** **

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 

**(MarkOne)**

| **ý** | ** ** | **Quarterly report pursuant to Section  13 or 15(d) of the Securities Exchange Act of 1934 for the Quarterly Period  Ended March 31, 2005**                                                                                                             |
|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                   |
| **OR**     |
| ** ** | ** ** | ** **                                                                                                                                                                                                                                                   |
| **o**      | ** ** | **Transition  report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934  for the transition period from             to            ** |

 

**Commission file number: 0-49992**

 

**optionsXpress Holdings, Inc.**

(Exact name of registrant as specified in its charter)

 
| **Delaware**                                                    | ** ** | **20-1444525**                           |
|-----------------------------------------------------------------|------------|------------------------------------------|
| (State or other jurisdiction of  incorporation or organization) | ** ** | (I.R.S. Employer  Identification Number) |
| ** **                                                      |
| **39 S. LaSalle, Suite 220, Chicago, Illinois  60603**     |
| (Address of principal executive offices)                        |
| ** **                                                      |
| (Zip Code)                                                      |
| **(312) 630-3300**                                              |
| ** **                                                      |
| (Registrant’s telephone number, including area code)       |

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding twelve months, and (2) has been subject to suchfiling requirements for the past ninety days. Yes   **ý**** ** No  **o**

 

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

 

Asof March 31, 2005, there were 61,731,659 outstanding shares of theregistrant’s Common Stock.

 

 

----

 

**TABLEOF CONTENTS**

 
| Part I -  FINANCIAL INFORMATION |                                                                                                        |
|--------------------------------------|-------------------------------------------------------------------------------------------------------------|
|                                 | Item 1. -  Condensed Consolidated Financial Statements                                                 |   |
|                                 |                                                                                                        | Condensed  Consolidated Statements of Financial Condition |   |
|                                 |                                                                                                        | Condensed  Consolidated Statements of Operations |   |
|                                 |                                                                                                        | Condensed  Consolidated Statements of Cash Flows |   |
|                                 |                                                                                                        | Notes  to Condensed Consolidated Financial Statements |   |
|                                 | Item 2.  - Management’s Discussion and Analysis of Financial Condition and Results of  Operations |   |
|                                 | Item 3.  - Quantitative and Qualitative Disclosures about Market Risk                                  |   |
|                                 | Item 4. -  Controls and Procedures                                                                     |   |
| Part II - OTHER  INFORMATION    |                                                                                                        |
|                                 | Item 1. - Legal  Proceedings                                                                           |   |
|                                 | Item 6.  - Exhibits                                                                                    |   |
|                                 | 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                                              |   |
|                                 | Signatures                                                                                                  |   |
|                                      |                                                                                                             |  |  |  |  |

 

2

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**Part I- FINANCIAL INFORMATION**

 

**optionsXpress Holdings, Inc.**

 

**Condensed Consolidated Statements of FinancialCondition**

 

**(Unaudited)**

 

(In thousands, except per share data)

 
| ** **                                                                                                                                                                                                          | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| **Assets**                                                                                                                                                                                                          |       |                     |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                                           |       | $                        | 30,374     |                        | $          | 24,759 |   |
| Short-term investments                                                                                                                                                                                              |       |                     | 50,119     |                        |       | — |   |
| Receivable from  brokers                                                                                                                                                                                            |       | 10,038                   |       | 9,299                       |       |
| Security  deposits                                                                                                                                                                                                  |       | 314                      |       | 313                         |       |
| Fixed assets,  net of accumulated depreciation and amortization                                                                                                                                                     |       | 3,848                    |       | 3,732                       |       |
| Other assets                                                                                                                                                                                                        |       | 1,083                    |       | 1,892                       |       |
| Investment in  optionsXpress Australia Pty Limited                                                                                                                                                                  |       | 248                      |       | 100                         |       |
|                                                                                                                                                                                                                |       |                     |       |                        |       |
| Total assets                                                                                                                                                                                                        |       | $                        | 96,024     |                        | $          | 40,095 |   |
|                                                                                                                                                                                                                |       |                     |       |                        |       |
| **Liabilities  and stockholders’ equity**                                                                                                                                                                      |       |                     |       |                        |       |
| Liabilities:                                                                                                                                                                                                        |       |                     |       |                        |       |
| Accounts payable  and accrued liabilities                                                                                                                                                                           |       | $                        | 4,928      |                        | $          | 5,023 |   |
| Current income  taxes payable                                                                                                                                                                                       |       | 5,634                    |       | 1,152                       |       |
| Net deferred  income tax liabilities                                                                                                                                                                                |       | 864                      |       | 914                         |       |
|                                                                                                                                                                                                                |       |                     |       |                        |       |
| Total  liabilities                                                                                                                                                                                                  |       | 11,426                   |       | 7,089                       |       |
|                                                                                                                                                                                                                |       |                     |       |                        |       |
| Stockholders’  equity:                                                                                                                                                                                         |       |                     |       |                        |       |
| Common stock,  $0.0001 par value, 187,500,000 shares authorized; March 31, 2005 –  61,731,659 shares issued and outstanding, December 31, 2004 – 38,295,698  shares issued and outstanding      |       | 6                        |       | 4                           |       |
| Convertible  preferred stock, $0.0001 par value, 75,000,000 shares authorized;  March 31, 2005 – 0 shares issued and outstanding, December 31, 2004  – 18,196,073 shares issued and outstanding |       | —                   |       | 2                           |       |
| Additional  paid-in capital                                                                                                                                                                                         |       | 87,738                   |       | 12,450                      |       |
| Accumulated  other comprehensive income                                                                                                                                                                             |       | 1                        |       | 2                           |       |
| Retained  earnings (accumulated deficit)                                                                                                                                                                            |       | (3,147                   | )          | 20,548                      |       |
|                                                                                                                                                                                                                |       |                     |       |                        |       |
| Total  stockholders’ equity                                                                                                                                                                                    |       | 84,598                   |       | 33,006                      |       |
|                                                                                                                                                                                                                |       |                     |       |                        |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                    |       | $                        | 96,024     |                        | $          | 40,095 |   |

