10-Q 1 gwre-10312016x10q.htm 10-Q Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________________________________
FORM 10-Q
______________________________________________________________
(Mark one)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 2016
OR
¨  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: 001-35394
 ______________________________________________________________
Guidewire Software, Inc.
(Exact name of registrant as specified in its charter)
 ______________________________________________________________
Delaware
36-4468504
(State or other jurisdiction of
Incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
1001 E. Hillsdale Blvd., Suite 800
Foster City, California
94404
(Address of principal executive offices)
(Zip Code)
 
(650) 357-9100
(Registrant’s telephone number, including area code)
 ______________________________________________________________
N/A
(Former name, former address and former fiscal year, if changed since last report)
 ______________________________________________________________
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 x    No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes x     No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. 
Large accelerated filer
 
x
 
Accelerated filer
 
¨
 
 
 
 
Non-accelerated filer
 
¨ (do not check if a smaller reporting company)
 
Smaller reporting company        
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨     No x
On October 31, 2016, the registrant had 73,510,967 shares of common stock issued and outstanding.



Guidewire Software, Inc.
Index


 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
 
 
Item 1.
 
 
 
Item 1A.    
 
 
 
Item 6.
 
 



FORWARD-LOOKING STATEMENTS

The “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section and other parts of this Quarterly Report on Form 10-Q and certain information incorporated herein by reference contain forward-looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934, which are subject to risks and uncertainties. The forward-looking statements include statements concerning, among other things, our business strategy (including anticipated trends and developments in, and management plans for, our business and the markets in which we operate), financial results, results of operations, revenues, gross margins, operating expenses, products, projected costs and capital expenditures, research and development programs, sales and marketing initiatives and competition. In some cases, you can identify these statements by forward-looking words, such as “will,” “may,” “might,” “should,” “could,” “estimate,” “expect,” “suggest,” “believe,” “anticipate,” “intend,” “plan” and “continue,” the negative or plural of these words and other comparable terminology. Actual events or results may differ materially from those expressed or implied by these statements due to various factors, including but not limited to the matters discussed below, in the section titled “Item 1A. Risk Factors,” and elsewhere in this Quarterly Report on Form 10-Q. Many of the forward-looking statements are located in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Examples of forward-looking statements include statements regarding:

growth prospects of the property and casualty (“P&C”) insurance industry and our company;
trends in our future sales, including seasonality;
opportunities for growth by technology leadership;
our market strategy in relation to our competitors;
competitive attributes of our software application solutions;
opportunities to further expand our position outside of the United States;
our research and development investment and efforts;
benefits to be achieved from our acquisitions;
our gross margins and factors that affect gross margins;
our provision for tax liabilities and other critical accounting estimates;
the anticipated timing of implementation of our services or the completion of other projects;
our exposure to market risks, including geographical and political events that may negatively impact our customers; and
our ability to satisfy future liquidity requirements.

Forward-looking statements are not guarantees of future performance and involve risks and uncertainties. The forward-looking statements contained in this Quarterly Report on Form 10-Q are based on information available to us as of the filing date of this Quarterly Report on Form 10-Q and our current expectations about future events, which are inherently subject to change and involve risks and uncertainties. You should not place undue reliance on these forward-looking statements.

We do not undertake any obligation to update any forward-looking statements in this report or in any of our other communications, except as required by law. All such forward-looking statements should be read as of the time the statements were made and with the recognition that these forward-looking statements may not be complete or accurate at a later date.

_____________

Unless the context requires otherwise, we are referring to Guidewire Software, Inc. when we use the terms “Guidewire,” the “Company,” “we,” “our” or “us.”






PART I – Financial Information
 
ITEM 1.
Financial Statements (unaudited)
GUIDEWIRE SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited, in thousands)
 
 
October 31,
2016
 
July 31,
2016
ASSETS
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
131,063

 
$
223,582

Short-term investments
399,279

 
404,655

Accounts receivable
55,132

 
62,792

Prepaid expenses and other current assets
20,019

 
16,643

Total current assets
605,493

 
707,672

Long-term investments
155,856

 
107,565

Property and equipment, net
13,010

 
12,955

Intangible assets, net
28,166

 
14,204

Deferred tax assets, net
45,571

 
31,364

Goodwill
46,343

 
30,080

Other assets
8,955

 
12,338

TOTAL ASSETS
$
903,394

 
$
916,178

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
10,566

 
$
9,929

Accrued employee compensation
19,594

 
41,267

Deferred revenues, current
63,023

 
60,270

Other current liabilities
6,887

 
7,617

Total current liabilities
100,070

 
119,083

Deferred revenues, noncurrent
5,788

 
9,745

Other liabilities
3,317

 
3,415

Total liabilities
109,175

 
132,243

STOCKHOLDERS’ EQUITY:
 
 
 
Common stock
7

 
7

Additional paid-in capital
761,906

 
742,690

Accumulated other comprehensive loss
(7,667
)
 
(6,593
)
Retained earnings
39,973

 
47,831

Total stockholders’ equity
794,219

 
783,935

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
903,394

 
$
916,178

See accompanying Notes to Condensed Consolidated Financial Statements.

3


GUIDEWIRE SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands except share and per share amounts)
 
 
Three Months Ended October 31,
 
2016
 
2015
Revenues:
 
 
 
License and other
$
38,721

 
$
32,340

Maintenance
16,532

 
14,013

Services
38,874

 
35,927

Total revenues
94,127

 
82,280

Cost of revenues:
 
 
 
License and other
2,430

 
1,164

Maintenance
3,325

 
2,475

Services
36,264

 
31,531

Total cost of revenues
42,019

 
35,170

Gross profit:
 
 
 
License and other
36,291

 
31,176

Maintenance
13,207

 
11,538

Services
2,610

 
4,396

Total gross profit
52,108

 
47,110

Operating expenses:
 
 
 
Research and development
30,750

 
25,672

Sales and marketing
25,500

 
19,291

General and administrative
14,160

 
11,110

Total operating expenses
70,410

 
56,073

Loss from operations
(18,302
)
 
(8,963
)
Interest income
1,342

 
696

Other income (expense), net
(681
)
 
217

Loss before income taxes
(17,641
)
 
(8,050
)
Benefit from income taxes
(9,783
)
 
(6,420
)
Net loss
$
(7,858
)
 
$
(1,630
)
Net loss per share:
 
 
 
Basic
$
(0.11
)
 
$
(0.02
)
Diluted
$
(0.11
)
 
$
(0.02
)
Shares used in computing net loss per share:
 
 
 
Basic
73,293,467

 
71,242,897

Diluted
73,293,467

 
71,242,897


                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
See accompanying Notes to Condensed Consolidated Financial Statements.

4


GUIDEWIRE SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(unaudited, in thousands)
 

 
Three Months Ended October 31,
 
2016
 
2015
 
(in thousands)
Net loss
$
(7,858
)
 
$
(1,630
)
Other comprehensive loss:
 
 
 
Foreign currency translation adjustments
(851
)
 
(287
)
Unrealized gains (losses) on available-for-sale securities, net of tax benefit of $134 and $4 for the three months ended October 31, 2016 and 2015, respectively
(196
)
 
(50
)
Reclassification adjustment for realized losses (gains) included in net loss
(27
)
 
(20
)
Other comprehensive loss
(1,074
)
 
(357
)
Comprehensive loss
$
(8,932
)
 
$
(1,987
)

See accompanying Notes to Condensed Consolidated Financial Statements

5


GUIDEWIRE SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
 
 
Three Months Ended October 31,
 
2016
 
2015
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net loss
$
(7,858
)
 
$
(1,630
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization
3,074

 
1,791

Stock-based compensation
17,877

 
15,147

Excess tax benefit from exercise of stock options and vesting of restricted stock units

 
(475
)
Deferred tax assets
(10,502
)
 
(6,905
)
Amortization of premium on available-for-sale securities
463

 
877

Other non-cash items affecting net loss
4

 
18

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
8,682

 
7,638

Prepaid expenses and other assets
191

 
(1,071
)
Accounts payable
902

 
(2,542
)
Accrued employee compensation
(21,300
)
 
(19,840
)
Other liabilities
(1,251
)
 
(1,039
)
Deferred revenues
(3,192
)
 
(2,859
)
Net cash used in operating activities
(12,910
)
 
(10,890
)
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchases of available-for-sale securities
(200,893
)
 
(195,336
)
Sales of available-for-sale securities
157,163

 
188,867

Purchase of property and equipment
(2,474
)
 
(3,016
)
Acquisition of business, net of acquired cash
(33,593
)
 

Net cash used in investing activities
(79,797
)
 
(9,485
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from issuance of common stock upon exercise of stock options
1,112

 
1,463

Taxes remitted on RSU awards vested

 
(874
)
Excess tax benefit from exercise of stock options and vesting of restricted stock units

 
475

Net cash provided by financing activities
1,112

 
1,064

Effect of foreign exchange rate changes on cash and cash equivalents
(924
)
 
(320
)
NET CHANGE IN CASH AND CASH EQUIVALENTS
(92,519
)
 
(19,631
)
CASH AND CASH EQUIVALENTS—Beginning of period
223,582

 
212,362

CASH AND CASH EQUIVALENTS—End of period
$
131,063

 
$
192,731

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
Cash paid for income taxes
$
1,062

 
$
394

SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
Accruals for purchase of property and equipment
$
188

 
$
177



See accompanying Notes to Condensed Consolidated Financial Statements.

