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Form S-1
Table of Contents

As filed with the Securities and Exchange Commission on April 30, 2010

Registration No. 333-            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

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

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   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

 

 

CALCULATION OF REGISTRATION FEE

 

 
Title of Each Class of
Securities to be Registered
   Proposed Maximum
Aggregate Offering Price(1)(2)
   Amount of
Registration Fee

Common Stock, par value $0.0001 per share

   $86,250,000    $6,150
 
 
(1) Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended.
(2) Includes offering price of shares the underwriters have the option to purchase to cover overallotments, if any.

 

 

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.

 

 

 


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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 April 30, 2010.

 

LOGO

             Shares

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.

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.

 

 

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.

 

 

 

     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.

The underwriters expect to deliver the shares against payment in New York, New York on                     , 2010.

Goldman, Sachs & Co.

William Blair & Company

Keefe, Bruyette & Woods

Macquarie Capital

Piper Jaffray

ThinkEquity LLC

 

 

Prospectus dated                     , 2010.


Table of Contents

TABLE OF CONTENTS

 

     Page

Prospectus Summary

   1

Risk Factors

   11

Special Note Regarding Forward-Looking Statements

   25

Use of Proceeds

   27

Dividend Policy

   27

Dilution

   28

Capitalization

   30

Selected Consolidated Financial Data

   31

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

   33

Business

   57

Management

   72

Certain Relationships and Related Transactions

   106

Principal and Selling Stockholders

   108

Description of Capital Stock

   111

Shares Eligible for Future Sale

   116

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

   119

Underwriting

   123

Legal Matters

   126

Experts

   126

Where You Can Find More Information

   127

Index to Consolidated Financial Statements

   F-1

 

 

Through and including                     , 2010 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription.

 

 

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.

 

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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 55,000 mortgage professionals to the mortgage lenders, investors and service providers integral to the origination and funding of residential mortgages. In 2009, over 2.8 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 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 2009, we had revenues of $37.7 million and net income of $1.7 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 2009, approximately 250,000 mortgage

 

 

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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professionals were 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:

 

 

  Ÿ  

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.

 

  Ÿ  

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 are approximately 15,000 mortgage brokerages, 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.3

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.4 In 2009, less than 1% of residential mortgage originations were processed completely electronically.5

Recent Mortgage Industry Trends and Developments

The mortgage industry has undergone significant change since 2007, largely in reaction 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:

 

  Ÿ  

increased regulation;

 

  Ÿ  

increased quality standards imposed by lenders and investors;

 

2 Bureau of Labor Statistics, Mortgage Employment Statistics, January 2009.
3 Inside Mortgage Finance, Correspondent Production Continued Strong Run in 2009; Broker Market Hit New Low, February 26, 2010.
4 Mortgage Bankers Association, MISMO—A “Time and Motion” Study, October 2004.
5 National Mortgage News, 5% Share for E-Mortgages? Next Year. Or Maybe 2011, May 21, 2009.

 

 

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  Ÿ  

greater focus on operational efficiencies; and

 

  Ÿ  

market shift from mortgage brokerages to mortgage lenders.

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:

 

  Ÿ  

Encompass software provides mortgage originators 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.

 

  Ÿ  

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.

 

  Ÿ  

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:

 

  Ÿ  

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.

 

  Ÿ  

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.

For lenders and service providers subscribing to our Ellie Mae Network Plus offerings:

 

  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.

 

  Ÿ  

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:

 

  Ÿ  

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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  Ÿ  

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

 

  Ÿ  

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

 

  Ÿ  

Selling lenders and service providers Ellie Mae Network Plus offerings.

 

  Ÿ  

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:

 

  Ÿ  

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

 

  Ÿ  

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

 

  Ÿ  

our future performance will be highly dependent on our ability to continue to attract Encompass SaaS customers, and to grow revenues from our recently-introduced Ellie Mae Network Plus offerings and our services;

 

  Ÿ  

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

 

  Ÿ  

we recently introduced many of our current products and services and as a result, we cannot assure that we will achieve widespread market acceptance of these products and services; and

 

  Ÿ  

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, Ellie Mae Network Plus, 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.

 

  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 45,356,318 shares outstanding as of December 31, 2009, and excludes:

 

  Ÿ  

9,062,617 shares of common stock issuable upon the exercise of options to purchase our common stock outstanding as of December 31, 2009 at a weighted average exercise price of $0.73 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;

 

  Ÿ  

1,604,288 shares of common stock issuable upon the exercise of warrants outstanding as of December 31, 2009 at a weighted average exercise price of $1.27 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

 

  Ÿ  

an aggregate of 2,101,856 additional shares of common stock reserved for issuance under our equity incentive plans.

 

 

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

 

  Ÿ  

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;

 

  Ÿ  

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

 

  Ÿ  

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.

 

 

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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, 2007, 2008 and 2009 and the consolidated balance sheet data as of December 31, 2009 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,
     2007     2008     2009
     (in thousands, except share and per share data)

Consolidated statements of operations data:

      

Revenues

   $ 38,493      $ 33,573      $ 37,707

Cost of revenues(1)

     12,823        12,875        11,896
                      

Gross profit

     25,670        20,698        25,811

Operating expenses:

      

Sales and marketing(1)

     9,890        7,553        7,532

Research and development(1)

     7,140        6,898        7,945

General and administrative(1)

     8,273        7,470        8,213

Amortization of intangibles

     273        153        267
                      

Total operating expenses

     25,576        22,074        23,957
                      

Income (loss) from operations

     94        (1,376     1,854

Other income, net

     544        293        72
                      

Income (loss) before income taxes

     638        (1,083     1,926

Income tax provision (benefit)

     104        (24     264
                      

Net income (loss)

     534        (1,059     1,662

Accretion of preferred stock to redemption value, net

     (96           
                      

Net income (loss) available to common stockholders

   $ 438      $ (1,059   $ 1,662
                      

Net income (loss) per share:

      

Basic

   $ 0.05      $ (0.11   $ 0.17
                      

Diluted

   $ 0.01      $ (0.11   $ 0.04
                      

Weighted average shares outstanding:

      

Basic

     9,576,474        9,620,871        9,798,399
                      

Diluted

     46,400,281        9,620,871        46,606,150
                      

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

      

Basic

       $ 0.04
          

Diluted

       $ 0.04
          

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

      

Basic

         45,110,158
          

Diluted

         46,606,150
          

 

 

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     As of December 31, 2009
            Actual            Pro Forma
(unaudited)(3)
    Pro Forma
as Adjusted
(unaudited)(4)
     (in thousands)

Consolidated balance sheet data:

      

Cash and cash equivalents

   $ 11,491      $        $  

Short-term investments

     4,719       

Property and equipment, net

     2,921       

Working capital

     11,548       

Total assets

     57,718       

Redeemable convertible preferred stock

   $ 82,672      $        $  

Total stockholders’ deficit

     (35,516    
                      

Total capitalization

   $ 47,156      $        $  
                      
     Years Ended December 31,
     2007     2008     2009

Other operational data(5):

      

Encompass-related revenues per Average Active Encompass User

   $ 331      $ 427      $ 556

Active Encompass Users at end of period

     74,768        58,228        55,976

Average number of Active Encompass Users during
period

     83,052        68,950        59,217

Encompass-related revenues (in thousands)

   $ 27,481      $  29,436      $  32,953
     Years Ended December 31,
     2007     2008     2009
     (in thousands, unaudited)

Non-GAAP financial data(6):

      

Adjusted EBITDA

   $ 4,023      $ 3,032      $ 5,836

Adjusted net income (loss)

     657        (627     3,052

 

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

 

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

Cost of revenues

   $ (39   $ 19    $ 144

Sales and marketing

            35      145

Research and development

     (45     78      271

General and administrative

     (66     147      563
                     

Total

   $      (150   $     279    $   1,123
                     
(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 application of the

 

 

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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’ deficit 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.

(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. Average number of Active Encompass Users during a period is calculated by averaging the Active Encompass Users monthly during a period. Encompass-related revenues for a period are all revenues derived from Encompass users as well as any other revenue derived from interactions between Encompass users 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 during the period.
(6) Adjusted EBITDA represents net income (loss) before accretion of preferred stock, 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 accretion of preferred stock, 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:

 

  Ÿ  

for planning purposes, including the preparation of annual budgets;

 

  Ÿ  

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

 

  Ÿ  

to evaluate the effectiveness of our business strategies; and

 

  Ÿ  

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 and accretion of preferred stock which terminated after 2007. 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:

 

  Ÿ  

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

 

  Ÿ  

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

 

  Ÿ  

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

 

  Ÿ  

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;

 

  Ÿ  

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 $15.0 million and $15.1 million, respectively, as of December 31, 2009, have been fully utilized or expired; and

 

 

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  Ÿ  

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 level 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,  
     2007     2008     2009  
     (in thousands, unaudited)  

Net income (loss)

   $ 438      $ (1,059   $ 1,662   

Accretion of preferred stock

     96                 

Interest (income) expense, net

     (544     (293     (72

Income tax expense (benefit)

     104        (24     264   

Depreciation and amortization

     3,806        3,976        2,592   

Amortization of acquired intangibles

     273        153        267   

Stock-based compensation expense

     (150     279        1,123   
                        

Adjusted EBITDA

   $       4,023      $       3,032      $       5,836   
                        

 

  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,
     2007     2008     2009
     (in thousands, unaudited)

Net income (loss)

   $ 438      $ (1,059   $ 1,662

Accretion of preferred stock

     96              

Amortization of acquired intangibles

     273        153                  267

Stock-based compensation expense

     (150               279        1,123
                      

Adjusted net income (loss)

   $           657      $ (627   $ 3,052
                      

 

 

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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 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 29% from approximately 79,000 at December 31, 2006 to approximately 56,000 at December 31, 2009. In addition, 30 of the 44 lenders accepting loans through the Ellie Mae Network went out of business or stopped funding loans for other mortgage originators between March 2007 and August 2009. In addition, the population of mortgage origination professionals who are the potential users of our Encompass software dropped 49% from approximately 495,000 at December 31, 2006 to approximately 253,000 at December 31, 2009. If conditions in the mortgage industry were to deteriorate further, our business would be materially adversely affected.

The anticipated increase in mortgage interest rates, as well as other factors, is expected to decrease mortgage lending volume in 2010 and 2011, which could adversely affect our business.

Mortgage interest rates are currently near historic lows and many economists predict that mortgage interest rates will rise in 2010. 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.

Additional factors that adversely impact mortgage lending volumes include reduced consumer and investor demand for mortgages, 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 and other macroeconomic factors.

The expected decrease in residential mortgage loan volume from 2009 volume for at least the next two years will require us to increase our revenues per loan effected through the Ellie Mae Network in order to maintain our financial performance. Any additional unforeseen 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.

 

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Our future performance will be highly dependent on our ability to continue to attract Encompass SaaS customers, and to grow revenues from our recently-introduced Ellie Mae Network Plus offerings and our services.

Mortgage loan volume is expected to decrease from 2009 volume levels for each of 2010 and 2011. 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 must also increase use of our Ellie Mae Network Plus offerings and our services, such as compliance and document preparation. We only began to offer Ellie Mae Network Plus in the fourth quarter of 2009 and our Encompass Compliance Service in the first quarter of 2010. Revenue from them has not been significant and we cannot assure you that these offerings will 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 Encompass users and other Ellie Mae Network participants or retain existing users and participants, our business may be harmed.

Our growth depends in large part on increasing the number of Encompass users and other Ellie Mae Network participants. To attract 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, we must enhance the features and functionality of our Encompass software, convince mortgage originators 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 and 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 Encompass users and other Ellie Mae Network participants and if we are unsuccessful in these efforts, our business may be harmed.

Additionally, existing 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.

We recently introduced many of our current products and services and as a result, we cannot assure that we will achieve widespread market acceptance of these products and services.

We introduced our Encompass software solution in 2003 and released the Encompass 360 version in 2009. We enhanced our Encompass Closer document preparation services in 2008, introduced our Ellie Mae Network Plus offerings in the fourth quarter of 2009, and commenced our Encompass Compliance Service in early 2010. We cannot assure that these products and services will achieve market acceptance.

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 three out of ten transactions per loan file,

 

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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 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 2009.6 We market our Encompass software to mortgage lenders and mortgage brokerages rather than to the retail channels of the mega lenders that 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 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:

 

  Ÿ  

fluctuations in mortgage lending volume;

 

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the number of mortgage origination professionals who use Encompass software;

 

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the volume of mortgages originated by our Encompass users;

 

  Ÿ  

transaction volume on the Ellie Mae Network;

 

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

 

  Ÿ  

the timing of the introduction and acceptance of our Ellie Mae Network Plus offerings;

 

  Ÿ  

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

 

  Ÿ  

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 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.

 

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

 

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If we fail to implement proper and effective internal controls, disclosure controls and corporate governance procedures, our ability to produce accurate and timely financial reports and public disclosures could be impaired and our stock price could decline.

Prior to this offering, we have been a private company and have not filed reports with the SEC. We will become subject to the public reporting requirements of the Securities Exchange Act of 1934 upon the completion of this offering. As a public reporting company listed on the NYSE, we will be required, among other things, to maintain a system of effective internal control over financial reporting. We produce our consolidated financial statements in accordance with the requirements of generally accepted accounting principles in the United States, or U.S. GAAP, but our internal controls do not currently meet all of the standards applicable to companies with publicly-traded securities. We also will be required to implement effective disclosure controls and procedures and maintain corporate governance standards that were not applicable to us as a private company.

Effective internal controls are necessary for us to produce reliable financial reports and are important in our effort to prevent financial fraud. As a public company, we will be required to evaluate periodically the effectiveness of the design and operation of our internal controls over financial reporting. These evaluations may result in the conclusion that enhancements, modifications or changes to our internal controls are necessary or desirable. Although we have begun recruiting additional finance and accounting personnel with public company experience, we will need to hire additional personnel to meet these requirements. Our ability to hire and retain qualified personnel may affect our ability to meet these requirements. We have not yet begun the process of documenting, evaluating and adjusting certain of our internal control processes and systems. Improvements in our internal control processes and systems can only be accomplished over time, and our initiatives ultimately may not result in an effective internal control environment.

Our independent registered public accountants have determined that we have significant deficiencies in internal controls with respect to our issuances of equity securities and granting of stock options as a private company and corporate governance and qualifications of key personnel. Due in part to these significant deficiencies, certain issuances of capital stock and option grants were not documented or properly authorized in compliance with all corporate law requirements. We have taken certain actions to remediate the significant deficiencies with respect to the issuance of equity securities and the granting of stock options, including re-allocating responsibilities for issuances of equity securities and stock options, and are commencing actions to remediate the significant deficiency with respect to corporate governance. We cannot however assure that such actions will be successful in remediating the significant deficiencies. In addition, we have taken actions to address the issuances which were not properly authorized. We cannot assure you that we will not receive claims in the future from other persons asserting rights to shares of our capital stock or to stock option grants. Any such claims could result in substantial costs, dilution and diversion of resources.

