10-Q 1 gwre-4302017x10q.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 April 30, 2017
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,” “smaller reporting company,” and “emerging growth 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        
 
¨
 
 
 
 
 
 
 
 
 
 
 
Emerging growth company
 
¨



If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

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 April 30, 2017, the registrant had 74,378,533 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;
the impact of new accounting standards and any contractual changes we have made in anticipation of such changes;
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)
 
 
April 30,
2017
 
July 31,
2016
ASSETS
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
180,166

 
$
223,582

Short-term investments
297,307

 
404,655

Accounts receivable
94,955

 
62,792

Prepaid expenses and other current assets
30,743

 
16,643

Total current assets
603,171

 
707,672

Long-term investments
113,913

 
107,565

Property and equipment, net
11,896

 
12,955

Intangible assets, net
76,091

 
14,204

Deferred tax assets, net
42,960

 
31,364

Goodwill
142,027

 
30,080

Other assets
13,156

 
12,338

TOTAL ASSETS
$
1,003,214

 
$
916,178

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
11,768

 
$
9,929

Accrued employee compensation
37,451

 
41,267

Deferred revenues, current
104,335

 
60,270

Other current liabilities
10,511

 
7,617

Total current liabilities
164,065

 
119,083

Deferred revenues, noncurrent
2,848

 
9,745

Other liabilities
2,393

 
3,415

Total liabilities
169,306

 
132,243

STOCKHOLDERS’ EQUITY:
 
 
 
Common stock
7

 
7

Additional paid-in capital
799,491

 
742,690

Accumulated other comprehensive loss
(7,718
)
 
(6,593
)
Retained earnings
42,128

 
47,831

Total stockholders’ equity
833,908

 
783,935

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
1,003,214

 
$
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 April 30,
 
Nine Months Ended April 30,
 
2017
 
2016
 
2017
 
2016
Revenues:
 
 
 
 
 
 
 
License and other
$
58,971

 
$
45,796

 
$
161,767

 
$
131,512

Maintenance
16,858

 
14,676

 
49,972

 
42,945

Services
47,607

 
38,388

 
121,445

 
108,812

Total revenues
123,436

 
98,860

 
333,184

 
283,269

Cost of revenues:
 
 
 
 
 
 
 
License and other
5,208

 
2,137

 
10,419

 
4,878

Maintenance
3,480

 
3,034

 
9,884

 
8,145

Services
42,780

 
33,836

 
113,995

 
96,055

Total cost of revenues
51,468

 
39,007

 
134,298

 
109,078

Gross profit:
 
 
 
 
 
 
 
License and other
53,763

 
43,659

 
151,348

 
126,634

Maintenance
13,378

 
11,642

 
40,088

 
34,800

Services
4,827

 
4,552

 
7,450

 
12,757

Total gross profit
71,968

 
59,853

 
198,886

 
174,191

Operating expenses:
 
 
 
 
 
 
 
Research and development
34,090

 
29,273

 
94,865

 
80,354

Sales and marketing
28,788

 
22,908

 
77,808

 
64,860

General and administrative
13,429

 
13,449

 
40,649

 
36,015

Total operating expenses
76,307

 
65,630

 
213,322

 
181,229

Loss from operations
(4,339
)
 
(5,777
)
 
(14,436
)
 
(7,038
)
Interest income
1,394

 
2,211

 
4,280

 
3,665

Other income (expense), net
11

 
804

 
(335
)
 
(161
)
Loss before income taxes
(2,934
)
 
(2,762
)
 
(10,491
)
 
(3,534
)
Benefit from income taxes
(1,115
)
 
(2,358
)
 
(4,788
)
 
(2,413
)
Net loss
$
(1,819
)
 
$
(404
)
 
$
(5,703
)
 
$
(1,121
)
Net loss per share:
 
 
 
 
 
 
 
Basic
$
(0.02
)
 
$
(0.01
)
 
$
(0.08
)
 
$
(0.02
)
Diluted
$
(0.02
)
 
$
(0.01
)
 
$
(0.08
)
 
$
(0.02
)
Shares used in computing net loss per share:

 

 

 

Basic
74,175,603

 
72,297,934

 
73,731,132

 
71,769,613

Diluted
74,175,603

 
72,297,934

 
73,731,132

 
71,769,613


                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
See accompanying Notes to Condensed Consolidated Financial Statements.