 

*See accompanying notes*

 

3

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**optionsXpress Holdings, Inc.**

 

**Condensed Consolidated Statements of Operations**

 

**(Unaudited)**

 

(In thousands, except per share data)

 
| ** **                                      | ** ** | **Three Months Ended**   | ** ** |
|-------------------------------------------------|------------|--------------------------|------------|
| ** **                                      | ** ** | **March 31,  2005** | ** ** | **March 31,  2004** | ** ** |
| **Revenues:**                                   |       |                     |       |   |   |
| Commissions                                     |       | $                        | 19,509     |   | $ | 18,316 |   |
| Other  brokerage-related revenue                |       | 5,161                    |       | 4,931 |   |
| Interest income                                 |       | 2,137                    |       | 545 |   |
| Other income                                    |       | 59                       |       | 11 |   |
|                                            |       |                     |       |   |   |
| Total revenues                                  |       | 26,866                   |       | 23,803 |   |
|                                            |       |                     |       |   |   |
| **Expenses:**                                   |       |                     |       |   |   |
| Brokerage,  clearing and other related expenses |       | 3,646                    |       | 3,102 |   |
| Compensation and  benefits                      |       | 2,825                    |       | 1,766 |   |
| Advertising                                     |       | 1,347                    |       | 1,939 |   |
| Quotation  services                             |       | 1,074                    |       | 797 |   |
| Depreciation and  amortization                  |       | 522                      |       | 367 |   |
| Technology and  telecommunication               |       | 490                      |       | 217 |   |
| Other                                           |       | 720                      |       | 379 |   |
|                                            |       |                     |       |   |   |
| Total expenses                                  |       | 10,624                   |       | 8,567 |   |
|                                            |       |                     |       |   |   |
| Income before  income taxes                     |       | 16,242                   |       | 15,236 |   |
| Income taxes                                    |       | 6,438                    |       | 6,058 |   |
| Net income                                      |       | $                        | 9,804      |   | $ | 9,178 |   |
|                                            |       |                     |       |   |   |
| Earnings per  common share:                     |       |                     |       |   |   |
| Basic                                           |       | $                        | 0.16       |   | $ | 0.17 |   |
| Diluted                                         |       | 0.16                     |       | 0.16 |   |
|                                            |       |                     |       |   |   |
| Weighted-average  number of common shares:      |       |                     |       |   |   |
| Basic                                           |       | 54,614,091               |       | 37,813,602 |   |
| Diluted                                         |       | 60,736,159               |       | 56,939,744 |   |

 

*See accompanying notes.*

 

4

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**optionsXpress Holdings, Inc.**

 

**Condensed Consolidated Statements of Cash Flows**

 

**(Unaudited)**

 

(In thousands)

