**SECURITIESAND 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 June 30, 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                   ** |

 

**Commissionfile number: 0-49992**

 

**optionsXpressHoldings, Inc.**

(Exact name ofregistrant as specified in its charter)

 
| **Delaware**                                                     | ** ** | **20-1444525**                           |
|------------------------------------------------------------------|------------|------------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification Number) |

 

**39S. LaSalle, Suite 220, Chicago, Illinois**

**60603**

(Address ofprincipal executive offices)

** **

(Zip Code)

**(312)630-3300**

** **

(Registrant’stelephone number, including area code)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the precedingtwelve months, and (2) has been subject to such filing requirements forthe past ninety days. Yes   **ý ** No  **o**

 

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

 

As of June 30, 2005,there were 61,859,889 outstanding shares of the registrant’s Common Stock.

 

 

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**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**

 

**optionsXpressHoldings, Inc.**

 

**CondensedConsolidated Statements of Financial Condition**

 

**(Unaudited)**

 

(In thousands,except per share data)

 
| ** **                                                                                                                                                                                                 | ** ** | **June 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **Assets**                                                                                                                                                                                                 |       |                    |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                                                 |       | $                       | 74,213     |                        | $          | 24,759 |   |
| Short-term  investments                                                                                                                                                                                    |       | 10,625                  |       | —                      |       |
| Receivable from  brokers                                                                                                                                                                                   |       | 10,378                  |       | 9,299                       |       |
| Security  deposits                                                                                                                                                                                         |       | 313                     |       | 313                         |       |
| Fixed assets,  net of accumulated depreciation and amortization                                                                                                                                            |       | 3,996                   |       | 3,732                       |       |
| Other assets                                                                                                                                                                                               |       | 1,058                   |       | 1,892                       |       |
| Investment in  optionsXpress Australia Pty Limited                                                                                                                                                         |       | 288                     |       | 100                         |       |
|                                                                                                                                                                                                       |       |                    |       |                        |       |
| Total assets                                                                                                                                                                                               |       | $                       | 100,871    |                        | $          | 40,095 |   |
|                                                                                                                                                                                                       |       |                    |       |                        |       |
| **Liabilities  and stockholders’ equity**                                                                                                                                                             |       |                    |       |                        |       |
| Liabilities:                                                                                                                                                                                               |       |                    |       |                        |       |
| Accounts payable  and accrued liabilities                                                                                                                                                                  |       | $                       | 5,059      |                        | $          | 5,023 |   |
| Dividend payable                                                                                                                                                                                           |       | 2,474                   |       | —                      |       |
| Current income  taxes payable                                                                                                                                                                              |       | (204                    | )          | 1,152                       |       |
| Net deferred  income tax liabilities                                                                                                                                                                       |       | 751                     |       | 914                         |       |
|                                                                                                                                                                                                       |       |                    |       |                        |       |
| Total  liabilities                                                                                                                                                                                         |       | 8,080                   |       | 7,089                       |       |
|                                                                                                                                                                                                       |       |                    |       |                        |       |
| Stockholders’  equity:                                                                                                                                                                                |       |                    |       |                        |       |
| Common stock,  $0.0001 par value, 187,500 shares authorized; June 30, 2005 – 61,860  shares issued and outstanding, December 31, 2004 – 38,296 shares issued  and outstanding          |       | 6                       |       | 4                           |       |
| Convertible  preferred stock, $0.0001 par value, 75,000 shares authorized; June 30,  2005 – 0 shares issued and outstanding, December 31, 2004 – 18,196  shares issued and outstanding |       | —                  |       | 2                           |       |
| Additional paid-in  capital                                                                                                                                                                                |       | 87,761                  |       | 12,450                      |       |
| Accumulated  other comprehensive (loss)/income                                                                                                                                                             |       | (10                     | )          | 2                           |       |
| Retained  earnings                                                                                                                                                                                         |       | 5,034                   |       | 20,548                      |       |
|                                                                                                                                                                                                       |       |                    |       |                        |       |
| Total  stockholders’ equity                                                                                                                                                                           |       | 92,791                  |       | 33,006                      |       |
|                                                                                                                                                                                                       |       |                    |       |                        |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                           |       | $                       | 100,871    |                        | $          | 40,095 |   |

 

*Seeaccompanying notes*

 

3

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**optionsXpressHoldings, Inc.**

 

**CondensedConsolidated Statements of Operations**

 

**(Unaudited)**

 

(In thousands,except per share data)

