Document
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________________
FORM 10-Q
_____________________________
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2018
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 001-35140 
_____________________________
ELLIE MAE, INC.
(Exact name of registrant as specified in its charter)
_____________________________
Delaware
 
94-3288780
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
4420 Rosewood Drive, Suite 500
Pleasanton, California
 
94588
(Address of principal executive offices)
 
(Zip Code)
(925) 227-7000
(Registrant’s telephone number, including area code)
_____________________________
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “small reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
x
Accelerated filer
¨
 
 
 
 
Non-accelerated filer
o  (Do not check if smaller reporting company)
Smaller reporting company
¨
 
 
 
 
 
 
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ¨
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
Indicate the number of shares outstanding of each of the registrant’s classes of common stock as of the latest practicable date:
As of May 2, 2018:
Class
  
Number of Shares
Common Stock, $0.0001 par value
  
34,346,729

 


Table of Contents

TABLE OF CONTENTS
 
 
 
 
Page
PART I—FINANCIAL INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
PART II—OTHER INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Table of Contents

PART I—FINANCIAL INFORMATION
ITEM 1—CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Ellie Mae, Inc.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(in thousands)
 
 
March 31,
2018
 
December 31,
2017
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
117,342

 
$
137,698

Short-term investments
113,931

 
103,345

Accounts receivable, net
45,123

 
43,121

Prepaid expenses and other current assets
31,864

 
18,474

Total current assets
308,260

 
302,638

Property and equipment, net
198,907

 
186,991

Long-term investments
83,627

 
107,363

Intangible assets, net
74,568

 
80,874

Deposits and other assets
30,602

 
9,290

Goodwill
144,279

 
144,451

Total assets
$
840,243

 
$
831,607

Liabilities and Stockholders' Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
20,924

 
$
24,913

Accrued and other current liabilities
24,338

 
26,188

Deferred revenues
17,975

 
26,287

Total current liabilities
63,237

 
77,388

Other long-term liabilities
19,727

 
18,880

Total liabilities
82,964

 
96,268

Stockholders' equity:
 
 
 
Common stock
3

 
3

Additional paid-in capital
659,114

 
649,817

Accumulated other comprehensive loss
(1,417
)
 
(880
)
Retained earnings
99,579

 
86,399

Total stockholders' equity
757,279

 
735,339

Total liabilities and stockholders' equity
$
840,243

 
$
831,607


See accompanying notes to these condensed consolidated financial statements (unaudited).

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Ellie Mae, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
(in thousands, except per share amounts)
 
 
 
 
 
Three Months ended March 31,
 
2018
 
2017
Revenues
$
117,912

 
$
93,002

Cost of revenues
49,347

 
34,768

Gross profit
68,565

 
58,234

Operating expenses:
 
 
 
Sales and marketing
23,064

 
19,380

Research and development
22,489

 
17,407

General and administrative
26,314

 
16,942

Total operating expenses
71,867

 
53,729

Income (loss) from operations
(3,302
)
 
4,505

Other income, net
848

 
501

Income (loss) before income taxes
(2,454
)
 
5,006

Income tax benefit
(4,658
)

(4,593
)
Net income
$
2,204

 
$
9,599

Net income per share of common stock:
 
 
 
Basic
$
0.06

 
$
0.28

Diluted
$
0.06

 
$
0.27

Weighted average common shares used in computing net income per share of common stock:
 
 
 
Basic
34,143

 
33,702

Diluted
35,602

 
35,609

 
 
 
 
Net income
$
2,204

 
$
9,599

Other comprehensive income, net of taxes:
 
 
 
Unrealized gain (loss) on investments
(537
)
 
58

Comprehensive income
$
1,667

 
$
9,657


See accompanying notes to these condensed consolidated financial statements (unaudited).

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Ellie Mae, Inc.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands)
 
 
 
 
 
Three Months ended March 31,
 
2018
 
2017
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
2,204

 
$
9,599

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
11,366

 
7,339

Amortization of acquisition-related intangibles
6,306

 
1,078

Stock-based compensation expense
9,532

 
7,851

Deferred income taxes
(4,658
)
 
(4,647
)
Amortization (accretion) of investments
181

 
(164
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
(2,002
)
 
(511
)
Prepaid expenses and other current assets
(5,203
)
 
(973
)
Deposits and other assets
(4,331
)
 
(89
)
Accounts payable
121

 
1,860

Accrued, other current and other long-term liabilities
(2,928
)
 
(19,442
)
Deferred revenues
(4,187
)
 
(3,323
)
Net cash provided by (used in) operating activities
6,401

 
(1,422
)
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Acquisition of property and equipment
(8,544
)
 
(11,327
)
Acquisition of internal-use software
(17,153
)
 
(11,439
)
Purchases of investments
(23,599
)
 
(38,907
)
Maturities of investments
36,031

 
13,851

Other investing activities, net
172

 

Net cash used in investing activities
(13,093
)

(47,822
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Payment of capital lease obligations
(30
)
 
(111
)
Proceeds from issuance of common stock under employee stock plans
7,829

 
7,283

Payment of issuance costs relating to common stock issued in public offering


(15
)
Payments for repurchase of common stock
(14,740
)
 

Tax payments related to shares withheld for vested restricted stock units
(6,723
)
 
(3,894
)
Net cash provided by (used in) financing activities
(13,664
)
 
3,263

NET DECREASE IN CASH AND CASH EQUIVALENTS
(20,356
)
 
(45,981
)
CASH AND CASH EQUIVALENTS, Beginning of period
137,698

 
380,907

CASH AND CASH EQUIVALENTS, End of period
$
117,342

 
$
334,926


See accompanying notes to these condensed consolidated financial statements (unaudited).

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Ellie Mae, Inc.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1Description of Business
Ellie Mae, Inc. (“Ellie Mae,” and the “Company”) is the leading cloud-based platform provider for the mortgage finance industry. The Company’s technology solutions enable lenders to originate and close residential mortgage loans. Banks, credit unions and mortgage lenders use the Company’s Encompass® all-in-one mortgage management solution (“Encompass”) to originate and fund mortgages and improve compliance, loan quality and efficiency.
NOTE 2Basis of Presentation and Significant Accounting Policies
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“U.S. GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) regarding interim financial reporting. Certain information and note disclosures included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such rules and regulations. Therefore, these condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, which was filed with the SEC on March 1, 2018 (“2017 Form 10-K”).
The condensed consolidated balance sheet as of December 31, 2017, included herein, was derived from the audited financial statements as of that date but does not include all disclosures, including notes, required by U.S. GAAP.
In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all normal recurring adjustments necessary to present fairly the financial position, results of operations, and cash flows for the interim periods but are not necessarily indicative of the results of operations to be anticipated for the full fiscal year ending December 31, 2018 or any future period.
Principles of Consolidation
The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated.
Use of Estimates
The preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management evaluates estimates on a regular basis including those relating to revenue recognition, allowance for doubtful accounts, goodwill, intangible assets, valuation of deferred income taxes, stock-based compensation, and unrecognized tax benefits, among others. Actual results could differ from those estimates, and such differences may have a material impact on the Company’s condensed consolidated financial statements and footnotes.
Segment Information
The Company operates in one industry—mortgage-related software and services. The Company’s chief operating decision maker is its chief executive officer, who makes decisions about resource allocation and reviews financial information presented on a consolidated basis. Accordingly, the Company has determined that it has a single reporting segment and operating unit structure, specifically technology-enabled solutions to help streamline and automate the residential mortgage origination process in the United States.
Significant Accounting Policies
Except for the accounting policies described below that were updated as a result of adopting Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), as amended (“Topic 606”), there have been no significant changes to the Company’s significant accounting policies described in Note 2 of the Notes to Consolidated Financial Statements in its 2017 Form 10-K.


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Revenue Recognition
The Company applies the provisions of Topic 606 for revenue recognition on contracts with customers. Pursuant to Topic 606, the Company recognizes revenues under the core principle to depict the transfer of control to the Company’s customers in an amount reflecting the consideration to which the Company expects to be entitled. In order to achieve that core principle, the following five step approach is applied:
Identification of the contract, or contracts, with a customer;
Identification of the performance obligations in the contract;
Determination of the transaction price;
Allocation of the transaction price to the performance obligations in the contract; and
Recognition of revenue when, or as, the Company satisfies a performance obligation.
The Company generates revenues primarily from hosted software services, transaction-based fees and related services including professional services and its annual user conference, and recognizes revenues as performance obligations are satisfied. For services where the customer simultaneously receives and consumes the benefit from the Company's performance, revenue is recognized over time using an output method based on the passage of time as this provides a faithful depiction of the transfer of control. Under Company-hosted Encompass software subscriptions that customers access through the Internet, revenues are comprised of fees for software services sold both as a subscription and on a transactional basis. Transaction fees include fees based on a per closed loan, or success basis, subject to monthly base fees, which the Company refers to as Success-Based Pricing, as well as Ellie Mae Network fees and transaction fees charged for other services. Revenues are also comprised of fees for loan product, policy and guideline data and analytics services under the AllRegs brand, fees for lead management, marketing and customer relationship management, and fees for professional services which include consulting, implementation and education and training services. Sales taxes assessed by governmental authorities are excluded from the transaction price.
In contracts where variable consideration is required to be estimated and included in the transaction price, the Company estimates such amounts at contract inception considering historical trends, industry data, and contract specific factors to determine an expected amount to which the Company expects to be entitled. Estimates are included in the transaction price to the extent that it is considered probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved. The assessment of whether such an estimate is constrained requires the Company to consider methods, inputs, and assumptions relating to the nature of the underlying products, customer-specific trends, and economic factors including industry data. Other forms of variable consideration such as refunds and penalties, which are recorded in accrued and other current liabilities, are estimated at contract inception and are allocated to the performance obligations to which they relate.
The Company enters into arrangements that generally include multiple subscriptions and professional services. For arrangements with multiple services, the Company evaluates whether the individual services qualify as distinct performance obligations. In its assessment of whether a service is a distinct performance obligation, the Company determines whether the customer can benefit from the service on its own or with other readily available resources and whether the service is separately identifiable from other services in the contract. This evaluation requires the Company to assess the nature of each individual service offering and how the services are provided in the context of the contract, including whether the services are significantly integrated, highly interrelated, or significantly modify each other, which may require judgment based on the facts and circumstances of the contract.
When agreements involve multiple distinct performance obligations, the Company allocates arrangement consideration to all performance obligations at the inception of an arrangement based on the relative standalone selling prices of each performance obligation. Where the Company has standalone sales data for its performance obligations which are indicative of the price at which the Company sells a promised good or service separately to a customer, such data is used to establish standalone selling prices. In instances where standalone sales data is not available for a particular performance obligation, the Company estimates standalone selling prices by maximizing the use of observable market and cost-based inputs.
When estimating standalone selling prices, the Company reviews company-specific factors used to determine list price and makes adjustments as appropriate to reflect current market conditions and pricing behavior. The Company’s process for establishing list price includes assessing the cost to provide a particular product or service, surveying customers to determine market expectations, analyzing customer demographics, and taking into account similar products and services historically sold by the Company. The Company continues to review the factors used to establish list price and will adjust standalone selling price methodologies as necessary on a prospective basis.
Hosted Software Services Revenues.  Hosted software services generally include a combination of the Company’s products delivered as software-as-a-service (“SaaS”) subscriptions that are a performance obligation consisting of a series of distinct services and support services. These arrangements are generally non-cancelable and do not contain refund-type provisions. These revenues typically include the following:

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Encompass Revenues.  The Company offers web-based, on-demand access to its Encompass loan origination software for a monthly recurring fee. Customers under SaaS arrangements do not take control of the underlying software at any time during the term of the agreement. Fixed fees for subscription revenues are recognized over time, using an output method of the passage of time (or ratably) over the contract terms as performance obligations are satisfied as this method best depicts the Company’s pattern of performance for such services. Contracts generally range from one year to five years.
Alternatively, customers can elect to pay on a success basis. Success basis contracts are subject to monthly billing calculations whereby customers are obligated to pay the greater of a contractual base fee or variable closed loan fee, which is based on the number of closed loan transactions processed by the customer in the specific month.
Monthly base fees are recognized ratably over the contract terms as subscription performance obligations are satisfied.
Closed loans fees in excess of base fees are considered variable consideration. For the majority of contracts that include variable consideration, these fees are recognized in the month in which they are earned because the terms of the variable payments relate specifically to the outcome from transferring the distinct time increment (month) of service, which is consistent with the allocation objective when considering all of the performance obligations and payment terms in the contract (i.e., where “the allocation objective is met”). For certain contracts where the allocation objective would not be met by allocating variable consideration in this way, total variable consideration to be received is estimated at contract inception and recognized ratably over the contract term, with estimates of variable consideration being updated at each reporting date. For these contracts, variable consideration is estimated using the expected value method, utilizing forecast data for each contract to determine the expected value.
Services Revenues.  The Company provides a variety of mortgage-related and other business services, including: automated documentation; fraud detection, valuation, validation, and risk analysis; income verification; lead management; marketing and customer relationship management; product and pricing; flood zone certifications; website and electronic document management; and compliance reports. Services that include fixed fee subscriptions are a single performance obligation consisting of a series of distinct services. The fixed fees are recognized ratably over the contract terms as performance obligations are satisfied as this method best depicts the Company’s pattern of performance for such services. Variable fees are recognized either over time in the month in which the allocation objective is met or at the point in time when control is transferred.
Subscriptions to Online Research and Data Resources.  The Company provides mortgage originators and underwriters with access to online databases of various federal and state laws and regulations and forms as well as investor product guidelines. Fixed fees are recognized over time, using an output method of the passage of time or ratably over the contract terms as performance obligations are satisfied as this method best depicts the Company’s pattern of performance for such services.
Ellie Mae Network Revenues.  The Company has entered into agreements with various lenders, service providers and certain government-sponsored entities participating in the mortgage origination process to provide those suppliers with access to, and ability to interoperate with, mortgage originators on the Ellie Mae Network. The services are delivered via subscriptions that are comprised of a performance obligation consisting of a series of distinct services. The Company acts as an agent when it arranges for services to be provided by the supplier to the customer. Fixed fees are recognized ratably over the contract terms as performance obligations are satisfied as this method best depicts the Company’s pattern of performance for such services. Variable fees are recognized over time in the month in which the allocation objective is met.
Professional Services Revenues.  Professional services, including implementation services for our subscription products, are performance obligations which are capable of being distinct and are distinct within the context of the contract. Such services are generally provided on a time and materials or fixed price basis. The majority of the Company’s professional services are provided on a fixed price basis and the Company recognizes revenue over time as the performance obligations are satisfied utilizing an input method based on the proportion of hours incurred to total estimated hours. Any changes in the estimate of progress towards completion are accounted for in the period of change using the cumulative catch-up method. Revenues from professional services contracts provided on a time and materials basis are recognized when invoiced as amounts correspond directly with the value of the services.
Deferred Revenues
Deferred revenues represent billings or payments received in advance of revenue recognition and is recognized upon transfer of control. Balances consist primarily of prepaid subscription services and professional and training services not yet provided as of the balance sheet date. Deferred revenues that will be recognized during the succeeding 12-month period are recorded as current deferred revenues, and the remaining portion is recorded as other non-current liabilities.

