10-Q 1 gwre-4302018x10q.htm 10-Q Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________________________________________________
FORM 10-Q
______________________________________________________________
(Mark one)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended April 30, 2018
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 May 31, 2018, the registrant had 80,263,759 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
(unaudited, in thousands)
 
 
April 30,
2018
 
July 31,
2017
 
 
 
 
ASSETS
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
476,101

 
$
263,176

Short-term investments
518,151

 
310,027

Accounts receivable
101,146

 
79,433

Prepaid expenses and other current assets
31,229

 
26,604

Total current assets
1,126,627

 
679,240

Long-term investments
164,206

 
114,585

Property and equipment, net
15,929

 
14,376

Intangible assets, net
103,001

 
71,315

Deferred tax assets, net
58,597

 
37,430

Goodwill
342,469

 
141,851

Other assets
21,704

 
20,104

TOTAL ASSETS
$
1,832,533

 
$
1,078,901

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
19,357

 
$
13,416

Accrued employee compensation
43,427

 
48,882

Deferred revenues, current
113,894

 
91,243

Other current liabilities
12,016

 
10,075

Total current liabilities
188,694

 
163,616

Convertible senior notes, net
302,184

 

Deferred revenues, non-current
20,667

 
19,892

Other liabilities
1,121

 
2,112

Total liabilities
512,666

 
185,620

STOCKHOLDERS’ EQUITY:
 
 
 
Common stock
8

 
8

Additional paid-in capital
1,276,379

 
830,014

Accumulated other comprehensive loss
(6,598
)
 
(5,796
)
Retained earnings
50,078

 
69,055

Total stockholders’ equity
1,319,867

 
893,281

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
1,832,533

 
$
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 April 30,
 
Nine Months Ended April 30,
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 
 
 
 
 
 
License and other
$
50,359

 
$
58,971

 
$
164,673

 
$
161,767

Maintenance
18,749

 
16,858

 
56,789

 
49,972

Services
71,361

 
47,607

 
190,966

 
121,445

Total revenues
140,469

 
123,436

 
412,428

 
333,184

Cost of revenues:
 
 
 
 
 
 
 
License and other
9,742

 
5,208

 
25,497

 
10,419

Maintenance
3,828

 
3,480

 
10,888

 
9,884

Services
60,751

 
42,780

 
168,599

 
113,995

Total cost of revenues
74,321

 
51,468

 
204,984

 
134,298

Gross profit:
 
 
 
 
 
 
 
License and other
40,617

 
53,763

 
139,176

 
151,348

Maintenance
14,921

 
13,378

 
45,901

 
40,088

Services
10,610

 
4,827

 
22,367

 
7,450

Total gross profit
66,148

 
71,968

 
207,444

 
198,886

Operating expenses:
 
 
 
 
 
 
 
Research and development
46,787

 
34,090

 
126,155

 
94,865

Sales and marketing
30,378

 
28,788

 
85,949

 
77,808

General and administrative
18,170

 
13,429

 
57,907

 
40,649

Total operating expenses
95,335

 
76,307

 
270,011

 
213,322

Loss from operations
(29,187
)
 
(4,339
)
 
(62,567
)
 
(14,436
)
Interest income
3,762

 
1,400

 
7,247

 
4,286

Interest expense
(2,228
)
 
(6
)
 
(2,239
)
 
(6
)
Other income (expense), net
(356
)
 
11

 
1,040

 
(335
)
Loss before income taxes
(28,009
)
 
(2,934
)
 
(56,519
)
 
(10,491
)
Provision for (benefit from) income taxes
20,613

 
(1,115
)
 
46,572

 
(4,788
)
Net loss
$
(48,622
)
 
$
(1,819
)
 
$
(103,091
)
 
$
(5,703
)
Net loss per share:
 
 
 
 
 
 
 
Basic
$
(0.62
)
 
$
(0.02
)
 
$
(1.32
)
 
$
(0.08
)
Diluted
$
(0.62
)
 
$
(0.02
)
 
$
(1.32
)
 
$
(0.08
)
Shares used in computing net loss per share:
 
 
 
 
 
 
 
Basic
78,777,484

 
74,175,603

 
78,246,146

 
73,731,132

Diluted
78,777,484

 
74,175,603

 
78,246,146

 
73,731,132


                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
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 April 30,
 
Nine Months Ended April 30,
 
2018
 
2017
 
2018
 
2017
Net loss
$
(48,622
)
 
$
(1,819
)
 
$
(103,091
)
 
$
(5,703
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustments
(1,522
)
 
183

 
(94
)
 
(654
)
Unrealized (losses) gains on available-for-sale securities, net of tax benefit of $124 and $14 for the three months ended April 30, 2018 and 2017, respectively; $291 and $289 for the nine months ended April 30, 2018 and 2017, respectively
(198
)
 
49

 
(623
)
 
(352
)
Reclassification adjustment for realized gains included in net loss
(100
)
 
(60
)
 
(85
)
 
(119
)
Other comprehensive income (loss)
(1,820
)
 
172

 
(802
)
 
(1,125
)
Comprehensive loss
$
(50,442
)
 
$
(1,647
)
 
$
(103,893
)
 
$
(6,828
)

See accompanying Notes to Condensed Consolidated Financial Statements

5


GUIDEWIRE SOFTWARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
 
 
Nine Months Ended April 30,
 
 
2018
 
2017
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
Net loss
 
$
(103,091
)
 
$
(5,703
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
26,117

 
12,208

Amortization of debt discount and issuance costs
 
1,568

 

Stock-based compensation
 
68,494

 
53,661

Excess tax benefit from stock-based compensation
 

 
962

Deferred income tax
 
43,421

 
(6,779
)
Amortization of premium on available-for-sale securities, and other non-cash items
 
(34
)
 
1,201

Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable
 
(16,809
)
 
(25,745
)
Prepaid expenses and other assets
 
(1,972
)
 
(7,172
)
Accounts payable
 
4,569

 
546

Accrued employee compensation
 
(7,237
)
 
(3,589
)
Other liabilities
 
886

 
(1,085
)
Deferred revenues
 
20,703

 
33,032

Net cash provided by operating activities
 
36,615

 
51,537

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
 
Purchases of available-for-sale securities
 
(535,310
)
 
