**UNITEDSTATES SECURITIES AND EXCHANGE**

**COMMISSION**

 

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

 

**(MARKONE)**

**ý****QUARTERLY REPORTPURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**FORTHE QUARTERLY PERIOD ENDED JUNE 30, 2005**

 

**OR**

 

**o****TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**FORTHE TRANSITION PERIOD FROM       TO**

 

**COMMISSIONFILE NUMBER: 001-32274**

 

**ARCHIPELAGOHOLDINGS, INC.**

(Exact name ofRegistrant as specified in its charter)

 
| **DELAWARE**                                                           | ** ** | **86-1075595**                             |
|------------------------------------------------------------------------|------------|--------------------------------------------|
| (State or other  jurisdiction of incorporation or   organization) |       | (I.R.S. Employer    Identification Number) |

 

**100South Wacker Drive, Suite 1800**

**Chicago,IL 60606**

**(312)960-1696**

(Address,including zip code, and

telephone numberincluding area code, of

Registrant’sprincipal executive offices)

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required tofile such reports) and (2) has been subject to such filing requirementsfor the past 90 days.  Yes ý No o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12B-2of the Exchange Act).  Yes o No ý

 

As of August 2,2005, the Registrant had approximately 47,254,000 shares of common stock, $0.01par value per share, outstanding.

 

 

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**ARCHIPELAGOHOLDINGS, INC.**

**QUARTERLYREPORT ON FORM 10-Q**

**TABLE OFCONTENTS**

 
| PART I  – Financial Information                                                                                   |   |
|-----------------------------------------------------------------------------------------------------------------------------|--------|
| Item  1. Financial Statements                                                                                               |   |
| Condensed Consolidated Statements of Financial  Condition as of December 31, 2004 and June 30, 2005 (unaudited)   |   |
| Condensed Consolidated Statements of Operations for  the Three and Six Months Ended June 30, 2004 and 2005 (unaudited) |   |
| Condensed  Consolidated Statements of Cash Flows for the Six Months Ended June 30,  2004 and 2005 (unaudited)          |   |
| Notes  to Condensed Consolidated Financial Statements (unaudited)                                                           |   |
| Item 2. Management’s Discussion and  Analysis of Financial Condition and Results of Operations                         |   |
| Item 3. Quantitative and Qualitative  Disclosures about Market Risk                                                         |   |
| Item 4. Controls and Procedures                                                                                             |   |
| PART II – Other Information                                                                                       |   |
| Item 1. Legal Proceedings                                                                                                   |   |
| Item 2. Unregistered Sale of Equity  Securities and Use of Proceeds                                                         |   |
| Item 3. Defaults Upon Senior  Securities                                                                                    |   |
| Item 4. Submission of Matters to a  Vote of Security Holders                                                                |   |
| Item 5. Other Information                                                                                                   |   |
| Item 6. Exhibits                                                                                                            |   |
| Signatures                                                                                                                  |   |

 

**FORWARD-LOOKINGSTATEMENTS**

 

In addition to historicalinformation, this Quarterly Report on Form 10-Q contains forward-lookingstatements regarding Archipelago Holdings, Inc. and its subsidiaries(collectively “Archipelago”). These statements relate to future events or ourfinancial performance and may include information relating to pendingtransactions involving Archipelago (including the benefits of the transactionand future plans and expectations following the consummation of transaction)and are intended to be covered by the safe harbor for “forward-lookingstatements” provided by the Private Securities Litigation Reform Act of 1995.Forward-looking statements are based on the current belief of management andinvolve unknown risks, uncertainties and other factors that may cause ouractual results, levels of activity, performance or achievements, to bematerially different from those expressed or implied in this Report. In somecases, you can identify forward-looking statements with terminology such as “may”,“will”, “should”, “expects”, “intends”, “plans”, “anticipates”, “believes”, “estimates”,“predicts”, “potential”, “continue”, “pending” or the negative of these termsor other comparable terminology.  These statements are only predictions.You should not place undue reliance on forward-looking statements which speakonly as of the date of this Report.  Actual events or results may differmaterially and we undertake no on going obligation, other than that imposed bylaw, to update these statements. You should, however, consult any further disclosuresof a forward-looking nature Archipelago may make in our Annual Reports on Form 10-K,Quarterly Reports on Form 10-Q and Current Reports on Form 8-K.

 

Although we believe thatthe expectations reflected in the forward-looking statements are reasonable, wecannot guarantee future results, levels of activity, performance orachievements. These forward-looking statements are subject to numerous risksand uncertainties, including, but not limited to; general economic conditions;our future operating results; market penetration and financial condition;industry trading activity and fluctuations; regulatory changes and competition;the ability to obtain governmental approval of any pending transaction on theproposed terms and schedule; the failure to obtain stockholder approval for anypending transaction; the inability to integrate businesses successfullyfollowing the consummation of any pending transaction; the risk that anyexpected cost savings and any revenue synergies resulting from any pendingtransaction may not be fully realized or may take longer to realize thanexpected; the risk that disruption from any pending transaction may make itmore difficult to maintain relationships with clients, employees or suppliers;as well as the risks and uncertainties described in Part I, Item 1. underthe section heading ”Certain Factors That May Affect OurBusiness” of our Form 10-K filed with the Securities and ExchangeCommission on March 23, 2005 and the factors discussed below under “Management’sDiscussion and Analysis.” You are urged to carefully consider these factors.All forward-looking statements attributable to us are expressly qualified intheir entirety by the foregoing cautionary statements.

 

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**Important Acquisition Informationwith Respect to Archipelago’s Merger with the New York Stock Exchange (“NYSE”)**

 

In connection with theproposed merger of Archipelago and NYSE, the parties filed a registrationstatement on Form S-4 with the Securities and Exchange Commission (“SEC”)on July 21, 2005, containing a preliminary joint proxystatement/prospectus regarding the proposed transaction.  This registration statement has not yetbecome effective.  The parties will fileother relevant documents concerning the proposed transaction with the SEC.  INVESTORS ARE URGED TO READ THE DEFINITIVEJOINT PROXY STATEMENT/PROSPECTUS REGARDING THE PROPOSED TRANSACTION WHEN ITBECOMES AVAILABLE AND ANY OTHER RELEVANT DOCUMENTS FILED BY THE PARTIES WITHTHE SEC, BECAUSE THEY WILL CONTAIN IMPORTANT INFORMATION. Investors can obtaina free copy of the joint proxy statement/prospectus, as well as other filingscontaining information about Archipelago and the NYSE, at the SEC’s website(http://www.sec.gov) as they are filed with the SEC. Copies of the joint proxystatement/prospectus can also be obtained, without charge, by directing arequest to Archipelago, Attention: Investor Relations, at 100 South WackerDrive, Suite 1800, Chicago, Illinois 60606 or calling (888) 514-7284.

 

Archipelago, NYSE andtheir respective directors and executive officers and other members ofmanagement and employees may be deemed to be participants in the solicitationof proxies from Archipelago shareholders in respect of the proposedtransaction. Information regarding Archipelago’s directors and executiveofficers is available in Archipelago’s proxy statement for its 2005 annualmeeting of stockholders, dated March 31, 2005.  Additional information regarding theinterests of such potential participants is also included in the joint proxystatement/prospectus and the other relevant documents filed with the SEC whenthey become available.  This filing shallnot constitute an offer to sell or the solicitation of an offer to buy anysecurities, nor shall there be any sale of securities in any jurisdiction inwhich such offer, solicitation or sale would be unlawful prior to registrationor qualification under the securities laws of any such jurisdiction. Nooffering of securities shall be made except by means of a prospectus meetingthe requirements of Section 10 of the Securities Act of 1933, as amended.

 

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**PART I – Financial Information**

 

**Item 1. Financial Statements**

 

ArchipelagoHoldings, Inc.

Condensed Consolidated Statementsof Financial Condition

(In thousands,except per share data)

 
| ** **                                                                                                  | ** ** | **December 31,** | ** ** | **June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------|------------|
| ** **                                                                                                  | ** ** | **2004**              | ** ** | **2005**          | ** ** |
| ** **                                                                                                  | ** ** | ** **            | ** ** | **(unaudited)**   | ** ** |
| **Assets**                                                                                                  | ** ** | ** **            | ** ** | ** **        | ** ** |
| Current  assets:                                                                                            |       |                  |       |              |       |
| Cash  and cash equivalents                                                                                  |       | $                     | 177,878    |              | $          | 207,034 |   |
| Receivables  from brokers, dealers and customers, net                                                       |       | 31,400                |       | 24,020            |       |
| Receivables  from related parties                                                                           |       | 41,726                |       | 36,060            |       |
| Total  current assets                                                                                       |       | 251,004               |       | 267,114           |       |
|                                                                                                        |       |                  |       |              |       |
| Fixed  assets, net                                                                                          |       | 49,495                |       | 48,113            |       |
| Goodwill                                                                                                    |       | 131,865               |       | 131,865           |       |
| Intangible  asset - Pacific Exchange facility agreement                                                     |       | 90,000                |       | 90,000            |       |
| Other  intangible assets, net                                                                               |       | 2,169                 |       | 1,356             |       |
| Deferred  tax asset, net                                                                                    |       | 1,839                 |       | 474               |       |
| Other  assets                                                                                               |       | 8,076                 |       | 9,983             |       |
| Total  assets                                                                                               |       | $                     | 534,448    |              | $          | 548,905 |   |
|                                                                                                        |       |                  |       |              |       |
| **Liabilities and Stockholders’ Equity**                                                               |       |                  |       |              |       |
| Current  liabilities:                                                                                       |       |                  |       |              |       |
| Accounts  payable and accrued expenses                                                                      |       | $                     | 36,269     |              | $          | 36,556 |   |
| Payables  to brokers, dealers and exchanges                                                                 |       | 19,408                |       | 10,347            |       |
| Payables  to related parties                                                                                |       | 16,353                |       | 21,084            |       |
| Capital  lease obligations                                                                                  |       | 1,545                 |       | 524               |       |
| Total  liabilities                                                                                          |       | 73,575                |       | 68,511            |       |
|                                                                                                        |       |                  |       |              |       |
| Commitments  and contingencies                                                                              |       |                  |       |              |       |
|                                                                                                        |       |                  |       |              |       |
| Stockholders’  equity                                                                                  |       |                  |       |              |       |
| Common  stock, $0.01 par value, 165,000 shares authorized; 47,138 and 47,245 shares  issued and outstanding |       | 471                   |       | 472               |       |
| Additional  paid-in capital                                                                                 |       | 451,625               |       | 461,292           |       |
| Unearned  stock-based compensation                                                                          |       | (19                   | )          | (6,367            | )          |
| Retained  earnings                                                                                          |       | 8,796                 |       | 24,997            |       |
| Total  stockholders’ equity                                                                            |       | 460,873               |       | 480,394           |       |
| Total  liabilities and stockholders’ equity                                                            |       | $                     | 534,448    |              | $          | 548,905 |   |

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

 

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ArchipelagoHoldings, Inc.

Condensed Consolidated Statements of Operations

(In thousands,except per share data)

(unaudited)

 
| ** **                                                                                                      | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                      | ** ** | **2004**                              | ** ** | **2005**                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| **Revenues**                                                                                                    |       |                                  |       |                                |       |   |   |   |   |
| Transaction  fees ($48,046, $44,214, $102,278 and $89,769 with related parties)                                 |       | $                                     | 116,291    |                                | $          | 111,805 |   | $ | 251,292 |   | $ | 230,531 |   |
| Market  data fees ($5,152, $7,451, $9,396 and $14,118 with related parties)                                     |       | 12,448                                |       | 15,863                              |       | 24,172 |   | 30,713 |   |
| Listing  fees                                                                                                   |       | 117                                   |       | 123                                 |       | 206 |   | 241 |   |
| Total  revenues                                                                                                 |       | 128,856                               |       | 127,791                             |       | 275,670 |   | 261,485 |   |
|                                                                                                            |       |                                  |       |                                |       |   |   |   |   |
| **Cost of revenues**                                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Liquidity  payments ($13,997, $12,481, $29,330 and $25,897 with related parties)                                |       | 48,251                                |       | 50,482                              |       | 101,455 |   | 102,420 |   |
| Routing  charges ($11,668, $8,574, $25,540 and $18,431 with related parties)                                    |       | 22,032                                |       | 17,255                              |       | 48,512 |   | 36,096 |   |
| Clearance,  brokerage and other transaction expenses ($4,992, $1,486, $10,597 and $2,914  with related parties) |       | 10,759                                |       | 5,651                               |       | 23,425 |   | 13,317 |   |
| Total  cost of revenues                                                                                         |       | 81,042                                |       | 73,388                              |       | 173,392 |   | 151,833 |   |
|                                                                                                            |       |                                  |       |                                |       |   |   |   |   |
| **Gross margin**                                                                                                |       | 47,814                                |       | 54,403                              |       | 102,278 |   | 109,652 |   |
|                                                                                                            |       |                                  |       |                                |       |   |   |   |   |
| **Indirect expenses**                                                                                           |       |                                  |       |                                |       |   |   |   |   |
| Employee  compensation and benefits                                                                             |       | 10,831                                |       | 13,527                              |       | 21,164 |   | 26,031 |   |
| Depreciation  and amortization                                                                                  |       | 5,520                                 |       | 5,283                               |       | 16,252 |   | 10,704 |   |
| Communications  ($1,205, $1,230, $2,078 and $2,498 with related parties)                                        |       | 4,631                                 |       | 5,768                               |       | 9,160 |   | 11,277 |   |
| Marketing  and promotion ($233, $0, $241 and $0 with related parties)                                           |       | 2,736                                 |       | 10,197                              |       | 4,482 |   | 13,272 |   |
| Legal  and professional ($388, $600, $638 and $1,200 with related parties)                                      |       | 3,573                                 |       | 2,524                               |       | 5,876 |   | 5,657 |   |
| NYSE  merger costs ($0, $3,500, $0 and $3,500 with related parties)                                             |       | —                                |       | 8,432                               |       | — |   | 8,432 |   |
| Occupancy                                                                                                       |       | 1,010                                 |       | 1,343                               |       | 1,986 |   | 2,787 |   |
| General  and administrative                                                                                     |       | 2,385                                 |       | 3,527                               |       | 4,319 |   | 6,615 |   |
| Total  indirect expenses                                                                                        |       | 30,686                                |       | 50,601                              |       | 63,239 |   | 84,775 |   |
|                                                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Operating  income                                                                                               |       | 17,128                                |       | 3,802                               |       | 39,039 |   | 24,877 |   |
| Interest  and other, net                                                                                        |       | 193                                   |       | 1,344                               |       | 261 |   | 2,210 |   |
| Income  before income tax provision                                                                             |       | 17,321                                |       | 5,146                               |       | 39,300 |   | 27,087 |   |
| Income  tax provision                                                                                           |       | —                                |       | 2,110                               |       | — |   | 10,886 |   |
| **Net income**                                                                                                  |       | $                                     | 17,321     |                                | $          | 3,036 |   | $ | 39,300 |   | $ | 16,201 |   |
|                                                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Basic  earnings per share (a)                                                                                   |       | $                                     | 0.48       |                                | $          | 0.06 |   | $ | 1.09 |   | $ | 0.34 |   |
| Diluted  earnings per share (a)                                                                                 |       | $                                     | 0.42       |                                | $          | 0.06 |   | $ | 0.96 |   | $ | 0.34 |   |
|                                                                                                            |       |                                  |       |                                |       |   |   |   |   |
| Basic  weighted average shares outstanding (a)                                                                  |       | 36,169                                |       | 47,227                              |       | 36,169 |   | 47,185 |   |
| Diluted  weighted average shares outstanding (a)                                                                |       | 40,939                                |       | 48,171                              |       | 40,943 |   | 47,966 |   |

 

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(a)         Adjusted to reflect ourreorganization from a Delaware limited liability company to a Delawarecorporation on August 11, 2004. See Note 1 to condensed consolidated financialstatements.

