hosted software licenses and related implementation (except for customer-hosted success-based pricing revenues included in on-demand revenues described above), training and maintenance services.
A component of our on-demand and on-premise revenues is software revenues which are derived from mortgage originators who either subscribe to SaaS Encompass, our on-demand solution, or license Encompass software for an initial perpetual license fee with annual maintenance, our on-premise solution. Mortgage originators subscribing to SaaS Encompass pay monthly per-user subscription fees and/or, if on the success-based pricing model, fees based on the number of loans they fund. In addition, we offer CenterWise software either as a standalone product on a subscription-fee basis or bundled as part of our SaaS Encompass offering. Software services revenues are derived from fees paid by mortgage originators for the Encompass services they order. These services include Encompass Closer, Encompass Compliance Service and Encompass Product and Pricing Services. Lender-investors, service providers and certain government-sponsored entities participating on the Ellie Mae Network pay us fees when they effect a transaction by receiving and accepting an electronic service request over the Ellie Mae Network from an Encompass user.
Our on-demand revenues generally track the seasonality of the 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. These revenues are also affected by factors that impact mortgage volumes, such as interest rate fluctuations, home sale activity and general economic conditions. Mortgage loan volume is expected to be lower in 2013 than it is projected to be in 2012 due to various economic factors, which could adversely impact our revenue growth. The mortgage industry has undergone significant changes since 2007, largely in response to the hundreds of billions of dollars of loan defaults and massive losses suffered by lenders and investors. Our business strategy has evolved to address recent industry trends, including:
• lower lending volume;

• greater focus on operational efficiencies;

• significant market shift from mortgage brokerages to mortgage lenders;

• increased quality standards imposed by regulators, lenders and investors; and

• increased regulation affecting lenders and investors.

We are responding to these trends as follows:
Lower lending volume. Beginning in late 2009, we focused our marketing and sales efforts on our on-demand SaaS Encompass offering, and particularly our SaaS Encompass success-based pricing model, in contrast to our on-premise license model. In our on-demand SaaS Encompass 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 Encompass success-based pricing model builds on this value proposition by aligning the customers' payments for our software solutions with their own receipts of revenues. SaaS Encompass success-based pricing customers are composed of new Encompass customers and users that have converted from our licensed Encompass or DataTrac software or flat monthly per-user hosted offerings. We are also focusing on increasing use of our Ellie Mae Network offerings and our other services, which were introduced from late 2009 through late 2011. These offerings include our Total Quality Loan, or TQL, initiative, Encompass Compliance Services, Encompass Product and Pricing Services and Encompass Closer Services.
At September 30, 2012 and December 31, 2011, we had 35,677 and 24,252 Active SaaS Encompass Users, respectively, which are mortgage origination professionals who have used our SaaS Encompass software at least once within the preceding 90 days. SaaS Encompass revenues represented 49%, 45% and 36% of our revenues for the three and nine months ended September 30, 2012 and year ended December 31, 2011, respectively. We typically generate greater revenues per user through our on-demand SaaS Encompass offering than through our on-premise license offering. At September 30, 2012, we had two investor customers for our TQL initiative. Greater focus on operational efficiencies. Mortgage originators have experienced increased operational costs since 2009 as a result of increased regulation and investor demands for quality. By automating many of the functions of mortgage origination, we enable our users to 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. Significant market shift from mortgage brokerages to mortgage lenders. The industry has experienced a significant decline in the number of mortgage brokerages and an increase in the relative importance of mortgage lenders. We believe this shift toward lender users will provide us increased opportunities because mortgage lenders typically use more sophisticated and