(343,761
)
Sales of available-for-sale securities
 
276,686

 
442,830

Purchases of property and equipment
 
(4,710
)
 
(3,236
)
Capitalized software development costs
 
(1,850
)
 
(374
)
Strategic investment
 

 
(4,677
)
Acquisitions of business, net of acquired cash
 
(130,058
)
 
(187,590
)
Net cash used in investing activities
 
(395,242
)
 
(96,808
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
 
Proceeds from issuance of convertible senior notes, net of issuance costs
 
387,239

 

Proceeds from issuance of common stock, net of issuance costs
 
220,948

 

Purchase of capped calls
 
(37,200
)
 

Proceeds from issuance of common stock upon exercise of stock options
 
1,055

 
3,419

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

 
(962
)
Net cash provided by financing activities
 
572,042

 
2,457

Effect of foreign exchange rate changes on cash and cash equivalents
 
(490
)
 
(602
)
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
 
212,925

 
(43,416
)
CASH AND CASH EQUIVALENTS—Beginning of period
 
263,176

 
223,582

CASH AND CASH EQUIVALENTS—End of period
 
$
476,101

 
$
180,166

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
 
Cash paid for income taxes, net of tax refunds
 
$
3,786

 
$
2,487

SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
 
Accruals for purchase of property and equipment
 
$
823

 
$
569


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.

Public Offerings

In March 2018, the Company closed a public offering of 2,628,571 shares of its common stock, including the underwriters’ exercise in full of their option to purchase additional shares of common stock from the Company. The public offering price of the shares sold in the offering was $87.50 per share. No shares were sold by the Company’s stockholders in this public offering. Concurrently, the Company offered and sold $400.0 million aggregate principal amount of its 1.250% Convertible Senior Notes due 2025 (the “Convertible Senior Notes”), including the underwriters’ exercise in full of their option to purchase additional Convertible Senior Notes. Net of offering expenses and underwriting discounts (“issuance costs”), the Company received net proceeds of approximately $220.9 million related to the common stock offering and $387.2 million related to the convertible note offering.
Basis of Presentation
The accompanying 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 U.S. Securities and Exchange Commission (“SEC”).
These 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 filed with the SEC on September 19, 2017, except changes to the income taxes and stock-based compensation policies resulting from the adoption of Accounting Standards Update (“ASU”) 2016-09 during the first quarter of fiscal year 2018.
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, convertible senior notes fair value, 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

7


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.
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.
No customer individually accounted for 10% or more of the Company’s revenues for the three and nine months ended April 30, 2018 and nine months ended April 30, 2017. One customer individually accounted for 10% or more of the Company’s revenues for the three months ended April 30, 2017. No customer individually accounted for 10% or more of the Company’s total accounts receivable as of April 30, 2018. As of July 31, 2017, one customer individually accounted for 11% of the Company’s total accounts receivable.
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, software license subscriptions and cloud-based subscriptions (collectively referred to as “subscriptions”), and perpetual software licenses;
(ii)
Maintenance fees associated with term or perpetual licenses relate 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

8


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.
The Company’s subscriptions 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, in certain cases, 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.

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.

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.

9


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 tax regulations and resulting changes in the deferred tax valuation allowance, changes in the mix and level of income or losses, changes in the expected outcome of tax audits, as well as permanent differences for stock-based compensation, including excess tax benefits, research and development credits, the tax rate differences between the United States and foreign countries, foreign withholding taxes, certain non-deductible expenses including executive compensation, and acquisition-related expenses.

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, restricted stock awards (“RSAs”), 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”). RSAs, RSUs, PSUs, and TSR PSUs are collectively referred to as “Stock Awards”.
The fair value of the Company’s RSAs, RSUs, and PSUs equal 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, subsequent adjustments, if any, 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, 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 condensed consolidated balance sheet.
Impairment of Long-Lived Assets, Intangible Assets and Goodwill

10


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.
Convertible Senior Notes
In March 2018, the Company issued $400.0 million aggregate principal amount of 1.250% Convertible Senior Notes due 2025. The Company accounts for the issued Convertible Senior Notes as separate liability and equity components. The carrying amount of the equity component, representing the conversion option, was determined by deducting the fair value of the liability component from the par value of the Convertible Senior Notes as a whole. This difference represents a debt discount that is amortized to interest expense using the effective interest method over the term of the Convertible Senior Notes. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The equity component of the Convertible Senior Notes is recorded at its initial fair value and will not be remeasured as long as it continues to meet the requirements for equity classification. The equity component is net of issuance costs and recorded in additional paid in capital.
Recently Adopted Accounting Pronouncements

Share-Based Payment Accounting (Topic 718): Improvements on Employee Share-Based Payment Accounting
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. For the three and nine months ended April 30, 2018, the provision for income taxes included tax benefits of $2.9 million and $8.0 million, respectively, in tax effects related to settled stock-based awards.
Recent Accounting Pronouncements Not Yet Adopted
Income Statement, Reporting Comprehensive Income (Topic 220): Reclassification of Certain Effects from Accumulated Other Comprehensive Income
In February 2018, the FASB issued ASU No. 2018-02, Income Statement, Reporting Comprehensive Income (Topic 220): Reclassification of Certain Effects from Accumulated Other Comprehensive Income (“ASU 2018-02”), which allows a reclassification of stranded tax effects from accumulated other comprehensive income to retained earnings, as a result of the Tax Cuts and Jobs Act (“Tax Act”). ASU 2018-02 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating the impact of adopting the new standard for its 2019 fiscal year and subsequent periods.
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.

11


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.
In March 2016, the FASB issued ASU No. 2016-08, Principal Versus Agent Consideration (or Reporting Revenue Gross versus Net), 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 term software licenses, software subscriptions, and to a lesser extent, cloud-based subscriptions. 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.
The Company currently anticipates that the impact of Topic 606 on its cloud-based subscriptions, will be more modest than for term licenses and will impact, primarily, those subscriptions that contractually provide for increasing annual subscription payments during the term of the arrangement.
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 cloud-based subscription offerings, including new revenue models acquired from recent acquisitions.

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.

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, and presentation and disclosure of financial instruments. Under ASU 2016-01, unconsolidated non-equity method investments shall be measured at fair value. If such investments do not have a readily determinable fair value, an election may be made to measure them at cost after considering observable price changes for similar

12


instruments. 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 strategic equity investment in a privately-held company.