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Contract Assets
Contract assets represent amounts recognized as revenues for which the Company does not have the unconditional right to consideration. Amounts related to invoices expected to be issued during the succeeding 12-month period are recorded as prepaid expenses and other current assets, and the remaining portion is recorded as deposits and other non-current assets.
Deferred Costs
Deferred costs mainly consist of sales commissions and related fringe benefits that are incremental costs of obtaining contracts with customers. The Company amortizes the costs incurred on initial contracts on a straight-line basis over a period of benefit determined to be approximately five years. The period of benefit is determined based on a review of customer churn rates and technological lifecycles of the underlying product offerings. All deferred costs on renewal contracts are amortized on a straight-line basis over the applicable renewal period. Additionally, the Company exercises the practical expedient to expense commissions on arrangements in which the amortization period is expected to be one year or less. Deferred costs that will be recognized during the succeeding 12-month period are recorded as prepaid expenses and other current assets, and the remaining portion is recorded as deposits and other non-current assets.
Recent Accounting Pronouncements
In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-02, Leases (Topic 842) (“ASU 2016-02”), as subsequently amended, which requires lessees to put most leases on their balance sheets, but recognize the expenses on their income statements in a manner similar to current practice. ASU 2016-02 states that a lessee would recognize a lease liability for the obligation to make lease payments and a right-to-use asset for the right to use the underlying asset for the lease term. The standard is effective for interim and annual periods beginning after December 15, 2018, and early adoption is permitted. The Company currently does not intend to early adopt and is evaluating the impact of this accounting standard update on its consolidated financial statements.
Standards Adopted
ASU No. 2014-09
In May 2014, the FASB issued ASU 2014-09 (“Topic 606”), as subsequently amended, which outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. This standard requires expanded disclosures about revenue recognition to better communicate the nature, amount, timing, and uncertainty of the Company’s revenues and cash flows, including significant judgments and estimates. The standard also provides guidance on the recognition of costs related to obtaining customer contracts under Subtopic 340-40, Other Assets and Deferred Costs - Contracts with Customers. The effective date for public entities is fiscal years beginning after December 15, 2017 and early adoption was permitted. On January 1, 2018, the Company adopted Topic 606 using the modified retrospective method and applied Topic 606 to those contracts which were not completed as of January 1, 2018.
On January 1, 2018, the Company recognized the cumulative effect of initially applying Topic 606 as an adjustment to the opening balance of retained earnings and the corresponding balance sheet accounts, which resulted in a net increase to retained earnings of $22.7 million, which includes the tax effect of approximately $7.2 million in deferred tax liabilities recorded in other long-term liabilities and corresponding adjustments to selected consolidated balance sheet line items. The impact on the Company’s opening balances primarily is related to its straight-line calculations for subscription revenue and the capitalization of additional commission costs under Topic 606. The comparative information has not been restated and continues to be reported under the accounting standards in effect in those prior periods. Refer to the tables below and Note 3 “Revenue Recognition” for additional accounting policy and transition disclosures.

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The Company recognized the cumulative effect of initially applying ASC 606 as an adjustment to retained earnings in the balance sheet as of January 1, 2018 as follows:
Selected Consolidated Balance Sheet Line Items
 
Balance at December 31, 2017
 
Adjustments Due to ASC 606
 
Balance at January 1, 2018
 
(in thousands)
Current assets:
 
 
 
 
 
Prepaid expenses and other current assets
$
18,474

 
$
8,187

 
$
26,661

Non-current assets:
 
 
 
 
 
Deposits and other assets
$
9,290

 
$
18,859

 
$
28,149

Current liabilities:
 
 
 
 
 
Accrued and other current liabilities
$
26,188

 
$
810

 
$
26,998

Deferred revenues
$
26,287

 
$
(4,435
)
 
$
21,852

Non-current liabilities:
 
 
 
 
 
Other long-term liabilities
$
18,880

 
$
7,991

 
$
26,871

Stockholders' equity:
 
 
 
 
 
Retained earnings
$
86,399

 
$
22,680

 
$
109,079


The following tables summarize the impacts of Topic 606 adoption on the Company's condensed consolidated financial statements for the quarter ended March 31, 2018.
Selected Consolidated Balance Sheet Line Items
 
March 31, 2018
 
(in thousands)
 
As Reported
 
Adjustments
 
Balances without adoption of Topic 606
Current assets:
 
 
 
 
 
Prepaid expenses and other current assets
$
31,864

 
$
(9,938
)
 
$
21,926

Non-current assets:
 
 
 
 
 
Deposits and other assets
$
30,602

 
$
(15,636
)
 
$
14,966

Current liabilities:
 
 
 
 
 
Accrued and other current liabilities
$
24,338

 
$
(824
)
 
$
23,514

Deferred revenues
$
17,975

 
$
2,688

 
$
20,663

Non-current liabilities:
 
 
 
 
 
Other long-term liabilities
$
19,727

 
$
(2,829
)
 
$
16,898

Stockholders' equity:
 
 
 
 
 
Retained earnings
$
99,579

 
$
(24,609
)
 
$
74,970


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Selected Consolidated Statement of Comprehensive Income Line Items
 
Three Months ended March 31, 2018
 
(in thousands, except per share amounts)
 
As Reported
 
Adjustments
 
Balances without adoption of Topic 606
Revenues
$
117,912

 
$
(1,929
)
 
$
115,983

Gross profit
$
68,565

 
$
(1,929
)
 
$
66,636

Operating expenses:
 
 
 
 
 
Sales and marketing
$
23,064

 
$
78

 
$
23,142

Loss from operations
$
(3,302
)
 
$
(2,007
)
 
$
(5,309
)
Income tax benefit
$
(4,658
)
 
$
(79
)
 
$
(4,737
)
Net income
$
2,204

 
$
(1,928
)
 
$
276

Basic income per share of common stock
$
0.06

 
$
(0.05
)
 
$
0.01

Diluted income per share of common stock
$
0.06

 
$
(0.05
)
 
$
0.01

Selected Consolidated Statement of Cash Flows Line Items
 
Three Months ended March 31, 2018
 
(in thousands)
 
As Reported
 
Adjustments
 
Balances without adoption of Topic 606
Net income
$
2,204

 
$
(1,928
)
 
$
276

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
Deferred income taxes
$
(4,658
)
 
$
(79
)
 
$
(4,737
)
Changes in operating assets and liabilities:
 
 
 
 
 
Prepaid expenses and other current assets
$
(5,203
)
 
$
1,752

 
$
(3,451
)
Deposits and other assets
$
(4,331
)
 
$
1,851

 
$
(2,480
)
Accrued, other current and other long-term liabilities
$
(2,928
)
 
$
(14
)
 
$
(2,942
)
Deferred revenues
$
(4,187
)
 
$
(1,582
)
 
$
(5,769
)
Net cash provided by operating activities
$
6,401

 
$

 
$
6,401

ASU No. 2018-05
In March 2018, the FASB issued ASU No. 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 (“ASU 2018-05”). ASU 2018-05 addresses certain circumstances arising in accounting for the income tax effects of the Tax Cuts and Job Act (“Tax Act”) in conformity with SEC Staff Accounting Bulletin No. 118 (“SAB 118”) including provisional estimates of those effects. The Company adopted SAB 118 in the fourth quarter of 2017 and continues to analyze the impact of the Tax Act on an ongoing basis. Due to the timing of the enactment and the complexity in applying the provisions of the Tax Act, the provisional net charge is subject to revisions as the Company continues to complete its analysis of the Tax Act. Adjustments may materially impact the Company’s provision for income taxes and effective tax rate in the period in which the adjustments are made. The Company expects to finalize the impact analysis in the fourth quarter of 2018. Additional information regarding the accounting for income taxes for the Tax Act is contained in Note 8 “Income Taxes.”

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NOTE 3Revenue Recognition
Disaggregation of Revenue
The following table provides information about disaggregated revenue from customers.
 
March 31,
2018
 
(in thousands)

Hosted software services
$
97,120

Ellie Mae Network
13,271

Professional services
7,521

Revenues
$
117,912

Contract Balances
The following table provides information about receivables, contract assets and deferred revenues from contracts with customers.
 
Balance Sheet Line Reference
March 31,
2018
 
 
(in thousands)
Accounts receivables, net
Accounts receivables, net
$
45,123

Contract assets - current
Prepaid expenses and other current assets
$
7,915

Contract assets - noncurrent
Deposits and other assets
$
15,275

Deferred revenues - current
Deferred revenue
$
17,975

Deferred revenues - noncurrent
Other long-term liabilities
$
900

Changes in the contract assets and the deferred revenues balances during the three months ended March 31, 2018 are as follows:
 
January 1,
2018
 
March 31,
2018
 
$ Change
 
(in thousands)
Contract assets
$
19,667

 
$
23,190

 
$
3,523

Deferred revenues
$
23,062

 
$
18,875

 
$
(4,187
)
The increase in contract assets from $19.7 million to $23.2 million as of March 31, 2018 was primarily driven by the recognition of revenue that has not yet been billed. The decrease in deferred revenues from $23.1 million to $18.9 million was due to additional performance on certain arrangements in which billing occurred in advance. During the three months ended March 31, 2018, $12.1 million of revenue recognized was included in the deferred revenues balance at the beginning of the period, which was offset by additional deferrals during the period.

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Revenues Allocated to Remaining Performance Obligations
Remaining performance obligations represent contracted revenues that have not yet been recognized, which includes deferred revenues and amounts that will be invoiced and recognized as revenues in future periods.
The Company expects to recognize revenue on the remaining performance obligations as follows:
  
March 31,
2018
 
(in thousands)
Within 1 year
$
291,943

2-3 years
293,805

Thereafter
68,306

 
$
654,054

Remaining performance obligations exclude variable consideration allocated entirely to future distinct services as well as variable consideration in arrangements in which revenue recognition under the as-billed practical expedient corresponds directly to the amount the Company has the right to invoice, which includes most arrangements that involve services revenues priced on a transactional basis and professional services invoiced on a time and materials basis. Additionally, in instances where an estimate of variable consideration is constrained, such estimate of variable consideration is not included in revenues allocated to remaining performance obligations.
Deferred Costs
Deferred costs, which consist of deferred sales commissions, were $15.7 million as of March 31, 2018 and $8.5 million for December 31, 2017. For the three months ended March 31, 2018 and 2017, amortization expense for deferred costs was $1.4 million and $0.8 million, respectively and there was no impairment loss related to the costs capitalized.
NOTE 4Net Income Per Share of Common Stock
Net income per share of common stock is calculated by dividing net income by the weighted average shares of common stock outstanding during the period. Diluted net income per share of common stock is calculated by dividing net income by the weighted average shares of common stock outstanding and potential shares of common stock during the period. Potential shares of common stock include dilutive shares attributable to the assumed exercise of stock options, restricted stock unit awards (“RSUs”), performance-vesting RSUs, performance share awards (“Performance Awards”), and Employee Stock Purchase Plan (“ESPP”) shares using the treasury stock method, if dilutive.
The components of net income per share of common stock were as follows:
  
Three Months ended March 31,
  
2018
 
2017
 
(in thousands, except per share amounts)
Net income
$
2,204

 
$
9,599


 
 
 
Weighted average common shares outstanding used to compute basic net income per share
34,143

 
33,702

Effect of potentially dilutive securities:
 
 
 
Employee stock options, RSUs, performance-vesting RSUs, Performance Awards and ESPP shares
1,459

 
1,907

Weighted average common shares outstanding used to compute diluted net income per share
35,602

 
35,609

Net income per share:
 
 
 
Basic
$
0.06

 
$
0.28

Diluted
$
0.06

 
$
0.27


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The following potential weighted average common shares were excluded from the computation of diluted net income per share, as their effect would have been anti-dilutive:
  
Three Months ended March 31,
  
2018
 
2017
 
(in thousands)
Employee stock options and awards
10

 
73

Performance-vesting RSUs and Performance Awards are included in the diluted shares outstanding for each period if the established performance criteria have been met at the end of the respective periods. However, if none of the required performance criteria have been met for such awards, the Company includes the number of shares that would be issuable if the end of the reporting period were the end of the contingency period. Accordingly, in addition to the employee stock options and awards noted above, 129,079 and 71,939 shares underlying performance-vesting RSUs and Performance Awards were excluded from the dilutive shares outstanding for each of the three months ended March 31, 2018 and 2017, respectively.
NOTE 5Financial Instruments and Fair Value Measurement
As of March 31, 2018 and December 31, 2017, the Company’s cash, cash equivalents and investments were primarily comprised of cash and investment-grade, fixed maturity interest-bearing debt securities, such as money market funds, certificates of deposit, commercial paper, corporate bonds, municipal and government agency obligations, and guaranteed obligations of the United States government. Cash equivalents and investments are recorded at fair value. All investments are considered available for sale.
The following table summarizes cash and investments in financial instruments that are measured at fair value on a recurring basis and are categorized using the fair value hierarchy by investment type:
 
March 31, 2018
 
December 31, 2017
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Carrying or Fair Value
 
Amortized 
Cost
 
Unrealized Gains
 
Unrealized Losses
 
Carrying or
Fair Value
 
(in thousands)
 
(in thousands)
Cash
$
85,193

 
$

 
$

 
$
85,193

 
$
119,035

 
$

 
$

 
$
119,035

Level 1:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Money market funds
2,970

 

 

 
2,970

 
3,623

 

 

 
3,623

U.S. government and government agency obligations
61,176

 

 
(438
)
 
60,738

 
52,255

 

 
(266
)
 
51,989

 
149,339

 

 
(438
)
 
148,901

 
174,913

 

 
(266
)
 
174,647

Level 2:
 

 
 
 
 

 
 

 
 

 
 
 
 

 
 

Corporate notes and obligations
79,065

 

 
(636
)
 
78,429

 
81,062

 

 
(304
)
 
80,758

Certificates of deposit
5,628

 
1

 

 
5,629

 
6,527

 
2

 

 
6,529

Municipal obligations
8,381

 

 
(38
)
 
8,343

 
10,274

 

 
(46
)
 
10,228

U.S. government and government agency obligations
73,903

 

 
(305
)
 
73,598

 
76,510

 

 
(266
)
 
76,244

Total financial instruments
316,316

 
1

 
(1,417
)
 
314,900

 
349,286

 
2

 
(882
)
 
348,406

Less investments
198,974

 
1

 
(1,417
)
 
197,558

 
211,588

 
2

 
(882
)
 
210,708

Cash and cash equivalents
$
117,342

 
$

 
$

 
$
117,342

 
$
137,698

 
$

 
$

 
$
137,698

The Company classifies its money market funds that are specifically backed by debt securities and U.S. government obligations as Level 1 instruments due to the use of observable market prices for identical securities that are traded in active markets.
Valuation of the Company’s marketable securities investments classified as Level 2 is achieved primarily through broker quotes when such investments exist in a non-active market.
At March 31, 2018 and December 31, 2017, the Company did not have any assets or liabilities that were valued using Level 3 inputs.
Realized gains and losses from the sale of investments were immaterial during the three months ended March 31, 2018 and 2017.