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

 

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ArchipelagoHoldings, Inc.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(unaudited)

 
| ** **                                                                         | ** ** | **Six months ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                         | ** ** | **2004**                            | ** ** | **2005** | ** ** |
| **Cash flows from operating activities**                                           |       |                                |       |   |   |
| Net  income                                                                        |       | $                                   | 39,300     |   | $ | 16,201 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                                |       |   |   |
| Depreciation  and amortization                                                     |       | 15,438                              |       | 9,891 |   |
| Amortization  of other intangible assets                                           |       | 814                                 |       | 813 |   |
| Deferred  taxes                                                                    |       | —                              |       | 1,365 |   |
| Stock-based  compensation                                                          |       | 76                                  |       | 1,281 |   |
| Tax  benefit from stock option exercises                                           |       | —                              |       | 793 |   |
| Provision  for doubtful accounts                                                   |       | (500                                | )          | (100 | ) |
| Changes  in operating assets and liabilities:                                      |       |                                |       |   |   |
| Accounts  receivable                                                               |       | 1,523                               |       | 13,146 |   |
| Other  assets                                                                      |       | (2,700                              | )          | (1,907 | ) |
| Accounts  payable and accrued expenses                                             |       | 25,863                              |       | (4,043 | ) |
| Net  cash provided by operating activities                                         |       | 79,814                              |       | 37,440 |   |
|                                                                               |       |                                |       |   |   |
| **Cash flows from investing activities**                                           |       |                                |       |   |   |
| Additions  to fixed assets                                                         |       | (13,864                             | )          | (8,509 | ) |
| Net  cash used in investing activities                                             |       | (13,864                             | )          | (8,509 | ) |
|                                                                               |       |                                |       |   |   |
| **Cash flows from financing activities**                                           |       |                                |       |   |   |
| Direct  costs of initial public offering                                           |       | (5,274                              | )          | — |   |
| Repayment  of note payable                                                         |       | (4,429                              | )          | — |   |
| Principal  payments under capital lease obligations                                |       | (1,266                              | )          | (1,021 | ) |
| Proceeds  from exercises of stock options                                          |       | —                              |       | 1,246 |   |
| Net  cash (used in) provided by financing activities                               |       | (10,969                             | )          | 225 |   |
|                                                                               |       |                                |       |   |   |
| Net  increase in cash and cash equivalents                                         |       | 54,981                              |       | 29,156 |   |
| Cash  and cash equivalents at beginning of period                                  |       | 111,815                             |       | 177,878 |   |
| Cash  and cash equivalents at end of period                                        |       | $                                   | 166,796    |   | $ | 207,034 |   |
|                                                                               |       |                                |       |   |   |
| **Supplemental disclosures of cash flow  information**                             |       |                                |       |   |   |
| Cash  paid for:                                                                    |       |                                |       |   |   |
| Interest                                                                           |       | $                                   | 268        |   | $ | 38 |   |
| Income  taxes                                                                      |       | —                              |       | 8,858 |   |

 

The accompanyingnotes are an integral part of these condensed consolidated financialstatements.

 

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**ArchipelagoHoldings, Inc.**

**Notes toCondensed Consolidated Financial Statements (unaudited)**

**June 30,2005**

 

**1. ORGANIZATION AND BASIS OF PRESENTATION**

 

**Organization**

 

Archipelago Holdings, Inc.operates the Archipelago Exchange, or ArcaEx® (“ArcaEx”), the first openall-electronic stock market in the United States for trading in all NYSE,Nasdaq, AMEX and Pacific Exchange-listed stocks. Archipelago Holdings, L.L.C. (“HoldingsLLC”), a Delaware limited liability company and the predecessor to the Company,was organized in January 1999.  In July 2000, Holdings LLCentered into a facility services agreement with the Pacific Exchange, Inc.(“PCX”) which allowed it to establish and operate ArcaEx. The Securities andExchange Commission’s (“SEC”) approval of ArcaEx was announced in October 2001and ArcaEx began trading operations for listed securities in March 2002and for over-the-counter securities in April 2003.

 

On August 11, 2004,Holdings LLC converted to a Delaware corporation, Archipelago Holdings, Inc. We refer to Archipelago Holdings, Inc. and, prior to its conversion to aDelaware corporation, Holdings LLC, as the “Company”.  On August 19,2004, the Company completed an initial public offering (“IPO”) of its commonstock. See below discussion of the “*ConversionTransaction*” and the “*InitialPublic Offering.*”

 

Through certainsubsidiaries, the Company also provides broker execution services toinstitutions for orders involving Nasdaq and listed securities, as well asintroducing broker services for ArcaEx to broker-dealers that do not hold an equitytrading permit (“ETP”).

 

**ConversionTransaction**

 

On August 11, 2004,prior to the consummation of the IPO, Holdings LLC converted from a Delawarelimited liability company to a Delaware corporation, Archipelago Holdings, Inc.As a limited liability company, all income taxes were paid by the members ofHoldings LLC. As a corporation, the Company is responsible for the payment ofall federal and state corporate income taxes.

 

As a result of thereorganization of Holdings LLC from a Delaware limited liability company into aDelaware corporation, the members of Holdings LLC received 0.222222 shares ofcommon stock of the Company for each of their membership interests held by suchmember in Holdings LLC, which corresponds to a 4.5-for-1 reverse stock split.The weighted average number of shares used in the basic and diluted earningsper share computations gives retroactive effect to the 4.5-for-1 reverse stocksplit.

 

As approved by theCompany’s board of managers on July 16, 2004, the Company made a $24.6million cash distribution to the members of Holdings LLC immediately prior tothe conversion transaction. The cash distribution permitted the members to paythe taxes that the members owe for their share of the Company’s profits in 2004as a limited liability company through the date of the conversion transaction,calculated primarily based on the highest federal and state income tax rateapplicable for the tax withholding purposes to an individual.

 

**InitialPublic Offering**

 

On August 19, 2004,the Company completed the IPO of its common stock as a result of which theCompany sold 6,325,000 shares of common stock at $11.50 per share.  TheCompany received net proceeds of $67.6 million and incurred approximately $6.8million in expenses in connection with the IPO. In addition, 6,325,000 sharesof common stock were sold in the IPO by certain selling stockholders of theCompany, for which the Company received no proceeds.  The Company’s stockis listed on the Pacific Exchange and is traded on ArcaEx under the symbol “AX”. A summary of the terms of the IPO can be found in the Company’s RegistrationStatement on Form S-1 (File No. 333-113226), which was declaredeffective by the SEC on August 12, 2004.

 

**Basis ofPresentation**

 

The accompanyingcondensed consolidated financial statements are prepared in accordance withaccounting principles generally accepted in the United States of America andinclude the accounts of the Company and its wholly-owned subsidiaries. Managementhas made estimates and assumptions that affect the reported amounts of assetsand liabilities and disclosure of contingent assets and liabilities as of thedate of the financial statements and the reported amounts of revenues andexpenses during the reporting period. Management believes that the estimatesutilized in preparing its financial statements are reasonable and prudent.Actual results could differ from these estimates.

 

In the opinion ofmanagement, all adjustments considered necessary for a fair presentation havebeen included. All material intercompany accounts and transactions have beeneliminated in consolidation. Certain reclassifications have been made to theprior periods in order to conform to the current period’s presentation.

 

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Certain information andfootnote disclosures normally included in financial statements have beencondensed or omitted; however, management believes that the disclosures areadequate to make the information presented not misleading.

 

The condensed consolidatedfinancial statements are unaudited and should be read in conjunction with theCompany’s audited financial statements as of and for the year ended December 31,2004, included in the Company’s Annual Report on

Form 10-K filed withthe SEC on March 23, 2005. Operating results for the three and six monthsended June 30, 2005 are not necessarily indicative of the results that maybe expected for the year ending December 31, 2005.

 

**2. ACQUISITION OF PCX HOLDINGS, INC. (“PCXH”)**

 

On January 3, 2005,Archipelago Holdings, Inc., PCXH and a newly formed wholly-ownedsubsidiary of Archipelago (“Newco”) entered into a definitive Agreement andPlan of Merger (“Original PCX Agreement”) under which Archipelago agreed toacquire PCXH and all of its wholly owned subsidiaries including the PacificExchange, Inc. (“Pacific Exchange”) and PCX Equities, Inc. (“PCXEquities”), by way of a merger of PCXH with and into Newco. On July 22,2005, Archipelago, PCXH and Newco entered into a definitive Amended andRestated Agreement and Plan of Merger (“Amended PCX Agreement”) that amendedand restated the terms and conditions of the Original PCX Agreement. TheAmended PCX Agreement made the following three principal revisions to theOriginal PCX Agreement: (i) revised the form of consideration (but not theamount of consideration) the PCXH shareholders and holders of options topurchase shares of PCXH will receive upon closing of the transaction; (ii) revisedthe language of the amendment to PCXH’s Certificate of Incorporation (“PCXHCharter Amendment”) to be effective upon closing of the transaction; and (iii) revisedthe agreement to provide that PCXH must hold a meeting of its shareholders toconsider approval of the transaction within 45 days of the SEC’s publication ofa notice of filing of proposed rule change relating to the PCXH CharterAmendment. Except with regard to the foregoing, all other terms and conditionsof the Original PCX Agreement are not materially changed by the Amended PCXAgreement and continue to be effective.

 

Under the terms of theAmended PCX Agreement, at the closing, the PCXH shareholders and holders ofoptions to purchase PCXH shares will receive only cash in exchange for theirPCXH securities. As a result of this revision to the type of consideration to beissued in connection with the transaction, Archipelago is no longer required toprepare and file a registration statement with the SEC with respect to thetransaction.  Under the terms of theAmended PCX Agreement, the aggregate cash consideration to be paid byArchipelago at closing to all PCXH shareholders and option holders willcontinue to equal the total dollar value of all shares of Archipelago commonstock held by PCXH (currently 1,645,415 shares), either directly or indirectlythrough subsidiaries at closing, plus $17.0 million. The value of the shares ofArchipelago common stock will be determined using the average closing price pershare of Archipelago’s common stock for the ten trading days immediatelypreceding the date of the closing of the transaction, due to the factArchipelago entered into an agreement to merge with the New York Stock Exchange, Inc.on April 20, 2005 (see Note 3 below). In addition, the final calculationof the purchase price will depend upon several factors and adjustments,including but not limited to: (i) an adjustment relating to any workingcapital excess or shortfall of PCXH at closing that is either over or under anagreed upon threshold; and (ii) a downward adjustment in the event thatany change of control and related payments to certain executives of the sellerexceeds approximately $4.9 million.

 

Management expects thatafter consummation of the PCXH Transaction, the Company will be able to offerall-electronic trading of equity securities and options products and to expandand diversify the Company’s business lines and products. The consummation ofthe PCXH Transaction also will result in the Company acquiring theself-regulatory organization of the PCX.

 

The acquisition continuesto be subject to approval by PCX Holdings shareholders and the SEC, in additionto other required regulatory approvals and other customary closing conditions.Subject to such approvals and closing conditions, the Company anticipates thatthe acquisition of PCXH will close in the third quarter of 2005.

 

In October 2004, theCompany entered into a financial advisory services engagement with astockholder, under which the stockholder agreed to perform financial advisoryservices in relation to the PCXH Transaction. The Company has not made any payments under this agreement as of June 30,2005.

 

**3. MERGER WITH NEW YORK STOCK EXCHANGE, INC. (“NYSE”)**

 

On April 20, 2005,Archipelago Holdings, Inc., entered into a definitive merger agreement(the “Original NYSE Agreement”) with the New York Stock Exchange, Inc., aNew York Type A not-for-profit corporation, pursuant to which Archipelago and NYSEagreed to combine their businesses and become wholly-owned subsidiaries of NYSEGroup, Inc. (“NYSE Group”), a newly-created, for-profit and publicly-tradedholding company (the “Transaction”).  On July 20,2005, Archipelago and NYSE entered into a definitive Amended and RestatedAgreement and Plan of Merger (“Amended NYSE Agreement”) that amended andrestated the terms and condition of the Original NYSE Agreement.  The Amended NYSE Agreement made the followingthree principal revisions to the Original NYSE Agreement:  (i) added a provision allowing NYSEmembers to make a cash election or a stock election with regard to their mergerconsideration; (ii) added newly created entities (including NYSE Group) assignatories to the merger agreement as contemplated by the Original NYSEAgreement; and (iii)  shortened the duration of the transfer restrictionsapplicable to the shares of 

 

8

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common stock, par value$0.01 per share, of NYSE Group (“NYSE Group Common Stock”), to be received bythe NYSE members in the Transaction. Except with regard to the foregoing, allother terms and conditions of the Original NYSE Agreement are not significantlychanged by the Amended NYSE Agreement and continue to be effective in themanner amended and restated in the Amended NYSE Agreement.

 

Under the terms of theOriginal NYSE Agreement, each NYSE member is entitled to receive in exchangefor its NYSE membership, $300,000 in cash, plus a pro rata portion of theaggregate number of shares of NYSE Group Common Stock issued to all of the NYSEmembers in the Transaction (the “Standard Mix of Consideration”). Under theterms of the Original NYSE Agreement which remain unchanged by the Amended NYSEAgreement, the aggregate number of shares of NYSE Group Common Stock to beissued to all of the NYSE members in the Transaction, together with theaggregate number of shares reserved for issuance to NYSE employees, will equal70% of the NYSE Group common stock issued and outstanding at the time ofcompletion of the mergers, on a diluted basis.

 

Under the terms of theAmended NYSE Agreement, however, instead of receiving the Standard Mix ofConsideration, each NYSE member will have the opportunity to make either a cashelection to increase the cash portion (and decrease the stock portion) of theirmerger consideration, or a stock election to increase the stock portion (anddecrease the cash portion) of their merger consideration. These elections aresubject to proration to ensure that in no event, will the total amount of cashpaid (not counting the cash paid in respect of fractional shares of the NYSEGroup Common Stock), and the total number of shares of NYSE Group Common Stockissued in the Transaction to the NYSE members, as a whole exceed the totalamount of cash and number of shares of NYSE Group Common Stock that would havebeen paid and issued if all NYSE members received the Standard Mix of Consideration.

 

Through a single mergerwith a wholly-owned subsidiary of NYSE Group, under which the Company will bethe surviving entity: (i) each share of the issued and outstanding sharesof the Company’s common stock will convert automatically into the right toreceive one share of NYSE Group common stock; (ii) all outstanding stockoptions of the Company, whether vested or unvested, will convert into optionsto purchase an equivalent number of shares of NYSE Group common stock; and (ii) alloutstanding restricted stock units of the Company will convert into an equalnumber of restricted stock units of NYSE Group common stock. The aggregatenumber of shares (including shares underlying stock options and restrictedstock units) to be received by the Company’s stockholders will equal 30% of theissued and outstanding shares of NYSE Group common stock at the closing of theTransaction, on a diluted basis.

 

The consummation of the Transactionis subject to a number of customary closing conditions, including the receiptof approval by the NYSE members and the Company’s stockholders as well ascertain government approvals, including the SEC, and the expiration ortermination of the applicable waiting period under the Hart-Scott-Rodino Act.The Company anticipates that the Transaction will close in the first quarter of2006.

 

The Amended NYSEAgreement contains customary representations and warranties, including therepresentation that each party has received: (i) the requisite approval ofits board of directors to enter into the merger agreement; and (ii) anopinion of its financial advisor stating, to the effect that the considerationto be received in the transaction is fair from a financial point of view.