4


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

 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2017
 
2016
 
2017
 
2016
Net loss
(1,819
)
 
(404
)
 
(5,703
)
 
(1,121
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustments
183

 
1,754

 
(654
)
 
339

Unrealized gains (losses) on available-for-sale securities, net of tax benefit (expense) of $14 and $(202) for the three months ended April 30, 2017 and 2016, respectively; $289 and $(129) for the nine months ended April 30, 2017 and 2016, respectively
49

 
336

 
(352
)
 
213

Reclassification adjustment for realized losses (gains) included in net income (loss)
(60
)
 
4

 
(119
)
 
4

Other comprehensive income (loss)
172

 
2,094

 
(1,125
)
 
556

Comprehensive income (loss)
(1,647
)
 
1,690

 
(6,828
)
 
(565
)

See accompanying Notes to Condensed Consolidated Financial Statements

5


GUIDEWIRE SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
 
 
Nine Months Ended April 30,
 
 
2017
 
2016
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
Net loss
 
(5,703
)
 
(1,121
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
12,208

 
5,835

Stock-based compensation
 
53,661

 
47,885

(Excess tax benefit) shortfall from exercise of stock options and vesting of restricted stock units
 
962

 
(566
)
Deferred income tax
 
(6,779
)
 
(4,767
)
Amortization of premium on available-for-sale securities
 
1,174

 
2,672

Other non-cash items affecting net loss
 
27

 
(954
)
Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable
 
(25,745
)
 
1,568

Prepaid expenses and other assets
 
(7,172
)
 
(4,977
)
Accounts payable
 
546

 
(691
)
Accrued employee compensation
 
(3,589
)
 
(8,095
)
Other liabilities
 
(1,085
)
 
(556
)
Deferred revenues
 
33,032

 
14,408

Net cash provided by operating activities
 
51,537

 
50,641

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
 
Purchases of available-for-sale securities
 
(343,761
)
 
(492,474
)
Sales of available-for-sale securities
 
442,830

 
474,297

Purchases of property and equipment
 
(3,236
)
 
(5,243
)
Capitalized software development costs
 
(374
)
 

Strategic investment
 
(4,677
)
 

Acquisitions of business, net of acquired cash
 
(187,590
)
 
(39,530
)
Net cash used in investing activities
 
(96,808
)
 
(62,950
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
 
Proceeds from issuance of common stock upon exercise of stock options
 
3,419

 
5,421

Taxes remitted on RSU awards vested
 

 
(1,488
)
Excess tax benefit (shortfall) from exercise of stock options and vesting of restricted stock units
 
(962
)
 
566

Net cash provided by financing activities
 
2,457

 
4,499

Effect of foreign exchange rate changes on cash and cash equivalents
 
(602
)
 
53

NET DECREASE IN CASH AND CASH EQUIVALENTS
 
(43,416
)
 
(7,757
)
CASH AND CASH EQUIVALENTS—Beginning of period
 
223,582

 
212,362

CASH AND CASH EQUIVALENTS—End of period
 
180,166

 
204,605

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
 
Cash paid for income taxes, net of tax refunds
 
2,487

 
3,219

SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
 
Accruals for purchase of property & equipment
 
569

 
802


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. The stock-based compensation policy includes updates that address awards with market conditions granted in the first quarter of fiscal 2017. There have been no other 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.
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 primarily 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”).
One customer individually accounted for 10% or more of the Company’s revenues for the three months ended April 30, 2017. No customer individually accounted for 10% or more of the Company’s revenues for the nine months ended April 30, 2017, or for the three and nine months ended April 30, 2016. One customer individually accounted for 10% or more of the Company’s total accounts receivable as of April 30, 2017. 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). For a substantial majority of its sales, 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.

8


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.

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 basis, and the related revenues are recognized ratably over the term of the arrangement typically upon provisioning the products.
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

9


(“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 a specified performance period or specified performance periods, service periods, 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 that contain either a performance condition, market conditions, or both using the graded vesting 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 over the vesting period 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.
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 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

10


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

Improvements on Employee Share-Based Payment Accounting

In March 2016, the FASB issued Accounting Standards Update (“ASU”) 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. As required, the Company will make a cumulative-effect adjustment to shareholders' equity as of August 1, 2017 for unrecognized excess tax benefits or tax deficiencies that exist as of that date. In addition, beginning August 1, 2017, excess tax benefits and tax deficiencies will be reflected as income tax benefit or expense in the Company’s consolidated statement of operations, the impact of which could result in material earnings volatility. The extent of the excess tax benefits or tax deficiencies that will impact future earnings are subject to variation in our stock price and the timing of RSU vesting and employee stock option exercises.
Revenue from Contracts with Customers
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”), 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, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date (“ASU 2015-14”), deferring the effective date of this standard. As a result, the ASU and related amendments will be effective for the Company for its fiscal year beginning August 1, 2018, including interim periods within that fiscal year. Early adoption is permitted, but not before the original effective date of the ASU, August 1, 2017.
Subsequently, the FASB issued ASU No. 2016-08, Principal Versus Agent Consideration (or Reporting Revenue Gross versus Net) (“ASU 2016-08”) 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 these ASUs (collectively, Topic 606) on August 1, 2018. Topic 606 permits two methods of adoption: retrospectively to each prior reporting period presented (the “Full Retrospective Method”), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the “Modified Retrospective Method”). The Company currently intends to apply the Modified Retrospective Method.
The Company has evaluated the potential impact of Topic 606 on its revenue recognition policy and practices and has concluded that Topic 606 will impact the pattern of its revenue recognition associated with its software licenses. The Company’s term licenses require payments to be made annually or quarterly in advance and are subject to extended payment terms. Currently, revenues associated with the payment for term software licenses are recognized in the earlier of the period in which the payments are due or actually made. Under Topic 606, the Company will be required to recognize the revenue associated with such payments not when they are made or due, but when control of the software license is transferred to the customer, which occurs at or near the time a contract with a customer is executed. As a result, under Topic 606, all contractually obligated payments under a term license would be recognized upon delivery. In conjunction with its evaluation of this new standard, the Company began revising its contracting practices and amending existing agreements with certain customers primarily by shortening the initial, non-refundable term of its licenses. Since fiscal 2016, a substantial majority of new contracts feature a two-year initial term with subsequent one-year auto renewal options. The Company has engaged with its existing and prospective customers on its new licensing model.
The Company continues to evaluate the other potential impacts that Topic 606 will have on its consolidated financial statements, internal controls, business processes, and information technology systems including, for example, how to account for commission expense and revenue models acquired from recent acquisitions.
Business Combinations (Topic 805): Clarifying the Definition of a Business