Other recent accounting pronouncements that are or will be applicable to the Company did not, or are not expected to, have a material impact on the Company's present or future financial statements.

2.
Fair Value of Financial Instruments
Available-for-sale investments within cash equivalents and investments consist of the following:
 
April 30, 2018
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
 
(in thousands)
U.S. Government agency securities
$
22,521

 
$

 
$
(43
)
 
$
22,478

Commercial paper
506,732

 
8

 
(212
)
 
506,528

Corporate bonds
351,653

 
44

 
(955
)
 
350,742

U.S. Government bonds
72,276

 

 
(118
)
 
72,158

Foreign government bonds
1,764

 
3

 

 
1,767

Certificates of deposit
83,952

 
53

 
(23
)
 
83,982

Money market funds
66,363

 

 

 
66,363

     Total
$
1,105,261

 
$
108

 
$
(1,351
)
 
$
1,104,018

 
July 31, 2017
 
Amortized Cost
 
Unrealized Gains
 
Unrealized Losses
 
Estimated Fair Value
 
(in thousands)
U.S. Government 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

Foreign government bonds

 

 

 

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 an unrealized loss position:

13


 
April 30, 2018
 
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. Government agency securities
$
7,937

 
$
(17
)
 
$
14,541

 
$
(25
)
 
$
22,478

 
$
(42
)
Commercial paper
167,316

 
(212
)
 

 

 
167,316

 
(212
)
Corporate bonds
275,769

 
(916
)
 
21,225

 
(40
)
 
296,994

 
(956
)
U.S. Government bonds
47,277

 
(15
)
 
24,881

 
(103
)
 
72,158

 
(118
)
Foreign government bonds
764

 

 

 

 
764

 

Certificate of deposit
24,708

 
(23
)
 

 

 
24,708

 
(23
)
     Total
$
523,771

 
$
(1,183
)
 
$
60,647

 
$
(168
)
 
$
584,418

 
$
(1,351
)

As of April 30, 2018, the Company had 194 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 April 30, 2018 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 available-for-sale investments measured at fair value:
 
April 30, 2018
 
Less Than 12 Months
 
12 to 24 Months
 
Total
 
(in thousands)
U.S. Government agency securities
$
15,540

 
$
6,938

 
$
22,478

Commercial paper
506,528

 

 
506,528

Corporate bonds
211,737

 
139,005

 
350,742

U.S. Government bonds
72,158

 

 
72,158

Foreign government bonds
1,003

 
764

 
1,767

Money market funds
66,363

 

 
66,363

Certificates of deposit
66,483

 
17,499

 
83,982

     Total
$
939,812

 
$
164,206

 
$
1,104,018

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



14



Available-for-sale investments
The following tables summarize the Company’s available-for-sale investments measured at fair value on a recurring basis, by level within the fair value hierarchy:
 
April 30, 2018
 
Level 1
 
Level 2
 
Level 3
 
Total
 
 (in thousands)
Cash equivalents:
 
 
 
 
 
 
 
     Commercial paper

 
341,829

 

 
341,829

     Money market funds
66,363

 

 

 
66,363

     U.S. Government bonds

 
9,969

 

 
9,969

Certificates of deposit

 
3,500

 

 
3,500

Short-term investments:
 
 
 
 
 
 
 
     U.S. Government agency securities

 
15,540

 

 
15,540

     Commercial paper

 
164,699

 

 
164,699

     U.S. Government bonds

 
62,189

 

 
62,189

Foreign government bonds


 
1,003

 


 
1,003

     Corporate bonds

 
211,736

 

 
211,736

Certificates of deposit

 
62,984

 

 
62,984

Long-term investments:
 
 
 
 
 
 
 
     U.S. Government agency securities

 
6,938

 

 
6,938

Certificates of deposit

 
17,498

 

 
17,498

     Corporate bonds

 
139,006

 

 
139,006

     U.S. Government bonds

 

 

 

Foreign government bonds

 
764

 

 
764

       Total
$
66,363

 
$
1,037,655

 
$

 
$
1,104,018



15


 
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

  U.S. Government bonds

 

 

 

Certificates of deposit

 

 

 

Short-term investments:
 
 
 
 
 
 
 
     U.S. Government agency securities

 
20,583

 

 
20,583

     Commercial paper

 
49,165

 

 
49,165

U.S. Government bonds

 
47,105

 

 
47,105

Foreign government bonds

 

 

 

     Corporate bonds

 
170,654

 

 
170,654

Certificate of deposit

 
22,520

 

 
22,520

Long-term investments:
 
 
 
 
 
 
 
     U.S. Government 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

Foreign government bonds

 

 

 

      Total
$
96,313

 
$
522,786

 
$

 
$
619,099


Convertible Senior Notes

The carrying value of the Convertible Senior Notes was $310.5 million before consideration of issuance costs, which approximates their fair value at April 30, 2018. In accounting for the issuance of the notes, the Company separated the notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated conversion feature. The carrying amount of the equity component representing the conversion option was determined by deducting the fair value of the liability component from the par value of the notes as a whole.

The Company estimates the fair value of the Convertible Senior Notes using commonly accepted valuation methodologies and market-based risk measurements that are indirectly observable, such as credit risk (Level 2). The Company carries the Convertible Senior Notes at face value less unamortized debt discount and issuance costs on its consolidated balance sheet, and presents the fair value for required disclosure purposes only. For further information on the Convertible Senior Notes see Note 6.

3.
Acquisitions

Cyence Acquisition

On November 1, 2017, the Company completed its acquisition of Cyence, Inc. (“Cyence”) for an aggregate consideration of approximately $260.3 million, including approximately $146.6 million in cash, and equity consideration valued at approximately $113.7 million of newly issued Guidewire common stock and options, net of certain adjustments including a net working capital adjustment (the “Cyence Acquisition”).  Through the acquisition, the Company gained a cloud-based data listening and risk analytics technology offering for the P&C insurance industry which enables underwriting new and evolving risks, such as cyber risk. This acquisition was accounted for as a business combination. The results of Cyence’s operations have been included in the Company’s results of operations since November 1, 2017, the date of acquisition.
    