If we fail to implement and maintain an effective system of internal control over financial reporting and disclosure controls and procedures, we may be unable to produce timely, reliable financial reports and public disclosures or prevent fraud. Similarly, if management or our independent registered public accounting firm were to discover material weaknesses in our internal controls or if we fail to transition to 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

 

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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 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. 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 maximum exposure is limited under our services agreements; however, under certain circumstances our exposure could be as high as $5.0 million. Although we have not historically incurred any claims and maintain a total of $5.0 million in professional liability insurance coverage, 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.

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 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

 

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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.

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

 

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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. 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. 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 provider’s website and then manually uploading loan data or entering 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.

 

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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:

 

  Ÿ  

enhance our existing solutions;

 

  Ÿ  

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

 

  Ÿ  

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

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

 

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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 our solutions; and enter into potentially unfavorable royalty or license agreements in order to obtain the right to use necessary technologies. Any required royalty or licensing agreements may be unavailable on terms acceptable to us, if at all.

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”

 

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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 December 2009 we acquired Mavent Holdings Inc. to add automated regulatory compliance to our services offerings. The identification of suitable acquisition candidates can be difficult, time-consuming and costly, and we may not be 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.

 

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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, 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:

 

  Ÿ  

our operating performance and the operating performance of similar companies;

 

  Ÿ  

the overall performance of the equity markets;

 

  Ÿ  

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

 

  Ÿ  

threatened or actual litigation;

 

  Ÿ  

changes in laws or regulations relating to our solutions;

 

  Ÿ  

any major change in our board of directors or management;

 

  Ÿ  

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

 

  Ÿ  

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

 

  Ÿ  

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:

 

  Ÿ  

delaying, deferring or preventing a change in corporate control;

 

  Ÿ  

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

 

  Ÿ  

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, 2009, 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, 2009, an additional              shares will be eligible for sale in the public market. Representatives of the underwriters may, in their sole discretion, permit our officers, directors, employees and current stockholders to sell shares prior to the expiration of the lock-up agreements. In addition, 9,126,617 shares subject to outstanding options, as of December 31, 2009, and 2,037,856 shares reserved for future issuance under our equity incentive plans, as of December 31, 2009, 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

 

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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 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:

 

  Ÿ  

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;

 

  Ÿ  

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

 

  Ÿ  

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;

 

  Ÿ  

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;

 

  Ÿ  

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

 

  Ÿ  

the requirement that a special meeting of stockholders may be called only by the chairman of the board of directors, the chief executive officer 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

 

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  Ÿ  

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:

 

  Ÿ  

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

 

  Ÿ  

the impact of changes in mortgage interest rates;

 

  Ÿ  

the volume of mortgages originated by our Encompass users;

 

  Ÿ  

fluctuations in mortgage lending volume;

 

  Ÿ  

the number of mortgage origination professionals who use Encompass software;

 

  Ÿ  

transaction volume on the Ellie Mae Network;

 

  Ÿ  

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

 

  Ÿ  

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

 

  Ÿ  

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

 

  Ÿ  

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

 

  Ÿ  

the timing of the introduction and acceptance of our Ellie Mae Network Plus offerings;

 

  Ÿ  

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

 

  Ÿ  

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

 

  Ÿ  

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

 

  Ÿ  

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

 

  Ÿ  

the attraction and retention of qualified employees and key personnel;

 

  Ÿ  

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

 

  Ÿ  

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

 

  Ÿ  

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

 

  Ÿ  

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

 

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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.

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, 2009 was $47.2 million, or $4.69 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, 2009 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, 2009

   $ 4.69   

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, 2009, 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 tables are based on 45,356,318 shares of common stock issued and outstanding as of December 31, 2009 and excludes:

 

  Ÿ  

9,062,617 shares of common stock issuable upon the exercise of options to purchase our common stock outstanding as of December 31, 2009 at a weighted average exercise price of $0.73 per share;

 

  Ÿ  

1,604,288 shares of common stock issuable upon the exercise of warrants outstanding as of December 31, 2009 at a weighted average exercise price of $1.27 per share; and

 

  Ÿ  

an aggregate of 2,101,856 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, 2009:

 

  Ÿ  

on an actual basis;

 

  Ÿ  

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, 2009; and

 

  Ÿ  

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, 2009
             Actual             Pro Forma
(unaudited)
   Pro Forma
as Adjusted
(unaudited)(1)
     (in thousands)

Cash, cash equivalents and short-term investments

   $ 16,210      $                         $                     
                     

Redeemable convertible preferred stock

   $ 82,672      $      $  

Common stock(2)

     1        

Additional paid-in capital

     6,036        

Accumulated deficit

     (41,553     
                     

Total stockholders’ deficit

     (35,516     
                     

Total capitalization

   $ 47,156      $      $  
                     

 

(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’ deficit 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) Outstanding share information set forth above excludes:

 

  (a) 9,062,617 shares of common stock issuable upon the exercise of options to purchase our common stock outstanding as of December 31, 2009 at a weighted average exercise price of $0.73 per share;
  (b) 1,604,288 shares of common stock issuable upon the exercise of warrants outstanding as of December 31, 2009 at a weighted average exercise price of $1.27 per share; and
  (c) an aggregate of 2,101,856 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, 2007, 2008 and 2009 and the consolidated balance sheets data as of December 31, 2008 and 2009 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, 2005 and 2006 and the consolidated balance sheets data as of December 31, 2005, 2006 and 2007 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,
    2005     2006     2007     2008     2009
    (in thousands, except share and per share data)

Consolidated statements of operations data:

         

Revenues

  $ 30,672      $ 38,542      $ 38,493      $ 33,573      $ 37,707

Cost of revenues(1)

    8,185        10,350        12,823        12,875        11,896
                                     

Gross profit

    22,487        28,192        25,670        20,698        25,811

Operating expenses:

         

Sales and marketing(1)

    10,063        11,979        9,890        7,553        7,532

Research and development(1)

    5,669        7,183        7,140        6,898        7,945

General and administrative(1)

    4,947        6,265        8,273        7,470        8,213

Amortization of intangibles

    531        272        273        153        267
                                     

Total operating expenses

    21,210        25,699        25,576        22,074        23,957
                                     

Income (loss) from operations

    1,277        2,492        94        (1,376     1,854

Other income, net

    138        427        544        293        72
                                     

Income (loss) before income taxes

    1,415        2,919        638        (1,083     1,926

Income tax provision (benefit)

    90        138        104        (24     264
                                     

Net income (loss)

    1,325        2,781        534        (1,059     1,662

Accretion of preferred stock to redemption value, net

    (38     (65     (96           
                                     

Net income (loss) available to common stockholders

  $ 1,287      $ 2,716      $ 438      $ (1,059   $ 1,662
                                     

Net income (loss) per share:

         

Basic

  $ 0.14      $ 0.29      $ 0.05      $ (0.11   $ 0.17
                                     

Diluted

  $ 0.03      $ 0.06      $ 0.01      $ (0.11   $ 0.04
                                     

Weighted average shares outstanding:

         

Basic

    9,083,199        9,418,382        9,576,474        9,620,871        9,798,399
                                     

Diluted

    45,787,865        47,014,233        46,400,281        9,620,871        46,606,150
                                     

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

         

Basic

          $ 0.04
             

Diluted

          $ 0.04
             

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

         

Basic

            45,110,158
             

Diluted

            46,606,150
             

 

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     As of December 31,  
     2005     2006     2007     2008     2009  
     (in thousands)  

Consolidated Balance Sheet Data:

          

Cash and cash equivalents

   $ 11,225      $ 12,165      $ 13,011      $ 10,754      $ 11,491   

Short-term investments

     700        1,487               997        4,719   

Property and equipment, net

     4,167        6,164        7,461        4,924        2,921   

Working capital

     5,648        7,363        7,399        8,834        11,548   

Total assets

     51,842        55,532        56,180        52,676        57,718   

Redeemable convertible preferred stock

   $ 82,511      $ 82,576      $ 82,672      $ 82,672      $ 82,672   

Total stockholders’ deficit

     (41,503     (38,258     (37,832     (38,565     (35,516
                                        

Total capitalization

   $ 41,008      $ 44,318      $ 44,840      $ 44,107      $ 47,156   
                                        

 

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

 

       

     Years Ended December 31,  
     2005     2006     2007     2008     2009  
     (in thousands)  

Cost of revenues

   $ 1      $ 42      $ (39   $ 19      $ 144   

Sales and marketing

     1        40               35        145   

Research and development

     2        32        (45     78        271   

General and administrative

     3        77        (66     147        563   
                                        

Total

   $ 7      $ 191      $ (150   $ 279      $ 1,123   
                                        
(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.

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 recently introduced Ellie Mae Network Plus offerings for subscribing lenders and service providers, for which we charge premium fees. Revenues from Ellie Mae Network Plus have not been significant to date.

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 per closed loan basis with monthly minimums. 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.

 

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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 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 only exercisable by 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 was not expected by the individual, we paid employee bonuses aggregating approximately $36,400 and, in one case, agreed to loan an individual approximately $26,000 if he exercises 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 have determined that the actions taken by our board of directors will result in a stock-based compensation expense of approximately $160,000 in the second quarter of 2010, but no additional stock-based compensation in subsequent periods. We also have determined that the actions taken by our board of directors will 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.

As a result of a stock option repricing that occurred in December 2001, as of December 31, 2009, there were outstanding stock options to purchase an aggregate of 549,000 shares of common stock that are subject to variable accounting. These options will expire in December 2011 if not exercised prior to expiration. Under applicable variable accounting rules, we will recognize stock-based compensation expense or gain in each quarter through the quarter ending 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 period multiplied by the difference between the fair market value of our common stock at the end of the quarter and the fair market value of our common stock at the end of the immediately preceding quarter. For this purpose, the deemed fair market value of our common stock at March 31, 2010 is $2.95 per share.

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—Compensation Discussion and Analysis—Outstanding Equity Awards at 2009 Fiscal Year-End.”

 

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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 to enhance our document preparation services in 2008 and commenced our compliance services offering at the end of 2009 through our acquisition of Mavent Holdings Inc.

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 research and development expenses have remained relatively constant over the period covered by this prospectus and our business is not capital intensive. 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:

 

  Ÿ  

the potential decrease in mortgage lending volume through 2011 forecast by the Mortgage Bankers Association;

 

  Ÿ  

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

 

  Ÿ  

a continued 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;

 

  Ÿ  

increased lender quality requirements for new loans; and

 

  Ÿ  

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 and our Ellie Mae Network Plus offerings 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 360 Banker edition software, which provides additional functionalities for mortgage lenders. 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, and use more services and effect more Network Transactions on the Ellie Mae Network. Ellie Mae Network Plus directly addresses 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 recently purchased Mavent Holdings Inc. to provide compliance services for our Encompass users to respond to the increased focus on regulatory compliance due to recent regulatory reforms.

 

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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. We focus on this metric to determine our success in leveraging our Encompass User base to increase our revenues. The components used to calculate this metric 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.

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

Encompass-related revenues for a period.    All revenues derived from Encompass users as well as any other revenue derived from interactions between Encompass users and third parties through the Ellie Mae Network during the period. This operating metric excludes revenues from our legacy and acquired products, to the extent it does not involve a sale to Encompass users.

We also track Active Encompass Users at the end of a period to gauge the degree of our market penetration.

The following table shows these operating metrics for each of 2007, 2008 and 2009.

 

     Year Ended December 31,
     2007    2008    2009

Encompass-related revenues per Average Active Encompass User

   $ 331    $ 427    $ 556

Active Encompass Users at end of period

     74,768      58,228      55,976

Average number of Active Encompass Users during period

     83,052      68,950      59,217

Encompass-related revenues (in thousands)

   $ 27,481    $ 29,436    $ 32,953

Basis of Presentation

General

Our consolidated financial statements include the accounts of Ellie Mae, Inc. and, through the year ended December 31, 2007, its wholly owned subsidiary, Ellie Mae Insurance Services, LLC, a provider of mortgage credit, errors and omissions, and homeowners’ insurance products, which we operated from 2004 to December 31, 2007. 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

 

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Transaction has occurred and collection of payment from the participating lender, service provider or other participant is reasonably assured. Network Transaction revenues include revenues from our Ellie Mae Network Plus offerings. 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.

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, we began offering customers the ability to pay on a closed loan basis with a monthly minimum. The closed loan 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.

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.

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; 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

 

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expenses also include expenses for trade shows, public relations and other promotional and marketing activities, including travel and entertainment expenses. We expect sales and marketing expenses to increase in 2010 due to an increase in our sales force and a continued increase in marketing activities. We recently hired sales personnel to focus on sales of our Ellie Mae Network Plus 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 Plus 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. Our research and development expenses have remained relatively constant over the periods presented.

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 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, 2009, for federal and state tax purposes, we had $15.0 million of federal and $15.1 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, 2009, we also had federal and state research and development tax credit carryforwards of approximately $1.4 million and $1.6 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 and 2009.

We have determined that we have sufficient NOL and tax credit carryforwards to offset our federal taxable income for 2009 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

 

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changes in the valuation allowance in 2008 and 2009. Income tax expense for 2007 was comprised of federal alternative minimum tax and state income tax where NOL carryforwards were not available. The valuation allowance increased by $0.4 million and $0.6 million in 2007 and 2008, respectively and 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. 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. Network Transaction revenues include revenues from our Ellie Mae Network Plus offerings. 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.

 

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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 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 closed loan basis with a monthly minimum. The closed loan 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.

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.

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

 

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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.

Effective January 1, 2007, we adopted new accounting guidance which prescribes the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. Any necessary adjustment was recorded directly to retained earnings and reported as a change in accounting principle as of the date of adoption. The authoritative guidance on income taxes prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns.

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:

 

  Ÿ  

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.

 

  Ÿ  

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

 

  Ÿ  

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.

 

  Ÿ  

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.

 

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The following table summarizes the assumptions relating to our stock options for the year ended December 31, 2009:

 

     Year Ended
December 31, 2009

Volatility

   47.00 – 48.00%

Expected term

   5.0 – 6.08 years

Risk free rate

   1.87% – 3.21%

Dividend yield

   0%

Using the Black-Scholes option-pricing model, we recorded non-cash stock-based compensation expenses related to employee stock options granted of approximately $1.1 million for the year ended December 31, 2009.

The fair values of the common stock underlying stock options granted during 2008 and 2009 were estimated by our board of directors, which intended all options granted to be exercisable at a price per share not less than the per share fair 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 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.