 
| ** **                                      | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                      | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                            |       |                                  |       |                                |       |   |   |   |   |
| **Revenues:**                                   |       |                                  |       |                                |       |   |   |   |   |
| Commissions                                     |       | $                                     | 20,573     |                                | $          | 19,197 |   | $ | 40,082 |   | $ | 37,513 |   |
| Other brokerage-related  revenue                |       | 5,368                                 |       | 4,120                               |       | 10,529 |   | 9,051 |   |
| Interest income                                 |       | 2,582                                 |       | 660                                 |       | 4,719 |   | 1,205 |   |
| Other income                                    |       | 58                                    |       | 9                                   |       | 117 |   | 20 |   |
|                                            |       |                                  |       |                                |       |   |   |   |   |
| Total revenues                                  |       | 28,581                                |       | 23,986                              |       | 55,447 |   | 47,789 |   |
|                                            |       |                                  |       |                                |       |   |   |   |   |
| **Expenses:**                                   |       |                                  |       |                                |       |   |   |   |   |
| Brokerage,  clearing and other related expenses |       | 3,232                                 |       | 3,814                               |       | 6,878 |   | 6,916 |   |
| Compensation and  benefits                      |       | 3,260                                 |       | 2,156                               |       | 6,085 |   | 3,922 |   |
| Advertising                                     |       | 1,424                                 |       | 1,806                               |       | 2,771 |   | 3,745 |   |
| Quotation  services                             |       | 939                                   |       | 913                                 |       | 2,013 |   | 1,710 |   |
| Depreciation and  amortization                  |       | 565                                   |       | 375                                 |       | 1,087 |   | 742 |   |
| Technology and  telecommunication               |       | 539                                   |       | 281                                 |       | 1,029 |   | 498 |   |
| Other                                           |       | 1,121                                 |       | 599                                 |       | 1,841 |   | 978 |   |
|                                            |       |                                  |       |                                |       |   |   |   |   |
| Total expenses                                  |       | 11,080                                |       | 9,944                               |       | 21,704 |   | 18,511 |   |
|                                            |       |                                  |       |                                |       |   |   |   |   |
| Income before  income taxes                     |       | 17,501                                |       | 14,042                              |       | 33,743 |   | 29,278 |   |
| Income taxes                                    |       | 6,845                                 |       | 5,585                               |       | 13,283 |   | 11,643 |   |
| Net income                                      |       | $                                     | 10,656     |                                | $          | 8,457 |   | $ | 20,460 |   | $ | 17,635 |   |
|                                            |       |                                  |       |                                |       |   |   |   |   |
| Earnings per  common share:                     |       |                                  |       |                                |       |   |   |   |   |
| Basic                                           |       | $                                     | 0.17       |                                | $          | 0.15 |   | $ | 0.34 |   | $ | 0.32 |   |
| Diluted                                         |       | $                                     | 0.17       |                                | $          | 0.15 |   | $ | 0.33 |   | $ | 0.31 |   |
|                                            |       |                                  |       |                                |       |   |   |   |   |
| Weighted-average  number of common shares:      |       |                                  |       |                                |       |   |   |   |   |
| Basic                                           |       | 61,845                                |       | 37,796                              |       | 58,269 |   | 37,805 |   |
| Diluted                                         |       | 62,474                                |       | 57,251                              |       | 61,623 |   | 57,097 |   |

 

*Seeaccompanying notes.*

 

4

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**optionsXpressHoldings, Inc.**

 

**CondensedConsolidated Statements of Cash Flows**

 

**(Unaudited)**

 

(In thousands)

 
| ** **                                                                     | ** ** | **Six Months Ended**   | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                     | ** ** | **June 30, 2005** | ** ** | **June 30, 2004** | ** ** |
| **Operating  activities**                                                      |       |                   |       |   |   |
| Net income                                                                     |       | $                      | 20,460     |   | $ | 17,635 |   |
| Adjustments to  reconcile net income to cash provided by operating activities: |       |                   |       |   |   |
| Depreciation and  amortization                                                 |       | 1,087                  |       | 742 |   |
| Stock options  expensed                                                        |       | 1                      |       | — |   |
| Tax benefit                                                                    |       | —                 |       | 646 |   |
| Gain on  investment in optionsXpress Australia Pty Limited                     |       | (95                    | )          | — |   |
| Changes in  operating assets and liabilities:                                  |       |                   |       |   |   |
| (Increase)  decrease in:                                                       |       |                   |       |   |   |
| Receivable from  brokers                                                       |       | (1,079                 | )          | (2,242 | ) |
| Loan deposit                                                                   |       | —                 |       | (10,025 | ) |
| Security  deposits                                                             |       | —                 |       | (20 | ) |
| Other assets                                                                   |       | 834                    |       | (102 | ) |
| Increase  (decrease) in:                                                       |       |                   |       |   |   |
| Accounts payable  and accrued liabilities                                      |       | 36                     |       | 933 |   |
| Current income  taxes payable                                                  |       | (1,356                 | )          | 666 |   |
| Deferred income  taxes                                                         |       | (163                   | )          | 281 |   |
| Net cash  provided by operating activities                                     |       | 19,725                 |       | 8,514 |   |
|                                                                           |       |                   |       |   |   |
| **Investing  activities**                                                      |       |                   |       |   |   |
| Loan to  optionsXpress Australia Pty Limited                                   |       | (98                    | )          | — |   |
| Purchases of short-term  investments                                           |       | (124,828               | )          | — |   |
| Proceeds from  sale of short-term investments                                  |       | 114,195                |       | — |   |
| Purchases and  development of computer software                                |       | (689                   | )          | (860 | ) |
| Purchases of  fixed assets                                                     |       | (662                   | )          | (443 | ) |
| Net cash used in  investing activities                                         |       | (12,082                | )          | (1,303 | ) |
|                                                                           |       |                   |       |   |   |
| **Financing  activities**                                                      |       |                   |       |   |   |
| Exercise of  stock options                                                     |       | 471                    |       | 111 |   |
| Dividends paid                                                                 |       | (33,500                | )          | (7,014 | ) |
| Proceeds from  initial public offering                                         |       | 76,725                 |       | — |   |
| Redemption of  common stock                                                    |       | —                 |       | (88,708 | ) |
| Issuance of  convertible preferred stock                                       |       | —                 |       | 88,390 |   |
| Issuance of  common stock                                                      |       | —                 |       | 2,000 |   |
| Direct costs of  capital raised                                                |       | (1,885                 | )          | (2,492 | ) |
| Net cash  provided by (used in) financing activities                           |       | 41,811                 |       | (7,713 | ) |
|                                                                           |       |                   |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                          |       | 49,454                 |       | (502 | ) |
| Cash and cash  equivalents, beginning of period                                |       | 24,759                 |       | 2,777 |   |
| Cash and cash  equivalents, end of period                                      |       | $                      | 74,213     |   | $ | 2,275 |   |
|                                                                           |       |                   |       |   |   |
| Supplemental  disclosure of cash flow information:                             |       |                   |       |   |   |
| Income taxes  paid                                                             |       | $                      | 14,767     |   | $ | 10,136 |   |
| Interest paid                                                                  |       | 9                      |       | — |   |
| Supplemental  disclosure of non-cash activity:                                 |       |                   |       |   |   |
| Non–cash  exercise of options                                             |       | —                 |       | 38 |   |

* *

*Seeaccompanying notes.*

 

5

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**optionsXpressHoldings, Inc.**

 

**Notesto Condensed Consolidated Financial Statements**

 

**(Unaudited)**

 

(In thousands,except per share data)

 

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

 

**Basis ofPresentation**

 

Effective July 31,2004, the consolidated financial statements include the accounts ofoptionsXpress Holdings, Inc., optionsXpress, Inc., brokersXpress LLC andits other subsidiaries (collectively, the Company).  Prior to July 31, 2004, the consolidatedfinancial statements included the accounts of optionsXpress, Inc., bXHoldings LLC and brokersXpress LLC (collectively, the Company).  See the Corporate Reorganization paragraph belowfor additional information regarding the corporate reorganization.  All significant intercompany balances andtransactions have been eliminated in consolidation.