As part of the acquisition, the Company assumed certain Cyence compensation agreements, consisting of RSAs, stock options, and cash compensation, with an estimated fair value of $37.6 million. Based on the period earned prior to the acquisition date,

16


$18.2 million was allocated to the purchase price, and $19.4 million relating to post-acquisition services will be recorded as operating expenses over the remaining requisite service periods. RSAs were valued based on the November 1, 2017 grant date value, and the estimated fair value of the stock options assumed by the Company was determined using the Black-Scholes option pricing model.

The adjustments reflected herein to determine the purchase consideration are preliminary and may change as the Company finalizes these adjustments during the measurement period based on new information as it becomes available. The preliminary purchase consideration is as follows:
 
Preliminary Purchase Consideration
 
(in thousands)
Cash consideration paid at close
$
146,651

Equity issued to shareholders
102,493

Issuance of replacement awards
11,205

Total preliminary purchase consideration
$
260,349


In conjunction with the preliminary purchase price allocation, the Company determined that Cyence’s separately identifiable intangible assets were developed technology, customer contracts and related relationships, order backlog, and trade names. The Company utilized the discounted cash flow methodology and the profit allocation methodology under the income approach to estimate the fair values of intangible assets. The Company used the cost build-up approach to estimate the fair value of deferred revenue by estimating the costs related to fulfilling the obligation plus an additional markup for an assumed operating margin to reflect the profit a third party would expect to realize on the costs incurred. These fair value measurements were based on significant inputs that were not observable in the market and thus represent a Level 3 measurement. The valuation models were based on estimates of future operating projections of Cyence and rights to sell new products containing the acquired technology as well as judgments on the discount rates used and other variables. The Company developed forecasts based on a number of factors including future revenue and operating cost projections, a discount rate that is representative of the weighted average cost of capital, in addition to royalty and long-term sustainable growth rates based on a market analysis. The Company amortizes the acquired intangibles over their estimated useful lives as set forth in the table below.

The allocation of purchase price is preliminary pending the final valuation of intangible and tangible assets acquired and liabilities assumed, certain acquired deferred tax assets and completion of certain statutory tax filing requirements and is therefore subject to potential future measurement period adjustments. The preliminary allocation of the purchase consideration is as follows:
 
 
Preliminary Purchase Price Allocation
 
Estimated Useful Lives
 
 
(in thousands)
 
(in years)
Acquired assets, net of assumed liabilities
 
$
8,026

 
 
Developed technology
 
28,400

 
5
Customer contracts and related relationships
 
17,700

 
5
Order backlog
 
3,200

 
2
Trademarks
 
2,500

 
7
Goodwill
 
200,523

 
 
Total preliminary purchase consideration
 
$
260,349

 
 
The goodwill of $200.5 million arising from the Cyence Acquisition consists largely of the acquired workforce and the opportunity to expand the Company’s customer base. The goodwill recognized is not expected to be deductible for income tax purposes.
For the three months ended April 30, 2018, total revenue and net loss attributable to Cyence was approximately $2.9 million and $8.5 million, respectively. For the nine months ended April 30, 2018, total revenue and net loss attributable to Cyence was approximately $5.0 million and $18.2 million, respectively. The Company incurred no acquisition-related costs for the three months ended April 30, 2018 and $5.2 million of total acquisition-related costs for the nine months ended April 30, 2018 that were recognized in general and administrative expenses.

17


Unaudited Pro Forma Financial Information
The following unaudited pro forma financial information presents the combined results of operations for the Company and Cyence for the three and nine months ended April 30, 2018 and 2017, after giving effect to the Cyence Acquisition as if it had occurred on August 1, 2016. The unaudited pro forma financial information includes adjustments to give effect to pro forma events that are directly attributable to the business combination and factually supportable. The unaudited pro forma financial information presented includes the business combination accounting effects resulting from the acquisition, including adjustments for the amortization of intangible assets, stock-based compensation, deferred revenue, and transaction costs on August 1, 2016 with a corresponding reduction of these amounts in the period originally recognized.
The unaudited pro forma financial information is presented for illustrative purposes only and is not necessarily indicative of the results of operations that would have been realized if the Cyence acquisition had been completed on August 1, 2016, nor does it purport to project the results of operations of the combined company in future periods. The unaudited pro forma financial information does not give effect to any anticipated integration costs related to the acquired company. Consequently, actual results will differ from the unaudited pro forma financial information.
The unaudited pro forma financial information is as follows (in thousands):
 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2018
 
2017
 
2018
 
2017
Pro forma revenue
$
140,469

 
$
125,494

 
$
417,360

 
$
340,560

Pro forma net loss
$
(48,622
)
 
$
(9,454
)
 
$
(106,043
)
 
$
(31,710
)
Pro forma net loss per share -- basic
$
(0.62
)
 
$
(0.13
)
 
$
(1.36
)
 
$
(0.43
)
Pro forma net loss per share -- diluted
$
(0.62
)
 
$
(0.13
)
 
$
(1.36
)
 
$
(0.43
)
The pro forma revenue and net loss reflects material, nonrecurring adjustments, such as transaction, transition and integration-related charges (including legal, accounting and other professional fees, and retention bonuses) that resulted from the acquisition.

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 was finalized in the fiscal quarter ended April 30, 2018. A portion of the consideration was 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. The results of ISCS’ operations have been included in the Company’s results of operations since February 16, 2017, the acquisition date.

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 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:     

18


 
 
Total Purchase Price Allocation
 
Estimated Useful Lives
 
 
(in thousands)
 
(in years)
Acquired assets, net of assumed liabilities
 
$
4,530

 

Developed technology
 
43,300

 
4
Customer contracts and related relationships
 
7,000

 
9
Order backlog
 
3,500

 
4
Deferred tax assets
 
171

 

Goodwill
 
96,431

 

Total 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.
4. Balance Sheet Components
Property and Equipment, net
Property and equipment consist of the following:
 
April 30, 2018
 
July 31, 2017
 
(in thousands)
Computer hardware
$
24,349

 
$
21,408

Purchased software
4,173

 
3,855

Capitalized software development costs
2,850

 
1,065

Furniture and fixtures
3,979

 
3,253

Leasehold improvements
9,489

 
8,251

      Total property and equipment
44,840

 
37,832

(Less) accumulated depreciation
(28,911
)
 
