10-Q 1 gwre-10312017x10q.htm 10-Q Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________________________________
FORM 10-Q
______________________________________________________________
(Mark one)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 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 October 31, 2017, the registrant had 75,362,109 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 & casualty (“P&C”) insurance industry and our company;
the developing market for subscription services and uncertainties attendant on emerging sales and delivery models;
trends in future sales, including the mix of licensing and subscription models and seasonality;
our competitive environment and changes thereto;
competitive attributes of our software applications and delivery models;
challenges to further increase sales outside of the United States;
our research and development investment and efforts;
expenses to be incurred, and benefits to be achieved from our acquisitions;
our gross and operating margins and factors that affect such margins;
our provision for tax liabilities and other critical accounting estimates;
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. together with its subsidiaries 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
(in thousands)
 
 
October 31,
2017
 
July 31,
2017
 
(unaudited)
 
 
ASSETS
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
255,399

 
$
263,176

Short-term investments
305,685

 
310,027

Accounts receivable
78,408

 
79,433

Prepaid expenses and other current assets
28,142

 
26,604

Total current assets
667,634

 
679,240

Long-term investments
92,388

 
114,585

Property and equipment, net
13,806

 
14,376

Intangible assets, net
66,538

 
71,315

Deferred tax assets, net
146,005

 
37,430

Goodwill
141,924

 
141,851

Other assets
21,853

 
20,104

TOTAL ASSETS
$
1,150,148

 
$
1,078,901

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
14,233

 
$
13,416

Accrued employee compensation
24,579

 
48,882

Deferred revenues, current
86,661

 
91,243

Other current liabilities
9,959

 
10,075

Total current liabilities
135,432

 
163,616

Deferred revenues, noncurrent
24,519

 
19,892

Other liabilities
1,796

 
2,112

Total liabilities
161,747

 
185,620

STOCKHOLDERS’ EQUITY:
 
 
 
Common stock
8

 
8

Additional paid-in capital
850,705

 
830,014

Accumulated other comprehensive loss
(6,567
)
 
(5,796
)
Retained earnings
144,255

 
69,055

Total stockholders’ equity
988,401

 
893,281

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
1,150,148

 
$
1,078,901

See accompanying Notes to Condensed Consolidated Financial Statements.

3


GUIDEWIRE SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands except shares and per share amounts)
 
 
Three Months Ended October 31,
 
2017
 
2016
Revenues:
 
 
 
License and other
$
30,093

 
$
38,721

Maintenance
18,930

 
16,532

Services
59,148

 
38,874

Total revenues
108,171

 
94,127

Cost of revenues:
 
 
 
License and other
6,715

 
2,430

Maintenance
3,467

 
3,325

Services
52,712

 
36,264

Total cost of revenues
62,894

 
42,019

Gross profit:
 
 
 
License and other
23,378

 
36,291

Maintenance
15,463

 
13,207

Services
6,436

 
2,610

Total gross profit
45,277

 
52,108

Operating expenses:
 
 
 
Research and development
35,711

 
30,750

Sales and marketing
23,610

 
25,500

General and administrative
18,671

 
14,160

Total operating expenses
77,992

 
70,410

Loss from operations
(32,715
)
 
(18,302
)
Interest income
1,908

 
1,342

Other expense, net
(262
)
 
(681
)
Loss before income taxes
(31,069
)
 
(17,641
)
Benefit from income taxes
(22,155
)
 
(9,783
)
Net loss
$
(8,914
)
 
$
(7,858
)
Net loss per share:
 
 
 
Basic
$
(0.12
)
 
$
(0.11
)
Diluted
$
(0.12
)
 
$
(0.11
)
Shares used in computing net loss per share:

 

Basic
75,187,430

 
73,293,467

Diluted
75,187,430

 
73,293,467


                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
See accompanying Notes to Condensed Consolidated Financial Statements.

4


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

 
Three Months Ended October 31,
 
2017
 
2016
Net loss
(8,914
)
 
(7,858
)
Other comprehensive loss:
 
 
 
Foreign currency translation adjustments
(696
)
 
(851
)
Unrealized losses on available-for-sale securities, net of tax benefit of $45 and $134 for the three months ended October 31, 2017 and 2016, respectively
(90
)
 
(196
)
Reclassification adjustment for realized losses (gains) included in net loss
15

 
(27
)
Other comprehensive loss
(771
)
 
(1,074
)
Comprehensive loss
(9,685
)
 
(8,932
)

See accompanying Notes to Condensed Consolidated Financial Statements

5


GUIDEWIRE SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
 
 
Three Months Ended October 31,
 
 
2017
 
2016
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
Net loss
 
$
(8,914
)
 
$
(7,858
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
6,634

 
3,074

Stock-based compensation
 
19,623

 
17,877

Deferred income tax
 
(23,708
)
 
(10,502
)
Amortization of premium on available-for-sale securities, and other non-cash items
 
210

 
467

Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable
 
855

 
8,682

Prepaid expenses and other assets
 
(3,575
)
 
191

Accounts payable
 
1,868

 
902

Accrued employee compensation
 
(23,953
)
 
(21,300
)
Other liabilities
 
(356
)
 
(1,251
)
Deferred revenues
 
68

 
(3,192
)
Net cash used in operating activities
 
(31,248
)
 
(12,910
)
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
 
Purchases of available-for-sale securities
 
(66,843
)
 
(200,893
)
Sales of available-for-sale securities
 
93,039

 
157,163

Purchases of property and equipment
 
(1,899
)
 
(2,474
)
Capitalized software development costs
 
(517
)
 

Acquisitions of business, net of acquired cash
 

 
(33,593
)
Net cash provided by (used in) investing activities
 
23,780

 
(79,797
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
 
Proceeds from issuance of common stock upon exercise of stock options
 
365

 
1,112

Net cash provided by financing activities
 
365

 
1,112

Effect of foreign exchange rate changes on cash and cash equivalents
 
(674
)
 
(924
)
NET DECREASE IN CASH AND CASH EQUIVALENTS
 
(7,777
)
 
(92,519
)
CASH AND CASH EQUIVALENTS—Beginning of period
 
263,176

 
223,582

CASH AND CASH EQUIVALENTS—End of period
 
$
255,399

 
$
131,063

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
 
Cash paid for income taxes, net of tax refunds
 
$
1,283

 
$
1,062

SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
 
Accruals for purchase of property and equipment
 
$
374

 
$
188


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. The Company’s technology platform 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 (“P&C”) 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, 2017. There have been no changes in the Company’s significant accounting policies from those that were disclosed in the Company’s consolidated financial statements for the fiscal year ended July 31, 2017 included in the Company’s Annual Report on Form 10-K except changes to the income taxes and stock based compensation policies resulting from the adoption of Accounting Standards Update (“ASU”) 2016-09.
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 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 classified as available-for-sale. 