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The following table shows the gross unrealized losses and the related fair values of the Company’s investments that have been in a continuous unrealized loss position. The Company did not identify any investments as other-than-temporarily impaired at March 31, 2018 or December 31, 2017 based on its evaluation of available evidence, such as the Company’s intent to hold and whether it is more likely than not that the Company will be required to sell the investment before recovery of the investment’s amortized basis. The Company expects to receive the full principal and interest on these investments.
 
March 31, 2018
 
Less than 12 Months
 
12 Months or Greater
 
Total
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
(in thousands)
Corporate notes and obligations
$
60,690

 
$
(571
)
 
$
6,935

 
$
(66
)
 
$
67,625

 
$
(637
)
Certificates of deposit

 

 
1,480

 

 
1,480

 

U.S. government, government agency, and municipal obligations
119,011

 
(672
)
 
12,933

 
(108
)
 
131,944

 
(780
)
 
$
179,701

 
$
(1,243
)
 
$
21,348

 
$
(174
)
 
$
201,049

 
$
(1,417
)
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2017
 
Less than 12 Months
 
12 Months or Greater
 
Total
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
Fair Value
 
Unrealized Losses
 
(in thousands)
Corporate notes and obligations
$
62,099

 
$
(253
)
 
$
7,574

 
$
(51
)
 
$
69,673

 
$
(304
)
Certificates of deposit
482

 

 
1,348

 

 
1,830

 

U.S. government, government agency, and municipal obligations
119,456

 
(492
)
 
13,070

 
(86
)
 
132,526

 
(578
)
 
$
182,037

 
$
(745
)
 
$
21,992

 
$
(137
)
 
$
204,029

 
$
(882
)
The following table summarizes the contractual maturities of the Company’s investments at March 31, 2018:
 
 
 
Amortized Cost
 
Carrying or
Fair Value
 
 
 
(in thousands)
Due within one year
 
 
$
114,254

 
$
113,931

Due after one year through three years (1)
 
 
84,720

 
83,627

Total
 
 
$
198,974

 
$
197,558

________________
(1) Maximum maturity of individual investments is three years.
Actual maturities may differ from the contractual maturities because borrowers may have the right to call or prepay certain obligations.

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NOTE 6Property and Equipment, net
Property and equipment, net, consisted of the following:
 
March 31,
 
December 31,
 
2018
 
2017
 
(in thousands)
Computer equipment and software
$
72,627

 
$
67,068

Internal-use software
117,758

 
108,710

Furniture and fixtures
8,284

 
8,311

Leasehold improvements
27,310

 
27,356

Internal-use software and other assets not placed in service
60,575

 
52,659

Property and equipment, gross
286,554

 
264,104

Accumulated depreciation and amortization
(87,647
)
 
(77,113
)
Property and equipment, net
$
198,907

 
$
186,991

Depreciation and amortization expense for the three months ended March 31, 2018 and 2017 was $11.4 million and $7.3 million, respectively. These amounts include amortization of assets under capital leases of $0.6 million and $0.8 million for the three months ended March 31, 2018 and 2017, respectively.

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NOTE 7Intangible Assets, net
Intangible assets, net, consisted of the following:
  
March 31, 2018
  
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Intangibles
 
Weighted Average Remaining Useful Life
 
(in thousands)
 
(in years)
Assets subject to amortization:
 
 
 
 
 
 
 
Developed technology
$
53,535

 
$
(12,402
)
 
$
41,133

 
7.2
Trade names
1,931

 
(598
)
 
1,333

 
2.5
Customer relationships
34,900

 
(13,981
)
 
20,919

 
7.6
Order backlog
14,370


(7,226
)

7,144


0.5
Total assets subject to amortization
104,736

 
(34,207
)
 
70,529

 
6.6
Assets not subject to amortization:
 
 
 
 
 
 
 
Trade name
4,039

 

 
4,039

 
 
 
$
108,775

 
$
(34,207
)
 
$
74,568

 
 
 
 
 
 
 
 
 
 
  
December 31, 2017
  
Gross Carrying
Amount
 
Accumulated
Amortization
 
Net Intangibles
 
Weighted Average Remaining Useful Life
 
(in thousands)
 
(in years)
Assets subject to amortization:
 
 
 
 
 
 
 
Developed technology
$
53,535

 
$
(10,810
)
 
$
42,725

 
7.5
Trade names
1,931

 
(464
)
 
1,467

 
2.8
Customer relationships
34,900

 
(13,050
)
 
21,850

 
7.7
Order backlog
14,370

 
(3,577
)
 
10,793

 
0.8
Total assets subject to amortization
104,736

 
(27,901
)
 
76,835

 
6.5
Assets not subject to amortization:
 
 
 
 
 
 
 
Trade name
4,039

 

 
4,039

 
 
 
$
108,775

 
$
(27,901
)
 
$
80,874

 
 
Amortization expense associated with intangible assets for the three months ended March 31, 2018 and 2017 was $6.3 million and $1.1 million, respectively.
Future amortization expense for intangible assets at March 31, 2018 was as follows:
  
Amortization
 
(in thousands)
Remainder of 2018
$
15,083

2019
10,499

2020
8,978

2021
7,114

2022
7,055

2023
6,800

Thereafter
15,000

 
$
70,529


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NOTE 8Income Taxes
The Company’s tax provision for interim periods is determined using an estimate of its annual effective tax rate, adjusted for discrete items, if any, that arise during the period. Each quarter, the Company updates the estimate of the annual effective tax rate and, if the estimated annual effective tax rate changes, the Company makes a cumulative adjustment in such period. The Company’s income tax benefit, and its effective tax rate, for the periods ended March 31, 2018 and 2017 are as follows:

  
Three Months ended March 31,
  
2018
 
2017
 
(dollars in thousands)
Income tax benefit
$
(4,658
)
 
$
(4,593
)
Effective tax rate
189.8
%
 
(91.7
)%
The Company’s effective tax rate was 189.8% and (91.7)% for the three months ended March 31, 2018 and 2017, respectively. For the three months ended March 31, 2018, the Company’s effective tax rate differs from the U.S. federal statutory rate of 21% primarily due to the discrete impact of the excess tax benefits from stock-based compensation and the reduced state blended income tax rate. For the three months ended March 31, 2017, the Company’s effective tax rate differs from the U.S. federal statutory rate of 35% primarily due to the discrete impact of excess tax benefits from stock-based compensation as well as non-deductible stock-based compensation and federal R&D credits.
The Company regularly assesses the realizability of the deferred tax assets and establishes a valuation allowance if it is more-likely-than-not that some or all of the Company's deferred tax assets will not be realized. The Company evaluates and weighs all available positive and negative evidence such as historic results, future reversals of existing deferred tax liabilities, as well as projected future taxable income. Generally, more weight is given to objectively verifiable evidence. The Company will continue to assess the realizability of the deferred tax assets in each of the applicable jurisdictions.
The Company’s tax positions are subject to income tax audits by multiple tax jurisdictions. The Company accounts for uncertain tax positions and believes that it has provided adequate reserves for its unrecognized tax benefits for all tax years still open for assessment. The Company also believes that it does not have any tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase or decrease within the next twelve months.
The Company has a policy to classify accrued interest and penalties associated with uncertain tax positions together with the related liability in the balance sheet, and to include the expenses incurred related to such accruals in the provision for income taxes. There were no interest or penalties included in the provision for income taxes during the three months ended March 31, 2018 and 2017.
The SEC staff issued SAB 118, which provides guidance for companies that are not able to complete their accounting for the income tax effects of the Tax Act in the period of enactment. The guidance allows the Company to record provisional amounts to the extent a reasonable estimate can be made and provides the Company with up to one year from enactment date to finalize the accounting for the impact of the Tax Act.
The Tax Act is effective in the Company’s fourth quarter of 2017. As of March 31, 2018, we have not completed our accounting for the tax effects of the Tax Act. During the quarter, no material revision has been made to the Company’s provisional assessments made as of December 31, 2017. In order to complete the accounting for the impact of the Tax Act, the Company continues to obtain, analyze and interpret additional guidance as such guidance becomes available from the U.S. Treasury Department, the Internal Revenue Service (“IRS”), state taxing jurisdictions, the FASB, and other standard-setting and regulatory bodies. New guidance or interpretations may materially impact the Company’s provision for income taxes in future periods. Additional information that is needed to complete the analysis but is currently unavailable includes, but is not limited to, the final determination of certain net deferred tax assets and liabilities subject to remeasurement and when the related temporary differences will be settled or realized, and the tax treatment of such provisions of the Tax Act by various state tax authorities. In addition, we do not currently have sufficient information and guidance to determine the impact of “transition rule” related to the Company’s covered employees’ compensation stemming from written binding contracts entered on or before November 2, 2017. The provisional accounting impacts may change in future reporting periods until our accounting analysis is finalized, which is expected to be completed by the Company’s fourth quarter of 2018. For additional information related to the impact of the 2017 Tax Act on our tax provision and tax rate, please see Note 8 of our consolidated financial on our Annual Report on Form 10-K, for the calendar year ended December 30, 2017, filed with the SEC on March 01, 2018.

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Table of Contents

NOTE 9Commitments and Contingencies
Leases
As of March 31, 2018, the Company leased nine facilities under operating lease arrangements. The lease expiration dates range from September 2019 to December 2025. Certain leases contain escalation clauses calling for increased rents. The Company recognizes rent expense on a straight-line basis over the lease period.
Legal Proceedings
On December 1, 2017, a pension fund and stockholder purporting to act on the Company’s behalf filed a derivative lawsuit in the Superior Court of California for the County of Alameda, captioned United Association of Plumbers and Pipefitters, Journeymen, Local #38 Defined Benefit Pension Plan v. Jonathan H. Corr, et al. (Case No. RG17884445). The lawsuit purports to assert claims against certain of the Company’s officers and directors for insider trading under California law, breach of fiduciary duty, corporate waste, and unjust enrichment based on allegations that: (1) the Company overstated its financial prospects in public filings between February 10, 2017 and July 27, 2017; and (2) certain of the Company’s officers and directors sold shares during this same period. Plaintiff seeks unspecified monetary damages, attorneys’ fees and costs, as well as certain changes to the Company’s corporate governance and internal procedures. The Company’s demurrer to plaintiff’s complaint was filed on February 15, 2018. Plaintiff has opposed the Company’s demurrer and the Company has filed a reply in support of its demurrer. On May 8, 2018, the court sustained the Company’s demurrer with leave to amend within 30 days. At this time, the Company is unable to estimate a probable loss for this matter, if any, and accordingly has not accrued for any amount.
From time to time, the Company is involved in litigation that it believes is of the type common to companies engaged in the Company’s line of business, including commercial and employment disputes. As of the date of this Quarterly Report on Form 10-Q, the Company is not involved in any other pending legal proceedings whose outcome the Company expects to have a material adverse effect on its financial position, results of operations or cash flows.
NOTE 10Equity and Stock Incentive Plans
The 2011 Equity Incentive Award Plan (the “2011 Plan”) serves as the successor to the Company’s 2009 Stock Option and Incentive Plan (together with the 2011 Plan, the “Stock Plans”). The Company recognized stock-based compensation expense related to awards granted under the Stock Plans and ESPP.
Total stock-based compensation expense recognized consisted of:
 
Three Months ended March 31,
 
2018
 
2017
 
(in thousands)
Cost of revenues
$
1,894

 
$
1,444

Sales and marketing
1,556

 
1,176

Research and development
2,534

 
1,861

General and administrative
3,548

 
3,370

 
$
9,532

 
$
7,851


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Table of Contents

Stock Plans
Stock Options
The following table summarizes the Company’s stock option activity under the Stock Plans:
 
Number of
Shares
 
Weighted
Average
Exercise
Price
 
Weighted
Average
Remaining
Contractual
Term
 
Aggregate
Intrinsic
Value
 
 
 
 
 
(in years)
 
(in thousands)
Outstanding at January 1, 2018
1,436,031

 
$
27.06

 
5.43
 
$
89,554

Granted
4,641

 
$
92.28

 
 
 
 
Exercised
(92,838
)
 
$
23.57

 
 
 
 
Forfeited or expired
(4,298
)
 
$
43.69

 
 
 
 
Outstanding at March 31, 2018
1,343,536

 
$
27.47

 
5.18
 
$
86,631

Ending vested and expected to vest at March 31, 2018
1,341,283

 
$
27.43

 
5.18
 
$
86,551

Exercisable at March 31, 2018
1,212,913

 
$
24.82

 
4.98
 
$
81,411

The aggregate intrinsic value of the stock options outstanding at March 31, 2018 represents the value of the Company’s closing stock price of $91.94 on March 31, 2018 in excess of the exercise price multiplied by the number of options outstanding for options that were in-the-money.
As of March 31, 2018, total unrecognized stock-based compensation expense related to unvested stock options, adjusted for estimated forfeitures, was $3.0 million and is expected to be recognized over a weighted average period of 1.1 years.
Restricted Stock Units, Performance-Vesting Restricted Stock Units, and Performance Awards
The following table summarizes the Company’s RSU, Performance Award, and performance-vesting RSU activity:
 
RSUs
 
Performance Awards and Performance-Vesting RSUs
 
Number of
Shares
 
Weighted
Average
Grant Date
Fair Value
Per Share
 
Number of
Shares
 
Weighted
Average
Grant Date
Fair Value
Per Share
 
 
 
 
 
 
 
 
Outstanding at January 1, 2018
1,179,458

 
$
82.84

 
294,464

 
$
56.17

Granted
104,142

 
$
91.33

 
121,102

 
$
92.28

Released
(73,171
)
 
$
61.21

 
(115,325
)
 
$
43.95

Forfeited or expired
(30,094
)
 
$
79.74

 
(20,645
)
 
$
61.11

Outstanding at March 31, 2018
1,180,335

 
$
85.01

 
279,596

 
$
76.48

Ending vested and expected to vest at March 31, 2018
1,065,414

 
 
 
279,593

 
 
RSUs, performance-vesting RSUs, and Performance Awards that are expected to vest are presented net of estimated future forfeitures. RSUs released during the three months ended March 31, 2018 and 2017 had an aggregate intrinsic value of $6.6 million and $5.3 million, respectively, and had an aggregate grant-date fair value of $4.5 million and $2.7 million, respectively. Performance-vesting RSUs and Performance Awards released during the three months ended March 31, 2018 and 2017 had an aggregate intrinsic value of $10.6 million and $13.7 million, respectively, and had an aggregate grant-date fair value of $5.1 million and $5.8 million, respectively. The number of RSUs released includes shares that the Company withheld on behalf of employees to satisfy the minimum statutory tax withholding requirements.
As of March 31, 2018, total unrecognized compensation expense related to unvested RSUs, performance-vesting RSUs, and Performance Awards was $83.7 million and is expected to be recognized over a weighted average period of 2.5 years.

