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EX-31.1 - EXHIBIT 31.1 - PROSPER MARKETPLACE, INCp10q3d31d201031d1.htm
EX-31.2 - EXHIBIT 31.2 - PROSPER MARKETPLACE, INCp10q3d31d201031d2.htm
EX-32.1 - EXHIBIT 32.1 - PROSPER MARKETPLACE, INCp10q3d31d201032d1.htm
EX-3.1 - EXHIBIT 3.1 - PROSPER MARKETPLACE, INCcertificateofinc4d15d2010.htm
 
 



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

FORM 10-Q
(Mark One)
     
þ
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2010

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

For the transition period from                       to                     

Commission File Number: 333-147019

PROSPER MARKETPLACE, INC.
(Exact name of registrant as specified in its charter)

Delaware
 
6199
 
73-1733867
(State or other jurisdiction of
 
(Primary Standard Industrial
 
(I.R.S. Employer
incorporation or organization)
 
Classification Code Number
 
Identification Number)

111 Sutter Street, 22nd Floor
San Francisco, CA  94104
(415) 593-5400
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes o No þ
 
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). Yes o  No o
 
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 definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o
Accelerated filer o
Non-accelerated filer o(Do not check if a smaller reporting company)
Smaller reporting company þ
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

As of May 10, 2010, there were 4,460,667 shares of the registrant’s common stock outstanding.

TABLE OF CONTENTS
 
 
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FORWARD-LOOKING STATEMENTS

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. 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 “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, we express an expectation or belief as to future results or events, such expectation or belief is based on the current plans and expectations of our management and expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. More information on factors that could cause actual results or events to differ materially from those anticipated is included from time to time in our reports filed with the Securities and Exchange Commission (the “SEC”), including our Annual Report on Form 10-K for the year ended December 31, 2009, particularly under the caption “Risk Factors.”

 
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 or our Annual Report on Form 10-K for the year ended December 31, 2009, particularly under the caption “Risk Factors.” We 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.
 

PART I. Financial Information
Item 1. Interim Consolidated Financial Statements and Notes

Prosper Marketplace, Inc.
 Consolidated Balance Sheets
   
March 31,
   
December 31,
 
   
2010
   
2009
 
   
(Unaudited)
   
(Audited)
 
ASSETS
           
  Cash and cash equivalents
  $ 749,460     $ 616,089  
  Restricted cash
    2,020,655       2,135,330  
  Servicing rights
    17,205       24,319  
  Receivables
    8,427       14,373  
  Borrower Loans receivable at fair value
    10,981,683       7,020,363  
  Property and equipment, net
    906,536       861,923  
  Prepaid and other assets
    147,844       190,174  
  Intangible assets, net
    140,855       171,038  
                 
Total assets
  $ 14,972,665     $ 11,033,609  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
  Accounts payable
  $ 1,023,409     $ 950,308  
  Accrued liabilities
    1,153,132       1,071,759  
  Borrower Payment Dependent Notes at fair value
    10,799,892       6,903,173  
  Repurchase obligation
    50,001       40,001  
  Notes Payable
    3,638,048       1,273,312  
  Total liabilities
    16,664,482       10,238,553  
                 
  Commitments and contingencies (see Note 12)
               
                 
  Stockholders' (Deficit) Equity
               
  Convertible preferred stock – Series A ($0.001 par value; 4,023,999 shares authorized, issued and outstanding as of March 31, 2010 and December 31, 2009)
    4,024       4,024  
  Convertible preferred stock – Series B ($0.001 par value; 3,310,382 shares authorized, issued and outstanding as of March 31, 2010 and December 31, 2009)
    3,310       3,310  
  Convertible preferred stock – Series C ($0.001 par value; 2,063,558 shares authorized; issued and outstanding as of March 31, 2010 and December 31, 2009)
    2,064       2,064  
  Common stock ($0.001 par value; 17,000,000 shares authorized; 4,460,667 shares issued and outstanding as of March 31, 2010 and December 31, 2009, respectively)
    4,462       4,462  
  Additional paid-in capital
    41,562,304       41,406,457  
  Accumulated deficit
    (43,267,981 )     (40,625,261 )
  Total stockholders' (defecit) equity
    (1,691,817 )     795,056  
                 
Total liabilities and stockholders' equity
  $ 14,972,665     $ 11,033,609  
                 
                 
The accompanying notes are an integral part of these consolidated financial statements.
 
 

 
1

 
 
Prosper Marketplace, Inc.
Consolidated Statements of Operations
(Unaudited)
   
Three Months Ended March 31,
 
   
2010
   
2009
 
Revenues
           
  Agency fees
  $ 148,605     $ -  
  Loan servicing fees
    65,085       180,942  
  Interest income on Borrower Loans and Payment Dependent Notes, net
    25,874       -  
  Rebates and promotions
    (1,668 )        
      237,896       180,942  
Cost of revenues
               
  Cost of services
    (182,391 )     (120,610 )
  Provision for loan and Note repurchases
    (8,033 )     (231 )
Total revenues, net
    47,472       60,101  
                 
Operating expenses
               
  Compensation and benefits
    1,174,825       1,429,630  
  Marketing and advertising
    287,048       31,326  
  Depreciation and amortization
    129,731       155,837  
General and administrative
               
  Professional services
    724,209       917,083  
  Facilities and maintenance
    163,856       173,176  
  Other
    315,327       266,291  
  Total expenses
    2,794,996       2,973,343  
Loss before other income (expense)
    (2,747,524 )     (2,913,242 )
                 
Other income (expense)
               
  Interest income
    469       25,372  
  Change in fair value on Borrower Loans and  Payment Dependent Notes, net
    90,709       -  
  Loss on impairment of fixed assets
    -       (40,515 )
  Other income
    13,626       37,383  
Total other income, net
    104,804       22,240  
                 
Loss before income taxes
    (2,642,720 )     (2,891,002 )
Income taxes
    -       -  
Net loss
  $ (2,642,720 )   $ (2,891,002 )
                 
Net loss per share – basic and diluted
  $ (0.59 )   $ (0.66 )
Weighted average shares - basic and diluted net loss per share
    4,460,667       4,390,340  
                 
The accompanying notes are an integral part of these consolidated financial statements.
 

 
 

Prosper Marketplace, Inc.
 
Consolidated Statements of Stockholders' Equity (Deficit)
 
                                           
   
Preferred Stock
   
Common Stock
   
Additional Paid-In
   
Accumulated
       
   
Shares
   
Amount
   
Shares
   
Amount
   
Capital
   
Deficit
   
Total
 
Balance as of January 1, 2009 (Audited)
    9,397,939     $ 9,398       4,346,118     $ 4,347     $ 40,946,853     $ (30,217,946 )   $ 10,742,652  
                                                         
Issuance of common stock
                    4,500       4       8,725               8,729  
                                                      -  
Exercise of stock options
                    44,666       44       11,773               11,817  
                                                      -  
Compensation expense
                                    110,778               110,778  
                                                      -  
Net loss
                                            (2,891,002 )     (2,891,002 )
                                                         
Balance as of March 31, 2009 (Unaudited)
    9,397,939     $ 9,398       4,395,284     $ 4,395     $ 41,078,129     $ (33,108,948 )   $ 7,982,974  
                                                         
Balance as of January 1, 2010 (Audited)
    9,397,939     $ 9,398       4,460,667     $ 4,462     $ 41,406,457     $ (40,625,261 )   $ 795,056  
                                                         
Issuance of common stock warrants
                              96,625               96,625  
                                                         
Compensation expense
                                    59,222               59,222  
                                                         
Net loss
                                            (2,642,720 )     (2,642,720 )
                                                         
Balance as of March 31, 2010 (Unaudited)
    9,397,939     $ 9,398       4,460,667     $ 4,462     $ 41,562,304     $ (43,267,981 )   $ (1,691,817 )
                                                         
The accompanying notes are an integral part of these consolidated financial statements.
 


 
Consolidated Statements of Cash Flows
 
(Unaudited)
 
             
   
Three Months Ended March 31,
 
   
2010
   
2009
 
Cash flows from operating activities:
           
Net loss
  $ (2,642,720 )   $ (2,891,002 )
Adjustments to reconcile net loss to net cash used in operating activities:
         
  Depreciation and amortization
    129,731       155,836  
  Loss on impairment of fixed assets
          40,516  
  Change in fair value of Borrower Loans
    634,691        
  Change in fair value of Borrower Payment Dependent Notes
    (725,400 )      
  Stock-based compensation expense
    59,222       119,507  
  Provision for loan and Note repurchases
    8,033       231  
  Change in fair value of servicing rights
    7,114       11,838  
  Amortization of discount on long-term debt
    74,649       5,476  
  Changes in operating assets and liabilities:
               
     Restricted cash
    114,675        
     Receivables
    5,946        
     Prepaid and other assets
    42,330       44,880  
     Accounts payable and accrued liabilities
    241,187       119,284  
     Loan and Note repurchases
    1,967       (10,231 )
Net cash used in operating activities
    (2,048,575 )     (2,403,665 )
                 
Cash flows from investing activities:
               
Origination of Borrower Loans held at fair value
    (5,933,690 )      
Repayment of Borrower Loans held at fair value
    1,337,679        
Purchases of property and equipment
    (144,162 )     (97,070 )
Net cash used in investing activities
    (4,740,173 )     (97,070 )
                 
Cash flows from financing activities:
               
Proceeds from issuance of Notes held at fair value
    5,933,690        
Payment of Notes held at fair value
    (1,311,571 )      
Proceeds from the issuance of notes payable
    2,300,000          
Proceeds from issuance of common stock
          11,817  
Net cash provided by financing activities
    6,922,119       11,817  
                 
Net increase (decrease) in cash and cash equivalents
    133,371       (2,488,918 )
Cash and cash equivalents at beginning of the year
    616,089       9,839,758  
Cash and cash equivalents at end of the period
  $ 749,460     $ 7,350,840  
                 
The accompanying notes are an integral part of these consolidated financial statements.
 
 

PROSPER MARKETPLACE, INC.
 
Notes to Consolidated Financial Statements
(Unaudited)
 
1. Operations and Business
 
Prosper Marketplace, Inc. (“Prosper”, the “Company”, “we”, “us”, “our”) was incorporated in the state of Delaware on March 22, 2005. Prosper is an online marketplace for peer-to-peer lending. Prosper’s website provides an online marketplace for loans where people list and bid on loans with interest rates of return determined through Prosper’s online auction platform. Prosper’s lender members set the minimum interest rate that they are willing to earn and bid in increments of $25 to $25,000. Borrowers create loan listings from $1,000 up to $25,000 and set the maximum rate they are willing to pay on a loan. Prosper facilitates the lending and borrowing activities and acts as an agent to the lender by maintaining its online auction platform. Prosper also handles all ongoing loan administration tasks, including loan servicing and collections on behalf of the lenders. Prosper generates revenue by collecting one-time fees from borrowers on funded loans and from loan servicing fees paid by lender members.
 
All loans requested and obtained by Prosper borrower members through our platform are unsecured obligations of individual borrower members with a fixed interest rate and a loan term set at three years.  All borrowers are funded by WebBank, an FDIC-insured, Utah-chartered industrial bank.  After funding a loan, WebBank assigns the loan to Prosper, without recourse to WebBank, in exchange for the principal amount of the borrower loan.  WebBank does not have any obligation to purchasers of the Notes.

On July 13, 2009, we implemented a new operating structure and began issuing Borrower Payment Dependent Notes (“Notes”).  The post registration operating structure resulted in Prosper purchasing loans from WebBank, and holding the loans until maturity.  Prosper issues new securities, the Notes, to the winning lenders.  Prosper’s obligation to repay the Notes is conditioned upon the repayment of the associated borrower loan owned by Prosper.  As a result of these changes, borrower loans and the Notes originated on or after July 13, 2009 are carried on Prosper’s balance sheet as assets and liabilities, respectively.  Prosper has elected to carry the borrower loans and the Notes on its balance sheet at fair value.
 
