ISE Gold, ISE Semiconductor, ISE Homeland Security, ISE Oil and Gas and ISE
Homebuilders.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In July 2005, we expanded our sector index offering with the launch of ISE SINdex Index, ISE Bio-Pharmaceuticals Index and ISE U.S. Regional Banks Index.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In July 2005, we launched our first broad based proprietary indexes including ISE 50 Index, ISE 100® Index and ISE 250 Index.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------



We have begun charging for non-broker-dealer customer orders in index options, which we currently generally do not do for
equity options. To date, revenues generated from index options have not been material and we do not expect such revenues to be material in the near future.



Offering a Market Data Product Suite



Our operations generate significant volumes of raw market data. As do all of our competitors, we currently distribute this market data in return for a
trade-based fee to OPRA, which consolidates it with data OPRA receives from other options exchanges and redistributes it to vendors and customers.



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We believe that we can leverage our market data that we generate more profitably by analyzing, packaging and marketing it to market makers, broker-dealers,
investors and institutions in new and different ways. For example, in 2003, we devised ISEE®, an index based on purchases of long calls and long puts that is designed to show how investors view stock prices. By collating the buying decisions of options investors, ISEE® may enable investors to gain a better understanding of
marketplace trends, which can help refine investment decisions. In October 2005, we announced that we intend to offer an enhanced version of ISEE® in the first half of 2006 which would allow subscribers to identify bullish and bearish investor sentiment for any issue traded on ISE, including ISE
proprietary and licensed indexes and customized sectors. The enhanced sentiment offering will be available on-line to investors on a subscription basis, as well as through a broker marketing alliance program. We also announced we would provide, on a
subscription basis, access to depth of market data to provide transparency for investors beyond the best bid and offer by offering a consolidated view of tradable prices and liquidity. We intend to roll out a more enhanced and robust market data
suite in 2006.



Other Initiatives



We continue to explore opportunities in other asset classes where we believe
we could add value. As part of this effort, we are becoming a participant in the Consolidated Tape Association and Consolidated Quotation Plans, or CTA/CQ Plans, and the Over-the-Counter/Unlisted Trading Privileges Plan, or OTC/UTP Plan. The CTA/CQ
Plans cover quotation and last sale information for stocks listed on NYSE and American Stock and Options Exchange, or AMEX. The OTC/UTP Plan covers quotation and last sale information for Nasdaq stocks. We believe opportunities exist for us to add
value and expand our offering by creating an exchange facility to electronically trade equity securities which capitalizes on the changes occurring in the equities market trading patterns and equity market structure. In addition, this would allow us
to compete with other U.S. options exchanges that also have the ability to trade equities as well as compete against other larger trading venues.



Preferencing



We and two other exchanges have introduced new functionality referred to as preferencing, which would permit order-entry firms (the equivalent
of our EAMs) to direct their order flow to certain market makers. A market maker that is quoting at the best available ask price or the best available bid price on any market that is so preferenced would receive an enhanced allocation in the trade
resulting from such order. We introduced this functionality in a competitive response to rule filings of a number of competing options exchanges, despite the fact that we have submitted comment letters to the SEC arguing that this form of
preferencing could be harmful to the market.



Preferencing may
reduce the value attributable to our Class B-1 shares (which are held by our PMMs). PMMs are guaranteed to receive a minimum percent of incoming orders that are allocated among other market maker quotes and non-customer orders at the same price as
the PMM. The PMM is also given preference over other market makers and non-customers orders for execution of small orders but only when the PMM is quoting at the best price. These guarantees are overridden if the order is preferenced to another
market maker. Preferencing may also increase the opportunity for some order flow providers to internalize their order flow or encourage payment for order flow arrangements on our exchange or on other options exchanges. We are in the process of
amending our payment for order flow program to accommodate the introduction of preferencing. Under the newly amended proposal, which has been approved by our board and will be filed with the SEC, we propose to establish a separate pool of funds for
each preferenced market maker that participates in the program. That is, when a market maker is preferenced on an order, any payment for order flow fee that is collected in connection with the execution of that order will be placed into the
preferenced market makers pool, with payment administered by the preferenced market maker. If no market maker is preferenced on the order, any payment for order flow fee that is collected in connection with the execution of that order will
continue to be placed into the single pool of funds for that trading bin, with payment administered by the PMM. This amendment to our payment for order flow program is similar to an amendment recently made by Philadelphia Stock Exchange, or PHLX to
its program.



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We do not know whether order flow providers are more or less likely to send orders to us as a result of
the availability of preferencing on us and on other options exchanges. Accordingly, although we believe preferencing could be harmful to the market as a whole, we do not know whether preferencing may benefit us, have no effect or be detrimental to
us.



Litigation



On January 5, 2005, we announced our plans to list options on SPDRs®, an exchange traded fund, or ETF commonly referred to
as Spiders. Subsequent to our announcement, McGraw-Hill, the parent company of Standard & Poors, obtained a temporary restraining order barring us from listing options on SPDRs® without a license. We then entered into a provisional 90-day license agreement with
McGraw-Hill authorizing us to list options on SPDRs® and we, along with the other options exchanges, listed SPDRs® on January 10, 2005. Effective as of January 10, 2005, we became party to a definitive five-year license agreement with McGraw-Hill authorizing us to list options on SPDRs®. In May 2005, we announced our plans to list options on
DIAMONDS®, another ETF. Subsequent to our
announcement, Dow Jones obtained a temporary restraining order barring us from listing options on DIAMONDS® without a license. However, unlike SPDRs®, we did not enter into a license agreement with Dow Jones authorizing us to list options on DIAMONDS® during the litigation. The SDPRs® and DIAMONDS® litigation were consolidated into one matter, by court order. On September 1, 2005, the court issued an opinion and order granting our motion to
dismiss McGraw-Hills complaint and denying Dow Jones motion for a preliminary injunction. On September 1, 2005 we listed options on DIAMONDS®. On September 6, 2005, we entered into a stipulation of dismissal with Dow Jones pursuant to which Dow Jones complaint was also
dismissed in its entirety with prejudice. Dow Jones and McGraw-Hill have each filed an appeal with the U.S. Court of Appeals for the Second Circuit. If, at the conclusion of the litigation, including the exhaustion of all appeals, it is concluded
that no license from McGraw-Hill is required by us in connection with the creation, listing, trading, clearing, marketing and promotion of SPDR® options, McGraw-Hill has agreed to refund to us all license fees paid pursuant to the provisional and definitive licenses, with interest.