 

The Company followsUnited States generally accepted accounting principles, including certainaccounting guidance used by the brokerage industry.  Certain notes and other information normallyincluded in financial statements prepared in accordance with United Statesgenerally accepted accounting principles have been condensed or omitted.

 

**Natureof 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), the Chicago Board Options Exchange and the National Futures Association(NFA). brokersXpress LLC is a broker-dealer registered with the SEC and amember of the NASD and the NFA. The Company provides internet-based options,stock and futures brokerage services to retail customers located throughout theUnited States and the world. The Company clears all customer transactionsthrough two clearing brokers on a fully disclosed basis.

 

**CorporateReorganization**

 

Prior to July 31,2004, optionsXpress, Inc. wholly owned bX Holdings LLC and bX Holdings LLCwholly owned brokersXpress LLC. Effective July 31, 2004, optionsXpressHoldings, Inc. was formed as a Delaware Corporation and optionsXpress, Inc.entered into a corporate reorganization whereby optionsXpress Holdings, Inc.acquired 100 percent of optionsXpress, Inc., bX Holdings LLC andbrokersXpress LLC. The stockholders of optionsXpress, Inc. at July 31,2004 exchanged shares in optionsXpress, Inc. for shares in optionsXpressHoldings, Inc. on a one for one basis. Subsequent to the corporatereorganization, optionsXpress, Inc., bX Holdings LLC and brokersXpress LLCbecame wholly owned by optionsXpress Holdings, Inc.

 

**2.Summary of Significant Accounting Policies**

 

Except as described inthe following paragraph, there have been no changes in the significantaccounting policies from those included in the Company’s most recent AnnualReport filed on Form 10-K.

 

**Short-TermInvestments**

 

All of our short-term investmentsare 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 are reported at fair market value,and net unrealized gains or losses are recorded in accumulated othercomprehensive income or loss, a separate component of

 

6

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stockholders’ equity, netof taxes.  Any gains or losses on sales of short-term investments are computedbased upon specific identification.  Currently, short-term investmentsprimarily consist of auction rate securities.  The interest rates on thesesecurities are typically reset to market prevailing rates every 90 days orless, but may have longer stated maturities.

 

**3.Stock-Based Compensation**

 

Prior to the corporatereorganization effective July 31, 2004, optionsXpress, Inc.maintained the stock compensation plan. Subsequent to the corporatereorganization, the Company now maintains the stock compensation plan. All ofthe options outstanding at June 30, 2005 are options to buy common stockof the Company granted to employees of optionsXpress, Inc. andbrokersXpress, LLC.

 

In December 2002,the Financial Accounting Standards Board (FASB) issued Statement of FinancialAccounting 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 more prominentdisclosures in annual and interim financial statements about the method ofaccounting for stock-based compensation and the effect of the method used onreported results.

 

As permitted in SFAS No. 123and 148, the Company has elected to continue to follow Accounting PrinciplesBoard Opinion No. 25 (APB 25),*Accounting for Stock Issued to Employees*. Under APB 25, the Company,utilizing the intrinsic value-based method of accounting, recognizes nocompensation expense related to employee stock options as long as options aregranted with an exercise price equal to, or greater than, the fair market valueof the underlying common stock on the date of 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  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                                          | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                                                                |       |                                  |       |                                |       |   |   |   |   |
| Net income, as  reported                                                                                                            |       | $                                     | 10,656     |                                | $          | 8,457 |   | $ | 20,460 |   | $ | 17,635 |   |
| Deduct – Total  stock-based employee compensation expense determined under fair value-based  method for all awards, net of tax |       | 83                                    |       | 30                                  |       | 162 |   | 62 |   |
| Pro forma net  income                                                                                                               |       | 10,573                                |       | 8,427                               |       | 20,298 |   | 17,573 |   |
| Less income  allocable to preferred stock                                                                                           |       | —                                |       | 2,739                               |       | 871 |   | 5,640 |   |
| Pro forma net  income applicable to common stockholders                                                                             |       | $                                     | 10,573     |                                | $          | 5,688 |   | $ | 19,427 |   | $ | 11,933 |   |
|                                                                                                                                |       |                                  |       |                                |       |   |   |   |   |
| Income per  share:                                                                                                                  |       |                                  |       |                                |       |   |   |   |   |
| Basic, as  reported                                                                                                                 |       | $                                     | 0.17       |                                | $          | 0.15 |   | $ | 0.34 |   | $ | 0.32 |   |
| Basic, pro forma                                                                                                                    |       | $                                     | 0.17       |                                | $          | 0.15 |   | $ | 0.33 |   | $ | 0.32 |   |
| Diluted, as  reported                                                                                                               |       | $                                     | 0.17       |                                | $          | 0.15 |   | $ | 0.33 |   | $ | 0.31 |   |
| Diluted, pro  forma                                                                                                                 |       | $                                     | 0.17       |                                | $          | 0.15 |   | $ | 0.33 |   | $ | 0.31 |   |

 