As reflected in the accompanying consolidated financial statements, Prosper has incurred net losses and negative cash flows from operations since inception, and has an accumulated deficit of approximately $43.3 million as of March 31, 2010.  For the three months ended March 31, 2010 the Company incurred a net loss of $2.6 million and the Company had negative cash flow from operations of $2.0 million. Since its inception, Prosper has financed its operations primarily through equity financing from various sources. The Company 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 Prosper’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.

As discussed in Note 15, “Subsequent Events”, on April 15, 2010, Prosper entered into a Stock Purchase Agreement with certain new investors and certain of its existing investors pursuant to which, the Company issued and sold to such investors 20,340,705 shares of the Company’s Series D Preferred Stock for an aggregate purchase price of $14.7 million.



2. Summary of Significant Accounting Policies
 
Basis of Presentation
 
The accompanying consolidated financial statements include the accounts of Prosper and its wholly-owned subsidiary, Prosper Loans Marketplace, Inc.  Prosper Loans Marketplace, Inc. was incorporated on April 3, 2009 in the state of California but has not had significant operations. All significant intercompany transactions and balances have been eliminated. On February 8, 2010, the Company dissolved Prosper Loans Marketplace, Inc.
 
The Company’s interim consolidated unaudited 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 consolidated financial statements.  The unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes included in our Annual Report on Form 10-K for the year ended December 31, 2009.  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 or any other interim period.

Use of Estimates
 
The preparation of financial statements in conformity US GAAP 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. Prosper bases its estimates on historical experience and on various other assumptions that Prosper 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 encounters two significant types of risk: credit and regulatory. Financial instruments that potentially subject Prosper to significant concentrations of credit risk consist primarily of cash, cash equivalents and restricted cash. The Company places cash, cash equivalents and restricted cash with high-quality financial institutions. Prosper is exposed to credit risk in the event of default by these institutions to the extent the amount recorded on the balance sheet exceeds FDIC insured amounts. Prosper 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.

As previously described, beginning on July 13, 2009, loans originated by Prosper are carried on our balance sheet.  The loans are funded by the Notes and repayment of the Notes is wholly dependent on the repayment of the loan associated with a Note.  As a result, Prosper does not bear the risk associated with the repayment of principal on loans carried on its balance sheet.  A decrease in the value of the loans carried on Prosper’s balance sheet associated with increased credit risk is directly offset by a reduction in the value of the Notes Prosper issued in association with the loan. However, Prosper charges a servicing fee that is deducted from loan payments.  To the extent that loan payments are not made, Prosper’s servicing income will be reduced.  

Prosper 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’s financial position and results of operations (See Note 12 — Commitments and Contingencies — Securities Law Compliance).

 
Cash and Cash Equivalents
 
Prosper invests its excess cash primarily in money market funds and in highly liquid debt instruments of U.S. municipalities, and 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 an irrevocable letter of credit held by a financial institution in connection with the Company’s office lease and cash deposits required to support the Company’s Automated Clearing House activities and secured corporate credit cards.
  
Servicing Rights
 
Prosper accounts for its servicing rights for loans originated prior to October 16, 2008 under the fair value measurement method of reporting in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 860-50, Servicing Assets and Liabilities (formerly, Statement of Financial Accounting Standards (SFAS) No. 156, Accounting for Servicing of Financial Assets – an Amendment of FAS 140). Under the fair value method, Prosper measures its servicing rights at fair value at each reporting date and reports changes in fair value in earnings in the period in which the changes occur.
 
Prosper estimates the fair value of the servicing rights using a discounted cash flow model to project future expected cash flows based upon a set of valuation assumptions Prosper believes market participants would use for similar rights. The primary assumptions Prosper uses to value its servicing rights include prepayment speeds, default rates, cost to service, profit margin, and discount rate. Prosper reviews these assumptions quarterly to ensure that they remain consistent with market conditions. Inaccurate assumptions in valuing servicing rights could affect Prosper’s results of operations.

Borrower Loans and Borrower Payment Dependent Notes

 As of July 13, 2009, the Company implemented its new operating structure and began issuing Notes and purchasing loans from WebBank, and holding the loans until maturity.  Prosper’s obligation to repay the Notes is conditioned upon the repayment of the associated borrower loan owned by Prosper.   As a result of these changes, borrower loans and the Notes are carried on our consolidated balance sheet as assets and liabilities, respectively.  In conjunction with our new operating structure, we adopted the provisions of ASC Topic 825, Financial Instruments (formerly, SFAS No. 159, The Fair Value Option for Financial Assets and Financial Measurements.  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, we 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.  We do not record a specific allowance account related to the borrower loans and Notes in which we have elected the fair value option, but rather estimate the fair value of the borrower loans and Notes using discounted cash flow methodologies adjusted for Prosper’s historical loss and recovery rates.  We have reported the aggregate fair value of the borrower loans and Notes as separate line items in the assets and liabilities sections of the consolidated balance sheet using the methods described in ASC Topic 820, Fair Value Measurements and Disclosures (formerly, SFAS No. 157, Fair Value Measurements) – See Fair Value Measurement. We did not apply the provisions of ASC Topic 825 to loans issued prior to July 13, 2009.
 


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 on the estimated useful lives of the assets, which range from three to seven years. Prosper capitalizes expenditures for replacements and betterments and expenses amounts for maintenance and repairs as they are incurred.  Depreciation and amortization commences once the asset is placed in service.
 
Internal Use Software and Website Development

Prosper 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 (formerly, Statement of Position (SOP) No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use and Emerging Issues Task Force (EITF) No. 00-02, Accounting for Website Development Costs). In accordance with ASC Topic 350-40 and 350-50, the costs to develop software for Prosper’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 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 Company 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.
 
Intangible Assets
 
Prosper records the purchase of intangible assets not purchased in a business combination in accordance with ASC Topic 350 (formerly, SFAS No. 142, Goodwill and Other Intangible Assets). Prosper has an intangible asset resulting from the purchase of the “Prosper.com” domain name.  The intangible asset is amortized on a straight-line basis over five years.
 


Impairment of Long-Lived Assets Including Acquired Intangible Assets
 
In accordance with ASC Topic 360, Property Plant and Equipment (formerly, SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets), Prosper reviews property and equipment and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying values of those assets may not be recoverable.  Recoverability of assets to be held and used is measured by comparing the carrying value of the asset to future net undiscounted cash flows that the assets are expected to generate. If an asset is considered to be impaired, the impairment to be recognized equals the amount by which the asset’s carrying value exceeds its fair value. Fair value is estimated using discounted net cash flows.
 
During the first quarter of 2009, management made the decision to discontinue the development of one of its planned software development projects. The software asset previously capitalized in 2008 was deemed to be impaired in accordance with ASC Topic 360. An impairment charge of $40,515, encompassing the amount capitalized in 2008, is included as a component of other income (expense) in our Consolidated Statement of Operations for the three months ended March 31, 2009.  There were no such impairment charges for the three months ended March 31, 2010.
 
Repurchase Obligation
 
Prosper is obligated to indemnify lenders and repurchase certain loans and Notes sold to lenders in the event of Prosper’s violation of applicable federal, state, or local lending laws, or verifiable identify theft. The amount of the loan repurchase obligation is estimated based on historical experience. Prosper accrues a provision for the repurchase obligation when the loans are funded. Repurchased loans and Notes associated with federal, state, or local lending laws, or verifiable identity thefts are written off at the time of repurchase.

Revenue Recognition
 
Prosper recognizes revenue in accordance with ASC Topic 605, Revenue Recognition (formerly, Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition in Financial Statements).  Under ASC Topic 605, Prosper recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price of the services is fixed and determinable and collectability is reasonably assured.
 
Agency fees

Agency fees are a percentage of the amount borrowed varying by Prosper Rating1 and are recognized when the loan is funded to the borrower. Borrowers with a AA Prosper Rating are charged 0.5% with no minimum fee and borrowers with a Prosper Rating of A through HR are charged 3% or $50, whichever is greater. Prior to October 16, 2008, agency fees charged were the greater of 1% to 3% of the loan amount borrowed or $75.
 
Loan servicing fees

Loan servicing revenue includes 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 borrower loan but are not recognized until payment is received due to the uncertainty of collection of borrower loan payments. Servicing fees for a loan vary based on the credit grade of the borrower.  Prosper charges a NSF fee to borrowers on the first failed payment of each billing period.  NSF fees are charged to the customer and collected and recognized immediately.



 
1 Please see “Management Discussion And Analysis Of Financial Condition And Results Of Operation” for background regarding Prosper Ratings.


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

We recognize interest income on our borrower loan receivable using the accrual method based on the stated interest rate to the extent that we believe it to be collectable.  We record interest expense on the corresponding Payment Dependent Note based on the contractual interest rate. Gross interest income earned and gross interest expense incurred were $459,491 and $433,617, for the three months ended March 31, 2010, respectively.
 
 
Advertising and Promotional Expenses
 
Under the provisions of ASC Topic 720, Other Expenses (formerly, SOP 93-7, Reporting on Advertising Costs), the costs of advertising are expensed as incurred. Advertising costs were approximately $287,000 and $31,000 for the three months ended March 31, 2010 and 2009, respectively.
 
Stock-Based Compensation
 
The Company accounts for its stock-based compensation for employees using fair-value-based accounting in accordance with ASC Topic 718, Compensation-Stock Compensation (formerly, SFAS No. 123R, Share-Based Payment).  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 is 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 forfeitures were estimated based on historical experience. The Company estimated its annual forfeiture rate to be 23.5% and 22.9% for the three months ended March 31, 2010 and 2009, respectively.
 
Prosper has granted options to purchase shares of common stock to nonemployees in exchange for services performed. Prosper accounts for stock options and restricted stock issued to nonemployees in accordance with the provisions of ASC Topic 505-50, Equity-Based Payments to Non-Employees (formerly, EITF Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring or in Conjunction with Selling Goods, or Services), which requires that equity awards be recorded at their fair value.  Under ASC Topic 718 and 505-50, Prosper uses the Black-Scholes model to estimate the value of options granted to nonemployees at each vesting date to determine the appropriate charge to stock-based compensation. The volatility of common stock was based on comparative company volatility.
 
The fair value of stock option awards for the three months ended March 31, 2010 and 2009 was estimated at the date of grant using the Black-Scholes model with the following average assumptions:
 
 
Three Months Ended March 31,
 
 
2010
 
2009
 
Volatility of common stock
**
 
64.9%
 
Risk-free interest rate
**
 
1.74%
 
Expected life*
**
 
5.8 years
 
Dividend yield
**
 
0%
 
Weighted-average fair value of grants
**
 
1.94%
  
   
 
*For nonemployee stock option awards, the expected life is the contractual term of the award, which is generally ten years.
 
**No stock option awards were granted during the quarter ended March 31, 2010.
 
The Black-Scholes model requires the input of highly subjective assumptions, including the expected stock price volatility. Because Prosper’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 employee and non-employee stock-option awards reflected in the Consolidated Statements of Operations was $59,222 and $119,507 for the three months ended March 31, 2010 and 2009, respectively.  As of March 31, 2010, the unamortized stock-based compensation expense related to unvested stock-based awards was $195,396, which will be recognized over the remaining vesting period of approximately 2.1 years.
 
Net Loss Per Share
 
Prosper computes net loss per share in accordance with ASC Topic 260 Earnings Per Share (formerly, SFAS No. 128, 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, 2010, there were outstanding convertible preferred stock and options convertible into 9,397,939 and 1,757,440 common shares, respectively, which may dilute future earnings per share. Due to the Company reporting a net loss for the three months ended March 31, 2010 and 2009, there is no calculation of fully-diluted earnings per share as all common stock equivalents are anti-dilutive.