After our announcement to list our ISE Gold Index, PHLX sought and
received a temporary restraining order barring us from listing options on our ISE Gold Index based on alleged misappropriation of intellectual property. The court subsequently declined to extend the temporary restraining order, and we are
currently listing options on our ISE Gold Index. The parties have agreed in principle to a settlement, whereby PHLXs claims and ISEs counterclaims would be dismissed. The final terms of the settlement agreement are currently being
negotiated.



We have incurred legal costs of $0.7 million in
2005 related to this litigation and the McGraw-Hill and Dow Jones litigation matters described above. These litigations may continue; however, the revenues we generated from trading these options, collectively, has more than offset the litigation
costs we have incurred.



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Our Reorganization and Offering Costs



We intend to reorganize into a holding company structure to allow us to have greater organizational flexibility, facilitate
our access to the capital markets, promote new business opportunities, facilitate future acquisitions and the formation of strategic alliances and create a framework for future growth. As a registered securities exchange, we are required to submit
all changes to our organizational documents to the SEC for approval and certain changes to the organizational documents are generally deemed necessary to create the holding company structure. As such, we have incurred charges of $0.2 million in the
nine months ended September 30, 2005 and may incur additional reorganization costs in the future as we continue to create the holding company structure.



The holders of all shares of Class A common stock outstanding prior to our initial public offering are parties to a Stockholders Agreement. In accordance
with this agreement, we will bear all expenses incurred in connection with the registration of their shares of Class A common stock, for up to two such registrations per calendar year, other than underwriting discounts and commissions and transfer
taxes whether or not such registration becomes effective, subject to certain specified exceptions. We have incurred $0.3 million of expenses during the first nine months of 2005 related to our secondary offering and expect to incur additional costs
in the future.



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Seasonality



In the securities trading industry, quarterly revenue fluctuations are common and are due primarily to variations in trading volumes. We believe we
experience increased levels of trading activity in the first and fourth quarters, and decreased levels of trading activity in the second and third quarters. To date, these seasonal trends may have been masked by the significant quarter over quarter
growth in our trading volumes and operating results. As a result of this and other factors described elsewhere herein, period-to-period comparisons of our revenues and operating results are not necessarily meaningful, and the results of any quarter
are not necessarily indicative of results of any future period.



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##### Table of Contents

Business Trends and Drivers



Revenues



Transaction Fees



Transaction fees have accounted for, and continue to account for, a majority of our revenues and are primarily driven by contract trading volumes, pricing
changes and the proportion of non-broker-dealer customer volume in the trading mix. As a result of competitive pressures, we generally do not charge our members for executing non-broker-dealer customer orders on our exchange. However, we recently
began charging non-broker-dealer customers for executing orders for certain products which we believe warrant the same pricing as our other members. The products include options on SPDRs®, most other licensed and proprietary index options we offer, and, beginning in August 1, 2005, options on certain other ETFs. We
collectively refer to these as our premium products. Generally, an increase in our non-broker-dealer customer orders reduces our average revenue per side. As a percent of our total sides, non-broker-dealer customer sides have continued
to increase, reaching a high of 41.7% during the three months ended September 30, 2005. We expect our non-broker-dealer customer orders to level off and remain in the 40% range.



The transaction fee varies based upon the overall contract trading volume on our exchange. As our ADV rises above certain
levels, the transaction fee for all of our members is reduced. Therefore, as our volumes have increased, this fee has decreased from $0.22 per side in 2002 to $0.18 in 2004. For the first nine months of 2005, this fee was $0.15; however, beginning
in October 2005, this fee decreased to $0.14.



Based on our
current fee structure, our transaction fee will change when our monthly ADV reaches the following thresholds:



|                           |  |               |     
|-------------------------- |  | ------------- | ----
|Monthly ADV (in
thousands) |  | Execution Fee
|1,045 - 1,343              |  | $             | 0.19
|1,343 - 1,880              |  | $             | 0.18
|1,880 - 3,133              |  | $             | 0.17
|3,133 - 9,400              |  | $             | 0.16
|Greater than 9,400         |  | $             | 0.15



We continually examine
our fee structure in light of competitive changes in the marketplace.



Other Member Fees



Other member fees
are primarily driven by the number of participants that become members of our exchange, the number of users logging onto our trading system and the capacity requirements that are dictated by the number of quotes, or orders submitted to our trading
system as well as the communication method chosen by the member. As of September 30, 2005, we sold 46 Class B-2 memberships, including one during the three months ended September 30, 2005. We anticipate selling the remaining 14 Class B-2
memberships, and may effect such sales at any time. However, we have no present agreements with any entity with respect to the purchase of such Class B-2 memberships and cannot assure any such sales will occur.



Market Data Fees



Market data revenues are primarily driven by the proportional number of
trades executed on our exchange as well as OPRAs profits. We expect our market data revenues to continue to fluctuate based upon trading volumes and OPRAs profitability.



Other Revenues



Other revenue is primarily driven by our available cash balances and changes in the market values of securities owned in our previous long-term deferred
compensation plan. We anticipate higher interest income as we invest the cash raised in our initial public offering.



Expenses



Compensation and Benefits



Employee compensation and benefits expense is primarily driven by changes in our headcount and levels of incentive compensation. In connection with our
initial public offering, we changed our long-term performance-based profit sharing plan to a stock based plan, which will likely result in higher expenses than our previous long-term deferred compensation plan. Additionally,



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we have expensed stock options in accordance with SFAS No. 123(R). We expect to incur stock based compensation costs of approximately $4.8 million in
2005, which includes $0.9 million for options expense and $3.9 million for restricted stock we granted to our employees as part of year end compensation and in connection with our initial public offering to recognize their contributions to our
success. We expect our headcount to continue to increase as we grow our business. We will also incur costs for a success bonus, in the form of cash and/or stock, payable to our executive officers and certain directors if and when we sell our
remaining 14 Class B-2 memberships.



Technology and
Communication



Technology and communication expense is
primarily driven by costs associated with our central trading system and generally fluctuates based upon long-term trends in our business activity. Certain elements of this expense, which we incur in anticipation of certain transaction volume
levels, have both a fixed and variable nature. Once we incur these expenses initially, we may not incur them going forward on a recurring, annual basis. As a result of the importance of our systems to the viability of our business, we continue to
invest heavily in areas such as system capacity and reliability, increased functionality and performance and security. We also must modify our systems from time to time to comply with various regulatory requirements and competitive responses. The
expenses we incur for these modifications may vary substantially from period to period. We anticipate technology and communication expense to fluctuate with increases in volumes and trading system enhancements as well as technology changes in the
industry.