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 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.
One customer individually accounted for 10% of the Company’s revenues for the three months ended October 31, 2017. No customer accounted for 10% or more of the Company’s revenues for the three months ended October 31, 2016. One customer individually accounted for 11% of the Company’s total accounts receivable as of October 31, 2017, and another customer individually accounted for 11% of the Company’s total accounts receivable as of July 31, 2017.
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 the 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 software subscriptions;
(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 expenses.
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 advance in annual or quarterly installments over the term of the agreement beginning on the effective date of the license and represent extended payment terms. A significant majority are invoiced annually. As a result, term license fees are not considered to be fixed and determinable until they become due or payment is received. Perpetual license fees are generally due between 30 and 60 days from delivery of software. We offer extended payment terms in limited cases. 
Collectability is probable or reasonably assured. 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 reasonably assured, or cash is collected, assuming all other revenue recognition criteria are satisfied.
VSOE of fair value does not exist for the Company’s software licenses; therefore, the Company allocates revenues to software licenses using the residual method. Under the residual method, the amount recognized for license fees is the difference between the total fixed and determinable fees and the VSOE of fair value for the undelivered elements under the arrangement.
The VSOE of fair value for elements of an arrangement is based upon the normal pricing and discounting practices for those elements when sold separately. VSOE of fair value for maintenance is established using the stated maintenance renewal rate in the customer’s contract. For term licenses with duration of one year or less, no VSOE of fair value for maintenance exists. VSOE of fair value for services is established if a substantial majority of historical stand-alone selling prices for a service fall within a reasonably narrow price range.
If the undelivered elements are all service elements and VSOE of fair value does not exist for one or more service element, the total arrangement fee is recognized ratably over the longest service period starting at software delivery, assuming all the related services have been made available to the customer.


8


Substantially all of the Company’s professional services engagements are billed on a time and materials basis. Services are typically not considered to be essential to the functionality of the software, and the related revenues and costs are recognized in the period incurred.
    
In select situations, the Company will contract its professional services on a fixed fee basis. In these situations, if reliable estimates of total project costs are available, the Company recognizes services revenues on a proportional performance basis as the performance obligations are completed by using the ratio of labor hours to date as an input measure compared to total estimated labor hours for the consulting services.    
        
In the limited 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 revenue recognition is measured based on 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.

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 professional 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.
The Company also sells its software 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 on its condensed consolidated balance sheets. 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 tax audits, changes 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 actual forfeitures. To date, the Company has granted stock options, time-based restricted stock units (“RSUs”), performance-based restricted stock units (“PSUs”), and 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 (“S&P Index”) for a specified performance period or specified performance periods, service periods, and in select cases, subject to certain performance conditions (“TSR PSUs”).

9


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 may fluctuate depending on the achievement of the performance conditions. All TSR PSUs will vest at the end of a three-year period.
Business Combinations

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.

Software Development Costs

For qualifying costs incurred for computer software developed for internal use, the Company begins to capitalize its costs to develop software when preliminary development efforts are successfully completed, management has authorized and committed project funding, and it is probable that the project will be completed and the software will be used as intended. These capitalized costs are amortized to expense over the estimated useful life of the related asset, generally estimated to be three years. Costs incurred prior to meeting these capitalization criteria and costs incurred for training and maintenance are expensed as incurred and recorded in research and development expense on the Company’s consolidated statements of operations. Capitalized software development costs are recorded in property and equipment on the Company’s consolidated balance sheet.
Impairment of Long-Lived Assets, Intangible Assets and Goodwill
The Company evaluates its long-lived assets, consisting of property and equipment and 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 has not written down any of its long-lived assets as a result of impairment during the periods presented.
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. There have been no goodwill impairments during the periods presented.
Recent Accounting Pronouncements

Share-Based Payment Accounting (Topic 718): Improvements on Employee Share-Based Payment Accounting

10



In March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-09, “Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“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 Company adopted ASU No. 2016-09 on August 1, 2017.
This ASU requires excess tax benefits and tax deficiencies related to share based payments to be recorded as income tax expense or benefit in the income statement when awards vest or are exercised. Cash flows associated with excess tax benefits are no longer classified as cash flows from financing activities but will be classified as operating activities, consistent with other income tax cash flows. The ASU also requires recognition of a windfall tax benefit at the time of settlement, instead of delaying recognition until it reduces current taxes payable; subject to normal valuation allowance considerations. Previously unrecognized excess tax benefits of $85.7 million have been recorded as deferred tax assets net of valuation allowances of $0.6 million, on a modified retrospective basis with a net cumulative effect adjustment to opening retained earnings of $85.1 million. For the three months ended October 31, 2017, the benefit from income taxes included $4.4 million in tax effects related to stock based awards settled in the period.
The Company elected to account for forfeitures based on actuals, as they occur, and using a modified retrospective transition method,recorded a cumulative-effect adjustment of $1.0 million to decrease the Company’s opening retained earnings balance as of the adoption date.
The Company has prospectively classified excess tax benefits and deficiencies as operating activities on the condensed consolidated statement of cash flows, these were previously classified as financing activities.
The Company prospectively excluded excess tax benefits and deficiencies from assumed future proceeds in the calculation of diluted shares when using the treasury stock method. The effect of this change on the fully diluted net income per share was immaterial for the three months ended October 31, 2017.

Revenue from Contracts with Customers (Topic 606): Revenue Recognition
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: Deferral of the Effective Date , which deferred 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) 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 are 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 that the Company reasonably expects to collect 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.

11


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 expenses, and the accounting for new subscription based offerings, including new revenue models acquired from recent acquisitions.
Financial Instruments (Topic 825): Recognition and Measurement of Financial Assets and Financial Liabilities

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments (Topic 825) (“ASU 2016-01”), which impacts certain aspects of recognition, measurement, presentation and disclosure of financial instruments. The standard will be effective for the Company beginning August 1, 2018. The Company is currently evaluating the effect the updated standard will have on its consolidated financial statements and related disclosures.

Share-Based Payment Accounting (Topic 718): 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.
Leases (Topic 842): 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.

2.
Fair Value of Financial Instruments
Available-for-sale investments within cash equivalents and investments consist of the following:
 
October 31, 2017
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
 
(in thousands)
U.S. agency securities
$
21,652

 
$

 
$
(56
)
 
$
21,596

Commercial paper
70,277

 

 
(14
)
 
70,263

Corporate bonds
257,458

 
89

 
(221
)
 
257,326

U.S. Government bonds
58,162

 

 
(172
)
 
57,990

Certificates of deposit
28,976

 
14

 
(4
)
 
28,986

Money market funds
183,467

 

 

 
183,467

     Total
$
619,992

 
$
103

 
$
(467
)
 
$
619,628


12


 
July 31, 2017
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
 
(in thousands)
U.S. agency securities
$
22,662

 
$

 
$
(66
)
 
$
22,596

Commercial paper
147,371

 
2

 
(34
)
 
147,339

Corporate bonds
258,334

 
157

 
(146
)
 
258,345

U.S. Government bonds
67,164

 

 
(185
)
 
66,979

Certificate of deposit
27,498

 
29

 

 
27,527

Money market funds
96,313

 

 

 
96,313

Total
$
619,342

 
$
188

 
$
(431
)
 
$
619,099

The following table shows the gross unrealized losses and fair value of the Company’s investments with unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position:
 
October 31, 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
$
16,059

 
$
(34
)
 
$
5,537

 
$
(23
)
 
$
21,596

 
$
(57
)
Commercial paper
18,079

 
(14
)
 

 

 
18,079

 
(14
)
Corporate bonds
174,857

 
(202
)
 