In June 2008, the FASB issued ASC Topic 260-45-60, Presentation-Earning Per Share-Other Presentation (formerly, FASB Staff Position No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities) which addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore need to be included in the earnings allocation in computing earnings per share under the two-class method. Management has evaluated the provisions of the ASC Topic 260-45-60 and has determined it has no impact on the Company based on its current capital structure.
 
Income Taxes
 
Prosper uses the liability method to account for 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, Income Taxes (formerly, FIN 48, Accounting for Uncertainty in Income Taxes) our policy to include interest and penalties related to gross unrecognized tax benefits within our provision for income taxes did not change.

Fair Value Measurement

Prosper adopted ASC Topic 820 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 consolidated 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.

Prosper 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.

The Company’s financial instruments consist principally of cash and cash equivalents, restricted cash, receivables, borrower loans, servicing rights, accounts payable and accrued liabilities, borrower payment dependent notes and notes payable.  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 as of March 31, 2010 (unaudited) and December 31, 2009 (audited):
 
March 31, 2010 
 
Level 1 Inputs
   
Level 2 Inputs
   
Level 3 Inputs
   
Fair Value
 
Assets
                               
Servicing Rights
   
     
   
$
17,205
   
$
17,205
 
Borrower Loans Receivable
   
     
   
$
10,981,683
   
$
10,981,683
 
                                 
Liabilities
                               
Notes
   
     
   
$
10,799,892
   
$
10,799,892
 
 
December 31, 2009
 
Level 1 Inputs
   
Level 2 Inputs
   
Level 3 Inputs
   
Fair Value
 
Assets
                               
Servicing Rights
   
     
   
$
24,319
   
$
24,319
 
Borrower Loans
   
     
     
7,020,363
     
7,020,363
 
                                 
Liabilities
                               
Notes
   
     
   
$
6,903,173 
   
$
6,903,173 
 
 
As observable market prices are not available for the borrower loans and notes we hold, or for similar assets and liabilities, we believe the borrower loans and notes should be considered Level 3 financial instruments under ASC Topic 820.  In a hypothetical transaction as of the measurement date, the Company believes that differences in the principal marketplace in which the loans are originated and the principal marketplace in which the Company 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 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.

 Our obligation to pay principal and interest on any Note is equal to the loan payments, if any, we receive on the corresponding borrower loan, net of our 1.0% servicing fee.  As such, the fair value of the Note is approximately equal to the fair value of the borrower loans, adjusted for the 1.0% servicing fee.  Any unrealized gains or losses on the borrower loans and Notes for which the fair value option has been elected is recorded as a separate line item in the consolidated statement of operations.  The effective interest rate associated with the Notes will be less than the interest rate earned on the borrower loans due to the 1.0% servicing fee.  See Note 4 for a rollforward and further discussion of the significant assumptions used to value borrower loans and payment dependent notes.

Servicing rights related to loans originated prior to October 16, 2008 do not trade in an active open market with readily observable prices. Although sales of servicing assets do occur, the nature and character of the assets underlying those transactions are not similar to those held by the Company and, therefore, the precise terms and conditions typically seen in the marketplace would likely not be available to the Company. Accordingly, management determines the fair value of its servicing rights using a discounted cash flow model to project future expected cash flows based upon a set of valuation assumptions Prosper believes market participants would use for similar rights. The primary assumptions Prosper uses for valuing its servicing asset include prepayment speeds, default rates, cost to service, profit margin, and discount rate.

Prosper reviews these assumptions to ensure that they remain consistent with the market conditions. Inaccurate assumptions in valuing the servicing rights could affect Prosper’s results of operations. Due to the nature of the valuation inputs, servicing assets are classified as Level 3. The change in the fair-value of servicing rights is included in cost of services in the consolidated statement of operations.  See Note 3 for a rollforward and further discussion of the significant assumptions used to value servicing rights.

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)
 
   
Servicing Rights
   
Borrower Loans
   
Borrower Payment Dependent Notes
   
Total
 
Balance at January 1, 2010
  $ 24,319     $ 7,020,363     $ (6,903,173 )   $ 141,509  
Originations
            5,933,690       (5,933,690 )        
Principal Repayments
            (1,337,679 )     1,311,571       (26,108 )
Change in fair value on borrower loans and Payment Dependent Notes
            (634,691 )     725,400       90,709  
Change in fair value of servicing rights
    (7,114 )                     (7,114 )
Balance at March 31, 2010
  $ 17,205     $ 10,981,683     $ (10,799,892 )   $ 198,996  
 


New Accounting Pronouncements

In January 2010, FASB issued ASU No. 2010-06, “Fair Value Measurements and Disclosures,” that requires reporting entities to make new disclosures about recurring or nonrecurring fair-value measurements including significant transfers into and out of Level 1 and Level 2 fair-value measurements and information on purchases, sales, issuances, and settlements on a gross basis in the reconciliation of Level 3 fair-value measurements. The FASB also clarified existing fair-value measurement disclosure guidance about the level of disaggregation, inputs, and valuation techniques. The new and revised disclosures are required to be implemented in fiscal years beginning after December 15, 2009. The adoption of this standard did not have a material impact on our consolidated financial statements.

3. Servicing Rights
 
Prosper calculates the fair value of the servicing asset based on the following assumptions:
 
 
  March 31,
 
2010
 
2009
Unpaid principal loan balance under service
$20,100,000
 
$66,809,000
Servicing fees
0.0% - 1.0%
 
0.0% - 1.0%
Projected prepayment speed
1.20%
 
1.20%
Discount rate
25%
 
 25%
 
A rollforward of the servicing asset is summarized below:
 
   
Three Months Ended March 31,
 
   
2010
   
2009
 
Beginning of period balance
 
$
24,319
   
$
67,685
 
  Change in fair value of servicing rights
   
(7,114
)
   
(11,838
End of period balance
 
$
17,205
   
$
55,847
 
 
No servicing rights were purchased or sold during the three months ended March 31, 2010.

4. Borrower Loans and Notes Held at Fair Value

Prosper estimates the fair value of the borrower loans and Notes using discounted cash flow methodologies based upon a set of valuation assumptions. The main assumptions Prosper used to value the borrower loans and 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. Our obligation to pay principal and interest on any Note is equal to the loan payments, if any, we receive on the corresponding borrower loan, net of our 1.0% servicing fee.  As such, the fair value of the Note is approximately equal to the fair value of the borrower loans, adjusted for the 1.0% servicing fee.  The effective interest rate associated with the Notes will be less than the interest rate earned on the borrower loans due to the 1.0% servicing fee.
 


For borrower loans originated and Notes issued after July 13, 2009, we used the following average assumptions to determine the fair value as of March 31, 2010:
 
Monthly prepayment rate speed
    1.43 %
Recovery rate
    4.86 %
Discount rate *
    26.33 %
Weighted Average Default Rate
    7.80 %
         
* This is the average discount rate among all of Prosper’s credit grades        

The following table presents additional information about borrower loans and Notes measured at fair value on a recurring basis for the three months ended March 31, 2010:
 
   
Borrower Loans
   
Notes
 
Fair value at January 1, 2010 (audited)
 
$
7,020,363
   
$
6,903,173
 
  Originations
   
5,933,690
     
5,933,690
 
  Principal repayments
   
(1,337,679
)
   
(1,311,571
)
  Realized and unrealized losses included in earnings
   
(634,691
)
      —  
  Realized and unrealized gains included in earnings
           
(725,400
)
Fair value at March 31, 2010 (unaudited)
 
$
10,981,683
   
$
10,799,892
 
 
Due to the recent origination of the borrower loans and Notes, the change in fair value attributable to instrument-specific credit risk is immaterial.  The Company had no originations of borrower loans or issuances of Notes prior to July 13, 2009. Of the loans originated from July 13, 2009 to March 31, 2010, the Company had 4 loans in charge off status for an aggregate charge off principal amount of $19,236, as of March 31, 2010.

5. Notes Payable
 
As of March 31, 2010 and 2009, notes payable consist of the following:
 
   
March 31,
 
   
2010
   
2009
 
Non-interest bearing promissory note
  $ 320,000     $ 340,000  
Unamortized discount on the note
    (27,949 )     (49,892 )
Convertible promissory notes
    3,408,082        
Unamortized discount on convertible promissory notes
    (62,085 )      
Total promissory notes payable
  $ 3,638,048     $ 290,108  
 
Non-interest bearing promissory note
 
In 2006, we entered into a non-interest bearing promissory note in the amount of $380,000 for the purchase of the “Prosper.com” domain name. The note was discounted by $109,583 for a net payable of $270,417. The promissory note includes both principal and interest and is payable in annual installments of $20,000 due on the first, second, third, and fourth anniversary of the note and $300,000 due on the fifth anniversary of the note. Interest on the note was imputed at an 8% annual rate and is amortized to interest expense over the five year life of the loan.  The carrying value at March 31, 2010 and 2009 is $292,051 and $290,108, respectively.  The fair value is calculated based on discounted cash flows and is estimated to be $268,266 and $333,336 for three months ended March 31, 2010 and 2009, respectively.  Amortized interest expense of $5,514 and $5,476 was recorded for the three months ended 2010 and 2009, respectively.

 
Convertible Promissory Notes

On November 10, 2009, Prosper Marketplace, Inc. and QED Fund I, L.P., a Delaware limited partnership (“QED”), entered into a Note and Warrant Purchase Agreement (the “QED Purchase Agreement”), pursuant to which, Prosper issued to QED a Convertible Promissory Note (the “QED Note”) dated as of November 10, 2009.  The QED Note has a principal amount of $1,000,000.  Interest on the QED Note accrues at a per annum rate of 15.0%.  All principal and accrued interest under the QED Note are due on November 10, 2011 (the “Maturity Date”).  On the Maturity Date and for 90 days after, QED may elect to convert all principal and accrued interest under the QED Note into Prosper’s preferred stock. Prosper’s obligations under the QED Note are unsecured. The carrying value at March 31, 2010 is $1,058,356. The estimated fair value of the QED Note is $1,303,468 for the three months ended March 31, 2010.  The QED Note is valued based on discounted cash flows and on the Company’s current incremental borrowing rate.

In connection with the QED Purchase Agreement, Prosper also issued to QED a fully vested warrant (the “QED Warrant”) to purchase 164,178 shares of Prosper’s common stock at an exercise price of $0.56 per share. The QED Warrant is exercisable any time from the date of issuance and will expire on November 10, 2014. The Company allocated the QED Note proceeds to the QED Note and QED Warrants based on their relative fair values. The relative fair value attributable to the QED Warrant is $37,740, which was recorded as a discount to the QED Note and a corresponding credit to additional paid-in capital.  The debt discount will be amortized to interest expense over the life of the QED Note. At March 31, 2010, the unamortized balance was $29,877.

On February 1, 2010, the Company entered into a Note and Warrant Purchase Agreement (the “February Bridge Purchase Agreement”) with certain of its existing investors, pursuant to which, the Company issued and sold to such investors a series of Convertible Promissory Notes (the “February Bridge Notes”) in the aggregate principal amount of $2,000,000. Interest on the February Bridge Notes accrues at a per annum rate of 15.0%.  All principal and accrued interest under the February Bridge Notes are due in a single payment on April 1, 2010. The estimated fair value approximates its carrying value because of its short term nature.
 