During 2009, in connection with the preparation of our consolidated financial statements, and consistent with prior years, we contracted with an independent valuation company to perform ongoing analyses to assess the fair value of our common stock at certain quarter end and year end dates for financial reporting purposes. These analyses were performed to assist management and our board of directors in determining fair market value for our stock options at quarter end or year end periods. These valuation analyses were performed as of December 2006, December 2007, December 2008, June 2009, September 2009 and December 2009. 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 redeemable convertible preferred stock, common stock, common stock warrants and common stock options. As described below, the BEV was estimated using a combination of income and market-based methods.

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 is 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. The market

 

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approach 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.

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 or exercise, as appropriate. This 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.

Common Stock Valuations

We granted stock options with the following exercise prices during 2009:

 

Option Grant Dates

   Number of
Shares
Underlying
Options
   Exercise
Price Per
Share
   Fair Market
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

 

(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.

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. 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 and $514,000 in the years ended December 31, 2008 and 2009, respectively, related to the variable plan accounting for these options. We recognized a reduction in compensation expense of $406,000 in 2007 due to a decrease in the market value of the our common stock as of December 31, 2007.

As of December 31, 2009, 548,946 shares under these repriced options remained outstanding. We will continue to record stock-based compensation expenses or benefits, based on changes in the fair value of our common stock, until these options are modified, cancelled, exercised or expire unexercised. As of December 31, 2009, a 10% change in the fair market value of the our common stock would result in a change of approximately $120,000 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.

 

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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 2007, 2008 and 2009 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 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.

 

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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,
    2007     2008     2009
    (in thousands)

Consolidated statements of operations data:

     

Revenues

  $ 38,493      $ 33,573      $ 37,707

Cost of revenues(1)

    12,823        12,875        11,896
                     

Gross profit

    25,670        20,698        25,811

Operating expenses:

     

Sales and marketing(1)

    9,890        7,553        7,532

Research and development(1)

    7,140        6,898        7,945

General and administrative(1)

    8,273        7,470        8,213

Amortization of intangibles

    273        153        267
                     

Total operating expenses

    25,576        22,074        23,957
                     

Income (loss) from operations

    94        (1,376     1,854

Other income, net

    544        293        72
                     

Income (loss) before income taxes

    638        (1,083     1,926

Income tax provision (benefit)

    104        (24     264
                     

Net income (loss)

    534        (1,059     1,662

Accretion of preferred stock to redemption value, net

    (96           
                     

Net income (loss) available to common stockholders

  $ 438      $ (1,059   $ 1,662
                     

 

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

 

     Year Ended December 31,
     2007     2008    2009
     (in thousands)

Cost of revenues

   $ (39   $ 19    $ 144

Sales and marketing

            —        35      145

Research and development

     (45     78      271

General and administrative

     (66     147      563
                     

Total(a)

   $ (150   $      279    $   1,123
                     

 

  (a) Approximately $(406,000), $0 and $514,000 of stock-based compensation expense (benefit) for the years ended December 31, 2007, 2008 and 2009, respectively related to variable accounting for repriced stock options.

 

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     Year Ended December 31,  
         2007             2008             2009      
     (as a percentage of revenues)  

Consolidated statements of operations data:

      

Revenues

            100.0           100.0           100.0

Cost of revenues

   33.3      38.3      31.5   
                  

Gross profit

   66.7      61.7      68.5   

Operating expenses:

      

Sales and marketing

   25.7      22.5      20.0   

Research and development

   18.5      20.5      21.1   

General and administrative

   21.5      22.3      21.8   

Amortization of intangibles

   0.7      0.5      0.7   
                  

Total operating expenses

   66.4      65.8      63.6   
                  

Income (loss) from operations

   0.2      (4.1   4.9   

Other income, net

   1.5      0.9      0.2   
                  

Income (loss) before income taxes

   1.7      (3.2   5.1   

Income tax provision (benefit)

   0.3      0.0      0.7   
                  

Net income (loss)

   1.4      (3.2   4.4   

Accretion of preferred stock to redemption value, net

   (0.2   0.0      0.0   
                  

Net income (loss) available to common stockholders

   1.2   (3.2 )%    4.4
                  

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

 

     Year Ended December 31,
     2007    2008    2009

Encompass-related revenues per Average Active Encompass User

   $ 331    $ 427    $ 556

Active Encompass Users at end of period

     74,768      58,228      55,976

Average number of Active Encompass Users during period

         83,052          68,950          59,217

Encompass-related Revenues (in thousands)

   $ 27,481    $ 29,436    $ 32,953

Years ended December 31, 2007, 2008 and 2009

Revenues

 

     Year Ended December 31,  
     2007     2008     2009  
     (dollars in thousands)  

Revenues by type:

      

Software and Services

   $ 24,018      $ 23,683      $     29,195   

Network Transactions

         14,475              9,890        8,512   
                        

Total

   $ 38,493      $ 33,573      $ 37,707   
                        

Percentage of revenues by type:

      

Software and Services

     62.4     70.5     77.4

Network Transactions

     37.6        29.5        22.6   
                        

Total

     100.0     100.0     100.0
                        

 

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The $4.1 million increase in revenues from 2008 to 2009 was due to an increase in Software and Services revenues, primarily related to 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. 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 primarily due to a significant increase in market acceptance. These increases were offset in part by a decline in Network Transaction revenues primarily due to a decline in the number of mega lenders and volume of loan activity on our network reflecting overall industry declines, and a slight decline in revenues from our Encompass software due to a decline in the average number of Active Encompass Users as a result of the significant decline in the number of mortgage originators in the industry generally.

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 continued to decrease from 279,800 to 253,400,7 a 9.4% decrease. Encompass revenue per Average Active Encompass User increased due primarily to increased use of Encompass Closer and CenterWise.

The decline in Software and Services revenues from 2007 to 2008 reflected the decline in the number of mortgage originators operating in the industry, partially offset by (i) an increase in Encompass Closer revenues as a result of an increasing percentage of our customer base being mortgage lenders that use more of our services than mortgage brokers and (ii) our purchase of document preparation assets from ODI at the beginning of the fourth quarter of 2008. The turmoil in the mortgage industry began to affect our Network Transactions revenues in the second quarter of 2007 and that effect significantly increased in 2008 as lenders and other participants in the mortgage origination business decreased their activities and many went out of business.

Encompass-related revenues per Average Active Encompass User increased by 29.0% from 2007 to 2008 due to increased use of Encompass Closer and CenterWise services and as a result of a shift in our Active Encompass User base from mortgage brokerages to mortgage lenders. Mortgage lenders are responsible for handling a greater portion of the mortgage origination process and typically order more Transactions and more services. The growth in Encompass-related revenues per Average Active Encompass User is consistent with our focus on leveraging the value of the Ellie Mae Network.

Gross Profit

 

     Year Ended December 31,  
     2007     2008     2009  
     (dollars in thousands)  

Gross profit

   $     25,670      $     20,698      $     25,811   

Gross margin

     66.7     61.7     68.5

The increase in gross profit as a percentage of revenues, or gross margin, from 2008 to 2009 was primarily a result of increased revenues, greater margin on our Encompass Closer services due to the ODI transaction in September 2008, reduced depreciation expense arising from smaller fixed asset purchases and a reduction in data center expenses due to our decision in 2008 to consolidate our data centers. These changes were offset in part by an increase in compensation expense due to additional headcount associated with our employment of former ODI employees at the end of 2008. We intend to continue to reduce our cost of revenues attributable to document preparation by acquiring or internally developing additional document preparation technology.

 

7 Bureau of Labor Statistics, Mortgage Employment Statistics, January 2009.

 

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Gross margin decreased from 2007 to 2008 due primarily to a change in mix from higher margin Network Transaction revenues to increased document preparation service revenues, which have lower gross margins, particularly prior to the ODI transaction. Gross margin was also impacted by increased depreciation and amortization arising from our decision in 2008 to build out data center infrastructure in support of our increased focus on Encompass SaaS as a method of delivering our Encompass software and our CenterWise product.

Sales and Marketing

 

     Year Ended December 31,  
     2007     2008     2009  
     (dollars in thousands)  

Sales and marketing

   $       9,890      $       7,553      $       7,532   

Sales and marketing as % of revenues

     25.7     22.5     20.0

Sales and marketing expenses were essentially the same in 2008 and 2009 due primarily to the effects of a headcount reduction in mid-2008, offset by increased 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.

Sales and marketing expense decreased from 2007 to 2008 due primarily to a reduction in headcount as well as reduced marketing spending.

We expect sales and marketing expenses to increase in 2010 due to an increase in the sales force and continued increases in marketing activities. We recently hired sales personnel focused on sales of our recently-introduced Ellie Mae Network Plus 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 our Encompass Banker Edition, our Ellie Mae Network Plus offerings and our Encompass Compliance Service.

Research and Development

 

     Year Ended December 31,  
     2007     2008     2009  
     (dollars in thousands)  

Research and development

   $       7,140      $   6,898      $       7,945   

Research and development as % of revenues

     18.5     20.5     21.1

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

Research and development expenses decreased from 2007 to 2008 due to headcount reductions as part of our cost containment efforts in response to the significant decline in the mortgage market.

General and Administrative

 

     Year Ended December 31,  
     2007     2008     2009  
     (dollars in thousands)  

General and administrative

   $       8,273      $       7,470      $       8,213   

General and administrative as % of revenues

     21.5     22.3     21.8

 

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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 primarily to increased non-cash stock based compensation and increases in legal fees associated primarily with a lawsuit filed against us in August 2009. We expect general and administrative expenses to increase significantly due to costs associated with our initial public offering, including ongoing costs of being a public company, and legal fees associated with a lawsuit. See “Business—Legal Proceedings” and Note 7 to the consolidated financial statements.

The decrease in general and administrative expenses from 2007 to 2008 was primarily the result of reduced headcount expenses of $0.7 million due to our reduction in force in mid-2008 and a $0.6 million reduction in bad debt expense from improved collections, offset in part by a $0.4 million increase in legal and consulting expenses.

Amortization of Intangibles

 

     Year Ended December 31,  
         2007             2008             2009      
     (dollars in thousands)  

Amortization of intangibles

   $           273      $           153      $           267   

Amortization of intangibles as % of revenues

     0.7     0.5     0.7

The increase in amortization of intangibles from 2008 to 2009 was primarily attributable to the ODI transaction on September 30, 2008, which resulted in only one quarter of associated amortization in 2008 in contrast to a full year of amortization in 2009.

The decrease in amortization of intangibles from 2007 to 2008 was primarily attributable to customer lists that were fully amortized during 2007.

Other Income, Net

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

The decrease in other income, net from 2007 to 2008 was primarily due to a decrease in interest income earned on cash, cash equivalents and short-term investments as a result of significantly lower interest rates in the financial markets.

Income Taxes

The increase in income tax expense from 2008 to 2009 was primarily 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 primarily 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.

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, 2009. We have prepared the quarterly data on a consistent basis with the audited consolidated financial statements included elsewhere in this prospectus, and the

 

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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,
2008
   Jun 30,
2008
    Sep 30,
2008
    Dec 31,
2008
    Mar 31,
2009
   Jun 30,
2009
   Sep 30,
2009
    Dec 31,
2009
 
     (in thousands)  

Consolidated Statement of Operations Data:

                   

Revenues

   $ 9,329    $ 8,461      $ 7,770      $ 8,013      $ 10,111    $ 10,464    $ 8,334      $ 8,798   

Cost of revenues(1)

     3,467      3,476        2,895        3,037        3,266      3,419      2,749        2,462   
                                                             

Gross Profit

     5,862      4,985        4,875        4,976        6,845      7,045      5,585        6,336   

Operating expenses:

                   

Sales and marketing(1)

     1,935      1,905        1,857        1,856        1,673      1,594      1,757        2,508   

Research and development(1)

     1,697      1,681        1,734        1,786        1,857      1,907      1,872        2,309   

General and administrative(1)

     1,719      2,038        1,961        1,752        1,728      1,878      2,041        2,566   

Amortization of intangibles

     31      28        28        66        67      67      67        66   
                                                             

Total operating expenses

     5,382      5,652        5,580        5,460        5,325      5,446      5,737        7,449   
                                                             

Income (loss) from operations

     480      (667     (705     (484     1,520      1,599      (152     (1,113

Other income, net

     120      76        56        41        17      10      12        33   
                                                             

Income (loss) before income taxes

     600      (591     (649     (443     1,537      1,609      (140     (1,080

Income tax (benefit) provision

     14      (14     (14     (10     183      191      (16     (94
                                                             

Net income (loss)

   $ 586    $ (577   $ (635   $ (433   $ 1,354    $ 1,418    $ (124   $ (986
                                                             

 

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

 

    For the Three Months Ended
    Mar 31,
2008
  Jun 30,
2008
    Sep 30,
2008
  Dec 31,
2008
  Mar 31,
2009
  Jun 30,
2009
  Sep 30,
2009
  Dec 31,
2009
    (in thousands)

Cost of revenues

  $ 1   $ 6      $ 6   $ 6   $   6   $   8   $   12   $ 118

Operating expenses:

               

Sales and marketing

    19     (15     9     22     10     19     23     93

Research and development

    18     19        21     20     28     46     50     147

General and administrative

    31     34        39     43     53     91     112     307

 

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    For the Three Months Ended  

Percentage of Revenue

  Mar 31,
2008
    Jun 30,
2008
    Sep 30,
2008
    Dec 31,
2008
    Mar 31,
2009
    Jun 30,
2009
    Sep 30,
2009
    Dec 31,
2009
 

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

    37.2        41.1        37.3        37.9        32.3        32.7        33.0        28.0   

Gross Margin

    62.8        58.9        62.7        62.1        67.7        67.3        67.0        72.0   

Operating expenses:

               

Sales and marketing

    20.7        22.5        23.9        23.2        16.5        15.2        21.1        28.5   

Research and development

    18.2        19.9        22.3        22.3        18.4        18.2        22.5        26.2   

General and administrative

    18.4        24.1        25.2        21.9        17.1        17.9        24.5        29.2   

Amortization of intangibles

    0.3        0.3        0.4        0.8        0.7        0.6        0.8        0.8   
                                                               

Total operating expenses

    57.6        66.8        71.8        68.2        52.7        51.9        68.9        84.7   
                                                               

Income (loss) from operations

    5.1        (7.9     (9.1     (6.0     15.0        15.3        (1.8     (12.7

Other income, net

    1.3        0.9        0.7        0.5        0.2        0.1        0.1        0.4   
                                                               

Income (loss) before income taxes

    6.4        (7.0     (8.4     (5.5     15.2        15.4        (1.7     (12.3

Income tax (benefit) provision

    0.2        (0.2     (0.2     —          1.8        1.8        0.2        (1.1
                                                               

Net income (loss)

    6.2     (6.8 )%      (8.2 )%      (5.5 )%      13.4     13.6     (1.5 )%      (11.2 )% 
                                                               
    For the Three Months Ended  
    Mar 31,
2008
    Jun 30,
2008
    Sep 30,
2008
    Dec 31,
2008
    Mar 31,
2009
    Jun 30,
2009
    Sep 30,
2009
    Dec 31,
2009
 
    (dollars in thousands)  

Revenues by type:

               

Software and Services

  $ 6,177      $ 5,876      $ 5,587      $ 6,043      $ 7,702      $ 8,024      $ 6,456      $ 7,013   

Network Transactions

    3,152        2,585        2,183        1,970        2,409        2,440        1,878        1,785   
                                                               

Total

  $ 9,329      $ 8,461      $ 7,770      $ 8,013      $ 10,111      $ 10,464      $ 8,334      $ 8,798   
                                                               

Percentage of revenues by type:

               

Software and Services

    66.2     69.5     71.9     75.4     76.2     76.7     77.5     79.7

Network Transactions

    33.8        30.5        28.1        24.6        23.8        23.3        22.5        20.3   
                                                               

Total

    100.0     100.0     100.0     100.0     100.0     100.0     100.0     100.0
                                                               
    For the Three Months Ended  
    Mar 31,
2008
    Jun 30,
2008
    Sep 30,
2008
    Dec 31,
2008
    Mar 31,
2009
    Jun 30,
2009
    Sep 30,
2009
    Dec 31,
2009
 

Operating Metrics:

               

Encompass-related revenues per Average Active Encompass User

  $ 102      $ 102      $ 109      $ 116      $ 142      $ 149      $ 126      $ 139   

Active Encompass Users at end of period

    75,168        71,523        65,240        58,228        60,696        60,971        58,391        55,976   

Average number of Active Encompass Users during period

    74,994        73,532        66,925        60,349        59,704        61,134        59,370        56,660   

Encompass-related Revenues (in thousands)

  $ 7,651        7,526      $ 7,279      $ 6,980      $ 8,486      $ 9,131      $ 7,464      $ 7,872   

The decline in revenues in the third and fourth quarters of 2008 reflects the effects of the turmoil in the mortgage industry as well as normal seasonal trends in the fourth quarter. Revenues increased in the first two quarters of 2009, 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, which adversely affected our Network Transactions revenues and the services component of our Software and Services revenues.