The Company’scalculations were made using the Black-Scholes option-pricing model taking intoaccount the stock price and exercise price and the following assumptionsapplied to grants made in the following periods:

 
| ** **                                             | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                             | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                   |       |                                  |       |                                |       |   |   |   |   |
| Dividend yield                                         |       | 1                                     | %          | 3                                   | %          | 1 | % | 3 | % |
| Expected  volatility                                   |       | 41                                    | %          | 30                                  | %          | 41 | % | 30 | % |
| Risk-free  interest rate                               |       | 3.98                                  | %          | 3.81                                | %          | 3.98 | % | 3.81 | % |
| Expected life of  option following vesting (in months) |       | 60                                    |       | 60                                  |       | 60 |   | 60 |   |

 

7

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TheJune 30, 2005 expected volatility percentage represents the impliedvolatility of our stock as a publicly traded company.  The June 30, 3004 expected volatilitypercentage is based on the implied volatility of other publicly tradedcompanies in our industry during that period.

 

**4.Recent Accounting Pronouncements**

 

In December 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 fair valuemethod 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. 123Rare required to be adopted as of the beginning of the first interim or annualreporting period that begins after December 31, 2005, and the Company iscurrently evaluating the impact of the adoption on its consolidated financialstatements.

 

**5.Guarantees**

 

Under the terms of theclearing agreements with Goldman Sachs Equity & Clearing (GSEC) andLegent Clearing Corp., the Company introduces its customers’ accounts to GSECand Legent who, as the clearing brokers, clear and carry all customer accountactivity. As such, the Company is required to guarantee the performance of itscustomers in meeting their contractual obligations. The Company has agreed toindemnify the clearing brokers for losses that they may sustain for thecustomer accounts introduced by the Company. In accordance with applicablemargin lending practices and in conjunction with the clearing brokers, customerbalances are typically collateralized by customer securities or supported byother types of recourse provisions. Compliance with the various guidelines aremonitored daily and, pursuant to such guidelines, customers may be required todeposit additional collateral, or reduce positions, when necessary.

 

As of June 30, 2005and 2004, the Company had $97,514 and $60,285 in credit extended to itscustomers through its clearing brokers, respectively. The amount of risk towhich the Company is exposed from the leverage extended to its customers andspecifically from short sale transactions by its customers is not quantifiablesince the risk would be dependent upon analysis of a potential significant andundeterminable rise or fall in stock prices. The account level margin andleverage requirements meet or exceed those required by Regulation T of theBoard of Governors of the Federal Reserve. The Company believes that it isunlikely 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 condensedconsolidated financial statements.

 

**6.Capitalization**

 

**CommonStock**

 

At June 30, 2005,the Company had 187,500 shares of $0.0001 par value common stock authorized. Ofthe authorized common stock, 61,860 shares were issued and outstanding.

 

On January 26, 2005,the Company effected a 7.5 to 1 stock split. The condensed consolidatedfinancial statements reflect the retroactive effect of the stock split andappropriate restatement of the capital accounts.

 

On January 27, 2005,the Company completed an initial public offering of 5,000 newly issued sharesof common stock and 7,000 shares from existing stockholders, at an offeringprice of $16.50 per share, with net proceeds to the Company of $74.8 million.The underwriters’ also exercised their over-allotment option to purchase anadditional 1,800 shares from existing stockholders.

 

8

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**PreferredStock**

 

At June 30, 2005,the Company had 75,000 shares of $0.0001 par value convertible preferred stockauthorized. Of the authorized shares, 18,750 were designated as a new Series AConvertible Preferred. On January 26, 2005, all shares of this new Series Apreferred stock were converted into shares of common stock, prior to the stocksplit, on a one for one basis in connection with the initial publicoffering.  At June 30, 2005, theCompany had no shares of convertible preferred stock issued and outstanding.

 

**Dividends**

 

On January 25, 2005,the Company declared a dividend of $33,500, to be payable pro rata to theholders of record of common stock and Series A preferred stock of the Company,as of that date.

 

On January 26, 2005,the Company declared a common stock dividend of 606 shares. The condensedconsolidated financial statements reflect the retroactive effect of the stockdividend and appropriate restatement of the capital accounts.

 

On June 7, 2005, theCompany declared a common stock dividend of $0.04 per share to shareholders ofrecord on June 17, 2005, payable on July 7, 2005.

 

**7.Regulatory Requirements**

 

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

 

optionsXpress, Inc.and brokersXpress, LLC also are subject to the Commodity Futures TradingCommission (“CFTC”) Regulation 1.17 under the Commodity Exchange Act,administered by the CFTC and the National Futures Association, which alsorequires the maintenance of minimum net capital.  optionsXpress, Inc., as a futurescommission merchant, is required to maintain net capital equal to the greaterof its capital requirement under Rule 15c3-1; $250; 4% of customer segregatedfunds (with some adjustments); or the sum of 8% of the total risk marginrequirements for all positions carried in customer accounts and 4% of the totalrisk margin requirements for all positions carried in non-customer accounts.  brokersXpress, LLC, as an introducing broker,is required to maintain net capital equal to the greater of its capitalrequirement under Rule 15c3-1 or $30.

 

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

 
| ** **               | ** ** | **June 30, 2005**    | ** ** |
|--------------------------|------------|---------------------------|------------|
| ** **               | ** ** | **Required  Net Capital** | ** ** | **Net  Capital** | ** ** | **Excess  Net  Capital** | ** ** | **Ratio of Aggregate  Indebtedness  to Net Capital** | ** ** |
|                     |       |                      |       |   |   |   |   |   |   |
| optionsXpress, Inc. | ** ** | $                         | 467        |   | $ | 4,451 |   | $ | 3,984 |   | 1.65 to 1 |   |
| brokersXpress  LLC       |       | 50                        |       | 534 |   | 484 |   | 0.41 to 1 |   |
|                          |            |                           |            |  |  |  |  |  |  |  |  |  |

 
| ** **               | ** ** | **June 30, 2004**    | ** ** |
|--------------------------|------------|---------------------------|------------|
| ** **               | ** ** | **Required  Net Capital** | ** ** | **Net  Capital** | ** ** | **Excess  Net  Capital** | ** ** | **Ratio of Aggregate  Indebtedness  to Net Capital** | ** ** |
|                     |       |                      |       |   |   |   |   |   |   |
| optionsXpress, Inc. |       | $                         | 250        |   | $ | 2,500 |   | $ | 2,250 |   | 1.27 to 1 |   |
| brokersXpress  LLC       |       | 50                        |       | 358 |   | 308 |   | 0.27 to 1 |   |
|                          |            |                           |            |  |  |  |  |  |  |  |  |  |

 

9

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The net capital rules mayeffectively restrict the payment of cash distributions or other equitywithdrawals.