In connection with the February Bridge Purchase Agreement, the Company issued to the February Bridge Note purchasers fully vested warrants (the “February Bridge Warrants”) to purchase an aggregate of 328,356 shares of its Common Stock at an exercise price of $0.56 per share.  The February Bridge Warrants are exercisable any time from the date of issuance and will expire on February 1, 2015. The Company allocated the February Bridge Note proceeds to the convertible February Bridge Note and February Bridge Warrants based on their relative fair values. The relative fair value attributable to the February Bridge Warrants is $95,532, which was recorded as a discount to the February Bridge Note and a corresponding credit to additional paid-in capital.  The debt discount will be amortized to interest expense over the life of the February Bridge Note. At March 31, 2010, the unamortized balance was $31,844.
 
On March 15, 2010, we entered into a Note Option Agreement (the “Larsen Option Agreement”) with Christian A. Larsen, our Chairman and Chief Executive Officer as well as one of its principal stockholders, pursuant to which, Mr. Larsen granted the Company an option (the “Option”) to sell him an aggregate principal amount of up to $300,000 of unsecured Convertible Promissory Notes (the “Larsen Bridge Notes”), in $100,000 increments.  On March 22, 2010, the Company exercised the Option in full and sold to Mr. Larsen, Larsen Bridge Notes in the aggregate principal amount of $300,000.  Interest on the Larsen Bridge Notes accrued at a per annum rate of 15.0%.  All principal and accrued interest under the Larsen Bridge Notes are due in a single payment on April 30, 2010.  

On April 15, 2010, Prosper entered into a Stock Purchase Agreement with certain new investors and certain of its existing investors pursuant to which, the QED Note and the February Bridge Note were converted to Series D Preferred Stock.  See Note 15 for further discussion.



6. Accrued Liabilities
 
As of March 31, 2010, and December 31, 2009, accrued liabilities consist of the following:
 
   
March 31,
   
December 31,
 
   
2010
   
2009
 
Professional Fees
 
$
676,257
   
$
787,057
 
Other
   
476,875
     
284,702
 
   
$
1,153,132
   
$
1,071,759
 

7. Repurchase Obligation
 
Changes in the repurchase obligation are summarized below:
 
   
Three Months Ended March 31,
 
   
2010
   
2009
 
Beginning of period balance
 
$
40,001
   
$
80,000
 
  Increase in provision for repurchases
   
8,033
     
231
 
  Loans and Notes repurchased and immediately charged off (net of recoveries)
   
1,967
     
(10,231
)
End of period balance
 
$
50,001
   
$
70,000
 
 
8. Net Loss Per Share
 
As mentioned in Note 2, the Company 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,
 
   
2010
   
2009
 
Numerator:
       
  Net loss
  $ (2,642,720 )   $ (2,891,002 )
Denominator:
               
  Weighted average shares used in computing basic and diluted net loss per share
    4,460,667       4,390,340  
Basic and diluted net loss per share
  $ (0.59 )   $ (0.66 )
 


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:
 
 
Three Months Ended March 31,
 
 
2010
 
2009
 
Excluded securities:
       
  Weighted-average convertible preferred stock issued and outstanding
9,397,939
   
9,397,939
 
  Weighted-average stock options issued and outstanding
1,757,440
   
1,655,910
 
Total weighted average common stock equivalents excluded from diluted net loss per common share computation
11,155,379
   
11,053,849
 
 
 9. Stockholders’ Equity
 
Preferred Stock
 
Under Prosper’s articles 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 April 2005, Prosper issued and sold 4,023,999 shares of Series A convertible preferred stock (Series A) in a private placement for $7,464,450, net of issuance costs of $80,550. In February 2006, Prosper issued and sold 3,310,382 shares of Series B convertible preferred stock (Series B) in a private placement for $12,412,302, net of issuance costs of $87,700. In June 2007, Prosper issued and sold 2,063,558 shares of Series C convertible preferred stock (Series C) in a private placement for $19,919,009, net of issuance costs of $80,996.

Dividends
 
The holders of the Series A, Series B and Series C preferred stock are entitled to receive dividends at an annual rate of 8% per share for the preferred stock. Such dividends shall be payable only when, as, and if declared by the Board of Directors. To date, no dividends have been declared, and there are no dividends in arrears at March 31, 2010. No dividends will be paid on any common stock of Prosper until dividends on the Series A, Series B and Series C have been paid or declared and set apart during that fiscal year.
 
Conversion
 
Each share of Series A, Series B and Series C is automatically convertible into shares of common stock at the Series A, Series B and Series C conversion price then in effect upon the earlier of (i) the date specified by vote or written consent or agreement of holders of 60% of the voting power of the shares of the Series A, Series B and Series C then outstanding, or (ii) immediately prior to the closing of the sale of Prosper’s common stock in a firm commitment, underwritten public offering registered under the Securities Act of 1933, as amended (the Securities Act), at a public offering price (before underwriters’ discounts and expenses) of at least two times the Original Series A, Series B and Series C Issue Price (as defined, per share as adjusted for any stock splits, stock dividends or other recapitalizations), and with gross proceeds to Prosper of at least $30,000,000.

Liquidation Rights
 
In the event of any liquidation, dissolution, or winding up of Prosper, whether voluntary or involuntary, the holders of the preferred stock are entitled to receive prior and in preference to any distribution of any of the proceeds of such liquidation event to holders of common stock, $1.875 for each share of Series A, $3.776 for each share of Series B, and $9.692 for each share of Series C (as adjusted for any stock dividends, combinations, or splits), plus all declared but unpaid dividends (if any) on each share of preferred stock. If upon the occurrence of such liquidation event, the assets and funds thus distributed among the holders of the Series A, Series B and Series C are insufficient to pay the preferential amount, then the entire assets and funds of Prosper legally available for distribution will be distributed ratably among the holders of the Series A, Series B and Series C in proportion to the preferential amount each such holder is otherwise entitled to receive.


Voting
 
Each holder of shares of the 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 Prosper. The holders of the preferred stock shall vote as one class with the holder of the common stock except with certain restrictions.

Common Stock
 
Prosper is authorized to issue up to 17,000,000 shares of common stock, $0.001 par value, of which 4,460,067 shares were issued and outstanding as of March 31, 2010, and December 31, 2009.  Each holder of common stock shall be entitled to one vote for each share of common stock held.
 
Common Stock Issued for Services

Nonemployees

The Company granted 0 and 4,500 immediately vested common shares for the three months ended March 31, 2010 and 2009, respectively.  The 4,500 shares issued in 2009 were valued at $1.94 per share.  Expense of approximately $8,700 was recognized for the three months ended March 31, 2009.
 
Common Stock Issued upon Exercise of Stock Options
 
For the three months ended March 31, 2010 and 2009, the Company issued 0 and 44,666 shares of common stock, respectively, upon the exercise of options for cash proceeds of $0 and $11,818, respectively.

10. Stock Option Plan and Other Stock Compensation
 
In 2005, Prosper’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 Prosper’s business. On January 31, 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. On October 6, 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.
 
Incentive stock options are granted to employees at an exercise price not less than 100% of the fair value of Prosper’s common stock on the date of grant. Nonstatutory stock options are granted to consultants and directors at an exercise price not less than 85% of the fair value of Prosper’s common stock on the date of grant. If options are granted to stockholders who hold 10% or more of Prosper’s common stock on the option grant date, then the exercise price shall not be less than 110% of the fair value of Prosper’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 estimates 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 Option Plan is summarized as follows for the periods below:
 
 
Options Issued and Outstanding
 
Weighted-Average Exercise Price
Balance as of January 1, 2009 (audited)
1,734,647
 
$1.14
  Options granted (weighted average fair value of $1.94)
131,000
 
$1.94
  Options exercised
(44,666)
 
$0.26
  Options canceled
(62,830)
 
$1.33
Balance as of March 31, 2009 (unaudited)
1,758,151
 
$1.21
       
Balance as of January 1, 2010 (audited)
1,897,126
 
$0.96
  Options granted (weighted average fair value of $0.00 )
-
 
$0.00
  Options exercised
-
 
$0.00
  Options canceled
(139,686)
 
$1.05
Balance as of March 31, 2010 (unaudited)
1,757,440
 
$0.95
       
Options outstanding and exercisable at March 31, 2010
1,055,949
 
$0.94

Other Information Regarding Stock Options
 
Additional information regarding common stock options outstanding as of March 31, 2010 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
 
 
$0.25 - $0.25
     
274,158
     
5.34
   
0.25
   
84,989
     
274,158
   
0.25
   
84,989
 
 
$0.50 - $0.50
     
481,719
     
6.66
     
0.50
     
28,903
     
420,872
     
0.50
     
25,252
 
 
$0.56 - $0.56
     
446,250
     
9.32
     
0.56
     
     
8,750
     
0.56
     
 
 
$1.94 - $1.94
     
412,502
     
8.76
     
1.94
     
     
261,444
     
1.94
     
 
 
$2.17 - $2.17
     
142,811
     
7.99
     
2.17
     
     
90,725
     
2.17
     
 
       
1,757,440
     
7.73
   
$
0.95
   
$
113,892
     
1,055,949
   
$
0.94
   
$
110,241
 
 
The intrinsic value is calculated as the difference between the value of Prosper's common stock at March 31, 2010, which was $0.56 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, 2010 and 2009 reflect the expenses that Prosper expects to recognize after the consideration of estimated forfeitures.
 


11. Income Taxes
 
As part of the process of preparing the Company’s financial statements, the Company is required to estimate its income taxes in each of the jurisdictions in which it operates. This process involves determining the Company’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 Company 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, 2010 and 2009, Prosper has not incurred any income tax expense during those periods.  In addition, Prosper 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.
 
12. Commitments and Contingencies
 
Future minimum lease payments and other commitments
 
Prosper leases its corporate office and co-location facility under noncancelable operating leases that expire in July 2011 and August 2011, respectively. Prosper’s corporate office lease has the option to renew for an additional three years. Future minimum rental payments under these leases as of March 31, 2010 are as follows:
 
        Remaining nine months ending December 31, 2010
  $ 324,852  
Years ending December 31:
       
2011
    265,513  
Total future operating lease obligations
  $ 590,365  
 
 
Rental expense under premises-operating lease arrangements was approximately $102,431 and $104,721 for the three months ended March 31, 2010 and 2009, respectively.
 
On April 14, 2008, the Company entered into an agreement with a Utah-chartered industrial bank whereby all loans originated through the Prosper marketplace resulting from listings posted on or after April 15, 2008 are made by WebBank under its bank charter. The arrangement allows for loans to be offered to borrowers at uniform nationwide terms. The Company 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.
 
On March 3, 2009, the Company entered into an agreement with a third party broker-dealer in which the third party agreed to operate and maintain Prosper’s Note Trader Platform for the purchase and sale of Borrower Payment Dependent Notes resulting from the sale of such Notes after the Company’s effective date.  The Company 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, the Company sold approximately $178.1 million of loans to unaffiliated lender members, and $1.0 million of loans to affiliated lender members through the Prosper platform whereby the Company assigned promissory notes directly to lender members. The Company did
not register the offer and sale of the promissory notes offered and sold through the Prosper platform under the Securities Act of 1933 or under the registration or qualification provisions of the state securities laws.


The Company’s management believes that the question of whether or not the operation of the Prosper platform involved an offer or sale of a “security” involved a complicated factual and legal analysis and was uncertain. If the sales of promissory notes offered through the Company’s platform were viewed as a securities offering, the Company 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 of 1933 is one year from the violation.

The Company’s decision to restructure its operations and cease sales of promissory notes offered through the platform effective October 16, 2008 limited this contingent liability to the period covering Prosper's activities prior to October 16, 2008, the date on which the Company ceased sales of promissory notes offered through the platform.
 
The Company has not recorded an accrued loss contingency in connection with the sale of promissory notes to lender members. 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.

The Company has assessed the contingent liability related to prior sales of loans on the platform and has determined that the occurrence of the contingency is reasonably possible but not probable and that contingent liability ranges from $0 in the event the Company prevails to a maximum of $63.4 million which represents the remaining outstanding principal amount of $19.9 million and loans charged off of $43.5 million as of March 31, 2010.

