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EX-4.7 - AMENDMENT TO AMENDED AND RESTATED INVESTOR RIGHTS AGREEMENT - ELLIE MAE INCdex47.htm
EX-3.1 - AMENDED AND RESTATED CERTIFICATE OF INCORPORATION - ELLIE MAE INCdex31.htm
EX-4.1 - FORM OF ELLIE MAE, INC.'S COMMON STOCK CERTIFICATE - ELLIE MAE INCdex41.htm
EX-3.5 - CERTIFICATE OF AMENDMENT - ELLIE MAE INCdex35.htm
EX-1.1 - FORM OF UNDERWRITING AGREEMENT - ELLIE MAE INCdex11.htm
EX-23.4 - CONSENT OF HASKELL & WHITE LLP, INDEPENDENT AUDITOR - ELLIE MAE INCdex234.htm
EX-10.23 - RESELLER AGREEMENT - ELLIE MAE INCdex1023.htm
EX-10.22 - AMENDMENT NO. 1 TO AMENDED STRATEGIC RELATIONSHIP AGREEMENT - ELLIE MAE INCdex1022.htm
EX-10.21 - AMENDED STRATEGIC RELATIONSHIP AGREEMENT - ELLIE MAE INCdex1021.htm
EX-10.24 - AMENDMENT TO THE ELLIE MAE, INC. 2009 STOCK OPTION AND INCENTIVE PLAN - ELLIE MAE INCdex1024.htm
EX-10.25 - AMENDMENT TO THE ELLIE MAE, INC. 2009 STOCK OPTION AND INCENTIVE PLAN - ELLIE MAE INCdex1025.htm
EX-23.3 - CONSENT OF GRANT THORNTON LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM - ELLIE MAE INCdex233.htm
Table of Contents

As filed with the Securities and Exchange Commission on February 17, 2011

Registration No. 333-166438

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

AMENDMENT NO. 3

TO

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

ELLIE MAE, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   7372   94-3288780
(State or other jurisdiction of incorporation or organization)   (Primary Standard Industrial Classification Code Number)   (I.R.S. Employer
Identification Number)

 

 

4155 Hopyard Road, Suite 200

Pleasanton, California 94588

(925) 227-7000

(Address, including zip code, and telephone number, including

area code, of registrant’s principal executive offices)

 

 

Sigmund Anderman

Chief Executive Officer

Ellie Mae, Inc.

4155 Hopyard Road, Suite 200

Pleasanton, CA 94588

(925) 227-7000

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies To:

 

Christopher L. Kaufman

Robert W. Phillips
Latham & Watkins LLP
140 Scott Drive
Menlo Park, California 94025
(650) 328-4600

  

Elisa Lee

Vice President and General Counsel

Ellie Mae, Inc.
4155 Hopyard Road, Suite 200
Pleasanton, California 94588
(925) 227-7000

  

Jeffrey D. Saper

Steven V. Bernard

Michael Nordtvedt

Wilson Sonsini Goodrich & Rosati, P.C.

650 Page Mill Road

Palo Alto, California 94304

(650) 493-9300

 

 

Approximate date of commencement of the proposed sale to the public: As soon as practicable after this Registration Statement becomes effective.

If any of the securities being registered on this form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


Table of Contents

The information in this prospectus is not complete and may be changed. These securities may not be sold until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell nor does it seek an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

Subject to Completion. Dated February 17, 2011.

PROSPECTUS

 

 

             Shares

LOGO

[LOGO] 

Ellie Mae, Inc.

Common Stock

 

 

This is an initial public offering of shares of common stock of Ellie Mae, Inc.

Ellie Mae is offering              of the shares to be sold in the offering. The selling stockholders identified in this prospectus are offering an additional              shares. Ellie Mae will not receive any of the proceeds from the sale of the shares being sold by the selling stockholders. The selling stockholders include our chief executive officer, our chief technology officer and entities affiliated with members of our board of directors.

Prior to this offering, there has been no public market for the common stock. It is currently estimated that the initial public offering price per share will be between $             and $            . Ellie Mae intends to list the common stock on the New York Stock Exchange under the symbol “ELLI”.

See “Risk Factors” on page 11 to read about factors you should consider before buying shares of the common stock.

 

     Per Share      Total  

Initial public offering price

   $                    $                

Underwriting discount

     

Proceeds, before expenses, to Ellie Mae

     

Proceeds, before expenses, to the selling stockholders

     

To the extent that the underwriters sell more than              shares of common stock, the underwriters have the option to purchase up to an additional              shares from selling stockholders at the initial public offering price less the underwriting discount.

Neither the Securities and Exchange Commission nor any state securities commission nor any other regulatory body has approved or disapproved of these securities or passed upon the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the shares against payment in New York, New York on                     , 2011.

 

 

 

Barclays Capital

 

William Blair & Company

  Piper Jaffray

Morgan Keegan

Prospectus dated                     , 2011.


Table of Contents

TABLE OF CONTENTS

 

     Page  

Prospectus Summary

     1   

Risk Factors

     11   

Special Note Regarding Forward-Looking Statements

     24   

Use of Proceeds

     26   

Dividend Policy

     26   

Dilution

     27   

Capitalization

     29   

Selected Consolidated Financial Data

     30   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     32   

Business

     62   

Management

     78   

Certain Relationships and Related Transactions

     112   

Principal and Selling Stockholders

     114   

Description of Capital Stock

     118   

Shares Eligible for Future Sale

     123   

Material U.S. Federal Income Tax Consequences to Non-U.S. Holders of Our Common Stock

     126   

Underwriting

     130   

Legal Matters

     133   

Experts

     133   

Where You Can Find More Information

     134   

Index to Consolidated Financial Statements

     F-1   

 

 

No dealer, salesperson or other person is authorized to give any information or to represent anything not contained in this prospectus. You must not rely on any unauthorized information or representations. This prospectus is an offer to sell only the shares offered hereby, but only under circumstances and in jurisdictions where it is lawful to do so. The information contained in this prospectus is current only as of its date.

 

i


Table of Contents

PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus and does not contain all of the information that you should consider in making your investment decision. Before investing in our common stock, you should carefully read this entire prospectus, including our consolidated financial statements and the related notes included elsewhere in this prospectus and the information set forth under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Unless the context requires otherwise, the words “Ellie Mae,” “we,” “company,” “us” and “our” refer to Ellie Mae, Inc. and our wholly-owned subsidiaries.

Ellie Mae, Inc.

Overview

We host one of the largest electronic mortgage origination networks in the United States. Our network and the technology-enabled solutions we provide help streamline and automate the mortgage origination process, increasing efficiency, facilitating regulatory compliance and reducing documentation errors for our network participants.

The Ellie Mae Network electronically connects approximately 51,000 mortgage professionals to the mortgage lenders, investors and service providers integral to the origination and funding of residential mortgages. In 2010, over 2.0 million residential mortgage applications were initiated over the Ellie Mae Network. We believe, based in part on industry volume data reported by the Mortgage Bankers Association, this represented approximately 20% of the total U.S. residential mortgage market.

For mortgage originators, we provide Encompass software, a comprehensive operating system that handles key business and management functions involved in running a mortgage origination business, and serves as a gateway to the Ellie Mae Network. Mortgage originators use Encompass as a single tool for loan processing, marketing, customer communication and to interact electronically with lenders, investors and service providers over the Ellie Mae Network. We also offer Encompass users a variety of additional services, including automated preparation of the disclosure and closing documents borrowers must sign to obtain a loan, electronic document management and websites used for customer relationship management. For the lenders, investors and service providers on our network, we provide electronic connectivity that allows them to do business with a significant percentage of the mortgage origination professionals in the United States.

Mortgage originators pay us licensing and recurring subscription fees or fees on a per closed loan, or success, basis for our Encompass software, and fees on a subscription or transaction basis for our additional services. Lenders and service providers participating in the Ellie Mae Network also pay us fees, generally on a per transaction basis for business received from Encompass users. In 2010, we had revenues of $43.2 million and net income of $0.8 million.

Mortgage Industry Overview

Overview of Mortgage Origination Market

In each of the past ten years, at least eight million new residential mortgages, totaling at least $1.0 trillion, were funded in the United States.1 At the end of 2010, approximately 260,000 mortgage professionals were

 

1 Mortgage Bankers Association, U.S. Residential Originations from 1997 to 2010; Federal Housing Finance Agency, Combined Datasets Average Loan Size: 2009Q4.

 

 

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engaged in originating residential mortgages.2 Mortgage originators advise borrowers, process loan files and collect and verify the property and borrower data upon which lending decisions are based. Mortgage originators generally fall into three main categories:

 

   

Mega Lenders.    There are approximately 20 “mega lenders” which typically are large commercial banks that have both a retail channel in which they work directly with borrowers to originate loans and a wholesale channel in which they buy loans originated by other mortgage originators, such as mortgage banks, smaller lenders, credit unions and mortgage brokerages.

 

   

Mortgage Lenders.    There are approximately 7,500 other mortgage lenders, such as mortgage banks, smaller commercial banks, thrifts and credit unions. Mortgage lenders source and fund loans and generally sell most of these funded loans to mega lenders or other investors.

 

  Ÿ  

Mortgage Brokerages.    There were forecasted to be approximately 12,000 mortgage brokerages at the end of 20103, which are independent sales companies originating loans for multiple mortgage lenders. Mortgage brokerages process and submit loan files to a mortgage lender or mega lender that funds the loan.

In 2009, 48% of mortgages originated nationwide were funded directly through the retail channels of the mega lenders and the remaining 52% were funded through other mortgage lenders and brokerages.4 Based on information published by Inside Mortgage Finance, for the first nine months of 2010, this split was, on average, 50% / 50%.5

The Mortgage Origination Process

Originating a residential mortgage involves multiple parties and requires a complex series of data-laden transactions that must be handled accurately under tight time constraints. By the time a mortgage has been funded, the typical loan package contains over one thousand pages of documents that come from over a dozen different entities, usually operating on disparate technology systems and databases. Traditionally, much of the data used to prepare these documents has been gathered manually, rather than electronically, with documents exchanged among the many participants by facsimile, courier or mail. The entire process results in significant duplicative efforts, time delays, errors, costs and redundant paper documentation, and often exposes borrower data to privacy and security breaches.

It is estimated that electronic processing of mortgages would reduce origination costs by approximately $700 per loan.6 In 2009, less than 1% of residential mortgage originations were processed completely electronically.7

Recent Mortgage Industry Trends and Developments

The mortgage industry has undergone significant change since 2007, largely in response to the hundreds of billions of dollars of loan defaults and massive losses suffered by lenders and investors. This has led to four major trends that have significantly impacted the residential mortgage industry, including:

 

   

increased regulation;

 

   

increased quality standards imposed by lenders and investors;

 

 

2

Bureau of Labor Statistics, Mortgage Employment Statistics, February 2011.

3

Access Mortgage Research & Consulting, Inc., Mortgage Brokers 2010, September 2010.

4

Inside Mortgage Finance, Correspondent Production Continued Strong Run in 2009; Broker Market Hit New Low, February 26, 2010.

5

Inside Mortgage Finance, November 19, 2010, p. 3, Lenders Turn to Wholesale to Absorb Expanding Originations Market During Third Quarter of 2010. Copyright 2010.

6

Mortgage Bankers Association, MISMO—A “Time and Motion” Study, October 2004.

7

National Mortgage News, 5% Share for E-Mortgages? Next Year. Or Maybe 2011, May 21, 2009.

 

 

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greater focus on operational efficiencies; and

 

   

a significant market shift from mortgage brokerages to mortgage lenders as the number of mortgage brokerages has declined.

The Ellie Mae Solution

Our technology-enabled solutions help streamline and automate the mortgage origination process, increasing efficiency, facilitating regulatory compliance and reducing documentation errors for all Ellie Mae Network participants.

For mortgage originators:

 

   

Encompass software provides our customers with a core business operating system, streamlining and enhancing business-critical functions, including customer acquisition, loan processing, task management, communication with borrowers and other mortgage origination participants, reporting, regulatory compliance and general business management. We provide our Encompass software to mortgage lenders, or Lender Encompass Users, and mortgage brokerages, or Broker Encompass Users. We do not market Encompass to the retail channels of the mega lenders, which generally have their own proprietary loan origination software.

 

   

The Encompass services we offer our Encompass users include disclosure and closing document preparation, electronic document management, automated verification of regulatory compliance and borrower-facing websites enabling them to market to and support their customers.

 

   

The Ellie Mae Network enables Encompass users to submit loan data and entire files electronically and securely to lenders and electronically order and receive settlement services necessary to originate a loan.

For lenders, investors and service providers:

 

   

The Ellie Mae Network provides greater and more cost-effective electronic access to a significant percentage of mortgage origination professionals, increasing their revenue opportunities and lowering their marketing and loan aggregation costs.

 

   

Lenders, investors and service providers can seamlessly receive data directly from mortgage originators, reducing redundant data entries and errors and lowering loan-fulfillment and customer support costs.

 

  Ÿ  

The Ellie Mae Network facilitates targeted marketing by lenders, investors and service providers allowing them to set specific criteria to identify the loans for which they wish to provide funding or their settlement services, thereby significantly reducing traditional sales and marketing costs and potentially increasing market penetration for existing participants as well as new entrants.

 

   

Lenders can also use the Ellie Mae Network to ensure that they only receive loan applications that meet their specific loan quality and compliance standards.

Our Strategy

Our mission is to be the industry standard electronic network for residential mortgage origination in the United States. Key elements of our strategy include:

 

   

Increasing the number of participants on the Ellie Mae Network by continuing to enhance the features and functionality of our Encompass software for mortgage originators and by educating lenders and service providers of the benefits of automated origination and network participation.

 

 

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Table of Contents
   

Focusing on Lender Encompass Users, both because mortgage origination volume has shifted significantly to mortgage lenders, and because mortgage lenders typically order more of our services than mortgage brokers.

 

   

Focusing on selling our Encompass SaaS, or software as a service, success-based pricing model to align customer payment to Ellie Mae with their receipt of revenues.

 

   

Selling Encompass users additional products and services, such as document preparation, electronic document management, compliance services, website hosting and product and pricing services.

 

   

Encouraging Encompass users to order more settlement services electronically through the Ellie Mae Network.

 

   

Selling lenders and service providers Ellie Mae Network offerings.

 

   

Acquiring businesses to complement our Encompass software and services offerings.

Risks Associated with our Business

There are a number of risks and uncertainties that may affect our business, financial and operating performance and growth prospects. You should carefully consider all of the risks discussed in “Risk Factors,” which begins on page 11, before investing in our common stock. These risks include, among others:

 

   

the extreme turmoil in the mortgage industry that began in 2007 has adversely affected and may continue to adversely affect our business;

 

   

the anticipated increase in mortgage interest rates, as well as other factors, is expected to result in lower mortgage lending volume in 2011 and 2012 than in 2010, which could adversely affect our business;

 

   

our future performance will be highly dependent on our ability to continue to attract Encompass SaaS customers, and, to a lesser extent, to grow revenues from new Ellie Mae Network offerings and new services;

 

   

if we fail to increase the number of Lender Encompass Users and other Ellie Mae Network participants or retain existing users and participants, our business may be harmed; and

 

   

the success of our business depends both on the continuation of the trend toward electronic processing of mortgages and our ability to increase the use of the Ellie Mae Network to order settlement services.

Corporate Information

We were originally incorporated in California in August 1997. We reincorporated in Delaware in November 2009. Our principal executive offices are located at 4155 Hopyard Road, Suite 200, Pleasanton, CA 94588, and our telephone number is (925) 227-7000. Our website address is www.elliemae.com. Information contained on our website is not a part of this prospectus and the inclusion of our website address in this prospectus is an inactive textual reference only.

Ellie Mae®, the Ellie Mae logo, Encompass®, Encompass360®, Ellie Mae Network, Encompass CenterWise, Encompass Closer, Mavent® and other trademarks or service marks of Ellie Mae appearing in this prospectus are the property of Ellie Mae. Trade names, trademarks and service marks of other companies appearing in this prospectus are the property of the respective holders.

 

 

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The Offering

 

Common stock offered:

 

by us

             shares.

 

by the selling stockholders

             shares (or              shares if the underwriters exercise their overallotment option in full).

 

Shares outstanding after the offering

             shares.

 

Use of proceeds

We estimate that we will receive net proceeds from this offering of approximately $             million based on an assumed initial public offering price of $             per share (the midpoint of the price range set forth on the cover of this prospectus) and after deducting underwriting discounts and commissions and estimated offering expenses payable by us. We intend to use the net proceeds from this offering for general corporate purposes. Although we have no present understandings, commitments or agreements to enter into any acquisitions or investments, we may also use a portion of the net proceeds for the acquisition of, or investment in, technologies, solutions or businesses that complement our business.

We will not receive any proceeds from the sale of shares to be offered by the selling stockholders. However, we will receive approximately $             million in the aggregate from selling stockholders who will pay to us the exercise price for options or warrants exercised by them for the purpose of selling shares in this offering. The selling stockholders include our chief executive officer, our chief technology officer and entities affiliated with members of our board of directors. See “Principal and Selling Stockholders.”

 

Risk factors

See “Risk Factors” beginning on page 11 and the other information included elsewhere in this prospectus for a discussion of factors you should carefully consider before deciding to invest in our common stock.

 

Proposed New York Stock Exchange symbol

ELLI

The number of shares of our common stock outstanding after this offering is based on 46,200,882 shares outstanding as of December 31, 2010, plus (1)             shares to be sold by us in this offering and (2)             shares that will be issued upon exercise of options or warrants held by selling stockholders for the purpose of selling shares in this offering.

As of December 31, 2010, we had 46,200,882 shares outstanding, excluding:

 

   

10,838,045 shares of common stock issuable upon the exercise of options to purchase our common stock outstanding as of December 31, 2010 at a weighted average exercise price of $1.17 per share, including              shares that will be issued upon the exercise of options with a weighted average exercise price of $             per share by selling stockholders and sold by them in this offering;

 

   

1,341,793 shares of common stock issuable upon the exercise of warrants outstanding as of December 31, 2010 at a weighted average exercise price of $1.32 per share, including              shares that will be issued upon the exercise of warrants with a weighted average exercise price of $             per share by selling stockholders and sold by them in this offering; and

 

 

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an aggregate of 1,539,365 additional shares of common stock reserved for issuance under our equity incentive plans.

Except as otherwise indicated, information in this prospectus reflects or assumes the following:

 

   

a 1-for-             reverse stock split of our common stock to be effected immediately prior to the effectiveness of the registration statement, of which this prospectus is a part;

 

   

that our amended and restated certificate of incorporation, which we will file in connection with the completion of this offering, is in effect;

 

   

the automatic conversion of all of our outstanding preferred stock into an aggregate of 35,311,759 shares of common stock immediately prior to the completion of this offering; and

 

  Ÿ  

no exercise of the underwriters’ overallotment option to purchase additional shares of our common stock.

 

 

6


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Summary Consolidated Financial Data

The following tables present our consolidated financial and other data for our business for the periods indicated. We derived the consolidated statements of operations data for the years ended December 31, 2008, 2009 and 2010 from our audited consolidated financial statements included elsewhere in this prospectus. Our historical results are not necessarily indicative of the results to be expected in the future. You should read this summary financial data in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes, all included elsewhere in this prospectus.

