10-Q 1 form10q.htm PROSPER MARKETPLACE, INC 10-Q 3-31-2013 form10q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 


FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2013
 
 
Commission
File Number
 
Exact Name of Registrant as Specified in its Charter,
State or Other Jurisdiction of Incorporation,
Address of Principal Executive Offices, Zip Code
and Telephone Number (Including Area Code)
 
I.R.S. Employer
Identification Number
     
333-147019,
333-182599, and
333-179941-01
 
PROSPER MARKETPLACE, INC.
a Delaware corporation
111 Sutter Street, 22nd Floor
San Francisco, CA 94104
Telephone: (415)593-5400
 
73-1733867
     
333-179941
 
PROSPER FUNDING LLC
a Delaware limited liability company
111 Sutter Street, 22nd Floor
San Francisco, CA 94104
Telephone: (415)593-5479
 
45-4526070
 
Indicate by check mark whether each 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 and (2) has been subject to such filing requirements for the past 90 days.
 
Prosper Marketplace, Inc.
Yes x No ¨
Prosper Funding LLC
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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
Prosper Marketplace, Inc.
Yes x No ¨
Prosper Funding LLC
Yes x No ¨
 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
 
Large
Accelerated
Filer
 
Accelerated
Filer
 
Non-
Accelerated
Filer
 
Smaller
Reporting
Company
         
Prosper Marketplace, Inc.
¨
 
¨
 
¨
 
x
         
Prosper Funding LLC
¨
 
¨
 
¨
 
x
         
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
Prosper Marketplace, Inc.
Yes ¨ No x
Prosper Funding LLC
Yes ¨ No x
 


 
 

 
 
Prosper Funding LLC meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is therefore filing this Form 10-Q with the reduced disclosure format specified in General Instruction H(2) of Form 10-Q.
 
 
Registrant
 
 
Number of Shares of Common
Stock of the Registrant
Outstanding at  May 6, 2013
Prosper Marketplace, Inc.
 
65,362,852
($.001 par value)
Prosper Funding LLC
 
None
 
THIS COMBINED FORM 10-Q IS SEPARATELY FILED BY PROSPER MARKETPLACE, INC AND PROSPER FUNDING LLC.  INFORMATION CONTAINED HEREIN RELATING TO ANY INDIVIDUAL REGISTRANT IS FILED BY SUCH REGISTRANT ON ITS OWN BEHALF. EACH REGISTRANT MAKES NO REPRESENTATION AS TO INFORMATION RELATING TO THE OTHER REGISTRANT.
 
 
 

 
 
 
 
Page No.
i
1
 
Prosper Marketplace, Inc.
 
1
2
3
4
5
Prosper Funding LLC
 
20
21
22
23
30
50
50
PART II. OTHER INFORMATION
 
Item 1.    Legal Proceedings
52
Item 1A. Risk Factors
52
52
52
52
Item 5.    Other Information
52
Item 6.    Exhibits
52
53
54
 
 
 
This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). Forward-looking statements include all statements that do not relate solely to historical or current facts, and can generally be identified by the use of words such as “may,” “believe,” “will,” “expect,” “project,” “estimate,” “intend,” “anticipate,” “plan,” “continue” or similar expressions. In particular, information appearing under “Business,” “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” includes forward-looking statements. Forward-looking statements inherently involve many risks and uncertainties that could cause actual results to differ materially from those projected in these statements. Where, in any forward-looking statement, Prosper Funding LLC (“Prosper Funding”) or Prosper Marketplace, Inc. (“PMI” and, collectively with Prosper Funding, the “Registrants”) expresses an expectation or belief as to future results or events, such expectation or belief is based on the current plans and expectations of Prosper Funding and PMI’s respective managements, expressed in good faith and is believed to have a reasonable basis.  Nevertheless, there can be no assurance that the expectation or belief will result or be achieved or accomplished. The following include some but not all of the factors that could cause actual results or events to differ materially from those anticipated:
 
 
·
the performance of the Borrower Payment Dependent Notes or “Notes”, which, in addition to being speculative investments, are special, limited obligations that are not secured, guaranteed or insured;

 
·
Prosper Funding’s ability to make payments on the Notes, including in the event that borrowers fail to make payments on the corresponding loans;

 
·
the reliability of the information about borrowers that is supplied by borrowers;

 
·
Prosper Funding and PMI’s ability to service the loans, and their ability or the ability of a third party debt collector to pursue collection against any borrower, including in the event of fraud or identity theft;

 
·
credit risks posed by the credit worthiness of borrowers, the lack of a maximum debt-to-income ratio for borrowers, and the effectiveness of the registrants’ credit rating systems;

 
·
actions by some borrowers to defraud lender members and risks associated with identity theft;

 
·
Prosper Funding and PMI’s limited operational history and lack of significant historical performance data about borrower performance;

 
·
the impact of current economic conditions on the performance of the Notes and loss rates of the Notes;

 
·
payments by borrowers on the loans in light of the facts that the loans do not impose restrictions on borrower and do not include cross-default provisions;

 
·
Prosper Funding and PMI’s compliance with applicable local, state and federal law, including the Investment Advisers Act of 1940, the Investment Company Act of 1940 and other laws;

 
·
potential efforts by state regulators or litigants to characterize Prosper Funding or PMI, rather than WebBank, as the lender of the loans originated through the platform;

 
·
the application of federal and state bankruptcy and insolvency laws to borrowers and to Prosper Funding and PMI;

 
·
the impact of borrower delinquencies, defaults and prepayments on the returns on the Notes;

 
·
the lack of a public trading market for the Notes and any inability to resell the Notes on the Note Trader platform;

 
·
the federal income tax treatment of an investment in the Notes and the PMI Management Rights;

 
·
Prosper Funding and PMI’s ability to prevent security breaches, disruptions in service, and comparable events that could compromise the personal and confidential information held on their data systems, reduce the attractiveness of the platform or adversely impact their ability to service loans;
 
 
 
·
the resolution of pending litigation involving PMI, including any state or federal securities litigation; and

 
·
Prosper Funding’s ability to compete successfully in the peer-to-peer and consumer lending industry.
 
There may be other factors that may cause actual results to differ materially from the forward-looking statements in this Quarterly Report on Form 10-Q.  Prosper Funding and PMI can give no assurances that any of the events anticipated by the forward-looking statements will occur or, if any of them does, what impact they will have on Prosper Funding or PMI’s results of operations and financial condition. You should carefully read the factors described in the “Risk Factors” section of our Annual Report on Form 10-K for a description of certain risks that could, among other things, cause Prosper Funding and PMI’s actual results to differ from these forward-looking statements.

All forward-looking statements speak only as of the date of this Quarterly Report on Form 10-Q and are expressly qualified in their entirety by the cautionary statements included in this Quarterly Report on Form 10-Q. Prosper Funding and PMI undertake no obligation to update or revise forward-looking statements that may be made to reflect events or circumstances that arise after the date made or to reflect the occurrence of unanticipated events, other than as required by law.

WHERE YOU CAN FIND MORE INFORMATION
 
We file annual, quarterly and current reports and other information with the SEC. You can inspect, read and copy these reports and other information at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You can obtain information regarding the operation of the SEC’s Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website at www.sec.gov that makes available reports, proxy statements and other information regarding issuers that file electronically.
 
 
Item 1. Consolidated Financial Statements
Prosper Marketplace, Inc.

   
March 31,
   
December 31,
 
   
2013
   
2012
 
   
(Unaudited)
   
(Note 2)
 
Assets
 
 
   
 
 
Cash and Cash Equivalents
  $ 17,318,152     $ 2,300,073  
Restricted Cash
    5,809,918       5,949,311  
Short Term Investments
    -       999,895  
Receivables
    395,539       91,900  
Loans Held for Investment at Fair Value
    189,710       175,471  
Borrower Loans Receivable at Fair Value
    176,943,953       166,899,587  
Property and Equipment, net
    1,820,495       1,529,992  
Prepaid and Other Assets
    689,386       376,207  
Total Assets
  $ 203,167,153     $ 178,322,436  
                 
Liabilities and Stockholders' Equity
               
Liabilities
               
Accounts Payable
  $ 1,418,134     $ 1,787,520  
Accrued Liabilities
    2,168,306       2,978,676  
Borrower Payment Dependent Notes at Fair Value
    177,577,514       167,477,941  
Repurchase and Indemnification Obligation
    139,600       40,900  
Total Liabilities
    181,303,554       172,285,037  
                 
Commitments and contingencies (see Note 10)
               
                 
Stockholders' Equity
               
Convertible preferred stock – Series A ($0.001 par value; 4,023,999 shares authorized, issued and outstanding as of December 31, 2012)
    -       4,024  
Convertible preferred stock – Series B ($0.001 par value; 3,310,382 shares authorized, issued and outstanding as of December 31, 2012)
    -       3,310  
Convertible preferred stock – Series C ($0.001 par value; 2,063,558 shares authorized, issued and outstanding as of December 31, 2012)
    -       2,064  
Convertible preferred stock – Series D ($0.001 par value; 20,340,705 shares authorized, issued and outstanding as of December 31, 2012)
    -       20,341  
Convertible preferred stock – Series E ($0.001 par value; 23,222,747 shares authorized, issued and outstanding as of December 31, 2012)
    -       23,223  
Convertible preferred stock – Series E-1 ($0.001 par value; 10,000,000 shares authorized, issued and outstanding as of December 31, 2012)
    -       10,000  
Convertible preferred stock – Series F ($0.001 par value; 8,996,739 shares authorized, issued and outstanding as of December 31, 2012)
    -       8,997  
Convertible preferred stock – Series A '13 ($0.001 par value; 138,681,680 shares authorized, issued and outstanding as of March 31, 2013)
    138,682       -  
Convertible preferred stock – Series A-1 '13 ($0.001 par value; 51,171,951 shares authorized, issued and outstanding as of March 31, 2013)
    51,172       -  
Common stock ($0.001 par value; 277,363,460 shares authorized; 65,354,552 issued and outstanding as of March 31, 2013; and $0.001 par value; 82,630,003 shares authorized; 3,006,745 issued and outstanding as of December 31, 2012)
    67,177       4,829  
Additional Paid in Capital
    102,995,854       83,150,447  
Less Treasury Stock
    (291,046 )     (291,046 )
Accumulated Deficit
    (81,098,240 )     (76,898,790 )
Total Stockholders' Equity
    21,863,599       6,037,399  
                 
Total Liabilities and Stockholders' Equity
  $ 203,167,153     $ 178,322,436  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
Prosper Marketplace, Inc.
(Unaudited)

   
Three months ended March 31,
 
   
2013
   
2012
 
   
 
   
 
 
Revenues
 
 
   
 
 
Interest income on Borrower Loans
  $ 7,732,209     $ 4,630,326  
Origination Fees
    1,571,108       1,382,455  
Interest Income on PMI Borrower Loans and PMI Notes, net
    (7,325,438 )     (4,403,143 )
Rebates and Promotions
    (274,390 )     (284,366 )
Total Revenues
    1,703,489       1,325,272  
                 
Cost of Revenues
               
Cost of Services
    (482,459 )     (335,635 )
Provision for Loan and Note Repurchases
    (127,079 )     (3,433 )
Net revenues
    1,093,951       986,204  
                 
Operating Expenses
               
Compensation and Benefits
    2,505,217       2,456,804  
Marketing and Advertising
    1,571,965       1,274,526  
Depreciation and Amortization
    206,375       158,296  
General and Administrative
               
Professional Services
    687,987       993,944  
Facilities and Maintenance
    311,904       323,878  
Other
    327,133       469,244  
Total Expenses
    5,610,581       5,676,692  
Loss Before Other Income and Expenses
    (4,516,630 )     (4,690,488 )
                 
Other Income and Expenses
               
Interest Income
    125       (360 )
Change in Fair Value on Borrower Loans, Loans Held for Investment and PMI Notes, net
    175,833       279,124  
Loss on Impairment of Fixed Assets
    (1,195 )     -  
Other Income
    142,417       47,518  
Total Other Income and Expenses, net
    317,180       326,282  
                 
Loss Before Income Taxes
    (4,199,450 )     (4,364,206 )
Provision For Income Taxes
    -       -  
Total Net Loss
  $ (4,199,450 )   $ (4,364,206 )
                 
Net loss per share - basic and diluted   $ (0.08 )   $ (1.51
Weighted average shares - basic and diluted net loss per share   $ 54,808,499     $ 2,887,581  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
Prosper Marketplace, Inc.