6


GUIDEWIRE SOFTWARE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

1.
The Company and Summary of Significant Accounting Policies and Estimates
Business
Guidewire Software, Inc., a Delaware corporation, was incorporated on September 20, 2001. Guidewire Software, Inc., together with its subsidiaries (the “Company”), provides a technology platform which consists of three key elements: core transaction processing, data management and analytics, and digital engagement. It supports core insurance operations, including underwriting and policy administration, claim management and billing, enables new insights into data that can improve business decision making and supports digital sales, service and claims experiences for policyholders, agents, and other key stakeholders. The Company’s customers are primarily insurance carriers for property and casualty insurance.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements and accompanying notes include the Company and its wholly-owned subsidiaries, and reflect all adjustments (all of which are normal and recurring in nature) that, in the opinion of management, are necessary for a fair presentation of the interim periods presented. All inter-company balances and transactions have been eliminated in consolidation. Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) have been condensed or omitted under the rules and regulations of the Securities and Exchange Commission (“SEC”).
These unaudited interim condensed consolidated financial statements should be read in conjunction with the Company’s financial statements and related notes, together with management’s discussion and analysis of financial condition and results of operations, presented in the Company’s Annual Report on Form 10-K for the fiscal year ended July 31, 2016. There have been no changes in the Company’s significant accounting policies from those that were disclosed in the Company’s consolidated financial statements for the fiscal year ended July 31, 2016 included in the Company’s Annual Report on Form 10-K except for the stock-based compensation policy which has been updated to address awards with market conditions in the first quarter of fiscal 2017.
Use of Estimates
The preparation of the accompanying condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions about future events that affect the amounts of assets and liabilities reported, disclosures about contingent assets and liabilities, and reported amounts of revenues and expenses. Significant items subject to such estimates include, but are not limited to, revenue recognition, the useful lives of property and equipment and intangible assets, allowance for doubtful accounts, valuation allowance for deferred tax assets, stock-based compensation, annual bonus attainment, income tax uncertainties, valuation of goodwill and intangible assets, and contingencies. These estimates and assumptions are based on management’s best estimates and judgment. Management regularly evaluates its estimates and assumptions using historical experience and other factors; however, actual results could differ significantly from these estimates.
Cash and Cash Equivalents
Cash and cash equivalents are comprised of cash and highly liquid investments with remaining maturities of 90 days or less at the date of purchase. Cash equivalents consist of commercial paper and money market funds.
Investments

 Management determines the appropriate classification of investments at the time of purchase based upon management’s intent with regard to such investments. All investments are held as available-for-sale investments. 

The Company classifies investments as short-term when they have remaining contractual maturities of one year or less from the balance sheet date, and as long-term when the investments have remaining contractual maturities of more than one year from the balance sheet date. All investments are recorded at fair value with unrealized holding gains and losses included in accumulated other comprehensive income (loss).

7


Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash, cash equivalents, investments and accounts receivable. The Company maintains its cash, cash equivalents and investments with high quality financial institutions. The Company is exposed to credit risk for cash held in financial institutions in the event of a default to the extent that such amounts recorded on the balance sheet are in excess of amounts that are insured by the Federal Deposit Insurance Corporation (“FDIC”).
No customer individually accounted for 10% or more of the Company’s revenues for the three months ended October 31, 2016 or 2015. One customer individually accounted for 10% or more of the Company’s total accounts receivable as of October 31, 2016. No customer individually accounted for 10% or more of the Company’s total accounts receivable as of July 31, 2016.
Revenue Recognition
The Company enters into arrangements to deliver multiple products or services (multiple-elements). The Company applies software revenue recognition rules and allocates the total revenues among elements based on vendor-specific objective evidence (“VSOE”) of fair value of each element. The Company recognizes revenue on a net basis excluding indirect taxes, such as sales tax and value added tax collected from customers and remitted to government authorities.
Revenues are derived from three sources:
(i)
License fees related to term (or time-based) licenses, perpetual software licenses, and other software subscription models including those from recently acquired companies;
(ii)
Maintenance fees related to email and phone support, bug fixes and unspecified software updates and upgrades released when, and if, available during the maintenance term; and
(iii)
Services fees from professional services related to the implementation of the Company’s software, reimbursable travel and training.
Revenues are recognized when all of the following criteria are met:
Persuasive evidence of an arrangement exists. Evidence of an arrangement consists of a written contract signed by both the customer and management prior to the end of the period.
Delivery or performance has occurred. The Company’s software is delivered electronically to the customer. Delivery is considered to have occurred when the Company provides the customer access to the software along with login credentials.
Fees are fixed or determinable. The Company assesses whether a fee is fixed or determinable at the outset of the arrangement, primarily based on the payment terms associated with the transaction. Fees from term licenses are invoiced in annual or quarterly installments over the term of the agreement beginning on the effective date of the license. A significant majority are invoiced annually. Perpetual license fees are generally due between 30 and 60 days from delivery of software. Generally, the Company offers extended payment terms to its customers for term licenses. As a result, term license fees are not considered to be fixed and determinable until they become due or payment is received.
Collectability is probable. Collectability is assessed on a customer-by-customer basis, based primarily on creditworthiness as determined by credit checks and analysis, as well as customer payment history. Payment terms generally range from 30 to 90 days from invoice date. If it is determined prior to revenue recognition that collection of an arrangement fee is not probable, revenues are deferred until collection becomes probable or cash is collected, assuming all other revenue recognition criteria are satisfied.
VSOE of fair value does not exist for the Company’s software licenses; therefore, the Company allocates revenues to software licenses using the residual method. Under the residual method, the amount recognized for license fees is the difference between the total fixed and determinable fees and the VSOE of fair value for the undelivered elements under the arrangement.
The VSOE of fair value for elements of an arrangement is based upon the normal pricing and discounting practices for those elements when sold separately. VSOE of fair value for maintenance is established using the stated maintenance renewal rate in the customer’s contract. For term licenses with duration of one year or less, no VSOE of fair value for maintenance exists. VSOE of fair value for services is established if a substantial majority of historical stand-alone selling prices for a service fall within a reasonably narrow price range.
If the undelivered elements are all service elements and VSOE of fair value does not exist for one or more service element, the total arrangement fee is recognized ratably over the longest service period starting at software delivery, assuming all the related services have been made available to the customer.

8



Substantially all of the Company’s professional services engagements are billed on a time and materials basis. Services are typically not considered to be essential to the functionality of the software and the related revenues and costs are recognized in the period incurred.
    
In select situations, the Company will contract its professional services on a fixed fee basis. In these situations, if reliable estimates of total project costs are available, the Company recognizes services revenues on a proportional performance basis as the performance obligations are completed by using the ratio of labor hours to date as an input measure compared to total estimated labor hours for the consulting services.
    
If reliable estimates of total project costs cannot be made, the zero gross margin or the completed contract method is applied to revenues and direct costs. Under the zero gross margin method, revenues recognized are limited to the direct costs incurred for the implementation services. Under the completed contract method, revenues and direct costs are deferred until the project is complete. When the zero gross margin method is applied for lack of reliable project estimates and subsequently project estimates become reliable, the Company switches to the percentage-of-completion method, resulting in a cumulative effect adjustment for deferred license revenues to the extent of progress toward completion, and the related portion of the deferred professional service margin is recognized in full as revenues.
    
In cases where professional services are deemed to be essential to the functionality of the software, the arrangement is accounted for using contract accounting until the essential services are complete. If reliable estimates of total project costs can be made, the Company applies the percentage-of-completion method whereby percentage toward completion is measured by using the ratio of service billings to date compared to total estimated service billings for the consulting services. Service billings approximate labor hours as an input measure since they are generally billed monthly on a time and material basis. The fees related to the maintenance are recognized over the period the maintenance is provided.
The Company sells some of its products on a subscription or software-as-a-service (“SaaS”) basis, and the related revenues are recognized ratably over the contract term.
As noted above, the Company generally invoices fees for licenses and maintenance to its customers in annual or quarterly installments payable in advance. Deferred revenues represent amounts, which are billed to or collected from creditworthy customers for which one or more of the revenue recognition criteria have not been met. The deferred revenues balance does not represent the total contract value of annual or multi-year, non-cancellable arrangements.

Income Taxes
Income taxes are accounted for under the asset and liability method. Under this method, the Company determines deferred tax assets and liabilities on the basis of the differences between the financial statement carrying amounts of existing assets and liabilities by using enacted tax rates in effect for the year in which the difference is expected to reverse. All deferred tax assets and liabilities are classified as non-current. Deferred tax assets related to excess tax benefits are recorded when utilized. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance against deferred tax assets is recorded when it is more likely than not that some portion or all of such deferred tax assets will not be realized and is based on the positive and negative evidence about the future including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, and results of recent operations.
The effective tax rate in any given financial statement period may differ materially from the statutory rate. These differences may be caused by changes in the mix and level of income or losses, changes in the expected outcome of audits, change in tax regulations, or changes in the deferred tax valuation allowance.
The Company records interest and penalties related to unrecognized tax benefits as income tax expense in its condensed consolidated statement of operations.
Stock-Based Compensation

The Company accounts for stock-based compensation using the fair value method, which requires the Company to measure the stock-based compensation based on the grant-date fair value of the awards and recognize the compensation expense over the requisite service period. The Company recognizes compensation expense net of estimated forfeitures. To date, the Company has granted stock options, time-based restricted stock units (“RSUs”), performance-based restricted stock units (“PSUs”), and beginning in the first quarter of fiscal 2017, restricted stock units that may be earned subject to the Company’s total shareholder return ranking relative to the software companies in the S&P Software and Services Select Industry Index for

9


a specified performance period or specified performance periods, time-based, and in select cases, subject to certain performance conditions (“TSR PSUs”).
The fair value of the Company’s RSUs and PSUs equals the market value of the Company’s common stock on the date of grant. These awards are subject to time-based vesting, which generally occurs over a period of four years. The Company recognizes compensation expense for awards which contain only service conditions on a straight-line basis over the requisite service period, which is generally the vesting period of the respective awards. The Company recognizes the compensation cost for awards which contain either performance condition, market conditions, or both using the graded method.
The fair value of the Company’s TSR PSUs are estimated at the grant date using a Monte Carlo simulation method. The assumptions utilized in this simulation require judgments and estimates. Changes in these inputs and assumptions could affect the measurement of the estimated fair value of the related compensation expense. Compensation expense associated with these TSR PSUs will be recognized regardless of whether the market condition is ultimately satisfied, however, the expense will be reversed if a grantee terminates prior to satisfying the requisite service period. For TSR PSUs containing an additional performance condition, a portion of the expense will fluctuate depending on the achievement of the performance conditions. All TSR PSUs will vest at the end of a three-year period.
The fair value of each stock option award is estimated on the grant date using the Black-Scholes option-pricing model and is recognized on a straight-line basis over the applicable service period. The assumptions utilized in the option pricing model are expected term, expected volatility, risk-free interest rate and expected dividend. Each of these assumptions generally requires judgment to determine. Changes in these inputs and assumptions could affect the measurement of the estimated fair value of the related compensation expense.
Business Combinations, Intangible Assets and Goodwill Impairment