 
| ** **                                                                     | ** ** | **Three Months Ended**  | ** ** |
|--------------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                     | ** ** | **March 31, 2005** | ** ** | **March 31, 2004** | ** ** |
| **Operating  activities**                                                      |       |                    |       |   |   |
| Net income                                                                     |       | $                       | 9,804      |   | $ | 9,178 |   |
| Adjustments to  reconcile net income to cash provided by operating activities: |       |                    |       |   |   |
| Depreciation and  amortization                                                 |       | 522                     |       | 367 |   |
| Net deferred  income taxes                                                     |       | (50                     | )          | 86 |   |
| Tax benefit                                                                    |       | —                  |       | 616 |   |
| Gain on  investment in optionsXpress Australia Pty Limited                     |       | (51                     | )          | — |   |
| Changes in  operating assets and liabilities:                                  |       |                    |       |   |   |
| (Increase)  decrease in:                                                       |       |                    |       |   |   |
| Receivable from  brokers                                                       |       | (739                    | )          | (2,045 | ) |
| Security  deposits                                                             |       | (1                      | )          | 3 |   |
| Other assets                                                                   |       | 809                     |       | (12 | ) |
| Loan deposit                                                                   |       | —                  |       | (10,005 | ) |
| Increase  (decrease) in:                                                       |       |                    |       |   |   |
| Accounts payable  and accrued liabilities                                      |       | (95                     | )          | 340 |   |
| Current income  taxes payable                                                  |       | 4,482                   |       | 5,107 |   |
| Net cash  provided by operating activities                                     |       | 14,681                  |       | 3,635 |   |
|                                                                           |       |                    |       |   |   |
| **Investing  activities**                                                      |       |                    |       |   |   |
| Loan to  optionsXpress Australia Pty Limited                                   |       | (98                     | )          | — |   |
| Purchases of short-term  investments                                           |       | (50,119                 | )          | — |   |
| Purchases and  development of computer software                                |       | (304                    | )          | (237 | ) |
| Purchases of  fixed assets                                                     |       | (334                    | )          | (351 | ) |
| Net cash used in  investing activities                                         |       | (50,855                 | )          | (588 | ) |
|                                                                           |       |                    |       |   |   |
| **Financing  activities**                                                      |       |                    |       |   |   |
| Exercise of  stock options                                                     |       | 282                     |       | 48 |   |
| Dividends paid                                                                 |       | (33,500                 | )          | — |   |
| Proceeds from  initial public offering                                         |       | 76,725                  |       | — |   |
| Redemption of  common stock                                                    |       | —                  |       | (88,390 | ) |
| Issuance of  convertible preferred stock                                       |       | —                  |       | 88,390 |   |
| Issuance of common  stock                                                      |       | —                  |       | 2,000 |   |
| Direct costs of  capital raised                                                |       | (1,718                  | )          | (2,491 | ) |
| Net cash  provided by (used in) financing activities                           |       | 41,789                  |       | (443 | ) |
|                                                                           |       |                    |       |   |   |
| Net increase in  cash and cash equivalents                                     |       | 5,615                   |       | 2,604 |   |
| Cash and cash  equivalents, beginning of period                                |       | 24,759                  |       | 2,777 |   |
| Cash and cash  equivalents, end of period                                      |       | $                       | 30,374     |   | $ | 5,381 |   |
|                                                                           |       |                    |       |   |   |
| Supplemental  disclosure of cash flow information:                             |       |                    |       |   |   |
| Income taxes  paid                                                             |       | $                       | 1,900      |   | $ | 250 |   |
| Interest paid                                                                  |       | 5                       |       | — |   |
| Supplemental  disclosure of non-cash activity:                                 |       |                    |       |   |   |
| Non–cash  exercise of options                                             |       | —                  |       | 35 |   |

 

*See accompanying notes.*

 

5

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**optionsXpress Holdings, Inc.**

 

**Notes to Condensed Consolidated Financial Statements**

 

**(Unaudited)**

 

(In thousands, except per share data)

 

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

 

**Basis of Presentation**

 

EffectiveJuly 31, 2004, the consolidated financial statements include the accountsof optionsXpress Holdings, Inc., optionsXpress, Inc., bX HoldingsLLC, and brokersXpress LLC (collectively, the Company). In addition, effective October 13,2004, the consolidated financial statements also include the accounts of anewly formed subsidiary, OX Australia, LLC (OXA LLC). Prior to July 31,2004, the consolidated financial statements included the accounts ofoptionsXpress, Inc., bX Holdings LLC and brokersXpress LLC (collectively,the Company). See Corporate Reorganization below for additional information.All significant intercompany balances and transactions have been eliminated inconsolidation.  Certain notes and otherinformation normally included in financial statements prepared in accordancewith generally accepted accounting principles have been condensed or omitted.

 

TheCompany follows United States generally accepted accounting principles,including certain accounting guidance used by the brokerage industry.

 

**Nature of Operations**

 

optionsXpress, Inc.is a broker-dealer registered with the Securities and Exchange Commission (SEC)and a member of the National Association of Securities Dealers, Inc.(NASD) and the Chicago Board Options Exchange. brokersXpress LLC is abroker-dealer registered with the SEC and a member of the NASD. The Companyprovides internet-based options and stock brokerage services to retailcustomers located throughout the United States and the world. The Companyclears all customer transactions through two clearing brokers on a fullydisclosed basis.

 

**Corporate Reorganization**

 

Priorto July 31, 2004, optionsXpress, Inc. wholly owned bX Holdings LLCand bX Holdings LLC wholly owned brokersXpress LLC. Effective July 31,2004, optionsXpress Holdings, Inc. was formed as a Delaware corporationand optionsXpress, Inc. entered into a corporate reorganization wherebyoptionsXpress Holdings, Inc. acquired 100 percent of optionsXpress, Inc.,bX Holdings LLC and brokersXpress LLC. The stockholders 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 brokersXpressLLC are wholly owned by optionsXpress Holdings, Inc.

 

**2. Summary of Significant Accounting Policies**

 

Except as described in the following paragraph, therehave been no changes in the significant accounting policies from those includedin the Company’s most recent Annual Report filed on Form 10-K.

 

**Short-TermInvestments**

 

Allof our investments are considered available for sale.  These investments are classified asshort-term investments, as these investments generally consist of highlymarketable securities that are intended to be available to meet current cashrequirements.  Short term investments arereported at fair market value, and net unrealized gains or losses are recordedin accumulated other comprehensive income or loss, a separate component ofstockholders' equity, net of taxes.  Anygains or losses on sales of short-term investments are computed based uponspecific identification.  Currently,short-term investments primarily consist of auction rate securities.  The interest rates on these securities aretypically reset to market prevailing rates every 90 days or less, but may havelonger stated maturities.

 

**3. Stock-Based Compensation**

 

Priorto the corporate reorganization effective July 31, 2004, optionsXpress, Inc.maintained the stock compensation plan. Subsequent to the corporatereorganization, the Company now maintains the stock compensation plan. Alloptions outstanding at March 31, 2005 are options to buy common stock of theCompany granted to employees of optionsXpress, Inc. and brokersXpress,LLC.