 

The Amended NYSEAgreement also contains customary termination provisions which, under certaincircumstances in the event of a termination under the Amended NYSE Agreement,may subject the parties to liability for the payment of termination fees andreimbursement of expenses in an amount up to $40.0 million, and includes aprovision which permits either party to terminate the merger agreement if thetransaction fails to close by February 1, 2006 (unless extended under theterms of the merger agreement). Either party may extend the term of the mergeragreement without the consent of the other party for two separate three-monthperiods (with the first period ending on May 1, 2006 and the second endingon August 1, 2006), provided that the only conditions that remain to besatisfied are the receipt of the approvals of either the NYSE members, theCompany’s stockholders or any regulatory entity, and outstanding litigation.

 

The parties expect thatthe combined businesses will bring together the strength of NYSE’s auctionmarket and the speed and innovation of the Company and its technology andmanagement.  The parties believe this combination will create a strong anddynamic enterprise with diverse products that will be well positioned tocompete in the industry and possess enhanced growth potential.

 

In April 2005, the Companyentered into a letter agreement with a stockholder under which the stockholderagreed to perform certain services in relation to the proposed merger of theCompany and NYSE which included facilitating discussions between the partiesand providing certain valuation analysis.  The Company agreed to pay thestockholder a transaction fee of $3.5 million in cash upon consummation of theTransaction. The Company also agreed to reimburse the stockholder for one-halfof the stockholder’s reasonable out-of-pocket expenses (including the fees anddisbursements of attorneys plus any sales, use or similar taxes) in an amountnot to exceed $50,000 without the prior written consent of the Company. In theevent the Transaction is terminated or not consummated, the Company will pay atransaction fee to be mutually agreed upon between the parties. The Company hasnot made any payments under this agreement as of June 30, 2005.

 

9

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**4. FIXED ASSETS**

 

Fixed assets consisted ofthe following:

 
| ** **                                      | ** ** | **December 31,  2004** | ** ** | **June 30,  2005** | ** ** |
|-------------------------------------------------|------------|-----------------------------|------------|-------------------------|------------|
| ** **                                      | ** ** | **(In thousands)**          | ** ** |
| Software,  including software development costs |       | $                           | 44,511     |                    | $          | 47,838 |   |
| Computers  and equipment                        |       | 43,131                      |       | 48,129                  |       |
| Leasehold  improvements                         |       | 18,770                      |       | 18,848                  |       |
| Equipment  under capital leases                 |       | 18,070                      |       | 18,070                  |       |
| Routers                                         |       | 5,524                       |       | 5,597                   |       |
| Furniture  and fixtures                         |       | 3,074                       |       | 3,107                   |       |
|                                            |       | 133,080                     |       | 141,589                 |       |
| Accumulated  depreciation and amortization      |       | (83,585                     | )          | (93,476                 | )          |
|                                            |       | $                           | 49,495     |                    | $          | 48,113 |   |

 

The Company capitalizedsoftware development costs of approximately $1.8 million for the six monthsended June 30, 2005.

 

**5. GOODWILL AND OTHER INTANGIBLE ASSETS**

 

**Goodwill**

 

In March 2002, theCompany acquired REDIBook in a transaction accounted for as a purchase businesscombination. Approximately $20.8 million of the $150.5 million purchase pricewas assigned to the net tangible and intangible assets acquired, with theremaining value of $129.7 million ascribed to goodwill.  In August 2004,the Company issued contingent consideration to former REDIBook members in theform of 192,194 shares of the Company’s common stock valued at $11.50 per shareand recorded $2.2 million of additional goodwill.

 

**PCXExchange Facility Agreement**

 

In May 2001, theCompany acquired the right to operate as the exclusive equity trading facilityof PCX Equities, Inc. including the rights to certain revenue streamscomprised primarily of transaction fees, market data fees, and listing fees,for an aggregate consideration of $90.0 million consisting of a $40.0million cash payment and 10.8% equity interest in the Company. The Companydetermined that this intangible asset had an indefinite life and, as such, itis not subject to amortization.

 

**OtherIntangible Assets**

 

In October 2002, theCompany acquired Globenet Securities, Inc. and the net assets of itsparent, Globenet Capital Corporation in a transaction accounted for as an assetacquisition.  The Company assigned $4.9 million to an intangibleasset related to the technology acquired.  This intangible asset is amortizedover three years from the implementation of the technology in May 2003. The Company recorded approximately $0.4 million in amortization on thisintangible asset for the three months ended June 30, 2004 and 2005 andapproximately $0.8 million for the six months ended June 30, 2004 and 2005.  As of June 30, 2005, the net book valueof this intangible asset was approximately $1.4 million.

 

10

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**6. RELATED PARTY TRANSACTIONS**

 

The following is asummary of the related party transactions involving the Company and certainformer members (i.e., owners of Holdings LLC prior to the IPO) and currentstockholders (i.e., stockholders of the Company after the IPO), PCX and otheraffiliates as part of its operations:

 
| ** **                                                                                                                    | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                                    | ** ** | **2004**                              | ** ** | **2005**                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                                                                                    | ** ** | **(In thousands)**                    | ** ** |
|                                                                                                                          |       |                                  |       |
| **Revenues**                                                                                                                  |       |                                  |       |                                |       |   |   |   |   |
| Transaction  fees earned from stockholders/former members and affiliates(1)                                                   |       | $                                     | 48,046     |                                | $          | 44,214 |   | $ | 102,278 |   | $ | 89,769 |   |
| Market  data fees received from PCX (net of amounts shared with customers of $4,669,  $6,207, $8,313 and $11,966) (2)         |       | 5,152                                 |       | 7,451                               |       | 9,396 |   | 14,118 |   |
| **Cost of revenues**                                                                                                          |       |                                  |       |                                |       |   |   |   |   |
| Liquidity  payments to stockholders/former members and affiliates(1)                                                          |       | 13,997                                |       | 12,481                              |       | 29,330 |   | 25,897 |   |
| Routing  charges:                                                                                                             |       |                                  |       |                                |       |   |   |   |   |
| Routing  fees paid to stockholder/former member(3)                                                                            |       | 10,938                                |       | 7,878                               |       | 23,946 |   | 17,167 |   |
| Routing  fees for listed securities paid to stockholders/former members(4)                                                    |       | 730                                   |       | 696                                 |       | 1,594 |   | 1,264 |   |
| Clearance,  brokerage and other transaction expenses:                                                                         |       |                                  |       |                                |       |   |   |   |   |
| Clearing  services provided by a stockholder/former member(5)                                                                 |       | 3,565                                 |       | 650                                 |       | 7,237 |   | 1,294 |   |
| Clearing  services provided by an affiliated clearing broker(5)                                                               |       | 798                                   |       | —                              |       | 2,052 |   | — |   |
| Regulatory  services fees paid to PCX(6)                                                                                      |       | 1,891                                 |       | 2,050                               |       | 3,504 |   | 4,004 |   |
| Registered  representative fees received from PCX(6)                                                                          |       | (1,262                                | )          | (1,214                              | )          | (2,196 | ) | (2,384 | ) |
| **Indirect expenses**                                                                                                         |       |                                  |       |                                |       |   |   |   |   |
| Communications:                                                                                                               |       |                                  |       |                                |       |   |   |   |   |
| Back  office services provided by an affiliate(7)                                                                             |       | 300                                   |       | 300                                 |       | 600 |   | 600 |   |
| Software  related services provided by an affiliate (net of amounts charged to  customers of $584, $476, $1,269 and $976) (8) |       | 905                                   |       | 930                                 |       | 1,478 |   | 1,898 |   |
| Marketing and  promotion:                                                                                                     |       |                                  |       |                                |       |   |   |   |   |
| Business  development costs(9)                                                                                                |       | 233                                   |       | —                              |       | 241 |   | — |   |
| Legal  and professional:                                                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Professional  fees for services provided by an affiliate(10)                                                                  |       | 388                                   |       | 450                                 |       | 638 |   | 900 |   |
| Consulting  fees for services from a firm whose principal serves a director of the  Company (11)                              |       | —                                |       | 150                                 |       | — |   | 300 |   |
| NYSE  merger costs:                                                                                                           |       |                                  |       |                                |       |   |   |   |   |
| Valuation  analysis and other services provided by a stockholder (12)                                                         |       | —                                |       | 3,500                               |       | — |   | 3,500 |   |
|                                                                                                                               |            |                                       |            |                                     |            |  |  |  |  |  |  |  |  |

 

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(1)                                 Certainstockholders/former members of Holdings LLC and affiliates execute transactionsthrough ArcaEx, and previously through the Company’s ECN, and are charged atransaction service fee by the Company for such activities. Liquidity paymentsare made to stockholders/former members of Holdings LLC and affiliates inrelation to such transaction fees.

 

(2)                                 TheCompany participates in the consolidation, dissemination and sale of marketdata in U.S. exchange-listed securities and Nasdaq-listed securities throughArcaEx. In connection with that, the Company receives market data fees, basedon the level of trading activity on ArcaEx, for providing data to centralizedaggregators that in turn sell the data to third-party consumers. PCX is adirect participant in the plans governing the consolidation and disseminationof market data and as a direct participant in these plans collects tape revenuesfor trading activities on ArcaEx. Under the terms of the facility servicesagreement, the Company is entitled to all tape revenues earned in connectionwith trading activities on ArcaEx.

 

(3)                                 Astockholder/former member of Holdings, LLC receives routing fees for tradesexecuted through ArcaEx, that ultimately route through to thestockholder/former member’s ECN.

 

(4)                                 Certainstockholders/former members of Holdings LLC provide routing services for listedsecurities through the New York Stock Exchange, Inc. on behalf of theCompany.

 

(5)                                 TheCompany clears its transactions for institutional customers through anaffiliated clearing broker and transactions for non-institutional customersthrough a stockholder/former member of Holdings LLC/clearing broker.

 

(6)                                 Underthe terms of the facility services agreement, PCX provides certain regulatoryservices to the Company in return for regular payments as negotiated betweenthe parties. Also, PCX forwards registered representative fees received fromthe NASD to the Company.

 

(7)                                 Anaffiliate provides back-office services to Wave Securities, L.L.C. (“Wave”).The services include offering and managing connectivity to alternativeexecution venues, clearing technology, as well as reporting to the NASD’s OrderAudit Trail Systems through which NASD members are required to reportinformation regarding Nasdaq transactions.

 

(8)                                 Anaffiliate provides software related services to the Company, a portion of whichis charged to the Company’s customers.

 

11

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(9)                                 In2004, the Company paid rental fees for the yacht that it leased for certainbusiness development functions, which is operated by the domestic partner of asister of a member of management.

 

(10)                          Anaffiliate provides software related services to the Company.

 

(11)                          TheCompany signed an agreement on June 1, 2004 with a consulting firm whoseprincipal serves as a director.  The consulting agreement provides for aminimum fee of $150,000 per quarter.

 

(12)                          The Companyentered into a letter agreement with a stockholder under which the stockholderagreed to perform certain services in relation to the proposed merger of the Companyand the NYSE.

 

An affiliate providedsoftware development services to the Company in the amount of $0.5 million and$1.5 million for the three and six months ended June 30, 2004,respectively.

 

On October 5, 2004,the Company entered into a financial advisory services engagement with astockholder affiliate, under which the affiliate agreed to perform financialadvisory services to the Company in relation to the PCXH Transaction.  The Company has not made any payments underthis agreement as of June 30, 2005.

 

In the opinion ofmanagement, transactions were made at customary rates and negotiated terms andconditions, and do not involve more than the normal risk of collectibility orpresent other unfavorable features.

 

**7. STOCK-BASED COMPENSATION**

 

The Company accounts forstock option grants to employees in accordance with Accounting Principles BoardOpinion (“APB”) No. 25, “Accounting for Stock Issued to Employees”, and,accordingly, recognizes compensation expense using the intrinsic value method.Under the intrinsic value method, stock-based compensation, if any, is measuredas the excess of the estimated fair value of the Company’s stock over theoption exercise price.

 

The Company adopted thedisclosure provisions of SFAS No. 123, “Accounting for Stock-BasedCompensation” and SFAS No. 148, “Accounting for Stock-BasedCompensation—Transition and Disclosure”.   Had compensation expensefor the Company’s stock option plans been determined based upon fair valueconsistent with SFAS No. 123, the Company’s net income and earnings pershare would have been changed to the following pro forma amounts:

 
| ** **                                                                                                                                                          | ** ** | **Three months ended  June 30,**     | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                                                                          | ** ** | **2004**                                  | ** ** | **2005**                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                                                                                                                          | ** ** | **(in thousands, except per share data)** | ** ** |
| Net  income, as reported                                                                                                                                            |       | $                                         | 17,321     |                                | $          | 3,036 |   | $ | 39,300 |   | $ | 16,201 |   |
| Add:  Stock-based employee compensation cost included in net income                                                                                                 |       | 38                                        |       | 523                                 |       | 76 |   | 756 |   |
| Deduct:  Stock-based employee compensation cost determined under the fair value based  method for all awards, net of related tax effects of $0, $620, $0 and $1,012 |       | 430                                       |       | 892                                 |       | 866 |   | 1,456 |   |
| Net  income, pro forma                                                                                                                                              |       | $                                         | 16,929     |                                | $          | 2,667 |   | $ | 38,510 |   | $ | 15,501 |   |
|                                                                                                                                                                |       |                                      |       |                                |       |   |   |   |   |
| Earnings  per share:                                                                                                                                                |       |                                      |       |                                |       |   |   |   |   |
| Basic,  as reported                                                                                                                                                 |       | $                                         | 0.48       |                                | $          | 0.06 |   | $ | 1.09 |   | $ | 0.34 |   |
| Basic,  pro forma                                                                                                                                                   |       | $                                         | 0.47       |                                | $          | 0.06 |   | $ | 1.06 |   | $ | 0.33 |   |
| Diluted,  as reported                                                                                                                                               |       | $                                         | 0.42       |                                | $          | 0.06 |   | $ | 0.96 |   | $ | 0.34 |   |
| Diluted,  pro forma                                                                                                                                                 |       | $                                         | 0.41       |                                | $          | 0.06 |   | $ | 0.94 |   | $ | 0.32 |   |

 

The fair value of eachoption grant was estimated on the date of grant using the Black-Scholes optionpricing model with the following assumptions:

 
| ** **                | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                | ** ** | **2004**                              | ** ** | **2005**                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| Dividend  yield           |       | —                                |       | —                              |       | — |   | — |   |
| Expected  volatility      |       | 30.0                                  | %          | 30.0                                | %          | 30.0 | % | 30.0 | % |
| Risk-free  interest rate  |       | 3.8                                   | %          | 4.2                                 | %          | 3.8 | % | 4.2 | % |
| Expected  life (in years) |       | 7                                     |       | 7                                   |       | 7 |   | 7 |   |

 

12

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The Black-Scholes optionpricing model was developed for use in estimating the value of traded optionsthat have no vesting restrictions and are fully transferable.  Inaddition, option pricing models require the input of highly subjectiveassumptions.  Because the Company’s employee stock options havecharacteristics significantly different from those of traded options, andbecause changes in the subjective input assumptions can materially affect theestimate, in management’s opinion, the existing valuation models may notprovide a reliable measure of the fair value of the Company’s employee stockoptions.

 

The above pro formainformation gives effect to the Company’s conversion into a Delawarecorporation as if it occurred at the beginning of the periods presented. In addition, the pro forma information was tax effected at combined federal,state and local rates of 41.0% for the three and six months ended June 30,2005.

 

In December 2004,the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123(R)(revised 2004), “Share-Based Payment”, requiring that compensation costassociated with share-based payment transactions be recognized in financialstatements. This cost is to be measured at the fair value of the instrumentissued. SFAS No. 123(R) covers a wide range of share-based compensationarrangements including stock options, restricted stock plans, performance basedawards, share appreciation rights and employee stock purchase plans. Statement No. 123(R)replaces the former SFAS No. 123 and supersedes APB No. 25.  TheCompany plans to adopt SFAS No. 123(R) on January 1, 2006 using themodified-prospective method.  The Company is currently evaluating theoption pricing model to be utilized and the overall impact of the adoption ofSFAS No. 123(R).  The adoption of the fair value method will have animpact on the Company’s results of operations, although it will have no impacton the Company’s overall financial condition.