11


In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business (“ASU 2017-01”), which provides a more robust framework to use in determining when a set of assets and activities is a business. The standard will be effective for the Company beginning August 1, 2018. Based on its current assessment, the Company does not expect the adoption of this update to have a material impact on its consolidated financial statements.
Statement of Cash Flows (Topic 230): Restricted Cash

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18”), which requires the statement of cash flows to report changes in cash, cash equivalents, and restricted cash. The standard will be effective for the Company beginning August 1, 2018. Based on its current assessment, the Company does not expect the adoption of this update to have a material impact on its consolidated financial statements.
Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments

In August 2016, the FASB issued ASU No. 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 will be effective for the Company beginning August 1, 2018.
Based on its current assessment, the Company does not expect the adoption of this update to have a material impact on its consolidated financial statements.
Income Tax Consequences of an Intra-Entity Transfer of Assets Other Than Inventory

In October 2016, the FASB issued ASU No. 2016-16, Income Taxes - Intra-Entity Transfers of Assets Other Than Inventory (“ASU 2016-16”), which requires entities to recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. The new standard must be adopted using a modified retrospective transition method which is a cumulative-effective adjustment to retained earnings as of the beginning of the first effective reporting period. The standard will be effective for the Company beginning August 1, 2018. Based on its current assessment, the Company does not expect the adoption of this update to have a material impact on its consolidated financial statements.

Scope of Modification Accounting

In May 2017, the FASB issued ASU No. 2017-09, Scope of Modification Accounting (Topic 718) (“ASU 2017-09”), which amends the scope of modification accounting for share-based payment arrangements. ASU 2017-09 provides guidance on the types of changes to the terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting under ASC 718. Specifically, an entity would not apply modification accounting if the fair value, vesting conditions, and classification of the awards are the same immediately before and after the modification. The new standard is effective for annual periods beginning after December 15, 2017 and interim periods within those years. Early adoption is permitted. The standard will be effective for the Company beginning August 1, 2018. The Company is currently evaluating the impact this update will have on its consolidated financial statements.
Accounting for Leases

In February 2016, the FASB issued ASU 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 standard will be effective for the Company beginning August 1, 2019. The Company is currently evaluating the impact this update will have on its consolidated financial statements.
Simplifying the Test for Goodwill Impairment

In January 2017, the FASB issued ASU No. 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (“ASU 2017-04”), which removes the requirement for an entity to calculate the implied fair value of goodwill (as part of step 2 of the current goodwill impairment test) in measuring a goodwill impairment loss. The standard will be effective for the Company beginning August 1, 2020. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is currently evaluating the impact this update will have on its consolidated financial statements.

12


2.
Fair Value of Financial Instruments
Available-for-sale investments within cash equivalents and investments consist of the following:
 
April 30, 2017
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
 
(in thousands)
U.S. agency securities
$
26,675

 
$

 
$
(72
)
 
$
26,603

Commercial paper
94,741

 
1

 
(15
)
 
94,727

Corporate bonds
254,149

 
89

 
(198
)
 
254,040

U.S. government bonds
77,198

 

 
(213
)
 
76,985

Foreign government bonds
2,419

 

 
(6
)
 
2,413

Certificates of deposit
31,997

 
28

 
(2
)
 
32,023

Money market funds
38,887

 

 

 
38,887

     Total
$
526,066

 
$
118

 
$
(506
)
 
$
525,678

 
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:
 
April 30, 2017
 
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)
U.S. agency securities
$
25,601

 
$
(72
)
 
$

 
$

 
$
25,601

 
$
(72
)
Commercial paper
40,446

 
(15
)
 

 

 
40,446

 
(15
)
Corporate bonds
168,499

 
(198
)
 

 

 
168,499

 
(198
)
U.S. government bonds
76,986

 
(213
)
 

 