Occupancy



Occupancy expense is primarily driven by our facility needs due to headcount
or system needs as well as back-up facilities. We anticipate higher occupancy costs in the future to support our growth, computer operations and disaster recovery needs.



Professional Fees



Professional fees are generally discretionary in nature; however there are fixed components. As a self-regulatory organization, or SRO, we are required to
regulate our members and as such, we employ the services of the NASD, Inc., or NASD, to perform certain of these functions. We also believe that, as an SRO, we will likely be subject to additional corporate governance, transparency, oversight and
ownership rules proposed by the SEC in November 2004. We are presently evaluating and monitoring developments with respect to the proposed rules and cannot predict or estimate the full extent to which these proposals, if adopted as proposed, may
affect us or our operations or the amount of the additional costs we may incur or the timing of such costs. Furthermore, certain expenses, such as those related to new business initiatives or litigation, may fluctuate from year to year. Also, as a
result of becoming a public company, we have incurred higher legal and audit fees.



Marketing and Business Development



Marketing and business development expense is generally discretionary in nature and is primarily driven by our

public
relations and product promotion campaigns, such as our new index offerings, which we began to actively market and advertise in 2005.



Depreciation and Amortization



Depreciation and amortization expense is primarily driven by purchases of software licenses and leasehold improvements we purchase and capitalize. We
expect to incur additional software amortization expense related to enhancements to our trading system in order to remain competitive. In addition, our leasehold improvements amortization may increase as we review our office space requirements,
computer operations and disaster recovery needs.



Other
Expenses



Other expenses is primarily driven by our
trading volumes in licensed products as we pay a licensing fee for our members to trade options on ETFs and indexes. Licensing fees are offset by surcharges we charge members for trading licensed products, which are included in transaction fee
revenues. We expect other expenses to increase as we increase our trading of licensed products.



Provision for Income Taxes



Provision for income taxes is based on the application of prevailing federal, state and local tax rates. The difference between our effective tax rate and
the statutory tax rate may vary from period to period, but primarily results from state and local taxes and the effect of certain non-deductible expenses. We expect our effective tax rate to range from approximately 44% to 46% in 2005.





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##### Table of Contents

Public Company and SRO Corporate Governance Expenses



As a public company, we are subject to the requirements of the
Sarbanes-Oxley Act of 2002, which requires us to incur significant expenditures to establish systems and hire and train personnel to comply with these requirements. In addition, we have incurred additional costs for external advisors such as legal,
accounting and auditing fees as well as additional marketing and investor relations expenses.



We also believe that, as an SRO, we will likely be subject to additional corporate governance, transparency, oversight and ownership rules proposed by the SEC in November 2004. We are presently evaluating and
monitoring developments with respect to the proposed rules and cannot predict or estimate the full extent to which these proposals, if adopted as proposed, may affect us or our operations or the amount of the additional costs we may incur or the
timing of such costs.



Fixed and Variable Expenses



Our expense structure is predominantly fixed. However, there are some variable components that fluctuate with volumes. In addition, we incur certain costs
in anticipation of certain transaction volume levels. If demand for our services should decline suddenly and we are unable to adjust our fixed cost base on a timely basis, it could have a material adverse effect on our operating results and
financial condition. In addition, we may continue to make significant expenditures related to technological innovations over long periods of time, so that our operating margins and profitability could be adversely affected.



Critical Accounting Policies



Our accounting policy related to our revenue recognition from the sale of
Class B-2 memberships is our most critical accounting policy that requires management to make estimates and judgments that could affect our results.



As of September 30, 2005 we have sold 46 Class B-2 memberships. The Class B-2 memberships were sold pursuant to a purchase agreement for $1.5 million
each. Certain Class B-2 memberships were paid in full on the purchase date, while others are payable in annual installments; however, the agreement grants immediate membership upon execution of the agreement.



The Class B-2 membership rights are transferable and have no contractual
term. We have an implied performance obligation to maintain our marketplace over the life of the membership, and therefore recognize the revenue from the sale of the membership rights over the estimated life of the membership, as the implied
performance obligation is fulfilled. We have estimated the life of the membership at 14 years, and recognize revenue over this period on a straight-line basis.



In order to determine the estimated service life of a membership, we identified three broad factors affecting the securities industry that have a
significant impact on our operations, and therefore, the estimated service life of the Class B-2 memberships  the securities industrys challenging operating environment, regulatory changes and technology innovations. We identified
specific historical events in the options industry and the broader securities industry for each of these factors, assigned an appropriate time horizon for each event, and calculated an average time horizon for each factor. Based on this analysis, we
used the average across all factors, 14 years, as an estimate for the service life of the Class B-2 memberships.



The occurrence of each historical event considered in the analysis has necessitated significant changes in the business models of the securities exchanges
and market participants. Each of the factors identified have had a significant impact on the options industry or broader securities industry, and will have a significant impact on our memberships.



On a periodic basis, or if certain circumstances come to our attention, we
review the original factors or assumptions used in determining the estimated service period to ascertain the effect, if any, current events may have on those factors and assumptions. If the current facts warrant a change in the estimated service
period, we will adjust the remaining revenue to be recognized in accordance with the new estimated service life using the prospective method. The service period may increase or decrease from our current estimate of 14 years based upon the facts and
circumstances, and therefore, these revenues may fluctuate in the future.



We recognized revenue of $3.4 million during the nine months ended September 30, 2005 from the sale of Class B-2 memberships.





