1. Summary of Significant Accounting Policies

The Company

Actuate Software Corporation was incorporated in November 1993 in the State of California and reincorporated in the State of Delaware in July 1998 as Actuate Corporation (“We”, “Actuate” or the “Company”). Actuate enabled solutions help its enterprise customers maximize revenue, cut costs, create more effective customer communications, streamline operations and create competitive advantage. Applications built using Actuate’s products or embed capabilities of Actuate’s products within existing applications have delivered personalized analytics and insights to more than 200 million people. More than 3.5 million developers have downloaded open source BIRT, the open source Eclipse interactive development environment (IDE)-based project founded and co-led by Actuate. Many of these BIRT developers use commercial, value-added products from Actuate to enhance, embed and deploy BIRT-based applications and services to deliver personalized analytics and insights to customers, partners and employees.

Enterprises use Actuate products to create and enhance customer-facing, Big Data analytics and customer communications management (CCM) applications with intuitive and visually-engaging experiences. These applications provide unique insights from multiple data sources, delivered securely across high volume of users and devices with proven scalability to millions of users. Developers use BIRT and BIRT iHub™, (Actuate’s commercial deployment platform for BIRT-based applications), to develop, embed and deploy high scale applications that deliver information personalized for each user to enrich the brand experience and gain competitive advantage. BIRT iHub further ensures organizations can gain effective insights from Big Data and take advantage of mobile touch devices. Actuate’s BIRT Analytics™ delivers self-service predictive analytics to enhance customer engagement from Big Data. Actuate Content Services™ empowers ECM architects to easily transform, personalize and archive high volume content and customer correspondences. Actuate’s goal is to ensure that its customers can seamlessly incorporate information and business analysis into their day-to-day activities and decision-making, enabling organizations to explore new avenues for improving the bottom line. Actuate’s principal executive offices are located at the BayCenter Campus at 951 Mariners Island Boulevard, in San Mateo, California. Actuate’s telephone number is 650-645-3000. Actuate maintains Web sites at www.actuate.com, developer.actuate.com, www.birtondemand.com, www.quiterian.com and www.legodo.com. The information posted on our Web sites is not incorporated into this Form 10-Q.

Basis of Presentation

The Company has prepared the accompanying unaudited condensed consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Pursuant to these rules and regulations, the Company has condensed or omitted certain information and footnote disclosures it normally includes in its annual consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP). In management’s opinion, the Company has made all adjustments (consisting only of normal, recurring adjustments, except as otherwise indicated) necessary to fairly present its financial position, results of operations and cash flows. The Company’s interim period operating results do not necessarily indicate the results that may be expected for any other interim period or for the full fiscal year. These financial statements and accompanying notes should be read in conjunction with the consolidated financial statements and notes thereto in Actuate’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013 filed with the SEC on March 7, 2014.

To prepare financial statements in conformity with GAAP, management must make estimates and assumptions that affect the amounts reported in the unaudited condensed consolidated financial statements and accompanying notes. Actual results could differ from these estimates and may result in material effects on the Company’s operating results and financial position.

The condensed consolidated financial statements include the accounts of Actuate and its wholly-owned subsidiaries. Actuate has offices throughout North America, Europe and Asia including offices in the United States, Canada, Switzerland, United Kingdom, Germany, Spain, Singapore, Japan and Australia. All intercompany balances and transactions have been eliminated.

Revisions of Prior Period Reported Amounts

During the second quarter of 2014, we identified and recorded adjustments associated with certain equity accounts reported in prior periods. The adjustments related entirely to the classification of accounts within shareholders’ equity. Specifically, it affected the classification amongst additional paid-in-capital (“APIC”), retained earnings and Treasury stock accounts for Employee Stock Purchase Plan (ESPP) shares that were previously reissued from Treasury. The reissuance resulted in a cumulative increase of approximately $3.75 million to Treasury stock account for the weighted average cost of the treasury shares reissued, a decrease of approximately $3.47 million to APIC for the reissuance price over cost (net gain) of the ESPP shares and an decrease of approximately $280,000 to retained earnings for the cost over price (net loss) from reissuance of the ESPP shares. Since these accounts are separate components within Stockholders equity, the net overall impact on the Consolidated Balance Sheet was zero for the period presented.

Pursuant to the guidance of SEC Staff Accounting Bulletin (“SAB”) No. 99, Materiality, and SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatement in the Current Year Financial Statements, we concluded that the adjustments were not material to any of our annual or interim periods or the current period.