 

InDecember 2002, the Financial Accounting Standards Board (FASB) issuedStatement of Financial Accounting Standards (SFAS) No. 148, *Accounting for Stock-Based Compensation – Transitionand Disclosure*. SFAS No. 148 amends SFAS No. 123, *Accounting for Stock-Based Compensation*,to require more prominent disclosures in annual and interim financialstatements about the method of accounting for stock-based compensation and theeffect of the method used on reported results.

 

Aspermitted in SFAS No. 123 and 148, the Company has elected to continue tofollow Accounting Principles Board Opinion No. 25 (APB 25), *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. The following tableillustrates the effect on the Company’s reported net income and earnings percommon share if the Company had applied the fair value recognition provisionsof SFAS No. 123 to stock-based employee compensation:

 
| ** **                                                                                                                          | ** ** | **Three months ended March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                          | ** ** | **2005**                              | ** ** | **2004** | ** ** |
|                                                                                                                                |       |                                  |       |   |   |
| Net income, as  reported                                                                                                            |       | $                                     | 9,804      |   | $ | 9,178 |   |
| Deduct – Total  stock-based employee compensation expense determined under fair value-based  method for all awards, net of tax |       | 78                                    |       | 32 |   |
| Pro forma net  income                                                                                                               |       | 9,726                                 |       | 9,146 |   |
| Less income  allocable to preferred stock                                                                                           |       | 854                                   |       | 2,897 |   |
| Pro forma net  income applicable to common stockholders                                                                             |       | $                                     | 8,872      |   | $ | 6,249 |   |
|                                                                                                                                |       |                                  |       |   |   |
| Income per  share:                                                                                                                  |       |                                  |       |   |   |
| Basic, as  reported                                                                                                                 |       | $                                     | 0.16       |   | $ | 0.17 |   |
| Basic, pro forma                                                                                                                    |       | 0.16                                  |       | 0.17 |   |
| Diluted, as  reported                                                                                                               |       | 0.16                                  |       | 0.16 |   |
| Diluted, pro  forma                                                                                                                 |       | 0.16                                  |       | 0.16 |   |

 

The Company's calculations were made using theBlack-Scholes option-pricing model taking into account the stock price andexercise price and the following assumptions applied to grants made in thefollowing periods:

 
| ** **                                             | ** ** | **Three months ended March 31,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                             | ** ** | **2005**                              | ** ** | **2004** | ** ** |
|                                                   |       |                                  |       |   |   |
| Dividend yield                                         |       | 3                                     | %          | 3 | % |
| Expected volatility                                    |       | 30                                    | %          | 30 | % |
| Risk-free interest rate                                |       | 4.18                                  | %          | 2.80 | % |
| Expected life of option  following vesting (in months) |       | 60                                    |       | 60 |   |

 

**4. Recent Accounting Pronouncements**

 

InDecember 2004, the FASB issued Statement of Financial Accounting Standards(SFAS) No. 123R (revised 2004), *Share-BasedPayment*. This statement requires use of the fair value method ofaccounting for share-based payment transactions with employees. With theadoption of SFAS No. 123R, the Company will be required to account forstock options under the fair value method of accounting and to estimateexpected forfeitures of stock grants instead of its current practice of accountingfor forfeitures as they occur. In addition, the Company will begin to classifythe excess tax benefits, if any, related to employee option exercises asfinancing activities rather than operating activities in its consolidatedstatements of cash flows. The Company will also consider whether to begin usinga binomial model as a valuation technique to determine the fair value of stockoption grants rather than the Black Scholes model that is currently used. Theprovisions of SFAS No. 123R are required to be adopted as of the beginningof the first interim or annual reporting period that begins after December 31,2005, and the Company is currently evaluating the impact of the adoption on itsconsolidated financial statements.

 

6

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**5. Guarantees**

 

Underthe terms of the clearing agreements with Goldman Sachs Equity &Clearing (GSEC) and Legent Clearing Corp., the Company introduces its customers’accounts to GSEC and Legent who, as the clearing brokers, clear and carry allcustomer account activity. As such, the Company is required to guarantee theperformance of its customers in meeting their contractual obligations. TheCompany has agreed to indemnify the clearing brokers for losses that they maysustain for the customer accounts introduced by the Company. In accordance withapplicable margin lending practices and in conjunction with the clearingbrokers, customer balances are typically collateralized by customer securitiesor supported by other types of recourse provisions. Compliance with the variousguidelines are monitored daily and, pursuant to such guidelines, customers maybe required to deposit additional collateral, or reduce positions, whennecessary.

 

Asof March 31, 2005 and 2004, the Company had $90,170 and $61,831 in creditextended to its customers through its clearing brokers, respectively. Theamount of risk to which the Company is exposed from the leverage extended toits customers and specifically from short sale transactions by its customers isnot quantifiable 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 condensed consolidatedfinancial statements.

 

**6. Capitalization**

 

**Common Stock**

 

AtMarch 31, 2005, the Company had 187,500,000 shares of $0.0001 par valuecommon stock authorized. Of the authorized common stock, 61,731,659 shares wereissued and outstanding.

 

OnJanuary 26, 2005, the Company effected a 7.5 to 1 stock split. The condensedconsolidated financial statements reflect the retroactive effect of the stocksplit and appropriate restatement of the capital accounts.