 

**8. COMPUTATION OF EARNINGS PER SHARE**

 

The following is areconciliation of the basic and diluted earnings per share computations:

 
| ** **                                                | ** ** | **Three months ended  June 30,**     | ** ** | **Six months ended  June 30,** | ** ** |
|-----------------------------------------------------------|------------|-------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                | ** ** | **2004**                                  | ** ** | **2005**                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| ** **                                                | ** ** | **(In thousands, except per share data)** | ** ** |
|                                                      |       |                                      |       |                                |       |   |   |   |   |
| Net  income                                               |       | $                                         | 17,321     |                                | $          | 3,036 |   | $ | 39,300 |   | $ | 16,201 |   |
| Shares  of common stock and common stock equivalents:     |       |                                      |       |                                |       |   |   |   |   |
| Weighted  average shares used in basic computation        |       | 36,169                                    |       | 47,227                              |       | 36,169 |   | 47,185 |   |
| Dilutive  effect of:                                      |       |                                      |       |                                |       |   |   |   |   |
| Preferred  shares converted to common in August 2004 |       | 3,732                                     |       | —                              |       | 3,732 |   | — |   |
| Stock  options and restricted stock units                 |       | 1,038                                     |       | 944                                 |       | 1,042 |   | 781 |   |
|                                                      |       |                                      |       |                                |       |   |   |   |   |
| Weighted  average shares used in diluted computation      |       | 40,939                                    |       | 48,171                              |       | 40,943 |   | 47,966 |   |
|                                                      |       |                                      |       |                                |       |   |   |   |   |
| Basic  earnings per share                                 |       | $                                         | 0.48       |                                | $          | 0.06 |   | $ | 1.09 |   | $ | 0.34 |   |
|                                                      |       |                                      |       |                                |       |   |   |   |   |
| Diluted  earnings per share                               |       | $                                         | 0.42       |                                | $          | 0.06 |   | $ | 0.96 |   | $ | 0.34 |   |

 

For the three and sixmonths ended June 30, 2004, approximately 1.4 million securities wereexcluded from the computation of diluted earnings per share because their effectwould have been antidilutive.

 

**9. SEGMENT REPORTING**

 

The Company operates intwo reportable segments: Transaction Execution Services and Agency BrokerageServices.

 

Transaction ExecutionServices consist primarily of transaction execution services, market dataservices on a real-time or summary basis and, through the Company’s alliancewith PCX, a trading venue for issuers of equity securities, exchange tradedfunds and structured products. Under PCX rules, issuers are listed on PCX fortrading on ArcaEx. The customers in this segment are required to hold an ETP orbe a broker-dealer introduced to ArcaEx by an ETP. An ETP holder must be abroker-dealer.

 

Agency Brokerage Servicesare provided through Wave and consist of order execution services, on an agencybasis, for orders received from institutions involving primarily Nasdaq andlisted securities. This segment provides institutions that are not ETP holdersor are not sponsored by ETP holders access to all U.S. Nasdaq andexchange-listed securities markets through ArcaEx.

 

Revenues are generatedprimarily in the United States of America. Revenues derived from onestockholder/former member of Holdings LLC and its affiliates representedapproximately 10.2% and 10.1% for the three and six months ended June 30,2004, respectively, and 8.1% and 8.5% for the three and six months ended June 30,2005, respectively, of the consolidated revenues for each respective period.

 

13

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Summarized financialinformation concerning the Company’s reportable segments is as follows (inthousands):

 
| **Three  months ended June 30,** | ** ** | **Transaction  Execution  Services** | ** ** | **Agency  Brokerage  Services** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
|                                  |       |                                 |       |                            |       |             |       |             |       |
| 2004                                  |       |                                 |       |                            |       |             |       |             |       |
| Revenues                              |       | $                                    | 117,763    |                            | $          | 12,606           |       | $                | (1,513     | ) | $ | 128,856 |   |
| Cost  of revenues                     |       | 74,433                               |       | 8,122                           |       | (1,513           | )          | 81,042           |       |
| Gross  margin                         |       | 43,330                               |       | 4,484                           |       | —           |       | 47,814           |       |
| Indirect  expenses                    |       | 26,674                               |       | 4,012                           |       | —           |       | 30,686           |       |
| Operating  income                     |       | 16,656                               |       | 472                             |       | —           |       | 17,128           |       |
|                                  |       |                                 |       |                            |       |             |       |             |       |
| 2005                                  |       |                                 |       |                            |       |             |       |             |       |
| Revenues                              |       | $                                    | 119,829    |                            | $          | 9,085            |       | $                | (1,123     | ) | $ | 127,791 |   |
| Cost  of revenues                     |       | 69,185                               |       | 5,326                           |       | (1,123           | )          | 73,388           |       |
| Gross  margin                         |       | 50,644                               |       | 3,759                           |       | —           |       | 54,403           |       |
| Indirect  expenses                    |       | 46,627                               |       | 3,974                           |       | —           |       | 50,601           |       |
| Operating  income (loss)              |       | 4,017                                |       | (215                            | )          | —           |       | 3,802            |       |

 
| **Six  months ended June 30,** | ** ** | **Transaction  Execution  Services** | ** ** | **Agency  Brokerage  Services** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
|                                |       |                                 |       |                            |       |             |       |             |       |
| 2004                                |       |                                 |       |                            |       |             |       |             |       |
| Revenues                            |       | $                                    | 250,836    |                            | $          | 28,176           |       | $                | (3,342     | ) | $ | 275,670 |   |
| Cost  of revenues                   |       | 159,325                              |       | 17,409                          |       | (3,342           | )          | 173,392          |       |
| Gross  margin                       |       | 91,511                               |       | 10,767                          |       | —           |       | 102,278          |       |
| Indirect  expenses                  |       | 55,180                               |       | 8,059                           |       | —           |       | 63,239           |       |
| Operating  income                   |       | 36,331                               |       | 2,708                           |       | —           |       | 39,039           |       |
|                                |       |                                 |       |                            |       |             |       |             |       |
| 2005                                |       |                                 |       |                            |       |             |       |             |       |
| Revenues                            |       | $                                    | 242,995    |                            | $          | 20,977           |       | $                | (2,487     | ) | $ | 261,485 |   |
| Cost  of revenues                   |       | 141,810                              |       | 12,510                          |       | (2,487           | )          | 151,833          |       |
| Gross  margin                       |       | 101,185                              |       | 8,467                           |       | —           |       | 109,652          |       |
| Indirect  expenses                  |       | 76,469                               |       | 8,306                           |       | —           |       | 84,775           |       |
| Operating  income                   |       | 24,716                               |       | 161                             |       | —           |       | 24,877           |       |

 

**10. NET CAPITAL REQUIREMENTS**

 

Wave, ArchipelagoSecurities, L.L.C. (“ARCAS”) and Archipelago Trading Services, Inc. (“ATSI”)are registered broker-dealers and are subject to net capital requirements underSEC Rule 15c3-1. Wave and ATSI compute their net capital using the basicmethod. Under this method, these subsidiaries must maintain minimum net capital(as defined) and the ratio of aggregate indebtedness (as defined) to netcapital may not exceed 15 to 1. ARCAS computes its net capital under thealternative method. This method requires that minimum net capital not be lessthan the greater of $250,000 or 2% of aggregate debit items arising fromcustomer transactions.

 

14

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As of June 30, 2005,these subsidiaries were in compliance with their respective net capitalrequirements and their net capital, net capital in excess of required netcapital, and ratio of aggregate indebtedness to net capital were as follows (inthousands, except ratios):

 
| **Net capital**                                    |   |     |   |
|----------------------------------------------------|--------|----------|--------|
| Wave                                               |   | $        | 17,125 |   |
| ARCAS                                              |   | 10,652   |   |
| ATSI                                               |   | 4,207    |   |
| **Net capital in excess of required net capital**  |   |     |   |
| Wave                                               |   | $        | 16,280 |   |
| ARCAS                                              |   | 10,402   |   |
| ATSI                                               |   | 4,061    |   |
| **Ratio of aggregate indebtedness to net capital** |   |     |   |
| Wave                                               |   | .74 to 1 |   |
| ARCAS                                              |   | N/A      |   |
| ATSI                                               |   | .52 to 1 |   |

 

Advances to affiliates,dividend payments and other equity withdrawals are subject to certainnotification and other provisions of the net capital rule of the SEC andother regulatory bodies.

 

The Company’sinternational broker-dealer subsidiaries are subject to capital adequacyrequirements promulgated by authorities of the countries in which they operate.As of June 30, 2005, these subsidiaries had met their local capitaladequacy requirements.

 

**Item 2.  Management’s Discussionand Analysis of Financial Condition and Results of Operations**

 

You should read thefollowing discussions together with the condensed consolidated financialstatements and related notes as well as the forward looking statements includedelsewhere in this report.

 

**ExecutiveOverview**

 

We operate ArcaEx, thefirst open, all-electronic stock market in the United States for trading inNYSE-, Nasdaq-, AMEX- and PCX-listed equity securities, exchange-traded fundsand other exchange-listed securities. During the six months ended June 30,2004 and 2005, our customers executed 200.8 million and 235.3 milliontransactions in U.S. equity securities through ArcaEx, respectively,representing 71.3 billion and 71.5 billion shares. Our trading platforms andservices have been designed to enhance the speed and quality of trade executionfor our customers. Our trading platforms provide our customers with fastelectronic execution and open, direct and anonymous market access. Thetechnological capabilities of our trading systems, together with our tradingrules, have allowed us to create a pool of liquidity that is available to ourcustomers internally on ArcaEx and externally through other market centers. Wealso operate The ArcaEdge®, a broker-dealer sponsored trading platform designedto bring the benefits of ArcaEx—fast electronic execution, transparency andopen market access—to the trading of small-cap equity securities.

 

We earn revenues andgenerate cash from transaction fees collected in connection with trade execution(whether matched internally or routed out) on ArcaEx. We also generate revenuesfrom fees collected for introducing broker-dealers that do not hold an ArcaEx equitytrading permit (“ETP”). In addition, we receive market data fees, based on thelevel of trading activity on ArcaEx, for providing data to centralizedaggregators that in turn sell the data to third-party consumers. Through ouralliance with PCX, we also collect listing fees from companies and indexproviders that list on PCX as a trading venue for their equity securities,exchange-traded funds and other structured products. Through our wholly-ownedsubsidiary, Wave Securities, L.L.C., we offer and derive revenues from feescollected in connection with agency brokerage services for institutionalcustomers seeking to access ArcaEx and other U.S. market centerselectronically.

 

Our business is dependenton the liquidity (i.e., the number and range of buy orders and sell ordersposted on our system and available to our customers) of ArcaEx. As a result,our most significant cost of generating revenues is the cost of liquidity,which we pay for in one of two ways. First, to enhance the liquidity of oursystem, we pay a small fee per share (denominated in tenths of a cent pershare) to participants, referred to as “liquidity providers,” that post buyorders and sell orders on the Archipelago system, when the quote is executedagainst, or “hit,” by liquidity takers purchasing or selling securitiesinternally on our system. Second, as part of our best execution business model,we incur routing charges when the Archipelago system does not have the best buyor sell order in the market for a security that a customer is trying to buy orsell on our system. In that case, we will route the customer’s order to theexternal market center that displays the best buy order or sell order. Theexternal market center will charge us a fee per share (denominated in tenths ofa cent per share) for routing to its system.

 

Making liquidity paymentsand incurring routing charges are part of the costs we incur to generaterevenues through increased liquidity on the Archipelago system. We seek tooffset these costs by increased trade execution on the Archipelago system. Ourcost of liquidity generally fluctuates based on (i) trading volumes and (ii) theper share fee we pay liquidity providers for trades executed 

 

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internally on ArcaEx orthe per share routing charge we pay to external market centers for outboundtrades.

 

We also incur clearance,brokerage and related transaction expenses, which primarily include transactionexpenses paid to clearing entities for clearing and settlement, service feespaid per trade to exchanges for trade execution. As the operator of a facilityof PCX Equities, Inc., we do not incur clearing charges for internallymatched trades executed on ArcaEx by our customers. As a result, our clearingcosts are lower for trades executed internally on ArcaEx. If we route a tradeto an external market center, we bear clearing and settlement costs.

 

In addition to our directcost of revenues, we incur the following indirect expenses:

 

•                                          employeecompensation and benefits expenses, which include salaries, incentivecompensation and related employee benefits and taxes as well as amortization ofstock-based compensation;

 

•                                          depreciationand amortization expenses, which result primarily from the depreciation of thefixed assets we purchase, including computer software and hardware used in thedevelopment of our trading systems;

 

•                                          communicationsexpenses, which consist primarily of costs for our network connection with ourcustomers and our data centers, as well as connectivity to various other marketcenters;

 

•                                          marketingand promotion expenses, which consist primarily of media, print and otheradvertising expenses as well as customer marketing expenses;

 

•                                          legaland professional expenses, which consist primarily of legal and accountingexpenses;

 

•                                          occupancyexpenses, which consist primarily of rental expenses; and

 

•                                          generaland administrative expenses, which include insurance premiums, travel andentertainment expenses and other administrative expenses and general officecosts.

 

On August 11, 2004we converted from a limited liability company to a “C” corporation inconnection with the consummation of our Initial Public Offering (“IPO”). Please refer to Note 1 — Organization and Basis of Presentation under thesub-headings “Conversion Transaction” and “Initial Public Offering” for furtherdiscussion in our unaudited condensed consolidated financial statements.

 

For financial reportingpurposes, our business is divided into two reportable segments: transactionexecution services and agency brokerage services. Our transaction executionbusiness includes trade execution on the Archipelago system as well as fees wereceive for market data and from issuers with equity securities listed on thePacific Exchange for trading on ArcaEx. Our trade execution customers arerequired to hold an ETP or be a broker-dealer introduced to ArcaEx by an ETPholder in order to trade on ArcaEx. An ETP holder must be a broker-dealer. Ouragency brokerage services are provided through Wave Securities, L.L.C., ourbroker-dealer subsidiary, and consist of order execution services, on an agencybasis, for orders received exclusively from institutions involving primarilyNasdaq and listed securities. This segment provides institutions that are notETP holders or are not sponsored by ETP holders access to all U.S. Nasdaq andexchange-listed securities markets through ArcaEx.

 

**BusinessDevelopment**

 

***Acquisition ofPCX Holdings, Inc. (“PCXH”)***

 

OnJanuary 3, 2005, we entered into a definitive agreement (which was amendedand restated on July 22, 2005) to acquire PCXH and all of its wholly-ownedsubsidiaries for a purchase price equal to the total dollar value of all sharesof Archipelago common stock held by PCXH (currently 1,645,415 shares), eitherdirectly or indirectly through subsidiaries at closing, plus $17.0 million.  At closing, the value of the all shares ofArchipelago common stock will be determined using the average closing price pershare of Archipelago’s common stock for the ten trading days immediatelypreceding the date of the closing of the transaction. This purchase price issubject to working capital and certain other possible adjustments. We expectthat after consummation of the PCXH acquisition, we will be able to offerall-electronic trading of equity securities and options products and will beable to expand and diversify our business lines and products. The consummationof the PCXH acquisition also will result in our acquisition of theself-regulatory organization (“SRO”) of the PCX. This transaction is subject toapprovals from PCXH shareholders as well as the Securities and ExchangeCommission (“SEC”) and other regulatory entities. We anticipate that the PCXHacquisition will close in the third quarter of 2005.