 
76,986

 
(213
)
Foreign government bonds
2,413

 
(6
)
 

 

 
2,413

 
(6
)
Certificate of deposit
5,996

 
(2
)
 

 

 
5,996

 
(2
)
     Total
$
319,941

 
$
(506
)
 
$

 
$

 
$
319,941

 
$
(506
)

As of April 30, 2017, the Company had 124 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

13


unrealized losses. The Company does not consider any portion of the unrealized losses at April 30, 2017 to be an other-than-temporary impairment, nor are any unrealized losses considered to be credit losses. The Company has recorded the securities at 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 April 30, 2017: 
 
Less Than 12 Months
 
12 to 36 Months
 
Total
 
(in thousands)
U.S. agency securities
$
12,077

 
$
14,526

 
$
26,603

Commercial paper
94,727

 

 
94,727

Corporate bonds
183,424

 
70,616

 
254,040

U.S. government bonds
52,127

 
24,858

 
76,985

Foreign government bonds

 
2,413

 
2,413

Money market funds
38,887

 

 
38,887

Certificates of deposit
30,523

 
1,500

 
32,023

     Total
$
411,765

 
$
113,913

 
$
525,678

 
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.

14


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 April 30, 2017 and July 31, 2016:
 
April 30, 2017
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 (in thousands)
Assets
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
     Corporate bonds
$

 
$
4,200

 
$

 
$
4,200

     Commercial paper
$

 
$
71,371

 
$

 
$
71,371

     Money market funds
38,887

 

 

 
38,887

Short-term investments:
 
 
 
 
 
 
 
     U.S. agency securities

 
12,077

 

 
12,077

     Commercial paper

 
23,356

 

 
23,356

     U.S. government bonds

 
52,127

 

 
52,127

     Corporate bonds

 
179,224

 

 
179,224

Certificates of deposit

 
30,523

 

 
30,523

Long-term investments:
 
 
 
 
 
 
 
     U.S. agency securities

 
14,526

 

 
14,526

Certificates of deposit

 
1,500

 

 
1,500

     Corporate bonds

 
70,616

 

 
70,616

     U.S. government bonds

 
24,858

 

 
24,858

Foreign government bonds

 
2,413

 

 
2,413

       Total assets
$
38,887

 
$
486,791

 
$

 
$
525,678


 
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


15


3.
Acquisitions
    
ISCS Acquisition

On February 16, 2017, pursuant to the Agreement and Plan of Merger entered into on December 18, 2016, the Company completed its acquisition of ISCS, Inc., a privately-held company that provides a cloud-based, all-in-one system for policy administration, billing and claims management to P&C insurers (“ISCS Acquisition”). The gross purchase price of the ISCS Acquisition was $160 million, subject to certain preliminary adjustments including a net working capital adjustment, which resulted in cash consideration paid of $154.9 million. A portion of the consideration has been placed into an escrow account as partial security to satisfy any potential claims, including the indemnification liability for state sales taxes. The ISCS Acquisition is intended to enhance the Company's ability to serve those P&C insurers that prefer a cloud-based, all-in-one platform that offers policy, billing, and claims management functionality. Total acquisition costs of $1.1 million were expensed as incurred and recorded as general and administrative expenses in the accompanying condensed consolidated statement of operations.

In connection with the ISCS Acquisition, we recorded an indemnification asset of $1.6 million, which represents the selling security holders’ obligation under the Agreement and Plan of Merger to indemnify the Company for unpaid state sales taxes. The indemnification asset was recognized on the same basis as the corresponding liability, which is based on its estimated fair value as of the date of acquisition.
The ISCS Acquisition was accounted for as a business combination. As part of the preliminary purchase price allocation, the Company determined that ISCS’s separately identifiable intangible assets were developed technology, customer contracts and related relationships, and order backlog. The Company utilized the discounted cash flow methodology and the profit allocation methodology under the income approach to estimate the fair values of the intangible assets. The Company is amortizing the acquired intangible assets over their estimated useful lives. The Company used the cost build-up approach to estimate the fair value of deferred revenue by estimating the costs related to fulfilling the obligation plus an additional markup for an assumed operating margin to reflect the profit a third party would expect to make on the costs incurred. These fair value measurements were based on significant inputs that were not observable in the market and thus represent 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 preliminary 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 allocation of the purchase price is preliminary pending the final valuation of intangibles and liabilities assumed, and is therefore subject to potential future measurement period adjustments. The finalization of the valuation will occur no later than the third quarter of fiscal 2018. The preliminary allocation of the purchase price was as follows:     
 
 
Total Purchase Price Allocation
 
Estimated Useful Lives
 
 
(in thousands)
 
(in years)
Acquired assets, net of assumed liabilities
 
$
4,460

 

Developed technology
 
43,300

 
4
Customer contracts and related relationships
 
7,000

 
9
Order backlog
 
3,500

 
4
Deferred tax assets
 
171

 

Goodwill
 
96,501

 

Total preliminary purchase price
 
$
154,932

 
 
The goodwill of $96.5 million arising from the ISCS Acquisition consists largely of the acquired workforce, the expected company-specific synergies and the opportunity to expand the Company’s customer base. The goodwill recognized is deductible for income tax purposes.
ISCS’s post-acquisition results of operations were included in the Company’s results of operations. Since the acquisition date, total revenue of ISCS for the period from February 16, 2017 through April 30, 2017 was $7.4 million. Net loss for ISCS for the period from February 16, 2017 through April 30, 2017 was $2.0 million.

