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Problem 4 Using the client?s financial statements and notes to the financial statements, determine what issues relating to GAAP to which the predecessor auditor may be referring.

Ensure you answer correctly

ABC, INC. A Comprehensive Decision Based Case, 3rd Edition, 2015 ISBN: 9780986165832 support@capstoneeducationalpublishing.com No Refunds After 30 Days of Downloading File TABLE OF CONTENTS 1. 2. 3. 4. 5. 6. Financial Statements and Notes Additional Company and Industry Information General Risk Management Questionnaire and Problem Control Environment Questionnaire and Problem Client Acceptance and Planning Problem Statistical Auditing Problems a. Attribute Sampling Problem 1 b. Attribute Sampling Problem 2 c. Probability Proportionate to Size Problem d. Variables Sampling Problem 7. Internal Control Problems a. Internal Control Questionnaire and Assertions Problem b. Cash Handling Questionnaire Problem c. Receivables Questionnaire Problem d. Inventory Questionnaire Problem e. Personnel and Payroll Questionnaire Problem f. Internal control over purchasing Problem g. Internal control over sales Problem 8. Substantive Testing Problems a. Cash Problem b. Accounts receivable Problem c. Investment Objectives Problem d. Current liabilities Problem e. Long-term liabilities Problem 9. Completing the Audit Problems 10. Report Writing Problems Section 1 FINANCIAL STATEMENTS AND NOTES ABC INC SIC Code 7372 - Prepackaged Software Industry Software & Programming Sector Technology Fiscal Year 1 12/31 BUSINESS Our Company We provide on-demand software solutions and services for the residential mortgage industry in the United States . Our mortgage management solutions help streamline and automate the process of originating and funding new mortgage loans, thereby increasing efficiency, improving loan quality, facilitating regulatory compliance and reducing documentation errors while providing one system of record for loans . Our Awesome software is an end-to-end, comprehensive enterprise solution that handles most of the functions involved in running the business of originating mortgages: customer relationship management; loan processing; underwriting; preparation of application, disclosure and closing documents; funding and closing the loan for the borrower; compliance with regulatory and investor requirements and overall enterprise management that provides one system of record. Delivery of our Awesome software in an on-demand Software-as-a-Service, or SaaS, environment provides customers with the added benefits of lower up front implementation costs and reduced need for an infrastructure of servers, storage and network devices as well as providing access to the most current release of an application, periodic upgrades and regulatory updates. We also host the ABC Network , a proprietary electronic platform that allows Awesome users to conduct electronic business transactions with investors and settlement service providers they work with in order to process and fund loans. As of December 31, 2013 , the ABC Network electronically connects the approximately 92,000 mortgage professionals using Awesome to the broad array of mortgage lenders, investors and third-party service providers integral to the origination and funding of residential mortgages. For mortgage originators, Awesome is a comprehensive operating system that handles key business and management functions involved in running a mortgage origination business. Mortgage originators use Awesome as a single tool for loan processing, marketing, customer communication and to interact electronically with lenders, investors and service providers over the ABC Network. We also offer Awesome users a variety of other on-demand software services, including : Awesome Docs Solution , which automatically prepares the disclosure and closing documents necessary to fund a mortgage ; Awesome CenterWise , a bundled offering of electronic document management, or EDM , and websites used for customer relationship management; Total Quality Loan, or TQL , which offers a suite of fraud detection, valuation, validation and risk analysis services ; Awesome Compliance Service , which automatically checks for compliance with federal, state and local regulations throughout the origination process ; tax transcript services which provide income verification capability; services for ordering and managing appraisals; Awesome CRM , a suite of tools for managing contacts, leads and marketing campaigns; Awesome Product and Pricing Service , which allows Awesome users to compare loans offered by different lenders and investors to determine appropriate mortgage programs available to a particular borrower ; and Awesome Flood Service , which allows Awesome users to order and transfer flood zone certifications. For the lenders, investors and service providers on the ABC Network, we provide electronic connectivity that allows them to do business with a significant percentage of the mortgage origination professionals in the United States. Mortgage originators purchase Awesome software as a service, paying either recurring subscription fees or monthly fees based on the number of licensed users and mortgages funded. Our additional services are paid on a subscription or transaction basis. Lenders and service providers participating in the ABC Network also pay us fees, generally on a per transaction basis, for business received from Awesome users. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read the following discussion of our financial condition and results of operations in conjunction with the financial statements and the notes thereto included elsewhere in this Annual Report on Form 10-K. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this Annual Report on Form 10-K, particularly in \"Risk Factors\" and \"Special Note Regarding Forward-Looking Statements.\" Overview We provide on-demand software solutions and services for the residential mortgage industry in the United States. Our mortgage management solutions help streamline and automate the process of originating and funding new mortgage loans, thereby increasing efficiency, improving loan quality, facilitating regulatory compliance and reducing documentation errors while providing one system of record for loans . Mortgage originators use our Awesome software, a comprehensive operating system that handles key business and management functions involved in running a mortgage origination business. Mortgage originators use Awesome as a single tool for loan processing, marketing, customer communication and to interact electronically with lenders, investors and service providers over the ABC Network. Our software also 2 enables enforcement of rules and business practices designed to ensure loan quality, adherence to processing standards and regulatory compliance. We also offer Awesome users a variety of other on-demand software services, including : Awesome Docs Solution, which automatically prepares the disclosure and closing documents necessary to fund a mortgage ; Awesome CenterWise, a bundled offering of EDM and websites used for customer relationship management; TQL , which offers a suite of fraud detection, valuation, validation and risk analysis services using streamlined workflows and processing rules; Awesome Compliance Service, which automatically checks for compliance with federal, state and local regulations throughout the origination process ; tax transcript services which provide income verification capability to our customers; Awesome Product and Pricing Service, which allows Awesome users to compare loans offered by different lenders and investors to determine appropriate mortgage programs available to a particular borrower