 

     Years Ended December 31,  
             2008                     2009                      2010          
     (in thousands, except share and per share data)  

Consolidated statements of operations data:

       

Revenues

   $ 33,573      $ 37,707       $ 43,234   

Cost of revenues(1)

     13,028        12,163         12,505   
                         

Gross profit

     20,545        25,544         30,729   

Operating expenses:

       

Sales and marketing(1)

     7,553        7,532         9,555   

Research and development(1)

     6,898        7,945         10,468   

General and administrative(1)

     7,470        8,213         9,823   
                         

Total operating expenses

     21,921        23,690         29,846   
                         

Income (loss) from operations

     (1,376     1,854         883   

Other income, net

     293        72         119   
                         

Income (loss) before income taxes

     (1,083     1,926         1,002   

Income tax provision (benefit)

     (24     264         225   
                         

Net income (loss)

   $ (1,059   $ 1,662       $ 777   
                         

Net income (loss) per share:

       

Basic

   $ (0.11   $ 0.17       $ 0.07   
                         

Diluted

   $ (0.11   $ 0.04       $ 0.02   
                         

Weighted average shares outstanding:

       

Basic

     9,620,871        9,798,399         10,487,193   
                         

Diluted

     9,620,871        46,606,153         51,440,551   
                         

Pro forma net income (loss) per share (unaudited)(2):

       

Basic

        $ 0.02   
             

Diluted

        $ 0.02   
             

Pro forma weighted average shares outstanding (unaudited)(2):

       

Basic

          45,798,952   
             

Diluted

          51,440,551   
             

 

     As of December 31, 2010  
            Actual            Pro Forma
(unaudited)(3)
     Pro Forma
as Adjusted
(unaudited)(4)
 
     (in thousands)  

Consolidated balance sheet data:

       

Cash and cash equivalents

   $ 14,349      $ 14,349       $                

Short-term investments

     2,556        2,556      

Property and equipment, net

     2,710        2,710      

Working capital

     15,788        15,788      

Total assets

     62,956        62,956      

Redeemable convertible preferred stock

     82,672             

Total stockholders’ equity (deficit)

     (31,825     50,847      

 

 

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    Years Ended December 31,  
    2008     2009     2010  
    (unaudited)  

Other operational data(5):

     

Active Encompass Users (at end of period):

     

Active Lender Encompass Users

    28,083        33,221        39,687   

Active Broker Encompass Users

    29,344        21,806        11,014   
                       

Total Active Encompass Users

    57,427        55,027        50,701   
                       

Average Active Encompass Users (during period):

     

Average Active Lender Encompass Users

    29,614        32,836        36,625   

Average Active Broker Encompass Users

    38,155        25,447        15,352   
                       

Average Total Active Encompass Users

    67,769        58,283        51,977   
                       

Encompass-related revenues (in thousands):

     

Encompass-related revenues—Lenders

  $ 20,389      $ 26,386      $ 34,116   

Encompass-related revenues—Brokers

    8,762        5,482        4,683   
                       

Total Encompass-related revenues

  $ 29,151      $ 31,868      $ 38,799   
                       

Encompass-related revenues per Average Active Encompass Users:

     

Encompass-related revenues—Lenders per Average Active Lender Encompass Users

  $ 688      $ 804      $ 932   

Encompass-related revenues—Brokers per Average Active Broker Encompass Users

    230        215        305   

Encompass-related revenues per Average Active Encompass Users

    430        547        746   

SaaS success-based pricing-related data:

     

Active SaaS Success-Based Pricing Encompass Users (at end of period)

           1,261        8,704   

SaaS success-based pricing-related revenues (in thousands)

  $      $      $ 4,944   
    Years Ended December 31,  
        2008             2009         2010  
    (in thousands, unaudited)  

Non-GAAP financial data(6):

     

Adjusted EBITDA

  $ 3,032      $ 5,836      $ 4,932   

Adjusted net income (loss)

    (627     3,052        3,215   

 

(1) Stock-based compensation included in above line items:

 

     Years Ended December 31,  
         2008              2009              2010      
     (in thousands)  

Cost of revenues

   $ 19       $ 144       $ 192   

Sales and marketing

     35         145         303   

Research and development

     78         271         443   

General and administrative

     147         563         1,130   
                          

Total

   $ 279       $ 1,123       $ 2,068   
                          
(2) Calculated assuming the automatic conversion of all of our outstanding shares of preferred stock into an aggregate of 35,311,759 shares of common stock prior to the completion of this offering.
(3) Reflects, on a pro forma basis, a 1-for              reverse stock split of our common stock to be effected immediately prior to the effectiveness of the registration statement of which this prospectus is a part and the automatic conversion described in footnote (2).
(4)

Reflects, on a pro forma basis, the automatic conversion described in footnote (2) and the reverse split described in footnote (3) and, on an as adjusted basis, the sale by us of              shares of common stock offered by this prospectus at an assumed initial public offering price of $             per share (the midpoint of the price range set forth on the cover of this prospectus), the issuance of             shares upon the exercise of options and warrants at a weighted average exercise price of $            per share by the selling stockholders for the purpose of selling shares in this offering, and our

 

 

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application of the estimated net proceeds as described in “Use of Proceeds.” A $1.00 increase (decrease) in the assumed initial public offering price of $             per share would increase (decrease) the amount of total stockholders’ equity by approximately $             million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting underwriting discounts and commissions and estimated offering expenses payable by us.

(5) An Active Encompass User is a mortgage origination professional who has used Encompass software at least once within a 90-day period preceding the measurement date, and represents the total of both subcategories of Active Lender Encompass Users and Active Broker Encompass Users. Average number of Active Encompass Users during a period is calculated by averaging the monthly Active Encompass Users or subcategory during a period. Encompass-related revenues for a period are all revenues derived from Encompass users or subcategory as well as any other revenue derived from interactions between Encompass users or subcategory and third parties through the Ellie Mae Network during the period, excluding revenues from our legacy and acquired products, to the extent it does not involve a sale to Encompass users. Encompass-related revenues per Average Active Encompass User is calculated by dividing Encompass-related revenues by the average number of Active Encompass Users or subcategory during the period. An Active SaaS Success-Based Pricing Encompass User is a mortgage origination professional who has used the Encompass SaaS software under our success-based pricing model at least once within a 90-day period preceding the measurement date. SaaS success-based pricing revenues for a period consists of revenues derived from Active SaaS Success-Based Pricing Encompass Users as well as any other revenue derived from interactions between such users and third parties through the Ellie Mae Network during the period (excluding legacy and acquired products to the extent it does not involve a sale to such users).
(6) Adjusted EBITDA represents net income (loss) before interest (income) expense, income tax expense (benefit), depreciation and amortization, amortization of acquired intangibles and stock-based compensation expense.

Adjusted net income (loss) represents net income (loss) before amortization of acquired intangibles and stock-based compensation expense.

We use adjusted EBITDA and adjusted net income (loss) in conjunction with traditional GAAP operating performance measures as part of our overall assessment of our performance, including:

 

   

for planning purposes, including the preparation of annual budgets;

 

   

to allocate resources to enhance the financial performance of our business;

 

   

to evaluate the effectiveness of our business strategies; and

 

   

in communications with our board of directors concerning our financial performance.

We also present adjusted EBITDA and adjusted net income (loss) as supplemental performance measures because we believe that these measures provide our board of directors, management and investors with important additional information to measure our performance. These non-GAAP financial measures enable period to period comparisons by excluding potential differences caused by variations in the age and book depreciation of fixed assets and amortization of intangibles related to acquisitions, and changes in interest expense and interest income that are influenced by capital market conditions. We also believe it is useful to exclude stock-based compensation expense from adjusted EBITDA and adjusted net income (loss) because the amount of non-cash expenses associated with stock-based awards made at a certain price and point in time (a) do not necessarily reflect how our business is performing at any particular time and (b) can vary significantly between periods due to the timing of new stock-based awards.

We believe adjusted EBITDA and adjusted net income (loss) are useful to investors in evaluating our operating performance because securities analysts use these non-GAAP financial measures as supplemental measures to evaluate the overall performance of companies and we anticipate that our investor and analyst presentations after we become publicly traded will include adjusted EBITDA and adjusted net income (loss). We note, however, that adjusted EBITDA and adjusted net income (loss) are not measurements of our financial performance under GAAP and should not be considered as an alternative to net income (loss), operating loss or any other performance measures derived in accordance with GAAP, or as an alternative to cash flows from operating activities as a measure of our profitability or liquidity. We understand that adjusted EBITDA and adjusted net income (loss) have limitations as an analytical tool, and you should not consider them in isolation, or as a substitute for an analysis of our results as reported under GAAP. In particular, you should consider:

 

   

Adjusted EBITDA and adjusted net income (loss) do not reflect our cash expenditures, or future requirements for capital expenditures or contractual commitments;

 

 

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Adjusted EBITDA and adjusted net income (loss) do not reflect changes in, or cash requirements for, our working capital needs;

 

   

Adjusted EBITDA and adjusted net income (loss) do not reflect the non-cash component of employee compensation;

 

   

Although depreciation and amortization are non-cash charges, the assets being depreciated or amortized often will have to be replaced in the future, and adjusted EBITDA does not reflect any cash requirements for such replacements;

 

   

The expected increase in income tax payments if we generate net income before income tax expenses and our existing net operating loss carryforwards for federal and state income taxes of approximately $13.2 million and $15.0 million, respectively, as of December 31, 2010, have been fully utilized or expired; and

 

   

Other companies in our industry may calculate adjusted EBITDA and adjusted net income (loss) differently than we do, limiting their usefulness as a comparative measure.

We seek to address the inherent limitations associated with using these non-GAAP financial measures through disclosure of such limitations, the presentation of our financial statements in accordance with GAAP and the presentation of a reconciliation of adjusted EBITDA and adjusted net income (loss) to the most directly comparable GAAP measure, net income (loss). We also review GAAP measures and evaluate individual measures that are not included in Adjusted EBITDA and adjusted net income (loss), such as our levels of capital expenditures, equity issuance and interest expense, among other measures.

The table below sets forth a reconciliation of net income (loss) to adjusted EBITDA based on our historical results:

 

     Years Ended December 31,  
     2008     2009     2010  
     (in thousands, unaudited)  

Net income (loss)

   $ (1,059   $ 1,662      $ 777   

Interest (income) expense, net

     (293     (72     (119

Income tax expense (benefit)

     (24     264        225   

Depreciation and amortization

     3,976        2,592        1,611   

Amortization of acquired intangibles

     153        267        370   

Stock-based compensation expense

     279        1,123        2,068   
                        

Adjusted EBITDA

   $ 3,032      $ 5,836      $ 4,932   
                        

The table below sets forth a reconciliation of net income (loss) to adjusted net income (loss) based on our historical results:

 

     Years Ended December 31,  
     2008     2009      2010  
     (in thousands, unaudited)  

Net income (loss)

   $ (1,059   $ 1,662       $ 777   

Amortization of acquired intangibles

     153        267         370   

Stock-based compensation expense

     279        1,123         2,068   
                         

Adjusted net income (loss)

   $ (627   $ 3,052       $ 3,215   
                         

 

 

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RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully consider the risks described below and the other information in this prospectus before making a decision to invest in our common stock. If any of such risks actually occur, our business, operating results, financial condition or growth prospects could be adversely affected. In those cases, the trading price of our common stock could decline and you may lose all or part of your investment.

Risks Related to Our Business

The extreme turmoil in the mortgage industry that began in 2007 has adversely affected and may continue to affect our business adversely.

As a result of the extreme turmoil in the mortgage industry and general economy that began in 2007, many mortgage originators, especially mortgage brokers, and other mortgage industry participants have gone out of business. In addition, those industry participants that continue in business face increased operating and regulatory challenges. Conditions that negatively impact our Encompass users or Ellie Mae Network participants have had a significant adverse effect on our business. For example, the number of Encompass users declined 35% from approximately 79,000 at December 31, 2006 to approximately 51,000 at December 31, 2010. During this period, the number of Active Broker Encompass Users declined by 80% and 30 of the 44 lenders accepting loans through the Ellie Mae Network went out of business or stopped funding loans through their wholesale channel for mortgage brokers between March 2007 and August 2009. In addition, the population of mortgage origination professionals who are the potential users of our Encompass software dropped 47% from approximately 495,000 at December 31, 2006 to approximately 260,000 at December 31, 2010.8 If conditions in the mortgage industry were to deteriorate further, our business would be materially adversely affected.

Mortgage lending volume is expected to be lower in 2011 and 2012 than it was in 2010 due to various economic factors, including the anticipated increase in mortgage interest rates, which could adversely affect our business.

Factors that adversely impact mortgage lending volumes include reduced consumer and investor demand for mortgages, more stringent underwriting guidelines, increased illiquidity in the secondary mortgage market, high levels of unemployment, high levels of consumer debt, lower consumer confidence, changes in tax and other regulatory policies, including the recent expiration of the home buyer’s tax credit, and other macroeconomic factors.

In addition, mortgage interest rates are currently near historic lows and many economists predict that mortgage interest rates will rise in 2011. Mortgage interest rates are influenced by a number of factors, particularly monetary policy. The Federal Reserve Bank may raise the Federal funds rate and has ceased purchasing Fannie Mae and Freddie Mac mortgage-backed securities, each of which would likely cause mortgage interest rates to rise. Increases in mortgage interest rates would reduce the volume of new mortgages originated, in particular the volume of mortgage refinancings. For example, the increase in mortgage interest rates in the second half of 2009 contributed to a significant decline in our revenues from transactions through the Ellie Mae Network and the services we provide.

The expected lower levels in residential mortgage loan volume in 2011 and 2012 as compared to 2010 levels will require us to increase our revenues per loan effected through the Ellie Mae Network in order to maintain our financial performance. Any additional decrease in residential mortgage volumes would exacerbate our need to increase revenues per loan effected through the Ellie Mae Network. We cannot assure you that we will be successful in our efforts to increase our revenues per loan effected through the Ellie Mae Network, which could materially adversely affect our business.

 

8 Bureau of Labor Statistics (Department of Labor), Mortgage Employment Statistics, February 2011.

 

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Our future performance will be highly dependent on our ability to continue to attract Encompass SaaS customers, and, to a lesser extent, to grow revenues from new Ellie Mae Network offerings and new services.

Mortgage loan volume is expected to be lower in 2011 and 2012 than it was in 2010. To increase our revenues, we must increase the percentage of our software users who choose Encompass SaaS, from which we generate higher revenues than from our license offering. We believe that recent increases in the number of Encompass SaaS customers have been driven by our success-based pricing strategy. Initiatives that we have implemented in the past have, from time to time, been successful initially but not over the long term. We cannot assure you that our success-based pricing strategy will continue to be successful. If it is not successful, or if we are unable to identify an alternate strategy and successfully increase the number of Encompass SaaS customers, we may be materially adversely affected.

We must also increase use of our Ellie Mae Network offerings and our services, such as compliance and document preparation. We only began to offer certain Ellie Mae Network offerings in the fourth quarter of 2009 and our Encompass Compliance Service in the first quarter of 2010. Revenue from these Ellie Mae Network offerings has not been significant to date and we cannot assure you that these Ellie Mae Network offerings will achieve market acceptance and be successful. In the event these efforts are not successful, our business and growth prospects would be adversely affected.

If we fail to increase the number of Lender Encompass Users and other Ellie Mae Network participants or retain existing users and participants, our business may be harmed.

Ellie Mae revenue from Broker Encompass Users has declined significantly as a result of the significant reduction in the number of mortgage brokers. Our growth depends in large part on increasing the number of Lender Encompass Users and other Ellie Mae Network participants. To attract mega lenders and service providers to the Ellie Mae Network, we must convince them that the utility of, and access to mortgage originators on, the Ellie Mae Network is worth making payments to us for transactions ordered through the network by Encompass users. To grow our base of Encompass software users, in particular, we must increase the number of our Lender Encompass Users. We must also enhance the features and functionality of our Encompass software, convince mortgage lenders of the benefits of our software solution and the Ellie Mae Network and encourage them to switch from competing loan origination software products or to forego using traditional mortgage origination methods, including paper, facsimile, courier, mail and e-mail. Due to the fragmented nature of the mortgage industry, many mortgage industry participants may not be familiar with our Encompass solutions and the benefits of the Ellie Mae Network. We cannot assure you that we will be successful in attracting new Lender Encompass Users and other Ellie Mae Network participants and if we are unsuccessful in these efforts, our business may be harmed.

Additionally, existing Lender Encompass Users and other Ellie Mae Network participants may decide not to continue to use our solutions in favor of other means for financial or other reasons. We have agreements in place with various third-party lenders, service providers and investors to facilitate integration between their businesses and the Ellie Mae Network. Most of these contracts are not long term or are subject to termination rights. An unexpected termination, or a failure to renew, of a significant number of our agreements or relationships with third-party lenders, service providers or investors could have an adverse effect on our business.

The success of our business depends both on the continuation of the trend toward electronic processing of mortgages and our ability to increase the use of the Ellie Mae Network to order settlement services.

In order to grow our business, we must expand the use of settlement services on, and increase the number of transactions ordered through, the Ellie Mae Network. Our Encompass users currently employ the Ellie Mae Network to handle on average only four out of the approximately ten transactions per loan file, typically including ordering credit reports and accessing the automatic underwriting systems of Fannie Mae and Freddie Mac. This limited use is in part due to the fact that many providers of other settlement services, such as title

 

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reports and appraisals, do not provide electronic solutions that are superior to traditional processes. Increasing the number of transactions ordered through the Ellie Mae Network depends in large part on our ability to educate providers of settlement services of the benefits of electronic origination and network participation and our ability to encourage providers of settlement services to deliver their services electronically through the Ellie Mae Network in a manner that is attractive to mortgage professionals. If our future sales and marketing efforts are not successful in educating and encouraging additional mortgage originators and providers of settlement services to change their current business practices and adopt electronic mortgage origination and electronic delivery practices, our business may be adversely affected.

A continuation of the shift in residential mortgage volume to the retail channels of mega lenders would adversely affect our business opportunities.

Due in part to the turmoil in the mortgage industry, the percentage of the national volume of residential mortgages in the United States that were funded directly through the retail channels of mega lenders increased from 38% in 2006 to 48% in 2009.9 Based on information published by Inside Mortgage Finance, for the nine months ended September 30, 2010, these retail channels funded, on average, approximately 50%.10 We provide our Encompass software to mortgage lenders and mortgage brokers. We do not market Encompass software to the mega lenders, as they generally have their own proprietary loan origination software and do not participate on the Ellie Mae Network. If this shift continues, our business and growth prospects would be materially adversely affected.

We expect a number of factors to cause our operating results to fluctuate on a quarterly and annual basis, which may make it difficult to predict our future performance.

Our revenues and operating results have in the past varied and could in the future vary significantly from quarter to quarter and year to year because of a variety of factors, many of which are outside of our control. As a result, comparing our operating results on a period-to-period basis may not be meaningful. In addition to other risk factors discussed in this section, factors that may contribute to the variability of our quarterly and annual results include:

 

   

fluctuations in mortgage lending volume;

 

   

the number of Encompass users;

 

   

the volume of mortgages originated by our Encompass users;

 

   

transaction volume on the Ellie Mae Network;

 

   

the level of demand for our Encompass Closer document preparation and other services we offer;

 

   

the timing of the introduction and acceptance of new Ellie Mae Network offerings and additional services;

 

   

costs associated with defending intellectual property infringement and other claims; and

 

   

changes in government regulation affecting Ellie Mae Network participants or our business.

As a result of these and other factors, our results have in the past not achieved and may in the future not achieve our internal projections. In addition, our operating results in future periods may not meet the expectations of investors or public market analysts who follow our company, which could cause our stock price to decline rapidly and significantly. The results of any prior quarterly or annual periods should not be relied upon as indications of our future operating performance.

 

9 Inside Mortgage Finance, Correspondent Production Continued Strong Run in 2009; Broker Market Hit New Low, February 26, 2010.
10 Mortgage Finance, November 19, 2010, p.3, Lenders Turn to Wholesale to Absorb Expanding Originations Market During Third Quarter of 2010. Copyright 2010.

 

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As a public company, we will be required to maintain a system of effective control over financial reporting. Our independent registered public accountants have determined that we have significant deficiencies in internal controls with respect to our accounting and recordkeeping for stock-based compensation and corporate governance and qualifications of key personnel. If we do not remediate these significant deficiencies and develop effective controls, our impaired ability to produce accurate and timely financial reports could cause our stock price to decline.

As a public company following this offering, we will be required to maintain a system of effective internal controls over financial reporting. In addition, we will be required to evaluate periodically the effectiveness of the design and operation of these internal controls. We will need to hire additional personnel to meet these requirements. We have not begun the process of evaluating or documenting our internal control processes and systems. We cannot assure that we will be successful in these activities.

In connection with the audit of our financial results for 2009, our independent registered public accountants determined that we had significant deficiencies in internal controls relating to our accounting and recordkeeping for stock-based compensation. These significant deficiencies arose from minutes of meetings of the board of directors that did not adequately document the granting of stock options or the terms of stock options granted, the absence of stock option agreements for a number of holders of options, errors in our stock option database and the failure in one case to identify and properly to account for a specific stock-based compensation arrangement in 2004 and subsequent periods. By reason of these inadequate controls and a lack of understanding of the legal issues associated with proper documentation of stock option grants that led to an inappropriate attempt by the employee who was then responsible for stock option administration and documentation to recreate missing documentation, our independent registered public accountants also determined that we had significant deficiencies with respect to corporate governance and qualification of key personnel. In addition, we had deficiencies in our issuances of outstanding equity securities, which included in certain cases our failure to document properly the issuance of stock as evidenced by missing signatures or stock purchase agreements, inadequate stock ledger documentation of transfers and names of record holders or the absence of resolutions of our board of directors and stockholders properly authorizing the issuances of shares.