(23,456
)
      Property and equipment, net
$
15,929

 
$
14,376

As of April 30, 2018 and July 31, 2017, no property and equipment was pledged as collateral. Depreciation expense, excluding the amortization of software development costs, was $2.0 million and $1.6 million for the three months ended April 30, 2018 and 2017, respectively; and was $5.7 million and $4.9 million for the nine months ended April 30, 2018 and 2017, respectively.
During the third fiscal quarter of 2017, the Company began to capitalize software development costs for technology applications that the Company will offer solely as cloud-based subscriptions. The amounts capitalized as of April 30, 2018 and July 31, 2017 were $2.9 million and $1.1 million, respectively, and primarily comprised compensation and related headcount costs for employees who were directly associated with the software development projects. During the fiscal quarter ended April 30, 2018, we continued to amortize the Company’s technologies that were ready for their intended use. The Company recognized approximately $0.2 million and $0.3 million in amortization expense in cost of revenues, license and other on the accompanying condensed consolidated statements of operations during the three and nine months ended April 30, 2018. There was no such amortization during the three and nine months ended April 30, 2017.
Other Assets
The Company’s other assets of $21.7 million and $20.1 million at April 30, 2018 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 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.

19


As of April 30, 2018 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

Acquisition - Cyence
200,523

Changes in carrying value
95

Goodwill, April 30, 2018
$
342,469

The Company’s intangible assets are amortized over their estimated useful lives. Intangible assets consist of the following:
 
April 30, 2018
 
July 31, 2017
 
(in thousands)
 
Cost
 
Accumulated Amortization
 
Net Book Value
 
Cost
 
Accumulated Amortization
 
Net Book Value
Amortized intangible assets:
 
 
 
 
 
 
 
 
 
 
 
Acquired technology
$
93,600

 
$
29,205

 
$
64,395

 
$
65,200

 
$
14,710

 
$
50,490

Customer contracts and related relationships
35,700

 
5,150

 
30,550

 
18,000

 
1,683

 
16,317

Partner relationships
200

 
46

 
154

 
200

 
30

 
170

Trademarks
2,500

 
179

 
2,321

 

 

 

Order backlog
8,700

 
3,119

 
5,581

 
5,500

 
1,162

 
4,338

Total amortized intangible assets
$
140,700

 
$
37,699

 
$
103,001

 
$
88,900

 
$
17,585

 
$
71,315

Amortization expense was $7.6 million and $4.2 million for the three months ended April 30, 2018 and 2017, respectively, and was $20.1 million and $7.3 million for the nine months ended April 30, 2018 and 2017, respectively. The estimated aggregate amortization expense for existing intangible assets as of April 30, 2018, based on their current useful lives, is estimated as follows:
 
Future Amortization
 
(in thousands)
Fiscal year ending July 31,
 
2018 (remainder of fiscal year)
$
7,347

2019
29,112

2020
26,834

2021
19,965

2022
11,143

Thereafter
8,600

     Total future amortization expense
$
103,001

Accrued Employee Compensation

20


Accrued employee compensation expense consists of the following:
 
April 30, 2018
 
July 31, 2017
 
(in thousands)
 Accrued bonuses
$
21,132

 
$
26,581

 Accrued commission
1,718

 
5,228

 Accrued vacation
12,966

 
10,873

 Accrued salaries, payroll taxes and benefits
7,611

 
6,200

     Total accrued employee compensation
$
43,427

 
$
48,882

Deferred Revenues
Deferred revenues, current and non-current, consist of the following:
 
April 30, 2018
 
July 31, 2017
 
(in thousands)
Deferred license and other revenues
$
47,059

 
$
23,727

Deferred maintenance revenues
44,945

 
47,727

Deferred services revenues
42,557

 
39,681

     Total deferred revenues
$
134,561

 
$
111,135

Accumulated Other Comprehensive Loss
Changes in accumulated other comprehensive loss by component during the nine months ended April 30, 2018 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 income (loss) before reclassification
(94
)
 
(914
)
 
(1,008
)
Amounts reclassified from accumulated other comprehensive loss to earnings

 
(85
)
 
(85
)
Tax effect

 
291

 
291

Balance as of April 30, 2018
$
(5,724
)
 
$
(874
)
 
$
(6,598
)


21


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 April 30,
 
Nine Months Ended April 30,
 
2018
 
2017
 
2018
 
2017
 
(in thousands, except share and per share amounts)
Numerator:
 
 
 
 
 
 
 
   Net loss
$
(48,622
)
 
$
(1,819
)
 
$
(103,091
)
 
$
(5,703
)
Net loss per share:
 
 
 
 
 
 
 
   Basic
$
(0.62
)
 
$
(0.02
)
 
$
(1.32
)
 
$
(0.08
)
   Diluted
$
(0.62
)
 
$
(0.02
)
 
$
(1.32
)
 
$
(0.08
)
Denominator:
 
 
 
 
 
 
 
Weighted average shares used in computing net loss per share:
 
 
 
 
 
 
 
   Basic
78,777,484

 
74,175,603

 
78,246,146

 
73,731,132

     Weighted average effect of dilutive stock options

 

 

 

     Weighted average effect of dilutive restricted stock units

 

 

 

   Diluted
78,777,484

 
74,175,603

 
78,246,146

 
73,731,132


The shares used in computing basic and diluted net loss per share includes 2,628,571 shares related to the March 2018 common stock offering.
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 anti-dilutive:
 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2018
 
2017
 
2018
 
2017
Stock options to purchase common stock
615,421

 
895,743

 
605,951

 
978,734

Restricted stock units
3,220,916

 
2,906,840

 
3,265,584

 
3,050,091


Since the Company has the intent and ability to settle the principal amount of the Convertible Senior Notes in cash and any excess in shares of the Company’s common stock, the Company uses the treasury stock method for calculating any potential dilutive effect of the conversion spread on diluted net income per share, if applicable. The conversion spread will have a dilutive impact on net loss per share of common stock when the average market price of the Company’s common stock for a given period exceeds the conversion price of $113.75 per share for the Convertible Senior Notes. During the three months ended April 30, 2018, the Company's weighted average common stock price was below the conversion price of the Convertible Senior Notes.