The Company uses its best estimates and assumptions to assign fair value to the tangible and intangible assets acquired and liabilities assumed at the acquisition date. Goodwill is calculated as the difference between the acquisition-date fair value of the consideration transferred and the values assigned to the assets acquired and liabilities assumed. The Company’s estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and subject to refinement and, as a result, actual results may differ from estimates. During the measurement period, which may be up to one year from the acquisition date, if new information is obtained about facts and circumstances that existed as of the acquisition date, the Company may record adjustments to the fair value of these assets and liabilities, with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the fair value of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to the Company’s consolidated statements of operations.
The Company evaluates its acquired intangible assets for indicators of possible impairment when events or changes in circumstances indicate that the carrying amount of certain assets may not be recoverable. Impairment exists if the carrying amounts of such assets exceed the estimates of future net undiscounted cash flows expected to be generated by such assets. Should impairment exist, the impairment loss would be measured based on the excess carrying value of the assets over the estimated fair value of the assets.
The Company tests goodwill for impairment annually during the fourth quarter of each fiscal year and in the interim whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The Company evaluates qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. In performing the qualitative assessment, the Company considers events and circumstances, including but not limited to, macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, changes in management or key personnel, changes in strategy, changes in customers, changes in the composition or carrying amount of a reporting unit’s net assets and changes in the price of the Company’s common stock. If, after assessing the totality of events or circumstances, the Company determines that it is more likely than not that the fair value of a reporting unit is greater than its carrying amount, then the two-step goodwill impairment test is not performed.
In assessing impairment on the Company’s goodwill, the Company first analyzes qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. The qualitative factors the Company assesses include long-term prospects of its performance, share price trends and market capitalization, and Company specific events. If the Company concludes it is more likely than not that the fair value of a reporting unit exceeds its carrying amount, the Company does not need to perform the two-step impairment test. If based on that qualitative assessment, the Company believes it is more likely than not that the fair value of the reporting unit is less than its carrying value, a two-step goodwill impairment test will be performed. The first step measures for impairment by applying fair value-based tests at the reporting unit level. The second step (if necessary) measures the amount of impairment by applying fair value-based tests to the individual assets and liabilities

10


within each reporting unit. Reporting units are determined by the components of operating segments that constitute a business for which (1) discrete financial information is available, (2) segment management regularly reviews the operating results of that component, and (3) whether the component has dissimilar economic characteristics to other components. The Company determined that it was more likely than not that the fair value of its reporting unit exceeded its carrying amount and, as such, the Company did not need to perform the two-step impairment test.

Recent Accounting Pronouncements
Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments

In August 2016, the FASB issued ASU. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (ASU 2016-15), which clarifies how companies present and classify certain cash receipts and cash payments in the statement of cash flows. The standard is effective for public business entities for annual reporting years beginning after December 15, 2017, and interim periods within that reporting period. Early adoption is permitted. The Company is currently evaluating the impact of adopting this new accounting guidance on its consolidated financial statements.

Improvements on Employee Share-Based Payment Accounting

In March 2016, the FASB issued Accounting Standards Update No. 2016-09, “Improvements on Employee Share-Based Payment Accounting (Topic 718)” (“ASU 2016-09”), which simplifies several aspects of the accounting for employee share-based payment transactions for both public and nonpublic entities, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The new standard is effective for annual periods beginning after December 15, 2016 and interim periods within those years. Early adoption is permitted. The standard will be effective for the Company beginning August 1, 2017. The Company is currently evaluating the impact to its consolidated financial statements.
Accounting for Leases

In February 2016, the FASB issued Accounting Standards Update No. 2016-02, “Leases (Topic 842)” (“ASU 2016-02”), which requires lessees to put most leases on their balance sheets but recognize the expenses on their income statements in a manner similar to current practice. ASU 2016-02 states that a lessee would recognize a lease liability for the obligation to make lease payments and a right-to-use asset for the right to use the underlying asset for the lease term. The new standard is effective for annual periods beginning after December 15, 2018 and interim periods within those years. Early adoption is permitted. The standard will be effective for the Company beginning August 1, 2019. The Company is currently evaluating the impact to its consolidated financial statements.
Revenue from Contracts with Customers
In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)”, which provides guidance for revenue recognition. This ASU affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of non-financial assets. This ASU will supersede the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance. In August 2015, the FASB issued ASU No. 2015-14 which deferred the effective date to annual reporting periods and interim periods within fiscal years beginning after December 15, 2017. Early adoption is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period.
Subsequently, the FASB issued ASU No. 2016-08, Principal Versus Agent Consideration (or Reporting Revenue Gross versus Net) in March 2016, ASU No. 2016-10, Identifying Performance Obligations and Licensing in April 2016, and ASU No. 2016-12, Narrow-Scope Improvements and Practical Expedients in May 2016. These amendments clarified certain aspects of Topic 606 and have the same effective date as ASU 2014-09.
The Company will adopt the guidance on August 1, 2018 and currently intends to select the cumulative effect transition method. In evaluating the potential impacts that this guidance will have on its revenue recognition practices, the Company has begun to revise its contracting practices primarily by shortening the initial non-refundable term of its licenses. The Company continues to evaluate the other potential impacts that this guidance will have on its consolidated financial statements.

11


2.
Fair Value of Financial Instruments
Available-for-sale investments within cash equivalents and investments consist of the following:
 
October 31, 2016
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
 
(in thousands)
U.S. agency securities
$
47,024

 
$
18

 
$
(16
)
 
$
47,026

Commercial paper
168,359

 
13

 
(27
)
 
168,345

Corporate bonds
290,812

 
150

 
(131
)
 
290,831

U.S. government bonds
82,273

 
18

 
(21
)
 
82,270

Foreign government bonds
2,418

 
1

 

 
2,419

Certificates of deposit
22,500

 
9

 

 
22,509

Money market funds
41,307

 
1

 

 
41,308

     Total
$
654,693

 
$
210

 
$
(195
)
 
$
654,708

 
July 31, 2016
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
 
(in thousands)
U.S. agency securities
$
58,070

 
$
30

 
$
(12
)
 
$
58,088

Commercial paper
152,317

 
12

 
(6
)
 
152,323

Corporate bonds
274,656

 
321

 
(38
)
 
274,939

U.S. government bonds
90,593

 
58

 
(2
)
 
90,649

Foreign government bonds
2,418

 
9

 

 
2,427

Money market funds
114,833

 

 

 
114,833

Total
$
692,887

 
$
430

 
$
(58
)
 
$
693,259

The following table shows the gross unrealized losses and fair value of the Company’s investments with unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:
 
October 31, 2016
 
Less Than 12 Months
 
12 Months or Greater
 
Total
 
Fair Value
 
Gross Unrealized Losses
 
Fair Value
 
Gross Unrealized Losses
 
Fair Value
 
Gross Unrealized Losses
 
(in thousands)
Commercial paper
$
61,065

 
$
(27
)
 
$

 
$

 
$
61,065

 
$
(27
)
U.S. agency securities
9,552

 
(16
)
 

 

 
9,552

 
(16
)
Corporate bonds
153,172

 
(128
)
 
3,253

 
(3
)
 
156,425

 
(131
)
U.S. government bonds
38,721

 
(21
)
 

 

 
38,721

 
(21
)
     Total
$
262,510

 
$
(192
)
 
$
3,253

 
$
(3
)
 
$
265,763

 
$
(195
)

As of October 31, 2016, the Company had 106 investments in a gross unrealized loss position. The unrealized losses on its available-for-sale securities were primarily a result of changes in interest rates subsequent to the initial purchase of these securities. The Company does not intend to sell, nor believe it will need to sell, these securities before recovering the associated unrealized losses. The Company does not consider any portion of the unrealized losses at October 31, 2016 to be an other-than-temporary impairment, nor are any unrealized losses considered to be credit losses. The Company has recorded the securities at

12


fair value in its condensed consolidated balance sheets, with unrealized gains and losses reported as a component of accumulated other comprehensive loss. The amounts of realized gains and losses reclassified into earnings are based on the specific identification of the securities sold. The realized gains and losses from sales of securities in the periods presented were not significant.
The following table summarizes the contractual maturities of the Company’s investments measured at fair value as of October 31, 2016: 
 
Less Than 12 Months
 
12 to 36 Months
 
Total
 
(in thousands)
U.S. agency securities
$
29,957

 
$
17,069

 
$
47,026

Commercial paper
168,345

 

 
168,345

Corporate bonds
196,192

 
94,639

 
290,831

U.S. government bonds
40,541

 
41,729

 
82,270

Foreign government bonds

 
2,419

 
2,419

Money market funds
41,308

 

 
41,308

Certificates of deposit
22,509

 

 
22,509

     Total
$
498,852

 
$
155,856

 
$
654,708

 
Fair Value Measurement
The current accounting guidance for fair value measurements defines a three-level valuation hierarchy for disclosures as follows:
Level 1—Unadjusted quoted prices in active markets for identical assets or liabilities;
Level 2—Inputs other than quoted prices included within Level 1 that are observable, unadjusted quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data; and
Level 3—Unobservable inputs that are supported by little or no market activity, which require the Company to develop its own assumptions.