and Awesome Flood Service, which allows Awesome users to order and transfer flood zone certifications. By the nature of our on-demand service, even with our robust security monitoring and detection systems, we cannot guarantee that our security measures will prevent security breaches and we may need to expend significant resources to protect against and remedy any potential security breaches and their consequences. The ABC Network electronically connects the approximately 92,000 mortgage professionals using Awesome to the broad array of mortgage lenders, investors and third-party service providers integral to the origination and funding of residential mortgages. During the mortgage origination process, mortgage originators may order various services through the ABC 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. We were formed as a California corporation in 1997 and reincorporated in Delaware in November 2009. From inception through 2000, we developed consumer-facing websites and initial versions of our network. We launched our first transaction platform in late 2000, the present version of which is the ABC Network . Our revenues consist of on-demand and on-premise revenues. On-demand revenues are generated primarily from software subscriptions we host that customers access through the Internet, including customers who pay fees based on the number of loans they fund, or success basis, subject to monthly base fees, which we refer to as Success-Based Pricing On-demand revenues also include software services that are sold transactionally as well as ABC Network transaction fees paid by lender-investors, service providers and certain government-sponsored entities participating on the ABC Network . On-premise revenues are generated from customer-hosted software licenses and implementations, training and maintenance services. For further discussion of the sources of our revenue and our revenue recognition policy, please see our Critical Accounting Policies and Estimates below. Our on-demand revenues generally track the seasonality of the residential mortgage industry, typically, but not always, 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 and general economic conditions, which can lead to departures from the typical seasonal pattern. For example, increases in mortgage interest rates could reduce the volume of new mortgages originated and, in particular, the volume of mortgage refinancings. We currently estimate that approximately 30% to 40% of our revenues has some sensitivity to volume. Contracted revenues, which are not sensitive to volume, represented 57% of total revenues for the year ended December 31, 2013. 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. During 2013, we accelerated our investments in our sales and client services capabilities, in research and development and in technology infrastructure to support our user additions and overall business growth. These investments included expanding our talent across the organization by hiring additional personnel, especially for our customer acquisition, client services and implementation teams and our research and development teams; developing nextgeneration products and enhancements; purchasing computer equipment; upgrading our telephony systems and building out new office facilities. In addition to our internal initiatives, our business strategy has evolved to address recent industry trends, including: expected lower lending volume; increased quality standards imposed by regulators, lenders and investors; increased regulation affecting lenders and investors; greater focus by our customers on operational efficiencies; and customers adopting multi-channel strategies We are responding to these trends as follows: Expected lower lending volume. Mortgage lending volume is expected to be lower in 2014 than in 2013 , as forecasted by Fannie Mae, Freddie Mac and the Mortgage Bankers Association. Since late 2009, we have focused our marketing and sales efforts on our on-demand SaaS Awesome offering, and particularly our SaaS Awesome Success-Based Pricing model, in contrast to our on-premise license model. In our on- 3 demand SaaS Awesome offering, the customer does not pay the significant up-front licensing fee associated with our license model, which we believe is particularly attractive in the present climate of the residential mortgage origination market. Our SaaS Awesome Success-Based Pricing model builds on this value proposition by aligning customers' payments for our software solutions with their own receipts of revenues . Our focus on our SaaS Awesome offering is important in light of lower lending volumes because we typically generate greater revenues per user through our on-demand SaaS Awesome offering than through our on-premise license offering. We are also focusing on increasing use of our ABC Network offerings and our other services, which were introduced from late 2009 through late 2011. These offerings include our TQL program, Awesome Compliance Service, Awesome Product and Pricing Service , Awesome Docs Solution and Awesome 4506-T Service . During 013 and 2012 , Awesome users employed the ABC Network to process on average approximately six and five transactions per loan file, respectively . By continuing to enhance our service offerings and encouraging providers of settlement services to deliver their services electronically through the ABC Network , we will continue to build value for ABC Network participants while increasing the number of transactions for which the ABC Network is used. Increased quality standards imposed by regulators, lenders and investors. Awesome is designed to automate and streamline the process of originating mortgages to, among other things, satisfy increased quality requirements of investors. Relevant features of Awesome 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 TQL program is designed to further enhance the quality, compliance and saleability of loans that are originated through Awesome. Additionally, TQL is intended to reduce the opportunities for errors in the process of transferring information from originator to investor and 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 an increased number of 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 by approximately 42% from December 31, 2012 to December 31, 2013 in order to address anticipated demand for our software solutions Increased regulation affecting lenders and investors. Regulatory reforms have significantly increased the complexity and importance of regulatory compliance. We devote considerable resources to continually upgrading software to help customers address regulatory changes. We offer Awesome Compliance Service, which automatically checks loan files for compliance with the myriad of federal, state and local regulations and alerts users to possible violations of these regulations. In addition, we have a staff of attorneys and work with compliance experts who help assure that documents prepared using our software and the processes recommended by the Awesome workflow comply with applicable rules and regulations. We believe we are well-positioned to help our customers meet additional requirements from the Dodd-Frank Wall Street Reform and Consumer Protection Act, or Dodd-Frank Act, that became effective in January 2014. Our ATR / QM , functionality is designed to allow our customers to document their compliance with the CFPB 's ATR / QM Final Rule that applies to the majority of residential mortgage loan originations in the United States. We believe we are also well-positioned to help our customers meet future Dodd-Frank Act requirements as they are published and become effective. Greater focus on operational efficiencies. Mortgage originators experienced