12,973

 
(19
)
 
187,830

 
(221
)
U.S. Government bonds
45,301

 
(155
)
 
12,690

 
(16
)
 
57,991

 
(171
)
Certificate of deposit
12,974

 
(4
)
 

 

 
12,974

 
(4
)
     Total
$
267,270

 
$
(409
)
 
$
31,200

 
$
(58
)
 
$
298,470

 
$
(467
)

As of October 31, 2017, the Company had 110 investments in a gross unrealized loss position. The unrealized losses on its available-for-sale securities were primarily a result of unfavorable changes in interest rates subsequent to the initial purchase of these securities. The Company does not intend to sell, nor does it believe it will need to sell, these securities before recovering the associated unrealized losses. The Company does not consider any portion of the unrealized losses at October 31, 2017 to be other-than-temporarily impaired, nor are any unrealized losses considered to be credit losses. The Company has recorded the securities at fair value in its consolidated balance sheets, with unrealized gains and losses reported as a component of accumulated other comprehensive loss. The amount 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 material.
The following table summarizes the contractual maturities of the Company’s investments measured at fair value:
 
October 31, 2017
 
Less Than 12 Months
 
12 to 24 Months
 
Total
 
(in thousands)
U.S. agency securities
$
21,596

 
$

 
$
21,596

Commercial paper
70,263

 

 
70,263

Corporate bonds
169,940

 
87,386

 
257,326

U.S. Government bonds
57,990

 

 
57,990

Money market funds
183,467

 

 
183,467

Certificates of deposit
23,984

 
5,002

 
28,986

     Total
$
527,240

 
$
92,388

 
$
619,628

 

13


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.
The following tables summarize the Company’s financial assets measured at fair value on a recurring basis, by level within the fair value hierarchy as of October 31, 2017 and July 31, 2017:
 
October 31, 2017
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 (in thousands)
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
     Commercial paper
$

 
$
38,088

 
$

 
$
38,088

     Money market funds
183,467

 

 

 
183,467

Short-term investments:
 
 
 
 
 
 
 
     U.S. agency securities

 
21,596

 

 
21,596

     Commercial paper

 
32,175

 

 
32,175

     U.S. Government bonds

 
57,990

 

 
57,990

     Corporate bonds

 
169,940

 

 
169,940

Certificates of deposit

 
23,984

 

 
23,984

Long-term investments:
 
 
 
 
 
 
 
     U.S. agency securities

 

 

 

Certificates of deposit

 
5,002

 

 
5,002

     Corporate bonds

 
87,386

 

 
87,386

     U.S. Government bonds

 

 

 

       Total
$
183,467

 
$
436,161

 
$

 
$
619,628



14


 
July 31, 2017
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 (in thousands)
 
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
     Commercial paper
$

 
$
98,174

 
$

 
$
98,174

     Money market funds
96,313

 

 

 
96,313

Short-term investments:
 
 
 
 
 
 
 
     U.S. agency securities

 
20,583

 

 
20,583

     Commercial paper

 
49,165

 

 
49,165

U.S. Government bonds

 
47,105

 

 
47,105

     Corporate bonds

 
170,654

 

 
170,654

Certificate of deposit

 
22,520

 

 
22,520

Long-term investments:
 
 
 
 
 
 
 
     U.S. agency securities

 
2,013

 

 
2,013

     Certificate of deposit

 
5,007

 

 
5,007

     Corporate bonds

 
87,691

 

 
87,691

     U.S. Government bonds

 
19,874

 

 
19,874

Total
$
96,313

 
$
522,786

 
$

 
$
619,099

3.
Acquisitions

ISCS Acquisition

On February 16, 2017, 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 purchase price of the ISCS Acquisition was approximately $160 million, subject to certain adjustments including a net working capital adjustment, which resulted in cash consideration paid of $154.9 million. The fair value of all assets acquired and liabilities assumed will be finalized by the fiscal quarter ending April 30, 2018. 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, the Company 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 valuation method used was in accordance with the Company’s policy, practice and experience as described above:     

15


 
 
Total Purchase Price Allocation
 
Estimated Useful Lives
 
 
(in thousands)
 
(in years)
Acquired assets, net of assumed liabilities
 
$
4,551

 

Developed technology
 
43,300

 
4
Customer contracts and related relationships
 
7,000

 
9
Order backlog
 
3,500

 
4
Deferred tax assets
 
171

 

Goodwill
 
96,410

 

Total preliminary purchase price
 
$
154,932

 
 
The goodwill of $96.4 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.

FirstBest Acquisition
In August 2016, the Company purchased all of the outstanding equity interests of FirstBest, Inc. During the three months ended October 31, 2017, the fair value of all assets acquired and liabilities assumed in the transaction, including acquired deferred tax assets, were finalized, and did not result in any additional adjustments to the preliminary purchase price allocation in the current quarter.
4. Balance Sheet Components
Property and Equipment, net
Property and equipment consist of the following:
 
October 31, 2017
 
July 31, 2017
 
(in thousands)
Computer hardware
$
21,537

 
$
21,408

Purchased software
3,884

 
3,855

Capitalized software development costs
1,520

 
1,065

Furniture and fixtures
3,404

 
3,253

Leasehold improvements
8,230

 
8,251

      Total property and equipment
38,575

 
37,832

(Less) accumulated depreciation
(24,769
)
 
(23,456
)
      Property and equipment, net
$
13,806

 
$
14,376

As of October 31, 2017 and July 31, 2017, no property and equipment was pledged as collateral. Depreciation expense was $1.9 million and $1.6 million for the three months ended October 31, 2017 and 2016, respectively.
During the third fiscal quarter of 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. The amounts capitalized as of October 31, 2017 and July 31, 2017 were $1.5 million and $1.1 million, respectively, and comprised primarily of compensation and related headcount costs for employees who were directly associated with the software development projects.
Other Assets
The Company’s other assets of $21.9 million and $20.1 million at October 31, 2017 and at July 31, 2017, respectively, include a strategic equity investment in a privately-held company of $10.7 million, which was accounted for using the cost method of accounting. Strategic investments are non-marketable equity securities, in which the Company does not have a controlling interest or the ability to exert significant influence. These investments do not have a readily determinable market value. Under the cost method of accounting, the non-marketable securities are carried at cost and are adjusted only for other-than temporary impairments, certain distributions and additional investments. Accordingly, if the Company were to disclose the fair value of the

16


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.
As of October 31, 2017 and July 31, 2017, there were no indicators that the investment with carrying value of $10.7 million was 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, 2017
$
141,851

Changes in carrying value
73

Goodwill, October 31, 2017
$
141,924

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

 
$
18,596

 
$
46,604

 
$
65,200

 
$
14,710

 
$
50,490

Customer contracts and related relationships
18,000

 
2,183

 
15,817

 
18,000

 
1,683

 
16,317

Partner relationships
200

 
35

 
165

 
200

 
30

 
170

Order backlog
5,500

 
1,548

 
3,952

 
5,500

 
1,162

 
4,338

Total amortized intangible assets
$
88,900

 
$
22,362

 
$
66,538

 
$
88,900

 
$
17,585

 
$
71,315

Amortization expense was $4.8 million and $1.4 million for the three months ended October 31, 2017 and 2016, respectively. As of October 31, 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,
 