On November 25, 2008, the Company signed a settlement agreement with the North American Securities Administrators Association (“NASAA”) to pay penalties not to exceed $1.0 million to the States in order to resolve matters relating to Prosper’s alleged unregistered offer and sale of securities. The $1.0 million penalty would be allocated among the states where Prosper conducts business, based on the loan sale transaction volume in each state. However, Prosper will not be required to pay any portion of the fine to those states which elect not to participate in the settlement. As of March 31, 2010 and December 31, 2009, the Company had accrued approximately $322,000 and $356,157, respectively, in connection with this contingent liability in accordance with ASC Topic 450, Contingencies (formerly, SFAS No. 5, Accounting for Contingencies). The methodology applied to estimate the accrual was to divide the $1,000,000 maximum fee pro-rata by state using the Company’s originations since inception. A weighting was then applied by state to assign a likelihood that the penalty will be claimed. In estimating the probability of a claim being made, we considered factors such as the nature of the settlement agreement, whether the states had given any indication of their concern regarding the sale of the promissory notes, and the probability of states opting out of the settlement to pursue their own litigation against the Company, whether penalty is sufficient to compensate these states for the cost of processing the settlement and finally the impact that current economic conditions have had on state governments. The Company will continue to evaluate this accrual and related assumptions as new information becomes known. Penalties will be paid promptly after a state reviews and agrees to the language of the consent order. There is no deadline for the states to decide whether to enforce the consent order. On April 21, 2009, the Company and NASAA finalized a template consent order, which NASAA is recommending that the states adopt in settling any state initiated matters with the Company. As of March 31, 2010, the Company has entered into 28 consent order agreements and has paid an aggregate of $390,712 in penalties.

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 us, certain of our executive officers and our directors in the Superior Court of California, County of San Francisco, California.  The suit was brought on behalf of all loan note purchasers in our online lending platform from January 1, 2006 through October 14, 2008.  The lawsuit alleges that Prosper 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 Prosper and the other named defendants, as well as treble damages against Prosper and the award of attorneys’ fees, experts’ fees and costs, and pre-judgment and post-judgment interest.


Some of the individual defendants filed a demurrer to the First Amended Complaint, which was heard on June 11, 2009 and sustained by the court with leave to amend until July 10, 2009.  The plaintiffs filed a Second Amended Complaint on July 10, 2009, to which the same individual defendants demurred.  On September 15, 2009, this demurrer was sustained by the court without leave to amend.
 
Prosper’s insurance carrier with respect to the class action lawsuit, Greenwich Insurance Company (“Greenwich”), has denied coverage.  On August 21, 2009, Prosper filed suit against Greenwich in the Superior Court of California, County of San Francisco, California.  The lawsuit seeks a declaration that Prosper is 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-judgment and post-judgment interest.

We intend to vigorously defend the class-action lawsuit and vigorously prosecute our suit against Greenwich.  We cannot, however, presently determine or estimate the final outcome of either lawsuit, and there can be no assurance that either matter will be finally resolved in our favor.  If the class-action lawsuit is not resolved in our favor, we might be obliged to pay damages, and might be subject to such equitable relief as a court may determine.  If our lawsuit against Greenwich is not resolved in our favor, we might not be able to recover any proceeds from Greenwich to offset any losses we incur in the class action lawsuit.

As of March 31, 2010, the lawsuits are in their preliminary stages and their probable outcomes cannot presently be determined, nor can the amount of damages or other costs that might be borne by Prosper be estimated.

13. Related Parties

Prosper’s executive officers, directors and certain affiliates participate on the Company’s lending platform by placing bids and purchasing loans originated from Prosper.  The aggregate amount of loans purchased and the income earned by these related parties as of March 31, 2010 and 2009 are summarized below:
 
Related Party
    Aggregate Amount of Loans Purchased  
   
March 31,
   
 March 31,
 
   
2010
   
2009
 
Executive officers and management
 
$
519,190
   
$
444,053
 
Directors
   
553,193
     
460,090
 
Affiliate
   
167,259
     
167,259
 
   
$
1,239,642
   
$
1,071,402
 
 
The loans were obtained on the same terms and conditions as those obtained by other lenders. Of the total aggregate amount of loans purchased since inception approximately $158,166 or 13% and $103,383 or 10% of principal has been charged off through March 31, 2010 and 2009, respectively. Prosper earned approximately $1,544 and $2,607 in servicing fee revenue related to these loans for the three months ended March 31, 2010 and 2009, respectively.



 
14. Postretirement Benefit Plans
 
Prosper 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. Prosper’s contributions to the plan are discretionary. Prosper has not made any contributions to the plan to date.
 
15. Subsequent Events

On April 1, 2010, we entered into a Note Purchase Agreement with certain of our existing investors, pursuant to which, we issued and sold an additional series of unsecured Convertible Promissory Notes (the “April Bridge Notes”), dated as of April 1, 2010, in the aggregate principal amount of $250,000.  Interest on the April Bridge Notes accrued at a per annum rate of 15.0%.  All principal and accrued interest under the April Bridge Notes was due in a single payment on April 30, 2010.  On March 31, 2010, we received $237,060 of the April Bridge Notes in advance of the effective date of the purchase agreement and accordingly, has been classified in accrued liabilities in the Consolidated Balance Sheets.    

On April 15, 2010, Prosper entered into a Stock Purchase Agreement with certain new investors and certain of its existing investors pursuant to which, the Company issued and sold to such investors 20,340,705 shares of the Company’s Series D Preferred Stock for an aggregate purchase price of $14.7 million (the “Series D Financing”).  In connection with the consummation of the Series D Financing, (i) pursuant to an amendment to the QED Note entered into by QED and the Company, the QED Note and all accrued interest thereunder was converted into Series D Shares equal to principal and accrued interest on the QED Note, plus $300,000 which represented consideration for QED’s agreement to convert the QED Note prior to its maturity date; (ii) pursuant to an amendment to each of the February Bridge Notes entered into by the Company and each February Bridge Note purchaser, the maturity date of each February Bridge Note was deferred until the later of April 30, 2010 or the consummation of the Series D Financing; all accrued interest under the February Bridge Notes were subsequently converted into Series D Shares; (iii) the Larsen Bridge Notes and all accrued interest thereunder were paid in full pursuant to the terms thereof; (iv) each of the April Bridge Notes and all accrued interest thereunder was converted into Series D Shares pursuant to the terms thereof.
 


MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATION

This management’s discussion and analysis of financial condition and results of operations, or MD&A, contains forward-looking statements that involve risks and uncertainties. Please see “Forward-Looking Statements” in this Quarterly Report on Form 10-Q for a discussion of the uncertainties, risks and assumptions associated with these statements. This discussion should be read in conjunction with our historical financial statements and related notes thereto and the other disclosures contained elsewhere in this Quarterly Report on Form 10-Q. The results of operations for the periods reflected herein are not necessarily indicative of results that may be expected for future periods, and our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including but not limited to those included elsewhere in this Quarterly Report on Form 10-Q and those included in the “Risk Factors” section and elsewhere in our Annual Report on Form 10-K.
 
Overview

We provide a peer-to-peer online loan auction platform that enables our borrower members to borrow money and our lender members to purchase Notes that we issue, the proceeds of which facilitate the funding of specific loans made to borrowers.  Our platform enables our borrower members to request and obtain personal, unsecured loans by posting anonymous “listings” on the platform indicating the principal amount of the desired loan and the maximum interest rate the borrower is willing to pay.  We assign a Prosper Rating consisting of one of seven letter credit grades, based in part on the borrower’s credit score, to each borrower who requests a borrower loan.  Prosper borrower members’ Prosper Rating and credit score range, debt-to-income ratios and other credit data are displayed with their listings and are available for viewing by lender members on an anonymous basis.  Lender members access our platform and “bid” the amount they are willing to commit to the purchase of a Note that is dependent for payment on the corresponding borrower loan and the minimum yield percentage they are willing to receive, subject to a minimum yield percentage based on the Prosper Rating assigned to each listing. The highest yield percentage lender members may bid on a listing is the yield percentage that corresponds to the maximum interest rate set by the borrower.  The lowest yield percentage lender members may bid will be the minimum yield percentage set forth in the listing. The minimum yield percentage applicable to each listing is based on the Prosper Rating assigned to the listing and will be calculated by adding the national average certificate of deposit rate that matches the term of the borrower loan, as published by BankRate.com, to the minimum estimated loss rate associated with the Prosper Rating assigned to the listing, which is based on the historical performance of similar Prosper borrower loans. As of March 31, 2010, for listings with AA Prosper Ratings, an estimated loss rate of 1.0%, which represents the middle of the estimated loss rate range, is added to the national average certificate of deposit rate to determine the minimum yield percentage. By making a bid on a listing, a lender member is committing to purchase from Prosper a Note in the principal amount of the lender’s winning bid.  The lender members who purchase the Notes will designate that the sale proceeds be applied to facilitate the funding of a corresponding borrower loan listed on our platform.  Loans originated to borrower members are made by WebBank, an FDIC-insured, Utah-chartered industrial bank, and sold and assigned to Prosper.
 
All loans requested and obtained by Prosper borrower members through our platform are unsecured obligations of individual borrower members with a fixed interest rate and a loan term currently set at three years, although Prosper anticipates in the near future extending available loan terms to between three months to seven years.  With respect to loans resulting from listings posted by Prosper borrower members prior to April 15, 2008, Prosper is the originating lender for licensing and regulatory purposes.  All borrower loans resulting from listings posted on or after April 15, 2008 are funded by WebBank, an FDIC-insured, Utah-chartered industrial bank.  After funding a loan, WebBank assigns the loan to Prosper, without recourse to WebBank, in exchange for the principal amount of the borrower loan.  WebBank does not have any obligation to purchasers of the Notes.  For all borrower loans, listings are posted without our obtaining any documentation of the borrower’s ability to afford the loan.  In limited instances, we verify the income, employment, occupation or other information provided by Prosper borrower members in listings.  This verification is normally done after the listing has already been created and bidding is substantially completed and, therefore, the results of our verification are not reflected in the listings.
  
Borrowers with AA Prosper Rating are charged 0.5% with no minimum fee and borrowers with a Prosper Rating of A through HR are charged 3% or $50, whichever is greater.  Prior to October 16, 2008, agency fees charged were the greater of 1% to 3% of the loan amount borrowed or $75.  Agency fees are charged by WebBank and Prosper receives amounts equal to the transaction fees as compensation for loan origination activities.  We also receive servicing fees at an annualized rate of 1.0% of the outstanding principal balance of a Prosper borrower member’s loan, which we deduct from each lender member’s share of borrower loan payments.
 
Our Operating History

We incorporated in Delaware in March 2005 and launched our public website, www.prosper.com on February 13, 2006.  As of March 31, 2010, our platform has facilitated 32,290 borrower loans since its launch.

We have a limited operating history and have incurred net losses since our inception.  Our net loss was $2,642,720 and $2,891,002 for the three months ending March 31, 2010 and 2009.  At this stage of our development, we have funded our operations primarily with proceeds from equity financings. Our decision to temporarily stop accepting lender members’ commitments, effective from October 16, 2008 until July 10, 2009, significantly slowed the ramp up of our operations, resulting in a negative impact on our cash flow and liquidity. On July 13, 2009, we began accepting new commitments from our lender members on our platform, as such we will generate increased revenue from borrower transaction fees and non-sufficient funds fees and lender members’ servicing fees.  Over time, we expect that the number of borrowers and lender members and the volume of borrower loans originated through our platform will increase.

Our operating plan calls for a continuation of the current strategy of increasing transaction volume to increase revenue until we reach profitability and become cash-flow positive, which we do not expect to occur before the end of 2010.