13


The following tables summarize the Company’s financial assets measured at fair value on a recurring basis, by level within the fair value hierarchy as of October 31, 2016 and July 31, 2016:
 
October 31, 2016
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 (in thousands)
Assets
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
     Commercial paper
$

 
$
58,265

 
$

 
$
58,265

     Money market funds
41,308

 

 

 
41,308

Short-term investments:
 
 
 
 
 
 
 
     U.S. agency securities

 
29,957

 

 
29,957

     Commercial paper

 
110,080

 

 
110,080

     U.S. government bonds

 
40,541

 

 
40,541

     Corporate bonds

 
196,192

 

 
196,192

Certificates of deposit

 
22,509

 

 
22,509

Long-term investments:
 
 
 
 
 
 
 
     U.S. agency securities

 
17,069

 

 
17,069

     Corporate bonds

 
94,639

 

 
94,639

     U.S. government bonds

 
41,729

 

 
41,729

Foreign government bonds

 
2,419

 

 
2,419

       Total assets
$
41,308

 
$
613,400

 
$

 
$
654,708


 
July 31, 2016
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 (in thousands)
Assets
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
     Commercial paper
$

 
$
66,206

 
$

 
$
66,206

     Money market funds
114,833

 

 

 
114,833

Short-term investments:
 
 
 
 
 
 
 
     U.S. agency securities

 
51,539

 

 
51,539

     Commercial paper

 
86,117

 

 
86,117

U. S. government bonds

 
61,565

 

 
61,565

     Corporate bonds

 
205,434

 

 
205,434

Long-term investments:
 
 
 
 
 
 
 
     U.S. agency securities

 
6,549

 

 
6,549

     Corporate bonds

 
69,505

 

 
69,505

     U.S. government bonds

 
29,084

 

 
29,084

Foreign government bonds

 
2,427

 

 
2,427

Total assets
$
114,833

 
$
578,426

 
$

 
$
693,259

The Company’s equity investment in a privately-held company was accounted for under the cost method of accounting, and reported in long term other assets on the Company’s condensed consolidated balance sheet. The fair value of the investment is not readily available as there is no quoted market prices for the investment. The Company assesses the investment for impairment when events or changes in circumstances indicate that its carrying amount may not be recoverable. As of October 31, 2016 and July 31, 2016, the investment with a carrying value of $6.0 million was not impaired.

14


3.
Acquisition
    
On August 31, 2016, the Company acquired all of the outstanding equity interests of FirstBest Systems, Inc.(“FirstBest”), a privately-held provider of underwriting management systems and related applications to P&C insurers. Total consideration for the transaction was $37.8 million which included amounts placed into escrow to cover future potential claims. The Company believes that the acquisition will enable the expansion of its insurance platform by providing insurers in the U.S. and Canada writing complex commercial, specialty, and workers’ compensation lines greater support for their risk assessment and decision-making processes. Total acquisition costs of $1.2 million were expensed as incurred and recorded as general and administrative expenses in the accompanying condensed consolidated statement of operations, of which, $0.9 million were expensed as incurred during the three months ended October 31, 2016 and $0.3 million were expensed as incurred in the prior fiscal year.
The transaction was accounted for as a business combination. As part of the preliminary purchase price allocation, the Company determined that FirstBest’s separately identifiable intangible assets were developed technology, customer contracts and related relationships, and order backlog. The Company measured fair values of the intangible assets by applying the income and relief from royalty approach. These fair value measurements were based on significant inputs that were not observable in the market and thus represents a Level 3 measurement. The valuation models were based on estimates of future operating projections of the acquired business and rights to sell new products containing the acquired technology as well as judgments on the discount rates used and other variables. The Company developed forecasts based on a number of factors including future revenue and operating cost projections, a discount rate that is representative of the weighted average cost of capital, in addition to royalty and long-term sustainable growth rates based on market analysis. The Company is amortizing the acquired intangible assets over their estimated useful lives.
The allocation of the purchase price is preliminary pending the final valuation of intangible assets, certain acquired deferred tax assets and completion of certain statutory tax filing requirements and is therefore subject to potential future measurement period adjustments. Preliminary allocation of the purchase consideration was as follows:
 
 
Total Purchase Price Allocation
 
Estimated Useful Lives
 
 
(in thousands)
 
(in years)
Acquired assets, net of assumed liabilities
 
$
2,518

 

Developed technology
 
8,000

 
5
Customer contracts and related relationships
 
6,500

 
9
Order backlog
 
900

 
3
Deferred tax assets, net
 
3,651

 

Goodwill
 
16,263

 

Total purchase price
 
$
37,832

 
 
The goodwill of $16.3 million arising from the acquisition consists largely of the acquired workforce, the expected company-specific synergies and the opportunity to expand the Company’s customer base. None of the goodwill recognized is expected to be deductible for income tax purposes.
The results of FirstBest’s operations since the date of acquisition were included in the Company’s results of operations for the fiscal quarter ended October 31, 2016, and were not material. The pro forma results of operations have not been presented because the effects of the business combination were not material to the Company’s consolidated results of operations.

15


4. Balance Sheet Components
Property and Equipment, net
Property and equipment consist of the following:
 
October 31, 2016
 
July 31, 2016
 
(in thousands)
Computer hardware
$
20,218

 
$
19,257

Software
5,263

 
5,066

Furniture and fixtures
3,570

 
3,492

Leasehold improvements
8,394

 
8,434

      Total property and equipment
37,445

 
36,249

Less accumulated depreciation
(24,435
)
 
(23,294
)
      Property and equipment, net
$
13,010

 
$
12,955

As of October 31, 2016 and July 31, 2016, no property and equipment was pledged as collateral. Depreciation expense was $1.6 million and $1.4 million for the three months ended October 31, 2016 and 2015, respectively.
Goodwill and Intangible Assets
The following table presents changes in the carrying amount of goodwill for the period presented:
 
Total
 
(in thousands)
Goodwill, July 31, 2016
$
30,080

Addition - FirstBest acquisition
16,263

Goodwill, October 31, 2016
$
46,343

The Company’s intangible assets are amortized over the estimated useful lives. Intangible assets consist of the following:
 
October 31, 2016
 
July 31, 2016
 
(in thousands)
 
Cost
 
Accumulated Amortization
 
Net Book Value
 
Cost
 
Accumulated Amortization
 
Net Book Value
Amortized intangible assets:
 
 
 
 
 
 
 
 
 
 
 
Acquired technology
$
21,900

 
$
6,245

 
$
15,655

 
$
13,900

 
$
5,199

 
$
8,701

Customer contracts and related relationships
11,000

 
412

 
10,588

 
4,500

 
167

 
4,333

Partner relationships
200

 
13

 
187

 
200

 
8

 
192

Order backlog
2,000

 
264

 
1,736

 
1,100

 
122

 
978

Total
$
35,100

 
$
6,934

 
$
28,166

 
$
19,700

 
$
5,496

 
$
14,204


16


Amortization expense was $1.4 million and $0.4 million for the three months ended October 31, 2016 and 2015, respectively. As of October 31, 2016, the estimated aggregate amortization expense for each of the next five fiscal years is as follows:
 
Future Amortization
 
(in thousands)
Fiscal year ending July 31,
 
2017 (remainder of fiscal year)
$
4,970

2018
6,305

2019
5,064

2020
3,986

2021
2,844

Thereafter
4,997

Total
$
28,166

Accrued Employee Compensation
Accrued employee compensation expense consists of the following:
 
October 31, 2016
 
July 31, 2016
 
(in thousands)
 Accrued bonuses
$
5,524

 
$
24,872

 Accrued commission
576

 
2,571

 Accrued vacation
9,522

 
9,067

 Accrued payroll taxes and benefits
3,972

 
4,757

     Total
$
19,594

 
$
41,267


Deferred Revenues
Deferred revenues, current and non-current, consist of the following:
 
October 31, 2016
 
July 31, 2016
 
(in thousands)
Deferred license and other revenues
$
22,672

 
$
19,841

Deferred maintenance revenues
30,881

 
38,928

Deferred services revenues
15,258

 
11,246

     Total
$
68,811

 
$
70,015


Deferred services revenues included $9.9 million and $5.1 million of deferred services revenues related to one customer engagement as of October 31, 2016 and July 31, 2016, respectively.

17


Accumulated Other Comprehensive Loss
Changes in accumulated other comprehensive loss by component during the three months ended October 31, 2016 were as follows:
 
Foreign Currency Translation Adjustments
 
Unrealized Gain (Loss) on Available-for-Sale Securities
 
Total
 
(in thousands)
Balance as of July 31, 2016
$
(6,809
)
 
$
216

 
$
(6,593
)
Other comprehensive gain (loss) before reclassification
(851
)
 
(330
)
 
(1,181
)
Amounts reclassified from accumulated other comprehensive loss to earnings

 
(27
)
 
(27
)
Tax effect

 
134

 
134

Balance as of October 31, 2016
$
(7,660
)
 
$
(7
)
 
$
(7,667
)
5. Net Loss Per Share
The following table sets forth the computation of the Company’s basic and diluted net income loss per share for the periods presented: 
 
Three Months Ended October 31,
 
2016
 
2015
 
(in thousands, except share and per share amounts)
Numerator:
 
 
 
   Net loss 
$
(7,858
)
 
$
(1,630
)
Net loss per share:
 
 
 
   Basic
$
(0.11
)
 
$
(0.02
)
   Diluted
$
(0.11
)
 
$
(0.02
)
Denominator:
 
 
 
Weighted average shares used in computing net loss per share:
 
 
 
   Basic
73,293,467

 
71,242,897

   Diluted
73,293,467

 
71,242,897


The following weighted shares outstanding of potential common stock were excluded from the computation of diluted loss per share for the periods presented because including them would have been antidilutive:
 
Three Months Ended October 31,
 
2016
 
2015
Stock options to purchase common stock
1,054,183

 
1,573,487

Restricted stock units
3,078,219

 
3,360,099

6.Commitments and Contingencies
There has been no material change in the Company’s contractual obligations and commitments other than in the ordinary course of business since the Company’s fiscal year ended July 31, 2016. See the Annual Report on Form 10-K for the fiscal year ended July 31, 2016 for additional information regarding the Company’s contractual obligations.