2018 (remainder of fiscal year)
$
14,006

2019
17,541

2020
16,464

2021
9,995

2022
2,156

Thereafter
6,376

Total
$
66,538

Accrued Employee Compensation

17


Accrued employee compensation expense consists of the following:
 
October 31, 2017
 
July 31, 2017
 
(in thousands)
 Accrued bonuses
$
6,526

 
$
26,581

 Accrued commission
403

 
5,228

 Accrued vacation
11,509

 
10,873

 Accrued salaries, payroll taxes and benefits
6,141

 
6,200

     Total
$
24,579

 
$
48,882

Deferred Revenues
Deferred revenues, current and non-current, consist of the following:
 
October 31, 2017
 
July 31, 2017
 
(in thousands)
Deferred license and other revenues
$
30,145

 
$
23,727

Deferred maintenance revenues
37,554

 
47,727

Deferred services revenues
43,481

 
39,681

     Total
$
111,180

 
$
111,135

Accumulated Other Comprehensive Loss
Changes in accumulated other comprehensive loss by component during the three months ended October 31, 2017 were as follows:
 
Foreign Currency Translation Adjustments
 
Unrealized Gain (Loss) on Available-for-Sale Securities
 
Total
 
(in thousands)
Balance as of July 31, 2017
$
(5,630
)
 
$
(166
)
 
$
(5,796
)
Other comprehensive loss before reclassification
(696
)
 
(135
)
 
(831
)
Amounts reclassified from accumulated other comprehensive loss to earnings

 
15

 
15

Tax effect

 
45

 
45

Balance as of October 31, 2017
$
(6,326
)
 
$
(241
)
 
$
(6,567
)

18


5. Net Loss Per Share
The following table sets forth the computation of the Company’s basic and diluted net loss per share: 
 
Three Months Ended October 31,
 
2017
 
2016
 
(in thousands, except share and per share amounts)
Numerator:
 
 
 
   Net loss 
$
(8,914
)
 
$
(7,858
)
Net loss per share:
 
 
 
   Basic
$
(0.12
)
 
$
(0.11
)
   Diluted
$
(0.12
)
 
$
(0.11
)
Denominator:
 
 
 
Weighted average shares used in computing net loss per share:
 
 
 
   Basic
75,187,430

 
73,293,467

   Diluted
75,187,430

 
73,293,467


The following weighted shares outstanding of potential common stock were excluded from the computation of diluted loss per share for the periods presented because including them would have been antidilutive:
 
Three Months Ended October 31,
 
2017
 
2016
Stock options to purchase common stock
545,470

 
1,054,183

Restricted stock units
2,556,366

 
3,078,219

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, 2017. See the Annual Report on Form 10-K for the fiscal year ended July 31, 2017 for additional information regarding the Company’s contractual obligations.

Leases
The Company leases certain facilities and equipment under operating leases. Lease expense for all worldwide facilities and equipment, which is being recognized on a straight-line basis over terms of the various leases, was $1.9 million and $1.6 million for the three months ended October 31, 2017 and 2016, respectively.
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. The Company has not accrued for estimated losses in the accompanying condensed consolidated financial statements as the Company has determined that no provision for liability nor disclosure is required related to any claim against the Company because: (a) there is not a reasonable possibility that a loss exceeding amounts already recognized (if any) may be incurred with respect to such claim; (b) a reasonably possible loss or range of loss cannot be estimated; or (c) such estimate is immaterial. The Company has not recorded any accrual for claims as of October 31, 2017 or July 31, 2017. The Company expenses legal fees in the period in which they are incurred.
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.

19


The Company has not had to reimburse any of its customers for losses related to indemnification provisions and no material claims against the Company were outstanding as of October 31, 2017 or July 31, 2017. 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.
7.Stockholders’ Equity and Stock-Based Compensation
Stock-Based Compensation Expense
Stock-based compensation expense related to stock-based awards is included in the Company’s condensed consolidated statements of operations as follows:
 
Three Months Ended October 31,
 
2017
 
2016
 
(in thousands)
Total stock-based compensation
$
19,614

 
$
18,104

Impact of capitalized stock-based compensation
9

 
(227
)
 Total stock-based compensation expenses
$
19,623

 
$
17,877

 
 
 
 
Stock-based compensation was charged to the following categories:
 
 
 
 Cost of license and other revenues
$
174

 
$
51

 Cost of maintenance revenues
455

 
413

 Cost of services revenues
5,226

 
4,695

 Research and development
4,912

 
4,467

 Sales and marketing
4,217

 
4,223

 General and administrative
4,639

 
4,028

 Total stock-based compensation expenses
$
19,623

 
$
17,877



As of October 31, 2017, total unamortized stock-based compensation cost was as follows:
 
 As of October 31, 2017
 
Unrecognized Expense
 
Weighted Average Expected Recognition Period
 
(in thousands)
 
(in years)
 Stock options
$
704

 
1.0
 Restricted stock units
191,030

 
2.7
 
$
191,734

 
 


20


Restricted Stock Units

A summary of the Company’s RSU, PSU and TSR PSU, (collectively “Stock Awards”), activity under the Company’s equity incentive plans is as follows:
 
 Stock Awards Outstanding
 
 Number of Stock Awards Outstanding
 
 Weighted Average Grant Date Fair Value
 
 Aggregate Intrinsic Value (in thousands) (1)
Balance as of July 31, 2017
2,634,085

 
$
56.62

 
$
190,076

Granted
1,066,831

 
$
79.12

 

Released
(332,100
)
 
$
52.63

 
$
25,930

Canceled
(63,586
)
 
$
61.08

 

Balance as of October 31, 2017
3,305,230

 
$
64.20

 
$
264,352

Expected to vest as of October 31, 2017
3,305,230

 
$
64.20

 
$
264,352

(1)
Aggregate intrinsic value at each period end represents the total market value of Stock Awards at the Company’s closing stock price of $79.98 and $72.16 on October 31, 2017 and July 31, 2017, respectively. Aggregate intrinsic value for released RSUs represents the total market value of released Stock Awards 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 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, 2017
555,636

 
$
22.17

 
4.0
 
$
27,777

Granted

 
 
 
 
 
 
Exercised
(22,384
)
 
$
16.31

 
 
 
$
1,380

Canceled

 
 
 
 
 
 
Balance as of October 31, 2017
533,252

 
$
22.42

 
3.8
 
$
30,696

Vested and expected to vest as of October 31, 2017
533,252

 
$
22.42

 
3.8
 
$
30,696

Exercisable as of October 31, 2017
493,449

 
$
20.34

 
3.6
 
$
29,429

(1) 
Aggregate intrinsic value at each period end represents the difference between the Company's closing stock prices of $79.98 and $72.16 on October 31, 2017 and July 31, 2017, respectively, and the exercise price of outstanding options. Aggregate intrinsic value for exercised options represents the difference between the Company’s stock price at date of exercise and the exercise price.
Valuation of Awards
    
TSR PSUs
    

21


The fair values of our TSR PSUs were estimated at the date of grant using the Monte Carlo simulation model which included the following assumptions:    
 