Revenue Recognition

Actuate generates revenues from the sales of software licenses and related services. The Company receives software license revenues from licensing its products directly to end-users and indirectly through resellers, system integrators and original equipment manufacturers (OEMs). The Company receives service revenues from maintenance contracts, consulting services and training that Actuate performs for customers.

For sales to end-user customers, Actuate recognizes license revenues when a license agreement has been signed by both parties or a definitive agreement has been received from the customer, the product has been physically shipped or electronically made available, there are no unusual uncertainties surrounding the product acceptance, the fees are fixed or determinable, collectability is probable and vendor-specific objective evidence (VSOE) of fair value exists to allocate the fee to the undelivered elements of the arrangement. Vendor-specific objective evidence of fair value of sales to end users is based on the price charged when an element is sold separately.

Actuate has not established vendor-specific objective evidence of fair value for its licenses. Therefore, the Company recognizes revenues from software arrangements with multiple elements involving software licenses under the residual method, which means the fair value of the undelivered elements is deferred while the remaining value of the arrangement is allocated to the delivered elements. If we are unable to determine the fair value of the undelivered elements, it is not possible to allocate revenues separately to the undelivered elements in the arrangement and consequently, the entire amount of the arrangement fee is recognized ratably over the performance period of that undelivered element, assuming all other revenue recognition criteria are satisfied. If the license agreement contains payment terms that would indicate that the fee is not fixed or determinable, revenues are recognized as the payments become due and payable, assuming that all other revenue recognition criteria are met.

Actuate enters into reseller and distributor arrangements that typically give such distributors and resellers the right to distribute its products to end-users headquartered in specified territories. Actuate recognizes license revenues from arrangements with U.S. resellers and distributors when there is persuasive evidence of an arrangement with the reseller or distributor, the product has been shipped, the fees are fixed or determinable, collectability is probable and vendor-specific objective evidence of fair value exists to allocate the fee to the undelivered elements of the arrangement. Actuate recognizes license revenues from arrangements with international resellers and distributors upon receipt of evidence of sell-through and when all other revenue recognition criteria have been met. If it is not practical to obtain evidence of sell-through, the Company defers revenues until the end-user has been identified and cash has been received. In some instances there is a timing difference between when a reseller completes its sale to the end-user and the period in which Actuate receives the documentation required for revenue recognition. Because Actuate delays revenue recognition until the reporting period in which the required documentation is obtained, it may recognize revenue in a period subsequent to the period in which the reseller completes the sale to its end-user.

Actuate also enters into OEM arrangements that provide for license fees based on the bundling or embedding of its products with the OEM’s products. These arrangements generally provide for fixed, irrevocable royalty payments. Actuate recognizes license fee revenues from U.S. and international OEM arrangements when a license agreement has been executed by both parties, the product has been shipped, there are no unusual uncertainties surrounding the product acceptance, the fees are fixed or determinable, collectability is probable and vendor-specific objective evidence of fair value exists to allocate the fee to the undelivered elements of the arrangement.

In addition to licenses sold on a perpetual basis, Actuate also sells its products on a time-based arrangement. In these time-based licensing arrangements, the customer is licensing our products for use only during a specific timeframe. After the expiration of such timeframe, they no longer have the ability to use the product, unless they choose to renew the subscription license. The time-based licenses are sold either as on-premise, or as hosted Software-as-a-Service (SaaS) offerings. The on-premise subscription transactions are broken down into separate license and maintenance components. The license component is typically recognized ratably over the term of the underlying arrangement as license revenue while the maintenance component is recognized ratably over the term of the underlying arrangement in services revenue in the Company’s Condensed Consolidated Statement of Operations. In certain instances, if we are able to establish VSOE and satisfy the stringent criteria governing time based licenses, we may recognize the license revenue component of these on-premise subscriptions entirely at the time of contract execution.

In our SaaS Subscriptions, Actuate hosts and maintains the software on behalf of the customer. Actuate recognizes revenue on these licenses ratably over the term of the underlying arrangement. Revenues from Actuate’s SaaS offerings are reported as services revenue in the Company’s Condensed Consolidated Statement of Operations.

The Company establishes vendor specific objective evidence of fair value for maintenance and support using a “bell-shaped curve” approach for certain types of license transactions, and uses a “stated maintenance renewal” approach for other categories of license transactions. When applying the “bell-shaped curve” approach the Company analyzes all maintenance renewal transactions over the past twelve months for that category of license and plots those data points on a bell-shaped curve to ensure that a high percentage of the data points are within an acceptable margin of the established VSOE rate. This analysis is performed quarterly.