 

**8.Earnings Per Share**

 

The computations of basicand diluted EPS were as follows for the following periods ended:

 
| ** **                                                           | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                           | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                 |       |                                  |       |                                |       |   |   |   |   |
| Reported net  income                                                 |       | $                                     | 10,656     |                                | $          | 8,457 |   | $ | 20,460 |   | $ | 17,635 |   |
| Less income  allocable to preferred stock                            |       | —                                |       | 2,748                               |       | 878 |   | 5,660 |   |
| Adjusted net  income applicable to common stockholders               |       | $                                     | 10,656     |                                | $          | 5,709 |   | $ | 19,582 |   | $ | 11,975 |   |
|                                                                 |       |                                  |       |                                |       |   |   |   |   |
| Weighted-average  number of common shares outstanding – basic   |       | 61,845                                |       | 37,796                              |       | 58,269 |   | 37,805 |   |
| Effect of  dilutive securities                                       |       | 629                                   |       | 19,455                              |       | 3,354 |   | 19,292 |   |
| Weighted-average  number of common shares outstanding – diluted |       | 62,474                                |       | 57,251                              |       | 61,623 |   | 57,097 |   |
|                                                                 |       |                                  |       |                                |       |   |   |   |   |
| Basic EPS                                                            |       | $                                     | 0.17       |                                | $          | 0.15 |   | $ | 0.34 |   | $ | 0.32 |   |
| Diluted EPS                                                          |       | $                                     | 0.17       |                                | $          | 0.15 |   | $ | 0.33 |   | $ | 0.31 |   |

 

**Item 2.– Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

 

**Forward-LookingStatements**

 

**FORWARD-LOOKINGSTATEMENTS**

 

The following discussionof the financial condition and results of operations of the Company should beread in conjunction with the Selected Financial Data and the ConsolidatedFinancial Statements and Notes thereto included in the Company’s annual reporton Form 10-K for the fiscal year ended December 31, 2004, and theCondensed Consolidated Financial Statements and Notes thereto contained in thisquarterly report on Form 10-Q. This discussion contains forward-lookingstatements that relate to future events or our future financial performance andinvolve known and unknown risks, uncertainties and other factors that may causeour 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. Insome cases, you can identify 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 othercomparable terminology. These statements are only predictions. Actual events orresults may differ materially. 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.

 

Important factors thatmay cause such differences include, but are not limited to: risks related togeneral economic conditions, regulatory developments, the competitivelandscape, the volume of securities trading generally or by our customersspecifically, competition, systems failures and capacity constraints and theother risks and uncertainties set forth under the heading “Risk Factors” inItem 1 of the Company’s annual report on Form 10-K for the fiscalyear ended December 31, 2004.

 

In particular,forward-looking statements include, 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

 

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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; and

 

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

 

**Resultsof Operations**

 

The following table setsforth our total revenues and consolidated statements of income data for the periodspresented as a percentage of total revenues:

 
| ** **                                       | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                       | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                             |       |                                  |       |                                |       |   |   |   |   |
| **Results  of Operations**                       |       |                                  |       |                                |       |   |   |   |   |
| Total revenues  (in thousands)                   |       | $                                     | 28,581     |                                | $          | 23,986 |   | $ | 55,447 |   | $ | 47,789 |   |
| Brokerage,  clearing, and other related expenses |       | 11.3                                  | %          | 15.9                                | %          | 12.4 | % | 14.5 | % |
| Compensation and  benefits                       |       | 11.4                                  |       | 9.0                                 |       | 11.0 |   | 8.2 |   |
| Advertising                                      |       | 5.0                                   |       | 7.5                                 |       | 5.0 |   | 7.8 |   |
| Quotation  services                              |       | 3.3                                   |       | 3.8                                 |       | 3.6 |   | 3.6 |   |
| Depreciation and  amortization                   |       | 2.0                                   |       | 1.6                                 |       | 2.0 |   | 1.6 |   |
| Technology and  telecommunication                |       | 1.9                                   |       | 1.2                                 |       | 1.9 |   | 1.0 |   |
| Other                                            |       | 3.9                                   |       | 2.5                                 |       | 3.3 |   | 2.0 |   |
| Income before  income taxes                      |       | 61.2                                  |       | 58.5                                |       | 60.8 |   | 61.3 |   |
| Income taxes                                     |       | 23.9                                  |       | 23.3                                |       | 23.9 |   | 24.4 |   |
| Net income                                       |       | 37.3                                  |       | 35.2                                |       | 36.9 |   | 36.9 |   |
|                                                  |            |                                       |            |                                     |            |  |  |  |  |  |  |  |  |

 

**StatisticalData**

 