an approximately 40% increase in direct production costs per loan between 2009 and 2011 1 , and we expect this trend to continue due to continued increased regulation 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 a loan and lowers the risk of buy back demands from investors resulting from poorly originated or documented loans and/or loans that fail to comply with applicable regulations. With an eye towards providing customers with ever-greater tools to enhance efficiency, we will continue to develop new service offerings through the ABC Network and pursue adoption of our services through initiatives such as our TQL program. By integrating and expanding our current and new services, we will provide a more comprehensive benefit to our users. In addition to providing efficiency-enhancing solutions, delivery of our Awesome software in an on-demand SaaS environment provides customers with the added benefits of lower up front implementation costs and reduced need for an infrastructure of servers, storage and network devices as well as providing access to the most current release of an application, periodic upgrades and regulatory updates. Customers adopting multi-channel strategies. Customers are developing multi-channel strategies beyond a single retail, correspondent or wholesale 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. 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. Acquisition Strategy Our industry is highly fragmented, and we believe there are strategic opportunities available to acquire competing software companies or software providers that offer related mortgage origination functionality that will complement and increase the attractiveness of Awesome For example, in January 2014, we acquired substantially all the assets of MortgageCEO , 4 This page left intentionally blank This 5 The following table shows these operating metrics as of and for the years ended December 31, 2013, 2012 and 2011: Year ended December 31, 2013 Revenues (in thousands): Total revenues Total contracted revenues Total SaaS Awesome revenues Users at end of period: Contracted SaaS users Active Awesome users Active SaaS Awesome users Active SaaS Awesome users as a percentage of active Awesome users Active SaaS Awesome users as a percentage of contracted SaaS users Average users during period: Active Awesome users Active SaaS Awesome users Active SaaS Awesome users as a percentage of active Awesome users Revenue per average user during period: Revenue per average active Awesome user SaaS Awesome revenue per average active SaaS Awesome user $ $ $ 2012 128,481 72,967 73,698 $ $ $ 95,044 92,161 63,695 $ $ $ 45% 68% 63,993 33,203 64% 51,455 19,330 52% $ $ 1,592 1,444 55,494 30,312 19,803 35,745 53,767 24,252 56% 69% 87,276 55,421 1,472 1,330 101,845 48,768 47,940 60,187 73,687 41,458 69% 67% $ $ 2011 38% $ $ 1,078 1,024 Basis of Presentation General Our consolidated financial statements include the accounts of ABC , Inc. and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated upon consolidation. Revenue Recognition We generate revenue primarily from transaction-based fees and fees for software and related services. Our software can be accessed either through a company-hosted subscription or a customer-hosted license. Accordingly, our revenues are now described as on-demand and onpremise revenues. Sales taxes assessed by governmental authorities are excluded from revenue. On-demand Revenues On-demand revenues are revenues generated from company-hosted software subscriptions that customers access through the Internet as well as revenues from a small number of customers that have opted to self-host a portion of the software but pay fees based on a per closed loan, or success, basis subject to monthly base fees, which we refer to as Success-Based Pricing. On-demand revenues are also comprised of software services sold transactionally and ABC Network transaction fees. On-premise Revenues On-premise revenues are revenues generated from maintenance services, sales of customer-hosted software licenses (except for customerhosted Success-Based Pricing revenues, which are included in on-demand revenues described above), and professional services, which include consulting, implementation and training services. Cost of Revenues and Operating Expenses Cost of Revenues Our cost of revenues consists primarily of: salaries and benefits, including stock-based compensation; expenses for document preparation, income verification and compliance services; customer support; data centers; depreciation on computer equipment used in supporting the ABC Network , SaaS Awesome and Awesome CenterWise offerings; amortization of acquired intangible assets such as developed technology and trade names; professional services associated with implementation of our software; and allocated facilities costs. We expect that our cost of 6 revenues will continue to increase in absolute dollars as our revenues increase, as we make additional investments in our technology infrastructure and as we continue to hire additional personnel in our implementation and customer support departments to support new customers. Sales and Marketing Our sales and marketing expenses consist primarily of: salaries, benefits and incentive compensation, including stock-based compensation and commissions; allocated facilities costs; expenses for trade shows, public relations and other promotional and marketing activities; expenses for travel and entertainment; and amortization of acquired intangible assets such as customer lists and contracts. We expect that our sales and marketing expense will continue to increase as we continue to hire additional sales personnel in order to address anticipated demand for our software solutions as we expect an increased number of mortgage lenders to assess new platform options and replace their legacy systems We also intend to increase marketing activities focused on SaaS Awesome, our ABC Network offerings and our other Awesome services. Research and Development Our research and development expenses consist primarily of: salaries and benefits, including bonuses and stock-based compensation; fees to contractors engaged in the development and support of the ABC Network infrastructure, Awesome software 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 infrastructure, including hiring additional engineering and product development personnel. General and Administrative Our general and administrative expenses consist primarily of: salaries and benefits, including bonuses and stock-based compensation, for employees involved in finance, accounting, human resources, administrative and legal roles; consulting, legal, accounting and other professional services by third-party providers; and allocated facilities costs. We expect general and administrative expenses to continue to increase in absolute dollars primarily due to greater amounts of stock compensation expense relating to awards granted to attract and retain the employees needed to continue to grow our business. Other Income (Expense), Net Other income (expense), net consists of interest income earned on investments, cash accounts and notes receivable, offset by investment discount amortization and imputed interest expense related to the DMD acquisition holdback payments (see Note 5 of the Notes to Consolidated Financial Statements) and interest expense paid on equipment and software leases. Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements which are prepared in accordance with generally accepted accounting principles in the United States, or GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. We evaluate our estimates and assumptions on an ongoing basis. Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Our actual results could differ from these estimates. We believe that the assumptions and estimates associated with revenue recognition, income taxes, stock-based compensation, goodwill and intangible assets, fair value of investments, deferred commissions and software and website development costs have the greatest potential impact on our consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates. For further information on all of our significant accounting policies, please see Note 2 of the Notes to Consolidated Financial Statements Revenue Recognition We generate revenue primarily from on-demand and on-premise fees for software and related services. On-Demand Revenues Subscription Services and Usage-Based Fee Arrangements. Subscription services and usage-based fee arrangements generally include a combination of our products delivered as software-as-a-service, or SaaS, and support services. These arrangements are non-cancelable and do not contain refund-type provisions. These revenues generally include the following: SaaS Awesome Revenues. We offer web-based, on-demand access to Awesome for a monthly recurring fee. We provide the right to access our loan origination software and handle the responsibility of managing the servers, providing security, backing up the data and applying updates; however, except where customers self-host a portion of the software in a Success-Based Pricing structure, customers under SaaS arrangements may not take possession of the software at any time during the term of the agreement. Subscription revenues are recognized ratably over the contract terms beginning on the commencement date of each contract, which is the date the Company's service 7 is made available to customers. Contracts generally range from one to five years . Alternatively, customers can elect to pay on a per closed loan, or success, basis. Success basis contracts generally have a term of one to five years and are subject to monthly base fees, which enable customers to close loans up to a contractually agreed-to minimum number of transactions, and additional closed loan fees, which are assessed for loans closed in excess of the minimum. Revenue is earned from both base fees and additional closed loan fees as the result of the customer's usage of Awesome. Monthly base fees are recognized over the respective monthly service period as the software is utilized. Additional closed loans fees are recognized when the loans are reported as closed. This offering also includes Awesome CenterWise, Awesome Compliance Service and Awesome Docs Solution for Awesome as integrated components, which are combined elements of the arrangement that is delivered in conjunction with the SaaS Awesome offering and therefore is not accounted for separately. Awesome CenterWise Revenues. Awesome CenterWise is a bundled offering of EDM and websites used for customer relationship management. Generally, revenue is recognized for Awesome CenterWise after the service is rendered, except when Awesome CenterWise is automatically included as an integrated component of the SaaS Awesome offering, in which case the associated revenue is recognized as described above. Services Revenues. We provide mortgage-related and other business services, including automated documentation preparation and compliance reports. Services revenues are recognized after the services are rendered. Transaction Revenues. We have entered into agreements with various lenders, service providers and certain government agencies participating in the mortgage origination process that provide them access to, and ability to interoperate with, mortgage originators on the ABC Network. Under these agreements, we earn transaction fees when transactions are processed through the ABC Network. Transaction revenues are recognized when there is evidence that the qualifying transactions have occurred on the ABC Network and collection of the resulting receivable is reasonably assured. On- Premise Revenues With the exception of revenue from customers that self-host a portion of the software in a Success-Based Pricing structure , which is recognized as described above , revenue from the sale of software licenses is recognized in the month in which the required revenue recognition criteria are met, generally in the month in which the software is delivered. Revenue from the sale of maintenance services and professional services is recognized over the period in which the services are provided. Income Taxes We account for income taxes under the asset and liability method, which requires the recognition of taxes payable or refundable for the current year, and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in our financial statements or tax returns. The measurement of current and deferred tax liabilities and assets is based on provisions of the enacted tax law; the effects of future changes in tax laws or rates are not anticipated. Valuation allowances are established when necessary to reduce deferred tax assets to the amount that we believe is more likely than not to be realized. Goodwill and Other Intangible Assets Goodwill and other intangible assets are stated at cost less accumulated amortization, as appropriate. Other intangible assets include developed technology, trade names and customer lists and contracts. Intangibles with finite lives are amortized on a straight-line basis over the estimated periods of benefit, generally one to nine years. Goodwill is not amortized, but tested for impairment at least annually, or whenever changes in circumstances indicated that the carrying amount of goodwill or intangible assets may not be recoverable. These tests are performed at the reporting unit level, which is the company as a whole, using a two-step, fair-value approach. We completed annual impairment tests for the years ended December 31, 2013, 2012 and 2011 and determined that our goodwill was not impaired for those years. If management's estimates of future operating results change, if there are changes in identified reporting units or if there are changes to other significant assumptions, the estimated carrying values of any such reporting units and the estimated fair value of goodwill could change significantly, and could result in an impairment charge. Such changes could also result in goodwill impairment charges in future periods, which could have a significant impact on our operating results and financial condition therein. We assess the impairment of identifiable intangible assets whenever events or changes in circumstances indicate that an asset's carrying amount may not be recoverable. An impairment loss would be recognized when the sum of the undiscounted estimated future cash flows expected to result from the use of the asset and its eventual disposition is less than its carrying amount. Such impairment loss would be measured as the difference between the carrying amount of the asset and its fair value. Cash flow assumptions are based on historical and forecasted revenue, operating costs and other relevant factors. If management's estimates of future operating results change, or if there are changes to other assumptions, the estimate of the fair value of our acquired product rights and other identifiable intangible assets could change significantly. Such change could result in impairment charges in future periods, which could have a significant impact on our operating results and financial condition. 