 

OnJanuary 27, 2005, the Company completed an initial public offering of5,000,000 newly issued shares of common stock and 7,000,000 shares from existingstockholders, at an offering price of $16.50 per share, with net proceeds tothe Company of $75.0 million. The underwriters’ also exercised theirover--allotment option to purchase an additional 1,800,000 shares from existingstockholders.

 

**Preferred Stock**

 

AtMarch 31, 2005, the Company had 75,000,000 shares of $0.0001 par valueconvertible preferred stock authorized. Of the authorized shares, 18,750,000were designated as a new Series A Convertible Preferred. At March 31,2005, the Company had 0 shares of convertible preferred stock issued andoutstanding.

 

OnJanuary 26, 2005, all shares of this new Series A preferred stock were convertedinto shares of common stock, prior to the stock split, on a one for one basisin connection with the initial public offering.

 

**Dividends**

 

OnJanuary 25, 2005, the Company declared a dividend of $33,500, to bepayable pro rata to the holders of record of common stock and Series Apreferred stock of the Company, as of that date.

 

OnJanuary 26, 2005, the Company declared a common stock dividend of 606,068shares. The condensed consolidated financial statements reflect the retroactiveeffect of the stock dividend and appropriate restatement of the capitalaccounts.

 

**7. Regulatory Requirements**

 

optionsXpress, Inc.and brokersXpress LLC are subject to the Securities and Exchange CommissionUniform Net Capital Rule (Rule 15c3-1) under the SecuritiesExchange Act of 1934, administered by the SEC and NASD, which requires themaintenance of minimum net capital. Under this Rule, optionsXpress Inc. isrequired to maintain net capital of 6 2/3% of “aggregate indebtedness” or $250,whichever is greater, as these terms are defined. brokersXpress LLC is requiredto maintain net capital of 6 2/3% of “aggregate indebtedness” or $50. Netcapital and aggregate indebtedness change from day to day.

 

Belowis a summary of the capital requirements for optionsXpress, Inc. and brokersXpressLLC:

 
| ** **          | ** ** | **March 31, 2005**   | ** ** |
|---------------------|------------|---------------------------|------------|
| ** **          | ** ** | **Required  Net Capital** | ** ** | **Net  Capital** | ** ** | **Excess  Net  Capital** | ** ** | **Ratio of Aggregate  Indebtedness  to Net Capital** | ** ** |
|                |       |                      |       |   |   |   |   |   |   |
| optionsXpress,  Inc | ** ** | **$**                     | **270**    | ** ** | **$** | **4,730** | ** ** | **$** | **4,460** | ** ** | **0.85 to 1** | ** ** |
| brokersXpress  LLC  | ** ** | **50**                    | ** ** | **393** | ** ** | **343** | ** ** | **0.63 to 1** | ** ** |
|                     |            |                           |            |  |  |  |  |  |  |  |  |  |

 
| ** **               | ** ** | **March 31, 2004**   | ** ** |
|--------------------------|------------|---------------------------|------------|
| ** **               | ** ** | **Required  Net Capital** | ** ** | **Net  Capital** | ** ** | **Excess  Net  Capital** | ** ** | **Ratio of Aggregate  Indebtedness  to Net Capital** | ** ** |
|                     |       |                      |       |   |   |   |   |   |   |
| optionsXpress, Inc. |       | $                         | 465        |   | $ | 1,401 |   | $ | 936 |   | 4.97 to 1 |   |
| brokersXpress  LLC       |       | 50                        |       | 158 |   | 108 |   | 0.10 to 1 |   |
|                          |            |                           |            |  |  |  |  |  |  |  |  |  |

 

Thenet capital rule may effectively restrict the payment of cashdistributions or other equity withdrawals.

 

7

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**8. Earnings Per Share**

 

The computations of basic and diluted EPS were as follows for the threemonths ended:

 
| ** **                                                           | ** ** | **March 31, 2005** | ** ** | **March 31, 2004** | ** ** |
|----------------------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
|                                                                 |       |                    |       |                    |       |
| Reported net  income                                                 | ** ** | **$**                   | **9,804**  |                    | $          | 9,178 |   |
| Less income  allocable to preferred stock                            | ** ** | **861**                 |       | 2,908                   |       |
| Adjusted net  income applicable to common stockholders               | ** ** | **$**                   | **8,943**  |                    | $          | 6,270 |   |
|                                                                 |       |                    |       |                    |       |
| Weighted-average  number of common shares outstanding – basic   | ** ** | **54,614,091**          |       | 37,813,602              |       |
| Effect of  dilutive securities                                       | ** ** | **6,122,068**           |       | 19,126,142              |       |
| Weighted-average  number of common shares outstanding – diluted | ** ** | **60,736,159**          |       | 56,939,744              |       |
|                                                                 |       |                    |       |                    |       |
| Basic EPS                                                            | ** ** | **$**                   | **0.16**   |                    | $          | 0.17 |   |
| Diluted EPS                                                          | ** ** | **0.16**                |       | 0.16                    |       |

 

**Item 2. - Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

**Forward-LookingStatements**

 

**FORWARD-LOOKING STATEMENTS**

 