   
Preferred Stock
   
Common Stock
   
Treasury Stock
                   
   
Shares
   
Amount
   
Shares
   
Amount
   
Shares
   
Amount
   
Additional Paid-In Capital
   
Accumulated Deficit
   
Total
 
                                                       
Balance as of January 1, 2012
    71,958,130     $ 71,959       4,695,499     $ 4,696       (1,822,640 )   $ (291,046 )   $ 82,733,624     $ (60,789,032 )   $ 21,730,201  
                                                                         
Exercise of stock options
    -       -       25,000       25       -       -       2,975       -       3,000  
                                                                         
Issuance of common stock warrants
    -       -       -       -       -       -       1,923       -       1,923  
                                                                         
Compensation expense
    -       -       -       -       -       -       80,652       -       80,652  
                                                                         
Net loss
    -       -       -       -       -       -       -       (4,364,206 )     (4,364,206 )
                                                                         
Balance as of March 31, 2012 (unaudited)
    71,958,130     $ 71,959       4,720,499     $ 4,721       (1,822,640 )   $ (291,046 )   $ 82,819,174     $ (65,153,238 )   $ 17,451,570  
                                                                         
                                                                         
Balance as of January 1, 2013
    71,958,130     $ 71,959       4,829,385     $ 4,829       (1,822,640 )   $ (291,046 )   $ 83,150,447     $ (76,898,790 )   $ 6,037,399  
                                                                         
Issuance of convertible preferred stock, Series A'13
    138,681,680       138,682       -       -       -       -       19,810,146       -       19,948,828  
Issuance cost of convertible preferred stock, Series A'13
                                              (100,857 )             (100,857 )
Issuance of convertible preferred stock, Series A-1'13
    51,171,951       51,172       -       -       -       -       -       -       51,172  
                                                                         
Conversion of Preferred Series A-F
    (71,958,130 )     (71,959 )     61,912,702       61,913       -       -       10,046       -       -  
                                                                         
Exercise of stock options
    -       -       426,905       427       -       -       72,713       -       73,140  
                                                                         
Exercise of common stock warrants
    -       -       8,200       8       -       -       74       -       82  
                                                                         
Compensation expense
    -       -       -       -       -       -       53,285       -       53,285  
                                                                         
Net loss
    -       -       -       -       -       -       -       (4,199,450 )     (4,199,450 )
                                                                         
Balance as of March 31, 2013 (unaudited)
    189,853,631     $ 189,854       67,177,192     $ 67,177       (1,822,640 )   $ (291,046 )   $ 102,995,854     $ (81,098,240 )   $ 21,863,599  
                                                                         

The accompanying notes are an integral part of these consolidated financial statements.
 
 
Prosper Marketplace, Inc.
(Unaudited)
 
   
For the three months ended March 31,
 
   
2013
   
2012
 
Cash flows from operating activities:
 
 
   
 
 
Net loss
  $ (4,199,450 )   $ (4,364,206 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Change in fair value of Borrower Payment Dependent Notes
    287,993       935,267  
Depreciation and amortization
    206,375       158,296  
Loss on disposal of fixed assets
    1,195        
Stock-based compensation expense
    53,285       82,574  
Provision for loan and Note repurchases
    98,700       6,832  
Change in fair value of Loans held for investment
    (2,327 )     3,076  
Change in fair value of Borrower Loans
    (461,499 )     (1,217,466 )
Changes in operating assets and liabilities:
               
Restricted cash
    139,393       (297,603 )
Receivables
    (303,639 )     (12,943 )
Prepaid and other assets
    (313,179 )     73,512  
Accounts payable and accrued liabilities
    (1,179,756 )     533,690  
Net cash used in operating activities
    (5,672,909 )     (4,098,971 )
                 
Cash flows from investing activities:
               
Origination of Borrower Loans held at fair value
    (33,942,504 )     (33,064,181 )
Repayment of Borrower Loans held at fair value
    24,359,637       12,891,294  
Maturities of short term investments
    999,895       2,000,000  
Repayment of Loans held for investment at fair value
    30,562       33,295  
Purchases of property and equipment
    (498,072 )     (163,305 )
Origination of Loans held for investment at fair value
    (42,474 )     (132,802 )
Purchases of short term investments
          (2,996,990 )
Net cash used in investing activities
    (9,092,956 )     (21,432,689 )
                 
Cash flows from financing activities:
               
Proceeds from issuance of convertible preferred stock
    20,000,000        
Proceeds from issuance of Notes held at fair value
    33,942,504       33,064,181  
Payment of Notes held at fair value
    (24,130,924 )     (12,666,887 )
Proceeds from issuance of common stock
    73,222       3,000  
Issuance costs of convertible preferred stock
    (100,857 )      
Net cash provided by financing activities
    29,783,945       20,400,294  
                 
Net increase (decrease) in cash and cash equivalents
    15,018,079       (5,131,366 )
Cash and cash equivalents at beginning of the period
    2,300,073       9,216,133  
Cash and cash equivalents at end of the period
  $ 17,318,152     $ 4,084,767  

The accompanying notes are an integral part of these consolidated financial statements.
 
 
Prosper Marketplace, Inc.
(Unaudited)

1.
Organization and Business
 
Prosper Marketplace, Inc. (“PMI”) was incorporated in the state of Delaware on March 22, 2005. PMI developed and operated a peer-to-peer online credit platform (the “platform”) that permitted its borrower members to apply for loans (“PMI Borrower Loans”) and lender members to purchase notes issued by PMI (“PMI Notes”), the proceeds of which facilitated the funding of specific loans to borrowers. On February 1, 2013, PMI transferred ownership of the platform, including all of the rights related to the operation of the platform, to its wholly-owned subsidiary, Prosper Funding LLC (“Prosper Funding” and, collectively with PMI, the “PMI Group”). Since February 1, 2013, all notes (the “Notes” and, together with PMI Notes, the “PMI Group Notes”) issued and sold through the platform are issued and sold by Prosper Funding.  Pursuant to a Loan Account Program Agreement between PMI and WebBank, PMI manages the operation of the platform, as agent of WebBank, in connection with the submission of loan applications by potential borrowers, the making of related loans by WebBank and the funding of such loans by WebBank. Pursuant to an Administration Agreement between Prosper Funding and PMI, PMI manages all other aspects of the platform on behalf of Prosper Funding.

The platform enables borrower members to request and obtain personal, unsecured loans by posting anonymous “listings” on the platform indicating the principal amount of the desired loan. Loan terms are subject to minimum and maximum loan amounts determined by the borrower’s credit bureau score and Prosper score, at interest rates set by PMI. PMI sets the interest rates for borrower loans based on Prosper Ratings, as well as additional factors, such as estimated loss rate, loan terms, general economic environment, previous Prosper loans and competitive conditions. As of March 31, 2013, borrowers could create loan listings from $2,000 up to $25,000.

All loans requested and obtained through the platform are unsecured obligations of individual borrower members with a fixed interest rate and loan terms set at one, three and five years as of March 31, 2013. All loans made through the platform are funded by WebBank, an FDIC-insured, Utah chartered industrial bank. Prior to February 1, 2013, after funding a loan, WebBank assigned the loan to PMI, without recourse to WebBank, in exchange for the principal amount of the loan. Since February 1, 2013, after funding a loan, WebBank assigns the loan to Prosper Funding, without recourse to WebBank, in exchange for the principal amount of the loan.  WebBank does not have any obligation to purchasers of the PMI Notes or the Notes.

As reflected in the accompanying consolidated financial statements, the PMI Group has incurred net losses and negative cash flows from operations since inception, and has an accumulated deficit of approximately $81.1 million as of March 31, 2013.  At March 31, 2013, the PMI Group had approximately $17.3 million in cash and cash equivalents on its consolidated balance sheet. Since its inception, the PMI Group has financed its operations primarily through equity financing from various sources and is dependent upon raising additional capital or debt financing to fund its current operating plan.  Failure to obtain sufficient debt and equity financings and, ultimately, to achieve profitable operations and positive cash flows from operations could adversely affect the PMI Group’s ability to achieve its business objectives and continue as a going concern.  Further, there can be no assurances as to the availability or terms upon which the required financing and capital might be available.  On January 15, 2013, PMI entered into a Stock Purchase Agreement (the “Purchase Agreement”) with certain new investors and certain of its existing investors (each, a “Share Purchaser” and, collectively, the “Share Purchasers”), pursuant to which PMI issued and sold to such Share Purchasers (either directly or through certain of their respective affiliates) 138,681,680 shares of PMI’s Series A Preferred Stock (the “Shares”) for an aggregate purchase price of $20 million.  See Note 7 for additional information.
 
2.
Summary of Significant Accounting Policies

 Basis of Presentation
 
The Company’s unaudited interim consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (US GAAP) and disclosure requirements for interim financial information and the requirements of Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by US GAAP for complete financial statements. The unaudited interim consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2012. The balance sheet at December 31, 2012 has been derived from the audited financial statements at that date. Management believes these unaudited interim consolidated financial statements reflect all adjustments, including those of a normal recurring nature, which are necessary for a fair presentation of the results for the interim periods presented. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year of any other interim period.
 
The accompanying consolidated financial statements include the accounts of PMI and its wholly owned subsidiary Prosper Funding. All intercompany balances and transactions between Prosper Funding and PMI have been eliminated in consolidation. Prosper Funding and PMI's financial statements have been prepared in accordance with U.S. generally accepted accounting principles.
 
 
Use of Estimates
 
The preparation of the PMI Group’s consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and the related disclosures at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. These estimates, judgments and assumptions include but are not limited to the following: valuation of borrower loans receivable and associated member payment dependent notes, valuation of servicing rights, valuation allowance on deferred tax assets, valuation and amortization periods of intangible assets, repurchase obligation, stock-based compensation expense, and contingent liabilities. The PMI Group bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances. Actual results could differ from those estimates.