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Table of Contents

Employee Stock Purchase Plan
For the three months ended March 31, 2018 and 2017, employees purchased 77,339 shares and 52,619 shares, respectively, under the ESPP, resulting in cash proceeds of $5.6 million and $4.3 million, respectively. As of March 31, 2018, unrecognized compensation expense related to the current semi-annual ESPP offering period, which ends on August 31, 2018, was $1.5 million and is expected to be recognized over five months.
Valuation Information
The fair value of stock options and stock purchase rights granted under the Stock Plans, and the ESPP were estimated at the date of grant using the Black-Scholes option valuation model with the following weighted average assumptions:
  
Three Months ended March 31,
  
2018
 
2017
Stock option plans:
 
 
 
 
 
Risk-free interest rate
2.63
%
 
2.04
%
Expected life of options (in years)
6.08
 
 
6.08
 
Expected dividend yield
%
 
%
Volatility
45
%
 
48
%
Employee Stock Purchase Plan:
 
 
 
 
 
Risk-free interest rate
1.86
%
 
0.69
%
Expected life of options (in years)
0.50
 
 
0.50
 
Expected dividend yield
%
 
%
Volatility
27
%
 
35
%
Common Stock
The following numbers of shares of common stock were reserved and available for future issuance at March 31, 2018: 
  
Reserved
Shares
Options and awards outstanding under the Stock Plans
2,803,467

Shares available for future grant under the 2011 Plan
6,730,095

Shares available under the ESPP
1,879,626

Total
11,413,188

In March 2018, 342,276 additional shares were reserved under the ESPP, and 1,711,384 additional shares were reserved under the 2011 Plan, pursuant to the automatic increase provisions in each plan.
Stock Repurchase Program
In August 2017, the Company’s audit committee, under the authority delegated to it by the Company’s board of directors, approved a new stock repurchase program under which the Company is authorized to repurchase up to $250.0 million of its common stock. This authorization expires in August 2020. All shares are retired upon repurchase. During the three months ended March 31, 2018, the Company repurchased a total of 159,141 shares for $14.7 million. As of March 31, 2018, $200.0 million remained available for future repurchases under the program.
ITEM 2—MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
This Quarterly Report on Form 10-Q and the documents incorporated herein by reference contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” created by those sections. Forward-looking statements may include words such as “may,” “will,” “should,” “expect,” “plan,” “intend,” “target,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “project,” “continue,” or other wording indicating future results or expectations. These forward-looking statements include, but are not limited to, statements about:
expectations regarding demand for home purchases;

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Table of Contents

the impact of changes in mortgage interest rates, home sale activity and regulatory changes;
the impact of seasonality of our revenues;
estimates of the percentage of our revenues that have direct sensitivities to volume;
changes in mortgage originator, lender, investor or service provider behavior and any related impact on the residential mortgage industry;
our revenue and cost forecasts and drivers;
the number of estimated Encompass closed loans;
anticipated benefits of our new solutions;
anticipated timing of roll-out of new solutions and features;
our planned offerings to address regulatory changes;
our planned investments;
the anticipated benefits and growth prospects from our acquisitions ;
the timing of future acquisitions of businesses, solutions or technologies and new product launches;
our acquisition strategy;
our belief that believe that our existing cash, cash equivalents, and short-term investments will be sufficient to fund capital expenditures, operating expenses and other cash requirements for at least the next 12 months; and
our planned stock repurchases.
We caution you that the foregoing list may not contain all of the forward-looking statements made in this Quarterly Report on Form 10-Q. You should not rely upon forward-looking statements as predictions of future events. The outcomes of the events described in these forward-looking statements are subject to substantial risks, uncertainties and other factors described in Part II, Item 1A “Risk Factors,” and elsewhere, in this Quarterly Report on Form 10-Q. Moreover, we operate in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements contained in this Quarterly Report on Form 10-Q. We cannot assure you that the results, events and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events or circumstances could differ materially from those described in the forward-looking statements.
The forward-looking statements made in this Quarterly Report on Form 10-Q relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statements made in this Quarterly Report on Form 10-Q to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect new information or the occurrence of unanticipated events, except as required by law. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements, and you should not place undue reliance on our forward-looking statements.
In this report, references to “Ellie Mae,” the “Company,” “we,” “our,” or “us” refer to Ellie Mae, Inc., unless the context requires otherwise.
Overview
We are the leading cloud-based platform provider for the mortgage finance industry. Our technology solutions are used by lenders to originate and close residential mortgage loans. Banks, credit unions and mortgage lenders use our Encompass® all-in-one mortgage management solution to originate and fund mortgages and improve compliance, loan quality, and efficiency.
Mortgage originators use our Encompass software, a comprehensive digital mortgage solution that handles key business and management functions involved in running a residential mortgage origination business. Mortgage originators use Encompass as a single tool for marketing, loan origination, processing, and customer communication, and to interact electronically with lenders, investors, and service providers over the Ellie Mae Network. Our software also enables enforcement of rules and business practices designed to ensure loan quality, adherence to processing standards and regulatory compliance.

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The Ellie Mae Network electronically connects approximately 191,000 mortgage professionals using Encompass to the broad array of third-party service providers, mortgage lenders and investors integral to the origination and funding of residential mortgages. During the mortgage origination process, mortgage originators may order various services through the Ellie Mae Network, including credit reports; product eligibility and pricing services; automated underwriting services; appraisals; title reports; insurance; flood certifications and flood insurance; compliance reviews; fraud detection; document preparation; and verification of income, identity, and employment. Mortgage originators can also initiate secure data transmission to and from lenders and investors.
In October 2017, we acquired Velocify, Inc. (“Velocify”), a cloud-based sales engagement platform that provides customers the capabilities to generate and manage leads and customer relationships.
On January 1, 2018, we adopted the Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”) including its subsequent amendments (collectively “Topic 606”) for all open contracts as of January 1, 2018 using the modified retrospective method. Prior period amounts were not adjusted and are reported under Topic 605, Revenue Recognition.
Our revenues are generated primarily from subscriptions to the company-hosted Encompass Software that customers access through the Internet, including customers who pay fees based on the number of loans they close, or success basis, subject to monthly base fees, which we refer to as Success-Based Pricing, and related professional services such as consulting, implementation, and training services. Our revenues also include software related services that are sold on a transactional basis, as well as Ellie Mae Network fees, fees for education and training, loan product, policy and guideline data and analytics services that are provided under the AllRegs brand.
Our revenues typically, but not always, track the seasonality of the residential 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. Mortgage volumes are also impacted by other factors such as interest rate fluctuations, home sale activity, regulatory changes such as the TILA-RESPA Integrated Disclosure rule which became effective in October 2015, and general economic conditions, which can lead to departures from the typical seasonal pattern. In the first quarter of 2018, mortgage volumes declined relative to the first quarter of 2017 due to an increase in mortgage interest rates resulting in a lower number of refinancings. This had the effect of reducing the number of closed loans per active user on our platform in the first quarter of 2018 relative to the same period in 2017. Although the market is expected to transition to one in which increasing volumes are driven primarily by demand for home purchases, a tight housing supply in certain markets is currently limiting the rate of growth in purchase volumes.
In spite of lower industry volume, we continued to experience period-over-period increases in revenues as our customers use our platform to process an increasing percentage of loans originated in the United States and we are able to increase the revenue we earned per loan. This was achieved by the continued addition of new users and the increased adoption of our broader service offerings by our customers.
We currently estimate that approximately 25% to 35% of our revenues have some direct sensitivity to volume. The base fee portion of success based revenues, subscription revenues, and professional services revenues are generally not affected by fluctuations in mortgage origination volume. However, the impact on our revenues from a substantial decline in mortgage volumes is difficult to predict. Please refer to the risks relating to a decline in mortgage lending volumes described in Part II, Item 1A “Risk Factors” for additional information.
We are investing aggressively in initiatives that we believe will help us continue to grow our business, improve our products and services, and strengthen our competitive advantage while bringing sustainable long-term value to our customers. Our recent launch of Developer Connect will enable developers to create new features for Encompass, easily integrate Encompass with external systems and data, and build and deploy custom applications in the cloud. We believe this open and simplified architecture will enable us to deploy services more easily and drive more revenue per loan. In addition, lenders are also looking for a technology partner to deliver a better digital mortgage experience to consumers. The acquisition of Velocify accelerates our vision of offering a fully digital mortgage by combining Velocify’s lead management, engagement and distribution capabilities with our Encompass CRM and Consumer Connect service offerings, which allows lenders to provide better digital tools and a more easy-to-use web based experience as a seamless extension of Encompass.
In 2017 and the first quarter of 2018, we increased our investment in our platform, research and development, technology infrastructure, and data security in an effort to support our growing user base. This includes the roll out of our Connect solutions in 2017, the development of our hybrid cloud infrastructure, and the development of our next generation Encompass platform and capabilities, which we expect to continue to progressively roll out to customers this year and 2019. The amortization expense of capitalized costs associated with our Connect solutions and intangible assets from the Velocify acquisition resulted in a decrease in our gross margin and increased operating expenses in the first quarter of 2018 as compared to the same period in 2017. Conversely, capitalized costs associated with solutions that we have not yet introduced are reflected as an asset on our Condensed Consolidated Balance Sheet.

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We have also invested in our sales and client services capabilities to continue to increase sales of our products and to assist our customers in implementing our solutions. To continue to support customers as we grow our business and further differentiate ourselves, we intend to invest in key areas, such as research and development, enterprise sales, services, technical support, data security, and our hybrid cloud infrastructure. We expect that our cost of revenues will continue to increase as our revenues increase, as we make additional and accelerated investments to bolster our infrastructure and enhance our system capacity, reliability, and data security, as we place new internal-use software into service, and as we pursue additional strategic acquisitions. As we continue to invest in these areas, such expenditures may affect our ability to improve our margins as we grow revenue.
In addition to our internal initiatives, our business strategy has evolved to address recent industry trends, including:
greater focus on operational efficiencies;
customers adopting multi-channel strategies;
consumer demand for a digital based experience from lenders;
changes in regulation affecting lenders and investors;
increased quality standards imposed by regulators, lenders, and investors; and
greater focus by customers and regulators on data security and consumer privacy.
We are responding to these trends as follows:
Greater focus on operational efficiencies. The average total production cost per loan was $8,475 in the fourth quarter of 20171. We expect operational costs to continue to be a significant consideration for mortgage originators due to the continuously changing regulatory environment and heightened quality standards. By automating many of the functions of mortgage origination, we enable our users to comply with regulations and process quality loans more efficiently and effectively. This reduces the cost of originating loans and lowers the risk of buy-back demands from investors resulting from poorly originated or documented loans or loans that fail to comply with applicable regulations. We continually address the changing needs of our customers by developing and enhancing tools to allow for simplified regulatory compliance, increased availability of information, and enhanced system functionality and performance.
With an eye towards providing customers with ever-improving tools to enhance efficiency, we currently anticipate that we will continue to develop new service offerings through the Ellie Mae Network and encourage adoption of our services through initiatives such as our Encompass Connect Solutions. By integrating and expanding our current and new services, we aim to provide a more comprehensive solution to our users.
Customers adopting multi-channel strategies. Customers are developing multi-channel strategies beyond a single retail, correspondent or wholesale mortgage lending channel in order to grow their businesses. The requirements of these different channels vary and in order to maintain a single operating system, customers must use a robust system with customizable functionality. Encompass includes support for multi-channel workflows, allowing our customers to drive efficiencies and boost productivity by creating distinct workflows for each channel that map to our customers’ business needs. Encompass users can customize workflows based on channel, loan purpose or specific loan criteria - all of which can vary between lending channels. With the introduction of Encompass TPO Connect, Encompass users are able to utilize a customizable and interactive web experience for wholesale and correspondent lending channels, which gives lenders and investors a modern and collaborative web experience for their third-party origination (“TPO”) partners that promotes compliance, data integrity, and easy bi-directional communication throughout the entire loan process. Additionally, Encompass Consumer Connect enables our customers to originate loans directly from borrowers by offering an online loan application that can be accessed by anyone with a web browser.
Consumer Demand for a Digital Based Experience from Lenders. Borrowers expect transparency, service and speed, and a human touch. To meet these requirements, lenders must offer a seamless, online experience that continues even after the application has been submitted. It is our goal to provide a true digital mortgage process that enables the lender to originate more loans, lower origination costs, reduce the time to close and make smarter decisions through data and predictive analytics, all while ensuring the highest levels of compliance, quality and efficiency. Our digital mortgage vision encompasses all phases of the mortgage loan lifecycle, with each milestone informing the next. The market will require lenders to adapt, as the pressure to meet closing dates, increased competition, and the emerging high-tech and human touch expectations of borrowers continue to drive the use of the next generation of technology.