Unaudited Pro Forma Financial Information

16


The following unaudited pro forma financial information presents the consolidated results of the Company and ISCS for the three and nine months ended April 30, 2017 and 2016, after giving effect to the ISCS Acquisition as if it had occurred on August 1, 2015, and combines the historical financial results of the Company and ISCS. The unaudited pro forma financial information includes adjustments to give effect to pro forma events that are directly attributable to the ISCS Acquisition. The pro forma financial information includes adjustments for the amortization of intangible assets, adjustments to stock-based compensation expense, the effect of reduction on deferred revenue, and the inclusion of transaction costs on August 1, 2015 with a corresponding reduction of these amounts in the period originally recognized.
The unaudited pro forma financial information is presented for illustrative purposes only and is not necessarily indicative of the results of operations that would have been realized had the ISCS Acquisition been completed on August 1, 2015, nor does it purport to project the results of operations of the combined company in future periods. The unaudited pro forma financial information does not give effect to any anticipated synergies and integration costs related to the acquired company. Consequently, actual results will differ from the unaudited pro forma financial information.
 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands except for per share amounts)
Pro forma revenues
$
125,574

 
$
109,349

 
$
358,102

 
$
310,125

Pro forma net loss
$
(3,966
)
 
$
(4,302
)
 
$
(15,561
)
 
$
(17,253
)
Pro forma net loss per share -- basic
$
(0.05
)
 
$
(0.06
)
 
$
(0.21
)
 
$
(0.24
)
Pro forma net loss per share -- diluted
$
(0.05
)
 
$
(0.06
)
 
$
(0.21
)
 
$
(0.24
)

FirstBest Acquisition

On August 31, 2016, the Company acquired all of the outstanding equity interests of FirstBest Systems, Inc. (the “FirstBest Acquisition”), a privately-held provider of underwriting management systems and related applications to P&C insurers. Total consideration for the FirstBest Acquisition was $37.8 million which included amounts placed into escrow to cover future potential claims. The Company believes that the FirstBest 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 nine months ended April 30, 2017 and $0.3 million were expensed as incurred in the prior fiscal year.
The FirstBest Acquisition 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 utilized the discounted cash flow methodology and the profit allocation methodology under the income approach to estimate the fair values of the intangible assets. The Company used the cost build-up approach to estimate the fair value of deferred revenue by estimating the costs related to fulfilling the obligation plus an additional markup for an assumed operating margin to reflect the profit a third party would expect to make on the costs incurred. 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. The preliminary allocation of the purchase consideration was as follows:

17


 
 
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
 
4,394

 
 
Goodwill
 
15,446

 
 
Total purchase price
 
$
37,758

 
 
The goodwill of $15.4 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 nine months ended April 30, 2017, 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.
4. Balance Sheet Components
Property and Equipment, net
Property and equipment consist of the following:
 
April 30, 2017
 
July 31, 2016
 
(in thousands)
Computer hardware
$
20,448

 
$
19,257

Purchased software
4,548

 
5,066

Capitalized software development costs
498

 

Furniture and fixtures
3,609

 
3,492

Leasehold improvements
8,400

 
8,434

      Total property and equipment
37,503

 
36,249

Less accumulated depreciation
(25,607
)
 
(23,294
)
      Property and equipment, net
$
11,896

 
$
12,955

As of April 30, 2017 and July 31, 2016, no property and equipment was pledged as collateral. Depreciation expense was $1.6 million and $1.7 million for the three months ended April 30, 2017 and 2016, respectively, and was $4.9 million and $4.5 million for the nine months ended April 30, 2017 and 2016, respectively.
During the three months ended April 30, 2017, the Company began to capitalize software development costs for a cloud-based technology application that the Company will offer solely as a software subscription service. Costs incurred in the preliminary stages of development were expensed as incurred. Once the application reached the development stage, we began to capitalize direct costs. Capitalization will continue until the software is substantially complete and ready for its intended use. The amount capitalized was $0.5 million for the three months ended April 30, 2017, primarily comprised of compensation and related headcount costs for employees who were directly associated with the software development.