When applying the “stated renewal rate” approach, the Company ensures that the individual license transaction includes a clear and substantive renewal rate explicitly stated in the documentation for the transaction. Furthermore, the Company ensures that it has a practice of consistently renewing those transactions at the contractual rate. This is done by reviewing maintenance renewals on these contracts and making sure that a very high percentage are renewed at the renewal rates stipulated in the contract.

The Company assesses the collectability of fees from end-users based on payment history and current credit profile. When a customer is not deemed credit-worthy, revenues are deferred and recognized upon cash receipt.

Actuate recognizes maintenance revenues, which consist of fees for ongoing support and unspecified product updates, ratably over the term of the contract, typically one year. Consulting revenues are primarily related to standard implementation and configuration. Training revenues are generated from classes offered at the Company’s offices and customer locations. Revenues from consulting and training services are typically recognized as the services are performed. When a contract includes both license and service elements, the license fee is typically recognized on delivery of the software, assuming all other revenue recognition criteria are met, provided services do not include significant customization or modification of the product and are not otherwise essential to the functionality of the software.

Share-Based Compensation

The Company has various types of share-based compensation plans. These plans are administered by the compensation committee of the Board of Directors, which selects persons to receive awards and determines the number of shares subject to each award and the terms, conditions, performance measures and other provisions of the award. Readers should refer to Note 9 of the Company’s consolidated financial statements in the Annual Report on Form 10-K for the fiscal year ended December 31, 2013, for additional information related to these share-based compensation plans. Share-based compensation expense and the related income tax benefit reflected in the Condensed Consolidated Statements of Operations in connection with stock options, restricted stock units, performance-based stock units and the Employee Stock Purchase Plan (“ESPP”) for three and nine months ended September 30, 2014 and 2013 were as follows (in thousands):


	Three Months Ended				Nine Months Ended
	September 30, 2014		September 30, 2013		September 30, 2014		September 30, 2013
Stock options	$	318	$	737	$	1,323	$	2,922
Restricted stock units		1,260		453		3,012		1,287
Performance-based stock units ⁽¹⁾		161		276		498		776
ESPP		172		235		403		807

Total share-based compensation	$	1,911	$	1,701	$	5,236	$	5,792

Income tax benefit	$	576	$	524	$	1,637	$	1,738

(1)	Includes Performance Stock Units (“PSUs”) and market-performance based units (“MSUs”).

In May 2012, MSUs were granted to the Chief Executive Officer (“CEO”) and the Chief Financial Officer (“CFO”) of the Company. Each MSU represents the right to one share of Actuate’s common stock. The actual number of MSUs which will be eligible to vest will be based on the performance of Actuate’s stock price relative to the performance of the Standard & Poor’s (“S&P”) Small Cap 600 Index over a two-year vesting period, up to 200% of the MSUs initially granted. After the initial performance period, 50% of the earned award vests immediately and the remaining 50% is subject to an additional one year service period. We valued the MSUs using the Monte Carlo simulation model and amortize the compensation expense over the three year performance and service period.

In April 2013, additional MSUs were granted to the CEO and the CFO of the Company. The actual number of MSUs which will be eligible to vest will be based on the performance of Actuate’s stock price relative to the performance of the Russell 2000 Index over the vesting period, up to 200% of the MSUs initially granted. The award is divided into two tranches. The first tranche has a two year performance period and the second has a three year performance period.

In April 2014, the CEO and CFO were each granted two PSU awards, each with its own distinct internal, company-wide performance metric. The metric for the first award has a one year performance period to determine the number of earnable shares, up to 100% of the initial grant, followed by a three-year vesting period with one-third vesting at the end of each calendar year. The metric for the second award has a one year performance period to determine the number of earnable shares, up to 150% of the initial grant, followed by a two-year vesting period with half vesting at the end of each calendar year. Vesting for both grants is subject to continued employment with the Company. The PSU awards have a fair value equal to the stock price on the grant date. We amortize the compensation expense over the three or four year performance and service periods if and when achievement of the performance metrics are determined probable.