8 Fair Value of Investments All of our investments that have maturities of greater than 90 days are classified as available-for-sale and are carried at fair value. We invest excess cash primarily in investment-grade interest-bearing securities such as money market accounts, certificates of deposit, commercial paper, corporate bonds, municipal and government agency obligations and guaranteed obligations of the U.S. government all of which are subject to minimal credit and market risks. Fair value is determined based on quoted market rates when observable or utilizing data points that are observable, such as quoted prices, interest rates and yield curves. The cost of available-for-sale marketable securities sold is based on the specific identification method. Unrealized gains and losses, net of tax, are reported in stockholders' equity as accumulated other comprehensive loss Realized gains and losses are included in other income (expense), net Interest and dividends are included in other income (expense), net when they are earned . As of December 31, 2013, our assets measured and recorded at fair value on a recurring basis included $16.4 million of money market funds and $105.5 million of marketable debt instruments. Of these marketable debt instruments, $11.4 million was classified as Level 1 and $94.1 million as Level 2. All of our money market funds are classified as Level 1. When determining fair value, we consider the principal or most advantageous market in which we would transact, and we consider assumptions that market participants would use when pricing the asset or liability. For further information, see \"Fair Value of Financial Instruments\" in Notes 2 and 4 of the Notes to Consolidated Financial Statements. Credit risk is factored into the valuation of financial instruments that we measure and record at fair value. When fair value is determined using pricing models, such as a discounted cash flow model, the issuer's credit risk is factored into the calculation of the fair value, as appropriate. Our money market funds and marketable debt instruments that are measured and recorded at fair value on a recurring basis and classified as Level 1 were classified as such due to the use of observable market prices for identical securities that are traded in active markets . Management judgment was required to determine the levels for the frequency of transactions that should be met for a market to be considered active. Our assessment of an active market for our marketable debt instruments generally takes into consideration the number of days each individual instrument trades over a specified period. When we use observable market prices for identical securities that are traded in less active markets, we classify our marketable financial instruments as Level 2. When observable market prices for identical securities are not available, we price our marketable financial instruments using non-binding market consensus prices that are corroborated with observable market data; quoted market prices for similar instruments; or pricing models with all significant inputs derived from or corroborated with observable market data. Non-binding market consensus prices are based on the proprietary valuation models of pricing providers. These valuation models incorporate a number of inputs, including non-binding and binding broker quotes; observable market prices for identical or similar securities; and the internal assumptions of pricing providers or brokers that use observable market inputs and, to a lesser degree, unobservable market inputs. We corroborate non-binding market consensus prices with observable market data as such data exists. We had no investments classified as Level 3 at December 31, 2013. Deferred Commissions Deferred commission expenses are the incremental costs that are directly associated with non-cancelable subscription contracts with customers and consist of sales commissions paid to our direct sales force. Commissions are calculated based on a percentage of the revenues for the non-cancelable term of subscription contracts, which are typically one to five years . Prior to 2013, commissions were paid and recognized as sales expense when customer payments for contracted services were received on a monthly basis because commissions were earned based on receipt of customer payments. In 2013, we amended our commission plans to provide for payment after the customer's contract is signed. As a result of the change in commission plans, beginning in 2013, commission expense is deferred and amortized to sales expense over the non-cancelable terms of the related subscription contracts. The deferred commission expense amounts are recoverable through the future revenue streams under the non-cancelable customer contracts. The new plans also include claw back provisions, which require repayment of a proportionate amount of commissions, should customers cancel their contracts prior to the end of the initial contractual term. Software and Website Development Costs The Company capitalizes internal and external costs incurred to develop internal-use software and website applications. Capitalized internal costs include salaries, benefits and stock-based compensation charges for employees that are directly involved in developing the software or website application, and depreciation of assets used in the development process. Capitalized external costs include third-party consultants involved in the development process, as well as other direct costs incurred as part of the development process. Capitalization of costs begins when the preliminary project stage is completed, and management authorizes and commits to funding a 9 project and it is probable that the project will be completed and the software or website application will be used to perform the function intended. Internal and external costs incurred as part of the preliminary project stage are expensed as incurred. Capitalization ceases at the point at which the project is substantially complete and ready for its intended use, after all substantial testing is completed. Internal and external training costs and maintenance costs during the post-implementation operation stage are expensed as incurred. Internal-use software is amortized on a straight-line basis over its estimated useful life, generally three years. Our management evaluates the useful lives of these assets on an annual basis and tests for impairment whenever events or changes in circumstances occur that could impact the recoverability of these assets. The capitalized costs are included in the property and equipment, net line in the accompanying consolidated balance sheets. For the years ended December 31, 2013 and 2012 , we capitalized software and website application development costs of $5.0 million and $0.5 million , respectively. There were no such costs capitalized in the year ended December 31, 2011 . There was $69,000 in amortization of capitalized internal-use software and website development costs recorded during the year ended December 31, 2013 and no such amortization recorded during the years ended December 31, 2012 and 2011. Total revenues increased $26.6 million , or 26.2% , for the year ended December 31, 2013 as compared to the same period of 2012 . On-demand revenues increase d by $27.2 million , consisting primarily of a $25.8 million increase in SaaS Awesome revenues, of which $24.2 million related to our Success-Based Pricing model. SaaS Awesome revenues increased as a result of the addition of new SaaS Awesome users and as a result of upgrades of existing customers to our SaaS platform. The number of average active SaaS Awesome users increase d by 66.9% from 33,203 for the year ended December 31, 2012 to 55,421 for the year ended December 31, 2013 due to the addition of new customers and the transition of on-premise licensed users to our SaaS Awesome Success-Based Pricing offering. The revenue growth attributable to the increase in average active SaaS Awesome users was partially offset by a 7.9% decrease in SaaS Awesome revenue per average active