________________
(1) 
Mortgage Bankers Association, Independent Mortgage Bank Production Profits Down in Fourth Quarter 2017, March 23, 2018.

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Changes in regulation affecting lenders and investors. Regulations continue to be subject to change, and many regulatory reforms have significantly increased the complexity and importance of regulatory compliance. We devote considerable resources to continually upgrade our software to help our customers address regulatory changes. We offer Encompass Compliance Service, which analyzes mortgage loan data for compliance with consumer protection laws and institutionally mandated compliance policies and also alerts users to possible violations of these laws and policies. In addition, we have a staff of attorneys who work with compliance experts and help ensure that documents prepared using our software and the processes recommended by the Encompass workflow comply with applicable rules and regulations. For example, additional tools and product updates were required to address the Ability-to-Repay/Qualified Mortgage and Federal and State High Cost rules that became effective in January 2014. In addition, we updated certain of our products to comply with the TILA-RESPA Integrated Disclosure rule changes that took effect in October 2015 and we will provide a complete offering of readiness initiatives, tools and training programs in advance of the 2018 Home Mortgage Disclosure Act and Regulation C collection and reporting changes. We believe we are well-positioned to help our customers comply with changing regulatory requirements as they are published and become effective. However, 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 so that our customers remain compliant with such laws and regulations.
Increased quality standards imposed by regulators, lenders, and investors. Encompass is designed to automate and streamline the process of originating mortgages to, among other things, satisfy increased quality requirements of investors. Relevant features of Encompass include enabling customers’ management to impose processing rules and formats, and providing milestone and process reminders, automated population of forms with accurate data, and accurate and automated transmission of loan files and data from originators to investors and lenders. Our Total Quality Loan Program (“TQL”) is designed to further enhance the quality, compliance, and salability of loans that are originated through Encompass. Additionally, TQL is intended to reduce the possibility of errors in the process of transferring information from originator to investor and to give investors confidence in the accuracy and regulatory compliance of the information that is underlying loan files.
In response to the increased quality standards and compliance mandates affecting the industry, we expect many non-Encompass mortgage lenders to assess new platform options and replace their legacy systems. We have increased the size of our customer acquisition, implementation, and support teams in order to address anticipated demand for our software solutions.
Greater focus by customers and regulators on data security and consumer privacy. Recent high-profile data security incidents affecting banking institutions and cloud-service software providers have resulted in an increased focus on data security by our customers and our customers’ regulators. We are making significant investments in the security of the Encompass service, as well as our internal systems, processes, and monitoring capabilities to protect our customers’ data and help minimize the risk of data security loss. We expect the industry focus on data security to continue to increase, and we anticipate that our investments in data security will increase substantially over time.
Acquisition Strategy
We evaluate strategic acquisition and investment opportunities within our core mortgage vertical and across complementary fintech verticals. To date, our acquisitions have been focused on enhancing the delivery of an end-to-end digital mortgage experience for our clients and their customers. The acquisition of Velocify accelerates our vision of offering a fully digital mortgage. We expect to continue to evaluate and explore strategic opportunities that will enhance the breadth and depth of our solutions, and furthers our mission of automating the entire end-to-end mortgage process for our customers.
Operating Metrics
We use certain operational metrics to evaluate our business, determine allocation of our resources, and make decisions regarding corporate strategy. We focus on these metrics to determine our success in leveraging our user base to increase our revenues and to gauge the degree of our market penetration.
This quarter we have provided what we believe is an improved set of supplemental metrics to align with how management evaluates our business as described above. We believe these metrics provide better visibility into the fundamentals of our business.
Our key operating metrics are defined below.
Contracted revenues. Contracted revenues are those revenues that are fixed by the terms of a contract and are generally not affected by fluctuations in mortgage origination volume. These revenues consist of the base fee portion of Success-Based Pricing revenues, monthly per-user subscription revenues, professional services revenues, and subscription revenues paid for products other than Encompass.
Active users. An active user is a mortgage origination professional who has used Encompass at least once within a 90-day period preceding the measurement date. A user is a mortgage origination professional working at an Encompass mortgage lender, such as a mortgage bank, commercial bank, thrift or credit union, which sources and funds loans and generally sells these funded loans to investors; or a mortgage brokerage, which typically processes and submits loan files to a mortgage lender or mega lender that funds the loan.

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Average active users. Average active users during a period is calculated by averaging the monthly active users during a reporting period.
Estimated Encompass closed loans. “Encompass Loans” is an estimate of the number of loans originated by Encompass users, calculated as loans originated by our Success-Based Pricing customers, which does not include certain brokered loans or correspondent purchased loans, plus an estimate of the number of loans originated by Encompass customers who are on purely subscription, or SaaS, licenses, which estimate is derived by applying the ratio of active Success-Based Pricing customers to loans originated by these customers to the number of active SaaS users of Encompass for the same period of time.
Revenues per loan. This is all our revenues for the applicable period of time divided by Estimated Encompass closed loans originated during the same period.
The following table shows these operating metrics as of and for the three months ended March 31, 2018 and 2017:
 
Three Months ended March 31,
 
2018
 
2017
Revenues (in thousands):
 
 
 
Revenues
$
117,912

 
$
93,002

Contracted revenues
$
82,804

 
$
62,858

Users:
 
 
 
Active users
190,656

 
171,579

Average active users during the period
188,385

 
168,775

Loans:
 
 
 
Estimated Encompass closed loans
553,000

 
515,000

Revenues per loan
$
213

 
$
181

Basis of Presentation
General
Our consolidated financial statements include the accounts of Ellie Mae, Inc. and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated upon consolidation.
Revenue Recognition
Effective January 1, 2018, we apply the provisions of Topic 606 for revenue recognition on contracts with customers. Pursuant to Topic 606, we recognize revenues under the core principle to depict the transfer of control to our customers in an amount reflecting the consideration to which we expect to be entitled. In order to achieve that core principle, the following five step approach is applied:
Identification of the contract, or contracts, with a customer;
Identification of the performance obligations in the contract;
Determination of the transaction price;
Allocation of the transaction price to the performance obligations in the contract; and
Recognition of revenue when, or as, we satisfy a performance obligation.
We generate revenues primarily from hosted software services, transaction-based fees and related services, including professional services and our annual user conference, and recognizes revenues as performance obligations are satisfied. Sales taxes assessed by governmental authorities are excluded from transaction price.
Our revenues are generated from the Company-hosted Encompass software subscriptions that customers access through the Internet. Our revenues are also comprised of fees for software services sold both as a subscription and on a transactional basis, including fees based on a per closed loan, or success basis, subject to monthly base fees, which we refer to as Success-Based Pricing, as well as Ellie Mae Network fees, fees for loan product, policy and guideline data and analytics services under the AllRegs brand, fees for lead management, marketing and customer relationship management, and fees for professional services which include consulting, implementation, and education and training services.

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Cost of Revenues and Operating Expenses
Cost of Revenues
Our cost of revenues consists primarily of: salaries and benefits, including stock-based compensation expense; data center operating costs; depreciation on data center computer equipment; amortization of internal-use software and acquired intangible assets such as developed technology and trade names; customer support; professional services associated with implementation of our software; third-party royalty expenses; and allocated facilities costs. We expect that our cost of revenues will continue to increase in absolute dollars as our revenues increase, as we make additional and accelerated investments to bolster our infrastructure and enhance our system capacity, reliability, and data security, as we place new internal-use software into service, as we pursue additional strategic acquisitions, and as we continue to hire personnel in our implementation and customer support departments to support new customers and provide new services. We anticipate that we will continue to invest in key areas such as development of internal-use software, professional services, technical support, data security, and data center infrastructure to better support our customers and further differentiate ourselves. This includes development of our next generation Encompass platform, which we expect to continue to roll out to customers throughout 2018 and 2019.
Sales and Marketing
Our sales and marketing expenses consist primarily of: salaries, benefits, and incentive compensation, including stock-based compensation expense and commissions; allocated facilities costs; expenses for trade shows, public relations, our annual user conference, and other promotional and marketing activities; expenses for travel and entertainment; and amortization of acquired intangible assets such as customer relationships. We expect that our sales and marketing expenses will continue to increase as we hire additional sales personnel in order to address anticipated demand for our software solutions, as we pursue additional strategic acquisitions, and as our annual user conference continues to increase in size.
Research and Development
Our research and development expenses consist primarily of: salaries and benefits, including bonuses and stock-based compensation expense; fees to contractors engaged in the development of the Encompass software, Ellie Mae Network, and other products; and allocated facilities costs. We expect that our research and development expenses will continue to increase in absolute dollars as we continue to invest in our products and services and related next-generation enhancements, including hiring additional engineering and product development personnel and as we pursue additional strategic acquisitions.
General and Administrative
Our general and administrative expenses consist primarily of: salaries and benefits, including bonuses and stock-based compensation expense for employees involved in finance, accounting, human resources, administration, information technology, and legal; third-party provider expenses such as general consulting, legal, accounting, and other professional services; and allocated facilities costs. We expect general and administrative expenses to continue to increase in absolute dollars as we expand our facilities and invest in our back office infrastructure to enhance our system capacity, reliability, and security. We also expect general and administrative expenses to continue to increase as we hire additional personnel and grant stock-based awards to attract and retain the employees needed to continue to grow our business and as we pursue additional strategic acquisitions.
Other Income, Net
Other income, net consists of interest income earned on investments and cash accounts, offset by investment discount amortization, and interest expense paid on equipment and software leases.
Income Taxes
Our tax provision for interim periods is determined using an estimate of its annual effective tax rate, adjusted for discrete items, if any, that arise during the period. Each quarter, we update our estimate of the annual effective tax rate and, if the estimated annual effective tax rate changes, we make a cumulative adjustment in such period.
We operate in various tax jurisdictions and are subject to audit by various tax authorities. We recognize the tax benefit of an uncertain tax position only if it is more likely than not that the position is sustainable upon examination by the taxing authority, based on the technical merits. The tax benefit recognized is measured as the largest amount of benefit which is greater than 50 percent likely to be realized upon settlement with the taxing authority. We recognize interest accrued and penalties related to unrecognized tax benefits in our income tax provision.
Valuation allowances are established when necessary to reduce deferred tax assets to the amounts that are more likely than not expected to be realized based on the weighting of positive and negative evidence. Future realization of deferred tax assets

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ultimately depends on estimates of future sources of taxable income for the jurisdictions in which we operate and the periods over which our deferred tax assets will be realizable. 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.
Critical Accounting Policies and Estimates
There have been no significant changes during the three months ended March 31, 2018 to our critical accounting policies and estimates previously disclosed in our 2017 Form 10-K except in relation to our adoption of Topic 606 as discussed in Notes 2 and 3 of the Notes to Condensed Consolidated Financial Statements.
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.
 
Three Months ended March 31,
 
2018
 
2017
 
(in thousands)
Revenues
$
117,912

 
$
93,002

Cost of revenues(1)
49,347

 
34,768

Gross profit
68,565

 
58,234

Operating expenses:
 
 
 
Sales and marketing(1)
23,064

 
19,380

Research and development(1)
22,489

 
17,407

General and administrative(1)
26,314

 
16,942

Total operating expenses
71,867

 
53,729

Income (loss) from operations
(3,302
)
 
4,505

Other income, net
848

 
501

Income (loss) before income taxes
(2,454
)
 
5,006

Income tax benefit
(4,658
)
 
(4,593
)
Net income
$
2,204

 
$
9,599

________________
(1) Stock-based compensation included in the above line items:
 
Three Months ended March 31,
 
2018
 
2017
 
(in thousands)
Cost of revenues
$
1,894

 
$
1,444

Sales and marketing
1,556

 
1,176

Research and development
2,534

 
1,861

General and administrative
3,548

 
3,370

 
$
9,532

 
$
7,851


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Three Months ended March 31,
 
2018
 
2017
 
 
 
 
Revenues
100.0
 %
 
100.0
 %
Cost of revenues
41.9

 
37.4

Gross profit
58.1

 
62.6

Operating expenses:
 
 
 
Sales and marketing
19.6

 
20.8

Research and development
19.1

 
18.7

General and administrative
22.2

 
18.2

Total operating expenses
60.9

 
57.7

Income (loss) from operations
(2.8
)
 
4.9

Other income, net
0.7

 
0.5

Income (loss) before income taxes
(2.1
)
 
5.4

Income tax benefit
(4.0
)
 
(4.9
)
Net income
1.9
 %
 
10.3
 %
Comparison of the Three Months Ended March 31, and 2017
Revenues
 
Three Months ended March 31,
 
2018
 
2017
 
(dollars in thousands)
Revenues
$
117,912

 
$
93,002

Three months ended March 31, 2018. Total revenues increased $24.9 million, or 26.8%, for the three months ended March 31, 2018 as compared to the same period in 2017. The increase in revenues is primarily due to an increase in revenue per loan to $213 from $181, which was primarily driven by an increase in Encompass closed loans to 553,000 from 515,000, and increased adoption of our service offerings, as a result of a larger user base.
Gross Profit
 
Three Months ended March 31,
 
2018
 
2017
 
(dollars in thousands)
Gross profit
$
68,565

 
$
58,234

Gross margin
58.1
%
 
62.6
%
Gross profit increased by $10.3 million and gross margin decreased by 4.5% during the three months ended March 31, 2018 as compared to the same period in 2017. The decrease in gross margin was primarily the result of a $4.9 million increase in amortization related to intangibles acquired from the Velocify acquisition, a $4.1 million increase in salaries, employee benefits, and stock-based compensation expenses associated with additional headcount, $3.4 million increase in amortization related to internal-use software and depreciation related to infrastructure hardware and a $2.0 million increase in expenses related to upgrades and services to our data centers hardware and technology as we increase capacity to accommodate new customers through our hybrid cloud architecture.