18


Other Assets
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. Accordingly, if the Company were to disclose the fair value of the investment, the fair value measurement would be Level 3 in the valuation hierarchy. The Company assesses the investment for impairment when events or changes in circumstances indicate that its carrying amount may not be recoverable. During the three months ended April 30, 2017, the Company invested an additional $4.7 million in this privately-held company resulting in no significant change in ownership or degree of influence. As of April 30, 2017 and July 31, 2016, there were no indicators that the investment with carrying values of $10.7 million and $6.0 million, respectively, were impaired.
Goodwill and Intangible Assets
The following table presents changes in the carrying amount of goodwill for the period presented:
 
(in thousands)
Goodwill, July 31, 2016
$
30,080

Addition -- FirstBest acquisition
15,446

Addition -- ISCS acquisition
96,501

Goodwill, April 30, 2017
$
142,027

The Company’s intangible assets are amortized over the estimated useful lives. Intangible assets consist of the following:
 
April 30, 2017
 
July 31, 2016
 
(in thousands)
 
Cost
 
Accumulated Amortization
 
Net Book Value
 
Cost
 
Accumulated Amortization
 
Net Book Value
Amortized intangible assets:
 
 
 
 
 
 
 
 
 
 
 
Acquired technology
$
65,200

 
$
10,825

 
$
54,375

 
$
13,900

 
$
5,199

 
$
8,701

Customer contracts and related relationships
18,000

 
1,183

 
16,817

 
4,500

 
167

 
4,333

Partner relationships
200

 
24

 
176

 
200

 
8

 
192

Order backlog
5,500

 
777

 
4,723

 
1,100

 
122

 
978

Total amortized intangible assets
$
88,900

 
$
12,809

 
$
76,091

 
$
19,700

 
$
5,496

 
$
14,204

Amortization expense was $4.2 million and $0.6 million for the three months ended April 30, 2017 and 2016, respectively, and was $7.3 million and $1.3 million for the nine months ended April 30, 2017 and 2016, respectively. As of April 30, 2017, 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)
$
4,776

2018
18,782

2019
17,542

2020
16,464

2021
9,995

Thereafter
8,532

Total
$
76,091


19


Accrued Employee Compensation
Accrued employee compensation expense consists of the following:
 
April 30, 2017
 
July 31, 2016
 
(in thousands)
 Accrued bonuses
$
16,940

 
$
24,872

 Accrued commission
4,753

 
2,571

 Accrued vacation
10,493

 
9,067

 Accrued payroll taxes and benefits
5,265

 
4,757

     Total
$
37,451

 
$
41,267


Deferred Revenues
Deferred revenues, current and non-current, consist of the following:
 
April 30, 2017
 
July 31, 2016
 
(in thousands)
Deferred license and other revenues
$
34,045

 
$
19,841

Deferred maintenance revenues
42,371

 
38,928

Deferred services revenues
30,767

 
11,246

     Total
$
107,183

 
$
70,015


Deferred services revenues included $19.8 million as of April 30, 2017 and $5.1 million as of July 31, 2016, of deferred services revenues related to one customer engagement.
Accumulated Other Comprehensive Loss
Changes in accumulated other comprehensive loss by component during the nine months ended April 30, 2017 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
(654
)
 
(641
)
 
(1,295
)
Amounts reclassified from accumulated other comprehensive loss to earnings

 
(119
)
 
(119
)
Tax effect

 
289

 
289

Balance as of April 30, 2017
$
(7,463
)
 
$
(255
)
 
$
(7,718
)

20


5. Net Loss Per Share
The following table sets forth the computation of the Company’s basic and diluted net loss per share for the periods presented: 
 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands, except share and per share amounts)
Numerator:
 
 
 
 
 
 
 
   Net loss 
$
(1,819
)
 
$
(404
)
 
$
(5,703
)
 
$
(1,121
)
Net loss per share:
 
 
 
 
 
 
 
   Basic
$
(0.02
)
 
$
(0.01
)
 
$
(0.08
)
 
$
(0.02
)
   Diluted
$
(0.02
)
 
$
(0.01
)
 
$
(0.08
)
 
$
(0.02
)
Denominator:
 
 
 
 
 
 
 
Weighted average shares used in computing net loss per share:
 
 
 
 
 
 
 
   Basic
74,175,603

 
72,297,934

 
73,731,132

 
71,769,613

     Weighted average effect of dilutive stock options

 

 

 

     Weighted average effect of dilutive restricted stock units

 

 

 

   Diluted
74,175,603

 
72,297,934

 
73,731,132

 
71,769,613


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 April 30,
 
Nine Months Ended April 30,
 
2017
 
2016
 
2017
 
2016
Stock options to purchase common stock
895,743

 
1,233,705

 
978,734

 
1,491,148

Restricted stock units
2,906,840

 
3,048,276

 
3,050,091

 
3,287,777

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 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 $1.8 million and $1.5 million for the three months ended April 30, 2017 and 2016, respectively, and was $5.0 million and $4.2 million for the nine months ended April 30, 2017 and 2016, respectively.

Letters of Credit
The Company had two outstanding letters of credit required to secure contractual commitments and prepayments as of April 30, 2017 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 $2.6 million as of April 30, 2017) to secure contractual commitments and prepayments. No amounts were outstanding under the Company’s unsecured letters of credit as of April 30, 2017 or July 31, 2016.