Certain Risks and Concentrations

In the normal course of its business, the PMI Group encounters two significant types of risk: credit and regulatory. Financial instruments that potentially subject the PMI Group to significant concentrations of credit risk consist primarily of cash, cash equivalents, restricted cash and short term investments. The PMI Group places cash, cash equivalents, restricted cash and short term investments with high-quality financial institutions and is exposed to credit risk in the event of default by these institutions to the extent the amount recorded on the balance sheet exceeds federally insured amounts. The PMI Group also performs periodic evaluations of the relative credit standing of these financial institutions and has not sustained any credit losses from instruments held at these financial institutions.
 
Prior to February 1, 2013, PMI Borrower Loans originated by PMI were carried on its consolidated balance sheet.  The PMI Borrower Loans were funded by the PMI Notes and repayment of the PMI Notes is wholly dependent on the repayment of the PMI Borrower Loans associated with a PMI Note.  As a result, PMI did not bear the risk associated with the repayment of principal on loans carried on its consolidated balance sheet.  A decrease in the value of the PMI Borrower Loans carried on PMI's balance sheet associated with increased credit risk was directly offset by a reduction in the value of the PMI Notes issued in association with the PMI Borrower Loans. However, PMI charged a servicing fee that was deducted from loan payments.  To the extent that loan payments were not made, PMI’s servicing income was reduced.  On January 22, 2013, PMI entered into an Asset Transfer Agreement with Prosper Funding (the “Asset Transfer Agreement”), pursuant to which PMI transferred substantially all of its remaining assets to Prosper Funding, including (i) all outstanding PMI Notes issued by PMI under the Indenture dated June 15, 2009 (the “Indenture”) between PMI and Wells Fargo Bank, as trustee (the “Trustee”), (ii) all PMI Borrower Loans, (iii) all lender/borrower/group leader registration agreements related to the PMI Notes or the PMI Borrower Loans, and (iv) all documents and information related to the foregoing, effective February 1, 2013.

The PMI Group is subject to various regulatory requirements. The failure to appropriately identify and address these regulatory requirements could result in certain discretionary actions by regulators that could have a material effect on PMI's consolidated financial position and results of operations (See Note 10—Commitments and Contingencies—Securities Law Compliance).

Cash and Cash Equivalents

The PMI Group invests its excess cash primarily in highly liquid debt instruments of the U.S. government and its agencies. All highly liquid investments with stated maturities of three months or less from date of purchase are classified as cash equivalents. Cash equivalents are recorded at cost, which approximates fair value. Such deposits periodically exceed amounts insured by the FDIC.

Restricted Cash
 
Restricted cash consists primarily of cash deposits required to support the PMI Group’s ACH activities and secured corporate credit cards.
 
 Short Term Investments

The PMI Group's short term investments consist of highly liquid debt instruments of the U.S. government and its agencies with maturity periods greater than three months and less than 12 months.
 
 
Borrower Loans and Borrower Payment Dependent Notes

Prior to February 1, 2013, PMI issued PMI Notes and purchased PMI Borrower Loans from WebBank, and held the PMI Borrower Loans until maturity.  PMI's obligation to repay the PMI Notes was conditioned upon the repayment of the associated PMI Borrower Loans owned by PMI.   The PMI Borrower Loans and the PMI Notes were carried on PMI's balance sheets as assets and liabilities, respectively, until February 1, 2013, when such PMI Borrower Loans and PMI Notes were transferred to Prosper Funding pursuant to the Asset Transfer Agreement.  In conjunction with PMI's prior operating structure, Prosper Funding has adopted the provisions of ASC Topic 825, Financial Instruments.  ASC Topic 825 permits companies to choose to measure certain financial instruments and certain other items at fair value on an instrument-by-instrument basis with unrealized gains and losses on items for which the fair value option has been elected reported in earnings.  The fair value election, with respect to an item, may not be revoked once an election is made.  In applying the provisions of ASC Topic 825, the PMI Group has recorded assets and liabilities measured using the fair value option in a way that separates these reported fair values from the carrying values of similar assets and liabilities measured with a different measurement attribute.  The PMI Group does not record a specific allowance account related to the Borrower Loans and PMI Borrower Loans (collectively, the “PMI Group Borrower Loans”) and PMI Group Notes in which it has elected the fair value option, but rather estimates the fair value of such PMI Group Borrower Loans and PMI Group Notes using discounted cash flow methodologies adjusted for the PMI Group’s historical payment, loss and recovery rates. An account is considered to be a loss, or charged-off, when it reaches more than 120 days past due.  The PMI Group has reported the aggregate fair value of the PMI Group Borrower Loans and PMI Group Notes as separate line items in the assets and liabilities sections of the accompanying balance sheets using the methods described in ASC Topic 820, Fair Value Measurements and Disclosures—See Fair Value Measurement.
 
 Property and Equipment
 
Property and equipment consists of computer equipment, office furniture and equipment, and software purchased or developed for internal use. Property and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method based upon estimated useful lives of the assets, which range from three to seven years. The PMI Group capitalizes expenditures for replacements and betterments and recognizes as expenses amounts for maintenance and repairs as incurred.  Depreciation and amortization commences once the asset is placed in service.
 
Internal Use Software and Website Development

The PMI Group accounts for internal use software costs, including website development costs, in accordance with ASC Topic 350-40, Internal Use Software and ASC Topic 350-50, Website Development Costs. In accordance with ASC Topic 350-40 and 350-50, the costs to develop software for the PMI Group’s website and other internal uses are capitalized when management has authorized and committed project funding, preliminary development efforts are successfully completed, and it is probable that the project will be completed and the software will be used as intended. Capitalized software development costs primarily include software licenses acquired, fees paid to outside consultants, and salaries and payroll related costs for employees directly involved in the development efforts.

Costs incurred prior to meeting these criteria, together with costs incurred for training and maintenance, are expensed. Costs incurred for upgrades and enhancements that are considered to be probable to result in additional functionality are capitalized. Capitalized costs are included in property and equipment and amortized to expense using the straight-line method over their expected lives. The PMI Group evaluates its software assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable.  Recoverability of software assets to be held and used is measured by a comparison of the carrying amount of the asset to the future net undiscounted cash flows expected to be generated by the asset.  If such software assets are considered to be impaired, the impairment to be recognized is the excess of the carrying amount over the fair value of the software asset.

Repurchase and Indemnification Obligation

The PMI Group is obligated to indemnify lenders and repurchase certain PMI Group Notes sold to the lenders in the event of violation of applicable federal, state, or local lending laws, or verifiable identify theft. The loan indemnification and repurchase obligation is estimated based on historical experience. The PMI Group accrues a provision for the repurchase and indemnification obligation when the PMI Group Notes are issued. Indemnified or repurchased PMI Group Notes associated with federal, state, or local lending laws, or verifiable identity thefts are written off at the time of repurchase or at the time an indemnification payment is made.
 
 
Revenue Recognition

The PMI Group recognizes revenue in accordance with ASC Topic 605, Revenue Recognition. Under ASC Topic 605, The PMI Group recognizes revenue when persuasive evidence of an arrangement exists, services have been rendered, the price of the services is fixed and determinable, and collectability is reasonably assured.

Origination fees

Borrowers pay an origination fee upon the successful closing of a loan. The PMI Group deducts and retains the origination fee from the loan amount prior to disbursing the net amount to the borrower member. The loan origination fee is determined by the term and credit grade of the loan, and ranges from 0.50% to 4.95% of the original principal amount. Since the PMI Group accounts for PMI Group Borrower Loans, loans held for investment and PMI Group Notes at fair value, origination fees are not deferred but are recognized at origination of the loan, and direct costs to originate loans are recorded as expenses as incurred.

Loan servicing fees

Loan servicing revenue included monthly loan servicing fees and non-sufficient funds (“NSF”) fees. Loan servicing fees are accrued daily based on the current outstanding loan principal balance of the PMI Group Borrower Loan but are not recognized until payment was received due to the uncertainty of collection of borrower loan payments. The PMI Group charges a NSF fee to borrowers on the first failed payment of each billing period.  NSF fees were charged to the customer and collected and recognized immediately.

Interest income (expense) on PMI Group Borrower Loans receivable and PMI Group Notes

The PMI Group recognizes interest income on PMI Group Borrower Loans using the accrual method based on the stated interest rate to the extent that is believed it to be collectable.  The PMI Group records interest expense on the corresponding PMI Group Notes based on the contractual interest rate. Gross interest income earned and gross interest expense incurred were $7,732,000 and $7,325,000, respectively for the three months ended March 31, 2013. Gross interest income earned and gross interest expense incurred were $4,630,000 and $4,403,000, respectively for the three months ended March 31, 2012.
 
 Marketing and Advertising Expense
 
Under the provisions of ASC Topic 720, Other Expenses, the costs of advertising are expensed as incurred. Advertising costs were approximately $1,572,000 and $1,275,000 for the three months ended March 31, 2013 and 2012, respectively.
 
 Rebate and Promotional Expenses
 
The PMI Group accounts for rebates and promotions in accordance with ASC Topic 605, Revenue Recognition.  From time to time rebates and promotions are offered to borrower and lender members.  The PMI Group records these rebates and promotions as an offset to revenue if a particular rebate or promotion is earned upon the origination of the loan. The PMI Group's rebate and promotions have in the past been in the form of cash back and other incentives paid to lender and borrowers.

Stock-Based Compensation

The PMI Group accounts for its stock-based compensation for employees using fair-value-based accounting in accordance with ASC Topic 718, Stock Compensation.  ASC Topic 718 requires companies to estimate the fair value of stock-based awards on the date of grant using an option-pricing model. The stock-based compensation related to awards that are expected to vest is amortized using the straight line method over the vesting term of the stock-based award, which is generally four years. Expected forfeitures of unvested options are estimated at the time of grant and reduce the recognized stock-based compensation expense. The PMI Group estimated its annual forfeiture rate to be 20.1% and 23.8% for the three months ended March 31, 2013 and 2012, respectively.

The PMI Group has granted options to purchase shares of common stock to nonemployees in exchange for services performed which it accounts for in accordance with the provisions of ASC Topic 505-50, Equity-Based Payments to Non-Employees. Because ASC 505 requires that nonemployee equity awards be recorded at their fair value, the PMI Group uses the Black-Scholes model to estimate the fair value of options granted to nonemployees at each vesting date until performance is complete to determine the appropriate charge for the services provided. The volatility of the PMI Group’s common stock was based on comparative company volatility.
 
 Net Loss Per Share
 
The PMI Group computes net loss per share in accordance with ASC Topic 260 Earnings Per Share. Under ASC Topic 260, basic net loss per share is computed by dividing net loss per share available to common shareholders by the weighted average number of common shares outstanding for the period and excludes the effects of any potentially dilutive securities. Diluted earnings per share, if presented, would include the dilution that would occur upon the exercise or conversion of all potentially dilutive securities into common stock using the “treasury stock” and/or “if converted” methods as applicable. At March 31, 2013, there were outstanding convertible preferred stock, warrants and options convertible into 138,681,720, 2,187,969 and 9,196,703 common shares, respectively, which may dilute future earnings per share. As the PMI Group’s reporting a net loss for the three months ended March 31, 2013 and 2012, potentially dilutive securities are excluded from the computation of net loss per share, as their effect would be antidilutive.
 

