**UNITED STATES SECURITIES ANDEXCHANGE COMMISSION**

**Washington,DC  20549**

 

**FORM 10-K**

 
| **ý**                                            | **ANNUAL REPORT PURSUANT TO SECTION 13 OR  15(d)**     |
|-------------------------------------------------------|-------------------------------------------------------------|
| **OF THE SECURITIES EXCHANGE ACT OF 1934**            |
|                                                  |
| **for the  fiscal year ended December 31, 2004** |
|                                                  |
| **OR**                                                |
|                                                  |
| **o**                                                 | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d)** |
| **OF THE SECURITIES EXCHANGE ACT OF 1934**            |
| **(NO FEE  REQUIRED)**                                |

 

**For thetransition period from                   to                   **

 

**COMMISSIONFILE NUMBER:  001-32419**

 

**optionsXpressHoldings, Inc.**

(Exactname of registrant as specified in its charter)

 
| **Delaware**                                                    |       | **20-1444525**                                             |
|-----------------------------------------------------------------|------------|------------------------------------------------------------|
| (State or  other jurisdiction of incorporation or organization) |       | (I.R.S.  Employer Identification No.)                      |
|                                                            |       |                                                       |
| **39 S.  LaSalle, Suite 220**                                   |       |                                                       |
| **Chicago,  Illinois 60603**                                    | ** ** | **(312)  630-3332**                                        |
| (Address of  Principal Executive Offices, including Zip Code)   |       | (Registrant’s  Telephone Number, Including Area Code) |

 

Securities Registered Pursuantto Section 12(b) of the Act:**Common Stock, Par Value $.0001 Per Share**

 

Securities Registered Pursuantto Section 12(g) of the Act:**None**

 

Indicate by check mark whether the Registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Actof 1934 during the preceding 12 months (or for such shorter period that it wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes oNo ý

 

Indicate by check mark if disclosure of delinquent filers pursuant toItem 405 of Regulation S-K is not contained herein, and will not be contained,to the best of the Registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K.  ý

 

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

 

As of March 21, 2005, there were 61,723,907 shares ofoptionsXpress Common Stock $0.0001 par value outstanding. The aggregate marketvalue of the voting stock held by non-affiliates of the registrant wasapproximately $342,977,020 based on the closing sale price of such stock asreported by the Nasdaq National Market on March 22, 2005, assuming that allshares beneficially held by executive officers and members of the registrant’sBoard of Directors are shares owned by “affiliates,” a status which each of theexecutive officers and directors may individually disclaim.

 

**DOCUMENTSINCORPORATED BY REFERENCE**

 

None

 

 

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**TABLE OF CONTENTS**

 
| PART I                                                                                                   |   |
|----------------------------------------------------------------------------------------------------------|--------|
| ITEM 1. BUSINESS                                                                                         |   |
| ITEM 2. PROPERTIES                                                                                       |   |
| ITEM 3. LEGAL PROCEEDINGS                                                                                |   |
| ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF  SECURITY HOLDERS                                             |   |
| PART II                                                                                                  |   |
| ITEM 5. MARKET FOR THE REGISTRANT’S COMMON  EQUITY AND RELATED STOCKHOLDER MATTERS                  |   |
| ITEM 6. SELECTED FINANCIAL DATA                                                                          |   |
| ITEM 7. MANAGEMENT’S DISCUSSION AND  ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS      |   |
| ITEM 7A. QUANTITATIVE AND QUALITATIVE  DISCLOSURES ABOUT MARKET RISK                                     |   |
| ITEM 8. FINANCIAL STATEMENTS AND  SUPPLEMENTARY DATA                                                     |   |
| ITEM 9. CHANGES IN AND DISAGREEMENTS WITH  ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE            |   |
| ITEM 9A. CONTROLS AND PROCEDURES                                                                         |   |
| PART  III                                                                                                |   |
| ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS  OF THE REGISTRANT                                             |   |
| ITEM 11. EXECUTIVE COMPENSATION                                                                          |   |
| ITEM 12. SECURITY OWNERSHIP OF CERTAIN  BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |   |
| ITEM 13. CERTAIN RELATIONSHIPS AND RELATED  TRANSACTIONS                                                 |   |
| ITEM 14. PRINCIPAL ACCOUNTANT FEES AND  SERVICES                                                         |   |
| PART IV                                                                                                  |   |
| ITEM 15. EXHIBITS, FINANCIAL STATEMENT  SCHEDULES, AND REPORTS ON FORM 8-K                               |   |
| SIGNATURES                                                                                               |   |
| REPORT OF INDEPENDENT REGISTERED PUBLIC  ACCOUNTING FIRM                                                 |   |
| CONSOLIDATED STATEMENTS OF OPERATIONS                                                                    |   |
| CONSOLIDATED STATEMENTS OF FINANCIAL  CONDITION                                                          |   |
| CONSOLIDATED STATEMENT OF CHANGES IN  STOCKHOLDERS’ EQUITY                                          |   |
| CONSOLIDATED STATEMENTS OF CASH FLOWS                                                                    |   |
| NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                                                               |   |
| EX-3.1 AMENDED AND RESTATED CERTIFICATE OF  INCORPORATION                                                |   |
| EX-14.1 CODE OF ETHICS                                                                                   |   |
| EX-23.1 CONSENT OF ERNST & YOUNG LLP                                                                 |   |
| EX-31.1  SECTION 302 CERTIFICATION OF THE CEO                                                       |   |
| EX-31.2 SECTION 302 CERTIFICATION OF  THE CFO                                                       |   |
| EX-32.1 SECTION 906 CERTIFICATION OF  THE CEO AND THE CFO                                           |   |

 

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**PARTI**

 

**ITEM1. BUSINESS**

 

**Overview**

 

optionsXpress offers acomprehensive suite of brokerage services for stock, mutual fund, option andfixed-income product investors. We have been recognized as offering the leadingonline retail brokerage platform for the rapidly expanding listed equityoptions market, based on the quality of our proprietary technology and ourcustomer experience. We were selected by *Forbes*as “Best of the Web, Favorite Options Site” in 2004, by *Barron’s* as “Best Online Broker” in 2003and 2004, and by *SmartMoney* as “BestDiscount Broker” in 2004.  We commenceddoing business as optionsXpress, Inc. in February 2000 and opened ourfirst customer account in December 2000. Since that time, we have grown toover 100,000 customer accounts. We formed a holding company, optionsXpressHoldings, Inc., in June 2004 to provide us with the flexibility to, amongother things, engage in future acquisitions of complementary businesses,products and technologies.

 

Our brokerage platformreflects the combination of our advanced technology and highly-responsivecustomer service. Our innovative browser-based technology delivers an array ofdifferentiating trading tools, allowing both retail and professional investorsto identify, analyze and execute a wide range of investment strategies. Many ofthese internally developed tools, which enhance our customers’ experience, arenot available from other online or full service brokers. In addition, ourreal-time customer service approach, featuring what we call “point of contactresolution” designed to ensure that customer questions are answered quickly andduring the initial contact, yields a high degree of customer satisfaction andloyalty.

 

We opened our first customeraccount in December 2000. Since that time, we have grown to over 100,000customer accounts. Our option trades represented approximately 3% of all listedU.S. options volume for the year ended December 31, 2004. We believe thismakes us one of the largest retail online options brokers. Our revenue consistsprimarily of commissions from customers’ trades of options, stocks, mutualfunds and fixed-income products. For the year ended December 31, 2004, ourdaily average revenue trades, which are our total revenue-generating trades fora period divided by the number of trading days in that period, wereapproximately 13,600, compared to approximately 7,600 for the year ended December 31,2003. Option trades represent approximately 79% of our customers’ trades, withapproximately 20% coming from stocks and 1% from mutual funds and fixed-incomeproducts.

 

Our business generatesstrong cash flows and wide margins compared to many of our competitors. Ourexpense structure is largely variable based on commissions generated andbenefits from our relatively low account acquisition cost and loyal customerbase. In addition, all of our tools and services are offered online,eliminating the cost of maintaining retail locations. The option tradingportion of our business generates a recurring revenue stream because whenoptions expire, investors need to acquire new positions if they wish to stayinvested. We have experienced growth in revenue and market share every yearsince inception and have been net income and cash flow positive since the firstquarter of 2002. We generated $93.1 million of revenue for the year ended December 31,2004 with $52.2 million of income before income taxes and$31.2 million of net income.

 

**Market Opportunity**

 

Approximately 15 million households have onlinebrokerage accounts (13% of all U.S. households), although nearly 70% of suchhouseholds execute fewer than five trades per year. The number of householdswith online brokerage accounts is forecasted to increase by 11.9% per year toapproximately 26 million by 2008 (22% of all U.S. households). The totalU.S. listed options market has grown by 22.5% per year over the past10 years. Despite this growth, it is estimated that only 9% of onlineaccounts are authorized to trade options.

 

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**Growth Strategy**

 

***Growing Share of GrowingMarket — Retail Online Options***

 

We have generated rapidgrowth since inception by appealing to the growing retail options market. Weaim to continue to expand our customer base by both gaining market share inthis market and by accelerating the growth of retail options trading generally.Our strategy for gaining market share includes making effective use of ourcustomer-driven online brokerage platform and implementing our targetedmarketing strategy. To accelerate the growth of options trading, we willcontinue to cultivate new retail options investors by making options tradingmore intuitive and accessible and through our educational initiatives.

 

***Increased Penetration in LargerMarkets — Retail Online Stocks, Mutual Funds and Fixed-Income Products***

 

We plan to continuepenetrating the much larger stock, mutual fund and fixed-income markets. Thekey components of our platform that have made us successful in the optionsmarkets are also applicable to these other markets. Furthermore, sincecustomers who trade options often trade the underlying securities, we haveample opportunity to cross-sell stocks, mutual funds and fixed-income products.In addition, there are significant opportunities for us to expand into thefutures, foreign exchange and other derivative markets where our technology canbe easily adapted.

 

***brokersXpress — Expansion intoProfessional Advisor and Institutional Markets***

 

Launched in March 2004,our brokersXpress subsidiary has allowed us to expand beyond the self-directedinvestor market. brokersXpress offers an extension of our optionsXpressplatform geared towards independent registered representatives and registeredinvestment advisors. We offer these professionals a complete, easy-to-set-upaccount and execution management platform including all of the features of ourretail platform. Industry-wide, total assets under management by theseprofessionals have grown at a rate of approximately 19% per year in the lastsix years to the current level of over $800 billion. While still at anearly stage, we aim to continue to expand the distribution of our platform toinstitutional investors such as hedge funds and money managers.

 

***International Expansion***

 

We intend to continueexpanding our international customer base through cost-effective targeting ofonline customers in economically and legally compatible foreign jurisdictionswhere there is an interest in accessing U.S. markets. We also plan to continuepartnering with foreign-registered brokers who want to offer their customersaccess to U.S. markets.

 

**Our Brokerage Platform**

 

We have developed anaward-winning, comprehensive and technologically advanced, yet easy-to-usebrokerage platform. Our software is empowering, efficient and user-friendly:

 

•                  We empower our customers by making accessiblecutting-edge position management and order execution technology, advancedanalytical tools, education and real-time financial information from any webbrowser.

•                  Our software was designed to ensure anefficient customer experience, beginning with a highly automated accountopening process and ending with fast trade execution and thorough, real-timeposition monitoring.

•                  Our user-friendly interface providesinteractive real-time views of account balances, positions, profits or lossesand buying power to enable our customers to more easily make informedinvestment decisions. Customers are able to access all features from any webbrowser without downloading software.

 

The end result is a highlycustomizable platform best represented by our “Three E’s” customer-centricapproach:

 

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Our brokerage platformcaters to both novice and expert investors. Novice investors are provided with,among other things, both educational and research material and comprehensivecustomer support all via a customer-friendly interface. Trading features morerelevant to expert traders include data streaming, charting services andadvanced order services.

 

Our efficient, in-housedevelopment capabilities allow us to continuously innovate and improve ourplatform with frequent enhancements such as:

 

•                  ***StrategyScan®.***    StrategyScan enables an investor to transform a trading idea into an executable trade.It accomplishes this by identifying up to three trading opportunities for ourcustomers based upon their bullish, bearish or neutral opinion of a specificstock over a specified time frame. We clearly identify the range of potentialgain or loss for each trading opportunity.

 

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•                  ***Xspreads®.***    Our Xspreadstechnology simplifies and expedites the execution of our customers’ combinationtrades. The Xspreads Order BookSM electronically displays customers’orders, thereby creating greater transparency in the market, resulting inincreased liquidity for both our customers and the broader marketplace. Inaddition, Xspreads enables our customers to execute all portions of acombination trade simultaneously, thereby eliminating the risk that allportions will not be executed at the desired price.

 

•                  ***XecuteSM(patent pending).   ***** **We pioneered online auto-trading for the retail investor. Our Xecuteproduct allows our customers who subscribe to specified third-party advisorynewsletters and other financial publications to automate the trading of thethird-party recommendations. This not only benefits our customers who subscribeto these newsletters, but also makes us the logical brokerage platform forother subscribers to such newsletters.

 

•                  ***AdvancedOrder Management (patent applied).***    Our software allows our retail customers toautomate professional trading strategies involving order sequencing withoutmanual intervention. Our customers are able to enter contingent orders whichare executed in accordance with specified time, price or other triggers. Asignificant advantage of this feature is that our customers do not have toconstantly monitor the market in order to execute their orders.

 

•                  ***VirtualTrading.***    Virtualtrading provides our customers with a mock trading environment where they canpractice strategies and educate themselves without risk, utilizing currentmarket information. This provides our customers with a practical method ofgaining real market experience without putting money at risk. Our customers canmock trade almost any strategy involving stocks, options and mutual funds,including spreads, straddles, and covered calls. We believe virtual trading providesour customers with a better environment to learn versus simply studying tradingstrategies.

 

***Portfolio Tracking***

 

Customers have unrestrictedonline access to a complete listing of all their account activity over the lifeof the account, including transaction data on the date of purchase, cost basis,current price, current market value and margin balances. Detailed accountbalance and transaction information includes money market balances, buyingpower, net market portfolio value, dividends, commissions paid, trade dates,settlement dates, deposits and withdrawals. Brokerage history includes adetailed status of all orders placed, including whether any order is pending oropen or has been executed or canceled. There is no limit on how far back a customeris able to obtain data, nor is there a charge for the provision of thisservice. In addition, customers can synchronize their portfolio and activitywith third-party personal financial software, including Microsoft Money,Quicken, Gainskeeper and GreenTrader.

 

***Integration with Third-PartyInvestment Software***

 

The design of our technologyallows customers to integrate our execution with third-party investment oranalytical software, including e-Signal, Quotracker, Prophet, PowerOptions andWizetrade. This is a key design feature of our platform and differentiates usfrom other online trading systems that rely on legacy technologies. Giving thecustomer access to other technologies allows us to service customers who usecomplementary analytical software. The design of our technology allows us toeasily and cost-effectively private label our website for other financialinstitutions.

 

**Customer Service**

 

Our customer serviceapproach, which is embedded in our culture, has been a significant factor inour success. We strive to provide excellent service during the customer’sentire investing experience, from education to evaluation to execution topost-trade monitoring.

 

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Our customer-friendlywebsite contains a self-help library of user guides and customer messageboards. For customers requiring more personalized attention, customer serviceis available via live individual web chat, e-mail and telephone. We have over60 dedicated customer service employees located in Chicago, Illinois and ElPaso, Texas. New customer service employees attend a three-week trainingprogram, and we also provide ongoing training for all customer serviceemployees.

 

We are responsive to ourcustomers, aiming for a real-time response to all customer inquiries. Werespond to over 50% of customer inquiries via the Internet, facilitatingindividualized service in a timely and cost-effective manner. Customer e-mailinquiries are routed by managers to the appropriate business area for timely andaccurate response. Communications with customers are continually reviewed andcritiqued for quality assurance. The result is what we call “point-of-contactresolution,” which we define as providing each customer with an answer withouthaving to speak to multiple people, repeat the question or call back.

 

We also continually updateour technology to maximize the customer’s experience. Customer questions aretracked and, if repeated, analyzed to determine how best to clarify the pointor answer the inquiry during the customer’s online experience. This analysis isused to improve and enhance our website.

 

**Marketing**

 

The goal of our marketingprograms is to cost-effectively attract new customers, while further developingthe optionsXpress brand. Our marketing targets long-term investors, rather thanthe daytrader. To employ our marketing strategy, we use a mix of “grass roots,”online and traditional advertising. This strategy has enabled us to attractloyal customers at a significantly lower cost per account than our majorcompetitors. We believe that the rapid growth in our accounts and industryaccolades evidence the powerful brand we have built.

 

Our “grass roots” marketingstrategy, which has been crucial to our success, consists of a strategic publicand media relations program and channel partnerships. Our public and mediarelations initiative has been very successful in positioning us as an expertindustry resource and broadening our customer base. We use channelpartnerships, such as relationships with securities exchanges, optionseducators, investment publishers, software vendors and financial portals, todistribute our product to new customers. These relationships also allow us toreach existing retail options investors through a source that is familiar tothem. In addition, we frequently appear at various industry events, tradeconferences and investor clubs. These events further contribute to our “grass-roots”marketing by allowing us to discuss new applications and functionalityavailable to investors on our website in a large forum.

 

Our advertising strategyfocuses on our unique online trading tools and industry awards we havereceived. Advertising directs interested prospects to our website foradditional information, as opposed to generating primarily telephone-basedinquiries. At our website, prospective customers can get detailed informationon our services and fees, use an interactive demonstration system, requestadditional information and complete an account application online. Ouradvertising is primarily conducted through third-party websites, though we alsoplace print advertisements in a broad range of business, technology andfinancial publications, including The Wall Street Journal, Barrons, Investors’Business Daily and Forbes. We also advertise on a limited basis on televisionand on national business radio networks. We believe this component of ouradvertising strategy has significantly contributed to brand re-enforcement andincreased our name recognition in the marketplace.

 

As the final step in ourmarketing process, we improve the conversion rate of prospective customers intofunded accounts by mailing registration kits to investors who have registeredonline. In addition, customers can print a pre-paid Federal Express label atthe end of their registration process for easy submission of theirapplications.

 

**brokersXpress**

 

Launched in March 2004,brokersXpress enables independent brokers and other investment professionals toenhance their existing capabilities via an extension of our optionsXpressretail platform. brokersXpress provides highly automated account management,stock, options and mutual fund functionality and sophisticated customer

 

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support. brokersXpress’ core customers are brokersand investment advisors; other customers include professional investors such ashedge funds and investment clubs.

 

We believe this businessrepresents a significant growth opportunity as brokersXpress provides access tothe non-self-directed retail investor base via financial advisors.Industry-wide, total assets under management by independent registeredrepresentatives and registered investment advisors have grown at a rate ofapproximately 19% per year in the last six years to the current level of over$800 billion. In addition, the number of licensed registeredrepresentatives at each of the top 25 independent broker-dealers has grown atan annual rate of approximately 14% over the last five years to over 60,000representatives today.

 

**Broker-Dealer Operations**

 

***Order Processing***

 

We receive the vast majorityof our customer orders through the Internet. Market orders for exchange-listedsecurities, other than those with special qualifiers or that are outside ofmarket size limitations, are executed at the National Best Bid and Offer, orNBBO, or better at the time of receipt by the relevant market maker orexchange. Eligible orders are exposed to the marketplace for possible priceimprovement or enhanced liquidity, subject to the NBBO. Limit orders areexecuted based on an indicated price and time priority. Market orders forNasdaq securities, other than those that are outside of market sizelimitations, are executed at the Best Bid/Offer (inside market) or better atthe time of receipt by the relevant market center. Eligible orders are subjectto possible price improvement in the marketplace.

 

We aim to provide customerswith the best execution of each trade, which we define as the fastest fill atthe best price. We believe we differentiate ourselves from our majorcompetitors by incorporating our dynamic technology into our order managementand execution review process. For example, we have designed monitors that warnus of any instances where an order can be filled on another exchange or thebest price was not achieved on a particular trade. These real-time alerts allowus to proactively re-present orders, seek adjustments on orders that were notcompleted at the best available price, and recognize exchange issues that mightwarrant a routing change.

 

***Clearing and Custody***

 

We introduce accounts to ourclearing agents on a “fully disclosed” basis. This means that the clearingagents hold customer cash and equities in accounts unique to each customer,receive and deliver securities after execution, settle and administertransactions, extend credit for margin and leverage, generate customerstatements, arrange for or directly provide any related banking services andperform other back-office functions. We do not rely on our clearing agents withrespect to the operation of our website, our real-time account, trade andmarket data, or our execution routing. We reconcile account and tradeinformation with the clearing agents on a daily basis.

 

In September 2004, weentered into a clearing agreement with GSEC, a wholly owned subsidiary of TheGoldman Sachs Group, Inc., pursuant to which GSEC will act as our primaryclearing agent. GSEC is regulated by the New York Stock Exchange, the OptionsClearing Corporation, the NASD, the Commodity Futures Trading Commission, orCFTC, and other self-regulatory organizations. We believe that GSEC’s financialposition and operational capabilities are very strong. We also clear throughLegent Clearing, LLC, or Legent. As a clearing broker, GSEC and Legent aresubject to SEC and other regulatory requirements, including those imposed byclearing organizations of which it is a member. The financial requirementsimposed by such clearing organizations can exceed the financial and otherrequirements imposed by the SEC.

 

***Payment for Order Flow***

 

Payment for order flowoccurs when options specialists, market makers, exchanges and other marketcenters make payments to broker-dealers in return for receiving customerorders. Like other retail brokerage firms, we receive payment for order flowfrom exchanges and liquidity providers where our customers’ orders are routed.Our automatic order routing software ensures that payment for order flow doesnot affect the routing of orders in a manner

 

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detrimental to our customers. In addition, customerscan either rely on our automatic order routing or designate where to routetheir orders. We disclose our payment for order flow policies on our website.

 

***Margin and Leverage***

 

We provide eligible customers with the ability toreceive margin credit and leverage from our clearing broker. Margin creditinvolves the use of securities as collateral for a loan from the broker inorder to purchase other securities. Leverage involves securing a largepotential future obligation with a proportional amount of cash or securities.Margin credit and leverage-related minimum requirements are set by the SEC andSROs.

 

We rely on our clearingbroker to support the margin credit and leverage needs of our customers. Since weintroduce our accounts to a clearing broker, we do not bear the burden of thecapital requirements of the customer protection rule. See “Regulation.” Theclearing broker is responsible for extending and maintaining credit tocustomers in accordance with applicable regulatory requirements.

 

Under the terms of ourclearing agreement, we are responsible if a customer defaults on any obligationowed to our clearing broker. As such, we have input into the margin credit andleverage process, we make decisions regarding margin credit and leveragelevels, and we are largely responsible for the notification to customers ofmargin calls. We also take responsibility for supervising the risks associatedwith leverage and we monitor our customers’ margin positions to identifycustomer accounts that may need additional collateral or liquidation. Ingeneral, our minimum margin credit requirements are more stringent than the SEC’sand SROs’ requirements.

 

***Supervision and Compliance***

 

The role of our compliancedepartment is to provide education, supervision, surveillance, mediation andcommunication review. Many of our employees are NASD-registered principals withsupervisory responsibility over options trading or other aspects of ourbusiness. In addition, over half of our employees have successfully completedNASD licensing exams required for registered representatives. Each of theseemployees is trained and responsible for complying with securities regulations.

 

Our anti-money launderingscreening is conducted using a mix of automated and manual review and has beenstructured to comply with recent regulations. We collect required informationthrough our new account process and then screen accounts with two third-partydatabases for the purposes of identity verification and for review of negativeinformation and appearance on the Office of Foreign Assets and Control,Specially Designated Nationals and Blocked Persons lists. Additionally, we havedeveloped proprietary methods for risk control and continue to add upon specializedprocesses, queries and automated reports designed to identify money laundering,fraud and other suspicious activities.

 

**Technology Systems and Architecture**

 

We place an emphasis onstability, scalability and survivability in all of our technical architecture.We maintain three production data centers. Each of these centers is capable ofserving our website independently in the event of service interruptions to theother two data centers. Each center is also linked to the others via redundantcommunication to minimize the likelihood of a data center being unable to servecustomers. We replicate and synchronize our primary databases, ensuring acurrent copy of all customer data at each center. Our technology includesencryption and protective features to ensure investor confidence and protectour customers’ assets and information. In addition, our servers are loadbalanced which prevents the failure of a single server or components fromhaving a significant impact on our customers and allows for the easy additionof servers, resulting in the ability to quickly and cost-efficiently scale ourplatform. Our daily average revenue trades for the twelve months ended December 31,2004 was approximately 13,600, and our largest number of trades in a single daywas approximately 29,000, while the current capacity of our software andhardware is approximately 50,000 trades per day. We believe we can doublethe capacity of our software and hardware to 100,000 trades per day at anapproximate one-time cost of $120,000.

 

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**Intellectual Property**

 

We rely on a combination ofpatent, trademark, copyright and trade secret laws in the United States andother jurisdictions as well as confidentiality procedures and contractual provisionsto protect our proprietary technology and our brand. We also enter intoconfidentiality and invention assignment agreements with our employees andconsultants and confidentiality agreements with other third parties, and werigorously control access to proprietary technology.

 

The following intellectualproperty is pending or registered as indicated with the U.S. Patent TradeOffice (USPTO):

 

•                  PendingPatent: Xecute (Serial no. 10-062,590)USPTO patent pending application filing date of January 31, 2002

 

•                  PendingPatent: Triggers (Serial no. 60-614,625)USPTO patent pending application filing date of September 30, 2004

 

•                  PendingService Mark: Xpress (Serial no. 76-572,924)USPTO service mark registration application filing date of January 28,2004

 

•                  PendingService Mark: Take the Xpress (Serial no. 76-572,923)USPTO service mark registration application filing date of January 28,2004

 

•                  PendingService Mark: brokersXpress (Serial no. 76-600,588)USPTO service mark registration application filing date of July 2, 2004

 

•                  RegisteredMark: Xspreads (Serial no. 2-814,744)USPTO issued Certificate of Registration on February 17, 2004

 

•                  RegisteredMark: Strategy Scan (Serial no. 76-365,415)USPTO issued Certificate of Registration on January 21, 2003

 

•                  RegisteredMark: optionsXpress (Serial no. 76-348,669)USPTO issued Certificate of Registration on September 10, 2002

 

•                  PendingService Mark: Xecute (Serial no. 76-605,707)USPTO service mark registration application filing date of January 31, 2002

 

**Competition and Pricing**

 

The market for brokerageservices, particularly electronic brokerage services, is rapidly evolving andhighly competitive. Our direct competitors in the online marketplace take theform of larger-scale broker-dealers that offer online services, includingCharles Schwab & Co., Inc., E*TRADE Group, Inc., TDWaterhouse Group, Inc., Ameritrade, Inc., TradeStationGroup, Inc. and smaller “niche-market” online or licensed software-basedbrokers, including Tradestation and Interactivebrokers. We also encountercompetition from full commission brokerage firms including Merrill Lynch, SmithBarney (a division of Citigroup), as well as financial institutions, mutualfund sponsors, including Fidelity, and other organizations, some of whichprovide online brokerage services.