Three Months Ended October 31,
 
2017
 
2016
Expected term (in years)
2.88
 
2.87-2.88
Risk-free interest rate
1.44%
 
0.89%-0.93%
Expected volatility of the Company
28.0%
 
31.5%
Average expected volatility of the peer companies in the S&P Index
34.7%
 
36.9%-37.0%
Expected dividend yield
-%
 
-%
    
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 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 October 31, 2017 and July 31, 2017, the Company was authorized to issue 500,000,000 shares of common stock with a par value of $0.0001 per share and, of these, 75,362,109 and 75,007,625 shares of common stock were issued and outstanding, respectively. As of October 31, 2017 and July 31, 2017, the Company had reserved shares of common stock for future issuance as follows:
 
October 31, 2017
 
July 31, 2017
 Exercise of stock options to purchase common stock
533,252

 
555,636

 Vesting of restricted stock units
3,305,230

 
2,634,085

 Shares available under stock plans
17,450,429

 
18,453,674

      Total common stock reserved for issuance
21,288,911

 
21,643,395

8.Income Taxes
The Company recognized income tax benefits of $22.2 million and $9.8 million for the three months ended October 31, 2017 and 2016, respectively. The increase in tax benefits for the three months ended October 31, 2017 was primarily due to the increase in the loss before taxes and an increase in tax benefits related to stock-based compensation from the adoption of ASU 2016-09 for the period, as compared to the same period a year ago. The effective tax rate of 71% for the three months ended October 31, 2017, differs from the statutory U.S. federal income tax rate of 35% mainly due to permanent differences for stock-based compensation, research and development credits, the tax rate differences between the United States and foreign countries, foreign withholding taxes, and certain non-deductible expenses including executive compensation.
The Company provides U.S. income taxes on the earnings of foreign subsidiaries, unless the subsidiaries’ earnings are considered indefinitely reinvested outside the United States. As of October 31, 2017, U.S. income taxes were not provided for on the cumulative total of $35.4 million undistributed earnings from certain foreign subsidiaries. As of October 31, 2017, the unrecognized deferred tax liability for these earnings was approximately $10.6 million.
During the three months ended October 31, 2017, the increase in unrecognized tax benefits from the beginning of the period was $0.5 million. Accordingly, as of October 31, 2017, the Company had unrecognized tax benefits of $4.8 million that if recognized, would affect the Company’s effective tax rate.


22


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. The Company’s principal operations and decision-making functions are located in the United States.
The following table sets forth revenues by country and region based on the billing address of the customer:
 
Three Months Ended October 31,
 
2017
 
2016
 
(in thousands)
United States
$
69,834

 
$
46,849

Canada
10,195

 
14,494

Other Americas
4,742

 
5,224

Total Americas
84,771

 
66,567

United Kingdom
9,337

 
8,390

Other EMEA
6,624

 
8,941

Total EMEA
15,961

 
17,331

Total APAC
7,439

 
10,229

Total revenues
$
108,171

 
$
94,127

No country, other than those presented above, accounted for more than 10% of revenues during the three months ended October 31, 2017 and 2016, respectively.
The following table sets forth the Company’s long-lived assets, including intangibles and goodwill, net by geographic region: 
 
October 31, 2017
 
July 31, 2017
 
 (in thousands)
Americas
$
219,679

 
$
224,667

EMEA
2,493

 
2,747

APAC
96

 
128

Total
$
222,268

 
$
227,542


23


10. Subsequent Events

On November 1, 2017, the Company completed its acquisition of Cyence, Inc. (“Cyence”) for an aggregate consideration of approximately $275 million, subject to customary transaction adjustments. The consideration consisted of net cash of approximately $130 million and approximately 1.7 million shares of newly issued Guidewire common stock and options. Of those shares, approximately 250,000 are in the form of deferred equity consideration, which are subject to the achievement of certain retention and operating milestones.The Cyence acquisition is intended to provide the Company with a cloud-based data listening and risk analytics technology that enables the P&C insurance industry to grow by underwriting new and evolving risks such as cyber risk, that have gone underinsured or uninsured. The acquisition will be accounted for as a business combination.  The Company has not yet completed its acquisition accounting for this transaction, and is in the process of evaluating the impact of the business combination on its consolidated financial statements.    

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 assume no obligation to revise or update any forward-looking statements for any reason, except as required by law.
Overview
We are a provider of software products and subscription services for the global property and casualty (“P&C”) industry. Our software serves as a technology platform for P&C insurance primary carriers. Guidewire InsurancePlatformTM consists of applications to support core operations, data management and analytics, and digital engagement, and is connected to numerous data sources and third party applications. Our applications are designed to work together to strengthen our customers’ ability to adapt and succeed in a rapidly changing market. Guidewire InsuranceSuite™ and Guidewire InsuranceNowTM provide core transactional systems of record supporting the entire insurance lifecycle, including product definition, distribution, underwriting, policy holder services and claims management. Guidewire InsuranceSuite is a highly configurable and scalable system comprised primarily of three applications (ClaimCenter, PolicyCenter and BillingCenter) that can be licensed separately or together and can be deployed on-premise or in the cloud. Guidewire InsuranceNow is a cloud-based system that offers policy, billing, and claims management functionality to insurers that prefer an all-in-one solution. Our data and analytics applications enable insurers to manage data more effectively and gain insights into their business. Our digital engagement applications enable digital sales, omni-channel service and enhanced claims experiences for policyholders, agents, vendor partners and field personnel. The applications and services of Guidewire InsurancePlatform can be deployed on-premise, in the cloud or in a hybrid mode. To support P&C insurers globally, we have localized, and will continue to localize, our software for use in a variety of international regulatory, language and currency environments.
We sell our products to a wide variety of global P&C insurers ranging from some of the largest global insurance carriers or their subsidiaries to national and regional carriers. Our customer engagement is led by our direct sales model and supported by our system integrator (“SI”) partners. We maintain and continue to grow our sales and marketing efforts globally, and maintain regional sales centers in the Americas, Europe and Asia. Strong customer relationships are a key driver of our success given the long-term nature of our engagements 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. These evaluation periods can extend further if the customer purchases multiple products, which is common; or assesses the benefits of a cloud-based subscription in addition to our more traditional term licensing models. Sales to new customers also involve extensive customer due diligence and reference checks. We must earn credibility with each successful implementation as we expand our sales operations, market products that have been acquired or newly introduced, and expand the ways we deliver our software. The success of our sales efforts relies on continued improvements and enhancements to our current products, the introduction of new products, and the continued development of relevant local content and the automated tools that we believe are optimal for updating that content.
To date, we have primarily licensed our software under term-license contracts. We generally price our licenses based on the amount of direct written premiums (“DWP”) that will be managed by our solutions. Our term licenses for both recurring term license and maintenance fees are typically invoiced annually in advance or, in certain cases, quarterly, and generally include extended payment terms. We assess whether a fee is fixed or determinable at the outset of the arrangement, primarily based on

