UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K

ý	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

for the fiscal year ended December 31, 2004

OR

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
(NO FEE REQUIRED)

For the transition period from to

COMMISSION FILE NUMBER: 001-32419

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 No.)

39 S. LaSalle, Suite 220
Chicago, Illinois 60603		(312) 630-3332
(Address of Principal Executive Offices, including Zip Code)		(Registrant’s Telephone Number, Including Area Code)

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

Securities Registered Pursuant to Section 12(g) of the Act:
None

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that it was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes o No ý

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

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

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

DOCUMENTS INCORPORATED BY REFERENCE

None

PART I

ITEM 1. BUSINESS

Overview

optionsXpress offers a comprehensive suite of brokerage services for stock, mutual fund, option and fixed-income product investors. We have been recognized as offering the leading online retail brokerage platform for the rapidly expanding listed equity options market, based on the quality of our proprietary technology and our customer experience. We were selected by Forbes as “Best of the Web, Favorite Options Site” in 2004, by Barron’s as “Best Online Broker” in 2003 and 2004, and by SmartMoney as “Best Discount Broker” in 2004. We commenced doing business as optionsXpress, Inc. in February 2000 and opened our first customer account in December 2000. Since that time, we have grown to over 100,000 customer accounts. We formed a holding company, optionsXpress Holdings, Inc., in June 2004 to provide us with the flexibility to, among other things, engage in future acquisitions of complementary businesses, products and technologies.

Our brokerage platform reflects the combination of our advanced technology and highly-responsive customer service. Our innovative browser-based technology delivers an array of differentiating trading tools, allowing both retail and professional investors to identify, analyze and execute a wide range of investment strategies. Many of these internally developed tools, which enhance our customers’ experience, are not available from other online or full service brokers. In addition, our real-time customer service approach, featuring what we call “point of contact resolution” designed to ensure that customer questions are answered quickly and during the initial contact, yields a high degree of customer satisfaction and loyalty.

We opened our first customer account in December 2000. Since that time, we have grown to over 100,000 customer accounts. Our option trades represented approximately 3% of all listed U.S. options volume for the year ended December 31, 2004. We believe this makes us one of the largest retail online options brokers. Our revenue consists primarily of commissions from customers’ trades of options, stocks, mutual funds and fixed-income products. For the year ended December 31, 2004, our daily average revenue trades, which are our total revenue-generating trades for a period divided by the number of trading days in that period, were approximately 13,600, compared to approximately 7,600 for the year ended December 31, 2003. Option trades represent approximately 79% of our customers’ trades, with approximately 20% coming from stocks and 1% from mutual funds and fixed-income products.

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

Market Opportunity

Approximately 15 million households have online brokerage accounts (13% of all U.S. households), although nearly 70% of such households execute fewer than five trades per year. The number of households with online brokerage accounts is forecasted to increase by 11.9% per year to approximately 26 million by 2008 (22% of all U.S. households). The total U.S. listed options market has grown by 22.5% per year over the past 10 years. Despite this growth, it is estimated that only 9% of online accounts are authorized to trade options.

Growth Strategy

Growing Share of Growing Market — Retail Online Options

We have generated rapid growth since inception by appealing to the growing retail options market. We aim to continue to expand our customer base by both gaining market share in this market and by accelerating the growth of retail options trading generally. Our strategy for gaining market share includes making effective use of our customer-driven online brokerage platform and implementing our targeted marketing strategy. To accelerate the growth of options trading, we will continue to cultivate new retail options investors by making options trading more intuitive and accessible and through our educational initiatives.

Increased Penetration in Larger Markets — Retail Online Stocks, Mutual Funds and Fixed-Income Products

We plan to continue penetrating the much larger stock, mutual fund and fixed-income markets. The key components of our platform that have made us successful in the options markets are also applicable to these other markets. Furthermore, since customers who trade options often trade the underlying securities, we have ample opportunity to cross-sell stocks, mutual funds and fixed-income products. In addition, there are significant opportunities for us to expand into the futures, foreign exchange and other derivative markets where our technology can be easily adapted.

brokersXpress — Expansion into Professional Advisor and Institutional Markets

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

International Expansion

We intend to continue expanding our international customer base through cost-effective targeting of online customers in economically and legally compatible foreign jurisdictions where there is an interest in accessing U.S. markets. We also plan to continue partnering with foreign-registered brokers who want to offer their customers access to U.S. markets.