Leases
The Company leases certain facilities and equipment under operating leases. On December 5, 2011, the Company entered into a seven-year lease for a facility to serve as its corporate headquarters, located in Foster City, California, for approximately

18


97,674 square feet of space which commenced on August 1, 2012. In connection with this lease, the Company opened an unsecured letter of credit with Silicon Valley Bank for $1.2 million. On July 1, 2015, the unsecured letter of credit was reduced to $0.4 million in accordance with the lease agreement.
Lease expense for all worldwide facilities and equipment, which is being recognized on a straight-line basis over terms of the various leases, was $1.6 million and $1.4 million for the three months ended October 31, 2016 and 2015, respectively.

Letters of Credit
The Company had two outstanding letters of credit required to secure contractual commitments and prepayments as of October 31, 2016 and July 31, 2016, respectively. In addition to the unsecured letter of credit for the building lease, the Company had an unsecured letter of credit agreement related to a customer arrangement for Polish Zloty 10.0 million (approximately $2.5 million as of October 31, 2016) to secure contractual commitments and prepayments. No amounts were outstanding under the Company’s unsecured letters of credit as of October 31, 2016 or July 31, 2016.
Legal Proceedings
From time to time, the Company is involved in various legal proceedings and receives claims, arising from the normal course of business activities. Although the outcomes of legal proceedings are inherently difficult to predict, the Company is not currently involved in any legal proceeding in which the outcome, in the Company’s judgment based on information currently available, is likely to have a material adverse effect on the Company’s business or financial position. The Company accrues for estimated losses in the accompanying condensed consolidated financial statements for matters with respect to which the Company believes the likelihood of an adverse outcome is probable and the amount of the loss is reasonably estimable. There is no such accrual as of October 31, 2016 or July 31, 2016.
Indemnification
The Company sells software licenses and services to its customers under contracts (“Software License”). Each Software License contains the terms of the contractual arrangement with the customer and generally includes certain provisions for defending the customer against any claims that the Company’s software infringes upon a patent, copyright, trademark, or other proprietary right of a third party. Software Licenses also indemnify the customer against losses, expenses, and liabilities from damages that may be assessed against the customer in the event the Company’s software is found to infringe upon such third party rights.
The Company has not had to reimburse any of its customers for losses related to indemnification provisions and no material claims against the Company were outstanding as of October 31, 2016 or July 31, 2016. For several reasons, including the lack of prior indemnification claims and the lack of a monetary liability limit for certain infringement cases under various Software Licenses, the Company cannot estimate the amount of potential future payments, if any, related to indemnification provisions.
The Company has also agreed to indemnify its directors and executive officers for costs associated with any fees, expenses, judgments, fines and settlement amounts incurred by any of these persons in any action or proceeding to which any of these persons is, or is threatened to be, made a party by reason of the person’s service as a director or officer, including any action by the Company, arising out of that person’s services as the Company’s director or officer or that person’s services provided to any other company or enterprise at the Company’s request. The Company maintains director and officer insurance coverage that may enable the Company to recover a portion of any future amounts paid.

19


7.Stockholders’ Equity and Stock-Based Compensation
Stock-Based Compensation Expense
Stock-based compensation expense related to stock-based awards is included in the Company’s condensed consolidated statements of operations as follows:
 
 
Three Months Ended October 31,
 
2016
 
2015
 
(in thousands)
Total cost of stock-based compensation
$
18,104

 
$
15,147

Amount capitalized in deferred cost of services revenues during the year
(227
)
 

Amount charged to income
$
17,877

 
$
15,147


 
 
 
Stock-based compensation cost charged to the following expense categories:
 
 
 
 Cost of license revenues
$
51

 
$
89

 Cost of maintenance revenues
413

 
339

 Cost of services revenues
4,695

 
4,363

 Research and development
4,467

 
3,672

 Sales and marketing
4,223

 
3,430

 General and administrative
4,028

 
3,254

 Total stock-based compensation expenses
$
17,877

 
$
15,147



As of October 31, 2016, total unamortized stock-based compensation cost, adjusted for estimated forfeitures, was as follows:
 
 As of October 31, 2016
 
Unrecognized Expense
 
Weighted Average Expected Recognition Period
 
(in thousands)
 
(in years)
 Stock options
$
2,131

 
1.6
 Restricted stock units
152,871

 
2.7
 
$
155,002

 
 


20


Restricted Stock Units

A summary of the Company’s RSU, PSU and TSR PSU activity under the Company’s equity incentive plans is as follows:
 
 RSUs Outstanding
 
 Number of RSUs Outstanding
 
 Weighted Average Grant Date Fair Value
 
 Aggregate Intrinsic Value (in thousands) (1)
Balance as of July 31, 2016
2,727,724

 
$
50.08

 
$
167,673

Granted
1,128,702

 
$
61.90

 
 
Released
(380,696
)
 
$
46.29

 
$
23,195

Canceled
(49,192
)
 
$
51.50

 
 
Balance as of October 31, 2016
3,426,538

 
$
54.37

 
$
196,855

Expected to vest as of October 31, 2016
3,157,893

 
$
54.07

 
$
181,421

(1)
Aggregate intrinsic value at each period end represents the total market value of RSUs at the Company’s closing stock price of $57.45 and $61.47 on October 31, 2016 and July 31, 2016, respectively. Aggregate intrinsic value for released RSUs represents the total market value of released RSUs at date of release.
Certain executives and employees of the Company received PSUs and TSR PSUs in addition to RSUs. The PSUs included performance-based conditions and vest over a four-year period. The TSR PSUs are subject to total shareholder return rankings relative to the software companies in the S&P Software and Services Select Industry Index for a specified performance period or specified performance periods, and vest at the end of three years. In select cases, certain TSR PSUs are also subject to performance-based conditions.
Stock Options
Stock option activity under the Company’s equity incentive plans is as follows:
 
 Stock Options Outstanding
 
 Number of Stock Options Outstanding
 
 Weighted Average Exercise Price
 
Weighted Average Remaining Contractual Life
 
 Aggregate Intrinsic Value (1)
 
 
 
 
 
(in years)
 
 (in thousands)
Balance as of July 31, 2016
1,158,572

 
$
15.45

 
4.0
 
$
53,316

Granted

 


 
 
 
 
Exercised
(90,352
)
 
$
12.30

 
 
 
$
4,431

Canceled

 


 
 
 
 
Balance as of October 31, 2016
1,068,220

 
$
15.72

 
3.8
 
$
44,579

Vested and expected to vest as of October 31, 2016
1,064,976

 
$
15.62

 
3.8
 
$
44,549

Exercisable as of October 31, 2016
950,706

 
$
11.82

 
3.3
 
$
43,384

(1) 
Aggregate intrinsic value at each period end represents the difference between the Company's closing stock prices of $57.45 and $61.47 on October 31, 2016 and July 31, 2016, respectively, and the exercise price of outstanding options. Aggregate intrinsic value for exercised options represents the difference between the Company’s stock price at date of exercise and the exercise price.
Valuation of Awards
    
TSR PSUs
    

21


The fair values of our TSR PSUs were estimated at the date of grant using the Monte Carlo simulation model which included the following assumptions:
    
 
Three Months Ended October 31,
 
2016
 
2015
Expected term (in years)
2.87 - 2.88
 
*
Risk-free interest rate
0.89% - 0.93%
 
*
Expected volatility of the Company
31.5%
 
*
Average expected volatility of the peer companies in the index
36.9% - 37.0%
 
*
Expected dividend yield
—%
 
*
* There were no TSR PSUs granted during the three months ended October 31, 2015.
    
The number of shares that may ultimately vest will vary based on the relative performance of the Company’s total shareholder return rankings relative to the software companies in the S&P Software and Services Select Industry Index for a specified performance period or specified performance periods. The Monte Carlo methodology incorporates into the valuation all possible outcomes, including that the Company’s relative performance may result in no shares vesting. As a result, stock-based compensation expense is recognized regardless of the ultimate achievement of the plan’s performance metrics. The expense will be reversed only in the event that a grantee is terminated prior to satisfying the requisite service period.

For a subset of TSR PSUs, the number of shares that may ultimately vest will vary based on the achievement of certain Company specific financial performance metrics in addition to the Company’s total shareholder return condition noted above. As a result, the expense recognized will fluctuate based on the Company’s estimated financial performance relative to the target financial performance metrics.
    