We have made significant changes to the operation of our lending platform that became effective on July 10, 2009.  Our historical financial results and this discussion reflect the structure of our lending platform and our operations both prior to and after July 10, 2009.  For a discussion of the effect of our new structure on our financial statements, see “Borrower Loans and Payment Dependent Notes” under Critical Accounting Policies and Estimates below.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of our financial condition and consolidated results of operations is based on our financial statements, which we have prepared in accordance with U.S. generally accepted accounting principles.  The preparation of financial statements requires management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses and the related disclosures.  Prosper bases its estimates on historical experience and on various other assumptions that Prosper believes to be reasonable under the circumstances.  Actual results could differ from those estimates.  Our significant accounting policies are more fully described in Note 2 to our consolidated financial statements included elsewhere in this quarterly report.

Critical accounting policies are those policies that we believe present the most complex or subjective measurements and have the most potential to impact our financial position and operating results.  While all decisions regarding accounting policies are important, we believe that the following policies could be considered critical.  These critical policies relate to fair value measurement, borrower loans and Payment Dependent Notes, servicing rights, repurchase obligation, revenue recognition, stock-based compensation, and income taxes.



Fair Value Measurement

We adopted Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 820 Fair Value Measurements and Disclosures (formerly, Statement of Financial Accounting Standard (SFAS) No. 157, Fair Value Measurements) 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.

 
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.

We determine 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. We use 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, we determine fair value using assumptions that we believe a market participant would use in pricing the asset or liability.

For additional information and discussion, see Note 2, Note 4 and Note 5 to the consolidated financial statements included elsewhere in this report.
 
Borrower Loans and Payment Dependent Notes

On July 13, 2009, we implemented our new operating structure and began issuing Notes.  The post registration operating structure resulted in Prosper purchasing loans from WebBank, and holding the loans until maturity.  Prosper issues new securities, the Notes, to the winning lenders.  Prosper’s obligation to repay the Notes is conditioned upon the repayment of the associated borrower loan owned by Prosper.  As a result of these changes, Prosper carries the borrower loans and the Notes on its balance sheet as assets and liabilities, respectively.

 In conjunction with our new operating structure effective July 10, 2009, we adopted the provisions of ASC Topic 825 (formerly, SFAS No. 159, The Fair Value Option for Financial Assets and Financial Measurements).  ASC Topic 825 permits companies to choose to measure certain financial instruments and certain other items at fair value.  The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings.  We apply the provisions of ASC Topic 825 to the borrower loans and Notes issued subsequent to July 13, 2009 on an instrument by instrument basis.  We did not apply the provisions of ASC Topic 825 to loans issued prior July 13, 2009.  The aggregate fair value of the borrower loans and Notes are reported as separate line items in the assets and liabilities sections of the consolidated balance sheet using the methods described in ASC Topic 820.



The following table presents additional information about borrower loans and Notes measured at fair value on a recurring basis for the three months ended March 31, 2010:
 
   
Borrower Loans
   
Payment Dependent Notes
 
Fair value at January 1, 2010 (audited)
 
$
7,020,363
   
$
6,903,173
 
  Originations
   
5,933,690
     
5,933,690
 
  Principal repayments
   
(1,337,679
)
   
(1,311,571
)
  Realized and unrealized losses included in earnings
   
(634,691
)
      —  
  Realized and unrealized gains included in earnings
           
(725,400
)
Fair value at March 31, 2010 (unaudited)
 
$
10,981,683
   
$
10,799,892
 
 
We determine the fair value of the borrower loans and Notes in accordance with the fair value hierarchy established in ASC Topic 820, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  As observable market prices are not available for the borrower loans and Notes we hold or for similar assets and liabilities, we believe the borrower loans and Notes should be considered Level 3 financial instruments under ASC Topic 820.  ASC Topic 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  In a hypothetical transaction as of the measurement date, we believe that differences in the principal marketplace in which the loans are originated and the principal marketplace in which we might offer those loans may result in differences between the originated amount of the loans and their fair value as of the transaction date. Changes in fair value of the borrower loans and Notes subject to the provisions of ASC Topic 820 are recognized in earnings, and fees and costs associated with the origination or acquisition of borrower loans are recognized as incurred.  Prosper estimates the fair value of the borrower loans and Notes using a discounted cash flow methodology based upon a set of valuation assumptions Prosper believes market participants would use for similar assets and liabilities. The main assumptions used to value the borrower loans and Notes include default rates, discount rates applied to each credit tranche/grade, prepayment rates, and recovery rates.

For borrower loans and Notes issued after July 13, 2009, we used the following average assumptions to determine the fair value as of March 31, 2010:
 
Monthly prepayment rate speed
1.43%
Recovery rate
4.86%
Discount rate *
26.33%
Weighted Average Default Rate
7.80%
   
* This is the weighted average discount rate among all of Prosper’s credit grades
 
 


Key economic assumptions and the sensitivity of the current fair value to immediate adverse changes in those assumptions at March 31, 2010 for borrower loans and Notes are presented in the following table:
 
   
Borrower Loans
   
Payment Dependent Notes
 
Discount rate assumption:
    26.33 %     26.33 %
    Decrease in fair value and income (loss) to earnings from:
               
     100 basis point increase
  $ (137,100 )   $ 135,200  
     200 basis point increase
    (245,600 )     242,300  
    Increase in fair value and income (loss) to earnings from:
               
     100 basis point decrease
  $ 85,400     $ (84,200 )
     200 basis point decrease
    199,400       (196,600 )
                 
Default rate assumption:
    7.80 %     7.80 %
Decrease in fair value and income (loss) to earnings from:
               
     10% higher default rates
  $ (66,300 )   $ 70,800  
     20% higher default rates
    (131,300 )     140,200  
Increase in fair value  and income (loss) to earnings from:
               
     10% lower default rates
  $ 67,600     $ (72,200 )
     20% lower default rates
    136,600       (145,800 )
 
Overall, if the fair value of the borrower loans decrease or increase due to any changes in our assumptions, there will also be a corresponding decrease or increase in the fair value of the linked Notes. As a result, the effect on Prosper’s earnings of adverse changes in key assumptions is mitigated. However, the impact of these changes in fair value could have a material adverse impact on lender member's investments in the Notes.  

As we receive scheduled payments of principal and interest on the borrower loans we will in turn make principal and interest payments on the Notes.  These principal payments will reduce the carrying value of the borrower loans and Notes.  If we do not receive payments on the borrower loans, we are not obligated to and will not make payments on the Notes.  The fair value of the Note is approximately equal to the fair value of the borrower loan, less the 1.0% service fee.  If the fair value of the borrower loan decreases due to our expectation of both the rate of default of the loan and the amount of loss in the event of default, there will also be a corresponding decrease in the fair value of the Note (an unrealized gain related to the Note and an unrealized loss related to the borrower loan).

We do not record a specific allowance account related to the borrower loans and Notes in which we have elected the fair value option, but rather estimate the fair value of the borrower loans and Notes using discounted cash flow methodologies adjusted for Prosper’s historical loss and recovery rates. Due to the recent origination of the borrower loans and Notes, the change in fair value attributable to instrument-specific credit risk is immaterial.  The Company had no originations of borrower loans or issuances of Notes prior to July 13, 2009.  Of the loans originated from July 13, 2009 to March 31, 2010, the Company had 4 loans in charge off status for an aggregate charge off principal amount of $19,236, as of March 31, 2010.

We recognize interest income on our borrower loans using the accrual method based on the stated interest rate to the extent that we believe it to be collectable.  We record interest expense on the corresponding Note based on the contractual interest rate.

Actual proceeds from the origination of Notes and scheduled principal payments are shown as financing activities in the consolidated statement of cash flows included elsewhere in this report.


Servicing Rights

We account for our servicing rights under the fair value measurement method of reporting in accordance with ASC Topic 860, Transfer and Servicing (formerly, SFAS No. 156, Accounting for Servicing of Financial Assets – an Amendment of FAS 140).  Under the fair value method, we measure servicing rights at fair value at each reporting date and report changes in fair value in earnings in the period in which the changes occur.

We estimate the fair value of the servicing rights as it relates to loans originated prior to July 13, 2009, using a discounted cash flow model to project future expected cash flows based upon a set of valuation assumptions that we believe market participants would use for similar rights.  The primary assumptions we use for valuing our servicing rights include prepayment speeds, default rates, cost to service, profit margin, and discount rate.  We review these assumptions to ensure that they remain consistent with the market conditions.  Inaccurate assumptions in valuing servicing rights could affect our results of operations.  The significant assumptions used in the calculation of servicing rights are discussed in detail in Note 3 to our consolidated financial statements.

Repurchase Obligation

We are obligated to indemnify lenders and repurchase the Notes sold to the lenders in the event of violation of the applicable federal/state/local lending laws or verifiable identify theft.  Our limited operating history, the lack of industry comparables and the potential to impact financial performance make the Repurchase Obligation a critical accounting policy.
 
We accrue a provision for the repurchase obligation when the Notes are funded to the lender in an amount considered appropriate to reserve for our repurchase obligation related to the Notes sold to the lenders in the event of violation of the applicable federal/state/local lending laws or verifiable identify theft.  The repurchase obligation is evaluated at least once a quarter and represents an estimate based on the rate of historical repurchases as a percentage of originations (which generally occur within six to nine months of origination).  The repurchase obligation includes a judgmental management adjustment  due to our limited operating history, changes in current economic conditions, the risk of new and as yet undetected fraud schemes, origination unit and dollar volumes, and the lack of industry comparables.
 
At March 31, 2010 and December 31, 2009, we have recorded a repurchase obligation of $50,001 and $40,001, respectively.  For the three months ended March 31, 2010 the Company incurred no loan repurchases. For the three months ended March 31, 2009, the Company repurchased loans and Notes of $10,231, net of recoveries due to identity theft and legal and regulatory requirements.  Since the latter part of 2007, we have been successful at identifying and preventing a number of fraud attempts involving a series of fraudulent loan requests as our risk indicators and related operational controls in this area have significantly improved.    The overall decrease in the number of repurchases is due in large part by the Company’s increased efforts in identifying and preventing various fraud schemes.  The overall increase in the provision from the prior year end is due to the increase in the number and amount of originations in the current quarter.  Although we believe our fraud controls have resulted in a lower incidence of fraud in 2010 and 2009 as compared to prior years, our controls are largely based on experience from past fraud attempts. Accordingly, future repurchase and repayment obligations could vary significantly from our estimates.



Revenue Recognition

The Company recognizes revenue in accordance with ASC Topic 605, Revenue Recognition (formerly, Staff Accounting Bulletin (SAB) No. 104, Revenue Recognition in Financial Statements).  Under ASC Topic 605, Prosper recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price of the services is fixed and determinable and collectibility is reasonably assured.

Agency Fees

Borrowers with an AA Prosper Rating are charged 0.5% with no minimum fee and borrowers with a Prosper Rating of A through HR are charged 3% or $50, whichever is greater.  Prior to October 16, 2008, agency fees charged were the greater of 1% to 3% of the loan amount borrowed or $75.  Agency fees are charged by WebBank and we receive amounts equal to the transaction fees as compensation for loan origination activities.  

Servicing Fees
  
Loan servicing revenue includes loan servicing fees and non-sufficient funds fees.  Loan servicing fees are accrued daily based on the current outstanding loan principal balance of (a) borrower loan(s), but are not recognized until payment is received due to uncertainty of collection of borrower loan payments.  Currently, we charge servicing fees at an annualized rate of 1.0% of the outstanding principal balance of a Prosper borrower member’s loan, which we deduct from each lender member’s share of borrower loan payments.

We charge a non-sufficient funds fee to borrowers on the first failed payment of each billing period.  Non-sufficient funds fees are charged to the borrower and collected and recognized immediately.