To remediate these deficiencies, we have taken a number of actions. With respect to outstanding stock issuances we are in the process of obtaining agreements from our stockholders confirming the securities they hold. With respect to stock options, we have corrected the identified errors in our stock option database, transferred stock option responsibilities to our finance and legal departments and engaged an outside stock option administration consultant who is training the personnel who we have now put in charge of stock option administration. We also took action in April 2010 to provide the holders of defective stock options with economic benefits equal to the defective stock options. We cannot assure that these actions will entirely remediate these deficiencies or that we will not receive claims in the future from other persons asserting rights to shares of our capital stock or to stock options.

If we do not remediate these deficiencies and develop effective controls, we may be unable to produce accurate and timely financial reports and our stock price could decline. Similarly, if we fail to establish and maintain corporate governance standards applicable to companies with publicly traded securities, it could result in loss of investor confidence and a decline in our stock price.

The mortgage industry is heavily regulated and changes in current legislation or new legislation could adversely affect our business.

Changes in the regulations that govern our customers could adversely affect our business.

The U.S. mortgage industry is heavily regulated. Federal and state governments and agencies could enact legislation or other policies that could negatively impact the business of our Encompass users and other Ellie Mae Network participants. Any changes to existing laws or regulations or adoption of new laws or regulations that increase restrictions on the residential mortgage industry may decrease residential mortgage volume or

 

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otherwise limit the ability of our Encompass users and Ellie Mae Network participants to operate their businesses, resulting in decreased usage of our solutions.

Changes in current legislation or new legislation may increase our costs by requiring us to update our products and services.

Changes to existing laws or regulations or adoption of new laws or regulations relating to the residential mortgage industry could require us to incur significant costs to update our products and services. For example, our Encompass Compliance Service analyzes mortgage loan data for compliance with consumer protection laws and institutionally mandated compliance policies and must continually be updated to incorporate changes to such laws and policies. Additionally, we substantially updated our Encompass software in 2009 to reflect the changes to the Real Estate Settlement Procedures Act of 1974, as amended, or RESPA, that went into effect on January 1, 2010. The Dodd-Frank Wall Street Reform and Consumer Protection Act, or Dodd-Frank Act, will also cause us to make similar updates to our Encompass software to address, among other things, regulations that protect consumers against unfair, deceptive and abusive practices by lenders. These updates have caused us to incur significant expense, and future updates will likely similarly cause us to incur significant expense.

A failure of our products and services or a failure to appropriately update our products and services to reflect and comply with changes to existing laws or regulations or with new laws or regulations may contribute to violations by our customers of such laws and regulations. We provide a limited warranty for our Encompass Compliance Service, pursuant to which we agree to reimburse customers for losses incurred due to fines, penalties or judgments as a result of a violation of a specific law, rule or regulation tied to an error in the provision of our Encompass Compliance Service. Our typical services agreement with new customers limits our exposure to $2,500 per occurrence. However, with respect to some legacy customers that we inherited from our acquisition of Mavent Holdings Inc., or Mavent, our exposure could be greater. For most customers, our exposure for warranties is limited to an amount equal to the total service fees paid by a customer for base services during a specified period preceding the relevant claim, typically six to 12 months. For a few customers we inherited from Mavent, our liability is a specified dollar amount, which in the aggregate does not exceed approximately $2.0 million. Although we have not historically incurred any claims and maintain professional liability insurance coverage of $5.0 million per occurrence and in the aggregate, to the extent we were to become liable for an amount in excess of such coverage, our business and our reputation would be materially adversely affected.

Potential structural changes in the U.S. residential mortgage industry, in particular recent proposals to diminish the role of Fannie Mae and Freddie Mac, could disrupt the mortgage market and have a material adverse affect on our business.

Fannie Mae and Freddie Mac play a very important role in providing liquidity, stability and affordability in the current U.S. residential mortgage market. In particular, they participate in the secondary mortgage market by purchasing mortgage loans and mortgage-related securities for investment and by issuing guaranteed mortgage-related securities. In February 2011, the Obama administration delivered a report to Congress, which proposed the winding down of Fannie Mae and Freddie Mac and shrinking the federal government’s role in the housing market. This proposal includes the withdrawal of government insurance currently available on certain residential loans and increasing the down payment requirements for borrowers, both of which could reduce mortgage lending volume. The effects of this proposal or any significant structural change to the U.S. residential mortgage industry, if implemented, would cause significant disruption to the mortgage market. If we are unable to react effectively and quickly to changes in the residential mortgage industry, our business could be harmed.

We may be limited in the way in which we market our business or generate revenue by U.S. federal law prohibiting referral fees in real estate transactions; if we are found to be in violation of such laws we would be subject to significant liability.

RESPA generally prohibits the payment or receipt of fees or any other thing of value for the referral of business related to a residential real estate settlement service and prohibits fee shares or splits or unearned fees in

 

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connection with the provision of such services. Our Encompass software and services and the Ellie Mae Network were designed with payment methods that are not currently prohibited by the restrictions under RESPA. Nonetheless, RESPA may restrict our ability to enter into marketing and distribution arrangements with third-parties, for existing or newly developed products and services, particularly to the extent that such arrangements may be characterized as involving payments for the referral of residential real estate settlement service business. Additionally, any amendments to RESPA that result in restrictions on our current payment methods, or any determination that our payment methods have been and currently are subject to the restrictions under RESPA, could have a material adverse effect on our business. Finally, if we were found to be in violation of RESPA rules, we would be exposed to significant potential liability that could have a material adverse effect on our reputation and business.

Our failure to protect the confidential information of our Encompass users, our Ellie Mae Network participants and their respective customers could damage our reputation and brand and substantially harm our business.

Certain confidential information relating to certain of our Encompass users, our Ellie Mae Network participants and their respective customers resides on our third-party hosted data center servers and is transmitted over our network. We rely on encryption and authentication technology licensed from third parties to effect secure transmission of confidential information, including personal information and credit card numbers. Advances in computer capabilities, new discoveries in the field of cryptography or other developments may result in a compromise or breach of the technology used by us to protect customer transaction data. These servers may also be vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems, which could lead to loss of critical data or the unauthorized disclosure of confidential customer data.

The possession and use of personal information in conducting our business subject us to legislative and regulatory burdens that may require notification to customers of a security breach, restrict our use of personal information and hinder our ability to acquire new customers or market to existing customers.

We cannot guarantee that our security measures will prevent security breaches. Any such compromise of our security could damage our reputation and brand and expose us to a risk of loss or litigation and potential liability, which would substantially harm our business and operating results. We may need to expend significant resources to protect against and remedy any potential security breaches and their consequences.

We depend on key and highly skilled personnel to operate our business, and if we are unable to retain our current or hire additional personnel, our ability to develop and successfully market our business could be harmed.

We believe our future success will depend in large part upon our ability to attract and retain highly skilled managerial, technical, finance, creative and sales and marketing personnel. Moreover, we believe that our future success is highly dependent on the contributions of our named executive officers, as defined in “Management-Executive Compensation” below. All of our officers and other employees are at-will employees, which means they may terminate their employment relationship with us at any time, and their knowledge of our business and industry would be extremely difficult to replace. In addition, the loss of any key employees or the inability to attract or retain qualified personnel could delay the development and introduction of, and harm our ability to sell, our solutions and harm the market’s perception of us. Competition for qualified personnel is particularly intense in the San Francisco Bay Area, where our headquarters are located. Qualified individuals are in high demand, and we may incur significant costs to attract them. We may be unable to attract and retain suitably qualified individuals who are capable of meeting our growing sales, operational and managerial requirements, or may be required to pay increased compensation in order to do so. If we are unable to attract and retain the qualified personnel we need to succeed, our business will suffer.

 

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Volatility or lack of performance in our stock price may also affect our ability to attract and retain our key employees. Our named executive officers have become, or will soon become, vested in a substantial amount of stock options. Employees may be more likely to leave us if the shares they own or the shares underlying their vested options have significantly appreciated in value relative to the original purchase prices of the shares or the exercise prices of the vested options, or if the exercise prices of the options that they hold are significantly above the market price of our common stock. If we are unable to retain our named executive officers or other key employees, our business will be harmed.

Growth may place significant demands on our management and our infrastructure.

Our growth has placed and may continue to place significant demands on our management and our operational and financial infrastructure. As our operations grow in size, scope and complexity, we will need to improve and upgrade our systems and infrastructure to offer an increasing number of customers enhanced solutions, features and functionality. The expansion of our systems and infrastructure will require us to commit substantial financial, operational and technical resources in advance of an increase in the volume of business, with no assurance that the volume of business will increase. Continued growth could also strain our ability to maintain reliable service levels for our customers, develop and improve our operational, financial and management controls, enhance our reporting systems and procedures and recruit, train and retain highly skilled personnel.

Managing our growth will require significant expenditures and allocation of valuable management resources. If we fail to achieve the necessary level of efficiency in our organization as it grows, our business would be harmed.

We operate in a highly competitive market, which could make it difficult for us to attract and retain Encompass users and Ellie Mae Network participants.

The mortgage origination software market is highly competitive. There are many software providers, such as Calyx Technology, Inc., Byte Software Inc., Del Mar DataTrac, Inc., PCLender.com and Harland Financial Solutions, that compete with us by offering loan origination software to mortgage originators. Some software providers, including Calyx Technology, Inc., also provide connectivity between their software users and lenders and service providers. Other connectivity alternatives are provided by vendors such as MGIC Investment Corporation and RealEC Technologies. We also compete with compliance and document preparation service providers that are much larger and more established than us. There is vigorous competition among providers of these services and we may not succeed in convincing potential customers, which use other services, to switch to our services. Many service providers connect directly to mortgage originators without using any loan origination software. Some of our competitors also offer services on a closed loan basis, which could adversely impact the effectiveness of our success-based pricing strategy for increasing the number of Encompass SaaS customers. If we are unsuccessful in competing effectively by providing attractive functionality, customer service or value, we could lose existing Encompass users to our competitors and our ability to attract new Encompass users could be harmed.

We only offer our Encompass services to Encompass users. There are many other service providers that offer our Encompass users competing services, including borrower-facing websites, document preparation services, compliance services and electronic document management. We may be unsuccessful in continuing to differentiate our Encompass service offerings to the extent necessary to effectively compete in some or all of these markets.

The Ellie Mae Network is only available to mortgage originators using Encompass software. The principal alternative to the use of the Ellie Mae Network by Encompass users remains traditional methods of exchanging data and documents among mortgage industry participants by e-mail, facsimile, phone, courier and mail. In addition, mortgage originators use standalone web browsers to go individually to each investor, lender or service

 

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provider’s website and then manually upload loan data or enter information into the website. Mortgage originators may continue to use these methods due to habit, personal business relationships or otherwise. The success of the Ellie Mae Network depends on our ability to achieve and offer access to both the critical mass of investors, lenders and service providers necessary to attract and retain mortgage originators on the Ellie Mae Network and the critical mass of active mortgage originators necessary to attract and retain investors, lenders and service providers on our network.

Many of our actual and potential competitors have longer operating histories and significantly greater financial, technical, marketing and other resources than we do and, as a result, these companies may be able to respond more quickly to changes in regulations, new technologies or customer demands, or devote greater resources to the development, promotion and sale of their software and services than we can. We expect the mortgage origination market to continue to attract new competitors and there can be no assurance that we will be able to compete successfully against current or future competitors, or that competitive pressures we face will not materially adversely affect our business.

System interruptions that impair access to the Ellie Mae Network or our hosted Encompass software could damage our reputation and brand and substantially harm our business.

The satisfactory performance, reliability and availability of the Ellie Mae Network, our hosted Encompass software, website and network infrastructure are critical to our reputation and our ability to attract and retain Ellie Mae Network participants and Encompass software users. Any systems interruption that results in the unavailability of our network or impairs access to Ellie Mae Network participants connected to our network could result in negative publicity, damage our reputation and brand and cause our business and operating results to suffer.

We may experience temporary system interruptions, either to the Ellie Mae Network or to our Encompass software hosting locations, for a variety of reasons, including network failures, power failures, software errors or an overwhelming number of Ellie Mae Network participants and Encompass software users trying to access our network during periods of strong demand. In addition, our two primary data centers, located in Santa Clara, California and Chicago, Illinois, are hosted by a third-party service provider over which we have little control. We depend on this third-party service provider to provide continuous and uninterrupted access to the Ellie Mae Network and our hosted Encompass software. If for any reason our relationship with this third-party were to end, it would require a significant amount of time to transition the hosting of our data centers to a new third-party service provider.

Because we are dependent on third-parties for the implementation and maintenance of certain aspects of our systems and because some of the causes of system interruptions may be outside of our control, we may not be able to remedy such interruptions in a timely manner, if at all. As we rely heavily on our servers, computer and communications systems and the Internet to conduct our business, any system disruptions could negatively impact our ability to run our business and either directly or indirectly disrupt our customers’ businesses, which could have an adverse effect on our business.

Failure to adapt to technological changes may render our technology obsolete or decrease the attractiveness of our solutions to our customers.

If new industry standards and practices emerge, or if competitors introduce new solutions embodying new services or technologies, our Encompass software and the Ellie Mae Network technology may become obsolete. Our future success will depend on our ability to:

 

   

enhance our existing solutions;

 

   

develop and potentially license new solutions and technologies that address the needs of our prospective customers; and

 

   

respond to changes in industry standards and practices on a cost-effective and timely basis.

 

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We must continue to enhance the features and functionality of our Encompass software and the Ellie Mae Network. The effective performance, reliability and availability of our Encompass software and the Ellie Mae Network infrastructure are critical to our reputation and our ability to attract and retain Encompass users and Ellie Mae Network participants. If we do not continue to make investments in product development and, as a result, or due to other reasons, fail to attract new and retain existing mortgage originators, lenders, investors and service providers, we may lose existing Ellie Mae Network participants, which could significantly decrease the value of the Ellie Mae Network to all participants.

Failure to adequately protect our intellectual property could harm our business.

The protection of our intellectual property rights, including our proprietary Encompass software and Ellie Mae Network technology, is crucial to the success of our business. We rely on a combination of patent, copyright, trademark and trade secret law and contractual restrictions to protect our intellectual property. Our present and future patents may provide only limited protection for our technology and may not be sufficient to provide competitive advantage to us. Furthermore, we cannot assure you that any patents will be issued to us as a result of our patent applications. We also rely in part on confidentiality and invention assignment agreements with our employees, independent contractors and consultants. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our Ellie Mae Network and Encompass software features and functionality or obtain and use information that we consider proprietary. Policing our proprietary rights is difficult and may not always be effective.

We have registered “Ellie Mae” and “Encompass” and certain of our other trademarks as trademarks in the United States. Competitors may adopt service names similar to ours, thereby impeding our ability to build brand identity and possibly leading to customer confusion. In addition, there could be potential trade name or trademark infringement claims brought by owners of other registered trademarks or trademarks that incorporate variations of the terms Ellie Mae, Encompass or our other trademarks.

Litigation or proceedings before the U.S. Patent and Trademark Office or other governmental authorities and administrative bodies in the United States and abroad may be necessary in the future to enforce our intellectual property rights, protect our patent and copyright rights, trade secrets and domain names and determine the validity and scope of the proprietary rights of others. Our efforts to enforce or protect our proprietary rights may be ineffective and could result in substantial costs and diversion of resources and could harm our business.

Assertions that we infringe third-party intellectual property rights could result in significant costs and substantially harm our business.

Other parties have asserted, and may in the future assert, that we have infringed their intellectual property rights. In addition, we generally agree to indemnify our customers against legal claims that our software products infringe intellectual property rights of third parties and, in the event of an infringement, to modify or replace the infringing product or, if those options are not reasonably possible, to refund the cost of the software, as pro-rated over a period of years. We cannot predict whether assertions of third-party intellectual property rights or claims arising from such assertions will substantially harm our business and operating results. If we are forced to defend against any infringement claims, whether they are with or without merit or are determined in our favor, we may face costly litigation and diversion of technical and management personnel. Furthermore, an adverse outcome of a dispute may require us to: pay damages, potentially including treble damages and attorneys’ fees if the infringement were found to be willful; cease providing solutions that allegedly incorporate the intellectual property of others; expend additional development resources to redesign or reengineer our solutions and products, if feasible; and enter into potentially unfavorable royalty or license agreements in order to obtain the right to use necessary technologies. We cannot be certain of the outcome of any litigation. Any royalty or licensing agreement, if required, may not be available to us on acceptable terms or at all. Our failure to obtain the necessary licenses or other rights could prevent the sale or distribution of some of our products and services and, therefore, could have a material adverse effect on our business.

 

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Current or future litigation could substantially harm our business.

We have been and continue to be involved in legal proceedings, claims and other litigation. For example, we are currently a defendant in litigation initiated by DocMagic Inc., which alleges, among other claims, that we had engaged in monopolization and/or attempted monopolization, intentional interference with contractual relationship, interference with prospective economic advantage, unfair competition and breach of contract. In addition, we are currently involved in defending against other lawsuits alleging, among other claims, breach of contract, tortious interference with business relationship, unfair trade practices, defamation and negligence. See “Business—Legal Proceedings” below. Furthermore, we are also subject to various other legal proceedings and claims arising out of the ordinary course of business. While we do not expect the outcome of any such pending litigation to have a material adverse effect on our financial position, litigation is unpredictable and excessive verdicts, both in the form of monetary damages and injunctions, could occur. In the future, litigation could result in substantial costs and diversion of resources and we could incur judgments or enter into settlements of claims that could have a material adverse effect on our business.

If one or more U.S. states or local jurisdictions successfully assert that we should have collected or in the future should collect additional sales or use taxes on our fees, we could be subject to additional liability with respect to past or future sales, and the results of our operations could be adversely affected.

We do not collect state and local sales and use taxes in all jurisdictions in which our customers are located, based on our belief that such taxes are not applicable. Sales and use tax laws and rates vary by jurisdiction and such laws are subject to interpretation. Jurisdictions in which we do not collect sales and use taxes may assert that such taxes are applicable, which could result in the assessment of such taxes, interest and penalties, and we could be required to collect such taxes in the future. This additional sales and use tax liability could adversely affect the results of our operations.

Our business is subject to the risks of earthquakes, fires, floods and other natural catastrophic events and to interruption by man-made problems such as terrorism.

Our systems and operations are vulnerable to damage or interruption from earthquakes, fires, floods, power losses, telecommunications failures, terrorist attacks, acts of war and similar events. For example, a significant natural disaster, such as an earthquake, fire or flood, could have a material adverse impact on our business, operating results and financial condition, and our insurance coverage may be insufficient to compensate us for losses that may occur. Our corporate offices and one of the facilities we lease to house our computer and telecommunications equipment are located in the San Francisco Bay Area, a region known for seismic activity. In addition, acts of terrorism, which may be targeted at metropolitan areas which have higher population density than rural areas, could cause disruptions in our or our customers’ businesses or the economy as a whole. We may not have sufficient protection or recovery plans in certain circumstances, such as natural disasters affecting the San Francisco Bay Area, and our business interruption insurance may be insufficient to compensate us for losses that may occur.

Future acquisitions could disrupt our business, harm our financial condition and operating results or dilute, or adversely affect the price of, our common stock.

Our success will depend, in part, on our ability to expand our solutions and services and grow our business in response to changing technologies, customer demands and competitive pressures. In some circumstances, we may pursue growth through the acquisition of complementary businesses, solutions or technologies rather than through internal development. For example, in September 2008 we acquired the assets of Online Documents, Inc., or ODI, to enhance our Encompass Closer document preparation services, in December 2009 we acquired Mavent to add automated regulatory compliance to our services offerings and in January 2011 we acquired and began integrating assets from Mortgage Pricing Systems to introduce our Encompass Product and Pricing Service, which allows Encompass users to compare loan pricing from multiple lending sources. The identification of suitable acquisition candidates can be difficult, time-consuming and costly, and we may not be

 

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able to complete identified acquisitions successfully. Even if we successfully complete an acquisition, we may not be able to assimilate and integrate effectively the acquired business, technologies, solutions, assets, personnel or operations, particularly if key personnel of an acquired company decide not to work for us. In addition, we may issue equity securities to complete an acquisition, which would dilute our stockholders’ ownership and could adversely affect the price of our common stock.

We will incur increased costs as a result of being a public company, which may strain our resources and adversely affect our operating results and financial condition.

As a public company, we will incur significant accounting, legal and other expenses that we did not incur as a private company. We will incur costs associated with our public company reporting requirements, since we will be subject to the requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act, the Sarbanes-Oxley Act of 2002, the New York Stock Exchange, or NYSE, and other rules and regulations. We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly. Furthermore, these laws and regulations could make it more difficult or more costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these requirements could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers.

Risks Related to Owning Our Common Stock

An active, liquid and orderly market for our common stock may never develop or be sustained.