The average number of Active Encompass Users and Encompass-related revenues declined each quarter throughout 2008 due to the turmoil in the mortgage industry and the corresponding reduction in mortgage originators generating loan activity. The average number of Active Encompass

 

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Users, Encompass-related revenues, and Encompass-related revenues per Average Active Encompass User all increased in the first and second quarters of 2009 due to interest rate reductions and a temporary surge in residential mortgage refinancings during those quarters. This refinancing activity decreased in the third and fourth quarters of 2009, which accounts for the decline in the Encompass-related revenues per Average Active Encompass User 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.

Sales and marketing expenses decreased in the first quarter of 2009 due to planned reductions in sales personnel in response to conditions in the mortgage industry, including the continuing significant decline in the number of potential mortgage origination customers, as well as decreases in marketing expenses. Sales and marketing expenses increased in the third and fourth quarters of 2009 due to marketing efforts for Encompass and Ellie Mae Network Plus 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.

Research and development expenses increased in the fourth quarter of 2009 primarily due to increased compensation for employees acquired in the Mavent transaction and year-end performance bonuses and stock-based compensation expense.

General and administrative expenses are affected by the timing of accounting and legal expenses for both litigation and transactional matters. General and administrative expenses increased in the third and fourth quarters of 2009 primarily due to preparation for our initial public offering and expenses relating to litigation.

Liquidity and Capital Resources

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 equity financing and have been able to finance our operations with existing cash and cash flow from operating activities.

We have a $2.0 million line of credit to fund working capital. We have never drawn any amounts under this line of credit, which expires on March 31, 2011.

As of December 31, 2009, we had cash, cash equivalents and short term investments of $16.2 million. Cash and cash equivalents consist of cash, money market accounts, certificates of deposit and commercial paper. Short-term investments consist of U.S. government notes and agencies, commercial paper and treasury bills.

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. 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.

 

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

 

     Year Ended December 31,  
     2007     2008     2009  
     (in thousands)  

Consolidated Statements of Cash Flows Data:

      

Cash flows provided by (used in) operating activities

   $ 4,981      $ (175   $ 6,453   

Cash flows used in investing activities

     (3,021     (1,650     (5,443

Cash flows used in financing activities

     (1,114     (432     (273

Purchases of property and equipment

            4,603        557        268   

Depreciation and amortization

     3,806               3,976               2,592   

Operating Activities

Cash provided by operating activities in 2009 was primarily 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 primarily to higher rate of maintenance renewals, a $0.5 million decrease in accounts receivable due to improved collections and net positive changes in accounts payable and accrued liabilities of $0.6 million due primarily to timing of payments, 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 primarily 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.

Cash provided by operating activities in 2007 was primarily the result of a $3.8 million non-cash adjustment for depreciation and amortization, a $1.0 million increase in accounts payable, a $0.9 million non-cash provision for uncollectible accounts receivable and $0.5 million of net income. The increase in accounts payable was due to timing of payments. The non-cash provision for uncollectible accounts receivable arose from the commencement of the recession in the United States generally, and particularly its effect on mortgage brokerages. These amounts were offset in part by a $0.5 million decrease in accrued liabilities due to timing of payments and a $0.5 million decrease in deferred revenues due to a reduction in prepaid maintenance revenues associated with licenses of our Encompass software.

Investing Activities

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

Cash used in investing activities in 2009 was the result of $7.7 million of purchases of short-term investments and a $1.0 million loan to a customer, 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.

 

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Cash used in investing activities in 2007 resulted from the purchase of $6.4 million of short-term investments and $4.6 million for the acquisition of property and equipment, offset in part by $8.0 million of cash from sales of short-term investments.

Financing Activities

Our financing activities have consisted primarily of payments on our capital lease obligations, offset in minor amounts by proceeds from the exercise of stock options by our employees and directors. Capital lease obligation payments were $0.3 million in 2009, $0.5 million in 2008 and $1.2 million in 2007.

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 31, 2009 we did not have any off balance sheet arrangements.

 

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Contractual Obligations

We lease our office space in Pleasanton, California and other locations under various non-cancelable operating leases that expire between 2010 and 2015. We have no debt obligations. We have a $2.0 million line of credit for working capital, under which we have not incurred any obligations. This line of credit expires on March 31, 2011. 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
       Total      Less than
1 year
     1 – 3
years
     3 – 5
years
     More than
5 years
       (in thousands)

Contractual Obligations(1):

                        

Capital lease obligations

     $ 532      $ 416      $ 116      $      $      —

Operating lease obligations

       5,320        1,350        2,742        1,228       
                                            

Total

     $ 5,852      $ 1,766      $ 2,858      $ 1,228      $
                                            

 

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

 

  Ÿ  

In connection with our acquisition of ODI, 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. We estimate that the remaining performance-based payments will be approximately $300,000.

 

  Ÿ  

In connection with our acquisition of Mavent, 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. We estimate that the aggregate amount of these performance-based payments will be approximately $150,000.

Recent Accounting Pronouncements

In June 2009, the Financial Accounting Standards Board, or FASB, issued an update to Accounting Standards Codification, or ASC, 810, Consolidation, which modifies how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The modification clarifies that the determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. This modification to ASC 810 requires an ongoing reassessment of whether a company is the primary beneficiary of a variable interest entity. It also requires additional disclosures about a company’s involvement in variable interest entities and any significant changes in risk exposure due to that involvement. This modification to ASC 810 is effective for fiscal years beginning after November 15, 2009 and is effective for us on January 1, 2010. We expect that this modification may have an impact on our financial position and results of operations in future periods, but the nature and magnitude of the specific effects will depend upon the nature, terms and size of the transactions that are consummated in the future.

In October 2009, the FASB issued an amendment to ASC 605-25, Multiple Element Arrangements, which modifies how a company separates consideration in multiple-delivery arrangements. The amendment establishes a selling price hierarchy for determining the selling price of a deliverable. The amendment also clarifies the allocation of revenue is based on entity-specific assumptions rather than assumptions of a marketplace participant. The amendment also eliminates the residual method of allocating revenue and requires the use the relative selling price method. This amendment to ASC 605-25 is effective for new revenue arrangements entered into or modified in fiscal

 

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years beginning after June 15, 2010. Early adoption is permitted. The adoption of this amendment is not expected to have a material impact on our consolidated financial statements.

In October 2009, the FASB issued an amendment to ASC 985-605, Software-Revenue Recognition, which modifies the accounting model for revenue arrangements that include both tangible products and software elements. This amendment to ASC 985-605 is effective for new revenue arrangements entered into or modified in fiscal years beginning after June 15, 2010. Early adoption is permitted. We do not currently sell products that include both tangible products and software elements, therefore this amendment is not expected to impact our consolidated financial statements.

 

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BUSINESS

The Company

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 55,000 mortgage professionals to the mortgage lenders, investors and service providers integral to the origination and funding of residential mortgages. In 2009, over 2.8 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 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 2009, we had revenues of $37.7 million and net income of $1.7 million.

Mortgage Industry Overview

Overview of Mortgage Origination Market

In each of the past ten years, more than eight million new residential mortgages, totaling at least $1.0 trillion, have been funded in the United States.8 At the end of 2009, approximately 250,000 mortgage professionals were engaged in originating residential mortgages.9 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:

 

  Ÿ  

Mega Lenders. There are approximately 20 “mega lenders.” Mega lenders 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. These mega lenders include Wells Fargo Bank, N.A., Bank of America, N.A., JPMorgan Chase Bank, N.A. and PHH Mortgage Corporation.

 

 

8 Mortgage Bankers Association, U.S. Residential Originations from 1997 to 2010; Federal Housing Finance Agency, Combined Datasets Average Loan Size:  2009Q4.
9 Bureau of Labor and Statistics, Mortgage Employment Statistics, January 2009.

 

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  Ÿ  

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 are approximately 15,000 mortgage brokerages, 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.10

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.

The following diagram of the mortgage origination process provides a framework for understanding the complexity and inefficiency of the process, and the need for automated solutions.

LOGO

 

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

 

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In addition to the challenges involved in processing loans, mortgage originators must address basic business needs, including marketing, sales, product fulfillment, customer support, reporting, regulatory compliance and general management functions. Historically, most mortgage originators have operated their businesses using separate task-specific software applications that were interconnected, if at all, through customized integrations. This often resulted in constraints on effective collaboration among operating departments, limited ability to monitor the business comprehensively, increased risk of error due to inconsistent data, inadequate security and control over the process, and expensive technical integration and maintenance costs.

It is estimated that electronic processing of mortgages would reduce origination costs by approximately $700 per loan.11 In 2009, fewer than 1% of residential mortgage originations were processed completely electronically.12

Recent Mortgage Industry Trends and Developments

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. The underlying causes of the loan defaults and losses included the widespread availability, for several years prior to 2007, of high-risk mortgage loans made to unqualified borrowers, significantly reduced underwriting and documentation requirements, and overall lack of controls over the mortgage origination process. The losses incurred have led to four major trends that have significantly impacted the residential mortgage industry.

Increased Regulation

Many regulatory reforms have been introduced or proposed to assure meaningful disclosures by lenders to borrowers, increased transparency and objectivity of settlement services and greater accountability of lenders and mortgage originators, including:

 

  Ÿ  

material changes to Regulation X of the Real Estate Settlement Procedures Act of 1974, as amended, or RESPA, by the Department of Housing and Urban Development, or HUD, effective January 1, 2010, which requires enhanced disclosure to protect borrowers in the mortgage process;

 

  Ÿ  

changes to the Truth in Lending Act of 1968, as amended, or TILA, and the Mortgage Disclosure Improvement Act of 2008, as amended, or MDIA, which are intended to increase consumer protection and expand disclosure requirements;

 

  Ÿ  

the Secure and Fair Enforcement for Mortgage Licensing Act of 2008, as amended, or SAFE, designed to require licensing and tracking of mortgage originators; and

 

  Ÿ  

the proposed adoption of the Wall Street Reform and Consumer Protection Act of 2009, which is in part designed to prevent predatory lending practices and other borrower abuses.

These regulatory reforms further complicate the process and increase the amount of documentation required to originate and fund residential mortgages.

Increased Quality Standards Imposed by Lenders and Investors

Lenders and investors have eliminated almost all high-risk loan product offerings and have significantly tightened underwriting and processing requirements. Consistent with these tightened standards, lenders and investors are demanding increased levels of documentation of the data upon which a lending decision will be based, an increased use of third-party services to obtain unbiased and independent verification of borrowers’ creditworthiness, greater proof of the adequacy of the collateral

 

11 Mortgage Bankers Association, MISMO—A “Time and Motion” Study, October 2004.
12 National Mortgage News, 5% Share for E-Mortgages? Next Year. Or Maybe 2011, May 21, 2009.

 

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securing mortgages and strict compliance with regulatory requirements. This trend further complicates the process by increasing the amount of documentation and number of services required to originate and fund residential mortgages.

Greater Focus on Operational Efficiencies

The reduced volume of mortgages, and elimination of high profit, high risk loans, is encouraging mortgage originators to increase their efficiency and reduce fixed expenses. This has led mortgage originators to explore technology solutions to automate their business processes as well as methods to avoid or reduce expenses that are not tied to revenue generating activities.

Market Shift from Mortgage Brokerages to Mortgage Lenders

Investors increasingly prefer acquiring loans from mortgage lenders that actually fund the underlying loan and retain financial risk for non-performing loans. As a result, mortgage origination volume has shifted significantly from mortgage brokerages to mortgage banks, commercial banks, thrifts and credit unions. These mortgage lenders generally require software with greater functionality to meet their business needs and typically order more settlement and other services in the process of funding loans.

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:

 

  Ÿ  

Encompass software provides mortgage originators 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. Encompass software also provides the ability to collaborate effectively between departments and monitor the business comprehensively, all within a secure environment.

 

  Ÿ  

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.

 

  Ÿ  

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:

 

  Ÿ  

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.

 

  Ÿ  

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.

 

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For lenders and service providers subscribing to our Ellie Mae Network Plus offerings:

 

  Ÿ  

The Ellie Mae Network facilitates targeted marketing by lenders, investors and service providers and allows 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.

 

  Ÿ  

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.

We market our Encompass software to mortgage lenders and mortgage brokerages rather than to mega lenders. However, the wholesale divisions of many mega lenders participate in the Ellie Mae Network to interact electronically with Encompass users and fund or purchase loans processed by mortgage originators.

Our Strategy

Our mission is to be the industry standard electronic network for domestic residential mortgage originations. Key elements of our strategy include:

Increase the number of participants on the Ellie Mae Network.    According to Metcalfe’s law, as the number of participants in a network grows, the benefit to all its participants increases. We intend to increase the number of Ellie Mae Network participants 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.