Interest Income (expense) on Borrower Loans Receivable & Payment Dependent Notes

We recognize interest income on our borrower loans using the accrual method based on the stated interest rate to the extent that we believe it to be collectable.  We record interest expense on the corresponding Note based on the contractual interest rate.

Stock-Based Compensation

We account for stock-based compensation for employees using fair-value-based accounting in accordance with ASC Topic 718, Compensation – Stock Compensation (formerly, SFAS No. 123R, Share-Based Payment).  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 is expected to vest is amortized 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 forfeitures were estimated based on historical experience.  The significant assumptions used in the calculation of stock based compensation are discussed in detail in Note 2 to our consolidated financial statements included elsewhere in this report.
 
Prosper has granted options to purchase shares of common stock to non-employees in exchange for services performed.  Prosper accounts for stock options, restricted stock, and warrants issued to non-employees in accordance with the provisions of ASC 505-50, Equity-Based payments to Non-Employees (formerly, EITF Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring or in Conjunction with Selling Goods, or Services) which requires that equity awards be recorded at their fair value.  Under ASC Topic 718 and 505, we use the Black-Scholes model to estimate the value of options granted to non-employees at each vesting date to determine the appropriate charge to stock-based compensation.  The volatility of common stock was based on comparative company volatility.  The Black-Scholes model requires the input of highly subjective assumptions, including the expected stock price volatility.  Because Prosper’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.

 
Income Taxes

ASC Topic 740, Income Taxes (formerly, SFAS No. 109, Accounting for Income Taxes) provides for the recognition of deferred tax assets if realization of such assets is more likely than not.  Based upon the weight of available evidence, which includes our historical operating performance and the reported cumulative net losses in all prior years, we have provided a full valuation allowance against our net deferred tax assets.  We will continue to evaluate the realizability of the deferred tax assets on a quarterly basis.

Results of Operations
 
Our results of operations for the three months ended March 31, 2010 and 2009, together with the percentage change between periods, are set forth below.
 
Prosper Marketplace, Inc.
Consolidated Statements of Operations
(Unaudited)
                               
 
Three Months Ended March 31,
   
Change from prior period
 
 
2010
   
2009
 
     
As % of sales
       
As % of sales
   
$ Increase / (Decrease)
   
%
 
 Revenues
                             
Agency fees
$ 148,605         $ -         $ 148,605       n/a  
Loan servicing fees
  65,085           180,942           (115,857 )     (64 %)
Interest income (expense) on Borrower Loans and Borrower Payment Dependent Notes, net
  25,874           -           25,874       n/a  
Rebates and promotions
  (1,668 )         -           (1,668 )     n/a  
    237,896           180,942           56,954       31 %
 Cost of Revenues
                                     
Cost of services
  (182,391 )   (77 %)     (120,610 )   (67 %)     (61,781 )     51 %
Provision for loan and Note repurchases
  (8,033 )   (3 %)     (231 )   (0 %)     (7,802 )     3377 %
 Total revenues, net
  47,472             60,101             (12,629 )     (21 %)
                                           
 Operating expenses
                                         
Compensation and benefits
  1,174,825     494 %     1,429,630     790 %     (254,805 )     (18 %)
Marketing and advertising
  287,048     121 %     31,326     17 %     255,722       816 %
Depreciation and amortization
  129,731     55 %     155,837     86 %     (26,106 )     (17 %)
 General and administrative
                                         
Professional services
  724,209     304 %     917,083     507 %     (192,874 )     (21 %)
Facilities and maintenance
  163,856     69 %     173,176     96 %     (9,320 )     (5 %)
Other
  315,327     133 %     266,291     147 %     49,036       18 %
 Total expenses
  2,794,996             2,973,343             (178,347 )     (6 %)
 Loss before other income (expense)
  (2,747,524 )           (2,913,242 )           165,718       (6 %)
                                           
 Other income (expense)
                                         
        Interest Income
  469     0 %     25,372     14 %     (24,903 )     (98 %)
Change in fair value on Borrower Loans and Borrower Payment Dependent Notes, net
  90,709     38 %     -     0 %     90,709       n/a  
        Loss on impairment of fixed assets
  -     0 %     (40,515 )   (22 %)     40,515       (100 %)
Other income
  13,626     6 %     37,383     21 %     (23,757 )     (64 %)
 Total other income   104,804             22,240             82,564       371
 Loss before income taxes   (2,642,720            (2,891,002            248,282        (9 %) 
Income taxes
  -     0 %     -     0 %     -       n/a  
 Net Loss
$ (2,642,720 )         $ (2,891,002 )         $ 248,282       (9 %)


Revenues

Our business model involves the charging of transaction fees to borrowers and servicing fees to lender members.  Borrowers are charged a transaction fee for loan origination services and the lender members pay a fee to us for managing the payments on the loans and maintaining account portfolios.  We also charge NSF fees to our borrowers for failed payments.  In addition, we generate revenue from interest earned on cash, cash equivalents and borrower loans.

Agency Fees

Our borrowers pay a one-time transaction fee at the time a borrower loan is funded.  Borrowers with an AA Prosper Rating are charged 0.5% with no minimum fee and borrowers with a Prosper Rating of A through HR are charged 3% or $50, whichever is greater.  The borrower agency fee is included in the annual percentage rate (APR) calculation provided to the borrowers and is deducted from the gross loan proceeds prior to disbursement of funds to the borrowers.  Borrowers are only charged an agency fee if a borrower loan is funded.  Prior to October 16, 2008, agency fees on the platform have ranged from 1.0% and 3.0% depending on the credit quality of the borrower, with a minimum fee of $75, whichever was greater.  Agency fees were $148.6 thousand for the three months ended March 31, 2010.  The Company had no agency fees for the three months ending March 31, 2009, stemming from the Company not originating any new loans during our quiet period which extended into the third quarter of 2009.  Prosper originated 1,243 loans in the three months ended March 31, 2010.
 
Loan Servicing Fees

Lender members are charged a servicing fee on the Notes, which is accrued daily based on the current outstanding Note principal balance.  Currently the servicing fee is an annualized rate of 1.0% of the outstanding principal balance of the loan.  Prior to October 14, 2008 servicing fees ranged between 0% and 1.0% for some loans depending on the borrower’s credit grade.  Loan servicing fees were $65.1 thousand and $180.9 thousand for the three months ended March 31, 2010 and 2009, respectively.  The decrease in loan servicing fees is attributed primarily to the overall decrease in the outstanding principal balance of loans serviced from the comparable prior year periods.
 
Our procedures generally require the automatic debiting of borrower member bank accounts by automated clearing house (ACH) transfer, although we allow payment by check and bank draft.  We charge a non-sufficient funds fee to a borrower member to cover the cost we incur if an automatic payment fails and is rejected by the borrower member’s bank, for example if there is an insufficient balance in the bank account or if the account has been closed or otherwise suspended.  If an automatic payment fails we make up to two additional attempts to collect; however, there is no additional fee charged to the borrower if these attempts fail.  We retain the entire amount of the non-sufficient funds fee, which is currently $15.00 per initial payment failure, or such lesser amount required by law, to cover our costs.



Interest Income on Borrower Loans and Payment Dependent Notes

Since July 13, 2009, the implementation of our new operating structure, we began recording interest income from our borrower loans and corresponding interest expense from our Notes. Gross interest income earned and gross interest expense incurred were $459.5 thousand and $433.6 thousand, respectively for the three months ended March 31, 2010. Over time, we expect that revenues and expenses related to borrower loans and Notes will increase as we grow our platform.

Cost of Revenues
 
Cost of Services

Our cost of services are comprised primarily of credit bureau fees, payments to strategic partners, collections expenses, referral award programs, the change in fair value of servicing rights and other expenses directly related to loan funding and servicing.  For the three months ended March 31, 2010 cost of service expenses were $182.4 thousand, an increase of $61.8 thousand or 51% as compared to $120.6 thousand for the three months ended March 31, 2009.  The increase is primarily due to the fact that we did not originate any new loans during the first quarter of 2009 while operating in a quiet period, which extended into the third quarter of 2009.

Loan and Note Repurchases

For the three months ended March 31, 2010 and 2009, we recorded recoveries on prior repurchase losses (i.e., income) of approximately $2.0 thousand and $2.3 thousand, respectively.  Judgments in our favor have lead to recoveries during the period which correspond to certain loan repurchases.  There were no repurchase losses for the three months ended March 31, 2010, as compared to repurchase losses of $12.5 thousand for the three months ended March 31, 2009. We have devoted a significant amount of attention to fraud prevention and will continue to implement additional fraud prevention and control procedures to maintain a low level of repurchase losses due to identity theft and operational errors.

Other Income (Expense)
 
Interest Income

Interest income on cash and cash equivalents was nominal for the three months ended March 31, 2010, a decrease of $24.9 thousand or 98% as compared to $25.4 thousand for the three months ended March 31, 2009.  The decrease in investment income is primarily attributable to lower average cash balances through the first quarter of 2010 as compared to 2009 cash balances and a general decrease in interest rates.
 
Change in Fair Value on Borrower Loans and Payment Dependent Notes, net
 
Under the methods described in ASC Topic 820, Fair Value Measurements and Disclosures (formerly, SFAS No. 157, Fair Value Measurements), unrealized gains or losses on the borrower loans and borrower payment dependent notes for which the fair value option has been elected are recorded as a separate line item in our consolidated statement of operations. The total fair value adjustment was $634.7 thousand and $725.4 thousand for the borrower loans and Notes, respectively, resulting in a net unrealized gain of $90.7 thousand for the three months ended March 31, 2010. 

Impairment of Fixed Assets

During the first quarter of 2009, management made the decision to discontinue the development of one of its planned software development projects. The software asset previously capitalized in 2008 was deemed to be impaired in accordance with ASC Topic 360. An impairment charge of $40,515, encompassing the amount capitalized in 2008, is included as a component of other income (loss) in our consolidated statement of operations for the three months ended March 31, 2009.


Other Income

        Other income consists primarily of credit referral fees, where partner companies pay us an agreed upon amount for referrals of customers from our website.  Other income was $13.6 thousand for the three months ended March 31, 2010, a decrease of $23.8 thousand or 64% as compared to $37.4 thousand for the three months ended March 31, 2009.  The decrease in other income is primarily due to the loss of a credit referral partner which was in place in the first quarter of the prior year as well as the slight decline in the amount of volume for other credit referral partners.
 
   
Three Months Ended March 31,
   
 
 
   
2010
   
2009
     Change from prior period  
   
(Unaudited)
   
(Unaudited)
   
$ Increase / (Decrease)
   
%
 
Operating expenses
                       
      Compensation and benefits
  $ 1,174,825     $ 1,429,630     $ (254,805 )     (18 %)
      Marketing and advertising
    287,048       31,326       255,722       816 %
      Depreciation and amortization
    129,731       155,837       (26,106 )     (17 %)
General and administrative
                               
      Professional services
    724,209       917,083       (192,874 )     (21 %)
      Facilities and maintenance
    163,856       173,176       (9,320 )     (5 %)
      Other
    315,327       266,291       49,036       18 %
Total expenses
  $ 2,794,996     $ 2,973,343     $ (178,347 )     (6 %)
 
Operating Expenses

Compensation and benefits were $1.2 million and $1.4 million for the three months ended March 31, 2010 and 2009, respectively. The decreases were predominantly due to employee reductions through voluntary and involuntary termination which in turn decreased salaries and wages, related payroll taxes and benefits expense.  There was a reduction in the amount of contract labor we used as well as a decreases in stock-based compensation expense.

Marketing and advertising costs consist primarily of search engine marketing, online and offline marketing campaigns, public relations and tradeshows and events.  Marketing and advertising costs were $287.0 thousand for the three months ended March 31, 2010 compared to $31.3 thousand for the three months ended March 31, 2009, an increase of $255.7 thousand or 816%.  The increase in marketing and advertising expenditures resulted from the fact that we were not offering loans on our platform through the first quarter of 2009.