SaaS user from $1,444 for the year ended December 31, 2012 to $1,330 for year ended December 31, 2013, caused primarily by a decline in closed loan volume, lenders' focus on preparing for ATR / QM rules and longer implementation cycles for some of the larger customers that were added earlier in 2013. Additional contributors to the growth in on-demand revenues were a $1.0 million increase in revenues from our Awesome CenterWise offering primarily due to an increase in our customers, a $2.5 million increase in revenues from our TQL program and a $0.3 million increase in revenues from network transactions due to increased network usage for the year ended December 31, 2013 compared to the same period of 2012. Partially offsetting the increase in on-demand revenues was a $2.9 million decrease in revenues from our standalone Awesome Docs Solution for the year ended December 31, 2013 compared to the same period of 2012, primarily as a result of the conversion of customers from standalone solutions to SaaS Awesome and partially from two standalone solutions subscription customers having gone out of business during the third quarter of 2013. On-premise revenues decrease d by $0.6 million for the year ended December 31, 2013 compared to the same period of 2012, primarily due to a $2.7 million decrease in software license and maintenance fees as our on-premise customers converted to SaaS Awesome SuccessBased Pricing users. This decrease in revenues was offset by a $2.2 million increase in revenues from implementation services for the year ended December 31, 2013 compared to the same period of 2012, as we began to charge for implementation services during the third quarter of 2013. Total revenues increased $46.4 million or 83.5% , for the year ended December 31, 2012 as compared to the same period of 2011 . On-demand revenues increased by $41.9 million , consisting primarily of a $27.7 million increase in SaaS Awesome revenue resulting from the addition of new SaaS Awesome users and upgrades of existing customers to our SaaS platform resulting from our continued marketing focus on our Success-Based Pricing model as well as an increase in mortgage origination volume. The number of active SaaS Awesome users increased by 70.9% to 41,458 users at December 31, 2012 from 24,252 users at December 31, 2011 due to the addition of new customers as well as the transition of on-premise licensed users to our SaaS Awesome Success-Based Pricing offering. SaaS Awesome Revenue per average active SaaS user increased by 41.0% for the year ended December 31, 2012 compared to same period of 2011 due to an increase in the number of closed loans per Active SaaS User as well as the continued movement of users to our Success-Based Pricing model, which offers higher revenue per user compared to our traditional license model. On-demand revenues also increased due to continued adoption of new product offerings. Revenues from our tax transcript services that we began offering in the first quarter of 2011 increased by $2.3 million while our appraisal and title services increased by $1.2 million for the year ended December 31, 2012 compared to same period of 2011. Our TQL program was introduced during the fourth quarter of 2011 and TQL revenues increased by $1.4 million for the year ended December 31, 2012 compared to the year ended December 31, 2011. Other on-demand revenues increased due to a $4.0 million increase in vendor transaction revenues due to increased network usage and a greater number of users, a $2.1 million increase in compliance services due to increased usage by our customers as well as a greater number of users, a $2.0 million increase in document preparation revenues and a $1.2 million increase in other on-demand and transaction revenues. On-premise revenues increased by $4.5 million primarily due to DMD license and maintenance revenues. We acquired DMD in August 2011. 10 Gross profit increase d by $17.0 million and gross margin decrease d by 2.8 percentage points during the year ended December 31, 2013 as compared to the same period of 2012 as revenues increased by $26.6 million and cost of revenues increased by $9.6 million. The decrease in the gross margin for 2013 is primarily a result of an increase in fixed costs associated with headcount added to our implementation, professional services and customer support organizations and investments we have made in expanding our data centers. Cost of revenues increased primarily due to a $1.2 million increase in third-party royalty expenses to support the increased revenues, a $5.8 million increase in salaries and employee benefits from increased professional services and customer support headcount, a $0.5 million increase in stock-based compensation expense relating to our increased headcount, a $0.5 million increase in temporary staff and consulting costs associated with improvements to our data center operations and a $1.2 million increase in depreciation expense due to capital additions. Gross profit and gross margin increased by $39.0 million and 5.7 percentage points, respectively, in the year ended December 31, 2012 as compared to the same period of 2011 as revenues increased by $46.4 million and cost of revenues increased by $7.3 million. The increase in the gross margin for 2012 is primarily a result of our ability to utilize existing infrastructure to accommodate revenue growth and the fixed nature of certain costs such as intangible amortization. Cost of revenues increased primarily due to a $2.6 million increase in third-party royalty expenses to support the increased revenues, a $2.6 million increase in salaries and employee benefits from increased professional services and customer support headcount as well as the increase in headcount in hiring former DMD employees following the DMD acquisition in August 2011 , a $1.0 million increase in consulting costs associated with improvements to our data center operations and a $0.9 million increase in depreciation expense due to property and equipment additions. The increase in cost of revenues was partially offset by the capitalization of $1.0 million in compensation and consulting costs associated with data center improvements. Sales and marketing expenses increase d by $3.4 million, or 19.3% , in the year ended December 31, 2013 as compared to the same period of 2012. This increase was primarily due to a $1.9 million increase in salaries and employee benefits as well as a $0.6 million increase in stockbased compensation expense, both reflecting an increase in headcount as we continued to grow our sales and marketing departments in an effort to increase our market share. Additionally, travel and entertainment expenses in support of our sales function increase d by $0.5 million, and technology and telecommunications expenses incurred in support of our sales function increase d by $0.3 million . Sales and marketing expenses increased by $5.8 million, or 47.5%, in the year ended December 31, 2012 as compared to the same period of 2011. This increase was primarily due to a $2.2 million increase in salaries and employee benefits reflecting additional headcount as we have grown our sales department in order to address anticipated demand for our software solutions and additional headcount from the hiring of former DMD employees in August 2011 , a $1.2 million increase in commissions commensurate with the increase in revenues, a $0.8 million increase due to the increased level of sales and marketing activities in 2012 as compared to the prior-year period including our Awesome User Summit in the fourth quarter of 2012 and a $0.6 million increase in amortization of acquired intangible assets related to the DMD acquisition which occurred in August 2011 . Research and Development