Prior to this offering there has been no market for shares of our common stock. An active trading market for our common stock may never develop or be sustained, which could depress the market price of our common stock and could affect your ability to sell your shares. The initial public offering price will be determined through negotiations between us and the representative of the underwriters and may bear no relationship to the price at which our common stock will trade following the completion of this offering. The trading price of our common stock following this offering is likely to be highly volatile and could be subject to wide fluctuations in response to various factors, some of which are beyond our control. In addition to the factors discussed in this “Risk Factors” section and elsewhere in this prospectus, these factors include:

 

   

our operating performance and the operating performance of similar companies;

 

   

the overall performance of the equity markets;

 

   

the number of shares of our common stock publicly owned and available for trading;

 

   

threatened or actual litigation;

 

   

changes in laws or regulations relating to our solutions;

 

   

any major change in our board of directors or management;

 

   

publication of research reports about us or our industry or positive or negative recommendations or withdrawal of research coverage by securities analysts;

 

   

large volumes of sales of our shares of common stock by existing stockholders; and

 

   

general political and economic conditions.

In addition, the stock market in general has experienced extreme price and volume fluctuations. These fluctuations may be even more pronounced in the trading market for our stock shortly following this offering. Securities class action litigation has often been instituted against companies following periods of volatility in the overall market and in the market price of a company’s securities. This litigation, if instituted against us, could result in very substantial costs, divert our management’s attention and resources and harm our business.

 

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Our directors, executive officers and principal stockholders will continue to have substantial control over us after this offering and could delay or prevent a change in corporate control.

After this offering, our directors, executive officers and holders of more than 5% of our common stock, together with their affiliates, will beneficially own, in the aggregate, approximately     % of our outstanding common stock, assuming no exercise of the underwriters’ option to purchase additional shares of our common stock in this offering. As a result, these stockholders, acting together, would have the ability to control the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, consolidation or sale of all or substantially all of our assets. In addition, these stockholders, acting together, would have the ability to control the management and affairs of our company. Accordingly, this concentration of ownership might harm the market price of our common stock by:

 

   

delaying, deferring or preventing a change in corporate control;

 

   

impeding a merger, consolidation, takeover or other business combination involving us; and

 

   

discouraging a potential acquiror from making a tender offer or otherwise attempting to obtain control of us.

Future sales of shares of our common stock by existing stockholders could depress the price of our common stock.

If our existing stockholders sell, or indicate an intent to sell, substantial amounts of our common stock in the public market after the 180-day contractual lock-up and other legal restrictions on resale discussed in this prospectus lapse, the trading price of our common stock could decline significantly and could decline below the initial public offering price. Based on shares outstanding as of December 31, 2010, upon completion of this offering, we will have outstanding approximately              shares of common stock.              shares of common stock, plus any shares sold upon exercise of the underwriters’ overallotment option, will be immediately freely tradable, without restriction, in the public market.

After the lock-up agreements pertaining to this offering expire and based on shares outstanding as of December 31, 2010, an additional              shares will be eligible for sale in the public market. The representative of the underwriters may, in its sole discretion, permit our officers, directors, employees and current stockholders to sell shares prior to the expiration of the lock-up agreements. In addition, 10,838,045 shares subject to outstanding options, as of December 31, 2010, and 1,539,365 shares reserved for future issuance under our equity incentive plans, as of December 31, 2010, will become eligible for sale in the public market, subject to certain legal and contractual limitations. If these additional shares are sold, or if it is perceived that they will be sold, in the public market, the price of our common stock could decline substantially.

If we issue additional shares of common stock to raise capital, it may have a dilutive effect on your investment.

If we raise additional capital through further issuances of equity or convertible debt securities, our existing stockholders could suffer significant dilution in their percentage ownership of us. Moreover, any new equity securities we issue could have rights, preferences and privileges senior to those of holders of our common stock, including shares of common stock sold in this offering.

If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.

The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business. Securities and industry analysts do not currently, and may never, publish research on our company. If no securities or industry analysts commence coverage of our company, the trading price for our stock would likely be negatively impacted. In the event securities or industry analysts initiate coverage, if one or more of the analysts who cover us downgrade our stock or publish inaccurate

 

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or unfavorable research about our business, our stock price would likely decline. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, demand for our stock could decrease, which might cause our stock price and trading volume to decline.

Our management will have broad discretion over the use of the proceeds we receive in this offering and might not apply the proceeds in ways that increase the value of your investment.

Our management will have broad discretion to use the net proceeds to us from this offering, and you will be relying on the judgment of our management regarding the application of these proceeds. Our management might not apply the net proceeds from this offering in ways that increase the value of your investment. We expect to use the net proceeds to us from this offering for working capital and other general corporate purposes, including the funding of our marketing activities and the costs of operating as a public company, as well as further investment in the development of our proprietary technologies. We may also use a portion of the net proceeds for the acquisition of businesses, solutions and technologies that we believe are complementary to our own, although we have no agreements or understandings with respect to any acquisition at this time. We have not allocated the net proceeds from this offering for any specific purposes. Until we use the net proceeds to us from this offering, we plan to invest them, and these investments may not yield a favorable rate of return. If we do not invest or apply the net proceeds from this offering in ways that enhance stockholder value, we may fail to achieve expected financial results, which could cause our stock price to decline.

Certain provisions in our charter documents and Delaware law could discourage takeover attempts and lead to management entrenchment.

Our certificate of incorporation and bylaws that will be in effect prior to the closing of this offering will contain provisions that could have the effect of delaying or preventing changes in control or changes in our board of directors. These provisions will include:

 

   

a classified board of directors with three-year staggered terms, which may delay the ability of stockholders to change the membership of a majority of our board of directors;

 

   

no cumulative voting in the election of directors, which limits the ability of minority stockholders to elect director candidates;

 

   

the exclusive right of our board of directors to elect a director to fill a vacancy created by the expansion of the board of directors or the resignation, death or removal of a director, which prevents stockholders from being able to fill vacancies on our board of directors;

 

   

the ability of our board of directors to determine to issue shares of preferred stock and to determine the price and other terms of those shares, including preferences and voting rights, without stockholder approval, which could be used to significantly dilute the ownership of a hostile acquiror;

 

   

a prohibition on stockholder action by written consent, which forces stockholder action to be taken at an annual or special meeting of our stockholders;

 

   

the requirement that a special meeting of stockholders may be called only by the chairman of the board of directors, the chief executive officer, the president or the board of directors, which may delay the ability of our stockholders to force consideration of a proposal or to take action, including the removal of directors; and

 

   

advance notice procedures that stockholders must comply with in order to nominate candidates to our board of directors or to propose matters to be acted upon at a stockholders’ meeting, which may discourage or deter a potential acquiror from conducting a solicitation of proxies to elect the acquiror’s own slate of directors or otherwise attempting to obtain control of us.

We are also subject to certain anti-takeover provisions under Delaware law. Under Delaware law, a corporation may not, in general, engage in a business combination with any holder of 15% or more of its capital stock unless the holder has held the stock for three years or, among other things, the board of directors has approved the transaction.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus includes forward-looking statements. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends affecting our business. Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate indications of the times at, or by, which such performance or results will be achieved. Forward-looking statements are based on information available at the date of this prospectus and/or management’s good faith belief as of such date with respect to future events, and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in or suggested by the forward-looking statements. Important factors that could cause such differences include, but are not limited to:

 

   

our ability to accurately forecast revenues and appropriately plan our expenses;

 

   

the impact of changes in mortgage interest rates;

 

   

the volume of mortgages originated by our Encompass users;

 

   

fluctuations in mortgage lending volume;

 

   

the number of Encompass users, and in particular, Lender Encompass Users;

 

   

transaction volume on the Ellie Mae Network;

 

   

the impact of uncertain domestic and worldwide economic conditions, including the resulting effect on residential mortgage volumes;

 

   

the effectiveness of our marketing and sales efforts to attract new and retain existing Encompass SaaS users and Ellie Mae Network participants;

 

   

our ability to enhance the features and functionality of our Encompass software and the Ellie Mae Network;

 

   

the level of demand for our Encompass Closer document preparation and other services we offer;

 

   

the timing of the introduction and acceptance of new Ellie Mae Network offerings and additional services including our Encompass SaaS offering;

 

   

changes in mortgage originator, lender, investor or service provider behavior and any related impact on the residential mortgage industry;

 

   

changes in government regulation affecting Ellie Mae Network participants or our business;

 

   

our ability to successfully manage any future acquisitions of businesses, solutions or technologies;

 

   

the timing of future acquisitions of businesses, solutions or technologies and new product launches;

 

   

the attraction and retention of qualified employees and key personnel;

 

   

our ability to protect our intellectual property, including our proprietary Encompass software;

 

   

interruptions in Ellie Mae Network service and any related impact on our reputation;

 

   

costs associated with defending intellectual property infringement and other claims; and

 

   

other risk factors included under “Risk Factors” in this prospectus.

In addition, in this prospectus, the words “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “expect,” “predict,” “potential” and similar expressions, as they relate to our company, our business and our management, are intended to identify forward-looking statements. In light of these risks and uncertainties, the future events and circumstances discussed in this prospectus may not occur and actual results could differ materially from those anticipated or implied in the forward-looking statements.

 

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Forward-looking statements speak only as of the date of this prospectus. You should not put undue reliance on any forward-looking statements. We assume no obligation to update forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting forward-looking information, except to the extent required by applicable laws. If we update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements.

 

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USE OF PROCEEDS

We estimate that the net proceeds to us from the sale of the shares of common stock offered by us will be approximately $             million, based on an assumed initial public offering price of $             per share (the midpoint of the price range set forth on the cover page of this prospectus) and after deducting underwriting discounts and commissions and estimated offering expenses payable by us. A $1.00 increase (decrease) in the assumed initial public offering price of $             per share would increase (decrease) the net proceeds to us from this offering by $             million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us. We will also receive in the aggregate approximately $             million, or approximately $             million if the underwriters’ overallotment option is exercised in full, from selling stockholders who will pay to us the exercise price of options or warrants exercised by them for the purpose of selling shares in this offering. Otherwise we will not receive any proceeds from the shares of common stock to be offered by the selling stockholders, although we will pay the expenses, other than underwriting discounts and commissions, associated with the sale of those shares. The selling stockholders include our chief executive officer, our chief technology officer and entities affiliated with members of our board of directors. See “Principal and Selling Stockholders.”

We currently intend to use the net proceeds to us from this offering for general corporate purposes, including working capital, sales and marketing activities, general and administrative matters and capital expenditures. We may also use a portion of the net proceeds for the acquisition of, or investment in, technologies, solutions or businesses that complement our business. We have no present understandings, commitments or agreements to enter into any acquisitions or investments. Our management will have broad discretion over the uses of the net proceeds from this offering. Pending these uses, we intend to invest the net proceeds from this offering in short-term, investment-grade interest-bearing securities such as money market accounts, certificates of deposit, commercial paper and guaranteed obligations of the U.S. government. We cannot predict whether the proceeds invested will yield a favorable return.

DIVIDEND POLICY

We have never declared or paid, and do not anticipate declaring or paying, any cash dividends on our common stock. Any future determination as to the declaration and payment of dividends, if any, will be at the discretion of our board of directors and will depend on then existing conditions, including our financial condition, operating results, contractual restrictions, capital requirements, business prospects and other factors our board of directors may deem relevant.

 

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DILUTION

If you invest in our common stock you will experience immediate and substantial dilution in the pro forma net tangible book value of your shares of common stock. Dilution in pro forma net tangible book value represents the difference between the public offering price per share of our common stock and the pro forma net tangible book value per share of our common stock immediately after the offering.

The historical net tangible book value of our common stock as of December 31, 2010 was $18.7 million, or $1.72 per share. Historical net tangible book value per share represents our total tangible assets (total assets less intangible assets) less total liabilities divided by the number of shares of outstanding common stock.

After giving effect to (i) a 1-for-    reverse stock split of our common stock to be effected immediately prior to the effectiveness of the registration statement, of which this prospectus is a part, (ii) the automatic conversion of our outstanding preferred stock into an aggregate of 35,311,759 shares of common stock immediately prior to the completion of this offering, (iii) the issuance of              shares of our common stock in this offering, and (iv) receipt of the net proceeds from our sale of              shares of common stock in this offering at an assumed initial public offering price of $             per share (the midpoint of the price range set forth on the cover of this prospectus), after deducting underwriting discounts and commissions and estimated offering expenses payable by us and (v) the receipt by us of approximately $             million in the aggregate from selling stockholders who will pay to us the exercise price for options or warrants exercised by them for the purpose of selling shares in this offering, our pro forma as adjusted net tangible book value as of December 31, 2010 would have been approximately $             million, or $             per share. This represents an immediate increase in pro forma as adjusted net tangible book value of $             per share to existing stockholders and an immediate dilution of $             per share to new investors purchasing common stock in this offering.

The following table illustrates this dilution on a per share basis (unaudited) to new investors:

 

Assumed initial public offering price

      $                        

Net tangible book value per share as of December 31, 2010

   $ 1.72      

Decrease per share attributable to conversion of preferred stock

     

Pro forma net tangible book value per share before this offering

     

Increase per share attributable to this offering

     
           

Pro forma net tangible book value per share, as adjusted to give effect to this offering

     
           

Dilution in pro forma net tangible book value per share to new investors in this offering

      $                
           

A $1.00 increase (decrease) in the assumed initial public offering price of $             per share would increase (decrease) the pro forma net tangible book value, as adjusted to give effect to this offering, by $             per share and the dilution to new investors by $             per share, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting underwriting discounts and commissions and estimated expenses payable by us.

 

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The table below summarizes as of December 31, 2010, on a pro forma as adjusted basis as described above, the number of shares of our common stock, the total consideration and the average price per share (i) paid to us by existing stockholders and (ii) to be paid by new investors purchasing our common stock in this offering at an assumed initial public offering price of $             per share.

 

     Shares Purchased     Total Consideration     Average Price
Per Share
 
     Number      Percent     Amount      Percent    
     (in thousands, other than per share data and percentages)  

Existing stockholders

            $                          $                

New investors

            
                                          

Total

        100.0   $           100.0   $     
                                          

A $1.00 increase (decrease) in the assumed initial public offering price of $             per share would increase (decrease) total consideration paid by new investors by $             million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same.

The above discussion and table are based on 46,200,882 shares outstanding as of December 31, 2010, plus (1)              shares to be sold by us in this offering and (2)              shares that will be issued upon exercise of options or warrants held by selling stockholders for the purpose of selling shares in this offering. As of December 31, 2010, we had 46,200,882 shares outstanding, excluding:

 

   

10,838,045 shares of common stock issuable upon the exercise of options to purchase our common stock outstanding as of December 31, 2010 at a weighted average exercise price of $1.17 per share, including              shares that will be issued upon the exercise of options with a weighted average exercise price of $             per share by selling stockholders and sold by them in this offering;

 

   

1,341,793 shares of common stock issuable upon the exercise of warrants outstanding as of December 31, 2010 at a weighted average exercise price of $1.32 per share, including              shares that will be issued upon the exercise of warrants with a weighted average exercise price of $             per share by selling stockholders and sold by them in this offering; and

 

   

an aggregate of 1,539,365 additional shares of common stock reserved for issuance under our equity incentive plans.

 

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CAPITALIZATION

The following table sets forth our cash, cash equivalents and short-term investments and capitalization as of December 31, 2010:

 

   

on an actual basis;

 

   

on a pro forma basis, to reflect a 1-for-             reverse stock split of our common stock and the automatic conversion of all outstanding preferred stock into an aggregate of 35,311,759 shares of common stock as if such reverse stock split and conversion had occurred on December 31, 2010; and

 

   

on a pro forma as adjusted basis, giving effect to the sale by us of              shares of common stock in this offering, at an assumed initial public offering price of $             per share (the midpoint of the price range set forth on the cover page of this prospectus), the issuance of              shares upon the exercise of options and warrants at a weighted average exercise price of $             per share by the selling stockholders for the purpose of selling shares in this offering, and our application of the estimated net proceeds from this offering, as described under “Use of Proceeds.”

 

     As of December 31, 2010  
             Actual             Pro Forma
(unaudited)
    Pro Forma
as Adjusted
(unaudited)(1)
 
     (in thousands)  

Cash, cash equivalents and short-term investments

   $ 16,905      $ 16,905      $                        
                        

Redeemable convertible preferred stock

   $ 82,672      $ —        $     

Common stock(2)

     1        5     

Additional paid-in capital

     8,950        91,618     

Accumulated deficit

     (40,776     (40,776  
                        

Total stockholders’ equity (deficit)

     (31,825     50,847     
                        

Total capitalization

   $ 50,847      $ 50,847      $     
                        

 

(1) A $1.00 increase (decrease) in the assumed initial public offering price of $             per share would increase (decrease) the amount of additional paid-in capital, total stockholders’ equity and total capitalization by approximately $             million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting underwriting discounts and commissions and estimated offering expenses payable by us.
(2) The number of as adjusted shares of common stock shown as issued and outstanding in the table above is based on 46,200,882 shares outstanding as of December 31, 2010, plus (a)             shares to be sold by us in this offering and (b)             shares that will be issued upon exercise of options or warrants held by selling stockholders for the purpose of selling shares in this offering. As of December 31, 2010, we had 46,200,882 shares outstanding, excluding:

 

  (i) 10,838,045 shares of common stock issuable upon the exercise of options to purchase our common stock outstanding as of December 31, 2010 at a weighted average exercise price of $1.17 per share, including              shares that will be issued upon the exercise of options with a weighted average exercise price of $             per share by selling stockholders and sold by them in this offering;
  (ii) 1,341,793 shares of common stock issuable upon the exercise of warrants outstanding as of December 31, 2010 at a weighted average exercise price of $1.32 per share, including              shares that will be issued upon the exercise of warrants with a weighted average exercise price of $             per share by selling stockholders and sold by them in this offering; and
  (iii) an aggregate of 1,539,365 additional shares of common stock reserved for issuance under our equity incentive plans.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

The consolidated statements of operations data for the years ended December 31, 2008, 2009 and 2010 and the consolidated balance sheets data as of December 31, 2009 and 2010 are derived from our audited consolidated financial statements included elsewhere in this prospectus. The consolidated statements of operations data for the years ended December 31, 2006 and 2007 and the consolidated balance sheets data as of December 31, 2006, 2007 and 2008 are derived from our audited consolidated financial statements not included elsewhere in this prospectus. Our historical results are not necessarily indicative of the results to be expected in the future. You should read the following selected consolidated financial data below in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements, related notes and other financial information included elsewhere in this prospectus. The selected consolidated financial data in this section are not intended to replace the consolidated financial statements and are qualified in their entirety by the consolidated financial statements and related notes included elsewhere in this prospectus.

 

    Years Ended December 31,  
    2006     2007     2008     2009     2010  
    (in thousands, except share and per share data)  

Consolidated statements of operations data:

         

Revenues

  $ 38,542      $ 38,493      $ 33,573      $ 37,707      $ 43,234   

Cost of revenues(1)

    10,622        13,096        13,028        12,163        12,505   
                                       

Gross profit

    27,920        25,397        20,545        25,544        30,729   

Operating expenses:

         

Sales and marketing(1)

    11,979        9,890        7,553        7,532        9,555   

Research and development(1)

    7,183        7,140        6,898        7,945        10,468   

General and administrative(1)

    6,265        8,273        7,470        8,213        9,823   
                                       

Total operating expenses

    25,427        25,303        21,921        23,690        29,846   
                                       

Income (loss) from operations

    2,493        94        (1,376     1,854        883   

Other income, net

    427        544        293        72        119   
                                       

Income (loss) before income taxes

    2,920        638        (1,083     1,926        1,002   

Income tax provision (benefit)

    138        104        (24     264        225   
                                       

Net income (loss)

    2,782        534        (1,059     1,662        777   

Accretion of preferred stock to redemption value, net

    (65     (96                     
                                       

Net income (loss) available to common stockholders

  $ 2,717      $ 438      $ (1,059   $ 1,662      $ 777   
                                       

Net income (loss) per share:

         

Basic

  $ 0.29      $ 0.05      $ (0.11   $ 0.17      $ 0.07   
                                       

Diluted

  $ 0.06      $ 0.01      $ (0.11   $ 0.04      $ 0.02   
                                       

Weighted average shares outstanding:

         

Basic

    9,418,382        9,576,474        9,620,871        9,798,399        10,487,193   
                                       

Diluted

    47,014,233        46,400,281        9,620,871        46,606,153        51,440,551   
                                       

Pro forma net income (loss) per share (unaudited)(2):

         

Basic and diluted

          $ 0.02   
               

Pro forma weighted average shares outstanding (unaudited)(2):

         

Basic

            45,798,952   
               

Diluted

            51,440,551   
               

 

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     As of December 31,  
     2006     2007     2008     2009     2010  
     (in thousands)  

Consolidated Balance Sheet Data:

          

Cash and cash equivalents

   $ 12,165      $ 13,011      $ 10,754      $ 11,491      $ 14,349   

Short-term investments

     1,487               997        4,719        2,556   

Property and equipment, net

     6,164        7,461        4,924        2,921        2,710   

Working capital

     7,363        7,399        8,834        11,548        15,788   

Total assets

     55,532        56,180        52,676        57,718        62,956   

Redeemable convertible preferred stock

     82,576        82,672        82,672        82,672        82,672   

Total stockholders’ equity (deficit)

     (38,258     (37,832     (38,565     (35,516     (31,825

 

(1) Stock-based compensation included in above line items:

 

     Years Ended December 31,  
     2006      2007     2008      2009      2010  
     (in thousands)  

Cost of revenues

   $ 42       $ (39   $ 19       $ 144       $ 192   

Sales and marketing

     40                35         145         303   

Research and development

     32         (45     78         271         443   

General and administrative

     77         (66     147         563         1,130   
                                           

Total

   $ 191       $ (150   $ 279       $ 1,123       $ 2,068   
                                           
(2) Calculated assuming the automatic conversion of all of our outstanding shares of preferred stock into an aggregate of 35,311,759 shares of common stock prior to the completion of this offering.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion of our financial condition and results of operations in conjunction with the financial statements and the notes thereto included elsewhere in this prospectus. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this prospectus, particularly in “Risk Factors” and “Special Note Regarding Forward-Looking Statements.”