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Recently Issued Accounting Pronouncements



None



Key Statistical Information



In evaluating the performance of our business, management closely monitors these key statistics:



|                                                           |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|---------------------------------------------------------- |  | -------------------------------- | ------- | - | ------------------------------- | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                                           |  | Three Months Ended September 30, |         |   | Nine Months Ended September 30, |  
|                                                           |  | 2005                             |         |   | 2004                            |   |         | 2005 |  |   | 2004    |  
|Trading days                                               |  |                                  | 64      |   |                                 |   | 62      |      |  |   | 189     |   |  |   | 188     |  
|                                                           |  |                                  |         |  
|Average daily trading volume: (1) (2)                      |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Equity Options                                             |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Total U.S. industry equity options traded (in thousands)   |  |                                  | 5,203   |   |                                 |   | 3,747   |      |  |   | 5,115   |   |  |   | 4,164   |  
|Our equity options traded (in thousands)                   |  |                                  | 1,694   |   |                                 |   | 1,290   |      |  |   | 1,672   |   |  |   | 1,378   |  
|Our market share of equity options traded                  |  |                                  | 32.6    | % |                                 |   | 34.4    | %    |  |   | 32.7    | % |  |   | 33.1    | %
|Index Options                                              |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Total U.S. industry index options traded (in thousands)    |  |                                  | 531     |   |                                 |   | 367     |      |  |   | 509     |   |  |   | 379     |  
|Our index options traded (in thousands)                    |  |                                  | 23      |   |                                 |   | 1       |      |  |   | 16      |   |  |   |        |  
|Our market share of index options traded                   |  |                                  | 4.3     | % |                                 |   | 0.0     | %    |  |   | 3.1     | % |  |   | 0.0     | %
|                                                           |  |                                  |         |  
|Our member total trading volume (sides, in thousands): (3) |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Customer                                                   |  |                                  | 91,555  |   |                                 |   | 64,787  |      |  |   | 265,093 |   |  |   | 198,211 |  
|Firm proprietary                                           |  |                                  | 22,124  |   |                                 |   | 12,689  |      |  |   | 58,709  |   |  |   | 38,186  |  
|Market maker                                               |  |                                  | 106,095 |   |                                 |   | 87,767  |      |  |   | 314,190 |   |  |   | 281,707 |  
|                                                           |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Total Sides                                                |  |                                  | 219,774 |   |                                 |   | 165,243 |      |  |   | 637,992 |   |  |   | 518,104 |  
|                                                           |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Our market share of total industry trading: (4)            |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Customer                                                   |  |                                  | 30.1    | % |                                 |   | 28.6    | %    |  |   | 30.2    | % |  |   | 36.4    | %
|Firm proprietary                                           |  |                                  | 23.1    | % |                                 |   | 20.2    | %    |  |   | 21.8    | % |  |   | 20.0    | %
|Market maker                                               |  |                                  | 31.8    | % |                                 |   | 36.9    | %    |  |   | 32.1    | % |  |   | 36.8    | %
|                                                           |  |                                  |         |  
|Revenue:                                                   |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Average transaction fee per side (5)                       |  | $                                | 0.11    |   |                                 | $ | 0.11    |      |  | $ | 0.11    |   |  | $ | 0.12    |  
|Average transaction fee per revenue side (6)               |  | $                                | 0.18    |   |                                 | $ | 0.18    |      |  | $ | 0.18    |   |  | $ | 0.18    |  
|                                                           |  |                                  |         |  
|Our trades: (7)                                            |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Average contracts per trade                                |  |                                  | 18.6    |   |                                 |   | 17.9    |      |  |   | 17.6    |   |  |   | 17.7    |  
|Average trades per day (in thousands)                      |  |                                  | 92.4    |   |                                 |   | 72.2    |      |  |   | 95.7    |   |  |   | 77.8    |  
|Total trades (in thousands)                                |  |                                  | 5,913   |   |                                 |   | 4,619   |      |  |   | 18,086  |   |  |   | 14,626  |  
|Our market share of industry trade volume                  |  |                                  | 32.8    | % |                                 |   | 35.2    | %    |  |   | 34.3    | % |  |   | 34.3    | %
|                                                           |  |                                  |         |  
|Our listed issues: (8)                                     |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Average number of issues traded during the period          |  |                                  | 747     |   |                                 |   | 672     |      |  |   | 737     |   |  |   | 643     |  
|                                                           |  |                                  |         |  
|Our members (average number trading during period)         |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|PMMs                                                       |  |                                  | 10      |   |                                 |   | 10      |      |  |   | 10      |   |  |   | 10      |  
|CMMs                                                       |  |                                  | 129     |   |                                 |   | 139     |      |  |   | 135     |   |  |   | 135     |  
|EAMs                                                       |  |                                  | 94      |   |                                 |   | 93      |      |  |   | 95      |   |  |   | 96      |  
|                                                           |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Total                                                      |  |                                  | 233     |   |                                 |   | 242     |      |  |   | 240     |   |  |   | 241     |  
|                                                           |  |                                  |         |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Employees at end of period                                 |  |                                  | 182     |   |                                 |   | 156     |      |  |   | 182     |   |  |   | 156     |  

---

|(1) | Represents single counted contract volume. For example, a transaction of 500 contracts on our exchange is counted as a single 500 contract transaction for purposes of calculating
our volumes, even though we may receive transaction fees from parties on both sides of the transaction, one side of a transaction, or in some cases, neither side of a transaction.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Our market share is calculated based on the number of contracts executed on our exchange as a percentage of total industry contract volume.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Represents each side of a buy or sell transaction. For example, a transaction of 500 contracts on our exchange is counted as two sides of 500 contracts, representing a buy and a
sell transaction. We do not currently receive transaction fees from non-broker-dealer customer sides, except for our premium products.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | Represents our market share of total U.S. industry equity trading for members trading on our exchange based on contract trading volume.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------

|(5) | Average transaction fee per side is calculated by dividing our transaction fees by the total number of sides executed on our exchange. We generally do not charge our members for
executing non-broker-dealer customer orders on our exchange and we reduce or waive fees for members exceeding volume thresholds on certain other products. Comparing our average transaction fee per side to our average transaction fee per revenue side
reflects the negative effect of our fee waivers or reductions on our revenues, on a per side basis. For the three months ended September 30, 2005 and 2004, we have waived and discounted $6,748 and $4,921 of our fees, respectively. For the nine
months ended September 30, 2005 and 2004, we have waived and discounted $19,735 and $15,057 of our fees, respectively.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(6) | Our average transaction fee per revenue side reflects the transaction fee we charge to our market participants per our publicly available pricing schedules. These schedules were
part of rule proposals that became effective upon filing pursuant to Section 19(b)(3)(A) of the Securities Exchange Act of 1934, as amended (the Exchange Act). The SEC may abrogate such rule proposals within 60 days of filing if it
determines that such action is necessary or appropriate in the public interest, for the protection of investors or otherwise in furtherance of the purposes of the Exchange Act.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(7) | Members can have several contracts per trade. Trades represent the number of trades cleared through the OCC. Market data revenue is generated on a per trade basis, not on a contract
basis.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(8) | By issues we mean the number of securities underlying our options. We trade multiple options series on each underlying security.
|--- | ----------------------------------------------------------------------------------------------------------------------------------



We derive our data from our own records and data for the markets in which we
compete from information published by or prepared for the OCC and the OPRA.