Depreciation and amortization were $129.7 thousand and $155.8 thousand for the three months ended March 31, 2010 and 2009, respectively, a decrease of $26.1 thousand or 17%.  The decreases were primarily due to assets becoming fully depreciated during the period.

General and Administrative Expenses

Professional service expenses are comprised of legal expenses, audit and accounting fees and consulting services.  Professional service expenses for the three months ending March 31, 2010 were $724.2 thousand, a decrease of $192.9 thousand or 21% as compared to $917.1 thousand for the three months ended March 31, 2009.  For the three months ended March 31, 2009, we incurred higher legal and audit fees associated with the preparation and filing of our Registration Statement. These expenses were not incurred in the three months ended March 31, 2010. These decreases in legal and audit fees were partially offset by an increase in legal fees stemming from our class action lawsuit as discussed further in Note 12 of our consolidated financial statements.

Facilities and maintenance expenses consist primarily of rents paid for our corporate office lease and data co-location facility, office expenses and equipment and software costs that did not meet capitalization criteria. Facilities and maintenance expenses for the three months ended March 31, 2010 were $163.9 thousand, a decrease of $9.3 thousand or 5% as compared to $173.2 thousand for the three months ended March 31, 2009.  The overall decline in facilities and maintenance expenses is due to a reduction in office supply expense, software costs that did not meet capitalization criteria, and hardware and software maintenance and support costs.



        Other general and administrative expenses consist of bank service charges, NASAA state penalty settlement expenses, travel and entertainment, taxes and licenses, communications costs and other miscellaneous expenses.  Other general and administrative expenses for the three months ended March 31, 2010 were $315.3 thousand, an increase of $49.0 thousand or 18% as compared to $266.3 thousand for the three months ended March 31, 2009.  The increase is primarily due to the additional interest expense that we incurred in connection with additional bridge funding as discussed in Note 5 of our consolidated financial statements, and was partially offset by decreases in EDGAR printing and filing services and bank service charges.

Liquidity and Capital Resources

We have incurred operating losses since our inception and we anticipate that we will continue to incur net losses through 2010.  We had negative cash flows from operations of $2.0 million and $2.4 million for the three months ended March 31, 2010 and 2009, respectively.  Additionally, since our inception through March 31, 2010, we have an accumulated deficit of $43.3 million.

To date, we have financed our operations with proceeds primarily from the sale of equity securities. We are dependent upon raising additional capital or debt financing to fund our 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 our ability to achieve our business objectives and continue as a going concern.  Further, an unfavorable outcome of the class action lawsuit at the high end of the range could hinder our ability to continue operations, absent other extenuating circumstances. There can be no assurances as to the availability or terms upon which the required financing and capital might be available.

Net cash used in operating activities was $2.0 million and $2.4 million for the three months ended March 31, 2010 and 2009, respectively.  Net cash used in operating activities consisted mostly of payroll and benefits, costs associated with legal and accounting services, marketing expenses and cost of service expenses.  The expected increase in origination revenue is expected to reduce our on-going cash requirements.

Net cash provided by financing activities for the three months ended March 31, 2010 was $6.9 million which consisted of proceeds from the issuance of Lender Notes of $5.9 million, proceeds from the issuance of a long term promissory note of $2.3 million, offset by repayments of Notes of $1.3 million.  Net cash used in financing activities for the year ended March 31, 2009 was $11.8 thousand which consisted solely of proceeds from the exercise of stock options.

In 2006, we entered into a non-interest bearing promissory note in the amount of $380,000 for the purchase of the “Prosper.com” domain name. As of March 31, 2010 the remaining principal balance remaining on the note was $320,000.  A principal payment of $20,000 is due in June 2010 with the remaining principal amount of $300,000 will be due in June 2011.

In November of 2009, we and QED Fund I, L.P. (“QED”), entered into a note and Warrant Purchase Agreement, pursuant to which, Prosper sold to QED a Convertible Promissory Note (the “QED Note’).  The QED Note is in the principal amount of $1,000,000.  Interest on the QED Note accrued at a per annum rate of 15.0%.  All principal and accrued interest under the note were due in a single payment on November 10, 2011.  These amounts were converted into Series D Shares on April 15, as noted below.

On February 1, 2010, we entered into a note and Warrant Purchase Agreement with certain of our existing investors, pursuant to which, we issued and sold to such investors a series of unsecured Convertible Promissory Notes (the “February Bridge Notes”), dated as of February 1, 2010, in the aggregate principal amount of $2,000,000.  Interest on the February Bridge Notes accrues at a per annum rate of 15.0%.  All principal and accrued interest under the February Bridge Notes were due in a single payment on April 1, 2010.  These notes and all accrued interest thereunder were converted into Series D Shares on April 15, as noted below.

 
On March 15, 2010, we entered into a Note Option Agreement (the “Larsen Option Agreement”) with Christian A. Larsen, our Chairman and Chief Executive Officer as well as one of our principal stockholders, pursuant to which, Mr. Larsen granted us an option (the “Option”) to sell him an aggregate principal amount of up to $300,000 of unsecured Convertible Promissory Notes (the “Larsen Bridge Notes”), in $100,000 increments.  On March 22, 2010, we exercised the Option in full and sold to Mr. Larsen, Larsen Bridge Notes in the aggregate principal amount of $300,000.  Interest on the notes accrued at a per annum rate of 15.0%.  All principal and accrued interest under the notes were due in a single payment on April 30, 2010.   These notes and all accrued interest thereunder were paid in full on April 15, 2010, as discussed below.

On April 1, 2010, we entered into a Note Purchase Agreement with certain of our existing investors, pursuant to which, we issued and sold to such investors an additional series of unsecured Convertible Promissory Notes (the “April Bridge Notes”), dated as of April 1, 2010, in the aggregate principal amount of $250,000.  Interest on the April Bridge Notes accrued at a per annum rate of 15.0%.  All principal and accrued interest under the April Bridge Notes was due in a single payment on April 30, 2010.  These notes and all accrued interest thereunder were converted into Series D Shares on April 15, 2010, as discussed below.

On April 15, 2010, we entered into a Stock Purchase Agreement with certain new investors and certain of its existing investors, pursuant to which, Prosper issued and sold to such purchasers (either directly or through certain of their respective affiliates) 20,340,705 Series D shares for an aggregate purchase price of $14.7 million (“Series D Financing”).  

In connection with the consummation of the Series D Financing, (i) pursuant to an amendment to the QED Note entered into by QED and the Company, the QED Note and all accrued interest thereunder was converted into Series D Shares, equal to principal and accrued interest on the QED Note, plus $300,000 which represented consideration for QED’s agreement to convert the QED Note prior to its maturity date; (ii) pursuant to an amendment to each of the February Bridge Notes entered into by the Company and each February Bridge Note purchaser, the maturity date of each February Bridge Note was deferred until the later of April 30, 2010 or the consummation of the Series D Financing; all accrued interest under the February Bridge Notes were subsequently converted into Series D Shares; (iii) the Larsen Bridge Notes and all accrued interest thereunder were paid in full pursuant to the terms thereof; and (iv) each of the April Bridge Notes and all accrued interest thereunder was converted into Series D Shares pursuant to the terms thereof.

Net cash used in investing activities for the three months ended March 31, 2010 was $4.7 million which consisted of $5.9 million of originations of borrower loans, and purchases of property plant and equipment of $144.2 thousand, offset by borrower loan repayments of $1.3 million.  Net cash used in investing activities was $97.1 thousand for the three months ended March 31, 2009, and was comprised solely of purchases of property and equipment.

We have assessed the contingent liability related to prior sales of loans on the platform and has determined that the occurrence of the contingency is reasonably possible but not probable and that contingent liability ranges from $0 in the event the company prevails to a maximum of $63.4 million which represents the remaining outstanding principal amount of $19.9 million and loans charged off of $43.5 million as of March 31, 2010 as discussed in Note 12 of our consolidated financial statements located elsewhere in this report.

Since our inception, inflation and changing prices have not had a material effect on our business and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future.

 
Income Taxes

We incurred no income tax provision for the three months ended March 31, 2010 and 2009.  Given our history of operating losses and inability to achieve profitable operations, it is difficult to accurately forecast how results will be affected by the realization and use of net operating loss carry forwards.

ASC Topic 740, Income Taxes (formerly, SFAS No. 109, Accounting for Income Taxes) provides for the recognition of deferred tax assets if realization of such assets is more likely than not.  Based upon the weight of available evidence, which includes our historical operating performance and the reported cumulative net losses in all prior years, we have provided a full valuation allowance against our net deferred tax assets.  We will continue to evaluate the realizability of the deferred tax assets on a quarterly basis.

Off-Balance Sheet Arrangements

As of March 31, 2010, we have not engaged in any off-balance sheet financing activities.  We do not have any interest in entities referred to as variable interest entities, which include special purpose entities and other structured finance entities.



Additional Information about the Prosper Marketplace Loan Platform
 
Prosper Rating

Each listing is assigned a Prosper Rating. The Prosper Rating is a letter that indicates the level of risk associated with a listing and corresponds to an estimated average annualized loss rate range, or loss rate, for the listing. This rating system allows Prosper to maintain consistency when assigning a rating to the listing. There are currently seven Prosper Ratings, but this, as well as the loss ranges associated with each, may change over time as the marketplace dictates. 

The Prosper Ratings that were in place as of March 31, 2010 and the estimated loss ranges associated with them are as follows:
 
Prosper Rating
 
Est. Avg. Annual Loss Rate
AA
 
0.00% - 1.99 %
A
 
2.00% - 3.99%
B
 
4.00% - 5.99%
C
 
6.00% - 8.99%
D
 
9.00% - 11.99%
E
 
12.00% - 14.99%
HR
 
>=15.00%
 
 The loss rate is based on the historical performance of borrowers on Prosper borrower loans with similar characteristics and is determined by two scores: (1) a custom Prosper score, discussed below, and (2) a credit score obtained from a credit reporting agency (currently, Experian’s Scorex PLUS score). The use of these two scores determines an estimated loss rate for each listing, which then determines the Prosper Rating.

The following table provides an example of how the system works. Each of the two scores is divided into 10 segments and each cell indicates an estimated loss rate based on the intersection of the two scores. The score ranges were chosen based on loss rate differentiation. Estimated net loss rates for the cells in the chart below are based on performance of historical Prosper borrower loans through March 31, 2009, that fall into given cells; cells are combined due to small volumes or similar behavior, or both.  For example, a borrower listing with a Prosper score of 9 and a credit agency score of 715 has an estimated loss rate of 2.1%.  The 2.1% loss rate equates to an “A” Prosper Rating.  The loss rates will be updated at least annually, but no more frequently than quarterly, based on the performance history of the borrower loans.  These are the estimated loss rates that are published on our website as of March 31, 2010. 
 
       
Experian Scorex PLUS Score
 
 
 Prosper Score/ (raw score)
   
600-619
   
620-639
   
640-679
   
680-699
   
700-729
   
730-769
   
770-799
   
800+
 
 1
(35.0-100)
   
34.5
%
 
34.5
%
 
34.5
%
 
34.5
%
 
34.5
%
 
34.5
%
 
34.5
%
 
34.5
%
 2
(28.0-34.99)
   
25
%
 
25
%
 
25
%
 
25
%
 
25
%
 
18
%
 
18
%
 
18
%
 3
(22.0-27.99)
   
25
%
 
25
%
 
25
%
 
25
%
 
18
%
 
18
%
 
18
%
 
18
%
 4
(18.0-21.99)
   
19
%
 
19
%
 
18
%
 
18
%
 
18
%
 
18
%
 
8.5
%
 
6.2