24


the payment terms associated with the transaction. As a result of our extended payment terms, our term license fees are not considered to be fixed and determinable until they become due or payment is received, resulting in a deferral of the related revenues until this revenue recognition criteria is met, assuming all other revenue recognition criteria are satisfied. In preparing for our adoption of the new revenue recognition standard, we began revising our contracting practices in fiscal 2016 by selling substantially all term-based licenses with an initial two-year committed term and optional annual renewals. We also began a program to amend existing long-term contracts to the same committed term of two-years with optional annual renewals. A small portion of our revenues are derived from perpetual licenses, for which license revenues are typically recognized upon delivery of the software, provided that all revenue recognition criteria have been met.
We also offer subscriptions to our cloud-based services. Currently, subscriptions may be for terms greater than two years, and we anticipate that a majority of our subscription arrangements will be billed annually or quarterly in advance, although in some instances additional fees may be assessed in arrears as customers increase their DWP. Revenues derived from subscriptions are recognized ratably over the contractual term beginning after the service is effectively provisioned, which is the date our service is made available to customers. We anticipate that sales of our subscriptions will increase as a percentage of annual sales as we sell more cloud-based services. As a result of the ratable recognition of revenues associated with subscriptions, a significant shift from term licenses to subscriptions may adversely affect our reported revenue growth. As this relatively new sales model matures, we may decide to change certain terms for future orders to remain competitive or otherwise meet market demands.
To extend our technology leadership in the global market, we continue to invest in research and development to enhance and improve our current products and introduce new products to market. Continued investment in product innovation is critical as we seek to: assist our customers in their IT goals; maintain our competitive advantage; grow our revenues and expand internationally; and meet evolving customer demands. In certain cases we will also acquire skills and technologies to accelerate our time to market for new products and solutions.
Our track record of success with customers and their implementations is central to maintaining our strong competitive position. We rely on our services teams and leading SI partners to meet our customers’ implementation needs. Our services organization is comprised of on-site, near-shore and off-shore technical experts. The services organization seeks to ensure that teams with the right combination of product and language skills are utilized in the most efficient way. Our partnerships with leading SIs allows us to increase 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. We continue to grow our services organization 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. Our investments in services are designed to ensure customer success, both with on-premise and cloud-based solutions.
Acquisitions
On November 1, 2017, we completed the acquisition of Cyence, Inc. (“Cyence”), for an aggregate consideration of approximately $275 million, including approximately $130 million in cash and approximately 1.7 million shares of newly issued Guidewire common stock and options. Through the acquisition we gained a cloud-based data listening and risk analytics technology that enables the P&C insurance industry to grow by underwriting new and evolving risks such as cyber risk, that have gone underinsured or uninsured. This acquisition will be accounted for as a business combination. We have not yet completed our acquisition accounting for this transaction, and we are in the process of evaluating the impact of the business combination on our consolidated financial statements.
In February 2017, we completed the acquisition of ISCS, Inc. (“ISCS”), for cash consideration, net of certain adjustments, of approximately $154.9 million. Through the acquisition we gained a cloud-based, all-in-one transactional platform that combines policy, claims and billing management functionality for P&C insurers. Re-branded InsuranceNow, this platform enhances our ability to serve P&C insurers that have less complex businesses, require the functionality of a suite, and prefer cloud-based delivery. We will continue to invest in this platform, improving its scalability and performance, reducing its cost to implement and deliver,

25


adapting it for international markets and integrating it to our data and analytics and digital products. The results of ISCS’s operations have been included in our results of operations since February 16, 2017, the date of acquisition.
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, this acquisition will allow us to expand our insurance platform by providing insurers in the U.S. and Canada that write 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 August 31, 2016, the date of acquisition.
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 a modest increase in orders in our second fiscal quarter, which is the quarter ending January 31, due to customer buying patterns. We also see significantly 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 or the receipt of early payments 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. As we increase subscription sales, a concentration of such sales in our fiscal fourth quarter will reduce the revenues we can recognize in the fiscal year, which will impact the revenues reported in the fiscal year and our revenue growth.
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. This seasonal pattern, however, may be absent in any given year.

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 four-quarter recurring revenues as well as operating cash flows and capital expenditures.
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. In addition, growth in this metric will be adversely impacted during periods in which subscriptions increase as a percentage of total customer orders, as more of the revenue under those agreements will be deferred to future periods. 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 eight periods presented were:
 
Four quarters ended
 
 
October 31, 2017
 
July 31, 2017
 
April 30, 2017
 
January 31, 2017
 
October 31, 2016
 
July 31, 2016
 
April 30, 2016
 
January 31, 2016
 
 
(in thousands)
 
Term license and other revenues
$
253,792

 
$
258,322

 
$
237,919

 
$
220,494

 
$
210,278

 
$
208,430

 
$
194,458

 
$
184,647

 
Maintenance revenues
71,041

 
68,643

 
66,958

 
64,776

 
62,451

 
59,931

 
56,103

 
53,610

 
Total four-quarter recurring revenues
$
324,833

 
$
326,965

 
$
304,877

 
$
285,270

 
$
272,729

 
$
268,361

 
$
250,561

 
$
238,257

 



26


Operating Cash Flows and Capital Expenditures
We monitor our cash flows from operating activities and used for capital expenditures, 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 the timing of invoicing and collections of accounts receivable, the size of annual bonus payment, as well as payments of payroll and other taxes. As a result, our operating cash flows fluctuate significantly on a year over year basis. Cash used in operations were $31.2 million and $12.9 million for the three months ended October 31, 2017 and 2016, respectively. Additionally, cash used for capital expenditures were $1.9 million and $2.5 million for the three months ended October 31, 2017 and 2016, respectively. Our capital expenditures consisted of purchases of property and equipment, most of which was computer hardware, software and leasehold improvements. For a further discussion of our operating cash flows, see “Liquidity and Capital Resources-Cash Flows.”

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;
Business combinations; and
Long-lived assets, intangible assets and goodwill impairment.
There have been no changes to our significant accounting policies and estimates described in our Annual Report on Form 10-K that have had a material impact on our condensed consolidated financial statements and related notes, except for our election to change our accounting policy to account for the forfeitures and tax effects from stock-based compensation awards as they occur. The change was applied on a modified retrospective basis with a net cumulative effect adjustment of $1.0 million recorded to our retained earnings balance as of August 1, 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 19, 2017 for a more complete discussion of our critical accounting policies and estimates.

27


Results of Operations
The following tables set forth our results of operations for the periods presented. The data has been derived from the unaudited Condensed Consolidated Financial Statements contained in this Quarterly Report on Form 10-Q which, in the opinion of our management, reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position and results of operations for the interim periods presented. The operating results for any period should not be considered indicative of results for any future period. This information should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in our Annual Report on Form 10-K filed with the SEC on September 19, 2017.
 