Increase monetization of the Ellie Mae Network.    We intend to increase revenues derived from the Ellie Mae Network by focusing on three strategies:

Expand the use of settlement services on the Ellie Mae Network.    The Ellie Mae Network provides mortgage originators with electronic access to many of the lenders and most of the service providers with which they need to interact in order to process and fund loans. Currently our Encompass users employ the Ellie Mae Network to handle on average three transactions per loan file, typically including electronic ordering of credit reports and accessing the automatic underwriting systems of Fannie Mae and Freddie Mac. Electronic interaction is less frequent with other service providers, such as appraisers, title and flood reporting companies and other data verification services. We believe limited use is in part due to the fact that providers of other settlement services do not provide electronic solutions that are superior to traditional processes. We intend to encourage providers of settlement services, such as title reports and appraisals, to deliver these services electronically through the Ellie Mae Network.

Sell additional products and services to Encompass users.    We intend to encourage more mortgage originators in the Ellie Mae Network to use the Encompass services we currently offer, such as document preparation, electronic document management, compliance services and website hosting. We also intend to develop additional products and services to sell to our Encompass users.

Sell Ellie Mae Network Plus offerings to lenders and service providers.    We intend to continue to add functionality and electronic and real-time marketing services to the Ellie Mae Network so that lenders and service providers can more effectively market to, and do business with, mortgage originators. For example, we recently introduced our Ellie Mae Network Plus offerings, which provides targeted marketing for lenders and service providers, allowing them to set specific criteria for the loans or settlement services they wish to offer mortgage originators, thereby significantly reducing their sales and marketing costs. Lenders can populate mortgage originators’ Encompass software with specific compliance, underwriting and documentation

 

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requirements for loans prior to delivery in order to screen loans based on quality and regulatory compliance. We charge premium fees for these Ellie Mae Network Plus offerings.

Acquire complementary businesses.    Our industry is highly fragmented and we believe there are strategic opportunities available that will complement and increase the attractiveness of our Encompass software offerings. For example, in December 2009 we acquired Mavent Holdings Inc. to increase the regulatory compliance functionality of our Encompass software. We intend to continue pursuing additional strategic acquisitions.

Products and Services

The Ellie Mae Network

The Ellie Mae Network enables mortgage originators to choose from, and connect to, a broad array of lenders and service providers essential to the processing and funding of loans. Key functions of the Ellie Mae Network are:

 

  Ÿ  

Mortgage originators can electronically and securely submit loan files to lenders in order to underwrite, price and lock rates for individual loans.

 

  Ÿ  

Mortgage originators can electronically order settlement services, including credit, title, appraisal, flood, compliance, mortgage insurance, fraud detection and other reports.

 

  Ÿ  

Lenders and settlement service providers can gain instant electronic access to a large number of mortgage originators, potentially increasing their revenue opportunities and lowering their marketing, loan processing and customer support costs.

Lenders and service providers enter into contracts with us that allow their proprietary operating systems to interoperate with the Ellie Mae Network. Lenders and service providers generally pay us fees on a per transaction basis when the mortgage originator orders these services through the Ellie Mae Network. The table below describes some of the services that mortgage originators may order during the mortgage origination process.

 

Type

  

Description

Credit Report

   A report verifying a loan applicant’s credit standing to predict statistically how likely the applicant is to repay future debts.

Product Eligibility and Pricing Engine

  

A service that allows a mortgage originator to compare loans offered by different lenders and investors to determine the best product and price available to a particular borrower.

Automated Underwriting

   A service provided by Fannie Mae and Freddie Mac that analyzes and determines whether a loan meets the requirements for eventual acquisition by them.

Data Transmission to and from Lenders and Investors

  

Mortgage originators transmit data for loan underwriting, pricing and registration prior to delivery of loan package to the lender.

Appraisal Report

   An estimate of value of the property securing the mortgage conducted by a licensed appraiser and used by the lender to determine whether the loan is adequately collateralized.

Title Report; Insurance

   A report ordered on the property to examine public records to ensure that no one except the seller or borrower has a valid claim on the property and to disclose past and current facts regarding ownership of and liens on the property; title insurance protects the insured against any loss caused by defect of title to the property.

 

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Type

  

Description

Flood Certification

   A report that determines whether the property is located in a flood hazard area based on federal flood regulations and whether the lender or investor will require flood insurance on the property.

Compliance Review

   A service that automatically reviews a loan file to confirm whether a loan complies with federal, state and local regulations.

Fraud Detection

   A service that searches through a number of data fields on a loan application, identifies inaccurate or inconsistent data or suspicious circumstances and delivers a fraud filter score report.

Document Preparation

   A service that automates the process of preparing the legal documents required for closing a loan.

Mortgage Insurance

   Insurance that protects mortgage lenders against loss in the event of default by the borrower, which can allow lenders to make loans with lower down payments from borrowers.

Income, Identity and Employment Verifications

  

Services that automate the verification of each of a borrower’s income, identity and employment through a variety of sources, including the Internal Revenue Service, Social Security Administration and other third parties.

Ellie Mae Network Plus

We recently introduced our Ellie Mae Network Plus offerings for subscribing lenders and service providers. Ellie Mae Network Plus includes electronic and real-time marketing and quality enforcement services that optimize business interactions with mortgage originators. Ellie Mae Network Plus offers a real time aggregate view of all the mortgage applications on the Ellie Mae Network enabling lenders and service providers to make informed decisions about the types of loans they want to target. Ellie Mae Network Plus then allows the lender or service provider to set specific criteria for identifying targeted loans and, when a loan application being processed matches the criteria, a targeted offer will automatically appear on the mortgage originator’s computer screen. For example, lenders and service providers can set specific criteria for loans they desire, such as loan size, loan-to-value ratio, borrower credit score and property location. Finally, Ellie Mae Network Plus allows the lender or service provider to define and enforce specific compliance, processing, underwriting and documentation requirements prior to loan delivery.

Ellie Mae Network Plus can significantly reduce distribution, technology and sales force costs by replacing many traditional sales and back office activities. This allows new entrants to compete with lenders and service providers that have larger infrastructures and marketing resources and allows larger lenders and service providers to market more cost effectively. We charge premium fees for these services.

Encompass Software

Encompass is our proprietary software product that combines loan origination, business management and customer relationship management software for mortgage originators, and also provides seamless access to the lenders and service providers on the Ellie Mae Network. The Encompass software platform helps users structure and streamline their mortgage origination process and facilitates collaboration among internal departments of a mortgage origination company. It creates efficiency in gathering, reviewing and verifying mortgage related data and in producing accurate documentation. It also enables enforcement of rules and business practices designed to ensure loan quality, adherence to processing standards and regulatory compliance. The core architecture of Encompass uses a single database that is accessible to all participants throughout the mortgage origination process.

 

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We offer two versions of Encompass, Broker Edition and Banker Edition. Encompass Broker Edition is marketed to mortgage brokerages and as an entry-level product to mortgage lenders. Encompass Banker Edition is marketed to mortgage lenders and provides additional functionality, including underwriting, secondary marketing, closing, funding and interim servicing tools. Both versions of Encompass provide the following features and benefits:

 

Feature

 

Benefits

Customer Acquisition and Relationship Management

 

•   Sales and marketing tools to help acquire and grow new business, and pre-qualify prospective borrowers.

 

•   Integration to a custom branded website to help attract new borrowers and create new loans through an online application that flows directly into the Encompass loan pipeline.

 

•   Automatic lead follow-up and customer retention through campaign management capabilities that allow design and execution of multi-step marketing campaigns.

 

•   Pre-qualification tools to start loan applications, access integrated pricing engines and easily find appropriate loan products and prices for a borrower.

 

•   Automatic status updates posted to a branded website to keep customers and their real estate and other designated agents informed throughout the loan process.

Processing

 

•   Configurable pipeline, forms, and workflow enable faster loan processing, reduced errors, and more efficient business operations.

 

•   “Alert” management allows focus on urgent and relevant issues.

 

•   Collaboration tools help keep everyone informed and reduce need to manually update other employees, partners and borrowers.

 

•   Seamless access to electronic document management, or EDM, helps simplify document handling and increases data security.

Risk Management and Business Reporting

 

•   Centralization of all business data and electronic images.

 

•   Built-in rules and safeguards to set and help enforce business practices.

 

•   Management dashboard highlighting key performance indicators.

 

•   Predefined reports provide out-of-the-box intelligence and can be modified with a custom report writer.

Connectivity, Personalization and Integration

 

•   Seamless and secure connections to thousands of service providers and lenders on the Ellie Mae Network.

 

•   Workflow management to define customer-specific business processes.

 

•   User-defined experience through a personalized Homepage.

 

•   Integration with third-party applications through a software development kit to leverage existing technology investments.

 

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The following additional features and benefits, tailored to the specific needs of mortgage lenders, are available on Encompass Banker Edition:

 

Feature

  

Benefits

Underwriting

  

•   Collaboration with all origination team members to respond effectively to underwriting requests and track underwriting conditions.

 

•   Communicate loan conditions, request and receive mortgage documents and track conditions and documents in a single system.

 

•   Access electronic copies of borrower documents within the loan file and compare them with actual loan data to reduce risk of data inconsistencies.

Secondary Marketing and Trade Management

  

•   Manage lock requests and accurately track buy-side and sell-side pricing.

 

•   Allocate loans that qualify for trades, track progress and capture key trade details.

 

•   Alerts provide notification of deadlines to help avoid late-delivery fees.

Closing and Funding

  

•   Enter closing data, perform audits and order closing documents all within a single loan file.

 

•   Closing data automatically populates funding worksheets, helping to reduce errors and enable faster funding.

Post-Closing, Shipping and Delivery

  

•   Comprehensive tracking, fulfillment and shipping of loan package.

 

•   Tools to manage interim servicing before selling loans to investors.

Advanced Customization and Business Rule Management

  


•   Enterprise-level functionality for higher level security, more granular control of processes and flexible customization of the software.

 

•   Comprehensive control over workflow, business rules, processes and user groups.

Mortgage originators can license Encompass software for an initial fee as a perpetual license with annual maintenance fees or subscribe to Encompass Anywhere, our software as a service version. Mortgage originators subscribing to Encompass Anywhere pay monthly per user subscription fees or fees on a per closed loan basis, either separately or as a bundled package, with monthly minimums.

 

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Encompass Services

Our Encompass services include Encompass Closer, CenterWise and the Encompass Compliance Service, which are offered either as separate services or bundled in various combinations with our Encompass software, in each case on a subscription or per loan basis.

Encompass Closer

Encompass Closer is a document preparation solution that electronically generates the dozens of documents that the borrower must receive and sign prior to the funding of a loan. Unlike other third-party document preparation services, mortgage originators using Encompass Closer do not have to move loan data from their loan origination system to a separate closing system of an outside vendor. As a result, Encompass Closer accelerates the closing process, eliminates re-typing of data and reduces errors in the loan package. We also provide document preparation services to a number of legacy accounts of ODI that do not use Encompass software.

CenterWise

CenterWise is a bundled offering of Electronic Document Management, or EDM, and Encompass Webcenters.

Electronic Document Management.    EDM gives Encompass users the ability to create virtual loan folders, or eFolders, which contain all of the documents involved in the loan process. These include documents generated with the Encompass software, documents received electronically and paper documents that are digitized using fax, document recognition and scanner technology. With EDM, Encompass users can receive, store, manage and deliver any documents electronically and securely to borrowers, real estate agents, builders, lenders and settlement service providers. Once a loan is funded, the eFolder is stored on Ellie Mae servers for long-term storage and compliance.

Encompass WebCenter.    Our Encompass WebCenter uses a website to facilitate the interaction of Encompass users with borrowers, allowing prospective borrowers to initiate loan applications online. If an application is initiated online, it is automatically fed into the mortgage originator’s Encompass loan processing pipeline. Encompass WebCenter allows borrowers and mortgage originators to electronically sign and transmit required disclosures and other loan documentation. It also provides borrowers and their real estate agents real-time 24/7 loan status updates.

Encompass Compliance Service

Our Encompass Compliance Service, powered by Mavent analyzes mortgage loan data for compliance with consumer protection laws and institutionally mandated compliance policies. Encompass Compliance Service can, in seconds, check loan data multiple times during processing, underwriting, closing or funding a loan. Encompass Compliance Service is integrated with Encompass software but can be used with other loan origination software as well under the Mavent brand. It is also used by Fannie Mae and several mega lenders.

Sales, Marketing and Customer Support

Our sales force consists of 21 employees who are deployed in our Major Accounts Group and the Inside Sales Group. The Major Accounts Group maintains relationships with our largest 1,000 customers and identifies new potential Encompass Banker Edition and large brokerage customers. The Inside Sales Group focuses primarily on relationships with smaller mortgage brokerages.

To build brand awareness and generate sales leads, we conduct direct marketing campaigns, web-based workshops, public relations campaigns and media advertising. We also attend and sponsor many mortgage and banking industry conferences.

 

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We have a staff of 22 customer support representatives who offer live and online technical support. We have also established a variety of training programs for our customers, including in-field seminars for large groups of customers, live or recorded on-line webinars to assist customers in conducting a mortgage business in general and in using our products in particular, and in-product and on-demand training videos.

Technology

Our technology infrastructure supports the Ellie Mae Network and all of our products and services.

Data Centers and Network Access

Our primary data centers are hosted by a leading SAS-70 Type II certified provider of hosting services in Santa Clara, California and Chicago, Illinois. All applications provided by Ellie Mae will run actively in either of these two sites at any time.

The data centers host all of the Ellie Mae Network Services and SaaS versions of our Encompass software. The data centers are designed with fault tolerance protection for all layers of the platform and infrastructure, including routers, switches, load balancers and firewalls, as well as the web and application services and backend database connections. In the event of a complete site failure, such as may occur in the event of a regional natural disaster, all of the services in a site can be redirected to the other site as a part of our disaster recovery strategy.

Our infrastructure is designed to scale substantially to accommodate foreseeable growth in the number of participants and transaction volume on the Ellie Mae Network.

Network Security

All information processed by our servers is encrypted, password protected and stored on secure servers. Customers transmit data to our servers though a 128-bit SSL encryption channel protecting the data against third party disclosure in transit. All of our servers are protected from Internet intruders by industry standard hardened firewalls, intrusion detection and prevention systems and access control lists as well as other methods. All security services are monitored and maintained by our staff as well as IBM/ISS on a regular basis. We employ industry standard, centrally controlled anti-virus packages and intrusion prevention systems that are monitored and updated on a continual basis.

Research and Development

With 54 dedicated software engineers and support staff in our research and development group, we devote substantial resources to enhance the features and functionality of our product and service offerings. Our research and development expenses totaled $7.1 million, $6.9 million and $7.9 million in 2007, 2008 and 2009, respectively.