Stock Options
The assumptions used to estimate the grant date fair value of options and the estimated weighted average grant date fair value of options for the three months ended October 31, 2016 and 2015 were as follows:
 
Three Months Ended October 31,
 
2016
 
2015
Expected life (in years)
*
 
4.9
Risk-free interest rate
*
 
1.49%
Expected volatility
*
 
38.8%
Expected dividend yield
*
 
—%
Weighted average grant date fair value of options
*
 
$19.18
* There were no options granted during the three months ended October 31, 2016.
Common Stock Reserved for Issuance
As of October 31, 2016 and July 31, 2016, the Company was authorized to issue 500,000,000 shares of common stock with a par value of $0.0001 per share, and 73,510,967 and 73,039,919 shares of common stock were issued and outstanding, respectively. As of October 31, 2016 and July 31, 2016, the Company had reserved shares of common stock for future issuance as follows:
 
October 31, 2016
 
July 31, 2016
 Exercise of stock options to purchase common stock
1,068,220

 
1,158,572

 Vesting of restricted stock units
3,426,538

 
2,727,724

 Shares available under stock plans
15,667,244

 
16,746,754

      Total common stock reserved for issuance
20,162,002

 
20,633,050


22


8.Income Taxes
The Company recognized income tax benefits of $9.8 million and $6.4 million for the three months ended October 31, 2016 and 2015, respectively. The increase in tax benefits for the three months ended October 31, 2016 was primarily due to an increase in the net loss in the three months ended October 31, 2016, as compared to the same period a year ago. The effective tax rate of 55% for the three months ended October 31, 2016 differs from the statutory U.S. federal income tax rate of 35% mainly due to permanent differences for stock-based compensation, research and development credits, domestic manufacturing deduction, the tax rate differences between the United States and foreign countries, and certain non-deductible expenses.
The Company provides U.S. income taxes on the earnings of foreign subsidiaries, unless the subsidiaries’ earnings are considered indefinitely reinvested outside the United States. As of October 31, 2016, U.S. income taxes were not provided for on the cumulative total of $31.1 million undistributed earnings from certain foreign subsidiaries. As of October 31, 2016, the unrecognized deferred tax liability for these earnings was approximately $10.1 million.
During the three months ended October 31, 2016, the increase in unrecognized tax benefits from the beginning of the period was $1.1 million. Accordingly, as of October 31, 2016, the Company had unrecognized tax benefits of $3.8 million that, if recognized, would affect the Company’s effective tax rate.
9.Segment Information

The Company operates in one segment. The Company’s chief operating decision maker (the “CODM”), its Chief Executive Officer, manages the Company’s operations on a consolidated basis for purposes of allocating resources. When evaluating the Company’s financial performance, the CODM reviews separate revenues information for the Company’s license, maintenance and professional services offerings, while all other financial information is reviewed on a consolidated basis. All of the Company’s principal operations and decision-making functions are located in the United States.
The following table sets forth revenues by country and region based on the billing address of the customer:
 
Three Months Ended October 31,
 
2016
 
2015
 
(in thousands)
United States
$
46,849

 
$
43,107

Canada
14,494

 
9,058

Other Americas
5,224

 
2,449

Total Americas
66,567

 
54,614

United Kingdom
8,390

 
9,687

Other EMEA
8,941

 
6,875

Total EMEA
17,331

 
16,562

Total APAC
10,229

 
11,104

Total revenues
$
94,127

 
$
82,280

No country, other than those presented above, accounted for more than 10% of revenues during the three months ended October 31, 2016 and 2015, respectively.
The following table sets forth the Company’s long-lived assets, including intangibles and goodwill, net by geographic region: 
 
October 31, 2016
 
July 31, 2016
 
 (in thousands)
Americas
$
83,749

 
$
53,826

EMEA
3,495

 
3,085

APAC
275

 
328

Total
$
87,519

 
$
57,239


23


ITEM 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with our condensed consolidated financial statements and the notes thereto included elsewhere in this document and the Risk Factors included in Item 1A of Part II of this Quarterly Report on Form 10-Q. All information presented herein is based on our fiscal calendar. Unless otherwise stated, references in this report to particular years or quarters refer to our fiscal years ended in July and the associated quarters of those fiscal years. We do not undertake, and specifically disclaim, any obligation to update any forward-looking statements to reflect the occurrence of events or circumstances after the date of such statements except as required by law.
Overview
We are a leading provider of a software platform for property and casualty (“P&C”) insurers. Guidewire InsurancePlatformTM consists of three key elements: core transaction processing, data management and analytics, and digital engagement, which work together to strengthen our customers’ ability to engage and empower their customers, agents, and employees. Our InsuranceSuite™ products provide transactional systems of record, which support the entire insurance lifecycle. Our data management and analytics products enable insurers to manage data more effectively and gain insights that can lead to better business decisions. Our digital engagement products support digital sales, service and claims experiences for policyholders, agents, and other key stakeholders.
We sell our products to a wide variety of global P&C insurance carriers ranging from some of the largest global insurance carriers or their subsidiaries to national carriers to regional carriers. We continue to expand our global reach through investments in sales and marketing in Europe, Asia and Latin America. Our customer engagement is led by our direct sales model and supported by our system integrator (“SI”) partners. In addition to our investments in sales and marketing and in our SI partnerships, we work to align with each insurer’s strategic goals in order to address any sales cycle risk. Strong customer relationships are a key driver of our success given the long-term nature of our contracts and the importance of customer references for new sales. We continue to focus on deepening our customer relationships through continued successful product implementations, robust product support, strategic engagement on new products and technologies, and ongoing account management.
Our sales cycles for new and existing customers remain protracted as customers are deliberate and the decision making and product evaluation process is long. Sales to new customers also involve extensive customer due diligence and reference checks. We must also earn credibility as we expand our sales operations and enter new markets which require investment not only in sales and services capabilities, but in the continued enhancement of our products and the development of locally-relevant content.
Customers can buy our core transaction processing applications, Guidewire PolicyCenter, Guidewire ClaimCenter and Guidewire BillingCenter, either separately or in combination as a suite. We refer to the combination of all three applications as InsuranceSuite. Sales of our core applications typically include sales of add-on applications such as Rating Management and Reinsurance Management that offer additional functionality which customers may find valuable.
Our data management and analytics and digital engagement products are sold to customers of InsuranceSuite or one of its component applications, which naturally limits the quantity of potential customers. Some sales of new products are generated at the same time as an insurance carrier becomes a new customer of InsuranceSuite or one of its applications, or are sold later as cross-sell opportunities.
    
In preparing for our adoption of the new revenue recognition standard, we have begun revising our contracting practices by shifting our existing customers to a two-year committed term with optional annual renewals. In fiscal 2016, substantially all of our term-based licenses were sold with an initial two-year committed term and optional annual renewals. We generally price our licenses based on the amount of direct written premiums (“DWP”) that will be managed by our solutions. We typically invoice our customers annually in advance or, in certain cases, quarterly for both recurring term license and maintenance fees. Our sales and marketing efforts are affected by seasonal variations in which our customer orders are generally higher in the second and fourth quarters of our fiscal year. This seasonal pattern may not be exhibited in each fiscal year. We primarily derive our services revenues from implementation, integration and training services. Our implementation teams assist customers in building implementation plans, defining business rules and requirements unique to each customer, and integrating our software with their existing systems.
To extend our technology leadership in the global market, we continue to invest in research and development to enhance and improve our current products and introduce new products to market. Continued investment in product innovation is critical as we seek to: assist our customers in their IT goals; maintain our competitive advantage; grow our revenues and expand internationally; and meet evolving customer demands. In certain cases we will also acquire skills and technologies to accelerate our time to market for new products and solutions.

24


In March 2016, we acquired EagleEye Analytics Inc. (“EagleEye”), a provider of cloud-based predictive analytics products specifically designed for property and casualty insurers for cash consideration of approximately $42 million. The acquisition added Guidewire Predictive Analytics to our product offerings. We believe that, over time, the acquisition will enable our customers to apply predictive analytics to make better decisions across the insurance lifecycle.
In August 2016, we added Guidewire Underwriting Management through the acquisition of FirstBest, a provider of underwriting management systems and related applications to P&C insurers for total consideration of approximately $37.8 million. We believe that, over time, the acquisition will allow us to expand our insurance platform by providing insurers in the U.S. and Canada writing complex commercial, specialty, and workers’ compensation lines greater support for their risk assessment and decision-making processes. The results of FirstBest’s operations have been included in our results of operations since the date of acquisition.
We partner with leading SIs to assist in the implementation of our products in a manner that increases efficiency and scale while reducing customer implementation costs. Our extensive relationships with SIs and industry partners have strengthened and expanded in line with the interest in and adoption of our products. We encourage our partners to co-market, pursue joint sales initiatives and drive broader adoption of our technology, helping us grow our business more efficiently and focus our engineering resources on continued innovation. Our track record of success with customers and their implementations are central to our strategy. We continue to focus and invest time and resources in increasing the number of qualified consultants employed by our SI partners, develop relationships with new SIs in existing and new markets, and ensure that all partners are ready to assist with implementing our products.
We face a number of risks in the execution of our strategy including risks related to expanding to new markets, managing lengthy sales cycles, competing effectively in the global market, relying on sales to a relatively small number of large customers, developing new or acquiring existing products successfully, and increasing the overall adoption of our products. In response to these and other risks we might face, we continue to invest in many areas of our business. Our investments in sales and marketing align with our goal of winning new customers in both existing and new markets, and enable us to maintain a persistent, consultative relationship with our existing customers. Our investments in product development are designed to meet the evolving needs of our customers.
Seasonality
We have historically experienced seasonal variations in our license and other revenues as a result of increased customer orders in our second and fourth fiscal quarters. We generally see increased orders in our second fiscal quarter, which is the quarter ended January 31, due to customer buying patterns. We also see increased orders in our fourth fiscal quarter, which is the quarter ended July 31, due to efforts by our sales team to achieve annual incentives. This seasonal pattern, however, may be absent in any given year. On an annual basis, our maintenance revenues which are recognized ratably, may also be impacted in the event that seasonal patterns change significantly.
Our services revenues are also subject to seasonal fluctuations, though to a lesser degree than our license revenues. Our services revenues are impacted by the number of billable days in a given fiscal quarter. The quarter ended January 31 usually has fewer billable days due to the impact of the Thanksgiving, Christmas and New Year’s holidays. The quarter ended July 31 usually also has fewer billable days due to the impact of vacation times taken by our professional staff. Because we pay our services professionals the same amounts throughout the year, our gross margins on our services revenues are usually lower in these quarters.
Key Business Metrics
We use certain key metrics to evaluate and manage our business, including rolling four-quarter recurring revenues from term licenses and total maintenance. In addition, we present select GAAP and non-GAAP financial metrics that we use internally to manage the business and that we believe are useful for investors. These metrics include Adjusted EBITDA and operating cash flows.
Four-Quarter Recurring Revenues
We measure four-quarter recurring revenues by adding the total term license and other revenues and total maintenance revenues recognized under GAAP in the preceding four quarters ended in the stated period. This metric excludes perpetual license revenues, revenues from perpetual buyout rights and services revenues. This metric allows us to better understand the trends in our recurring revenues because it typically reduces the variations in any particular quarter caused by seasonality, the effects of the annual invoicing of our term licenses and certain effects of contractual provisions that may accelerate or delay revenue recognition in some cases. This metric applies revenue recognition rules under GAAP and does not substitute