 

***Merger with NewYork Stock Exchange, Inc. (“NYSE”)***

 

OnApril 20, 2005, we entered into a definitive merger agreement with NYSE(which was amended and restated on July 21, 2005) under which, each ofArchipelago and NYSE will operate as a wholly-owned subsidiary under anewly-created, for-profit and

 

16

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publicly-tradedholding company, which the parties expect to be named the NYSE Group, Inc.Under the terms of the merger agreement, we will be the surviving entity of amerger with a newly created for-profit Delaware corporation and wholly-ownedsubsidiary of NYSE Group.  In thistransaction, each share of the issued and outstanding shares of our commonstock will convert automatically into the right to receive one share of NYSEGroup common stock, with the aggregate amount of such shares of NYSE Groupcommon stock equaling 30% of the issued and outstanding shares of common stockof NYSE Group at the closing.

 

Theparties expect that the combined businesses will bring together the strength ofthe NYSE’s auction market and our speed and innovation.  The parties believe this combination willcreate a strong and dynamic enterprise with diverse products that will be wellpositioned to compete in the industry and possess enhanced growth potential.

 

Theconsummation of the transaction is subject to the receipt of approval by themembers of the NYSE and our stockholders as well as certain governmentapprovals, including the SEC. We anticipate that our merger with NYSE willclose in the first quarter of 2006.

 

Themerger agreement contains customary termination provisions which, under certaincircumstances in the event of a termination under the merger agreement, maysubject the parties to liability for the payment of termination fees orreimbursement of expenses in an amount up to $40.0 million, and includes aprovision which permits either party to terminate the agreement if thetransaction fails to close by February 1, 2006. Either party may extendthe term of the merger agreement without the consent of the other party for twoseparate three-month periods (with the first period ending on May 1, 2006and the second ending on August 1, 2006), provided that the onlyconditions that remain to be satisfied are the receipt of the approvals ofeither the NYSE members, our stockholders or any regulatory entity, andoutstanding litigation.

 

***Regulation NMS Release of Final Rules***

 

On June 9, 2005, the SEC released the final rules relatingto Regulation NMS. The provisions of Regulation NMS are described below andinclude the Order Protection Rule, Access Rule, Market Data Rule andSub-Penny Rule.

 

In its final release, the SEC provide for extendedcompliance dates for each provision of Regulation NMS, specifically: (1) compliancewith the Access Rule and Order Protection Rule will begin with asmall group of representative NMS stocks (which are stocks included in thenational market system that can be traded on a variety of venues, includingnational securities exchanges, alternative trading systems and market-makingsecurities dealers), with the first phase beginning June 29, 2006, withall securities being subject to the rule beginning August 31, 2006; (2) compliancewith the Sub-Penny Pricing Rule will begin on January 31, 2006 and (3) compliancewith the Market Data Rule will begin on September 1, 2006.

 

*Order Protection Rule.* The OrderProtection Rule changed the “trade-through” rule which previouslyapplied only to NYSE-listed and American Stock Exchange-listed securities. Itrequires trading centers to establish, maintain, and enforce written policiesand procedures that are reasonably designed to prevent trade-throughs on thattrading center of protected quotations and, if relying on exceptions to theOrder Protection Rule, that are reasonably designated to assure compliance withthe terms of the exception. To qualify for protection, a bid or offer must bean automated trading center’s best bid or best offer (i.e., one that, amongother things, is displayed and immediately accessible through automaticexecution). An “automated trading center” is essentially one that executes anincoming order on an immediate basis without human intervention. Atrade-through is defined as the purchase or sale of an NMS stock during regulartrading hours, either as principal or agent, at a price lower than a protectedbid or higher than a protected offer. Displayed bids and offers not immediatelyaccessible through automatic execution will not be protected from being tradedthrough by any market under the Order Protection Rule. The Order Protection Rule alsoextends the trade-through provisions to all NMS stocks including Nasdaq-listedstocks.

 

The trade-through rule that currently appliesmakes no distinction between quotations available immediately for automatedexecution and those only available for manual execution. It also does not applyto Nasdaq-listed stocks. The Order Protection Rule also includesexceptions to the trade-through provisions such as intermarket sweep orders,single-priced opening, reopening or closing transactions, benchmark orders,upstairs stops, quotations displayed by markets that fail to meet the responserequirements for automated quotations, and flickering quotations with multipleprices displayed in a single second.

 

*Access Rule.* The Access Rule sets forth new standardsgoverning access to quotations in NMS stocks. It requires fair and non-discriminatoryaccess to quotations and establishes a limit on access fees to harmonize thepricing of quotations across different trading centers. Specifically, theAccess Rule establishes a limit on the access fees charged by tradingcenters when incoming orders execute against their displayed quotes andundisplayed interests at the best bid or offer to $0.003 per share (30 centsper 100 share order) or, if the price of the best bid or offer is less than$1.00, to no more than 0.3% of the quotation price per share. The Access Rule alsorequires SROs to establish, maintain and enforce rules that require theirmembers to reasonably avoid displaying quotes that lock or cross any protectedquotation in an NMS stock, or manual quotations that lock or cross quotationsin NMS stocks and prohibit their members from engaging in a pattern or practiceof displaying quotations that lock or cross quotations. A locked market occurswhen, for example, the price to buy a stock is the same as the price to sellthe stock. A crossed market occurs when the price to buy a stock is higher thanthe price to sell the stock.

 

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*Market Data Rules and Plans.* Regulation NMSupdates the requirements for consolidating, distributing, and displaying marketinformation, as well as amending the joint industry plans for disseminatingmarket information to modify the formulas for allocating plan revenues andbroaden participation in plan governance. The new formula allocates revenues tomarket centers based on the value of the quotes and trades for all securitiesrather than the current system that is based simply on the number of trades (asit relates to NYSE-listed securities) or a combination of trades and shares (asit relates to Nasdaq-listed securities). The new rule gives market centersand their members the ability to distribute their own data independently withor without charging fees. However, market centers will still be required toprovide their best bids and offers and last sale information for consolidateddissemination through the joint-industry plans. The Market Data Rule alsorequires the SROs participating in the market data consolidation systems tocreate advisory committees composed of non-SRO representatives to the jointindustry plans.

 

*Sub-Penny Rule.* The Sub-Penny Rule prohibits marketparticipants from displaying, ranking, or accepting quotations in NMS stocksthat are priced in an increment of less than $0.01, unless the price of thequotation is less than $1.00.

 

Currently, we cannot predict the effect of theimposition of the final rules relating to Regulation NMS on our business,however, we continue to analyze the potential impact to our business andresults of operations.

 

***PhiladelphiaStock Exchange***

 

On June 16, 2005,The Philadelphia Stock Exchange (“PHLX”) announced that it had entered into astrategic alliance with Merrill Lynch and Citadel Derivatives Group LLC underwhich both Merrill Lynch and Citadel acquired a 10% equity interest in PHLX,with provisions that allow for each firm to obtain additional equity interestsbased on specific performance criteria. According to PHLX, these investmentsare expected to be the first in a series of strategic investments by securitiesindustry firms designed to advance the PHLX’s goal of growing its business,supported by its technology.

 

***BATSTrading, Inc.***

 

On June 17, 2005,BATS Trading, Inc. (“BATS”), a company located in Kansas City, announcedits intention to launch a new alternative trading system. Subject to pendingregulatory approvals, BATS anticipates that its new platform will be ready fortrading in early 2006.

 

***BarclaysGlobal Investors Transfer of Listings to ArcaEx***

 

On July 20, 2005,Barclays Global Investors announced its plans to transfer the listing of twentyof its iShares(R) exchange-traded products to ArcaEx.

 

**KeyStatistical Information**

 

Our revenues and grossmargin are directly impacted by trading volumes of U.S. equity securities onthe Archipelago system. Our profitability depends to a significant extent onour ability to attract and retain trading volumes, both in absolute terms andrelative to other market centers. We derive revenues on both a per-share basisand a per-transaction basis, depending upon the source of revenue. Thetransaction fees we receive for trade execution and the payments we make toliquidity providers are determined on a per-share basis. Market data fees forexchange-listed securities are determined on a per-transaction basis, andmarket data fees for Nasdaq-listed securities are determined on a combinationof share volume and transaction volume.

 

The following tablepresents unaudited key transaction volume information, as well as selectedoperating information, for the periods presented. A description of how wecalculate our market share, our trading volumes and other operating measures isset forth below.

 

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| ** **                                                                | ** ** | **Three months ended  June 30,** | ** ** | **Six months ended  June 30,** | ** ** |
|---------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                | ** ** | **2004**                              | ** ** | **2005**                            | ** ** | **2004** | ** ** | **2005** | ** ** |
|                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Trading  Days                                                             |       | 62                                    |       | 64                                  |       | 124 |   | 125 |   |
|                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Total  U.S. market volume (millions of shares)(1)                         |       | 239,972                               |       | 258,625                             |       | 508,847 |   | 521,471 |   |
| Our  total U.S. market volume (millions of shares)(1)                     |       | 33,595                                |       | 35,620                              |       | 71,345 |   | 71,450 |   |
|                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Our  share of total U.S. market volume(1)(2)                              |       | 14.00                                 | %          | 13.77                               | %          | 14.02 | % | 13.70 | % |
| % of  handled shares matched internally(3)                                |       | 10.67                                 | %          | 11.08                               | %          | 10.59 | % | 10.96 | % |
| % of  handled shares routed out(3)                                        |       | 3.33                                  | %          | 2.69                                | %          | 3.43 | % | 2.74 | % |
|                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Total  volume of Nasdaq-listed securities (millions of shares)            |       | 108,330                               |       | 113,955                             |       | 234,071 |   | 236,193 |   |
| Our  total volume of Nasdaq-listed securities (millions of shares)        |       | 27,627                                |       | 26,360                              |       | 59,866 |   | 55,128 |   |
|                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Our  share of total volume of Nasdaq-listed securities(2)                 |       | 25.50                                 | %          | 23.13                               | %          | 25.58 | % | 23.34 | % |
| % of  handled shares matched internally(3)                                |       | 19.30                                 | %          | 18.50                               | %          | 19.28 | % | 18.59 | % |
| % of  handled shares routed out(3)                                        |       | 6.20                                  | %          | 4.63                                | %          | 6.30 | % | 4.75 | % |
|                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Total  volume of NYSE-listed securities (millions of shares)              |       | 112,553                               |       | 127,745                             |       | 235,621 |   | 252,939 |   |
| Our  volume in NYSE-listed securities (millions of shares)                |       | 1,731                                 |       | 4,239                               |       | 3,703 |   | 7,365 |   |
|                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Our  share of total volume of NYSE-listed securities(2)                   |       | 1.54                                  | %          | 3.32                                | %          | 1.57 | % | 2.91 | % |
| % of  handled shares matched internally(3)                                |       | 0.96                                  | %          | 2.54                                | %          | 0.96 | % | 2.18 | % |
| % of  handled shares routed out(3)                                        |       | 0.58                                  | %          | 0.78                                | %          | 0.61 | % | 0.73 | % |
|                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Total  volume of AMEX-listed securities (millions of shares)              |       | 19,090                                |       | 16,925                              |       | 39,156 |   | 32,340 |   |
| Our  volume in AMEX-listed securities (millions of shares)                |       | 4,236                                 |       | 5,021                               |       | 7,775 |   | 8,957 |   |
|                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Our  share of total volume of AMEX-listed securities(2)                   |       | 22.19                                 | %          | 29.67                               | %          | 19.86 | % | 27.70 | % |
| % of  handled shares matched internally(3)                                |       | 19.00                                 | %          | 25.64                               | %          | 16.69 | % | 23.89 | % |
| % of  handled shares routed out(3)                                        |       | 3.19                                  | %          | 4.03                                | %          | 3.17 | % | 3.81 | % |
|                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Our  ETF volume (millions of shares)                                      |       | 3,783                                 |       | 6,215                               |       | 6,829 |   | 11,158 |   |
|                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Our  U.S. equity transaction volume (thousands of transactions)           |       | 99,558                                |       | 119,588                             |       | 200,831 |   | 235,334 |   |
|                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Our  average U.S. equity transaction size (shares per transaction)        |       | 337                                   |       | 298                                 |       | 355 |   | 304 |   |
| Our  average U.S. equity transactions per day (thousands of transactions) |       | 1,606                                 |       | 1,869                               |       | 1,620 |   | 1,883 |   |
|                                                                      |       |                                  |       |                                |       |   |   |   |   |
| Our  average transaction-related revenue (per share)(4)              |       | $                                     | 0.0035     |                                | $          | 0.0031 |   | $ | 0.0035 |   | $ | 0.0032 |   |
| Our  average transaction-related cost of revenue (per share)(5)      |       | $                                     | 0.0021     |                                | $          | 0.0019 |   | $ | 0.0021 |   | $ | 0.0019 |   |
| Our  average transaction-related gross margin (per share)(6)         |       | $                                     | 0.0014     |                                | $          | 0.0012 |   | $ | 0.0014 |   | $ | 0.0013 |   |
|                                                                      |       |                                  |       |                                |       |   |   |   |   |
| % of  customer order volume matched internally(7)                         |       | 86.3                                  | %          | 88.9                                | %          | 85.9 | % | 88.7 | % |
| % of  customer order volume routed out(7)                                 |       | 13.7                                  | %          | 11.1                                | %          | 14.1 | % | 11.3 | % |
|                                                                      |       |                                  |       |                                |       |   |   |   |   |

 

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(1) U.S. marketvolume is calculated based on the number of shares of equity securities tradedon the NYSE, AMEX and Nasdaq, including exchange-traded funds, as reported inthe consolidated tape. The “consolidated tape” is the system that continuouslyprovides the last sale price and volume of securities transactions in listedsecurities to the public.

 

(2) Our market shareis calculated based on the number of shares handled on the Archipelago systemas a percentage of total volume.

 

(3) Represents ourshare of the total volume of such securities handled on ArcaEx that was eithermatched internally on ArcaEx or routed out to an external market center.

 

(4) The per shareamount is calculated based on our total revenues derived from transaction feesof $116.4 million and $111.8 million for the three months ended June 30,2004 and 2005, respectively and $251.3 million and $230.6 million forthe six months ended June 30, 2004 and 2005, respectively.

 

(5) The per shareamount is calculated based on our cost of revenues derived from transactionfees, which consist of routing charges and liquidity payments of $70.3 millionand $67.7 million for the three months ended June 30, 2004 and 2005,respectively, and $150.0 million and $138.5 million for the six months ended June 30,2004 and 2005, respectively, and our total U.S. market volume for the relevantperiod. The cost of revenue from transaction fees used in the per sharecomputation does not include clearance, brokerage and other transactionexpenses.

 

(6) The per shareamount is calculated based on our net revenues received from transaction fees,and our total U.S. market volume for the relevant period.

 

(7) The percentageof customer order volume matched internally is calculated by dividing thevolume of customer orders executed

 

19

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within our internalliquidity pool (including the volume of both buy orders and sell orders) by thetotal volume of customer orders (again including the volume of both buy ordersand sell orders when such orders are matched internally). The percentage ofcustomer orders routed out is calculated by dividing the volume of customerorders routed to other market centers by the total volume of customer orders.

 

For purposes ofcalculating our volume, we include all shares that are “handled” on theArchipelago system. Handled shares include both shares that are bought or soldwithin our internal liquidity pool and shares that are routed to externalmarkets for execution. We count every transaction handled by the Archipelagosystem once; we do not count both sides of any transaction. For example, if acustomer’s 10,000 share buy order is matched with another customer’s 10,000share sell order in our internal liquidity pool, our handled volume will be10,000 shares. As another example, if one of our customers sends us an order tobuy 10,000 shares and the best price for that order is displayed at anothermarket center, we will route that order to the other market center forexecution. The other market center will report a 10,000 share transaction inthe consolidated tape, and our handled volume will be 10,000 shares. As aresult, the 10,000 shares we report as handled by us in this example are alsohandled by the external market center.