Intellectual Property

Our success depends in large part on our proprietary products and technology for which we seek protection from a combination of patent, copyright, trademark and trade secret laws and other agreements with employees and third parties. We require our officers, employees and consultants to enter into standard agreements containing provisions requiring confidentiality of proprietary information and assignment to us of all inventions made during the course of their employment or consulting relationship. We also enter into nondisclosure agreements with our commercial counterparties and limit access to, and distribution of, our confidential information.

 

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We are committed to developing and protecting our intellectual property and, where appropriate, file patent applications to protect our technology. As of December 31, 2009, we held three U.S. patents, and we currently have several patent applications pending in the United States. The term of any issued patent in the United States is 20 years from its filing date and if our applications are pending for a long time period, we may have a correspondingly shorter term for any patent that may issue. Our present and future patents may provide only limited protection for our technology and may not be sufficient to provide competitive advantages to us. Furthermore, we cannot assure you that any patents will be issued to us as a result of our patent applications.

We hold a number of registered and unregistered trademarks, service names and domain names that are used in our business in the United States.

Competition

The mortgage origination software market is highly competitive. There are many software providers catering to mortgage brokerages and mortgage lenders. Our current principal software competitors include Calyx Technology, Inc., Byte Software Inc., Del Mar DataTrac, Inc., ISGN Solutions Inc., PCLender.com, Avista Solutions, Inc., Mortgage Builder Software, Inc., OpenClose Mortgage Software and Harland Financial Solutions. Some of these software providers, including Calyx Technology, Inc., also provide connectivity between their software users to lenders and service providers.

Competition with Software Providers

We compete against software providers based on our ability to provide:

 

  Ÿ  

a comprehensive software solution that provides all 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;

 

  Ÿ  

solutions that create efficiencies in gathering, reviewing and verifying mortgage related data and producing accurate documentation;

 

  Ÿ  

customizable business rules to automate processes, drive accountability and enforce business practices that help assure loan quality and regulatory compliance;

 

  Ÿ  

a single database to reduce data errors and facilitate collaboration among departments within a mortgage origination company and comprehensive monitoring of the business of the entire enterprise;

 

  Ÿ  

an integrated network to submit loan files electronically and securely to lenders and electronically order all of the services necessary to originate a loan; and

 

  Ÿ  

security, reliability, and data protection.

Competition with Service Providers

We only offer our Encompass services to Encompass users. There are many other service providers that also offer our Encompass users competing services, including:

Borrower-facing Websites.    We compete against providers of borrower-facing websites for mortgage originators, including MGIC Investment Corporation, Mortgagebot, Vlender and a la mode inc.

 

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Document Preparation Services.    We compete against document preparation service providers, including DocMagic Inc., MRG, DigitalDocs, ProClose, Guardian Mortgage Documents, Wolters Kluwer Financial Services and DocuTech Corporation.

Compliance Service Providers.    We compete against compliance software service providers, including LogicEase Solutions Inc., Wolters Kluwer Financial Services and Interthinx, Inc.

Electronic Document Management.    We compete against electronic document management providers, including Xerox Mortgage Services, Inc., VirPack Corporation, SigniaDocs, Inc. and Encomia, LLC.

We compete against these providers not only based on the quality of the service we offer, but also on integration of each specific service provided within the overall workflow of Encompass. This enhances mortgage originators’ control over the mortgage origination process and reduces errors and costs through the seamless exchange of data across applications and services.

Competition Regarding the Ellie Mae Network

The Ellie Mae Network is only available to mortgage originators using Encompass software. The principal competition to the use of the Ellie Mae Network remains traditional methods of exchanging data and documents among mortgage industry participants by e-mail, facsimile, phone, courier and mail. In addition, competition comes from mortgage originators using a standalone web browser to go individually to each investor, lender, or service 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 for other reasons, despite the disadvantages of duplicative efforts, time delays, errors and costs, redundant paper documentation, and potential privacy and security breaches.

Lenders and service providers, including those who participate on the Ellie Mae Network can and do connect with mortgage originators that are not Encompass users in a variety of ways, including through other networks between mortgage originators and lenders and service providers such as MGIC Investment Corporation and RealEC Technologies, Inc.

We compete with respect to the Ellie Mae Network based on offering mortgage originators accessibility to a critical mass of investors, lenders and service providers and enabling mortgage originators to transact all aspects of the mortgage origination process over the network. In addition, we compete as to the Ellie Mae Network by providing investors, lenders and service providers with greater access to the mortgage origination community, which enables them to increase their revenue opportunity and lower the cost of marketing and customer support.

We believe we generally compete favorably with our competitors, however, many of our actual and potential competitors enjoy substantial competitive advantages over us, such as longer operating histories and significantly greater financial, technical, marketing and other resources.

Government Regulation

The U.S. mortgage industry is heavily regulated. Mortgage originators, lenders, investors and service providers with which we do business are subject to federal, state and local laws that regulate and restrict the manner in which they operate in the residential mortgage industry, including RESPA, TILA, MDIA and SAFE. Although currently we are not directly subject to these laws and regulations, changes to these laws and regulations could broaden the scope of parties or activities subject to regulation and require us to comply with their restrictions, and new products and services developed by us may be subject to, or have to reflect, these laws or regulations.

 

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In addition, we are subject to general business laws and regulations, as well as laws and regulations specifically governing the Internet, such as laws and regulations covering taxation, tariffs, user privacy, data protection, pricing, content, copyrights, distribution, electronic contracts and other communications, consumer protection, broadband residential Internet access and the characteristics and quality of services.

Employees

As of December 31, 2009, we had 176 full-time employees, including 87 in sales and marketing, 68 in research and development and technology and 21 in general and administrative functions. None of our employees are covered by collective bargaining agreements.

Facilities

Our corporate headquarters are located in Pleasanton, California, in a 43,000 square-foot facility, under a sublease expiring on April 29, 2015. We also have field-based staff operating in several areas around the country, primarily based in Irvine, California and Calabasas, California.

Legal Proceedings

On August 28, 2009, DocMagic Inc., or DocMagic, filed a lawsuit against Ellie Mae, Inc. in the U.S. District Court for the Northern District of California (DocMagic, Inc. v. Ellie Mae, Inc., Case No. 3:09-CV-4017), which we refer to in this prospectus as the Federal Action, alleging that we had engaged in monopolization and/or attempted monopolization of an alleged product market composed of “internet portal[s] providing electronic linkages for mortgage loan closing document preparation services”, and alleging liability for related state court claims for intentional interference with contractual relationship, interference with prospective economic advantage and unfair competition. In the Federal Action, DocMagic alleges that our conduct constitutes a violation of U.S. and California antitrust laws and seeks (i) injunctive relief enjoining us from engaging in conduct that monopolizes or attempts to monopolize the alleged product market, (ii) monetary damages in an unspecified amount, (iii) punitive damages, and (iv) attorneys’ fees and costs of suit.

On October 6, 2009, we filed our answer and counterclaim, denying all material allegations of the Complaint and seeking affirmative relief based on claims against DocMagic for copyright infringement, violation of the federal Computer Fraud and Abuse Act, and for state law claims for breach of contract, inducing our customers to breach certain contracts with us and unfair competition. On April 26, 2010, we filed an amended counterclaim which realleged claims previously filed by us in the state court action (described below) and alleging an additional claim for violation of California’s Comprehensive Computer Data Access and Fraud Act.

On the same day that it filed the Federal Action, DocMagic filed a lawsuit against us in the Superior Court of California for the City and County of San Francisco (DocMagic, Inc. v. Ellie Mae, Inc., Case No. CGC-09-491986), which we refer to in this prospectus as the State Action, alleging breach of contract between the parties and unfair competition. DocMagic’s claims arise from the our alleged use of unspecified proprietary information in connection with bringing to market our closing document preparation solution, Encompass Closer, in 2009. In the State Action, DocMagic sought injunctive relief in the form of the return of DocMagic’s alleged “proprietary information” and an injunction against the continued manufacture, sale and/or distribution of Encompass Closer, and for attorneys’ fees and costs of suit. On December 7, 2009, we filed our answer, denying all material allegations of the complaint, and filed our cross-complaint against DocMagic for breach of contract, intentional interference with contractual relationship, intentional interference with prospective economic advantage and unfair competition. On April 9, 2010, the State Action was dismissed without prejudice pursuant to an

 

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agreement between the parties, in order that the parties could re-file their state law claims in the Federal Action. We expect that DocMagic will re-file its state law claims in the Federal Action and that all claims between the parties will be resolved in the Federal Action.

On July 27, 2009, James Van Law filed a lawsuit against us, one of our employees and several other defendants in U.S. District Court for the District of Connecticut, alleging breach of contract, tortious interference with business relationship, unfair trade practices and defamation and seeking monetary damages, costs and interest. On November 4, 2009, the court approved a voluntary dismissal of our employee from the case. We have denied the substantive allegations in subsequent court filings and plan to defend these claims vigorously.

Although we believe that we have substantial and meritorious defenses in each of these cases, neither the outcomes of the litigation nor the amount and range of potential damages associated with the litigation can be assessed with certainty.

We are also subject to various other legal proceedings and claims arising in the ordinary course of business. Although occasional adverse decisions or settlements may occur, management believes that the final disposition of such matters will not have a material adverse effect on our business, financial position, results of operations or cash flows.

 

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MANAGEMENT

The following table provides information regarding our executive officers and directors as of April 30, 2010:

 

Name

   Age   

Position(s)

Sigmund Anderman

   68    President and Chief Executive Officer, Director

Jonathan H. Corr

   43    EVP, Business Development & Product Strategy, Chief Strategy Officer

Limin Hu

   48    EVP, Technology & Operations, Chief Technology Officer

Joseph H. Langner

   46    EVP, Sales & Client Implementation, Chief Sales Officer

Edgar A. Luce

   58    EVP, Finance & Administration, Chief Financial Officer

Elisa Lee

   35    Vice President, General Counsel and Secretary

Carl Buccellato(2)

   67    Director

Craig Davis(2)(3)

   58    Director

A. Barr Dolan(2)

   60    Director

Alan S. Henricks(1)

   59    Director

Jerald L. Hoerauf

   60    Director

Robert Levin(1)(3)

   54    Director

Bernard M. Notas(1)(2)

   59    Director

Frank Schultz(3)

   71    Director

 

(1) Member of the audit committee
(2) Member of the compensation committee
(3) Member of the nominating and corporate governance committee

Executive Officers

Sigmund Anderman, one of our co-founders, has served as our chief executive officer and as a member of our board of directors since the inception of the company in August 1997. Mr. Anderman co-founded American Home Shield Corporation, a home warranty company, in 1973, and served as its general counsel until 1979 and as its president from 1979 to 1981. Mr. Anderman founded CompuFund, Inc., a computerized mortgage banking company, in 1981 and served as its chief executive officer until 1990. Mr. Anderman founded Inspectech Corporation, a computerized home inspection company in 1991 and served as its chief executive officer until 1998. Mr. Anderman holds a Bachelor of Arts degree in Education from City University of New York and a Juris Doctor from New York University. Our board of directors has concluded that Mr. Anderman should serve on the board based on his extensive knowledge of our company gained from his positions as one of our founders and chief executive officer.

Jonathan H. Corr has served as our executive vice president and chief strategy officer since August 2005. Mr. Corr served as our senior vice president of product management from October 2002 to August 2005. Prior to joining us, from October 2001 to August 2002, Mr. Corr served as vice president product strategy at PeopleSoft, Inc. From May 1998 to August 2001, Mr. Corr served in various positions at Kana/Broadbase Software/Rubric, a number of software companies that combined through acquisition, most recently as vice president of product management. From July 1997 to May, 1998, Mr. Corr served as senior product manager of Netscape Communications Corporation. Mr. Corr holds a Bachelor of Science degree in Engineering from Columbia University and a Master of Business Administration degree from Stanford University.

Limin Hu, one of our co-founders, has served as our chief technology officer since the inception of the company in August 1997. From January 1996 to August 1997, Mr. Hu served as chief executive officer and president of Hugo Technologies, Inc., a technology consulting firm. From December 1994 to

 

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January 1996, he served as vice president and general manager of Teknekron Systems LLC, a software and business development company, and from March 1994 to December 1994, Mr. Hu was Director of Systems Technology at Teknekron Corporation, a software company. From December 1990 to March 1994, Mr. Hu held various research positions at IBM Research Center. Mr. Hu holds a Bachelor of Science degree in Electrical Engineering from National Taiwan University and a Ph.D. in Electrical Engineering and Computer Science from the University of California at Berkeley.

Joseph H. Langner has served as our executive vice president and chief sales officer since November 2009. Mr. Langner previously served as our chief operating officer from August 2005 to November 2009 and as our vice president, sales and marketing from December 2002 to August 2005. From April 1986 to June 2002, Mr. Langner held various executive positions with The Dun & Bradstreet Corporation, a credit reporting agency, most recently as senior vice president and general manager, small business solutions division. Mr. Langner holds a Bachelor of Science degree in Genetics from the University of California at Davis.

Edgar A. Luce has served as our chief financial officer since July 2005. From November 2004 to July 2005, Mr. Luce served as our acting chief financial officer. From January 2001 to April 2004, Mr. Luce served as chief financial officer for Sanarus Medical, Inc., a medical device company. From March 2000 to January 2001, he was chief financial officer, secretary, and treasurer at ComView Corporation, a cardiology imaging software company. From February 1997 to March 2000, Mr. Luce was chief financial officer at Biex, Inc., a healthcare company, and from August 1991 to February 1997, he served as vice president, finance & administration and corporate secretary for Penederm Inc., a public dermatology products company. Mr. Luce holds a Bachelor of Arts degree in Economics from Stanford University and a Master of Business Administration degree in Finance from the University of California at Los Angeles.

Elisa Lee has served as our vice president, general counsel and secretary since November 2009. Prior to joining us, from March 2008 to November 2009, Ms. Lee served as senior counsel of The Cooper Companies, Inc., a specialty medical products company, and served in various positions at CooperVision, Inc., a subsidiary of The Cooper Companies, Inc., most recently as assistant general counsel. From 2000 to February 2008, Ms. Lee was an attorney at Latham & Watkins LLP. Ms. Lee holds a Bachelor of Arts degree in Political Science from the University of California at Berkeley and a Juris Doctor from New York University.