6. Convertible Senior Notes

In March 2018, the Company offered and sold $400.0 million aggregate principal amount of its 1.250% Convertible Senior Notes due 2025, including the underwriters’ exercise in full of their option to purchase an additional $40.0 million of the Convertible Senior Notes. The Convertible Senior Notes were issued in accordance with the First Supplemental Indenture (the “Supplemental Indenture”), dated March 13, 2018 (the “Base Indenture” and together with the Supplemental Indenture, the “Indenture”) between the Company and U.S. Bank National Association, as trustee. The net proceeds from the issuance of the Convertible Senior Notes were $387.2 million, after deducting issuance costs.

The Convertible Senior Notes are unsecured obligations of the Company, and interest is payable semi-annually in arrears at a rate of 1.250% per year, on March 15 and September 15 of each year, beginning on September 15, 2018. The Convertible Senior Notes will mature on March 15, 2025 unless repurchased, redeemed, or converted prior to such date. Prior to the close of business on the business day immediately preceding October 15, 2024, the Convertible Senior Notes are

22


convertible at the option of holders during certain periods, upon satisfaction of certain conditions. On or after October 15, 2024, the Convertible Senior Notes are convertible at any time until the close of business on the second scheduled trading day immediately preceding the maturity date. The Convertible Senior Notes will have an initial conversion rate of 8.7912 shares of common stock per $1,000 principal (equivalent to an initial conversion price of approximately $113.75 per share of its common stock). The conversion rate is subject to customary adjustments upon the occurrence of certain events but will not be adjusted for any accrued and unpaid interest. Upon conversion, the Company will pay or deliver, as the case may be, cash, shares of its common stock or a combination of cash and shares of its common stock, at its election.

The Company may redeem the Convertible Senior Notes, at its option, on or after March 20, 2022, at a redemption price equal to 100% of the principal amount thereof, plus accrued and unpaid interest if the last reported sale price of the Company’s common stock has been at least 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive), including at least one of the 3 trading days immediately preceding the date on which the Company provides notice of redemption, during any 30 consecutive trading day period ending on, and including, the trading day immediately preceding the date on which we provide notice of redemption. No sinking fund is provided for the Notes. Upon the occurrence of a fundamental change (as defined in the Indenture) prior to the maturity date, holders may require the Company to repurchase all or a portion of the Notes for cash at a price equal to 100% of the principal amount of the notes to be repurchased, plus any accrued and unpaid interest to, but excluding, the fundamental change repurchase date.

The Convertible Senior Notes rank senior in right of payment to any of the Company’s indebtedness that is expressly subordinated in right of payment to the Convertible Senior Notes, and equal in right of payment to any of its indebtedness that is not so subordinated. The Convertible Senior Notes are effectively junior in right of payment to any of the Company’s secured indebtedness to the extent of the value of the assets securing such indebtedness; and structurally junior to all indebtedness and other liabilities (including trade payables) and any preferred equity of its current or future subsidiaries.
In accounting for the issuance of the Convertible Senior Notes, the Company separated the Convertible Senior Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component representing the conversion option was determined by deducting the fair value of the liability component from the par value of the Convertible Senior Notes as a whole. The excess of the principal amount of the Convertible Senior Notes over its carrying amount is amortized to interest expense using the effective interest method over the term of the Convertible Senior Notes. The equity component of the Convertible Senior Notes is recorded as the difference between the initial proceeds less the fair value of the liability component and will not be remeasured as long as it continues to meet the requirements for equity classification. The equity component is net of issuance costs and recorded as additional paid-in capital in stockholders' equity.

The net carrying value of the liability component of the Convertible Senior Notes was as follows (in thousands):
 
April 30, 2018
 
(in thousands)
Principal
$
400,000

Less: unamortized debt discount and issuance costs
97,816

Net carrying amount
302,184

    
The net carrying value of the unamortized debt discount and issuance costs of the Convertible Senior Notes was as follows (in thousands):
 
April 30, 2018
 
(in thousands)
Proceeds allocated to the conversion option (debt discount)
$
88,039

Issuance Costs
9,777

Net carrying amount
97,816


The following table sets forth the interest expense recognized related to the Convertible Senior Notes (in thousands, except for percentages):


23


 
Three Months Ended April 30, 2018
 
(in thousands)
Contractual interest expense
$
653

Amortization of debt discount
1,438

Amortization of debt issuance costs
130

Total
2,221

Effective interest rate of the liability component
5.53
%

Capped Call

The Company paid $37.2 million to purchase capped calls with certain financial institutions pursuant to capped call confirmations (the “Capped Calls”). The Capped Calls have an initial strike price of $113.75 per share, subject to certain adjustments, which corresponds to the initial conversion price of the Notes. The Capped Calls have initial cap prices of $153.13 per share, subject to certain adjustments. The Capped Calls cover, subject to anti-dilution adjustments, 3.5 million shares of common stock. By entering into the Capped Calls, the Company expects to reduce the potential dilution to its common stock (or, in the event the conversion is settled in cash, to reduce its cash payment obligation) in the event that at the time of conversion its stock price exceeds the conversion price under the Convertible Senior Notes. The Capped Calls are subject to either adjustment or termination upon the occurrence of specified extraordinary events affecting the Company, including a merger event, tender offer, and a nationalization, insolvency, or delisting involving the Company. Additionally, the Capped Calls are subject to certain specified additional disruption events that may give rise to a termination of the Capped Calls, including change in law, insolvency filing, and hedging disruptions. The Capped Calls were recorded as a reduction of the Company’s additional paid-in capital in the accompanying condensed consolidated balance sheets.

7.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 $2.3 million and $1.8 million for the three months ended April 30, 2018 and 2017, respectively, and was $6.3 million and $5.0 million for the nine months ended April 30, 2018 and 2017, respectively.
In December 2017, the Company entered into a new lease agreement for its potential future headquarter facility. The lease term is expected to commence on December 1, 2018, for a period of 10.5 years. Total payments committed under the lease amount to $132.1 million. In connection with this lease agreement, the Company also entered into an irrevocable stand-by letter of credit to guarantee the $1.8 million security deposit.
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 April 30, 2018 or July 31, 2017. The Company expenses legal fees in the period in which they are incurred.
Indemnification

24


The Company sells software licenses and services to its customers under contracts (“Software License”). Each Software License contains the terms of the contractual arrangement with the customer and generally includes certain provisions for defending the customer against any claims that the Company’s software infringes upon a patent, copyright, trademark, or other proprietary right of a third party. Software Licenses also indemnify the customer against losses, expenses, and liabilities from damages that may be assessed against the customer in the event the Company’s software is found to infringe upon such third-party rights.
The Company has not had to reimburse any of its customers for losses related to indemnification provisions and no material claims against the Company were outstanding as of April 30, 2018 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.