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Sales and Marketing
 
Three Months ended March 31,
 
2018
 
2017
 
(dollars in thousands)
Sales and marketing
$
23,064

 
$
19,380

Sales and marketing as a % of revenues
19.6
%
 
20.8
%
Sales and marketing expenses increased by $3.7 million, or 19.0%, for the three months ended March 31, 2018 as compared to the same period in 2017. Sales and marketing expenses as a percentage of revenues decreased by 1.2%. The increase in sales and marketing expenses was primarily due to a $2.6 million increase in salaries, employee benefits, and stock-based compensation expenses related to increased headcount.
Research and Development
 
Three Months ended March 31,
 
2018
 
2017
 
(dollars in thousands)
Research and development
$
22,489

 
$
17,407

Research and development as a % of revenues
19.1
%
 
18.7
%
Research and development expenses increased by $5.1 million, or 29.2%, for the three months ended March 31, 2018 as compared to the same period in 2017. Research and development expenses as a percentage of revenues remained relatively flat. The increase in research and development expenses was primarily driven by salaries, employee benefits, and stock-based compensation expenses related to increased headcount as we continued to invest in our products and services.
General and Administrative
 
Three Months ended March 31,
 
2018
 
2017
 
(dollars in thousands)
General and administrative
$
26,314

 
$
16,942

General and administrative as a % of revenues
22.2
%
 
18.2
%
General and administrative expenses increased by $9.4 million, or 55.3%, for the three months ended March 31, 2018 as compared to the same period in 2017. General and administrative expenses as a percentage of revenues increased by 4.1%. The increase in general and administrative expenses was primarily due to a $3.0 million increase in professional services related to the adoption of the new revenue recognition standard, a $2.9 million increase in salaries, employee benefits, and stock-based compensation related to increased headcount, and a $1.5 million increase in third-party service fees due to consulting services related to the adoption of the new revenue recognition standard.
Income Tax Provision
  
Three Months ended March 31,
  
2018
 
2017
 
(dollars in thousands)
Income tax benefit
$
(4,658
)
 
$
(4,593
)
Effective tax rate
189.8
%
 
(91.7
)%
Our effective tax rate was 189.8% and (91.7)% for the three months ended March 31, 2018 and 2017, respectively. For the three months ended March 31, 2018, our effective tax rate differs from the U.S. federal statutory rate of 21% primarily due to the discrete impact of the excess tax benefits from stock-based compensation and the reduced state blended income tax rate. For the three months ended March 31, 2017, our effective tax rate differs from the U.S. federal statutory rate of 35% primarily due to the discrete impact of excess tax benefits from stock-based compensation as well as non-deductible stock-based compensation and federal R&D credits.

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The SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provides guidance for companies that are not able to complete their accounting for the income tax effects of the Tax Cuts and Job Act (“Tax Act”) in the period of enactment. The guidance allows us to record provisional amounts to the extent a reasonable estimate can be made and provides us with up to one year from enactment date to finalize the accounting for the impact of the Tax Act. Since the Tax Act was passed in our fourth quarter of 2017, we continue to perform an impact analysis on the Tax Act on an ongoing basis. The analysis is expected to be completed within the 12-month measurement period which is our fourth quarter of 2018.
For further discussion of our income tax provision, see Note 8 of Notes to Condensed Consolidated Financial Statements.
Liquidity and Capital Resources
As of March 31, 2018, we had cash, cash equivalents, and short-term investments of $231.3 million and long-term investments of $83.6 million. Cash and cash equivalents consist of cash, money market accounts, and highly liquid investments purchased with an original maturity of three months or less. Both short and long-term investments consist of U.S. government notes, and U.S. government agency securities, corporate bonds and obligations, certificates of deposit and municipal obligations.
We believe that our existing cash, cash equivalents, and short-term investments will be sufficient to fund capital expenditures, operating expenses and other cash requirements for at least the next 12 months. We have used our cash and investments to repurchase our stock and may continue to do so in the future periods. Acquisitions that we enter into are funded by our cash and investments or require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all.
The following table sets forth our statement of cash flows data for the periods presented:
 
Three Months ended March 31,
 
Net
 
2018
 
2017
 
Change
 
(in thousands)
Net cash provided by (used in) operating activities
$
6,401

 
$
(1,422
)
 
$
7,823

Net cash used in investing activities
(13,093
)
 
(47,822
)
 
34,729

Net cash provided by (used in) financing activities
(13,664
)
 
3,263

 
(16,927
)
Net decrease in cash and cash equivalents
$
(20,356
)
 
$
(45,981
)
 
$
25,625

Operating Activities
Cash provided by operating activities consists of net income adjusted for non-cash items and changes in operating assets and liabilities.
Cash provided by operating activities for the three months ended March 31, 2018 increased by $7.8 million as compared to the same period in 2017. The increase in cash provided by operating activities was primarily due to increased revenue and related cash collections, partially offset by higher payments for operating expenses primarily driven by increased headcount, payments related to the integration of Velocify, and an increase in professional and consulting services due to the adoption of the new revenue standard.
Investing Activities
Our primary investing activities have consisted of purchases and maturities of investments, and purchases of property and equipment (including costs incurred to develop internal-use software). Purchases of property and equipment may vary from period to period due to the timing of the expansion of our operations and the timing of our internal-use software projects subject to capitalization. We plan to continue to invest in the expansion of our operations and facilities as well as the next generation Encompass platform, and we intend to continue pursuing strategic acquisitions.
Cash used in investing activities of $13.1 million for the three months ended March 31, 2018 was primarily the result of $8.5 million in expenditures for purchases of property, including capital improvements to our corporate headquarters, investments to bolster our infrastructure and enhance our system capacity, reliability, and security, and $17.2 million in expenditures incurred to develop internal-use software and website applications, including the development of our next generation Encompass platform. We also incurred $12.4 million in net purchases of investments.
Cash used in investing activities of $47.8 million for the three months ended March 31, 2017 was primarily the result of $11.3 million in expenditures for purchases of property, including capital improvements to our new corporate headquarters, investments to bolster our infrastructure and enhance our system capacity, reliability, and security, and $11.4 million in expenditures incurred to develop internal-use software and website applications, including the development of our next generation Encompass platform. We also incurred $25.1 million in net purchases of investments.

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Financing Activities
Financing activities have consisted primarily of cash provided from the exercise of stock options and purchases under the employee stock purchase plan, reduced by the payments related to capital lease obligations, repurchases of common stock and tax payments related to shares withheld for vested restricted stock units, or RSUs. In August 2017, our audit committee, under the authority delegated to it by our board of directors, approved a new stock repurchase program under which we are authorized to repurchase up to $250.0 million of our common stock. This authorization expires in August 2020.
Cash used in financing activities of $13.7 million for the three months ended March 31, 2018 consisted primarily of $14.7 million in common stock repurchases and $6.7 million in tax payments related to shares withheld for vested RSUs, partially offset by $7.8 million in proceeds from employee stock purchases and the exercise of stock options.
Cash provided by financing activities of $3.3 million for the three months ended March 31, 2017 consisted primarily of $7.3 million in proceeds from employee stock purchases and the exercise of stock options, partially offset by $4.0 million in payments on capital leases and tax payments related to shares withheld for vested RSUs.
Off Balance Sheet Arrangements
As of March 31, 2018, we had no off-balance sheet arrangements, and operating leases were the only financing arrangements not reported on our condensed consolidated financial statements.
Contractual Obligations
During the three months ended March 31, 2018, there have been no material changes to our contractual obligations outside the ordinary course of business from those specified in the 2017 Form 10-K.
ITEM 3QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We believe that there have been no significant changes in our market risk exposures for the three months ended March 31, 2018, as compared with those discussed in our 2017 Form 10-K.
ITEM 4CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2018. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of March 31, 2018, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at a reasonable assurance level.
Changes in Internal Control over Financial Reporting
Beginning January 1, 2018, we adopted Topic 606, the new revenue recognition standard. We implemented changes to our revenue recognition policies and processes to support the adoption and we have also updated internal controls over financial reporting to ensure compliance with the new accounting and disclosure rules. Except in relation to our adoption of Topic 606, there were no other changes in our internal control over financial reporting identified in connection with the evaluation required by Rule 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II—OTHER INFORMATION
ITEM 1LEGAL PROCEEDINGS
On December 1, 2017, a pension fund and stockholder purporting to act on our behalf filed a derivative lawsuit in the Superior Court of California for the County of Alameda, captioned United Association of Plumbers and Pipefitters, Journeymen, Local #38 Defined Benefit Pension Plan v. Jonathan H. Corr, et al. (Case No. RG17884445). The lawsuit purports to assert claims against certain of our officers and directors for insider trading under California law, breach of fiduciary duty, corporate waste, and unjust enrichment based on allegations that: (1) we overstated our financial prospects in public filings between February 10, 2017 and July 27, 2017; and (2) certain of our officers and directors sold shares during this same period. Plaintiff seeks unspecified monetary damages, attorneys’ fees and costs, as well as certain changes to our corporate governance and internal procedures. Our demurrer to plaintiff’s complaint was filed on February 15, 2018. Plaintiff has opposed our demurrer and we have filed a reply in support of our demurrer. On May 8, 2018, the court sustained our demurrer with leave to amend within 30 days.
From time to time, we are involved in litigations that we believe are of the type common to companies engaged in our line of business, including commercial and employment disputes. As of the date of this Quarterly Report on Form 10-Q, we are not involved in any other pending legal proceedings whose outcome we expect to have a material adverse effect on our financial position, results of operations or cash flows. However, 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.
ITEM 1A.
RISK FACTORS
You should carefully consider the risks described below and the other information in this Quarterly Report on Form 10-Q. If any of the following risks materialize, our business could be materially harmed, and our financial condition and results of operations could be materially and adversely affected. The risks described below are not the only ones facing us. Additional risks not currently known to us or that we currently believe are immaterial may also impair our business, results of operations, financial condition, and liquidity.
The following discussion of risk factors contains forward-looking statements. These risk factors may be important to understanding other statements in this Quarterly Report on Form 10-Q. The following information should be read in conjunction with the condensed consolidated financial statements and related notes in Part I, Item 1, “Financial Statements” and Part I, Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Quarterly Report on Form 10-Q.
Because of the following risks, as well as other factors affecting our financial condition and operating results, past financial performance should not be considered to be a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in future periods.
Any outages or system interruptions that impair access to Encompass, the Ellie Mae Network, or our other services could damage our reputation and brand and may substantially harm our business and operating results.
The satisfactory performance, reliability, and availability of Encompass, the Ellie Mae Network, and our other services are critical to our reputation and our ability to attract and retain Encompass users and Ellie Mae Network participants. Because our services are complex and incorporate a variety of hardware and proprietary and third-party software, our services may have errors or defects that could result in unanticipated downtime for our customers. Internet-based services frequently contain undetected errors when first introduced or when new versions or enhancements are released, and we have from time to time found errors and defects in our services and new errors and defects in our services may be detected in the future. 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.
Moreover, we have experienced and may in the future continue to experience temporary system interruptions to Encompass, the Ellie Mae Network, or our other services for a variety of other reasons, including:
network or power failures;
problems with Encompass and other third-party firmware updates;
an overwhelming number of users trying to access our services during periods of strong demand;
security or denial of services attacks which result in service interruptions;
use of our services by our customers in unanticipated ways that may cause a disruption in services for other customers; and

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disruptions or congestions in the portions of the Internet linking us to our customers.
Since our customers use our service for important aspects of their business, any errors, defects, disruptions in service, or other performance problems could result in negative publicity, damage to our reputation and brand, reduce our revenue, increase our operating expenses, negatively impact our ability to run our business, hinder our ability to enroll new customers, cause us to incur legal liability or issue refunds or service credits to our customers and cause us to lose current customers, all of which could substantially harm our business and operating results.
We depend on data centers and computing infrastructure operated by third parties and any disruption in these operations could damage our reputation and brand and substantially harm our business and operating results.
We host our applications and serve our customers from third-party data centers located within the United States. We utilize a hybrid cloud approach to our third-party data centers consisting of (i) two primary production data centers, located in Santa Clara, California and Elk Grove (Chicago), Illinois, which are each hosted by a third-party service provider, as well as third party data centers located in St. Louis, Missouri and Richardson, Texas, which host our Encompass CRM and Velocify products, and (ii) a network of Amazon Web Services (“AWS”) data centers within the United States which provides a distributed computing infrastructure platform for business operations. We maintain regular oversight but have little direct control over our third party data centers. In the case of AWS, we do not control any aspects of the AWS data center operations and do not own any of the underlying computing hardware. We rely on these third-party service providers to provide continuous and uninterrupted access to our products and services, including Encompass and the Ellie Mae Network. If for any reason our relationship with any of these third parties were to end unexpectedly, it could require a significant amount of time to transition the hosting of our computing infrastructure to new third-party service providers.
Problems faced by our third-party data center providers or AWS, or with the telecommunications network providers with whom we or they rely, could adversely affect the experience of our customers. Our third-party data center operators or AWS could decide to close their facilities or reduce services to us without adequate notice. In addition, any financial difficulties, such as bankruptcy, faced by our third-party data center providers, AWS or any of the other service providers with whom we or they contract may have negative effects on our business, the nature and extent of which are difficult to predict. Additionally, if our data center providers or AWS are unable to keep up with our needs for capacity, this could have an adverse effect on our business. Any changes in third-party service levels at our data centers or at AWS or any errors, defects, disruptions, or other performance problems with our applications or the hosted infrastructure on which they run could adversely affect our reputation and may damage our customers’ stored files or result in lengthy interruptions in our services. Interruptions in our services, as discussed in the preceding risk factor, could substantially harm our business and operating results.
Our failure to maintain the security of the confidential information of the customers of the users of our software and services could damage our reputation and brand and substantially harm our business and operating results.
We collect, process, transmit, and maintain certain confidential information relating to the customers (borrowers and loan applicants) of the users of our software and services, including personally identifiable information. This information resides on data center servers hosted by third-party providers and on AWS, and is transmitted to, across, and from our networks. While we have security measures in place to protect this information and prevent security breaches, these security measures may be compromised as a result of third-party action, including intentional misconduct by computer hackers, advanced persistent cyber-attacks (by hacktivists or cybercriminal organizations), employee error or malfeasance, service provider or vendor error, malfeasance or other intentional or unintentional acts by third parties. Furthermore, our customers’ data, including personally identifiable information, may be lost, exposed, or subject to unauthorized access and/or use as a result of accidents, errors, or malfeasance by our employees, independent contractors, or others working with us or on our behalf. Our servers and systems, and those of our service providers, may also be vulnerable to computer malware, break-ins, denial-of-service attacks, and similar disruptions from unauthorized tampering with our computer systems, which could result in someone obtaining unauthorized access to our customers’ data or our data, including our intellectual property and other confidential business information. Because the techniques used to obtain unauthorized access to, or to sabotage, systems change frequently and often are not recognized until launched against a target, we may be unable to anticipate these techniques or implement adequate preventative measures. We may also experience security breaches that may remain undetected for an extended period. The possession and use of personally identifiable information in conducting our business subjects us to legislative and regulatory burdens that may require notification to customers in the event of a security breach, restrict our use of personally identifiable 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 or the loss or exposure of confidential information or other information we maintain or process. Any actual or perceived compromise of our security could result in the loss of customer data, intellectual property or trade secrets, and could damage our reputation and brand, negatively affect our ability to attract new customers and retain existing customers, adversely affect investor confidence, and expose us to a risk of litigation or regulatory actions and orders, penalties for violation of applicable laws, regulations, or contractual obligations and/or other liabilities, which would substantially harm our business and operating results. We will need to expend significant resources