Our Brokerage Platform

We have developed an award-winning, comprehensive and technologically advanced, yet easy-to-use brokerage platform. Our software is empowering, efficient and user-friendly:

• We empower our customers by making accessible cutting-edge position management and order execution technology, advanced analytical tools, education and real-time financial information from any web browser.

• Our software was designed to ensure an efficient customer experience, beginning with a highly automated account opening process and ending with fast trade execution and thorough, real-time position monitoring.

• Our user-friendly interface provides interactive real-time views of account balances, positions, profits or losses and buying power to enable our customers to more easily make informed investment decisions. Customers are able to access all features from any web browser without downloading software.

The end result is a highly customizable platform best represented by our “Three E’s” customer-centric approach:

Our brokerage platform caters to both novice and expert investors. Novice investors are provided with, among other things, both educational and research material and comprehensive customer support all via a customer-friendly interface. Trading features more relevant to expert traders include data streaming, charting services and advanced order services.

Our efficient, in-house development capabilities allow us to continuously innovate and improve our platform with frequent enhancements such as:

• Strategy Scan®. Strategy Scan enables an investor to transform a trading idea into an executable trade. It accomplishes this by identifying up to three trading opportunities for our customers based upon their bullish, bearish or neutral opinion of a specific stock over a specified time frame. We clearly identify the range of potential gain or loss for each trading opportunity.

• Xspreads®. Our Xspreads technology simplifies and expedites the execution of our customers’ combination trades. The Xspreads Order Book^SM electronically displays customers’ orders, thereby creating greater transparency in the market, resulting in increased liquidity for both our customers and the broader marketplace. In addition, Xspreads enables our customers to execute all portions of a combination trade simultaneously, thereby eliminating the risk that all portions will not be executed at the desired price.

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

• Advanced Order Management (patent applied). Our software allows our retail customers to automate professional trading strategies involving order sequencing without manual intervention. Our customers are able to enter contingent orders which are executed in accordance with specified time, price or other triggers. A significant advantage of this feature is that our customers do not have to constantly monitor the market in order to execute their orders.

• Virtual Trading. Virtual trading provides our customers with a mock trading environment where they can practice strategies and educate themselves without risk, utilizing current market information. This provides our customers with a practical method of gaining real market experience without putting money at risk. Our customers can mock trade almost any strategy involving stocks, options and mutual funds, including spreads, straddles, and covered calls. We believe virtual trading provides our customers with a better environment to learn versus simply studying trading strategies.

Portfolio Tracking

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

Integration with Third-Party Investment Software

The design of our technology allows customers to integrate our execution with third-party investment or analytical software, including e-Signal, Quotracker, Prophet, PowerOptions and Wizetrade. This is a key design feature of our platform and differentiates us from other online trading systems that rely on legacy technologies. Giving the customer access to other technologies allows us to service customers who use complementary analytical software. The design of our technology allows us to easily and cost-effectively private label our website for other financial institutions.

Customer Service

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

Our customer-friendly website contains a self-help library of user guides and customer message boards. For customers requiring more personalized attention, customer service is available via live individual web chat, e-mail and telephone. We have over 60 dedicated customer service employees located in Chicago, Illinois and El Paso, Texas. New customer service employees attend a three-week training program, and we also provide ongoing training for all customer service employees.

We are responsive to our customers, aiming for a real-time response to all customer inquiries. We respond to over 50% of customer inquiries via the Internet, facilitating individualized service in a timely and cost-effective manner. Customer e-mail inquiries are routed by managers to the appropriate business area for timely and accurate response. Communications with customers are continually reviewed and critiqued for quality assurance. The result is what we call “point-of-contact resolution,” which we define as providing each customer with an answer without having to speak to multiple people, repeat the question or call back.

We also continually update our technology to maximize the customer’s experience. Customer questions are tracked and, if repeated, analyzed to determine how best to clarify the point or answer the inquiry during the customer’s online experience. This analysis is used to improve and enhance our website.

Marketing

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

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

Our advertising strategy focuses on our unique online trading tools and industry awards we have received. Advertising directs interested prospects to our website for additional information, as opposed to generating primarily telephone-based inquiries. At our website, prospective customers can get detailed information on our services and fees, use an interactive demonstration system, request additional information and complete an account application online. Our advertising is primarily conducted through third-party websites, though we also place print advertisements in a broad range of business, technology and financial publications, including The Wall Street Journal, Barrons, Investors’ Business Daily and Forbes. We also advertise on a limited basis on television and on national business radio networks. We believe this component of our advertising strategy has significantly contributed to brand re-enforcement and increased our name recognition in the marketplace.