 

We attribute our competitivesuccess to the customer experience we deliver, which results from our advancedtechnology and superior customer service. Unlike a number of our directcompetitors, we developed our platform to operate free from reliance onmainframe systems common in the brokerage industry. Our hardware and softwarehave proven reliable and versatile and we believe they can be expanded moreeconomically than our major competitors’ systems. Although competition mayincrease if the larger-scale online brokers become more aggressive in marketingoptions, we believe we will maintain a competitive advantage due to thestrength and flexibility of our platform.

 

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We do not use price as a significant basis forcompetition and do not strive to be a deep-discount broker. We offer what webelieve to be a competitive price for the services and tools we provide,although we do not grant free trades or provide other sales incentives involvingprice, such as 30-day discount commission offers.

 

Our options commissions are$1.50 per option contract with a minimum of $14.95. Our commissions on listedand Nasdaq stocks are $14.95 up to and including 1,000 shares and then $0.015per share for 1,001 shares and above. Active traders receive a discount, suchas a minimum commission of $12.95 for 1 to 9 option contracts and $9.95 for upto 1,000 shares of stock. There are no “hidden fees”; no monthly minimum fees;no charges for non-activity; no volume requirements; no postage and handlingcharges; and no extra fees for placing telephone orders.

 

The brokersXpress pricingmodel has two components: a fixed charge per trade and a percentage of thebroker’s commissions. Both components are negotiated with each broker and arebased on the volume of trades produced.

 

**Employees**

 

At December 31, 2004,we had 125 full-time and 3 part-time employees. Of these employees, 85 wereengaged in brokerage operations, providing trade execution and customersupport, 60 of which were licensed brokers, 27 were engaged in technology anddevelopment and 13 were engaged in general management, business development,finance, marketing and administration. None of our employees are covered by acollective bargaining agreement. We consider our relations with our employeesto be excellent.

 

**REGULATION**

 

**Overview**

 

Our business and industryare highly regulated. As a matter of public policy, regulatory bodies in theUnited States are charged with safeguarding the integrity of the securities andother financial markets and with protecting the interest of customersparticipating in those markets, not with protecting the interests of creditorsor stockholders of securities firms such as our broker-dealer subsidiaries.optionsXpress, Inc. is registered as a broker-dealer with the SEC and is amember of the NASD and the CBOE, which serves as its designated examiningauthority. brokersXpress is also a registered broker-dealer with the SEC and isa member of the NASD, which serves as its designated examining authority.optionsXpress and brokersXpress are also registered in each of the fiftystates, the District of Columbia and Puerto Rico. These jurisdictions alsoregulate our conduct in their respective jurisdictions.

 

Broker-dealers are subjectto laws, rules and regulations that cover all aspects of the securitiesbusiness, including:

 

•                  salesmethods,

•                  tradepractices,

•                  useand safekeeping of customers’ funds and securities,

•                  capitalstructure,

•                  record-keeping,

•                  financingof customers’ purchases and

•                  conductof directors, officers and employees.

 

The commodity futures andoptions industry in the United States is subject to regulation under theCommodity Exchange Act. The CFTC is the federal agency charged with theadministration of this act and the related regulations. optionsXpress andbrokersXpress are registered with the CFTC as introducing brokers and aremembers of the National Futures Association, a self-regulatory organization.

 

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**Net Capital Rule**

 

Our broker-dealersubsidiaries are subject to the SEC’s Net Capital Rule. The Net Capital Rule,which specifies minimum net capital requirements for registered broker-dealers,is designed to measure the general financial integrity and liquidity of abroker-dealer. The Net Capital Rule requires that at least a minimum part of aregistered broker-dealer’s assets be kept in relatively liquid form. Ingeneral, net capital is defined as net worth, meaning assets minus liabilities,plus qualifying subordinated borrowings and discretionary liabilities, and lessmandatory deductions that result from excluding assets that are not readilyconvertible into cash and from valuing conservatively other assets.

 

If a firm fails to maintainthe required net capital, the SEC and the SROs or other regulatory bodies maysuspend the firm or revoke its registration and ultimately could require thefirm’s liquidation. The Net Capital Rule prohibits the payment of dividends,the redemption of stock, the prepayment of subordinated indebtedness and themaking of any unsecured advance or loan to a stockholder, employee oraffiliate, if the payment would reduce the firm’s net capital below requiredlevels.

 

**Foreign Jurisdictions andRegulation**

 

We and our subsidiaries arenot registered with any financial regulatory authorities outside of the UnitedStates. While optionsXpress and brokersXpress effect transactions solely in theUnited States, our customers access our services through the Internet. In anyforeign jurisdiction in which we have customers, there is a possibility that aregulatory authority could assert jurisdiction over our activities and seek tosubject us to the laws, rules and regulations of that jurisdiction.

 

In February 2004, wereceived an inquiry from the British Columbia Securities Commission regardingwhether we were or should be registered as a dealer in Canada. In response tothe inquiry, we formed a new subsidiary, optionsXpress Canada, Corp., toregister as a dealer in Canada. We have filed for the registration ofoptionsXpress Canada with the Canadian provincial securities commissions. Oncethis registration has been completed, optionsXpress Canada will be a member of,and regulated by, the Investment Dealers Association of Canada, a self-regulatoryorganization, as well as the securities regulators of the various provinces. Weintend to transfer accounts of Canadian customers to optionsXpress Canada assoon as optionsXpress Canada is licensed to do business in Canada. We areseeking an exemptive order from the British Columbia Securities Commission andother Canadian securities authorities to permit it to continue to conductbusiness in Canada. The exemptive order is pending.

 

In July 2004, theOntario Securities Commission, or OSC, advised us that it was consideringenforcement action against us for conducting business with customers located inOntario without being registered. Pending resolution of this matter, we havecommitted to the OSC not to accept additional Canadian customers absent exemptiverelief. For more information, see “Business — Legal and AdministrativeProceedings.”

 

We currently serviceaccounts for customers located in Singapore. We have contacted the securitiesregulators in Singapore to verify our exemption from the registrationrequirements in that country. In connection with that inquiry, we havecommitted to the Singapore regulators that we will not take on additionalcustomers pending their response.

 

Accounts for customerslocated in Canada and Singapore combined represent less than 5% of our totalcustomer accounts as of December 31, 2004.

 

The laws, rules andregulations of each foreign jurisdiction differ. In the four jurisdictionsother than Canada and Singapore where we have the most foreign customers, webelieve we are exempt from registration due to our limited conduct and/or ourlack of solicitation in those jurisdictions. In any jurisdiction where we arerelying on an exemption from registration, there remains the risk that we couldbe required to register, and therefore be subject to regulation and enforcementaction or, in the alternative, to reduce or terminate our activities in thesejurisdictions.

 

**Patriot Act**

 

Registered broker-dealers traditionally have beensubject to a variety of rules that require that they know their customers andmonitor their customers’ transactions for suspicious financial activities. Withthe passage of the Uniting

 

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andStrengthening America by Providing Appropriate Tools Required to Intercept andObstruct Terrorism Act of 2001, or the Patriot Act, broker-dealers are nowsubject to even more stringent requirements. As required by the Patriot Act, wehave established comprehensive anti-money laundering and customeridentification procedures, designated an anti-money laundering complianceofficer, trained our employees and conducted an independent audit of ourprogram. There are significant criminal and civil penalties that can be imposedfor violations of the Patriot Act. For more information, see “Business —Broker-Dealer Operations — Supervision and Compliance.”

 

**RISK FACTORS**

 

**We have a limited operating historyupon which to evaluate our performance.**

 

We commenced doing businessin February 2000. Accordingly, we have only a limited operating historyupon which you can evaluate our prospects and future performance. Our prospectsmay be materially adversely affected by the risks, expenses and difficultiesfrequently encountered in the operation of a new business in a rapidly evolvingindustry characterized by intense competition.

 

**We may be unable to effectivelymanage our rapid growth and retain our customers.**

 

Our rapid growth has placedsignificant demands on our management and other resources. If our businessincreases, we may need to expand and upgrade the reliability and scalability ofour transaction processing systems, network infrastructure and other aspects ofour technology. We may not be able to accurately project the rate, timing orcost of any increases in our business, or to expand and upgrade our systems andinfrastructure to accommodate any increases in a timely manner. Failure to makenecessary expansions and upgrades to our systems and infrastructure andmaintain our customer service levels could lead to failures and delays, whichcould cause a loss of customers or a reduction in the growth of our customerbase, increased operating expenses, financial losses, additional litigation orcustomer claims, and regulatory sanctions or additional regulatory burdens.

 

In addition, due to ourrapid growth, we will need to attract, hire and retain highly skilled andmotivated officers and employees. We cannot assure you that we will be able toattract or retain the officers and employees necessary to manage this growtheffectively.

 

**We operate in a highly regulatedindustry and compliance failures could adversely affect our business.**

 

We operate under extensiveregulation, which increases our cost of doing business and is a limiting factoron the operations and development of our business. The Securities and ExchangeCommission, or SEC, the NASD, the Chicago Board Options Exchange, Inc., orCBOE, and other self-regulatory organizations, commonly called SROs, and statesecurities commissions regulate us. Outside the United States, we also may besubject to regulation by securities regulatory authorities in the countrieswhere our customers are located. The securities industry in the United Statesis subject to extensive regulation covering all aspects of the securitiesbusiness, including:

 

•                  salesmethods;

•                  tradepractices;

•                  useand safekeeping of customer funds and securities;

•                  capitalstructure;

•                  record-keeping;

•                  financingof customers’ purchases; and

•                  conductof directors, officers and employees.

 

Failure to comply with anyof the laws, rules or regulations applicable to us, even inadvertently, couldlead to adverse consequences including censure, fine, the issuance ofcease-and-desist orders or the suspension or disqualification of directors,officers or employees. Any of these adverse consequences could affect ourbusiness. It is

 

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also possible that any noncompliance could subjectus to criminal penalties and civil lawsuits. An adverse ruling against us orour officers or other employees could cause our subsidiaries or our officersand other employees to pay a substantial fine or settlement, and could resultin their suspension or expulsion. Any of these events could have a materialadverse effect on our business.

 

**Changes in legislation orregulations may affect our ability to conduct our business or reduce ourprofitability.**

 

The regulatory environmentin which we operate may change. These changes may affect our ability to conductour business or reduce our profitability. Our activities may be affected notonly by legislation or regulations of general applicability, but also byindustry-specific legislation or regulations. The SEC, other U.S. or foreigngovernmental authorities, the NASD or other SROs may adopt new or revised regulationswhich affect our business. Changes in the interpretation or enforcement ofexisting laws and rules by those entities may also affect our business. Forexample, in early 2004, the SEC issued “Concept Release: CompetitiveDevelopments in the Options Markets,” which addressed recent developments inthe options marketplace. The SEC’s goal in issuing this concept release is toimprove the functioning of the options marketplace for the benefit of theinvesting public. The SEC has not yet issued any formal statements or proposedchanges in response to the comments it has received.

 

The SEC is also consideringwhether to continue to permit “payment for order flow” in the options markets.Payment for order flow is a practice in accordance with which specialists andexchanges pay broker-dealers to route customer orders to them. We benefit frompayment for order flow because we earn revenue by directing orders to specificlocations. Payment for order flow represented approximately 19% of our revenuefor the year ended December 31, 2004. Changes to the options marketplace,the primary marketplace in which we conduct business, could, if adopted,materially adversely affect our business. If the SEC or other authorities wereto prohibit payment to broker-dealers for order flow, this would decrease ourincome and materially adversely affect our profitability.

 

In addition, we use theInternet as the distribution channel to provide services to our customers. Anumber of regulatory agencies have recently adopted regulations regardingcustomer privacy and the use of customer information by service providers.Additional laws and regulations relating to the Internet may be adopted in thefuture, including regulations regarding the pricing, taxation, content andquality of products and services delivered over the Internet. Complying withthese laws and regulations is expensive and time consuming and could limit ourability to use the Internet as a distribution channel.

 

**Servicing customers outside theUnited States involves special challenges that we may not be able to meet,which could negatively impact our financial results.**

 

To date, our operations havebeen limited to physical facilities in the United States, with Internet accessto our products from outside the United States. Since our services areavailable over the Internet in foreign countries and we have customers residingin foreign countries, foreign jurisdictions may claim that we are required toqualify to do business in their country. For example, Canadian authorities haveadvised us that doing business with Canadian customers requires registrationwith the applicable authorities. For more information, see “Business —Legal and Administrative Proceedings.” We believe that the number of ourcustomers residing outside of the United States will increase over time. We arerequired to comply with the laws and regulations of each country in which weconduct business, including laws and regulations currently in place or whichmay be enacted related to Internet services available to their citizens fromservice providers located elsewhere. Any failure to develop effectivecompliance and reporting systems could result in regulatory penalties in theapplicable jurisdiction, which could have a material adverse effect on our business,financial condition and operating results. For more information, see “Regulation— Foreign Jurisdictions and Regulation.”

 

In addition, in the futurewe may choose to offer foreign securities brokerage services. There are certainrisks inherent in doing so. Among other risks, we may face less developedtechnological infrastructures, less developed automation in exchanges,depositories and national clearing systems, exchange rate fluctuations,increased credit risk and unexpected changes in regulatory requirements,tariffs and other trade barriers. If we choose to do business through aninternational entity, we may also face barriers to repatriation of foreignearnings. Any of these factors

 

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could have a material adverse effect on our future internationaloperations and consequently on our business, financial condition and operatingresults.

 

**Substantial competition couldreduce our market share and harm our financial performance.**

 

The market for electronicbrokerage services is young, rapidly evolving and intensely competitive. Weexpect the competitive environment to continue in the future. We face directcompetition from numerous online and software-based brokerage firms, includingCharles Schwab & Co., Inc., E*TRADE Group, Inc., TDWaterhouse Group, Inc., Ameritrade, Inc. and TradeStationGroup, Inc. We also encounter competition from the broker-dealeraffiliates of established full commission brokerage firms as well as from financialinstitutions, mutual fund sponsors and other organizations, some of whichprovide online brokerage services. Some of our competitors have greaterfinancial, technical, marketing and other resources, and have greater namerecognition and a more extensive customer base than we do.

 

This intense competition hasresulted in several trends that may adversely affect our financial conditionand results of operation, including the implementation of new pricingstrategies, consolidation in the industry and increased emphasis on advertisingand promotional efforts. In addition, some of our competitors are activelypursuing a larger share of the options trading market.

 

We believe that the generalfinancial success of companies within the online securities industry willcontinue to attract new competitors to the industry, such as banks, softwaredevelopment companies, insurance companies, providers of online financialinformation and others. These companies may provide a more comprehensive suiteof services than we do. We may not be able to compete effectively with ourcurrent or future competitors.

 

**Our business is primarilytransaction-based, and decreases in trading or other changes in our revenuebase could harm our business.**

 

Our revenues are derivedprimarily from securities brokerage services, and we expect this business tocontinue to account for almost all of our revenues. We are directly affected byeconomic and political conditions, broad trends in business and finance andchanges in the conditions of the securities markets in which our customerstrade. Over the past several years, volume in the securities market in theUnited States has fluctuated considerably. During periods of low tradingvolume, our revenue would be adversely affected. Severe decreases in marketprices could also have an impact on our business because of the adverse impacton investor sentiment and losses in investor portfolios. In addition, a portionof our revenue is derived from payment for order flow. By custom in theindustry, these cash payments are not the subject of any written agreement. Asa result, they could be changed or eliminated at any time. If these paymentswere to be reduced or eliminated for competitive or other reasons, our businesscould be materially adversely affected.

 

**Our strong dependence upon revenuesderived from commissions from option trades may place us at a competitivedisadvantage.**

 

Our revenue is derivedprimarily from commissions from options, stock, mutual fund and fixed-incomeproduct trades, but option trades represent approximately 79% of our customers’trades. The revenues of some of our major competitors may be more diversifiedthan ours, and they may withstand a downturn in the securities industry betterthan we could.

 

**If we fail to attract customers ina cost-effective manner, our profitability and growth may be impaired.**

 

Our profitability and growthdepends on increasing our customer base in a cost-effective manner. For theyears ended December 31, 2002, 2003 and 2004, we incurred advertisingexpenses of $1.1 million, $3.0 million and $6.7 million,respectively. Although we have spent significant financial resources onadvertising and related expenses and plan to continue to do so, there are noassurances that these efforts will be cost-effective at attracting new customers.In particular, we believe that rates for desirable advertising and marketingplacements are likely to increase

 

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in the foreseeable future, and we may bedisadvantaged relative to our larger competitors in our ability to expand ormaintain our advertising and marketing commitments. Additionally, filtersoftware programs that limit or prevent our advertisements and othercommunications from being displayed on or delivered to our current and potentialcustomers’ computers are becoming increasingly available. If this type ofsoftware becomes widely accepted, it would negatively affect Internetadvertising. Finally, our sales and marketing methods are subject to regulationby the CBOE and the NASD. The rules and regulations of these organizationsimpose specific limitations on our sales methods, including our advertising andpayments to non-broker-dealers. If we do not achieve our advertisingobjectives, our profitability and growth may be impaired.

 

**We are subject to various forms ofcredit risk, and those risks could have a material adverse effect on ourfinancial situation.**

 

Through an arrangement withour clearing firms, we extend margin credit and leverage to our customers,which is subject to various regulatory and clearing firm margin requirements.Margin credit is collateralized by cash and securities in the customers’accounts. Leverage involves securing a large potential future obligation with aproportional amount of cash or securities. The risks associated with margincredit and leverage increase during periods of fast market movements or incases where leverage or collateral is concentrated and market movements occur.During such times, customers who utilize margin credit or leverage and who havecollateralized their obligations with securities may find that the securitieshave a rapidly depreciating value and may not be sufficient to cover theirobligations in the event of a liquidation. We are also exposed to credit riskwhen our customers execute transactions, such as short sales of options andequities that can expose them to risk beyond their invested capital.

 

We expect this kind ofexposure to increase with growth in our overall business. Because we indemnifyand hold harmless our clearing firms from certain liabilities or claims, theuse of margin credit, leverage and short sales may expose us to significantoff-balance-sheet risk in the event that collateral requirements are notsufficient to fully cover losses that customers may incur and those customersfail to satisfy their obligations. As of December 31, 2004, we had $78.0million in margin credit extended to our customers through our clearing firms.The amount of risk to which we are exposed from the leverage we extend to ourcustomers and from short sale transactions by our customers is unlimited andnot quantifiable as the risk is dependent upon analysis of a potentialsignificant and undeterminable rise or fall in stock prices.

 

**Our risk management policies andprocedures may not be effective and may leave us exposed to unidentified orunexpected risks.**

 

Our policies, procedures andpractices used to identify, monitor and control a variety of risks may fail tobe effective. As a result, we face the risk of losses, including losses resultingfrom firm errors, customer defaults, market movements, fraud andmoney-laundering. Our risk management methods rely on a combination oftechnical and human controls and supervision that are subject to error andfailure. Some of our methods of managing risk are based on internally developedcontrols and observed historical market behavior, and also involve reliance onindustry standard practices. These methods may not adequately prevent futurelosses, particularly as they relate to extreme market movements, which may besignificantly greater than the historical measures indicate. These methods alsomay not adequately prevent losses due to technical errors if our testing andquality control practices are not effective in preventing technical software orhardware failures.

 

**We may suffer losses if ourreputation is harmed.**

 

Our ability to attract andretain customers and employees may be adversely affected to the extent ourreputation is damaged. If we fail, or appear to fail, to deal with variousissues that may give rise to reputational risk, we could harm our businessprospects. These issues include, but are not limited to, appropriately dealingwith potential conflicts of interest, legal and regulatory requirements,ethical issues, money-laundering, privacy, record-keeping, sales and tradingpractices, and the proper identification of the legal, reputational, credit,liquidity, and market risks inherent in our business. Failure to appropriatelyaddress these issues could also give rise to additional legal risk to us, whichcould, in turn, increase the size and number of claims and damages assertedagainst us or subject us to regulatory enforcement actions, fines, andpenalties.

 

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**Systems failures and delays couldharm our business.**

 

We receive and process tradeorders through a variety of electronic channels. Our online trading servicesare heavily dependent on the integrity of the systems supporting them. Oursystems and operations, including our Web servers, and those of our third-partyservice providers are vulnerable to damage or interruption from human error,sabotage, encryption failures, break-ins, intentional acts of vandalism,earthquakes, terrorist attacks, floods, fires, power loss, telecommunicationsfailures, computer viruses, computer denial of service attacks or otherattempts to harm our systems and operations, and similar events. Our disasterrecovery planning cannot account for all eventualities. In addition,extraordinary trading volumes could cause our computer systems to operate at anunacceptably low speed or even fail. While we have invested significant amountsto upgrade the reliability and scalability of our systems, there can be noassurance that our systems will be sufficient to handle such extraordinarytrading volumes.

 

Systems failures or delaysmay occur in the future and could cause, among other things, unanticipateddisruptions in service to our customers, slower system response time resultingin transactions not being processed as quickly as our customers desire,decreased levels of customer service and customer satisfaction and harm to ourreputation. If any of these events were to occur, we could suffer:

 

•                  aloss of customers or a reduction in the growth of our customer base;

•                  increasedoperating expenses;

•                  financiallosses;

•                  litigationor other customer claims; and

•                  regulatorysanctions or additional regulatory burdens.

 

Our business also depends onthe continued reliability of the Internet infrastructure. This includesmaintenance of a reliable network backbone with the necessary speed, datacapacity and security for providing reliable Internet services. Internetinfrastructure may be unable to support the demands placed on it if the numberof Internet users continues to increase, or if existing or future Internetusers access the Internet more often or increase their bandwidth requirements.In addition, viruses, worms and similar programs may harm the performance ofthe Internet. The Internet has experienced a variety of outages and otherdelays as a result of damage to portions of its infrastructure, and it couldface outages and delays in the future. These outages and delays could reducethe level of Internet usage and our business could be materially adverselyaffected.

 

**Our networks and those of ourthird-party service providers may be vulnerable to security risks.**

 

The secure transmission ofconfidential information over public networks is a critical element of ouroperations. Our networks and those of our third-party service providers may bevulnerable to unauthorized access, computer viruses and other securityproblems. Persons who circumvent security measures could wrongfully use ourconfidential information or our customers’ confidential information or causeinterruptions or malfunctions in our operations. We or our service providersmay be required to expend significant additional resources to protect againstthe threat of security breaches or to alleviate problems caused by anybreaches. We or our service providers may not be able to implement securitymeasures that will protect against all security risks.

 

**Our inability to protect ourintellectual property rights or our infringement of the intellectual propertyrights of others could adversely affect our business.**

 

Our success and ability tocompete in the online securities industry depends in part upon our technology.Laws and our contractual terms may not be sufficient to protect our technologyfrom use or theft by third parties. For instance, a third party might try toreverse engineer or otherwise obtain and use our technology without ourpermission and without our knowledge, allowing competitors to duplicate ourproducts. We may have legal or contractual rights that we could assert againstsuch illegal use, but lawsuits claiming infringement or misappropriation arecomplex and expensive, and the outcome would not be certain. We may choose notto enforce or protect our intellectual property rights, depending on ourstrategic evaluation and judgment regarding the best use of our intellectualproperty portfolio and the recourse available to us.

 

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Patents of third parties mayhave an important bearing on our ability to offer certain of our products andservices. Our major competitors as well as other companies and individuals mayobtain and may have obtained patents related to the technologies for tradingthe types of products and providing the services we offer or plan to offer. Wecannot assure you that we are or will be aware of all patents containing claimsthat may pose a risk of infringement by our products and services. In addition,some patent applications in the United States are confidential until a patentis issued and, therefore, we cannot evaluate the extent to which technologyconcerning our products and services may be covered or asserted to be coveredby claims contained in pending patent applications. In general, if one or moreof our products or services were found by a court to infringe patents held byothers, we may be required to stop developing or marketing the products orservices, to obtain licenses to develop and market the services from theholders of the patents or to redesign the products or services in such a way asto avoid infringing those patents. An adverse ruling arising out of anyintellectual property dispute could also subject us to significant liabilityfor damages.

 

We cannot assess the extentto which we may be required in the future to obtain licenses with respect topatents held by others, whether such licenses would be available or, ifavailable, whether we would be able to obtain such licenses on commerciallyreasonable terms. If we are unable to obtain licenses with respect to patentsheld by others, and are unable to redesign our products or services to avoidinfringement of any such patents, this could materially adversely affect ourbusiness, financial condition and operating results.

 

Also, protection may not beavailable for our other intellectual property. Although we have registeredtrademarks in the United States, there can be no assurance that we will be ableto secure significant protection for these marks. It is possible that ourcompetitors will adopt product or service names similar to ours, therebyimpeding our ability to build brand identity and possibly leading to customerconfusion. Our inability to adequately protect our marks would have a materialadverse effect on our business, financial condition and operating results.

 

**We will need to introduce newproducts and services to remain competitive.**

 

Our future success dependsin part on our ability to develop and enhance our products and services. Thefinancial services industry is characterized by rapid technological change andthe emergence of new industry standards and practices that could render ourexisting technology and systems obsolete. There are significant technical andfinancial risks in the development of new or enhanced products and services,including the risk that we will be unable to effectively use new technologiesor adapt our services to emerging industry standards, or develop, introduce andmarket enhanced or new products and services. In addition, the adoption of newInternet, networking or telecommunications technologies or other technological changescould require us to incur substantial expenditures to modify or adapt ourservices or infrastructure.

 

**We may make acquisitions, and wemay be unable to successfully integrate those acquisitions with our business,impairing our financial performance.**

 

If appropriate opportunitiespresent themselves, we may acquire businesses, products or technologies that webelieve are strategic. If we do succeed in acquiring a business, product ortechnology, we have limited experience in integrating an acquisition into ourbusiness. The process of integration may produce unforeseen operatingdifficulties and expenditures and may absorb significant attention of ourmanagement that would otherwise be available for the ongoing development of ourbusiness, which may harm our business, financial condition or results ofoperations.

 

**Failure to comply with net capitalrequirements could adversely affect our business.**

 

The SEC, the NASD, the CBOEand other SROs have stringent rules with respect to the maintenance of specificlevels of net capital by securities broker-dealers. Our broker-dealersubsidiaries are required to comply with the net capital requirements. If wefail to maintain the required net capital, the SEC could fine us or evensuspend or revoke our registration, or the CBOE or NASD could sanction us,including by limiting our growth or expelling us from membership. Any of theseactions could have a material adverse effect on our business. See “Management’sDiscussion and Analysis of Financial Condition and Results of Operations —Liquidity and Capital Resources” for a discussion of our net capital position.

 

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The net capital requirementsalso provide that the SEC may restrict for up to 20 business days any withdrawalof equity capital, or unsecured loans or advances to stockholders, employees oraffiliates, commonly called capital withdrawal, if the capital withdrawal,together with all other net capital withdrawals during a 30-day period, exceeds30% of excess net capital and the SEC concludes that the capital withdrawal maybe detrimental to the financial integrity of the broker-dealers.

 

As a holding company, weaccess the earnings of our broker-dealer subsidiaries through receipt ofdividends from those subsidiaries. Net capital requirements may limit ourability to access those earnings.