Year ended December 31, 2013 2012 2011 (in thousa nds except percentages) Research and development Research and development $ 24,695 19.2% $ 18,053 17.7% $ 12,975 23.4% Research and development expenses increase d by $6.6 million, or 36.8% , in the year ended December 31, 2013 compared to the same period of 2012. The increase was primarily due to a $3.8 million increase in salaries and employee benefits reflecting an increase in headcount, a $1.9 million increase in stock-based compensation expense primarily resulting from Performance Awards granted to certain executives during the third quarter of 2012 and the first quarter of 2013 and stock option and RSU grants made to new and existing employees and a $0.5 million increase in the use of consultants. Research and development expenses increased by $5.1 million, or 39.1%, in the year ended December 31, 2012 compared to the same period of 2011. The increase was primarily due to a $2.8 million increase in salaries and employee benefits reflecting an increase in headcount which included the hiring of former DMD employees in August 2011, a $1.1 million increase in stock-based compensation expense primarily resulting from Performance Awards granted to certain executives during the third quarter of 2012 as well as stock option grants made to new employees and a $0.6 million increase in the use of consultants. 11 General and Administrative Year ended December 31, 2013 2012 2011 (in thousa nds except percentages) General and administrative General and administrative $ 30,853 24.0% $ 21,601 21.2% $ 12,900 23.2% General and administrative expenses increase d by $9.3 million, or 42.8% , in the year ended December 31, 2013 as compared to the same period of 2012. This increase was primarily due to a $4.4 million increase in stock-based compensation expense primarily resulting from Performance Awards granted to certain executives during the third quarter of 2012 and the first quarter of 2013 and stock option and RSU grants made to new and existing employees, a $1.4 million increase in the use of consultants and temporary contractors for infrastructure and compliance projects, a $1.1 million increase in technology expenses relating to licenses and support for software used to manage our business, a $0.9 million increase in fees to professional service firms for accounting, tax, and investor relations services and a $0.4 million increase in depreciation expenses resulting from overall growth of our business and headcount. General and administrative expenses increased by $8.7 million, or 67.4%, in the year ended December 31, 2012 as compared to the same period of 2011. This increase was primarily due to a $3.6 million increase in stock-based compensation expense primarily resulting from Performance Awards granted to certain executives during the third quarter of 2012 as well as stock option grants made to new employees, a $1.3 million increase in salaries and other employee benefits due to an increase in headcount, which included the hiring of former DMD employees, a $1.4 million increase in bonus expense due to a greater number of employees eligible for bonus pay as well as improved operating performance of the Company, a $1.1 million increase in hardware and software expenses associated with infrastructure upgrades, a $0.6 million increase in the use of consultants and temporary workers, a $0.3 million increase in credit card processing fees resulting from higher sales volumes and a $0.2 million increase in depreciation expense due to recent increases in capital expenditures. The increases were offset by a $0.5 million decrease in legal fees due to decreased usage of outside legal services and a $0.4 million decrease in bad debt expenses resulting from the shift in the mix of our customer base from mortgage brokerages to mortgage lenders and improvement in the economy. Other (Expense) Income, Net Other income (expense), net includes imputed interest expense related to the DMD acquisition holdback liability and interest income from notes receivable and investments. The amounts were not significant in the years ended December 31, 2013, 2012 and 2011. Liquidity and Capital Resources As of December 31, 2013, we had cash, cash equivalents and short-term investments of $79.8 million and long-term investments of $56.3 million . Cash and cash equivalents consist of cash and money market accounts. Both short and long-term investments consist of corporate bonds and obligations, certificates of deposit, municipal obligations, U.S. government notes and U.S. government agency securities. 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 may enter into acquisitions in the future, which could require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all. The following table sets forth our statement of cash flows data for the periods presented: Year ended December 31, 2013 2012 2011 (in thousands) Net cash provided by operating activities Net cash used in investing activities Net cash provided by financing activities $ $ $ 29,248 $ (52,314) $ 12,414 $ Net increase (decrease) in cash and cash equivalents $ (10,652) $ 27,753 $ (69,121) $ 61,750 $ 20,382 $ 6,372 (21,268) 24,279 9,383 Operating Activities Cash provided by operating activities increased by $1.5 million from $27.8 million in 2012 to $29.2 million in 2013 . In the consolidated statements of cash flows, cash provided by operating activities is presented as net income adjusted for non-cash expense items and changes in operating assets and liabilities. Net income decreased by $6.9 million for the year ended December 31, 2013 as compared to the same period of 12 2012. The net contribution of non-cash expense items to cash provided by operating activities increased by $3.3 million for the year ended December 31, 2013 as compared to the same period of 2012 . The net contribution of changes in operating assets and liabilities to cash provided by operating activities increased by $5.1 million for the year ended December 31, 2013 as compared to the same period of 2012. Contributing to the increase in the net contribution of non-cash expense items was a $7.4 million increase in stock-based compensation expense, primarily due to Performance Awards granted to certain executives during the third quarter of 2012 and the first quarter of 2013 and new stock option and RSUs grants made to new and existing employees, offset in part by reductions from fully vested, fully amortized stock options, which no longer impacted expense in 2013. Also contributing was a $1.7 million in depreciation expense, primarily due to purchases of property and equipment for our data centers and for our new ERP system, which was placed into service during the fourth quarter of 2013. Additionally, amortization of investment premium increased by $1.6 million due to purchases of short-term and long-term investments starting in the fourth quarter of 2012. Offsetting these contributors to cash provided by operating activities were excess tax benefits, which reduce cash provided by operating activities and increased by $4.7 million primarily as a result of windfall tax benefits on the exercise of stock options, of which there were none in 2012. Also reducing cash provided by operating activities was the benefit from deferred income taxes, which increased by $2.4 million , primarily due to increases to deferred taxes related to stock-based compensation, and the lack of a reduction in the deferred tax asset valuation allowance during 2013, as there was in 2012. Changes in operating assets and liabilities resulted in a net increase of $5.1 million to cash provided by operating activities in the year ended December 31, 2013 as compared to the same period in 2012. Our net accounts receivable balance fluctuates