25


individually tailored revenue recognition and measurement methods. Our four-quarter recurring revenues for each of the nine periods presented were:

 
Four quarters ended
 
 
 
October 31, 2016
 
July 31, 2016
 
April 30, 2016
 
January 31, 2016
 
October 31, 2015
 
July 31, 2015
 
April 30, 2015
 
January 31, 2015
 
October 31, 2014
 
(in thousands)
 
 
Term license and other revenues
$
210,278

 
$
208,430

 
$
194,458

 
$
184,647

 
$
173,232

 
$
169,366

 
$
160,114

 
$
157,542

 
$
150,309

Maintenance revenues
62,451

 
59,931

 
56,103

 
53,610

 
51,516

 
50,024

 
48,785

 
47,041

 
44,768

Total four-quarter recurring revenues
$
272,729

 
$
268,361

 
$
250,561

 
$
238,257

 
$
224,748

 
$
219,390

 
$
208,899

 
$
204,583

 
$
195,077


Adjusted EBITDA
We believe Adjusted EBITDA, a non-GAAP financial measure, is useful in evaluating our operating performance compared to that of other companies in our industry, as this metric generally eliminates the effects of certain items that may vary for different companies for reasons unrelated to overall operating performance. We believe that:
Adjusted EBITDA provides investors and other users of our financial information consistency and comparability with our past financial performance, facilitates period-to-period comparisons of operations and facilitates comparisons with other companies, many of which use similar non-GAAP financial measures to supplement their GAAP results;
it is useful to exclude non-cash charges, such as depreciation and amortization and stock-based compensation because the amount of such expenses in any specific period may not directly correlate to the underlying performance of our business operations and these expenses can vary significantly between periods; and
it is also useful to exclude the effect of income taxes, interest income and other income or expenses because the amount of such items may not directly correlate to the underlying performance of our business operations.
We use Adjusted EBITDA in conjunction with traditional GAAP measures as part of our overall assessment of our performance, including the preparation of our annual operating budget and quarterly forecasts, to evaluate the effectiveness of our business strategies and to communicate with our board of directors concerning our financial performance.
Adjusted EBITDA should not be considered as a substitute for other measures of financial performance reported in accordance with GAAP. There are limitations to using non-GAAP financial measures, including that other companies may calculate these measures differently than we do. We compensate for the inherent limitations associated with using Adjusted EBITDA through disclosure of these limitations, presentation of our financial statements in accordance with GAAP and reconciliation of Adjusted EBITDA to the most directly comparable GAAP measure, net income (loss). The following table provides a reconciliation of net loss to Adjusted EBITDA:
 
Three Months Ended October 31,
 
2016
 
2015
 
(in thousands)
Reconciliation of Adjusted EBITDA:
 
 
 
Net loss
$
(7,858
)
 
$
(1,630
)
Non-GAAP adjustments:
 
 
 
Benefit from income taxes
(9,783
)
 
(6,420
)
Interest income
(1,342
)
 
(696
)
Other expense (income), net
681

 
(217
)
Depreciation and amortization
3,074

 
1,791

Stock-based compensation
17,877

 
15,147

Adjusted EBITDA
$
2,649

 
$
7,975


26


Operating Cash Flows
We monitor our cash flows from operating activities, or operating cash flows, as a key measure of our overall business performance, which enables us to analyze our financial performance without the effects of certain non-cash items such as depreciation and amortization and stock-based compensation expenses. Additionally, operating cash flows takes into account the impact of changes in deferred revenues, which reflects the receipt of cash payment for products before they are recognized as revenues. Our operating cash flows are significantly impacted by timing of invoicing and collections of accounts receivable, annual bonus payment, as well as payments of payroll and other taxes. As a result, our operating cash flows fluctuate significantly on a quarterly basis. Cash used by operations was $12.9 million and $10.9 million for the three months ended October 31, 2016 and 2015, respectively. For a further discussion of our operating cash flows, see “Liquidity and Capital Resources—Cash Flows from Operating Activities.”
Critical Accounting Policies and Estimates
Our condensed consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”). Accounting policies, methods and estimates are an integral part of the preparation of condensed consolidated financial statements in accordance with U.S. GAAP and, in part, are based upon management’s current judgments. Those judgments are normally based on knowledge and experience with regard to past and current events and assumptions about future events. Certain accounting policies, methods and estimates are particularly sensitive because of their significance to the condensed consolidated financial statements and because of the possibility that future events affecting them may differ markedly from management’s current judgments. While there are a number of accounting policies, methods and estimates affecting our condensed consolidated financial statements, areas that are particularly significant include:
Revenue recognition policies;
Stock-based compensation;
Income taxes; and
Business combinations, intangible assets and goodwill impairment
As described in Stock-Based Compensation in Note 1 “The Company and Summary of Significant Accounting Policies”, we granted TSR PSUs in the first quarter of fiscal year 2017. The fair value of our TSR PSUs are estimated at the grant date using a Monte Carlo simulation method. The assumptions utilized in this simulation require judgment and estimates. Changes in these inputs and assumptions could affect the measurement of the estimated fair value of the related compensation expense. Compensation expense associated with these TSR PSUs will be recognized regardless of whether the market condition is ultimately satisfied, however, the expense will be reversed if a grantee terminates prior to satisfying the requisite service period. For TSR PSUs containing an additional performance condition, a portion of the expense will fluctuate depending on the achievement of the performance conditions. All TSR PSUs will vest at the end of a three-year period.
Other than stock-based compensation, there were no significant changes in our critical accounting policies and estimates during the three months ended October 31, 2016. Please refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K filed on September 15, 2016 for a more complete discussion of our critical accounting policies and estimates.

27


Results of Operations
The following tables set forth our results of operations for the periods presented. The data has been derived from the unaudited Condensed Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q which, in the opinion of our management, reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position and results of operations for the interim periods presented. The operating results for any period should not be considered indicative of results for any future period. This information should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in our Annual Report on Form 10-K filed with the SEC on September 15, 2016.
 
Three Months Ended October 31,
 
2016
 
2015
 
(in thousands)
Revenues:
 
 
 
License and other
$
38,721

 
$
32,340

Maintenance
16,532

 
14,013

Services
38,874

 
35,927

Total revenues
94,127

 
82,280

Cost of revenues:
 
 
 
License and other
2,430

 
1,164

Maintenance
3,325

 
2,475

Services
36,264

 
31,531

Total cost of revenues
42,019

 
35,170

Gross profit:
 
 
 
License and other
36,291

 
31,176

Maintenance
13,207

 
11,538

Services
2,610

 
4,396

Total gross profit
52,108

 
47,110

Operating expenses:
 
 
 
Research and development
30,750

 
25,672

Sales and marketing
25,500

 
19,291

General and administrative
14,160

 
11,110

Total operating expenses
70,410

 
56,073

Loss from operations
(18,302
)
 
(8,963
)
Interest income
1,342

 
696

Other income (expense), net
(681
)
 
217

Loss before income taxes
(17,641
)
 
(8,050
)
Benefit from income taxes
(9,783
)
 
(6,420
)
Net loss
$
(7,858
)
 
$
(1,630
)

28


 
Three Months Ended October 31,
 
2016
 
2015
 
(percentage of total revenues)
Revenues:
 
 
 
License and other
41
 %
 
39
 %
Maintenance
18
 %
 
17
 %
Services
41
 %
 
44
 %
Total revenues
100
 %
 
100
 %
Cost of revenues:
 
 
 
License
3
 %
 
1
 %
Maintenance
4
 %
 
3
 %
Services
38
 %
 
39
 %
Total cost of revenues
45
 %
 
43
 %
Gross profit:
 
 
 
License
38
 %
 
38
 %
Maintenance
14
 %
 
14
 %
Services
3
 %
 
5
 %
Total gross profit
55
 %
 
57
 %
Operating expenses:
 
 
 
Research and development
33
 %
 
31
 %
Sales and marketing
27
 %
 
23
 %
General and administrative
15
 %
 
14
 %
Total operating expenses
75
 %
 
68
 %
Loss from operations
(20
)%
 
(11
)%
Interest income
1
 %
 
1
 %
Other income (expense), net
 %
 
 %
Loss before income taxes
(19
)%
 
(10
)%
Benefit from income taxes
(11
)%
 
(8
)%
Net loss
(8
)%
 
(2
)%


Revenues
We derive our revenues from licensing our software applications, providing maintenance support, and professional services.
Our license and other revenues are comprised primarily of term license fees. We also recognize revenue from sales of perpetual licenses and subscription fees from software we deliver as a service. Our term license revenues are primarily generated through annual license fees that recur during the contract term. In fiscal 2016, a majority of our term based licenses were sold with a two year committed term and optional annual renewals. In certain cases, when required by a customer, we license our software on a perpetual basis. In addition, certain of term licenses provide the customer with the option to purchase a perpetual license at the end of the initial contract term, which we refer to as a perpetual buyout right. We generally price our licenses based on the amount of direct written premiums, or DWP, that will be managed by our solutions. We typically invoice our customers annually in advance or quarterly for both term license and maintenance fees, and we invoice our perpetual license customers either in full at contract signing or on an installment basis and invoice related maintenance fees annually in advance. Our license revenues have generally been recognized when payment is due or cash is received from our customers. Revenues derived from software as a service subscriptions are recognized ratably over the contract term.
Our maintenance revenues are generally recognized over the committed maintenance term. Our maintenance fees are typically priced as a fixed percentage of the associated license fees.
Our professional services revenues are primarily derived from implementation services performed for our customers, reimbursable travel expenses and training fees. A substantial majority of our services engagements generate revenues on a time and materials basis and revenues are typically recognized upon delivery of our services.
We will adopt ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” on August 1, 2018, which provides revenue recognition guidance. We currently expect that we will apply the cumulative effect method. In evaluating the

29


potential impacts that this guidance will have on our consolidated financial statements, we have begun revising our contracting practices primarily by shortening the initial non-refundable term of our licenses.
Refer to Note 1 of Notes to Condensed Consolidated Financial Statements for a description of our accounting policy related to revenue recognition. 
 