Overview

We host one of the largest electronic mortgage origination networks in the United States, connecting mortgage origination professionals to lenders, investors and service providers integral to the origination and funding of residential mortgages. Mortgage originators participating in the Ellie Mae Network use our Encompass software, a comprehensive operating system that handles key business and management functions in running a mortgage origination business. Mortgage originators use Encompass as a single tool for loan processing, marketing, customer communication and to interact electronically with lenders, investors and service providers over the Ellie Mae Network. We also offer Encompass users a variety of additional services, including Encompass Closer, which automatically prepares the disclosure and closing documents necessary to fund a mortgage; CenterWise, a bundled offering of electronic document management and websites used for customer relationship management; and Encompass Compliance Service, our compliance service powered by Mavent. In addition, in January 2011 we acquired and began integrating assets from Mortgage Pricing Systems to introduce our Encompass Product and Pricing Service, which allows Encompass users to compare loans offered by different lenders and investors to determine the best product and price available to a particular borrower.

Lenders, service providers and certain government sponsored entities using the Ellie Mae Network pay us fees, which we refer to as Network Transaction revenues, when they effect a transaction over the Ellie Mae Network. A Network Transaction occurs when an Encompass user sends an electronic service request to any lender, service provider or other participant through our network and that request has been accepted.

We also generate revenues from the sale of our software and services, which we refer to as Software and Services revenues. The software component of Software and Services revenues is derived from mortgage originators who either license Encompass software for an initial fee as a perpetual license with annual maintenance fees or subscribe to the Encompass software as a service, or Encompass SaaS, for a monthly per user subscription fee or for fees on a success basis with monthly minimums, which we refer to as success-based pricing. In addition, we offer CenterWise software either as a standalone product on a subscription fee basis or bundled as part of our Encompass SaaS offering. The services component of Software and Services revenues is derived from fees paid by mortgage originators for Ellie Mae services they order. These services include document preparation and Encompass compliance reports.

Our Network Transaction revenues and the services component of Software and Services revenues generally track the seasonality of the mortgage industry, with increased activity in the second and third quarters and reduced activity in the first and fourth quarters as home buyers tend to purchase their homes during the spring and summer in order to move to a new home before the start of the school year. These revenues are also affected by factors that impact mortgage volumes, such as interest rate fluctuations and general economic conditions. For example, the decline in interest rates in the first half of 2009 drove a significant increase in mortgage refinancings, which led to increased Network Transaction revenues as well as increased revenues from the services component of Software and Services revenues during those periods.

We achieve our highest gross margins on our Network Transaction revenues. Our gross margins on the services component of our Software and Services revenues have been affected by our use of third-party providers

 

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and we intend to continue to reduce third-party costs by internally developing or acquiring additional document preparation and other technology.

In connection with the preparation for this initial public offering, we discovered that certain of the stock option agreements held by our directors, employees, ex-employees and consultants had not been authorized in accordance with all corporate law requirements. Management determined, based on other existing documentation, that we had intended to grant the options in question and our board of directors determined in most cases to provide these individuals with as close to the economic equivalent of these stock options as practicable. Accordingly, in April 2010, our board of directors authorized the confirmation of certain stock options and the grant of certain replacement stock options, or Replacement Options, to certain individuals. The board also granted short-term rights to purchase common stock to certain individuals whose stock option agreements had terminated. The Replacement Options are fully-vested but only exercisable in 2011 and the short-term purchase rights were fully vested but were only exercisable through May 2010. None of the Replacement Options, the confirmed options or the rights to purchase common stock has an exercise or purchase price that is less than the exercise price under the stock option agreement it replaces. In certain cases where an individual was subject to withholding for taxes that were not expected by the individual, we paid employee bonuses aggregating approximately $36,400 and, in one case, provided a loan to an individual of approximately $26,000 when he exercised his short-term purchase right, in each case to pay the applicable withholding for taxes. In addition, in the case of Sigmund Anderman, our chief executive officer, and Limin Hu, our chief technology officer, in lieu of such short-term rights to purchase common stock, we granted stock purchase rights that are fully vested and exercisable until March 14, 2011.

We recorded stock-based compensation expense of approximately $363,000 in the second quarter of 2010 for these transactions, but no additional stock-based compensation in subsequent periods. We also determined that the actions taken by our board of directors did not result in any change in stock-based compensation expense for prior periods because all terms of the stock option agreements and the recipients were determined by management to be fixed at the time these individuals were originally informed of their rights to purchase shares.

At December 31, 2010, we had outstanding stock options to purchase an aggregate of 399,800 shares of common stock that are subject to variable accounting. These options were repriced pursuant to a stock option repricing that occurred in December 2001. Under applicable variable accounting rules, we will recognize stock-based compensation expense or gain with respect to the shares underlying these options. For more information, see “—Critical Accounting Policies and Estimates—Stock-based Compensation—Repricing of Stock Options.”

In subsequent periods, we may incur additional stock-based compensation expense as a result of an outstanding stock option held by Sigmund Anderman, our chief executive officer, to purchase an aggregate of 1,350,000 shares of our common stock that vest based on the trading price of our common stock or the price obtained in connection with the sale of our company. The fair value of the option award was determined at the date of grant. The total stock-based compensation expense that would be recognized if the stock option vested in full would be approximately $490,000. See “Executive Compensation—Outstanding Equity Awards at 2010 Fiscal Year-End.”

We were formed in 1997 and reincorporated in Delaware in November 2009. From inception through 2000, we developed initial versions of our network. We launched our first transaction platform in late 2000, the present version of which is the Ellie Mae Network. We acquired two software companies in 2000 and 2001 as our initial entry into the business of providing loan processing software and document preparation services for mortgage originators. We introduced our internally developed Encompass software solution in 2003. We acquired software and related assets from Online Documents, Inc., or ODI, to enhance our document preparation services in September 2008, commenced our compliance services offering in December 2009 through our acquisition of Mavent and added our Encompass Product and Pricing Service to our Encompass software in January 2011 through our acquisition of assets from Mortgage Pricing Systems.

 

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Prior to 2006, we financed our operations and capital expenditures primarily through private sales of preferred stock and lease financing. Since 2006, we have not required additional equity financings and have financed our operations with existing cash and cash flows from operating activities. Our business is not capital intensive and we have responded to adverse economic conditions, such as those that commenced in 2007, by reducing headcount, which is a major component of our operating expenses.

The mortgage industry has undergone significant changes since 2007, largely in response to the hundreds of billions of dollars of loan defaults and massive losses suffered by lenders and investors. Our business strategy has evolved to address recent industry trends, including:

 

   

the lower mortgage lending volumes expected in 2011 and 2012 as compared to 2010, as forecasted by the Mortgage Bankers Association;

 

   

decreased profitability for mortgage originators as a result of reduced mortgage originations;

 

   

a continued significant decline in the number of mortgage brokerages and an increase in the relative importance of mortgage lenders, which not only arrange but also fund loans;

 

   

increased lender quality requirements for new loans; and

 

   

regulatory reforms that have significantly increased the complexity and importance of regulatory compliance.

We are responding to the forecasted decline in mortgage lending volume in several ways. We are promoting increased use of the Ellie Mae Network to produce additional Network Transactions revenues, and seeking to expand the services component of our Software and Services revenues through an increase in the number and usage of our services, such as compliance and document preparation. We believe that Encompass and the Ellie Mae Network also directly address mortgage originators’ need for increased efficiency and profitability during a period of decreased mortgage origination volumes. We are addressing the increasing role of mortgage lenders, as compared to mortgage brokerages, by emphasizing our Encompass Banker Edition software, which provides additional functionality for mortgage lenders. We have hired sales personnel focused on sales of our Ellie Mae Network offerings and our Encompass Banker Edition in light of the increasing percentage of potential customers which are mortgage lenders rather than mortgage brokerages. We also intend to continue to increase marketing activities focused on our Encompass Banker Edition, our Ellie Mae Network offerings and our Encompass Compliance Service. We believe that this shift will provide us increased opportunities because mortgage lenders typically use more sophisticated and comprehensive software solutions to run their businesses, use more services and effect more Network Transactions on the Ellie Mae Network. Our offerings through the Ellie Mae Network directly address lenders’ and service providers’ increased emphasis on efficiency and quality standards by allowing lenders and service providers to set specific criteria for loans and obtain automated responses when a loan fits those criteria. We purchased Mavent to provide compliance services for our Encompass users to respond to the increased focus on regulatory compliance due to regulatory reforms.

As an additional response to market conditions, we have, beginning in late 2009, focused our marketing and sales efforts on our Encompass SaaS offering, and particularly our Encompass SaaS success-based pricing model, in contrast to our license model. In our Encompass SaaS offering, the customer does not pay the significant up-front licensing fee associated with our license model, which we believe is particularly attractive in the present residential mortgage origination market. Our Encompass SaaS success-based pricing model builds on this value proposition by aligning the payments of our customers for our software and services with their own receipt of revenues. The effect of these changes is a delay in our receipt of a significant portion of our revenues from the time of the initial sale until subsequent periods, which has decreased our revenues in the first half of 2010. Customers of our Encompass SaaS success-based pricing model are comprised of customers that have converted from our licensed Encompass software or flat monthly per user hosted offerings and new customers to Encompass. At December 31, 2010, we had 14,678 Active SaaS Encompass Users, of which 8,704 used our success-based pricing model. SaaS Encompass Users generated $38.8 million of our revenues in 2010, of which

 

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$4.9 million was generated by users of our success-based pricing model. We typically generate higher revenues per user through our Encompass SaaS offering than through our license offering.

Operating Metrics

Encompass-related revenues per Average Active Encompass User is a key operational metric we use to evaluate our business, determine allocation of our resources and make decisions regarding corporate strategy. This metric is calculated by dividing Encompass-related revenues by the average number of Active Encompass Users during the period.

This metric has two subcategories: Encompass-related revenues per Average Active Lender Encompass User and Encompass-related revenues per Average Active Broker Encompass User. An Active Lender Encompass User is a mortgage origination professional working at a mortgage lender, such as a mortgage bank, commercial bank, thrift or credit union which source and fund loans and generally sell these funded loans to investors. An Active Broker Encompass User is a mortgage origination professional working for a mortgage brokerage which typically processes and submits loan files to a mortgage lender or mega lender that funds the loan. We believe it is important to evaluate these subcategories separately for two reasons. First, the percentage of the overall loan origination market represented by mortgage lenders, including mortgage banks, commercial banks, thrifts and credit unions continues to increase as the number of mortgage brokerages has declined. In addition, mortgage lenders normally require more software and other service functionality, providing potential leverage for revenue growth. We focus on these metrics to determine our success in leveraging our Encompass User base to increase our revenues. We also track each Active Encompass User subcategory at the end of a period to gauge the degree of our market penetration.

We believe that marketing Encompass through our Encompass SaaS offering on a success-based pricing model is at present our most important marketing method. Accordingly, we track the number of Active SaaS Success-Based Pricing Encompass Users at the end of each period to gauge the degree of market penetration. In addition, we track revenues generated by our Active SaaS Success-Based Pricing Encompass Users during each period.

The components used to calculate these metrics are defined below.

Active Encompass Users.    An Active Encompass User is a mortgage origination professional who has used Encompass software at least once within a 90-day period preceding the measurement date. This metric represents the sum total of the subcategories of Active Lender Encompass Users and Active Broker Encompass Users.

Average Active Encompass Users. Average Active Encompass Users during a period is calculated by averaging the monthly Active Encompass Users or subcategory during a period.

Active SaaS Success-Based Pricing Encompass Users.    An Active SaaS Success-Based Pricing Encompass User is a mortgage origination professional who has used the Encompass SaaS system under our success-based pricing model at least once within a 90-day period preceding the measurement date.

Encompass-related revenues and SaaS success-based pricing revenues for a period consists of revenues derived from such users as well as any other revenue derived from interactions between such users and third parties through the Ellie Mae Network during the period. These operating metrics exclude revenues from our legacy and acquired products to the extent it does not involve a sale to such users.

 

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The following table shows these operating metrics for each of 2008, 2009 and 2010:

 

    Year Ended December 31,  
    2008     2009     2010  
   

(unaudited)

 

Active Encompass Users (at end of period):

     

Active Lender Encompass Users

    28,083        33,221        39,687   

Active Broker Encompass Users

    29,344        21,806        11,014   
                       

Total Active Encompass Users

    57,427        55,027        50,701   
                       

Average Active Encompass Users (during period):

     

Average Active Lender Encompass Users

    29,614        32,836        36,625   

Average Active Broker Encompass Users

    38,155        25,447        15,352   
                       

Average Total Active Encompass Users

    67,769        58,283        51,977   
                       

Encompass-related revenues (in thousands):

     

Encompass-related revenues—Lenders

  $ 20,389      $ 26,386      $ 34,116   

Encompass-related revenues—Brokers

    8,762        5,482       
4,683
  
                       

Total Encompass-related revenues

  $ 29,151      $ 31,868      $ 38,799   
                       

Encompass-related revenues per Average Active Encompass Users:

     

Encompass-related revenues—Lenders per Average Active Lender Encompass Users

  $ 688      $ 804      $
932
  

Encompass-related revenues—Brokers per Average Active Broker Encompass Users

    230        215        305   

Encompass-related revenues per Average Active Encompass Users

    430        547        746   

SaaS success-based pricing related data:

     

Active SaaS Success-Based Pricing Encompass Users (at end of period)

           1,261        8,704   

SaaS success-based pricing-related revenues (in thousands)

  $      $      $ 4,944   

Basis of Presentation

General

Our consolidated financial statements include the accounts of Ellie Mae, Inc. and its wholly owned subsidiaries through the year ended December 31, 2010. All significant intercompany accounts and transactions have been eliminated upon consolidation.

Revenues

We classify our revenues in two categories: Network Transaction revenues and Software and Services revenues.

Network Transaction Revenues

A Network Transaction occurs when an Encompass user sends an electronic service request to any lender, service provider or other participant through our network and that request has been accepted. We recognize Network Transaction revenues when there is evidence that the Network Transaction has occurred and collection of payment from the participating lender, service provider or other participant is reasonably assured. We recognize set-up fees for the integration of lender and service provider participants into the Ellie Mae Network ratably from completion of the integration over the longer of the estimated life of the customer relationship and the term of the contract, which is typically one year.

 

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Software and Services Revenues

Software and Services revenues include license and maintenance revenues, Encompass SaaS revenues, CenterWise for Encompass licensees and services revenues.

License and Maintenance Revenues.    We recognize revenues from the sale of licenses of Encompass software, typically in the month in which the software is delivered. For arrangements with multiple obligations such as undelivered maintenance and support contracts bundled with licenses, we allocate revenues to the delivered elements of the arrangement using the residual value method based on objective evidence of the fair value of the undelivered elements when vendor specific objective evidence, or VSOE, is determinable. The fair value of maintenance services for software licenses, whether an initial license or a renewal, is recognized ratably over the term of the maintenance contract. When VSOE is not determinable, we allocate all revenues to the undelivered elements and the entire arrangement is recognized ratably over the term of the contract. We believe that we have VSOE for our maintenance and support obligations based upon the prices our customers pay for the separate renewal of these services. If collectability is not assured, we recognize revenues under this model upon receipt of cash payment.

Encompass SaaS Revenues.    We offer web-based access to our Encompass software. Customers can elect to pay a monthly recurring fee, which we recognize ratably when the service is performed. Associated set-up fees are recognized ratably over the life of the relationship with the customer, which is generally the term of the contract. Contracts generally range from one to three years. In addition, in the fourth quarter of 2009, our SaaS success-based pricing model, which offers customers the ability to pay on a per closed loan, or success, basis with a monthly minimum. The success basis contracts generally have a term of two years. We recognize the monthly minimums as the service is performed and recognize additional amounts arising from closed loans when the loans close. Our Encompass SaaS offering also includes CenterWise for Encompass as an integrated component, which is a combined element of the arrangement that is delivered in conjunction with the Encompass SaaS offering and therefore is not accounted for separately.

CenterWise for Encompass Licensees.    For Encompass licensees, CenterWise is offered as a standalone hosted product with revenues recognized when the service is performed. CenterWise is also automatically included as an integrated component of the Encompass SaaS offering for which revenue is recognized as discussed above.

Services Revenues.    Mortgage originators, whether Encompass users or legacy customers acquired as a result of acquisitions, such as our ODI and Mavent acquisitions, pay fees for services that they order, such as automated document preparation and compliance reports. We recognize revenues for these services when the service is performed.

Cost of Revenues

Our cost of revenues consists primarily of: salaries and benefits, including stock-based compensation and allocated facilities costs; expenses for document preparation and compliance services, operations and customer support personnel; depreciation on computer equipment used in supporting the Ellie Mae Network, our Encompass SaaS and CenterWise offerings; amortization of acquired intangible assets that are directly related to our revenues; and professional services associated with implementation of our software.

Operating Expenses

Sales and Marketing

Our sales and marketing expenses consist primarily of: salaries, benefits and incentive compensation, including stock-based compensation, and allocated facilities costs. Sales and marketing expenses also include expenses for trade shows, public relations and other promotional and marketing activities, including travel and

 

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entertainment expenses. Sales and marketing expenses increased throughout 2010 primarily due to an increase in the sales force and we expect a further increase in 2011 as we continue to increase marketing activities. We have hired sales personnel to focus on sales of our Ellie Mae Network offerings and our Encompass Banker Edition in light of the increasing percentage of potential customers which are mortgage lenders rather than mortgage brokerages. We also intend to increase marketing activities focused on Encompass Banker Edition, our Ellie Mae Network offerings and our compliance services.

Research and Development

Our research and development expenses consist primarily of: salaries and benefits, including bonuses and stock-based compensation; fees to contractors engaged in the development and support of the Ellie Mae Network infrastructure, Encompass software and other products; and allocated facilities costs. We expect that our research and development expenses will continue to increase in absolute dollars.

General and Administrative

Our general and administrative expenses consist primarily of: salaries and benefits, including stock-based compensation, for employees involved in finance, accounting, human resources, administrative and legal roles, and allocated facilities costs. In addition, general and administrative expenses include consulting, legal, accounting and other professional fees for third-party providers. We expect general and administrative expenses to increase in absolute dollars due to costs associated with our initial public offering, including ongoing costs of being a public company, and legal fees and expenses associated primarily with a lawsuit filed against us in August 2009.

Other Income, Net

Other income, net consists primarily of interest income earned on our cash accounts, net of interest expense paid on equipment and software lease lines.

Income Taxes

We are subject to income tax in the United States. As of December 31, 2010, for federal and state tax purposes, we had $13.2 million of federal and $15.0 million of state net operating loss, or NOL, carryforwards available to reduce future taxable income. These NOL carryforwards begin to expire in 2020 and 2013 for federal and state tax purposes, respectively. As of December 31, 2010, we also had federal and state research and development tax credit carryforwards of approximately $1.7 million and $1.8 million, respectively. The federal tax credit carryforwards will expire commencing in 2021. The state tax credit may be carried forward indefinitely. Our ability to use our NOL and tax credit carryforwards to offset any future taxable income will be subject to limitations attributable to equity transactions that result in a change of ownership as defined by Section 382 of the Internal Revenue Code. They also may be subject to suspension by government authority. For example, the State of California tax authority suspended taxpayers’ ability to use NOL carryforwards in 2008 through 2011.