comprehensive software solutions to run their businesses and use more services and effect more transactions on the Ellie Mae Network. We focus significant research and development effort on providing Encompass functionality for mortgage lenders. We have also hired sales personnel focused on sales of our solutions to mortgage lenders rather than mortgage brokerages and we are focused on selling our products and services to such larger customers. In addition, on August 15, 2011, we completed the acquisition of DMD, a mortgage lending automation business with approximately 200 mortgage lenders as customers. The acquisition was made to expand our client base and gain market share with mortgage lenders.
Increased investor and lender quality standards imposed by regulators, lenders and investors. Encompass software 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 software 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.
Increased regulation affecting lenders and investors. Regulatory reforms have significantly increased the complexity and importance of regulatory compliance. We offer Encompass 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 processes recommended by Encompass work flow comply with applicable rules and regulations. Operating Metrics
Revenue per Average Active Encompass User and SaaS Encompass Revenue per Average Active SaaS Encompass User are key operational metrics we use to evaluate our business, determine allocation of our resources and make decisions regarding corporate strategy. The Revenue per Average Active Encompass User metric is calculated by dividing total revenues by Average Active Encompass Users during the period. The SaaS Encompass Revenue per Average Active SaaS Encompass User metric is calculated by dividing total SaaS Encompass Revenues by Average Active SaaS Encompass Users during the period. We focus on these metrics to determine our success in leveraging our user base to increase our revenues. We track Active Encompass Users and Active SaaS Encompass Users as well as related revenues generated by each group at the end of a period to gauge the degree of our market penetration.
The components used to calculate these metrics are defined below. Active Encompass Users. An Active Encompass User is a mortgage origination professional who has used Encompass software at least once within a 90-day period preceding the measurement date. An Encompass user is a mortgage origination professional working at a 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.
Average Active Encompass Users. Average Active Encompass Users during a period is calculated by averaging the monthly Active Encompass Users during a period. Active SaaS Encompass Users. An Active SaaS Encompass User is a mortgage origination professional who has used the SaaS Encompass software at least once within a 90-day period preceding the measurement date.
Average Active SaaS Encompass Users. Average Active SaaS Encompass Users during a period is calculated by averaging the monthly active SaaS Encompass users during a period.

The following table shows these operating metrics as of and for the three and nine months ended September 30, 2012 and 2011:

                                          Three months ended September 30,          Nine months ended September 30,
                                              2012                 2011                2012                 2011
Revenues (in thousands):
Total revenues                         $        27,456       $        14,673     $       71,931       $       36,740
Total SaaS Encompass revenues          $        13,400       $         5,086     $       32,491       $       12,308
Users at end of period:
Active Encompass users                          67,201                51,558             67,201               51,558
Active SaaS Encompass users                     35,677                21,328             35,677               21,328
Active SaaS Encompass users as a
percentage of active Encompass users                53 %                  41 %               53 %                 41 %
Average users during period:
Active Encompass users                          65,465                50,986             61,266               50,876
Active SaaS Encompass users                     34,267                20,359             30,988               17,922
Active SaaS Encompass users as a
percentage of active Encompass users                52 %                  40 %               51 %                 35 %
Revenue per average user during
period:
Revenue per average active Encompass
user                                               419                   288              1,174                  722
SaaS Encompass revenue per average
active SaaS Encompass user                         391                   250              1,049                  687

Source of Revenues
We generate revenue primarily from transaction-based fees and fees for software and related services. We re-categorized our revenues beginning with the first quarter of 2012 to better align with our strategic plan. Accordingly, our revenues are now described as on-demand and on-premise revenues. Sales taxes assessed by governmental authorities are excluded from revenue. On-demand Revenues
On-demand revenues are revenues generated from software subscriptions we host that customers access through the Internet and revenues from 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 also include software services that are sold transactionally and Ellie Mae Network transaction fees. In general, we recognize revenue for monthly subscription fees, including monthly base fees, on a straight-line basis over the contractual subscription period commencing on the date the services are made available to the customer. Additional amounts arising from closed loans are recognized when the loans close or in the subsequent month when revenue recognition criteria are met. Transaction revenues are recognized when there is evidence that the qualifying transactions have occurred on the Ellie Mae Network and collection of the resulting receivable is reasonably assured. In general, upfront non-refundable fees received at the inception of an arrangement are deferred and recognized over the longer of the contractual term or the estimated customer relationship period.
On-premise Revenues
On-premise revenues are revenues generated from customer-hosted software licenses and related implementation (except for customer-hosted success-based pricing revenues included in on-demand revenues described above), training and maintenance services.
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. Maintenance revenues are recognized ratably over the period of the contract.