Three Months Ended October 31,
 
 
 
 
 
2016
 
2015
 
 
 
 
 
 
 
% of total
 
 
 
% of total
 
Change
 
Amount
 
revenues
 
Amount
 
revenues
 
($)
 
(%)
 
(in thousands, except percentages)
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 License and other
$
38,721

 
41
%
 
$
32,340

 
39
%
 
$
6,381

 
20
%
 Maintenance
16,532

 
18
%
 
14,013

 
17
%
 
2,519

 
18
%
 Services
38,874

 
41
%
 
35,927

 
44
%
 
2,947

 
8
%
 Total revenues
$
94,127

 
100
%
 
$
82,280

 
100
%
 
$
11,847

 
14
%
 
 
 
 
 
 
 
 
 
 
 
 

License and Other Revenues

License and other revenues increased by $6.4 million during the three months ended October 31, 2016, as compared to the same period a year ago. The increase in license and other revenues was primarily driven by the continued sale of our products.
 
Three Months Ended October 31,
 
 
 
 
 
2016
 
2015
 
 
 
 
 
 
 
 % of license
 
 
 
 % of license
 
 Change
 
 Amount
 
revenues
 
 Amount
 
revenues
 
 ($)
 
 (%)
 
(in thousands, except percentages)
License and other revenues:
 
 
 
 
 
 
 
 
 
 
 
Term and other
$
34,500

 
89
%
 
$
32,652

 
101
 %
 
$
1,848

 
6
%
Perpetual
4,221

 
11
%
 
(312
)
 
(1
)%
 
4,533

 
1,453
%
Total license and other revenues
$
38,721

 
100
%
 
$
32,340

 
100
 %
 
$
6,381

 
20
%
 
 
 
 
 
 
 
 
 
 
 
 

Term license and other revenues increased by $1.8 million during the three months ended October 31, 2016, as compared to the same period a year ago, as an increase of $3.6 million in revenues recognized primarily from current quarter orders was partially offset by a $1.8 million decrease in revenues attributable to the timing of invoices and corresponding due dates, payments received, and other contractual terms that affect revenue recognition from existing orders. 

Perpetual license revenues increased by $4.5 million during the three months ended October 31, 2016, as compared to the same period a year ago. While term license remains our predominant licensing model, revenues from the sale and delivery of perpetual licenses will continue to represent a small percentage of our total license revenues. Nevertheless, we expect perpetual license revenues to remain volatile on a sequential quarter basis due to the large amount of perpetual revenue from a single customer order, whether the customer purchases new licenses or exercises their perpetual buyout rights. 
Additionally, our license revenues may fluctuate if our customers pay their annual license fees in advance of the invoice due date which may cause an unexpected increase in revenues in one quarter which can reduce revenue growth rates in future periods.

Maintenance Revenues

Maintenance revenues increased by $2.5 million during the three months ended October 31, 2016, as compared to the same period a year ago primarily due to our increased license revenues as a result of our growing customer base.

We expect that our maintenance revenues will continue to grow as our license revenues grow.


30


Services Revenues

Services revenues increased by $2.9 million during the three months ended October 31, 2016, as compared to the same period a year ago primarily due to an increase of $1.9 million in billings for new and existing customer engagements performed in the current period and an increase of $1.0 million attributable to services performed in prior periods for which the recognition of revenue was contingent upon the acceptance of our software.

Services revenues in the three months ended October 31, 2016 exclude $4.7 million of services billings deferred in the current period which we have delivered through our work with a large, national insurer to implement Guidewire InsurancePlatformTM in a cloud-delivered format. As a result of our agreement to develop new digital portal functionality in conjunction with the implementation, all services revenues and direct services costs will be deferred until revenue recognition criteria are met, which we currently project to occur during the second half of fiscal 2017. At such point, revenue will be recognized ratably. As a result of this arrangement, we anticipate deferred service revenues to increase significantly above historical norms.

While we continue to expand our network of third-party system integrators with whom our customers can contract for services related to our products, our services revenues may fluctuate as the result of several factors, including the rates we charge for our services and unexpected difficulty in projects as we support the sale of new products, enter into new markets, or introduce different software delivery models.

Deferred Revenues
 
As of
 
 
 
 
 
October 31, 2016
 
July 31, 2016
 
 Change
 
 Amount
 
 Amount
 
 ($)
 
 (%)
 
(in thousands, except percentages)
Deferred revenues:
 
 
 
 
 
 
 
Deferred license and other revenues
$
22,672

 
$
19,841

 
$
2,831

 
14
 %
Deferred maintenance revenues
30,881

 
38,928

 
(8,047
)
 
(21
)%
Deferred services revenues
15,258

 
11,246

 
4,012

 
36
 %
Total deferred revenues
$
68,811

 
$
70,015

 
$
(1,204
)
 
(2
)%
The $2.8 million increase in deferred license and other revenues compared to the prior fiscal year end was primarily driven from an aggregate increase of $4.9 million for new customer contracts that are being deferred due to the timing of the invoices and the corresponding due dates, billings that are recognized on a ratable basis, or acceptance criteria that have not been met for revenue recognition. This $4.9 million was partially offset by the recognition of $2.1 million in license revenues from contracts executed in prior periods.
The $8.0 million decrease in deferred maintenance revenues compared to the prior fiscal year end was primarily driven by revenues recognized in excess of new billings during the three months ended October 31, 2016, and reflects the seasonal nature of the billings of maintenance revenues.
The $4.0 million increase in deferred services revenues compared to the prior fiscal year end was primarily due to the net effect from an increase of $5.5 million of services billings deferred in the current period, partially offset by the recognition of $1.5 million from prior fiscal year billings which were recognized in the current period upon the fulfillment of certain contractual obligations. The $5.5 million in deferred service billings includes $4.7 million related to an arrangement entered into during fiscal 2016 with a large, national insurer to implement Guidewire InsurancePlatformTM in a cloud-delivered format which includes InsuranceSuite and our data products together with a new version of our digital portal product. As a result of our agreement to develop new digital portal functionality in conjunction with the implementation, all license and services revenues will be deferred until the implementation is complete, which we currently project to occur during the second half of fiscal 2017. At such point, revenue will be recognized ratably. As a result of this arrangement, we anticipate deferred revenues to increase significantly above historical norms until such time that we can recognize revenue generated by this arrangement. Total service revenue deferred for this contract was $9.9 million as of October 31, 2016 and is included in our accompanying condensed consolidated balance sheet.
Our deferred revenues consist only of amounts that have been invoiced, but not yet recognized as revenues. As a result, deferred revenues and change in deferred revenues are incomplete measures of the strength of our business and are not necessarily indicative of our future performance.

31


Cost of Revenues and Gross Profit
Our cost of revenues and gross profit are variable and depend on the type of revenues earned in each period. Our cost of license revenues is primarily comprised of royalty fees paid to third parties, amortization of our acquired intangible assets, and fulfillment services personnel costs. Our cost of maintenance revenues is comprised of compensation and benefit expenses for our technical support team, including stock-based awards, and allocated overhead. Our cost of services revenues is primarily comprised of compensation and benefit expenses for our professional service employees and contractors, including stock-based awards, travel-related costs and allocated overhead.
We allocate overhead such as IT support, facility, and other administrative costs to all functional departments based on headcount. As such, general overhead expenses are reflected in cost of revenue and each functional operating expense category.  
 
Three Months Ended October 31,
 
 
 
 
 
2016
 
2015
 
 Change
 
 Amount
 
 Amount
 
 ($)
 
 (%)
 
(in thousands, except percentages)
Cost of revenues:
 
 
 
 
 
 
 
License and other
$
2,430

 
$
1,164

 
$
1,266

 
109
%
Maintenance
3,325

 
2,475

 
850

 
34
%
Services
36,264

 
31,531

 
4,733

 
15
%
Total cost of revenues
$
42,019

 
$
35,170

 
$
6,849

 
19
%
 
 
 
 
 
 
 
 
Includes stock-based awards of:
 
 
 
 
 
 
 
        Cost of license and other revenues
$
51

 
$
89

 
$
(38
)
 

        Cost of maintenance revenues
413

 
339

 
74

 

        Cost of services revenues
4,695

 
4,363

 
332

 

        Total
$
5,159

 
$
4,791

 
$
368

 

 
 
 
 
 
 
 
 
The $6.8 million increase in cost of revenues during the three months ended October 31, 2016 was primarily driven by increases from increased cost of license revenues of $1.3 million, increased cost of maintenance revenues of $0.9 million, and a $4.7 million increase in costs of service revenues. The $1.3 million increase in cost of license revenues was primarily attributable to increased amortization of intangible assets and royalty expense, and to a lesser extent the aggregate effect of increased headcount and related expenses. The $0.9 million increase in cost of maintenance revenues was primarily attributable to increased costs for headcount and consulting expenses. The $4.7 million increase in cost of services revenues was primarily attributable to an increase in costs for headcount and related expenses, including stock-based compensation expense. We had 610 professional service employees and 71 technical support and licensing operations employees at October 31, 2016 compared with 498 professional services employees and 58 technical support and licensing operations employees at October 31, 2015. The increase in hiring was driven by our anticipated need to staff a large, cloud-based deployment, our need to meet demand for new implementations of our data products and to minimize capacity constraints in the Americas.
Services costs in the three months ended October 31, 2016 exclude $2.4 million of direct costs which we have incurred through our work with a large, national insurer to implement Guidewire InsurancePlatformTM in a cloud-delivered format. We will begin recognizing these costs on a ratable basis at such time as we recognize the related revenues.