Income Taxes

The PMI Group uses the asset and liability method to account for income taxes as codified in ASC Topic 740, Income Taxes. Under this method, deferred income tax assets and liabilities are based on the differences between the financial statements and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.

Under ASC Topic 740, the PMI Group’s policy to include interest and penalties related to gross unrecognized tax benefits within its provision for income taxes did not change.

Fair Value Measurement

The PMI Group adopted ASC Topic 820, Fair Value Measurements and Disclosures, on January 1, 2008. ASC Topic 820 provides a framework for measuring the fair value of assets and liabilities. ASC Topic 820 also provides guidance regarding a fair value hierarchy, which prioritizes information used to measure fair value and the effect of fair value measurements on earnings and provides for enhanced disclosures determined by the level within the hierarchy of information used in the valuation. ASC Topic 820 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances.

ASC Topic 820 defines fair value in terms of the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

The price used to measure the fair value is not adjusted for transaction costs while the cost basis of certain financial instruments may include initial transaction costs. Under ASC Topic 820, the fair value measurement also assumes that the transaction to sell an asset occurs in the principal market for the asset or, in the absence of a principal market, the most advantageous market for the asset. The principal market is the market in which the reporting entity would sell or transfer the asset with the greatest volume and level of activity for the asset. In determining the principal market for an asset or liability under ASC Topic 820, it is assumed that the reporting entity has access to the market as of the measurement date. If no market for the asset exists or if the reporting entity does not have access to the principal market, the reporting entity should use a hypothetical market.

Under ASC Topic 820, assets and liabilities carried at fair value in the balance sheets are classified among three levels based on the observability of the inputs used to determine fair value:

Level 1 — The valuation is based on quoted prices in active markets for identical instruments.

Level 2 — The valuation is based on observable inputs such as quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3 — The valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the instrument. Level 3 valuations are typically performed using pricing models, discounted cash flow methodologies, or similar techniques, which incorporate management’s own estimates of assumptions that market participants would use in pricing the instrument or valuations that require significant management judgment or estimation.

The PMI Group determines the fair values of its financial instruments based on the fair value hierarchy established in that standard, which requires an entity to maximize the use of quoted prices and observable inputs and to minimize the use of unobservable inputs when measuring fair value. Various valuation techniques are utilized, depending on the nature of the financial instrument, including the use of market prices for identical or similar instruments, or discounted cash flow models. When possible, active and observable market data for identical or similar financial instruments are utilized. Alternatively, fair value is determined using assumptions that management believes a market participant would use in pricing the asset or liability.
 
 
Recent Accounting Pronouncements

There have been no recent accounting pronouncements or changes in accounting pronouncements during the three months ended March 31, 2013 that are of significance, or potential significance to the PMI Group.

3.
PMI Group Borrower Loans and PMI Group Notes Held at Fair Value

The PMI Group’s financial instruments consist principally of cash and cash equivalents, restricted cash, short term investments, borrower loans receivable, accounts payable and accrued liabilities, Borrower Payment Dependent Notes and long-term debt.  The estimated fair values of cash and cash equivalents, restricted cash, accounts payable and accrued liabilities approximate their carrying values because of their short term nature.

The following tables present the assets and liabilities measured at fair value on a recurring basis at March 31, 2013 and December 31, 2012:

March 31, 2013
 
Level 1 Inputs
   
Level 2 Inputs
   
Level 3 Inputs
   
Fair Value
 
Assets
 
 
   
 
   
 
   
 
 
Borrower loans receivable
  $ -     $ -     $ 176,943,953     $ 176,943,953  
Loans held for investment
    -       -       189,710       189,710  
Liabilities
                               
Borrower payment dependent notes
  $ -     $ -     $ 177,577,514     $ 177,577,514  
 
December 31, 2012
 
Level 1 Inputs
   
Level 2 Inputs
   
Level 3 Inputs
   
Fair Value
 
Assets
                               
Short term investments
  $ 999,895     $ -     $ -     $ 999,895  
Borrower loans receivable
    -       -       166,899,587       166,899,587  
Loans held for investment
    -       -       175,471       175,471  
Liabilities
                               
Borrower payment dependent notes
  $ -     $ -     $ 167,477,941     $ 167,477,941  

The PMI Group’s short term investments consist of United States Treasuries with maturity periods greater than three months and less than 12 months.  In general, fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the PMI Group has the ability to access. The PMI Group classifies United States Treasuries as Level 1 assets which it intends to hold until maturity.

As observable market prices are not available for the PMI Group Borrower Loans and PMI Group Notes the PMI Group holds, or for similar assets and liabilities, the PMI Group believes the PMI Group Borrower Loans and PMI Group Notes should be considered Level 3 financial instruments under ASC Topic 820.  In a hypothetical transaction as of the measurement date, the PMI Group believes that differences in the principal marketplace in which the loans are originated and the principal marketplace in which it might offer those loans may result in differences between the originated amount of the loans and their fair value as of the transaction date.  For PMI Group Borrower Loans, the fair value is estimated using discounted cash flow methodologies based upon valuation assumptions including prepayment speeds, roll rates, recovery rates and discount rates based on the perceived credit risk within each credit grade.

The PMI Group's obligation to pay principal and interest on any PMI Group Note is equal to the loan payments, if any, the PMI Group receives on the corresponding PMI Group Borrower Loan, net of its 1.0% servicing fee.  The fair value election for PMI Group Notes and PMI Group Borrower Loans allows both the assets and the related liabilities to receive similar accounting treatment for expected losses which is consistent with the subsequent cash flows to lenders that are dependent upon borrower payments.  As such, the fair value of the PMI Group Notes is approximately equal to the fair value of the PMI Group Borrower Loans, adjusted for the 1.0% servicing fee and the timing of borrower payments subsequently disbursed to PMI Group Note holders.  Any unrealized gains or losses on the PMI Group Borrower Loans and PMI Group Notes for which the fair value option has been elected is recorded as a separate line item in the statement of operations.  The effective interest rate associated with the PMI Group Notes is less than the interest rate earned on the PMI Group Borrower Loans due to the 1.0% servicing fee.  See further in this note for a roll-forward and further discussion of the significant assumptions used to value PMI Group Borrower Loans and PMI Group Notes.
 
 
The PMI Group estimates the fair value of the PMI Group Notes and PMI Group Borrower Loans using discounted cash flow methodologies based upon a set of valuation assumptions. The main assumptions the PMI Group used to value the PMI Group Borrower Loans and PMI Group Notes include prepayment rates derived from historical prepayment rates for each credit score, default rates derived from historical performance, recovery rates and discount rates applied to each credit tranche based on the perceived credit risk of each credit grade. The PMI Group's obligation to pay principal and interest on any PMI Group Note is equal to the loan payments, if any, received on the corresponding PMI Group Borrower Loan, net of the PMI Group's 1.0% servicing fee.  As such, the fair value of the PMI Group Notes is approximately equal to the fair value of the PMI Group Borrower Loans, adjusted for the 1.0% servicing fee and the timing of borrower payments subsequently disbursed to the PMI Group Note holders.  The effective interest rate associated with the PMI Group Notes will be less than the interest rate earned on the PMI Group Borrower Loans due to the 1.0% servicing fee.

For PMI Group Borrower Loans originated and PMI Group Notes, we used the following average assumptions to determine the fair value as of March 31, 2013:
 
Monthly prepayment rate speed
    1.53 %
Recovery rate
    5.52 %
Discount rate *
    9.87 %
 
*
This is the average discount rate among all of the PMI Group's credit grades

The following table presents additional information about PMI Group Borrower Loans and PMI Group Notes measured at fair value on a recurring basis for the period ended March 31, 2013:
 
   
Borrower Loans
 
   
Notes
 
 
Fair value at December 31, 2012
  $ 166,899,587     $ 167,477,941  
Originations
    33,942,504       33,942,504  
Principal repayments
    (24,359,637 )     (24,130,924 )
Unrealized gains or losses included in earnings
    461,499       287,993  
Fair value at March 31, 2013
  $ 176,943,953     $ 177,577,514  

The changes in Level 3 assets measured at fair value on a recurring basis are as follows:
 
Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
 
   
PMI Group
Borrower Loans
   
PMI Group Notes
   
Loans Held for
Investment
   
Total
 
Balance at January 1, 2013
  $ 166,899,587     $ (167,477,941 )   $ 175,471     $ (402,883 )
Originations
    33,942,504       (33,942,504 )     42,474       42,474  
Principal repayments and credit losses
    (24,359,637 )     24,130,924       (30,562 )     (259,275 )
Change in fair value on borrower loans and Payment Dependent Notes
    461,499       (287,993 )     -       173,506  
Change in fair value of loans held for investment
    -       -       2,327       2,327  
Balance at March 31, 2013
  $ 176,943,953     $ (177,577,514 )   $ 189,710     $ (443,851 )
                                 
Balance at January 1, 2012
  $ 75,762,894     $ (76,159,501 )   $ 137,314     $ (259,293 )
Originations
    33,064,181       (33,064,181 )     132,802       132,802  
Principal repayments and credit losses
    (12,891,294 )     12,666,887       (33,295 )     (257,702 )
Change in fair value on borrower loans and Payment Dependent Notes
    1,217,466       (935,267 )     -       282,199  
Change in fair value of loans held for investment
    -       -       (3,076 )     (3,076 )
Balance at March 31, 2012
  $ 97,153,247     $ (97,492,062 )   $ 233,745     $ (105,070 )
 
 
Due to the recent origination of the PMI Group Borrower Loans and PMI Group Notes, the change in fair value attributable to instrument-specific credit risk is immaterial.  The PMI Group had no outstanding PMI Group Borrower Loans or PMI Group Notes originated or issued prior to July 13, 2009.  Of the loans originated from July 13, 2009 to March 31, 2013, the PMI Group had 264 loans which were 90 days or more delinquent for an aggregate principal amount of $1,512,866 and a fair value of $137,066 as of March 31, 2013.

No other assets or other liabilities were carried at fair value as of March 31, 2013 and December 31, 2012.

4.
Loans Held for Investment at Fair Value

As of March 31, 2013, the PMI Group retained a total of $189,710 of PMI Group Borrower Loans originated through the platform. When a borrower member loan has been funded in whole, or in part, by PMI Group, the PMI Group retains the portion of the borrower’s monthly loan payment that corresponds to the percentage of the loan that the PMI Group funded. In these cases, the PMI Group records interest income on these PMI Group Borrower Loans.

Fair Value Measurements Using Significant Unobservable Inputs (Level 3)
 
   
 
 
   
Loans Held for Investment
 
Balance at January 1, 2013
  $ 175,471  
Originations
    42,474  
Principal repayments and credit losses
    (30,562 )
Change in fair value of loans held for investment
    2,327  
Balance at March 31, 2013
  $ 189,710  
         
Balance at January 1, 2012
  $ 137,314  
Originations
    132,802  
Principal repayments
    (33,295 )
Change in fair value of loans held for investment
    (3,076 )
Balance at March 31, 2012
  $ 233,745  
 
Origination fees earned from PMI Group Borrower Loans funded by the PMI Group are initially deferred and subsequently amortized ratably over the term of the PMI Group Borrower Loan and are reported in the statement of operations as Origination fees.