Board of Directors

Carl Buccellato has served on our board of directors since December 1997. From May 2008 to the present, Mr. Buccellato has served as chief executive officer and a director of Savings Street LLC, an e-commerce company. From 1996 to May 2008, Mr. Buccellato was a private investor and, from June 2000 to May 2002, he served as a consultant to Ultrastrip Technologies, currently known as Echosphere Technologies, an engineering, technology development and manufacturing company. Mr. Buccellato was a co-founder of Homeowners Group, Inc., a real estate services company, and served as its president and chief executive officer from 1982 to 1996. Mr. Buccellato is a member of the board of directors of Landstar System Inc., a provider of integrated supply chain solutions, and Senergy SNRG, a global waste recycling and de-vulcanization technology company. Mr. Buccellato has also served on a variety of industry boards, including the President’s Advisory Council on Real Estate and the Real Estate Buyers Council. Mr. Buccellato holds a Bachelor of Arts degree from the City College of New York. Our board of directors has concluded that Mr. Buccellato should serve on the board and the compensation committee based on his experience in founding and managing a large, nationwide real estate services company, and his extensive background in advising and serving as a director of many high growth companies.

 

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Craig Davis has served on our board of directors since January 2004. From September 2003 to the present, Mr. Davis has been a private investor. From December 1996 to September 2003, Mr. Davis served as president of the Home Loans and Insurance Services Group at Washington Mutual, a national bank. From January 1989 to December 1996, Mr. Davis held various positions at American Savings Bank, a financial services company, most recently as executive vice president and director of Mortgage Origination/ASB Subsidiaries. From May 1982 to January 1989, Mr. Davis was executive vice president at Griffin Financial Services, a financial services company and subsidiary of Home Savings of America. Mr. Davis has served on numerous boards and councils including the Real Estate Board of Governors of the Mortgage Bankers Association and Fannie Mae’s National Advisory Council. Mr. Davis holds Bachelor of Arts degrees in English and History from United States International University. Our board of directors has concluded that Mr. Davis should serve on the board and the compensation and nominating and corporate governance committees based on his extensive experience in the residential mortgage industry and his service as an executive at some of the largest residential mortgage lenders in the United States.

A. Barr Dolan has served on our board of directors since June 2005 and was a member of our board of directors from December 1997 to November 2000. From 1982 to April 2010, Mr. Dolan served as a general partner of Charter Ventures, a venture capital firm. From 1986 to May 2008, Mr. Dolan was a member of the board of directors for Heska Corporation, a veterinary products company. Mr. Dolan is a member of the board of directors for several private companies, including Revascular Systems, CoRepair, KFX Inc., CMD Consulting and Xlumina. Mr. Dolan holds a Bachelor of Arts degree in Chemistry and an Master of Science degree in Engineering from Cornell University, a Master of Arts degree in Applied Science from Harvard University and a Master of Business Administration degree from Stanford University. Our board of directors has concluded that Mr. Dolan should serve on the board and the compensation committee based on his significant experience in analyzing, investing in and serving on the boards of directors many start-up and high growth companies.

Alan S. Henricks has served on our board of directors since April 2010. From September 2009 to the present, Mr. Henricks has served as acting chief financial officer of Livescribe, Inc., a consumer electronics company. From September 2006 to May 2009, Mr. Henricks served as chief financial officer of Pure Digital Technologies, a consumer electronics company, and from May 2009 to August 2009 he was a private consultant. From December 2003 to September 2006, Mr. Henricks served as chief financial officer of Traiana, a software company. From November 2001 to July 2003, Mr. Henricks served as chief executive officer and a member of the board of directors of Cenzic, a security software company. Prior to November 2001, Mr. Henricks served as a senior executive officer at a variety of companies, including serving as chief financial officer of Informix Software, Documentum, Borland International, Cornish & Carey and Maxim Integrated Products. Mr. Henricks holds a Bachelor of Science degree in Engineering from Massachusetts Institute of Technology and a Master of Business Administration degree from Stanford University. Our board of directors has concluded that Mr. Henricks should serve on the board and the audit committee based on extensive experience serving as chief financial officer of both public and private companies.

Jerald L. Hoerauf has served on our board of directors since June 2008. From October 1998 to the present, Mr. Hoerauf has served as a senior vice president of business development of First American CoreLogic, Inc., a subsidiary of The First American Corporation, a real estate services company. In 1986, Mr. Hoerauf founded and operated TRW Property Data, the predecessor company to First American CoreLogic, Inc., where he currently serves as a member of the board of directors. Mr. Hoerauf also serves as a member of the board of directors of RP Data, Dorado, ComplianceEase, Signature Information Solutions and Lone Wolf. Mr. Hoerauf holds a Bachelor of Arts degree in Economics from the University of California at Santa Barbara and a Master of Business Administration degree from California State University, Fullerton. Mr. Hoerauf serves on our board as a designee of The First American Corporation, one of our stockholders. In addition, our board of directors has concluded that Mr. Hoerauf should serve on the board based on his extensive background in and

 

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knowledge of the mortgage and settlement services industries, as well as his experience in founding and developing a successful services organization serving the mortgage industry.

Robert J. Levin has served on our board of directors since August 2009. From May 2009 to the present, Mr. Levin has been a consultant to Redbrick Partners, a real estate investment firm. From August 2008 to February 2009, Mr. Levin was a senior advisor to Fannie Mae and from March 2009 to April 2009 he was a private consultant. From May 1981 to August 2008, Mr. Levin served in a variety of executive positions at Fannie Mae, including serving as chief business officer from January 2006 to August 2008, interim chief financial officer from December 2004 to December 2005 and executive vice president for housing and community development from August 1998 to December 2004. Mr. Levin currently serves as a member of the board of trustees for Morehouse College and has previously served as a member of the board of the National Alliance to End Homelessness. Mr. Levin holds a Bachelor of Arts degree in Economics from the University of North Carolina at Chapel Hill and a Master of Business Administration degree from the University of Chicago. Our board of directors has concluded that Mr. Levin should serve on the board and the audit and nominating and corporate governance committees based on his extensive experience as a key executive for many years, serving a variety of functions, of Fannie Mae, the largest investor in residential mortgages in the United States.

Bernard M. Notas has served on our board of directors since March 1998. From February 2003 to February 2010, Mr. Notas served as chief financial officer and a managing director of BTIG, LLC, a securities firm. From July 1998 to January 2001, Mr. Notas served as chief operating officer and chief financial officer of OffRoad Capital Corporation, a securities firm, as president of OffRoad Securities, Inc., a securities firm, and as a member of the board of directors for each company from July 1998 to August 2001. From September 1987 to December 1997, Mr. Notas served as chief financial officer and a managing director at Montgomery Securities, a securities firm. From January 1986 to February 1987, Mr. Notas served as chief financial officer and group managing director of Rooney, Pace Group, Inc., a brokerage firm. Mr. Notas previously served on the board of directors of JB Oxford Inc., from July 2004 to October 2007. Mr. Notas holds a Bachelor of Business Administration degree in Finance and Accounting from Pace University and a Master of Business Administration degree in Management from Long Island University. Our board of directors has concluded that Mr. Notas should serve on the board and the audit and compensation committees based on his extensive background as chief financial officer of a securities firm, as well as his broad experience in entrepreneurial business environments.

Frank Schultz has served on our board of directors since June 2000. From 1995 to the present, Mr. Schultz has been a private investor. From 1992 to 1995, Mr. Schultz served as chief executive officer, president and chairman of the board of directors of ITT Financial Corp., a financial services company. From 1983 to 1992, Mr. Schultz was an executive vice president at Bank of America, a financial services company, at which he oversaw consumer marketing, credit card and mortgage divisions. Mr. Schultz previously has served as a member of Fannie Mae’s National Advisory Board and as a member of the Mortgage Bankers Association’s Presidents’ Council. Mr. Schultz holds a Bachelor of Arts degree from Princeton University and a Master of Business Administration degree from Harvard University. Our board of directors has concluded that Mr. Schultz should serve on the board and the nominating and corporate governance committee based on his extensive experience serving as an executive and board member of companies in the mortgage and financial services industry.

Board Composition and Risk Oversight

Upon completion of this offering, our board of directors will consist of nine members, six of whom will qualify as “independent” according to NYSE rules and regulations.

 

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In accordance with our amended and restated certificate of incorporation, immediately after this offering, our board of directors will be divided into three classes with staggered three-year terms. At each annual general meeting of stockholders, the successors to directors whose terms then expire will be elected to serve from the time of election and qualification until the third annual meeting following election. Our directors will be divided among the three classes as follows:

 

  Ÿ  

The Class I directors will be Messrs.                     ,                      and                      and their terms will expire at the annual general meeting of stockholders to be held in 2011;

 

  Ÿ  

The Class II directors will be Messrs.                     ,                      and                      and their terms will expire at the annual general meeting of stockholders to be held in 2012; and

 

  Ÿ  

The Class III directors will be Messrs.                     ,                      and                      and their terms will expire at the annual general meeting of stockholders to be held in 2013.

Any additional directorships resulting from an increase in the number of directors will be distributed among the three classes so that, as nearly as possible, each class will consist of one-third of the directors.

The division of our board of directors into three classes with staggered three-year terms may delay or prevent a change of our management or a change in control.

Our board of directors is responsible for, among other things, overseeing the conduct of our business; reviewing and, where appropriate, approving our major financial objectives, plans and actions; and reviewing the performance of our chief executive officer and other members of management based on reports from our compensation committee. Following the end of each fiscal year, our board of directors conducts an annual self-evaluation, which includes a review of any areas in which the board of directors or management believes the board of directors can make a better contribution to our corporate governance, as well as a review of the committee structure and an assessment of the board of directors’ compliance with corporate governance principles. In fulfilling the board of directors’ responsibilities, directors have full access to our management and independent advisors. With respect to the board of directors’ role in our risk oversight, our audit committee discusses with management our policies with respect to risk assessment and risk management and our significant financial risk exposures and the actions management has taken to limit, monitor or control such exposures. Our audit committee reports to the full board of directors with respect to these matters, among others.

Board Committees

Our board of directors has established the following committees: an audit committee, a compensation committee and a nominating and corporate governance committee. The composition and responsibilities of each committee are described below. Members serve on these committees until their resignation or until otherwise determined by our board of directors.

Audit Committee

Our audit committee oversees our corporate accounting and financial reporting process. Among other matters, the audit committee evaluates the independent auditors’ qualifications, independence and performance; determines the engagement of the independent auditors; reviews and approves the scope of the annual audit and the audit fee; discusses with management and the independent auditors the results of the annual audit and the review of our quarterly consolidated financial statements; approves the retention of the independent auditors to perform any proposed permissible non-audit services; monitors the rotation of partners of the independent auditors on the Ellie Mae engagement

 

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team as required by law; reviews our critical accounting policies and estimates and annually reviews the audit committee charter and the committee’s performance. The current members of our audit committee are Bernard Notas, who is the chairman of the committee, Alan Henricks and Robert Levin. All members of our audit committee meet the requirements for financial literacy under applicable SEC and NYSE rules and regulations. Our board of directors has determined that Mr. Notas is an audit committee financial expert as defined under the applicable rules of the SEC and has the requisite financial sophistication as defined under applicable NYSE rules and regulations. Messrs. Notas, Henricks and Levin are independent directors as defined under applicable SEC and NYSE rules and regulations. The audit committee will operate under a written charter that will satisfy the applicable standards of the SEC and the NYSE.

Compensation Committee

Our compensation committee reviews and recommends policies relating to compensation and benefits of our officers and employees. The compensation committee reviews and approves corporate goals and objectives relevant to compensation of our chief executive officer and other executive officers, evaluates the performance of these officers in light of those goals and objectives, and sets the compensation of these officers based on such evaluations. The compensation committee also administers the issuance of stock options and other awards under our stock plans. The compensation committee will review and evaluate, at least annually, the performance of the compensation committee and its members, including compliance of the compensation committee with its charter. The current members of our compensation committee are Barr Dolan, Carl Buccellato and Craig Davis with Mr. Dolan serving as the chairman of the committee. All of the members of our compensation committee are independent under the applicable rules and regulations of the SEC, the NYSE and the Internal Revenue Code.

Nominating and Corporate Governance Committee

The nominating and corporate governance committee is responsible for making recommendations regarding candidates for directorships and the size and composition of our board of directors. In addition, the nominating and corporate governance committee is responsible for overseeing our corporate governance guidelines and reporting and making recommendations concerning governance matters. The current members of our compensation committee are Frank Schultz, Craig Davis and Robert Levin, with Mr. Schultz serving as the chairman of the committee. The nominating and corporate governance committee will consider diversity of relevant experience, expertise and background in identifying nominees for directors.

There are no family relationships among any of our directors or executive officers.

Compensation Committee Interlocks and Insider Participation

None of the members of our compensation committee is or has at any time during the past year been an officer or employee of ours. None of our executive officers currently serves or in the past year has served as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving on our board of directors or compensation committee.

Code of Business Conduct and Ethics

We intend to adopt a code of business conduct and ethics that applies to all of our employees, officers and directors, including those officers responsible for financial reporting. The code of business conduct and ethics will be available on our website at www.elliemae.com. We expect that any amendments to the code, or any waivers of its requirements, will be disclosed on our website.

 

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Director Compensation

We do not currently provide any cash compensation to our non-employee directors. In connection with the commencement of service on our board of directors, each non-employee member of our board of directors is granted an option to purchase shares of common stock. Historically, the number of shares of our common stock subject to the stock option granted to a new non-employee director has not been determined using a formula. Instead, the number of shares underlying the initial option grant varies depending on the board of directors’ assessment of the new director’s experience and the value of our common stock at the time of the director’s commencement of service. Likewise, the vesting schedule for initial option grants has varied by director, with a portion vested immediately generally based on the amount of time the director has served prior to the granting of the initial stock option and the remainder vesting monthly over three to four years, as determined by our board of directors. On each anniversary of their commencement of service on our board of directors, each of our non-employee directors is granted an option to purchase 15,000 shares of our common stock for service on our board of directors and an option to purchase 2,000 shares of our common stock for each committee the director serves on. Each of these options vests with respect to 100% of the shares subject to the option on the date of grant. Our directors who are also employees are compensated for their service as employees and do not receive any additional compensation for their service on our board.

We intend to adopt a policy pursuant to which, following the completion of this offering, non-employee directors will receive an annual retainer of $26,000. In addition to the annual retainer all non-employee members of our board of directors will be eligible to receive, non-employee directors who serve on one or more committees will be eligible to receive the following annual retainers:

 

Committee

   Chair    Other Member

Audit committee

   $ 15,000    $ 5,000

Compensation committee

     7,000      3,000

Nominating and governance committee

     3,000      1,500

Other than the annual retainers described above, non-employee directors will not be entitled to receive any cash fees in connection with their service on our board of directors. However, pursuant to the new policy, such non-employee directors will be entitled to receive an option to purchase 50,000 shares of our common stock upon initial election or appointment to the board of directors and an option to purchase 30,000 shares of our common stock annually thereafter. Options granted to non-employee directors will have a per share exercise price equal to the per share fair market value of our common stock as of the date of grant. The initial option grant will vest in equal monthly installments over three years from the date of grant. Subsequent options will vest in equal monthly installments over one year from the date of grant.