27



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##### Table of Contents

Three Months Ended September 30, 2005 versus September 30, 2004



Overview



Net income increased 45.9% to $8.4 million during the three months ended September 30, 2005 from $5.8 million during
the comparable period in 2004, primarily due to increased trading. Our expenses increased 19.5% to $20.8 million during the three months ended September 30, 2005 from $17.4 million during the comparable period in 2004, primarily due to
increased compensation costs and other expenses. We incurred reorganization costs of $0.2 million and $1.0 million during the three months ended September 30, 2005 and 2004, respectively. We also incurred $0.3 million of costs related to our
secondary offering in the three months ended September 30, 2005.



Revenues



Transaction Fees



Transaction fee revenues increased 32.9% to $25.2
million during the three months ended September 30, 2005 from $19.0 million during the comparable period in 2004, primarily due to increased trading volumes on our exchange. This volume growth was due to several factors, including the
following:



| |  |  | Industry ADV for equity options during the three months ended September 30, 2005 increased 38.9% from the comparable period in 2004. Our ADV increased 31.3% over the same
period and our market share decreased to 32.7% from 34.4%. Our ADV in index options was 23,000 for the three months ended September 30, 2005. We began to actively market our index trading initiative in 2005. Prior to that, our trading in index
options was negligible.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The average number of issues available to trade on our exchange increased to 747 during the three months ended September 30, 2005 from 672 during the comparable period in 2004.
Contributing to the increase was our Rapid Allocation Program, where we quickly list new options that have recently increased volume on other exchanges, as well as our launch of index options.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Our average transaction fee per side was $0.115 during the three months ended
September 30, 2005 and comparable period in 2004. The effect of a proportional increase in customer sides was offset by fees we introduced on certain customer options transactions. We currently do not charge any fees for most customer equity
options transactions, except for our premium products. Had we not charged customer sides for trading our premium products, our average transaction fee per side would have been $0.004 less for the three months ended September 30, 2005. Customer
transactions represented 41.7% of all sides executed on our exchange during the three months ended September 30, 2005 compared to 39.2% during the comparable period in 2004. However, overall revenues generated from increased market maker and
firm proprietary sides, on which we do charge transaction fees, more than offset the increase in customer sides and the decrease in average transaction fee per side.



Other Member Fees



Other member fees decreased 4.3% to $5.3 million during the three months ended September 30, 2005 from $5.6 million during the comparable period in
2004. The decrease was primarily driven by lower communication and software fees as well as connectivity and membership fees. Communication fees decreased $0.2 million as we continue to direct our members to obtain and pay for their own
communication lines to our network, which, in turn, reduces some of our costs associated with these lines. Connectivity and membership fees decreased $0.1 million driven by a decrease in the amount of trading sessions our members initiated due to
their own systems efficiencies.



Market Data Fees



Market data revenues decreased 0.2% to $4.4 million
during the three months ended September 30, 2005 from $4.4 million during the comparable period in 2004. The decrease was primarily attributable to a decrease in our market share of industry trading volume, which serves as the primary basis for
allocation of OPRA revenue. Our number of trades increased 28.0% during the timeframe. We accounted for 32.8% of total industry trades during the three months ended September 30, 2005 compared to 35.2% during the comparable period in 2004.



Other Revenues



Other revenues increased to $1.3 million during the three months ended
September 30, 2005 from $0.2 million during the comparable period in 2004. The increase was primarily attributable to $0.7 million of additional interest income on higher average cash balances as well as an increase in unrealized gains on
securities owned of $0.5 million.



Expenses



Compensation and Benefits



Compensation and benefits expense increased
22.7% to $9.3 million during the three months ended September 30, 2005 from $7.6 million during the comparable period in 2004. The increase was primarily due to higher stock based compensation and increased headcount. Our headcount increased to
182 as of September 30, 2005 from 156 as of September 30, 2004 driven by new business initiatives, support for our overall growth and public company requirements. Stock based compensation related to options and restricted stock we granted
in connection with year-end compensation and our initial public offering was $1.5 million for the three months ended September 30, 2005. We adopted SFAS No. 123(R) effective January 1, 2005 as part of our initial public offering, and
accordingly began to expense options, which accounted for $0.2 million of our total stock based compensation for the three months ended September 30, 2005.



Technology and Communication



Technology and communication expense increased 22.0% to $3.6 million during the three months ended September 30, 2005 from $3.0 million during the
comparable period in 2004. Fees paid to OMX increased $0.4 million due to maintenance of our trading system software as well as upgrades to our equipment for capacity purposes. Costs related to our office technology increased $0.1 million primarily
due to a new communication system for our market operations and office facility, as well as an increase in market data expense for our index initiative.



Occupancy



Occupancy expense increased 5.7% to $1.2 million during the three months ended September 30, 2005 from $1.1 million during the comparable period in
2004, primarily due to higher operating costs at our business continuity space.



Professional Fees



Professional fees increased 115.0% to $1.7 million during the three months ended September 30, 2005 from $0.8 million during the comparable period in 2004. The increase was primarily due to higher public company related expenses as
well as increased legal fees associated with ongoing litigation. The litigation arose from our decision to trade options on certain ETFs without seeking a license from the creators of the indexes underlying those ETFs, and a challenge to our right
to trade options on the ISE Gold Index. Also accounting for the increase were fees related to our secondary offering. The holders of all shares of Class A common stock outstanding prior to our initial public offering are parties to a
Stockholders Agreement. In accordance with this agreement, we will bear all expenses incurred in connection with the registration of their shares of Class A common stock, for up to two such registrations per calendar year, other than
underwriting discounts and commissions and transfer taxes whether or not such registration becomes effective, subject to certain specified exceptions. We have incurred $0.3 million of expenses during the first three months of 2005 related to our
secondary offering and expect to incur additional costs in the future.



Marketing and Business Development



Marketing and business development expense increased 20.4% to $1.2 million during the three months ended September 30, 2005 from $1.0 million during the comparable period in 2004. The increase was primarily due to higher media spending
for the launch of our index products.



Depreciation and
Amortization



Depreciation and amortization increased
4.4% to $1.5 million during the three months ended September 30, 2005 from $1.5 million during the comparable period in 2004. The increase was primarily due to leasehold improvements out our business continuity space.