Thefollowing discussion of the financial condition and results of operations ofthe Company should be read in conjunction with the Selected Financial Data andthe Consolidated Financial Statements and Notes thereto included in the Company’sannual report on Form 10-K for the fiscal year ended December 31,2004, and the Condensed Consolidated Financial Statements and Notes theretocontained in this quarterly report on Form 10-Q. This discussioncontains forward-looking statements that relate to future events or our futurefinancial performance and involve known and unknown risks, uncertainties andother factors that may cause our actual results, levels of activity,performance or achievements to be materially different from any future results,levels of activity, performance or achievements expressed or implied by theseforward-looking statements. In some cases, you can identify forward-lookingstatements 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. Thesestatements are only predictions. Actual events or results may differmaterially. The forward-looking statements made in this Form 10-Qrelate only to events as of the date on which the statements are made, and weundertake no ongoing obligation, other than any imposed by law, to update thesestatements. Although we believe that the expectations reflected in theforward-looking statements are reasonable, we cannot guarantee future results,levels of activity, performance or achievements.

 

Importantfactors that may cause such differences include, but are not limited to: risksrelated to general economic conditions, regulatory developments, thecompetitive landscape, the volume of securities trading generally or by ourcustomers specifically, competition, systems failures and capacity constraintsand the other risks and uncertainties set forth under the heading “Risk Factors”in Item 1 of the Company’s annual report on Form 10-K for thefiscal year ended December 31, 2004.

 

Inparticular, forward-looking statements include, but are not limited to, thefollowing:

 

•                                          the statements about our intention to paydividends;

•                                          the statements about future growth in onlinebrokerage accounts, options trading and online options trading;

•                                          the statements relating to the registrationof, and transfers of accounts to, optionsXpress Canada and other potentialresponses to possible enforcement actions against us by Canadian authorities;

•                                          the statement that on a per trade basis,brokerage, clearing and other related expenses generally decrease as the numberof customer trades increase;

•                                          the statements concerning continued financingoptions; and

•                                          the statements regarding scalability of our systemsand the cost of increases.

 

**Results of Operations**

 

Thefollowing table sets forth our total revenues and consolidated statements ofincome data for the quarters presented as a percentage of total revenues:

 
| ** **                                       | ** ** | **Three months ended March 31,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                       | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| **Results  of Operations**                       |       |                                  |       |   |   |
| Total revenues  (in thousands)                   |       | $                                     | 26,866     |   | $ | 23,803 |   |
| Brokerage,  clearing, and other related expenses |       | 13.6                                  | %          | 13.0 | % |
| Compensation and  benefits                       |       | 10.5                                  |       | 7.4 |   |
| Advertising                                      |       | 5.0                                   |       | 8.1 |   |
| Quotation  services                              |       | 4.0                                   |       | 3.4 |   |
| Depreciation and  amortization                   |       | 1.9                                   |       | 1.6 |   |
| Technology and  telecommunication                |       | 1.8                                   |       | 0.9 |   |
| Other                                            |       | 2.7                                   |       | 1.6 |   |
| Income before  income taxes                      |       | 60.5                                  |       | 64.0 |   |
| Income taxes                                     |       | 24.0                                  |       | 25.4 |   |
| Net income                                       |       | 36.5                                  |       | 38.6 |   |
|                                                  |            |                                       |            |  |  |  |  |

 

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**Statistical Data**

 

Thefollowing table sets forth our statistical data for the quarters presentedbelow:

 
| ** **                                            | ** ** | **Three months ended March 31,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                            | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| **Statistical  Data**                                 |       |                                  |       |   |   |
| Number of  customer accounts (1)                      |       | 116,600                               |       | 70,100 |   |
| Daily average  revenue trades (“DARTs”) (2) |       | 16,500                                |       | 13,700 |   |
| Customer trades  per account (3)                      |       | 37.0                                  |       | 53.3 |   |
| Average  commission per trade                         |       | $                                     | 19.38      |   | $ | 21.52 |   |
| Option trades as  a% of total trades                  |       | 75                                    | %          | 78 | % |
| Advertising  expense per new customer account (4)     |       | $                                     | 86         |   | $ | 157 |   |
| Total client  assets (000s)                           |       | $                                     | 2,172,413  |   | $ | 1,325,114 |   |
| Client margin  balances (000s)                        |       | $                                     | 90,170     |   | $ | 61,831 |   |

 

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(1)          Customeraccounts are open, numbered accounts.

(2)          DARTs aretotal revenue-generating trades for a period divided by the number of tradingdays in that period.

(3)          Customertrades per account are total trades divided by the average number of totalcustomer accounts during the period. Customer trades are annualized.

(4)          Calculated based on total new customeraccounts opened during the period.

 

***Three Months Ended March 31, 2005versus March 31, 2004***

 

*Overview*

 

Ourresults for the period reflect the following principal factors:

 

•                  total customeraccounts increased by 46,518 to 116,600, or 66.4%;

 

•                  total tradesincreased by 155,000 to 1,006,000, or 18.3%; and

 

•                  average commissionper trade decreased by $2.14 to $19.38, or 9.9%.

 

Asignificant factor in the quarter ended March 31, 2005 versus March 31,2004 was the strength of the overall equity markets in the first quarter of2004. The result in 2004 was an extremely strong first quarter followed by moremodest growth in the second and third quarters as the markets returned to moretypical levels.