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to protect against and remedy any potential security breaches and their consequences, including costs to deploy additional personnel and protection technologies, train employees, and engage third-party experts and consultants.
Our future performance will be highly dependent on both our ability to continue to attract new customers to our service offerings and our ability to sell additional service offerings to existing customers.
To maintain or increase our revenues, we may need to (i) increase the number of customers of our service offerings, and (ii) increase the adoption of our suite of other and newer service offerings to existing customers, in each case the failure to do so may have a materially adverse impact on our business.
Our success will depend on (i) the willingness of our customers, primarily mortgage lenders, to continue to accept the SaaS model for delivering software applications that they view as critical to the success of their business, (ii) our ability to successfully deliver new and improved SaaS service offerings that meet the needs of our existing customers and potential customers, and (iii) the available market of potential customers of our services and our ability to sell our services to these potential customers.
It is difficult to predict customer adoption rates and demand for our services, the future growth rate and size of the market for our service offerings, or the entry of competitive applications. The growth of the mortgage technology market depends on a number of factors, including the cost, performance, and perceived value associated with product offerings, most notably SaaS offerings such as our own, including the extent to which SaaS companies are successful in continuing to address security and reliability concerns. If other SaaS providers experience security incidents, loss of customer data, disruptions in delivery or other problems, the market for SaaS applications as a whole, including our own products and services, may be negatively affected. If there is a reduction in demand for mortgage technology caused by technological challenges, weakening economic conditions, interest rate increases, security or privacy concerns, competing technologies, and products, decreases in spending by mortgage lenders, or a decrease in the number of potential users of our service offerings, this could result in decreased revenues and our business could be adversely affected. In addition, we will need to continue to optimize our sales infrastructure in order to grow our customer base and our business. Identifying and recruiting qualified personnel and training them in the use of our software requires significant time, expense, and attention.
If we are not able to provide successful enhancements, new features, and modifications to our services, our business could be adversely affected. Further, impairment of software-related assets and other assets may materially adversely affect our operating results.
If we are unable to provide enhancements, new features, and modifications of our existing services, including the successful completion and deployment of our next generation Encompass software, the Encompass Lending Platform and our Encompass Connect solutions as well as changes to our services to reflect changes in laws and regulations relating to residential mortgage lending, our business and operating results could be adversely affected. If we do not successfully manage the migration of our customers to our next generation Encompass software or if the transition takes longer than expected, customers may not experience the benefits of new enhancements and features and our business and operating results could be adversely affected. In addition, we will need to continuously modify and enhance our services to keep pace with changes in software, communication, browser, database, and SaaS infrastructure technologies. We may not be successful in either developing these modifications and enhancements or in bringing them to market in a timely fashion, which could increase our costs and adversely affect our business. The failure of our services to operate effectively with future technologies could reduce the demand for our services, result in customer dissatisfaction, and adversely affect our business.
We have invested and continue to invest significant resources to develop and acquire technology related to our services that is capitalized to property and equipment or intangible assets and treated as an asset on our balance sheet. We may not launch this developed and acquired technology, the launch of such technology may result in disruptions to our business operations, or such technology might not meet our and our customers’ expectations. Also, changes to any of our implementation strategies or the failure of this technology to meet our and our customers’ expectations could result in the impairment of software-related assets, and our future operating results could be materially adversely affected if we are required to write down the carrying value of capitalized software development or other intangible assets.
Changes in current legislation or new legislation may increase our costs by requiring us to update our products and services and if our products and services fail to address relevant laws and regulations our business could be adversely affected.
Changes to existing laws or regulations or adoption of new laws or regulations relating to the residential mortgage industry or mortgage lending may require us to incur significant costs to update our products and services so that our customers remain compliant with such laws and regulations. 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. The Dodd-Frank Act has caused and will continue to cause us to make similar updates to Encompass, Encompass Compliance Service, Encompass Product and Pricing Service, Encompass Docs Solution, TQL, and the Ellie Mae Network to address, among other things, regulations that protect consumers against unfair, deceptive, and abusive practices by lenders. For example, additional tools and product updates were required to address the Ability-to-Repay/Qualified Mortgage and

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Federal and State High Cost rules that became effective in January 2014. In addition, we have updated certain products to comply with the TILA-RESPA Integrated Disclosure rule changes and the 2013 Loan Originator Rule under the Truth in Lending Act (Regulation Z) that became effective on October 3, 2015. The final rule amending Regulation C to implement amendments to the Home Mortgage Disclosure Act made by section 1094 of the Dodd-Frank Act was published on October 15, 2015. It includes various effective compliance dates, starting with January 1, 2017 through May 30, 2020. The final “Qualified Residential Mortgage” rule which implements the risk retention requirements in the Dodd-Frank Act became effective on December 24, 2015. On August 23, 2016, Fannie Mae and Freddie Mac published the first material updates to the Uniform Residential Loan Application (“URLA”) in more than 20 years. In September 2017, Fannie Mae and Freddie Mac announced that lenders may begin using the redesigned URLA starting in July 2019 and they will require the use of the redesigned URLA for all new loan applications beginning in February 2020. These additions and updates have caused us to incur significant expense, and future updates will likely cause us to incur similar significant expense. For example, if the new U.S. presidential administration and U.S. Congress significantly change or repeal the mortgage lending portions of the Dodd-Frank Act or the Consumer Financial Protection Bureau announces new rules or repeals previously announced rules, we may need to incur significant expense to make updates to our products and services.
In addition, if our products and services fail to adequately address laws or regulations relating to the residential mortgage industry or mortgage lending (including existing laws and regulations or newly introduced laws or regulations), we could be subject to claims by our customers that we have breached our customer contracts as well as potential claims by borrowers or government agencies. Such claims could result from a failure of our product to meet customer expectations regarding functionality or from errors or defects in our products. Such claims could result in substantial costs and we could incur judgments or enter into settlements of claims that could have a material adverse effect on our business and operating results. Furthermore, if our products and services fail to address relevant laws and regulations this could result in negative publicity, damage to our reputation and brand, hinder our ability to enroll new customers and cause us to lose current customers, all of which could substantially harm our business and operating results.
A decrease in mortgage lending volume could materially adversely affect our business.
Mortgage lending volume decreased in the first quarter of 2018 relative to 2017 and may continue to decrease materially for the remainder of 2018 and future years. Such a decrease and a continued decline in mortgage lending volumes could materially adversely affect our business and our operating results. A decline in mortgage lending volume could reduce the closed loan fees we receive as well as fees for transactions on our platform, including Ellie Mae Network transaction fees. In addition, a substantial decline in mortgage lending volumes by our customers could result in a reduction of Encompass users, consolidation of our customers with other lenders that do not use Encompass, or cessation of operations by our customers, in each case which would decrease the base fee portion of success based revenues, subscription revenues and professional services revenues we receive from our customers. Furthermore, the volumes of mortgages originated by our customers may decline more than the volume of mortgages originated by lenders who do not use Encompass. Factors that adversely impact mortgage lending volumes include increasing mortgage interest rates, reduced consumer and investor demand for mortgages, more stringent underwriting guidelines, decreased liquidity in the secondary mortgage market, high levels of unemployment, high levels of consumer debt, lower consumer confidence, changes in tax and other regulatory policies (including the passage of the Tax Act), the number of existing mortgages eligible for refinancing, the available inventory of housing, and other macroeconomic factors.
Mortgage interest rates are influenced by a number of factors, including monetary policy. The Federal Reserve Bank raised the target federal funds rate by 0.25% in each of March 2017, June 2017, December 2017, and March 2018, the most recent increase from 1.50% to 1.75%, and signaled that the federal funds rate could be increased further over the coming months and years. The increase in the federal funds rate since December 2016 has contributed to an increase in mortgage interest rates in 2017 and may result in future mortgage interest rate increases. Increases in mortgage interest rates materially reduced the volume of new mortgages originated in the first quarter of 2018 relative to 2017, in particular the volume of mortgage refinancings, and future increases may further decrease the volume of new mortgages originated. Furthermore, changes in tax law may have an impact on the number of mortgages originated. The Tax Act, which was enacted in December 2017 and which limits the deductibility of mortgage interest and local property taxes for federal income tax purposes, as well as increases the standard deduction (reducing the number of United States. tax payers who itemize deductions), may have a negative effect on the number of mortgages originated. In addition, our revenues typically, but not always, track the seasonality of the residential 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. As a result, a higher percentage of our revenues have historically been recognized during those quarters.

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A failure in our continued operation of revenue controls and procedures under Topic 606, the new revenue recognition standard, may impact our ability to produce accurate and timely financial statements, which could have a material adverse effect on our business and the market price of our common stock.
Our adoption of Topic 606 required us to make significant updates to our financial information technology systems, significant modifications to our accounting controls and procedures and continues to place a significant burden on our accounting and information technology teams, both financially and through the expenditure of management time. Many of these updates and modifications remain in process as we evolve our systems and controls. We have been able to make timely reporting requirements as of the date of this Quarterly Report on Form 10-Q, however, the significant system and process updates required for the efficient operation of our revenue process under ASC 606 remain an on-going initiative with no assurance that we will continue to be successful in meeting our reporting requirements. Our failure to meet our reporting obligations could have a material adverse effect on our business and the market price of our common stock. Furthermore, due to the implementation of Topic 606 and the changes we’re making to our internal control environment to adopt Topic 606, there is an increased risk that we fail to maintain an effective internal control environment. Our failure to maintain an effective internal control environment may, among other things, result in material misstatements in our financial statements and failure to meet our reporting obligations.
We cannot accurately predict subscription renewal or upgrade rates and the impact these rates may have on our future revenues and operating results.
Our customers have no obligation to renew their subscriptions for our service after the expiration of their initial subscription term, which ranges from one to five years. They may also choose to renew their subscriptions at lower levels. In addition, in the first year of a subscription, customers often purchase a higher level of professional services than they do in renewal years. As a result, our ability to grow is dependent in part on existing customers renewing their subscriptions and purchasing new services after the initial subscription term. It may be more difficult to predict renewal rates as our customer base grows, as we continue to expand suite of offerings, and as we continue to expand the number of multi-year subscription contracts. Our customers’ renewal rates may decline or fluctuate because of several factors, including merger and acquisition activity, their satisfaction or dissatisfaction with our services, the prices of our services, changes to the standard prices of our services, the prices of services offered by our competitors or reductions in our customers’ spending levels due to the macroeconomic environment or other factors. If our customers do not renew their subscriptions for our services, renew on less favorable terms, or do not purchase additional subscriptions or services, our revenues may grow more slowly than expected or decline and our profitability and gross margin may be harmed.
Our future performance will be highly dependent on our ability to expand the third-party services available on, and increase the number of transactions effected through, the Ellie Mae Network.
To grow our base of Ellie Mae Network participants, we must continue to enhance the features and functionality of the Ellie Mae Network, including the Application Program Interfaces (“APIs”) we make available to Ellie Mae Network providers. In addition, increasing the number of settlement service and other transactions effected through the Ellie Mae Network will depend, in part, on third-party service providers enhancing their technical capabilities, which is largely beyond our control.
We must also convince a variety of potential Ellie Mae Network participants, including mortgage lenders, originators, settlement service providers, and mega lenders, of the benefits of electronic origination and network participation as compared to traditional mortgage origination methods including paper, facsimile, courier, mail, and email.
We cannot guarantee that our Ellie Mae Network and other service offerings will achieve market acceptance. In the event these efforts are not successful, our business and growth prospects would be adversely affected.
We expect a number of factors to cause our operating results to fluctuate on a quarterly and annual basis, which may make it difficult to predict our future performance.
Our revenues and operating results have in the past varied and could in the future vary significantly from quarter-to-quarter and year-to-year because of a variety of factors, many of which are outside of our control. As a result, comparing our operating results on a period-to-period basis may not be indicative of future operating results. In addition to other risk factors discussed in this section, factors that may contribute to the variability of our quarterly and annual results include:
the volume of mortgages originated by Encompass users, especially users on our Success-Based Pricing model;
the number of Encompass users;
transaction volume on the Ellie Mae Network and the demand for our services;
fluctuations in mortgage lending volume and the number of closed loans relative to loan applications;
the relative mix of purchase and refinance volume handled by Encompass users;
the timing of the introduction and acceptance of new services and Ellie Mae Network service providers;

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how quickly larger customers implement our services and use our services to originate and close loans;
continued investment in the Encompass Lending Platform and our Encompass Connect solutions;
changes in accounting rules applicable to our business;
any write-downs in the value of our property and equipment, goodwill or intangible assets as a result of our investment or acquisition activities;
changes in government regulation affecting mortgage lenders and Ellie Mae Network participants or our business, and potential structural changes in the U.S. residential mortgage industry; and
costs associated with defending intellectual property infringement and other litigation claims.
Due to these and other factors, our future results may not reach our financial 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.
As we sell our services to larger customers, our sales cycle may become longer and more expensive, we may encounter pricing pressure and implementation challenges, and we may have to delay revenue recognition for some complex transactions or experience delays in these customers using our service to originate and close loans, all of which could harm our business and operating results.
Part of our business strategy is to target larger mortgage lenders that handle greater volumes of loans. As we target more of our sales and marketing efforts at larger customers, we could face greater costs, longer sales cycles, and less predictability in completing some of our sales. In this market, the customer’s decision to use our products and services may be an enterprise-wide decision and, if so, this type of sale could require us to provide greater levels of education regarding the use and benefits of our products and services. In addition, larger customers may demand more complex integration services, more comprehensive implementation services, and expanded or modified product functionality, which may result in implementations that take longer than we forecast or plan or result in delays in these customers using our service to originate and close loans. As a result of these factors, these sales opportunities may require us to devote greater sales support and professional services resources to individual customers, driving up costs and time required to complete sales and diverting our own sales and professional services resources to a smaller number of larger transactions. Furthermore, if implementations take longer than planned or these customers delay their use of our service to originate and close loans, we may be required to delay revenue recognition on some of these transactions until the technical or implementation requirements have been met and may not generate revenue from these customers as quickly as we had forecast.
If we are unable to scale our operations and increase productivity, we may not be able to successfully implement our business plan.
We continue to experience significant growth in our customer base, which has placed a strain on our management and administrative, operational, and financial infrastructure. Additional investments in our implementation capabilities, technical support, technical operations, research and development, and general and administrative functions will be required to scale our operations and increase productivity, address the needs of our customers, further develop and enhance our products and services, and scale with the overall growth of our company.
In addition, professional services, such as implementation services, are a key aspect of on-boarding new customers. The implementation process is complicated and we may need to scale our capabilities in this area to meet future revenue targets. If a customer is not satisfied with the quality of work performed by us or with the type of services or solutions delivered, then we could incur additional costs to address the situation, the profitability of that work might be impaired, and the customer’s dissatisfaction with our products and services could damage our ability to obtain additional work from that customer. In addition, negative publicity related to our customer relationships, regardless of its accuracy, may further damage our business by affecting our ability to compete for new business with current and prospective customers.
Our growth strategy will require significant expenditures and resources to improve our technology, systems, and operational infrastructure in order to support a growing number of customers. We will need to make such expenditures with no assurance that the volume of our business or revenues will actually increase.
Our strategy of growing our business and increasing the number of Encompass users has placed and may continue to place significant demands on our technology systems and operational infrastructure. As our operations grow in size, scope, and complexity, we will need to expand, improve, and upgrade our technology systems and operational infrastructure, including the data center infrastructure we utilize to offer an increasing number of customers enhanced solutions, features, and functionality, and to ensure that our services are reliable.