 

**We are dependent on clearingagents, including Goldman Sachs Execution & Clearing, L.P., andany failures by them or difficulties in our relationships could materially harmour business.**

 

We are dependent on GoldmanSachs Execution & Clearing, L.P., or GSEC (formerly known asSpear, Leeds & Kellogg L.P.), a subsidiary of The Goldman SachsGroup, Inc., Legent Clearing, LLC, or Legent, and certain otherclearing agents for the orderly processing of transactions. Our principalrelationship is with GSEC. We recently entered into that relationship and, assuch, could encounter operational and technological difficulties inherent in anew business relationship. In addition, this relationship represents GSEC’sinitial foray into the retail securities clearing business, which may increasethe risk of unforeseen difficulties.

 

Our clearing agreements withGSEC, Legent and our other clearing firms may be terminated by any of theparties upon prior written notice. Breaches or termination of these agreementsor the clearing firms’ agreements with their third-party suppliers could harmour business. Termination of our relationship with GSEC, Legent or any of ourother clearing firms could expose us to certain capital reserve requirementsand other complex regulatory requirements imposed by federal and statesecurities laws, which could have a material adverse effect on our business.Moreover, we have agreed to indemnify and hold harmless our clearing firms fromcertain liabilities or claims, including claims arising from the transactionsof our customers, and may incur significant costs as a result.

 

**The loss of or change in ourthird-party vendors may adversely affect our business.**

 

We rely on a number of thirdparties for various services. These include the services of market makers andexchanges to execute customer orders and other third parties for back-officeservices and other information necessary to run our business, includingtransaction summaries, data feeds for compliance and risk management, executionreports and trade confirmations. Third-party content providers provide us withall of the financial information, market news, charts, option and stock quotes,research reports and other fundamental data that we offer to customers.Furthermore, we have offsite third-party data center operations that arecritical to our business.

 

We cannot assure you thatany of these providers will be able to continue to provide these services in anefficient, cost-effective manner or that they will be able to adequately expandtheir services to meet our needs. An interruption in or the cessation ofservice by any third-party service provider as a result of systems failures,capacity constraints, unanticipated trading market closures or for any otherreason, and our inability to make alternative arrangements in a smooth andtimely manner, if at all, may have a material adverse effect on our business,financial condition and operating results.

 

**Our exposure to possible litigationcould adversely affect our business.**

 

Because of the extent andcomplexity of our regulatory environment and the products we offer, manyaspects of our business involve substantial risks of liability. In recentyears, there has been an increasing incidence of litigation involving thesecurities brokerage industry, including class action and other suits thatgenerally seek substantial damages, including in some cases punitive damages.Any such litigation brought in the future could have a material adverse effecton our business, financial condition and operating results.

 

We also face potentialindirect liability for claims of defamation, negligence, copyright, patent ortrademark infringement, violation of the securities laws and other claims basedupon the third-party content that we distribute online. Computer failures mayalso result in our widely publishing and distributing incorrect data. Ourinsurance may

 

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not necessarily cover any of these claims or may notbe adequate to protect us against all liability that may be imposed. Any suchlitigation brought in the future could have a material adverse effect on ourbusiness, financial condition and operating results.

 

**Losses due to employee or customerfraud could have an adverse effect on our business.**

 

We are exposed to potentiallosses resulting from fraud and other misconduct by employees and customers.Employees may bind us to transactions that exceed authorized limits or presentunacceptable risks, hide from us unauthorized or unsuccessful activities orimproperly use confidential information. Customers may engage in fraudulentactivities, including fraudulent access to legitimate customer accounts or theuse of a false identity to open an account, or the use of forged or counterfeitchecks for payment.

 

Such types of fraud may bedifficult to prevent or detect, and we may not be able to recover the lossescaused by such activities. Any such losses could have a material adverse effecton our business, financial condition and operating results.

 

**Procedures and requirements of thePatriot Act may expose us to significant costs or penalties.**

 

As participants in thefinancial services industry, our subsidiaries are subject to laws and regulations,including the Patriot Act of 2001, that require that they know their customersand monitor transactions for suspicious financial activities. The cost ofcomplying with the Patriot Act and related laws and regulations is significant.We face the risk that our policies, procedures, technology and personneldirected toward complying with the Patriot Act are insufficient and that wecould be subject to significant criminal and civil penalties due tononcompliance. Such penalties could have a material adverse effect on ourbusiness, financial condition and operating results. As an online broker withcustomers worldwide, we may face particular difficulties in identifying ourcustomers and monitoring their activities.

 

**Requirements associated with beinga public company will require significant company resources and managementattention.**

 

Prior to our initial publicoffering, we have not been subject to the reporting requirements of theSecurities Exchange Act of 1934, as amended, or the other rules and regulationsof the SEC or any securities exchange relating to public companies. We areworking with our independent legal, accounting and financial advisors toidentify those areas in which changes should be made to our financial andmanagement control systems to manage our growth and our obligations as a publiccompany. These areas include corporate governance, corporate control, internalaudit, disclosure controls and procedures and financial reporting andaccounting systems. We have made, and will continue to make, changes in theseand other areas, including our internal control over financial reporting.However, we cannot assure you that these and other measures we may take will besufficient to allow us to satisfy our obligations as a public company on a timelybasis. In addition, compliance with reporting and other requirements applicableto public companies will create additional costs for us and will require thetime and attention of management. We cannot predict or estimate the amount ofthe additional costs we may incur, the timing of such costs or the degree ofimpact that our management’s attention to these matters will have on ourbusiness.

 

**Marketvolatility may cause our stock price and the value of your investment todecline.**

 

Broad market and industryfactors may adversely affect the market price of our common stock, regardlessof our actual operating performance. Factors that could cause fluctuations inour stock price may include, among other things:

 

•                  actualor anticipated variations in quarterly operating results;

•                  changesin financial estimates by us or by any securities analysts who might cover ourstock;

•                  conditionsor trends in our industry, including trading volumes, regulatory changes orchanges in the securities marketplace;

•                  changesin the market valuations of other companies operating in our industry;

 

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•                  announcementsby us or our competitors of significant acquisitions, strategic partnerships ordivestitures;

•                  announcementsof investigations or regulatory scrutiny of our operations or lawsuits filedagainst us;

•                  additionsor departures of key personnel; and

•                  salesof our common stock, including sales of our common stock by our directors andofficers or our strategic investors.

 

**Ourofficers, directors and largest stockholders will maintain the ability tocontrol all matters submitted to stockholders for approval.**

 

Our officers, directors andholders of 5% or more of our outstanding common stock beneficially ownapproximately 67% of our outstanding common stock. As a result, thesestockholders, acting together, will have the ability to control the election ofour directors, the appointment of new management and the potential outcome ofall matters submitted to a vote of our stockholders, including entering intomergers, the sale of substantially all of our assets and other extraordinaryitems. The interests of this group of stockholders may not always coincide withour interests or the interests of other stockholders.  

 

**Our share price may decline due tothe large number of shares eligible for future sale.**

 

Salesof a substantial number of shares of our common stock in the public marketcould occur at any time. These sales, or the perception in the market that theholders of a large number of shares intend to sell their shares, could reducethe market price of our common stock. As of March 22, 2005, we had 61,723,907 sharesof common stock outstanding, of which 14,004,318 may be resold in the publicmarket immediately. The remaining 47,719,589 shares or 77% of our outstandingshares, are currently restricted as a result of securities laws or lock-upagreements but will be able to be sold in the near future.   We, our executive officers and directors,and substantially all of our other stockholders have agreed with theunderwriters not to dispose of or hedge any of our shares of common stockduring the 180-day period following January 26, 2004 without the consentof Goldman, Sachs & Co., except that beginning after the 90thday following January 26, 2004, each stockholder will be permitted to sellor hedge up to 10% of that stockholder’s shares if the average price of ourcommon stock over the 20 consecutive trading days ending on the 72ndday following the date of our initial public offering (or, if that day is not atrading day, the preceding trading day) exceeds 120% of the initial publicoffering price.

 

We have granted certainstockholders the right to require us to register their shares of our new commonstock, representing over 39,379,777 shares of our common stock followingcompletion of this offering. Accordingly, the number of shares subject toregistration rights is substantial and the sale of these shares may have anegative impact on the market price for our common stock.

 

**Provisions in our charter documentsand Delaware law could discourage potential acquisition proposals, could delay,deter or prevent a change in control and could limit the price certaininvestors might be willing to pay for our stock.**

 

Certain provisions of ourcertificate of incorporation and by-laws, may inhibit changes in control of ourcompany not approved by our board of directors or changes in the composition ofour board of directors, which could result in the entrenchment of currentmanagement. These provisions include:

 

•                  aclassified board of directors with staggered terms;

•                  aprohibition on stockholder action through written consents;

•                  arequirement that special meetings of stockholders be called only by the boardof directors;

•                  advancenotice requirements for stockholder proposals and director nominations;

•                  limitationson the ability of stockholders to amend, alter or repeal the by-laws; and

•                  theauthority of the board of directors to issue, without stockholder approval,preferred stock with such terms as the board of directors may determine andadditional shares of our common stock.

 

We are also afforded theprotections of Section 203 of the Delaware General Corporation Law, whichprevents us from engaging in a business combination with a person who becomes a15% or greater stockholder for a period of

 

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three years from the date such person acquired suchstatus unless certain board or stockholder approvals are obtained. Theseprovisions could limit the price that certain investors might be willing to payin the future for shares of our common stock.

 

**We may not pay dividends on ourcommon stock.**

 

We currently intend todeclare quarterly dividends on all outstanding shares of common stock. There canbe no assurance, however, as to the amount and frequency of any such dividendor that a dividend will be paid at all due to factors relating to our actualfuture earnings and capital requirements and to the discretion of our board ofdirectors.

 

**FORWARD-LOOKINGSTATEMENTS**

 

This Annual Report on Form10-K, including the sections “Additional Factors That Might Affect FutureResults,” “Management’s Discussion and Analysis of Financial Condition andResults of Operations” and “Business” contains forward-looking statements.These statements relate to future events or our future financial performanceand involve known and unknown risks, uncertainties and other factors that maycause our actual results, levels of activity, performance or achievements to bematerially different from any future results, levels of activity, performanceor achievements expressed or implied by these forward-looking statements. Youare urged to carefully consider these risks and factors, included in Form 10-KAnnual Report.  In some cases, you canidentify forward-looking statements by terminology such as “may,” “will,” “should,”“expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,”“potential,” “continue” or the negative of these terms or other comparable terminology.These statements are only predictions. Actual events or results may differmaterially. The forward-looking statements made in this Form 10-K Annual Report relate only to events as of the date on which thestatements are made, and we undertake no ongoing obligation, other than anyimposed by law, to update these statements. Although we believe that theexpectations reflected in the forward-looking statements are reasonable, wecannot guarantee future results, levels of activity, performance or achievements.

 

Forward-looking statementsinclude, but are not limited to, the following:

 

•                  thestatements about our intention to pay dividends;

•                  thestatements about future growth in online brokerage accounts, options tradingand online options trading;

•                  thestatements relating to the registration of, and transfers of accounts to,optionsXpress Canada and other potential responses to possible enforcementactions against us by Canadian authorities;

•                  thestatement that on a per trade basis, brokerage, clearing and other relatedexpenses generally decrease as the number of customer trades increase;

•                  thestatements concerning continued financing options

•                  thestatements regarding scalability of our systems and the cost of increases;

 

Theforward-looking statements made in this Annual Report relate only to events asof the date on which the statements are made. as required by law, we assume noobligation to update any forward-looking statements publicly, or to update thereasons actual results could differ materially from those anticipated in anyforward-looking statements, even if new information becomes available in thefuture.

 

**Available Information**

 

Weare required to file reports with the Securities and Exchange Commission (“SEC”),including annual reports on Form 10-K, quarterly reports on Form 10-Q, andother reports from time to time. We are an electronic filer and the SECmaintains an Internet site at www.sec.gov that contains the reports, proxy andinformation statements, and other information filed electronically. Our websiteaddress is www.optionsXpress.com. Please note that these website addresses areprovided as inactive textual references only. We make available free of chargethrough our website our Annual Report on Form 10-K, quarterly reports on Form10-Q, current reports on Form 8-K, and all amendments to those reports as soonas reasonably practicable after such material is electronically filed with orfurnished to the SEC. The information provided on our website is not part ofthis report, and is therefore not

 

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incorporated by referenceunless such information is otherwise specifically referenced elsewhere in thisreport.

 

**ITEM 2.PROPERTIES**

 

We lease our corporateheadquarters and primary data center, located in Chicago, Illinois. We alsolease office space in several cities throughout the United States. Thefollowing table sets forth certain information with respect to our facilities:

 
| **Location**             | ** ** | **Space**       | ** ** | **Principal  Usage**    | ** ** |
|--------------------------|------------|-----------------|------------|-------------------------|------------|
| ** **               | ** ** | ** **      | ** ** | ** **              | ** ** |
| Chicago, IL              |       | 19,108 sq. feet |       | Corporate Headquarters  |       |
| El Paso (Ripley St), TX  |       | 6,000 sq. feet  |       | Customer Service Center |       |
| El Paso (Granada St), TX |       | 2,200 sq. feet  |       | Office Space            |       |
| Thousand Oaks, CA        |       | 950 sq. feet    |       | Office Space            |       |

 

**ITEM 3.LEGAL PROCEEDINGS**

 

Many aspects of our businessinvolve substantial risk of liability. In recent years, there has been anincreasing incidence of litigation involving the securities brokerage industry,including class action suits that generally seek substantial damages, includingin some cases punitive damages. Like other securities brokerage firms, we havebeen named as a defendant in law suits and from time to time we have beenthreatened with, or named as a defendant in, arbitrations and administrativeproceedings. Compliance and trading problems that are reported to federal,state and provincial securities regulators, securities exchanges or otherself-regulatory organizations by dissatisfied customers are investigated bysuch regulatory bodies, and, if pursued by such regulatory body or suchcustomers, may rise to the level of arbitration or disciplinary action. We arealso subject to periodic regulatory audits and inspections.

 

We are not, nor are oursubsidiaries, currently a party to any litigation that we believe could have amaterial adverse effect on our business, financial condition or operatingresults. The NASD, through a number of Wells letters delivered to us, isconsidering disciplinary action against us for potential violations of NASDOrder Audit Trail System reporting rules including failure to maintain adequateprocedures and/or supervise. The probability of a finding against us on thesepending charges is unknown, and the potential fines or other disciplinaryaction for these kind of violations of NASD rules varies, but we believe thatsettlements for such violations range from $10,000 for single violations to$60,000 for settlement of a number of violations. We have responded to or arein the process of responding to these letters and have received no reply.

 

In July 2004, theOntario Securities Commission advised us that it was considering enforcementaction against us for conducting business with customers located in Ontariowithout being registered. If the Ontario Securities Commission or thesecurities commissions of other Canadian provinces proceed with an enforcementaction, we could choose to defend against any allegations relating toviolations of Canadian registration requirements, pursue settlement to resolvethe matter and/or withdraw completely from doing business in Canada. Based onother brokerage firms settling similar matters with the Ontario SecuritiesCommission, we anticipate that if we choose to settle this matter, we may berequired to pay a penalty. We recorded a reserve of $420,000 in the thirdquarter of 2004, which we believe is a reasonable estimate of our totalexposure relating to this issue.

 

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

 

None.

 

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**PART II**

 

**ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY AND RELATEDSTOCKHOLDER MATTERS**

 

Ourcommon stock began trading on the Nasdaq National Market under the symbol “OXPS”on January 27, 2005. Prior to that date, there was no established publictrading market for our common stock. On March 22, 2005, the last sale price ofour common stock on the Nasdaq National Market was $16.75 per share and therewere approximately 122 holders of record of the common stock.

 

We have paid dividends inthe past, we declared a dividend in the first quarter of 2005, and we currentlyintend to declare quarterly dividends on all outstanding shares of commonstock. We expect the quarterly dividend initially to be approximately $0.041per share. The first quarterly dividend will be for the second calendar quarterof 2005.

 

The declaration of any otherdividends and, if declared, the amount of any such dividend, will be subject toour actual future earnings, capital requirements, regulatory restrictions andto the discretion of our board of directors. Our board of directors may takeinto account such matters as general business conditions, our financialresults, capital requirements, contractual, legal and regulatory restrictionson the payment of dividends by us to our stockholders or by our subsidiaries tous, and such other factors as our board of directors may deem relevant.

 

TheCompany maintains an equity incentive plan (the Plan) whereby management may,at its discretion, grant eligible employees, directors, independentcontractors, or consultants of the Company restricted stock or options topurchase up to 3,750,000 shares of the Company’s common stock. In general,one-third of the options become exercisable on the first anniversary datefollowing the grant, and one-thirty-sixth of the options become exercisable oneach of the succeeding 24 monthly anniversaries of the first anniversarydate. All options expire ten years after the date of the grant. The followingtable summarizes the activities of the Plan for the year ended December 31,2004 (in thousands):

 
| ** **                                    | ** ** | ** **             | ** ** | **December 31, 2004**            | ** ** |
|-----------------------------------------------|------------|------------------------|------------|---------------------------------------|------------|
| ** **                                    | ** ** | **Number of  Options** | ** ** | **Weighted  Average  Exercise Price** | ** ** |
| Outstanding,  January 1                  |       | 1,951                  |       | $                                     | 0.69       |   |
| Granted to  employees                         |       | 371                    |       | 11.91                                 |       |
| Exercised by  employees                       |       | 986                    |       | 0.38                                  |       |
| Forfeited by  employees                       |       | 60                     |       | 2.60                                  |       |
| Outstanding,  December 31                |       | 1,276                  |       | 4.10                                  |       |
| Exercisable,  December 31                |       | 393                    |       | 0.84                                  |       |
| Available  for future grant, December 31 |       | 1,940                  |       |                                  |       |
| Weighted-average  remaining life (years)      |       | 8.4                    |       |                                  |       |
|                                               |            |                        |            |                                       |            |  |

 

**RecentSales of Unregistered Securities; Use of Proceeds from Registered Securities**

 

The table set forth belowlists the securities sold by us since January 1, 2002 (in thousands).

 
| **Event**                                 | ** ** | **Date**   | ** ** | **Type of Stock** | ** ** | **Number of Shares** | ** ** | **Total  Consideration** | ** ** |
|-------------------------------------------|------------|------------|------------|-------------------|------------|----------------------|------------|--------------------------|------------|
| **Preferred**                             | ** ** | **Common** |
| Sale of  Series A2 Preferred Stock(1)     |       | 7/31/2002  |       | Common            |       | —               |       | 2,437                    |       | $ | 3 |   |
| 2003  Employee Stock Options Exercises(2) |       | 2003       |       | Common            |       | —               |       | 764                      |       | $ | 162 |   |
| 2004  Employee Stock Options Exercises(2) |       | 2004       |       | Common            |       | —               |       | 986                      |       | $ | 375 |   |
| Sale of  Common Stock(3)                  |       | 3/12/2004  |       | Common            |       | —               |       | 412                      |       | $ | 2,000 |   |

 

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(1)  Exercise of warrants issued in connection withthe December 19, 2001 purchase of Series A2 preferred stock. The sale ofSeries A2 preferred stock and warrants to purchase our common stock were exemptfrom the registration requirements of the Securities Act in reliance onRegulation D (Rule 506) promulgated thereunder as a transaction by anissuer not involving a public offering. We sold the securities to 18 accreditedinvestors without any form of general solicitation or general advertising.

 

(2)  The employee stock option exercises wereexempt from the registration requirements of the Securities Act in reliance onRule 701 promulgated thereunder as transactions pursuant to compensatorybenefit plans and contracts relating to compensation as provided underRule 701.

 

(3)  The sale of common stock was exempt form theregistration requirements of the Securities Act in reliance onRegulation D (Rule 506) promulgated thereunder as a transaction by anissuer not involving a public offering. We sold the securities to 9 accreditedinvestors without any form of general solicitation or general advertising.

 

Inaddition, on December 17, 2003, we entered into a stock purchase andrecapitalization agreement with investment funds affiliated with SummitPartners, G-Bar Limited Partnership, JG 2002 Delta Trust, David S. Kalt,Ned W. Bennett, Delaware Charter Guarantee & Trust CompanyF/B/O Ned Bennett IRA and certain other stockholders pursuant to which, onJanuary 15, 2004, we issued approximately 18.2 million shares ofSeries A preferred stock in exchange for approximately $88.4 million.The issuance was exempt from the registration requirements of the SecuritiesAct in reliance on Regulation D (Rule 506) promulgated thereunder asa transaction by an issuer not involving a public offering. In conjunction withthis recapitalization, our former preferred stockholders converted theirpreferred stock into shares of common stock. Furthermore, we then redeemedapproximately 18.2 million shares of common stock (including a portion ofthe shares of preferred stock converted into common stock by our formerpreferred stockholders) for an aggregate amount of approximately$88.4 million.

 

OnJanuary 26, 2005, as a result of our initial public offering, all of ourissued and outstanding shares of preferred stock were converted into 18.2millionshares of common stock in accordance with the terms of such preferred stock.

 

Wehave granted stock options under our stock option plans covering an aggregateof 1,275,653 shares of common stock (net of exercises, expirations andcancellations) as of December 31, 2004, at exercise prices ranging from1.25 to 120.00 per share. As of December 31, 2004, options to purchase anaggregate of 1,749,218 shares of common stock have been exercised for anaggregate purchase price of $536,928, or a weighted exercise price of  $5.21 per share. We claimed exemption fromregistration under the Securities Act for the sale and issuance of securitiesin the transactions described in this paragraph by virtue of Section 4(2)of the Securities Act and Rule 701 promulgated under Section 3(b) ofthe Securities Act as a transaction under a compensatory benefit plan underRule 701.

 

OnJanuary 26, 2005, the SEC declared effective our first registrationstatement, filed on Form S-1 (File No. 333-119967) under the SecuritiesAct in connection with the initial public offering of our common stock.Goldman, Sachs & Co., Merrill Lynch & Co., Raymond James, William Blair& Company and Sandler O’Neill & Partners, L.P. acted as theunderwriters for the offering.

 

Our common stock begantrading on The Nasdaq National Market under the trading symbol “OXPS” on January 27,2005. We sold 5,000,000 shares and certain selling stockholders sold7,000,000 shares of common stock in our initial public offering at $16.50per share. The offering terminated after the sale of all of the securitiesregistered on the registration statement and the expiration of the underwriters’over-allotment option. The aggregate gross proceeds received by us from theshares of common stock we sold were $82.5 million. We will not receive anyof the proceeds from sales of common stock by the selling stockholders in theoffering. We paid the underwriters a commission of $5.8 million andincurred offering expenses estimated at $1.3 million, net of a $0.6million reimbursement by the underwriters of a portion of the expenses. Afterdeducting the underwriters’ commission and the estimated offering expenses, wereceived net proceeds of approximately $75.4 million. We invested the netproceeds in short-term securities and expect to use the net proceeds forgeneral corporate purposes. In addition, we may use a portion of the netproceeds from this offering for acquisitions of complementary businesses,products and technologies. Our management will have broad discretion over howwe use the net proceeds from this offering. None of the expenses, orapplication of the net proceeds, were paid, directly or indirectly, todirectors, officers or persons owning 10% or more

 

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of our common stock or to their associates, or to our affiliates.

 

**ITEM 6.SELECTED FINANCIAL DATA**

 

The following summary consolidated financial andoperating data should be read together with our consolidated financialstatements and the related notes included elsewhere in this Annual Report andthe discussion under “Management’s Discussion and Analysis of FinancialCondition and Results of Operations.” The financial information for the yearsended December 31,  2004, 2003,2002, 2001 and 2000 set forth below was derived from our audited consolidatedfinancial statements and related notes included elsewhere in this Form 10-KAnnual Report. The historical financial and operating information may not beindicative of our future performance.

 
| ** **                                       | ** ** | **Year ended December 31,**           | ** ** |
|--------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                       | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000(1)** | ** ** |
| ** **                                       | ** ** | **(in thousands, except per share  data)** | ** ** |
| **Results  of Operations**                       |       |                                       |       |   |   |   |   |   |   |   |   |
| **Revenues**                                     |       |                                       |       |   |   |   |   |   |   |   |   |
| Commissions                                      |       | $                                          | 71,567     |   | $ | 38,088 |   | $ | 14,173 |   | $ | 1,995 |   | $ | 2 |   |
| Other  brokerage related revenue                 |       | 17,751                                     |       | 8,793 |   | 2,751 |   | — |   | — |   |
| Interest  income                                 |       | 3,648                                      |       | 1,274 |   | 340 |   | 74 |   | 2 |   |
| Other                                            |       | 103                                        |       | 26 |   | 4 |   | 13 |   | — |   |
| Total  revenues                                  |       | $                                          | 93,069     |   | $ | 48,181 |   | $ | 17,268 |   | $ | 2,082 |   | $ | 4 |   |
| **Expenses**                                     |       |                                       |       |   |   |   |   |   |   |   |   |
| Brokerage,  clearing, and other related expenses |       | $                                          | 14,258     |   | $ | 8,494 |   | $ | 5,198 |   | $ | 1,108 |   | $ | 1 |   |
| Compensation  and benefits                       |       | 9,760                                      |       | 5,037 |   | 2,865 |   | 985 |   | 278 |   |
| Advertising                                      |       | 6,675                                      |       | 2,975 |   | 1,070 |   | 503 |   | 32 |   |
| Quotation  services                              |       | 3,693                                      |       | 1,984 |   | 786 |   | 210 |   | 14 |   |
| Depreciation  and amortization                   |       | 1,648                                      |       | 770 |   | 331 |   | 88 |   | 9 |   |
| Technology  and telecommunication                |       | 1,434                                      |       | 693 |   | 362 |   | 225 |   | 192 |   |
| Other                                            |       | 3,376                                      |       | 1,010 |   | 466 |   | 321 |   | 148 |   |
| Total  expenses                                  |       | 40,844                                     |       | 20,963 |   | 11,078 |   | 3,440 |   | 674 |   |
| Income  (loss) before income taxes               |       | 52,225                                     |       | 27,218 |   | 6,190 |   | (1,358 | ) | (670 | ) |
| Income taxes                                     |       | 21,015                                     |       | 10,862 |   | 1,819 |   | — |   | — |   |
| Net income  (loss)                               |       | $                                          | 31,210     |   | $ | 16,356 |   | $ | 4,371 |   | $ | (1,358 | ) | $ | (670 | ) |
| Net income  (loss) per share — basic   |       | $                                          | 0.56       |   | $ | 0.30 |   | $ | 0.08 |   | $ | (0.04 | ) | $ | (0.02 | ) |
| Net income  (loss) per share — diluted |       | $                                          | 0.55       |   | $ | 0.29 |   | $ | 0.08 |   | $ | (0.04 | ) | $ | (0.02 | ) |
| Weighted  average shares — basic       |       | 37,956                                     |       | 40,583 |   | 38,935 |   | 37,500 |   | 37,500 |   |
| Weighted  average shares — diluted     |       | 57,264                                     |       | 56,783 |   | 55,370 |   | 37,500 |   | 37,500 |   |

 
| ** **                                                | ** ** | **As of December 31,** | ** ** |
|-----------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000(1)** | ** ** |
| **Statistical  Data**                                     |       |                        |       |   |   |   |   |   |   |   |   |
| Number of  customer accounts (at period end)(2)           |       | 100,960                     |       | 57,728 |   | 22,171 |   | 4,759 |   | 20 |   |
| Daily  average revenue trades (“DARTs”)(3) |       | 13,560                      |       | 7,567 |   | 2,830 |   | 390 |   | 4 |   |
| Customer  trades per account (4)                          |       | 42.98                       |       | 46.5 |   | 53.2 |   | 41.3 |   | 12.2 |   |
| Average  commission per trade                             |       | $                           | 20.99      |   | $ | 19.90 |   | $ | 19.80 |   | $ | 20.19 |   | $ | 17.77 |   |
| Option  trades as a % of total trades                     |       | 79.1                        | %          | 79.3 | % | 89.7 | % | 87.9 | % | 57.4 | % |
| Advertising  expense per new customer account(5)          |       | $                           | 154        |   | $ | 84 |   | $ | 61 |   | $ | 106 |   | $ | 1,604 |   |
| **Balance  Sheet (at period end, in thousands)**          |       |                        |       |   |   |   |   |   |   |   |   |
| Cash                                                      |       | $                           | 24,759     |   | $ | 2,777 |   | $ | 2,604 |   | $ | 1,003 |   | $ | 14 |   |
| Total assets                                              |       | 40,095                      |       | 9,990 |   | 5,129 |   | 1,843 |   | 204 |   |
| Long-term  debt                                           |       | —                      |       | — |   | — |   | 387 |   | — |   |
| Total  liabilities                                        |       | 7,089                       |       | 2,011 |   | 2,213 |   | 509 |   | 72 |   |
| Total  stockholders’ equity                          |       | 33,006                      |       | 7,979 |   | 2,916 |   | 1,334 |   | 132 |   |
| **Dividends**                                             |       |                        |       |   |   |   |   |   |   |   |   |
| Dividends  declared per share (during the period)         |       | $                           | 0.13       |   | $ | 0.17 |   | $ | 0.05 |   | — |   | — |   |

 

26

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(1) Represents the periodfrom inception, February 1, 2000 to December 31, 2000.