 

In computing thepercentage of customer order volume matched internally and the percentage ofcustomer order volume routed out, we calculate the percentage based on thevolume of individual customer orders, not the volume of matched trades (i.e.,only counting one side of a matched transaction). For example, we calculate twocustomer orders matched internally on our system as two customer orders matchedinternally, and we include the volume of both the buy order and the sell orderin computing our percentages of customer order volume matched internally androuted out. We calculate one customer order routed to an external market center(which will be matched with an order at that other market center) as oneoutbound trade or one customer order. We calculate one customer order routed tous from an external market center and matched with an order on our system asone inbound trade or one customer order.

 

Transactions in Nasdaqand exchange-listed securities are reported in the consolidated tape, ahigh-speed system that continuously provides last sale price and volume inlisted securities. Our handled volume is higher than our volume reported to thecentralized aggregators for inclusion in the consolidated tape for two reasons.First, we do not report trades routed to another market center to thecentralized aggregators of this data. Instead, the destination market centerreports these trades. For example, if a customer’s 10,000 share buy order isrouted to another market center for execution, our handled volume will be10,000 shares, but we will not report the trade. Second, our handled volumeincludes odd lot transactions, generally defined as trades of fewer than 100shares, which, by rule, we do not report to the centralized aggregators forinclusion in the consolidated tape. For example, if one of our customers buys50 shares, our handled volume will be 50 shares but we will not report thistrade.

 

For purposes ofcalculating our market share, we use the volume of shares that are handled onthe Archipelago system (as described above) as the numerator, and the aggregatevolume of shares reported by all securities exchanges and associations in theconsolidated tape as the denominator. Our market share may be expressed as:

 

Number of shareshandled on the Archipelago system

Overall marketvolume as reported in the consolidated tape

 

As an alternative methodof calculating market share, we could include in the numerator of the aboveformula only transactions that we report in the consolidated tape. This wouldexclude shares routed to other market centers and odd-lot transactions from ourmarket share calculation.

 

For purposes ofcalculating the percentage of handled shares matched internally or routed out,we count all shares that are “handled” on the Archipelago system as describedabove. We count every transaction handled by the Archipelago system once; we donot count both sides of any transaction. Therefore, if five trades are executedon ArcaEx for 10,000 shares each, three of which are routed out, we will havehandled 50,000 shares and our percentage of that share volume matchedinternally would be 40% and routed out would be 60%.

 

Alternatively, for thepurpose of calculating the percentage of customer order volume matchedinternally or routed out, we count each customer order exactly once. If twocustomers’ orders are matched within our internal liquidity pool, we count thevolume of both the buy order and the matched sell order. On the other hand, ifa customer’s order is routed to another market center and matched with an orderposted at that other market center, we count only the volume of the orderrouted out.

 

20

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**Resultsof Operations**

 

**Three Months Ended June 30, 2005 versus ThreeMonths Ended June 30, 2004**

 

The following table setsforth our consolidated statements of operations data for the periods presented:

 
| ** **                          | ** ** | ** **              | ** ** | ** **    | ** ** | **Amount**        | ** ** | **Percentage**             | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------|------------|-------------------------|------------|---------------|------------|-------------------|------------|----------------------------|------------|------------|------------|------------|------------|
| ** **                          | ** ** | **Three months**        | ** ** | **Change**    | ** ** | **Change**        | ** ** | ** **                 | ** ** | ** ** | ** ** |
| ** **                          | ** ** | **ended June 30,** | ** ** | **Favorable** | ** ** | **Favorable**     | ** ** | **Percentage of Revenues** | ** ** |
| ** **                          | ** ** | **2004**                | ** ** | **2005**      | ** ** | **(Unfavorable)** | ** ** | **(Unfavorable)**          | ** ** | **2004**   | ** ** | **2005**   | ** ** |
| ** **                          | ** ** | **(In millions)**       | ** ** | ** **    | ** ** | ** **        | ** ** | ** **                 | ** ** |
| Revenues                            | ** ** | ** **              | ** ** | ** **    | ** ** | ** **        | ** ** | ** **                 | ** ** |
| Transaction  fees                   |       | $                       | 116.4      |          | $          | 111.8             |       | $                          | (4.6       | )          | (4.0       | )%         | 90.3       | % | 87.5 | % |
| Market  data fees                   |       | 12.4                    |       | 15.9          |       | 3.5               |       | 28.2                       | %          | 9.6        | %          | 12.4       | %          |
| Listing  fees                       |       | 0.1                     |       | 0.1           |       | —            |       | —                     | %          | 0.1        | %          | 0.1        | %          |
| Total  revenues                     |       | 128.9                   |       | 127.8         |       | (1.1              | )          | (0.9                       | )%         | 100.0      | %          | 100.0      | %          |
|                                |       |                    |       |          |       |              |       |                       |       |       |       |       |       |
| Cost  of revenues                   |       |                    |       |          |       |              |       |                       |       |       |       |       |       |
| Liquidity  payments                 |       | 48.3                    |       | 50.5          |       | (2.2              | )          | (4.6                       | )%         | 37.5       | %          | 39.5       | %          |
| Routing  charges                    |       | 22.0                    |       | 17.2          |       | 4.8               |       | 21.8                       | %          | 17.1       | %          | 13.5       | %          |
| Clearance,  brokerage and           |       |                    |       |          |       |              |       |                       |       |       |       |       |       |
| other  transaction expenses         |       | 10.8                    |       | 5.7           |       | 5.1               |       | 47.2                       | %          | 8.4        | %          | 4.5        | %          |
| Total  cost of revenues             |       | 81.1                    |       | 73.4          |       | 7.7               |       | 9.5                        | %          | 63.0       | %          | 57.5       | %          |
|                                |       |                    |       |          |       |              |       |                       |       |       |       |       |       |
| Gross  margin                       |       | 47.8                    |       | 54.4          |       | 6.6               |       | 13.8                       | %          | 37.0       | %          | 42.5       | %          |
|                                |       |                    |       |          |       |              |       |                       |       |       |       |       |       |
| Indirect  expenses                  |       |                    |       |          |       |              |       |                       |       |       |       |       |       |
| Employee  compensation and benefits |       | 10.8                    |       | 13.5          |       | (2.7              | )          | (25.0                      | )%         | 8.4        | %          | 10.6       | %          |
| Depreciation  and amortization      |       | 5.5                     |       | 5.3           |       | 0.2               |       | 3.6                        | %          | 4.3        | %          | 4.1        | %          |
| Communications                      |       | 4.6                     |       | 5.8           |       | (1.2              | )          | (26.1                      | )%         | 3.6        | %          | 4.5        | %          |
| Marketing  and promotion            |       | 2.7                     |       | 10.2          |       | (7.5              | )          | (277.8                     | )%         | 2.1        | %          | 8.0        | %          |
| Legal  and professional             |       | 3.6                     |       | 2.6           |       | 1.0               |       | 27.8                       | %          | 2.8        | %          | 2.0        | %          |
| NYSE  merger costs                  |       | —                  |       | 8.4           |       | (8.4              | )          | (100.0                     | )%         | —     | %          | 6.6        | %          |
| Occupancy                           |       | 1.0                     |       | 1.3           |       | (0.3              | )          | (30.0                      | )%         | 0.8        | %          | 1.0        | %          |
| General  and administrative         |       | 2.5                     |       | 3.5           |       | (1.0              | )          | (40.0                      | )%         | 1.9        | %          | 2.7        | %          |
| Total  indirect expenses            |       | 30.7                    |       | 50.6          |       | (19.9             | )          | (64.8                      | )%         | 23.9       | %          | 39.5       | %          |
|                                |       |                    |       |          |       |              |       |                       |       |       |       |       |       |
| Operating  income                   |       | 17.1                    |       | 3.8           |       | (13.3             | )          | (77.8                      | )%         | 13.1       | %          | 3.0        | %          |
| Interest  and other, net            |       | 0.2                     |       | 1.3           |       | 1.1               |       | 550.0                      | %          | 0.2        | %          | 1.0        | %          |
| Income  before income tax provision |       | 17.3                    |       | 5.1           |       | (12.2             | )          | (70.5                      | )%         | 13.3       | %          | 4.0        | %          |
| Income  tax provision               |       | —                  |       | 2.1           |       | (2.1              | )          | (100.0                     | )%         | —     | %          | 1.6        | %          |
| Net  income                         |       | $                       | 17.3       |          | $          | 3.0               |       | $                          | (14.3      | )          | (82.7      | )%         | 13.3       | % | 2.4 | % |

 

***Highlights***

 

Even though our totalrevenues decreased $1.1 million over the respective periods, gross margin forthe three months ended June 30, 2005 increased $6.6 million, or 13.8%, to$54.4 million compared to $47.8 million for the three months ended June 30,2004.  As a percentage of total revenues,our gross margin percentage increased to 42.5% from 37.0% for the respectiveperiods.  However, our income beforeincome tax provision declined $12.2 million, or 70.5%, from $17.3 million forthe three months ended June 30, 2004 to $5.1 million for the three monthsended June 30, 2005.  Our results of operations for the periodprimarily reflect the following principal factors:

 

*Moreliquidity posted on ArcaEx.*  For the three monthsended June 30, 2005, the percentage of customer orders matched internallyincreased to 88.9% as the percentage of shares routed to other market centersfor execution declined to 11.1%. This compares to an internal match rate of86.3% and 13.7% of customers orders routed out to other market centers forexecution for the three-month period a year ago, resulting in a change in theamount and mix of our cost of revenues:

 

•                  Liquiditypayments increased $2.2 million to $50.5 million for the three months ended June 30,2005 compared to $48.3 million for the three months ended June 30,2004.  As a percentage of total revenues, liquidity payments increased to39.5% from 37.5%.

•                  Routingcharges decreased $4.8 million to $17.2 million, or 13.5% of total revenues forthe three months ended June 30, 2005, compared to $22.0 million, or 17.1%of total revenues for the comparable period a year ago.

 

21

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•                  Clearance,brokerage and other transaction expenses decreased $5.1 million to $5.7million, or 4.5% of total revenues for the three months ended June 30,2005, compared to $10.8 million, or 8.4% of total revenues for the three month endedJune 30, 2004.

 

*Higherindirect expenses.*  Despite the $6.6 million increase inour gross margin, our income before income tax provision declinedsubstantially.  For the three monthsended June 30, 2005, total indirect expenses increased $19.9 million to$50.6 million compared to $30.7 million for the three months ended June 30,2004. During the 2005 period, we incurred $8.4 million of direct costs inrelation to our announced merger with NYSE, consisting primarily of banking,legal, and other advisory fees. We did not incur merger expenses during thesame period a year ago. In addition, for the three months ended June 30,2005, marketing and promotion expenses increased $7.5 million to $10.2 millioncompared to $2.7 million for the three months ended June 30, 2004, as aresult of management’s decision to accentuate our brand recognition advertisingefforts.

 

***Revenues***

 

Our total revenuesdeclined $1.1 million, or 0.9%, from $128.9 million for the three months ended June 30,2004 to $127.8 million for the three months ended June 30, 2005. The decline was the result of a decline intransaction fees that was partially offset by increased market data fees.  For the three months ended June 30,2005, transaction fees comprised 87.5%, market data fees comprised 12.4%, andlisting fees comprised 0.1% of our total revenues, compared to 90.3%, 9.6%, and0.1%, respectively, for the three months ended June 30, 2004.

 

Transaction fees declined$4.6 million, or 4.0%, to $111.8 million for the three months ended June 30,2005 from $116.4 million for the comparable period last year.  The total share volume traded on ArcaExincreased 6.0% to 35.6 billion shares compared to 33.6 billion shares for therespective periods.  Because there were64 trading days in the most recent quarter compared to 62 trading days in thesame quarter last year, our average daily volume increased 2.7% to 556.6million shares for the three months ended June 30, 2005 compared to 541.9million shares for the three months ended June 30, 2004.  Despite the increase in the share volume we handledperiod over period, transaction fees declined primarily as a result of the $3.5million decrease in revenues we derived from our agency brokerage servicessegment.

 

Market data feesincreased from $12.4 million for the three months ended June 30, 2004 to$15.9 million for the three months ended June 30, 2005, an increase of$3.5 million or 28.2%. Market data fees derived from trading Nasdaq-listedsecurities increased to $8.4 million from $7.2 million.  Market data fees derived from tradingAmex-listed securities increased to $6.4 million from $4.8 million. Market data fees derived from trading NYSE-listed securities increased to $1.1million from $0.4 million.

 

For the three monthsended June 30, 2005, revenues from listing fees were $0.1 million,unchanged from the three months ended June 30, 2004.

 

***Costof Revenues***

 

Our total cost ofrevenues declined to $73.4 million for the three months ended June 30,2005 from $81.1 million for the three months ended June 30, 2004, a $7.7million or 9.5% decrease.  As a percentage of total revenues, our cost ofrevenues declined to 57.5% from 63.0% for the respective periods.

 

Liquidity paymentsincreased $2.2 million, or 4.6%, to $50.5 million for the three months ended June 30,2005 compared to $48.3 million for the comparable period a year ago.  Thisincrease is attributable to (i) a 6.0% increase in our total tradingvolume, (ii) an increase in our internal match rate to 88.9% (with 11.1%routed out to other market centers for execution) from 86.3% (with 13.7% routedout to other market centers for execution), which was partially offset by (iii) alarger proportion of shares of NYSE-listed equity securities compared to ouroverall share volume traded. Our current pricing schedule for trades inNYSE-listed equity securities does not include liquidity payments.

 

Routing charges declinedto $17.2 million for the three months ended June 30, 2005 from $22.0million for the three months ended June 30, 2004, a $4.8 million or 21.8%decrease.  The decline is primarilyattributable to our increased internal match rate and the resulting reductionin routed volume as well as lower routing costs per share as a result of costmanagement initiatives, changes in trade behavior and product mix.  Although we experienced an increase of 6.0%in our total trading volume, the volume of shares routed declined 12.5% to 6.9billion shares for the three months ended June 30, 2005 compared to 7.9billion shares for the three months ended June 30, 2004.

 

Clearance, brokerage andother transaction expenses declined to $5.7 million for the three months ended June 30,2005 compared to $10.8 million for the comparable period a year ago, a $5.1million or 47.2% decrease.  Clearance,brokerage, and other expenses declined primarily as a result of the decrease inthe number of trades subject to clearing costs due to the lower percentage oforders routed out and the reduction of our clearing costs following theself-clearing of our introducing broker and routing broker businesses.

 

22

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***GrossMargin***

 

Gross margin increased $6.6million, or 13.8%, to $54.4 million for the three months ended June 30,2005 compared to $47.8 million for the three months ended June 30, 2004. As a percentage of total revenues, our gross margin percentage increased to42.5% from 37.0 % for the respective periods.  Despite declining revenues,our gross margin improved primarily as a result of the higher internal matchrate of customer orders and the greater contribution of market data fees to ourtotal revenues.

 

***IndirectExpenses***

 

Total indirect expensesincreased $19.9 million, or 64.8%, to $50.6 million for the three months ended June 30,2005 compared to $30.7 million for the three months ended June 30,2004.  Total indirect expenses increased as a percentage of total revenuesto 39.5% from 23.9% for the respective periods.  The increase was chieflyassociated with the following:

 

•                  $8.4million of direct costs incurred during the most recent quarterly period inrelation to our announced merger with NYSE, consisting primarily of banking,legal, and other advisory fees;

•                  a$7.5 million increase in marketing and promotion expenses due primarily toincreased advertising based on management’s decision to accentuate our brandrecognition efforts;

•                  a$2.7 million increase in employee compensation and benefits as a result ofincreased staffing and the employee stock-based compensation expense recordedin relation to restricted stock units granted after our August 2004 initialpublic offering. In the same period a year ago, long-term incentivecompensation consisted of stock options granted at the then estimated fairvalue of our stock for which no compensation expense was recognized due to theabsence of intrinsic value.

 

***Interest andOther***

 

Interest and other incomeand expenses increased $1.1 million to $1.3 million for the three months ended June 30,2005. The increase was primarily due to increased average cash balances andhigher interest rates on those balances.