The PMI Group estimates the fair value of the loans held for investment using discounted cash flow methodologies based upon a set of valuation assumptions similar to those of the PMI Group Borrower Loans, which are set forth in Note 3, as they have similar characteristics and the PMI Group expects these loans to behave in a comparable manner.  The valuation assumptions the PMI Group used to value these loans include prepayment rates, default rates and recovery rates derived from historical loan performance data and discount rates based on credit grade applied to each loan.

The fair value adjustment on these loans held for investment was $2,327, which is included in earnings for the three months ended March 31, 2013.  As of March 31, 2013 the PMI Group had received $154,442 in payments on these loans.  As of March 31, 2013, there was $32,124 in loans held for investment that were charged-off.
 
5.
Repurchase and Indemnification Obligation

Changes in the PMI Group Note repurchase and indemnification obligations are summarized below:

Balance at January 1, 2013:
  $ 40,900  
Provision for PMI Group Note repurchases and indemnifications
    98,700  
PMI Group Notes repurchased and immediately charged off or charged off and indemnified (net of recoveries)
    -  
Balance at March 31, 2013:
  $ 139,600  

 
6.
Net Loss Per Share
 
The PMI Group computes net loss per share in accordance with ASC Topic 260. Under ASC Topic 260, basic net loss per share is computed by dividing net loss per share available to common stockholders by the weighted average number of common shares outstanding for the period and excludes the effects of any potentially dilutive securities. Diluted earnings per share, if presented, would include the dilution that would occur upon the exercise or conversion of all potentially dilutive securities into common stock using the “treasury stock” and/or “if converted” methods as applicable.

Basic and diluted loss per share was calculated as follows:

   
Three months ended March 31,
 
   
2013
   
2012
 
Numerator:
 
 
   
 
 
Net loss
  $ (4,199,450 )   $ (4,364,206 )
Denominator:
               
Weighted average shares used in computing basic and diluted net loss per share
    54,808,499       2,887,581  
Basic and diluted net loss per share
  $ (0.08 )   $ (1.51 )

Due to losses attributable to common shareholders for each of the periods below, the following potentially dilutive shares are excluded from the diluted net loss per share calculation because they were anti-dilutive under the treasury stock method, in accordance with ASC Topic 260:
 
   
March 31,
 
   
2013
   
2012
 
Excluded Securities:
 
(shares)
   
(shares)
 
Convertible preferred stock issued and outstanding
    138,681,720       61,958,136  
Stock options issued and outstanding
    9,196,703       12,926,198  
Warrants  issued and outstanding
    2,187,969       2,220,191  
Total common stock equivalents excluded from diluted net loss per common share computation
    150,066,392       77,104,525  

7.
Stockholders’ Equity

Preferred Stock
 
Under PMI's certificate of incorporation, preferred stock is issuable in series, and the Board of Directors is authorized to determine the rights, preferences, and terms of each series.

In January 2013, PMI issued and sold 138,681,680 shares of its Series A preferred stock in a private placement at a purchase price of $0.144 per share for approximately $20 million.  In connection with that sale, PMI issued 51,171,951 shares at par value $0.001 per share of Series A-1 (“Series A-1”) convertible preferred stock to certain previous holders of PMI’s Series A, Series B, Series C, Series D, Series E and Series F Preferred Stock who participated in the sale. Upon issuance of PMI Series A and Series A-1 Preferred Stock, all of PMI’s preferred stock existing prior to such issuance was converted into PMI common stock at a 1:1 ratio if the holder of the preferred stock participated in this offering or at a 10:1 ratio if the holder of the preferred stock did not so participate. These securities were sold in reliance on the exemption from the registration requirements of the Securities Act set forth in Section 4(2) of the Securities Act and Regulation D promulgated thereunder regarding sales by an issuer not involving a public offering.
 
 
Dividends

Dividends on shares of the Series A Preferred Stock are payable only when, as, and if declared by the Board of Directors.  No dividends will be paid with respect to the Common Stock or Series A-1 Preferred Stock until any declared dividends on the Series A Preferred Stock have been paid or set aside for payment to the Series A Preferred Stock holders.  Holders of Series A-1 Preferred Stock are not entitled to receive dividends in preference and priority to, or on a pari passu basis with, the other Preferred Stock or the Common Stock. To date, no dividends have been declared on any of PMI’s Preferred Stock or Common Stock, and there are no dividends in arrears at March 31, 2013.
 
The holders of Series D, Series E and Series F Preferred Stock were entitled to receive an annual dividend per share in an amount equal to 8% times the liquidation preference tor such share, payable in preference and priority to any declaration or payment of any distribution on Common Stock in such calendar year. The right to receive dividends on shares of Series D, Series E and Series F Preferred Stock was cumulative from and after the date of issuance of such shares and were payable only when, as, and if declared by the Board of Directors. Holders of Series E-l Preferred Stock were not entitled to receive dividends in preference and priority to, or on a pari passu basis with, the other Preferred Stock or the Common Stock. Dividends on shares of Series E-l Preferred Stock were payable only when, as, and if declared by the Board of Directors. As of March 31, 2013, all shares of Series D, E, E-l and F were converted to Common Stock in connection with the January 2013 sale of Preferred Stock.

Conversion

On January 15, 2013, PMI entered into an equity financing transaction where shares of PMI’s preferred stock that were outstanding immediately prior to the financing (“Old Preferred Shares”) were converted into shares of PMI common stock. For holders of Old Preferred Shares who participated in the financing in proportion to their pro rata ownership interest in PMI, their Old Preferred Shares converted into common shares at a ratio of 1:1. In addition, each such participating holder received a share of PMI’s new Series A-1 Preferred Stock for every dollar of liquidation preference associated with an Old Preferred Share held by such holder. Each share of Series A-1 Preferred has a liquidation preference of $1.00 and converts into common stock at a ratio of 1,000,000:1.

Under the terms of the Shares, the Share Purchasers have the right to convert the Shares into common stock at any time. In addition, the Shares automatically convert into common stock (i) immediately prior to the closing of an IPO that values Prosper at least at $200 million and that results in aggregate proceeds to Prosper of at least $40 million or (ii) upon a written request from the holders of at least 70% of the voting power of the outstanding preferred stock (on an as-converted basis). In addition, if a holder of the Shares has converted any of the Shares, then all of such holder’s shares of Series A-1 Preferred Stock also will be converted upon a liquidation event. In lieu of any fractional shares of common stock to which a holder would otherwise be entitled, Prosper shall pay such holder cash in an amount equal to the fair market value of such fractional shares, as determined by Prosper’s Board of Directors (the “Board”). At present, the Series A Preferred Stock converts into Prosper common stock at a 1:1 ratio while the Series A-1 converts into Prosper common stock at a 10,000,000:1 ratio.

Liquidation Rights

PMI issued 51,171,951 shares at the par value $0.001 per share of Series A-1 convertible preferred stock (“Series A-1 Preferred Stock”) to certain previous holders of PMI’s preferred stock who participated in the sale. The Series A-1 shares established certain liquidation rights, have no voting rights and are convertible into one share of PMI common stock for every one million shares of Series A-1. PMI allocated the fair value of the shares of Series A-1 Preferred Stock at the par value of $.001 per share from the proceeds of Series A. Upon issuance of PMI Series A and Series A-1 Preferred Stock, all of PMI’s preferred stock existing prior to such issuance was converted into PMI common stock at a 1:1 ratio if the holder of the preferred stock participated in this offering or at a 10:1 ratio if the holder of the preferred stock did not so participate.

Voting
 
Each holder of shares of Preferred Stock shall be entitled to the number of votes equal to the number of shares of Common Stock into which such shares of Preferred Stock could be converted and shall have voting rights and powers equal to the voting rights and powers of the Common Stock (except as otherwise expressly provided herein or as required by law), voting together with the Common Stock as a single class, and shall be entitled to notice of any stockholders’ meeting in accordance with the Bylaws of PMI. The holders of Preferred Stock shall vote as one class with the holder of the Common Stock except with respect to certain matters that require separate votes.

Common Stock
 
PMI, through its certificate of incorporation, is the sole issuer of common stock and related options and warrants. PMI was authorized to issue up to 277,363,460 shares of common stock, $0.001 par value, of which 65,354,552 shares were issued and outstanding as of March 31, 2013 and 82,630,003 shares of common stock, $0.001 par value, of which 3,006,745 shares were issued and outstanding as of December 31, 2012.  Each holder of common stock shall be entitled to one vote for each share of common stock held.

Common Stock Issued for Services

Nonemployees

PMI did not grant any immediately vested common shares to nonemployees for services during the three months ended March 31, 2013 and 2012.

 
Common Stock Issued upon Exercise of Stock Options
 
For the three months ended March 31, 2013 and 2012, PMI issued 426,905 and 25,000 shares of common stock, respectively, upon the exercise of options for cash proceeds of $73,140 and $3,000, respectively.

Common Stock Issued upon Exercise of Stock Warrants
 
For the three months ended March 31, 2013 PMI issued 8,200 shares of common stock upon the exercise of warrants for cash proceeds of $82.

8.
Stock Option Plan and Compensation

In 2005, PMI’s stockholders approved the adoption of the 2005 Stock Option Plan (the “Plan”). Under the Plan, options to purchase up to 1,879,468 shares of common stock were reserved and may be granted to employees, directors, and consultants by the Board of Directors to promote the success of the PMI Group’s business. During 2008, the Board of Directors increased the total number of options under the Plan by 500,000 for a total of 2,379,468 options available for grant. During 2009, the Board of Directors increased the total number of options under the Plan by an additional 500,000 for a total of 2,879,468 options available for grant. During 2010, the Board of Directors increased the total number of options under the Plan by an additional 6,109,321 for a total of 8,988,789 options available to grant. During 2011, the Board of Directors increased the total number of options under the Plan by an additional 4,550,875 for a total of 13,539,664 available for grant. During 2012, the Board of Directors increased the total number of options under the plan by an additional 1,700,000 for a total of 15,239,664 available for grant. During the first three months of 2013, the Board of Directors increased the total number of options under the plan by an additional 56,483,417 for a total of 71,723,081 available for grant.
 
Incentive stock options are granted to employees at an exercise price not less than 100% of the fair value of PMI’s common stock on the date of grant. Non-statutory stock options are granted to consultants and directors at an exercise price not less than 85% of the fair value of PMI’s common stock on the date of grant. If options are granted to stockholders who hold 10% or more of PMI’s common stock on the option grant date, then the exercise price shall not be less than 110% of the fair value of PMI’s common stock on the date of grant. The fair value is based on a good faith estimate by the Board of Directors at the time of each grant. As there is no active trading market for these options, such estimate may ultimately differ from valuations completed by an independent party. The options generally vest over four years, which is the same as the performance period. In no event are options exercisable more than ten years after the date of grant.