8.Stock-Based Compensation Expense and Shareholders’ Equity
Stock-Based Compensation Expense
Stock-based compensation expense related to Stock Awards and stock options is included in the Company’s condensed consolidated statements of operations as follows:
 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2018
 
2017
 
2018
 
2017
 
(in thousands)
Total stock-based compensation
$
23,820

 
$
17,433

 
$
68,469

 
$
54,344

Net impact of capitalized stock-based compensation
19

 
(236
)
 
25

 
(683
)
 Total stock-based compensation expense
$
23,839

 
$
17,197

 
$
68,494

 
53,661

 
 
 
 
 
 
 
 
Stock-based compensation expense was charged to the following categories:
 
 
 
 
 
 
 
 Cost of license and other revenues
$
274

 
$
90

 
$
706

 
$
231

 Cost of maintenance revenues
462

 
416

 
1,398

 
1,265

 Cost of services revenues
5,310

 
4,459

 
15,982

 
13,969

 Research and development
7,236

 
4,508

 
19,845

 
13,625

 Sales and marketing
4,527

 
3,992

 
13,768

 
12,498

 General and administrative
6,030

 
3,732

 
16,795

 
12,073

 Total stock-based compensation expense
$
23,839

 
$
17,197

 
$
68,494

 
$
53,661


As of April 30, 2018, total unamortized stock-based compensation cost for our options and Stock Awards were as follows:
 
 As of April 30, 2018
 
Unrecognized Expense
 
Weighted Average Expected Recognition Period
 
(in thousands)
 
(in years)
Stock Options
$
6,732

 
2.3
Stock Awards
172,830

 
2.4
 
$
179,562

 
 

25



Stock Awards

A summary of the Company’s 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
1,714,276

 
$
78.69

 

Released
(965,699
)
 
$
56.07

 
$
76,291

Canceled
(192,365
)
 
$
62.72

 

Balance as of April 30, 2018
3,190,297

 
$
68.26

 
$
268,726

Expected to vest as of April 30, 2018
3,190,297

 
$
68.26

 
$
268,726

(1)
Aggregate intrinsic value at each period end represents the total market value of Stock Awards at the Company’s closing stock price of $84.62 and $72.16 on April 30, 2018 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.
RSAs are issued and outstanding upon grant; however, vesting is based on continued employment and achievement of certain milestones. The weighted average grant date fair value is based on the market value of our common stock on the date of grant.

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
137,057

 
 
 
 
 
 
Exercised
(93,973
)
 
$
11.23

 
 
 
$
6,430

Canceled
(1,970
)
 
 
 
 
 
 
Balance as of April 30, 2018
596,750

 
$
21.14

 
4.5
 
$
37,883

Vested and expected to vest as of April 30, 2018
596,750

 
$
21.14

 
4.5
 
$
37,883

Exercisable as of April 30, 2018
468,280

 
$
22.48

 
3.5
 
$
29,099

(1) 
Aggregate intrinsic value at each period end represents the difference between the Company's closing stock prices of $84.62 and $72.16 on April 30, 2018 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
    

26


TSR PSUs
    
The fair values of our TSR PSUs were estimated at the date of grant using the Monte Carlo simulation model which included the following assumptions:    
 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2018
 
2017
 
2018
 
2017
Expected term (in years)
*
 
*
 
2.88
 
2.66-2.88
Risk-free interest rate
*
 
*
 
1.44%
 
0.89%-1.34%
Expected volatility of the Company
*
 
*
 
28.0%
 
30.2%-31.5%
Average expected volatility of the peer companies in the S&P Index
*
 
*
 
34.7%
 
36.9%-37.0%
Expected dividend yield
*
 
*
 
—%
 
—%
*There were no TSR PSUs granted during the three months ended April 30, 2018 and 2017.

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 April 30, 2018 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, 80,259,688 and 75,007,625 shares of common stock were issued and outstanding, respectively. As of April 30, 2018 and July 31, 2017, the Company had reserved shares of common stock for future issuance as follows:
 