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Our growth and the improvement of our technology systems and operational infrastructure will require significant lead time and substantial financial, operational and technical resources in advance of the anticipated increase in the volume of business, with no assurance that the volume of business or our revenues will actually increase.
We have experienced rapid growth. If we fail to manage our growth effectively, we may be unable to execute our business plan, maintain high levels of service and operational controls, or adequately address competitive challenges.
We have experienced, and are continuing to experience, a period of rapid growth in our customers, headcount, and operations. We have grown from approximately 900 employees as of December 31, 2015 to approximately 1,500 employees as of March 31, 2018, and have also significantly increased the number of customers and loans originated using Encompass. We anticipate that we will significantly expand our operations in the near term and will continue to expand our loans originated on our platform. This growth has placed, and future growth will place, a significant strain on our management, general and administrative resources, and operational infrastructure.
Our success will depend in part on our ability to manage this growth effectively and to scale our operations. To manage the expected growth of our operations, we will need to continue to improve our operational, financial, and management controls and our reporting systems and procedures. As we continue to grow, we also need to ensure that our policies and procedures evolve to reflect our current operations and are appropriately communicated to and observed by employees, and that we appropriately manage our corporate information assets, including confidential and proprietary information. Failure to effectively manage growth could result in difficulty or delays in deploying customers, declines in quality or customer satisfaction, increases in costs, difficulties in introducing new features, or other operational difficulties, and any of these difficulties could adversely impact our business performance and results of operations.
Completing and integrating 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 to 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 October 2017, we purchased Velocify, a leading cloud-based sales engagement platform.
The identification of suitable acquisition candidates can be difficult, time-consuming, and costly, and we may not be able to complete acquisitions successfully. Moreover, if such acquisitions require us to seek additional debt or equity financing, we may not be able to obtain such financing on terms favorable to us or at all. Acquisitions and investments involve numerous risks which may have a negative impact on our results of operations, including:
write-offs of acquired assets or investments;
potential financial and credit risks associated with acquired customers;
unknown liabilities associated with the acquired businesses;
unanticipated expenses related to acquired technology and its integration into existing technology;
limitations to our ability to recognize revenue from acquired deferred revenues;
the potential loss of key employees;
depreciation and amortization of amounts related to acquired intangible assets, fixed assets, and deferred compensation; and
adverse tax consequences of any such acquisitions.
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. We may encounter difficulty in incorporating acquired technologies into our service and maintaining the quality standards that are consistent with our brand and reputation. In addition, we may issue debt or equity securities to complete an acquisition, which could dilute our stockholders’ ownership and adversely affect the price of our common stock.
The residential mortgage industry is heavily regulated and changes in current legislation or new legislation could adversely affect our business.
The U.S. mortgage industry is heavily regulated. Federal and state governments and agencies could enact legislation or other policies that could negatively impact the business of our Encompass users and other Ellie Mae Network participants. Any changes to existing laws or regulations or adoption of new laws or regulations that increase restrictions on the residential mortgage industry may decrease residential mortgage volume or otherwise limit the ability of our Encompass users and Ellie Mae Network participants to operate their businesses, resulting in decreased usage of our solutions. In addition, reduced regulatory requirements may reduce the demand for certain of our products and services, including the Encompass Compliance service.

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Potential structural changes in the U.S. residential mortgage industry, in particular, plans to diminish the role of Fannie Mae and Freddie Mac, could disrupt the residential mortgage market and have a material adverse effect on our business.
Fannie Mae and Freddie Mac play a very important role in providing liquidity, stability, and affordability in the current U.S. residential mortgage market. In particular, they participate in the secondary mortgage market by purchasing mortgage loans and mortgage-related securities for investment and by issuing guaranteed mortgage-related securities. There have been numerous executive branch proposals as well as proposed federal legislation which may wind down or recapitalize Fannie Mae and Freddie Mac and/or eliminate or reduce the government’s role in the housing market. Any significant structural change to the role of Fannie Mae and Freddie Mac or to the U.S. residential mortgage industry may cause significant disruption to the residential mortgage market. If we are unable to react effectively and quickly to changes in the residential mortgage industry or if such changes reduce the volume of mortgage lending, our business could be harmed.
We may be limited in the way in which we market our business or generate revenue by U.S. federal law prohibiting referral fees in real estate transactions, and if we are found to be in violation of such laws we would be subject to significant liability.
The Real Estate Settlement Procedures Act (“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. Encompass software and services and the Ellie Mae Network were designed with payment methods that are intended to comply with 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, court opinions interpreting the provisions of RESPA, or changes in the manner that RESPA is interpreted by the regulatory agencies responsible for enforcing 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. 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.
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. 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 employee 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 we 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. Most of our named executive officers are vested in a substantial number of stock options and performance awards. 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.
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 that compete with us by offering loan origination software to mortgage originators. These competitors include: Calyx Technology, Inc.; DH Corporation now Finastra; LendingQB; Mortgage Builder Software, Inc.; Mortgage Cadence, an Accenture Company; Wipro Gallagher Solutions, Inc.; and Black Knight Financial Technology Solutions, LLC (LoanSphere Empower and LoanSphere LendingSpace). Some of these software providers, including Calyx Technology, Inc. and Black Knight Financial Technology Solutions, LLC, also provide connectivity between their software users and lenders and service providers to make such services available to mortgage lenders. We also compete with compliance, document preparation service, and product eligibility and pricing service providers that are more established than us. There is vigorous competition among providers of these services and we may not succeed in convincing potential customers using other services to switch to ours. In addition, some of our competitors are consolidating, which facilitates greater cross-selling of services and could weaken our ability to differentiate our offering in the market. Some

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of our competitors also offer services on a per closed loan basis, which could adversely impact the effectiveness of our Success-Based Pricing strategy for increasing the number of Encompass customers. If we are unsuccessful in competing effectively by providing attractive functionality, customer service, or value, we could lose existing Encompass users to our competitors and our ability to attract new Encompass users could be harmed.
There are many service providers that offer our Encompass users competing services, including borrower-facing websites, customer relationship management solutions, document preparation services, compliance services, product eligibility and pricing services, and electronic document management services. 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. 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 email, facsimile, phone, courier, and mail. In addition, mortgage originators may use standalone web browsers 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 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 using Encompass 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.
Some 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. In addition, we may face increased competition as a result of continuing industry consolidation. 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.
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, Encompass and the Ellie Mae Network technology may become obsolete. Our future success will depend on our ability to:
enhance our existing solutions;
develop and potentially license new solutions and technologies that address the needs of our prospective customers; and
respond to changes in industry standards and practices on a cost-effective and timely basis.
We must continue to enhance the features and functionality of Encompass, our other services, and the Ellie Mae Network. The effective performance, reliability, and availability of Encompass, our other services, and the Ellie Mae Network infrastructure are critical to our reputation and our ability to attract and retain Encompass users, users of our other services, 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 and materially adversely affect our business.
We are subject to the risks of current and future legal proceedings, which could have a material adverse effect on our business, financial condition, results of operations, and future prospects.
At any given time, we are a defendant in various legal proceedings and litigation matters arising in the ordinary course of business including commercial and employment disputes. We can give no assurance that the outcome of any such matter would not have a material adverse effect on our consolidated financial condition, results of operations, or cash flows. We are unable to predict the ultimate outcome of these disputes or the actual impact of these matters on our profitability at this time, and any views we form as to the viability of these claims or the financial exposure in which they could result, could change from time to time as the matters proceed through their course, as facts are established, and as various judicial determinations are made.
If we agree to settle these matters or judgments are secured against us, we may incur charges which may have a material and adverse impact on our business, financial conditions, results of operations, and future prospects.

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Failure to adequately protect our intellectual property could harm our business.
The protection of our intellectual property rights, including our proprietary Encompass software and Ellie Mae Network technology, is crucial to the success of our business. We rely on a combination of patents, copyrights, trademarks, and trade secret laws, 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 guarantee 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 features and functionality or obtain and use information that we consider proprietary. Enforcing our proprietary rights is difficult and may not always be effective.
We have registered “Ellie Mae,” “Encompass,” “Velocify,” and “AllRegs” and certain of our other trademarks as trademarks in the United States. Competitors may adopt service names similar to ours, thereby impeding our ability to build brand identity and possibly leading to customer confusion. In addition, there could be potential trade name or trademark infringement claims brought by owners of other registered trademarks or trademarks that incorporate variations of the terms Ellie Mae, Encompass, or our other trademarks.
Litigation or proceedings before the U.S. Patent and Trademark Office or other governmental authorities and administrative bodies in the United States and abroad may be necessary in the future to enforce our intellectual property rights, protect our patent and copyright rights, trade secrets and domain names, and determine the validity and scope of the proprietary rights of others. Our efforts to enforce or protect our proprietary rights may be ineffective and could result in substantial costs and diversion of resources and could harm our business.
Assertions that we infringe third-party intellectual property rights could result in significant costs and substantially harm our business.
Other parties have asserted, and may in the future assert, that we have infringed their intellectual property rights. In addition, we generally agree to indemnify our customers against legal claims that our software products infringe intellectual property rights of third parties and, in the event of an infringement, to modify or replace the infringing product or, if those options are not reasonably possible, to refund the cost of the software, as pro-rated over a period of years. We cannot predict whether assertions of third-party intellectual property rights or claims arising from such assertions will substantially harm our business and operating results. If we are forced to defend against any infringement claims, whether they are with or without merit or are determined in our favor, we may face costly litigation and diversion of technical and management personnel. Furthermore, an adverse outcome of a dispute may require us to: pay damages, potentially including treble damages and attorneys’ fees if the infringement were found to be willful; cease providing solutions that allegedly incorporate the intellectual property of others; expend additional development resources to redesign or re-engineer our solutions and products, if feasible; and enter into potentially unfavorable royalty or license agreements in order to obtain the right to use necessary technologies. We cannot be certain of the outcome of any litigation. Any royalty or licensing agreement, if required, may not be available to us on acceptable terms or at all. Our failure to obtain the necessary licenses or other rights could prevent the sale or distribution of some of our products and services and, therefore, could have a material adverse effect on our business.
Our internal information technology systems are critical to our business. System integration and implementation issues could disrupt our operations, which could have a material adverse impact on our business or results in significant deficiencies or material weaknesses in our internal controls.
We rely on the efficient and uninterrupted operation of complex information technology systems, including systems for customer billing, human resources, enterprise resource planning, and customer relationship management.  As our business has grown in size and complexity, the growth has placed, and will continue to place, significant demands on our internal information technology systems. To effectively manage this growth, we must commit significant financial resources and personnel to maintain and enhance existing systems and develop or acquire new systems to keep pace with continuing changes in our business and information processing technology as well as evolving industry, regulatory, and accounting standards.  If the information we rely upon to run our businesses is determined to be inaccurate or unreliable, or if we fail to properly maintain or enhance our internal information technology systems, we could have operational disruptions, customer disputes, significant deficiencies, or material weaknesses in our internal controls, incur increased operating and administrative expenses, lose our ability to produce timely and accurate financial reports, or suffer other adverse consequences.

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For example, as discussed in more detail below, our implementation of Topic 606, a new revenue recognition standard which became effective on January 1, 2018 and as more fully described in Note 2 “Basis of Presentation and Significant Accounting Policies”, required significant updates to our financial technology systems. The timely and precise implementation of necessary systems updates for Topic 606 are critical to our ability to properly record and recognize revenue and any errors resulting from this implementation would have, and may continue in the future to, among other things, result in significant deficiencies or material weaknesses in our internal controls.
If we fail to maintain proper and effective internal controls, our ability to produce accurate financial statements could be impaired, which could result in a loss of investor confidence in our financial reports, significant expenses to remediate any internal control deficiencies, and ultimately have an adverse effect on the market price of our common stock.
As a publicly-traded company, we are subject to compliance with, among other regulations, Section 404 of the Sarbanes-Oxley Act of 2002 (“SOX”), which requires that we properly implement and maintain our internal control over financial reporting and disclosure controls and procedures. Ensuring that we have adequate functioning internal financial and accounting controls and procedures in place so that we can produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be re-evaluated frequently. Our compliance with SOX requires that we incur substantial expense and expend significant management time on compliance-related issues. If we fail to achieve and maintain an effective internal control environment, we could suffer material misstatements in our financial statements and fail to meet our re