 

(2) Customer accounts areopen, numbered accounts.

 

(3) DARTs are totalrevenue-generating trades for a period divided by the number of trading days inthat period.

 

(4) Customer trades peraccount are total trades divided by the average number of total customeraccounts during the period.

 

(5) Calculated based ontotal new customer accounts opened during the period.

 

**ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

*The statements in this discussionregarding the industry outlook, our expectations regarding the futureperformance of our business, and the other non-historical statements in thisdiscussion are forward-looking statements. These forward-looking statements aresubject to numerous risks and uncertainties, including, but not limited to, therisks and uncertainties described in the “Risk Factors” section. You shouldread the following discussion together with the section entitled “RiskFactors” and our consolidated financial statements and notes thereto includedelsewhere in this Form 10-K Annual Report.*

 

**Overview**

 

We offer a comprehensive suite of brokerage servicesfor stock, mutual fund, option and fixed-income product investors. We have beenrecognized as offering the leading online retail brokerage platform for therapidly expanding listed equity options market, based on the quality of ourproprietary technology and our customer experience. We opened our firstcustomer account in December 2000. Since that time, we have grown to over100,000 customer accounts. Our option trades represented approximately 3% ofall listed U.S. options volume for the twelve months ended December 31, 2004.We believe this makes us one of the largest retail online options brokers. Ourrevenue consists primarily of commissions from customers’ trades of options,stocks, mutual funds and fixed-income products.  In 2004, option trades represented approximately79% of our customers’ trades, with approximately 20% coming from stocks and 1%from mutual funds and fixed-income products. We have experienced growth inrevenue and market share every year since inception and have been net incomeand cash flow positive since the first quarter of 2002. We generated$93.1 million of revenue for the twelve months ending December 31,2004 with $52.2 million of income before income taxes and$31.2 million of net income.

 

**Sources of Revenue**

 

Our largest source of revenue is commissions earnedfrom our brokerage activities, which is driven largely by our customers’trading activities. Given the early stage of our brokersXpress operation, thisrevenue currently consists almost entirely of revenue from our optionsXpressretail trading platform. In addition, like other retail brokerage firms, wereceive payment for order flow from exchanges and liquidity providers where ourcustomers’ orders are routed. By custom in the industry, these cash paymentsare not the subject of any written agreement. As a result, they could be

 

27

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changedor eliminated at any time. Payment for order flow is included in otherbrokerage revenue. Commissions and their related clearing costs and payment fororder flow are recorded on a trade date basis as transactions occur. Interestincome consists of our portion of the income generated by charges to customerson margin balances and customer cash held and invested by our clearing firm,offset by interest paid to customers on their credit balances. Since we are anintroducing broker, all customer balances are held by our clearing firm on afully disclosed basis. Commissions represented 82.1%, 79.1% and 76.9% of ourtotal revenue in 2002, 2003 and 2004, respectively. Other brokerage revenuerepresented 15.9%, 18.3% and 19.1% of our total revenue in 2002, 2003 and 2004,respectively.

 

**Operating Expenses**

 

*Brokerage, clearing and otherrelated expenses*

 

Our largest single expense item is brokerage,clearing and other related expenses, which includes the costs of executing andclearing customer trades. These costs are paid to clearing agents as well asexchanges and third-party broker-dealers. These costs are largely variable withcommission revenues. On a per trade basis, these costs generally decrease asour total number of customer trades increase.

 

*Other Operating Expenses*

 

Our largest other operating expense is employeecompensation and benefits, which includes salaries, bonuses, group insurance,contributions to benefit programs and other related employee costs. Due to theefficiencies created by our technology and brokerage platform, however, ouremployee compensation expense is a lower percentage of revenue than our majoronline competitors and traditional, full service brokerage firms. Advertisingcosts are expensed as incurred, except for the production of broadcastadvertising, which is expensed when the first broadcast airs, and includesproduction and communication of advertising and other marketing activities.Quotation services include costs paid to exchanges and outside firms to providesecurities quotes to our customers. Depreciation and amortization includesdepreciation on property and equipment, as well as amortization of capitalizedsoftware. Other expenses include lease expenses on office space, data centers,computers and other equipment, telecommunications, postage and news costs,losses for execution errors, customer execution price adjustments, travelexpenses and other miscellaneous expenses.

 

As a public company, we are subject to therequirements of the Sarbanes-Oxley Act of 2002, which may require us to incursignificant expenditures in the near term to establish systems and hire andtrain personnel to comply with these requirements. In addition, as a publiccompany, we expect to incur additional costs for external advisors such aslegal, accounting and auditing fees. We will be required to adopt, atSeptember 30, 2005, Statement of Financial Accounting Standards (SFAS) No. 123R(revised 2004) and, to recordcompensation expense based on the fair value of options issued to employees.Currently, we are only required to record compensation expense to the extentthat the fair value of our common stock exceeds the exercise price of theoptions at the measurement date.

 

**Results of Operations**

 

The following table sets forth our total revenuesand consolidated statements of income data for the periods presented as apercentage of total revenues:

 
| ** **                                       | ** ** | **Year ended December 31,** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|
| ** **                                       | ** ** | **2002**                         | ** ** | **2003** | ** ** | **2004** | ** ** |
| **Results  of Operations**                       |       |                             |       |   |   |   |   |
| Total  revenues (in thousands)                   |       | $                                | 17,268     |   | $ | 48,181 |   | $ | 93,069 |   |
| Brokerage,  clearing, and other related expenses |       | 30.1                             | %          | 17.6 | % | 15.3 | % |
| Compensation  and benefits                       |       | 16.6                             |       | 10.5 |   | 10.5 |   |
| Advertising                                      |       | 6.2                              |       | 6.2 |   | 7.2 |   |
| Quotation  services                              |       | 4.6                              |       | 4.1 |   | 4.0 |   |
| Depreciation  and amortization                   |       | 1.9                              |       | 1.6 |   | 1.8 |   |
| Technology  and telecommunication                |       | 2.1                              |       | 1.4 |   | 1.5 |   |
| Other                                            |       | 2.7                              |       | 2.1 |   | 3.6 |   |
| Income  before income taxes                      |       | 35.8                             |       | 56.5 |   | 56.1 |   |
| Income taxes                                     |       | 10.5                             |       | 22.6 |   | 22.6 |   |
| Net income                                       |       | 25.3                             |       | 33.9 |   | 33.5 |   |
|                                                  |            |                                  |            |  |  |  |  |  |  |  |

 

28

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***Year Ended December 31,2004 versus Year Ended December 31, 2003***

 

*Overview*

 

Our improved results for the period reflect thefollowing principal factors:

 

•                  total customer accountsincreased by 43,232 to 100,960, or 74.9%;

 

•                  total trades increased by1.5 million to 3.4 million, or 78.1%; and

 

•                  average commission pertrade increased by $1.09 to $20.99, or 5.5%.

 

A significant factor in the growth of the year endedDecember 31, 2004 versus December 31, 2003 was the strength of theoverall equity markets in the first quarter of 2004. The result was anextremely strong first quarter followed by more modest growth in the second andthird quarters as the markets returned to more typical levels.

 

*Total revenues*

 

Our total revenues increased $44.9 million, or93.2%, for the year ended December 31, 2004 to $93.1 million comparedto $48.2 million for the year ended December 31, 2003. The increasein total revenues consisted primarily of an increase in brokerage commissionsfor the year ended December 31, 2004 of $33.5 million, or 87.9%, to$71.6 million compared to $38.1 million for the year ended December 31,2003, and an increase in payment for order flow of $9.0 million, or101.9%, to $17.8 million for the year ended December 31, 2004compared to $8.8 million for the year ended December 31, 2003. Theseincreases were primarily the result of the rise in the number of tradesprocessed, commission per trade and an increase in customer accounts.

 

*Brokerage, clearing, and otherrelated expenses*

 

Brokerage, clearing, and other related expensesincreased $5.8 million, or 67.9%, to $14.3 million for the year endedDecember 31, 2004 from $8.5 million for the year ended December 31,2003. Increased brokerage expenses were primarily due to the execution chargesassociated with the 78.7% increase in trades and $1.7 million ofnon-recurring charges for clearing that began in April 2004 and ended uponconversion to our new clearing agent, Goldman Sachs Execution and Clearing, in September 2004.Without these non-recurring charges, brokerage, clearing and other relatedcharges per trade decreased by 21% primarily due to improved pricing forincreased volume.

 

*Compensation and benefits*

 

Compensation and benefits expenses increased$4.8 million, or 93.8%, to $9.8 million for the year ended December 31,2004 from $5.0 million for the year ended December 31, 2003.Increased compensation expenses were primarily due to an increase in the numberof employees from 82 to 125 and a one-time expense of $0.7 million inconnection with a restricted stock grant.

 

*Advertising*

 

Advertising expenses increased $3.7 million, or124.4%, to $6.7 million for the year ended December 31, 2004 from$3.0 million for the year ended December 31, 2003. Increasedadvertising expenses were primarily due to increased print advertising and ourtrial use of television advertising, which temporarily resulted in a higheradvertising expense per new account.

 

*Quotation services*

 

Quotation services expenses increased$1.7 million, or 86.1%, to $3.7 million for the year ended December 31,2004 from $2.0 million for the year ended December 31, 2003.Increased quotation services expenses were primarily due to a 74.9% increase incustomer accounts.

 

29

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*Depreciation and amortization*

 

Depreciation and amortization expenses increased$0.8 million, or 114.0%, to $1.6 million for the year ended December 31,2004 from $0.8 million for the year ended December 31, 2003. Increaseddepreciation and amortization expenses were primarily due to increasedcapitalized costs relating to the continued development of our brokerageplatform and technology infrastructure.

 

*Technology and Telecommunication*

 

Technologyand telecommunication expenses increased $0.7 million, or 106.9%, to$1.4 million for the year ended December 31, 2004 from$0.7 million for the year ended December 31, 2003. Increased technologyand telecommunication expenses were primarily due to added telecommunications anddata expense to support the increase in customer accounts.

 

*Other*

 

Other expenses increased $2.4 million, or234.3%, to $3.4 million for the year ended December 31, 2004 from$1.0 million for the year ended December 31, 2003. Increased otherexpenses were primarily due to increased general administrative expenses and professionalfees expenses associated with registrations and licensing in foreign countries.

 

*Income taxes*

 

Income taxes increased $10.1 million, or 93.5%,to $21.0 million for the year ended December 31, 2004 from$10.9 million for the year ended December 31, 2003. Increased incometaxes were primarily due to the 91.9% increase in income before income taxes.

 

*Net income*

 

As a result of the foregoing, we reported$31.2 million in net income for the year ended December 31, 2004, ascompared to $16.4 million in net income for the year ended December 31,2003, an increase of $14.8 million, or 90.8%.

 

***Year Ended December 31,2003 versus Year Ended December 31, 2002***

 

*Overview*

 

Our improved results for the period reflect thefollowing principal factors:

 

•                  total customer accountsincreased by 35,557 to 57,728, or 160%;

 

•                  total trades increased by1.2 million to 1.9 million, or 168%; and

 

•                  commission per trade heldsteady at approximately $20.00 per trade.

 

*Total revenues*

 

Our total revenues increased $30.9 million, or179%, to $48.2 million, for the year ended December 31, 2003 comparedto $17.3 million for the year ended December 31, 2002. The increasein total revenues consisted primarily of an increase in brokerage commissionsfor the year ended December 31, 2003 of $23.9 million, or 169%, to$38.1 million compared to $14.2 million for the year ended December 31,2002, and an increase in payments for order flow of $6.0 million, or 220%,for the year ended December 31, 2003 to $8.8 million compared to$2.8 million for the year ended December 31, 2002. Revenue growth wasprimarily driven by a 160% increase in total customer accounts and a 168%increase in total trades.

 

30

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*Brokerage, clearing, and otherrelated expenses*

 

Brokerage, clearing, and other related expensesincreased $3.3 million, or 63%, to $8.5 million for the year ended December 31,2003 from $5.2 million for the year ended December 31, 2002.Increased brokerage expenses were primarily due to increased trade volume. Theper trade cost decreased as a result of volume incentives in our clearingagreement.

 

*Compensation and benefits*

 

Compensation and benefits expenses increased$2.1 million, or 76%, to $5.0 million for the year ended December 31,2003 from $2.9 million for the year ended December 31, 2002.Increased compensation expenses were primarily due to headcount increasing from49 at December 31, 2002 to 82 at December 31, 2003 to support thegrowth in our core business.

 

*Advertising*

 

Advertising expenses increased $1.9 million, or178%, to $3.0 million for the year ended December 31, 2003 from$1.1 million for the year ended December 31, 2002. Increasedadvertising expenses were primarily due to additional online advertising.

 

*Quotation services*

 

Quotation services expenses increased$1.2 million, or 152%, to $2.0 million for the year ended December 31,2003 from $0.8 million for the year ended December 31, 2002.Increased quotations services expenses were primarily due to the increase inthe number of accounts.

 

*Depreciation and amortization*

 

Depreciation and amortization expenses increased$0.5 million, or 133%, to $0.8 million for the year ended December 31,2003 from $0.3 million for the year ended December 31, 2002.Increased depreciation and amortization expenses were primarily due toincreased capitalized costs relating to the continued development of ourbrokerage platform and technology infrastructure.

 

*Technology and telecommunication*

 

Technology and telecommunication expenses increased$0.3 million, or 91.4%, to $0.7 million for the year ended December 31,2003 from $0.4 million for the year ended December 31, 2002.Increased other expenses were primarily due to added telecommunications anddata expense to support the increase in customer accounts.

 

*Other*

 

Other expenses increased $0.5 million, or116.7%, to $1.0 million for the year ended December 31, 2003 from$0.5 million for the year ended December 31, 2002. Increased otherexpenses were primarily due to added general and administrative expensesincluding professional fees and travel.

 

*Income taxes*

 

Income taxes increased $9.1 million, or 497%,to $10.9 million for the year ended December 31, 2003 from$1.8 million for the year ended December 31, 2002. Increased incometaxes were primarily due to increased pre-tax income and having exhausted allof our tax loss carry forwards.

 

*Net income*

 

As a result of the foregoing, we reported$16.4 million in net income for the year ended December 31, 2003, ascompared to $4.4 million in net income for the year ended December 31,2002.

 

31

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**Quarterly Results**

 

The following tables set forth selected unauditedconsolidated quarterly statement of income data and selected unauditedconsolidated operating data for the four quarters ended December 31, 2004.In management’s opinion, this unaudited information has been prepared onsubstantially the same basis as the consolidated financial statements appearingelsewhere in this Form 10-K and includes all adjustments (consisting of normalrecurring adjustments) necessary for a fair statement of the unauditedconsolidated quarterly data. The unaudited consolidated quarterly data shouldbe read together with the consolidated financial statements and related notesincluded elsewhere in this Form 10-K Annual Report. The results for any quarterare not necessarily indicative of results for any future period, and you shouldnot rely on them as such.

 
| ** **                                       | ** ** | **Quarter ended**        | ** ** |
|--------------------------------------------------|------------|--------------------------|------------|
| ** **                                       | ** ** | **March 31,  2004** | ** ** | **June 30,  2004** | ** ** | **Sept. 30,  2004** | ** ** | **Dec. 31,  2004** | ** ** |
| ** **                                       | ** ** | **(unaudited)**          | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** |
| ** **                                       | ** ** | **(in thousands)**       | ** ** |
| **Results  of Operations**                       |       |                     |       |   |   |   |   |   |   |
| Total  revenues                                  |       | $                        | 23,803     |   | $ | 23,986 |   | $ | 19,717 |   | $ | 25,563 |   |
| Brokerage,  clearing, and other related expenses |       | 3,102                    |       | 3,814 |   | 3,612 |   | 3,730 |   |
| Compensation  and benefits                       |       | 1,766                    |       | 2,156 |   | 3,117 |   | 2,721 |   |
| Advertising                                      |       | 1,939                    |       | 1,806 |   | 1,387 |   | 1,543 |   |
| Quotation  services                              |       | 797                      |       | 913 |   | 845 |   | 1,138 |   |
| Depreciation  and amortization                   |       | 367                      |       | 375 |   | 418 |   | 488 |   |
| Technology  and telecommunication                |       | 217                      |       | 281 |   | 411 |   | 525 |   |
| Other                                            |       | 379                      |       | 599 |   | 1,476 |   | 922 |   |
| Income taxes                                     |       | 6,058                    |       | 5,585 |   | 3,530 |   | 5,842 |   |
| Net income                                       |       | $                        | 9,178      |   | $ | 8,457 |   | $ | 4,921 |   | $ | 8,654 |   |

 

**Liquidity and Capital Resources**

 

We have historically financed our liquidity andcapital needs primarily through the use of funds generated from operations andthe issuance of common stock and Series A preferred stock for generalcorporate purposes. We plan to finance our future operating liquidity andregulatory capital needs from our earnings. Although we have no current plansto do so, we may issue equity or debt securities or enter into secured lines ofcredit from time to time.

 

As a holding company, we access the earnings of ouroperating subsidiaries through receipt of dividends from these subsidiaries.Some of our subsidiaries are subject to requirements of the SEC and NASDrelating to liquidity and capital standards, which limit funds available forthe payment of dividends to the holding company.

 

Our broker-dealer subsidiary,optionsXpress, Inc., is subject to the Securities and Exchange CommissionUniform Net Capital Rule (Rule 15c3-1). Under applicable provisions ofthis Rule, optionsXpress, Inc. is required to maintain net capital of 62¤3% of “aggregate indebtedness” or $0.25 million, whichever isgreater, as these terms are defined. Net capital and aggregate indebtednesschange from day to day, but at December 31, 2004, it had net capital ofapproximately $23.45 million and net capital requirements of$0.40 million. The ratio of aggregate indebtedness to net capital at December 31,2004 was 0.25 to 1.

 

Our other broker-dealer subsidiary, brokersXpressLLC, is also subject to Rule 15c3-1 and at December 31, 2004, had netcapital of approximately $0.27 million and applicable net capitalrequirements of $0.05 million.  Theratio of aggregate indebtedness to net capital at December 31, 2004 was0.55 to 1.

 

***Cash Flow***

 

Cash provided by operating activities was$32.0 million for the year ended December 31, 2004, compared to cashprovided by operating activities of $13.3 million for the year ended December 31,2003 and cash provided by operating activities of $6.0 million for theyear ended December 31, 2002. The primary reason for the increase in cash

 

32

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providedby operating activities was the increase in the number of trades offset in partby an increase in our receivable from our clearing broker.

 

Cash used in investing activities was$3.2 million for the year ended December 31, 2004, compared to cashused in investing activities of $1.8 million and $1.2 million for theyears ended December 31, 2003 and 2002, respectively. The increase in cashused in investing activities was primarily the result of increasedinfrastructure purchased, including furniture and technology, to support ourgrowth.

 

Cash used in financing activities was$6.8 million for the year ended December 31, 2004, compared to cashused in financing activities of $11.3 million and $3.2 million for theyears ended December 31, 2003 and 2002. In 2003, we redeemed approximately $2.0 million of existing stockfrom a stockholder. In addition, we paid dividends totaling $7.0 millionduring the year ended December 31, 2004. In 2003 and 2002, we paid dividends totaling $9.5 million and $2.9million, respectively.

 

***CapitalExpenditures***

 

Capital expenditures were $3.2 million for the yearended December 31, 2004, compared to $1.8 million and$1.2 million for the years ended December 31, 2003 and 2002,respectively. Capital expenditures for the years ended December 31, 2004and 2003 included capitalized software costs, which we capitalized inaccordance with Statement of Position (“SOP”) 98-1 “Accounting for the Costs ofComputer Software Developed or Obtained for Internal Use,” primarily related tothe development of our technology.

 

***SummaryDisclosures about Contractual Obligations and Commercial Commitments***

 

The following table reflects a summary of ourcontractual cash obligations and other commercial commitments at December 31,2004:

 
| ** **                   | ** ** | **Payments due by period** | ** ** |
|------------------------------|------------|----------------------------|------------|
| **Contractual Obligations**  | ** ** | **Total**                  | ** ** | **Less than  1 year** | ** ** | **1 - 3 years** | ** ** | **3 - 5 years** | ** ** | **More than  5 years** | ** ** |
| ** **                   | ** ** | **(in thousands)**         | ** ** |
| Capital  lease obligations   |       | $                          | 301        |   | $ | 125 |   | $ | 176 |   | $ | — |   | $ | — |   |
| Operating  lease obligations |       | 1,407                      |       | 527 |   | 880 |   | — |   | — |   |
| Purchase  obligations        |       | 1,313                      |       | 1,109 |   | 204 |   | — |   | — |   |
| Total                        |       | $                          | 3,021      |   | $ | 1,761 |   | $ | 1,260 |   | $ | — |   | $ | — |   |

 

**Critical Accounting Policies**

 

Our discussion and analysis of our financialcondition and results of operations are based on our financial statements,which have been prepared in accordance with accounting principles generallyaccepted in the United States. The preparation of these financial statementsrequires us to make estimates and judgments that affect the reported amounts ofassets, liabilities and expenses. We review our estimates on an on-going basis.We base our estimates on our experience and on various other assumptions thatwe believe to be reasonable under the circumstances. Actual results may differfrom these estimates under different assumptions or conditions. While oursignificant accounting policies are described in more detail in the notes toour financial statements included in this Form 10-K, we believe the accountingpolicies that require management to make assumptions and estimates involvingsignificant judgment are those relating to the capitalization of softwaredevelopment and the valuation of stock-based compensation.

 

***Software***

 

Costs associated with software developed for internaluse include capitalized costs based on SOP 98-1 and other related guidance.Capitalized costs include external direct costs of materials and servicesconsumed in developing or obtaining internal-use software and payroll foremployees directly associated with, and who devote time to, the development ofthe internal-use software. Costs incurred in development and enhancement of thesoftware that do not meet the capitalization criteria are expensed as incurred.These capitalized costs are amortized on a straight-line basis

 

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over three years. During 2002, 2003 and 2004, we capitalized$0.5 million, $0.7 million and $1.1 million, respectively, ofsoftware development costs.  In addition,during 2002, 2003, and 2004, we expensed $0.3 million, $0.3 million and $1.1million for costs associated with software that did not meet the capitalizationcriteria.

 

The critical estimate related to this process is thedetermination of the amount of time devoted by employees to specific stages ofinternal-use software development projects. We utilize a project managementtool to assist in validating the underlying estimates used in the determinationof time devoted. We review any impairment of the capitalized costs on a periodicbasis.

 

***Stock-BasedCompensation***

 

While we have not adopted the fair value basedmethod of accounting for stock-based compensation related to options underStatement of Financial Accounting Standards (SFAS) No. 148, “Accountingfor Stock-Based Compensation,” which amends SFAS No. 123, “Accounting forStock-Based Compensation,” we do make the required pro forma disclosures forthe effect on net income (loss) as if the fair market value based method ofaccounting provided for under SFAS No. 123 had been adopted. These proforma disclosures are based upon a number of assumptions utilized in avaluation model in determining the appropriate valuation of the fair marketvalue of options on the date of grant. We will be required to adopt, atSeptember 30, 2005, Statement of Financial Accounting Standards (SFAS) No. 123R(revised 2004), and record compensation expense based on the fair value ofoptions issued to employees.

 

The key assumptions used in the valuation model arestock price at date of grant, expected volatility, annual expected dividendyield and expected life of the options granted. The fact that we were a privatecompany until January 26, 2005 and our stock had not been publicly tradedmade this estimation process more subjective than it would be for a publiccompany. In addition, as we have only existed for a short time, we do not haveextensive experience on which to base these assumptions. We have utilizedassumptions we believe to be reasonable and appropriate.

 

**ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK**

 

We do not have materialexposure to interest rate changes, commodity price changes, foreign currencyfluctuations or similar market risks other than the effect they may have ontrading volumes. Accordingly, we have not entered into any derivative contractsto mitigate such risks. In addition, we do not trade securities for our ownaccount or maintain inventories of securities for sale, and therefore are notsubject to equity price risk.

 

Through an arrangement withour clearing firms, we extend margin credit and leverage to our customers,which is subject to various regulatory and clearing firm margin requirements.Margin credit is collateralized by cash and securities in the customers’accounts. Leverage involves securing a large potential future obligation with aproportional amount of cash or securities. The risks associated with margincredit and leverage increase during periods of fast market movements or incases where leverage or collateral is concentrated and market movements occur.During such times, customers who utilize margin credit or leverage and who havecollateralized their obligations with securities may find that the securitieshave a rapidly depreciating value and may not be sufficient to cover their obligationsin the event of a liquidation. We are also exposed to credit risk when ourcustomers execute transactions, such as short sales of options and equities,that can expose them to risk beyond their invested capital.

 

We expect this kind ofexposure to increase with growth in our overall business. Because we indemnifyand hold harmless our clearing firms from certain liabilities or claims, theuse of margin credit, leverage and short sales may expose us to significantoff-balance-sheet risk in the event that collateral requirements are notsufficient to fully cover losses that customers may incur and those customersfail to satisfy their obligations. As of December 31, 2004, we had$78.0 million in margin credit extended to our customers through ourclearing firms. The amount of risk to which we are exposed from the leverage weextend to our customers and from short sale transactions by our customers isunlimited and not quantifiable as the risk is dependent upon analysis of apotential significant and undeterminable rise or fall in stock prices. Ouraccount level margin credit and leverage requirements meet or exceed thoserequired by Regulation T of the Board of Governors of the Federal Reserve.

 

We have a comprehensivepolicy implemented in accordance with SRO standards to assess and monitor thesuitability of investors to engage in various trading activities. To mitigateour risk, we also continuously monitor customer accounts to detect excessiveconcentration, large orders or positions, patterns of day trading and otheractivities that indicate increased risk to us.