                Option activity under the Plan is summarized as follows for the periods below:

   
Options Issued
and Outstanding
   
Weighted-Average
Exercise Price
 
   
 
   
 
 
Balance as of January 1, 2012
    12,087,620     $ 0.21  
Options  granted (weighted average fair value of $0.11)
    1,573,200     $ 0.17  
Options exercised
    (25,000 )   $ 0.12  
Options canceled
    (709,622 )   $ 0.23  
Balance as of March 31, 2012
    12,926,198     $ 0.20  
                 
Balance as of January 1, 2013
    11,738,168     $ 0.20  
Options granted (weighted average fair value of $0.01)
    10,091     $ 0.17  
Options exercised
    (426,905 )   $ 0.17  
Options canceled
    (2,124,651 )   $ 0.22  
Balance as of March 31, 2013
    9,196,703     $ 0.20  
Options outstanding and exercisable at March 31, 2013
     5,799,440     $  0.23  
 
 
Other Information Regarding Stock Options

Additional information regarding PMI common stock options outstanding as of March 31, 2013 is as follows:
 
 
   
Options Outstanding
   
Options Exercisable
 
Range of Exercise
Prices
   
Number Outstanding
   
Weighted Avg. Remaining Life
   
Weighted Avg. Exercise Price
   
Intrinsic Value
   
Number Exercisable
   
Weighted Avg. Exercise Price
   
Intrinsic Value
 
$0.12 - $0.12       2,487,618       8.40     $ 0.12     $       1,343,376     $ 0.12     $  
$0.17 - $0.17       2,487,451       9.10       0.17             583,547       0.17        
$0.20 - $0.20       3,576,415       7.30       0.20             3,244,955       0.20        
$0.25 - $0.25       25,000       2.40       0.25             25,000       0.25        
$0.50 - $0.50       274,117       3.60       0.50             274,117       0.50        
$0.56 - $0.56       295,102       6.40       0.56             277,445       0.56        
$1.94 - $1.94       31,000       5.80       1.94             31,000       1.94        
$2.17 - $2.17       20,000       4.90       2.17             20,000       2.17        
        9,196,703       7.92     $ 0.20     $ -       5,799,440     $ 0.23     $ -  

The intrinsic value is calculated as the difference between the value of PMI's common stock at March 31, 2013, which was $0.01 per share, and the exercise price of the options.
 
No compensation expense is recognized for unvested shares that are forfeited upon termination of service, and the stock-based compensation expense for the three months ended March 31, 2013 and 2012 reflect the expenses that PMI expects to recognize after the consideration of estimated forfeitures.

The fair value of PMI stock option awards for the three months ended March 31, 2013 and 2012 was estimated at the date of grant using the Black-Scholes model with the following average assumptions:

   
Three months ended
March 31,
 
   
2013
   
2012
 
Volatility of common stock
    73.43 %     77.10 %
Risk-free interest rate
    0.82 %     0.97 %
Expected life*
 
8.7 years
   
5.0 years
 
Dividend yield
    0 %     0 %
Weighted-average fair value of grants
    0.01       0.11  
 
*
For nonemployee stock option awards, the expected life is the contractual term of the award, which is generally ten years.
 
The Black-Scholes model requires the input of highly subjective assumptions, including the expected stock price volatility. Because PMI's equity awards have characteristics significantly different from those of traded options, the changes in the subjective input assumptions can materially affect the fair value estimate.
 
Total stock-based compensation expense for PMI employees reflected in the statements of operations for the three months ended March 31, 2013 and 2012 is approximately $53,300 and $82,600, respectively.  As of March 31, 2013, the unamortized stock-based compensation expense related to PMI employees’ unvested stock-based awards was approximately $159,300, which will be recognized over the remaining weighted average vesting period of approximately 2.6 years.
 
9.
Income Taxes
 
As part of the process of preparing the PMI Group’s financial statements, the PMI Group is required to estimate its income taxes in each of the jurisdictions in which it operates. This process involves determining the PMI Group’s income tax expense (benefit) together with calculating the deferred income tax expense (benefit) related to temporary differences resulting from differing treatment of items, such as deferred revenue or deductibility of certain intangible assets, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the accompanying balance sheet. The PMI Group must then assess the likelihood that the deferred tax assets will be recovered through the generation of future taxable income.

 
Due to the book and tax net losses incurred during the three months ended March 31, 2013 and 2012, the PMI Group has not incurred any income tax expense during those periods. In addition, the PMI Group has incurred substantial historical losses and has maintained a full valuation allowance against its net deferred tax assets because the realization of those deferred tax assets is dependent upon future earnings, and the amount and timing of those earnings, if any is uncertain.
 
10.
Commitments and Contingencies
 
 Future minimum lease payments
 
The PMI Group leases its corporate office and co-location facility under non-cancelable operating leases that expire in July 2013 and August 2014, respectively.  In March 2013, PMI arranged a new 20 month lease agreement for its corporate office which commits PMI to a total of $678,015 in rent expense and will expire in December 2014.

Future minimum rental payments under these leases as of March 31, 2013 are as follows:
       
2013
  497,906  
2014
    501,334  
Total future operating lease obligations
  $ 999,240  

Rental expense under premises-operating lease arrangements was $135,000 and $134,000 for the three months ended March 31, 2013 and 2012, respectively.

The PMI Group amended and restated an agreement with WebBank, an FDIC-insured Utah-chartered industrial bank, under which all loans originated through the platform are made by WebBank under its bank charter. The arrangement allows for loans to be offered to borrowers at uniform nationwide terms. The PMI Group is required to pay the greater of a monthly minimum fee or a fee calculated based on a certain percentage of monthly loan origination volume.
 
The PMI Group has an agreement with a third party broker-dealer in which the third party agreed to operate and maintain the Note Trader Platform for the secondary trading of PMI Group Notes.  The PMI Group is required to pay the third party broker-dealer an agreed upon monthly fee which equals the difference between the minimum monthly fee and the transaction fees collected by the third party provider during that month.

Securities Law Compliance

From inception through October 16, 2008, PMI sold approximately $178.1 million of PMI Borrower Loans to lender members through the old platform structure, whereby PMI assigned promissory notes directly to lender members. PMI did not register the offer and sale of the promissory notes corresponding to these loans under the Securities Act or under the registration or qualification provisions of any state securities laws. The PMI Group believes that the question of whether or not the operation of the platform during this period constituted an offer or sale of “securities” involved a complicated factual and legal analysis and was uncertain. If the sales of promissory notes offered through the platform during this period were viewed as a securities offering, PMI would have failed to comply with the registration and qualification requirements of federal and state laws and lender members who hold these promissory notes may be entitled to rescission of unpaid principal, plus statutory interest. Generally, the federal statute of limitations for noncompliance with the requirement to register securities under the Securities Act is one year from the violation, although the statute of limitations period under various state laws may be for a longer period of time.
 
PMI’s decision to restructure the platform and cease sales of promissory notes offered through the platform effective October 16, 2008 limited this contingent liability to the period covering its activities prior to October 16, 2008.

On April 21, 2009, PMI and the North American Securities Administrators Association (“NASAA”) reached agreement on the terms of a model consent order between PMI and the states in which PMI offered loan notes for sale prior to November 2008. The consent order involves payment by PMI of up to an aggregate of $1.0 million in penalties, which have been allocated among the states based on PMI’s promissory note sale transaction volume in each state prior to November 2008. A state that enters into a consent order receives its portion of the $1.0 million in exchange for its agreement to terminate, or refrain from initiating, any investigation of PMI’s note sale activities prior to November 2008.  Penalties are paid promptly after a state enters into a consent order. NASAA has recommended that each state enter into a consent order.  However, no state is obliged to do so, and there is no deadline by which a state must make its decision. PMI is not required to pay any portion of the penalty to those states that do not elect to enter into a consent order. If a state does not enter into a consent order, it is free to pursue its own remedies against PMI, subject to any applicable statute of limitations. As of March 31, 2013, the PMI Group has entered into consent orders with 34 states and has paid an aggregate of $466,017 in penalties to those states.
 
 
As of March 31, 2013 and 2012, the PMI Group had accrued approximately $248,000 and $277,000, respectively, in connection with the contingent liability associated with the states that have not entered into consent orders, in accordance with ASC Topic 450, Contingencies. The methodology applied to estimate the accrual was to divide the $1,000,000 maximum fee pro-rata by state, using PMI’s note sales from inception through November 2008. A weighting was then applied by state to each state that has not entered into a consent order, assigning a likelihood that the penalty will be claimed. In estimating the probability of a claim being made by a state, the PMI Group considered factors such as the standard terms of the consent orders; whether the state ever gave any indication of concern regarding the sale of promissory notes through the platform; the probability of a state electing not to enter into a consent order in order to pursue its own litigation against PMI; whether the penalty is sufficient to compensate a state for the cost of processing the settlement consent order; and finally the impact that current economic conditions have had on state governments. The PMI Group will continue to evaluate this accrual and related assumptions as new information becomes known.

On November 26, 2008, plaintiffs, Christian Hellum, William Barnwell and David Booth, individually and on behalf of all other plaintiffs similarly situated, filed a class action lawsuit against PMI and certain of its executive officers and directors in the Superior Court of California, County of San Francisco, California.  The suit was brought on behalf of all promissory note purchasers on the platform from January 1, 2006 through October 14, 2008.  The lawsuit alleges that PMI offered and sold unqualified and unregistered securities in violation of the California and federal securities laws.  The lawsuit seeks class certification, damages and the right of rescission against PMI and the other named defendants, as well as treble damages against PMI and the award of attorneys’ fees, experts’ fees and costs, and pre-judgment and post-judgment interest.

On February 25, 2011, the plaintiffs filed a Third Amended Complaint, which removed David Booth as a plaintiff and added Brian Russom and Michael Del Greco as plaintiffs.  The new plaintiffs are representing the same class and prosecuting the same claims as the previously named plaintiffs. On February 29, 2012, the court issued a procedural order granting the plaintiffs’ motion for class certification.  On October 4, 2012, PMI and the other named defendants filed a motion for summary judgment seeking dismissal of the suit.  On January 17, 2013, the motion for summary judgment was denied.

PMI’s insurance carrier with respect to the class action lawsuit, Greenwich Insurance Company (“Greenwich”), denied coverage.  On August 21, 2009, PMI filed suit against Greenwich in the Superior Court of California, County of San Francisco, California.  The lawsuit sought a declaration that PMI was entitled to coverage under its policy with Greenwich for losses arising out of the class action lawsuit as well as damages and the award of attorneys’ fees and pre- and post-judgment interest.
 
On January 26, 2011, the court issued a final statement of decision finding that Greenwich has a duty to defend the class action lawsuit, and requiring that Greenwich pay PMI's past and future defense costs in the class action suit up to $2 million.  Greenwich subsequently made payments to PMI in the amount of $2 million to reimburse PMI for the defense costs it had incurred in the class action suit.  As a result, Greenwich has now satisfied its obligations with respect to PMI’s defense costs for the Hellum suit. On October 22, 2012 Greenwich made an additional payment of $142,585 to PMI for pre-judgment interest. As a result, Greenwich has now satisfied its obligations with respect to PMI’s defense costs for the Hellum suit.