We estimate the expected term of options granted by analyzing actual historical experience of exercises and cancellations under our plans. We also look at the average length of time in which our current outstanding options are expected to be exercised or cancelled based on past experience and the vesting and contractual term. We estimate the volatility of our common stock by using historical volatility over the expected term. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those previously estimated. Management’s estimate of forfeitures is based on historical experience; however actual forfeitures could differ as a result of employee terminations which may impact future share-based compensation expense. We base the risk-free interest rate used in the option valuation model on the daily Treasury yield curve interest rate published by the U.S. Department of the Treasury. We do not anticipate paying any cash dividends in the foreseeable future and therefore use an expected dividend yield of zero in the option valuation model. The assumptions used to estimate the fair value of stock options and stock purchase rights granted, and our Employee Stock Purchase Plan (the “Purchase Plan”) for the nine months ended September 30, 2014 and 2013 are as follows:


	Options Nine months Ended		ESPP Nine months Ended
	September 30, 2014	September 30, 2013	September 30, 2014	September 30, 2013
Volatility	42.39 – 49.94%	50.03 – 53.58%	21.4 – 62.24%	28.63 – 41.52%
Expected term (years)	5.53 – 5.57	5.61 – 5.67	1.25	1.25
Risk free interest rate	1.62 – 1.78%	0.77 – 1.40%	0.05 – 0.47%	0.08 – 0.35%
Expected dividend yield	0%	0%	0%	0%

Beginning January 2010, restricted stock units (“RSUs”) were granted to senior management as part of the Company’s annual incentive compensation program under the Amended and Restated 1998 Equity Incentive Plan. RSUs are valued based on the closing price of the Company’s common stock on the grant date. In general, restricted stock units vest over four years with annual cliff vesting and are subject to the employees’ continuing service to the Company. For each restricted stock unit granted under the 1998 Plan, a share reserve ratio is applied for the purpose of determining the remaining number of shares reserved for future grants under the plan. The share reserve ratio is 1:1 for each restricted stock unit granted, and an equivalent of 1 share will be deducted from the share reserve for each restricted stock unit issued. Likewise, each forfeited restricted stock unit increases the number of shares available for issuance by the applicable rate at the time of forfeiture.

In the first quarter of 2014 the Company expanded its equity incentive program to grant RSUs in-lieu of stock options to its employees across all levels based on performance. Stock options will continue to be granted as part of the Company’s new hire program.

Performance stock units (“PSUs”) were also granted for the first time to select key employees of the Company in March 2014. PSU vesting is contingent upon meeting certain company-wide performance goals.

As of September 30, 2014, a total of 2,348,750 RSUs and 685,000 performance-based awards have been granted to the Company’s senior management, employees and non-employee Board of Directors.

Net (loss) Income Per Share

The Company computes basic net (loss) income per share using the weighted-average number of common shares outstanding during the period, less weighted average shares subject to repurchase. The Company computes diluted net (loss) income per share using the weighted-average number of common shares and dilutive share-based awards during the period determined by using the treasury stock method.

The table below reconciles the weighted-average common shares used to calculate basic net (loss) income per share with the weighted-average common shares used to calculate diluted net (loss) income per share (in thousands).


	Three Months Ended September 30,				Nine months Ended September 30,
	2014		2013		2014		2013
Weighted-average common shares outstanding		46,883		48,175		47,088		48,046
Weighted-average dilutive common equivalent shares under the treasury stock method		—		3,253		—		2,805

Weighted-average common shares used in computing diluted net (loss) income per share		46,883		51,428		47,088		50,851

Under the treasury stock method, stock options with exercise prices exceeding the average share price of the Company’s common stock during the applicable period are excluded from the diluted earnings per share computation. Additionally, since the Company was in a loss position for the three and nine months ended September 30, 2014, diluted net loss per share is the same as basic net loss per share for each period, as the inclusion of all potential common equivalent shares outstanding would have been anti-dilutive.

The following table sets forth all securities excluded from the computation in the table above because their inclusion would have been either anti-dilutive due to basic net loss per share or dilutive due to the exercise price per share (shares in thousands):


	Three Months Ended September 30,				Nine months Ended September 30,
	2014⁽¹⁾		2013⁽²⁾		2014⁽¹⁾		2013⁽²⁾
Stock Options:
Weighted-average excluded shares		8,202		653		8,464		1,880
Weighted-average exercise price	$	5.25	$	6.16	$	5.25	$	6.01
Awards:
Weighted-average excluded shares		1,650		103		1,324		119

(1)	Common equivalent shares are excluded from the calculation of net loss per share for the three and nine months ended September 30, 2014.