 

***IncomeTax Provision***

 

For the three monthsended June 30, 2005, we provided for income taxes at a 41.0% combinedfederal, state and local tax rate.  Forthe three months ended June 30, 2004, we were treated as a partnershipand, as a result, all items of income, expense, gain or loss were generallyreportable on the tax returns of our members.

 

***Net Income***

 

As a result of theforegoing, we reported net income for the three months ended June 30, 2005of $3.0 million, a decrease of $14.3 million compared to the $17.3 million netincome we reported for the comparable period a year ago.

 

**Six Months Ended June 30, 2005 versus SixMonths Ended June 30, 2004**

 

The following table setsforth our consolidated statements of operations data for the periods presented:

 

23

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| ** **                                           | ** ** | ** **              | ** ** | ** **    | ** ** | **Amount**        | ** ** | **Percentage**             | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|---------------|------------|-------------------|------------|----------------------------|------------|------------|------------|------------|------------|
| ** **                                           | ** ** | **Six months**          | ** ** | **Change**    | ** ** | **Change**        | ** ** | ** **                 | ** ** | ** ** | ** ** |
| ** **                                           | ** ** | **ended June 30,** | ** ** | **Favorable** | ** ** | **Favorable**     | ** ** | **Percentage of Revenues** | ** ** |
| ** **                                           | ** ** | **2004**                | ** ** | **2005**      | ** ** | **(Unfavorable)** | ** ** | **(Unfavorable)**          | ** ** | **2004**   | ** ** | **2005**   | ** ** |
| ** **                                           | ** ** | **(In millions)**       | ** ** | ** **    | ** ** | ** **        | ** ** | ** **                 | ** ** |
| Revenues                                             |       |                    |       |          |       |              |       |                       |       |       |       |       |       |
| Transaction  fees                                    |       | $                       | 251.3      |          | $          | 230.6             |       | $                          | (20.7      | )          | (8.2       | )%         | 91.1       | % | 88.2 | % |
| Market  data fees                                    |       | 24.2                    |       | 30.7          |       | 6.5               |       | 26.9                       | %          | 8.8        | %          | 11.7       | %          |
| Listing  fees                                        |       | 0.2                     |       | 0.2           |       | —            |       | —                     | %          | 0.1        | %          | 0.1        | %          |
| Total  revenues                                      |       | 275.7                   |       | 261.5         |       | (14.2             | )          | (5.2                       | )%         | 100.0      | %          | 100.0      | %          |
|                                                 |       |                    |       |          |       |              |       |                       |       |       |       |       |       |
| Cost  of revenues                                    |       |                    |       |          |       |              |       |                       |       |       |       |       |       |
| Liquidity  payments                                  |       | 101.5                   |       | 102.4         |       | (0.9              | )          | (0.9                       | )%         | 36.8       | %          | 39.2       | %          |
| Routing  charges                                     |       | 48.5                    |       | 36.1          |       | 12.4              |       | 25.6                       | %          | 17.6       | %          | 13.8       | %          |
| Clearance,  brokerage and other transaction expenses |       | 23.4                    |       | 13.3          |       | 10.1              |       | 43.2                       | %          | 8.5        | %          | 5.1        | %          |
| Total  cost of revenues                              |       | 173.4                   |       | 151.8         |       | 21.6              |       | 12.5                       | %          | 62.9       | %          | 58.1       | %          |
|                                                 |       |                    |       |          |       |              |       |                       |       |       |       |       |       |
| Gross  margin                                        |       | 102.3                   |       | 109.7         |       | 7.4               |       | 7.2                        | %          | 37.1       | %          | 41.9       | %          |
|                                                 |       |                    |       |          |       |              |       |                       |       |       |       |       |       |
| Indirect  expenses                                   |       |                    |       |          |       |              |       |                       |       |       |       |       |       |
| Employee  compensation and benefits                  |       | 21.2                    |       | 26.0          |       | (4.8              | )          | (22.6                      | )%         | 7.7        | %          | 9.9        | %          |
| Depreciation  and amortization                       |       | 16.3                    |       | 10.7          |       | 5.6               |       | 34.4                       | %          | 5.9        | %          | 4.1        | %          |
| Communications                                       |       | 9.2                     |       | 11.3          |       | (2.1              | )          | (22.8                      | )%         | 3.3        | %          | 4.3        | %          |
| Marketing  and promotion                             |       | 4.5                     |       | 13.3          |       | (8.8              | )          | (195.6                     | )%         | 1.6        | %          | 5.1        | %          |
| Legal  and professional                              |       | 5.9                     |       | 5.7           |       | 0.2               |       | 3.4                        | %          | 2.1        | %          | 2.2        | %          |
| NYSE  merger costs                                   |       | —                  |       | 8.4           |       | (8.4              | )          | (100.0                     | )%         | —     | %          | 3.2        | %          |
| Occupancy                                            |       | 2.0                     |       | 2.8           |       | (0.8              | )          | (40.0                      | )%         | 0.7        | %          | 1.1        | %          |
| General  and administrative                          |       | 4.2                     |       | 6.6           |       | (2.4              | )          | (57.1                      | )%         | 1.5        | %          | 2.5        | %          |
| Total  indirect expenses                             |       | 63.3                    |       | 84.8          |       | (21.5             | )          | (34.0                      | )%         | 22.8       | %          | 32.4       | %          |
|                                                 |       |                    |       |          |       |              |       |                       |       |       |       |       |       |
| Operating  income                                    |       | 39.0                    |       | 24.9          |       | (14.1             | )          | (36.2                      | )%         | 14.3       | %          | 9.5        | %          |
| Interest  and other, net                             |       | 0.3                     |       | 2.2           |       | 1.9               |       | 633.3                      | %          | 0.1        | %          | 0.8        | %          |
| Income  before income tax provision                  |       | 39.3                    |       | 27.1          |       | (12.2             | )          | (31.0                      | )%         | 14.4       | %          | 10.3       | %          |
| Income  tax provision                                |       | —                  |       | 10.9          |       | (10.9             | )          | (100.0                     | )%         | —     | %          | 4.2        | %          |
| Net  income                                          |       | $                       | 39.3       |          | $          | 16.2              |       | $                          | (23.1      | )          | (58.8      | )%         | 14.4       | % | 6.1 | % |

 

***Highlights***

 

Eventhough our total revenues declined $14.2 million, or 5.2%, to $261.5 millionfrom $275.7 million for the respective periods, our gross margin for thesix months ended June 30, 2005 increased $7.4 million, or 7.2%, to $109.7million compared to $102.3 million for the six months ended June 30, 2004.  As apercentage of total revenues, our gross margin percentage increased to 41.9%from 37.1% for the respective periods.  However,our income before income tax provision declined $12.2 million, or 31.0%, from $39.3million for the six months ended June 30, 2004 to $27.1 million for thesix months ended June 30, 2005.  Ourresults of operations for the period primarily reflect the following principalfactors:

 

*Moreliquidity posted on ArcaEx.*  For the six months ended June 30,2005, the percentage of customer orders matched internally increased to 88.7% comparedto 85.9% for the six months ended June 30, 2004, and the percentage ofshares routed to other market centers for execution declined to 11.3% from14.1%, resulting in a change in the amount and mix of our cost ofrevenues:

 

•                  Liquidity payments increased $0.9 million to$102.4 million for the six months ended June 30, 2005 compared to $101.5million for the six months ended June 30, 2004.  As a percentage of total revenues, liquiditypayments increased to 39.2% from 36.8%.

•                  Routing charges decreased $12.4 million to$36.1 million for the six months ended June 30, 2005 compared to $48.5million for the six months ended June 30, 2004.  As a percentage of total revenues, routingcharges decreased to 13.8% from 17.6%.

•                  Clearance, brokerage and other transactionexpenses decreased $10.1 million to $13.3 million for the six months ended June 30,2005 compared to $23.4 million for the six months ended June 30,2004.  As a percentage of total revenues,clearance, brokerage and other transaction expenses decreased to 5.1% from8.5%.

 

*Higherindirect expenses.*  Despite the $7.4 million increase in ourgross margin, our income before income tax provision declinedsubstantially.  Total indirect expensesincreased $21.5 million to $84.8 million for the six months ended June 30,2005 compared to $63.3 million for the six months ended June 30,2004.  During the 2005 period, weincurred $8.4 million of direct costs in relation to our announced merger withNYSE, consisting primarily of banking, legal, and other advisory fees. We didnot incur merger expenses during the same period a year ago. In addition, forthe six months ended June 30, 2005, marketing and promotion expensesincreased $8.8 million to $13.3 million compared to $4.5 million for the sixmonths ended June 30, 2004, as a result of management’s decision

 

24

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to accentuate our brandrecognition advertising efforts.

 

***Revenues***

 

Ourtotal revenues declined $14.2 million, 5.2%, from $275.7 million for the sixmonths ended June 30, 2004 to $261.5 million for the six months ended June 30,2005.  The decline was the result of adecline in transaction fees that was partially offset by increased market datafees.  For the six months ended June 30,2005, transaction fees comprised 88.2%, market data fees comprised 11.7%, andlisting fees comprised 0.1% of our total revenues, compared to 91.1%, 8.8%, and0.1%, respectively, for the six months ended June 30, 2004.

 

Transactionfees declined $20.7, or 8.2%, to $230.6 million for the six months ended June 30,2005 from $251.3 million for the six months ended June 30, 2004.  The 0.2% increase of the total share volume tradedon ArcaEx from 71.3 billion shares in the 2004 to 71.5 billion shares in the2005 period is primarily attributable to the fact that the most recentsix-month period had 125 trading days compared to 124 trading days for the sameperiod a year ago.  Our average dailyvolume declined 0.7% to 571.6 million shares for the six months ended June 30,2005 compared to 575.4 million shares for the six months ended June 30,2004.  Despite the slight increase in theshare volume we handled period over period, transaction fees decreased as a resultof a reduction in our average gross revenue per share. This reduction was theresult of changes in our product mix - or the relative amounts ofNasdaq-listed, AMEX-listed, NYSE-listed, and ArcaEx-listed securities traded onArcaEx - and the lower contribution from our agency brokerage services segment.

 

Marketdata fees increased from $24.2 million for the six months ended June 30,2004 to $30.7 million for the six months ended June 30, 2005, an increaseof $6.5 million or 26.9%. Market data fees derived from trading Nasdaq-listedsecurities increased to $16.6 million from $14.8 million.  Market data fees derived from tradingAmex-listed securities increased to $12.3 million from $8.6 million.  Market data fees derived from tradingNYSE-listed securities increased to $1.8 million from $0.8 million.

 

Forthe six months ended June 30, 2005, revenues from listing fees were $0.2million, unchanged from the six months ended June 30, 2004.

 

***Cost of Revenues***

 

Ourtotal cost of revenues declined to $151.8 million for the six months ended June 30,2005 from $173.4 million for the six months ended June 30, 2004, a $21.6million or 12.5% decrease.  As apercentage of total revenues, our cost of revenues declined to 58.1% from 62.9%for the respective periods.

 

Liquiditypayments increased $0.9 million, or 0.9%, to $102.4 million for the six monthsended June 30, 2005 compared to $101.5 million for the comparable period ayear ago.  The increase is mainlyattributable to (i) a 0.2% increase in our total trading volume, (ii) anincrease in our internal match rate to 88.7% (with 11.3% routed out to othermarket centers for execution) from 85.9% (with 14.1% routed out to other marketcenters for execution), which was partially offset by (iii) a largerproportion of shares of NYSE-listed equity securities compared to our overallshare volume traded. Our current pricing schedule for trades inNYSE-listed equity securities does not include liquidity payments.

 

Routingcharges declined to $36.1 million for the six months ended June 30, 2005 comparedto $48.5 million for the six months ended June 30, 2004, a $12.4 millionor 25.6% decrease.  This decline isprimarily attributable to our increased internal match rate and the resultingreduction in routed volume as well as lower routing costs per share as aresult of cost management initiatives, changes in trade behavior and productmix. Although we experienced anincrease of 0.2% in our total trading volume, the volume of shares routeddeclined 17.8% to 14.3 billion shares for the six months ended June 30,2005 compared to17.4 billion shares for the six months ended June 30,2004.

 

Clearance,brokerage and other transaction expenses declined to $13.3 million for the sixmonths ended June 30, 2005 from $23.4 million for the comparable period ayear ago, a $10.1 million or 43.2% decrease. Clearance, brokerage, andother expenses declined primarily as a result of the decrease in the number oftrades subject to clearing costs due to the lower percentage of orders routedout and the reduction of our clearing costs following the self-clearing of ourintroducing broker and routing broker businesses.

 

***Gross Margin***

 

Grossmargin increased $7.4 million, or 7.2%, to $109.7 million for the six monthsended June 30, 2005 from $102.3 million for the six months ended June 30,2004.  As a percentage of total revenues,our gross margin percentage increased to 41.9% from 37.1% for the respectiveperiods.  Despite declining revenues, ourgross margin improved primarily as a result of the higher internal matchrate of customer orders and the greater contribution of market data fees to ourtotal revenues.

 

25

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***IndirectExpenses***

 

Total indirect expensesincreased $21.5 million, or 34.0%, to $84.8 million for the six months ended June 30,2005 compared to $63.3 million for the six months ended June 30,2004.  Total indirect expenses increased as a percentage of total revenuesto 32.4% from 22.8% for the respective periods.  The increase was chieflyassociated with the following:

 

•                  a$8.8 million increase in marketing and promotion expenses due primarily toincreased advertising based on management’s decision to accentuate our brandrecognition efforts during the three-month period ended June 30, 2005;

•                  $8.4million of direct costs incurred during the most recent quarterly period inrelation to our announced merger with NYSE, consisting primarily of banking,legal, and other advisory fees;

•                  a$4.8 million increase in employee compensation and benefits as a result ofincreased staffing and the employee stock-based compensation expense recordedin relation to restricted stock units granted after our August 2004 initialpublic offering. In the same period a year ago, long-term incentivecompensation consisted of stock options granted at the then estimated fairvalue of our stock for which no compensation expense was recognized due to theabsence of intrinsic value;

•                  a$2.4 million increase in general and administrative expenses primarily inrelation to higher insurance premiums and additional expenses incurred as apublic company; and

•                  a$2.1 million increase in communications expense that is mainly the result ofour operation of a data center in New Jersey since the third quarter of 2004.

 

Theaggregate $26.5 million effect of these increases was partially offset by a$5.6 million reduction of depreciation and amortization expenses.  In June 2003, we determined that certainsoftware and computer equipment would be retired by March 31, 2004 and,therefore, we accelerated depreciation on these assets. During the first quarterof 2004, we recorded an additional $3.9 million in relation to suchacceleration.

 

***Interest andOther***

 

Interest and other incomeand expenses increased $1.9 million to $2.2 million for the six months ended June 30,2005. The increase was primarily due to increased average cash balances andhigher interest rates on those balances.

 

***IncomeTax Provision***

 

For the six months ended June 30,2005, we provided for income taxes at a 40.2% combined federal, state and localtax rate.  For the six months ended June 30,2004, we were treated as a partnership and, as a result, all items of income,expense, gain or loss were generally reportable on the tax returns of ourmembers.

 

***Net Income***

 

As a result of theforegoing, we reported net income for the six months ended June 30, 2005of $16.2 million, a decrease of $23.1 million compared to the $39.3 million netincome we reported for the comparable period a year ago.

 

**Liquidityand Capital Resources**

 

Historically, our primarysources of liquidity have been cash provided by operations and proceedsgenerated from the sale of our common equity and preferred shares. On August 19,2004, we completed the sale of 6,325,000 shares of common stock at $11.50 pershare in our IPO, for which we received net proceeds of $67.6 million. Weincurred approximately $6.8 million in expenses related to our IPO. Certainformer members of Holdings LLC sold another 6,325,000 million shares to thepublic, for which we received no proceeds. We intend to use the net proceeds fromour IPO for general corporate purposes, including providing additional fundsfor our operations and to expand and diversify our products and serviceofferings.