As the final step in our marketing process, we improve the conversion rate of prospective customers into funded accounts by mailing registration kits to investors who have registered online. In addition, customers can print a pre-paid Federal Express label at the end of their registration process for easy submission of their applications.

brokersXpress

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

support. brokersXpress’ core customers are brokers and investment advisors; other customers include professional investors such as hedge funds and investment clubs.

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

Broker-Dealer Operations

Order Processing

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

We aim to provide customers with the best execution of each trade, which we define as the fastest fill at the best price. We believe we differentiate ourselves from our major competitors by incorporating our dynamic technology into our order management and execution review process. For example, we have designed monitors that warn us of any instances where an order can be filled on another exchange or the best price was not achieved on a particular trade. These real-time alerts allow us to proactively re-present orders, seek adjustments on orders that were not completed at the best available price, and recognize exchange issues that might warrant a routing change.

Clearing and Custody

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

In September 2004, we entered into a clearing agreement with GSEC, a wholly owned subsidiary of The Goldman Sachs Group, Inc., pursuant to which GSEC will act as our primary clearing agent. GSEC is regulated by the New York Stock Exchange, the Options Clearing Corporation, the NASD, the Commodity Futures Trading Commission, or CFTC, and other self-regulatory organizations. We believe that GSEC’s financial position and operational capabilities are very strong. We also clear through Legent Clearing, LLC, or Legent. As a clearing broker, GSEC and Legent are subject to SEC and other regulatory requirements, including those imposed by clearing organizations of which it is a member. The financial requirements imposed by such clearing organizations can exceed the financial and other requirements imposed by the SEC.

Payment for Order Flow

Payment for order flow occurs when options specialists, market makers, exchanges and other market centers make payments to broker-dealers in return for receiving customer orders. Like other retail brokerage firms, we receive payment for order flow from exchanges and liquidity providers where our customers’ orders are routed. Our automatic order routing software ensures that payment for order flow does not affect the routing of orders in a manner

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

Margin and Leverage

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

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

Under the terms of our clearing agreement, we are responsible if a customer defaults on any obligation owed to our clearing broker. As such, we have input into the margin credit and leverage process, we make decisions regarding margin credit and leverage levels, and we are largely responsible for the notification to customers of margin calls. We also take responsibility for supervising the risks associated with leverage and we monitor our customers’ margin positions to identify customer accounts that may need additional collateral or liquidation. In general, our minimum margin credit requirements are more stringent than the SEC’s and SROs’ requirements.

Supervision and Compliance

The role of our compliance department is to provide education, supervision, surveillance, mediation and communication review. Many of our employees are NASD-registered principals with supervisory responsibility over options trading or other aspects of our business. In addition, over half of our employees have successfully completed NASD licensing exams required for registered representatives. Each of these employees is trained and responsible for complying with securities regulations.

Our anti-money laundering screening is conducted using a mix of automated and manual review and has been structured to comply with recent regulations. We collect required information through our new account process and then screen accounts with two third-party databases for the purposes of identity verification and for review of negative information and appearance on the Office of Foreign Assets and Control, Specially Designated Nationals and Blocked Persons lists. Additionally, we have developed proprietary methods for risk control and continue to add upon specialized processes, queries and automated reports designed to identify money laundering, fraud and other suspicious activities.

Technology Systems and Architecture

We place an emphasis on stability, scalability and survivability in all of our technical architecture. We maintain three production data centers. Each of these centers is capable of serving our website independently in the event of service interruptions to the other two data centers. Each center is also linked to the others via redundant communication to minimize the likelihood of a data center being unable to serve customers. We replicate and synchronize our primary databases, ensuring a current copy of all customer data at each center. Our technology includes encryption and protective features to ensure investor confidence and protect our customers’ assets and information. In addition, our servers are load balanced which prevents the failure of a single server or components from having a significant impact on our customers and allows for the easy addition of servers, resulting in the ability to quickly and cost-efficiently scale our platform. Our daily average revenue trades for the twelve months ended December 31, 2004 was approximately 13,600, and our largest number of trades in a single day was approximately 29,000, while the current capacity of our software and hardware is approximately 50,000 trades per day. We believe we can double the capacity of our software and hardware to 100,000 trades per day at an approximate one-time cost of $120,000.