Cost of Revenues and Operating Expense
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; allocated facilities costs; customer support; data centers; depreciation on computer equipment used in supporting the Ellie Mae Network, SaaS Encompass and CenterWise offerings; amortization of acquired intangible assets such as developed technology and tradenames; professional services associated with implementation of our software; and allocated facilities costs. We expect that our cost of revenues will continue to increase in absolute dollars as our revenues increase and as we continue to make additional investments in our implementation and customer support departments. Sales and Marketing
Our sales and marketing expenses consist primarily of: salaries, benefits and incentive compensation, including stock-based compensation, and allocated facilities costs; expenses for trade shows, public relations and other promotional and marketing activities, including travel and entertainment expenses; 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 to focus on sales of our solutions to mortgage lenders in light of the increasing percentage of potential customers which are mortgage lenders rather than mortgage brokerages. We also intend to increase marketing activities focused on our SaaS Encompass Banker Edition, our Ellie Mae Network offerings and our other Encompass services.
Research and Development
Our research and development expenses consist primarily of: salaries and benefits, including bonuses and stock-based compensation; fees to contractors engaged in the development and support of the Ellie Mae Network infrastructure, Encompass software and other products; and allocated facilities costs. We expect that our research and development expenses will continue to increase in absolute dollars as we continue to invest in our products and services and infrastructure.
General and Administrative
Our general and administrative expenses consist primarily of: salaries and benefits, including stock-based compensation, for employees involved in finance, accounting, human resources, administrative and legal roles; 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 due to costs associated with being a public company and investing in the growth of our business. Other Income (Expense), Net
Other income (expense), net consists primarily of interest income earned on our cash accounts and notes receivables, net of interest expense paid on imputed interest related to the DMD acquisition holdback payments, and equipment and software leases.
Income Taxes
On a quarterly basis, we evaluate our expected income tax expense or benefit based on our year-to-date operations, and we record an adjustment in the current quarter. The net tax provision is the result of the mix of profits earned by us and our subsidiaries in tax jurisdictions with a broad range of income tax rates. We are required to estimate deferred tax assets and liabilities based on the differences between the financial reporting and tax bases of assets and liabilities measured using the enacted tax rates that will be in effect when the differences are expected to reverse. In general, deferred tax assets represent future tax benefits to be received when certain expenses previously recognized in our consolidated statements of operations become deductible expenses under applicable income tax laws or loss or credit carry forwards are utilized. Accordingly, realization of our deferred tax assets is dependent on future taxable income against which these deductions, losses and credits can be utilized. We use management judgment to assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not more likely than not, we must establish a valuation allowance to reduce the deferred tax assets to the amount that is more likely than not to be realized.

Critical Accounting Policies and Estimates There have been no material changes during the three and nine months ended September 30, 2012 to our critical accounting policies and estimates previously disclosed in our 2011 Form 10-K.

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 September 30,          Nine months ended September 30,
                                              2012                 2011                2012                 2011
                                                                       (in thousands)
Revenues                               $        27,456       $        14,673     $       71,931       $       36,740
Cost of revenues (1)                             6,049                 4,045             16,589               10,920
Gross profit                                    21,407                10,628             55,342               25,820
Operating expenses:
Sales and marketing (1)                          4,347                 3,047             12,579                7,995
Research and development (1)                     4,756                 3,452             13,188                8,862
General and administrative (1)                   6,023                 3,376             14,195                9,103
Total operating expenses                        15,126                 9,875             39,962               25,960
Income (loss) from operations                    6,281                   753             15,380                 (140 )
Other income (expense), net                         23                    16                (15 )                 95
Income (loss) before income taxes                6,304                   769             15,365                  (45 )
Income tax benefit                                (525 )              (1,895 )             (105 )             (1,870 )
Net income                             $         6,829       $         2,664     $       15,470       $        1,825


________
(1) Stock-based compensation included in the above line items:
                                       Three months ended September
                                                    30,                 Nine months ended September 30,
                                            2012            2011              2012              2011
                                                                (in thousands)
Cost of revenues                       $         80     $       22     $            170     $       59
Sales and marketing                              85             23                  256            132
Research and development                        532             98                  915            246
General and administrative                    1,551            233                2,302            696
                                       $      2,248     $      376     $          3,643     $    1,133



                                          Three months ended September 30,       Nine months ended September 30,
                                              2012                 2011              2012                 2011
Revenues                                      100.0  %              100.0  %         100.0  %              100.0  %
Cost of revenues                                 22                  27.6             23.1                  29.7
Gross margin                                   78.0                  72.4             76.9                  70.3
Operating expenses:
Sales and marketing                            15.8                  20.8             17.5                  21.8
. . .