 

*Total revenues*

 

Ourtotal revenues increased $3.1 million, or 12.9%, for the quarter ended March 31,2005 to $26.9 million compared to $23.8 million for the quarter endedMarch 31, 2004. The increase in total revenues consisted primarily of anincrease in commissions for the quarter ended March 31, 2005 of $1.2 million,or 6.5%, to $19.5 million compared to $18.3 million for the quarterended March 31, 2004, an increase in payment for order flow of $0.3 million,or 4.7%, to $5.2 million for the quarter ended March 31, 2005compared to $4.9 million for the quarter ended March 31, 2004 and anincrease in interest income of $1.6 million, or 292.1%, to $2.1million forthe quarter ended March 31, 2005 compared to $0.5 million for thequarter ended March 31, 2004. The increases in commission and payment fororder flow were primarily the result of the rise in the number of tradesprocessed, partially offset by a decrease in the average commission per trade. Theincrease in interest income was a result of an increase in customer cashbalances and margin balances, an increase in the average net interest rateearned on those customer cash balances and margin balances, and interest earnedon the proceeds from our initial public offering.

 

*Brokerage, clearing, and other related expenses*

 

Brokerage,clearing, and other related expenses increased $0.5 million, or 17.5%, to$3.6 million for the quarter ended March 31, 2005 from $3.1 millionfor the quarter ended March 31, 2004. Increased brokerage expenses wereprimarily due to variable clearing and execution charges associated with the 18.3%increase in trades.

 

*Compensation and benefits*

 

Compensationand benefits expenses increased $1.0 million, or 60.0%, to$2.8 million for the quarter ended March 31, 2005 from$1.8 million for the quarter ended March 31, 2004. Increasedcompensation expenses were primarily due to an increase in the number of employeesfrom 99 to 135 to service the growth in our accounts and to develop theinfrastructure for the Company for its initial public offering.

 

*Advertising*

 

Advertisingexpenses decreased $0.6 million, or 30.5%, to $1.3 million for thequarter ended March 31, 2005 from $1.9 million for the quarter ended March 31,2004. The decrease in advertising expenses was primarily due to thecancellation of our trial use of television advertising.

 

*Quotation services*

 

Quotationservices expenses increased $0.3 million, or 34.8%, to $1.1 millionfor the quarter ended March 31, 2005 from $0.8 million for thequarter ended March 31, 2004. Increased quotation services expenses wereprimarily due to a 66.4% increase in customer accounts, which was partiallyoffset by a reduction in per user fees from third-party vendors.

 

*Depreciation and amortization*

 

Depreciationand amortization expenses increased $0.1 million, or 42.2%, to$0.5 million for the quarter ended March 31, 2005 from$0.4 million for the quarter ended March 31, 2004. Increaseddepreciation and amortization expenses were primarily due to increasedcapitalized costs relating to the continued development of our brokerageplatform and technology infrastructure.

 

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*Technology and telecommunication*

 

Technologyand telecommunication expenses increased $0.3 million, or 125.8%, to $0.5 millionfor the quarter ended March 31, 2005 from $0.2 million for the quarterended March 31, 2004. Increased technology and telecommunication expenseswere primarily due to added telecommunications and data costs required tosupport the increase in trades and customer accounts.

 

*Other*

 

Otherexpenses increased $0.3 million, or 90.0%, to $0.7 million for the quarterended March 31, 2005 from $0.4 million for the quarter ended March 31,2005. Increased other expenses were primarily due to increased generaladministrative expenses consistent with the growth of the business and additionalfees associated with being a publicly traded company.

 

*Income taxes*

 

Incometaxes increased $0.3 million, or 6.3%, to $6.4 million for the quarterended March 31, 2005 from $6.1 million for the quarter ended March 31,2004. Increased income taxes were primarily due to the 6.6% increase in incomebefore income taxes.

 

*Net income*

 

Asa result of the foregoing, we reported $9.8 million in net income for the quarterended March 31, 2005, as compared to $9.2 million in net income forthe quarter ended March 31, 2004, an increase of $0.6 million, or 6.8%.

 

**Liquidity and Capital Resources**

 

Weplan to finance our future operating liquidity and regulatory capital needsfrom our earnings. Although we have no current plans to do so, we may issueequity or debt securities or enter into secured lines of credit from time totime. As a holding company, we access the earnings of our operatingsubsidiaries through receipt of dividends from these subsidiaries. Some of oursubsidiaries are subject to requirements of the SEC and NASD relating toliquidity and capital standards, which limit funds available for the payment ofdividends to the holding company.

 

Ourbroker-dealer subsidiary, optionsXpress, Inc., is subject to theSecurities and Exchange Commission Uniform Net Capital Rule (Rule 15c3-1).Under applicable provisions of this Rule, optionsXpress, Inc. is requiredto maintain net capital of 6 2¤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 March 31, 2005, it had net capital ofapproximately $4.73 million and net capital requirements of$0.27 million. The ratio of aggregate indebtedness to net capital at March 31,2005 was 0.85 to 1.

 

Ourother broker-dealer subsidiary, brokersXpress LLC, is also subject to Rule 15c3-1and at March 31, 2005, had net capital of approximately $0.39 millionand applicable net capital requirements of $0.05 million. The ratio ofaggregate indebtedness to net capital at March 31, 2005 was 0.63 to 1.