We have determined that we have sufficient NOL and tax credit carryforwards to offset our federal taxable income for 2010 and preceding periods.

Our net deferred tax assets consist primarily of NOL and research and development credit carryforwards generated before we achieved profitability. Due to the uncertainty surrounding the realization of the deferred tax assets in future tax returns, we have placed a full valuation allowance against our net deferred tax assets. Our effective tax rate differs from the statutory federal rate due to changes in the valuation allowance in 2008, 2009 and 2010. The valuation allowance increased by $0.6 million in 2008, decreased by $0.4 million in 2009, which is net of a $0.3 million increase associated with an acquisition that did not affect the effective tax rate, and

 

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decreased by $0.4 million in 2010. We will continue to assess the need for a valuation allowance on deferred tax assets by evaluating both positive and negative evidence that may exist. Any adjustment to the deferred tax asset valuation allowance will be recorded in the income statement for the periods that the adjustment is determined to be required.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements which are prepared in accordance with generally accepted accounting principles in the United States, or GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates.

We believe that the assumptions and estimates associated with revenue recognition, income taxes, stock-based compensation, and goodwill and intangible assets have the greatest potential impact on our consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates. For further information on all of our significant accounting policies, please see Note 2 of the accompanying notes to our consolidated financial statements included elsewhere in this prospectus.

Revenue Recognition

We classify our revenues in two categories: Network Transaction revenues and Software and Services revenues.

Network Transaction Revenues

We enter into agreements with lenders, service providers and certain government agencies participating in the mortgage origination process that provides them access to, and interoperability with, mortgage originators on the Ellie Mae Network. A Network Transaction occurs when an Encompass user sends an electronic service request to any lender, service provider or other participant through our network and that request has been accepted. We recognize Network Transaction revenues when there is evidence that the Network Transaction has occurred and collection of payment from the participating lender, service provider or other participant is reasonably assured. We recognize set-up fees for the integration of lender and service provider participants into the Ellie Mae Network as Network Transaction revenues ratably from completion of the integration over the longer of the estimated life of the customer relationship and the term of the contract, which is typically one year.

Software and Services Revenues

Software and Services revenues include license and maintenance revenues, Encompass SaaS revenues, CenterWise for Encompass licensees and services revenues.

License and Maintenance Revenues.    We recognize revenues from the sale of licenses of Encompass software, typically in the month in which the software is delivered. For arrangements with multiple obligations such as undelivered maintenance and support contracts bundled with licenses, we allocate revenues to the delivered elements of the arrangement using the residual value method based on objective evidence of the fair value of the undelivered elements when vendor specific objective evidence, or VSOE, is determinable. The fair value of maintenance services for software licenses, whether an initial license or a renewal, is recognized ratably over the term of the maintenance contract. When VSOE is not determinable, we allocate all revenues to the undelivered elements and the entire arrangement is recognized ratably over the term of the contract. We believe that we have VSOE for our maintenance and support obligations based upon the prices our customers pay for the

 

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separate renewal of these services. If collectability is not assured, we recognize revenues upon receipt of cash payment.

Encompass SaaS Revenues.    We offer web-based access to our Encompass software. Customers can elect to pay a monthly recurring fee, which we recognize ratably when the service is performed. Associated set-up fees are recognized ratably over the life of the relationship with the customer, which is generally the term of the contract. Contracts generally range from one to three years. Alternatively, customers can elect to pay on a per closed loan, or success, basis with a monthly minimum. The success-based contracts generally have a term of two years. We recognize the monthly minimums as the service is performed and recognize additional amounts arising from closed loans when the loans close. Our Encompass SaaS offering also includes CenterWise for Encompass as an integrated component, which is a combined element of the arrangement that is delivered in conjunction with the Encompass SaaS offering and therefore is not accounted for separately.

CenterWise for Encompass Licensees.    CenterWise is offered as a standalone product with revenues recognized when the service is performed. It is also automatically included in the Encompass SaaS offering for which revenue is recognized as discussed above.

Services Revenues.    Mortgage originators, whether Encompass users or legacy customers acquired as a result of our acquisitions, such as our ODI and Mavent acquisitions, pay fees for services that they order, such as automated document preparation and compliance reports. We recognize revenues for these services when the service is performed.

Income Taxes

We record income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. In estimating future tax consequences, generally all expected future events other than enactments or changes in the tax law or rates are considered. Valuation allowances are provided when necessary to reduce deferred tax assets to the amount expected to be realized. Our determination of our valuation allowance is based upon a number of assumptions, judgments and estimates, including forecasted earnings, future taxable income and the relative proportions of revenue and income before taxes in the various jurisdictions in which we operate.

We operate in various tax jurisdictions and are subject to audit by various tax authorities. We provide for tax positions whenever it is deemed likely that a tax asset has been impaired or a tax liability has been incurred for events such as tax claims or changes in tax laws. The tax effects of a position are recognized only when they are considered “more likely than not” to be sustained based solely on its technical merits as of the reporting date.

We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments and which may not accurately anticipate actual outcomes. Our judgments, assumptions, and estimates relative to the current provision for income tax take into account current tax laws, our interpretation of current tax laws, and possible outcomes of current and future audits conducted by foreign and domestic tax authorities. Changes in tax laws or our interpretation of tax laws and the resolution of current and future tax audits could significantly impact the amounts provided for income taxes in our consolidated balance sheets and consolidated statements of operations. We must also assess the likelihood that deferred tax assets will be realized from future taxable income and, based on this assessment, establish a valuation allowance, if required. Our determination of our valuation allowance is based upon a number of assumptions, judgments, and estimates, including forecasted earnings, future taxable income, and the relative proportions of revenue and income before taxes in the various jurisdictions in which we operate. To the extent we establish a valuation allowance or change the valuation allowance in a period, we reflect the change with a corresponding increase or decrease to our tax provision in our consolidated statements of operations.

 

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Stock-based Compensation

We recognize expense related to stock-based compensation awards that are ultimately expected to vest based on estimated fair values on the date of grant using the Black-Scholes option-pricing model. Stock compensation expense is recognized on a straight-line basis over the requisite service period of the award, which generally equals the vesting period.

We estimate potential forfeitures of stock grants and adjust stock-based compensation expense accordingly. The estimate of forfeitures is adjusted over the requisite service period to the extent that actual forfeitures differ, or are expected to differ, from the prior estimates. Changes in estimated forfeitures are recognized in the period of change and impact the amount of stock compensation expenses to be recognized in future periods, which could be material if actual results differ significantly from our estimates.

All stock option awards to non-employees are generally accounted for at the fair value of the equity instrument issued, as calculated using the Black-Scholes option-pricing model. The measurement of stock-based compensation for non-employees is subject to periodic adjustments as the options vest, and the expense is recognized over the period over which services are received.

The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model. We determined weighted average valuation assumptions as follows:

 

   

Volatility.    As we do not have a trading history for our common stock, the expected stock price volatility for our common stock was estimated by taking the median historic price volatility for industry peers based on daily price observations over a period equivalent to the expected term of the stock option grants. Industry peers consist of several public companies in the technology industry similar in size, stage of life cycle and financial leverage.

 

   

Expected term.    The expected term was estimated using the simplified method as permitted by the SEC.

 

   

Risk free rate.    The risk free interest rate is based on the yields of U.S. Treasury securities with maturities similar to the expected term of the options for each option group.

 

   

Dividend yield.    We have never declared or paid any cash dividends and do not presently plan to pay cash dividends in the foreseeable future. Consequently, we used an expected dividend yield of zero.

The following table summarizes the assumptions relating to our stock options for the year ended December 31, 2010:

 

     Year Ended
December 31, 2010

Volatility

   55.0% – 56.0%

Expected term

   5.0 – 6.08 years

Risk free rate

   1.18% – 3.12%

Dividend yield

   0%

Using the Black-Scholes option-pricing model, we recorded non-cash stock-based compensation expense related to employee stock options granted of approximately $2.1 million for the year ended December 31, 2010.

The fair market values of the common stock underlying stock options granted during 2009 and 2010 were estimated by our board of directors, which intended that all options granted be exercisable at a price per share not less than the per share fair market value of our common stock underlying those options on the date of grant. In the absence of a public trading market, our board of directors considered numerous objective and subjective factors to determine its best estimate of the fair market value of our common stock as of the date of each option

 

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grant, including but not limited to, the following factors: (i) the rights, preferences and privileges of our preferred stock relative to the common stock; (ii) our performance and stage of development; (iii) valuations of our common stock; and (iv) the likelihood of achieving a liquidity event for the shares of common stock underlying these stock options, such as an initial public offering or sale of our company, given prevailing market conditions. The assumptions we use in our valuation models are based on subjective future expectations combined with management judgment. If any of the assumptions used in the Black-Scholes option-pricing model changes significantly, stock-based compensation for future awards may differ materially compared with the awards granted previously.

As of each stock option grant date from January 1, 2009 through December 31, 2010, our board of directors evaluated numerous factors to determine the fair market value of our common stock and set the exercise price of the options granted equal to the fair market value of our common stock determined as of such date, accordingly. On each option grant date, our board of directors considered the most recent valuation of our common stock as one of several factors in estimating the fair market value of our common stock. In addition, our board of directors considered changes in our financial condition and results of operations that had occurred since the most recent valuation date, then-current general economic and market conditions as described more fully below, and other objective and subjective factors described above. Based on these considerations, our board of directors determined that no significant change in our business or expectations of future business had occurred as of each grant date since the most recent valuation that would have warranted a materially different determination of value of our common stock than that suggested by the valuation, except for option grants in October 2009 and February 2010 in which cases our board of directors determined that an increase from the previous valuation was appropriate given our progress towards consummating an initial public offering. The valuations were performed in a manner consistent with the guidance and methods outlined in the AICPA Practice Aid, Valuation of Privately- Held-Company Equity Securities Issued as Compensation, or AICPA Practice Aid, for all option grant dates listed below.

For 2009, in connection with the preparation of our consolidated financial statements, and in a manner consistent with prior years, we contracted with an independent valuation company to perform analyses to assess the fair market value of our common stock as of December 31, 2008, June 30, 2009, September 30, 2009 and December 31, 2009. We also had a similar valuation analyses performed for March 31, 2010, June 30, 2010, September 30, 2010 and December 31, 2010, which were used for grants during those respective periods. These analyses were performed to assist management and our board of directors in determining fair market value for our stock options. Each valuation analysis consisted of two major steps: the estimation of the aggregate value of the entire company, referred to as Business Enterprise Value, or BEV, and the allocation of this aggregate value to our capital structure, including our redeemable convertible preferred stock, common stock, common stock warrants and common stock options. This approach is consistent with the methods outlined in the AICPA Practice Aid.

Significant Factors, Assumptions and Methodologies Used in Determining Fair Value

In determining the fair value of our BEV and common stock, we used a combination of the income approach and the market approach, which were equally weighted, to estimate our aggregate BEV at each valuation date described above. The income approach involves making an estimate of the present value of the future monetary benefits expected to flow to the owners of a business. It requires a projection of the cash flows that the business is expected to generate over a forecast period and an estimate of the present value of cash flows beyond that period, which is referred to as residual value. These cash flows are converted to present value by means of discounting, using a rate of return that accounts for the time value of money and the appropriate degree of risks inherent in the business. With the market approach, one considers multiples of financial metrics based on both acquisitions and trading multiples of a peer group of companies. These multiples are then applied to our financial metrics to derive an indication of value.

 

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We used an average of results from the income approach and market approach valuation methods to estimate BEV for the December 2008 and June 2009 valuations, with each method being equally weighted. The calculated BEV was then allocated to the various securities that comprise our capital structure using the option-pricing method for these periods. The equal weighting of the income and market approaches reflected our belief that both these valuation methods provided a reasonable estimate of our BEV and were equally reliable.

The income approach involves applying certain assumptions, including the weighted average cost of capital, which reflected our estimated cost of equity and debt at a ratio of 95% and 5%, respectively. Our estimated cost of equity was determined by calculating the average cost of equity for a group of publicly-traded companies considered to be reasonably comparable to us. Our estimated cost of debt was determined by calculating the estimated cost of long term debt on an after-tax basis.

The market approach also involves the use of assumptions, including multiples of financial metrics for a peer group of companies, which were then applied to our projected revenues and earnings to derive an indication of value. Ranges of forecasted revenue multiples were considered in our December 31, 2008 and June 30, 2009 valuations, as well as forecasted earnings multiples.

The resulting BEV obtained by averaging the values calculated under the income approach and the market approach was then discounted for lack of marketability for being a private company.

The assumptions for each of the above factors used in determining estimated BEV were as follows:

 

Valuation

   Weighted
Average Cost of
Capital
    Forecasted
Revenue
Multiples
   Forecasted
Price to
Earnings
Multiples
   Marketability
Discount
 

December 31, 2008

     12   1.5-2.0x    14.0-16.0x      30.4

June 30, 2009

     13      1.5-2.0      12.0-14.0        32.0   

The option-pricing method was then applied to the calculated BEVs and involves making assumptions regarding the anticipated timing of a potential liquidity event, such as an initial public offering, and estimates of the volatility of our equity securities. The anticipated timing of a potential liquidity event was based on the plans of our board of directors and management at the time of the valuation. Estimating the volatility of the share price of a privately-held company is complex because there is no readily available market for our shares. Our board of directors estimated the volatility of our stock based on available information on the volatility of stocks of publicly-traded companies in our industry determined to be reasonably comparable to us.

The assumptions for each of the above factors used in the option pricing model valuations are as follows:

 

Valuation

   Risk Free
Interest Rate
    Term to
Liquidity
Event
   Volatility Rate     Fair Value
Determined
 

December 31, 2008

     1.00   3 years      60   $ 0.46   

June 30, 2009

     1.11      2                 65        0.52   

During the third quarter of 2009, we determined that it was more appropriate to use the probability weighted expected return method, or PWERM, rather than the option-pricing method used for the earlier valuations. The PWERM was used for the September 30, 2009, December 31, 2009, March 31, 2010, June 30, 2010, September 30, 2010 and December 31, 2010 valuations and is generally considered to be a more sound method to determine fair value of an enterprise that has reasonable expectations of a liquidity event. Given our board of directors’ and management’s evolving outlook in the second half of 2009 that a public offering might be more viable based on our financial performance and business prospects, and the generally improving conditions in the capital markets, we determined the PWERM was a more appropriate methodology with which to assess fair value of our common stock.

 

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Our valuations that used the PWERM to estimate fair value involved analyzing the probability weighted present value of expected future values assuming the occurrence of certain liquidity events, such as an initial public offering, sale of the company or continuation of operations as a private company, as well as the respective rights of common and preferred holders. For each of the possible future liquidity events, our board of directors and management estimated a range of future equity values. Based on a weighted combination of the approaches, a probability-weighted value per share of common stock was determined.

When estimating value under the initial public offering scenario, we determined our BEV based on our speculative pre-money initial public offering value assuming a 15-month, 11-month, 9-month, 13-month, 11-month and 8-month holding period for the September 30, 2009, December 31, 2009, March 31, 2010, June 30, 2010, September 30, 2010 and December 31, 2010 valuations, respectively, adjusted for an appropriate discount rate of 25%, 25%, 20%, 20%, 18% and 17%, respectively.

When estimating value under the sale scenario, we determined our BEV by utilizing the values determined in the private company scenario, but the calculated amounts were increased for an estimated 25% control premium, and adjusted for a marketability discount.

When estimating value under the private company scenario, we used an average of values calculated under the income and market approaches, and adjusted for a marketability discount. The equal weighting of the income and market approaches reflects our belief that both these valuation methods provide equally reasonable estimates of our BEV and are equally reliable. Under the income approach, we needed to use an estimate of weighted average cost of capital. Under the market approach, we considered estimates of forecasted revenue and earning multiples for upcoming periods.

The assumptions for each of the above factors used in determining BEV under the private company scenario were as follows:

 

Valuation

   Weighted
Average Cost of
Capital
    Forecasted
Revenue
Multiples
   Forecasted
Price to
Earnings
Multiples

September 30, 2009

     25   2.00-2.25x    16-18x

December 31, 2009

     25      2.25-2.50      17-19  

March 31, 2010

     20      2.50-2.75      16-18  

June 30, 2010

     20      2.25-2.50      16-18  

September 30, 2010

     18      2.50-2.75      15-17  

December 31, 2010

     17      3.00-3.25      17-19  

The assumed probabilities for each future liquidity event and marketability discount applied in the PWERM model, and the resulting fair value determined, are as follows:

 

Valuation

   IPO
Probability
    Sale
Probability
    Private
Company
Probability
    Marketability
Discount
    Fair Value
Determined
 

September 30, 2009

     25-30     15-20     50-60     22   $ 1.28   

December 31, 2009

     40-45        15-20        35-45        14        2.18   

March 31, 2010

     60-65        15-20        15-25        14        2.85   

June 30, 2010

     65-70        15-20        10-20        14        2.95   

September 30, 2010

     70-75        15-20        5-15        14        3.00   

December 31, 2010

     80-85        10-15        0-10        14        3.35   

Our indicated BEV at each valuation date was then allocated to the shares of redeemable convertible preferred stock, common stock, warrants to purchase shares of common stock and options to purchase shares of common stock assuming conversion for convertible instruments or exercise for options and warrants. This

 

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methodology treats the various components of our capital structure to be equivalent shares of common stock, and allocates the BEV to the resulting common stock on a fully diluted basis.

Changes in Fair Value Assessments

As noted above, at each option grant date in 2009 and in 2010, our board of directors considered the objective and subjective factors discussed above, including the valuations. The primary reasons for the changes in the fair value of our common stock during this period and between each valuation date are summarized as follows:

September 30, 2009 Valuation.    The increase in fair value determination from $0.52 as of June 30, 2009 to $1.28 as of September 30, 2009, was due primarily to continued operating performance above expectations, continued improved expectations for our future financial performance and continued improvements in the overall capital markets and fair values of peer group companies used to estimate fair value of our common stock. Specifically, the extended low interest rate environment continued to result in higher than anticipated refinancing activity and unanticipated transaction volume resulting in higher than expected revenue and profits. Management expectations also improved due to the advancement of certain strategic relationships, as well as potential acquisitions of related services companies. Our change to the PWERM as part of our fair value reassessment also contributed to a higher determination of value. The PWERM was considered more appropriate given our board of directors’ increased interest in pursuing a public offering of common stock if capital market conditions continued to improve. The assigned probability of an initial public offering was considered reasonable at that time, given a level of uncertainty that existed about the sustainability of the recovery of the capital markets, and general uncertainty among service providers in the mortgage industry.

December 31, 2009 Valuation.    The increase in fair value determination from $1.28 as of September 30, 2009 to $2.18 as of December 31, 2009, was due primarily to continued operating performance above expectations, continued improved prospects for our future financial performance and continued improvements in the overall capital markets and fair values of peer group companies used to estimate fair value of our common stock. We also modified input assumptions to the PWERM model to reflect our view at the time of such valuation that an initial public offering was more likely to occur than in September 2009, and to reflect that we had begun to have substantive discussions with potential underwriters about the prospects for an offering.

March 31, 2010 Valuation.    The increase in fair value determination from December 31, 2009 to March 31, 2010 from $2.18 to $2.85 was due primarily to increased revenues for the period, continued improved prospects for our future financial performance and continued improvements in the overall capital markets and fair values of peer group companies used to estimate fair value of our common stock. Specifically, there were a number of initial public offerings that had recently been executed and favorably received by the market. We also modified input assumptions to the PWERM model to reflect our view at the time of such valuation that an initial public offering was more likely than in December 2009, and to reflect that we had begun to prepare for an initial public offering with underwriters and other advisors.

June 30, 2010 Valuation.    The increase in fair value determination from March 31, 2010 to June 30, 2010 from $2.85 to $2.95 was due primarily to continued improvements in our financial performance for the period, continued improved prospects for our future financial performance and continued improvements in the overall capital markets and fair values of peer group companies used to estimate fair value of our common stock. We also modified input assumptions to the PWERM model to reflect our view at the time of such valuation that an initial public offering was slightly more likely than in March 2010, and to reflect our ongoing efforts for an initial public offering with underwriters and other advisors.

September 30, 2010 Valuation.    The increase in fair value determination from June 30, 2010 to September 30, 2010 from $2.95 to $3.00 was due primarily to continued improvements in our financial performance for the period, continued improved prospects for our future financial performance and continued improvements in the overall capital markets and fair values of peer group companies used to estimate fair value of our common stock.