The following table setsforth our statistical data for the periods presented below:

 
| ** **                                            | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                            | ** ** | **2005**                              | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                  |       |                                  |       |                                |       |   |   |   |   |
| **Statistical  Data**                                 |       |                                  |       |                                |       |   |   |   |   |
| Number of  customer accounts (1)                      |       | 133,200                               |       | 80,100                              |       | 133,200 |   | 80,100 |   |
| Daily average  revenue trades (“DARTs”) (2) |       | 17,000                                |       | 14,200                              |       | 16,800 |   | 14,000 |   |
| Customer trades  per account (3)                      |       | 35                                    |       | 47                                  |       | 36 |   | 50 |   |
| Average  commission per trade                         |       | $                                     | 18.90      |                                | $          | 21.79 |   | $ | 19.13 |   | $ | 21.66 |   |
| Option trades as  a % of total trades                 |       | 76                                    | %          | 81                                  | %          | 76 | % | 79 | % |
| Advertising  expense per new customer account (4)     |       | $                                     | 86         |                                | $          | 181 |   | $ | 86 |   | $ | 167 |   |
| Total client  assets (000s)                           |       | $                                     | 2,551,852  |                                | $          | 1,468,184 |   | $ | 2,551,852 |   | $ | 1,468,184 |   |
| Client margin  balances (000s)                        |       | $                                     | 97,514     |                                | $          | 60,285 |   | $ | 97,514 |   | $ | 60,285 |   |

 

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(1)     Customeraccounts are open, numbered accounts.

(2)     DARTsare total revenue-generating trades for a period divided by the number oftrading days in that period.

(3)     Customer tradesper account are total trades divided by the average number of total customeraccounts during the period. Customer trades are annualized.

(4)     Calculatedbased on total new customer accounts opened during the period.

 

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**Quarter**EndedJune 30, 2005 versus June 30, 2004**

 

*Overview*

 

Our results for theperiod reflect the following principal factors:

 

•           totalcustomer accounts increased by 53,100 to 133,200, or 66.3% from June 30,2004 to June 30, 2005;

 

•           totaltrades increased by 207,500 to 1,088,700, or 23.5% for the quarter ended June 30,2005, from the comparable period in 2004; and

 

•           averagecommissions per trade decreased by $2.89 to $18.90, or 13.3% for the quarterended June 30, 2005, from the comparable period in 2004.

 

*Totalrevenues*

 

Total revenues increased$4.6 million, or 19.2% to $28.6 million for the quarter ended June 30,2005 compared to $24.0 million for the quarter ended June 30, 2004. Theincrease in total revenues consisted primarily of an increase in commissionsfor the quarter ended June 30, 2005 of $1.4 million, or 7.2% to $20.6million compared to $19.2 million for the quarter ended June 30, 2004. The increase in total revenues alsoincludes an increase in the payment for order flow of $1.3 million, or 30.3%,to $5.4 million for the quarter ended June 30, 2005 compared to $4.1 millionfor the quarter ended June 30, 2004,. The increase in total revenue also resultedfrom an increase in interest income of $1.9 million, or 291.2%, to $2.6 millionfor the quarter ended June 30, 2005 compared to $0.7 million for thequarter ended June 30, 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.The increase 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, andother related expenses decreased $0.6 million, or 15.3%, to $3.2 million forthe quarter ended June 30, 2005 from $3.8 million for the quarter ended June 30,2004.  Decreased brokerage expenses wereprimarily due to the reduction in per trade clearing expenses associated with anew clearing agreement that commenced in September 2004, partially offsetby a 23.5% increase in trades for the quarter.

 

*Compensationand benefits*

 

Compensation and benefitsexpenses increased $1.1 million, or 51.2%, to $3.3 million for the quarterended June 30, 2005 from $2.2 million for the quarter ended June 30,2004.  Increased compensation expenseswere primarily due to an increase in the number of employees from 106 to 138from June 30, 2004 to June 30, 2005 to service the growth in ouraccounts and to develop the infrastructure for the Company related to itsinitial public offering.

 

*Advertising*

 

Advertising expensesdecreased $0.4 million, or 21.2%, to $1.4 million for the quarter ended June 30,2005 from $1.8 million for the quarter ended June 30, 2004. The decreasein advertising expenses was primarily due to the cancellation of our trial useof television advertising.

 

*Quotationservices*

 

Quotation servicesexpenses of $0.9 million for the quarter ended June 30, 2005 wasconsistent with the quarter ended June 30, 2004,.  A slight increase in quotation expensesassociated with a 66.3% increase in customer accounts was significantly offsetby a reduction in per user fees from third-party vendors.

 

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*Depreciationand amortization*

 

Depreciation andamortization expenses increased $0.2 million, or 50.7%, to $0.6 million for thequarter ended June 30, 2005 from $0.4 million for the quarter ended June 30,2004. Increased depreciation and amortization expenses were primarily due toincreased capitalized costs relating to the continued development of ourbrokerage platform and technology infrastructure.

 

*Technologyand telecommunication*

 

Technology andtelecommunication expenses increased $0.2 million, or 91.8%, to $0.5 millionfor the quarter ended June 30, 2005 from $0.3 million for the quarterended June 30, 2004.  Increasedtechnology and telecommunication expenses were primarily due to addedtelecommunications and data costs required to support the increase in tradesand customer accounts.

 

*Other*

 

Other expenses increased$0.5 million, or 87.1%, to $1.1 million for the quarter ended June 30,2005 from $0.6 million for the quarter ended June 30, 2004.  Increased other expenses were primarily due toincreased general administrative expenses consistent with the growth of thebusiness, additional costs associated with being a publicly traded company, andfees incurred to register our newly formed international subsidiaries in theirrespective jurisdictions.

 

*Incometaxes*

 

Income taxes increased $1.2million, or 22.6%, to $6.8 million for the quarter ended June 30, 2005from $5.6 million for the quarter ended June 30, 2004. Increased incometaxes were primarily due to a 24.6% increase in income before income taxes forthe quarter ended June 30, 2005.

 

*Netincome*

 

As a result of theforegoing, we reported $10.7 million in net income for the quarter ended June 30,2005, as compared to $8.5 million in net income for the quarter ended June 30,2004, an increase of $2.2 million, or 26.0%.