 

***Cash Flow***

 

Cashprovided by operating activities was $14.7 million for the quarter ended March 31,2005, compared to cash provided by operating activities of $3.6 millionfor the quarter ended March 31, 2004. The primary reason for the increasein cash provided by operating activities is due to the return of the loandeposit made to the Company’s clearing broker in the first quarter of 2004. Thisloan deposit was returned to the Company in the fourth quarter of 2004.

 

Cashused in investing activities was $50.9 million for the quarter ended March 31,2005, compared to cash used in investing activities of $0.6 million forthe quarter ended March 31, 2004. The primary reason for the increase incash used in investing activities was the transfer of most of the initialpublic offering proceeds into short-term investments.

 

Cashprovided by financing activities was $41.8 million for the quarter ended March 31,2005, compared to cash used in financing activities of $0.4 million forthe quarter ended March 31, 2004. The primary reason for the increase incash provided by financing activities is due to the net proceeds the Companyreceived from the initial public offering.

 

***Capital Expenditures***

 

Capitalexpenditures were $0.6 million for the quarter ended March 31, 2005,compared to $0.6 million for the quarter ended March 31, 2004. Capitalexpenditures for the quarter ended March 31, 2005 and 2004 includedcapitalized software costs, which we capitalized in accordance with Statementof Position (“SOP”) 98-1 “Accounting for the Costs of Computer SoftwareDeveloped or Obtained for Internal Use,” primarily related to the developmentof our technology.

 

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**Item 3. - 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 withboth of our 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 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 March 31, 2005, we had $90.2 millionin margin credit extended to our customers through our clearing firms. Theamount 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 account levelmargin credit and leverage requirements meet or exceed those required byRegulation 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.

 

**Item 4.– Controls and Procedures**

 

**Evaluation of 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 formsand that 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 and proceduresas of the end of the period covered by this report. Based on the evaluation ofthese disclosure controls and procedures, the Chief Executive Officer and ChiefFinancial Officer concluded that our disclosure controls and procedures wereeffective. It should be noted that any system of controls, however welldesigned and operated, can provide only reasonable, and not absolute, assurancethat the objectives of the system are met. In addition, the design of anycontrol system is based in part upon certain assumptions about the likelihoodof future events. Because of these and other inherent limitations of controlsystems, there can be no assurance that any design will succeed in achievingits stated goals under all potential future conditions, regardless of howremote.

 

**Changes in Internal Control Over Financial Reporting**

 

Therewere no changes in our internal control over financial reporting during thefirst quarter of 2005 that have materially affected, or are reasonably likelyto materially affect, our internal control over financial reporting.

 

**Part II- OTHER INFORMATION**

 

**Item 1.– 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, and insome cases, punitive damages. Like other securities brokerage firms, we havebeen threatened with, or named as a defendant in, lawsuits, arbitrations andadministrative proceedings. Compliance and trading problems that are reportedto federal, state and provincial securities regulators, securities exchanges orother self-regulatory organizations by dissatisfied customers are investigatedby such 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 the NASDOrder Audit Trail System reporting rules, including failure to maintainadequate procedures and/or supervise. The probability of a finding against uson these pending charges is unknown, and the potential fines or otherdisciplinary action for these kinds of violations of NASD rules varies,but we believe that settlements for such violations range from $10,000 forsingle violations to $60,000 for settlement of a number of violations. We haveresponded to or are in the process of responding to these letters.

 

InJuly 2004, the Ontario Securities Commission advised us that it wasconsidering enforcement action against us for conducting business withcustomers located in Ontario without being registered. If the OntarioSecurities Commission or the securities commissions of other Canadian provincesproceed with an enforcement action, we could choose to defend against anyallegations relating to violations of Canadian registration requirements,pursue settlement to resolve the matter and/or withdraw completely from doingbusiness in Canada. Based on other brokerage firms settling similar matterswith the Ontario Securities Commission, we anticipate that if we choose tosettle this matter, we may be required to pay a penalty. We recorded a reserveof $420,000 in the third quarter of 2004, which we believe is a reasonableestimate of our total exposure relating to this issue.

 

**Item 6. -Exhibits**

 

31.1                           Certification of DavidS. Kalt, Principal Executive Officer, as required pursuant to Section 302of the Sarbanes-Oxley Act of 2002

 

31.2                           Certification of DavidA. Fisher, Principal Financial Officer, as required pursuant to Section 302of the Sarbanes-Oxley Act of 2002

 

32.1                           Certification pursuantto 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002

 

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**Signatures**

 

Pursuantto the requirements of the Securities Act of 1934,the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 
| Dated:  May 3, 2005 | ** ** | **optionsXpress Holdings, Inc.**                        |
|---------------------|------------|--------------------------------------------------------------|
|                |       | (Registrant)                                                 |
|                |       |                                                         |
|                |       | By:                                                          | /s/ David  S. Kalt |   |
|                |       | David  S. Kalt                                               |
|                |       | Chief  Executive Officer (Principal Executive Officer)       |
|                |       |                                                         |
|                |       |                                                         |
|                |       | By:                                                          | /s/ David  A. Fisher |   |
|                |       |                                                         |
|                |       | Chief  Financial Officer (Principal Financial and Accounting |
|                |       | Officer)                                                     |
|                     |            |                                                              |  |  |  |  |

 

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