On July 1, 2011, PMI and Greenwich entered into a Stipulated Order of Judgment pursuant to which PMI agreed to dismiss its remaining claims against Greenwich.  On August 12, 2011, Greenwich filed a notice of appeal of the court's decision regarding Greenwich’s duty to defend up to $2 million.

PMI intends to vigorously defend the class action lawsuit.  PMI cannot, however, presently determine or estimate the final outcome of the lawsuit, and there can be no assurance that it will be finally resolved in PMI’s favor.  If the class action lawsuit is not resolved in PMI’s favor, PMI might be obliged to pay damages, and might be subject to such equitable relief as a court may determine.   Accordingly, the PMI Group has not recorded an accrued loss contingency in connection with PMI’s sale of notes through the platform prior to November 2008. Accounting for loss contingencies involves the existence of a condition, situation or set of circumstances involving uncertainty as to possible loss that will ultimately be resolved when one or more future event(s) occur or fail to occur. An estimated loss in connection with a loss contingency shall be recorded by a charge to current operations if both of the following conditions are met: first, the amount can be reasonably estimated; and second, the information available prior to issuance of the financial statements indicates that it is probable that a liability has been incurred at the date of the financial statements.

As of March 31, 2013, the probable outcome of the class action lawsuit cannot be determined, nor can the amount of damages or other costs that might be borne by the PMI Group be estimated.

 
11.
Related Parties

The PMI Group’s executive officers, directors who are not executive officers, and certain affiliates participate on the PMI Group’s lending platform by placing bids and purchasing PMI Group Notes.  The aggregate amount of PMI Group Notes and loans purchased and the income earned by parties deemed to be affiliates and related parties of the PMI Group as of March 31, 2013 and 2012 are summarized below:

Related Party
 
Aggregate Amount of Loans
Purchased March 31,
   
Income Earned on Loans for the
three months ended March 31,
 
   
2013
   
2012
   
2013
   
2012
 
Executive officers and management
  $ 357,832     $ 161,114     $ 74,735     $ 4,110  
Directors
    4,163,929       3,791,136       7,215       98,420  
Affiliate
    -       6,125,208       -       180,047  
    $ 4,521,761     $ 10,077,458     $ 81,950     $ 282,577  
 
The PMI Group Notes and loans were obtained on terms and conditions that were not more favorable than those obtained by other PMI Group Note and loan purchasers. Of the total aggregate amount of PMI Group Notes and loans purchased since inception approximately $290,000 or 6% and $528,103 or 5% of principal has been charged off through March 31, 2013 and 2012, respectively. The PMI Group has earned approximately $4,600 and $13,676 in servicing fee revenue related to these PMI Group Notes and loans for the three months ended March 31, 2013 and 2012, respectively.
 
12.
Postretirement Benefit Plans
 
PMI has a 401(k) plan that covers all employees meeting certain eligibility requirements. The 401(k) plan is designed to provide tax-deferred retirement benefits in accordance with the provisions of Section 401(k) of the Internal Revenue Code. Eligible employees may defer up to 90% of eligible compensation up to the annual maximum as determined by the Internal Revenue Service.  PMI’s contributions to the plan are discretionary. PMI has not made any contributions to the plan to date.

13.
Subsequent Events
 
Daniel P. Sanford resigned as SVP, Finance of PMI and as Treasurer of Prosper Funding, effective as of May 1, 2013.  On that same date, Kenneth L. Niewald was appointed to serve as Acting Chief Financial Officer of PMI and as Treasurer of Prosper Funding and was designated as the principal financial and accounting officer of both PMI and Prosper Funding.
 
 
Schedule I
 
Prosper Funding LLC

   
March 31,
   
December 31,
 
   
2013
   
2012
 
   
(Unaudited)
   
(Note 2)
 
Balance Sheet
 
 
   
 
 
Assets
 
 
   
 
 
Cash and Cash Equivalents
  $ 2,665,441     $ 5,000  
Restricted Cash
    4,140,569       -  
Receivables
    680       -  
Loans Held for Investment at Fair Value
    189,710       -  
Borrower Loans Receivable at Fair Value
    176,943,953       -  
Property and Equipment, net
    888,360       -  
Total Assets
  $ 184,828,713     $ 5,000  
                 
                 
                 
Liabilities and Member's Equity
               
Accounts Payable
  $ 107,060     $ -  
Accrued Liabilities
    867,618       -  
Borrower Payment Dependent Notes at Fair Value
    177,577,514       -  
Repurchase and Indemnification Obligation
    139,600       -  
Intercompany Payable
    80,151       -  
Total Liabilities
    178,771,943       -  
                 
                 
                 
Member's Equity
               
Member's Equity
    6,075,040       210,401  
Accumulated Deficit
    (18,270 )     (205,401 )
Total Member's Equity
    6,056,770       5,000  
                 
Total Liabilities and Member's Equity
  $ 184,828,713     $ 5,000  
 
The accompanying notes are an integral part of these financial statements.
 
 
Prosper Funding LLC
(Unaudited)
 
   
Three Months
Ended
March 31, 2013
   
From Inception
to
March 31, 2012
 
   
 
   
 
 
Revenues
 
 
   
 
 
Administration Fee Revenue
  $ 607,200     $ -  
Interest income on Borrower Loans
    5,072,713       -  
Interest expense on Notes
    (4,818,243 )     -  
Total Revenues
    861,670       -  
                 
Cost of Revenues
               
Cost of Services
    (225,395 )     -  
Provision for Loan and Note Repurchases
    (98,700 )     -  
Net revenues
    537,575       -  
                 
Operating Expenses
               
Administration Fee Expense
    381,960       -  
Depreciation and Amortization
    83,470       -  
Professional Services
    15,000       65,000  
Other
    44,555       58,600  
Total Operating Expenses
    524,985       123,600  
Income (Loss) Before Other Income and Expenses
    12,590       (123,600 )
                 
Other Income and Expenses
               
Change in Fair Value on Borrower Loans, Loans Held for Investment and Notes, net
    175,833       -  
Other Expense
    (1,292 )     -  
Total Other Income and Expenses, net
    174,541       -  
                 
Income (Loss) Before Income Taxes
    187,131       (123,600 )
Provision For Income Taxes
    -       -  
Total Net Income (Loss)
  $ 187,131     $ (123,600 )
 
The accompanying notes are an integral part of these financial statements.
 

Prosper Funding LLC
(Unaudited)
 
   
Three Months Ended
March 31, 2013
   
From Inception to
March 31, 2012
 
Cash flows from operating activities:
 
 
   
 
 
Net Income (loss)
  $ 187,131     $ (123,600 )
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
               
Change in fair value of Borrower Payment Dependent Notes
    287,993        
Depreciation and amortization
    83,470        
Reversal of loan and Note repurchases
    98,700        
Change in fair value of Loans held for investment
    (2,327 )      
Change in fair value of Borrower Loans
    (461,499 )      
Changes in operating assets and liabilities:
             
Restricted cash
    3,365        
Receivables
    (680 )      
Accounts payable and accrued liabilities
    195,517        
Net Intercompany Payable
    80,151        
Net cash provided by (used in) operating activities
    471,821       (123,600 )
                 
Cash flows from investing activities:
               
Origination of Borrower Loans held at fair value
    (24,121,109 )      
Repayment of Borrower Loans held at fair value
    17,981,805        
Repayment of Loans held for investment at fair value
    15,400        
Purchases of property and equipment
    (251,507 )      
Origination of Loans held for investment at fair value
    (26,531 )      
Net cash used in investing activities
    (6,401,942 )      
                 
Cash flows from financing activities:
               
Proceeds from Member's equity
          123,700  
Net cash included in transfer of assets from PMI
    1,874,202        
Proceeds from issuance of Notes held at fair value
    24,121,109        
Payment of Notes held at fair value
    (17,404,749 )      
Net cash provided by financing activities
    8,590,562       123,700  
                 
Net increase in cash and cash equivalents
    2,660,441       100  
Cash and cash equivalents at beginning of the period
    5,000        
Cash and cash equivalents at end of the period
  $ 2,665,441     $ 100  
 
The accompanying notes are an integral part of these financial statements.
 
 
Prosper Funding LLC
(Unaudited)

1.
Organization and Business
 
Prosper Funding LLC (“Prosper Funding”) was formed in the state of Delaware in February 2012 as a limited liability company with the sole equity member being Prosper Marketplace, Inc. (“PMI”).

Prosper Funding was formed by PMI to hold the borrower loans (the “Borrower Loans”) and issue the Borrower Payment Dependent Notes (the “Notes”).  Although Prosper Funding is consolidated with PMI for accounting and tax purposes, Prosper Funding has been organized and is operated in a manner that is intended to minimize the likelihood that it would be substantively consolidated with PMI in a bankruptcy proceeding.  Prosper Funding’s intention is to minimize the likelihood that its assets would be subject to claims by PMI’s creditors if PMI were to file for bankruptcy, as well as to minimize the likelihood that Prosper Funding will become subject to bankruptcy proceedings directly.  Prosper Funding seeks to achieve this by placing certain restrictions on its activities and implementing certain formal procedures designed to expressly reinforce its status as a distinct corporate entity from PMI.

Prosper Funding commenced operations as of February 1, 2013. On February 1, 2013, PMI transferred ownership of the platform, including all of the rights related to the operation of the platform, to Prosper Funding LLC. Since February 1, 2013, all Notes issued and sold through the platform are issued and sold by Prosper Funding.  Pursuant to a Loan Account Program Agreement between PMI and WebBank, PMI manages the operation of the platform, as agent of WebBank, in connection with the submission of loan applications by potential borrowers, the making of related loans by WebBank and the funding of such loans by WebBank. Pursuant to an Administration Agreement between Prosper Funding and PMI, PMI manages all other aspects of the platform on behalf of Prosper Funding.

2.
Summary of Significant Accounting Policies
 
 Basis of Presentation
 
The Company’s unaudited interim financial statements have been prepared in accordance with U.S. generally accepted accounting principles (US GAAP) and disclosure requirements for interim financial information and the requirements of Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by US GAAP for complete financial statements. The unaudited interim financial statements should be read in conjunction with the audited financial statements and notes thereto for the year ended December 31, 2012. The balance sheet at December 31, 2012 has been derived from the audited financial statements at that date. Management believes these unaudited interim financial statements reflect all adjustments, including those of a normal recurring nature, which are necessary for a fair presentation of the results for the interim periods presented. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year or any other interim period.
 
 Use of Estimates

The preparation of Prosper Funding’s financial statements in conformity with accounting principles generally accepted in the United States requires management to make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and the related disclosures at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. These estimates, judgments and assumptions include but are not limited to the following: valuation of Borrower Loans receivable and associated Notes, valuation of servicing rights, valuation allowance on deferred tax assets, valuation and amortization periods of intangible assets, repurchase obligation, stock-based compensation expense, and contingent liabilities. Prosper Funding bases its estimates on historical experience from all Borrower Loans and PMI Borrower Loans, and on various other assumptions that it believes to be reasonable under the circumstances. Actual results could differ from those estimates.