Other Expenses



Other expenses increased 35.3% to $2.1 million during the three months ended
September 30, 2005 from $1.6 million during the comparable period in 2004. Licensing fees we paid for trading options on indexes and index-based ETFs increased $0.4 million in as a result of increased trading in these products. These fees are
offset by surcharges we charge our members for trading these licensed options, which are included in transaction fee revenues. Insurance expense increased $0.2 million as a result of higher coverage subsequent to our initial public offering and
general administrative expenses decreased $0.1 million.



Reorganization



We incurred $0.2
million of reorganization costs during the three months ended September 30, 2005 and $1.0 million in the comparable period on 2004. These expenses consisted primarily of legal, accounting and other professional fees related to our
reorganization into a holding company structure.



Provision for Income Taxes



Our tax
provision increased to $7.1 million during the three months ended September 30, 2005 from $6.0 million during the comparable period in 2004. Our rate in the three months ended September 30, 2005 was 50.9% compared to 45.7% for the
comparable period in 2004. The rate in 2004 was significantly higher than our rate in the comparable period in 2005 due higher non-deductible reorganization expenses. Our rate in this years quarter also reflects a lower tax rate on returns
from our invested cash.



28



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##### Table of Contents

Nine Months Ended September 30, 2005 versus September 30, 2004



Overview



Net income increased 26.2% to $25.4 million during the nine months ended September 30, 2005 from $20.1 million during the
comparable period in 2004, primarily due to increased trading volumes on our exchange. Our expenses increased 16.7% to $59.4 million during the nine months ended September 30, 2005 from $50.9 million during the comparable period in 2004, primarily
due to increased compensation costs, professional fees and other expenses. We incurred reorganization costs of $0.2 million during the nine months ended September 30, 2005 and $1.5 million in the comparable period in 2004.



Revenues



Transaction Fees



Transaction fee revenues increased 21.2% to $73.2 million during the nine months ended September 30, 2005 from $60.4 million
during the comparable period in 2004, primarily due to increased trading volumes on our exchange. This volume growth was due to several factors, including the following:



| |  |  | Industry ADV for equity options during the nine months ended September 30, 2005 increased 22.8% from the comparable period in 2004. Our ADV increased 21.3% over the same period and
our market share decreased to 32.7% from 33.1%. Our ADV in index options was 16,000 for the nine months ended September 30, 2005. We began to actively market our index trading initiative in 2005. Prior to that, our trading in index options was
negligible.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The average number of issues available to trade on our exchange increased to 737 during the nine months ended September 30, 2005 from 643 during the comparable period in 2004.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Our average transaction fee per side decreased
1.6% to $0.115 during the nine months ended September 30, 2005 from $0.117 during the comparable period in 2004. This decrease was primarily due to the proportional increase in our non-broker-dealer customer sides. We currently do not charge any
fees for most non-broker-dealer customer equity options transactions, except for options on our premium products. Had we not charged non-broker-dealer customer sides for trading premium products, our average transaction fee per side would have been
$0.002 less for the nine months ended September 30, 2005. Non-broker-dealer customer transactions represented 41.6% of all sides executed on our exchange during the nine months ended September 30, 2005 compared to 38.3% during the comparable period
in 2004. However, overall revenues generated from increased market maker and firm proprietary sides, on which we do charge transaction fees, more than offset the increase in non-broker-dealer customer sides and the decrease in average transaction
fee per side.



Other Member Fees



Other member fees decreased 2.8% to $16.1 million during
the nine months ended September 30, 2005 from $16.6 million during the comparable period in 2004. The decrease was primarily driven by lower communication and software fees as well as lower regulatory and administrative fees. Software fees decreased
$0.5 million as reimbursement from our marketing fund ended in July 2004. Communication fees decreased $0.3 million as we continue to direct our members to obtain and pay for their own communication lines to our network, which, in turn, reduces some
of our costs associated with these lines. Regulatory and administrative fees decreased $0.1 million due to lower fines and inactivity fees assessed to members. Partly offsetting these decreases was an increase in revenue recognized from the sale of
Class B-2 memberships of $0.3 million and a corresponding increase in membership fees of $0.2 million.



Market Data Fees



Market data revenues increased 9.3% to $13.8 million during the nine months ended September 30, 2005 from $12.6 million during the comparable period in
2004. The increase was primarily attributable to increased profit by OPRA during the period. Our number of trades increased 23.7% during the timeframe. We accounted for 34.3% of total industry trades during the nine months ended September 30, 2005
and the comparable period in 2004.



29



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##### Table of Contents

Other Revenues



Other revenues increased to $2.7 million during the nine months ended September 30, 2005 from $1.0 million during the
comparable period in 2004. The increase was primarily attributable to $1.5 million of additional interest income on higher average cash balances as well as an increase in unrealized gains on securities owned of $0.2 million.



Expenses



Compensation and Benefits



Compensation and benefits expense increased 19.8% to $27.4 million during the nine months ended September 30, 2005 from
$22.9 million during the comparable period in 2004. The increase was primarily due to increased headcount and higher stock-based compensation. Our headcount increased to 182 as of September 30, 2005 from 156 as of September 30, 2004 driven by new
business initiatives, other support for our overall growth, and public company requirements. Also included in compensation and benefits is $3.4 million of stock-based compensation related to options and restricted stock we granted in connection with
year-end compensation and our initial public offering. We adopted SFAS No. 123(R) effective January 1, 2005 as part of our initial public offering, and accordingly began to expense options, which accounted for $0.6 million of our total stock based
compensation for the nine months ended September 30, 2005.



Technology and Communication



Technology and communication expense decreased 13.0% to $10.2 million during the nine months ended September 30, 2005 from $11.8 million during the comparable period in 2004. Fees paid to OMX decreased $2.0 million due to lower licensing
fees as we signed a new agreement in September 2004 changing this fee from usage based to a capitalized software license fee which we amortize through depreciation and amortization. Costs related to our trading system increased $0.2 million
primarily due to higher maintenance and enhancement costs for those systems. Costs related to our office technology increased $0.2 million primarily due to a new communication system for our market operations and office facility, as well as an
increase in market data expense for our index initiative.



Occupancy



Occupancy
expense increased 14.4% to $3.3 million during the nine months ended September 30, 2005 from $2.9 million during the comparable period in 2004, primarily due to additional space leased for business continuity purposes.



Professional Fees



Professional fees increased 88.2% to $4.5 million during the nine months
ended September 30, 2005 from $2.4 million during the comparable period in 2004. The increase was primarily due to higher public company related expenses as well as increased legal fees associated with ongoing litigation and the secondary offering.
The litigation arose from our decision to list options on certain ETFs without seeking a license from the creators of the indexes underlying those ETFs, and a challenge to our right to list options on ISE Gold Index.