 

On January 3, 2005,we entered into a definitive agreement (which was amended and restated on July 22,2005) to acquire PCXH and all of its wholly-owned subsidiaries for a purchaseprice equal to the total dollar value of all shares of Archipelago common stockheld by PCXH (currently 1,645,415 shares), either directly or indirectlythrough subsidiaries at closing, plus $17.0 million.  The value of the all shares of Archipelagocommon stock will be determined using the average closing price per share ofArchipelago’s common stock for the ten trading days immediately preceding thedate of the closing of the transaction. This purchase price is subject toworking capital and certain other possible adjustments.

 

In connection with ourcontemplated merger with NYSE, at closing, we will be expected to have at least$150.0 million in cash.  In addition, we anticipate that we will incursubstantial merger expenses consisting primarily of legal, accounting and otheradvisory fees. As of June 30, 2005, we had incurred merger costs ofapproximately $8.4 million, including $3.5 million to be paid to a stockholder uponconsummation of our merger with NYSE for services performed in relation to theproposed transaction.

 

Our principal liquidityrequirements are for working capital, capital expenditures and generalcorporate purposes. Our capital expenditures have historically relatedprimarily to developing our trading platforms, which included investments insoftware development and hardware, as well as building our data centers. Inaddition to the anticipated acquisition of PCXH, we estimate that our capitalexpenditures for 2005 will be approximately $23.0 million for continueddevelopment of our trading platforms, and the

 

26

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development of newproducts and services, including market data products.

 

As of June 30, 2005,we had cash and cash equivalents of $207.0 million, an increase of $29.2million as compared to December 31, 2004. For the six months ended June 30,2005, we provided cash of $37.4 million from our operating activities,consisting of net income of $16.2 million and the $21.2 million net effect ofnon-cash items and changes in working capital. We used $8.5 million ininvesting activities to purchase fixed assets and develop software, used $1.0million to make principal payments under a capital lease obligation andreceived $1.2 million in proceeds from the exercise of stock options by ouremployees.

 

We believe that cashflows from operating activities, together with net proceeds from our IPO,should be sufficient for us to fund our current operations for at least thenext twelve months. If this proves insufficient, we intend to seek additionalfinancing in the credit or capital markets, although we may be unsuccessful inobtaining additional financing on acceptable terms or at all.

 

Our broker-dealer subsidiariesare subject to regulatory requirements intended to ensure their respectivegeneral financial soundness and liquidity, which require that they comply withcertain minimum capital requirements. These regulations, which differ in theUnited States, the United Kingdom and Canada—the three countries in which ourbroker-dealer subsidiaries do business—generally prohibit a broker-dealersubsidiary from repaying borrowings from us or our affiliates, paying cashdividends, making loans to us or our affiliates or otherwise entering intotransactions that would result in a significant reduction in its regulatory netcapital position without prior notification or approval of its principalregulator. Our capital structure is designed to provide each of our subsidiarieswith capital and liquidity consistent with its business and regulatoryrequirements.

 

**Seasonality**

 

Our business experiencesseasonal fluctuations, reflecting reduced trading activity during summermonths, particularly in August.

 

**Item 3. Quantitative and QualitativeDisclosures About Market Risk**

 

We provided a discussionof our market risk in Item 7A of our Annual Report on Form 10-K for theyear ended December 31, 2004. For the three and six months ended June 30,2005, there was no substantive change in our market risk.

 

**Item 4. Controls and Procedures**

 

**Evaluationof Disclosure Controls and Procedures**

 

As of the end of theperiod covered by this report, an evaluation was carried out under thesupervision and with the participation of our management, including our ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of our disclosure controls and procedures. Based upon thatevaluation, the Chief Executive Officer and Chief Financial Officer concluded thatthe design and operation of these disclosure controls and procedures wereeffective.  No significant changes were made in our internal controls orin other factors that could significantly affect these controls subsequent tothe date of their evaluation.

 

**PART II – Other Information**

 

**Item 1. Legal Proceedings**

 

Thefollowing is a description of developments with regard to litigation mattersrelating to our Company and our Chief Executive Officer that were previouslyreported in our Annual Report on Form 10-K for the year ended December 31,2004,  as well as new litigation matters.

 

***Matters Relatingto Our Company***

 

OnMay 13, 2005, William Tipton Caldwell, JR., Morton B. Joselson and John F.Horn filed a class action law suit in the Supreme Court of the State of NewYork against the New York Stock Exchange, Inc., Archipelago Holdings andvarious other defendants, including The Goldman Sachs Group, Inc. (“GoldmanSachs”), in connection with the proposed merger of the NYSE and Archipelagoannounced on April 20, 2005.  Eachof the plaintiffs is an owner of a seat on the New York Stock Exchange.  In their complaint, the plaintiffs alleged: (i) breachof fiduciary duties against all defendants except Archipelago Holdings andGoldman Sachs; and (ii) aiding and abetting a breach of fiduciary dutyagainst Archipelago Holdings and Goldman Sachs. On July 27, 2005, however, the parties entered a motion under whichthe plaintiffs’ claims against Archipelago Holdings were dismissed withoutprejudice.

 

***Matters Relatingto Mr. Putnam***

 

*LozmanLitigation.*  On July 25, 2005, with respect to theLozman Litigation previously reported in our Annual Report on Form 10-Kand other filings with the SEC,  thecourt entered a final judgment in favor of Mr. Putnam and the otherdefendants on all counts including the plaintiffs’ claim of usurpation ofcorporate opportunity and breach of fiduciary duty.

 

27

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Inaddition to the matters described in our Annual Report on Form 10-K forthe year ended December 31, 2004, from time to time we are involved invarious legal proceedings arising in the ordinary course of our business. We donot believe, based on currently available information, that the results of anyof these proceedings will have a material adverse effect on our operatingresults or financial condition.

 

**Item 2. Unregistered Sales of EquitySecurities and Use of Proceeds**

 

(a) UnregisteredSale of Equity Securities

 

Between April 1,2005 and June 30, 2005, we granted: (i) 111,967 restricted stockunits to certain of our officers and key employees; and (ii) 6,731restricted stock units to our non-employee directors under our 2004 StockIncentive Plan. These transactions were effected under Rule 701 of theSecurities Exchange Act of 1933, as amended, as transactions by an issuer undercompensatory benefit plans and contracts relating to compensation within theparameters required by Rule 701.

 

* (b) Useof Proceeds*

 

All of the net initialpublic offering proceeds remain invested in short-term marketable securitiespending application of the funds to general corporate purposes. There has beenno material change in the planned use of the initial public offering proceedsas described in our final Prospectus dated August 12, 2004 filed with theSEC pursuant to Rule 424(b).

 

**Item 3. Defaults Upon SeniorSecurities**

 

None.

 

**Item 4. Submission of Matters to aVote of Security Holders**

 

The2005 annual meeting of shareholders of Archipelago Holdings, Inc. was heldon May 10, 2005.  Proxies forthe Annual Meeting were solicited pursuant to Regulation 14 under theSecurities Exchange Act of 1934 and there was no solicitation in opposition tothe Company’s nominees for election as directors. All nine nominees named inthe Company’s proxy statement were elected to serve as directors for a one-yearterm expiring in 2006.  The matters voted upon at the meetingand the votes cast with respect to such matters are as follows:

 

***Election of Directors***

 
| **Nominee**            | ** ** | **Votes For** | ** ** | **Votes Withheld** | ** ** |
|------------------------|------------|---------------|------------|--------------------|------------|
| ** **             | ** ** | ** **    | ** ** | ** **         | ** ** |
| Gerald  D. Putnam      |       | 35,984,493    |       | 195,537            |       |
| Richard  C. Breeden    |       | 36,100,824    |       | 79,206             |       |
| Phillip  D. DeFeo      |       | 36,141,339    |       | 38,691             |       |
| William  E. Ford       |       | 36,160,039    |       | 19,991             |       |
| James  J. McNulty      |       | 36,159,027    |       | 21,003             |       |
| George  Muñoz     |       | 36,132,851    |       | 47,179             |       |
| Michael  J. Passarella |       | 36,160,139    |       | 19,891             |       |
| Stuart  M. Robbins     |       | 36,160,139    |       | 19,891             |       |
| Robert  G. Scott       |       | 36,160,139    |       | 19,891             |       |

 

***Ratification ofthe appointment of Ernst & Young as the Company’s independentregistered public accountants for the fiscal year ending December 31, 2005***

 
| ** **      | ** ** | **Votes**  | ** ** |
|-----------------|------------|------------|------------|
| For             |       | 35,810,286 |       |
| Against         |       | 367,544    |       |
| Abstain         |       | 2,200      |       |
| Cede  Non-Votes |       | 0          |       |

 

**Item 5. Other Information**

 

The audit committee ofour Board of Directors approved all of the non-audit services performed byErnst & Young LLP, our independent registered public accountants,during the period covered by this report.

 

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**Item 6. Exhibits**

 

**(a) Exhibits**

 
| 2.1    |   | Exchange Agreement,  dated as of January 17, 2002, among Archipelago Holdings, L.L.C.,  REDIBook ECN L.L.C. and the parties named therein. Incorporated by reference  to the corresponding Exhibit to the Registrant’s registration statement  on Form S-1(No.333-113226).                                                                                                                                                                                                                                                                                                                                                                                     |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 2.2    |   | Contribution Agreement,  dated as of November 12, 2003, between Archipelago Holdings, L.L.C.  and GAP Arca Holdings, Inc. Incorporated by reference to the  corresponding Exhibit to the Registrant’s registration statement on Form S-1(No.333-113226).                                                                                                                                                                                                                                                                                                                                                                                                  |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 2.3    |   | Agreement and Plan of  Merger, dated as of February 27, 2004, between Archipelago Holdings, L.L.C.  and GAP Archa Holdings, Inc. Incorporated by reference to the  corresponding Exhibit to the Registrant’s registration statement on Form S-1(No.333-113226).                                                                                                                                                                                                                                                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 2.4    |   | Letter Agreement, dated  February 27, 2004, among GAP-W, L.L.C., Archipelago Holdings, L.L.C.  and GAP Archa Holdings, Inc. Incorporated by reference to the  corresponding Exhibit to the Registrant’s registration statement on Form S-1(No.333-113226).                                                                                                                                                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 2.5    |   | Contribution Agreement,  dated July 12, 2000, among Archipelago Holdings, L.L.C., Pacific  Exchange, Inc. and PCX Equities, Inc. Incorporated by reference to  the corresponding Exhibit to the Registrant’s registration statement on Form S-1(No.333-113226).                                                                                                                                                                                                                                                                                                                                                                                      |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 2.6    |   | Agreement and Plan of  Merger, dated January 3, 2005, among Archipelago Holdings, Inc.,  New Apple Acquisitions Corporation and PCX Holdings, Inc.  Incorporated by reference to the corresponding Exhibit to the Registrant’s  Form 8-K filed with the SEC on January 4, 2005.                                                                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 2.7    |   | Agreement and Plan of  Merger dated as of April 20, 2005, by and among the New York Stock  Exchange, Inc., Archipelago Holdings, Inc., and such other parties  that become signatories thereto pursuant to the terms thereof. Incorporated  by reference to the corresponding Exhibit to the Registrant’s report on Form 8-K  filed with the SEC on April 26, 2005                                                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 2.8    |   | Amended and Restated  Agreement and Plan of Merger, dated July 22, 2005, among Archipelago  Holdings, Inc., New Apple Acquisitions Corporation and PCX Holdings, Inc.  Incorporated by reference from Exhibit 2.1 to the Registrant’s Form 8-K  filed with the SEC on July 22, 2005.                                                                                                                                                                                                                                                                                                                                                                 |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 2.9    |   | Amended  and Restated Agreement and Plan of Merger dated as of July 20, 2005 by  and among New York Stock Exchange, Inc., a New York Type A  not-for-profit corporation, Archipelago Holdings, Inc., a Delaware  corporation, NYSE Group, Inc., a Delaware corporation, NYSE Merger Sub  LLC, a New York limited liability company, NYSE Merger Corporation Sub, Inc.,  a Delaware corporation, and Archipelago Merger Sub, Inc., a Delaware  corporation, filed as Exhibit 2.1 to Registration Statement No. 333-126780  of the NYSE Group, Inc. on Form S-4 filed on July 21, 2005  which is incorporated herein by reference. |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 3.1    |   | Form of  Certificate of Incorporation of Archipelago Holdings, Inc. Incorporated  by reference to the corresponding Exhibit to the Registrant’s  registration statement on Form S-1(No.333-113226).                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 3.2    |   | Form of Bylaws of  Archipelago Holdings, Inc. Incorporated by reference to the  corresponding Exhibit to the Registrant’s registration statement on Form S-1(No.333-113226).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 3.3    |   | Ninth Amended and  Restated Limited Liability Company Agreement of Archipelago  Holdings, L.L.C. Incorporated by reference to the corresponding Exhibit to  the Registrant’s registration statement on Form S-1(No.333-113226).                                                                                                                                                                                                                                                                                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 3.4    |   | Amendment No.1 to Ninth  Amended and Restated Limited Liability Company Agreement of Archipelago  Holdings, L.L.C. Incorporated by reference to the corresponding Exhibit to  the Registrant’s registration statement on Form S-1(No.333-113226).                                                                                                                                                                                                                                                                                                                                                                                                                   |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
| 4.1    |   | Specimen Certificate of  Common Stock. Incorporated by reference to the corresponding Exhibit to  the Registrant’s registration statement on Form S-1(No.333-113226).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |

 

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| 4.2    |   | Registration Rights  Agreement, dated November 12, 2003, among Archipelago  Holdings, L.L.C., General Atlantic Partners 77, L.P., GAP Coinvestment  Partners II, L.P., GapStar, L.L.C., GAPCO GmbH & Co. KG, GAP-W,  L.L.C., GAP Archa Holdings,  Inc., and the Class A Members of the  Archipelago Holdings, L.L.C. and the affiliates of certain of such Class A  Members. Incorporated by reference to the corresponding Exhibit to the  Registrant’s registration statement on Form S-1(No.333-113226). |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.1   |   | Letter Agreement  between Goldman Sachs & Co. and Archipelago Holdings, Inc.  Incorporated by reference to the corresponding Exhibit to the Registrant’s  Form 8-K filed with the SEC on January 4, 2005.                                                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.2   |   | Annual Director  Compensation Agreement. Incorporated by reference from Exhibit 10.1 to  the Registrant’s Form 8-K filed with the SEC on February 3, 2005.                                                                                                                                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.3   |   | Form Employee  Restricted Stock Unit Award Agreement. Incorporated by reference from Exhibit 10.1  to the Registrant’s Form 8-K filed with the SEC on February 10,  2005.                                                                                                                                                                                                                                                                                                                                                                |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 10.4   |   | Letter Agreement  between Goldman, Sachs & Co. and Archipelago Holdings, Inc.  Incorporated by reference to the corresponding Exhibit to the Registrant’s  report on Form 8-K filed with the SEC on April 26, 2005                                                                                                                                                                                                                                                                                                              |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 31.1   |   | Rule 13a-14(a) Certification  (CEO).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 31.2   |   | Rule 13a-14(a) Certification  (CFO).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
| 32.1   |   | Section 1350  Certifications.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                |

 

**Signature**

 

Pursuant to therequirements of the Securities Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned, thereunto dulyauthorized, on August 15, 2005.

 
|   | ARCHIPELAGO  HOLDINGS, INC. |
|--------|----------------------------------|
|   |                             |   |
|   |                             |   |
|   | By:                              | /s/  NELSON  CHAI |   |
|   |                             | Nelson Chai Chief Financial Officer |

 

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