(2)	Anti-dilutive common equivalent shares are excluded from the calculation of diluted net income per share for the three and nine months ended September 30, 2013.

Income Taxes

We provide for the effect of income taxes in our Condensed Consolidated Financial Statements using the asset and liability method which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, net operating loss carryovers, and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date. We also apply a two-step approach to determining the financial statement recognition and measurement of uncertain tax positions.

Income tax expense or benefit is recognized for the amount of taxes payable or refundable for the current year, and for deferred tax assets and liabilities for the tax consequences of events that have been recognized in an entity’s financial statements or tax returns. We must make significant assumptions, judgments and estimates to determine our current provision (benefit) for income taxes, our deferred tax assets and liabilities, and any valuation allowance to be recorded against our deferred tax assets. Our judgments, assumptions and estimates relating to the current provision (benefit) for income taxes include the geographic mix and amount of income (loss), our interpretation of current tax laws, and possible outcomes of current and future audits conducted by foreign and domestic tax authorities. Our judgments also include anticipating the tax positions we will record in the financial statements before actually preparing and filing the tax returns. Our estimates and assumptions may differ from the actual results as reflected in our income tax returns and we record the required adjustments when they are identified or resolved. Changes in our business, tax laws or our interpretation of tax laws, and developments in current and future tax audits, could significantly impact the amounts provided for income taxes in our results of operations, financial position, or cash flows.

Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to tax benefit carry-forwards and to differences between the financial statement amounts of assets and liabilities and their respective tax basis. We regularly review our deferred tax assets for recoverability and establish a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized. To make this assessment, we take into account predictions of the amount and category of taxable income from various sources and all available positive and negative evidence about these possible sources of taxable income. The weight given to the potential effect of negative and positive evidence is commensurate with the extent to which the strength of the evidence can be objectively verified. Based on the analysis of positive and negative factors noted above, we have no valuation allowance against U.S. Federal deferred tax assets. For U.S. states, we have determined that it is more likely than not that the Company’s California research credits will not be realized as we continue to generate credits significantly in excess of our yearly California tax liability. As such, we continue to maintain a full valuation allowance against our excess deferred tax asset for California research credit carry forwards. We maintain a full valuation allowance against deferred tax assets in foreign jurisdictions with a history of losses and a partial valuation allowance in foreign jurisdictions where operating results beyond a certain time frame are less reliable. If, in the future, we determine that these deferred tax assets are more likely than not to be realized, a release of all or part, of the related valuation allowance could result in an income tax benefit in the period such determination is made.

We only recognize an income tax expense or benefit with respect to uncertain tax positions in our financial statements that we judge are more likely than not to be sustained solely on their technical merits in a tax audit, including resolution of any related appeals or litigation processes. To make this judgment, we must interpret complex and sometimes ambiguous tax laws, regulations and administrative practices. If an income tax position meets the more likely than not recognition threshold, then we must measure the amount of the tax benefit to be recognized by determining the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon effective settlement with a taxing authority that has full knowledge of all of the relevant facts. It is inherently difficult and subjective to estimate such amounts, as this requires us to determine the probability of various possible settlement outcomes. To determine if a tax position is effectively settled, we must also estimate the likelihood that a taxing authority would review a tax position after a tax examination has otherwise been completed. We must also determine when it is reasonably possible that the amount of unrecognized tax benefits will significantly increase or decrease in the 12 months after each fiscal year-end. These judgments are difficult because a taxing authority may change its behavior as a result of our disclosures in our financial statements. We must reevaluate our income tax positions on a quarterly basis to consider factors such as changes in facts or circumstances, changes in tax law, effectively settled issues under audit, and new audit activity. Such a change in recognition or measurement would result in recognition of a tax benefit or an additional charge to the tax provision.

Sales Taxes

The Company presents its revenues net of sales tax in its Condensed Consolidated Statements of Operations.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued new accounting guidance related to revenue recognition. This new standard will replace all current GAAP guidance on this topic and eliminate all industry-specific guidance. The new revenue recognition guidance provides a unified model to determine when and how revenue is recognized. The core principle is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration for which the entity expects to be entitled in exchange for those goods or services. This guidance will be effective for Actuate beginning January 1, 2017 and can be applied either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. We are evaluating the impact of adopting this new accounting guidance on our financial statements.

In August 2014, the FASB issued new guidance related to the disclosures around going concern. The new standard provides guidance around management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. The adoption of this standard is not expected to have a material impact on our financial statements.