Marketing and Business Development



Marketing and business development expense increased 11.0% to $2.8 million
during the nine months ended September 30, 2005 from $2.6 million during the comparable period in 2004. The increase was primarily due to higher media spending for the launch of our index trading initiative.



30



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##### Table of Contents

Depreciation and Amortization



Depreciation and amortization increased to $4.5 million during the nine
months ended September 30, 2005 from $2.5 million during the comparable period in 2004. Amortization of our trading system licenses increased $2.2 million due to the purchase of expanded trading licenses from OMX in September 2003 and the
renegotiation of our agreements with OMX in September 2004 referred to above.



Other Expensees



Other expenses increased 45.8% to $6.3 million during the nine months ended September 30, 2005 from $4.3 million during the comparable period in 2004. Licensing fees we paid for listing options on indexes and
index-based ETFs increased $1.2 million as a result of increased trading in these products. These fees are offset by surcharges we charge our members for trading these licensed options, which are included in transaction fee revenues. Insurance
expense increased $0.4 million as a result of higher coverage subsequent to our initial public offering and general administrative expenses increased $0.4 million in conjunction with our overall growth.



Reorganization



We incurred $0.2 million of reorganization costs during the nine months
ended September 30, 2005 and $1.5 million during the comparable period in 2004. These expenses consisted primarily of legal, accounting and other professional fees related to our reorganization into a holding company structure.



Provision for Income Taxes



Our tax provision increased to $21.0 million during the nine months ended
September 30, 2005 from $19.6 million during the comparable period in 2004. Our rate was 49.3% in the nine months ended September 30, 2004 compared to 45.3% in the comparable period in 2005 due to higher levels of non-deductible reorganization
expenses. Our rate during the first nine months of this year also reflects a lower tax rate on returns from our invested cash.



31



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##### Table of Contents

Liquidity and Capital Resources



We presently finance our business primarily through cash generated by our operating activities. In the past, we financed our
business through cash generated by our operating activities, additional capital contributions or loans from our investors. On March 14, 2005, we sold 4,602,115 shares of Class A common stock at $18.00 per share in our initial public offering, for
which we received net proceeds of $70.7 million. We believe that cash flows generated by our operating activities, together with net proceeds from our initial public offering, should be sufficient for us to fund our current operations for at least
the next 12 months.In addition, we have access to an uncommitted $10.0 million credit facility and may have the
ability to raise capital through issuance of debt or equity to new or existing investors through private and public capital markets transactions, if necessary.



32



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##### Table of Contents

Cash and cash equivalents increased to $155.1 million as of September 30, 2005 from $44.8 million as of
December 31, 2004 primarily due to the net cash raised in our initial public offering of $70.7 million, partly offset by a special dividend of $11.8 million paid in January 2005 in connection with the proceeds from the sale of Class B-2 memberships.
In addition, cash from operations increased to $48.3 million primarily due to increased trading volumes on our exchange and changes in our tax balances. Our capital expenditures during the nine months ended September 30, 2005 primarily related to
the enhancement of our trading system.



As of September 30,
2005, included in cash and cash equivalents is $5.2 million for our payment for order flow program. Under this program we pay our EAMs on behalf of our market makers for order flow sent to the exchange. We assess fees to our market makers, PMMs and
CMMs, and distribute those funds to our EAMs. Each PMM has full discretion regarding the payment, and we administer the payments. Accordingly, we reflect the assessments and payments on a net basis with no impact on revenues or expenses. When fees
are assessed, we record an asset with a corresponding liability.



As of September 30, 2005, we had a letter of credit agreement totaling $0.4 million to satisfy lease commitments and administrative obligations.



Financial Condition



Our total assets increased to $264.0 million as of September 30, 2005 from $177.6 million as of December 31, 2004. This increase was primarily due to the
cash proceeds we received from our initial public offering as well as higher transaction volumes. Also affecting our total assets were the following:



| |  |  | Our securities owned decreased to $18.1 million as of September 30, 2005 from $27.2 million as of December 31, 2004. Our securities owned are comprised of investments of our
excess cash in U.S. treasuries as well as investments in various mutual funds related to our long-term deferred compensation plan for our employees. U.S. treasuries decreased primarily due to the maturities of available for sale securities which
were transferred to cash and cash equivalents as well as the re-classification of shorter dated securities. Mutual fund investments decreased primarily due to the withdrawal of vested balances by employees.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our income tax receivable decreased from $11.3 million as of December 31, 2004 to a payable of $3.1 million as of September 30, 2005 primarily due to increased provision for income
taxes. The receivable balance resulted from taxes we paid in connection with the sale of our Class B-2 memberships during 2003 and 2004.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Other assets decreased to $6.4 million as of September 30, 2005 from $9.4 million as of December 31, 2004 primarily due to prepaid costs related to our initial public offering which
were initially capitalized prior to closing and prepaid expenses associated with enhancement and maintenance of our systems.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



33



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##### Table of Contents

| |  |  | Our net deferred tax asset increased to $21.5 million as of September 30, 2005 from $15.8 million as of December 31, 2004 primarily due to the differences between the financial
statement and income tax basis we use to recognize revenue from the sale of our Class B-2 memberships.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Our total liabilities decreased from $96.1 million as of December 31, 2004 to $95.0 million as of September 30, 2005. This decrease was primarily due
to a decrease in our compensation and benefits payable due to the payment of incentive compensation awards and exercises of vested balances in our employee profit-sharing plan partly offset by an increase in our taxes payable due to our higher
pre-tax income.