 

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We also modified input assumptions to the PWERM model to reflect our view at the time of such valuation that an initial public offering was slightly more likely than in June 2010, and to reflect our ongoing efforts for an initial public offering with underwriters and other advisors.

December 31, 2010 Valuation.    The increase in fair value determination from September 30, 2010 to December 31, 2010 from $3.00 to $3.35 was due primarily to continued improvements in our financial performance for the period, continued improved prospects for our future financial performance and continued improvements in the overall capital markets and fair values of peer group companies used to estimate fair value of our common stock. We also modified input assumptions to the PWERM model to reflect our view at the time of such valuation that an initial public offering was slightly more likely than in September 2010, and to reflect our ongoing efforts for an initial public offering with underwriters and other advisors.

Common Stock Valuations

In connection with the preparation of our consolidated financial statements for the year ended December 31, 2009 and 2010, to be included in this prospectus, we reassessed our estimate of fair value of our common stock for financial reporting purposes using the PWERM instead of the combination of the income and market approaches applied during the course of 2009 and 2010. Due to differences between the dates of our valuations and dates of options granted after January 1, 2009, we adjusted the fair value of our common stock for financial reporting purposes for option grants made from January 1, 2009 through December 31, 2010, which resulted in these option grants having exercises prices below the subsequently determined fair value per share. These calculated fair values used for financial reporting purposes were derived based on linear interpolations between the valuations performed. Linear interpolations were considered appropriate because there were no individually significant factors, events, or changes in our business between the valuation dates that would indicate a more appropriate attribution model.

We granted stock options with the following exercise prices and fair value assessments from January 1, 2009 through December 31, 2010:

 

Option Grant Dates

   Number of
Shares
Underlying
Options
     Exercise
Price Per
Share
     Fair
Value Per
Share as of
Grant Date
     Intrinsic
Value
 

February 2009

     14,000       $ 0.46       $ 0.46       $   

April 2009(1)

     6,356,500         0.46         0.49         0.03   

August 2009

     90,000         0.52         1.02         0.50   

October 2009

     58,000         1.35         1.58         0.23   

February 2010

     736,500         2.25         2.63         0.38   

April 2010(2)

     142,500         0.46         2.88         2.42   

April 2010(2)

     105,000         1.22         2.88         1.66   

April 2010(2)

     420,730         1.25         2.88         1.63   

April 2010(2)

     5,541         4.61         2.88           

August 2010

     1,804,000         2.95         2.98         0.03   

September 2010

     75,000         2.95         3.00         0.05   

October 2010

     94,000         3.00         3.12         0.12   

 

(1) Includes 5,982,000 shares issuable upon exercise of options granted in an exchange of outstanding options on a 1-for-1 basis with new two-year vesting schedule for all vested portions of the exchanged option.
(2) Represents Replacement Options. For more information on Replacement Options, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Overview.”

The aggregate intrinsic value of vested and unvested stock options as of December 31, 2010, based on the initial public offering price of $             per share, which is the midpoint of the range set forth on the cover page of the prospectus, was $             million and $             million, respectively.

 

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Repricing of Stock Options

In December 2001, we made offers to replace employee options with an exercise price of $4.61 with options having an exercise price of $1.25. Options for a total of 2,274,149 shares were cancelled and repriced at $1.25 by December 31, 2001. In accordance with the applicable accounting guidance, the replacement options are being accounted for using variable plan accounting. We recognized stock-based compensation expense of $0, $514,000 and $622,000 in the years ended December 31, 2008, 2009 and 2010, respectively, related to the variable plan accounting for these options.

At December 31, 2010, we had outstanding stock options to purchase an aggregate of 399,800 shares of common stock remaining that were repriced pursuant to the stock option repricing that occurred in December 2001. Under the variable accounting rules, we will recognize stock-based compensation expense or gain with respect to the remaining shares through December 31, 2011 in an amount equal to the number of shares of common stock underlying such options that remain outstanding as of the end of the quarter multiplied by the difference between the fair value of our common stock at the end of the quarter and the fair value of our common stock at the end of the immediately preceding quarter. For this purpose, the deemed fair value of our common stock at December 31, 2010 is $3.35 per share.

As of December 31, 2010, a 10% change in the fair market value of the our common stock would result in a change of approximately $134,000 in stock-based compensation.

In February 2009, we made offers to replace employee options with exercise prices of $1.80 and $1.98 with options having an exercise price of $0.46 and which included new vesting periods in accordance with the terms of the repricing plan. A total of 5,982,000 shares were cancelled and repriced at $0.46 in April 2009. The replacement options are being accounted for as a modification to the original option grants and resulted in incremental stock-based compensation expense of approximately $717,000, which is recognized as the awards vest. For more information, see “—Overview” above.

Goodwill and Other Intangible Assets

Goodwill and other intangible assets are stated at cost less accumulated amortization, as appropriate. Other intangible assets include developed technology, trade names and customer lists and contracts. Intangibles with finite lives are amortized on a straight-line basis over the estimated periods of benefit, generally three to seven years. Goodwill and intangible assets with indefinite useful lives are not amortized, but tested for impairment at least annually, or whenever changes in circumstances indicated that the carrying amount of goodwill or intangible assets may not be recoverable. These tests are performed at the reporting unit level using a two-step, fair-value approach. We completed annual impairment tests for 2008, 2009 and 2010 and determined that our goodwill was not impaired for those years. The fair value of the reporting unit exceeded carrying value by over 100% for each of these periods.

The process of evaluating the potential impairment of goodwill requires significant judgment at many points during the analysis. To determine estimated fair value, we used the income approach, under which fair value was calculated based on estimated discounted future cash flows. The income approach was determined to be the most representative valuation technique that would be utilized by a market participant in an assumed transaction. Significant assumptions are based on historical and forecasted results of operations, and consider estimates of cash flows, including revenues, operating costs, growth rates and other relevant factors, as well as discount rates to be applied. Although the cash flow forecasts used are based on assumptions that are consistent with the plans and estimates used to manage the business, significant judgment was required.

If management’s estimates of future operating results change, if there are changes in identified reporting units or if there are changes to other significant assumptions, the estimated carrying values of such reporting units and the estimated fair value of goodwill could change significantly, and could result in an impairment

 

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charge. Such changes could also result in goodwill impairment charges in future periods, which could have a significant impact on our operating results and financial condition therein.

We assess the impairment of identifiable intangible assets whenever events or changes in circumstances indicate that an asset’s carrying amount may not be recoverable. An impairment loss would be recognized when the sum of the undiscounted estimated future cash flows expected to result from the use of the asset and its eventual disposition is less than its carrying amount. Such impairment loss would be measured as the difference between the carrying amount of the asset and its fair value. Cash flow assumptions are based on historical and forecasted revenue, operating costs, and other relevant factors. If management’s estimates of future operating results change, or if there are changes to other assumptions, the estimate of the fair value of our acquired product rights and other identifiable intangible assets could change significantly. Such change could result in impairment charges in future periods, which could have a significant impact on our operating results and financial condition.

Results of Operations

The following tables set forth our results of operations for the periods presented and as a percentage of our revenues for those periods. The period-to-period comparison of financial results is not necessarily indicative of future results.

 

    Year Ended December 31,  
    2008     2009     2010  
    (in thousands)  

Consolidated statements of operations data:

     

Revenues

  $ 33,573      $ 37,707      $ 43,234   

Cost of revenues(1)

    13,028        12,163        12,505   
                       

Gross profit

    20,545        25,544        30,729   

Operating expenses:

     

Sales and marketing(1)

    7,553        7,532        9,555   

Research and development(1)

    6,898        7,945        10,468   

General and administrative(1)

    7,470        8,213        9,823   
                       

Total operating expenses

    21,921        23,690        29,846   
                       

Income (loss) from operations

    (1,376     1,854        883   

Other income, net

    293        72        119   
                       

Income (loss) before income taxes

    (1,083     1,926        1,002   

Income tax provision (benefit)

    (24     264        225   
                       

Net income (loss)

  $ (1,059   $ 1,662      $ 777   
                       

 

(1) Stock-based compensation included in above line items:

 

     Year Ended December 31,  
     2008      2009      2010  
     (in thousands)  

Cost of revenues

   $ 19       $ 144       $ 192   

Sales and marketing

     35         145         303   

Research and development

     78         271         443   

General and administrative

     147         563         1,130   
                          

Total(a)

   $ 279       $ 1,123       $ 2,068   
                          

 

  (a) Approximately $0, $514,000 and $622,000 of stock-based compensation expense for the years ended December 31, 2008, 2009 and 2010, respectively, related to variable accounting for repriced stock options.

 

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     Year Ended December 31,  
     2008     2009     2010  
     (as a percentage of revenues)  

Consolidated statements of operations data:

      

Revenues

     100.0     100.0     100.0

Cost of revenues

     38.8        32.3        28.9   
                        

Gross profit

     61.2        67.7        71.1   

Operating expenses:

      

Sales and marketing

     22.5        20.0        22.1   

Research and development

     20.5        21.1        24.2   

General and administrative

     22.3        21.8        22.7   
                        

Total operating expenses

     65.3        62.9        69.0   
                        

Income (loss) from operations

     (4.1     4.9        2.1   

Other income, net

     0.9        0.2        0.2   
                        

Income (loss) before income taxes

     (3.2     5.1        2.3   

Income tax provision (benefit)

     0.0        0.7        0.5   
                        

Net income (loss)

     (3.2 )%      4.4     1.8
                        

The following table sets forth certain operating data for the periods presented:

 

     Year Ended December 31,  
     2008      2009      2010  

Active Encompass Users (at end of period):

        

Active Lender Encompass Users

     28,083         33,221         39,687   

Active Broker Encompass Users

     29,344         21,806         11,014   
                          

Total Active Encompass Users

     57,427         55,027         50,701   
                          

Average Active Encompass Users (during period):

        

Average Active Lender Encompass Users

     29,614         32,836         36,625   

Average Active Broker Encompass Users

     38,155         25,447         15,352   
                          

Average Total Active Encompass Users

     67,769         58,283         51,977   
                          

Encompass-related revenues (in thousands):

        

Encompass-related revenues—Lenders

   $ 20,389       $ 26,386       $ 34,116   

Encompass-related revenues—Brokers

     8,762         5,482         4,683   
                          

Total Encompass-related revenues

   $ 29,151       $ 31,868       $ 38,799   
                          

Encompass-related revenues per Average Active Encompass Users:

        

Encompass-related revenues—Lenders per Average Active Lender Encompass Users

   $ 688       $ 804       $ 932   

Encompass-related revenues—Brokers per Average Active Broker Encompass Users

     230         215         305   

Encompass-related revenues per Average Active Encompass Users

     430         547         746   

SaaS success-based pricing-related data:

        

Active SaaS Success-Based Pricing Encompass Users (at end of period)

     —           1,261         8,704   

SaaS success-based pricing-related revenues (in thousands)

   $ —         $ —         $ 4,944   

 

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Years ended December 31, 2008, 2009 and 2010

Revenues

 

     Year Ended December 31,  
     2008     2009     2010  
     (dollars in thousands)  

Revenues by type:

      

Software and Services

   $ 23,683      $ 29,195      $ 33,880   

Network Transactions

     9,890        8,512        9,354   
                        

Total

   $ 33,573      $ 37,707      $ 43,234   
                        

Percentage of revenues by type:

      

Software and Services

     70.5     77.4     78.4

Network Transactions

     29.5        22.6        21.6   
                        

Total

     100.0     100.0     100.0
                        

Total revenues increased $5.5 million, or 14.7%, from 2009 to 2010. This increase was primarily due to an increase in Software and Services revenues, comprised of a $4.9 million increase in success-based pricing revenues due to its first full year on the market, a $2.2 million increase in compliance service revenues from our Mavent acquisition in December 2009, and a $0.6 million increase in CenterWise revenues. These increases were partially offset by a $1.6 million decrease in document preparation services revenues arising from a decline in refinancing activities from the elevated level of refinancing activity in the first half of 2009 that arose from government incentives, a $0.5 million decrease in self-hosted software revenues due to our focus on our Encompass SaaS offering, which led to conversions of existing users of our license model and fewer new license sales, and a $1.0 million decrease in standard hosted Encompass revenues due to clients converting to the success-based pricing model.

Network Transaction revenues increased $0.8 million from 2009 to 2010 primarily due to a $1.2 million increase in appraisal transaction revenues reflecting a full year of appraisal transaction services in 2010 after its introduction in late 2009, partially offset by a decline in the volume of loan activity on the Ellie Mae Network from overall industry declines.

The number of Active Lender Encompass Users increased by 19.5% primarily due to new lender customers adopting our Encompass SaaS success-based pricing offering. However, the number of Active Encompass Users decreased 7.9% from the end of 2009 to the end of 2010 due to the 49.5% decline in Active Broker Encompass Users. Encompass-related Revenues per Average Active Broker Encompass User increased by 41.9% due to the significant loss of Active Broker Encompass Users that had previously provided only minimal revenues. Encompass-related revenues per Average Active Lender Encompass User increased by 15.9% due to the growth in the number of Active Lender Encompass Users using our success-based pricing offering.

The $4.1 million increase in revenues from 2008 to 2009 was due to an increase in Software and Services revenues, related to an increase of $5.8 million in our document preparation services. Document preparation services increased as a result of: (i) a significant increase in mortgage refinancings in the first half of 2009 in response to lower interest rates; (ii) a shift in our customer base from mortgage brokerages to mortgage lenders, the responsibilities of which include the preparation of closing documents; and (iii) our acquisition of ODI in the fourth quarter of 2008, which generated an additional $2.7 million of revenue in 2009. Software and Services revenues from CenterWise, which was fully launched at the beginning of 2008, increased from $1.2 million in 2008 to $3.1 million in 2009 due to a significant increase in market acceptance. These Software and Services revenue increases were offset by a $1.2 million decrease in self-hosted software and maintenance revenue and a $0.5 million decrease in website revenue. Network Transaction revenues decreased $1.4 million due to a decline in the number of mega lenders and volume of loan activity on our network reflecting overall industry declines.

 

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The number of Active Encompass Users decreased from the end of 2008 to the end of 2009 as the number of mortgage professionals in the industry decreased from 279,800 to 261,400,11 a 6.6% decrease. This was reflected in the 25.7% decline in Active Broker Encompass Users between 2008 and 2009. However, during the same period, the number of Active Lender Encompass Users increased by 18.3%. Encompass revenue per Average Active Encompass User increased due to increased sales and use of Encompass Closer, Centerwise, Banker Edition, and Network Transactions by Lender Encompass Users. Encompass-related revenues per Average Active Lender Encompass User increased by 16.9%, while Encompass-related revenues per Average Active Broker Encompass User declined by 7.0%.

Gross Profit

 

     Year Ended December 31,  
     2008     2009     2010  
     (dollars in thousands)  

Gross profit

   $ 20,545      $ 25,544      $ 30,729   

Gross margin

     61.2     67.7     71.1

Gross profit and gross margin increased by $5.2 million and 3.4%, respectively, from 2009 to 2010 as revenues increased by $5.5 million and cost of revenues increased by only $0.3 million. Cost of revenues increased due to a $0.9 million increase in salaries and employee benefits from increased headcount in implementation services and professional services primarily associated with our Mavent acquisition in December 2009, a $0.5 million increase in software maintenance and expense primarily for virtualization software and acquired software contract maintenance obligations from the Mavent acquisition, a $0.5 million increase in data center expenses from the Mavent acquisition, a $0.4 million increase in temporary staff expense for additional customer support and for assistance with the integration of Mavent, as well as a $0.4 million increase in expenses related to implementation services. These increases were offset in part by a $1.6 million reduction in document preparation costs attributable to a reduction in volume of document preparation services activities and a reduced reliance on outside document preparation vendors, a $0.7 million decrease in depreciation and amortization expense due to completion of amortization of certain network equipment and smaller fixed asset purchases during 2010, and a $0.1 million reduction in bonus expenses.

The increase in gross profit as a percentage of revenues, or gross margin, from 2008 to 2009 was a result of increased revenues, greater margin on our Encompass Closer services due to the ODI transaction in September 2008, a reduction of $1.2 million in depreciation expense arising from smaller fixed asset purchases and a $0.5 million reduction in data center expenses due to our decision in 2008 to consolidate our data centers. These changes were offset in part by a $0.2 million increase in compensation expense due to additional headcount associated with our employment of former ODI employees at the end of 2008.

Sales and Marketing

 

     Year Ended December 31,  
     2008     2009     2010  
     (dollars in thousands)  

Sales and marketing

   $ 7,553      $ 7,532      $ 9,555   

Sales and marketing as % of revenues

     22.5     20.0     22.1

Sales and marketing expenses increased in absolute dollars and as a percentage of revenues from 2009 to 2010 primarily due to our strategy of significantly increasing our sales activities focused on mortgage lenders.

 

11 Bureau of Labor Statistics, Mortgage Employment Statistics, February 2011.

 

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Sales and marketing expenses increased by $2.0 million, or 26.9%, from 2009 to 2010. This increase was due to a $0.9 million increase in salaries and employee benefits attributable to increased investment in sales activities for mortgage lenders including the addition of senior sales personnel and the transfer of a senior executive from general and administrative activities to sales activities, a $0.4 million increase in commissions and bonuses reflecting higher revenues in 2010, a $0.2 million increase in trade show and marketing expense due to increased marketing activities, a $0.2 million increase in stock based compensation and a $0.2 million increase in consulting expenses relating to lead generation for our compliance services.

Sales and marketing expenses were essentially the same in 2008 and 2009 due to a $0.3 million decrease arising from a headcount reduction in mid-2008, offset by a $0.3 million increase in commissions and bonuses on increased sales and the transfer of an executive from general and administrative activities to sales activities. The decrease in sales and marketing expense as a percentage of revenues was due to the increase in revenues from 2008 to 2009.

Research and Development

 

     Year Ended December 31,  
     2008     2009     2010  
     (dollars in thousands)  

Research and development

   $ 6,898      $ 7,945      $ 10,468   

Research and development as % of revenues

     20.5     21.1     24.2

Research and development expenses increased by $2.5 million, or 31.7%, from 2009 to 2010 primarily due to a $1.8 million increase in salary related expenses comprised of a $1.0 million increase for additional headcount from the Mavent acquisition and a $0.8 million increase for salary related expenses for additional research and development employees for other products. There was also a $0.2 million increase in consultant costs, a $0.2 million increase in stock-based compensation and a $0.3 million increase in benefits and payroll taxes related to the additional headcount.

Research and development expenses in 2009 increased as compared to 2008 due to increases in third-party consulting fees of $0.3 million and salaries of $0.2 million for employees hired from ODI to integrate the technology purchased from ODI into our Encompass Closer services, increases in legal costs of $0.1 million for patent application prosecution and $0.4 million of stock-based compensation and bonuses.

General and Administrative

 

     Year Ended December 31,  
     2008     2009     2010  
     (dollars in thousands)  

General and administrative

   $ 7,470      $ 8,213      $ 9,823   

General and administrative as % of revenues

     22.3     21.8     22.7

The increase in general and administrative expenses in absolute dollars and as a percentage of revenues was due in significant part to our preparation to become a publicly held company.

General and administrative expenses increased by $1.6 million, or 19.6%, from 2009 to 2010 due to a $0.6 million increase in salaries related to headcount increases in preparation to become a publicly held company, a $0.6 million increase in stock-based compensation, a $0.2 million increase in consulting, accounting and other professional fees related to integration of Mavent and preparation to become a publicly held company, a $0.3 million increase in accrued sales taxes arising from our review of potential exposures related to our sales tax positions in certain states, a $0.2 million increase in bad debt expenses primarily due to clients acquired in the Mavent acquisition, and a $0.2 million increase in director compensation under a new program initiated in 2010.

 

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These amounts were offset in part by a $0.2 million decrease in salaries resulting from the transfer of a senior executive from general and administrative activities to sales activities in late 2009, and a $0.1 million decrease in legal fees.

General and administrative expenses as a percentage of revenues decreased from 2008 to 2009 due to increased revenues. In absolute dollars, general and administrative expenses increased by $0.7 million due to increased non-cash stock-based compensation of $0.4 million and an increase in legal fees of $0.8 million associated with the DocMagic litigation filed against us in August 2009, offset by a $0.4 million decrease in consulting expense.

Other Income, Net

The increase in other income, net from 2009 to 2010 was due to increased interest income from a note receivable.

The decrease in other income, net from 2008 to 2009 was due to a decline in interest rates and interest earned on our cash and cash equivalents and short-term investments.

Income Taxes

The decrease in income tax expense from 2009 to 2010 was due primarily to usage of the California research tax credit in 2010, which was limited in 2009 under prior state law.