Three Months Ended October 31,
 
2017
 
As a % of total revenues
 
2016
 
As a % of total revenues
 
(in thousands except percentages)
Revenues:
 
 
 
 
 
 
 
License and other
$
30,093

 
28
 %
 
$
38,721

 
41
 %
Maintenance
18,930

 
18
 %
 
16,532

 
18
 %
Services
59,148

 
54
 %
 
38,874

 
41
 %
Total revenues
108,171

 
100
 %
 
94,127

 
100
 %
Cost of revenues:
 
 
 
 
 
 
 
License and other
6,715

 
6
 %
 
2,430

 
3
 %
Maintenance
3,467

 
3
 %
 
3,325

 
4
 %
Services
52,712

 
49
 %
 
36,264

 
38
 %
Total cost of revenues
62,894

 
58
 %
 
42,019

 
45
 %
Gross profit:
 
 
 
 
 
 
 
License and other
23,378

 
22
 %
 
36,291

 
38
 %
Maintenance
15,463

 
15
 %
 
13,207

 
14
 %
Services
6,436

 
5
 %
 
2,610

 
3
 %
Total gross profit
45,277

 
42
 %
 
52,108

 
55
 %
Operating expenses:
 
 
 
 
 
 
 
Research and development
35,711

 
33
 %
 
30,750

 
33
 %
Sales and marketing
23,610

 
22
 %
 
25,500

 
27
 %
General and administrative
18,671

 
17
 %
 
14,160

 
15
 %
Total operating expenses
77,992

 
72
 %
 
70,410

 
75
 %
Loss from operations
(32,715
)
 
(30
)%
 
(18,302
)
 
(20
)%
Interest income
1,908

 
2
 %
 
1,342

 
1
 %
Other expense, net
(262
)
 
 %
 
(681
)
 
 %
Loss before income taxes
(31,069
)
 
(28
)%
 
(17,641
)
 
(19
)%
Benefit from income taxes
(22,155
)
 
(20
)%
 
(9,783
)
 
(11
)%
Net loss
$
(8,914
)
 
(8
)%
 
$
(7,858
)
 
(8
)%

Revenues
We derive our revenues primarily from licensing our software applications, providing maintenance support and professional services. Additionally, a growing portion of our revenues are derived from subscriptions to our cloud-delivered software.
We will adopt ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606)” on August 1, 2018. We currently intend to apply the Modified Retrospective Method. We have evaluated the potential impact of Topic 606 on our revenue recognition policy and practices and have concluded that Topic 606 will impact the pattern of our revenue recognition associated with our software licenses. Refer to Note 1 of the Notes to Condensed Consolidated Financial Statements included in this Form 10-Q for further details on our evaluation of the potential impact of Topic 606 and our accounting policy related to revenue recognition.
Licenses and Other
A substantial majority of our license and other revenues are comprised of term license fees. We also recognize revenue from sales of perpetual licenses and software subscriptions. Our term license revenues are primarily generated through annual license fees that recur during the term of the contract. Since fiscal year 2016, a substantial majority of our term-based licenses have been sold with a contract of a two year committed term with optional annual renewals. Term-license revenues are generally recognized

28


upon the earlier of when payment is due or cash is received from our customers. In a limited number of cases, we license our software on a perpetual basis or our term licenses provide the customer with the option to purchase a perpetual license at the end of the initial contract term, which we refer to as a perpetual buyout right. Perpetual license revenues are generally recognized upon delivery.
Cloud-delivered software subscription revenues are generally recognized ratably over the term of the arrangement typically beginning upon the provisioning of our service for each engagement, which is the point in time our provisioning process has been completed and access has been made available to the customer, assuming that all other revenue recognition criteria have been met. Such arrangements are not necessarily structured with a two year initial term and the initial term may be longer.
We generally price our software based on the amount of direct written premiums, or DWP, that will be managed by our software. We typically invoice our term-license customers annually or quarterly in advance. We invoice our perpetual license customers either in full at contract signing or on an installment basis. We currently anticipate billing our subscription customers annually or quarterly in advance, but terms may change as our cloud business matures and the market develops.
Maintenance
Our maintenance revenues are generally recognized over the committed maintenance term. Our maintenance fees are typically priced as a fixed percentage of the associated license fees. We typically invoice our customers annually or quarterly in advance.
Professional Services
Our professional services revenues are primarily derived from implementation services performed for our customers, reimbursable travel expenses and training fees. A substantial majority of our services engagements generate revenues on a time and materials basis and revenues are typically recognized upon delivery of our services.
 
Three Months Ended October 31,
 
 
 
 
 
2017
 
2016
 
 
 
 
 
 
 
% of total
 
 
 
% of total
 
Change
 
Amount
 
revenues
 
Amount
 
revenues
 
($)
 
(%)
 
(in thousands, except percentages)
Revenues:
 
 
 
 
 
 
 
 
 
 
 
 License and other
$
30,093

 
28
%
 
$
38,721

 
41
%
 
$
(8,628
)
 
(22
)%
 Maintenance
18,930

 
18
%
 
16,532

 
18
%
 
2,398

 
15
 %
 Services
59,148

 
54
%
 
38,874

 
41
%
 
20,274

 
52
 %
 Total revenues
$
108,171

 
100
%
 
$
94,127

 
100
%
 
$
14,044

 
15
 %
 
 
 
 
 
 
 
 
 
 
 
 

License and Other Revenues
The $8.6 million decrease in our license and other revenues was primarily a result of: (i) the timing of early payments which operated to reduce recognized revenue, on a net basis, of approximately $4.8 million, (ii) perpetual license orders received in the first fiscal quarter of 2017, and (iii) the prevalence of subscription agreements in the first fiscal quarter of 2018. Our license and other revenues are primarily comprised of term license revenues. Term licenses remain our predominant licensing model, although we anticipate subscription licenses to grow as a percentage of annual sales in future periods. Due to the delayed and ratable recognition of subscription revenues, growth in subscription revenues will lag behind the growth of subscription sales and will impact the comparative growth of our reported revenues.


29


 
Three Months Ended October 31,
 
 
 
 
 
2017
 
2016
 
 
 
 
 
 
 
 % of license
 
 
 
 % of license
 
 Change
 
 Amount
 
revenues
 
 Amount
 
revenues
 
 ($)
 
 (%)
 
(in thousands, except percentages)
License and other revenues:
 
 
 
 
 
 
 
 
 
 
 
Term and other
$
29,970

 
100
%
 
$
34,500

 
89
%
 
$
(4,530
)
 
(13
)%
Perpetual
123

 
*

 
4,221

 
11
%
 
(4,098
)
 
(97
)%
Total license and other revenues
$
30,093

 
100
%
 
$
38,721

 
100
%
 
$
(8,628
)
 
(22
)%
* Not meaningful
 
 
 
 
 
 
 
 
 
 
 
The decrease in our term and other revenues was primarily a result of the timing of early payments received in the prior fiscal year’s fourth quarter in advance of their due dates and, to a lesser extent, the impact from the ratable nature of subscription revenues and the concentration of transactions in the fourth quarter of the prior fiscal year.

Perpetual license revenues accounted for less than 1% and approximately 11% of total license and other revenue in the first quarter of fiscal 2018 and 2017, respectively. We anticipate that revenues from the sale and delivery of perpetual licenses will continue to represent a small percentage of our total license and other revenues. Nevertheless, we expect perpetual license revenues to remain volatile across quarters due to the large amount of perpetual revenue that may be generated from a single customer order.

Additionally, our license revenues may fluctuate based on the timing of large orders or if our customers pay their annual license fees in advance of the invoice due date either of which may cause an unexpected increase in revenues in one quarter which can reduce revenue growth rates in future periods. Finally, we anticipate that the small amount of our license and other revenues derived from cloud-delivered software services will increase over time. As a result of the delayed and ratable nature of subscription revenues, near-term revenue growth rates will be negatively impacted.