Contractual Obligations



The following table summarizes our future cash payments associated with
contractual obligations as of September 30, 2005, which are primarily operating leases for office space and equipment and contractual agreements for trading software license technology enhancements and support of our core trading system from
OMX:



|                           |  |                        |        |                 |   |              |  |              |        |              |   |       |  |   |      
|-------------------------- |  | ---------------------- | ------ | --------------- | - | ------------ |  | ------------ | ------ | ------------ | - | ----- |  | - | -----
|                           |  | Payments Due by Period
|                           |  | Total                  |        | Less than1 Year |   | 1 to 3 Years |  | 3 to 5 Years |        | After 5Years
|                           |  | (in thousands)        
|Operating leases           |  | $                      | 22,424 |                 | $ | 6,209        |  | $            | 6,883  |              | $ | 2,795 |  | $ | 6,537
|OMX purchase obligations   |  | $                      | 15,935 |                 | $ | 3,489        |  | $            | 6,606  |              | $ | 5,192 |  | $ | 648  
|Other purchase obligations |  | $                      | 2,650  |                 | $ | 1,000        |  | $            | 1,650  |              | $ |      |  | $ |     
|                           |  |                        |        |                 |   |              |  |              |        |              |   |       |  |   |      
|Total                      |  | $                      | 41,009 |                 | $ | 10,698       |  | $            | 15,139 |              | $ | 7,987 |  | $ | 7,185
|                           |  |                        |        |                 |   |              |  |              |        |              |   |       |  |   |      



Our operating lease
commitments primarily relate to obligations under operating leases with initial non-cancelable terms in excess of one year for office space and computer equipment. OMX purchase obligations relate to contractual agreements for trading software
licenses, technology enhancements and support of our core trading system from OMX. Other purchase obligations relate to minimum license fees for certain index options.



Off-Balance Sheet Arrangements



We do not have any off-balance sheet arrangements.



Item 3. Quantitative and Qualitative Disclosures About Market Risk



Market risk to us generally represents the risk of changes in value of a financial instrument that might result from fluctuations in interest rates and
equity prices. We have established policies, procedures and internal processes governing our management of market risks in the normal course of our business operations. Furthermore, we have not entered into any derivative contracts to mitigate such
risks, though we may in the future.



Interest Rate Risk



In order to maximize yields, we invest portions of
our excess cash in short-term interest earning assets, primarily money market instruments at commercial banks and U.S. treasuries with maturities of less than 2 years, which totaled $53.7 million and $159.7 million as of
December 31, 2004 and September 30, 2005, respectively. We do not anticipate that changes in interest rates will have a material impact on our financial condition, operating results or cash flows.



Equity Price Risk



As an exchange, we do not trade securities for our own account nor maintain
inventories of securities for sale. However, we do have investments in various mutual funds that we hold on behalf of our employees as part of our previous long-term performance-based profit-sharing plan. Under the plan, fund awards were granted to
our employees, which they in turn invest in various mutual fund investments. Employees vest in the distributions over a period of three years. The participating employees bear the risk of the vested portion of the investments, and we bear the risk
of the unvested portion. In addition, we have purchased U.S. treasuries with our available excess cash in order to increase our return. As a result, we are exposed to market price risk. This risk is estimated as the potential loss in fair value
resulting from a hypothetical 10% adverse change in quoted market prices and amounted to approximately $0.8 million and $0.6 million as of December 31, 2004 and September 30, 2005, respectively.



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Item 4. Controls and Procedures



As of the end of the period covered by this report, the Companys management evaluated, with the participation of the Companys Chief Executive Officer and President and Chief Financial Officer, the effectiveness of our disclosure
controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based upon that evaluation, the Chief Executive Officer and President and Chief Financial Officer have concluded that the Companys disclosure controls and
procedures were effective as of the period covered by this report. There have not been any changes in the Companys internal control over financial reporting (as such term is defined in Rule 13a-15(f) under the Exchange Act) during the last
fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.



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##### Table of Contents

Part II. OTHER INFORMATION



Item 1. Legal Proceedings



As an
exchange, we are subject to routine reviews and inspections by the SEC as well as legal proceedings arising in the ordinary course of business. We are not currently a party to any litigation or other legal proceedings that we believe are reasonably
likely to have a material adverse effect on our operating results, financial conditions or cash flows.



Item 2. Unregistered Sales of Equity Securities and Use of Proceeds



Pending use, the net proceeds of our initial public offering remain invested in short-term, interest-bearing money market investments. We intend to use
the proceeds of the initial public offering for working capital and general corporate purposes, as described in our registration statement on Form S-1 (File No. 333-117145). There has been no material change in the planned use of the initial public
offering proceeds as described in our final Prospectus filed with the SEC pursuant to Rule 424(b).



Item 5. Other Information





At present, we do not pay regular dividends on our Class A common stock. We currently intend to pay regular quarterly dividends on our Class A common
stock for fiscal year 2006. We currently intend that the regular quarterly dividends expected to be declared in 2006 will be in an aggregate amount not less than the aggregate amount of the proceeds received from the sale of any new Class B-2
memberships in fiscal year 2005, net of success bonuses that we may pay in connection with the completion of the sales and taxes we will pay on the proceeds. As of the date of this prospectus, we have sold three Class B-2 memberships in 2005 for
$1.5 million each, for which we have not paid a dividend. We have 14 unsold Class B-2 memberships, and may effect such sales at any time. However, we have no present agreements with any entity with respect to the sale of such Class B-2 memberships
and cannot assure that any such sales will occur. Any payments of cash dividends in the future will be at the discretion of our board of directors, and the amount of any dividends we pay, if any, may vary from period to period. Our board of
directors may take into account such matters as general business conditions, our financial results, capital requirements, contractual restrictions, and other factors our board of directors may deem relevant. Our board of directors ability to
declare a dividend is also subject to limits imposed by the Delaware General Corporation Law and the SEC. Our rules require that any revenue we receive from regulatory fees or regulatory penalties be segregated, not be used to pay dividends to the
holders of our Class A common stock and instead be applied solely to fund our legal, regulatory and surveillance operations. The amounts of such regulatory fees and penalties have not been material to date. There can be no assurance that any
dividends will be paid in the anticipated amounts and frequency set forth in this quarterly report.



Item 6. Exhibits



| | 31.1 | Certifications by the Chief Executive Officer and President pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
| | ---- | ----------------------------------------------------------------------------------------------------------------------



| | 31.2 | Certifications by the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
| | ---- | --------------------------------------------------------------------------------------------------------



| | 32.1 | Certifications by the Chief Executive Officer and President and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
| | ---- | --------------------------------------------------------------------------------------------------------------------------------------------------



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SIGNATURES



Pursuant to the
requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



|                         |  |                                         |  |                                                          
|------------------------ |  | --------------------------------------- |  | ---------------------------------------------------------
|                         |  | INTERNATIONAL SECURITIES EXCHANGE, INC.
|                         |  |                                        
|Dated: November 10, 2005 |  | By:                                     |  | /s/ Bruce Cooperman                                      
|                         |  | Name:                                   |  | Bruce Cooperman                                          
|                         |  | Title:                                  |  | Chief Financial Officer                                  
|                         |  |                                        
|                         |  |                                         |  | (Duly Authorized Officer and Principal Financial Officer)





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