 

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

 

*Overview*

 

Our results for theperiod reflect the following principal factors:

 

•              totalcustomer accounts increased by 53,100 to 133,200, or 66.3% from June 30,2004 to June 30, 2005;

 

•              totaltrades increased by 362,700 to 2,094,900, or 20.9% for the six months ended June 30,2005 from the comparable period in 2004; and

 

•              averagecommissions per trade decreased by $2.53 to $19.13, or 11.7% for the six monthsended June 30, 2005 from the comparable period in 2004.

 

*Totalrevenues*

 

Total revenues increased$7.6 million, or 16.0% to $55.4 million for the six months ended June 30,2005 compared to $47.8 million for the six months ended June 30, 2004. Theincrease in total revenues consisted primarily of an increase in commissions of$2.6 million, or 6.8% to $40.1 million for the six months ended June 30,2004, compared to $37.5 million for the six months ended June 30,2004.  The increase in total revenuesalso includes an increase in the payment for order flow of $1.4 million, or16.3%, to $10.5 million for the six months ended June 30, 2005 compared to$9.1 million for the six months ended June 30, 2004. The increase in totalrevenue also resulted from an increase in interest income of $3.5 million, or291.6%, to $4.7 million for the six months ended June 30, 2005

 

13

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compared to $1.2 millionfor the six months ended June 30, 2004. The increases in commission andpayment for order flow were primarily the result of the rise in the number oftrades processed, partially offset by a decrease in the average commission pertrade. The increase in interest income was a result of an increase in customercash balances 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, andother related expenses remained consistent at $6.9 million in the six monthsended June 30, 2005 from the six months ended June 30, 2004.  The decreased brokerage expenses wereprimarily due to the reduction in per trade clearing expenses associated with anew clearing agreement that commenced in September 2004, partially offsetby a 20.9% increase in trades for the period.

 

*Compensationand benefits*

 

Compensation and benefitsexpenses increased $2.2 million, or 55.2%, to $6.1 million for the six monthsended June 30, 2005 from $3.9 million for the six months ended June 30,2004.  Increased compensation expenseswere primarily due to an increase in the number of employees from 106 to 138from June 30, 2004 to June 30, 2005 to service the growth in ouraccounts and to develop the infrastructure for the Company related to itsinitial public offering.

 

*Advertising*

 

Advertising expensesdecreased $0.9 million, or 26.0%, to $2.8 million for the six months ended June 30,2005 from $3.7 million for the six months ended June 30, 2004. Thedecrease in advertising expenses was primarily due to the cancellation of ourtrial use of television advertising.

 

*Quotationservices*

 

Quotation servicesexpenses increased to $0.3 or 17.7% to $2.0 million for the six months ended June 30,2005 from $1.7 million for the six months ended June 30, 2004.  Increased quotation services expenses wereprimarily due to a 66.3% increase in customer accounts, which was significantlyoffset by a reduction in per user fees from third-party vendors.

 

*Depreciationand amortization*

 

Depreciation andamortization expenses increased $0.4 million, or 46.5%, to $1.1 million for thesix months ended June 30, 2005 from $0.7 million for the six months ended June 30,2004. Increased depreciation and amortization expenses were primarily due toincreased capitalized costs relating to the continued development of ourbrokerage platform and technology infrastructure.

 

*Technologyand telecommunication*

 

Technology andtelecommunication expenses increased $0.5 million, or 106.6%, to $1.0 millionfor the six months ended June 30, 2005 from $0.5 million for the sixmonths ended June 30, 2004. Increased technology and telecommunication expenses were primarily dueto added telecommunications and data costs required to support the increase intrades and customer accounts.

 

*Other*

 

Other expenses increased$0.8 million, or 88.2%, to $1.8 million for the six months ended June 30,2005 from $1.0 million for the six months ended June 30, 2004.  Increased other expenses were primarily dueto increased general administrative expenses consistent with the growth of thebusiness, additional fees associated with being a publicly traded company, andfees incurred to register our newly formed international subsidiaries in theirrespective jurisdictions.

 

14

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*Incometaxes*

 

Income taxes increased$1.7 million, or 14.1%, to $13.3 million for the six months ended June 30,2005 from $11.6 million for the six months ended June 30, 2004. Increasedincome taxes were primarily due to a 15.3% increase in income before incometaxes for the six months ended June 30, 2005.

 

*Netincome*

 

As a result of theforegoing, we reported $20.5 million in net income for the six months ended June 30,2005, as compared to $17.6 million in net income for the six months ended June 30,2004, an increase of $2.9 million, or 16.0%.

 

**Liquidityand Capital Resources**

 

We plan to finance ourfuture operating liquidity and regulatory capital needs from our earnings.Although we have no current plans to do so, we may issue equity or debtsecurities or enter into secured lines of credit from time to time. As aholding company, we access the earnings of our operating subsidiaries throughreceipt of dividends from these subsidiaries. Some of our subsidiaries are subjectto requirements of the SEC, NASD and CFTC relating to liquidity and capitalstandards, which limit funds available for the payment of dividends to theholding company.

 

Our broker-dealersubsidiary, optionsXpress, Inc., is subject to the Securities and ExchangeCommission Uniform Net Capital Rule (Rule 15c3-1). Under applicableprovisions of this Rule, optionsXpress, Inc. is required to maintain netcapital of 6 2/3% of “aggregate indebtedness” or$0.25 million, whichever is greater, as these terms are defined. optionsXpress, Inc.is also subject to the Commodity Futures Trading Commission (“CFTC”) Regulation1.17 under the Commodity Exchange Act, administered by the CFTC and theNational Futures Association, which also requires the maintenance of minimumnet capital.  optionsXpress, Inc.,as a futures commission merchant, is required to maintain net capital equal tothe greater of its capital requirement under Rule 15c3-1; $.25 million; 4%of customer segregated funds (with some adjustments); or the sum of 8% of thetotal risk margin requirements for all positions carried in customer accountsand 4% of the total risk margin requirements for all positions carried innon-customer accounts.  Net capital andaggregate indebtedness change from day to day, but on June 30, 2005, optionsXpress, Inc.had net capital of approximately $4,451 million and net capital requirements of$467 million. The ratio of aggregate indebtedness to net capital at June 30,2005 was 1.65 to 1.