April 30, 2018
 
July 31, 2017
 Exercise of stock options to purchase common stock
596,750

 
555,636

 Vesting of restricted stock awards
2,945,450

 
2,634,085

 Shares available under stock plans
21,626,676

 
18,453,674

      Total common stock reserved for issuance
25,168,876

 
21,643,395



27


9.Income Taxes
The Company recognized income tax expense of $20.6 million and a benefit of $1.1 million for the three months ended April 30, 2018 and 2017, respectively. The increase in tax expense for the three months ended April 30, 2018 compared to the same period a year ago was primarily due to the increase in permanent differences for non-deductible executive compensation and acquisition-related expenses offset by tax benefits related to research and development credits and excess tax benefits. The effective tax rate of (73.6)% for the three months ended April 30, 2018, differs from the statutory U.S. federal income tax rate of 26.9% mainly due to permanent differences for stock-based compensation, including excess tax benefits, research and development credits, the tax rate differences between the United States and foreign countries, foreign withholding taxes, certain non-deductible expenses including executive compensation, and acquisition-related expenses.
The Company recognized income tax expense of $46.6 million and income tax benefit of $4.8 million for the nine months ended April 30, 2018 and 2017, respectively. The increase in tax expense for the nine months ended April 30, 2018 compared to the same period a year ago was primarily due to the impact of the Tax Cuts and Jobs Act (“Tax Act”), including discrete tax expense of $34.0 million related to the remeasurement of net deferred tax assets offset by the discrete tax benefit of $5.4 million related to the release of valuation allowance against certain deferred tax assets that are more likely than not to be realized and the increase in permanent differences for non-deductible executive compensation and acquisition-related expenses and offset by tax benefits related to research and development credits and excess tax benefits. The effective tax rate of (82.4)% for the nine months ended April 30, 2018 differs from the statutory U.S. federal income tax rate of 26.9% mainly due to the impact from the Tax Act and permanent differences for stock-based compensation, including excess tax benefits, research and development credits, the tax rate differences between the United States and foreign countries, foreign withholding taxes, certain non-deductible expenses including executive compensation, and acquisition-related expenses.
During the three months ended April 30, 2018, the increase in unrecognized tax benefits from the beginning of the period was $4.2 million. Accordingly, as of April 30, 2018, the Company had unrecognized tax benefits of $6.6 million that, if recognized, would affect the Company’s effective tax rate.
On December 22, 2017, the Tax Act was enacted into law which changed U.S. tax law, including, but not limited to: (1) reducing the U.S. federal corporate income tax rate from 35% to 21%; (2) requiring companies to pay a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries; (3) generally eliminating U.S. federal corporate income taxes on dividends from foreign subsidiaries; (4) capitalizing R&D expenses which are amortized over five to 15 years; and (5) other changes to how foreign and domestic earnings are taxed.
As a result of the Company’s fiscal non-calendar year end, the lower U.S. statutory federal income tax rate will result in a blended U.S. Federal statutory rate of 26.9% for the Company’s fiscal year 2018. During the quarter ended January 31, 2018, the Company remeasured deferred tax assets and liabilities based on the rates at which they are expected to reverse and recorded a provisional net charge of $34.0 million based on preliminary estimates of the tax effects. In addition, as a result of changes in tax law under the Tax Act, the Company recorded a provisional benefit of $5.4 million related to the release of valuation allowance against certain deferred tax assets that are more likely than not to be realized. The provisional net charge and provisional benefit are subject to revisions as the Company completes its analysis of the Tax Act. The Company estimates that no tax will be due related to the one-time transition tax on the deemed repatriation of deferred foreign income.
The Tax Act includes a provision to tax global intangible low-taxed income of foreign subsidiaries and a base erosion abuse tax measure that taxes certain payments between a U.S. corporation and its foreign subsidiaries. These provisions of the Tax Act will be effective for the Company beginning August 1, 2018. The Company is in the process of completing its analysis of the deferred tax accounting on global intangible low-taxed income and has not recorded provisional amounts. The Company is still evaluating an accounting policy to record amounts as deferred taxes or as period costs related to this provision. The SEC staff issued Staff Accounting Bulletin No. 118 which provides for a measurement period of up to one year after the enactment date of the Tax Act to finalize the related income tax impacts. The Company expects to complete the accounting for the Tax Act during this measurement period.
10.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.

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The following table sets forth revenues by country and region based on the billing address of the customer:
 
Three Months Ended April 30,
 
Nine Months Ended April 30,
 
2018
 
2017
 
2018
 
2017
 
(in thousands)
United States
$
92,040

 
$
80,239

 
$
266,296

 
$
191,594

Canada
10,065

 
12,359

 
36,718

 
41,208

Other Americas
6,415

 
3,869

 
14,575

 
12,965

Total Americas
108,520

 
96,467

 
317,589

 
245,767

United Kingdom
5,442

 
4,499

 
24,094

 
22,463

Other EMEA
11,625

 
10,344

 
28,803

 
28,094

Total EMEA
17,067

 
14,843

 
52,897

 
50,557

Total APAC
14,882

 
12,126

 
41,942

 
36,860

Total revenues
$
140,469

 
$
123,436

 
$
412,428

 
$
333,184

No country or region, other than those presented above, accounted for more than 10% of revenues during the three and nine months ended April 30, 2018 and 2017.
The following table sets forth the Company’s long-lived assets, including intangibles and goodwill, net by geographic region: 
 
April 30, 2018
 
July 31, 2017
 
 (in thousands)
Americas
$
457,985

 
$
224,667

EMEA
3,371

 
2,747

APAC
43

 
128

Total
$
461,399

 
$
227,542


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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 subscriptions 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 primarily comprised 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, gain insights into their business, and underwrite new and evolving risks. 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 in the cloud or on-premise. 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 team 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 or assesses the benefits of a cloud-based subscription in addition to our more traditional on-premises 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. Term licenses that are greater than one year are characterized by extended payment terms. We assess whether a fee is fixed or determinable at the outset of the arrangement, primarily based on the payment terms associated with the transaction. For term licenses with extended payment terms, 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 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 cloud-based subscriptions. Currently, these subscriptions may be for terms greater than two years, and we anticipate that a majority of these 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 these subscriptions are recognized ratably over the contractual term beginning after the subscription is effectively provisioned, which is the date our software service

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is made available to customers. We anticipate that sales of 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 will adversely affect our reported revenue growth. As this relatively new sales model matures, we may decide to change certain terms 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, introduce new products, and advance our ability to deploy cost-effectively each of our products in the cloud. 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, 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 SI partners to meet our customers’ implementation needs. Our services organization comprises 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 $260.3 million, including approximately $146.6 million in cash and equity consideration valued at approximately $113.7 million of newly issued Guidewire common stock and options, net of certain adjustments. 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 was accounted for as a business combination. The results of Cyence’s operations have been included in our results of operations since November 1, 2017, the date of acquisition.
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, adapting it for international markets, and integrating it with 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.
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. During fiscal years in which subscriptions increase as a percentage of total sales, the revenues we can recognize in the fiscal year will be reduced, and our reported revenue

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growth will be adversely affected. The seasonal nature of our sales and the concentration of such sales in our fiscal fourth quarter increases this impact.
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.
Public Offerings

On March 13, 2018, we closed a public offering of 2,628,571 shares of our common stock, including the underwriters’ exercise in full of their option to purchase additional shares of our common stock. The public offering price of the shares sold in the offering was $87.50 per share. Our stockholders did not sell any shares in this public offering. Concurrently, we offered and sold $400.0 million aggregate principal amount of our 1.250% Convertible Senior Notes due 2025, including the underwriters’ exercise in full of their option to purchase additional Convertible Senior Notes. Net of issuance costs, we received net proceeds of approximately $220.9 million related to the common stock offering and $387.2 million related to the convertible note offering.

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 reduces the variations in any particular quarter caused by seasonality. However, 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 can impact this metric. In addition, 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. The relevance and value of this metric may be impacted by our transition to a new revenue standard in fiscal year 2019. Our four-quarter recurring revenues for each of the eight periods presented were:
 
Four quarters ended