 

34

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**ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

TheReport of Independent Registered Public Accounting Firm Consolidated FinancialStatements and Selected Quarterly Financial Data are set forth in the index onpage F-1 of this Annual Report on Form 10-K.

 

**ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ONACCOUNTING AND FINANCIAL DISCLOSURE**

 

Therehave been no disagreements with our independent auditors on any matter ofaccounting principles or practices or financial statement disclosure.

 

**ITEM 9A. CONTROLS AND PROCEDURES**

 

**Evaluationof Disclosure Controls and Procedures**

 

Wemaintain disclosure controls and procedures that are designed to ensure thatinformation required to be disclosed in the reports that we file or submitunder the Securities Exchange Act is recorded, processed, summarized, andreported within the time periods specified in the SEC’s rules and forms andthat such information is accumulated and communicated to our management,including our Chief Executive Officer and Chief Financial Officer, asappropriate, to allow timely decisions regarding required disclosure. Our ChiefExecutive Officer and Chief Financial Officer carried out an evaluation of theeffectiveness of the design and operation of our disclosure controls andprocedures as of the end of the period covered by this report. Based on theevaluation of these disclosure controls and procedures, the Chief ExecutiveOfficer and Chief Financial Officer concluded that our disclosure controls andprocedures were effective. It should be noted that any system of controls,however well designed and operated, can provide only reasonable, and notabsolute, assurance that the objectives of the system are met. In addition, thedesign of any control system is based in part upon certain assumptions aboutthe likelihood of future events. Because of these and other inherentlimitations of control systems, there can be no assurance that any design willsucceed in achieving its stated goals under all potential future conditions,regardless of how remote.

 

**Changes inInternal Control Over Financial Reporting**

 

Therewere no changes in our internal control over financial reporting during 2004that have materially affected, or are reasonably likely to materially affect,our internal control over financial reporting.

 

**ITEM 9B.OTHER INFORMATION**

 

None.

 

**PART III**

 

**ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT**

 

Thefollowing table sets forth information about our directors, executive officersand other key employees as of March 22, 2005.

 

**Directors and Executive Officers**

 
| **Name**** ** | ** ** | **Age** | ** ** | **Position**** **               |
|--------------------|------------|---------|------------|--------------------------------------|
|               |       |    |       |                                 |
| James A. Gray      |       | 39      |       | Chairman of the Board                |
| David S. Kalt      |       | 37      |       | Chief Executive Officer and Director |

 

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| Ned W. Bennett      |   | 62 |   | Chief Operating Officer and Director |
|---------------------|--------|----|--------|--------------------------------------|
| David A. Fisher     |   | 35 |   | Chief Financial Officer              |
| Thomas E. Stern     |   | 58 |   | Chief Administrative Officer         |
| Benjamin Morof      |   | 36 |   | Chief Compliance Officer             |
| Christopher J. Dean |   | 31 |   | Director                             |

 

Executive officers areappointed by and serve at the pleasure of our board of directors. A briefbiography of each person who will serve as a director or executive officer uponconsummation of this offering follows.

 

James A. Gray has served asour Chairman of the Board since inception and has served as Chairman of theBoard of optionsXpress, Inc. since 2000. Mr. Gray also has served asPresident of G-Bar Limited Partnership, an independent proprietary tradingfirm, since 1996. Prior to that, Mr. Gray served as the Head of EquityTrading at G-Bar.

 

David S. Kalt has served asour Chief Executive Officer since inception and has served as President andChief Technology Officer of optionsXpress, Inc. from August 2000 topresent. From 1998 to 2000, Mr. Kalt served as Chief Technology Officerfor TRAMS Inc., a software developer for retail travel agencies. Prior tothat, Mr. Kalt served as President of Third Party Solutions, a firm hefounded in 1994 that developed technology and other solutions for the travelindustry.

 

Ned W. Bennett has served asour Chief Operating Officer since inception and has served as Chief ExecutiveOfficer of optionsXpress, Inc. from August 2000 to present. From July 1997to May 1999, Mr. Bennett served in various positions at DreyfusBrokerage Services, Inc. (Pacific Brokerage Services), including ChiefOperating Officer. Prior to that, Mr. Bennett served as the ChiefExecutive Officer and Chief Operating Officer of publicly-traded ED&F ManInternational Securities Inc. from December 1994 to July 1997.Mr. Bennett also served as President and Chief Executive Officer ofGeldermann Securities, a ConAgra company that he developed into a majorclearing firm, from November 1987 to December 1994, when the firm waspurchased by ED&F Man International Inc.

 

David A. Fisher has servedas our Chief Financial Officer since July 2004. From March 2001 to July 2004,Mr. Fisher served as Chief Financial Officer of Potbelly Sandwich Works, aquick service restaurant chain with over 60 units. Prior to that,Mr. Fisher served as Chief Financial Officer and Secretary of PrismFinancial Corporation, a publicly-traded, nationwide consumer financialservices company, from August 1997 to February 2001. Mr. Fisheris a member of the Illinois Bar.

 

Thomas E. Stern has servedas our Chief Administrative Officer since inception and has served as ChiefFinancial Officer of optionsXpress, Inc. since December 2001.Mr. Stern also serves as Chief Financial Officer of brokersXpress LLC.Prior to that, he served as President and Chief Operating Officer of EZStocks, Inc., a NASD member firm, from February 2000 to November 2001and as Senior Managing Director of Regal Discount Securities from January 1999to January 2000.

 

Benjamin Morof has served asour Chief Compliance Officer since inception and has also served as ChiefCompliance Officer of optionsXpress, Inc. since January 2002.Mr. Morof also served as Executive Vice President, Operations andCompliance, of optionsXpress, Inc. from October 2000 to December 2001.From August 1996 to September 2000, Mr. Morof served in variouspositions at ED&F Man International Securities Inc. Mr. Morof is amember of the Illinois Bar.

 

Christopher J. Dean hasserved as one of our directors since inception and has also served as one ofthe directors of optionsXpress, Inc. since January 2004.Mr. Dean has also served as a Vice President of Summit Partners, a privateequity and venture capital firm, since 2001. Prior to that, he attended HarvardBusiness School from 1999 to 2001 and served as an associate atJ.H. Whitney & Co., a venture capital firm, from 1997 to1999.

 

There are no familyrelationships between any of our executive officers or directors.

 

36

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**Board of Directors**

 

***Composition of the Board ofDirectors***

 

Our restated certificate ofincorporation provides for a classified board of directors consisting of threestaggered classes of directors. At each annual meeting of stockholders, a classof directors will be elected for a three-year term to succeed the directors ofthe same class whose terms are then expiring. The terms of the directors willexpire upon election and qualification of successor directors at the annualmeeting of stockholders to be held during the years 2005 for the Class Idirectors, 2006 for the Class II directors and 2007 for the Class IIIdirectors. This classification of our board of directors could have the effectof delaying or preventing changes in control or changes in our management.

 

•                  Theclass I director is Mr. Dean ;

•                  Theclass II director is Mr. Kalt; and

•                  Theclass III directors are Mr. Gray and Mr. Bennett.

 

We have an authorized Boardof Directors consisting of seven members, a majority of whom are “independent”under the Nasdaq Marketplace Rules and applicable SEC rules. Messrs. Deanand  Gray qualify as “independent” underthe rules of The Nasdaq National Market. Our by-laws provide that theauthorized number of directors may be changed by a resolution adopted by atleast two-thirds of our directors then in office. Any additional directorshipsresulting from an increase in number of directors may only be filled by thedirectors and will be distributed among the three classes so that, as nearly aspossible, each class will consist of one-third of the directors. We intend toadd three additional “independent” directors in the near future.

 

***Audit Committee***

 

OurAudit Committee consists of Mr. Gray and Mr. Dean, who are both “independentdirectors” for Audit Committee purposes under applicable Nasdaq and SEC rules.The functions of the Audit Committee include:

 

•                  the appointment, compensation, retention andoversight of the work of the independent auditors engaged for the purpose ofpreparing and issuing an audit report;

•                  reviewing the independence of the independentauditors and taking, or recommending that our board of directors take,appropriate action to oversee their independence;

•                  approving, in advance, all audit andnon-audit services to be performed by the independent auditors;

•                  overseeing our accounting and financialreporting processes and the audits of our financial statements;

•                  establishing procedures for the receipt,retention and treatment of complaints received by us regarding accounting,internal control or auditing matters and the confidential, anonymous submissionby our employees of concerns regarding questionable accounting or auditingmatters;

•                  engaging independent counsel and otheradvisers as the audit committee deems necessary;

•                  determining compensation of the independentauditors, compensation of advisors hired by the audit committee and ordinaryadministrative expenses;

•                  reviewing and assessing the adequacy of aformal written charter on an annual basis; and

•                  handling such other matters that arespecifically delegated to the audit committee by our board of directors fromtime to time.

 

Our board of directors has adopted a written charterfor our audit committee, which is posted on our website. Ernst & YoungLLP currently serves as our independent auditors.

 

***Nominating and Corporate GovernanceCommittee***

 

Ournominating and corporate governance committee consists of Mr. Gray and  Mr. Dean, who are both “independent directors”under applicable Nasdaq and SEC rules. The functions of the nominating and corporate governance committeeinclude:

 

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•                  selecting, or recommending to our board ofdirectors for selection, nominees for election to our board of directors;

•                  making recommendations to our board ofdirectors regarding the size and composition of the board, committee structureand makeup and retirement procedures affecting board members;

•                  monitoring our performance in meeting ourobligations of fairness in internal and external matters and our principles ofcorporate governance; and

•                  such other matters that are specificallydelegated to the nominating and corporate governance committee by our board ofdirectors from time to time.

 

Our board of directors has adopted a written charterfor our nominating and corporate governance committee, which specificallyaddress the nominations process and is posted on our website.

 

***Compensation Committee***

 

Ourcompensation committee consists of Mr. Gray and  Mr. Dean, who are both “independent directors”under applicable Nasdaq and SEC rules. The functions of the nominating and corporate governance committeeinclude:

 

•                  determining, or recommending to our board ofdirectors for determination, the compensation and benefits of all of ourexecutive officers;

•                  reviewing our compensation and benefit plansto ensure that they meet corporate objectives;

•                  administering our stock plans and otherincentive compensation plans; and

•                  such other matters that are specificallydelegated to the compensation committee by our board of directors from time totime.

 

Our board of directors has adopted a written charterfor our compensation committee, which will be posted on our website.

 

**Compensation Committee Interlocks and InsiderParticipation**

 

None of our executiveofficers serves as a member of the board of directors or compensation committeeof any entity that has one or more executive officers serving on ourcompensation committee. No interlocking relationship exists between the boardor directors or the compensation committee of any other company.

 

***Director Compensation***

 

Weprovide cash compensation at a rate of $30,000 per year, payable quarterly toeach non-employee director. We also intend to pay the chairman of the AuditCommittee an additional fee of $15,000 per year, payable quarterly. Inaddition, we will reimburse directors for their reasonable expenses incurred inattending meetings of the Board of Directors.  Mr. Gray, the chairman of our board of directors, is a party to aretention agreement that provides him with an annual retainer of $167,000. Theother material terms of Mr. Gray’s retention agreement are substantiallysimilar to the terms of those agreements described under “— EmploymentAgreements.”

 

**CODE OFBUSINESS CONDUCT AND ETHICS**

 

Wehave adopted a code of business conduct and ethics for our employees, includingour Chief Executive Officer, Chief Operating Officer, Chief Financial Officerand other executives. A copy of this code is included as Exhibit 14.1 withthis Form 10-K Annual Report and is posted on our website.

 

**AUDITCOMMITTEE FINANCIAL EXPERT**

 

TheBoard of Directors has designated Mr. Dean as the audit committee financialexpert.

 

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**SECTION 16(a)BENEFICIAL OWNERSHIP REPORTING COMPLIANCE**

 

Weare not aware of any missed filings during the period.

 

**ITEM 11. EXECUTIVE COMPENSATION**

 

The following table presentsinformation regarding compensation paid by us relating to the fiscal year endedDecember 31, 2004 to our Chief Executive Officer and other executiveofficers whose total annual salary and bonus exceeded $100,000 for the fiscalyear ended December 31, 2004. These executives are referred to as the “namedexecutive officers” elsewhere in this Annual Report on Form 10-K.

 

**SummaryCompensation Table**

 
| ** **                                     | ** **       | **2004**      | ** **     | **2003**                            | ** **    |
|------------------------------------------------|------------------|---------------|----------------|-------------------------------------|---------------|
| ** **                                     | ** **       | ** **    | ** **     | **Long-Term  Compensation**         | ** **    | ** ** | ** ** | ** ** | ** ** | **Long-Term  Compensation** | ** ** | ** ** | ** ** |
| **Name and  Principal Position**               | ** **       | **Annual**    | ** **     | **Securities  Underlying  Options** | ** **    | **All Other  Compensation  ($)** | ** ** | **Annual** | ** ** | **Securities  Underlying  Options** | ** ** | **All Other  Compensation  ($)** | ** ** |
| **Compensation**                               | **Compensation** |
| **Salary ($)**                                 | ** **       | **Bonus ($)** | **Salary ($)** | ** **                          | **Bonus ($)** |
| David S.  Kalt  Chief Executive Officer        |             | 227,350       |           | 143,517                             |          | — |   | — |   | 188,000 |   | 145,000 |   | 45,000 |   | — |   |
| Ned W.  Bennett  Chief Operating Officer       |             | 220,150       |           | 144,316                             |          | — |   | — |   | 172,000 |   | 145,000 |   | 45,000 |   | — |   |
| David A.  Fisher  Chief Financial Officer(1)   |             | 131,250       |           | —                              |          | 117,188 |   | 654,144 | (2) | — |   | — |   | — |   | — |   |
| Thomas E.  Stern  Chief Administrative Officer |             | 169,350       |           | 75,000                              |          | — |   | — |   | 150,000 |   | 50,000 |   | — |   | — |   |
| Benjamin  Morof  Chief Compliance Officer      |             | 165,417       |           | 63,333                              |          | — |   | — |   | 126,667 |   | 40,000 |   | — |   | — |   |

 

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(1)  Mr. Fisher has served as our ChiefFinancial Officer since July 2004.

(2)  Represents a restricted stock grant of 60,938shares of common stock.

 

**Stock Option Grants in 2004**

 

The following table setsforth information regarding stock options granted to the named executiveofficers during the fiscal year ended December 31, 2004.

 

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| ** **       | ** ** | **Number of  Securities  Underlying  Options** | ** ** | **% of Total  Options  Granted to  Employees  in Fiscal** | ** ** | **Exercise Price  Per Share** | ** ** | **Expiration** | ** ** | **Potential Realizable  Value at Assumed  Annual Rates of  Stock Appreciation  for Option Term ** | ** ** |
|------------------|------------|------------------------------------------------|------------|-----------------------------------------------------------|------------|-------------------------------|------------|----------------|------------|--------------------------------------------------------------------------------------------------------|------------|
| **Name**         | ** ** | **Granted **                              | ** ** | **Year**                                                  | ** ** | **($/Share)**                 | ** ** | **Date**       | ** ** | **5%**                                                                                                 | ** ** | **10%** | ** ** |
| ** **       | ** ** | ** **                                     | ** ** | ** **                                                | ** ** | ** **                    | ** ** | ** **     | ** ** | ** **                                                                                             | ** ** | ** ** | ** ** |
| David S.  Kalt   |       | —                                         |       | —                                                    |       | —                        |       | —         |       | —                                                                                                 |       | — |   |
| Ned W.  Bennett  |       | —                                         |       | —                                                    |       | —                        |       | —         |       | —                                                                                                 |       | — |   |
| David A.  Fisher |       | 117,188                                        |       | 31.6                                                      | %          | 10.73                         |       | 7/15/14        |       | 790,789                                                                                                |       | 2,004,015 |   |
| Thomas E.  Stern |       | —                                         |       | —                                                    |       | —                        |       | —         |       | —                                                                                                 |       | — |   |
| Benjamin  Morof  |       | —                                         |       | —                                                    |       | —                        |       | —         |       | —                                                                                                 |       | — |   |

 

***Option Exercises in 2004 andYear-End Option Values***

 

The following table setsforth the number of shares of common stock subject to options and the value ofsuch options held by each of our named executive officers as of December 31,2004. This table assumes a per share price of $16.50, which we estimate to bethe fair market value of a share of our common stock on that date.

 
| ** **       | ** ** | **Number of Securities Underlying  Unexercised Options At  Fiscal Year-End ** | ** ** | **Value of Unexercised In-The-  Money Options At Fiscal Year-  End ($) ** | ** ** |
|------------------|------------|------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------|------------|
| **Name**         | ** ** | **Exercisable**                                                                    | ** ** | **Unexercisable**                                                              | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| ** **       | ** ** | ** **                                                                         | ** ** | ** **                                                                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| David S.  Kalt   |       | —                                                                             |       | 18,758                                                                         |       | — |   | 291,499 |   |
| Ned W.  Bennett  |       | —                                                                             |       | 18,758                                                                         |       | — |   | 291,499 |   |
| David A.  Fisher |       | —                                                                             |       | 117,188                                                                        |       | — |   | 837,425 |   |
| Thomas E.  Stern |       | —                                                                             |       | 12,503                                                                         |       | — |   | 202,174 |   |
| Benjamin  Morof  |       | —                                                                             |       | 315                                                                            |       | — |   | 5,144 |   |

 

**Benefit Plans**

 

***2005 Equity Incentive Plan***

 

Our board of directorsadopted and our stockholders approved our 2005 Equity Incentive Plan (the “EquityIncentive Plan”). The Equity Incentive Plan is designed to enable us to attract,retain and motivate our directors, officers, associates and consultants, and tofurther align their interests with those of our stockholders, by providing foror increasing their ownership interests in our company.

 

*Administration.*    The Equity IncentivePlan will be administered by the compensation committee of our board ofdirectors. Our board may, however, at any time resolve to administer the EquityIncentive Plan. Subject to the specific provisions of the Equity IncentivePlan, the compensation committee is authorized to select persons to participatein the Equity Incentive Plan, determine the form and substance of grants madeunder the Equity Incentive Plan to each participant, and otherwise make alldeterminations for the administration of the Equity Incentive Plan.

 

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*Participation.*    Individuals who willbe eligible to participate in the Equity Incentive Plan will be directors(including non-employee directors), officers (including non-employee officers)and employees of, and other individuals performing services for, or to whom anoffer of employment has been extended by, us or our subsidiaries.

 

*Type ofAwards.*    TheEquity Incentive Plan will provide for the issuance of stock options, restrictedstock, dividend equivalents, other stock-based awards and performance awards.Performance awards may be based on the achievement of certain business orpersonal criteria or goals, as determined by the compensation committee.

 

*AvailableShares.*    Anaggregate of 1,250,000 shares of our common stock will be reserved for issuanceunder the Equity Incentive Plan, subject to annual automatic increases andcertain other adjustments reflecting changes in our capitalization. If anygrant under the Equity Incentive Plan expires or terminates unexercised,becomes unexercisable or is forfeited as to any shares, or is tendered orwithheld as to any shares in payment of the exercise price of the grant or thetaxes payable with respect to the exercise, then such unpurchased, forfeited,tendered or withheld shares will thereafter be available for further grantsunder the Equity Incentive Plan. The Equity Incentive Plan will provide thatthe compensation committee shall not grant, in any one calendar year, to anyone participant awards to purchase or acquire a number of shares of commonstock in excess of 20% of the total number of shares authorized for issuanceunder the Equity Incentive Plan.

 

*OptionGrants.*    Optionsgranted under the Equity Incentive Plan may be either incentive stock optionswithin the meaning of Section 422 of the Internal Revenue Code ornon-qualified stock options, as the compensation committee may determine. Theexercise price per share for each option will be established by thecompensation committee, except that in the case of the grant of any incentivestock option, the exercise price may not be less than 100% of the fair marketvalue of a share of common stock as of the date of grant of the option. In thecase of the grant of any incentive stock option to an employee who, at the timeof the grant, owns more than 10% of the total combined voting power of all ofour classes of stock then outstanding, the exercise price may not be less than110% of the fair market value of a share of common stock as of the date ofgrant of the option.

 

*Terms ofOptions.*    Theterm during which each option may be exercised will be determined by thecompensation committee, but if required by the Internal Revenue Code and exceptas otherwise provided in the Equity Incentive Plan, no option will beexercisable in whole or in part more than ten years from the date it isgranted, and no incentive stock option granted to an employee who at the timeof the grant owns more than 10% of the total combined voting power of all ofour classes of stock will be exercisable more than five years from the date itis granted. All rights to purchase shares pursuant to an option will, unlesssooner terminated, expire at the date designated by the compensation committee.The compensation committee will determine the date on which each option willbecome exercisable and may provide that an option will become exercisable ininstallments. The shares constituting each installment may be purchased inwhole or in part at any time after such installment becomes exercisable,subject to such minimum exercise requirements as may be designated by thecompensation committee. Prior to the exercise of an option and delivery of theshares represented thereby, the optionee will have no rights as a stockholder,including any dividend or voting rights, with respect to any shares covered bysuch outstanding option. If required by the Internal Revenue Code, theaggregate fair market value, determined as of the grant date, of shares forwhich an incentive stock option is exercisable for the first time during anycalendar year under all of our equity incentive plans may not exceed $100,000.

 

*Amendmentof Options and Amendment/Termination of Plan.*    The board ofdirectors or the compensation committee generally will have the power andauthority to amend or terminate the Equity Incentive Plan at any time withoutapproval from our stockholders. The compensation committee generally will havethe authority to amend the terms of any outstanding award under the plan, including,without limitation, the ability to reduce the exercise price of any options orto accelerate the dates on which they become exercisable or vest, at any timewithout approval from our stockholders. No amendment will become effectivewithout the prior approval of our stockholders if stockholder approval would berequired by applicable law or regulations, including if required for continuedcompliance with the performance-based compensation exception of Section 162(m)of the Internal Revenue Code, under provisions of Section 422 of theInternal Revenue Code or by any listing requirement of the principal stockexchange on which our common stock is then listed. Unless previously terminatedby the board or the committee, the Equity Incentive Plan will terminate on thetenth anniversary of its adoption. No termination of the Equity Incentive Planwill materially and

 

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adversely affect any of the rights or obligations ofany person, without his or her written consent, under any grant of options orother incentives therefore granted under the Equity Incentive Plan.

 

***2005 Employee Stock Purchase Plan***

 

Our board of directors plansadopted and our stockholders approved our 2005 Employee Stock Purchase Plan.The purpose of the plan is to provide an incentive for our employees (andemployees of our subsidiaries designated by our board of directors) to purchaseour common stock and acquire a proprietary interest in us.

 

*Administration.*    A committeedesignated by our board will administer the plan. The plan vests the committeewith the authority to interpret the plan, to prescribe, amend, and rescindrules and regulations relating to the plan, and to make all otherdeterminations necessary or advisable for the administration of the plan,although our board of directors may exercise any such authority in lieu of thecommittee. In all cases, the plan will be required to be administered in such amanner as to comply with applicable requirements of Rule 16b-3 of the SecuritiesExchange Act of 1934 and Section 423 of the Internal Revenue Code.

 

*Eligibilityand Participation.*    Asof the date of our initial public offering, each person who is employed eitherby us or by one of our designated subsidiaries and is expected on aregularly-scheduled basis to work more than 20 hours per week for morethan five months per calendar year, automatically will be enrolled in the plan.Persons who subsequently become employed by us or one of our designatedsubsidiaries will be eligible once they have completed three months of service,provided they are expected on a regularly-scheduled basis to work more than20 hours per week for more than five months per calendar year.

 

*Options toPurchase/Purchase of Shares.*    Each participant will be granted an option topurchase shares of our common stock at the beginning of each 6-month “offeringperiod” under the plan, on each “exercise date,” during the offering period.Exercise dates generally will occur on each June 30 and December 31.Participants will purchase the shares of our common stock through after-taxpayroll deductions, not to exceed 15% of the participant’s total base salary.No participant may purchase more than $25,000 of common stock in any onecalendar year. The purchase price for each share will generally be the fairmarket value of a share on the first day of the offering period or the fairmarket value on the exercise date. If a participant’s employment with us or oneof our designated subsidiaries terminates, any outstanding option of thatparticipant also will terminate.

 

*ShareReserve.*    500,000shares of our common stock will be reserved for issuance over the term of theplan, subject to certain other adjustments reflecting changes in ourcapitalization. If any option to purchase reserved shares is not exercised by aparticipant for any reason, or if the option terminates, the shares that werenot purchased shall again become available under the plan.

 

*Amendmentand Termination.*    Ourboard or the committee generally will have the power and authority to amend theplan from time to time in any respect without the approval of our stockholders.However, no amendment will become effective without the prior approval of ourstockholders if stockholder approval would be required by applicable law orregulation, including Rule 16b-3 under the Securities Exchange Act of1934, Section 423 of the Internal Revenue Code, or any listing requirementof the principal stock exchange on which our common stock is then listed.Additionally, except as otherwise specified in the plan, no amendment may makeany change to an option already granted that adversely affects the rights ofany participant. The plan will terminate at the earliest of the tenthanniversary of its implementation, the time when there are no remainingreserved shares available for purchase under the plan, or an earlier time thatour board may determine.

 

***2001 Equity Incentive Plan***

 

We currently maintain anequity incentive plan pursuant to which our management may, at its discretion,grant eligible employees, directors, independent contractors or consultantsrestricted stock or options to purchase up to 3,750,000 shares of our commonstock. In general, one-third of the options become exercisable on the firstanniversary date following the grant, and one-thirty-sixth of the optionsbecome exercisable on each of the succeeding

 

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24 monthly anniversaries of the first anniversary date. Alloptions expire ten years after the date of the grant. Upon effectiveness of the2005 Equity Incentive Plan, no further grants will be made under the 2001Equity Incentive Plan.

 

At December 31, 2004,options to purchase up to 1,275,653 shares of our common stock wereoutstanding, with 392,828 vested.

 

Based on our management’sestimate, the fair market value at the date of grant for options granted duringthe year ended December 31, 2004 was $1,022,000.  The fair market value of each option grantwas estimated on the date of the grant using the Black-Scholes option-pricingmodel. The model takes into account the stock price and exercise price at thegrant date and the assumptions set forth in Note 11 to the AuditedConsolidated Financial Statements for the years ended December 31, 2003and 2004.

 

**Employment Agreements**

 

We entered into employmentagreements with David S. Kalt and Ned W. Bennett. Each of the employmentagreements provides that the executive will serve with us in his currentposition until his employment is terminated by either party upon writtennotice. Under the employment agreements, Messrs. Kalt and Bennett willreceive:

 

•                  anannual base salary, which may be increased from time to time by thecompensation committee, of: 

 
| **Name**       | ** ** | **Position(s)**         | ** ** | **Annual  Base Salary** | ** ** |
|----------------|------------|-------------------------|------------|-------------------------|------------|
| ** **     | ** ** | ** **              | ** ** | ** **              | ** ** |
| David S. Kalt  |       | Chief Executive Officer |       | $                       | 250,000    |   |
| Ned W. Bennett |       | Chief Operating Officer |       | $                       | 250,000    |   |

 

•                  an annual bonus to be determined by thecompensation committee; and

•                  employee benefits applicable to senior levelexecutives.