from period to period, depending on the timing of sales and billing activity, cash collections and changes to our allowance for doubtful accounts. The change in prepaid expenses and other current assets was primarily due to the timing of the payment for computer software licenses, as well as an increase in taxes receivable resulting from windfall tax benefits on the exercise of stock options. The change in deposits and other assets was due to deferred commission expenses which started in 2013 and timing of the payment for software licenses. The change in accounts payable and accrued and other liabilities was due to the timing of additional liabilities and payments in general, and does not reflect any significant change in the nature of accrued liabilities. Cash provided by operating activities increased by $21.4 million from $6.4 million in 2011 to $27.8 million in 2012. This increase was primarily due to an increase of net income of $15.8 million for the year ended December 31, 2012 as compared to the same period of 2011. Additionally, stock-based compensation expense increased by $5.2 million for the year ended December 31, 2012 as compared to the same period of 2011. This increase resulted from new grants and the increased market price per share of our common stock, offset in part by reductions from fully vested, fully amortized stock options. Additionally, the change in deferred tax assets and liabilities increased by $1.1 million primarily due to the reduction in our deferred tax asset valuation allowance. Depreciation expense increased by $1.2 million primarily due to purchases of property and equipment for our data center and amortization of other intangible assets increased by $0.7 million primarily due to the acquisition of DMD. The increases were also offset by the increase in the excess tax benefit from exercise of stock options of $2.0 million as well as the decrease in the provision for uncollectible accounts receivable of $0.4 million. Cash provided by operating activities is also affected by changes in operating assets and liabilities, which resulted in a net decrease of $0.4 million to operating cash flows in the year ended December 31, 2012 as compared to the same period in 2011. Our net accounts receivable balance fluctuates from period to period, depending on the timing of sales and billing activity, cash collections and changes to our allowance for doubtful accounts. The change in prepaid expenses was due to the timing of the payment for insurance renewals, computer software licenses and computer equipment maintenance contracts as well as payments for prepaid maintenance related to computer hardware purchased for our data centers. The change in accounts payable and accrued and other liabilities was due to the timing of additional liabilities and specifically, to the payment of bonuses to employees prior to December 31, 2012. Investing Activities Our primary investing activities have consisted of purchases of investments, purchases of property and equipment specifically related to the build out of our data centers, as well as payments for acquisitions. Purchases of property and equipment may vary from period to period due to the timing of the expansion of our operations and certain software development projects subject to capitalization. We plan to continue to invest in technology hardware and software to support our growth and corporate infrastructure. Additionally, consistent with our acquisition strategy, we intend to continue pursuing additional strategic acquisitions. Cash used in investing activities of $52.3 million for the year ended December 31, 2013 was primarily the result of $44.2 million in net purchases of investments, $6.1 million for purchases of property and equipment mainly for our data centers and a $3.0 million holdback payment relating to the acquisition of DMD . This was partially offset by collections of $1.0 million on an outstanding note receivable. Cash used in investing activities of $69.1 million for the year ended December 31, 2012 was primarily the result of $58.1 million in net purchases of investments, $8.1 million for purchases of property and equipment mainly for our data centers and a $2.9 million holdback payment relating to the acquisition of DMD. Cash used in investing activities of $21.3 million for the year ended December 31, 2011 was primarily the result of $18.2 million in cash payments related to the acquisitions of DMD and MPS as well as purchases of property and equipment of $3.7 million primarily related to computer equipment and software to support the growth of our business. 13 Financing Activities Financing activities have consisted primarily of proceeds from our public offerings of common stock in 2011 and 2012, net of offering costs. Additional cash has been provided from the exercise of stock options as well as from the effect of excess tax benefits from exercises of stock options. Cash provided by financing activities of $12.4 million for the year ended December 31, 2013 consisted primarily of $6.5 million in proceeds from the exercise of stock options and $6.7 million in excess tax benefit from exercise of stock options. Cash provided by financing activities of $61.8 million for the year ended December 31, 2012 consisted primarily of $55.5 million in proceeds from our follow-on public offering, net of offering costs, $4.3 million in proceeds from the exercise of stock options and $2.0 million in excess tax benefit from exercise of stock options. Cash provided by financing activities of $24.3 million for the year ended December 31, 2011 consisted primarily of $23.1 million in proceeds from our initial public offering, net of offering costs, and $1.3 million in proceeds from the exercise of stock options. Contractual Obligations As of December 31, 2013, our contractual payment obligations are as follows: Acquisition holdback, net of discounts Capital lease obligations Operating lease obligations Purchase obligations $ Total $ Payment due by period (as of December 31, 2012) 1,965 $ 1,965 $ $ 1,036 1,036 3,026 1,834 842 350 3,160 1,267 1,893 6,102 $ 2,735 $ 350 9,187 $ Acquisition holdback, net of discounts is related to the acquisition of DMD. See Notes 5 and 8 of the Notes to Consolidated Financial Statements. Purchase obligations are associated with agreements that are enforceable and legally binding and that specify all significant terms, including: fixed or minimum services to be used; fixed, minimum or variable price provisions; and the approximate timing of the transaction. Obligations under contracts that we can cancel without a significant penalty are not included in the table above. See Note 8 of the Notes to Consolidated Financial Statements. 14 ABC , Inc. CONSOLIDATED BALANCE SHEETS (in thousands, except share and per share amounts) December 31, 2013 Assets Current assets Cash and cash equivalents Short-term investments Accounts receivable, net of allowances for doubtful accounts of $81 and $74 as of December 31, 2013 and December 31, 2012, respectively Prepaid expenses and other current assets Note receivable $ Total current assets Property and equipment, net Long-term investments Other intangible assets, net Goodwill Deposits and other assets Total assets Liabilities and Stockholders' Equity Current liabilities Accounts payable Accrued and other current liabilities Acquisition holdback, net of discount Deferred revenue 33,462 46,325 2012 $ 44,114 16,243 12,024 6,473 9,753 3,601 1,000 98,284 12,751 56,285 5,089 51,051 5,112 74,711 9,494 43,728 6,531 51,051 100 $ 228,572 $ 185,615 $ 3,783 10,224 1,965 4,752 $ 2,039 6,044 2,948 4,896 Total current liabilities Acquisition holdback, net of current portion and discount Other long-term liabilities 20,724 952 15,927 1