Intellectual Property

We rely on a combination of patent, trademark, copyright and trade secret laws in the United States and other jurisdictions as well as confidentiality procedures and contractual provisions to protect our proprietary technology and our brand. We also enter into confidentiality and invention assignment agreements with our employees and consultants and confidentiality agreements with other third parties, and we rigorously control access to proprietary technology.

The following intellectual property is pending or registered as indicated with the U.S. Patent Trade Office (USPTO):

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

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

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

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

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

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

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

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

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

Competition and Pricing

The market for brokerage services, particularly electronic brokerage services, is rapidly evolving and highly competitive. Our direct competitors in the online marketplace take the form of larger-scale broker-dealers that offer online services, including Charles Schwab & Co., Inc., E*TRADE Group, Inc., TD Waterhouse Group, Inc., Ameritrade, Inc., TradeStation Group, Inc. and smaller “niche-market” online or licensed software-based brokers, including Tradestation and Interactivebrokers. We also encounter competition from full commission brokerage firms including Merrill Lynch, Smith Barney (a division of Citigroup), as well as financial institutions, mutual fund sponsors, including Fidelity, and other organizations, some of which provide online brokerage services.

We attribute our competitive success to the customer experience we deliver, which results from our advanced technology and superior customer service. Unlike a number of our direct competitors, we developed our platform to operate free from reliance on mainframe systems common in the brokerage industry. Our hardware and software have proven reliable and versatile and we believe they can be expanded more economically than our major competitors’ systems. Although competition may increase if the larger-scale online brokers become more aggressive in marketing options, we believe we will maintain a competitive advantage due to the strength and flexibility of our platform.

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

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

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

Employees

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

REGULATION

Overview

Our business and industry are highly regulated. As a matter of public policy, regulatory bodies in the United States are charged with safeguarding the integrity of the securities and other financial markets and with protecting the interest of customers participating in those markets, not with protecting the interests of creditors or stockholders of securities firms such as our broker-dealer subsidiaries. optionsXpress, Inc. is registered as a broker-dealer with the SEC and is a member of the NASD and the CBOE, which serves as its designated examining authority. brokersXpress is also a registered broker-dealer with the SEC and is a member of the NASD, which serves as its designated examining authority. optionsXpress and brokersXpress are also registered in each of the fifty states, the District of Columbia and Puerto Rico. These jurisdictions also regulate our conduct in their respective jurisdictions.

Broker-dealers are subject to laws, rules and regulations that cover all aspects of the securities business, including:

• sales methods,

• trade practices,

• use and safekeeping of customers’ funds and securities,

• capital structure,

• record-keeping,

• financing of customers’ purchases and

• conduct of directors, officers and employees.

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

Net Capital Rule

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

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

Foreign Jurisdictions and Regulation

We and our subsidiaries are not registered with any financial regulatory authorities outside of the United States. While optionsXpress and brokersXpress effect transactions solely in the United States, our customers access our services through the Internet. In any foreign jurisdiction in which we have customers, there is a possibility that a regulatory authority could assert jurisdiction over our activities and seek to subject us to the laws, rules and regulations of that jurisdiction.

In February 2004, we received an inquiry from the British Columbia Securities Commission regarding whether we were or should be registered as a dealer in Canada. In response to the inquiry, we formed a new subsidiary, optionsXpress Canada, Corp., to register as a dealer in Canada. We have filed for the registration of optionsXpress Canada with the Canadian provincial securities commissions. Once this registration has been completed, optionsXpress Canada will be a member of, and regulated by, the Investment Dealers Association of Canada, a self-regulatory organization, as well as the securities regulators of the various provinces. We intend to transfer accounts of Canadian customers to optionsXpress Canada as soon as optionsXpress Canada is licensed to do business in Canada. We are seeking an exemptive order from the British Columbia Securities Commission and other Canadian securities authorities to permit it to continue to conduct business in Canada. The exemptive order is pending.

In July 2004, the Ontario Securities Commission, or OSC, advised us that it was considering enforcement action against us for conducting business with customers located in Ontario without being registered. Pending resolution of this matter, we have committed to the OSC not to accept additional Canadian customers absent exemptive relief. For more information, see “Business — Legal and Administrative Proceedings.”