 

If we terminate an executive’semployment without cause or if he resigns with good reason, he will be entitledto receive his base salary for a period of twelve months following histermination. If an executive’s employment is terminated by us for cause or ifhe resigns without good reason, dies or becomes disabled, he will be entitledto receive his base salary through the date of termination. Each executive issubject to confidentiality, non-compete and non-solicitation provisions of theagreements. The non-compete and non-solicit provisions of the agreements remainin effect until the later of January 15, 2007, or one year following theexecutive’s termination. In addition, we have the option to extend thenon-compete and non-solicitation periods for up to 24 additional months,subject to certain conditions.

 

We have also entered into anemployment agreement with David A. Fisher. The agreement provides that Mr.Fisher will serve as Chief Financial Officer until his employment is terminatedby either party upon written notice. Under this agreement, Mr. Fisher willreceive an annual base salary, subject to increase, of $300,000, an annualbonus to be determined by the compensation committee, a one time bonus of$200,000 payable after January 1, 2005, and employee benefits applicableto senior level executives. The agreement also contains severance provisionsgenerally comparable to those applicable to Messrs. Kalt and Bennett and anon-compete, non-solicitation provision lasting for one year after Mr. Fisher’stermination. In connection with his employment, Mr. Fisher also receivedan option grant covering 117,188 shares of common stock at an exercise price of$10.73 per share and a restricted stock grant of 60,938 shares of common stock.Pursuit to the terms of the employment agreement, upon consummation of ourinitial public offering, Mr. Fisher received an additional option grantcovering 30,000 shares of common stock at an exercise price equal to the $16.50price of the common stock sold to the public in that offering.

 

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**Director and OfficerIndemnification and Limitation on Liability**

 

Our certificate ofincorporation provides that, to the fullest extent permitted by the DelawareGeneral Corporation Law and except as otherwise provided in our by-laws, noneof our directors shall be liable to us or our stockholders for monetary damagesfor a breach of fiduciary duty. In addition, our certificate of incorporationprovides for indemnification of any person who was or is made, or threatened tobe made, a party to any action, suit or other proceeding, whether criminal,civil, administrative or investigative, because of his or her status as adirector or officer of optionsXpress, or service as a director, officer,employee or agent of another corporation, partnership, joint venture, trust orother enterprise at our request to the fullest extent authorized under theDelaware General Corporation Law against all expenses, liabilities and lossesreasonably incurred by such person. Further, our certificate of incorporationprovides that we may purchase and maintain insurance on our own behalf and onbehalf of any other person who is or was a director, officer or agent ofoptionsXpress or was serving at our request as a director, officer, employee oragent of another corporation, partnership, joint venture, trust or otherenterprise.

 

Furthermore, we have enteredinto indemnification agreements with each of our executive officers anddirectors. The indemnification agreements provide our executive officers anddirectors with further indemnification to the fullest extent permitted by theDelaware General Corporation Law.

 

**ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS ANDMANAGEMENT AND RELATED STOCKHOLDER MATTERS**

 

Thefollowing table sets forth information as of March 22, 2004 regarding thebeneficial ownership of our common stock by:

 

•        eachperson, or group of affiliated persons, who is known by us to own beneficiallyfive percent or more of our common stock;

•        each ofour directors;

•        each ofour named executive officers; and

•        all ourdirectors and executive officers as a group.

 

Thenumber of shares owned and percentage ownership in the following table is basedon 61,723,907 shares of common stock outstanding on March 22, 2005.

 
| **Name and Address of Beneficial Owner**                                      | ** ** | **Number of  Shares  Owned** | ** ** | **Percentage  of  Outstanding  Shares** | ** ** |
|-------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------------------|------------|
| **Directors,  named executive officers and stockholders owning more than 5%** |       |                         |       |                                    |       |
| Summit  Partners(1)                                                           |       | 12,779,113                   |       | 20.7                                    |       |
| G-Bar  Limited Partnership(2)                                                 |       | 15,553,944                   |       | 25.2                                    |       |
| James A. Gray(3)                                                              |       | 18,694,800                   |       | 30.3                                    |       |
| David S.  Kalt(4)                                                             |       | 3,356,376                    |       | 5.4                                     |       |
| Ned W.  Bennett(5)                                                            |       | 3,030,213                    |       | 4.9                                     |       |
| Thomas E.  Stern                                                              |       | 89,803                       |       |                                    | *          |
| David A.  Fisher                                                              |       | 61,917                       |       |                                    | *          |
| Benjamin  Morof                                                               |       | 94,589                       |       |                                    | *          |
| Christopher J.  Dean                                                     |       | —                       |       | —                                  |       |
| All  directors and named executive officers as a group                        |       | 28,468,554                   |       | 46.1                                    |       |

 

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* Less than 1%.

 

(1)  Represents 8,662 shares held by SummitVentures VI-A, L.P., 3,612 shares held by SummitVentures VI-B, L.P.,

 

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277 shares held by Summit VI Advisors Fund, L.P.,180 shares held by Summit VI Entrepreneurs Fund, L.P. and49 shares held by Summit Investors VI, L.P. (such entitiescollectively referred to as “Summit Partners”). Summit Partners, L.P. isthe managing member of Summit Partners VI (GP), LLC, which is thegeneral partner of Summit Partners VI (GP), L.P., which is thegeneral partner of each of Summit Ventures VI-A, L.P., SummitVentures VI-B, L.P., Summit VI Advisors Fund, L.P., Summit VIEntrepreneurs Fund, L.P. and Summit Investors VI, L.P. SummitPartners, L.P., through a three-person investment committee composed ofcertain of the members of Summit Master Company, LLC, has voting anddispositive authority over the shares held by each of these entities and thereforebeneficially owns such shares. Decisions of the investment committee are madeby a majority vote of its members and, as a result, no single member of theinvestment committee has voting or dispositive authority over the shares.Gregory M. Avis, Peter Y. Chung, Scott C. Collins, Bruce R.Evans, Walter G. Kortschak, Martin J. Mannion, Kevin P. Mohan,Thomas S. Roberts, E. Roe Stamps, Joseph F. Trustee,Robert V. Walsh and Stephen G. Woodsum are the members of SummitMaster Company, LLC, which is the general partner of SummitPartners, L.P., and each disclaims beneficial ownership of the shares heldby Summit Partners. The address for each of these entities is 222 BerkeleyStreet, 18th Floor, Boston, MA 02116.

 

(2) Represents shares owneddirectly or indirectly by G-Bar Limited Partnership (“G-Bar”). Avrum Gray hasthe power to vote and/or dispose of these shares. James A. Gray is thePresident of G-Bar. Avrum Gray and James A. Gray each disclaim beneficialownership of these shares.

 

(3) Includes15,554 shares held by G-Bar of which Mr. Gray is the President and3,141 shares held by the JG 2002 Delta Trust in which Mr. Gray is thetrustee. He disclaims beneficial ownership of such shares.

 

(4) Includes 210 sharesheld by the David S. Kalt Family Trust and 210 shares held by the SusanSimon Kalt Family Trust.

 

(5) Includes 197 sharesheld by the Delaware Charter Guarantee & Trust Company F/B/O NedBennett IRA in which Mr. Bennett is the trustee and 1,631 shares heldby Whiskey Golf Investments LP and 1,175 shares held by Whiskey GolfInvestments II LP. He disclaims beneficial ownership of such shares.

 

Wehave determined beneficial ownership in accordance with the rules of the SEC.These rules generally attribute beneficial ownership of securities to personswho possess sole or shared voting power or investment power with respect tothose securities. In addition, the rules include shares of common stockissuable pursuant to the exercise of stock options that are either immediatelyexercisable or exercisable within 60 days of March 22, 2005. Theseshares are deemed to be outstanding and beneficially owned by the personholding those options for the purpose of computing the percentage ownership ofthat person, but they are not treated as outstanding for the purpose ofcomputing the percentage ownership of any other person. Unless otherwiseindicated, the persons or entities identified in this table have sole votingand investment power with respect to all shares shown as beneficially owned bythem.

 

**ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**

 

**CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS**

 

**Stock Purchase and RecapitalizationAgreement**

 

On December 17, 2003,we entered into a stock purchase and recapitalization agreement with investmentfunds affiliated with Summit Partners, G-Bar Limited Partnership, JG 2002 DeltaTrust, David S. Kalt, Ned W. Bennett, Delaware Charter Guarantee &Trust Company F/B/O Ned Bennett IRA and certain other stockholders pursuant towhich, on January 15, 2004, we issued approximately 18.2 million sharesof Series A preferred stock in exchange for approximately$88.4 million. In conjunction with this recapitalization, our formerpreferred stockholders converted their preferred stock into shares of commonstock. Furthermore, we then redeemed approximately 18.2 million shares ofcommon stock (including a portion of the shares of preferred stock convertedinto common stock by our former preferred stockholders) for an aggregate amountof approximately $88.4 million. In addition to the stock redemption amount,we paid dividends totaling approximately $7.0 million to our commonstockholders in connection with the transactions contemplated by the stockpurchase and recapitalization agreement.

 

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**Stockholders Agreement**

 

On January 15, 2004, weentered into a stockholders agreement with Summit Partners and substantiallyall of our other stockholders. The agreement governs the size and compositionof our board of directors and board committees. The agreement also generallyrestricts the transfer of shares of common stock and granted certainstockholders rights of first refusal in connection with any proposed transferby other stockholders and upon an issuance of new securities by us, subject tocertain exceptions. All of the foregoing provisions of the stockholdersagreement terminated upon the consummation of our initial public offering.

 

**Registration Agreement**

 

On January 15, 2004, we entered into aregistration agreement with Summit Partners and certain other stockholders,including G-Bar Limited Partnership, JG 2002 Delta Trust, David S. Kalt and NedW. Bennett. Upon consummation of our initial public offering, the agreemententitled both the holders of a majority of Summit Partners’ and holders of amajority of the other stockholders’ securities to two registrations onForm S-1 or any similar long-form registration statement and an unlimitednumber of registrations on Form S-2 or S-3 or any similar short-formregistration statement, so long as the aggregate value of the securities to beregistered on any short-form is at least $5 million. The agreementprohibits us from granting other registration rights with respect to our equitysecurities without the prior written consent of the holders of a majority of SummitPartners’ securities, except that we may grant registration rights if they aresubordinate to those of Summit Partners. The registration agreement grantspiggyback registration rights with respect to all other registrations proposedby us (except for demand registrations or registrations on a Form S-4, S-8or successor forms). We will pay all expenses related to demand and piggybackregistrations. We have also agreed to indemnify the parties to the agreement inconnection with all registrations pursuant to this agreement againstliabilities under the Securities Act.

 

**Investor Rights Agreement;Management Rights Agreement**

 

On January 15, 2004, weentered into an investor rights agreement and management rights agreement withSummit Partners. The investor rights agreement grants Summit Partners certaininformation rights with respect to our financial and other information, as wellas reasonable access to our properties, to consult with our directors,management and independent accountants and to inspect our corporate andfinancial records. The agreements also contain certain other affirmative andnegative covenants that terminated upon the consummation of our Initial PublicOffering.

 

**Dividends**

 

We declared and paiddividends totaling approximately $7.0 million to our common stockholdersduring the year ended December 31, 2004 in connection with thetransactions contemplated by the stock purchase and recapitalization agreementdescribed above in “— Stock Purchase and Recapitalization Agreement.” Inthe first quarter of 2005, prior to the completion of our Initial PublicOffering, we declared a cash dividend totaling $33.5 million to all commonand preferred stockholders.

 

**ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES**

 

TheBoard of Directors has appointed Ernst & Young LLP as the Company’sindependent auditors to audit the financial statements of the Company and toperform other accounting services, if appropriate, for the year ending December 31,2005. The Audit Committee will pre-approve Ernst & Young’s specific auditand professional services for the remainder of 2005 at the next scheduled AuditCommittee meeting. Fees for other non-audit services arising during the yearthat are permissible under the SEC’s rules on Auditor Independence must bepre-approved by the Audit Committee Chair, who must report such approvals atthe next meeting of the Audit Committee.

 

Feespaid to Ernst & Young for services provided during the years ended December 31,2004 and 2003, are presented below. “Audit Fees” include fees associated withthe annual audits and our initial public offering.

 

46

----

 

“Tax Fees” include fees associated with tax compliance, tax advice, andtax planning.  “Audit Related Fees” wereincurred in connection with a potential acquisition. 
| ** ** | ** ** | **Audit Fees** | ** ** | **Tax Fees** | ** ** | **Audit Related Fees** | ** ** | **Other** | ** ** |
|------------|------------|----------------|------------|--------------|------------|------------------------|------------|-----------|------------|
| 2004       |       | $              | 789,000    |         | $          | 44,300                 |       | $         | 110,000    |   | — |   |
| 2003       |       | $              | 100,500    |         | $          | 14,600                 |       | $         | —     |   | — |   |
|            |            |                |            |              |            |                        |            |           |            |  |  |  |  |

 

**PART IV**

 

**ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTSON FORM 10-K**

 

(a)(1)The following documents are filed as part of this Annual Report in Form 10-K:

 
| **Number** | ** ** | **Description**                                                                                                             |
|------------|------------|-----------------------------------------------------------------------------------------------------------------------------|
| F-1        |       | Index to Financial  Statements                                                                                              |
| F-2        |       | Report of Ernst &  Young LLP, Independent Registered Public Accounting Firm                                             |
| F-3        |       | Consolidated Statements of  Operations at December 31, 2004 and 2003                                                   |
| F-4        |       | Consolidated Statements of  Financial Condition for the years ended December 31, 2004, 2003 and 2002                   |
| F-5        |       | Consolidated Statements of  Changes in Stockholders’ Equity for the years ended December 31, 2004,  2003 and 2002 |
| F-6        |       | Consolidated Statements of  Cash Flows for the years ended December 31, 2002, 2003 and 2004                            |
| F-7        |       | Notes to Consolidated Financial  Statements                                                                                 |

 

(a)(2)Financial Statement Schedules

 

The following financial statement schedule is filed as part of this AnnualReport on Form 10-K:

 
|                                                            | **Page** |
|-----------------------------------------------------------------|----------|
| Schedule I – Condensed Financial Information of Registrant | S-1      |

 

All other schedules have been omitted because the information requiredto be set forth in those schedules is not applicable, or is shown in theconsolidated financial statements or notes thereto.

 

(a)(3)See attached Exhibit Index.

 

(b)Exhibits.  See attached Exhibit Index.

 

(c) none

 

47

----

 

**SIGNATURES**

 

Pursuant tothe requirements of the Securities Act of 1934, this report has been signed bythe following persons on behalf of the registrant and in the capacitiesindicated on March 23, 2005.

 
| **Signature**           | ** ** | **Title**                                                    |
|-------------------------|------------|--------------------------------------------------------------|
|                    |       |                                                         |
| /s/ JAMES A. GRAY       |       | Chairman of  the Board                                       |
| James A. Gray           |       |                                                         |
|                    |       |                                                         |
| /s/ DAVID S. KALT       |       | Chief  Executive officer (Principal Executive Officer) and   |
| David S. Kalt           |       | Director                                                     |
|                    |       |                                                         |
| /s/ NED W. BENNETT      |       | Chief  Operating Officer and Director                        |
| Ned W. Bennett          |       |                                                         |
|                    |       |                                                         |
| /s/ DAVID A. FISHER     |       | Chief  Financial Officer (Principal Financial and Accounting |
| David A. Fisher         |       | Officer)                                                     |
|                    |       |                                                         |
| /s/ CHRISTOPHER J. DEAN |       | Director                                                     |
| Christopher J. Dean     |       |                                                         |

 

 

48

----

 

Exhibits

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                      |
|-----------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1             |       | Agreement and Plan of  Merger, dated as of June 30, 2004, by and among  optionsXpress, Inc., optionsXpress Holdings, Inc. and optionsXpress  MergerCo, Inc. (1)                  |
| 2.2             |       | Omnibus Amendment, Waiver  and Consent, dated as of June 30, 2004, by and among  optionsXpress, Inc., optionsXpress Holdings, Inc. and each of the  other signatories thereto (1)     |
| 3.1             |       | Amended and Restated  Certificate of Incorporation of optionsXpress Holdings, Inc.                                                                                                              |
| 3.2             |       | Amended and Restated  By-laws of optionsXpress Holdings, Inc. (1)                                                                                                                               |
| 4.1             |       | Certificate of Common  Stock of optionsXpress Holdings, Inc. (1)                                                                                                                                |
| 4.2             |       | Registration Agreement,  dated as of January 15, 2004, by and among investment funds affiliated  with Summit Partners, L.P. and stockholders listed on the signature  pages thereto (1)    |
| 10.1            |       | Stock Purchase and  Recapitalization Agreement, dated as of December 17, 2003, by and among  optionsXpress, Inc., the purchasers named therein and the sellers named  therein (1)          |
| 10.2            |       | Stockholders Agreement,  dated as of January 15, 2004, by and among investment funds affiliated  with Summit Partners, L.P. and stockholders listed on the signature  pages thereto (1)    |
| 10.3            |       | Investor Rights Agreement,  dated as of January 15, 2004, by and among investment funds affiliated  with Summit Partners, L.P. and stockholders listed on the signature  pages thereto (1) |
| 10.4            |       | Amended and Restated  Restricted Stock Agreement, dated January 15, 2004, by and between  optionsXpress, Inc. and James A. Gray (1)(2)                                                |
| 10.5            |       | Amended and Restated  Restricted Stock Agreement, dated January 15, 2004, by and between  optionsXpress, Inc. and David S. Kalt (1)(2)                                                |
| 10.6            |       | Amended and Restated  Restricted Stock Agreement, dated January 15, 2004, by and between  optionsXpress, Inc. and Ned W. Bennett (1)(2)                                               |
| 10.7            |       | Restricted Stock  Agreement, by and between optionsXpress Holdings, Inc. and David A.  Fisher (1)(2)                                                                                            |
| 10.8            |       | Management Rights  Agreement, dated January 15, 2004, by and among investment funds  affiliated with Summit Partners, L.P. (1)                                                             |
| 10.9            |       | optionsXpress, Inc.  2001 Equity Incentive Plan (1)                                                                                                                                             |
| 10.10           |       | Form of optionsXpress  Holdings, Inc. 2005 Equity Incentive Plan (1)                                                                                                                            |
| 10.11           |       | Form of optionsXpress  Holdings, Inc. 2005 Employee Stock Purchase Plan (1)                                                                                                                     |
| 10.12           |       | Retention Agreement, by  and between optionsXpress, Inc. and James A. Gray (1)                                                                                                             |
| 10.13           |       | Employment Agreement,  dated as of January 15, 2004, by and between optionsXpress, Inc.  and David S. Kalt (1)(2)                                                                     |
| 10.14           |       | Employment Agreement,  dated as of January 15, 2004, by and between optionsXpress, Inc.  and Ned W. Bennett (1)(2)                                                                    |
| 10.15           |       | Employment Agreement, by  and between optionsXpress Holdings, Inc. and David A. Fisher (1)(2)                                                                                                   |
| 10.16           |       | Clearing Agreement, dated September 13,  2004, by and between optionsXpress, Inc. and Spear, Leeds &  Kellogg L.P. (n/k/a Goldman Sachs Execution & Clearing, L.P.) (1)  |
| 10.17           |       | Form of Indemnification  Agreement, dated as of January 15, 2004, by and between  optionsXpress, Inc. and its directors (1)                                                                |
| 14.1            |       | Code of Ethics                                                                                                                                                                                       |
| 21.1            |       | Subsidiaries of  optionsXpress Holdings, Inc. (1)                                                                                                                                               |
| 23.1            |       | Consent of  Ernst & Young LLP                                                                                                                                                          |

 
| 31.1 |   | Certification of Chief  Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                                                                                 |
|------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.2 |   | Certification of Chief  Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                                                                                 |
| 32.1 |   | Certification of Chief  Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350,  as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

----

(1)                                  Incorporatedby reference to the same exhibit filed with optionsXpress Holdings, IncRegistration Statement on Form S-1 (File No. 333-109700).

(2)                                  ManagementContract

 

49

----

 

optionsXpress Holdings,Inc.

 

Consolidated FinancialStatements

 

Years Ended December 31, 2004, 2003 and 2002

 

**Contents**

 
| Report  of Independent Registered Public Accounting Firm         |   |
|------------------------------------------------------------------|--------|
|                                                             |   |
| Consolidated Financial Statements                                |   |
|                                                             |   |
| Consolidated  Statements of Operations                           |   |
| Consolidated  Statements of Financial Condition                  |   |
| Consolidated  Statements of Changes in Stockholders’ Equity |   |
| Consolidated  Statements of Cash Flows                           |   |
| Notes to  Consolidated Financial Statements                      |   |
|                                                             |   |

 

F-1

----

 

Report of IndependentRegistered Public Accounting Firm

 

The Board of Directorsand Stockholders

optionsXpressHoldings, Inc.

 

We have audited the accompanying consolidatedstatements of financial condition of optionsXpress Holdings, Inc. as of December31, 2004 and 2003, and the related consolidated statements of operations,changes in stockholders’ equity, and cash flows for each of the three years inthe period ended December 31, 2004. These financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements based on our audits.

 

We conducted our audits inaccordance with the standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free ofmaterial misstatement. An audit includes consideration of internal control overfinancial reporting as a basis for designing audit procedures that areappropriate in the circumstances, but not for the purpose of expressing anopinion on the effectiveness of the Company’s internal control over financialreporting. Accordingly, we express no such opinion. An audit also includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion.

 

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of optionsXpress Holdings, Inc. at December 31, 2004 and 2003, and theresults of its operations and its cash flows for each of the three years in theperiod ended December 31, 2004, in conformity with United States generallyaccepted accounting principles.

 

Chicago, Illinois

February 4, 2005

 

F-2

----

 

optionsXpress Holdings, Inc.

 

Consolidated Statements of Operations

*(InThousands, Except Per Share Data)*

 
| ** **                                       | ** ** | **Years Ended December 31** | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|
| ** **                                       | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Revenues**                                     |       |                        |       |   |   |   |   |
| Commissions                                      |       | **$**                       | **71,567** |   | $ | 38,088 |   | $ | 14,173 |   |
| Other  brokerage-related revenue                 |       | **17,751**                  |       | 8,793 |   | 2,751 |   |
| Interest income                                  |       | **3,648**                   |       | 1,274 |   | 340 |   |
| Other income                                     |       | **103**                     |       | 26 |   | 4 |   |
| Total revenues                                   |       | **93,069**                  |       | 48,181 |   | 17,268 |   |
|                                             |       | ** **                  |       |   |   |   |   |
| **Expenses**                                     |       | ** **                  |       |   |   |   |   |
| Brokerage,  clearing, and other related expenses |       | **14,258**                  |       | 8,494 |   | 5,198 |   |
| Compensation and  benefits                       |       | **9,760**                   |       | 5,037 |   | 2,865 |   |
| Advertising                                      |       | **6,675**                   |       | 2,975 |   | 1,070 |   |
| Quotation  services                              |       | **3,693**                   |       | 1,984 |   | 786 |   |
| Depreciation and  amortization                   |       | **1,648**                   |       | 770 |   | 331 |   |
| Technology and  telecommunication                |       | **1,434**                   |       | 693 |   | 362 |   |
| Other                                            |       | **3,376**                   |       | 1,010 |   | 466 |   |
| Total expenses                                   |       | **40,844**                  |       | 20,963 |   | 11,078 |   |
| Income before  income taxes                      |       | **52,225**                  |       | 27,218 |   | 6,190 |   |
| Income taxes                                     |       | **21,015**                  |       | 10,862 |   | 1,819 |   |
| Net income                                       |       | **$**                       | **31,210** |   | $ | 16,356 |   | $ | 4,371 |   |
|                                             |       | ** **                  |       |   |   |   |   |
| Earnings per  common share:                      |       | ** **                  |       |   |   |   |   |
| Basic                                            |       | **$**                       | **0.56**   |   | $ | 0.30 |   | $ | 0.08 |   |
| Diluted                                          |       | **0.55**                    |       | 0.29 |   | 0.08 |   |
|                                             |       | ** **                  |       |   |   |   |   |
| Weighted-average  number of common shares:       |       | ** **                  |       |   |   |   |   |
| Basic                                            |       | **37,956**                  |       | 40,583 |   | 38,935 |   |
| Diluted                                          |       | **57,264**                  |       | 56,783 |   | 55,370 |   |

 

*Seeaccompanying notes.*

 

F-3

----

 

 

optionsXpress Holdings, Inc.

 

Consolidated Statements of Financial Condition

*(InThousands)*

 
| ** **                                                                                                                                                                                         | ** ** | **December 31** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------|------------|
| ** **                                                                                                                                                                                         | ** ** | **2004**        | ** ** | **2003** | ** ** |
| **Assets**                                                                                                                                                                                         |       |            |       |   |   |
| Cash and cash  equivalents                                                                                                                                                                         |       | **$**           | **24,759** |   | $ | 2,777 |   |
| Receivable from  brokers                                                                                                                                                                           |       | **9,299**       |       | 4,370 |   |
| Security  deposits                                                                                                                                                                                 |       | **313**         |       | 293 |   |
| Fixed assets  (net of accumulated depreciation and amortization of $2,333 and $776,  respectively)                                                                                                 |       | **3,732**       |       | 2,207 |   |
| Other assets                                                                                                                                                                                       |       | **1,892**       |       | 343 |   |
| Investment in  optionsXpress Australia Pty Limited                                                                                                                                                 |       | **100**         |       | — |   |
| Total assets                                                                                                                                                                                       |       | **$**           | **40,095** |   | $ | 9,990 |   |
|                                                                                                                                                                                               |       | ** **      |       |   |   |
| **Liabilities  and stockholders’ equity**                                                                                                                                                     |       | ** **      |       |   |   |
| Accounts payable  and accrued liabilities                                                                                                                                                          |       | **$**           | **5,023**  |   | $ | 1,354 |   |
| Current income  taxes payable                                                                                                                                                                      |       | **1,152**       |       | 212 |   |
| Net deferred  income tax liabilities                                                                                                                                                               |       | **914**         |       | 445 |   |
| Total liabilities                                                                                                                                                                                  |       | **7,089**       |       | 2,011 |   |
|                                                                                                                                                                                               |       | ** **      |       |   |   |
| **Stockholders’  equity**                                                                                                                                                                     |       | ** **      |       |   |   |
| Common stock,  $0.0001 par value, 187,500 shares  authorized; 2004 – 38,296 issued and outstanding,  2003 – 41,138 issued and outstanding                                                |       | **4**           |       | 4 |   |
| Convertible  preferred stock, $0.0001 par value,75,000  shares authorized as of December 31, 2004 and 2003;  2004 – 18,196 issued and outstanding,  2003 – 13,948 issued and outstanding |       | **2**           |       | 1 |   |
| Additional  paid-in capital                                                                                                                                                                        |       | **12,450**      |       | 11,275 |   |
| Accumulated  other comprehensive income                                                                                                                                                            |       | **2**           |       | — |   |
| Retained earnings                                                                                                                                                                                  |       | **20,548**      |       | (3,301 | ) |
| Total  stockholders’ equity                                                                                                                                                                   |       | **33,006**      |       | 7,979 |   |
| Total  liabilities and stockholders’ equity                                                                                                                                                   |       | **$**           | **40,095** |   | $ | 9,990 |   |

 

*Seeaccompanying notes.*

 

F-4

----

 

optionsXpress Holdings, Inc.