21


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 April 30, 2017 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 April 30, 2017 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.

22


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 April 30,
 
Nine Months Ended April 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Total cost of stock-based compensation
$
17,433

 
$
16,193

 
$
54,344

 
$
47,885

Impact of capitalized stock-based compensation
(236
)
 

 
(683
)
 

Amount charged to income
$
17,197

 
$
16,193

 
$
53,661

 
$
47,885

 
 
 
 
 
 
 
 
Stock-based compensation cost charged to the following expense categories:
 
 
 
 
 
 
 
 Cost of license revenues
$
90

 
$
107

 
$
231

 
$
299

 Cost of maintenance revenues
416

 
388

 
1,265

 
1,107

 Cost of services revenues
4,459

 
4,450

 
13,969

 
13,486

 Research and development
4,508

 
3,889

 
13,625

 
11,472

 Sales and marketing
3,992

 
3,602

 
12,498

 
10,648

 General and administrative
3,732

 
3,757

 
12,073

 
10,873

 Total stock-based compensation expenses
$
17,197

 
$
16,193

 
$
53,661

 
$
47,885



As of April 30, 2017, total unamortized stock-based compensation cost, adjusted for estimated forfeitures, was as follows:
 
 As of April 30, 2017
 
Unrecognized Expense
 
Weighted Average Expected Recognition Period
 
(in thousands)
 
(in years)
 Stock options
$
1,367

 
1.2
 Restricted stock units
129,574

 
2.5
 
$
130,941

 
 


23


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
1,434,943

 
$
60.66

 

Released
(1,067,232
)
 
$
48.89

 
$
60,842

Canceled
(204,874
)
 
$
53.01

 

Balance as of April 30, 2017
2,890,561

 
$
55.56

 
$
177,741

Expected to vest as of April 30, 2017
2,691,764

 
$
55.33

 
$
165,517

(1)
Aggregate intrinsic value at each period end represents the total market value of RSUs at the Company’s closing stock price of $61.49 and $61.47 on April 30, 2017 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
(271,382
)
 
$
12.60

 
 
 
$
12,132

Canceled

 
 
 
 
 
 
Balance as of April 30, 2017
887,190

 
$
16.32

 
3.2
 
$
40,070

Vested and expected to vest as of April 30, 2017
885,781

 
$
16.27

 
3.2
 
$
40,052

Exercisable as of April 30, 2017
810,973

 
$
13.38

 
2.8
 
$
39,015

(1) 
Aggregate intrinsic value at each period end represents the difference between the Company's closing stock prices of $61.49 and $61.47 on April 30, 2017 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
    

24


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 April 30,
 
Nine Months Ended April 30,
 
2017
 
2016
 
2017
 
2016
Expected term (in years)
*
 
*
 
2.66 - 2.88
 
*
Risk-free interest rate
*
 
*
 
0.89% - 1.34%
 
*
Expected volatility of the Company
*
 
*
 
30.2% - 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 April 30, 2017 and no TSR PSUs granted in the prior fiscal year.
    
The number of TSR PSUs 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.    
Common Stock Reserved for Issuance
As of April 30, 2017 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 74,378,533 and 73,039,919 shares of common stock were issued and outstanding, respectively. As of April 30, 2017 and July 31, 2016, the Company had reserved shares of common stock for future issuance as follows:
 
April 30, 2017
 
July 31, 2016
 Exercise of stock options to purchase common stock
887,190

 
1,158,572

 Vesting of restricted stock units
2,890,561

 
2,727,724

 Shares available under stock plans
18,494,736

 
16,746,754

      Total common stock reserved for issuance
22,272,487

 
20,633,050

8.Income Taxes
The Company recognized income tax benefits of $1.1 million and $2.4 million for the three months ended April 30, 2017 and 2016, respectively, and recognized income tax benefits of $4.8 million and $2.4 million for the nine months ended April 30, 2017 and 2016, respectively. The decrease in tax benefits for the three months ended April 30, 2017 was primarily due to a decrease in benefits from discrete tax items for the period, as compared to the same period a year ago. The increase in tax benefits for the nine months ended April 30, 2017 was primarily due to an increase in pre-tax net loss, partially offset by a decrease in benefits from discrete tax items, as compared to the same period a year ago. The effective tax rates of 38% and 46% for the three and nine months ended April 30, 2017, respectively, differ 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 April 30, 2017, U.S. income taxes were not provided for on the cumulative total of $32.3 million undistributed earnings from certain foreign subsidiaries. As of April 30, 2017, the unrecognized deferred tax liability for these earnings was approximately $9.7 million.