 

Our other broker-dealersubsidiary, brokersXpress LLC, is also subject to Rule 15c3-1 andRegulation 1.17.   brokersXpress, LLC, asan introducing broker under Regulation 1.17, is required to maintain netcapital equal to the greater of its capital requirement under Rule 15c3-1or $30,000.  At June 30, 2005, brokersXpresshad net capital of approximately $534 million and applicable net capitalrequirements of $0.05 million. The ratio of aggregate indebtedness to net capitalat June 30, 2005 was 0.41 to 1.

 

***Cash Flow***

 

Cash provided byoperating activities was $19.7 million for the six months ended June 30,2005, compared to cash provided by operating activities of $8.5 millionfor the six months ended June 30, 2004. The primary reason for theincrease in cash provided by operating activities is due to the loan depositmade to the Company’s clearing broker in the first quarter of 2004. This loandeposit was returned to the Company in the fourth quarter of 2004.

 

Cash used in investingactivities was $12.1 million for the six months ended June 30, 2005,compared to cash used in investing activities of $1.3 million for the sixmonths ended June 30, 2004. The primary reason for the increase in cashused in investing activities was the transfer of a portion of the initialpublic offering proceeds into short-term investments.

 

Cash provided byfinancing activities was $41.8 million for the six months ended June 30,2005, compared to cash used in financing activities of $7.7 million forthe six months ended June 30, 2004. The primary reason for the increase incash provided by financing activities is due to the net proceeds the Companyreceived from its initial public offering.

 

15

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***Capital Expenditures***

 

Capital expenditures were$0.7 million for the quarter ended June 30, 2005, compared to $0.7 millionfor the quarter ended June 30, 2004, and $1.3 million for the six monthperiod ended June 30, 2005, compared to $1.3 million for the six monthperiod ended June 30, 2004.  Capitalexpenditures for the periods ended June 30, 2005 and 2004 includedcapitalized software costs, which we capitalize in accordance with Statement ofPosition (“SOP”) 98-1 “Accounting for the Costs of Computer Software Developedor Obtained for Internal Use,” primarily related to the development of ourtechnology.

 

**Item 3.- Quantitative and Qualitative Disclosures about Market 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 arrangementwith both of our clearing firms, we extend margin credit and leverage to ourcustomers, which is subject to various regulatory and clearing firm marginrequirements. Margin credit is collateralized by cash and securities in thecustomers’ accounts. Leverage involves securing a large potential futureobligation with a proportional amount of cash or securities. The risksassociated with margin credit and leverage increase during periods of fastmarket movements or in cases where leverage or collateral is concentrated andmarket movements occur. During such times, customers who utilize margin creditor leverage and who have collateralized their obligations with securities mayfind that the securities have a rapidly depreciating value and may not besufficient to cover their obligations in the event of liquidation. We are alsoexposed to credit risk when our customers execute transactions, such as shortsales of options and equities that can expose them to risk beyond theirinvested 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 June 30, 2005, we had $97,514 inmargin credit extended to our customers through our clearing firms. The amountof risk to which we are exposed from the leverage we extend to our customersand from short sale transactions by our customers is unlimited and notquantifiable as the risk is dependent upon analysis of a potential significantand undeterminable rise or fall in stock prices. Our account level margincredit and leverage requirements meet or exceed those required by Regulation Tof 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**

 

**Evaluationof Disclosure Controls and Procedures**

 

We maintain disclosurecontrols and procedures that are designed to ensure that information requiredto be disclosed in the reports that we file or submit under the SecuritiesExchange Act is recorded, processed, summarized, and reported within the timeperiods specified in the SEC’s rules and forms and that such informationis accumulated and communicated to our management, including our ChiefExecutive Officer and Chief Financial Officer, as appropriate, to allow timelydecisions regarding required disclosure. Our Chief Executive Officer and ChiefFinancial Officer carried out an evaluation of the effectiveness of the designand operation of our disclosure controls and procedures as of the end of theperiod covered by this report. Based on the evaluation of these disclosurecontrols and procedures, the Chief Executive Officer and Chief FinancialOfficer concluded that our disclosure controls and procedures were effective.It should be noted that any system of controls, however well designed andoperated, can provide only reasonable, and not absolute, assurance that theobjectives of the system are met. In addition, the design of any control systemis based in part upon certain assumptions about the likelihood of future

 

16

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events. Because of theseand other inherent limitations of control systems, there can be no assurancethat any design will succeed in achieving its stated goals under all potentialfuture conditions, regardless of how remote.

 

**Changesin Internal Control Over Financial Reporting**

 

There were no changes inour internal control over financial reporting during the six months ended June 30,2005 that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

**Part II - OTHER INFORMATION**

 

**Item 1. – Legal Proceedings**

 

Many aspects of ourbusiness involve substantial risk of liability. In recent years, there has beenan increasing incidence of litigation involving the securities brokerageindustry, including class action suits that generally seek substantial damages,and in some cases, punitive damages. Like other securities brokerage firms, wehave been threatened with, or named as a defendant in, lawsuits, arbitrationsand administrative 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.  In addition, the Company is corresponding withits regulators about matters raised during regulatory examinations or subsequentto regulatory inquiry. These matters could result in censures, fines or othersanctions. Management believes the outcome of any resulting actions will not bematerial to the Company’s financial condition, results of operations or cashflows. However, the Company is unable to predict the outcome of these matters.

 

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 6. - Exhibits**

 

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

 

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

 

32.1         Certificationpursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906of the Sarbanes-Oxley Act of 2002

 

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**Signatures**

 

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

 
| Dated: August 9,  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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