 

Consolidated Statements of Changes in Stockholders’ Equity

*(InThousands)*

 
| ** **                                     | ** **                                | ** **  | ** ** | ** ** | ** ** | ** **  | ** ** | ** ** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Accumulated  Other  Comprehensive  Income** | ** ** | **Retained  Earnings** | ** ** | **Total**   | ** ** |
|------------------------------------------------|-------------------------------------------|-------------|------------|------------|------------|-------------|------------|------------|------------|----------------------------------|------------|-----------------------------------------------|------------|------------------------|------------|-------------|------------|
| **Common Stock**                               | **Series A Convertible  Preferred Stock** |
| **Shares**                                     | ** **                                | **Amount**  | **Shares** | ** ** | **Amount** |
|                                           |                                      |        |       |       |       |        |       |       |       |                             |       |                                          |       |                   |       |        |       |
| Balance, January  1, 2002 *(Note 16)*          |                                      | 37,902      |       | $          | 4          |        | 14,448     |       | $          | 1                                |       | $                                             | 12,429     |                   | $          | —      |       | $ | (11,099 | ) | $ | 1,335 |   |
| Net income                                     |                                      | —      |       | —     |       | —      |       | —     |       | —                           |       | —                                        |       | 4,371                  |       | 4,371       |       |
| Dividends  declared                            |                                      | —      |       | —     |       | —      |       | —     |       | —                           |       | —                                        |       | (2,893                 | )          | (2,893      | )          |
| Warrants  exercised                            |                                      | 2,437       |       | —     |       | —      |       | —     |       | 3                                |       | —                                        |       | —                 |       | 3           |       |
| Subscriptions  received                        |                                      | —      |       | —     |       | —      |       | —     |       | 100                              |       | —                                        |       | —                 |       | 100         |       |
| Stock dividend *(Note 16)*                     |                                      | 26          |       | —     |       | —      |       | —     |       | 432                              |       | —                                        |       | (432                   | )          | —      |       |
| Balance,  December 31, 2002                    |                                      | 40,365      |       | 4          |       | 14,448      |       | 1          |       | 12,964                           |       | —                                        |       | (10,053                | )          | 2,916       |       |
| Net income                                     |                                      | —      |       | —     |       | —      |       | —     |       | —                           |       | —                                        |       | 16,356                 |       | 16,356      |       |
| Dividends  declared                            |                                      | —      |       | —     |       | —      |       | —     |       | —                           |       | —                                        |       | (9,455                 | )          | (9,455      | )          |
| Convertible  preferred stock redeemed          |                                      | —      |       | —     |       | (500        | )          | —     |       | (2,000                           | )          | —                                        |       | —                 |       | (2,000      | )          |
| Options  exercised                             |                                      | 764         |       | —     |       | —      |       | —     |       | 162                              |       | —                                        |       | —                 |       | 162         |       |
| Stock dividend *(Note 16)*                     |                                      | 9           |       | —     |       | —      |       | —     |       | 149                              |       | —                                        |       | (149                   | )          | —      |       |
| Balance,  December 31, 2003                    |                                      | 41,138      |       | 4          |       | 13,948      |       | 1          |       | 11,275                           |       | —                                        |       | (3,301                 | )          | 7,979       |       |
| Dividends  declared                            |                                      | **—**  | ** ** | **—** | ** ** | **—**  | ** ** | **—** | ** ** | **—**                       | ** ** | **—**                                    | ** ** | **(7,014**             | **)**      | **(7,014**  | **)**      |
| Preferred stock  converted to common stock     |                                      | **13,948**  | ** ** | **1**      | ** ** | **(13,948** | **)**      | **(1**     | **)**      | **—**                       | ** ** | **—**                                    | ** ** | **—**             | ** ** | **—**  | ** ** |
| Convertible  preferred stock issued *(Note 8)* |                                      | **—**  | ** ** | **—** | ** ** | **18,196**  | ** ** | **2**      | ** ** | **88,388**                       | ** ** | **—**                                    | ** ** | **—**             | ** ** | **88,390**  | ** ** |
| Common stock  redeemed *(Note 8)*              |                                      | **(18,196** | **)**      | **(2**     | **)**      | ** **  | ** ** | **—** | ** ** | **(88,388**                      | **)**      | **—**                                    | ** ** | **—**             | ** ** | **(88,390** | **)**      |
| Direct cost of  capital raised                 |                                      | **—**  | ** ** | **—** | ** ** | **—**  | ** ** | **—** | ** ** | **(2,491**                       | **)**      | **—**                                    | ** ** | **—**             | ** ** | **(2,491**  | **)**      |
| Tax benefit *(Note 8)*                         |                                      | **—**  | ** ** | **—** | ** ** | **—**  | ** ** | **—** | ** ** | **646**                          | ** ** | **—**                                    | ** ** | **—**             | ** ** | **646**     | ** ** |
| Common stock  issued                           |                                      | **473**     | ** ** | **—** | ** ** | **—**  | ** ** | **—** | ** ** | **2,654**                        | ** ** | **—**                                    | ** ** | **—**             | ** ** | **2,654**   | ** ** |
| Common stock  redeemed                         |                                      | **(74**     | **)**      | **—** | ** ** | **—**  | ** ** | **—** | ** ** | **(355**                         | **)**      | **—**                                    | ** ** | **—**             | ** ** | **(355**    | **)**      |
| Options  exercised                             |                                      | **986**     | ** ** | **1**      | ** ** | **—**  | ** ** | **—** | ** ** | **374**                          | ** ** | **—**                                    | ** ** | **—**             | ** ** | **375**     | ** ** |
| Stock dividend *(Note 16)*                     |                                      | **21**      | ** ** | **—** | ** ** | **—**  | ** ** | **—** | ** ** | **347**                          | ** ** | **—**                                    | ** ** | **(347**               | **)**      | **—**  | ** ** |
|                                           |                                      | ** **  | ** ** | ** ** | ** ** | ** **  | ** ** | ** ** | ** ** | ** **                       | ** ** | ** **                                    | ** ** | ** **             | ** ** | ** **  | ** ** |
| Net income                                     |                                      | **—**  | ** ** | **—** | ** ** | **—**  | ** ** | **—** | ** ** | **—**                       | ** ** | **—**                                    | ** ** | **31,210**             | ** ** | **31,210**  | ** ** |
| Currency  translation adjustment               |                                      | **—**  | ** ** | **—** | ** ** | **—**  | ** ** | **—** | ** ** | **—**                       | ** ** | **2**                                         | ** ** | **—**             | ** ** | **2**       | ** ** |
| Total  comprehensive income                    |                                      | **—**  | ** ** | **—** | ** ** | **—**  | ** ** | **—** | ** ** | **—**                       | ** ** | **2**                                         | ** ** | **31,210**             | ** ** | **31,212**  | ** ** |
| Balance,  December 31, 2004                    |                                      | **38,296**  | ** ** | **$**      | **4**      | ** **  | **18,196** | ** ** | **$**      | **2**                            | ** ** | **$**                                         | **12,450** | ** **             | **$**      | **2**       | ** ** | **$** | **20,548** | ** ** | **$** | **33,006** | ** ** |

 

*Seeaccompanying notes.*

 

F-5

----

 

 

optionsXpress Holdings, Inc.

 

Consolidated Statements of Cash Flows

*(InThousands)*

** **

 
| ** **                                                                     | ** ** | **Years Ended December 31** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                     | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Operating  activities**                                                      |       |                        |       |   |   |   |   |
| Net income                                                                     |       | **$**                       | **31,210** | ** ** | $ | 16,356 |   | $ | 4,371 |   |
| Adjustments to  reconcile net income to cash provided by operating activities: |       | ** **                  | ** ** |   |   |   |   |
| Depreciation and  amortization                                                 |       | **1,648**                   | ** ** | 770 |   | 331 |   |
| Net deferred  income taxes                                                     |       | **469**                     | ** ** | 220 |   | 225 |   |
| Tax benefit *(Note 8)*                                                         |       | **646**                     | ** ** | — |   | — |   |
| Gain on  investment in optionsXpress Australia Pty Limited                     |       | **(41**                     | **)**      | — |   | — |   |
| Changes in  operating assets and liabilities:                                  |       | ** **                  | ** ** |   |   |   |   |
| (Increase)  decrease in:                                                       |       | ** **                  | ** ** |   |   |   |   |
| Receivable from  brokers                                                       |       | **(4,929**                  | **)**      | (3,498 | ) | (848 | ) |
| Security  deposits                                                             |       | **(20**                     | **)**      | (20 | ) | 81 |   |
| Other assets                                                                   |       | **(1,549**                  | **)**      | (95 | ) | (45 | ) |
| Increase  (decrease) in:                                                       |       | ** **                  | ** ** |   |   |   |   |
| Accounts payable  and accrued liabilities                                      |       | **3,669**                   | ** ** | 654 |   | 579 |   |
| Current income  taxes payable                                                  |       | **940**                     | ** ** | (1,076 | ) | 1,288 |   |
| Net cash  provided by operating activities                                     |       | **32,043**                  | ** ** | 13,311 |   | 5,982 |   |
|                                                                           |       | ** **                  | ** ** |   |   |   |   |
| **Investing  activities**                                                      |       | ** **                  | ** ** |   |   |   |   |
| Purchases and  development of computer software                                |       | **(1,593**                  | **)**      | (1,002 | ) | (586 | ) |
| Purchases of  fixed assets                                                     |       | **(1,580**                  | **)**      | (843 | ) | (457 | ) |
| Direct  acquisition costs of investment in optionsXpress Australia Pty Limited |       | **(57**                     | **)**      | — |   | — |   |
| Purchase of  exchange membership                                               |       | **—**                  | ** ** | — |   | (160 | ) |
| Net cash used in  investing activities                                         |       | **(3,230**                  | **)**      | (1,845 | ) | (1,203 | ) |
|                                                                           |       | ** **                  | ** ** |   |   |   |   |
| **Financing  activities**                                                      |       | ** **                  | ** ** |   |   |   |   |
| Exercise of  stock options                                                     |       | **338**                     | ** ** | 162 |   | 3 |   |
| Redemption of  convertible preferred stock                                     |       | **—**                  | ** ** | (2,000 | ) | — |   |
| Dividends paid                                                                 |       | **(7,014**                  | **)**      | (9,455 | ) | (2,893 | ) |
| Subscriptions received                                                         |       | **—**                  | ** ** | — |   | 100 |   |
| Repayment of  subordinated borrowings                                          |       | **—**                  | ** ** | — |   | (488 | ) |
| Proceeds from  subordinated borrowings                                         |       | **—**                  | ** ** | — |   | 100 |   |
| Redemption of  common stock                                                    |       | **(88,708**                 | **)**      | — |   | — |   |
| Issuance of  convertible preferred stock                                       |       | **88,390**                  | ** ** | — |   | — |   |
| Issuance of  common stock                                                      |       | **2,654**                   | ** ** | — |   | — |   |
| Direct costs of  capital raised                                                |       | **(2,491**                  | **)**      | — |   | — |   |
| Net cash used in  financing activities                                         |       | **(6,831**                  | **)**      | (11,293 | ) | (3,178 | ) |
|                                                                           |       | ** **                  | ** ** |   |   |   |   |
| Net increase in  cash and cash equivalents                                     |       | **21,982**                  | ** ** | 173 |   | 1,601 |   |
| Cash, beginning  of year                                                       |       | **2,777**                   | ** ** | 2,604 |   | 1,003 |   |
| Cash and cash  equivalents, end of year                                        |       | **$**                       | **24,759** | ** ** | $ | 2,777 |   | $ | 2,604 |   |
|                                                                           |       | ** **                  | ** ** |   |   |   |   |
| Supplemental  disclosure of cash flow information:                             |       | ** **                  | ** ** |   |   |   |   |
| Income taxes  paid                                                             |       | **$**                       | **18,950** | ** ** | $ | 11,729 |   | $ | 330 |   |
| Interest paid                                                                  |       | **7**                       | ** ** | — |   | 14 |   |
| Supplemental  disclosure of noncash activity:                                  |       | ** **                  | ** ** |   |   |   |   |
| Noncash exercise  of options                                                   |       | **$**                       | **37**     | ** ** | $ | — |   | $ | — |   |
| Noncash foreign  currency translation                                          |       | **$**                       | **2**      | ** ** | $ | — |   | $ | — |   |

 

*Seeaccompanying notes.*

 

F-6

----

 

optionsXpress Holdings,Inc.

 

Notes to ConsolidatedFinancial Statements

*(In Thousands, Except Per ShareData)*

 

**1. Basis of Presentation and Nature of Operations**

** **

**Basis of Presentation**

** **

Effective July 31, 2004, the consolidated financialstatements include the accounts of optionsXpress Holdings, Inc., optionsXpress,Inc., bX Holdings LLC, and brokersXpress LLC (collectively, the Company). Inaddition, effective October 13, 2004, the consolidated financial statementsalso include the accounts of a newly formed subsidiary, OX Australia LLC (OXALLC). Prior to July 31, 2004, the consolidated financial statements includedthe accounts of optionsXpress, Inc., bX Holdings LLC and brokersXpress LLC(collectively, the Company). See Corporate Reorganization below for additionalinformation. All significant intercompany balances and transactions have beeneliminated in consolidation.

 

The Company follows United States generally acceptedaccounting principles, including certain accounting guidance used by thebrokerage industry.

 

**Nature of Operations**

** **

optionsXpress, Inc. is a broker-dealer registered withthe Securities and Exchange Commission (SEC) and a member of the NationalAssociation of Securities Dealers, Inc. (NASD) and the Chicago Board OptionsExchange. brokersXpress LLC is a broker-dealer registered with the SEC and amember of the NASD. The Company provides internet-based options and stockbrokerage services to retail customers located throughout the United States andthe world. The Company clears all customer transactions through two clearingbrokers on a fully disclosed basis.

 

**Corporate Reorganization**

 

Prior to July 31, 2004, optionsXpress, Inc. whollyowned bX Holdings LLC and bX Holdings LLC wholly owned brokersXpress LLC. EffectiveJuly 31, 2004, optionsXpress Holdings, Inc. was formed as a Delawarecorporation and optionsXpress, Inc. entered into a corporate reorganizationwhereby optionsXpress Holdings, Inc. acquired 100 percent of optionsXpress,Inc., bX Holdings LLC and brokerXpress LLC. The shareholders’ of optionsXpress,Inc. at July 31, 2004, exchanged shares in optionsXpress, Inc. for sharesin optionsXpress Holdings, Inc. on a one for one basis. Subsequent to thecorporate reorganization, optionsXpress, Inc., bX Holdings LLC and brokerXpressLLC are wholly owned by optionsXpress Holdings, Inc.

 

F-7

----

 

**2. Summary of Significant Accounting Policies**

 

**Cash and Cash Equivalents**

 

The Company considers allhighly liquid investments with a maturity of three months or less at the timeof purchase to be cash equivalents.

 

**Investment in optionsXpressAustralia Pty Ltd**

 

The Company, through itssubsidiary, OXA LLC, carries its investment in optionsXpress Australia Pty Ltd(oX Australia) on the equity method as it owns a 41% voting interest in oX Australia.oX Australia is not deemed to be a variable interest entity as defined inFinancial Accounting Standards Board (FASB) Interpretation No. 46, *Consolidation of Variable Interest Entities* (FIN 46). TheCompany records its proportionate share of earnings in other income in the consolidatedstatements of operations.

 

The investment in oXAustralia is denominated in Australian dollars, which is also its functionalcurrency. In connection with applying the equity method, the financialstatements of oX Australia are first translated to U.S. dollars using theperiod-end exchange rate for all assets and liabilities and the averageexchange rate for the period for revenues and expenses. The resulting nettranslation gains and losses are reflected in cumulative translation adjustment,which is presented as a separate component of stockholders’ equity. The Companyreviews for any impairment on the investment on a periodic basis.

 

**Commissions**

** **

The Company derives commission revenues from retailcustomer transactions in options, equity, mutual fund, and fixed incomesecurities. Commission revenues and related brokerage and clearing costs arerecognized on a trade-date basis.

 

**Other Brokerage-Related Revenue**

** **

The Company receives payment for order flow fromexchanges and liquidity providers where its customers’ orders are routed.Payment for order flow is accrued when earned based on the respective tradesgenerating such payments.

 

F-8

----

 

**Interest Income**

** **

Interest income consists primarily of the Company’sportion of the income generated by charges to customers on margin balances andcustomer cash held and invested by the Company’s clearing brokers, offset byinterest paid to customers on their credit balances.

 

**Fixed Assets**

** **

Fixed assets consist of furniture, equipment,leasehold improvements, and computer software. Fixed assets are carried atcost, less accumulated depreciation and amortization. Furniture and equipmentare depreciated on a straight-line basis over three years. Leaseholdimprovements are amortized on a straight-line basis over three years.

 

The Company capitalizes costs associated with softwaredeveloped for internal use based on Statement of Position (SOP) 98-1, *Accounting for the Costs of Computer Software Developed or Obtained forInternal Use*, and other related guidance. Capitalized costs includeexternal direct costs of materials and services consumed in developing orobtaining internal-use software and payroll for employees directly associatedwith, and who devote time to, the development of the internal-use software.Costs incurred in development and enhancement of the software that do not meetthe capitalization criteria are expensed as incurred. Capitalized costs areamortized on a straight-line basis over three years. The Company reviews forany impairment of the capitalized costs on a periodic basis.

 

**Security Deposits**

** **

Security deposits include both the deposits made forthe Company’s offices, and the escrow deposit with Legent Clearing Corporation (Legent),one of the Company’s clearing brokers. Any interest on these deposits isaccrued as earned.

 

**Advertising**

** **

Advertising costs are incurred for the production andcommunication of advertising, as well as other marketing activities. TheCompany expenses the cost of advertising as incurred, except for costs relatedto the production of broadcast advertising, which are expensed when the firstbroadcast occurs.

 

F-9

----

 

**Earnings Per Share**

** **

Basic earnings per share (EPS) is computed using thetwo-class method, which allocates earnings to common stock and participatingpreferred stock according to dividends declared and participation rights inundistributed earnings. Diluted EPS reflects the potential dilution that couldoccur if securities or other contracts to issue common stock were exercised orconverted into common stock, except when the assumed exercise or conversionwould have an anti-dilutive effect on EPS.

 

**Stock-Based Compensation**

** **

Prior to the corporate reorganization effective July31, 2004, optionsXpress, Inc. maintained the stock compensation plan.Subsequent to the corporate reorganization, the Company now maintains the stockcompensation plan. All options outstanding at December 31, 2004, are options tobuy common stock of the Company granted to employees of optionsXpress, Inc. andbrokersXpress, LLC.

 

In December 2002, the Financial Accounting StandardsBoard (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 148,*Accounting for Stock-Based Compensation –Transition and Disclosure*. SFAS No. 148 amends SFAS No. 123, *Accounting for Stock-Based Compensation*, to require moreprominent disclosures in annual and interim financial statements about themethod of accounting for stock-based compensation and the effect of the methodused on reported results. The additional disclosures of SFAS No. 148 arerequired for interim periods and fiscal years ended after December 15, 2002.

 

As permitted in SFAS No. 123 and 148, the Company haselected to continue to follow Accounting Principles Board Opinion No. 25 (APB25), *Accounting for Stock Issued to Employees*.Under APB 25, the Company, utilizing the intrinsic value-based method ofaccounting, recognizes no compensation expense related to employee stockoptions as long as options are granted with an exercise price equal to, orgreater than, the fair market value of the underlying common stock on the dateof grant as determined by management.

 

F-10

----

 

The following table illustrates the effect on theCompany’s reported net income and earnings per common share if the Company hadapplied the fair value recognition provisions of SFAS No. 123 to stock-basedemployee compensation:

 

| ** **                                                                                                                          | ** ** | **Years Ended December 31** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                          | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                                                                                                |       |                        |       |   |   |   |   |
| Net income, as  reported                                                                                                            |       | **$**                       | **31,210** |   | $ | 16,356 |   | $ | 4,371 |   |
| Deduct – Total  stock-based employee compensation expense determined under fair value-based  method for all awards, net of tax |       | **196**                     |       | 93 |   | 55 |   |
| Pro forma net  income                                                                                                               |       | **31,014**                  |       | 16,263 |   | 4,316 |   |
| Less income  allocable to preferred stock                                                                                           |       | **9,989**                   |       | 4,250 |   | 1,168 |   |
| Pro forma net  income applicable to common stockholders                                                                             |       | **$**                       | **21,025** |   | $ | 12,013 |   | $ | 3,148 |   |
|                                                                                                                                |       | ** **                  |       |   |   |   |   |
| Income per  share:                                                                                                                  |       | ** **                  |       |   |   |   |   |
| Basic, as  reported                                                                                                                 |       | **$**                       | **0.56**   |   | $ | 0.30 |   | $ | 0.08 |   |
| Basic, pro forma                                                                                                                    |       | **0.55**                    |       | 0.30 |   | 0.08 |   |
| Diluted, as  reported                                                                                                               |       | **0.55**                    |       | 0.29 |   | 0.08 |   |
| Diluted, pro  forma                                                                                                                 |       | **0.54**                    |       | 0.29 |   | 0.08 |   |

 

The underlying assumptions to these fair valuecalculations are discussed in Note 10.

 

**Income Taxes**

** **

The Company files a consolidated income tax return with itssubsidiaries. Deferred income tax assets and liabilities are determined basedon the differences between the financial statement carrying amounts and taxbases of assets and liabilities using the currently enacted tax rates.Valuation allowances are established to reduce deferred tax assets to theamount that more likely than not will be realized.

 

F-11

----

 

**Fair Value of Financial Instruments**

** **

Financial Accounting Standards Board (FASB) StatementNo. 107, *Disclosure about Fair Value of FinancialInstruments*, requires the disclosure of the fair value of financialinstruments, including assets and liabilities recognized in the consolidatedstatements of financial condition. Management estimates that the fair value offinancial instruments recognized in the consolidated statements of financialcondition (including cash, receivables, payables, and accrued liabilities)approximates their carrying value.

 

**Use of Estimates**

** **

The preparation of financial statements in conformitywith United States generally accepted accounting principles requires managementto make estimates and assumptions regarding capitalization of internallydeveloped software and other matters affecting the consolidated financialstatements and the accompanying notes for the years presented. Actual resultscould differ from management’s estimates.

 

**Recent Accounting Pronouncements**

** **

**InDecember 2004, the FASB issued Statement of Financial Accounting Standards (SFAS)No. 123R (revised 2004), *Share-Based Payment*.This statement requires use of the fair value method of accounting forshare-based payment transactions with employees. With the adoption of SFAS No.123R, the Company will be required to account for stock options under the fairvalue method of accounting and to estimate expected forfeitures of stock grantsinstead of its current practice of accounting for forfeitures as they occur. Inaddition, the Company will begin to classify the excess tax benefits, if any,related to employee option exercises as financing activities rather thanoperating activities in its consolidated statements of cash flows. The Companywill also consider whether to begin using a binomial model as a valuationtechnique to determine the fair value of stock option grants rather than theBlack Scholes model that is currently used. The provisions of SFAS No. 123R arerequired to be adopted as of the beginning of the first interim or annualreporting period that begins after June 15, 2005, and the Company is currentlyevaluating the impact of the adoption on its consolidated financial statements.**

 

F-12

----

 

**3. Receivable from Brokers**

** **

Amounts receivable from brokers consisted of thefollowing at December 31:

 

| ** **                            | ** ** | **2004**  | ** ** | **2003** | ** ** |
|---------------------------------------|------------|-----------|------------|----------|------------|
| Receivable:                           |       |      |       |     |       |
| Net settlement  with clearing brokers |       | **$**     | **6,075**  |     | $          | 2,222 |   |
| Order flow  receivable from brokers   |       | **3,224** |       | 2,148    |       |
|                                  |       | **$**     | **9,299**  |     | $          | 4,370 |   |

 

The net settlement with the clearing brokersrepresents amounts due from commissions earned, a portion of the margininterest on customer balances held at the clearing brokers, and interest incomeearned, net of interest expense, on Company balances held at the clearingbrokers. In September 2004, the Company entered into an agreement with GoldmanSachs Execution & Clearing, L.P. (GSEC), whereby GSEC replaced LegentClearing, LLC (Legent) as the Company’s primary clearing broker. Legentcontinues to act as a clearing broker for a portion of the Company’s trades.

 

**4. Fixed Assets**

** **

Fixed assets, including leasehold improvements andcapitalized software development costs, consisted of the following at December31:

 

| ** **                                      | ** ** | **2004**   | ** ** | **2003** | ** ** |
|-------------------------------------------------|------------|------------|------------|----------|------------|
|                                            |       |       |       |     |       |
| Computer  software                              |       | **$**      | **3,188**  |     | $          | 1,620 |   |
| Computer  equipment                             |       | **2,602**  |       | 1,123    |       |
| Office furniture                                |       | **182**    |       | 118      |       |
| Leasehold  improvements                         |       | **93**     |       | 67       |       |
| Miscellaneous                                   |       | **—** |       | 55       |       |
|                                            |       | **6,065**  |       | 2,983    |       |
| Less accumulated  depreciation and amortization |       | **2,333**  |       | 776      |       |
|                                            |       | **$**      | **3,732**  |     | $          | 2,207 |   |

 

As of December 31, 2004 and 2003, the cost ofinternally developed software was $2,299 and $1,213, respectively. The relatedaccumulated amortization related to internally developed software was $971 and $294,respectively.

 

F-13

----

 

At December 31, 2003, a standby letter of credit for$70 was issued on behalf of the Company to a leasing company for an officefurniture lease. During October of 2004, this lease was terminated and thestandby letter of credit was cancelled.

 

**5. Other Assets**

 

Other assets consisted of the following at December31:

 

| ** **                                 | ** ** | **2004**  | ** ** | **2003** | ** ** |
|--------------------------------------------|------------|-----------|------------|----------|------------|
|                                       |       |      |       |     |       |
| Exchange  membership                       |       | **$**     | **160**    |     | $          | 160 |   |
| Prepaid expenses                           |       | **258**   |       | 144      |       |
| Deferred initial  public offering expenses |       | **1,426** |       | —   |       |
| Other                                      |       | **48**    |       | 39       |       |
|                                       |       | **$**     | **1,892**  |     | $          | 343 |   |

 

**6. Accounts Payable and Accrued Liabilities**

 

Accounts payable and accrued liabilities consisted ofthe following at December 31:

 

| ** **                     | ** ** | **2004**  | ** ** | **2003** | ** ** |
|--------------------------------|------------|-----------|------------|----------|------------|
|                           |       |      |       |     |       |
| Accrued employee  compensation |       | **$**     | **1,636**  |     | $          | 841 |   |
| Accounts payable               |       | **1,200** |       | 370      |       |
| Other accrued  expenses        |       | **2,187** |       | 143      |       |
|                           |       | **$**     | **5,023**  |     | $          | 1,354 |   |

 

F-14

----

 

**7. Commitments, Contingencies, and Guarantees**

 

**Commitments and Contingencies**

 

The Company leases office space and equipment undernoncancelable operating lease agreements that expire on various dates through November30, 2007. Future minimum annual lease commitments, exclusive of additionalpayments that may be required for certain increases in operating costs, are asfollows:

 

| **Years ended December 31:** | ** ** | ** ** | ** ** |
|------------------------------|------------|------------|------------|
| 2005                         |       | $          | 550        |   |
| 2006                         |       | 482        |       |
| 2007                         |       | 404        |       |
|                         |       | $          | 1,436      |   |

 

Rent expense for the office space during the yearsended December 31, 2004, 2003, and 2002, totaled approximately $309, $218, and$116, respectively.