25


During the nine months ended April 30, 2017, the increase in unrecognized tax benefits from the beginning of the period was $1.6 million. Accordingly, as of April 30, 2017, the Company had unrecognized tax benefits of $4.4 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 April 30,
 
Nine Months Ended April 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
United States
$
80,239

 
$
56,750

 
$
191,594

 
$
153,641

Canada
12,359

 
10,794

 
41,208

 
32,327

Other Americas
3,869

 
5,824

 
12,965

 
12,578

Total Americas
96,467

 
73,368

 
245,767

 
198,546

United Kingdom
4,499

 
4,206

 
22,463

 
25,783

Other EMEA
10,344

 
10,558

 
28,094

 
24,548

Total EMEA
14,843

 
14,764

 
50,557

 
50,331

Total APAC
12,126

 
10,728

 
36,860

 
34,392

Total revenues
$
123,436

 
$
98,860

 
$
333,184

 
$
283,269

No country, other than those presented above, accounted for more than 10% of revenues during the three and nine months ended April 30, 2017 and 2016, respectively.
The following table sets forth the Company’s long-lived assets, including intangibles and goodwill, net by geographic region: 
 
April 30, 2017
 
July 31, 2016
 
 (in thousands)
Americas
$
226,977

 
$
53,826

EMEA
2,869

 
3,085

APAC
168

 
328

Total
$
230,014

 
$
57,239


26


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. Guidewire InsuranceNow, which we acquired through the acquisition of ISCS, Inc., is a cloud-based platform that offers policy, billing, and claims management functionality to insurers, primarily smaller insurers, that prefer an all-in-one solution.
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 market products that have been acquired or newly introduced. The success of these efforts relies also on investments intended for 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. Customers that prefer an all-in-one, cloud-based solution can enter into a subscription arrangement with our InsuranceNow product.
Our data management and analytics and digital engagement products are sold to customers of InsuranceSuite or one of its component applications. In addition, we will over time integrate our data and digital offerings with InsuranceNow. In each case, the number of potential customers for these products is limited to our installed base of InsuranceSuite modules and, over time, of our InsuranceNow service.
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. Since fiscal 2016, substantially all of our term-based licenses have been 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

27


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.
In February 2017, we completed the acquisition of ISCS, Inc. (“ISCS”), for cash consideration, net of certain adjustments, of approximately $154.9 million. We believe that the acquisition will enhance our ability to serve those P&C insurers that prefer a cloud-based, all-in-one platform that offers policy, billing, and claims management functionality. This platform, which we refer to as InsuranceNow, will be augmented, over time, by the integration of our data and analytics and digital products. The results of ISCS’s operations have been included in our results of operations beginning February 16, 2017, the date of acquisition. We added approximately 193 employees in connection with the acquisition, which impacted our profitability in fiscal 2017 and we anticipate will continue to be dilutive to earnings through fiscal year 2018.
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.
In March 2016, we acquired EagleEye Analytics Inc. (“EagleEye”), a provider of cloud-based predictive analytics products specifically designed for P&C 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.
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. 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, migrating a portion of our business to a more ratable revenue recognition model as we bring to market more cloud-based solutions, 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. For example, the timing of a small number of large transactions may be sufficient to disrupt seasonal revenue trends. 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.

28


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

 
Four quarters ended
 
 
 
April 30, 2017
 
January 31, 2017
 
October 31, 2016
 
July 31, 2016
 
April 30, 2016
 
January 31, 2016
 
October 31, 2015
 
July 31, 2015
 
April 30, 2015
 
(in thousands)
 
 
Term license and other revenues
$
237,919

 
$
220,494

 
$
210,278

 
$
208,430

 
$
194,458

 
$
184,647

 
$
173,232

 
$
169,366

 
$
160,114

Maintenance revenues
66,958

 
64,776

 
62,451

 
59,931

 
56,103

 
53,610

 
51,516

 
50,024

 
48,785

Total four-quarter recurring revenues
$
304,877

 
$
285,270

 
$
272,729

 
$
268,361

 
$
250,561

 
$
238,257

 
$
224,748

 
$
219,390

 
$
208,899


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:

29


 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Reconciliation of Adjusted EBITDA:
 
 
 
 
 
 
 
Net loss
$
(1,819
)
 
$
(404
)
 
$
(5,703
)
 
$
(1,121
)
Non-GAAP adjustments:
 
 
 
 
 
 
 
Benefit from income taxes
(1,115
)
 
(2,358
)
 
(4,788
)
 
(2,413
)
Interest income
(1,394
)
 
(2,211
)
 
(4,280
)
 
(3,665
)
Other expense (income), net
(11
)
 
(804
)
 
335

 
161

Depreciation and amortization
5,825

 
2,293

 
12,208

 
5,835

Stock-based compensation
17,197

 
16,193

 
53,661

 
47,885

Adjusted EBITDA
$
18,683

 
$
12,709

 
$
51,433

 
$
46,682

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 provided by operations was $51.5 million and $50.6 million for the nine months ended April 30, 2017 and 2016, 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 nine months ended April 30, 2017. 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.

30


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 April 30,
 
Nine Months Ended April 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Revenues:
 
 
 
 
 
 
 
License and other
$
58,971

 
$
45,796