The increase in income tax expense from 2008 to 2009 was due to increases in taxable income and the State of California’s suspension of NOL carryforwards in 2009.

The income tax benefit for 2008 was the result of a U.S. federal statute which allowed for the accelerated use of research and development and alternative minimum tax credits based on fixed assets.

 

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Quarterly Results of Operations Data

The following tables set forth our unaudited quarterly consolidated statements of operations data and our unaudited statements of operations data as a percentage of revenues for each of the eight quarters in the period ended December 31, 2010. We have prepared the quarterly data on a consistent basis with the audited consolidated financial statements included elsewhere in this prospectus, and the financial information reflects all necessary adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of this data. The results of historical periods are not necessarily indicative of the results of operations for a full year or any future period.

 

     For the Three Months Ended  
     Mar 31,
2009
     Jun 30,
2009
     Sep 30,
2009
    Dec 31,
2009
    Mar 31,
2010
    Jun 30,
2010
    Sep 30,
2010
     Dec 31,
2010
 
    

(unaudited)

 
     (in thousands)  

Consolidated Statement of Operations Data:

                   

Revenues

   $ 10,111       $ 10,464       $ 8,334      $ 8,798      $ 8,879      $ 9,763      $ 11,924       $ 12,668   

Cost of revenues(1)

     3,333         3,486         2,816        2,528        3,075        3,087        3,146         3,197   
                                                                   

Gross Profit

     6,778         6,978         5,518        6,270        5,804        6,676        8,778         9,471   

Operating expenses:

                   

Sales and marketing(1)

     1,673         1,594         1,757        2,508        2,354        2,305        2,411         2,485   

Research and development(1)

     1,857         1,907         1,872        2,309        2,628        2,631        2,566         2,643   

General and administrative(1)

     1,728         1,878         2,041        2,566        2,446        3,067        2,040         2,270   
                                                                   

Total operating expenses

     5,258         5,379         5,670        7,383        7,428        8,003        7,017         7,398   
                                                                   

Income (loss) from operations

     1,520         1,599         (152     (1,113     (1,624     (1,327     1,761         2,073   

Other income, net

     17         10         12        33        32        29        31         27   
                                                                   

Income (loss) before income taxes

     1,537         1,609         (140     (1,080     (1,592     (1,298     1,792         2,100   

Income tax (benefit) provision

     183         191         (16     (94  

 

11

  

 

 

5

  

 

 

12

  

  

 

197

  

                                                                   

Net income (loss)

   $ 1,354       $ 1,418       $ (124   $ (986   $ (1,603   $ (1,303   $ 1,780       $ 1,903   
                                                                   

 

(1) Stock-based compensation included in above line items:

 

    For the Three Months Ended  
    Mar 31,
2009
    Jun 30,
2009
    Sep 30,
2009
    Dec 31,
2009
    Mar 31,
2010
    Jun 30,
2010
    Sep 30,
2010
    Dec 31,
2010
 
   

(unaudited)

(in thousands)

 

Cost of revenues

  $ 6      $ 8      $ 12      $ 118      $ 93      $ 25      $ 20      $ 54   

Operating expenses:

               

Sales and marketing

    10        19        23        93        103        50        59        91   

Research and development

    28        46        50        147        127        92        82        142   

General and administrative

    53        91        112        307        240        464        147        279   
                                                               

Total

  $   97      $ 164      $ 197      $ 665      $ 563      $ 631      $ 308      $ 566   
                                                               

 

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    For the Three Months Ended  

Percentage of Revenue

  Mar 31,
2009
    Jun 30,
2009
    Sep 30,
2009
    Dec 31,
2009
    Mar 31,
2010
    Jun 30,
2010
    Sep 30,
2010
    Dec 31,
2010
 
    (unaudited)  

Consolidated Statement of Operations Data:

               

Revenues

    100.0     100.0     100.0     100.0     100.0     100.0     100.0     100.0

Cost of revenues

    33.0        33.3        33.8        28.7        34.6        31.6        26.4        25.2   
                                                               

Gross Margin

    67.0        66.7        66.2        71.3        65.4        68.4        73.6        74.8   

Operating expenses:

               

Sales and marketing

    16.5        15.2        21.1        28.5        26.5        23.6        20.2        19.6   

Research and development

    18.4        18.2        22.5        26.2        29.6        27.0        21.5        20.9   

General and administrative

    17.1        17.9        24.5        29.2        27.5        31.4        17.1        17.9   
                                                               

Total operating expenses

    52.0        51.3        68.1        83.9        83.6        82.0        58.8        58.4   
                                                               

Income (loss) from operations

    15.0        15.4        (1.9     (12.6     (18.2     (13.6     14.8        16.4   

Other income, net

    0.2               0.2        0.3        0.2        0.3        0.2        0.2   
                                                               

Income (loss) before income taxes

    15.2        15.4        (1.7     (12.3     (18.0     (13.3     15.0        16.6   

Income tax (benefit) provision

    1.8        1.8        (0.2     (1.1     0.1        0.1        0.1        1.6   
                                                               

Net income (loss)

    13.4     13.6     (1.5 )%      (11.2 )%      (18.1 )%      (13.4 )%      14.9     15.0
                                                               
    For the Three Months Ended  
    Mar 31,
2009
    Jun 30,
2009
    Sep 30,
2009
    Dec 31,
2009
    Mar 31,
2010
    Jun 30,
2010
    Sep 30,
2010
    Dec 31,
2010
 
   

(unaudited)

(in thousands)

 

Revenues by type:

               

Software and Services

  $ 7,702      $ 8,024      $ 6,456      $ 7,013      $ 7,115      $ 7,559      $ 9,121      $ 10,085   

Network Transactions

    2,409        2,440        1,878        1,785        1,764        2,204        2,803        2,583   
                                                               

Total

  $ 10,111      $ 10,464      $ 8,334      $ 8,798      $ 8,879      $ 9,763      $ 11,924      $ 12,668   
                                                               

Percentage of revenues by type:

               

Software and Services

    76.2     76.7     77.5     79.7     80.1     77.4     76.5     79.6

Network Transactions

    23.8        23.3        22.5        20.3        19.9        22.6        23.5        20.4   
                                                               

Total

    100.0     100.0     100.0     100.0     100.0     100.0     100.0     100.0
                                                               

Active Encompass Users (at end of period):

               

Active Lender Encompass Users

    31,384        34,285        34,322        33,221        34,987        34,802        39,368        39,687   

Active Broker Encompass Users

    28,305        25,938        23,096        21,806        18,511        15,612        12,565        11,014   

Total Active Encompass Users

    59,689        60,223        57,418        55,027        53,498        50,414        51,933        50,701   

Average Active Encompass Users (during period):

               

Average Active Lender Encompass Users

    30,318        33,593        34,453        32,980        34,653        34,803        37,312        39,733   

Average Active Broker Encompass Users

    28,378        26,813        23,879        22,719        19,540        16,460        13,926        11,482   

Average Total Active Encompass Users

    58,696        60,406        58,332        55,699        54,193        51,263        51,238        51,215   

Encompass-related revenues (in thousands):

               

Encompass-related revenues—Lenders

  $ 6,603      $ 7,353      $ 6,041      $ 6,389      $ 6,440      $ 7,473      $ 9,549      $ 10,654   

Encompass-related revenues—Brokers

    1,537        1,388        1,222        1,335        1,316        1,266        1,143        958   
                                                               

Total Encompass-related revenues

  $ 8,140      $ 8,741      $ 7,263      $ 7,724      $ 7,756      $ 8,739      $ 10,692      $ 11,612   
                                                               

Encompass-related revenues per Average Active Encompass Users:

               

Encompass-related revenues—Lenders per Average Active Lender Encompass Users

  $ 218      $ 219      $ 175      $ 194      $ 186      $ 215      $ 256      $ 268   

Encompass-related revenues—Brokers per Average Active Broker Encompass Users

    54        52        51        59        67        77        82        83   

Encompass-related revenues per Average Active Encompass Users

    139        145        125        139        143        170        209        227   

SaaS success-based pricing-related data:

               

Active SaaS Success-Based Pricing Encompass Users (at end of period)

    —          —          —       

 

1,261

  

    2,738        4,200        6,785        8,704   

SaaS success-based pricing-related revenues (in thousands)

  $ —        $ —        $ —        $ —        $ 285      $ 700      $ 1,551      $ 2,408   

 

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Revenue levels in the first two quarters of 2009 were relatively high reflecting the significant increase in refinancing activity arising from low interest rates as well as normal seasonal trends in the second quarter. This refinancing activity decreased in the third and fourth quarters of 2009 and the first quarter of 2010, which adversely affected our Network Transactions revenues and the services component of our Software and Services revenues. The slight increase in revenues in the first quarter of 2010 reflects the first full quarter of compliance product revenues from our Mavent acquisition in December 2009, offset in part by a $0.3 million decline in document preparation services revenues. Revenues increased sequentially in the second, third and fourth quarters of 2010 primarily due to an increase in Encompass SaaS users under our success-based pricing model, reflecting our focus on sales and marketing of that offering. The increase was also due to increases in the second, third and fourth quarters of 2010 in document preparation and compliance services, and an increase in the second and third quarters of 2010 in the number of transactions processed through the Ellie Mae Network.

Encompass-related revenues and Encompass-related revenues per Average Active Encompass User were relatively high in the first and second quarters of 2009 due to a temporary surge in residential mortgage refinancings during those quarters. This refinancing activity decreased in the third and fourth quarters of 2009 and the first quarter of 2010, which accounts for the decline in the Encompass-related revenues per Average Active Encompass User in the third and fourth quarters of 2009 as compared to the previous quarters as well as the declines in the percentage of revenues attributable to Network Transactions and the services component of our Software and Services revenues. Our quarterly growth in Encompass-related revenues and Encompass-related revenues per Average Active Encompass User in the last three quarters of 2010 was primarily attributable to the increase in Encompass SaaS users under our success-based pricing model.

We believe the number of Active Lender Encompass Users has been positively affected by the introduction of our Encompass SaaS success-based pricing model. Consistent with industry trends, Active Broker Encompass Users decreased significantly in each quarter presented, and Encompass-related revenues from brokers have generally declined as well.

Encompass-related revenues per Active Lender Encompass User have generally increased subject to the extraordinary mortgage origination volume in the first half of 2009 and a smaller decline in the first quarter of 2010 as we implemented our Encompass SaaS-focused sales approach, which delays recognition of revenues as compared to licenses of Encompass.

Since the launch of our Encompass SaaS success-based pricing model in the fourth quarter of 2009, Active SaaS Success-Based Pricing Encompass Users and related revenues have sequentially grown each quarter, driven by increasing acceptance of this model by our target customer base.

Gross profit decreased in the first quarter of 2010 due to an overall increase in cost of revenues. The increase in cost of revenues was due to an increase in headcount in that quarter in addition to recognizing a full quarter of compensation, data center and software maintenance expenses related to our Mavent acquisition.

Sales and marketing expenses increased in the third and fourth quarters of 2009 due to marketing efforts for Encompass and Ellie Mae Network offerings. We incurred increased sales and marketing expenses in the fourth quarter of 2009 for several reasons including the addition of five sales employees, marketing expenses related to trade show attendance and the hosting of a targeted marketing event, increased commissions based on the achievement of sales milestones and additional bonuses. Sales and marketing expenses were relatively flat in the first three quarters of 2010 and increased in the fourth quarter of 2010 due to increased marketing activities at industry events and conferences.

Research and development expenses were relatively constant in absolute dollars for the first three quarters of 2009 and increased in the fourth quarter of 2009 due to increased compensation for employees acquired in the Mavent transaction and year-end performance bonuses and stock-based compensation expense. We incurred increased compensation expense in the first quarter of 2010 due to increases in salary-related expenses for the

 

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nine additional research and development employees from the Mavent acquisition, while total research and development expenses remained relatively flat in the second and third quarters of 2010. Research and development expenses increased in the fourth quarter of 2010 primarily due to increased stock-based compensation expense resulting from variable accounting treatment of outstanding stock options and increased bonuses.

General and administrative expenses are affected by the timing of accounting expenses as well as legal expenses for both litigation and transactional matters. General and administrative expenses increased in the third and fourth quarters of 2009 due to preparation for our initial public offering and expenses relating to litigation. General and administrative expenses decreased slightly in the first quarter of 2010 due to a reduction in legal expenses related to the DocMagic litigation. General and administrative expenses increased in the second quarter of 2010 due to increased legal expenses for the DocMagic litigation, increased stock-based compensation expense and sales tax reserve arising from our review of potential exposures related to our sales tax positions in certain states, partially offset by a decrease in accounting and bad debt expenses. General and administrative expenses for the third quarter of 2010 decreased due to a decrease in legal expenses for the DocMagic litigation, stock-based compensation and sales tax expenses. General and administrative expenses for the fourth quarter of 2010 increased due to increased stock-based compensation resulting from variable accounting treatment of outstanding stock options and increased year-end bonus accruals.

Liquidity and Capital Resources

Prior to 2006, we financed our operations and capital expenditures through private sales of preferred stock and lease financing. Since 2006, we have not required equity financing and have been able to finance our operations with existing cash and cash flow from operating activities.

As of December 31, 2010, we had cash, cash equivalents and short term investments of $16.9 million. Cash and cash equivalents consist of cash and money market accounts. Short-term investments consist of U.S. government agency securities.

We believe that our existing cash, cash generated from operating activities and the proceeds of our initial public offering will be sufficient to fund capital expenditures, operating expenses and other cash requirements for at least the next 12 months. In January 2011, we used $1.0 million of cash for the purchase of assets from Mortgage Pricing Systems. Although we are not currently a party to any agreement or letter of intent with respect to potential material investments in, or acquisitions of, complementary businesses, we may enter into these types of arrangements in the future, which could require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all.

The following table sets forth our statement of cash flows data for the periods presented:

 

    Year Ended December 31,  
    2008     2009     2010  
   

(in thousands)

 

Consolidated Statements of Cash Flows Data:

     

Cash flows provided by (used in) operating activities

  $ (175   $ 6,453      $ 1,676   

Cash flows (used in) provided by investing activities

    (1,650     (5,443     728   

Cash flows (used in) provided by financing activities

    (432     (273     454   

Purchases of property and equipment

    (557     (268     (1,436

Depreciation and amortization

    3,976        2,592        1,611   

Operating Activities

Cash provided by operating activities in 2010 was the result of net income of $0.8 million, adjusted by non-cash stock-based compensation of $2.1 million, depreciation and amortization expense of $2.0 million, an

 

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increase in accrued liabilities, other liabilities and accounts payable of $0.4 million due to increased accruals of $0.3 million for sales tax arising from our review of potential exposures related to our sales tax positions in certain states, and $0.2 million of increased litigation costs, and an increase in the allowance for doubtful accounts of $0.4 million primarily due to customers acquired as a result of the Mavent acquisition. These amounts were offset in part by a $1.9 million increase in accounts receivable due to the higher sales levels of Encompass software as well as compliance services after the Mavent acquisition in December 2009, a $1.6 million increase in deferred costs due to cash payments for legal and other fees that were capitalized in connection with our anticipated initial public offering, and a $0.5 million decrease in deferred rent arising from payments on vacant office space that we acquired in the ODI transaction.

Cash provided by operating activities in 2009 was the result of net income of $1.7 million, adjusted by non-cash charges of depreciation and amortization of $2.6 million, non-cash stock-based compensation of $1.1 million, a $0.7 million increase in deferred revenue due to higher rate of maintenance renewals, accrued liabilities of $0.6 million due to timing of payments, and a $0.5 million decrease in accounts receivable due to improved collections and net positive changes in accounts payable, offset in part by a $0.7 million decrease in deferred rent arising from payments on the vacant office space that we acquired in the ODI transaction.

Cash used in operating activities in 2008 was the result of a $2.1 million combined decrease in accounts payable and accrued liabilities due to the timing of payments covering the relocation of our principal executive offices and other operating expenses, a $2.0 million decrease in deferred revenues due to a reduction in prepaid maintenance revenues associated with licenses of our Encompass software, a net loss of $1.1 million and a $0.5 million increase in accounts receivable. These uses of cash were offset in large part by depreciation and amortization of $4.0 million, receipt of reimbursement of $0.8 million related to facility improvements and a $0.5 million increase in the provision for uncollectible accounts receivable.

Investing Activities

Our primary investing activities have consisted of purchases and sales of short-term investments and purchases of property and equipment, computer equipment for the Ellie Mae Network, Encompass SaaS and CenterWise services.

Cash provided by investing activities of $0.7 million in 2010 was the result of $2.2 million of net sales of short-term investments partially offset by $1.4 million for purchases of property and equipment primarily related to computer equipment to support the growth of our business and to enhance our disaster recovery solution.

Cash used in investing activities in 2009 was the result of $7.7 million of purchases of short-term investments, a $1.0 million loan to a customer and $0.5 million for the Mavent acquisition, offset in part by $4.0 million from the sale of short-term investments.

Cash used in investing activities in 2008 was the result of purchases of $1.0 million of short-term investments, $0.6 million for the acquisition of property and equipment and $0.1 million to purchase certain assets related to document preparation from ODI.

Financing Activities

Cash provided by financing activities in 2010 consisted of $0.8 million in proceeds from the exercise of stock options by our employees and directors, partially offset by $0.4 million in payments on our capital lease obligations.

Cash used in financing activities in 2009 and 2008 consisted of $0.3 million and $0.5 million, respectively, in capital lease obligation payments, offset in part by proceeds from the exercise of stock options by our employees and directors.

 

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Controls and Procedures

We have not performed an evaluation of our internal control over financial reporting, such as required by Section 404 of the Sarbanes-Oxley Act, nor have we engaged our independent registered public accounting firm to perform an audit of our internal control over financial reporting as of any balance sheet date or for any period reported in our financial statements. Had we performed such an evaluation or had our independent registered public accounting firm performed an audit of our internal control over financial reporting, control deficiencies, including material weaknesses and significant deficiencies, may have been identified.

Quantitative and Qualitative Disclosure About Market Risk

We are exposed to market risks in the ordinary course of our business. These risks include primarily interest rate risks and inflation.

Interest Rate Fluctuation Risk

We do not have any long-term borrowings.

Our investments include cash, cash equivalents and short-term investments. Cash and cash equivalents consist of cash, money market accounts, certificates of deposit and commercial paper. Short-term investments consist of U.S. government agency securities, commercial paper and certificates of deposit. The primary objective of our investment activities is to preserve principal while maximizing income without significantly increasing risk. We do not enter into investments for trading or speculative purposes. Our investments are exposed to market risk due to a fluctuation in interest rates, which may affect our interest income and the fair market value of our investments. Due to the short-term nature of our investment portfolio, we do not believe a 10% increase in interest rates would have a material effect on the fair market value of our portfolio, and therefore we do not expect our operating results or cash flows to be materially affected to any degree by a sudden change in market interest rates.

Inflation Risk

We do not believe that inflation has had a material effect on our business, financial condition or results of operations. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition and results of operations.

Off Balance Sheet Arrangements

As of December 30, 2010 we did not have any off balance sheet arrangements.

Contractual Obligations

We lease our office space in Pleasanton, California and other locations under various non-cancelable operating leases that expire between 2011 and 2015. We have no debt obligations. We have capital lease obligations that expire in 2011. Finally, we have no material long-term purchase obligations outstanding with any vendors or third parties.

 

       Payments Due by Period (as of December 31, 2010)  
       Total        Less than
1 year
       1 – 3
years
       3 – 5
years
       More than
5 years
 
       (in thousands)  

Contractual obligations(1):

                        

Capital lease obligations

     $ 114         $ 114         $         $         $   

Operating lease obligations

       3,970           984           2,673           313             
                                                      

Total

     $ 4,084         $ 1,098         $ 2,673         $ 313         $   
                                                      

 

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(1) Excludes contingent performance-based payments payable to sellers in the following transactions:

 

   

In connection with our acquisition of ODI in September 2008, we agreed to make three annual performance-based payments to ODI based on revenues generated by ODI’s legacy customers ordering legacy ODI services in excess of specified thresholds during the three years ending September 30, 2011. The earn-out payment for the first 12-month period was $171,000. There was no earn-out payment for 2010. We estimate that there will be no remaining performance-based payments.

 

   

In connection with our acquisition of Mavent in December 2009, we agreed to make performance-based payments to the former Mavent stockholders based on a percentage of adjusted revenues for sales of Mavent products being sold as of the acquisition date in excess of a minimum amount for each of the three years ended December 31, 2012. There was no earn-out payment for 2010. We estimate that the aggregate amount of these performance-based payments for the remaining two years will be