 

The Company enters into agreements to purchase publicrelations, telecommunications, and data services from various serviceproviders. These agreements expire on various dates through November, 2006. Thefixed and determinable portions of these obligations are $1,109 and $204 forthe years ended December 31, 2005 and 2006, respectively. The expenses incurredrelated to these service agreements during the years ended December 31, 2004,2003, and 2002, were $1,145, $502, and $93, respectively.

 

The Company is subject to pending and threatened legalactions arising in the normal course of business. In the opinion of management,based upon consultation with legal counsel, the disposition of such outstandinglegal actions will not have a material adverse effect on the financial positionor results of operations of the Company.

 

F-15

----

 

**Guarantees**

** **

Under the terms of the clearing agreements with GSECand Legent, the Company introduces its customers’ accounts to GSEC and Legentwho, as the clearing brokers, clear and carry all customer account activity. Assuch, the Company is required to guarantee the performance of its customers inmeeting their contractual obligations. The Company has agreed to indemnify theclearing brokers for losses that they may sustain for the customer accountsintroduced by the Company. In accordance with applicable margin lendingpractices and in conjunction with the clearing brokers, customer balances aretypically collateralized by customer securities or supported by other types ofrecourse provisions. Compliance with the various guidelines are monitored dailyand, pursuant to such guidelines, customers may be required to depositadditional collateral, or reduce positions, when necessary.

 

As of December 31, 2004, the Company had $77,974 incredit extended to its customers through its clearing brokers. The amount ofrisk to which the Company is exposed from the leverage extended to itscustomers and specifically from short sale transactions by its customers is notquantifiable since the risk would be dependent upon analysis of a potentialsignificant and undeterminable rise or fall in stock prices. The account levelmargin and leverage requirements meet or exceed those required by Regulation Tof the Board of Governors of the Federal Reserve. The Company believes that itis unlikely that it will have to make any significant payments under thesearrangements, and no liabilities related to these guarantees andindemnifications have been recognized in the accompanying consolidatedfinancial statements.

 

**8. Capitalization**

** **

**Common Stock**

** **

At December 31, 2004, 2003, and 2002, the Company had 187,500shares of $0.0001 par value common stock authorized. Of the authorized commonstock, 38,296, 41,138, and 40,365 shares were issued and outstanding atDecember 31, 2004, 2003, and 2002, respectively.

 

On March 12, 2004, the Company raised $2,000 byissuing 412 shares of common stock at a price of $4.86 per share. This sharesubscription was offered to all of the Company’s shareholders on a pro ratabasis based upon their ownership interest. The Company also issued 61 shares ofcommon stock with certain restrictions, as discussed below, as executivecompensation during July of 2004.

 

F-16

----

 

On April 30, 2004, the Company repurchased 74 sharesof common stock from original investors for $355. The stock was retired, andthe amount in excess of par value was charged to additional paid-in capital.

 

On December 31, 2004, 2003, and 2002, certainshareholders of the Company held 10,117, 15,000, and 15,000, respectively, ofshares under restricted stock agreements. These shares are restricted frombeing sold, assigned, transferred, pledged, gifted, or otherwise disposed ofuntil designated by the Company, or the Company issues shares to the public aspart of a qualified initial public offering.

 

The Company, in the event of termination, death, ordisability, has the right, but not the obligation, to purchase these shares atfair market value, as defined in the agreement. If the termination is forcause, the purchase price would be substantially less.

 

**Preferred Stock**

 

At December 31, 2004, 2003, and 2002, the Company had 75,000shares of $0.0001 par value convertible preferred stock authorized. Of theauthorized shares, 18,750 were designated as Series A Convertible Preferred. AtDecember 31, 2004, 2003, and 2002, the Company had 18,196, 13,948, and 14,448 shares,respectively, of convertible preferred stock issued and outstanding. Theconvertible preferred stock outstanding in 2003 and 2002 had the same votingand dividends rights as the common stock, and a preference value in liquidationthe greater of $0.20 per share or the amount each stockholder would receive ifthe convertible preferred stock was converted into common stock immediatelyprior to liquidation. This preferred stock was converted into shares of commonstock on a one for one basis on January 15, 2004.

 

On October 28, 2003, the Company repurchased 500shares of Series A Convertible Preferred Stock owned by Legent, its clearingbroker, for $2,000. The stock was retired, and the amount in excess of parvalue was charged to additional paid-in capital.

 

F-17

----

 

On January 15, 2004, the Company issued 18,196 sharesof a new Series A of convertible preferred stock in exchange for net proceeds of$88,390. The Company incurred $2,491 in costs in connection with thistransaction. In conjunction with this transaction, the outstanding preferredstock was converted into common stock on a one for one basis. The existingstockholders of the common stock, including employees with nonqualified stockoptions in January 2004, sold 18,196 shares of common stock back to the Companyfor an aggregate amount of $88,390. The convertible preferred stock issued onJanuary 15, 2004, is convertible on a one for one basis at any time, and participatesin dividends on the basis as if converted into common stock. This convertiblepreferred stock also has certain voting rights with regard to the election ofdirectors and certain corporate matters. If this convertible preferred stock isnot redeemed before January 15, 2009, by a liquidity event as defined in theagreement, these preferred stockholders also have the right to put their stockback to the Company for $88,390.

 

The Company will receive income tax benefits relatedto the exercise of nonqualified stock options as part of the transactiondescribed above. The Company is entitled to a deduction for income tax purposesof the amount that employees report as ordinary income on these non-qualifiedstock options. The tax benefit relating to the tax deduction, amounting to$646, is included in additional paid-in capital for the period of the taxreduction.

 

**Dividends**

 

The Company has declared and paid dividends totaling $7,014,$9,455, and $2,893 and during the years ended December 31, 2004, 2003, and2002, respectively, to all preferred and common stockholders of record.

 

F-18

----

 

Dividends per share for each class of shares were asfollows:

 

| ** **                   | ** ** | **2004**   | ** ** | **2003** | ** ** | **2002** | ** ** |
|------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Convertible preferred stock: |       |       |       |     |       |     |       |
| March 31                     |       | **$**      | **0.00**   |     | $          | 0.02     |       | $ | — |   |
| June 30                      |       | **0.00**   |       | 0.05     |       | —   |       |
| September 30                 |       | **0.00**   |       | 0.07     |       | 0.03     |       |
| December 31                  |       | **0.00**   |       | 0.03     |       | 0.02     |       |
|                         |       | ** ** |       |     |       |     |       |
| Common stock:                |       | ** ** |       |     |       |     |       |
| March 31                     |       | **0.00**   |       | 0.02     |       | —   |       |
| June 30                      |       | **0.13**   | *****      | 0.05     |       | —   |       |
| September 30                 |       | **0.00**   |       | 0.07     |       | 0.03     |       |
| December 31                  |       | **0.00**   |       | 0.03     |       | 0.02     |       |
|                              |            |            |            |          |            |          |            |  |  |  |

 

----

*Dividend paid to all stockholders of recordimmediately prior to the issuance of the new series of convertible preferred stockon January 15, 2004.

 

**9. Employee Benefit Plan**

** **

optionsXpress, Inc. maintains a 401(k) savings plancovering all eligible employees of optionsXpress, Inc. and brokersXpress, LLC.Discretionary contributions may be made to the plan although no suchcontributions have been made to the plan for the years ended December 31, 2004,2003, and 2002.

 

F-19

----

 

**10. Equity Incentive Plan**

** **

The Company maintains an equity incentive plan (thePlan) whereby management may, at its discretion, grant eligible employees,directors, independent contractors, or consultants of the Company and itssubsidiaries restricted stock or options to purchase up to 3,750 shares of theCompany’s common stock. In general, one-third of the options become exercisableon the first anniversary date following the grant, and one-thirty-sixth of theoptions become exercisable on each of the succeeding 24 monthly anniversariesof the first anniversary date. All options expire ten years after the date ofthe grant. The following table summarizes the activities of the Plan for theyears ended December 31, 2004, 2003, and 2002:

 

| ** **                               | ** ** | **2004**               | ** ** | **2003**                                | ** ** | **2002**               | ** ** |
|------------------------------------------|------------|------------------------|------------|-----------------------------------------|------------|------------------------|------------|
| ** **                               | ** ** | **Number of  Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Number of  Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Number of  Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
|                                     |       |                   |       |                                    |       |                   |       |   |   |   |   |   |   |
| Outstanding,  January 1                  |       | **1,951**              | ** ** | **$**                                   | **0.69**   |                   | 2,156      |   | $ | 0.25 |   | 1,095 |   | $ | 0.17 |   |
| Granted to  employees                    |       | **371**                | ** ** | **11.91**                               |       | 735                    |       | 1.38 |   | 1,204 |   | 0.31 |   |
| Exercised by  employees                  |       | **986**                | ** ** | **0.38**                                |       | 764                    |       | 0.21 |   | — |   | — |   |
| Forfeited by  employees                  |       | **60**                 | ** ** | **2.60**                                |       | 176                    |       | 0.20 |   | 143 |   | 0.21 |   |
| Outstanding,  December 31                |       | **1,276**              | ** ** | **4.10**                                |       | 1,951                  |       | 0.69 |   | 2,156 |   | 0.25 |   |
| Exercisable,  December 31                |       | **393**                | ** ** | **0.84**                                |       | 538                    |       | 0.25 |   | 522 |   | 0.17 |   |
| Available for  future grant, December 31 |       | **1,940**              | ** ** | **—**                              |       | 1,035                  |       | — |   | 1,594 |   | — |   |
| Weighted-average  remaining life (years) |       | **8.4**                | ** ** | **—**                              |       | 8.6                    |       | — |   | 8.9 |   | — |   |
|                                          |            |                        |            |                                         |            |                        |            |  |  |  |  |  |  |  |  |  |

 

F-20

----

 

The following table summarizes the options outstandingand exercisable at December 31, 2004:

 

| ** **     | ** ** | **Options Outstanding**          | ** ** | **Number of  Options  Exercisable** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
|----------------|------------|----------------------------------|------------|-------------------------------------|------------|-----------------------------------------|------------|
| **Number**     | ** ** | **Remaining  Contractual  Life** |
| Exercise Price |       |                             |       |                                |       |                                    |       |   |   |
| $0.17          |       | 38                               |       | 6.89                                |       | 34                                      |       | $ | 0.17 |   |
| $0.33          |       | 338                              |       | 7.53                                |       | 168                                     |       | $ | 0.33 |   |
| $0.96          |       | 466                              |       | 8.33                                |       | 166                                     |       | $ | 0.96 |   |
| $3.33          |       | 45                               |       | 8.75                                |       | 18                                      |       | $ | 3.33 |   |
| $7.14          |       | 123                              |       | 9.11                                |       | 7                                       |       | $ | 7.14 |   |
| $10.73         |       | 117                              |       | 9.54                                |       | —                                  |       | $ | 10.73 |   |
| $16.00         |       | 149                              |       | 9.61                                |       | —                                  |       | $ | 16.00 |   |
|           |       | 1,276                            |       |                                |       | 393                                     |       |   |   |

 

SFAS No. 123, *Accounting for Stock-BasedCompensation*, requires pro forma disclosures for the effect on netincome as if the fair market value based method of accounting provided forunder SFAS No. 123 has been adopted. Such disclosures are determined throughthe use of an option-pricing model and are included in Note 2.

 

Based on management’s estimate, the fair market valueof options granted at the date of grant during the years ended December 31, 2004,2003, and 2002 was $1,022, $284, and $237, respectively. The fair market valueof each option grant was estimated on the date of the grant using theBlack-Scholes option-pricing model. The model takes into account the stockprice and exercise price at the grant date and the following assumptions atDecember 31:

 

| ** **               | ** ** | **2004**     | ** ** | **2003** | ** ** | **2002** | ** ** |
|--------------------------|------------|--------------|------------|----------|------------|----------|------------|
|                     |       |         |       |     |       |     |       |
| Risk-free  interest rate |       | **3.65**     | **%**      | 3.27     | %          | 2.63     | %          |
| Expected  volatility     |       | **30**       | **%**      | 37       | %          | 100      | %          |
| Annual dividend  yield   |       | **3**        | **%**      | 3        | %          | 3        | %          |
| Expected life            |       | **5  years** | ** ** | 5 years  |       | 5 years  |       |

 

F-21

----

 

The risk-free interest rate assumption is based on therate available on zero-coupon U.S. government issues with a remaining term similarto the expected life of the options. The expected volatility assumption isestimated at 100% for 2002, in recognition of the Company’s rapid growth, andestimated at a reduced 37% in 2003, and 30% in 2004, in recognition of thelonger operating history and the private equity investment occurring in January2004.

 

**11. Credit Risk**

** **

Amounts receivable from the clearing brokers areprincipally for commissions charged to customers and represent a concentrationof credit risk. The Company does not anticipate non-performance by its clearingbrokers. In addition, the Company has a policy of reviewing, as considerednecessary, the creditworthiness of its clearing brokers with which it conductsbusiness. The Company’s business at December 31, 2004, constituted theprincipal portion of Legent’s business. The Company maintains its cash balancesat two financial institutions. Accounts are insured by the Federal DepositInsurance Corporation (FDIC) up to $100 per depositor, per institution.Uninsured balances were $2,319 and $2,542 at December 31, 2004 and 2003,respectively. Management believes that the Company is not exposed to anysignificant credit risk on these cash balances.

 

**12. Regulatory Requirements**

** **

optionsXpress Inc. and brokersXpress LLC are subjectto the Securities and Exchange Commission Uniform Net Capital Rule (Rule15c3-1) under the Securities Exchange Act of 1934 administered by the SEC andNASD, which requires the maintenance of minimum net capital. Under this Rule,optionsXpress Inc. is required to maintain net capital of 6 2/3% of “aggregateindebtedness” or $250, whichever is greater, as these terms are defined.brokersXpress LLC is required to maintain net capital of 6 2/3% of “aggregateindebtedness” or $50. Net capital and aggregate indebtedness change from day today.

 

F-22

----

 

Below is a summary of the capital requirements for optionsXpress,Inc. and brokersXpress LLC:

 
| ** **          | ** ** | **Year Ended December 31, 2004** | ** ** |
|---------------------|------------|----------------------------------|------------|
| ** **          | ** ** | **Required  Net Capital**        | ** ** | **Net  Capital** | ** ** | **Excess  Net  Capital** | ** ** | **Ratio of Aggregate  Indebtedness  to Net Capital** | ** ** |
|                |       |                             |       |   |   |   |   |   |   |
| optionsXpress,  Inc |       | **$**                            | **396**    | ** ** | **$** | **23,454** | ** ** | **$** | **23,058** | ** ** | **0.25 to  1** |   |
| brokersXpress  LLC  |       | **50**                           | ** ** | **269** | ** ** | **219** | ** ** | **0.55 to  1** |   |
|                     |            |                                  |            |  |  |  |  |  |  |  |  |  |

 
| ** **           | ** ** | **Year Ended December 31, 2003** | ** ** |
|----------------------|------------|----------------------------------|------------|
| ** **           | ** ** | **Required  Net Capital**        | ** ** | **Net  Capital** | ** ** | **Excess  Net  Capital** | ** ** | **Ratio of Aggregate  Indebtedness  to Net Capital** | ** ** |
|                 |       |                             |       |   |   |   |   |   |   |
| optionsXpress,  Inc. |       | $                                | 250        |   | $ | 3,420 |   | $ | 3,170 |   | 0.46 to 1 |   |
| brokersXpress  LLC   |       | 50                               |       | 250 |   | 200 |   | 0.02 to 1 |   |
|                      |            |                                  |            |  |  |  |  |  |  |  |  |  |

 

The net capital rule may effectively restrict thepayment of cash distributions or other equity withdrawals.

 

F-23

----

 

**13. Income Taxes**

** **

The components of income tax expense were:

 

| ** **                | ** ** | **Years Ended December 31** | ** ** |
|---------------------------|------------|-----------------------------|------------|
| ** **                | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
| Current:                  |       |                        |       |   |   |   |   |
| Federal                   |       | **$**                       | **16,727** |   | $ | 8,723 |   | $ | 1,306 |   |
| State                     |       | **3,819**                   |       | 1,919 |   | 288 |   |
|                      |       | **20,546**                  |       | 10,642 |   | 1,594 |   |
|                      |       | ** **                  |       |   |   |   |   |
| Deferred:                 |       | ** **                  |       |   |   |   |   |
| Federal                   |       | **382**                     |       | 180 |   | 190 |   |
| State                     |       | **87**                      |       | 40 |   | 35 |   |
|                      |       | **469**                     |       | 220 |   | 225 |   |
| Total income tax  expense |       | **$**                       | **21,015** |   | $ | 10,862 |   | $ | 1,819 |   |

 

The effective tax rate differs from the statutoryfederal income tax rate principally due to state income taxes.

 

A reconciliation of the statutory federal income taxrate to the effective tax rate applicable to pre-tax income was as follows:

 

| ** **                                     | ** ** | **Years Ended December 31** | ** ** |
|------------------------------------------------|------------|-----------------------------|------------|
| ** **                                     | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                           |       |                        |       |   |   |   |   |
| Federal income  tax at statutory rate          |       | **35.0**                    | **%**      | 35.0 | % | 34.0 | % |
| State income  taxes, net of federal tax effect |       | **4.8**                     | ** ** | 4.7 |   | 4.7 |   |
| Reduction in  valuation allowance              |       | **—**                  | ** ** | — |   | (9.3 | ) |
| Other                                          |       | **0.4**                     | ** ** | 0.2 |   | — |   |
|                                           |       | **40.2**                    | **%**      | 39.9 | % | 29.4 | % |

 

Net deferred tax liabilities were $914 and $445 atDecember 31, 2004 and 2003, respectively. The net deferred income tax liabilityis primarily attributable to the difference between the book and taxdepreciation, and the book and tax treatment of software developed for internaluse.

 

F-24

----

 

**14. Earnings Per Share**

 

The computations of basic and diluted EPS were asfollows:

 

| ** **                                                           | ** ** | **Years Ended December 31** | ** ** |
|----------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                           | ** ** | **2004**                    | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                                 |       |                        |       |   |   |   |   |
| Reported net  income                                                 |       | **$**                       | **31,210** |   | $ | 16,356 |   | $ | 4,371 |   |
| Less income  allocable to preferred stock                            |       | **10,052**                  |       | 4,275 |   | 1,183 |   |
| Adjusted net  income applicable to common stockholders               |       | **$**                       | **21,158** |   | $ | 12,081 |   | $ | 3,188 |   |
|                                                                 |       | ** **                  |       |   |   |   |   |
| Weighted-average  number of common shares outstanding – basic   |       | **37,956**                  |       | 40,583 |   | 38,935 |   |
| Effect of  dilutive securities                                       |       | **19,308**                  |       | 16,200 |   | 16,435 |   |
| Weighted-average  number of common shares outstanding – diluted |       | **57,264**                  |       | 56,783 |   | 55,370 |   |
|                                                                 |       | ** **                  |       |   |   |   |   |
| Basic EPS                                                            |       | **$**                       | **0.56**   |   | $ | 0.30 |   | 0.08 |   |
| Diluted EPS                                                          |       | **0.55**                    |       | 0.29 |   | 0.08 |   |

 

**15. Related Party Transactions**

 

Effective October 13, 2004, optionsXpress Holdings,Inc., through a wholly owned subsidiary, OXA LLC, acquired a 41% ownershipinterest in oX Australia in exchange for the Company’s contribution ofapproximately 1,700 customer accounts to oX Australia as part of thistransaction. The ownership interests at October 13, 2004, were determined basedprimarily on the relative number of accounts contributed by the differentshareholders of oX Australia and the efforts of the other shareholders informing and licensing oX Australia. At October 13, 2004, the Company recordedan investment of $57, at cost, based on the book value of zero for the non-monetaryassets contributed and $57 of legal costs incurred in making this investment. Concurrentwith the acquisition, the Company, through a wholly owned subsidiary,optionsXpress Inc., entered into a technology and execution and clearingservices agreement with oX Australia. Prior to October 13, 2004, brokersXpressLLC had a similar agreement with oX Australia. The Company also has acommitment to extend a loan of approximately $98 per the share subscriptionagreement.

 

F-25

----

 

For the year ended December 31, 2004, the Company earnedcommission income of $991 and incurred commission expense of $630 (reflected inbrokerage, clearing, and other related expenses in the consolidated statementsof operations) from the agreements with oX Australia. At December 31, 2004, theCompany recorded a net payable to oX Australia of $147 reflected in accountspayable and accrued liabilities in the consolidated statements of operations, consistingof customer commissions payable net of fees earned from oX Australia.

 

**16. Subsequent Events**

** **

On January 25, 2005, the Company declared a dividendof $33,500, to be payable pro rata to the holders of record of common stock andSeries A preferred stock of the Company, as of that date.

 

On January 26, 2005, the Company affected a 7.5 to 1stock split and declared a common stock dividend of 606 shares. Theconsolidated financial statements reflect the retroactive effect of the stocksplit and stock dividend and appropriate restatement of the capital accounts. Alsoas of that date, the Company completed an initial public offering of 5,000newly issued shares of common stock and 7,000 shares of existing shareholders,at an offering price of $16.50 per share, with net proceeds to the Company of$75.4 million. In connection with this offering, all shares of Series Apreferred stock were converted into shares of common stock on a one for onebasis.

 

On February 2, 2005, a dividend of $29,000 wasdeclared and paid to the Company by optionsXpress, Inc.

 

F-26

----

 

Schedule I - CondensedFinancial Information of the Registrant.

 

optionsXpress Holdings, Inc.

(Parent Company)

Statement of Operations

*(InThousands)*

 
| ** **                                                          | ** ** | **For the Period from  July 31, 2004 to****December 31,  2004** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| **Revenues**                                                        |       |                                                            |       |
| Interest income                                                     |       | **$**                                                           | **2**      |   |
| Dividend income  from subsidiary                                    |       | **1,000**                                                       |       |
|                                                                |       | **1,002**                                                       |       |
| **Expenses**                                                        |       | ** **                                                      |       |
| Stock based  compensation                                           |       | **654**                                                         |       |
| Other                                                               |       | **154**                                                         |       |
| Total expenses                                                      |       | **808**                                                         |       |
| Income before  income taxes                                         |       | **194**                                                         |       |
| Income tax  benefit                                                 |       | **399**                                                         |       |
| Income before  equity in undistributed net income from subsidiaries |       | **593**                                                         |       |
| Equity in  undistributed net income from subsidiaries               |       | **10,804**                                                      |       |
| Net income                                                          |       | **$**                                                           | **11,397** |   |

 

S-1

----

 

optionsXpress Holdings, Inc.

(Parent Company)

Statement of Financial Condition

*(InThousands)*

 
| ** **                                       | ** ** | **At  December 31,  2004** | ** ** |
|--------------------------------------------------|------------|----------------------------|------------|
| **Assets**                                       |       |                       |       |
| Cash                                             |       | **$**                      | **199**    |   |
| Current income  taxes receivable                 |       | **421**                    |       |
| Due from  subsidiary                             |       | **57**                     |       |
| Deferred initial  public offering expenses       |       | **1,426**                  |       |
| Investment in  subsidiaries                      |       | **32,267**                 |       |
| Total assets                                     |       | **$**                      | **34,370** |   |
|                                             |       | ** **                 |       |
| **Liabilities  and stockholders’ equity**   |       | ** **                 |       |
| Accounts payable  and accrued liabilities        |       | **$**                      | **536**    |   |
| Due to  subsidiary                               |       | **806**                    |       |
| Deferred income  tax payable                     |       | **22**                     |       |
| Total  liabilities                               |       | **1,364**                  |       |
|                                             |       | ** **                 |       |
| **Total  stockholders’ equity**             |       | **33,006**                 |       |
| Total  liabilities and stockholders’ equity |       | **$**                      | **34,370** |   |

 

S-2

----

 

optionsXpress Holdings, Inc.

(Parent Company)

Statement of Cash Flows

*(InThousands)*

 
| ** **                                                                     | ** ** | **For the Period from  July 31, 2004 to****December 31,  2004** | ** ** |
|--------------------------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| **Operating activities**                                                       |       |                                                            |       |
| Net income                                                                     |       | **$**                                                           | **11,397** | ** ** |
| Adjustments to reconcile net income to cash provided by operating  activities: |       | ** **                                                      | ** ** |
| Equity in undistributed net income from subsidiaries                           |       | **(10,804**                                                     | **)**      |
| Deferred income tax payable                                                    |       | **22**                                                          | ** ** |
| Stock based compensation                                                       |       | **654**                                                         | ** ** |
| Changes in operating assets and liabilities:                                   |       | ** **                                                      | ** ** |
| (Increase) decrease in:                                                        |       | ** **                                                      | ** ** |
| Current income taxes receivable                                                |       | **(421**                                                        | **)**      |
| Due from subsidiary                                                            |       | **(57**                                                         | **)**      |
| Deferred initial public offering expenses                                      |       | **(1,426**                                                      | **)**      |
| Increase (decrease) in:                                                        |       | ** **                                                      | ** ** |
| Accounts payable and accrued liabilities                                       |       | **536**                                                         | ** ** |
| Due to subsidiary                                                              |       | **353**                                                         | ** ** |
| Net cash provided by operating activities                                      |       | **254**                                                         | ** ** |
|                                                                           |       | ** **                                                      | ** ** |
| **Investing activities**                                                       |       | ** **                                                      | ** ** |
| Equity investment in subsidiary                                                |       | **(200**                                                        | **)**      |
| Net cash used in investing activities                                          |       | **(200**                                                        | **)**      |
|                                                                           |       | ** **                                                      | ** ** |
| **Financing activities**                                                       |       | ** **                                                      | ** ** |
| Exercise of stock options                                                      |       | **145**                                                         | ** ** |
|                                                                           |       | ** **                                                      | ** ** |
| Net increase in cash                                                           |       | **199**                                                         | ** ** |
| Cash, beginning of period                                                      |       | **—**                                                      | ** ** |
| Cash, end of period                                                            |       | **$**                                                           | **199**    | ** ** |
|                                                                           |       | ** **                                                      | ** ** |
| Supplemental disclosure of non-cash activity:                                  |       | ** **                                                      | ** ** |
| Non-cash foreign currency translation                                          |       | **$**                                                           | **2**      | ** ** |
| Non-cash investment in subsidiary                                              |       | **453**                                                         | ** ** |

 

S-3

----

 

**Notes to Condensed Financial Statements**

 

optionsXpress Holdings, Inc. (the Company) was formed on July 31, 2004as part of a Corporate Reorganization, whereby the Company acquired 100 percentof optionsXpress, Inc., bX Holdings LLC and brokersXpress LLC. Prior to theCorporate Reorganization, bX Holdings LLC and brokersXpress LLC were whollyowned subsidiaries of optionsXpress, Inc. optionsXpress Holdings, Inc., theregistrant, has no long-term liabilities, material contingencies or guarantees.

 

Cash dividends paid to the Company from optionsXpress, Inc. amounted to$1 million for the period from July 31, 2004 to December 31, 2004.

 

S-4

----