In February 2009, our board of directors approved a program to allow members of our board of directors, along with all our employees, to voluntarily reprice outstanding stock options having a per share exercise price of $1.80 or $1.98 to $0.46, which was the per share fair market value of our common stock on April 23, 2009, the effective date of the repricing. All options elected for exchange by the non-employee members of our board of directors were fully vested, but pursuant to the terms of the repricing, their repriced options vest in equal monthly installments over two years commencing on February 26, 2009. As part of this program, Messrs. Buccellato, Schultz, Notas and Davis repriced options to purchase 63,000, 12,000, 86,000 and 189,000 shares of our common stock, respectively.

In April 2009, our board of directors, granted options to purchase 72,000 and 48,000 shares of our common stock to Messrs. Buccellato and Schultz, respectively, with a per share exercise price of $0.46 per share, that vest in equal monthly installments over two years from the date of grant. These options were granted to replace options for a similar number of shares which had expired. Messrs. Buccellato and Schultz abstained from the decision to grant these replacement options.

 

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The following tables set forth information regarding compensation earned by our directors who are not named executive officers during the fiscal year ended December 31, 2009.

 

Name

   Option
Awards(1)
   Total

Carl Buccellato

   $ 25,644    $ 25,644

Craig Davis

     28,445      28,445

A. Barr Dolan

         

Garrett Gruener(2)

         

Jerald L. Hoerauf

         

Robert Levin

     32,560      32,560

Bernard M. Notas

     13,252      13,252

Stan Pachura(3)

         

Frank Schultz

     19,482      19,482

 

(1) Amount reflects the aggregate grant date fair value of options granted and the incremental fair value of options repriced during fiscal year 2009 computed in accordance with Statement of Financial Accounting Standard Board Accounting Standards Codification, or ASC, 718, Stock Compensation, as used by analogy for non-employees. The valuation assumptions used in determining such amounts are described in Note 2 to our financial statements included elsewhere in this prospectus. The table below sets forth options that were granted and repriced in 2009 held by each of our non-employee directors along with the incremental fair value of options repriced in and the grant date fair value of options granted in 2009.

 

Name

   Incremental Fair
Value of Options
Repriced
   Grant Date Fair Value
of Options Granted

Carl Buccellato

   $ 9,603    $ 16,062

Craig Davis

     28,445     

Robert Levin

          32,560

Bernard M. Notas

     13,252     

Frank Schultz

     8,787      10,694

As of December 31, 2009, each of our non-employee directors held the following options:

 

Name

   Shares Subject to Outstanding
Options (including Re-Priced
Options)

Carl Buccellato

   197,000

Craig Davis

   189,000

Robert Levin

   50,000

Bernard M. Notas

   131,000

Frank Schultz

   123,000

 

  (2) Mr. Gruener resigned from the board of directors effective March 2, 2010.
  (3) Mr. Pachura resigned from the board of directors effective March 31, 2010.

Executive Compensation

Compensation Discussion and Analysis

This section discusses the principles underlying our policies and decisions with respect to the compensation of our executive officers who are named in the “2009 Summary Compensation Table” and the material factors relevant to an analysis of these policies and decisions. Our named executive officers for 2009 were as follows: Sigmund Anderman, chief executive officer and president; Edgar Luce, chief financial officer and executive vice president of finance and administration; Limin Hu, chief technology officer and executive vice president of technology and operations; Joseph Langner, chief sales officer and executive vice president of sales and client services; and Jonathan Corr, chief strategy officer and executive vice president of business development and product strategy.

 

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Objectives and Philosophy of Our Executive Compensation Program

We recognize that the ability to excel depends on the integrity, knowledge, imagination, skill, diversity and teamwork of our named executive officers. To this end, we strive to create an environment of mutual respect, encouragement and teamwork that rewards commitment and performance and that is responsive to the needs of our named executive officers. The principles and objectives of our compensation and benefits programs for our employees generally, and for our named executive officers specifically, are to:

 

  Ÿ  

attract, engage and retain individuals of superior ability, experience and managerial talent enabling us to be an employer of choice in the highly-competitive and dynamic information technology industry;

 

  Ÿ  

ensure compensation is closely aligned with our corporate strategies, business and financial objectives and the long-term interests of our stockholders;

 

  Ÿ  

motivate and reward executives whose knowledge, skills and performance ensure our continued success; and

 

  Ÿ  

ensure that total compensation is fair, reasonable and competitive.

The compensation components described below simultaneously fulfill one or more of these principles and objectives.

Components of Our Executive Compensation Program

The individual components of our executive compensation program consist primarily of: (i) base salary, (ii) performance-based bonuses, (iii) equity incentives, (iv) retirement savings opportunities, (v) post-termination benefits and (vi) various other employee benefits. We view each of these components as related but distinct, reviewing them each individually, as well as collectively to ensure that the total compensation paid to our named executive officers meets the objectives of our executive compensation program as detailed above. Not all compensation components are provided to each named executive officer. Instead, we determine the appropriate level for each compensation component based in part, but not exclusively, on our understanding of the market in which we compete for talent based on the experience of members of our board of directors, the length of service of our named executive officers, our overall performance and other considerations we deem relevant. Following the completion of this offering, we expect our compensation committee to make compensation decisions that are consistent with our recruiting and retention goals. We review each compensation component for internal equity and consistency between named executive officers with similar levels of responsibility.

We strive to achieve an appropriate mix between equity incentive awards and cash payments in order to meet our objectives. We do not currently have any policies for allocating compensation between short- and long-term compensation or cash and non-cash. While we utilize both short- and long-term compensation components, our strategy with respect to the compensation of our named executive officers is to tie a greater percentage of their total compensation to stockholder returns, which we achieve through the use of equity incentives. Cash compensation paid to our named executive officers is kept at a competitive level, as determined by members of our board of directors based on their experience, with the opportunity for each named executive officer to achieve higher total compensation through equity incentives if we perform well over time. We believe that because the achievement of our business and financial objectives will be reflected in the value of our equity, thereby increasing stockholder value, our named executive officers will be incentivized to achieve these objectives when a larger percentage of their total compensation is tied to the value of our stock. In order to accomplish these goals, we use stock options as a significant component of compensation.

 

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While we offer competitive base salaries, we believe stock-based compensation is a significant motivator in attracting employees for technology companies. To this end, we believe that our 2009 stock option repricing program will help retain our named executive officers and to keep their interests aligned with those of our stockholders.

Each of the individual components of our named executive officers’ compensation is discussed in more detail below. While we have identified particular compensation objectives that each component of our named executive officers’ compensation serves, our compensation programs are designed to be flexible and complementary and to collectively serve all of the compensation objectives described above. Accordingly, whether or not specifically mentioned below, we believe that, as a part of our overall executive compensation policy, each individual element, to a greater or lesser extent, serves each of our objectives.

Compensation Determination Process

Compensation of our named executive officers has historically been highly individualized, resulting from independent negotiations between us and such individuals and based on a variety of informal factors considered at the time of the applicable compensation decisions including, in addition to the factors listed above:

 

  Ÿ  

our financial condition and available resources;

 

  Ÿ  

the need for a particular position to be filled;

 

  Ÿ  

the evaluation of the competitive market by members of our board of directors based on their experiences on boards of directors at other companies;

 

  Ÿ  

the length of service of the named executive officer; and

 

  Ÿ  

comparisons to the compensation levels of our other executives.

Historically, our chief executive officer, and, in the case of our chief executive officer, our board of directors, has typically reviewed the performance of each of our named executive officers on an annual basis, though we do not set a predetermined time for such review. Our chief executive officer, based on his experience and the performance reviews of our executives, recommends compensation levels for our named executive officers, other than himself, to our compensation committee for approval. Our compensation committee, based in part on the chief executive officer’s recommendations, then presents compensation levels to the board of directors for approval. In late 2008, we determined that there would be no merit increases to any compensation component for any of our named executive officers for 2009, except for a $6,000 increase to the variable component of Mr. Corr’s total compensation, because we determined that our compensation goals were being adequately met at their current levels given the then current economic climate. Upon consummation of this offering, we expect for the compensation committee to take on the responsibility for the initial determination, as well as annual review of, each component of our named executive officers’ compensation.

In December 2009, our compensation committee directly engaged Compensia, Inc. to conduct a review that will compare the compensation levels of our named executive officers to those of other executives at a peer group of companies to be developed by Compensia. Our compensation committee worked directly with Compensia to interpret the results and assist in setting compensation levels for our named executive officers for 2010.

 

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Base Salary

In general, base salaries for our named executive officers are initially established through arm’s-length negotiation at the time the named executive officer is hired, taking into account such named executive officer’s qualifications, experience and salary prior to joining our company. We strive to maintain base salaries for our named executive officers that are competitive, while remaining as cost-effective as possible.

Periodic adjustments to the base salaries our named executive officers are based on the level of each executive’s responsibilities, individual contribution, prior experience and sustained performance. Decisions regarding salary increases may take into account the executive’s current salary and equity ownership, and may consider the salaries paid to the executive’s peers within our company. Base salaries are typically reviewed as part of the promotion process or upon other significant changes in responsibility. No formulaic base salary increases are provided to our named executive officers.

The base salaries paid to our named executive officers in 2009 are set forth in the “2009 Summary Compensation Table.”

Annual Cash Bonuses

In addition to base salaries, annual cash bonus opportunities have been awarded to our named executive officers when our board of directors, upon recommendation of our compensation committee and our chief executive officer (other than with respect to the annual cash bonus opportunity for the chief executive officer), has determined that such an incentive is necessary to align our corporate goals with the cash compensation payable to an executive. Historically, annual cash bonus opportunities have been awarded to each of our named executive officers.

In 2009, we maintained the existing annual cash target bonus eligibility for Messrs. Anderman, Luce and Hu at $250,000, $100,000 and $100,000, respectively. Under their bonus arrangements, Messrs. Anderman, Luce and Hu are entitled to receive these amounts if bonus goals are achieved at target. Our compensation committee, in its discretion, may pay more than the target bonus amounts if achievement exceeds the bonus goal target. The level of these bonuses was set by our compensation committee based on the historical level of bonuses awarded to these executives. The goals for Messrs. Anderman, Luce and Hu were based on the company’s overall performance, measured in terms of net revenue and adjusted EBITDA (as defined in footnote 6 to the table in the Prospectus Summary—Summary Consolidated Financial Data section above), of $26.8 million and $762,225, respectively, for fiscal year 2009. We chose the net revenue and profitability goals in order to align their individual incentives with the overall success of the company. In early 2010, our compensation committee determined that our company exceeded the net revenue and adjusted EBITDA goals, achieving levels of $37.7 million and $5.8 million, respectively. As a result, Messrs. Anderman, Luce and Hu were each paid 100% of their target bonus amounts. In addition, because the goals were overachieved, with the net revenue goal being overachieved by approximately 40% and the adjusted EBITDA goal being overachieved by approximately 660%, our compensation committee awarded each of Messrs. Anderman, Luce and Hu an additional discretionary bonus of 40% of his targeted bonus amount.

In 2009, Messrs. Langner and Corr participated in individual bonus programs based primarily on the achievement of individual goals and to a lesser extent on the same corporate performance goals as the other named executive officers. Because these individuals have responsibility for the overall operations and strategy of their departments, their incentives were designed to be greater aligned with their responsibilities and less with overall corporate performance. The aggregate bonus targets for Messrs. Langner and Corr were $199,000 and $155,000, respectively. These bonus targets were set by our board of directors following the recommendation of our compensation committee and our chief executive officer using their experience in the industry and sense of the competitive market.

 

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The individual components of the bonus programs for Messrs. Langner and Corr included annual corporate performance goals, quarterly department performance goals, quarterly corporate revenue goals, monthly sales performance goals for Mr. Langner and annual strategic goals for Mr. Corr. The corporate performance goals for both Messrs. Langner and Corr were the same goals set forth above for the other named executive officers. The quarterly department performance goals were tied to adjusted EBITDA. The monthly sales performance goals for Mr. Langner related to new loan origination software, or LOS, license sales, the goal for which ranged between $460,000 and $660,000 per month, and overall corporate revenue, the goal for which was set at or near $3.4 million per month. The strategic goals for Mr. Corr included the release of new software and the launch of Ellie Mae Network Plus premium services through our website. The quarterly corporate revenue goals for Mr. Corr ranged between $6.4 million and $7.0 million per quarter in 2009. The following table sets forth the individual components of the individual bonus programs for Messrs. Langner and Corr and their achievement for 2009.

 

Name

   Target Bonus
Amount
  

Performance Goal

   Measurement
Frequency
   2009 Achievement  

Joseph Langner

   $ 25,000    Corporate performance    Annual    100% – $  25,000   
   $ 15,000    Adjusted EBITDA    Quarterly    > 110% – $  80,000 (1) 
   $ 3,500    Sales performance    Monthly    > 110% – $  58,500 (2) 
   $ 6,000    Corporate Revenue    Monthly    > 105% – $  90,000 (3) 
         Total    $253,500   

Jonathan Corr

   $ 25,000    Corporate performance    Annual    100% – $  25,000   
   $ 10,000    Adjusted EBITDA    Quarterly    > 110% – $  60,000   
   $ 10,000    New software release    Annual    100% – $  10,000   
   $ 40,000    Ellie Mae Network Plus premium services launch    Annual    100% – $  40,000   
   $ 10,000    Corporate revenue    Quarterly    > 110% – $  60,000   
         Total    $195,000   

 

(1) Achievement amount reflects sales performance target achieved in four quarterly periods.
(2) Achievement amount reflects sales performance target achieved in 12 monthly periods.
(3) Achievement amount reflects sales performance target achieved in 12 monthly periods.

In addition to his performance bonus, Mr. Corr received a $25,000 discretionary bonus for his exceptional contributions, above and beyond the levels anticipated in his 2009 Performance Bonus Plan, that allowed the Company to overachieve its 2009 goals.

The total bonuses paid to our named executive officers for 2009 are set forth in the “2009 Summary Compensation Table.”

Long-Term Equity Incentives

The goals of our long-term, equity-based incentive awards are designed to align the interests of our named executive officers with the interests of our stockholders. Because vesting is based on continued employment, our equity-based incentives also encourage the retention of our named executive officers through the vesting period of the awards.

In determining the size of the long-term equity incentives to be awarded to our named executive officers, we take into account a number of internal factors, such as the relative job scope, the value of existing long-term incentive awards, individual performance history, prior contributions to us and the size of prior grants. Historically, our board of directors has drawn upon the experience of its members, the members of our compensation committee and our chief executive officer in determining long-term

 

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equity incentive awards. Based upon these factors, our chief executive officer, other than with respect to himself, determines the size of the long-term equity incentives at levels he considers appropriate to create a meaningful opportunity for reward predicated on the creation of long-term stockholder value and recommends grants to our compensation committee, which presents the grants to our board of directors for approval. Using the experience of its members, our compensation committee recommends the level of grants for our chief exec