Certain Risks and Concentrations

In the normal course of its business, Prosper Funding encounters two significant types of risk: credit and regulatory. Financial instruments that potentially subject Prosper Funding to significant concentrations of credit risk consist primarily of cash, cash equivalents, restricted cash and short term investments. Prosper Funding places cash, cash equivalents, restricted cash and short term investments with high-quality financial institutions and is exposed to credit risk in the event of default by these institutions to the extent the amount recorded on the balance sheet exceeds federally insured amounts. Prosper Funding also performs periodic evaluations of the relative credit standing of these financial institutions and has not sustained any credit losses from instruments held at these financial institutions.

 
Prior to February 1, 2013, PMI Borrower Loans originated by PMI were carried on its consolidated balance sheet.  The PMI Borrower Loans were funded by the PMI Notes and repayment of the PMI Notes is wholly dependent on the repayment of the PMI Borrower Loans associated with a PMI Note.  As a result, PMI did not bear the risk associated with the repayment of principal on loans carried on its consolidated balance sheet.  A decrease in the value of the PMI Borrower Loans carried on PMI's balance sheet associated with increased credit risk was directly offset by a reduction in the value of the PMI Notes issued in association with the PMI Borrower Loans. However, PMI charged a servicing fee that was deducted from loan payments.  To the extent that loan payments were not made, PMI’s servicing income was reduced.  On January 22, 2013, PMI entered into an Asset Transfer Agreement with Prosper Funding (the “Asset Transfer Agreement”), pursuant to which PMI transferred substantially all of its remaining assets to Prosper Funding, including (i) all outstanding PMI Notes issued by PMI under the Indenture (the “Indenture”) dated June 15, 2009 between PMI and Wells Fargo Bank, as trustee (the “Trustee”), (ii) all PMI Borrower Loans, (iii) all lender/borrower/group leader registration agreements related to the PMI Notes or the PMI Borrower Loans, and (iv) all documents and information related to the foregoing, effective February 1, 2013.

Prosper Funding is subject to various regulatory requirements. The failure to appropriately identify and address these regulatory requirements could result in certain discretionary actions by regulators that could have a material effect on Prosper Funding's financial position and results of operations.

Cash and Cash Equivalents

Cash equivalents are recorded at cost, which approximates fair value. Such deposits periodically exceed amounts insured by the FDIC.

Restricted Cash
 
Restricted cash consists primarily of cash deposits required to support Prosper Funding’s ACH activities.
 
 Borrower Loans and Borrower Payment Dependent Notes
 
Prior to February 1, 2013, PMI issued PMI Notes and purchased PMI Borrower Loans from WebBank, and held the PMI Borrower Loans until maturity.  PMI's obligation to repay the PMI Notes was conditioned upon the repayment of the associated PMI Borrower Loans owned by PMI.   The PMI Borrower Loans and the PMI Notes were carried on PMI's balance sheets as assets and liabilities, respectively, until February 1, 2013, when such PMI Borrower Loans and PMI Notes were transferred to Prosper Funding pursuant to the Asset Transfer Agreement.  In conjunction with PMI's prior operating structure, Prosper Funding has adopted the provisions of ASC Topic 825, Financial Instruments.  ASC Topic 825 permits companies to choose to measure certain financial instruments and certain other items at fair value on an instrument-by-instrument basis with unrealized gains and losses on items for which the fair value option has been elected reported in earnings.  The fair value election, with respect to an item, may not be revoked once an election is made.  In applying the provisions of ASC Topic 825, Prosper Funding has recorded assets and liabilities measured using the fair value option in a way that separates these reported fair values from the carrying values of similar assets and liabilities measured with a different measurement attribute.  Prosper Funding does not record a specific allowance account related to the Borrower Loans and Notes in which it has elected the fair value option, but rather estimates the fair value of the Borrower Loans and Notes using discounted cash flow methodologies adjusted for historical payment, loss and recovery rates of Borrower Loans and PMI Borrower Loans. An account is considered to be a loss, or charged-off, when it reaches more than 120 days past due.  Prosper Funding has reported the aggregate fair value of the  Borrower Loans and Notes as separate line items in the assets and liabilities sections of the accompanying balance sheets using the methods described in ASC Topic 820, Fair Value Measurements and Disclosures—See Fair Value Measurement.

Internal Use Software and Website Development

Prosper Funding accounts for internal use software costs, including website development costs, in accordance with ASC Topic 350-40, Internal Use Software and ASC Topic 350-50, Website Development Costs. In accordance with ASC Topic 350-40 and 350-50, the costs to develop software for Prosper Funding's website and other internal uses are capitalized when management has authorized and committed project funding, preliminary development efforts are successfully completed, and it is probable that the project will be completed and the software will be used as intended. Capitalized software development costs primarily include software licenses acquired, fees paid to outside consultants, and salaries and payroll related costs for PMI employees directly involved in the development efforts.
 
 
Costs incurred prior to meeting these criteria, together with costs incurred for training and maintenance, are expensed. Costs incurred for upgrades and enhancements that are considered to be probable to result in additional functionality are capitalized. Capitalized costs are included in property and equipment and amortized to expense using the straight-line method over their expected lives. Prosper Funding evaluates its software assets for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable.  Recoverability of software assets to be held and used is measured by a comparison of the carrying amount of the asset to the future net undiscounted cash flows expected to be generated by the asset.  If such software assets are considered to be impaired, the impairment to be recognized is the excess of the carrying amount over the fair value of the software asset.

Repurchase and Indemnification Obligation

Prosper Funding is obligated to indemnify lenders and repurchase certain Notes sold to the lenders in the event of violation of applicable federal, state, or local lending laws, or verifiable identify theft. The loan indemnification and repurchase obligation is estimated based on historical experience of PMI Group loan originations. Prosper Funding accrues a provision for the repurchase and indemnification obligation when the Notes are issued. Indemnified or repurchased Notes associated with federal, state, or local lending laws, or verifiable identity thefts are written off at the time of repurchase or at the time an indemnification payment is made.
 
 Revenue Recognition

Prosper Funding recognizes revenue in accordance with ASC Topic 605, Revenue Recognition.  Under ASC Topic 605, Prosper Funding recognizes revenue when persuasive evidence of an arrangement exists, services have been rendered, the price of the services is fixed and determinable, and collectability is reasonably assured.

Administration Agreement License fees

Prosper Funding primarily generates revenues through license fees it earns through an Administration Agreement with PMI.  The Administration Agreement contains a license granted by Prosper Funding to PMI that entitles PMI to use the platform for and in relation to: (i) PMI’s performance of its duties and obligations under the Administration Agreement relating to corporate administration, loan platform services, loan and note servicing and marketing, and (ii) PMI’s performance of its duties and obligations to WebBank in relation to loan origination and funding.

Loan servicing fees

Loan servicing revenue includes monthly loan servicing fees and non-sufficient funds (“NSF”) fees on Borrower Loans.  Loan servicing fees are accrued daily based on the current outstanding loan principal balance of the Borrower Loan but are not recognized until payment is received due to the uncertainty of collection of borrower loan payments.  Prosper Funding’s servicing fee is currently equal to 1.0% of the outstanding principal balance of the corresponding Borrower Loan.  Prosper Funding charges a NSF fee to borrowers for the first failed payment of each billing period.  NSF fees are charged to the borrower and collected and recognized immediately.

Interest income (expense) on Borrower Loans receivable and Borrower Payment Dependent Notes

Prosper Funding recognizes interest income on its Borrower Loans receivable using the accrual method based on the stated interest rate to the extent that it believes it to be collectable.  It records interest expense on the corresponding Note based on the contractual interest rate.

Fair Value Measurement

Under ASC Topic 820 Fair Value Measurements and Disclosures, Prosper Funding determines the fair values of its financial instruments based on the fair value hierarchy established in that standard, which requires an entity to maximize the use of quoted prices and observable inputs and to minimize the use of unobservable inputs when measuring fair value. Prosper Funding uses various valuation techniques depending on the nature of the financial instrument, including the use of market prices for identical or similar instruments, or discounted cash flow models.  When possible, active and observable market data for identical or similar financial instruments are utilized. Alternatively, Prosper Funding may determine fair value using assumptions that it believes a market participant would use in pricing the asset or liability.

Under ASC Topic 820, assets and liabilities carried at fair value in the balance sheets are classified among three levels based on the observability of the inputs used to determine fair value:

Level 1 — The valuation is based on quoted prices in active markets for identical instruments.

 
Level 2 — The valuation is based on observable inputs such as quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3 — The valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the instrument. Level 3 valuations are typically performed using pricing models, discounted cash flow methodologies, or similar techniques, which incorporate management’s own estimates of assumptions that market participants would use in pricing the instrument or valuations that require significant management judgment or estimation.

The PMI Group determines the fair values of its financial instruments based on the fair value hierarchy established in that standard, which requires an entity to maximize the use of quoted prices and observable inputs and to minimize the use of unobservable inputs when measuring fair value. Various valuation techniques are utilized, depending on the nature of the financial instrument, including the use of market prices for identical or similar instruments, or discounted cash flow models. When possible, active and observable market data for identical or similar financial instruments are utilized. Alternatively, fair value is determined using assumptions that management believes a market participant would use in pricing the asset or liability.

Prosper Funding’s financial instruments consist principally of cash and cash equivalents, restricted cash, borrower loans, accounts payable and accrued liabilities and Notes.  The estimated fair values of cash and cash equivalents, restricted cash, accounts payable and accrued liabilities approximate their carrying values because of their short term nature.

Prosper Funding accounts for Borrower Loans and Notes on a fair value basis.

Borrower Loans and Notes

Prosper Funding purchases Borrower Loans from WebBank and, except as may otherwise be determined in connection with the servicing of any Borrower Loan, holds the Borrower Loans until maturity.  Prosper Funding also issues Notes to the lender members to fund its purchase of Borrower Loans.  Prosper Funding’s obligation to repay the Notes is conditioned upon the repayment of the associated Borrower Loan owned by Prosper Funding.  Prosper Funding carries the Borrower Loans and Notes on its balance sheet as assets and liabilities, respectively.

Recent Accounting Pronouncements

There have been no recent accounting pronouncements or changes in accounting pronouncements during the three months ended March 31, 2013 that are of significance, or potential significance to Prosper Funding.

3.
Borrower Loans and Borrower Payment Notes Held at Fair Value

Prosper Funding's financial instruments consist principally of cash and cash equivalents, restricted cash, short term investments, Borrower Loans receivable, accounts payable and accrued liabilities, Notes and long-term debt.  The estimated fair values of cash and cash equivalents, restricted cash, accounts payable and accrued liabilities approximate their carrying values because of their short term nature.

The following table presents the assets and liabilities measured at fair value at March 31, 2013:

March 31, 2013
 
Level 1 Inputs
   
Level 2 Inputs
   
Level 3 Inputs
   
Fair Value
 
Assets
 
 
   
 
   
 
   
 
 
Short term investments
  $ -     $ -     $ -     $ -  
Borrower loans receivable
    -       -       176,943,953       176,943,953  
Loans held for investment
    -       -       189,710       189,710  
Liabilities
                               
Borrower payment dependent notes
  $ -     $ -     $ 177,577,514