Maintenance Revenues
The increase in our maintenance revenues reflects our growing term and perpetual license customer base. Subscription arrangements include maintenance as part of the subscription service and are not priced or reported separately. As a result, an increase in the mix of subscription orders in the future will reduce the growth in maintenance revenues.

Services Revenues
The $20.3 million increase in our services revenues was primarily a result of a net increase in billings from new and existing customer engagements performed during the three months ended October 31, 2017, including service revenues associated with InsuranceNow engagements, as well as the recognition of previously deferred amounts.
Historically, we have relied on our network of third-party SI partners to facilitate new sales and implementations of our products. During the past several years we have undertaken a program which increased SI participation on our projects, causing growth in services revenues to moderate significantly. We believe this model will continue to serve us well and we intend, in the future, to continue to expand our network of SI partners and the number of trained consultants with whom we work.
We anticipate, however, that recent declines in services revenues growth rates will reverse as we increase our sales of cloud-based core, digital and data systems. While not essential to the functionality of the service, for a period of time implementations of InsuranceNow or InsuranceSuite Cloud will require significantly greater levels of participation by our services professionals than is currently necessary for on-premise versions of our products.  At the time of our acquisition, ISCS had few third-party resources to assist with implementations of InsuranceNow. We intend to qualify and train consultants from existing and new partners. In the interim, we anticipate taking primary responsibility for InsuranceNow implementations. With respect to InsuranceSuite Cloud, our obligation to manage the platform in production requires us to have a much greater familiarity with its configuration and integrations. As a result, we intend to control implementation work until effective processes have been established to reduce any risk we face in managing a production environment for a system we have not implemented.
As we gain experience with the deployment and maintenance of cloud solutions, we hope to leverage our SI partners more effectively and replicate more closely our current division of labor applicable with on-premise implementations. During this period, however, we anticipate higher levels of growth for our service revenues.


30


We also expect modestly higher levels of variability of our service revenues. As we continue to expand into new markets and new product categories, we have, and we expect to, enter into contracts that may require us to delay the recognition of service revenues and associated costs until we are able to meet certain contractual obligations, including customer acceptance criteria or the delivery of new products.  This has in the past, and may in the future, result in volatility in our reported services revenues and cost of revenues.

Deferred Revenues
 
As of
 
 
 
 
 
October 31, 2017
 
July 31, 2017
 
 Change
 
 Amount
 
 Amount
 
 ($)
 
 (%)
 
(in thousands, except percentages)
Deferred revenues:
 
 
 
 
 
 
 
Deferred license and other revenues
$
30,145

 
$
23,727

 
$
6,418

 
27
 %
Deferred maintenance revenues
37,554

 
47,727

 
(10,173
)
 
(21
)%
Deferred services revenues
43,481

 
39,681

 
3,800

 
10
 %
Total deferred revenues
$
111,180

 
$
111,135

 
$
45

 
*

* Not meaningful
 
 
 
 
 
 
 
Deferred License and Other Revenues
The $6.4 million increase in deferred license and other revenues was primarily a result of the combined net impact from increases in deferrals of amounts associated with subscription contracts that are recognized on a ratable basis, increases in license billings related to new contracts executed during fiscal year 2018 which will be recognized when contractual obligations are met, partially offset by the recognition of billings recognized based on timing of payments and upon meeting certain contractual obligations.
Deferred Maintenance Revenues
The $10.2 million decrease in deferred maintenance revenues was primarily driven by the impact from revenues recognized in excess of new billings during the three months ended October 31, 2017, and reflects the seasonal nature of the billings of maintenance revenues. Additionally, subscription arrangements include maintenance as part of the subscription service and are not priced or reported separately. As a result, an increase in the mix of subscription orders in the future will reduce the growth in deferred maintenance revenues.
Deferred Services Revenues
The $3.8 million increase in deferred services revenues was primarily driven by a $7.6 million increase in services billings associated with ongoing InsuranceNow implementations related to acquired contracts which are being deferred until go-live and then will be recognized ratably over the remaining contract term. This was partially offset by the net recognition of $3.8 million in previously deferred billings.
Generally, our deferred revenues consist only of amounts that have been invoiced, but not yet recognized as revenues. As a result, deferred revenues and change in deferred revenues represent incomplete measures of the strength of our business and are not necessarily indicative of our future performance. However, we believe that as we transition to a greater mix of subscription revenues, the change in our deferred revenues will become a more meaningful indicator of our future performance.
Cost of Revenues and Gross Profit
Our total cost of revenues and gross profit are variable and depend on the type of revenues earned in each period.
Our cost of license and other revenues is primarily comprised of compensation and benefit expenses for our cloud operations and Guidewire Production Services personnel, amortization of our acquired intangible assets and royalty fees paid to third parties. Our cost of maintenance revenues is comprised of compensation and benefit expenses for our technical support team. Our cost of services revenues is primarily comprised of compensation and benefit expenses for our professional service employees and contractors, travel-related costs and allocated overhead. In the instances we serve as a prime contractor, subcontractor fees are expensed as cost of service. In each case, personnel costs include stock-based awards and allocated overhead.

31


We allocate overhead such as IT support, facility and other administrative costs to all functional departments based on headcount. As such, general overhead expenses are reflected in cost of revenue and each functional operating expense.  
 
Three Months Ended October 31,
 
 
 
 
 
2017
 
2016
 
 Change
 
 Amount
 
 Amount
 
 ($)
 
 (%)
 
(in thousands, except percentages)
Cost of revenues:
 
 
 
 
 
 
 
License and other
$
6,715

 
$
2,430

 
$
4,285

 
176
%
Maintenance
3,467

 
3,325

 
142

 
4
%
Services
52,712

 
36,264

 
16,448

 
45
%
Total cost of revenues
$
62,894

 
$
42,019

 
$
20,875

 
50
%
 
 
 
 
 
 
 
 
Includes stock-based awards of:
 
 
 
 
 
 
 
        Cost of license and other revenues
$
174

 
$
51

 
$
123

 

        Cost of maintenance revenues
455

 
413

 
42

 

        Cost of services revenues
5,226

 
4,695

 
531

 

        Total
$
5,855

 
$
5,159

 
$
696

 

 
 
 
 
 
 
 
 
The $20.9 million increase in cost of revenues primarily resulted from increases in the costs of license and other revenues of $4.3 million and cost of service revenues of $16.4 million.
The increase in our cost of license and other revenues was primarily attributable to the combined impact from increases of $2.8 million related to the amortization of acquired intangible assets and $1.0 million related to increased headcount and related expenses as we grew our cloud operations and Guidewire Production Services staff. We anticipate higher cost of license and other revenue as we continue to grow the staffing for our cloud operations and Guidewire Production Services.
Cost of maintenance revenues remained primarily flat in line with term and perpetual license sales activities.
The increase in our cost of services revenues was primarily attributable to the combined impact of $10.3 million in higher compensation and related headcount expenses and $4.1 million in expenses for billable third-party consultants and sub-contractors.
We had 766 professional service employees and 94 technical support and licensing operations employees at October 31, 2017 compared to 610 professional services employees and 71 technical support and licensing operations employees at October 31, 2016. The increase in hiring included the 128 professional service, technical support and licensing operations employees hired on a permanent basis as part of the ISCS acquisition that we completed on February 16, 2017.
 
Three Months Ended October 31,