We currently service accounts for customers located in Singapore. We have contacted the securities regulators in Singapore to verify our exemption from the registration requirements in that country. In connection with that inquiry, we have committed to the Singapore regulators that we will not take on additional customers pending their response.

Accounts for customers located in Canada and Singapore combined represent less than 5% of our total customer accounts as of December 31, 2004.

The laws, rules and regulations of each foreign jurisdiction differ. In the four jurisdictions other than Canada and Singapore where we have the most foreign customers, we believe we are exempt from registration due to our limited conduct and/or our lack of solicitation in those jurisdictions. In any jurisdiction where we are relying on an exemption from registration, there remains the risk that we could be required to register, and therefore be subject to regulation and enforcement action or, in the alternative, to reduce or terminate our activities in these jurisdictions.

Patriot Act

Registered broker-dealers traditionally have been subject to a variety of rules that require that they know their customers and monitor their customers’ transactions for suspicious financial activities. With the passage of the Uniting

and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, or the Patriot Act, broker-dealers are now subject to even more stringent requirements. As required by the Patriot Act, we have established comprehensive anti-money laundering and customer identification procedures, designated an anti-money laundering compliance officer, trained our employees and conducted an independent audit of our program. There are significant criminal and civil penalties that can be imposed for violations of the Patriot Act. For more information, see “Business — Broker-Dealer Operations — Supervision and Compliance.”

RISK FACTORS

We have a limited operating history upon which to evaluate our performance.

We commenced doing business in February 2000. Accordingly, we have only a limited operating history upon which you can evaluate our prospects and future performance. Our prospects may be materially adversely affected by the risks, expenses and difficulties frequently encountered in the operation of a new business in a rapidly evolving industry characterized by intense competition.

We may be unable to effectively manage our rapid growth and retain our customers.

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

In addition, due to our rapid growth, we will need to attract, hire and retain highly skilled and motivated officers and employees. We cannot assure you that we will be able to attract or retain the officers and employees necessary to manage this growth effectively.

We operate in a highly regulated industry and compliance failures could adversely affect our business.

We operate under extensive regulation, which increases our cost of doing business and is a limiting factor on the operations and development of our business. The Securities and Exchange Commission, or SEC, the NASD, the Chicago Board Options Exchange, Inc., or CBOE, and other self-regulatory organizations, commonly called SROs, and state securities commissions regulate us. Outside the United States, we also may be subject to regulation by securities regulatory authorities in the countries where our customers are located. The securities industry in the United States is subject to extensive regulation covering all aspects of the securities business, including:

• sales methods;

• trade practices;

• use and safekeeping of customer funds and securities;

• capital structure;

• record-keeping;

• financing of customers’ purchases; and

• conduct of directors, officers and employees.

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

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

Changes in legislation or regulations may affect our ability to conduct our business or reduce our profitability.

The regulatory environment in which we operate may change. These changes may affect our ability to conduct our business or reduce our profitability. Our activities may be affected not only by legislation or regulations of general applicability, but also by industry-specific legislation or regulations. The SEC, other U.S. or foreign governmental authorities, the NASD or other SROs may adopt new or revised regulations which affect our business. Changes in the interpretation or enforcement of existing laws and rules by those entities may also affect our business. For example, in early 2004, the SEC issued “Concept Release: Competitive Developments in the Options Markets,” which addressed recent developments in the options marketplace. The SEC’s goal in issuing this concept release is to improve the functioning of the options marketplace for the benefit of the investing public. The SEC has not yet issued any formal statements or proposed changes in response to the comments it has received.

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

In addition, we use the Internet as the distribution channel to provide services to our customers. A number of regulatory agencies have recently adopted regulations regarding customer privacy and the use of customer information by service providers. Additional laws and regulations relating to the Internet may be adopted in the future, including regulations regarding the pricing, taxation, content and quality of products and services delivered over the Internet. Complying with these laws and regulations is expensive and time consuming and could limit our ability to use the Internet as a distribution channel.

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

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

In addition, in the future we may choose to offer foreign securities brokerage services. There are certain risks inherent in doing so. Among other risks, we may face less developed technological infrastructures, less developed automation in exchanges, depositories and national clearing systems, exchange rate fluctuations, increased credit risk and unexpected changes in regulatory requirements, tariffs and othe

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